O-I Glass, Inc. (OI) Q2 2016 Earnings Report, Transcript and Summary

Good morning and thank you for standing by. Welcome to OI's Second Quarter 2016 Earnings Call. My name is Deborah and I will be your operator. At this time, all participants are on a listen-only mode. After the speakers' remarks, there will be a question and answer session. [Operator Instructions] I will now turn the call over to your host, Mr. David Johnson, Treasurer and Vice President of Investor Relations. You may begin, sir.

Thank you, Deborah. Welcome, everyone, to OI's earnings conference call. Our discussion today will be led by Andres Lopez, our CEO; and Jan Bertsch, our Chief Financial Officer. Today, we will review our financial results for the second quarter of 2016, discuss key business developments and trends, and finish with 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 these materials. Unless otherwise noted, the financial results we are presenting today relate to adjusted earnings, which excludes certain items that management considers not representative of ongoing operations. Reconciliations of GAAP to non-GAAP measures 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 Andres.

Thank you, Dave, and good morning. We'll start on slide 3. I'm pleased to report that our second quarter results came in at the upper end of our guidance range. Earnings were $0.65 per share in the quarter. On a constant currency basis, this is a double-digit percentage improvement year-over-year. I would like to summarize our second quarter results which clearly demonstrate continued solid progress on the strategy we outlined at our Investor Day on March 1 of this year. Our investment in the acquisition of Vitro's food and beverage business is paying off. The acquisition is a key driver for both top and bottom line results in the quarter. In fact, the business is exceeding our expectations despite some weakness in the Mexican peso. Our strategic initiatives are delivering results with Europe's year-on-year gains as a key indicator. North America's legacy business and Asia Pacific both delivered results in line with our guidance. And the Latin America team has really continued to deliver exceptional performance, given macro conditions especially in Brazil, not letting the difficult environment get in the away of healthy year-on-year improvement. For the enterprise, we expanded margins and absolute segment operating profit. And with corporate and interest expense in line with expectations and a lower than expected tax rate, our results were quite good. And despite the economic conditions in the region, we remain confident that our business will deliver on the full year earnings guidance we set forth in the last quarter call. I would now like to spend a few minutes discussing the specifics of our actual performance, outlook and focus areas for each region. Please turn to slide 4. Starting with Europe, the stability and improvement programs we have undertaken in this region continue to make meaningful progress, driven by our strategic initiatives, operations are improving. Two-thirds of Europe's plants achieved higher productivity in the first half of 2016, building on the achievements we began to see in late 2015. And the overall demand environment across Europe continued to be constructive during the quarter. Local and consumer consumption is not particularly strong, especially in Southern Europe. However, Europe's strong branding and the weakening euro are helping exports. Shipment volumes for the region were up 3% for the quarter, driven by increases in beer and wine. Pricing was modestly lower, which is in line with our comments earlier this year. Deflation mostly offset lower prices. Together, improved operations and higher volumes led to a 130 basis point expansion in operating profit margin for the region. For the second half of the year, we expect to maintain the success achieved so far. We will continue to monitor the general country strikes in France that began a few months ago and the broader uncertainty in the region. With respect to a potential impact of Brexit on O-I's results, we currently estimate that the weakening British pound could negatively impact operating results by $5 million to $10 million in the second half, mostly due to translation. However, we are focusing our attention on finding offsets for these pressures through the balance of the year. Turning to slide 5, operating profit for North America showed nice improvement on a year-over-year basis. The legacy business was essentially on par with the year-ago period for both shipments and operating profits. In light of a few isolated asset challenges in the quarter that caused some unplanned downtime, we are pleased the legacy business results were in line with our expectations. The improvement in North America's operating profit in the quarter was largely due to the impact of O-I Packaging Solutions, the U.S. distribution arm of the food and beverage acquisition we made last year. Looking ahead, we expect the contribution from the legacy business to be up in the third quarter. Stronger volumes and improved operating performance will more than offset minor asset challenges like one plant that experienced a long power outage after a storm. You might recall that in the third quarter of 2015, we had a substantially higher level of engineering activity. Some was devoted to plant furnace rebuilds, some was devoted to projects to reduce end-to-end supply chain cost and provide more flexibility, and year-on-year gains will also be realized from the addition of O-I Packaging Solutions. Additionally, a plant improvement team in North America completed their initial work in Atlanta, driving up productivity several hundred basis points. This team has moved on to Zanesville, Ohio where their full-on engagement has just begun to record some improvement in plant operations. We still expect organic growth in shipments for North America to be about 1% this year. In the back half of the year, we expect higher sales to Constellation Brands, and beginning in September, higher sales by O-I Packaging Solutions will begin to lap prior year thereby contributing to organic growth. Overall, North America is on track to meet our expectations. Turning to slide 6, Latin America's operating profit was up significantly on a year-over-year basis, mostly due to O-I Mexico turning in yet another outstanding quarter. And the legacy business also delivered an excellent quarter, particularly in light of the challenging conditions in Brazil and also in Ecuador. Shipments for the overall region were down 7%, essentially driven by the continued weakness in Brazil. However, this volume decline is masking important market trends taking place in Brazil beer. In particular, the ongoing strength of the one-way glass container for premium beer continues to deliver impressive growth of 30% on a year-over-year basis in the quarter. Trends are improving in returnables, which were down only 1% year-on-year in the second quarter. The management teams throughout Latin America remained focused on key levers that drive our solid business performance, such as discretionary cost containment and new product and business development. We also continue to benefit from prior actions to rightsize production in this region. For the full year outlook, the economic situation in Brazil is likely to be difficult, but we remain cautiously hopeful that our own efforts could lead to a stabilization of legacy volumes as we exit the year. Mexico is expected to continue to be the bright spot in the region. Domestic demand is strong and operations continue to improve as part of our synergies program. In all, despite the difficult environment across much of the region, our teams there remain on track to achieve both our volume and margin targets for the year. Turning to slide 7. Shipments in Asia Pacific were up 2% year-over-year due to continued market strength in wine exports from Australia and New Zealand, as well as stronger beer shipments. From an operating profit standpoint, some of the underlying success this year is being masked by the work we are doing in the region to improve the flexibility and reliability of our assets for the long term, similar to investments we have made in Europe and North America in recent years. In 2016, the region will have four more furnace rebuilds than in the prior year. This includes accelerating one rebuild that was scheduled for 2017. While this is going to dampen our margins in the current year, with more downtime and more intra-region cross shipping, this is temporary, and now is the right time to do it. We expect margins to be essentially flat this year followed by a rebound next year as we lighten the investments going forward. In all, we are setting a firm foundation for volume and margin expansion in 2017 in this region. With the regional review complete, I would like to provide an update to you on some of the important performance metrics we are tracking as a company to monitor the progress being made across our operational improvement programs. Turning to slide 8. At Investor Day, we talked about a number of key programs we have under way to elevate the overall operational performance of the company. We are driving increased accountability throughout our organization through performance management and measurement. The key operational initiatives we discussed were our manufacturing improvement program, quality improvement initiatives, and our asset advancement program. Within the manufacturing improvement program, we have already emphasized the intensive work of our plant improvement teams. In addition, we are seeing a strong positive impact on the remaining focus plants we have targeted around the world. We are implementing detailed actionable manufacturing improvement plans within our plants, not high level narratives. Performance measurements are analyzed all the way down to the machine line in real time to ensure progress. And indeed, we are progressing. For the 24 focus plants in the program, tangible improvements have yielded over 200 basis points of manufacturing efficiencies so far this year, and improvements are even broader as we, as an enterprise, elevate expectations of manufacturing. Year-to-date, we have seen meaningful improvement at more than 60% of our plants globally and an even higher percentage in Europe. A related area that we talked about at our Investor Day is to improve our quality. While our quality performance is high, even a small gap in quality represents an opportunity to create value both in terms of cost savings and also commercial prospects. For instance, let me continue with the Alloa, Scotland plant story that we discussed in the last earnings call. The benefits of the plant improvement teams extended to quality. And now we have had a cycle of feedback from our customers on our level of quality at the plant, that is, our customers are very pleased with the progress we're making. Lastly, related to our asset advancement program, we are increasing our investments in our production assets which will pay dividends in the future through greater uptime, higher utilization rates, and fewer plant outages. Improved cross-functional coordination of asset repairs will not just reduce downtime, but will mitigate the impact throughout the supply chain and reduce our cost. Over time, this will have a positive multiplier effect across our top and bottom lines. Year-to-date, these operational initiatives have contributed about $20 million to our segment operating profit. In the second half of this year, we will not only maintain the gains so far, we will also be addressing new plants. As such, we are well on our way to achieve our 2016 goal of a $50 million to $60 million improvement in operating profit from these initiatives. Remember that our strategy is designed to move us from a historical state of operational instability to the near-term state of stability, and then to a future state of even higher sustained business performance. While we are making a steady progress on achieving stability, know that not all the sources of instability are completely gone. In the first half of the year, for instance, we had selected, mostly minor, asset incidents in North America and Asia Pacific that offset much of the gains from the initiatives in these two regions. This is not unexpected. As we continue to address additional plants, we will see the increasing benefits of our strategic initiatives and the decreasing cost of asset instability in our segment operating profit. Turning to slide 9. I would like to briefly comment on two other areas in which we are building capabilities to drive future earnings growth. Let's start in supply chain where we now have the right global leadership team in place. This team is working on complementing our existing talent base, leveraging best practices, improving team accountability, and setting the conditions to implement cross-functional integrated business planning. Think of this as a functional backbone supporting the business in a new and structural way. Of course, sustainable gains in inventory management and structurally reducing logistics and warehousing cost will take time because of the need for improved planning processes and higher flexibility. So, as we discussed at our Investor Day, we expect to deliver meaningful bottom line benefits in 2017 and beyond, yet I'm pleased that we will begin reducing inventory levels by the end of this year. Turning to our commercial efforts. We completed the first phase of our key account management deployment in the first half of 2016. With the right talent in place, we are beginning to improve cross-functional work to better serve our customer base and implement a structured and disciplined process to align with our customer's needs and execute consistently. This will help to drive prospect-to-sale conversion. We are elevating our customer awareness efforts, harnessing the insights of our customer base to support additional sales growth in the future. In addition, for the commercial and supply chain functions, we are investing in tools to more effectively manage customer relationships and to optimize our supply chain planning. Turning to slide 10. I want to briefly review the exceptional results we've seen from our investments in Mexico so far and reiterate how excited we are about the opportunities ahead. We remain on track to deliver substantial synergies from the integration as we continue to drive productivity and cost saving efforts across the region. The acquisition is a clear catalyst for growth. The new furnace in Monterrey has delivered solid gains so far and we expect to build on this success going forward. In fact, in the fourth quarter of this year, we expect the acquisition will deliver double-digit volume gains spread across Mexico and the U.S., a true success for the company. On a side note, our relationship with Constellation is yielding value, as expected. Overall demand is great. Mexican beer exports to the U.S. remain a bright spot. The startup of the joint venture second furnace in July is progressing very well. The ramp-up of this furnace will cause the JV to be accretive to earnings in the second half of 2016, very much in line with our expectations. With that update, I would now like to turn the call over to Jan to provide our financials and outlook. Jan?

Thank you, Andres. Let's turn to slide 11, where I would like to focus on segment operating profit compared with prior year. The sum of the parts that Andres discussed led to a segment operating profit of $233 million in the quarter. This is an increase of close to 25% compared with the $187 million generated in the prior period. In what I consider a welcome relief, currency was only a modest headwind, mainly from Latin America. The acquired business added $44 million to segment operating profit while generating nearly 20% margins. The price inflation spread was modestly positive. Some of this reflects price adjustment formulas clawing back prior inflation. As Andres mentioned, organic sales volume for the legacy business was essentially flat year-over-year, with gains in Europe and Asia Pacific offsetting the decline in legacy business in Latin America. We are diligently tracking the gains from strategic initiatives, which amounted to about $12 million in the quarter. Unfortunately, this was largely masked by selected external events and O-I-specific challenges, such as the general country strikes in France and Colombia, the Brexit vote, and a few isolated furnace issues that created some noise. Increasing flexibility and investments in reliability pressure our production volumes in the short term, but increase our ability to serve customers and reduce inventories and costs going forward. This was a very positive quarter in both the legacy business and the acquisition. In all, we are meeting our expectations while positioning ourselves well for the future to better meet our customer needs to drive revenue growth and to reduce structural costs. Turning to slide 12. Second quarter adjusted EPS was $0.65. When factoring in the $0.02 headwind from currency, earnings were up by 12%. Notwithstanding the $12 million in headwinds I just mentioned, we overcame this with strong results from our initiatives, better than expected results from the acquisition and a few cents of positive tax impacts. Unexpected things happen. It is what we do to overcome them that count. This reflects the cultural and mindset change within O-I. Segment operating profit, which I just reviewed, was the key driver for the improved results. Gains in our three largest regions drove the year-on-year improvement. Corporate, including hedging activities, was a modest headwind in the quarter year-on-year. Hedging gains last year did not repeat. And in light of our continued solid performance to-date, accruals for management incentives were a step higher than prior year. Interest expense was in line with expectations given the acquisition-related debt. Regarding our 21% tax rate in the quarter, let me highlight two different comparisons. First and as expected, the rate for the quarter came in higher than in the second quarter of 2015. While the prior year's rate was unusually low, the rate this year reflected different geographic mix of business, including Mexico. Second, our tax rate for the quarter came in lower than our 26% guidance primarily due to favorable tax audit settlements. Comparing tax rates on a quarterly basis is always a challenge. On a full-year basis, we now expect our tax rate will be in the range of 25% to 26%. Before moving on to the dashboard, I want to mention a shift in profitability within the Americas. As part of the process of finalizing the integration of the acquired business, we recently completed an updated analysis of how revenues, costs and profits are allocated within the Americas. This accounting change is meant to better reflect the actual business risks borne by O-I Mexico and O-I Packaging Solutions. The change, which took effect in the beginning of May, shifted about $5 million of segment operating profit from Latin America to North America. Importantly, this ongoing shift in profitability doesn't change our historical or prospective segment operating profit for the acquisition in total. It is just a reallocation between the two regions. Let's turn to slide 13. At our Investor Day, we said we would update you on certain metrics twice a year, and this is our inaugural report. Andres already spoke to you about our actions that are driving the results to date shown on the dashboard, so I'll try to be brief. I'm pleased to report that we are currently on track for achieving all of our full year targets. Generally speaking, we are ramping up in initiatives, so we continue to expect stronger contributions in the second half of the year compared with the first half. First, the manufacturing productivity index. Having generated 70 basis points improvement compared with the prior year, we are well on our way to achieving the 100 basis point target. Plants improvement teams, focus plants, performance management all working together to elevate our operational performance, building on prior improvements and accelerating benefits to our bottom line as we move forward. Next, quality. There is very strong cross-functional activity in this space, manufacturing, supply chain and commercial organizations all keenly interested in improving quality to enhance our customer's experience and produce less waste. The improvement in quality is broad-based with improvements in all regions. We have seen a 50 basis point increase in the quality index so far this year and are on pace to achieve our full year goal of 80 basis points of improvement. Turning to slide 14, let's continue with asset stability. Recall that this index measures unplanned downtime stemming from asset issues. This increases our cost and reduces our production volumes. So, how are we improving stability? Through investments in assets and our people. Capital investments are being optimized through our asset advancement program, and we continue to roll out our manufacturing fundamental training program that is proliferating best practices in our operations. The number of asset disruptions this year is half the amount experienced in the prior year, which is a tremendous improvement. The teams are doing a great job and we look forward to demonstrating further stability as the year unwinds. And finally, days of inventory. While inventory levels are currently higher than year-end levels, this is typical of the seasonal nature of our business. On a year-over-year basis, days of inventory was flat with prior year. Andres already touched on how we are rapidly building capabilities in supply chain. We are improving the service levels to our customers and on track to achieve our target of a two-day reduction in days of inventory by year-end. In all, we are on track to hit our targets. Turning to slide 15, let me focus on our third-quarter outlook. While we continue to expect currency-related headwinds to be more moderate in the second half of 2016 relative to the experience over the past 18 months, the recent news out of the UK in the form of the Brexit vote reminds us to remain vigilant and cautious on this front. We reported adjusted EPS of $0.57 in the third quarter of 2015. Factoring a $0.02 headwind from currency at June month-end rates, adjusted EPS would be $0.55 last year on a constant currency basis. We expect continued solid execution in Europe. On the upside, we expect to see the tangible benefits of our strategic initiatives and a 1% year-over-year increase in sales volume. These should more than offset challenges related to the ongoing modest cost - price headwind and the Brexit vote; on balance, higher earnings and expanding margins. In North America, we expect results for the coming quarter will be much higher than prior year. As Andres mentioned earlier, legacy business operations will be favorable to the prior year, and the region will benefit from a full quarter result from the Packaging Solutions business. In Latin America, the overall trends from the first half of the year are expected to continue. Mexico will be a key contributor to the substantial increase in operating profit. Be mindful that we had a month's worth of their earnings in the third quarter last year. And despite plenty of macro pressures, we expect that the legacy business will be about on par with prior year, perhaps even positive. Strong operations, disciplined cost containment and emerging benefits from new product development are expected to essentially offset a mid-single-digit decline in legacy volume. Again, very good performance, all things considered. And in Asia Pacific, we expect results to be nearly flat with prior year. We should see favorable development in sales volumes and cost containment, essentially offset by inflation and lower production volume as we continue our investment in the assets. For the company, segment operating profit may expand nearly 25% year-on-year, driven by both the legacy business and the acquisition. Regarding corporate expense and interest expense for that matter, ongoing trends suggest the absolute level of the expenses in the third quarter should be similar to levels reported in the second quarter of this year. In the fourth quarter though, net corporate expense should decline sequentially, partly due to higher income from our joint venture with CBI. As I mentioned earlier, the full-year tax rate is expected to be in the range of 25% to 26% and a similar range in the second half. Putting this all together, we are forecasting adjusted earnings per share for the third quarter in the range of $0.65 to $0.70 per share. Note that we see the full year unfolding pretty much as expected. For sure, we have discussed many uncertainties mostly outside of our control that can change the mix of the third quarter and fourth quarter results. We're working harder to offset these challenges. Yet to the extent such efforts will be realized in the fourth quarter, our third quarter earnings are under some pressure. Again, as you will see now on slide 16, I'm pleased to say that we are maintaining the increased earnings and cash flow guidance discussed in our last earnings call. Adjusted EPS guidance for 2016 is $2.25 to $2.35 and our free cash flow guidance is approximately $300 million. Our guidance reflects our continued belief that our performance will remain strong across both our legacy and acquired business, and while our forecast includes the weakening of the British pound as a result of the Brexit vote, it does not reflect any meaningful change in demand throughout Europe. And before handing the call back to Andres, let me simply say that we are on track to hit our volume and margin targets at the enterprise level as we outlined on Investor Day. Andres?

Thanks, Jan. Turning to slide 17, we are doing what we said we would. The company is performing in line with expectations and our priorities have not changed. We have the right leadership team in place with the right mix of competencies, high level of commitment to take O-I to sustainable performance improvement, and with the right leadership and strategic mentality. Uncertainty exists around the world, yet we are squarely focused on that which we can control. We had another quarter of solid results. We are maintaining our full year guidance and we are building what is needed to drive improved customer experience and shareholder value well into the future. I want to thank all of our employees around the world for their high level of commitment and the contributions to the enterprise performance improvement. And now, we will open the lines for your questions. [Operator Instructions]

And your first question comes from the line of George Staphos from Bank of America Merrill Lynch.

Thanks for the details. Congratulations on the progress thus far. Lots of questions, but again, I'll try to keep it to one. Andres or Jan, can you provide a little bit more color in terms of what you meant us to take away from your comments about there are challenges in the back half of the year, you're working hard to offset these, and yet there'll be some pressure, I think you said more so in the third quarter versus fourth quarter. Any discussion around that would be helpful. And how do you also offset some of the unplanned incidents that are maybe pressuring results? Thank you.

Yeah. I'll give you one example. The strike in Colombia. So, it impacted late last quarter, but the most impact is within this quarter. Now some of it is related to shipments as an example, and we expect to recover most of it through the remaining two months. But it might happen that some of it is recovering to the fourth quarter. So, that's what we're talking about it. We believe we can offset those events, it's just that the recovery might be a split between Q3 and Q4. Therefore, we're confident we can continue to meet our previous guidance, and that's why we are maintaining it.

And your next question comes from the line of Deborah Jones with Deutsche Bank.

Hi. Good morning. If you could just go back to the guidance. Can you help us understand, since you did maintain the EPS guidance, what was the impact now from tax, Mexico and Asia Pac, and the strikes? Those four things seemed to have moved around a bit from your previous guidance. Can you kind of discuss the puts and takes there and how that impacted your thoughts going forward?

Sure. Good morning, Deborah, it's Jan. Let me first walk you through the headwinds. Again, we talked about the strike in - the country strikes that we had in France and Colombia. And certainly in the second quarter, the France strike was much more impactful to us. And I would say that was probably worth somewhere - it could be $5 million to $6 million, so several cents in the quarter. The Brexit vote was probably about $0.01 for us. We're thinking in the full year, it's somewhere $5 million and $10 million. The lower tax rate, we settled several European audits during this quarter and they were favorable - net favorable to us. So, that was primarily the big change on the tax rate side of about $0.04. So, I like to think about it as though the tax rate kind of offsets some of those things that we had little control over. And then the acquisition, of course, performed a little bit better than I expected on the upside. So, in the underlying business, quite strong performance, on the initiative side, on the business performance side, and stability in the corporate costs side and interest. Maybe Andres would like to focus a little bit on the flexibility, what we're doing on that side that might add a little more color to it as well.

So, as we said, our improvement efforts are progressing very well. And we're dealing with two levers at the same time at this point. One is improvement in improvement initiatives which are progressing well. So imagine this is - we're going up an up-curve. And at the same time, we're improving the stability of the business and reducing on plan isolated events. At this point in time, as you heard from our comments during the call, we are seeing half the amount of isolated events we saw in the prior year. So, we're making substantial progress. Now, we're meeting and exceeding our guidance in EPS for the quarter. And for all purposes, I think one way to say that is our $0.65 are from operations. Now, I encourage you - all of you to look back and compare the stability and the consistency of our numbers today versus what we used to see a year ago or so. In our opinion, this business is gaining substantial stability and consistency. Now, again, we got to ride those two curves. One is improvement initiatives. The other one is decreasing the isolated events in which we are progressing very well.

And your next question comes from the line of Anthony Pettinari from Citigroup.

Good morning. Just a question on free cash flow. Do you have any update in talking with Mexican authorities in terms of receiving the VAT and just the confidence level of getting that in the fourth quarter? And are you still baking in $140 million for that, or is there any change with the peso?

Good morning, Anthony. Actually, we're progressing quite well on that front. We have high confidence that we will be on target in receiving the VAT refund in 2016. We do adjust that number each quarter, of course, relative to the peso. To me, it looks like it's more in the $130 million, $132 million kind of range right now versus the $140 million, but it will continue to move. And we expect settlements in the fourth quarter. We've been having very good dialogue with the authorities and believe that we have submitted all the necessary paperwork.

Your next question comes from the line of Lars Kjellberg from Credit Suisse.

Hey, good morning. Maybe a bit of a premature question, but you are building a very strong momentum as you exit 2016 in your improvement. In your Investor Day, you talked about a 40 basis points year-on-year improvement in margins both in 2017 and 2018. Are you ready to give us any update on that given the momentum you're building? And if I may just add a quick question, what sort of sterling rates do you assume to the dollar in your guidance?

Related to the 2017 margin, we believe that what we outlined in Investor Day is still appropriate, 40 basis points year-over-year for the next couple years. This is largely driven of course too by the fact that we should have a full year behind us in some of the initiatives that we're starting this year. So, we'll see a bigger impact from that perspective. And also, I think very importantly, the work that we're doing on the supply chain and improving our asset base will help drive some of that improvement going forward. You also asked about the sterling. I think $1.34 is the rate we're using.

Your next question comes from the line of Scott Gaffner with Barclays Capital.

Thanks. Good morning.

Good morning.

Morning.

Just wanted to dig in to the North American legacy business for a minute. In the press release, you said North America legacy volumes were on par with prior year. And when I look at the slide - actually the very first slide in the Appendix, it shows legacy - or it just shows North American volume, excluding acquisition, is down $13 million which would be a 2% volume decline. Can you just reconcile those numbers and then also talk about maybe some of the underlying businesses within that, food versus beverage, et cetera? Thanks.

So, when we look at our volumes for the first half in North America, they're essentially flat. And as we look into the second half, we are expecting that we're going to be up around low single-digits. And this is driven primarily by the volumes that will come to the region from the contracts we have with CBI to supply the growth that is taking place in the U.S. So, at this point in time, we see, overall, a positive year-end result, volume-wise, for the region.

And your next question comes from the line of Ghansham Panjabi with Robert W. Baird.

Hi. Good morning. It's actually Matt Krueger sitting in for Ghansham. Thanks for taking our questions. My first question is, have you experienced any unexpected changes in customer order patterns and have you seen any channel inventory shifts on a regional basis? And then, all of that in the context of how the Brexit vote is going to impact the back half of the year for your business, excluding the translational impact that you noted.

So, the overall demand has been quite consistent with our expectations. We see a strong demand in wine in Europe, which is driven by exports primarily, due to the competitive position of the wine in Europe due to the position of the euro at this point. And we're having a good demand in beer, which is consistent with our long-term contracts that we signed the year before. When we look at North America, I just described the situation, so we see a slightly positive overall scenario for the year, and it's been consistent, no major variances there. Latin America has been down and is consistent with what we projected and is driven primarily by Brazil. What was new in, let's say, as we went into the year what is new is the situation in Ecuador. We got quite disrupted by the earthquake down there. So, nevertheless, when we look at the full year for Latin America, we see the demand to be quite consistent. When we look at Brazil, specifically, it is low but is stable. So, we haven't seen any further deterioration in the patterns of demand in Brazil. Something important to highlight with regards to Brazil is we're seeing a very strong demand for premium beer which is primarily packed in glass. So, the growth of premium beer in one-way glass containers is really impressive and is totally out of the ordinary patterns that we saw in the previous years. So, that's a very positive and worth to track. And the returnable containers are performing better lately, they're recovering versus the performance in the first quarter. Andean countries, quite stable and strong in the beer side, all categories remain the same. And when we look at APAC, very strong demand in wine. We were expecting this because of the competitive position that both Australia and New Zealand are gaining because of the exchange rate. And we've seen quite a strong demand in beer. That will be probably something that is slightly out of what we were expecting here in the patterns that we saw in previous years.

And before we go on to the next question, I just wanted to circle back, Scott, with you on your prior question on North America. I mean while shipments were flat basically for the second quarter, they are up 1% for the full year. And then from an accounting basis, the dollar volumes are down primarily because we have more bulk sales versus - and less carton sales.

Your next question come from the line of Mark Wilde with BMO Capital Markets.

Good morning.

Good morning.

Question about Asia Pac, actually kind of two parts. One, Andres, what's the impact this year from that beer contract that I think you picked up late last year? And then, can you help us kind of bridge from 2016 and the profitability in Asia Pac in 2017? Because you talked about the few things going on this year that are depressing results down there.

Yes, so the beer contract, it was a signed a year ago. We're seeing those volumes on closing, that's part of the improvement we're seeing in beer. That is sustainable volume going forward. I don't have specific numbers of impact of that volume in the region. When it comes to the profitability going into 2017, what we're doing in Asia Pacific is dealing with improving the condition of our assets, so we're going to gain stability. That's consistent with what we did before in North America, at some point, and in Europe, later on, with very positive results. So, we think this is the right time given our projections, the business performance, to take care of Asia Pacific where we didn't do before any of that work. So we can guarantee or set the conditions to be able to increase our profitability in 2017 and beyond. So, I think we are very pleased by having the chance to put this emphasis in APAC, and I think it's going to give us a very good return as we move forward.

And, Mark, while we may be short now on the margin improvement relative to our target for the year in APAC, we do expect, based on the end-to-end supply chain improvements that we'll see going forward, that we'll be able to pick up 25 basis points next year and the year after in the margin versus where we had thought - where we had been, I should say.

And your next question comes from Chris Manuel with Wells Fargo.

Good morning and congratulations for a strong quarter here. Wanted to kind of focus on one area in particular, and that was kind of working capital inventories, et cetera. I mean, when I look through some of the financial statements, it looks like working capital's about $90 million behind where you were last year, or there's a little bit more of a build, and it looks inventories are up about $65 million, $70 million in total. Jan, help me with kind of where you are production versus inventories, different things to that year-to-date. Have you been building a little inventory? I remember earlier in the year, you talking about there was some replenishment or some elements in it that were going to happen that might reverse next year. Kind of bring me up to speed to kind of where we are production/inventory so far year-to-date and that activity as well.

Sure. So, there's a couple pieces to working capital. Obviously, one is the trade working capital piece, another is the rest. So, first of all, Vitro - again, the VAT refund for the Vitro acquisition is in our working capital. But also, we made a clear decision at the beginning of this year to try to maintain a flat working capital in relation to our payables and receivables, which had been a deviation from the past. So, that costs us about $90 million on a year-over-year basis in our working capital. But then we had the refund on the VAT side to somewhat offset that. On the inventory side, I think our inventory levels are going to be improving. They're basically flat year-over-year. We talked about in Investor Day that we were positioning ourselves in 2016 to be able to see big improvements in inventory going forward, and we still believe that next year we'll be able to see about a $50 million improvement on the inventory level side.

So, reducing the inventories, in our case, takes two significant improvements that got to precede the reduction. One is the increase in flexibility, which is progressing very well across the world in all regions. And the other aspect to it is developing the supply chain across the world. We put in place the global leadership team for supply chain. We have a global leader for that effort and we already have an agenda for the world. We are replicating best practices across the company. So, those capabilities are being built. We're progressing very well. Inventories at this point are flat, but we are now expecting that we're going to have an improvement at the end of the year which wasn't the case when we started. So, that is a positive change in position. Now, as we go into next year, that reduction of inventories will become stronger as per Jan's comments.

Your next question comes from the line of Tyler Langton with JPMorgan.

Hey. Good morning. Thanks. Jan...

Good morning.

I was just wondering, did Q2 benefit from any reductions in discretionary spending like Q1? And then does your guidance assume some increases in the second half? And then just, I guess, any kind of numbers around that would be great. Thanks.

I've seen no meaningful change in the - I mean, no meaningful extra discretionary spending decisions in the second quarter. And your second half of the question, can you repeat what - Deborah, can we allow him to repeat the second half of the question, please?

He would need to come back into queue and we can do a follow-up.

Okay.

Okay. That's fine. And if that doesn't happen, we'll be sure to get back with your, Tyler. I think it has something to do with the third quarter. And we really expect not a lot of change in the third quarter as well.

And your next question comes from the line of Adam Josephson with KeyBanc Capital Markets.

Thanks. Good morning, everyone.

Good morning.

Jan, just on pension. Can you talk about the potential implications of the 80 basis point or so decline year-to-date in interest rates on your funded status and pension expense, and what your expectations are for contributions this year and next? And just as a follow-up to Chris' question on working capital, are you saying inclusive of the VAT tax refund, that working capital will be a total source of about $50 million this year? And then what about next year? Thanks, Jan.

Okay. Sure. First of all, let's just talk about the working capital. Really, I think it's going to be less than that. We're trying to keep working capital basically flat for the year. And so I don't think $50 million, I think it's going to be a bit less - far less than that. Related to your question on the pensions, right now, our expense on the pension side was about $31 million in 2015 and we're looking at something similar in 2016. On the cash side, it's about $20 million. The change in discount rate, if you're looking at just a general formula, I would say somewhere about a 50 basis point change in the discount rate reduction is going to cost us about $8 million of expense per year. Now, we, at the end of every year, go through an exhaustive study of our discount rates and where we're positioned and payments made to-date and actuarial studies, and so, we don't really have a solid estimate yet for 2017. But I would use the formula of about 50 basis points, that's $8 million of expense.

Your next question comes from Chip Dillon with Vertical Research.

Hey, good morning.

Good morning.

My question is just as I try to make a guess at next year's numbers, which obviously the market and many of us on the phone are focusing on, if I think about the free cash flow, it seems like $300 million's the guidance, $20 million of it is going to go to the minority or non-controlling interests roughly. And then, I think you mentioned about $130 million would be for the - would comprise the VAT refund. So, that means we kind of start next year truly what's available to the O-I shareholder of about $150 million, if my math is right. And I know you've talked a little bit about working capital this year. But how should we see that number move next year in additional to or above and beyond whatever we all think, on this phone, your earnings will be?

Yeah. Well, we indicated on our Investor Day that our 2017 forecast was about $250 million to $270 million for next year. Now, we're running ahead of that already this year by $20 million. We do expect - and that will be driven by - even though the VAT refund will not repeat itself, inventories will improve, the business will improve and that's what's driving it. So, I would say that we're positioned quite well now based on everything that's happening this year and our expectation for next year to be running pretty close to what we said at Investor Day or maybe a little bit ahead based on our running ahead this year.

Your next question comes from the line of Phil Ng with Jefferies & Company.

Hey, guys. Demand was pretty solid in Europe, but you did see some modest slippage in pricing. I guess longer term, would you consider taking more of a cost-plus model in Europe like the U.S. as you view - or would you view the longer term opportunity for just better, favorable pricing backdrop? Thanks.

Okay. We've been living in Europe in a deflationary environment. So, in those conditions, it's obviously more common to see a trend towards a lower price. Now, we said before that there is an imbalance in capacity and demand in Europe that remains. We saw a significant activity in the region price-wise from some players trying to gain volume in 2015. We're seeing that decreasing as we move into 2016. So, at this point in time, we see more stability. So, that's what's driving that price. In our case, we said before, we want to take a very balanced approach to price and volume. That's what we're doing. We sustain the same position that we described to all of you before.

And your next question comes from Brian Maguire with Goldman Sachs.

Thank you for taking my question.

Good morning.

Most of my questions have already been answered, but I just had a follow-up on Adam's question about the pension. Just wondering if the move in the discount rate would change your thoughts around how much cash you might contribute to that either this year or next year. Does it make it more attractive to use some of your discretionary cash flow for pension? And then just a question on the Olympics. Any expected benefit down in Brazil from the Olympics coming up? Thanks.

Okay. Let me handle the pension one first, Brian. We haven't made a decision to change what our expectation is on the cash side this year for the pension, so I think it's hovering around $20 million. And I think once we see the position for next year based on the change in discount rates and our actuarial studies, we'll make a determination on the 2017 cash level for the pensions. But right at this point, I think it's a bit too early to really speculate on that. We are, though - I should say, we have in the past, and we continue to spend a lot of time on derisking our pension plan. We've had - we've worked with the Dutch plan recently, the Australia plan, of course, the U.S. plans, and we're going to continue to look at ways to derisk the liabilities on these plans.

Yeah, when we look at the Olympics, we don't expect a major change in position of demand in the country. Normally in Brazil, normally, what happens is because of the short-term nature of this, the overflowing demand goes to camps, and that's what happened with the World Cup, too. So, it's consistent with what we've seen in the past. When we look at glass overall in Brazil, and I think this is an important data point for you, we're seeing a very strong performance. The demand is down overall in the country for all categories. However, within that context and just looking at the statistics you normally look at and we commented on before, you will see a very strong performance in glass in the country, which is worth to track. Its premium but it's also a position - the sustained position of the returnable. And we see the key players in beer making a significant emphasis on that package at this point in time.

Thank you, everyone. That concludes our earnings conference call. Please note that our third quarter conference call is currently scheduled for October 26. We appreciate your interest in O-I, and remember to be one of the cool kids on the block. Be trendy. Buy glass. Thank you. Have a great day.

This does concludes today's conference call. You may now disconnect your lines.