O-I Glass, Inc. /DE/ Q2 FY2021 Earnings Call

Good day, and thank you for standing by. Welcome to the O-I Glass Second Quarter 2021 Earnings Conference Call. Please be advised that this conference is being recorded. I would now like to hand the conference over to your speaker today, Chris Manuel, Vice President of Investor Relations. Please go ahead.

Thank you, Alissa, and welcome, everyone, to the O-I Glass 2Q '21 Earnings 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'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. I'd now like to turn the call over to Andres, who will start on Slide 3.

Good morning, everyone. Thank you for your interest in O-I Glass. We are very happy with our performance during the second quarter. We reported adjusted earnings of $0.54 per share, which exceeded our guidance range and demonstrated stronger-than-expected shipment levels along with favorable operating performance. We continue to see positive results across key business factors. Shipments increased by 18% and production rebounded by 27% compared to last year, when we were affected by the pandemic. The strong demand reflects consumer preference for healthy, premium, and sustainable glass packaging as markets begin to reopen. Additionally, higher selling prices have significantly offset rising cost inflation, and ongoing favorable operating performance has been driven by our margin expansion initiatives. Cash flow in the second quarter was also strong due to solid operating performance. As I mentioned last quarter, O-I has reached a pivotal moment. We have observed a significant improvement in our ability to consistently perform and fulfill our commitments, supported by advanced capabilities developed across various areas over the last few years. I believe the results for the current quarter reinforce this perspective. As I will explain shortly, we are actively pursuing our ambitious plan to transform O-I's business fundamentals. Alongside better-than-expected earnings and cash flow, I’m very pleased with our progress in advancing our strategy. Our margin expansion initiatives are exceeding our expectations, and we hit a major milestone with the MAGMA project last quarter. We are also working on rebalancing our business portfolio and addressing our legacy asbestos liabilities. As we look ahead, we remain optimistic about our business outlook. We expect third quarter adjusted earnings to be around $0.47 to $0.52, representing a significant improvement from the previous year. Our full year earnings and cash flow guidance has also improved. We now project full year earnings of between $1.65 and $1.75 per share and cash flow of $260 million. Moving to Slide 4, recent volume trends show that second quarter shipments significantly increased compared to the same period last year, which was disrupted by the pandemic. Total shipments are up 18% this year compared to a 15% decline last year. In the Americas, second quarter shipments increased by 17%, with all regions showing improvement from last year. The most notable recovery was in Mexico and the Andean region, which faced severe disruptions in 2020. In Europe, shipments increased by 22%, with all regions showing double-digit improvement compared to last year. While the pandemic was disruptive, underlying trends indicate stable or slightly improving demand. For instance, second quarter shipments aligned with 2019 levels, signaling a return to pre-pandemic performance. Glass has demonstrated remarkable resilience despite significant market fluctuations, including supply chain disruptions, transportation challenges, and shifts in consumption patterns between retail and on-premise channels. The chart on the right outlines expected changes in food and beverage consumption patterns across channels in the next 18 to 24 months. On-premise consumption is anticipated to rebound post-pandemic, while retail purchases are expected to stay elevated compared to pre-pandemic levels. Although we initially shared these analyses last quarter, the evolution of packaging demand over the past couple of quarters continues to support and reinforce these predicted consumption patterns. Looking forward, we anticipate ongoing volume growth. While markets had already rebounded well in the third quarter of last year, we expect our shipments to be flat to up 1% in the third quarter of this year. Given solid demand year-to-date, we have increased our full-year growth outlook. Previously, we projected 3% to 4% growth, but we now anticipate growth between 4% and 5% in 2021. Turning to Slide 5, we achieved numerous key milestones during the first half of the year as we continue to advance our strategy. On this page, we shared our 2021 priorities and highlights of our progress. Let me discuss our three main platforms. First, we aim to expand margins. We have set a target of $50 million from our initiatives and continued performance improvement in North America. We have made good initial progress with our margin expansion initiatives, totaling $40 million in benefits during the first half, and we now expect to surpass our original $50 million target for the full year. North America has shown strong resilience in dealing with severe weather, high freight inflation, and tight supply chain conditions, with sales volumes comparable to 2019 levels. Next, we are focused on revolutionizing glass. To support this, we have successfully validated several technology milestones for the MAGMA Generation 1 line in Germany and are advancing our Glass Advocacy campaign and repositioning our ESG efforts. We remain on track to pilot the Generation 2 MAGMA line in Streator, Illinois, in the latter half of the year and are making solid progress on developing Generation 3. Additionally, we are actively pursuing a lightweighting program called Ultra, aimed at significant container weight reductions to enhance both the convenience and sustainability of glass. The Glass Advocacy campaign aims to shift the conversation around glass. Our digital marketing campaign is well underway, achieving over 660 million impressions so far and reaching over 80 million people in the U.S. We are building a community of glass advocates who engage regularly with our content, which highlights the relevance of our message. Similar to our technology developments, we are encouraged by the positive response and progress, and we plan to continue these marketing efforts. I will touch on ESG in a moment. Third, we will keep optimizing our structure. This includes various efforts, such as portfolio adjustments, improving our balance sheet, streamlining the organization, and addressing legacy liabilities. Regarding our divestiture program, we have either completed or entered into agreements for $930 million in asset sales so far, achieving over 80% of our targeted divestitures by the end of 2022. As John will elaborate, our cash flow during the first half of the year was quite favorable compared to historical seasonal trends, reflecting excellent working capital management that supports debt reduction. In March, we entered a long-term strategic agreement with Accenture to manage our global business services activities, and we completed the first phase of this transition in July. In addition to lowering G&A costs, we aim to enhance capabilities by leveraging world-class processes and technologies. As you know, we reached a preliminary agreement back in April to fairly and finally resolve our legacy asbestos-related liabilities. Efforts to complete the reorganization for Paddock are progressing as planned. Overall, we are very pleased with our progress, and I want to extend my gratitude to the O-I team for their relentless and effective efforts in advancing our strategy. Before handing it over to John, I would like to add a few remarks on sustainability. At O-I, our ESG and sustainability vision is comprehensive, rooted in innovation, and impacts every aspect of our business. Our vision includes a future where the inherent circularity of glass intersects with O-I's disruptive technologies and other innovations to transform how glass is produced, marketed, and recycled. This sustainable future entails the creation of significantly lighter glass containers through Ultra, leading to a lower carbon footprint per container. It also includes the utilization of cleaner gas oxygen fuels and improvements in traditional furnace technology. Moreover, O-I's innovative MAGMA melting technology will have the capability to utilize biofuels and other renewable carbon-neutral energy sources, like hydrogen, alongside a wider variety of recycled glass. MAGMA features a more adaptable manufacturing process, allowing for energy optimization through turning the unit on and off. It can also be located at manufacturing and filling facilities, reducing freight and enabling better use and recycling of water and other resources. Additionally, we are cultivating a future where innovative approaches, such as glass for good, enhance glass recycling and provide community benefits, elevating O-I's ESG profile. We look forward to sharing all of this and more in our upcoming sustainability report, which will be released at the end of Q3. Now, I’ll turn it over to John.

Thanks, Andres, and good morning, everyone. I plan to cover a few topics today, including recent performance, progress on our capital structure, as well as our most current 2021 business outlook. I'll start with a review of our second quarter performance on Page 7. O-I reported adjusted earnings of $0.54 per share. Results exceeded our guidance of $0.45 to $0.50, given stronger-than-anticipated shipments and favorable cost performance. In particular, sales volume was up more than 18% from last year compared to our expectation of 15% or higher. Segment profit was $232 million and significantly exceeded prior year results, which were impacted by the onset of the pandemic. Higher selling prices substantially offset elevated cost inflation linked to higher energy and freight costs. Naturally, higher sales volume and favorable mix boosted earnings. Likewise, favorable cost performance was driven by a 27% improvement in production levels as the prior year was impacted by forced curtailment due to lockdown measures. Keep in mind that maintenance and project activity costs have normalized for the disruption last year. Cost performance also reflected continued good operating performance and benefits from our margin expansion initiatives. The slide includes additional details on nonoperating items. Let me point out that we did record a gain on an indirect tax credit in Brazil after a favorable court ruling, which has been excluded from management earnings. Overall, we are pleased with favorable performance trends. Moving to Page 8, we have provided more information by segment. In the Americas, segment profit was $124 million, which is a significant increase compared to $52 million last year. Higher earnings reflected 17% higher sales volume as the prior year was affected by the onset of the pandemic. Higher prices substantially offset cost inflation, which was elevated due to higher freight costs. In Europe, segment profit was $108 million compared to $42 million last year. The significant earnings improvement reflected a 22% increase in sales volume, while the benefit of higher selling prices partially offset cost inflation. In the case of both regions, very good operating performance, mostly reflected higher production, which increased 28% in each segment, while supply chains remain very tight across the globe. Likewise, very good operating performance also benefited from our margin expansion initiatives. Keep in mind that we no longer report in Asia Pacific region following the sale of ANZ last summer. In addition to comparing results to last year, we have added a comparison to 2019 to better understand our performance against pre-pandemic trends. As illustrated on Page 9, our current underlying performance exceeds pre-pandemic levels. Adjusted primarily for the divestiture of ANZ, segment profit was up $7 million in the second quarter of 2021 compared to the same period in '19. Overall, higher selling prices have nearly offset elevated cost inflation, while sales volume and mix were comparable to 2019 levels. Favorable results were driven by improved operating and cost performance reflecting our margin expansion initiatives. Let's shift to cash flows and the balance sheet. I'm now on Page 10. We are following a specific set of guiding principles that are aligned with our strategy to increase shareholder value. As we focus on maximizing free cash flow, we expect significantly higher cash flow this year, and key working capital measures should be in line or favorable compared to 2020 levels. As illustrated on the chart, our second quarter cash flow was $117 million and was comparable to the prior year, which benefited from significant inventory reduction due to forced production curtailment. Over the past year, we have improved the consistency of our cash flows and now reflect normal seasonality in our business, solid operating results, and very good working management. Second, we preserved our strong liquidity and finished the second quarter with approximately $2.2 billion in committed liquidity, well above the established floor. Third, we are reducing debt. We expect net debt will end the year below $4.4 billion, and our BCA leverage ratio should end the year in the high 3s compared to 4.4x at the end of 2020. We expect to receive divestiture proceeds over the next several months, which will further improve our balance sheet position. Please note, these targets could shift if the Paddock trust funding occurs prior to year-end. At the end of the second quarter, net debt was down almost $1 billion from the same period last year, reflecting improved free cash flow and proceeds from divestitures. Furthermore, our bank credit agreement leverage ratio was around 3.8x as of midyear, which is well below our covenant limit. Finally, we intend to de-risk legacy liabilities as we advance the Paddock Chapter 11 process. As previously announced, we have an agreement-in-principle for a consensual plan of reorganization, whereby O-I will support Paddock's funding of a 524(g) trust. Total consideration is $610 million to be funded at the effective date of the plan. Importantly, the agreement provides a channeling injunction protecting Paddock, O-I and their affiliates from current and future liability. The Paddock reorganization is proceeding as expected, and timing will be a function of the remaining legal and court actions to conclude this matter. As previously noted, we have ample liquidity to fund the trust in the future. For clarity, we are not considering equity as a funding method. Likewise, we remain highly focused on reducing our total debt obligations over time through free cash flow and proceeds from divestitures. Let me wrap up with a few comments on our business outlook. I'm now on Page 11. As Andres mentioned, we anticipate our business performance will improve in 2021 as markets stabilize and recover. We expect third quarter adjusted earnings will approximate $0.47 to $0.52 per share. Naturally, this is a meaningful improvement from the third quarter of 2020, which was impacted by ongoing COVID-required production curtailments in Mexico and the Andeans. Overall, we expect shipments will be flat to up 1% from the prior year. Keep in mind, demand had already rebounded in the third quarter of 2020 from pandemic lows. Production should be up about 8% to 10% from last year, which was still impacted by lockdown measures in some markets. At the same time, certain costs like maintenance and depreciation have normalized following the pandemic-induced disruption last year. Likewise, the current supply chain is fairly stretched across the value chain, reflecting the impact of prior year production curtailments as well as a strained transportation situation in many markets. Finally, we expect continued solid operating performance and benefits from our margin expansion initiatives. Our full-year 2020 outlook has improved as we've tightened our earnings expectations to the high end of our guidance range and increased our free cash flow estimate. We now expect adjusted earnings of $1.65 to $1.75 per share and free cash flow of approximately $260 million. This adjustment reflects higher expected shipment levels, which we now anticipate will increase 4% to 5% compared to 2020. Likewise, we expect the benefit of our margin expansion initiatives will also exceed our original goal of $50 million. We anticipate the benefit of higher shipments and improved cost performance will more than offset the impact of winter storm Uri, which, of course, was not included in our original guidance. As a final note, we will be hosting our Investor Day the morning of September 28 at the New York Palace. During this session, we will update our plans that will include more details on MAGMA. Likewise, we will share key company targets and milestones. Subsequent investor events will expand on these key topics. With that, I'll turn it back to Andres.

Thanks, John. Let me wrap up with a few comments on Slide 12. Overall, we are very pleased with our second quarter performance, which exceeded our guidance due to stronger sales volumes and improved cost performance. In fact, our underlying performance was favorable across key business levers. Selling prices and volumes were up and costs were down. Our margin expansion initiatives are working well, and our ability to deliver on our commitments has improved, underpinned by advanced capabilities across business functions, rigorously built over the last few years. I'm very pleased with the progress we are making on our bold plan to change O-I's business fundamentals. Our business is more stable. We have well-structured business planning processes, and we are a much more agile and resilient organization. Likewise, we are removing the constraints of the past, such as legacy asbestos liabilities, while successfully advancing breakthrough innovations, such as MAGMA. Finally, we are encouraged by market trends, which is reflected in our improved earnings and cash flow guidance for 2021. Over the past several years, we have been hard at work, improving the foundational capabilities of our company as well as staging the company for continued transformation. We look forward to our Investor Day on September 28. During this event, we will share our exciting plans to align glass and O-I with the future packaging for decades to come. We are confident this plan will increase shareholder value and usher in a new period of prosperity for life. Thank you for your interest in O-I Glass, and we welcome your questions.

Your first question comes from the line of Ghansham Panjabi from RW Baird.

Can you provide more details on which regions and verticals performed better than you expected in the second quarter? Additionally, could you share your outlook for the second half of the year?

Well, from a demand perspective, all regions, all markets in which we operate across segments performed in line with our expectations or slightly ahead, and we're seeing a pretty solid common pattern across the world, which is the focus on premium products and trading up, and that's helping every category in our business.

Yes. I would add, as you look at the volume trajectories, they were particularly strong in the Latin American marketplaces and in certain pockets over in Europe, where actually strong also. Towards the southern part of Europe, we saw larger gains than other parts of the markets. And so really, when you think about the second quarter, I would say it was mostly a volume-driven upside to the business, and it was really driven by those particular markets. As we think about the performance going forward, we expect the volumes, as we mentioned in the prepared comments, to start to more normalize. Obviously, it was a very disruptive period last year in the comparisons, but still be up 0% to 1%. Keep in mind, the third quarter of last year was actually up 2%. So it was kind of a relatively difficult comp. So we're overall seeing pretty good trends. As we look at our business, really there is strong demand everywhere and the pent-up demand for our product, the real issue is where is the production capacity and where is the supply chain to be able to support that given the constrained transportation situation.

Sure. As a follow-up, could you provide an overview of new product introduction activity over the past couple of years? How does our current status compare to pre-pandemic levels? Additionally, in the regions you mentioned in Europe and Latin America, where capacity has been tight, what are your expectations for capacity moving into next year? Will there be any flexibility in capacity to support these faster-growing markets?

Thank you. We are seeing new product development activity increase across markets when compared to pre-pandemic levels. Statistics from Mintel indicate that glass's performance is quite strong and surpasses that of other substrates, which is promising. We are tightening our capacity, as you noted, and expect to see productivity improvements heading into next year. At the beginning of the year, we encountered severe weather in some regions that resulted in lost production, but we anticipate making up for that. Additionally, we are expanding our capacity in the Andean region, which will come into operation by the end of this year or early next year. We are also exploring other markets and opportunities due to the current strength of demand, and we expect these trends to persist in the future.

Your next question comes from the line of George Staphos from Bank of America.

I appreciate the details. I'd like to explore Europe a bit more. The performance was impressive in terms of volume, but the comparisons were relatively easy. What reasons should investors consider to view this as more than just a bounce back from an easy comparison? What points can you provide that would instill confidence in the idea that glass can genuinely grow for you in Europe, such as new contracts or developments in Holzminden? What leads you to believe this isn't merely a short-term spike? Additionally, it seems from the prepared remarks that there's still work to be done regarding price recovery in Europe compared to the Americas. Can you elaborate on what needs to be addressed? Do you anticipate that across the entire platform, both Americas and Europe, you'll be able to recover all of the negative price costs, approximately $26 million year-to-date, as we move into 2022?

Thank you, George. Volume and operating performance in Europe is quite strong. The all-in users in Europe are performing well, and mineral water, which was previously down, has started to recover with the reopening of the HORECA channel, which includes bars, hotels, and restaurants. Importantly, Champagne is performing significantly better and has returned to pre-pandemic levels. Bordeaux wine is also strong again due to improved exports following the removal of tariffs and China's recovery. A key data point is that Nielsen data shows glass beer containers are outperforming alternative packaging in Western Europe. Key markets for us include France, Italy, the Netherlands, and the U.K. Operating performance continues to be very strong, and we are confident that the current trends will persist. Regarding price and inflation recovery in Europe, we initially had expectations for inflation, but it has been higher than anticipated. While prices have increased, they have not fully covered the heightened inflation, resulting in a larger spread. However, we are confident in meeting our commitments for 2021 based on current information. Looking ahead to 2022, we are optimistic about a favorable pricing environment that will allow us to fully recover from inflation.

George, I would add just 2 points to that. One is if you look at our volume trend, other than the so-called COVID quarter last year, our volumes have been at flat to up 2% over the last 3 quarters. So we've seen a sustainable level of demand here to date. But more importantly, is the commercial pipeline for the business is developing quite well. There's a lot of demand for our product. And these aren't necessarily just transactional opportunities. These are strategic opportunities where our customers are looking to do meaningful things and looking for our support to do those. So that gives us the confidence that over the longer term, there's good demand for the product, and we should be there to help them out.

Yes. There is one aspect that is also important to support these trends. The food category, which went up significantly during the peak of the pandemic is retaining some of the gains, and it is expected to retain some of the gains. So that’s an important point. The other one is the emphasis of consumers and customers on premium products. That’s really happening pretty structurally across categories, and that is very good for glass.

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

A good quarter. I wondered just to come back on George's question, Andres, for the full year, where do you expect price cost to end up? I mean, as this was mentioned, we're down about $26 million in the first half. What should we expect we are going to have a full year number?

Yes, Mark, I'll address that one. A typical year of inflation for us is anywhere between $100 million and $140 million. In the last time we spoke last quarter, we were thinking it was on the high end of that range. I would think that we would rebase the view of inflation right now in a gross sense of about $150 million to $175 million, clearly we're seeing an increase. But at the same token, the last time we talked, we were talking about an unfavorable spread of about $30 million. I would say with the pricing activities and other initiatives underway, that negative spread has probably crept up to $40 million. So we haven't necessarily kept up dollar to dollar to the rising cost inflation, but we've done a pretty good job of being able to moderate that. Obviously, you know we have timely pass-throughs in some markets and energy in the U.S., for example, is a good one. But more importantly, when we get into the first quarter of next year is the typical price improvement window where, as Andres mentioned, we would look to pick things up. And as you look at the sequencing of activities, because you mentioned that the $26 million year-to-date, keep in mind, that the energy surcharges we incurred on winter storm Uri were really also included in that. So we have $15 million-$20 million of surcharges we've incurred year-to-date. So really, as we think about that, we'll have $40 million of negative spread plus the $15 million to $20 million of surcharges. That means that we still have most of the cost inflation impact in the back half of the year, and it was probably most pronounced in the fourth quarter because, as you recall, last year, during the pandemic, prices were declining, deflation even in some places. And that kind of troughed out in the fourth quarter, and it's been picking up since then. So really on a comp basis, you'll see it most pronounced at least in our business in the fourth quarter.

Okay. John, as I look ahead to next year, you're mentioning that supply and demand are very tight across all your regions. Should we expect to see some improvement from a price-cost perspective next year, or will you likely have to make concessions?

Time will tell. Clearly, we see an opportunity to increase prices to address the backlog we've had this year. To answer your question, it's more about whether inflation is transient or not. However, our intention is to pass the cost inflation of our business through to the system, and that is our plan.

Your next question comes from Mike Leithead from Barclays.

Great. First, I want to revisit the outlook. The second quarter is obviously stronger than you expected, but it seems the outlook for the second half hasn't been significantly raised. Is this just a result of better volumes being balanced out by cost inflation? Could you elaborate on the factors at play as you consider the latter part of the year?

Yes. I mean you hit the nail on the head. Volumes will be up a little bit. That will be certainly beneficial operating leverage in the business. But keep in mind that cost inflation is going to be more pronounced as we go through the end of the year, particularly in the fourth quarter. And we do have a couple of other things. For example, we do plan to have a little bit more maintenance activity in the back half of the year than we saw in the first half. That's probably about a $0.05 difference between the first half and the second half. And of course, I mean, I think we need to be cognizant of the Delta variant and what it could do. And so obviously, we're keeping a cautious eye on that as we look to the expectations for the business in the back half of the year.

Got it. That makes sense. And then Andres, maybe a question on the Glass Advocacy campaign. I know you highlighted the number of online impressions you're receiving. But is there a way to measure or how do you measure internally how successful this campaign is in ultimately getting consumers to choose glass? And maybe just bigger picture. I appreciate as the leading producer, you want to take the lead. But is this something where you think as an overall glass industry, you need to be more vocal getting out there about the benefits in your eyes of glass as the preferred substrate?

Yes. So the one way to reflect the impact of the campaign is the number of leads we’re getting into a C4C system from our customers. So that’s been at record levels, just looking for new product developments. I think the message is going through is being received by customers, but it’s also being received by consumers. And we’re seeing it by the level of impressions and the level of engagement that we’re seeing, which is interacting with our messages on social media. So we’re very encouraged by the progress. I think there was a long period of time in which we were very silent. This product has great attributes. And as we said before, we want to rebalance the dialogue around packaging, and that’s what we’re doing. And we’re very pleased with the progress, and we intend to continue.

Your next question comes from Adam Josephson from KeyBanc.

John just one more on the second half guidance and particularly the 4Q guidance, the implied 4Q guidance. So you talked about price-cost being a drag. You talked about the maintenance being deferred. What is the seasonality impact of that implied 4Q guidance? And the business used to be quite seasonal, and you've talked about making it much less so spreading production across the 4 quarters, such that you won't have the same working capital swings you used to have. What is the seasonality in the business at this point? Obviously, last year was kind of a throwaway year. Just trying to understand what impact seasonality is having on that implied 4Q guidance?

Yes, I would just say is that as a theme, we're seeing a reversion back to the normal here on the seasonality of our business. Of course, there's moving pieces, right? But what that implies is from an earnings standpoint, usually, the third and first quarters look a lot alike and the second and fourth quarters look a lot alike as well. You referred to our implied guidance, if you look at those overall, I think it reflects that. Now the one key thing, though, is in the fourth quarter, we do have this price-cost inflation pressure. And keep in mind, in the first part of the year is when we go after those prices and we start to normalize that. So overall, I think we're seeing more of a reversion back to the norm.

I appreciate it. Just one follow-up, John. I believe Ghansham asked about this, but your capacity is quite limited. You mentioned that demand is strong, but you're only anticipating flat to up 1% in volume for the third quarter. You do have capacity coming in the Andean region. However, given your current capacity situation, how much can you realistically grow volume at this time? Additionally, how should we anticipate shipment growth for next year considering this?

Capacity is tight, but productivity is expected to improve in the coming year, which should help us handle a higher volume. We also faced significant severe weather in Mexico and the United States, which affected our operations. As we approach Investor Day, we will share our growth opportunities. It's important to note that we are piloting Generation 2 in the second half of this year and expect to confirm our assumptions before the year ends. Generation 2 is significant as it allows us to go greenfield with MAGMA moving forward, and we anticipate it will be part of our future. Of course, we need to focus on projects and installations first, and this may have more of an impact in 2023. However, we are positioned to pursue growth, which has been challenging for a long time, by leveraging our sales and marketing capabilities, NPV capabilities, and product development in conjunction with new technology.

And then I would add on top of that, from an operational standpoint, we've also been working hard on the balance sheet to be able to stage that, so that we have the financial flexibility to go do the things that are necessary to be able to unlock that pent-up demand for our product that we've struggled for a long time to be able to enable within our business.

Yes. And I think it's important also to factor in the multi-year impact of the margin expansion initiatives. So we're seeing the impact of those initiatives last year, this year, and we expect to see it in the following years too. So that's going to be flowing through our numbers.

Your next question comes from Salvator Tiano from Seaport Global Securities.

Firstly, you mentioned that now your volumes are above pre-pandemic levels. Can you provide a little bit more color on some of the businesses, kind of food, alcoholic beverage, and non-alcoholic beverage, as well as on-premise versus off-premise? How do you compare now versus pre-pandemic?

Yes. So overall, the resilience of glass to channel shifts has been a lot better than we ever thought. And in fact, quite strong. When you look at the performance of glass over the last few quarters, even though lockdowns were up and down and shifts were happening back and forth between the channels, we continue to perform in the volume dimension. Now let me just give you an idea of what's taking place by market. So Europe is solid across all-in users, the mineral water recovery, which was expected to be once the lockdowns were raised. So that's working well. But the recovery of Champagne is pretty important, as well as the Bordeaux wine exports. I shared also in the earlier call, the performance of beer, which is quite significant. So Nielsen data clearly states that beer in glass is ahead of alternative packaging in Western European countries and very important countries like France, Italy, Netherlands, and the U.K. But when we look at the U.S., beyond the resilience to channel shifts, we're seeing a decrease in the rate of decline of beer in retail. We're seeing an increase in alcoholic beverage consumption in retail too. And we're seeing a permanent shift or gain of food consumption in on-premise coming from off-premise, which is important for our demand. Now when it comes to NABs and spirits, we're also seeing improved performance. In the case of NABs, with premium products like Kombucha or RTD coffee, in the case of spirits, it's driven by consumers trading up and focusing on premium products. We look at Mexico, Brazil, and the Andean countries, solid demand. We're selling the capacity. And in those markets, it's primarily about evaluating further opportunities for expansion. One data point that is important in Brazil is the recovery of the returnable segment when the peak of the pandemic took place back in April; the share of the returnable package went down to 20%, coming from 40%, is now back to 40%, so pre-pandemic levels. That's very important to create affordability for beer in that market, but it's also essential for sustainability because no package can equal the performance of the returnable container. And in the Andean region, there is a strong emphasis on global brands and premium products across categories, which is driving demand.

Okay. Perfect. And just my follow-up, I want to understand a little bit on the margin expansion initiatives. You said that now you're going to do over $50 million in 2021. Firstly, can you put a more precise color on this? And secondly, for 2022, what other opportunities do you see for expansion if you can ideally quantify the numbers?

Let me start by explaining the margin expansion initiatives. There are three main initiatives. The first is focused on increasing revenue through pricing, mix, volume, and working capital aspects related to the commercial organization. The second initiative addresses the overall cost of goods sold, and the third is targeting selling, general, and administrative expenses. These initiatives are designed to utilize the capabilities we've developed in our organization over the past few years, allowing us to benefit from them now. This is why they are considered structural and long-term. We are confident about their positive impact, not just this year but also in the future.

Yes. And to answer your first question on the margin expansion initiatives, our original target was $50 million this year. We believe it will probably be somewhere in the range of between $60 million and $70 million this year, so definitely higher. And keep in mind, those programs are net benefits. So that's net of other changes and other spend categories. So that's also absorbing some of the incremental logistics costs and some other spend categories that are in there. So it just shows that there's good underlying performance to Andres' point across the business. And we'll spend more time going into next year, but there are clearly continued run rate opportunities and momentum in this space. Maybe to put it into perspective a little bit, we did tighten our earnings guidance for the whole year, up in the upper half of it. What we're seeing is that the benefit of higher sales volume and the incremental margin expansion initiatives we're talking about is probably adding something like $0.30 to our earnings. At the same time, we do have some headwinds, such as what we incurred with winter storm Uri and then some of the increased pressure on the spread. But the good news is the things that are going the right way are fundamental underlying business performance, while some of the things that have been headwinds are more temporary or transient in nature. So we’re pretty optimistic about the future opportunities of the company to drive continued earnings improvement.

Your next question comes from Kyle White from Deutsche Bank.

On the on-premise, can you just talk about what you're seeing that gives you the confidence that on-premise consumption of glass or food and beverage will be higher post-pandemic than it was pre-pandemic? Is this mostly driven by food? And is it specific to the United States? Or are you seeing it in Europe as well?

Yes. I think it's the consumer trend, which is preferring glass first. Second is focused on premium products. That is a very important change in trends. And that is very favorable for glass. So now remember, we sell across multiple categories. And that gave us a pretty good diverse portfolio to count on for volume improvement. So we are in food, we are in spirits, we are in NABs, primarily premium, we are in wine. So multiple categories that are primarily categories served by glass.

Got it. And then you touched on this a little bit earlier, but just wondering if you're seeing any impacts from the Delta variant here in July and August? And how did you incorporate this uncertainty into your outlook?

We're being very cautious because we already have a year and a half of experience with this situation. At this stage, we're ramping up, and we expect all stakeholders to have learned enough over these 1.5 years to implement measures that won't be too disruptive. We don't anticipate reverting back to square one, although we may see some fluctuations. The key takeaway here is the resilience of our packaging amid channel shifts. Back in early 2020, we had initial expectations that as on-premise consumption declined, off-premise could not rise enough to compensate. However, the reality is that it mostly balanced out. As consumer behavior shifts back and forth, we swap one for the other, and right now, glass is doing quite well. Therefore, we feel optimistic about our ability to perform even if this variant continues to surge and impose some restrictions temporarily.

To expand on that, we have aimed to be somewhat conservative due to the trends and uncertainties we are observing. This caution is primarily connected to the fluctuations rather than any fundamental issues with demand. As Andres pointed out, our performance has been strong, and we have seen positive movement over the past nine months. Nevertheless, we have opted for a conservative outlook on the business, and we will monitor how things develop moving forward.

Your next question comes from Gabe Hajde from Wells Fargo.

I was wondering about Gironcourt. If I remember correctly, that startup experienced some delays due to the pandemic. So, I assume it is currently operating at full capacity or close to it. I’m curious if there will be any benefits in terms of volume that carry over into 2022 from that.

Yes. So we started Gironcourt last year. It was delayed, as you mentioned, originally because of the pandemic; we couldn't really mobilize the resources properly. But it started at the end of last year. So it's been running at full capacity this year and is sold out. So we're very pleased with the return of that investment. It was the right thing to do at the right time.

It won't represent an incremental variable going into 2022 since it's pretty much run in full the whole time.

Okay. And then I guess going back to the implied Q4 guidance, I'm more thinking about production levels relative to sales volumes. And I think here in the second quarter, you all produced by 10% or it seems like implied is 8% or 9% in the third quarter as well. What's embedded, I guess, in that Q4 guide in terms of production relative to shipments?

Yes. Let me first clarify one point. The reason why you’re seeing different sales volume versus production volumes doesn’t have anything to do with how we’re operating our business this year. I mean, we are producing at practical capacity, and then we’re selling what we can produce minus supply chain variations and things like that. So really, what you’re seeing is the comps are just because of the volatility last year with production and demand activity. So just to be clear, there’s no rebalancing going on, so to speak; we’re just kind of managing our inventories to be consistent across – on a comp basis. Now understanding that last year was still kind of had some of those issues. Production in the fourth quarter will be up 2% or something like that on a year-over-year basis. But most of the disruption was done on a production basis as of somewhere mid- to late third quarter of last year.

Your next question comes from Lars Kjellberg from Credit Suisse.

I wanted to revisit MAGMA. You're seeing good progress there. In other materials, there is actually premium pricing for low carbon products that have a positive environmental impact. Is this something you encounter in discussions with your customers? I would also like to know your thoughts on the premium offerings and the benefits of the mix you’re experiencing as the premium business returns. Do you expect this benefit to continue, and what have you observed in terms of that benefit?

Yes. So the sustainability profile of glass is something that is going to be incrementally clearer and more valued by consumers and by customers. It has a lot to do with the inherent attributes of glass. So let me just share something with you. From our perspective, glass is already what other packaging materials aspire to be. And there are 6 reasons for that. The first one is the only material that is 100% recyclable forever, a bottle transforming into a bottle endlessly. It is possible to have up to 100% recycled material in every bottle. It is already recycled at best-in-class rates in Europe, which shows its potential. Even if not recycled, glass is never trash. It doesn't hurt the earth or the ocean. It does not have plastic or plastic liner in contact with the product, and it has returnable glass, which is the most sustainable package in the packaging universe. No package, no substrate can meet those 6 conditions. So as you say, as we go into deploying our strategy, we're going to talk more about that. Not only do we have that, but we are working highly focused on addressing the recycling system in the United States. There are already pilots in place. They're working well. Not only do they help us with recycling, but with the community. We can cause a positive impact in the community. So we're going to talk more about that at that point in time. And then the production technology with true MAGMA and even for the existing technology is being designed to use fuels that will allow for a significantly better sustainability profile. So you will imagine that that's going to have significant value. It's not only the product with inherent capabilities, but the recycling system in the right place and the products and technology with the right profile from a sustainability standpoint. How are we going to price that? I think it's something that we're going to talk more in the future. We don't have that ready to go at this point in time, but it will be valuable for sure.

Got it. And on the price/mix now, with the premium coming back?

Well, that's consumer trends. And I think it's happening everywhere. Consumers are reallocating their disposable income to products that are more on the higher end. And that's happening across markets. I mean, every single market in which we are is seeing the same trend. Every single end-use is going through the same point. So I think it's a significant shift in what consumers value and where they put their disposable income.

Yes. I would say that the biggest growth categories are, in fact, those higher premium categories in many markets, given the capacity situation there’s a mix management opportunity for us as a business, and that implies what we’re doing right now and where we’re going to go in the future.

Your next question comes from Alton Stump from Longbow Research.

I just want to ask a follow-up on the Glass Advocacy Campaign. You obviously mentioned in the release that you have now reached 80 million. I guess, add a bit more color as to what that means, reached 80 million, and how much of that is a sustainable impact on that group of people?

Yes. If you look at our digital marketing efforts, we have a vast number of impressions, reaching into the hundreds of millions. We can track social media activity and see which individual accounts are viewed multiple times. Additionally, we measure engagement, such as whether someone read the content, watched the video, or commented and shared it. Think of this process as a funnel; we start with all those impressions and gradually understand the behaviors that resonate with people. It's crucial to note that we are conducting multiple campaigns on various topics rather than a single large one. This approach allows us to identify which campaigns truly connect with audiences and which ones don't have as much impact. Over time, we can fine-tune our marketing strategies. For instance, some campaigns may focus on specific interests. It’s fascinating to see how this all unfolds and how we can become more precise in tracking engagement over time.

Yes. Social media is the right vehicle for this because normally people's attention is for about 7 seconds. So it's very small messages, very short messages, the ones that really stick, and social media is perfect for that.

Okay. That's very helpful. And then just I think you mentioned, John, that here in 2Q, Latin America was one of the regions where you saw better-than-expected growth. I guess is there any certain product categories that drove that? And is that a stable benefit beyond 2Q in that region?

What I would say is that you are observing fundamentally capacity-constrained markets across most of Latin America. We have indicated our expansion in the Andeans, and we have noted that Brazil is experiencing a situation of well-over-demand. This trend is evident across the board, particularly in some beer categories, as there has been an increase in premium beer, which typically comes in one-way bottles. This trend has gained momentum over time and has significantly enhanced the demand profile.

I think we have time for one last question.

Yes, we have a question from Arun Viswanathan from RBC Capital Markets.

Maybe I could just ask a question on some of the structural changes you guys mentioned. So if I heard you correctly, it sounds like shipment growth in the future would settle into kind of 0% to 2% level? And then maybe you get another 100 basis points from price mix, i.e., some of this new product growth, MAGMA, and so on. Is that the right way to think about kind of top line, let's say, like 1% to 3%? And then there's some operating leverage there. So maybe you get 3% to 5% EBIT growth, and then that translates to maybe 5% to 7% EPS growth. Is that kind of the operating model that makes sense to you guys over the next couple of years?

Yes, yes. I mean, I don't think that we're going to get into too forward-looking. I mean, we have an Investor Day coming up in almost about 2 months. I think we'll lay out a lot of the forward-looking aspects of the business. But if we think about some of the major drivers going forward, especially in the next year, obviously, we don't think that we'll have some one-timers like we had with winter storm Uri, let's keep our fingers crossed in that regard. Demand is very good, but it's a capacity-constrained situation with some ability for incremental capacity in the shorter term. I think Euromonitor has indicated that there's about 1.7% projected glass demand growth over the next 3 years. So that might be a way to think about it. But of course, I think it's a capacity issue in addition to just the fundamental demand situation. We've talked about price and the fact that we intend to increase prices relative to the inflation that we're seeing. We expect to continue to see margin expansion initiative benefits. I mean, all of those elements are the things that we think are driving the improved performance of the business. Of course, we intend to continue to creep up the free cash flow conversion that we're seeing in the business over time. Again, we'll lay that out a lot bit more through the Investor Day and, of course, our year-end earnings guidance.

Yes. I think the Investor Day is the perfect opportunity to have this conversation. But overall, glass has very good potential. And glass, in fact, can grow if capacity can follow that pace of growth. So what we've been doing is preparing O-I to be able to enjoy that growth potential. And we've done so through, I would say, a pretty deep structural change across the entire business. And we're going to have the opportunity to explain that to you at the Investor Day.

Thank you very much. That concludes our earnings call. Please note that our third quarter call is scheduled for October 28, and as mentioned, we will be hosting an Investor Day in New York City on September 28, and we'd love to see you all in person at that event. So remember to make a memorable moment and choose safe, sustainable glass. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.