O-I Glass, Inc. (OI) Q4 2016 Earnings Report, Transcript and Summary

Good morning. My name is Andrew, and I will be your conference operator today. At this time, I would like to welcome everyone to the O-I Fourth Quarter Full Year 2016 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. David Johnson, Treasurer and VP of Investor Relations, you may begin your conference.

Thank you, Andrew. Welcome, everyone, to O-I’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 discuss key business developments, review financial results for 2016 and we’ll highlight our high level expectations for 2017. 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 Andres.

Thank you, Dave. And good morning everyone. Let us start on the Slide 3, where we provide highlights for our review and outlook. I’m pleased to report that our financial results came in near the top end of our guidance range. Closing out a solid performance to what I regard as a pivotal year for O-I. This strong earnings performance enables us to deliver our cash flow target and to make significant progress on reducing debt. A global economic backdrop presented us with numerals uncertainties and challenges throughout the year. Nonetheless as a company, we remain focus on disciplined execution of the things we could control, delivering operational improvements throughout the organization that drove sustainable gains to the bottom line. Starting to 2017, we expect to leverage our global market leadership to achieve operating profit gains overcoming the continued economic headwinds and uncertainties across the globe. We continue to expect a 10% compounded annual growth rate in adjusted EPS from 2015 to 2018. Our strategic initiatives are paying off. And we continue our focus on rigorous execution for the next phase of these initiatives. In turn, adjusted free cash flow is expected to remain strong and we will use this cash to continue to de-lever our balance sheet. Turning to Slide 4, as you have heard me outline in the past, we are on a multi-year journey. As a Company, we are one team leveraging the scale of the entire enterprise and effectively executing on one plan to deliver increasing shareholder value. One team, one enterprise with one plan is about flexibility and faster response to changing conditions in order to deliver on our promises. The first horizon of our transformation was focused on stabilizing the business. That is consistent execution across our geographies and establishing how we work as an enterprise. For the past year, the most important factors contributing to O-I’s increase in stability, include the successful integration of the Vitro food and beverage business and the focus on performance management and improvement in the legacy business. A step up in the level of investments in our assets and in new capabilities drove improvements in our culture, talent development, customer relationships, price, volume management, asset upcline and supply chain performance. Stability is the foundation for high performance. Building on this, we are now moving into the next horizon of our transformation, which we call agility. We will continue to strengthen our commercial and innovation practices and leverage the global supply chain function, we created in 2016. The standards goal of our structural cost reduction and simplify our organization while enhancing its integration and flexibility. These efforts will be integrated through a collaborative approach that will leverage integrated business planning, which is currently applied by many best-in-class corporations and will be particularly impactful for a company like O-I. All these efforts are expected to drive higher profitability and prosperity for our shareholders, as we maintain and elevate O-I’s position as the world’s leading preferred glass supplier. Moving to Slide 5, as part of our Investor Day in March of last year, we unveiled a number of key programs and performance measures that we undertook to elevate company performance. The hard work of our team members resulted in $55 million of additional operating income in 2016. I want to highlight and celebrate these great achievements. In fact, as you can see from the metrics on the last chart found on the slide, we make progress on each one of the metrics. Although we fell short against several of our ambitious goals the cumulative financial impact of them was very positive and inline with our expectations. Now that our operations have essentially stabilized and performance improving in several key metrics has been consistently take in place for more than a year. We are looking into a next phase of development, which I would like to discuss on Slide 6. Key performance indicators around productivity, quality and asset stability continue to be foundational for our success. However, we are measuring our performance more broadly through a total system cost approach. This metric considers end-to-end supply chain costs, while supporting on integrated approach to objectives around customer service, quality, flexibility, productivity, logistics costs and overall spending. We are attacking costs, whatever the source, while we focus on maximizing our customers experience and our overall profitability. Additionally we are actively measuring and managing inflation and are always working to find ways to offset FX, although these two variables are not formally part of our total system cost approach. On the manufacturing side, we will continue to deploy the plant improvement teams and replicate these practices across the enterprise in a more standardized way. And we have already began to address logistics cost. Taking together in 2017 we expect to generate an incremental $35 million to $45 million benefit to operating profit. This range is $10 million higher than our prior guidance for the impact of its strategic initiatives in 2017. Separately we plan to improve working capital in 2017 by about $50 million. Supply chain is driving an integrated approach to include manufacturing, commercial and finance to improve the cash tied up in working capital. This year we expect to reuse inventory by about four days building on early success in 2016. Moving to our commercial efforts, I’m very excited about what we are doing in this space and how we are interacting with our customers. We began to roll out our key account management program in 2016. This program design to elevate customer engagement and to more deeply understand their needs will help O-I to be in the forefront of customer service and improve the overall costumer experience. We have built a strong set of commercial plans and metrics against which we are executing. The energy is palpable and we deliver a healthy and strategic customer base performance despite not about market fluctuation and pressures. Customer reaction has been very positive and highly supportive. We are focusing our efforts on customers that believe in the value of building a strategic partnership. This makes available to them O-I’s value will know how guarantied supply through our global footprint as well as R&D and innovation developments. These more collaborative cross-functional links will continue to benefit our customers and O-I overtime. The benefits of our commercial efforts will support marketplace growth as well as much improved customer’s relationships. I will now like to give everyone a brief review and outlook of our regions. Turning to Slide 7, we close out the year in Europe with a strong performance as shipments increased by 3% on a year-over-year basis in the fourth quarter, this was inline with our exceptions going into a quarter and help us exceed our volume growth targets for the full year. Operationally the stability and improvement programs that we began in late 2015 really to call in 2016, in fact we came close to matching our 2016 operating profit margin expansion target despite some non-foreseeable events, such as strike in France and the fallout from the Brexit vote. For the year, these were essentially offset by the receipt of an energy credit at year end. For 2017 our European leadership team remains focus on the things that we can control. Our commercial initiatives should allow us to grow a bit faster than the flat market anticipated in 2017. On the pricing front the environment remains very competitive yet seems to be fairly constructive this year in comparison with 2016. Nevertheless it is important to highlight that for the portion of our business under long-term contract the price adjustment formulas will pass through energy deflation from 2016. Nonetheless we expect to achieve year-on-year margin improvement as we continue to drive operational improvements across our entire supply chain. In total, we expect another solid performance from our team in Europe in 2017. Turning to Slide 8, the North American segment also turn in a solid performance in 2016 as evidenced by the region exceeding is margin target. This was driven by contributions from several factors; our strategic initiatives, O-I packaging solutions and organic volume growth of 1%. For the full year volumes were up nearly 7% including the acquired business and higher shipments in all major end-users except beer, which was on par with the prior year. Taking together segment operating profit was up by 13% for the full year. Turning to 2017 outlook, we see a rather stable constructive environment in North America. Market trends suggest safe volumes will be on par with 2016, yet O-I stands to benefit from improving manufacturing productivity and a reduction in warehousing and delivery cost. Beginning in 2017, O-I will report the equity earnings contribution from its joint venture with CBI in the North American segment. In years prior it was reflected incorporate as the JV was mostly in construction mode. I suspect that the JV is contributing to our financial performance. It added about $0.05 to earnings in 2016 and it should add an incremental $0.05 this year. Turning to a Slide 9, in 2016 the Latin American region faced a difficult macro economic environment. However, the leadership team turn in a solid performance for the year. Operating profit increased by almost 50% in 2016 primarily due to the acquired business, which was reflected for the full year in 2016 compared with the last four months of 2015. The fourth quarter is a true apples to apples comparison, shipments increased by 3% led by Mexico. In the quarter, Brazil reported the smallest decline of the year down middle a mid-single digit. Look into 2017 for this region; we are not forecasting a significant improvement in the overall macro picture. But still we assume modest volume growth for the region. However FX induced inflation largely driven by the Mexican peso is expected to be significant in 2017. In fact more than half of the company’s forecasted inflation is expected to come from Latin America. And so, we envision this region will be on par with 2016. Similar profitability on higher sales volumes, of course implies lower margins. Turing to Slide 10, the performance for Asia Pacific for the quarter largely reflected O-I’s approach to this region for the year. Overall glass container demand across Asia Pacific remains favorable. However, as we’ve outlined previously, we weren’t able to fully capture the growth. We accelerate in engineering and investment activities in the region in 2016, which is the right call for the long haul. This caused lower production volumes in Australia and New Zealand. In turn, we supported sales thereby exporting O-I glass from China causing the domestic sales in this country to decline. We remain confident of our market position in the region as well as the opportunities in front of us going forward. A strong leadership team and improved capabilities built in the region in 2016 provide a firm foundation to drive improved profitability. As we look to 2017, we expect concrete benefit. Sales will be higher, production will increase, margins will expand. In fact, the region should be back on track with Investor Day expectations. Before I hand the call over to Jan, I will like to highlight two important developments in 2016 that might go unnoticed since they take place in the background. They are related to their smooth and efficient way O-I first integrated the acquired business. And second, expand the JV with Constellation. Those two important activities integration and expansion took place at the same time we were moving forward the transformation of the legacy business. The positive outcome reflects O-I’s very strong capabilities that when deployed with rigor and discipline, produce outstanding results. Now, let me turn the call over to Jan to review our financial performance as well as a more detailed review of our outlook for 2017.

Thank you, Andres, and good day. Let’s turn to Slide 11. O-I achieved full year adjusted earnings of $2.31 per share representing, an increase of 25% versus the prior year on a constant currency basis. For the full year, the clear drivers for earnings growth came from our strategic initiative and the acquired business. The latter benefit came with higher interest expense of course. In 2016, the net benefit of the acquired business reached the $0.30 per share that we promised. And the legacy business added to the bottom line as well. Separately corporate expenses came back in line with historical averages. The prior year was better due to substantially lower incentive accruals for management and gains on FX hedges. In all, the business improved as expected. Turning to Slide 12, cash generation remains one of our top priorities. In 2016, cash from the operations topped $750 million, substantially higher than the $612 million generated in the prior year. The key movements in working capital were as expected. We received a large VAT refund related to the acquisition and trade working capital was a modest use of funds particularly in payable. I wanted to pause for a moment to explain why we have adjusted free cash flow to exclude asbestos payment. In short, we believe this provides investors with more clarity about the cash flow generated by the business after reinvestment in CapEx. The asbestos payments are essentially relieving a legacy liability on our balance sheet. Turning to Slide 13, let me briefly compliment remarks Andres already made. On our 2017 outlook by region measured on a constant currency basis. Starting with Europe, we expect to continue under the same macroeconomic environment. So execution with rigor and discipline and elements, we can control are the key ingredients for financial performance accompanied by some modest volume growth. And Andres already mentioned mixed movements in price. That will probably not quite keep pace with the higher level of inflation we expect this year with energy costs now on the rise. You may have noticed that we took a restructuring charge at year-end 2016. This includes the plants in Netherlands that we are shuttering later in 2017 to adjust our footprint in Europe. In North America, we also expect higher operating profit in 2017 versus 2016, despite what we see right now as a flattish environment for sales volume. This will be driven by a positive mix shift as non-beer categories continue to outpace modest total beer decline. Of course the decline of megabeer is not new. In fact five years ago, megabeer was 40% of our sales in North America and is now only about 25%. Gains from disciplined execution on our strategic initiative and rising equity earnings should drive higher margins and profitability for the region. For Latin America, Andres already mentioned the uncertainty in the broader macros. Our outlook assumes modest growth for the region for the year, mostly in the second half. While challenges such as FX induced inflation abound in the region, our local management teams will continue to adapt and execute efficiently, just as they did in 2016. Summing up our expectations for Latin America for the year, we believe it will be essentially flat in constant currency with some upside perhaps as uncertainty subsides. In Asia Pacific, as we indicated the investments in 2016 are expected to benefit results going forward. Higher production and sales volume and lower logistics cost will get margins and profitability back on track with Investor Day expectations. Slide 14 gives you a snapshot of our outlook for non-operational items for 2017. Total corporate expenses are projected to be similar to the past five-year average for O-I. As Andres mentioned, the equity income from our joint venture with CBI will now be reflected in North America where it belongs, given the nature of the sales. Since the JV was accretive in 2016, this shift is the reason that corporate expense will increase in 2017, otherwise it is flat. Interest expense should be about flat as lower debt levels are expected to be offset by rising variable interest rates. Taxes should see a slight uptick in 2017, yet still in the 24% to 25% range. Turning to Slide 15, I want to view our 2017 outlook through an Investor Day lens we presented about a year ago. Each one of the company level metrics is on track to deliver margin, earnings, cash flow and deleveraging in particular. Of course in 2016 not all individual elements at the regional level were met due to various changing conditions, some of them coming from conscious positive trade-offs, some of them coming from changes in external conditions. But we have found our way to leverage one region of the company to compensate for pressures in another region. That’s the power of the one team, one enterprise with one plan approach. It focuses the company to meet its commitments with shareholders. Now I would like to drill down on key aspects of our guidance. Slide 16 walk through the components that shape our 2017 earnings forecast using 2016 as a base. Using end of January rates currency is an immediate headwind principally from the Mexican peso, the euro and carryover from the pound. From that constant currency base, we see EPS growth of 10% in 2017. As Andres and I have already described the key driver is business performance. While this is partially offset by higher non-operational costs, we are pleased to be on track to deliver on our earnings target as outlined in Investor Day. That is a 10% CAGR over a three-year period. Turning to Slide 17, I want to provide input into several of the moving pieces in our adjusted free cash flow projection. We first removed the one-time VAT refund related to the acquisition that aided 2016 performance. This would give us an adjusted starting point of about $300 million. From there we layer in better business performance and the contribution from working capital, which Andres mentioned will primarily come from inventory. Our cash flow projection assumes an uptick in investments in our assets, plus higher cash outflows from restructuring that are part of the fourth quarter 2016 charge. Of course both add values to the bottom line overtime. I will discuss legacy liabilities in a moment together they should be a lower drain on cash flow. And the last bucket includes the several non-operational items and incorporates the headwind we presently see from the strengthening dollar. Cash flow generation remains strong and it remains a top priority for O-I. Let me finish the slide by pointing out our business and inventory performance is allowing us to fill more than half of the void of the VAT refund. A solid projection, again, in line with Investor Day expectations. Touching on pension expense briefly on the next Slide 18. The key takeaway here continues to be that O-I’s annual pension expense and cash contribution continue to be remarkably stable. And we expect more of the same in 2017. Of course, this is because we continue to take actions to de-risk our pension plans converting from defined benefit plans and annuitizing plans to for instance. We continue to look for ways to manage this exposure. And while pension accounting is not the easiest to understand, we want to highlight that O-I has a significant non-cash element flowing through our earnings. The amortization of actuarial loss reduces our earnings by approximately $0.40 per share. Let’s now turn another legacy liability on Slide 19, just a few messages with regard to our asbestos-related liability. Overall trends continue to be favorable, the average age of claimants continue to increase, cash payments are expected to continue to decrease now by about $10 million to $15 million per year. And we completed our annual review of our accruals and no adjustment was needed. Asbestos continues to be a declining liability. Turning to Slide 20, I’d like to walk you through the key uses of our strong cash generation. First, we will invest in our business in 2017 cash contributions to our JV in Mexico should be lower than in 2016. Yet I already mentioned an uptick in total company CapEx these are sound investments to drive operational improvements, cost savings and increased sales. As mentioned we continue to manage O-I’s legacy liabilities by de-risking the balance sheet and reducing cash payments associated with these items. After that our main priority is to continue de-leveraging despite lower free cash flow generation in 2017, we expect debt reduction will be about $200 million consistent with prior year. I want to highlight that the company continues to enhance its focus on increasing shareholder value and evaluating opportunity to drive the best business decision for O-I and it shareholders. That said, our team is singularly focused on executing the one plan to meet our financial commitment to our owners. Turning to Slide 21, let’s drill down on expectations for the first quarter. Since so many of the trends in the first quarter are consistent with our full-year forecast, I will be brief. In Europe, sales volume should be flat. However, manufacturing and supply chain initiatives are expected to more than offset continued price comp pressure. Results from the contract negotiation season during the first quarter will start to materialize in the second quarter. In North America the business is essentially stable the region stands to benefit from higher equity earnings, though. Recall that Latin America operating profit is projected to be flat for the year and strengthening over the course of the year. So we envision it will be modestly down in the first quarter on flattish sales volumes. Asia Pacific is expected to bounce back beginning this quarter. Overall for the company, we expect solid business performance. Factoring incorporate costs and interest and taxes, we expect adjusted EPS for the first quarter of 2017 to be in the range $0.50 to $0.55. And now, I would like to briefly turn the call back to Andres.

Thanks, Jan. Before taking your questions, I want to thank all of our employees around the world for their high level of commitment and their very positive contributions to the enterprise performance. O-I is transforming its sales by leveraging its existing and strong capabilities in a rigorous and disciplined way as well as by quickly adding capabilities not readily available internally. We are focused on improving our customers experience and giving priority to long-term neutrally beneficial partnerships. We are addressing the structural cost across the end-to-end supply chain. We are simplifying the organization across the world. And we are becoming a flexible and nimble company able to more effectively and more quickly adapt to changing conditions. We are pleased with our progress and our confident our plans will continue to build shareholder value in 2017. And now, we will open the lines for your questions.

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of George Staphos with Bank of America Merrill Lynch. Your line is open. George Staphos with Bank of America Merrill Lynch. Your line is open.

I’m on the line. Hello?

Hi, George.

Good morning, George.

Hi, I’m not sure if – not sure why you could not hear me. The question, if you can hear me, is on Europe. First of all, on your European pricing, do you expect that by the second quarter you will have caught up with inflation? If you can provide some color around the construct for pricing this year. And the related point, were you expecting that energy credit to show up in the fourth quarter in Europe? Thank you, guys.

So George, let me just touch on pricing and then Jan can thoughts on the energy credit. So when we look at the pricing in Europe we’re seeing a more constructive environment this time. And we are actively engaged in Q1 in the negotiations that then will be reflected in our financial performance starting in Q2. As you know, we have around 35% of our business in Europe under contract. So our pass-through provisions will take some of the deflation that we experienced in 2016 into 2017. So that’s kind of the environment we’re facing in Europe in price. Jan?

On the energy credit side, George, we have of course had been expecting that for a long time and I think in the beginning of the year we were indicating, we thought it might be somewhere around $8 million. But we had not included it in our forecast because we never saw visibility on when that would come. It was very late in the year that we were notice that we should receive it. But there was no timing associated with that. So we weren’t certain if it would actually be received in 2016 or not. So it came very late in the year. Despite that I think, we had been guiding to within the range consistently throughout the year. We saw a strong performance by Europe not including that energy credit. So I think just enhanced the quarter a little bit in the end.

Our next question comes from the line of Lars Kjellberg with Credit Suisse. You’re line is open.

Yes. Good morning.

Good morning.

If you can refer to Page 5, you – obviously, you have delivered solidly in terms of absolute EBIT, but you are somewhat behind your targets. I gather, you’ve got about 78 basis points out of the 100 that you had expected from these operational things. So when you look into next year, should we not expect a meaningfully higher than a 40 BPS margin expansion? You indicate on the call that it will be higher, but is there a meaningful catch up between $25 million, $30 million? And also, if you can allude to your actual margin expansion when the 20 BPS versus 80 from 70, 80 from your programs on the – what was the source of that incremental margin expansion?

Okay, Lars. Hi, this is Jan.

Hi, Jan.

So first of all, let me just talk about the performance in 2016. On a total corporate basis, we did exceed our expectation of 100 basis points through the entire company. Now that didn’t necessarily come exactly as planned by region, because we can’t foresee all the things that come our way throughout the year, while we set up these targets at the beginning of the year. But as a total company, we exceeded those targets. We had indicated in Investor Day that we thought we would get about another 40 basis points of improvement year-over-year. We’re solidly seeing that for 2017 that 40 basis points. And remember that’s incremental over the 100 basis point that we already – 120 basis points that we already achieved last year. And while we’re tracking and we’ll be reporting out on the total systems cost as the year goes on that helps the company because as we look at the total end-to-end supply chain that incorporate so much of our business. And there’s always trade-offs and collaboration going on between the areas and between the regions related to how we achieve those benefits. So we think that’s a better way to track these costs going on. And I think the 40 basis points that we’ve signed up for 2017 is clearly achievable.

I will add that we’re very pleased with the evolution of these initiatives in 2016. We were able to meet our financial commitments and we were able to do very positive trade-offs that we need to have in the business. For example flexibility is important, we mentioned these all along. We got increased flexibility, which is going to drive down the manufacturing productivity index. But it’s going to increase our ability to serve our customers, it is going to increase our ability to reuse inventories and that’s all very positive. So I will say performance was very good, financial performance was achieved and the right trade-offs were played during the year.

Our next question comes from the line of Mark Wilde with BMO Capital Markets. Your line is open.

Yes, good morning.

Good morning.

Good morning.

I wondered if we can just talk a little bit more about the price cost. You pointed to that being a drag in both Europe and in Latin America in 2017. I wondered if it is possible to just quantify that in both regions? And also I think, if I heard you correctly, I think you suggested that maybe that price cost pressure would increase in the second quarter in Europe as some of these contract deflators roll in?

Okay, let me just cover some comments. And then I’ll hand the call over to Jan. So it is always challenging when we coming to – from a year of low inflation into a year of high inflation. Now we experience these in the past two. Now our inflation this year is largely driven by FX impact on input costs. That’s what’s driving the inflation primarily as well as the negative spread. Now this impact is primarily in Latin America and within Latin America is in Mexico. So we expect overall that our prices will recover inflation with exception on latest FX impact which we won’t be able to recover. We’re seeing a more constructive environment for price in Europe and the price adjustment formulas are kicking in from the beginning of the year. While we’re saying it will kick in its starting the second quarter is the product of our negotiations for all the business that is on annual contracts. We have these pass-through provisions – in a large portion of our business for North America is 95% of our business, for Europe is 35%, for Latin America is 40% and APAC is around 50%. So all-in-all, we expect that we’ll be having unfavorable spread but that’s driven primarily by FX impact on input. Jan?

I think the only thing I’d like to add to that really is that, as you recall in 2016, we were focused on setting up our global supply chain organization. And in 2017 now they’re up and running. And they really have the opportunity now to solidly focus on this challenge. If they have more visibility, transparency, I think we have more opportunity to make headway on these kinds of things as we look globally across the organization.

Yes, and the Latin America region is the one with the most pressure and they normally perform quite well recording inflation. So I would expect that as we go into the year we might be able to see an improvement in our position coming from that region.

Our next question comes from the line of Anthony Pettinari with Citigroup. Your line is open.

Good morning.

Good morning.

With the new administration, there’s been, obviously, a lot of talk about border adjustment tax, and I’m just wondering is this something that’s been the focus of discussions with customers in terms of contingency planning and impact to the business. And then when we think about Vitro and Constellation all together, is it possible to say what percentage of sales or volumes are produced and consumed in Mexico versus produced in Mexico and consumed in the United States?

Okay, so the first thing is we are in constant contact with our customers. And we haven’t seen any change in plans from them up to this point. Now it’s not clear yet what the changes are going to be and when those changes will take place if they do. Now, as a consequence of that it’s very early to defined consequences. Now, nevertheless I can offer a couple of comments. In the worst case scenario, the percentage of the O-I total business that could be potentially and eventually affected, will be in the low single-digit. And that wouldn’t happen overnight. I would compare any impact of that to any financial impact we’ve seen in the past when macros move up or down in any given region, so we wouldn’t expect anything major beyond what we normally have to deal with in any given year. Now, important consideration, the consumption of food and beverage business – excuse me, products in the U.S. will be the same. And if that consumption is not served by imported products, they’ve got to be served by local production, and we are very well-positioned within the U.S. to produce and deliver product to our customers. I would expect that also that any potential impact of any adjustment in tariffs will be absorbed somehow across the value chain including consumers. So the impact should be minimised by player in that value chain. And finally, I think it’s important to consider that every year one million tons of empty glass are imported into the U.S.; and if the borders are restricted, somebody’s got to produce those containers within the U.S. and we are again very well-positioned for that. So Jan, would you have anything to add to that?

I guess I would add that as Andres mentioned the impact to us from a volume reduction standpoint is very small and it certainly won’t happen overnight. But one thing, I think, that everyone has to recognize is that we have dealt with volatility before. In O-I Mexico we’ll work very hard to find offset domestically if that’s the case. We’ve dealt with FX issues, we’ve dealt with strikes, we’ve dealt with political uncertainty, and unrest and economic uncertainty around the world. And I think 2016 is a huge tribute to that. So I’m certain that we will find offsets to this as well.

Our next question comes from the line of Debbie Jones with Deutsche Bank. Your line is open.

Hi good morning.

Good morning.

I was wondering if we could talk about the free cash flow guidance, specifically on working cap. Could you just give us kind of order of magnitude, what’s driving that? And on the inventory reduction efforts, what regions that might impact the most? And if you could just focus a little bit more on the incremental CapEx spend by region as well.

Okay, hi Debbi. Let me walk through the working capital for you. As I did in my message, we do expect solid EBITDA growth in 2017. We expect working capital improvements too. And I would assume most of that working capital improvement is going to be coming from inventories. Inventories are probably going to be most impacted in Europe and Asia Pacific. I believe – so that’s where we’ll see the most benefit of that $50 million. CapEx, we expect to be up year-over-year as well. Now we do have one incremental furnace rebuild plant for 2017. So that is a big piece of it. And Andres mentioned about how critical it is to continue to build flexibility into our processes. So we’ll be investing in areas where we can continue to make progress there. And both of those – of course they are good for the long-term performance of O-I.

Our next question comes from the line of Ghansham Panjabi with R.W. Baird. Your line is open.

Hey guys, good morning. I guess going back to George Staphos’ question on Europe and inflation. It looks like Europe is having a cold winter and power prices have surged. So first off, do expect any incremental cost on the energy basket for Europe specifically, net of your current hedges? Second, can you sort of size the Netherlands plant shutdown for us from a production standpoint? And also, how much excess capacity do you estimate in the region for the European glass container industry as a whole at current? Thanks.

So, just talking about the shutdown of the factory in Europe, we’re taking this action with two primary objectives. The first one is cost reduction by producing our product in more cost effective locations going forward and then balancing demand and capacity in O-I Europe. We’re taking a special care as we do this on transferring the production for our existing customers to alternative locations. And that’s also part of the reason why this is going to take place primarily at the end of the year. Now we’re shutting down – I will say probably 30% of the existing excess of capacity in the total region. That’s what these capacity would equate to as we implement this shutdown.

And you also asked a question related to the energy. And certainly energy prices are going up, but it’s our practice to typically to hedge those costs. So there’s not too much energy impact on that front in 2017, a large portion of that has been hedged.

Our next question comes from the line of Scott Gaffner with Barclays. Your line is open.

Thanks, good morning.

Good morning.

Good morning.

Andres, I just want to go back to Slide 5 again in the 2016 operations dashboard you put out there. Because you did fall relatively short of the expectations for the year from on those – on three of the four metrics there, but yet as you mentioned you did meet your financial commitments. So I just wanted to one – sort of find out what went wrong that that led to the shortfall there? And secondly, obviously the correlation between the financial commitments and these targets is not at a 100%. So maybe these are the wrong metrics or maybe there was just some disconnect in 2016. But can you talk about how you regain that footing in 2017 on these targets?

Okay. So as I said before we’re very pleased with the performance we get nothing really went wrong. This is about trade-off. So for us to increase flexibility to support the top line and our customers on the top line is paramount. That’s a very important aspect of our business and we did so. Flexibility also supports reusing inventories and there is a significant free cash flow. We can’t get out of reusing inventories or time. So we supported that flexibility increase along the year. What was very important for us was to get the increased output out of our assets to able to match the incremental saves and we were able to do that. So what we needed to achieve, for example coming out of the manufacturing productivity index we got. And at the same time we were able to deal with service, customer service inventories and the free cash flow we need to generate. As to the stabilities improving, we continue to invest in a very discipline way in our assets and this is going to continue to improve our performance down the road. When you talk about correlation, while this slope of improvement is smaller, I think the contribution for this is higher. And that’s why we’re getting the same amount of dollars we were expecting. So I think we are seeing the evolution we want. This is the first time we’re measuring this way and I think that contribution of that is it drove discipline and execution within the company. But it also gave us the chance to show all of you that the areas in which we were focusing on and also give you a good idea of how rigorous we are in this process and how discipline we are as we execute.

Our next question comes from line of Philip Ng with Jefferies. Your line is open.

Hey, guys. Understanding any border tax impact would be very small from a sales standpoint; but, Andres, I think part of your initiative to integrate your business and supply chain across the Americas, would that have any impact on your ability to kind of integrate your global supply chain system? And the one million tons or so you said you called out that the industry exports from Mexico to U.S., is that mostly products packaging in Mexico, or are you shipping empty bottles into the U.S.? Thanks.

Okay. So the one million tons is global supply. So you will find a portion of them coming from China and from abroad. So it’s not only Mexico. Mexico would be just a portion of that. Now as I said before it’s not clear yet what changes are going to take place and when and what’s going to be the actual impact of that. I would expect that supply got to happen because consumption won’t go down. So somebody’s got to supply that. My expectation is that the value chain, the players in the value chain ultimately will share the impact of this and ultimate impact on volume might be minimized. So again this is all to be analyzed as more information is available. But at this point in time as we talk with our customers, we have no reason to project a change in position versus what we’re giving to you today.

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

Good morning. Thanks for taking my question. Just on the CBI joint venture, I think when you originally announced the deal, you talked about it growing to I think $0.15 of contribution over I think a four-year period. So I just wanted to see if that was still something that was – if that was achievable. And then just in terms of your guidance for flat sale volumes in North America for 2017, does that include the contribution of the JV, or does it exclude it?

So let me just start by saying that that excludes the contribution of the JV volume-wise. So we’re not including the volume in North America. Jan, would you have any comment?

Yes. As far as the EPS in 2016 about $0.05 was attributable equity earrings to CBI. 2017 will be about a dime. And we’re on track for 2018 as we continue to ramp and to be at about $0.15 per share.

Our next question comes from the line of Chip Dillon with Vertical Research. Your line is open.

Yes, good morning.

Good morning.

Just two questions, one clarification. You mentioned that the CBI’s a joint venture I guess contributed $0.05 in 2016, and you said an incremental $0.05 in 2017. I assume that means $0.10. I just want to be sure you didn’t mean a flat number. And then secondly, Jan, could you update us on the sensitivity? I know you did a bond deal in the fourth quarter, I believe, but just sort of the updated sensitivity to changes in short-term interest rates on your balance sheet?

Sure. So let me clarify CBI. It was a nickel of earnings in 2015 and it will raise to a dime in 2017. So an incremental nickel. And it will now be reported beginning in 2017 in the North America business region. On sensitivities and interest rates, we have a little less than $2 billion of floating rate debt now after we did our euro bond deal in the fourth quarter that swapped floating rate debt to fixed rate. About $1.4 billion or so of that is in the U.S. So from a sensitivity analysis I think if we had a 25 basis point increase on the $2 billion of debt that’s floating. It would equate to about $5 million on a full year basis.

Our next question comes from the line of Arun Viswanathan with RBC Capital Markets. Your line is open.

Great, thank you. I guess I just had a question on Europe. It looks like Q4 was pretty strong. Q3 was a little bit light, so was that a catch-up there? And then similarly, for Lat-Am, it looks like the volume read-through from Q4 to Q1 indicates that there’s potential decline in Q1. Maybe you can just touch on your sensitivities in both Europe and Latin America or your outlook? Thanks.

So let me start with Q4, it was a quite a strong quarter we were 3% or prior in that quarter. As we go into Q1 we will experience flat to a slightly up volume that’s what we expect. For the year in total, we don’t expect a deterioration. We should be flat to a slightly up. So in a market that is totally flat, we’re seeing a very good response in the market from our customers overall and I think that materialized in the Q4 and that’s why we see the strong volume performance in the region.

Our next question comes from the line of Brian Maguire with Goldman Sachs. Your line is open.

Yes. Thanks for taking my question. Jan, I think you mentioned that the CBI JV contributed about a dime to earnings in 2017 moving from corporate to North America. I guess that’s about $20 million of EBIT. Obviously, not having sales against that, that’ll boost the margin in North America quite a bit. Just wondering on the guidance and the outlook, if we could get a view on what North American margin might look like year-on-year in 2017 without that accounting impact just on a more apples to apples basis.

Yes. So we expect maybe about $15 million to $16 million of EBIT, which is generating that $0.10. And you’re right, I mean the margin is going to increase more in 2017 because that there was our equity earnings coming through. So that will explain why North Americas margin will jump up more than we would typically expect. But even in Investor Day, we expected a small North America improvement in their margin and we’ll continue to expect the small margin improvement without taking that into consideration.

Our last question comes from the line of George Staphos with Bank of America Merrill Lynch. Your line is open.

Hi. Thanks for taking my follow-on. I wanted to come back to the question on asbestos and philosophy there. Andres and Jan, to extract it from operating free cash flow and ultimately that’s for all of us to determine and handle as we would as well. That would suggest that from your discussions and analyses with your consultants, accountants, et cetera, that you really feel comfortable as a management team that asbestos liability, as you have it pegged, is, in fact, the appropriate valuation because otherwise we should continue to capitalize and taking it out of free cash flow. Can you comment as to why you feel comfortable that valuation on asbestos is, in fact, correctly pegged? Any color would be helpful. Thank you, guys and good luck in the quarter.

Thank you, George. Yes, we’ve had this liability on our books for a long time. Since we have restated our earnings in our books last year, we’ve done a lot of analysis course related to this. And we have a long trend of history on our claims on the age of our claimants, on our payments. So we feel – and so we have a very appropriate valuation on the books. We will continue, of course, to look at this on an annual basis like we would for any larger accrual that we have, what we’ve done in depth detail on this, and believe that it is appropriately disclosed.

So thank you everyone. That concludes our earnings conference call. Please note that our first quarter conference call is currently scheduled for April 25. Remember folks that packaging matters, go fresh, go pure, go glass. Have a good day.

This concludes today’s conference call. You may now disconnect.