O-I Glass, Inc. (OI) Earnings Call Transcript & Summary

Hi, everyone. Good afternoon. This is Debbie Jones, the Paper and Packaging Analyst at Deutsche Bank. This is a session for O-I Glass. Today, we have CEO, Andres Lopez; and CFO, John Haudrich. And I believe Chris Manuel is on the line as well. Today, we're going to start with Andres giving some prepared remarks with an attached presentation that should be available on the portal, and then we will go into a Q&A. If anyone would like to submit questions, please do so on the portal, and I'm happy to ask them. And with that, Andres, thank you for being here, and we -- I will pass it over to you for the presentation and prepared remarks.

As we begin, let me thank Debbie and the Deutsche Bank team for giving us the opportunity to discuss O-I Glass. I'm Andres Lopez, CEO; and with me, John Haudrich, our CFO. Before we start the presentation, for those following along on the webcast, the materials we are using today are located on our website at www.o-i.com under the Investor Relations section where we house presentations. On Slide 2, take note of our safe harbor disclosures as they relate to forward-looking statements, risks and the like. Moving to Slide 3. O-I Glass has a long and successful history as the global leader in glass packaging, a highly relevant packaging option given important macro trends like health, sustainability and premiumization. In fact, about 20% of all beverages consumed across the globe are in a glass bottle. As you can see, our product portfolio is balanced across several end-use categories, including beer, wine, food, spirits and NABs. While we serve over 6,000 direct customers, nearly half of our sales are with large blue chip global and international companies. Just one moment, we had a -- we lost the light for a second here. One moment. Yes, light is back now. Sorry about that. While we serve over 6,000 direct customers, nearly half of our sales are with large blue chip global international companies across the stable food and beverage industry. We also serve a diverse and vibrant group of local customers. Our customers are attracted to O-I as we establish solid long-term relationships, underpinned by our unmatched global presence and our strong capabilities across markets. While founded in 1903, the company embraces innovation as a strategic driver of future stakeholder value creation. We believe our new MAGMA glass production system will be the cornerstone of creating a new business model and will revolutionize glass. Today, John and I are going to provide you with an overview of actions we have been taking to improve operating performance, transform our business and strengthen our balance sheet. I'm confident that O-I can both navigate COVID-19 while also advancing our strategy to create shareholder value. I'm now on Slide 4. O-I has a very strong market position supported by our broad global footprint with presence in 3 geographic regions. The Americas is our largest unit comprising 55% of our total revenue. Europe is our second largest and represents 36% of sales. Asia Pacific is the smallest at 9% of 2019 revenue. As displayed, each region has a balanced portfolio serving various food and beverage categories, which are pretty stable through economic cycles. Approximately 75% to 80% of the products we package are consumed at home with the balance consumed on-premise in bars and restaurants. While the pandemic has temporarily impacted on-premise consumption, much has been rebalanced to the retail channel, which is where most of our products are sold. Moving to Page 5. Let me briefly outline why we believe O-I offers a compelling investment thesis. As we will cover, O-I is quickly adapting to the global pandemic as we remain squarely focused on our strategy to create long-term value. This strategy has 3 pillars: First, our turnaround initiatives focused on optimizing revenue, increasing manufacturing performance and taking cost out. The playbook has evolved and the scope and pace of execution have accelerated with the pandemic. We are permanently removing cost and reducing spending across both cost of goods sold and SG&A as we simplify our organization. Likewise, we are adjusting our global footprint to properly position the company as markets recover with a strong focus on free cash flow. Second, we are aiming to revolutionize glass as we create a new business model, leveraging breakthrough innovations like MAGMA and capitalize on glasses in highly sustainable qualities. We continue to make solid progress and are getting encouraging results with every MAGMA development milestone. Finally, O-I is optimizing its structure. We are readjusting our business portfolio, addressing legacy liabilities and focusing on debt reduction to increase shareholder value. Taken in concert, these bold actions are geared to change O-I's business fundamentals and drive long-term value creation. Next, let me build upon these tenets by providing some more color on their successful execution. I'm on Slide 6. Let me discuss our turnaround initiatives focused on improving the productivity and effectiveness in everything we do. The first is plant performance. We run a large and sophisticated network of 78 plants across 23 countries. There is a lot of value on improving the performance of the system. We have redoubled our efforts over the past 12 months applying on parallel glassmaking capabilities. As a result, safety, quality and operational efficiency across the footprint are at their highest level in several years, exceeding our initial expectations. This includes the 8 factories impacted by increased complexity last year. Our cost transformation initiative focuses on improving SG&A productivity and we have accelerated that effort recently given the pandemic. We have simplified the organizational structure to improve agility and execution. Likewise, we have reduced our focus on spending -- reduced and focused on our spending. Finally, we are addressing revenue by focusing on mix management, given the backdrop of the pandemic. Bottom line, we are highly focused on improving the performance of our business. These efforts are proceeding well, and we are accelerating many aspects. Importantly, the progress we have made in executing the initiatives has embraced our ability to navigate the challenges presented by COVID-19. Ultimately, we are establishing a strong and more nimble foundation to execute our value creation thesis for the years to come. Moving to Slide 7. At O-I, our goal is to revolutionize glass. This includes creating a new business model for glass leveraging MAGMA, which is a revolutionary way to produce glass as well as capitalize on glass' highly sustainable characteristics. MAGMA addresses head on many of the historic constraints glass has dealt with for decades. MAGMA enables new capacity with a lower capital commitment and total cost of ownership compared to legacy technology. Likewise, MAGMA will improve our position relative to alternative packaging and support margin expansion. It is rapidly scalable so we can more quickly match capacity to market demands capitalizing on growth opportunities. Being prefabricated, MAGMA can be rapidly deployed in line with market trends of lower capital intensity. MAGMA is very flexible. It can be switched on and off, which rebalances our cost profile from high fixed cost to more variable cost in nature. It also increases logistics flexibility, thereby reducing risk. Faced with the significant demand variance due to the pandemic, we will be much better off today if we have MAGMA in terms of flexibility across our network and avoiding fixed cost absorption. MAGMA promises to improve our sustainability profile, an area of increasing importance for customers and the consumers of their products. We have been hitting all of our key milestones. The next MAGMA unit will be located in Holzminden, Germany, which should be operational in early 2021. Importantly, this next step should confirm the viability of deploying Generation 1 MAGMA units for some applications without the need to wait for the Generation 3 system. This will help accelerate deployment and the benefit of this revolutionary development. Furthermore, we are jointly working with customers to secure mutual commitments for future deployments in the Americas and Europe. This underscores the potential strategic implications of this technology for O-I and its key customers. Moving to the right side of the page, glass has superior sustainability and packaging attributes compared to their substrates. This theme is front and center for customers and consumers alike. Glass is endlessly recyclable, meaning 100% of all used bottles can be easily converted into cullet and remelted to make new bottles one-for-one, making it ideal package for the circular economy. This is not the case with other packaging materials. Likewise, glass is the only food contact material that the U.S. Food and Drug Administration deems generally recognized as safe. Glass is a one-layer package made of 100 natural elements. This is highly important given the growing awareness and health and safety concerns by customers and consumers. Glass has a compelling sustainability story to tell, along with many other important health and safety benefits. As the clear #1 manufacturer, we most articulate it. Consequently, we are ramping up communications of glass attributes. Next, let me turn it over to John to continue our discussion, address recent trends and outline the steps we are taking during the pandemic.

Thanks, Andres, and hello, everyone. I'm now on Slide 8. One of our top priorities is to optimize our structure, which is the third pillar of our strategy. Following the efforts to increase our presence in the Americas, we are now rebalancing our business portfolio and focused on improving our balance sheet position. To support this effort, we are conducting a strategic portfolio review, which we expect will result in divestitures. However, this effort, including the potential sale of our ANZ business, has been temporarily halted during COVID-19. Our tactical divestiture program targeting proceeds of $400 million to $500 million by the end of 2021 is proceeding at a slower pace given the pandemic, but we remain committed to the original scope and time line. Earlier this year, the company took definitive action to establish a final, certain and equitable resolution of its legacy asbestos liabilities, which have consumed about 40% of our cash flows over the past 10 years. The Paddock Chapter 11 activity that began in January is proceeding as expected. As we seek to derisk the balance sheet, debt reduction is our top priority. We are also improving the company's financial flexibility. Following refinancing activity over the past year or so, liquidity is very strong, and there are no significant bond maturities until 2023. Consistent with our focus on debt reduction, the company has suspended its dividend and share repurchase program amid COVID-19. Turning to Slide 9. Let me update you on business conditions during the second quarter. Globally, our daily shipment levels were down 18% quarter-to-date compared to the prior year, given the disruption of on-premise consumption patterns and governmental policies to address the virus. This rate has been normalized to reflect the consistent number of shipping days year-over-year. While demand has been impacted in nearly all markets, it was most acute in Mexico and the Andean countries, where volumes were down 35%. This reflects very restrictive policies in those markets. On an encouraging note, we have seen a gradual improvement in demand as many markets have started to reopen over the past several weeks. Let me share some additional color on our overall volume trends, excluding Mexico and the Andeans, which have just started to reopen. First, quarter-to-date through May, total volumes were down about 16%, excluding these 2 markets. In the second half of May, shipments were down about 13% from the prior year. In early June, volumes were down high single digits. So we are pleased to see an inflection point over the past few weeks where markets are reopening. Based on these trends, we expect demand will gradually improve, and we continue to anticipate full year volumes will be down about 5% to 10% compared to 2019. As noted, we are matching supply with lower demand, which actually has a higher financial impact than the lost sales contribution. As such, we are actively managing downtime to reduce the impact of cost absorption from curtailment. Initially, all of our downtime was via line stoppage, which has a high cash cost contribution rate. Currently, a little over half of our downtime is via indefinite furnace or plant curtailment, which has a lower cash cost. Curtailment activity should peak in the second quarter and improve from there as market trends evolve. We continue to evaluate options to further optimize our networking footprint. We also stand ready to adjust capacity as markets recover to support our customers. As Andres mentioned, we are taking aggressive steps to manage costs. We have reduced our CapEx spending, accelerated our SG&A reduction initiative and implemented previously announced actions to temporarily reduce or defer wages for salaried employees and the Board of Directors. The company recently conducted a reduction-in-force program as part of its enhanced SG&A reduction initiative, which will help simplify the organization and improve decision-making. Overall, we believe we have endured the brunt of the pandemic, and we are encouraged by recent improving demand trends. Despite these unprecedented challenges and proactive measures to align capacity early, our segment results remain modestly profitable quarter-to-date through May. Furthermore, our cash flows for this period were comparable to the prior year despite the pandemic. So quarter-to-date through May, our cash flows were modestly positive adjusted for normal variations in AR factoring levels, which is a clear positive as cash flows are historically still a seasonal use of cash in the second quarter. Reflecting these cash flow trends, our strong liquidity position has remained stable. We continue to manage our business to maintain compliance with the covenant in our bank credit agreement, which includes some flexible terms. Importantly, we are modeling several different business scenarios with a range of recovery periods that include dozens of different levers totaling hundreds of millions of dollars to mitigate the impact of the pandemic. As I mentioned, this includes lower CapEx, working capital, COGS, SG&A spend, among others. So we are taking action. Looking ahead, we are not providing earnings guidance given the uncertainties due to COVID-19. But on the right, we have included our guiding principles as we navigate the pandemic. Over the course of 2020, we will focus on preserving our strong liquidity, maximizing free cash flow and managing our debt levels to remain at or below 2019 levels. Now I'll turn it over to Andres for some closing comments.

Thanks, John. So let me wrap things up with a few comments on Slide 10. 2020 is a year where we are squarely focused on navigating COVID-19 and implementing our strategy to create long-term value. As John mentioned, we have a number of scenarios covering a wide enough range of demand levels with levers clearly identified to deliver on our critical objectives. To address the pandemic, we are focused on maintaining a strong liquidity, maximizing free cash flow, improving EBITDA, partially offsetting the impact of the pandemic and reducing debt. Likewise, we are taking proactive measures to quickly align supply with demand and aggressively managing cost. It is clear what we need to do, and we're doing it. Importantly, we are not letting the pandemic distract us from critical priorities. We are squarely focused on simplifying O-I, improving its agility and ability to execute, and we are seeing the positive changes in results. We are improving performance, including our revenue line, driving efficiency and reducing costs on a sustainable manner. We are optimizing our structure, realigning our business portfolio, addressing legacy asbestos liabilities and in turn, reducing debt. Finally, we are revolutionizing glass as we intend to create a new business model, leveraging innovations like MAGMA and the unparalleled attributes of glass. As governments continue to lift the lockdowns and restrictions, we are seeing demand accelerating in geographies and markets like Europe, United States, Brazil, the Andean countries and Mexico. With the information available today and while markets may be a little choppy, we believe we already hit the inflection point. With gradually improving demand, our organization is highly focused on our response plan. As a result, I'm confident O-I is in the right path to improve performance in the following quarters and ultimately emerge stronger from the pandemic. Thank you for your interest in O-I. John and I will be happy to take your questions.

Great. We're going to do a Q&A right now and Andres is going to close out at the end with some prepared remarks again. I wanted to -- I have received a couple of questions already, but I'll start with mine. I wanted to just address MAGMA because you highlighted it a couple of times in the presentation. And frankly, you sound quite confident about it. And I'm curious, one, if you could kind of talk about that level of confidence in terms of really being able to push this into your infrastructure. And maybe one way to frame it is, if you come back in 2 or 3 years and speak at this conference, how ingrained is MAGMA going to be in your footprint if you reach your goals?

Well, so there are a few things that are very relevant in MAGMA, and we've been able to make progress on demonstrating them through our research and development and pilots. One of them is the ability to reduce capital intensity, which is critical for this business, the ability to lower the total cost of ownership, and with that then, have margin expansion or improve the competitive position of glass, and then improving flexibility and scalability, and then the strong sustainability profile that we are incorporating to MAGMA. Now what gives us the confidence is every milestone that we needed to cover so far has been covered with a positive outcome. And in particular, the melting side of this has been proved, and we've been able to produce out of that. So that is very important in this process of getting MAGMA ready. The milestone that we have scheduled for Germany in Holzminden is very important because that will tell us if we can deploy for selected applications MAGMA Gen 1. Initially, in our plants, we will only deploy when we have Gen 3 available. But this might give us the opportunity to deploy some units in some critical places and applications in the world just with Gen 1 while we continue to develop Gen 2 and Gen 3. Now if I look out 3 years, at that point in time, we're very close to have Gen 3 ready to go. And obviously, at that point, between Gen 1 and Gen 2, we have already a few units running around the world. And I think at that point, not just because of MAGMA, but everything we're planning to add to MAGMA to have a new business model for glass, I think this company and industry will be in a very different position to develop business and follow growth with our customers.

Okay. One question that did come in, so I was just going to focus on your business update is, some people are asking if you could define the profitability that you highlight. I'm assuming that's EBIT including corporate expense, but when you say you're modestly profitable through May, if you could address that. And then how you think about kind of the flow of profitability through the quarter. Do you typically earn about the same in every month in a normal year?

Yes. I can touch base on that. As we all know, the pandemic came on very quickly and resulted in double-digit declines early in the quarter there. Despite those challenges, as we mentioned, that we've been able to respond quickly adjusting capacity and reducing cost. So if you take a look at it, the incremental -- the decremental impact of the lost sales is we have about 25% gross profit margin on the contribution side. So that has been impacting us. But probably the most important component, as I mentioned in the prepared comments, is that on the front end of this, our earnings were impacted because we were taking lines down to adjust capacity. And we're committed to managing capacity in line with supply to -- I mean, demand to be able to avoid expensive inventory builds. Now that comes at a higher decremental margin than we were, for example, today, which is a much more balanced aspect of lines and furnaces and factories. We're not going to be quantifying that here today, Becky -- I'm sorry, Debbie. We're going to do that at the quarter end and things like that. But what I would say is that we have hit the inflection point in the volumes. We've hit the inflection points on the impact of that profitability. Exiting the quarter, we should be -- the worst of the capacity curtailment that we've taken on the front end should be done. And we think that things will be moving marketably up from that point.

Okay. And then the profitability metric?

Yes. I'm sorry, for clarity, that -- in our prepared comments and in our note out, it was on segment profit, okay? So it's segment profit which is prior to corporate costs and other elements such as interest expense and things like that.

Okay. And if we could address some of the other topics that you mentioned in the update. Could you walk us through kind of the differences between or maybe similarities of what's happening in Mexico and the Andean region and why it may be more exacerbated? I realize you say you're seeing some inflection, but just to help us kind of understand what the risk is in that region.

Yes. So what happened in those 2 markets and regions is the government orders and the lockdown measures that were taken paralyzed the countries and the markets. And that dropping activity is not driven by drop in demand. It is driven by the orders. Now I think as we see the governments lifting the lockdowns, what we're going to see is the actual demand in the countries, not just the effect of locking down the entire industry. So now for example, in Mexico, glass is considered an essential industry. So we're back into operation -- gradually back into operation. And the same happens with -- for Colombia and countries like Peru. So we're gradually going back, and we've seen the improvement when we look at the month of April, then May, second half of May and then June, too, month-to-date, we're seeing the positive evolution of them. Now Mexico is now turning. When we were in May, Mexico was hitting the peak of the drop in demand and activity. So now we're starting to see that coming back to higher layers.

Okay. If we were to focus on the U.S. and Europe, could you help us understand if you kind of just segment the market by nonalcoholic premium, what are you seeing in terms of where is the weakness? Where is the strength that people are consuming maybe a bit at home more in certain categories? And just kind of help us understand because I think there will be a continuation of a bit of social isolation, even if the economy opens up and people are trying to understand where people are going to pivot in that type of environment in terms of their alcohol consumption.

Yes. So the -- there is one end user category that is pretty much constant across the world, which is food. So food has been up with the off-premise consumption, and it continues to be up. So that's a constant. Now when we look at Europe, we are seeing beer coming back in Europe very strong. And this is the category that went down first out of all the categories in the world. So now it's coming back strong, high level of activity across all the countries in which we operate. We're seeing wine coming back. Champagne is still very slow. And we're seeing the spirits coming back in Europe. The U.S. has been a little bit more resilient than Europe was. Europe went into very drastic lockdowns in Italy and France and in Spain, as you know, and other countries. So it was a more drastic reduction. The U.S. has been a little bit more resilient, and we're seeing demand coming back across the various categories. And in the case of food, it's been strong and continues to be strong. When we look at countries -- other countries in the world, for example, Brazil, which is important, it has a significant drop. However, one-way containers have kept the share through all the decline in the pandemic. So the change remain -- the share remains the same even though demand dropped. And we're seeing Brazil coming back quite well. And by the way, beer is coming back quite strongly at this point.

Okay. Thank you for that. I wanted to also see if we could touch upon trends that you're seeing in Asia Pac specifically. I realize that the future of this business may not be part of O-I, but just help us understand what -- how this business is performing right now to get a sense of what this business could earn in a normalized year as well.

Yes. So the control of the pandemic has been quite good in Australia and New Zealand. And at this point in time, New Zealand is at very low levels. I think they declared that they're illness-free at this point. The virus is not a problem for them anymore. So that has been a positive. As a result, the demand in A&C has been in a better place than we've seen in the rest of the world. So that's been very encouraging. A very important market in that part of the world is China, too, and China has been in a constant recovery for the last, I will say, 2 months or 2.5 months. So that continues to happen. But overall, I will say that if the most important markets are there for us, which are A&C and China, we're seeing a better profile than we're seeing in the rest of the world just because China had -- went into issues earlier and it's recovering now faster and for 2.5 months and A&C never went as far down as we've seen in Europe or the United States or the Andean countries.

Okay. Question on CapEx. Obviously, there's been some shift in kind of what you're going to do this year in terms of projects. But what kind of impact is that going to have on 2021? I mean I realize you're not giving guidance here, but just in terms of necessity, what does that make the focus for next year?

Well, the -- not the -- we've been making sure that everything that is related to maintaining assets is being kept. And as far as we do that, then that continuity of taking care of the assets remain. We have reduced all those things that we believe -- well, that can be more discretionary in nature, or less strategic, and then we'll see based on the evolution when we go into the following year how much is the right level of CapEx and then we'll proceed accordingly. But the fundamental maintenance CapEx has been addressed in a way that we are protecting the assets.

And I would say those deferred projects this year, a couple of tens of millions of dollars of deferred projects, there's no one big item in there. There's nothing in there that's going to really adjust the company's capability.

Yes. And the -- when we had the various countries locking down, it was very difficult to move people around. So even the ability to execute projects within the year goes down. So for example, in Europe, we got to move labor across borders, and we couldn't move those resources anymore for at least a couple of months. So that by itself takes care of some of the pace.

Okay. And John, if you -- are you able -- or Andres, either of you, what does your volume guidance for the year now imply that you do in the back half of the year? Imagine I couldn't do that math, but just for those on the line that might be trying to understand the expectation.

Yes. I mean I can give you some color. Obviously, we haven't given specific guidance other than that fuller number. But keep in mind, in the first quarter, we were down 1%. We're down to 18% through May with a pretty good recovery back in June. So something in the teens there, yes, for the second quarter is probably reasonable, and with a ratable improvement coming out of that. Now keep in mind, when we give this 5% to 10% range, we're trying to capture a couple of different scenarios, as we mentioned before, ranging from either a shallow U shape or even V shape recovery on the low end or maybe even lower than that type of impact, all the way to something which is more of a U or W shape in case there's some recurrences in the back end. So we cover that range of scenarios depending on the play out in that particular ZIP Code. But the base case is that we would see a gradual recovery that probably continues into the first part of 2021.

Okay. I -- I'm sorry, just a question that came in. I wanted to ask one more question about leadership. You just recently announced some changes in the Americas. I was just wondering if you could discuss that. Andres, it looks like you're taking on some more responsibility and this is all part of your general acceleration of SG&A reduction. How to think about that?

Yes. So the O-I has made substantial progress and has made multiple changes along the last few years. And all of those changes are enabling having a simpler organization overall. So that's what we're doing. We have a better organization designed right now, better talent, better culture, communication tools are very, very, very good. Processes, practices have evolved significantly. So we are in a very different position. And that's enabling us to simplify. We're simplifying. We already did, by the way. That makes the organization a lot more agile and effective executing. So we're very pleased with the progress. I think the next -- it was the next logical step in our progress, evolution. We've done it, and I think it's working quite well for us.

Okay. Great. One question just coming in and then, Andres, please feel free to close out the session. What -- the question coming in is, what is your liquidity and debt maturities over the next 3 years after the recent bond issuance? And by the way, thank you both for doing this presentation. Really, really appreciate it.

Yes. So the bond maturities, we have $80 million due in the first half of 2022, and then we don't have anything due until, I think, it's $500 million of the next piece in 2023. So clearly, as we look to strategic activities, divestitures, tactical divestitures, free cash flow, we're looking at continuing to take out the debt going forward.

So a few comments to close. As John mentioned, we have modeled several scenarios reflecting several different levels of demand. And we have clear response plans associated to them. So we know well what needs to be done, and we're doing it. And we're taking costs out in a sustainable way. And as we do that, we are improving EBITDA, or EBITDA, which is helping to partially offset the effect of the pandemic. We are prioritizing cash flow and debt reduction, and we're leveraging working capital and have reduced CapEx to support cash generation. We are realigning our business portfolio, and we are addressing the legacy asbestos liabilities, as we mentioned before. We are successfully developing MAGMA, making good progress, and we believe MAGMA will enable a new business model for glass. And we are today a simpler and more agile organization. And this is sustainable and is helping us to execute more effectively with very good rigor and discipline. And finally, we believe demand has passed inflation point, as we mentioned a few minutes ago. And all of the above gives me the confidence that we are in the right track to improve the performance in the following quarters and emerge stronger after the pandemic. And thank you for your attention today.

Thank you, everybody. Have a nice day.

Thanks.

Thank you.