O-I Glass, Inc. (OI) Q3 2013 Earnings Report, Transcript and Summary

Good morning. My name is Angela, and I will be your conference operator today. At this time, I would like to welcome everyone to the O-I Third Quarter 2013 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Dave Johnson, Vice President, Investor Relations. Sir, please go ahead.

Thank you, Angela. Good morning, and welcome, everyone, to O-I's Third Quarter 2013 Earnings Conference Call. I am joined today by Al Stroucken, our Chairman and CEO; Steve Bramlage, our Chief Financial Officer; and several other members of our senior management team. Today, we will discuss key business developments, review our financial results for the third quarter and discuss trends affecting our business in 2013. Following our prepared remarks, we'll host a Q&A session. Presentation materials for this earnings call are available on the company's website at o-i.com. Please review the Safe Harbor comments and disclosure of our use of non-GAAP financial measures included in those materials. Unless otherwise noted, the financial results we are presenting today relate to adjusted earnings, which exclude certain items that management considers not representative of ongoing operations. A reconciliation of GAAP to non-GAAP earnings can be found in our earnings press release and in the appendix to this presentation. Now I'd like to turn the call over to Al.

Thank you, Dave, and good morning. We reported adjusted EPS of $0.79 for the third quarter, a 14% increase over prior year. Throughout the company, we continued to successfully take costs out, and our results again demonstrate the benefits of running a globally diversified operation. The return to growth in Europe and North America helped offset the impact of challenging demand and currency headwinds in South America. Shipments of glass containers were up more than 2% in the quarter overall. Global gains in wine were fueled by our success in recapturing share in Europe. Sales volumes also benefited from an improvement in beer demand. Although beer volume was flat globally, we experienced significant growth in Europe and modest gains in North America. From a geographic perspective, volumes were up in all regions except South America. We continue to focus on generating free cash flow and are on track to execute on our target of at least $300 million for 2013. And we remain committed to disciplined capital allocation, which we again demonstrated this quarter through continued debt paydown and share repurchases. Let me briefly review our regions, beginning with Europe on Slide 3. Sales expanded 12%, driven by a 7% increase in shipments. Sales also increased on the strength of the euro. While our price increases were in line with the market this year, local price gains were largely offset by an overall lower price point product mix in the quarter. This is the first time in 7 quarters that we have posted higher year-on-year volume in Europe. Our efforts to win back wine customers in Southern Europe continued to show traction. And after poor weather resulted in slow sales earlier in the year, we saw an uptick in beer sales volumes in the third quarter. Food volumes posted a double-digit gain in the quarter, and heavy rains in the second quarter had delayed much of the harvesting season, which impacted our food volumes. These volumes recovered nicely in the third quarter. And keep in mind also that European volumes benefited almost 2% from an extra shipping day in the quarter. As expected, our production volume was substantially higher than in the prior year third quarter, at which time, we had begun to idle capacity for inventory control. We're also pleased with progress in our European asset optimization program, which is now delivering about $10 million per quarter in cost savings. In North America, our operating profits increased 16% from the prior year. Shipments were up 1% in the quarter. Nonalcoholic beverages have been trending higher throughout the year. Consumers increasingly prefer premium products like iced coffees and teas packaged in glass, the substrate that best preserves taste and differentiates our customers' brands. Beer sales volumes were up slightly in North America, coming on the heels of dismal weather in the second quarter. Craft beer sales continued to show strong growth while mega beer performance improved modestly. Our production volume was essentially flat year-on-year. Our success in taking out structural costs in the region clearly helped expand our profitability. Moving on to Slide 4. Let's begin with South America. Although currency was a known headwind and we expected a slowdown in the region and indicated such at an investor conference in September, we were disappointed with our results in the region overall. Lower expectations for growth throughout South America served to lower consumer confidence and, as a result, consumption. As margins came under pressure, our customers delayed investments in returnables, a trend consistent with prior economic slowdowns. In fact, most all of the decline in the region was driven by contraction in beer and returnables in particular. In Brazil, overall sales volumes were flat as lower beer sales were effectively offset by growth in all other categories. The slowdown was felt more acutely outside of Brazil. For instance, in Colombia, already depressed sales levels were further exacerbated by a general strike that paralyzed the transportation system and temporarily forced us to stop customer shipments and to idle one plant. On the production front, our asset efficiency was dampened by several dynamics. Choppy sales within the quarter led to an unreliable order pattern that complicated our production configuration and resulted in more downtime. And we also accelerated some maintenance activity in the region, which resulted in higher expenses and increased asset downtime. Remember that through the decades in South America, we have faced many slowdowns of short duration, and we will continue to adapt to evolving business conditions in real time as we enter into South America's ice season. And Andres Lopez and his team are doing a terrific job to deal with these changing conditions, and we're very confident that we will get back on track very soon. And finally, to our fourth region, Asia Pacific. Volume for the quarter was consistent with prior year, but operating profits and segment margin were significantly higher. Volume gains were driven by continued strong growth in Southeast Asia, while China was essentially flat. Overall volume levels in Australia and New Zealand were down approximately 1%, and the contraction was primarily driven by modest ongoing weakness in Australian wine. The benefit of our cost savings efforts in the region has more than offset the weakening Australian dollar. So overall, a solid quarter for most of our operations and a good springboard for the rest of the year. I will now turn the call over to Steve to review the financials and provide our outlook for the fourth quarter.

Thanks, Al, and good morning. Turning to Slide 5, in the first column, third quarter 2013 segment sales were $1.8 billion, an increase of 2% over the prior year. Price and mix in the quarter were up $28 million, a step above prior year. Sales in tonnes were up more than 2% for the quarter as well. This increase was largely driven by broad-based gains in wine, particularly in Europe. All regions reported higher volume in nonalcoholic beverages. Beer, as Al mentioned, was nearly flat overall. The substantial decline in beer in South America was mostly offset by growth in other regions. Currency translation negatively impacted the top line by $17 million in the quarter, primarily due to the Brazilian real and the Australian dollar. Moving over to the second column. Segment operating profit in the third quarter was $259 million, approximately 6% more than prior year. In Europe, a changing product mix. For instance, beer as a higher proportion of sales, pulled down our average price per tonne. Although cost inflation has been quite stable this year, the aforementioned current dynamics with product mix caused our spread to turn negative in the quarter. Year-to-date, however, price mix has covered cost inflation. We have seen significant improvements in our operational costs. In line with our desire to reduce earnings volatility from production swings, higher production levels allowed us to absorb more fixed costs. And our successful cost savings programs driven by our asset optimization program in Europe helped as well. The net impact of currency was a headwind of approximately $5 million. Moving to the last column on the chart. We achieved adjusted earnings of $0.79 per share in the quarter compared to $0.69 in the prior year. Operational items driven by the factors just mentioned were up $0.06 from the prior year. Nonoperational items provided an additional $0.04 to earnings. Please note that the flat retained corporate cost line this quarter belies the fact that we successfully offset a sizable pension headwind via spending curtailment. Interest expense benefited from debt reduction as well as lower rates. Our tax rate was a bit lower than previous guidance, driven primarily by the mix of earnings. As Al mentioned earlier, we remain disciplined in our capital allocation. We will use approximately 90% of our free cash flow for deleveraging and the remaining 10% for share repurchases to offset dilution this year. During the third quarter, we repaid $168 million of debt and repurchased 10 million shares -- $10 million worth of shares. By the end of this year, we continue to expect our leverage ratio to be approximately 2.5x net debt to EBITDA. Let me begin our fourth quarter outlook on Slide 6, starting with Europe. Overall, we expect European sales volumes to be up low single digits. We will continue to benefit from our share recapture in the wine segment. Beer volumes should revert to being flat or modestly down as they have been on average over the past 2 quarters. We presently lack visibility into our customers' specific year-end plans for inventory management, which, of course, can have a considerable impact on European volumes for the quarter. That being said, European operating profit is projected to be substantially higher year-on-year. Higher sales volumes have a straightforward drop-through impact. Higher year-on-year production will favorably impact fixed cost absorption, and we expect about the same level of benefit from the asset optimization program that we saw during the third quarter. In North America, we expect the fourth quarter will unfold in a similar way to the third. We should see modest volume growth, with beer more or less flat and small gains elsewhere. We expect to continue to benefit from our structural cost reductions. Production levels are expected to be considerably higher than the fourth quarter last year when we scaled back our production quite a bit. And as a result, you should see better year-on-year bottom line performance in North America. It's difficult to gauge demand in South America. Consumer sentiment has been dampened by the macroeconomic slowdown, and we cannot predict exactly when our customers will choose to reinvest in their returnable floats, which are capital expenditures for most of them. On balance then, it seems prudent for us to plan at the moment for no growth in South America during the fourth quarter. We see Brazil flat to modestly up, and the remaining countries flat to slightly down. We should continue to see growth in spirits, nonalcoholic beverages and food. Beer volume is likely to remain soft. The devaluation of the real, which is down approximately 8% from prior year currently, will continue to weigh on earnings in South America. Finally, turning to Asia Pacific. Volumes are likely to be flat with overall declines in the mature markets offset completely by volume gains in the emerging markets. Given the divergent price points across the region, the geographic mix of sales will result in an unfavorable year-on-year price mix for the region. Assuming steady inflation, this will lead to a reported negative price cost spread during the quarter. While the region will continue to pursue cost reductions, the restructuring benefits realized over the past few quarters now have largely lapsed. A big headwind continues to be the adverse impact of the Australian dollar, which is presently off approximately 11% compared with last year. In all, even in Asia Pacific, is likely to be modestly down year-over-year. Corporate costs should be approximately $30 million. This is a notch lower than our typical quarterly guidance of $35 million, which reflects continued success on cost takeout. Our expectations for a modestly lower annual effective tax rate versus previous guidance are driven primarily by the geographic mix of our earnings. On the whole, we face a fair amount of uncertainty in the fourth quarter. It's particularly true in South America, which, due to seasonality, will have a disproportional influence on the company's performance in the fourth quarter. Still, for adjusted EPS, we expect a sizable improvement, at least 25% compared with last year. Now I'll turn the call back over to Al for some final comments.

Thanks, Steve. We continued to make progress on delivering on the priorities we laid out at investor day early this year. On the operational side, we have executed on our goal to reduce earnings volatility, which has historically been caused by production swings quarter-to-quarter. We have already seen the manifestation of smoother production on European profits, and in the fourth quarter, this will also be evident in the North American results. Year-to-date, price mix has kept pace with cost inflation. Although the third quarter product mix has modestly dampened price, we will continue to seek higher prices in the marketplace to recover inflation. Turning to our financial goals. We still expect to generate more than $300 million in free cash flow this year and continue to allocate it in a disciplined way. On the strategic front, we are on target with our European asset optimization program. There are several line upgrades underway in France, Czech Republic and the U.K. And the savings generated by the program overall are improving our European profit margins. Around the world, we are helping more and more customers differentiate their brands with our product design and innovation capabilities. We recently received first place in the Dieline Packaging Design Awards for our VersaFlow container, and we received 4 Clear Choice Awards for package design from the glass packaging industry. We are particularly excited that we lit the furnace in our new innovation center in Perrysburg this month. This small-scale R&D facility mimics our large-scale operations, affording us the opportunity to investigate new melting and forming processes as well as increase our speed to commercialization. Before opening the lines to your questions, let me summarize my thoughts on our performance. We delivered healthy third quarter results. The benefits of our geographic diversity and our focus on internal levers are clear. Sales and production volume gains in Europe and North America are more than compensating for the economic slowdown in South America, and our diligent efforts to reduce costs in the regions and at the center more than offset currency headwinds. And we will continue to relentlessly focus on that which we can control, reducing our cost structure, optimizing our assets and managing production volatility. These will be key to driving earnings and cash flow higher even in the challenging economic environment. Thank you, and now I will ask Angela to open up the lines for your questions.

[Operator Instructions] Your first question is from the line of Al Kabili with Macquarie Research.

South America, it sounds like September was a pretty tough month based on where you ended up with volumes relative to how you were thinking about earlier in the month. And I just wanted to get a -- get your kind of feeling, what gives you the confidence of kind of flattish volumes in 4Q given how you exited the quarter and what you're seeing in October thus far there?

Well, because we can really point the reason for the volume impact to specific actions and specific activities that happened in the marketplace. And in particular, it was the virtual shutdown of the Colombian economy by a general strike. And so most of the impact that we saw in volume were really in Colombia. We had already indicated earlier that we saw some weaknesses in the North Andean region, and so that was exacerbated by what we saw there. What we -- when the strike was over, we saw some recovery of volume, but we still have to deal with a customer base at this point in time. That's not yet very clear and prescriptive about what they're going to do with refilling the float because that's a decision that they can make on a moment's notice. And so we'll have to see how that's going to evolve. But overall, as you also saw from some of the brewers, reports underlying consumption in the North Andean region was virtually flat with last year. So it did not see the dramatic dropoff, and that gives us a confidence that we'll see some pretty decent recovery.

Okay, that's pretty helpful. And just to follow up, Al, just the trends you're kind of seeing thus far in October and also with the headwind on the Colombia plant shutdown, how much of that -- how much of a headwind earnings-wise was that in the third quarter that could come back in the fourth quarter just from the plant being back up?

I would say the impact of Colombia on the third quarter was approximately $7 million, and that includes the shutdown of the facility. Now we brought the facility back online in September, so that was really last quarter. And October overall is, of course, included in our comments that Steve made for the remainder of the year. So it's moving on track.

And your next question is from the line of George Staphos with Bank of America Merrill Lynch.

I just wanted to come back to South America. And, Al, I appreciate that a lot of times, your -- a company's regional mix or your mix of customers can have an effect on volume. But again, when I look at some of the other reports from companies in packaging or paper, South America hasn't been as bad as the volume decline that you saw. And it's interesting, too, that we're seeing growth in one-way containers, while your customers are not sure yet when they're going to replenish their float of existing glass. So do you think there's something else going on in terms of -- I know you get this question every quarter, but I think it's relevant here again -- that glasses may be losing some share to other materials and we're seeing evidence of this in the fourth quarter? And I had a follow-on.

All right. Well, let me try to address this. Number one, what we saw in volume evolution in Latin America in the third quarter, as I said earlier, particularly driven by Colombia. So we have to be careful that we keep our countries separate when we look at them, and what's happening in Colombia is not necessarily influencing what's happening in Brazil. As we said, our total volume in Brazil was flat with last year, so we did not really see a dropoff. What we did see was a dropoff in beer. Now since you are asking the question regularly, we, of course, are putting quite some emphasis behind trying to find out what's really happening in the Brazilian market. And what we're trying or what we're seeing at this point in time is that clearly, there is consumption expansion in more of the Midwestern region of Brazil. And there is not a lot of infrastructure there, neither as breweries nor really as glass manufacturing facilities. And what we surmise from this is that perhaps the trend that we're seeing is that to prepare the market and to establish market share, people are, brewers in particular, are focusing for those segments on cans because they don't have the established returnable infrastructure in place yet. But once they start building brewers -- breweries in those regions, we most probably will see that more equalized with what we see in the rest of the nation. I do not feel, and if you look back at the beer growth that we have seen in Brazil in particular over the last 3 or 4 years, that we really have been losing market share per se. I believe it really is driven more by geographic considerations. And also, one thing that we have to keep in mind, that if there are temporary increases in demand, like, for instance, if you have an event like the World Cup and so on, very often, brewers would tend to use one-way containers for those events because there are limits, of course, on the use of glass in stadiums and surrounding stadiums as you go forward. I think that's most likely impacting some of this stuff that we're seeing.

Okay, that's helpful, Al. I appreciate that. The other question I had, quick one, I think either in your remarks or Steve's remarks, the mention was made, you anticipate recovering inflation through pricing. I assume that was a comment into 2014. Could you affirm that that's the view? And do you see any opportunity to recover more than inflation in 2014 through your pricing?

I think that clearly, we are continuing with what we have been following over the last 5 or 6 or 7 years as basically recover inflation. Now if overall supply-demand gives us an opportunity to do more than that, we will, of course, do more than that. But that is also going to be a bit dependent on what the underlying markets trends are going to be with regard to consumption. So certainly, focuses on recovering inflation. If we can do more than that, we'll jump on it.

And your next question is from the line of Phil Gresh with JPMorgan. Phil M. Gresh - JP Morgan Chase & Co, Research Division: First question is just I guess hopefully a final question in South America. With respect to the fourth quarter, if I look back at last year, I believe you had start-up costs relative to the furnace, and so your margins were pressured relative to the prior year, down 400-plus basis points. And so I guess I was under the impression that you might get some of that back this year now that you're kind of ramped up. Obviously, I understand some of the puts and takes around volumes, but can you correct me if I'm wrong on that?

Yes. I think you're correct in that assumption, and, therefore, overall, when I look over the entire year, the margins in the region will approximate those that we had last year. Phil M. Gresh - JP Morgan Chase & Co, Research Division: Okay. And then I guess with respect to productivity kind of outside of the European cost savings programs, I was wondering if you could talk a little bit bigger picture about where you see those productivity opportunities as we enter 2014 and if you'd expect kind of a linear achievement of those productivity initiatives kind of as we go from '13 through '15 as you talked to at your analyst day?

Okay, I'll ask Steve to respond to the European question, but let me again clarify from what I said earlier. When I said the margins in the region will approximate those of last year, I mean, for the entirety of last year, not for the last quarter of last year. Steve?

Phil, I guess as it relates to Europe specifically, if we understood your question correctly, we've told people that we expect $25 million or so of year-over-year benefit in 2013 from our current year initiatives in Europe. I think we had about $4 million or $5 million in the second quarter, and I think we've realized somewhere in the neighborhood of $10 million during the third quarter. So doing the math, I would anticipate a run rate of about $10 million for the fourth quarter as well on that path. And it's not -- that will largely carry over likely into the first quarter as well if you think of the timing associated with our specific engineering projects. And then it probably takes 1 quarter or 2 for us to ramp it up into next year just based on how long it takes us to finish engineering on the next set of significant projects in 2014.

And your next question is from the line of Ghansham Panjabi with Robert W. Baird. Ghansham Panjabi - Robert W. Baird & Co. Incorporated, Research Division: Al, just on the -- switching to Europe again, in terms of the wine recapture in Europe that you mentioned, how do you think it affects your pricing initiatives in the region as you look out to 2014 and beyond, if at all?

I don't think it will have an impact because what you've been seeing this year is really a reaction to the actions that we took last year when we got to a fairly significant price increase because we were recovering 2 years of inflation. So it's only natural that this year's price increases are a bit lower. Also, as we had indicated, we wanted to recapture some of the volumes that we had lost last year. And typically, those are more price-conscious buyers, and that's why you see in the mix also of the portfolio this impact. I don't think it's fundamentally a question of not being able to recover inflation. And that's also why we believe that, going into next year, we have a good opportunity to continue on that trend. Ghansham Panjabi - Robert W. Baird & Co. Incorporated, Research Division: Okay. And then just one more on Latin America, just to clarify, and I'm sorry if I missed this. But did you say that October volumes for Latin America as a whole region, including Brazil and the Andean region, were they flat so far?

We've said, Ghansham, that our fourth quarter guidance is incorporating and reflective of everything we've seen in October thus far.

And your next question is from Scott Gaffner with Barclays.

Just wanted to dig in on the comment in Latin America. I think you mentioned that your customers with returnable bottles had -- maybe held onto those bottles a little bit longer given the softness in the macroeconomy there. Can you talk about how much longer they're keeping those? Is it now they're going to 25 turns per bottle versus 20 before? Some sort of quantification of that so that we can gain an understanding, and how long does that normally happen before that trend reverses?

Well, as I had indicated earlier, our customers are not necessarily telling us exactly what they're going to do. So a lot of these decisions are basically ad hoc decisions that got made by the customers based on their financial situation and also on the scuffing that they will see on the bottles that are in the float. But we have gone back over the last 20 years and looked at similar periods in the last 20 years when we saw a dropoff in demand for returnable bottles. And we typically saw a recovery generally within about 6 to 8 months of that dropoff, and sometimes that was still within the same years. In other cases, of course, it moved into the subsequent year. So it's -- was a little bit aperiodic at times. But clearly, the overall timeline of delays is limited, and given the overall underlying consumption that's showing a dramatic dropoff, we would expect that recovery to happen reasonably soon.

Okay. And then just switching to Europe for a minute, you said it was the first quarter instead, and then you actually got positive volume year-over-year in Europe. So you had the 2% benefit from the extra shipping days, and you did say beer was up. Can you just sort of parse that a little bit, how you're feeling about the underlying demand trends in Europe excluding the wine recapture and that 2% extra volume?

Well, I would say, overall, Europe is still very tentative in its recovery. But it is recovering, which is a good sign. I think the majority of the impact that we saw, in particular in the second quarter and then the first quarter, was really weather-related more than economy-related. So I would certainly expect that as we go forward, I mean, typically the fourth quarter is not a big beer quarter. But as we go into next year, that normal demand patterns will manifest themselves again. And when I look again on what the brewers are reporting, they also were reporting a gradual recovery in the third quarter related to weather. But overall, for the year, they're still slightly down in their projections. But that's about the magnitude of it, so 1% to 2% or 3% in beer weakness. I think wine has held up pretty decently, and certainly the harvest this year is a pretty solid harvest as we go into next year. And clearly, demand around the world for wine is increasing, which is going to help the European wine-producing economies more than domestic consumption in Europe, as it has been the case over the last decade.

And your next question is from Adam Josephson with KeyBanc.

Two questions. One is, can you give us perspective regarding the scope for continued cost savings in North America and Asia Pacific, particularly in light of the fact that you're already generating EBIT margins that are at your 2015 targets in both regions? And are you considering perhaps raising those targets?

Well, you're referring to the targets -- to the margins that are achieved in 1 quarter. You always have to look at the entirety of a year, and you know that most of our regions have at least 2 quarters where they're a little bit weaker than in the high-demand quarter. So I would not necessarily project 1 quarter to the entirety of the year. I think we still have opportunities to take costs out as we go forward. It's certainly a significant focus of our operations as well as of our administration activities in the company. And we believe there's still is quite a bit of runway.

Great. And just on Brazil, Al, what's driving the volume gains outside of beer? And I know you broke out South America in terms of product mix. But can you break out Brazil, specifically beer versus other?

Well, perhaps in the carbonated soft drink area and nonalcoholic beverages, we're seeing some pretty good growth. And that growth is also and very often in returnable containers.

And your next question is from the line of Alton Stump with Northcoast Research.

Yes. I guess just look back at Europe on the pricing front obviously, at this point, should be into early stages of '14 contract negotiations. Any color -- it's obviously early, but as to whether or not it appears that your competitors will once again stay rational? Or is there any insight either way that you can give us on that front?

Well, I would say it's still a bit too early right now. I mean, discussions are really only beginning, and they're at a very early stage. Like we have seen in the past, more determinant of where pricing and pricing posturing is going to be is really what the demand projections are going to be for next year overall and the consumption patterns that our customers see. I would say we mostly still have to wait a -- 2 or 3 months before we get clarity on what's going to happen with pricing. But if I look at comments that are being made by our competitors in their report-outs for the earlier quarters in the year, there clearly is a focus also by our competitors to recover inflation. And that's a good sign.

Okay. And then just one quick follow-up, Al. I know in the past, you have mentioned that you guys get close to a 60% contribution margin once the volumes come back in Europe. Is that still a good number to use currently?

Maybe I'll try to answer that, Alton. I -- no, 60% doesn't sound like -- it'd be great if it was, but it's not a number I'd be comfortable having people rely on. I mean, we would tend to get somewhere from an incremental margin standpoint where there's existing capacity. 30% to 40% is probably a better rule of thumb, very much dependent on region and mix. But as a general rule, something in that neighborhood is probably more realistic.

And your next question is from the line of Mark Wilde with Deutsche Bank.

Just one more South American question. Steve, I think you've mentioned that one other issue in the third quarter was increased maintenance spend, and I assume that some of that is going to come back in the fourth quarter. Can you just talk about that? Then I had a follow-on.

Yes. Mark, if I had to break it down into just the 3 or 4 largest drivers of the year-over-year negative delta in South America, Colombia is the one we've already talked about. That's $7 million or $8 million. Currency is probably another several million or so, as is an additional several million for the accounting change that we referenced last quarter where we've reclassed some things out of EBIT to the benefit of tax and interest to conform in South America. That's probably another $3 million to $4 million. Sales alone outside of Colombia, just overall sales volume decline, probably is another $7 million to $9 million or so. So that leaves everything else somewhere in the $4 million to $5 million range. And on the maintenance, asset downtime, that's the primary driver of those. So we did take some assets offline, some voluntarily, some not, in the case of Colombia. So that number should come back in the fourth quarter because we certainly don't have any plans right now for similar levels of downtime.

Okay. That's very helpful. And then just as a follow-on, there's -- looks like there's going to be some assets for sale in the North American industry. And I wondered, just generally, if you can give us some thoughts on how that might affect OI.

I don't know what's going to happen there. I think, of course, whenever assets become available, we take a look at it. But a determinant factor for us is going to be, what is it really going to do for us? I don't believe, though, that, given the discussions that we at least have been able to follow in the press, that it would be easy for us to make any acquisitions in North America without getting into a similar discussion that we've been able to follow in the press. So I would not really, at this point in time, believe that you will see a action from our side with regard to acquisition.

Your next question is from the line of Philip Ng with Jefferies.

You mentioned lack of visibility in the inventory dynamics in Europe going in Q4. Is that any different from years past? Or are your customers telling you they're just a little more cautious about demand going in Q4?

I believe we have seen over the last 5 or 6 quarters in Europe some fairly significant swing sometimes at the end of the quarter, in particular in the last week of the quarter, when most probably companies are scrambling to get their balance sheet in better shape. And that's really the big uncertainty. And then, of course, at any way, from about the 20th of December on, there is really not a lot of shipping days. And so if then and the one or other case, a customer or a company decides to cut back and push it out by a week or so, of course, it's going to have a significant impact on that quarter, but it's not really indicative of any underlying demand trend. And that's really the uncertainty that we're trying to bake in a little bit as we look into the future.

Okay. And I guess the question, bigger picture, Al, I know there's been some consolidation on the beer and spirits market in North America and Mexico. Probably one of the south manufacturers potentially are looking to put up some business to -- up for bid in North America and Europe. And some time from now, is that a big opening for you guys? And how should we be thinking about that down the road at least from a demand-supply standpoint?

Well, again, as we look at what's going to happen down the road, of course, it really depends on what the owners of those assets are going to decide, whether they want to keep running them, whether they want to just use them to supply their own captive consumption or whether they want to become active in the merchant market with those or whether they want to dispose of those facilities. And I think we will -- if the decision is to dispose of some of those facilities, again, as I said earlier, we'll take a look at it. And if it fits our strategy, if it fits our needs, we will, of course, take a stab at it.

And your next question is from the line of Chris Manuel with Wells Fargo.

Two questions for you. First, if you could kind of walk through maybe what some of the puts and takes are as we would start to build a bridge towards 2014 free cash flow, specifically what pension might look like, specifically what restructuring might look like next year given kind of where you've got things as they sit today.

Maybe I'll start with that, Chris. We're not going to make real specific comments yet at this point in time on 2014. We're still in the middle of our own internal budget process, and we'll be discussing that with the board later in the quarter. I think, in general, you could expect us -- later in this quarter, we have an investor event where we'll give some guidance on some of the bigger picture items into 2014. But certainly, as it relates to the couple you mentioned, pension very much is driven by the year-end discount rate, and I'm not willing to handicap what I think that rate would be here with everything happening in Washington. If it's higher than last year, yes, we will benefit to some extent for sure. And interest rates staying where they are with our debt balances going down, clearly, we would expect some benefit on the interest line. But we will give you a little more clarity here as we get further into the quarter for 2014.

Okay. And then my second question actually kind of falls a little bit on the first. But when you think about restructuring that you've done this year, it's primarily been to kind of your asset optimization plan in Europe. Seeing that volumes have been a little bit better out of Europe, how would you think about what you want to do on a go-forward basis to make sure that you do have -- how tight is the market, how much more do you want to do there, et cetera, and specifically, if we do see a little bit more volume recovery, even 1 point or 2 over the next couple of years, to make sure that you're leaving enough capacity to service that market?

I think our overall plan, as we indicated while we were talking about this project at the beginning, was not to take a lot of capacity out but basically to maintain our capacity with a lower amount of assets or with a lower degree of assets in the region and to get -- that way get some productivity improvements and cost improvements in our projects. And that's still the overall direction. So I believe the overall demand profile that Europe is going to evolve into, depending on the economic recovery, is well covered by our plan at this point in time and does not require us to modify or significantly alter the intended scope of the project.

And your next question is from the line of Anthony Pettinari with Citi.

Just a quick question on Asia. It seems like mature markets were a little weaker than expected and developing economies were a little stronger. And I'm wondering, the double-digit growth you saw in Southeast Asia, if you could give any color on what's driving that. Are you just growing with a strong market or gaining share? Or I think in the past, you've talked about using glass smart to gain traction. Just wondering if you can give any detail there.

Yes, it's a combination of points. Number one, we are clearly much more active with glass smart in the region and are finding new ways of presenting glass as a preferred solution to our customers for new product introductions. Also, Southeast Asia has done extremely well over the last couple of years, and what we're seeing in particular is, again, an increase in the middle class. So consumption is just growing at a proportion that we are not really ever going to see in Europe or in North America. So the dynamics of the market are a little bit different. And then the third aspect that is helping us is that we are using our established infrastructure in Asia Pacific to support some of the markets that may be either short in capacity or that may not have sufficient volume capability to produce locally. So we're seeing us supplying Southeastern -- Southeast Asian markets with capacity that we have in other facilities in the region to support that growth, and that's giving us a totally new dynamic.

Yes. And, Anthony, I would add to that, that one thing to remember for Southeast Asia for us is we do not consolidate all of that business, only a portion of it. So some of the sales, top line benefit that we're describing, qualitatively, you won't necessarily see in our financials. But you do see it when we get down to the EBIT. So the higher margins are reflective of sales that aren't necessarily always consolidated.

Okay, that's very helpful. And just turning to China, I think you talked about flat volumes. Can you talk about the margin environment you're seeing in China?

Well, China is still a challenging market, and that's why we have gone through some retrenchment over the last 1.5 years and 2 years. And the focus area for us, of course, is on those segments of the market where we can get decent margins and decent contribution. But I'd say, overall, if I look at China, also from our customer base, most of the multinationals, as you know, have a significant position in the Chinese market, it certainly is also for them not a big contributor to overall profitability. And I believe that is not going to change soon, but it's still important to have a foothold in the Chinese market. But of course, we've got to make sure that it stays at a level where it allows us to eventually, should markets turn, to take action and to establish ourselves more firmly. But be prudent at this point in time with our engagement and with our capital spending in those segments.

And your next question is from the line of Alex Ovshey with Goldman Sachs.

On Europe cost saves, I know you're talking about that number on a run rate basis, so the goal is to get to $80 million by the end of '14 and entering into '15. But you did talk about an absolute dollar cost savings number for the third quarter and what you expect it to be in the fourth quarter. So would you be able to give us an absolute -- or a range for what you expect the dollar cost savings to be for your European segment in 2014?

Alex, let me just clarify the one assumption right off the bat. The run rate of $80 million, which is accurate, is what we expect to be exiting 2015 with, not 2014, going into 2016 at the end of our 3-year investor day plan period. Again, we're expecting the $25 million or so for the entire calendar year of '13. Again, we will be more specific on '14 expectations as we get a little bit further into it. Clearly, we would expect a higher number obviously because we will have more project work under our belts. But we haven't quite finalized all of the timelines of the specific projects for '14. So I'll hold on '14 guidance until we give a more broader look later in the quarter.

Okay, it's fair, Steve. And then as you get ready to negotiate with your customer base entering '14 on the price cost side, can you just talk about what your initial feel for cost inflation is for 2014 and what cost buckets are you most concerned about, I mean, as you look in 2014?

Overall, we expect cost inflation for the next year to not be that much different from what we saw in this year. So I think it's just a continuation of the trends.

Yes. We are -- yes, I think we've guided for '13, if I recall correctly, somewhere in the neighborhood of $150 million to $175 million of total inflation. We'll probably be a little bit below that, probably closer to $140 million or so, which is a little bit under 3% if you take it across the global inclusive of the labor inflation. And so right now, we don't have any reason to believe it's going to be radically different from that. But we'll -- again, we'll plan to update that a little bit later in the quarter.

Your final set of questions is from Chip Dillon with Vertical Research.

Switching back to the U.S. market where the -- certainly, the numbers are turning up the right way, could you talk a little bit more about if how big of a dent in the business the craft beer business is having? I know it's a small base and maybe other specialty drinks that are moving more into glass. You talked a little bit about coffees and teas. And then on a separate note, could you just update us on how natural gas works in North America? I know you changed some of the contract terms a few years ago, but is there any ability to benefit on a lasting basis from what seems to be a very low and flat natural gas price?

Let me answer the first question, and I'll ask Steve to talk about the gas pass-throughs capabilities that we have. I think, certainly, the microbrewers have been a significant provider of growth over the last couple of years. And in fact, they have been the only providers of growth in the beer market over the last couple of years. I would say still overall, the microbrewers most probably are less than 10% of the total demand. But if they're growing 15% a year, that certainly equates to 1% to 1.5% growth for the entirety of the marketplace. And as you see from most of the large brewers reporting that their mega brands are showing some relative decline yet overall demand for beer and demand for beer consumption most probably is flat, it really shows the dynamics of the microbrewers. And I think that if this trend is going to continue as it likely will be, then I would not be surprised if microbrewers, within 3 or 4 years, are well in their teens with regard to percent of market share. And I think that's a position that we have built up gradually over many, many years and decades, I would say. And we'll -- we feel very comfortable in that space and have the ability to support and help our customers with their specific needs, which are sometimes quite different from what we see with mega brands.

And for the natural gas pass-through question, Chip, the short answer is no, I don't believe the way the market is structured in North America, specifically on natural gas, there's any opportunity for us to somehow take advantage or retain some disproportional benefit from low gas prices nor do I think there's significant risk to us to be exposed to an increase in gas. Granted that's hard to foresee in the very short term. The vast majority of our contracts, vast majority of our business in North America is under long-term contracts. The vast majority of those contracts have pass-through provisions, specifically for natural gas. And the majority of those pass-through provisions pass through on a quarterly or sometimes even a monthly basis. So we tend to pass all of that through good or bad very, very quickly.

Thank you, everyone. That concludes our third quarter earnings conference call. Please note that our fourth quarter 2013 conference call is currently scheduled for Wednesday, January 29, 2014, at 8:00 a.m. Eastern Time. We appreciate your interest in O-I. We wish you a happy Halloween. And remember, that glass is infinitely recyclable and always the most sustainable packaging choice. Thank you.

This does conclude today's conference. You may now disconnect.