O-I Glass, Inc. /DE/ Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for joining us for the O-I Second Quarter 2020 Earnings Conference Call. Currently, all participants are in listen-only mode. Following the presentations, there will be a question-and-answer session. Now, I would like to turn the call over to Mr. Chris Manuel, Vice President of Investor Relations. Thank you, and please proceed.

Thank you, Myra, and welcome everyone to the O-I Glass second quarter earnings conference call. Our discussion today will be led by Andres Lopez, our CEO; and John Haudrich, our CFO. Today we will discuss key business developments and review our financial results. Following prepared remarks, we will host a Q&A session. Presentation materials for today's 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. Some of the financials we're presenting today relate to non-GAAP measures such as adjusted earnings per share, free cash flow, segment operating profit, leverage ratio and net debt, which exclude certain items that management considers not representative of ongoing operations. A reconciliation of GAAP to non-GAAP items can be found in our earnings press release and in the appendix of this presentation. I'd now like to turn the call over to Andres, who will start on Slide 3.

Thanks, Chris. Good morning everyone and thank you for your interest in O-I Glass. First, let me say thank you to the entire O-I Glass team for their agile decision-making and effective execution during the pandemic. Despite many challenges, we continue to protect the health and safety of our employees, which is our top priority as we deliver high-quality sustainable glass packaging for the critical food and beverage industry. Last night, we reported results for the second quarter of 2020. Our adjusted earnings were $0.01 per share and free cash flow was $112 million. These results were consistent with our most recent business update as trends improved over the course of the quarter. Despite the most challenging business conditions in decades, we remain slightly profitable, generated a strong cash flow and positioned the business well for recovery. I'm proud of our results given significant demand volatility and severe operating disruptions due to the pandemic, in particular, drastic lockdowns across key markets such as Mexico and the Andean region. As we manage through the brunt of the pandemic, we continued to advance our strategy by taking bold actions to execute our investment thesis. Results benefited from exceptional execution of our turnaround initiatives. Likewise, we continued to advance MAGMA and we took important steps to optimize our structure. This includes the divestiture of our ANZ business at an attractive valuation to rebalance our portfolio and help improve our balance sheet. While the second quarter was very challenging and disruptive, business conditions did improve over the course of the quarter. Sales volume was down about 15% overall, yet we exited June down just 3% as markets began to reopen and volumes were up 2% in July. Given the ongoing uncertainties surrounding COVID-19, we have limited our guidance to sales volume outlook. Reflecting recent encouraging trends, we have revised our full-year sales guidance. We now expect shipments will be down 4% to 7% from last year, which compares favorably to our prior outlook of down 5% to 10%. Likewise, we continue to operate under key guiding principles that prioritize strong liquidity, maximizing free cash flow and reducing debt. Overall, I believe O-I responded to the pandemic with resilience and speed as we continue to execute our long-term strategy despite the challenging backdrop. We are encouraged by recent business trends as markets reopen. If you flip ahead to Slide 4, you will see some of the steps we have taken to mitigate these turbulent times. Back in March, we established our COVID response plan to focus on cash generation, mitigate the financial impact of the pandemic, and maintain financial flexibility. We swiftly aligned supply with demand to avoid costly inventory growth and you will see that our inventories in June were in line with prior year. Likewise, we have set the right conditions to reduce inventories on a year-over-year basis starting in July and through the second half of the year. As we balance capacity, we optimize our network to manage fixed cost absorption and establish the right flexibility for business recovery. Our turnaround initiatives have been the perfect platform to ensure we successfully navigate COVID-19. Our revenue optimization efforts have helped us achieve the best possible top-line, given the pressures imposed by the pandemic. Our factory profitability efforts have improved operating efficiency, including at our focus factories, which were impacted by increased complexity in 2019. Additionally, we have quickly implemented strict cost controls, which have generated significant and immediate results. Importantly, we established a new operating model for the company that simplifies the organization as well as improve decision-making and execution. We are watching capital closely. During the second quarter, both CapEx and working capital compared favorably to the prior year period. Finally, we reoriented our capital allocation priorities to focus on debt-free options. While we contend with the most difficult business environment in our lifetime, O-I remains focused on the bold structural actions to change the company's business fundamentals. I'm now on Slide 6. As indicated, we continue to make great progress with our turnaround initiatives. In fact, this is the best I've seen the company perform in a long time. MAGMA continues to advance and we remain on track for our first quarter of 2021 Generation 1 installation in Holzminden, Germany. This will be an important milestone, which will pave the way for broader Gen 1 deployment commencing in 2022. Finally, we are optimizing our structure as we rebalance our portfolio and improve our balance sheet. Late last year, we divested our soda ash joint venture and reduced debt by nearly $200 million. In January, we initiated the Chapter 11 filing for Paddock as we seek a final resolution for our legacy asbestos liability. And last week, we completed the previously announced sale of our ANZ unit. I strongly believe, these have been the right steps for O-I, our customers, our employees and our investors. Furthermore, I remain highly confident in our ability to execute across these fronts and unlock shareholder value. Let me share additional color on our business trends for context before I turn it over to John, who will discuss our final financial results. I'm now on Slide 6. The charts provide two sets of information. On the left, you'll see O-I's recent shipment rates. On the right, we have share retail purchase trends for key markets and categories for glass. Let me share some thoughts starting with O-I. While our volumes were stable for most of the first quarter, the pandemic sharply impacted orders in April and May. On an encouraging note, volumes covered significantly in June and July as markets reopened, consistent with the evolution of the pandemic. We realize the contraction and subsequent recovery in Europe first, followed by the Americas. Let's shift to the retail patterns on the right. As you can clearly see, off-premise sales have remained elevated since the pandemic, consistently up between 10% and 35% depending on category. This makes sense considering the sharp falloff in demand at bars and restaurants. Prior to the pandemic, retail represented about 75% to 80% of our sales, while off-premise was the remaining 20% to 25%. Bottom-line, we believe that strong retail activities generally offset the lost sales from bars and restaurants, with consumer consumption trends balanced overall. While consumption was relatively stable, our shipment levels were quite volatile. After a period of disruption, our demand rebounded and supply chains rebalanced for this channel. Going forward, we believe glass demand and underlying consumption patterns will eventually converge, but it could be choppy for a while as supply chains adjust depending on any further developments with the virus. Despite 2020 volumes being down due to market disruption, we are confident our glass volumes will return and eventually exceed pre-pandemic levels. Now, I'll turn it over to John.

Thank you, Andres, and good morning, everyone. I'm on Slide 7. As Andres mentioned, our second quarter results were $0.01 per share, which was consistent with our most recent business update. Let me walk through our earnings reconciliation on the right. Segment operating profit was $95 million, which compared to $236 million in the prior year. As noted, FX was a $6 million headwind. Higher selling prices offset cost inflation, which was elevated due to FX-induced inflation, especially in Latin America. Sales volume and mix was an $84 million headwind, which was fully attributed to the pandemic. This reflected a 15% decline in shipment levels plus the impact at our JVs. Operating costs were a $52 million headwind, which is the net effect of lower production and improved operating and cost performance. Production was down 20%, which impacted results by $109 million. The decline in production levels exceeded the decline in sales volume. This reflected our disciplined efforts to align supply with lower demand and control inventory levels, as well as the forced curtailment to comply with government decrees to address the virus. In particular, forced curtailment was drastic in both Mexico and the Andean region. Lower production was partially offset by $57 million in benefits from our turnaround initiatives and other cost control efforts. We expect the clear majority of these savings will be sustained and benefit future earnings. Non-operating items included lower interest expense following the recent refinancing activities. Our tax rate was elevated reflecting a shift in regional EBIT mix and other factors, given lower earnings. We will likely contend with an elevated tax rate for the balance of the year, which will not impact cash in 2020. All of these results pertain to adjusted earnings. The appendix includes more details on items that management does not consider representative of ongoing operations. These include charges for employee severance related to our recent reduction in force initiative, refinancing costs as we retired near-term debt, as well as restructuring primarily related to one site in Latin America. We continue to expect 2020 cash restructuring will approximate prior year levels. Bottom line, adjusted EPS was $0.01 compared to $0.69 in the prior year, as earnings were significantly impacted by lower volumes due to the pandemic, partially offset by favorable operating and cost performance. Moving to Slide 8, let me share a little color on regional performance during the quarter. In the Americas, profit was $52 million, down $88 million on a currency neutral basis. Higher selling prices mostly offset cost inflation, which was elevated due to FX induced inflation in Latin America. Sales volumes were down 18% during the quarter, but improved significantly later in the period and shipments were down about 8% in June. During June, volumes were about flat in North America and down high single-digits across most of Latin America. The exception was the Andean countries, which were still down double-digits. In July, sales volume was up low single-digits across the Americas, including mid-single-digit growth in North America. Second quarter production was down as we balanced supply with demand and complied with government decrees. Improved operating performance and cost controls partially offset the impact of the pandemic. Europe's operating profit was $42 million, down $45 million on a currency neutral basis. Higher selling prices more than offset cost inflation, which included the benefit of the region's revenue optimization efforts. Sales volumes were down 14% during the second quarter, but improved as markets began to reopen. June sales volumes were up 3% in the region and shipments were down slightly in July. Like the Americas, second quarter production was lower than last year to control inventory and improved operating performance and cost controls helped to mitigate the impact of lower volumes. Asia Pacific's operating profit was $1 million, which was comparable to the prior year. As noted, we completed the sale of ANZ last week, which is the clear majority of the Asia Pacific segment. Pro forma information is provided in the appendix. Let's shift to cash flows and the balance sheet. I'm now on Slide 10. We are operating under a set of specific capital allocation principles amid the pandemic. Let me review these principles and the progress we have made through mid-year. First, we are squarely focused on maximizing free cash flow. To support this, we are aligning supply with demand and limiting CapEx to normal maintenance investment in MAGMA. We have been making very good progress. Our second quarter free cash flow was $112 million, despite this period often being a seasonal use of cash for business. In fact, cash flow was about $160 million higher than the prior year, normalized for changes in AR factoring activity. Likewise, the Paddock Chapter 11 process has suspended any asbestos-related payments. All of this reflects a highly disciplined focus on cash and capital management, as our year-to-date cash flows compare favorably to the prior year. Second, we are preserving our strong liquidity. Despite the pandemic, our committed liquidity actually improved during the second quarter and exceeded $1.8 billion at mid-year. This is well above the liquidity floor we have identified for 2020. Third, we are reducing debt. As illustrated on the chart, net debt was $5.4 billion as of mid-year, which compared favorably both to the prior year period and first quarter levels. Our leverage ratio at mid-year was 4.1 for our bank credit agreement, which was just slightly higher than the first quarter despite the pandemic and well below our covenant limit of 5.0. With the completion of the ANZ divestiture last week, net proceeds are being used to improve the balance sheet. We have already repaid over $350 million in debt and the remaining debt reduction will occur in the near future. As our tactical divestiture program continues, we are in advanced stages on the sale of a few closed plant properties. While minor, we expect the transaction should be completed by year-end. All these actions will further improve our leverage position and we are highly confident O-I will remain in compliance with its bank covenant in 2020. Overall, we are making solid progress on our capital allocation priorities in 2020, despite the challenges of the pandemic. Let me wrap up with a few comments on our business outlook. I'm now on Slide 11. While we believe the worst of the pandemic is behind us, significant uncertainties remain, given O-I's earning sensitivities to changes in volume, we are not providing specific earnings and cash flow guidance. We will consider reinstating guidance in the future when there is more market and public health stability. However, we are providing our best estimates on demand trends, which could change due to the fluid nature of COVID-19. Reflecting recent favorable trends, we now expect our full-year 2020 sales volume will be down between 4% and 7% compared to the prior year. This reflects a more favorable outlook compared to our previous guidance of down 5% to 10% in 2020. Given the recent trends, we expect third quarter sales volumes will be flat to modestly lower than the prior year. Yet, we do expect third quarter production levels will be down 7% to 10% compared to last year, as we continue to trim our inventory levels. Most of this rebalancing is complete and our inventory at the end of July was below the prior year. After this quarter, production should be aligned with sales volume trends. Please note that our sales volume outlook has been normalized for the divestiture of ANZ, effective July 31. We do anticipate providing continued regular business updates during the pandemic that will include our evolving business outlook. With that, I'll turn it back to Andres.

Thank you, John. Let me conclude with a few comments. The second quarter presented many unique challenges, which we met with high resilience, speed, and agility. Despite these difficulties, we remain profitable and generated a strong cash flow supported by solid operating performance. After an abrupt downturn in demand earlier in the quarter, we've seen an equally strong rebound in demand since June, which is reflected in our improved sales volume outlook. Despite the global pandemic, we continue to advance our strategy and successfully take bold actions to change our business fundamentals. Let me reiterate what I have said in the past. We remain focused on creating long-term value. I'm confident the steps we're taking today will enable O-I to emerge in a stronger position that will benefit the company and its stakeholders in 2021 and beyond. Thank you for your interest in O-I Glass and we now welcome your questions.

Thank you. We have our first question from Ghansham Panjabi from Baird. Your line is open. Please go ahead.

Hey, guys. Good morning.

Good morning.

Good morning.

So, I guess, first off on the July volumes up 2%, can you give us a breakdown by region? And then why are volumes implied to decelerate during the third quarter, just given tight theoretical end market inventory levels in Mexico and the Andean region?

Yes, Ghansham. So sales shipments were up about 2% year-on-year in July and North America was the strongest performance being mid-to-high single-digits year-on-year. Europe was slightly down, but about flat when you put June and July together. So that market is stabilizing quite well in line with the prior year in those two months. Now, Brazil was up mid-teens, a very strong performance, Mexico is still down but has significantly improved, and in particular, the local market has improved quite well. We're still soft in the export market and the Andean region was about flat. Peru and Ecuador are performing very strong, Colombia is still down but recovering well.

Regarding your question about why we experienced a 2% increase in July followed by a decline later in the quarter, I'll start by addressing that...

Sure. Yes, go ahead.

Well, I think we're certainly seeing an inventory restocking process going on, right? After the dislocation in the second quarter we're certainly seeing that, but the question is how long will that be sustained and whatnot. So, Andres...

Yes. So demand signals, Ghansham, are encouraging across all markets. Nevertheless, we want to be cautious because there is high volatility and we've seen lots of instability in the market over the last few months. Now, we have to be mindful that there is uncertainty regarding Illinois's future evolution and the impact it might have in lockdowns and economies. Now, there is the inventory replenishment that John just mentioned. Now on the encouraging side, when we look at off-premise demand, it has been stronger than expected and it has been four consecutive months of very high demand, and glass has been performing quite strongly in off-premise. Just giving you a little bit of data related to the United States based on IRI, the premium products are performing quite well in off-premise. This is good for glass and it is good to see that consumers are not trading down. Now, if we look at the specific product categories, beer glass is up 10%, wine glass is up 14%, spirits are up 24%, and food is up between mid-teens and high double-digit depending on the product line. The on-premise channel has been down and you know that that normally is good for glass. Now it's been operating at low levels since the lockdowns were lifted. What that causes is CAx are of very low use and because they are of low use then single-serve containers have to replace that and that is very good for glass because then our demand increases. Now, it will require the on-premise demand to go back to high activity on rotation for CAx to be safe to use; otherwise, the life of the product is at risk. Now, you know that in the U.S., there is a shortage of aluminum cans and this is favorable to glass. Now we expect the shortage to extend through 2021 at this point. However, when we look at Europe, for example, and we look at Brazil, demand for beer is really high; in fact, we've been shipping all the capacity that we have active at this point in time, while they don't have this issue with the shortage of aluminum cans in the market. And I will say that the final factor that we are looking at is there is high new product development activity in the market. We've seen that in North America; we're seeing it in Mexico, in Brazil, and in the Andean countries, and we will continue to monitor the conditions. Again, we see encouraging signals of demand improvement, but we want to be cautious.

Okay, that's very comprehensive. Thanks so much.

We have our next question comes from the line of Brian Maguire from Goldman Sachs. Your line is open, please go ahead.

Hey, good morning, Andres, John and Chris.

Good morning.

Good morning.

Question on third quarter outlook. So I think the second half of the year outlook I guess, in general, you're sort of implying volumes will be flat to slightly down in both quarters. It seems like if you just triangulate for the four to seven for the end of the year. So I guess the question is, if volumes are roughly flat do you think the EBITDA could be flat year-over-year? And then sort of within that the decremental margin in 2Q was, I think, 45% for EBITDA, and I know you had a tough time sort of adjusting to the changing environment, and you've sort of talked about decremental margins going forward will be not quite that bad as you're thinking about taking some fixed cost actions. What kind of decremental margins do you think we could be looking at in the second half of the year if there is a range or a number you can kind of put on that?

Yes, this is John, and I will address several of those points. Looking at the second half of the year, foreign exchange should not be a major factor, though it may pose some headwinds later on. We will likely continue to face some inflation driven by foreign exchange throughout the year; we expect to pass that through, but it might take some time. As you mentioned, in a scenario where sales volumes are relatively flat, we should be able to manage that. We are taking additional production downtime in the third quarter to reduce our inventory levels, which will impact us. Keep in mind that we experienced a 20% decline in the second quarter, so if this quarter is half or a third of that decline, you can estimate the net effect. The costs were up around $50 million in the third quarter, so consider half or a third of that impact. Another key factor is taxes; we will face higher taxes due to the second quarter's earnings environment, likely averaging around a 40% effective tax rate for the year. This could decrease if we achieve flat volumes in the latter half of the year, or it might slightly increase. Additionally, the ANZ divestiture will likely result in a net loss of earnings from July 31st until the end of the year. I hope this gives you clarity on those points. Regarding decremental margins, as you noted, we experienced around 45% to 50% decremental margins during the second quarter, primarily due to decreased sales volume. Our joint ventures also slightly declined, which had a disproportionate effect on margins. On the production side, despite taking production down at a rate faster than the decline in demand, I believe we managed our operations effectively.

Demand.

Yes, demand we kept our decremental margins in that 40% to 50% type of range. In a world where you're actually now recalibrating on that, that probably would have been around 40% decremental or even high-30s decremental margin, given the very good cost reduction that we achieved during the business. So as we think about what it should be going forward, kind of a normalized gross profit margin decremental or its sensitivity on the sales side is about low-20s. And then if we can keep the decremental margin on production at another 15% to 20% or so, then you're pushing 35% to 40% decremental margin or incremental margin as we recover for that matter going forward.

Okay, thanks very much.

Thank you.

We have our next question comes from the line of George Staphos from Bank of America. Your line is open, please go ahead.

Thanks, operator. Hi guys, good morning, thanks for all the details.

Morning.

Morning to everybody on the call as well. Hey, Andres, I wanted to take a step back and look at what you're finding so far with MAGMA. What have been the findings out of Streator? What are the customers been saying? And importantly, how does this change the growth outlook, given what you're finding right now, looking out to '21 and '22? The related question I have, what are you finding in terms of the changes, if at all, in terms of the glass characteristics using MAGMA versus your traditional technologies, is the product performing as expected in line? Is it filling the right way? And again, tie that back to your growth expectations for '21 and '22. Thank you very much.

Thank you, George. So MAGMA, all the things we wanted to test in Streator has tested and the outcome has been positive. The most important part we wanted to grow over there was the melting and it's been proved. So at this point in time, we can melt glass of high quality, we can do it at good efficiency rates, we can form barrels with no problem at the levels of quality required by the industry. So that is going well. We're waiting for the Holzminden milestone to be covered. We want to confirm some other data points. If that is confirmed, we're going to be in a position to deploy MAGMA in some specific applications in 2022 and 2023. So customers are very encouraged by that. They see how this technology can increase flexibility significantly, and scalability follows growth better, which is part of your question. So they're looking forward to having MAGMA available and this is across end-users. Then, when we look at growth, having MAGMA is an important development because we can scale up in small increments, which has been a concern for the industry and really a constraint all the way to here. So we're going to be in a position to follow some of these growth opportunities in smaller increments, and then we can complement that with additional lines as the volume is developed. We were expected to deploy Gen 1 so far, the progress has been so positive that we are in a position to deploy Gen 1 if we get the confirmations we want in Holzminden. Glass quality is good. The product is good out of the MAGMA line. So we're now looking forward to the Holzminden operation.

Andres, just a quickie. How many trials have you done at Streator since you started? Thanks very much and good luck in the quarter.

Yes, multiple trials. We've been in operation in that line now for a year and a half, two years. So we go in and off because this is an R&D line, so we continuously test new things. And there are plans to test even more things in 2022 with regards to R&D development. But this is in constant activity. So we've been testing multiple kinds of containers in multiple conditions over this period of time.

Thank you very much.

Thank you.

We have our next question comes from the line of Debbie Jones from Deutsche Bank. Your line is open, please go ahead.

Hi, good morning. Thanks for taking my question. I realize it's early for have a specific 2021 CapEx guidance. So I just wanted to ask related to kind of a COVID recovery scenario. How long can you stick with kind of maintenance plus MAGMA CapEx? What are the areas where you would see a need for additional CapEx spending? And then just kind of in the context that you have two businesses now really, I realize they are big, but you don't have Asia anymore. If you just kind of think about the maintenance for each of the two remaining regions going forward, and kind of what is needed over the next two or three years in each of those regions?

Hey, Debbie, this is John. I'll address some of the questions regarding numbers. We have consistently indicated that maintenance costs are around $275 million to $300 million. For the ANZ business in Asia, we expect to normalize with about $35 million in annual CapEx. You can consider this when calculating the CapEx. Looking ahead to next year, it's still early, but last year we guided $350 million to $375 million, which included ANZ. This figure incorporates the maintenance level I mentioned, along with additional investment during MAGMA and some specific projects aimed at improving operational performance. Using that as a baseline, we now need to assess the requirements for next year, which depends on our understanding of the market landscape and what the new normal entails so we can adjust accordingly. So, Andres?

Yes, I believe the key difference will relate to strategic projects. Recently, we have observed that some customers are willing to make mid-term to long-term commitments following the pandemic. We are assessing this situation by examining the demand capacity balance to determine the necessary capacity for 2021 and 2022. This could represent the major distinction. I believe that maintenance for critical assets was addressed in 2020, and we have been investing in MAGMA, which we plan to continue into 2021.

Okay, thank you. And John, if I can just ask kind of looking back at the Green Bond that you guys did last year and thinking about the next couple of years, do you think there is a scenario in which you would be able to significantly lower your borrowing rates, just kind of given what you were able to do there?

Yes. I mean, first of all, we thought the Green Bond was a great success for us. I mean, the amount of interest that we had lined up, especially by ESG investors, at least 40% is from what we can tell of the investors in the Green Bond ended up being ESG related funds under either independent or under the umbrella. A lot of times companies target about an 8 of a percentage point improvement. I think we got better than that. I think we got a quarter point or better, to tell you the truth. Now, it's always hard to understand under any given set of circumstances, what you think that the value of that would be going forward, but we were very encouraged by that Green Bond and I certainly would look to evaluate doing more of those going forward. And our average borrowing rate right now is right around 4% or so. So across the spectrum of the investments. So that's a pretty good rate. Hopefully, we can continue to chip away at that, but it will depend on the rates when we get back in the market.

Okay, great. Alright, thank you very much. I'll turn it over.

Our next question comes from the line of Mark Wilde from Bank of Montreal. Your line is open, please go ahead.

Thank you for the clear presentation this morning. I would like to ask about the impact in the second quarter from one-time cost cuts and salary reductions, as well as any improvements we can expect moving forward.

Yes, Mark, your question seemed to be about the impact of cost cuts in the second quarter and their sustainability. We reported $57 million in cost reductions for the second quarter, with about $32 million, or roughly 60%, coming from our turnaround initiatives, which have led to improved efficiency at the factory level. This part is very sustainable. The remaining $25 million relates to other cost reduction efforts across the business. Some of this is sustainable as well; for instance, we had a reduction in force during the quarter, and we expect that component to continue. So, roughly half of that can be viewed as sustainable savings. However, some of the reductions were due to situational factors, such as lower volumes, reduced production, and limited labor access, leading to a decrease in maintenance spending during the second quarter. Many employees have been working from home, which has also contributed to lower operating expenses. Overall, I would estimate that about 70% or more of the savings are likely to be sustainable for the business.

Okay. And just as a follow-on, John, can you guys talk about how you're managing the production reductions in the third quarter? Is it shutting down lines, shutting down furnaces, just slowing back lines?

It's...

And the furnace footprint moves contemplated.

So, starting with the last part first. We identified the restructuring items, including one facility in Latin America. Any future decisions will be made later as we assess the business landscape over time. During the quarter, production management showed about 50% of lines down and 50% of furnaces down. Going into the second quarter, the situation was notably worse for lines, which impacts fixed cost absorption. However, we managed to balance that out to roughly 50-50 by the end of the quarter, which reflects what we experienced in July. This balance minimizes cost absorption while also providing operational flexibility as demand returns. That summarizes the situation we were facing. As mentioned in our prepared comments, with inventory aligning to our targets, we will begin reducing production activities around mid-quarter and will then increase production to align with sales volume activity.

Okay, very helpful.

We have our next question comes from the line of Anthony Pettinari from Citi. Your line is open, please go ahead.

Good morning.

Morning.

You talked about the strength in North America and I'm just wondering as some states are pausing or in some cases rolling back reopening plans with COVID cases increasing. Is it possible to say what your full-year shipment guidance assumes in terms of on-premise consumption? Is that expected to kind of improve sequentially through 3Q and 4Q with on-premise coming back, or are you kind of assuming maybe kind of a current level of activity?

Yes. We had a strong July. Currently, we are sold out of beer in North America, and we expect this to continue for the rest of the year. The on-premise situation is something we need to watch closely, as well as the off-premise, which has seen significant growth. There has been a noticeable increase in at-home consumption and cooking, which is shifting some trends. Initially, we thought the off-premise growth would be momentary, but it has remained elevated for four months now. We need to observe where this trend is heading. The on-premise segment also needs to recover, and it's important to track the pace and level of that recovery. Additionally, the use of CAx is significant, accounting for about 6.4 billion units of single-serve containers, which represents a considerable share. We will continue to monitor this closely. We anticipate the North America market will maintain a strong pace, but we may face capacity limitations in beer production since we are currently using all available capacity in the market.

Okay, that's very helpful. And then just with regards to the shortage of beverage cans, just so that I understand this and I heard it correctly, I think you indicated, North America, you are seeing those shortages, may be impacting the market through 2021, but you're not seeing them to the same degree in Brazil and Europe. If I heard that correctly. And then I guess, is it possible to quantify how much volume maybe you were able to pick up, whether it's a point or more? And is this volume that you're able to kind of lock up in the multi-year contracts or does this maybe just kind of go back next year? Any kind of color there.

We're observing an increase in demand for glass, which is resulting in a shortage. In Brazil, the demand for beer is very strong, and currently, we are sold out. One-way containers are performing well off-premise, and returnable containers are starting to make a comeback as restaurants and bars in major cities reopen. Brazil is showing strong performance, but we will face capacity constraints. In Europe, there is also robust demand for beer, although it is not experiencing the aluminum shortage that the United States is facing. We are closely monitoring the situation and expect that as consumers have more glass available and prefer to enjoy their favorite brands in glass, this will positively influence glass demand over time.

Okay, that's helpful. I'll turn it over.

We have our next question comes from the line of Adam Josephson from KeyBanc. Your line is open, please go ahead.

Thanks. Good morning, everyone.

Good morning.

Good morning.

John, two cash flow questions for you. The first is, you went into this year thinking you do $300 million, plus partly because you're not making asbestos payments and then, obviously, we had a pandemic such that your earnings were going to be much lower than what you initially thought, and then you sold the ANZ business recently. So, given all of these changes and given whatever your economic expectations are for the foreseeable future, what do you think is a reasonable kind of normalized level of free cash flow? When I say normalized, I mean in a year in which working capital is neither a major source nor a use and when your CapEx is comfortably above the maintenance level that it will be this year.

I would say a normalized level of CapEx still remains above $300 million for the business. When considering a more typical level and some of the factors involved, you can develop your own EBITDA outlook. Remember, we lose about $80 million of EBITDA from ANZ, but there is also a reduction of $35 million in CapEx spending and savings on interest payments on the debt. The net impact here is approximately $30 million to $35 million. Assuming that working capital is a slight modest use of cash restructuring in the $40 million range, and considering the CapEx at around $375 million—with the understanding that it could fluctuate—adjusted for ANZ, it brings it down to just under $350 million. Thus, we have an environment that supports over $300 million of cash flow for the business, which is the base we aim to grow from and improve upon.

Thanks. And just related question is, if that's a normalized level, that's what you were guiding to for this year of course before COVID and before you sold ANZ, can you talk about just your working capital expectation for this year, just given your efforts to reduce inventories, given whatever your AR factoring as compared to last year, etcetera?

Let me discuss that a bit. Last year, working capital required a significant amount of cash, around $150 million, and we projected that for 2020 it would decrease to about $75 million to $100 million. Right now, we have a few factors to consider. One is that the markets most affected have longer payment terms, which complicates things. Additionally, we've been actively focusing on improving our working capital internally, including managing receivables and inventory. I anticipate that we will be in the lower half of that range, comfortably below $75 million to $100 million, but it will still represent a modest cash outflow. Regarding factoring, we do not expect it to be a source or use of cash this year, assuming the markets remain stable. At the end of last year, about 45% of our gross receivables were factored. We aim to maintain that between 35% and 45%, noting that it typically rises at year-end due to business seasonality and cash requirements for Q1. A key point about free cash flow this year is that it may be somewhat complicated due to the divestiture of ANZ. Some adjustments will come through working capital impacts, and we will clarify these aspects for the investment community moving forward.

Thanks, John.

We have our next question comes from the line of Mike Leithead. Your line is open, please ask your question.

Great. Thank you. And just one for me, Andres, question on the U.S. beer dynamic that you talk through with cans sold out. Curious if this shift or this increased demand you're seeing in glass it's more driven by, say, your traditional canned beer customers who they're seeing tremendous demand and they're trying to get more products on the shelf. So, they're moving back towards more bottled beverages versus say consumers that are just kind of trading towards different brands, calling your more premium traditionally glass beer demand because everything else is sold out? Just how have your conversations with your customers kind of evolved given these dynamics?

Yes. So, I think we are seeing both. I think customers are interested in developing new products and we're seeing that activity picking up. As consumers get the opportunity to have their brands in glass, which they like, I think we're going to see a pickup in demand because of that, just because of that. Clearly, there is a shortage in aluminum cans right now, but there is an improvement in the interest in glass by its own right.

Yes, I think this is also evidenced by you see that a lot of interest in the new product development that we talked about earlier, is a lot of our customers are coming to us looking about ways that we can launch and revitalize brands and bring it forward in a different way. And that's a good sign that there is a fundamental interest in glass as a product.

And there are a number of premium products growing in the market and glass is a very good fit for premium products and branding. So that's what we are observing in the market taking place.

Great, thank you.

We have our next question comes from the line of Gabe Hajde from Wells Fargo. Your line is open, please go ahead.

Good morning, gentlemen. Hope you all are well.

Hi, Gabe.

I was curious, can you discuss at all, I guess, the competitive landscape in Europe and maybe more specifically the Iberian Peninsula. We've read some reports of heightened imports in France, particularly and others removing capacity in the market. So I think you guys kind of added a furnace, I know it was kind of spoken for premium beer product if I remember correctly. So I'm curious if that furnace is operational at this point. And then as it relates to MAGMA, I seem to remember that was going to be kind of on schedule for second-half 2020 and I appreciate obviously, it's difficult to get engineers and different folks into plants and factories. But being pushed to Q1, is that just a result of a pandemic, or is there something else there?

The competitive landscape for companies shipping into France from Spain or Portugal has been ongoing for some time. Currently, France is recovering well, and wine sales are returning to pre-pandemic levels. It's worth noting that wine was already a bit weak in the Devordo region prior to the pandemic, and the competitive dynamics have not changed. As for the furnace in Gironcourt, it will be operational in September. We're wrapping up construction, and despite some delays caused by the pandemic which made it challenging to move personnel across borders, we are on track. The situation with MAGMA is similar. We expected to complete it by the end of the year, in the fourth quarter, but had to push that timeline back a couple of months due to our inability to send personnel to suppliers for equipment construction or to proceed with the construction itself. However, everything is now back to normal, and we anticipate being operational in the first quarter.

Okay, thank you. And I recognize that you guys are kind of managing the business real-time and 2021 feels like a far way away today, but assuming, obviously, we don't have kind of lockdown measures in Q2 and we kind of have some sort of a volume recovery in 2021. How should we be thinking about production levels next year, again kind of particularly given you guys are trying to manage inventories pretty tight this year?

Yes, as we mentioned earlier, there is significant volatility and uncertainty at this moment. We are closely monitoring all the various factors we've previously discussed and plan to offer more insights on 2021 later this year. There are positive signs in demand, as I mentioned earlier, which are currently having an effect, and some of these could extend into the following year. However, it is still too early to provide an estimate for 2021.

I would just add that we are getting close to aligning our production with demand. We will need to assess the inventory at the end of the year and determine how much further progress we want to make. Overall, we are making significant progress very quickly. In just a couple of months, we accomplished what took the company over a year during the Great Recession. I believe we acted quickly to adjust our inventories, which is the right decision for cash and positions us well for the future.

Great, that's what I was looking for. Thank you.

Thank you.

We have our next question comes from the line of Lars Kjellberg from Credit Suisse. Your line is open, please go ahead.

Thank you and good morning. I have one final question regarding your margins in the most comparable region, which seem to be tracking in the range of 500 to 600 basis points. What options do you have to address that significant EBITDA margin gap, and what role do you believe MAGMA could play in that process?

Let me start by referencing the turnaround initiatives. A lot of our focus has been on cost reduction, and we have accelerated those efforts during the pandemic. I believe we are establishing a solid foundation for margin improvement going into the next year under similar conditions. MAGMA is anticipated to have a lower total cost of ownership when we advance to Gen 3, along with a lower capital intensity. We expect this to positively affect margins as we implement Gen 1, Gen 2, and then Gen 3.

Yes. And just one follow-up, in terms of the furnace activity, was that a meaningful sort of delay from the first half into the second half? And is that also weighing on the second half production level?

The rebuild schedule?

Yes.

Yes, well we needed to have a little bit of delay in some of the areas we had high level of activity scheduled for Europe when the year started. We had some delay, but we are moving all those projects forward. So we've already started most of them. So that's pretty much covered. In other parts of the world, we didn't have an issue because we didn't have the restrictions to move people across. So we've been performing according to our schedule as we came into the year.

I would say is that the capital spending, as we look through the balance of the year, is pretty evenly balanced between the third and the fourth quarter. And both of them will be favorable to the prior year levels.

Got it, thank you.

We have time for one last question.

Great, thanks for taking my question. I just have one maybe higher level question. When you think about all the changes you've made over the last couple of years and now selling ANZ and also I guess maybe thinking about some of the shifting demand dynamics, how are you thinking about the footprint now globally? Are there any regions where maybe there are opportunities to consolidate plants? Do you think that's necessary within the industry? Thanks.

We have been assessing our global footprint to ensure a proper balance between demand and capacity for a few years now. In North America, where we experienced a decrease in demand, we adjusted our capacity accordingly. Currently, we are witnessing an upward trend in demand, and we need to evaluate how this will influence our capacity requirements. Additionally, we see strong demand in markets like Brazil, prompting us to consider incremental capacity over time. Overall, we believe we have managed the balance between demand and capacity effectively. We are consistently evaluating our assets, focusing on those that yield high margins and strong returns, and this process will continue moving forward.

Okay, thank you, everyone. That concludes our call. Please note that our third quarter call is currently scheduled for October 28. And as always, make it a memorable moment by choosing sustainable glass. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you all for participating, and you may now disconnect. Have a good day.