O-I Glass, Inc. (OI) Q2 2018 Earnings Report, Transcript and Summary

Good morning. My name is Sylvia, and I will be your conference operator today. At this time, I would like to welcome everyone to O-I’s Second Quarter 2018 Earnings Conference Call. [Operator Instructions] It is now my pleasure to turn the call over to your host, Mr. Dave Johnson.

Thank you, Sylvia. 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 and provide a review and outlook of our financial results. 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 financials we are presenting today relate to adjusted earnings and adjusted cash flow, which exclude certain items that management considers not representative of ongoing items that 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. Today, I will briefly cover the current quarter and our guidance. Then I will like to provide a more strategic update on O-I's leading position in key markets, the favorable market environment for glass and how O-I is well-organized to capitalize on both to increasingly add shareholder value. Beginning with the current quarter on Slide 3, O-I is a resilient company. We went into a quarter with good volume, price and cost inflation trends and a weakening U.S. dollar. While most of the elements within our control unfolded or expected, we faced several unforeseen headwinds in the quarter, transportation strike in Brazil, strengthening U.S. dollar, high trucking cost in the U.S. and a batch disruption in Mexico. Yet, employees across O-I acted with a high level of commitment and a sense of urgency to effectively find a way to still meet our financial commitments. Good business performance, effective cost-reduction efforts, and energy craving Europe and a relatively low tax rate all supported the good performance in the quarter. We did this while continuing to make long-term investments in people, in capabilities, in assets and get JV partnerships that will further drive shareholder value for years to come. Our top line was up 1%, mostly driven by better mix and higher prices that has slightly outpaced cost inflation. Going into the quarter, we expected currency to be a clear wind fall compared with prior year. It was a mixed bag, however, being a more modest than expected tailwind in Europe and a strong headwind in the Americas. Global demand for O-I glass is about 1% higher year-on-year. This is consistent with growth underlying fundamentals for glass containers and reflects the ongoing increasing demand that we see in our JV with CBI that serves the fastest-growing beer segment in The United States. I'll touch on sales volume by region a bit later. Segment operating profit was essentially flat compared with prior year. Europe turned being a very good performance. Taking out the $9 million energy credit we received in the quarter, margins were up 100 basis points and profit is up by $12 million. The Americas was adversely impacted by the largely temporary issues I already mentioned. And Asia Pacific declined in line with our expectations due to lower production and higher manufacturing and delivery costs. That said we are pleased to say that the asset investment program has progressed very well. We have now completed nearly 90% of the program in Asia Pacific. We have one more asset project to execute to bring the program to conclusion. We expect to finish all key activities on time, fully ready to enjoy the seasonally high fourth quarter sales as planned. Let's turn to Slide 4 where I want call out the outlook for the balance of this year. The good news is that we continue to have a path to deliver our original guidance. While we've been hit with headwinds, we are diligently executing our plan to offset it. We've seen good margin expansion, partially driven by the by sales mix we have been targeting for some time. Product system cost in the second half will contribute at a higher level than the $12 million in the first half and share repurchases will add a few cents to EPS as well. Today, we are maintaining our original guidance for full year earnings and cash flow. Readings will suggest that we are likely towards the lower end of our earnings range in light of the headwinds even after accounting for some weakening of the U.S. dollar since quarter end. Still, under current circumstances, with good execution through the rest of the year, we have a path to achieve our target. On Slide 5, you will find the factors coming together at O-I to support sustainable value creation. Take favorable market trends supportive of glass, add a capable O-I organization and add discipline and strategy investments, leverage this with talented employees and a culture conducive to performance and results and O-I will continue to generate a higher top line, expanded margins on higher earnings and cash flow over the next three-year planning cycle. Let's take a dig deeper on market trends beginning on Slide 6. Emerging consumer preferences, distribution channel dynamics and evolving customer business models are coming together to reshape the business environment. Consumers value differentiation, customization and premium products. Consumers purchasing decisions are increasingly influenced by the environmental impact of packaging after the product is consumed. And consumers’ value glass packagings obvious health benefits to preserve contents on the shelf and at home until consumed. Concurrently, private labels continue to pose a challenge for brands, which need to be elevated and differentiated to maintain a strong position on the shelves. All these dynamics are renewing our customers’ interest in glass packaging, because glass is ideal to support branding, higher value, product recyclability and perfect preservation of products for pure and healthy qualities. While the attributes of glass we are highlighting are not new, the confluence of factors is just – I just described is new. And then, we need to factor in the transform O-I, an organization that is agile, flexible, innovative, broadly capable and committed to customer growth. As a result, our meetings with customers around the world are exciting and productive. We have all realized that together packaging and glass can create value for all the stakeholders. And on the following slide, you can see tangible examples of our new business development is gaining momentum. We have displayed a few of the recent launches by consumer trend. While the connection to premium and health and wellness is obvious, I want to point out how our customers are approaching the sustainability trend shown in the middle of the slide. For the vodka bottle on the left, the customer wanted a substantive reduction in both in barrel weight while the jars on the right are intended to be used again and again at home. Let me highlight the recent introductions of return of our glass containers in U.S., for beer on the West Coast and for milk in Michigan. Who will have thought just a couple of years ago, that these new product introductions will take place in this market. This is how much things are changing. For sure, positive factors are converging to create a renewed interest in glass. If you want to learn more about some of these exciting products packaged in glass, please see the products appendix in the slide deck. This is just a small sample of the outcome of our recent new product development activity in collaboration with our customers. Now I would like to switch our lens to a more geographic view of O-I beginning with Europe on Slide 8. Overall market trends for glass are very good in Europe, where consumers are ahead of us when it comes to the trends I just discussed. Consumer confidence is quite good and the glass packaging dynamics are fairly constrictive. Within Europe, our manufacturing teams are currently running our assets and higher operating rates. Our commercial team has been much more focused on segmentation and sales mix management. We are objectively choosing where to play in line with our strategy, bringing together the commercial team and the end-to-end supply chain team through our rigorous Integrated Business Planning process with adding substantial value to our customer relationships. As a result, we have also identified solid return investment opportunities to add several production lines to existing furnaces to be able to grow with our customers. At the same time, we are squarely focused on reducing the structural cost through product system cost, which is a sustainable effort with best-in-class processes, practices and tools now deeply embedded in O-I’s DNA. Just look at the results. While our sales has been increasing a bit over the past several years, the substantially increasing profits and margins is due to better sales mix, constructive pricing and reducing our cost structure. Going forward, we expect further gains in volumes, cost reduction and profitability. Turning to Americas on Slide 9, there are several points in common with Europe. The commercial and end-to-end supply chain organizations are collaborating well to meet customer needs and reduce cost. And prices are keeping up with cost inflation. Americas though has been growing. While I'll bring some more clarity on the U.S. and Brazil in a moment, there is obvious growth elsewhere. While I applaud the team's effort to effectively expand demand they are also focused on deepening the commitment and effectiveness reducing the structural costs through optimizing processes, practices and tools of total systems cost. For Americas, we see a long runway for low single-digit volume growth, prices keeping in pace with cost inflation, lower structural costs, all leading to a steady profit and margin improvement over time. Sure, we might see headwinds from time-to-time, as we saw in the second quarter of 2018. However, the underlying business performance is a strong and continuously improving and the Americas team is deeply focused on finding ways to achieve record profits and margins in the overall region. On the next several slides, I'd like to turn to – to walk through what we believe are a few misconceptions about our growth beginning with the U.S. on Slide 10. Back in 2014 I led the North American business before becoming the Chief Operating Officer of the company in 2015. At that time we initiated a segmentation effort to more fully understand whether the demand for glass packaging was growing. Leaders that followed significantly enhanced these efforts. We could see that growth was present in all product categories, primarily driven by emerging higher end or premium products. As a result, we moved forward at the time with two strategic actions. First, we focused on imported and premium beer. The largest move in this dimension was the investment in the joint venture with Constellation Brands. This allowed us exposure to the fastest-growing beer brands in The United States. Second, we expanded in the growing premium food and non-alcoholic beverages, spirits and wine segments by intentionally strengthening our commercial and end-to-end supply capabilities to meet evolving customer needs. On the commercial side, this means learning to grow in the segments, becoming innovative, agile and reliable in how we serve our customers. Meanwhile, in the end-to-end supply chain we have become a much more flexible, quality focused, cost-effective producer. Over the past several years we have proactively and successfully converted over 200,000 tonnes of beer capacity in The United States to non-beer segments. As you can see from the chart on the lower right, we execute about 25% more job changes today than a few years ago. This is a material change for the U.S. market and another key example of O-I's capabilities and our growing ability to leverage our name across the enterprise. We are building solid and long-term customer relationships. We are meeting customer needs which leads to new business, which leads to growth and profit. Let's now drill into a year where everyone seems to be acquainted with the round draft [ph] in mega beer, not new news. However, as we highlighted a moment ago, O-I made a strategic decision to invest in our joint venture with Constellation Brands. It's so important to look at the bigger picture which is clearly shown in the chart in the upper right. Customer demand for O-I glass in the U.S. has been steadily increasing over the last several years. Of course, we should include volumes from our JV with CBI in any assessment of the U.S. market because all that product is consumed in The United States. Our JV with CBI is the largest, most modern, most productive glass container production facility in the world, because it is located back-to-back with the brewery it makes economic sense to produce glass containers for Constellation Brands in this location. Therefore, as we optimize our production network across the Americas by aligning it to better support growth in local markets over time, some production volume was shifted from our vehicle and Monterey facilities to the JV. In all, O-I in the U.S. is benefiting from mid-single digit growth in non-beer segments, plus an additional increase, not decrease from beer. On the following slide, which is similar to the one we presented at the recent sell side conference, you can see several dynamics of the U.S. in chart form. On the left, there is a view of just beer. When including the JV with CBI, our beer volumes have been growing considerably over the past several years in the U.S. market. This growth will continue in the following years as we build out the fifth furnace in the JV. On the right, you can see that total volumes in the U.S. across all our categories have increased significantly. You can easily see the gains made in the non-beer categories. Clearly, we are growing faster than the market in The United States. Let me now turn to Brazil market dynamics on Slide 12. First, demand for glass in beer continues to increase dramatically. Premium beer of which about two-thirds is in glass continue to take market share in Brazil, from less than 4% in 2011 to nearly 10% last year. In 2018, it is growing even faster helped by the economic recovery in the country. We are also seeing a strong growth in one-way glass for mainstream beer, enjoying the conversion from returnable glass mainstream. As a result, O-I has been seeing great demand in beer in Brazil. In 2018, our sales in beer are approaching record levels and projected to be up more than 50% compared with last year. Yet, Brazil is not all about just beer. Over half of our sales in that country are in other segments, each with good growth prospects. Now that our assets are now running full, to continue to support customer growth, we will work diligently with our customers to make capacity available from elsewhere in our networks, and we have recently announced our decision to add incremental capacity in north east Brazil. This capacity, which will cost about $20 million will come online in the first half of 2019. I hope that you can see more clearly why O-I continues to view both the U.S. and Brazil as growing and increasingly value generating markets for us. Let's turn to Asia Pacific on Slide 13. Overall market trends in the region support continued volume gains. Emerging markets lead the way with low-to-mid single-digit increases. In Australia, domestic beer is growing modestly and wine continues to expand largely due to favorable exports. Taken together, we expect volume growth in the low-single-digits. On the manufacturing side we have nearly completed the intensive phase of the asset advancement program, similar to what we previously undertook in Europe and the Americas with very positive results. While the program temporarily suppresses our margins through lower production volumes and higher manufacturing and delivery costs, it is the right thing to do as shown by the growing overall performance of Europe and the Americas. And now, with the painful part behind us, we are ramping up production and unwinding a standard supply chain cost and are excited about the positive impact this will have in the region going forward. Our much improved assets are a better fit to market, will increase productivity, will reduce cost and will increase capacity to support growth. As Asia Pacific's profitability and margin profile is expected to increase in Q3 and will be a very strong Q3, as previously expected. Going into next year, we anticipate volume growth and lower structural costs. We are also – we also expect the asset advancement activity to go back to normal as in the other two regions. As we switch our lens back to the enterprise level on the Slide 14, you can see that I have already touched on many of the elements that our capable organization is delivering. We already have solid fundamentals in all the key capabilities we need in the organization. Through our talent organization design efforts, we are empowering our people and augmenting our processes to perform sustainably at a higher level. End-to-end supply chain continues to focus on taking our nearly 80 factories around the world toward significantly enhancement of manufacturing flexibility and productivity. While doing so, that total systems cost approach is delivering strong contributions. In the second quarter, the impact was $6 million, bringing the first half total to $12 million and well on our way to reach our full year goal of about $30 million. The investments in people and processes to improve our capabilities will continue to favorably impact the top and bottom line going forward. And on Slide 15, I'd like to turn to capital investments that are also increasing the bottom line today, while securing a more stable foundation for our future. Most importantly, I want to connect you with our reality. We have a lot of value added opportunities and we are investing in them in a prudent way. A substantial portion of our CapEx is devoted to growth, flexibility and footprint optimization. In this call, I have talked about modestly increasing our effective capacity in every region in order to grow with our customers. Generally, we have done this by adding additional firm in lines to existing furnaces. We then take a higher proportion of our CapEx to flexibility, clearly needed to profitability meet the evolving needs of our customers while optimizing our costs. We will also continue to increase the competitiveness and fit-to-market of our overall manufacturing network. Last year, we closed a plant in the Netherlands. And this year, we have talked about plant closures in Atlanta and Columbia. And as I mentioned earlier, we'll be adding capacity in Northeast Brazil next year. Regarding our kinds of investment, we'll continue to assess bolt-on immediately accretive acquisitions in growing segments or certain geographies. The excellent job of our team has done integrating Mexico and the JV with CBI into the Americas, give us the confidence in our ability to efficiently and effectively integrate any potential future acquisition. On the technology front, we continue to – the disciplined investment in product and process innovation. Our speed to commercialization continues to improve. This is crucial at a time when the markets are changing so much, fragmenting product portfolios through higher value product proliferation and value innovation. We are devoting resources to technology that will more efficiently address flexibility and scalability as well as product innovation in support of branding and customer growth. This is an important development for glass given the inherent attributes of our product and taking into consideration that glass did not advanced technologically for quite a while. This constitutes an upside opportunity and we at O-I as the leader of the industry are working to reposition glass from a technology and innovation perspectives. We continue to be encouraged after passing through key stage gates of our disciplined R&D efforts. Now I would like to turn the call over to Jan to talk broadly about risk management and the financials.

Thanks, Andres. Let's turn to Slide 16 where I would like to begin with risk management, one of my core passions and a continually growing focus at O-I. While we are fully committed on delivering higher earnings, cash flow and returns, reducing volatility is another key focus of ours. And I believe strongly that we have made great progress in this area, progress that may not be fully understood or appreciated at times. Our entire effort to expand business in non-beer and premium, for instance, is a massive diversification effort that mitigates commercial risk. And investing in flexibility not only allows us to meet evolving customer needs, it is a key element of contingency planning. Our ability to shift production to other parts of our network has improved significantly and is increasingly recognized by our customers. I see Integrated Business Planning as a great way to drive our risk management mindset as well. Commercial manufacturing, logistics, procurement and finance are all at the table on a consistent basis, working on the best approach to running the business over different rolling horizons, the next few months, the next year and the next three years. Turning now to Slide 17, let me update you on the more typical financial risks. We continue to proactively manage our debt structure. In late June, we finalized our five- year bank credit agreement, achieving all of our key objectives, including reducing our refinancing risk by extending the maturity date out to 2023; increasing liquidity by adding $100 million of capacity to our revolver; reducing our borrowing costs by securing a lower spread to LIBOR across the pricing grid; and ameliorating credit risk by securing better terms and conditions, including an uptick in the leverage ratio covenant. Another important element of our bank credit agreement is the ability to borrow outside of the U.S. and Europe because local borrowing is a natural hedge to translation risk. A few years ago, nearly three quarters of our debt was in U.S. dollars. Now about half of our debt is denominated in other currencies. Of course, we continue to intentionally manage our fixed float ratio, generally favoring fixed rate debt, especially at rates we've seen over the past two years. And within our floating-rate portfolio, we've shifted a substantial portion to Europe, where there is less pressure for rate hikes in the near term. Turning to Slide18, we also continue to mitigate pension risk. I expect later this year, we will offload more pension liabilities through annuitization programs like we have over the past several years, while we continue to look for other incremental improvements to address the risk and cost. I wanted to highlight two more pension-related items that are not always in the forefront of investor’s minds. Some people may take a siloed approach to the impact of interest rate movements, focusing simply on overall leverage. In reality, be mindful that rising rates are likely to positively impact our pension expense through the reduction in present value of pension liabilities, that is rising rates may be unfavorable for variable rate debt, yet good for pension expense. And secondly, we continue to see a heavy burden on our earnings from the noncash amortization of actuarial losses. This diminishes EPS by about $0.35, somewhat lower than in the past, as we continue to reduce overall pension liabilities. Let's turn to capital allocation on Slide 19. We continue to take a balanced approach to allocating our cash. We obviously focus on CapEx required to support organic growth and efficiency improvements within O-I. This should be around $500 million for the full year. We will make cash contributions to our joint venture with CBI as we continue to build out the fifth furnace. We invested nearly $100 million in our equity with perhaps a bit more to go this year, and we will continue to deleverage. Let me wrap up on Slide 20. I trust you can see that we are making steady progress through our transformation that is impacting every function in every geography. In doing so, we not only expect to hit every major financial deliverable we committed to at our last Investor Day, but we have also built a secured foundation upon which to continue to grow for the future. This will translate into better operational and financial performance going forward. Volume growth, cost improvement and margin expansion together leading to higher EBIT, earnings and cash flow. And we will continue to prudently allocate our cash from operations into CapEx, both maintenance and strategic, liability management and our own equity, while preserving liquidity to undertake bolt-on acquisitions in line with our overarching strategy to be the most preferred supplier of glass containers and with the most cost competitive operation. I invite you to learn much more about our next three-year plan, the what and the how, at our Investor Day, which we are holding in New York on November 14. And now, Sylvia, we can open the lines for questions.

[Operator Instructions] Your first question comes from Debbie Jones from Deutsche Bank.

Hi good morning.

Good morning.

Good morning Debbie.

You may sound pretty confidence that you're going to hit the mid-teens margin in Asia Pac as you exit the year, but the Q2 result was little below what we had targeted, and in Q3, you're planning to, I think, it's 6% or 7% margin. Can you just talk about the ramp up to that mid-teens margin? And how things there versus your expectations, has anything kind of changed the [indiscernible]?

Sure Debbie we achieved a little over 1% operating margin in the second quarter. We plan – third quarter is really a transitional quarter for us. Our expectation is that third quarter will have about 7% operating margin, and we are still on target to for about a 15% margin in margin in the fourth quarter as we exit this year.

Your next question comes from George Staphos from Bank of America Merrill Lynch.

Good morning. First of all, thanks for a very thorough presentation. I appreciate the details. I wanted to piggyback a little bit on Debbie's question with a two-part, if you will, emerging market question or non-U.S. question. How volume dependent, how macro dependent are your margin goals in Asia Pacific? And Andres, if you can comment on how risky, maybe that's not the right phrasing, but susceptible to a pullback in demand, one-way glass in Brazil would be, if you see some deceleration in economic activity there?

Thank you, George. Let me start by the second question. We've been seeing growth in one-way containers in Brazil over the last three years or so. It's been the fastest-growing package, and this has been in the midst of the largest recession in recent times in Brazil. So when the countries are focused on positioning premium that tends to be less susceptible to those at macro economic downturns than oil products. So this is a clear example of how premium products are resilient to recessions better than, let's say, mainstream products. And in Brazil, a lot of the demand that we're seeing is driven by that, by premium, plus the conversion out of returnable containers into one-way glass, which has been very positive too.

One other thing, maybe I can elaborate on is well, is that the volume in APAC is strong and the margin pressure that we've really been having throughout the first half of the year has been really due to the logistics cost. And as we're 90% complete with the APAC program, we see that the costs are coming down, the volume remains strong and that will, of course, reduce our supply chain costs overall. So that's what is enhancing the margins as we go throughout the balance of the year.

Yes, and mature markets are – have been fairly stable over there. I think the demand in Australia, New Zealand is very solid. When we look at the emerging markets they present very good growth. If there is a slowdown, obviously, that growth will slow down, but we are making sure, we're always keeping the pace of capacity increases below that, let's say, maximum demand that the market offers. So we should be in a fairly good position if the economy slows down.

Your next question comes from Anthony Pettinari from Citi.

Good morning.

Good morning.

Jan, I just wanted to confirm when you initially provided full year guidance earlier this year, it didn't include the impact of buybacks and now it does. And then in February, you announced $400 million repurchase program. I think you discussed executing $100 million in 2018. I guess, given that the underperformance of the stock despite some pretty stable business performance and you're basically done with $100 million, are there prospects for upsizing or accelerating the buyback this year?

Okay. Thank you, Anthony. Let me first talk about the 2018 guidance. When we guided to our range of $2.75 to $2.85, we have had a lot of happened to that since the time that we provided that guidance, both headwinds and tailwinds. So, some of the headwinds that we had, of course were related to foreign currency. We anticipated we were going to be in a position with about a $0.10 tailwind in 2018. And in the end, through ups and downs as we have seen and to current rates right now, we see that tailwind more like $0.02, not $0.10. So that's an $0.08 drag on the EPS for the year. We obviously didn't anticipate the Brazil transportation strike and that was several cents nor the U.S. freight inflation, which is somewhere around $0.05 to $0.06 perhaps, and then, our batch upset in Mexico as was mentioned previously, which is also several cents. So that's a significant amount of headwinds that are hitting us this year. Now on the tailwind side, you're correct, in that the share buyback was not incorporated into the guidance. So by the time the end rolls around for the year, we'll probably have close to $0.01 of earnings on that. Our effective tax rate, we're guiding down about 1 point on both the lower and upper end of that range. So that should equate to another several cents of improvement. And then, management actions have been put in place. Prudent spending good operational performance throughout the year and that has been a nice tailwind for us. So the combination of all those things still allows us to stay in the range, although primarily because of the foreign currency, we're guiding a little bit lower within inside of that range. But I hope that you can see that we – this team here has been extremely resilient in trying to offset so many of these headwinds that have hit us this year. And your last question was on the share buyback program. So the board did announce a $400 million program. It's true, the first half, we have repurchased $95 million worth of shares, and I believe that probably through the balance of the year, we'll do a bit more, certainly not to the level we have in the first half, but may be another $25 million or $30 million.

Your next question comes from Scott Gaffner from Barclays.

Thanks good morning.

Good morning.

Two quick ones, just around the guidance, where you are today versus the guidance you gave about, say, five or six weeks ago at a conference, it sounds like maybe it's a – just slight touch lower now that you're pointing at the lower-end of the range, if there is anything that changed in the last five or six weeks? And then Andres, longer-term, thanks for all the Analyst Day preview and bigger picture items, just trying to pull it all together because there's a lot there. Is there any reason to believe that volume growth going forward to the O-I volume growth that you referenced could climb above 1%? And if so, what sort of rage are we looking at? Thanks.

Scott, let me first start with the guidance question. I believe when we met at the sell-side analyst conference, we really were guiding to within the same consistent range that we originally guided to, but we said that we had a line of sight to that range. And what we meant by that was that there were a lot of headwinds that hit us in the second quarter, but that we had a lot of ideas and a lot of momentum building within the company on being able to find many offsets. So we were guiding within that range. There is no real particular change since that conference, five or six weeks ago. But right now, we're just saying, we're, obviously, lower within that range than we would have been without all those headwinds. So that pushes us down to the lower end of the range, not saying it's the lowest end of the range. I'm just saying it's a lower-end than where we would have been before and obviously, you can see why.

And with regards to demand, I think, in order to have a better visibility into the glass container demand for O-I, it's important to take into consideration what we mentioned in the remarks, which is, the volume that we reallocated to the JV because it's the right thing to do in order to optimize the Americas network as well as the JV volume in total. And when you look at the O-I volume for the year, just look at this year, and you add back the demand that we reallocated to the JV, you're going to find that we are projecting 100 basis points of growth. Now this is after losing about 30 basis points with the strike in Brazil and the issue in Queretaro. Now if we look at the demand for glass for O-I, when we'll add the JV, which is serving the fastest-growing segment of beer in the United States, you got to be accounted. We are growing at 150 basis points. Now as we described in the remarks, we are seeing opportunities across the markets we serve, which has been improving our ability to serve our customers, they see it, they acknowledge that, they like it. So we think we are in a very good place perhaps in the confluence of factors given the macro trends also in sustainability and all that that will favor glass. At this point, we are considering 100 basis points of growth in our projections going forward, but I tend to be more positive than that based on what we are seen emerging. And we are confident that when we get together for the I Day, we're going to able to be – to go into more detail on opportunities that are emerging around the world for O-I based on the transformation the company is going through.

Your next question comes from Mark Wilde from Bank of Montreal.

Good morning Andreas, good morning Jane.

Good morning.

Just a couple of things real quickly. Can you just tell us if there is any carryover on either the Brazilian strike or the Mexican furnace issue into the third quarter? And then, can you also talk about sort of potential U.S. tariffs on imported glass? And whether that's a positive or a negative or a bit of both for O-I potentially?

Okay, so the event in Brazil, it all have impacted the second quarter and it impacts the full year because we weren't recovered while we didn't sell, right. We are selling at full capacity in Brazil. We're adding capacity as we described. So when we shut down the capacity during the strike, we lost some volume, we won't be able to recover that. So it's already reflected in our projections, but all the effect is contained within that quarter. We're back to normal operation. We're chipping really high. Just beer itself in the quarter was up 54% and the total demand for O-I was around 60% up. So it's a very healthy performance, and we expect that to continue throughout the year. The same happened with the impact in Queretaro in Mexico. It is contained in a short period of time. We lost volume as a result because it was a batch upset. It is already reflected in the projections. No impact in Q3, no impact in Q4. So it's all contained back there. Now when we look at the tariffs, this is a topic that is still in evolution, and we're watching that closely. There are two ways in which this could influence or impact O-I. One is the inputs and the other one is the customers on demand and the impact that demand could have. Now when we look at the input side, with what we know today, the impact is expected to be very mild and manageable. When we look at the customer side, some customers are expecting no impact and important customers. Some are expecting some impact, but that impact is still to be determined. Overall, we expect a mild and very manageable impact with the information available today.

Your next question comes from Gabe Hajde from Wells Fargo Securities.

Good morning.

Yes. Just one question on Europe, kind of a two-part question. One is, can you kind of describe some of the nature of the capacity expansions there, thought of asking, in the context that you guys have been reducing capacity, maybe what end markets that, that capacity would be serving? And then size up maybe in dollar terms like you did for us in Brazil, what you're looking to spend there? And then also you did make a comment, I think, in the presentation that you feel pretty comfortable and confident about cost recovery next year. I think this is the earliest we've seen commentary about that. Can you explain maybe what's given you that confidence there?

Okay. So let me start with Europe capacity and demand. What we see in Europe is a very solid demand. Our capacity is at high utilization over there. So our focus over the last, let's say, a year or so, has been on segmenting the market, making sure we focus the company in the segments where we can add the most value and improve profits the most and improve margin the most. So as a consequence, we have been able to improve mix in Europe, and we're very pleased with the progress we're making over there. At the same time, we have identified some opportunities for growth in some segments, and we are supporting those opportunities through some small investments, primarily in lines that are either have been added to the total capacity or have been retrofitted so they can serve a different mix. When it comes to inflation, in general, going in to 2019 for the company, we feel very comfortable we're going to be able to recover inflation. And I want to highlight specifically Europe because I know there are growth concerns about high inflation in Europe. Now we are comfortable, O-I will recover inflation in Europe in 2019, too. Now Brazil, so we mentioned that we are expanding capacity over there by bringing the Victoria factory back into operation. We announced that recently, and we are expecting to invest $20 million in that commissioning – re-commissioning of the factory, which is, in fact, a very low investment when compared to the capacity we're bringing up. And we're also considering to – not considering, we already decided to add a high productivity line in Recife, so that those two are expected to be in operation, Victoria in the first quarter of 2019, and then, the line in Recife in the second quarter of 2019.

Your next question comes from Chip Dillon from Vertical Research.

Hi, yes good morning, just two quick questions, two-part question, I should say. One is, your guidance for operating margins in Europe for the fourth quarter looked to be like in the mid-teens to be the best we've seen in quite a while – I'm sorry, for Asia Pacific, my mistake. And as we think about next year and 2020, do you think a mid-teens margin is sustainable? Or is there something seasonal that makes the fourth quarter unusually high? And I guess, the second question is, Jan, you mentioned may be doing $25 million in buybacks in the second half. Well – I mean, is there a point where the market, if you will, dares you to buy more because I would imagine you want to be somewhat price sensitive, 60 is a lot better than 24, for example? So just love your thoughts on those two issues

Sure. So Chip, let me start with the share buyback. Clearly, we see the price of the stock, we're not happy with that. We started this year with a new buyback program. We continue to discuss the share buyback as well as all of our capital allocation on an ongoing period within the company, we talk about it all the time and we talk about it with our board all the time. So we will continue to always evaluate those options. Right now, I think we're looking at a bit more than that we're at, but again, we'll continue to look at that. Let me switch over to Asia Pacific, related to the margins. First of all, the fourth quarter is a seasonably higher quarter for the region and always has been. So we anticipate going out of the year at this 15% margin. And next year, I think, on a full year basis, we're looking at the low-double digit area for APAC, and I think that looks good for them next year and continue to look for ways to improve efficiencies and cost structures for the region.

And I think, the – when we came into the year, we have this project ahead of us. Obviously, it will be impactful now, is pretty much behind us. And what this does is improve the ability of this region to serve and perform financially going forward, the same way we've done this in Europe before and Americas. So we're very happy. This is now behind us. We are very confident we are going to get it done properly because it's a very finite event that we know how to handle well. It's behind us, and now we're moving up the curve for margins and profits.

Your next question comes from Tyler Langton from J.P. Morgan.

Good morning. Thank you.

Good morning.

I just had a question on volumes in the Americas. Could you just quantify the type of volume growth that you're seeing, I guess, in the U.S., Brazil and Mexico? And I guess, any details, I guess, on the impact that the strike in Brazil and disruption in Mexico had. Yes, just any details on that. I think you also said, Andres that beer was up 54% in Brazil, if I heard that right. So just detail on what's driving that?

Correct. So let me talk about U.S. for a moment. So we are clearly outpacing the market in the U.S., and there are a few reasons for that. The first one is, we are performing better than the market in mega beer. So we are declining mega beer at about half the rate of the market. But the other part is, we described in the remarks that we focus, started in 2014, on moving the organization to be able to grow and enjoy the growth of the other categories of business in the U.S. and we've been able to do that very effectively. So when we look at the full year, we are growing in all those categories that are non-beer, 600 basis points in 2018. So this is a very, very important development for us. Now when we look at the total presence of O-I glass containers in the U.S. market and having in consideration that O-I made a strategic decision on investing on the JV back in 2014, the total presence of O-I containers in the U.S. is growing in 2018 by 400 basis points is very significant. Now let me touch base on a very important fact. When we look at mega beer in the U.S., that is – that accounts for about 5% of the total O-I volume globally. Now when you look at the decline of that segment and you look at the impact of that in the total O-I, it's not more than a couple basis points. So it's is not that important when you come – when you look at the total O-I. Now when you look at Brazil, the overall sales are up for the quarter, in this case, it's quarter number, 16%, and this is after being impacted by the transportation strike. Beer was up 54% and premium beer is growing really fast. You see the chart that we showed in the slides. It's continuously growing and almost moving up exponentially. We know that at least 2/3 of that volume is in glass. Now as a result, we're seeing premium beer in one-way glass up for year-to-date 18% and we're – as for premium, up 34%. Now there is also comparison from returnable glass to one-way glass. And as a result, the fastest-growing package in Brazil as per Nielsen data is one-way glass for the year-to-date, which is growing at 15.7%. Now the Mexican market was impacted by the Queretaro event. It impacted us in about – for the year, about 15, one five, basis points of growth, that is behind us too. The Brazilian impact was about the same too. Now that market is going to – we are expecting to grow in that market in the second half. So we should be back to normal growth. We'll have this event behind us.

Your next question comes from Ghansham Panjabi from Baird.

Hi good morning. This is actually Matt Krueger sitting in for Ghansham.

Good morning.

Good morning.

Good morning. I was hoping that you could talk a little bit about the expected time line to recover from the higher freight costs here in the U.S., and then kind of building upon that and understanding that it's still somewhat early to look at 2019. Can you talk about some of the factors that you expect to impact EPS growth heading into next year, any benefits from incremental productivity programs, the cost-savings initiatives that you mentioned, capacity adjustments in Europe, Brazil and North America or any major other factors that you can kind of think of as far as the pluses and minuses go?

Sure, let me talk about 2019, and then Andres will talk about the higher freight cost in the U.S. I think it's still very early to provide guidance for next year, but I can provide some insights, I think, into some of the key elements for you. On a big picture, since 2015, we have exceeded our 10% CAGR for EPS. And I think that's pretty reasonable assumption for EPS growth next year during which we expect to receive benefits from 1% volume growth, price mix at least, keeping pace with inflation, continued momentum on the total systems cost front, footprint optimization including Atlanta, which we had guided to was equal to about $3 million per quarter, the Colombia cost reduction and the Brazil capacity that Andres just mentioned. Improvement in Asia Pacific, clearly, we'll see benefits from that throughout the entire year. So I know that all the modelers out there would like to add back some of the onetime headwinds too. However, I would suggest that we hold off on that for a little bit as much of those onetime items, like cost curtailments and minor assets sales, were used to offset some of those. And I really haven't seen a clean year yet in my nearly 40 years of working in the manufacturing space. So on the nonoperational side though, I think, we should presume a little uptick in interest rates and tax rates plus incremental investments in R&D like we're doing this year, specifically in the second half of 2018. And then when you factor all this together, leading to earnings next year that probably starts with a three handle and cash flow should grow as well driven by these higher earnings. Again, this is kind of a back of the envelope math, I would say, and assumes really no changes to FX or market conditions or any major external disruptions. But we'll have a lot more to say about our guidance for 2019 and beyond that at our upcoming Investor Day in November.

And when it comes to freight inflation in the U.S., we are expecting to have about half the impact we saw in the first half during the second half. That's, let's say, gross impact of freight increase. Now the net impact should be about one-third of what we saw in the first half. And the reason for that is that demand and supply is more balanced going into the second half, drivers availability is up, we negotiated better terms also, and we have been able to implement the pass-throughs for diesel and freight for the customers, that didn't happen. So altogether, we should see about one-third of net impact in the second half versus the first half. When we look at capacity, we've been actively deploying our strategic capital to put some lines to support segments that we believe can create good value for O-I. And just to give you a total number, we – in the last 12 months or so, we deployed at least changes or new lines in 30 lines in the company: 13 of those in the U.S.; about four in Europe; 13 in Asia Pacific. We are adding the capacity in Brazil too. And as we continue to go deeper into segmentation and doing something similar to what we've done in the U.S. so successfully and now in Europe, we will see what makes sense in terms of adding capacity

Your next comes from Adam Josephson from KeyBanc.

Thanks good morning everyone.

Good morning.

Jan, two-part question for you. Just one on the free cash flow guidance. You've pointed to some potential downside on FX. Can you just help quantify that, if possible? And then, just one more on the buybacks. Just can you help me with your thoughts about doing these buybacks as opposed to paying down yet more debt and/or initiating a dividend?

Sure. So first on the free cash flow side, let me just start at a really high level here. We are still expecting to achieve about $400 million in adjusted free cash flow for the year. Yes, FX clearly impacts this and it's embedded probably in a lot of different places here but we expect our EBITDA to go up year-over-year by about $40 million. Our CapEx is a little bit higher this year. Cash restructuring is probably a little lower this year. Our equity dividends from our joint ventures should be about $25 million this year. It's a little higher. And on the working capital side, we clearly expect to see improvement in inventories based on a several day improvement on a continued path that we're working on, and I would say; payables, probably relatively flat year-over-year, but last year, they were a much higher source of cash. So when you put all that together, I think, we're looking toward about a $400 million number. But FX embedded in all those areas is probably about a $40 million headwind. So it's taking us a lot of energy to get back to that number, but we think we have a path to do that. On the share buyback side, Adam, this is one piece of many in capital allocation, and we continuously look at what makes most sense. We are investing in organic growth as you heard a lot about from Andres today. We're looking always at any M&A opportunities that we can find that have – fills a niche that we may have. So there is a lot of demands on the cash, and we will balance what we think makes best sense for us and the shareholders and in this case for this year, I think, we're looking at a little bit over $100 million.

Your next question comes from Arun Viswanathan from RBC Capital Markets.

Thanks, good morning.

Good morning.

Just a question on this last issue. You'd noted 600 basis points of growth outside of beer in those categories, thanks for providing that. And you'd also kind of discussed some potential further portfolio realignment. You shut down the plant in Atlanta this quarter. Should we expect further footprint realignment in the U.S. away from beer and towards other categories? And if so, how do you look at that in the context of your ongoing CapEx for the next couple of years? Thanks.

Thank you. Well at this point in time, we are balanced in the U.S., so demand and capacity is balanced. We are clearly outpacing the market. So our performance is capitalizing on the growth of all the segments and categories that are providing that. And we're very comfortable with our capacity as we have it today. So we continue to look at the network and continue for – to look for ways or looking for ways to optimize it, but we don't see any need to take any action with regards to capacity at this point in time.

Your next question comes from Edlain Rodriguez from UBS.

Thank you. Good morning guys.

Good morning.

Good morning

Just one quick clarification on the freight costs. I mean, what types of mechanism do you have to recover those costs with your customers? Is it mostly contractual pass-through? Or do you have to go out and negotiate those costs?

So at this point, we have pretty much customers across the world with pass-through mechanisms in the U.S. So we have freight is passed through in an annual basis. Diesel is passed through in a monthly or quarterly basis. So that's implemented. When we came into the year, there was a portion of the business and that's primarily the one related to O-I PS that didn't have those provisions. So we worked actively through the first half to implement them, and then they're now in place.

Your next question comes from Brian Maguire from Goldman Sachs.

Hey good morning. Thanks for taking my question.

Good morning.

And I know it's pretty late in the call. I just have one pretty basic one. Just looking at Slide 29, some of the currency sensitivities, it looks like those changed pretty materially since last quarter, euro down $0.02, peso down about $0.03 for the EPS impact. Just wondering what maybe changed since the last call or maybe this is over the last couple of quarters, just sort of reduced those earning sensitivities to the currency?

Hi Brian, really our sensitivities here, we update on a regular basis. I don't think they've changed materially since earlier. We do an analysis on a regular basis with our earnings and where we are with our euro debt and everything and update for that. Now you do know that we do have more euro debt now than we had previously. So that of course, would have had some impact on this.

Ladies and gentlemen, we have time for one more question. And your final question comes from Debbie Jones from Deutsche Bank.

I have a question for Jan. You have a couple of slides in the deck around the derisking of your legacy liabilities. Can you just talk us through one, the implications of the renegotiated credit agreement and around your flexibility in interest cost? And then, I just wanted to get a sense for your pension obligation sensitivity with the current rate?

Sure. So Debbie, let me start with the bank credit agreement. We found an opportunity to renew that agreement a little bit prior to its maturity date of 2020, and the team took that opportunity. We found a very good capacity in the market, very good borrowing rates and also, as I mentioned, the terms and conditions have improved greatly. Across the board, on the pricing grid, we're seeing improvements in the borrowing rates that equate to about $5 million or so, on an annual basis. And so, we're very happy with the outcome of that renewal. On the pension – the legacy liabilities in general, I would say, I mentioned just briefly the pension plan this year. And we are going to continue to focus on our derisking efforts in that area. We're already into the details of the economics of that, and we hope to be able to annuitize another portion of our pension plans in the U.S., and even outside the U.S., we continue to look for opportunities. We have reduced our pension benefit obligations by about $1.8 billion in the last five years. I think in 2012, it was about $4.6 billion and now it's down to about $2.8 billion. So we want to continue on that momentum, and we're going to continue to look further at this. And while I'm talking about legacy liabilities I’d also like to talk for just a couple moments on asbestos. You will recall in July of 2016, following our restatement in May of that year, and the SEC initiated an investigation into certain accounting and control matters pertaining to the determination of our asbestos-related liabilities. And just recently, in May of this year, the SEC informed us that it had concluded its investigations. And based on the information that it had, it did not intend recommend an enforcement action against the company. So of course, we're very pleased with the results of that. And while we're on the general topic of asbestos, I just want to note that the asbestos litigation has involved now for 30 plus years and changes are pretty slow, and our disclosures over time have likewise evolved. And we added a bit more in our footnote and MD&A this quarter, as you will see when you review the 10-Q. We see O-I's pool of claimants shrinking and getting older and there could be some variability in how claims are presented, and ultimately, disposed of. And as you know, our annual asbestos payments have always been influenced by many factors and the long-term overall trend should remain pretty much the same. Although it's likely that we'll experience increased annual variability, and we may be also affected by opportunities to accelerate the disposition of certain discrete parts of the claimant pool, so you can read a little bit more about this in the 10-Q that will be filed this afternoon.

Thanks everybody. That concludes our earnings conference call. Please note that our third quarter conference call is currently scheduled for October 31. And remember, when you need a pure, pristine, practically perfect package for food or beverage, choose glass. It's not just the right choice, it's the only choice.

Ladies and gentlemen, this concludes O-I's second quarter 2018 earnings conference call. Thank you for your participation. You may now disconnect.