O-I Glass, Inc. /DE/ Q3 FY2021 Earnings Call

Thank you for joining us for the O-I Glass Third Quarter 2021 Earnings Conference Call. I will now turn the call over to Mr. Chris Manuel, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Laurence, and welcome, everyone, to the O-I Glass third quarter 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 this call are available on the company's website. 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. I appreciate your interest in O-I Glass. We are pleased to report third quarter adjusted earnings of $0.58 per share. Despite a number of macro challenges, O-I is once again delivering on its commitments as earnings exceeded our guidance range. Demand for glass containers is strong, yet our shipments were down about 1% in the quarter due to choppy demand patterns stemming from low inventory levels and ongoing global supply chain issues. On the other hand, production levels rebounded nicely from the prior year, which was impacted by the final stages of mandatory curtailments at the onset of the pandemic. Also, higher selling prices and the benefits of our revenue optimization initiative fully offset elevated cost inflation. Overall, better-than-expected results primarily reflected strong operating performance and cost management, enabled by our margin expansion initiatives. As we will discuss shortly, we're making great progress on our 2021 priorities, including today's announcement of intent to sell our Le Parfait brand and business at an attractive valuation as part of our Portfolio Optimization program. We are also accelerating O-I's transformation as we shared at our Investor Day last month. The combination of favorable market conditions for glass containers, O-I's ongoing transformation and the introduction of MAGMA is building the path to Yes. Yes, to an agile and resilient company. Yes, to a new paradigm for glass. And Yes to profitable growth. We are confident this plan will enhance value for all our stakeholders and ensure sustainable prosperity for O-I. If you haven't already, we encourage you to view our Investor Day presentation, which can be found on our website. Reflecting good momentum, we are increasing our full year earnings outlook. We now anticipate 2021 adjusted earnings will range between $1.77 and $1.82 per share, and we expect at least $260 million of free cash flow. We expect fourth quarter adjusted earnings will approximate $0.30 to $0.35 per share amid elevated cost inflation pending price recovery starting in early 2022. Let's turn to Slide 4. As we continue to deliver on our commitments, we are also making very good progress advancing O-I's strategy. On this page, we list our 2021 priorities as well as some highlights on our progress. I'll touch base on each of our 3 platforms. First, we aim to expand margins. We have targeted $50 million of initiative benefits as well as continued performance improvement in North America. As you can see, we have already achieved our full year initiative target and now expect benefits totaling around $60 million in 2021. Next, we seek to revolutionize glass. Our new MAGMA Generation 1 line has been commercialized in Germany, and our Generation 2 line in Streator, Illinois is being piloted in the second half of 2021. Our glass advocacy and ESG efforts are also gaining steam. Third, we will continue to optimize our structure. This includes a number of efforts ranging from portfolio adjustments, improving the balance sheet, simplifying the organization, and addressing legacy liabilities. Regarding our divestiture program, we have entered into agreements for over $1 billion of asset sales to date, including the recently announced intent to sell our Le Parfait brand and business in Europe. As laid out during our Investor Day, we are investing up to $680 million over the next 3 years that include up to 11 MAGMA lines to enable profitable growth. Expansion plans are focused on several markets across Latin America, premium spirits in the U.S. and the U.K., and premium beer in Canada. As John will expand upon, year-to-date free cash flow is quite favorable compared to past trends, and we continue to advance other important efforts, including the Paddock Chapter 11 process. Overall, we're very pleased with our progress. Moving to Slide 5, we have laid out the key elements of our strategy shared during Investor Day. As I've noted earlier, the combination of favorable market conditions for glass containers, O-I's ongoing transformation and the introduction of MAGMA are building the path to Yes. Just to profitable growth, glass is poised to benefit from key megatrends such as wellness, sustainability, premiumization and at-home living. Reflecting these tailwinds, global market growth is anticipated to average 1.6% a year and higher in the principal regions where we operate. Given these trends and a revitalized commercial approach, we are investing in new capacity to enable key growth opportunities within our strong organic commercial pipeline. Yes, to an agile and resilient company. Our transformation is well underway, and I believe recent performance demonstrates the momentum we are building. We expect significant benefits from our ongoing margin expansion initiatives. We are expanding our Portfolio Optimization program to realign our business portfolio, fund organic growth and improve our return on invested capital. Also, we intend to resolve legacy asbestos and pension liabilities that have been a burden on the organization for decades. Finally, we are introducing a new paradigm for glass enabled by MAGMA. This new breakthrough solution provides a host of additional capabilities to build on our world-class heritage network. With MAGMA, we can meet the needs of an evolving market and expand our business. These efforts are set to accelerate O-I's transformation through profitable growth, improved financial performance and value to all stakeholders. We are excited about the future, and we believe O-I represents a compelling investment opportunity. Now, 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 current 2021 business outlook. I'll start with a review of our third quarter performance on Page 6. O-I reported adjusted earnings of $0.58 per share. As noted during our Investor Day, we expected results would be at the high end or slightly exceed our guidance of $0.47 to $0.52. Stronger results reflected good operating momentum as we exited the quarter. Segment operating profit was $243 million, which significantly exceeded prior year. Higher selling prices fully offset elevated cost inflation linked to higher energy and freight costs. While demand remains strong, sales volumes dipped 1% due to choppy demand and ongoing supply chain challenges in several markets we serve. Likewise, favorable cost performance was driven by an 8% improvement in production levels as the prior year was impacted by forced curtailment due to lockdown measures. Cost performance also reflected continued good operating performance and benefits from our margin expansion initiatives. The slide includes additional details of non-operating items. Overall, we are pleased with favorable performance trends. Moving to Page 7. We have provided more information by segment. In the Americas segment, profit was $133 million, up from $113 million last year. Despite significant cost inflation pressures, favorable net price reflected timely pass-through on costs and the benefits of our revenue optimization initiatives. Sales volume was down 3%. In particular, we have seen some food categories rebalance as on-premise reopens, but food volume still remains above pre-pandemic levels. Likewise, we have intentionally mixed and managed certain low-value categories given tight inventory conditions and ongoing supply chain challenges. On the other hand, production rebounded 9%, and earnings benefited from good ongoing operating performance as well as our margin expansion initiatives, which offset elevated freight costs. In Europe, segment profit was $110 million compared to $88 million last year. Sales volume was up nearly 2% with strong growth in the wine category, while higher selling prices partially mitigated elevated cost inflation. Significantly lower operating costs reflected an 8% improvement in production levels, very good operating performance and benefits from our margin expansion initiatives. Keep in mind that we no longer report in the Asia Pacific region following the sale of ANZ last July. Let's shift to cash flows and the balance sheet. I'm now on Page 8. We are following a specific set of guiding principles for our cash flow and capital structure that are aligned with O-I's strategy to increase shareholder value. We expect significantly higher free 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 third quarter free cash flow was $213 million. Over the past year, we have improved the consistency of our cash flows, which now reflect the normal seasonality of our business, solid operating results and working capital management. Year-to-date, cash flows approximated $181 million, so we are well positioned to achieve our full year guidance of at least $260 million of free cash flow. Second, we preserved our strong liquidity and finished the third quarter with approximately $2.1 billion of committed liquidity, well above the established floor. Third, we are reducing debt. And into the third quarter, our net debt was $4.3 billion, the lowest level since 2015, and our BCA leverage ratio was around 3.6 times. Both net debt and our leverage ratio compare favorably to our full year targets. So far this year, we have entered into agreements to sell $128 million of assets as part of our portfolio optimization effort. This includes today's announcement of a binding commitment from a subsidiary of Berlin Packaging to acquire our Le Parfait brand and business for EUR 72 million or about $84 million. EBITDA for this business was EUR 7.5 million in 2020 with a similar performance on a 12-month trailing basis. This represents a compelling valuation in excess of a 9 multiple. We expect the proposed sale will be completed by year-end or early next year. The agreement also includes a long-term supply agreement for O-I to sell glass containers to Berlin to support expansion of this attractive and growing brand. Finally, we intend to derisk 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 where O-I will support Paddock's funding of a 524G 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. Overall, we continue to improve our cash flow and balance sheet position. Let me finish up with a few comments on our business outlook. I'm now on Page 9. We have increased our full year earnings guidance to between $1.77 and $1.82 per share, reflecting favorable third quarter results. We now expect free cash flow will be at least $260 million. We anticipate fourth quarter adjusted earnings will approximate $0.30 to $0.35 per share. Fourth quarter results should be down from the prior year as cost inflation peaks. Importantly, we are preparing to implement annual price increases early next year to recapture the impact of inflation. Given ongoing global supply chain challenges, we anticipate sales volume will be about flat with the prior year. Additionally, we expect continued strong operating performance and benefit from our margin expansion initiatives. This outlook is based upon current FX rates, as the dollar has strengthened some in recent weeks. Keep in mind that maintenance and engineering activity will be at their highest levels for the year during the fourth quarter. Also, our outlook reflects current conditions, which could shift given the level of macro uncertainties across the markets we serve. We have also shared some additional themes for 2022, which are consistent with our longer-term outlook shared at our Investor Day. With that, I'll turn it back to Andres.

Thanks, John. Let me wrap up with a few comments on Slide 10. Overall, we are pleased with our performance during the third quarter. Importantly, O-I continues to achieve its commitments despite a number of macro challenges and uncertainties. I believe this represents a step change improvement in our ability to consistently perform and deliver. At the same time, we continue to advance our key priorities for 2021. Our multi-year margin expansion initiatives are gaining steam, MAGMA is advancing, and we continue to improve our structure. We are now a much more agile and resilient organization that is well-positioned to accelerate our transformation. Finally, we're building the path to Yes, that we outlined last month at our Investor Day. Thank you for your interest in O-I, and we welcome your questions.

Laurence, we're ready.

Your first question comes from George Staphos from Bank of America.

My questions will be around pricing related to the choppy volume environment as you termed it. So you gave us a little bit of color, but could you dig a bit more deeply in terms of what is, in fact, happening in terms of the supply chain and what it's doing to your volume? What amount of earnings might you have lost because of the choppy patterns? And then as we look to '22 as you're trying to recover inflation through your pricing, what are the risks that this volume environment prevents you from doing that? Particularly as regards to Europe, what's the setup on European pricing?

Yes, George. So looking at the supply chain issues, we have external factors and we have internal factors too. In the external factors, as an example, when customers are facing input issues, they don't get their inputs on time; they tend to reduce our orders or delay our orders. When they're facing truck availability, it is the same thing or labor issues. Internally, we are limited by inventories in several markets. As you know, inventory has been running tight. Brazil too, Mexico is the same. In some cases, depending on the mix in North America, it is also the case. It is important to highlight that the food category has been rebasing as we have been going through the shift from off-premise to on-premise. It is also important to highlight that for that one, we're seeing the category retaining the gains versus pre-pandemic levels. As we mentioned in the opening remarks, we're also taking action, prioritizing margin and return. As we go into 2022, we've been very active managing to offset inflation. We're doing it on several fronts, in procurement as well as on the commercial side. From a procurement perspective, we have very solid policies in place and actions to mitigate, and we are executing on them. From a commercial perspective, we already have our plans for price increases going into the following year. We see a constructive environment for prices in 2022, and we expect to fully recover inflation.

George, I would add one other thing you had asked, what's the impact on the third quarter of these supply chain impacts and things like that. We had expected going into the quarter that volumes would be flat to up 2%. They were down 1%. So I think you can attribute that difference of say, 2% or 3% differential, mostly to the supply chain-related issues in one format or another. So it's having a marginal impact, but it's noticeable.

Yes. And going into '22, just to complement, George, the demand fundamentals are very solid. And just referring to Europe, which you asked for, the demand in champagne and Bordeaux wine is very strong. Demand for Prosecco and Italian wine is also very strong. We're seeing a very good recovery of mineral water as the on-premise channel resumes activity. And beer is growing quite well in key markets for us in Western Europe. We're seeing high single-digit growth for beer in glass in Italy, France and the U.K., which are very relevant markets for us. So with those solid fundamentals, we don't see any issues for our price increases. We're very confident we're going to fully recover inflation going into 2022.

Your next question comes from the line of Ghansham Panjabi from Baird.

This is actually Matt Krueger sitting in for Ghansham. How are you doing this morning?

Matt, thank you.

Great. So there's been some recent conversation about magnesium limitations causing supply shortages in aluminum, which is obviously a substrate that you compete with directly on several levels. If these shortages were indeed to come to fruition, how quick is O-I specifically to handle any potential volume that might flow into glass that's now being serviced by aluminum cans? And have you guys thought about what the potential benefit could be from that angle? Any details or thoughts there as far as capacity availability would really help?

Yes. So at this point in time, we are operating at high utilization levels, and that's why during Investor Day, we laid out a 3-year plan for capacity expansions. So we believe those expansions are timely. The markets that we are addressing through the expansions are quite strong. And through that plan, we expect to address the issue that you highlighted.

Your next question comes from the line of Anthony Pettinari from Citi.

It's actually Bryan Burgmeier sitting in for Anthony. On the price cost recovery in 2022, how much of what you're assuming is already secured via contracts in place, and it's just a matter of timing getting caught up? And how much needs to be recovered in contracts yet to be negotiated?

Yes, this is John. Between 55% and 60% of our business globally is covered under long-term agreements, which include price adjustment formulas. That part is secured as we move into the next year. The remaining 40% to 45% is in the open market and tends to be renegotiated annually. In Europe, for instance, about 70% of the business is typically renegotiated early in the year. This is the key area of focus for price movement as we enter the new year, in addition to the PAS.

Got it. That's very helpful. And on 4Q, can you parse out the drivers behind the negative price cost between energy, labor, freight, and raw materials? And then based on your contract structure, which of those buckets is going to be easiest and most difficult to recover next year?

I would say that the biggest issues we're observing are related to fuel, followed by freight. Electricity also plays a role, but its impact is more moderate. Specifically, on the fuel side, which is the largest factor, we see adjustments happening monthly or quarterly in North America. One reason we've managed to maintain a good price-cost spread year-to-date is the ability to implement these quick adjustments in North America. In Latin America, there tends to be a timely response to inflation as well. Overall, the inputs we're experiencing are widespread across the market, with the supply chain globally adapting to address these cost inflation pressures. This aligns closely with our price adjustment formulas and will be a focus for future negotiations.

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

I wonder, just going back to this European energy issue. If you can talk about what type of mechanisms you have in place to mitigate the impact of that on the European operations? Because it seems like Europe has really been the epicenter for the energy issue? And also whether those issues are having any impact on your ability to operate? In other words, if you can't get natural gas?

Yes. As I mentioned earlier, we have strategies in place to manage price increases from a procurement perspective, which positions us favorably. We have implemented effective measures and do not expect any challenges from this situation or in our commercial strategy moving forward, which we have clearly outlined. Regarding supply, predicting the winter's conditions is challenging. If we assume it will be a typical winter with no unusual occurrences, considering our markets, suppliers, and existing contracts, we foresee very minimal risk of supply issues during the winter. Should extreme situations arise, we will adapt as necessary. However, at this moment, we do not anticipate any significant risks to our operations based on our location, suppliers, and contracts.

That's helpful. Andres, could you clarify the recent reports about the shortage of glass bottles in North America? I'm interested in understanding how we arrived at this situation, especially since many in the industry were previously closing glass plants. How much of this do you attribute to trade and logistics issues, and how much is related to the duties on imported glass? What are the various factors at play, and how can we take advantage of this situation in the near future?

Yes. So demand for glass is strong, and it has been continuously increasing. In some cases, it comes in peaks that are difficult to serve. Now our inventories are tight, which is compounding that. The imports of glass, in particular from China, have been coming down. So that adds to the problem. So now at this point, we are utilizing our capacity the best we can. As we mentioned before, mix management is important in these circumstances. We can support margins and return. And then we're doing everything we can to improve productivity to be able to support this. We also have established a supply network across the Americas. In some cases, we support the United States out of Mexico or even the Andean country, depending on seasonality and all that. So all of that is in place to take advantage of the situation as we can. From a customer perspective, we've been very actively working with the customers, collaborating with them well to minimize these issues. And we're confident that as we go into '22, we're going to be in a better position because our inventories are better established to be able to support them through their peaks.

Your next question comes from the line of Mike Leithead from Barclays.

First, I wanted to follow up on the supply chain side of things and particularly on the external factors of your customers that Andres, I think you laid out well like labor, trucking, or other material shortages. Have your customers given you a sense? Or do they even have visibility, frankly, on how those factors should trend into the fourth quarter or '22? I'm just trying to get a sense of whether they're easing or staying the same as we sit here today?

Yes. So these supply chain issues are widespread; they're across industries and they're impacting everyone. What is good in our case is that our relationships with customers are in a very good place, and our coordination is very strong. So that gives us the ability to respond better. As I mentioned before, because of that work, we expect that we will be able to better manage through these situations going into 2022. Also, knowing their actual needs based on the growing demand, we can also plan better for this supply across the Americas network, which we are leveraging to the best we can to support the supply for our customers.

Great. That's super helpful. And maybe as a follow-up for John. Looking at the '22 outline, I appreciate it's still early and there's a ton of moving parts. But I wanted to ask about the free cash flow conversion. Should we still think about that kind of 20% to 25% of conversion rate from EBITDA before the step-up in growth CapEx? Just how should we think about that flow through next year?

Yes. I think, Telly, we're introducing a new measure we call adjusted free cash flow. And so that looks just at the maintenance capital. I think when you take a look at that adjusted free cash flow as a percent of EBITDA, you're actually looking at a number higher than that because it's just the maintenance capital component of it, is something probably north of 30% on adjusted free cash flow conversion.

Your next question comes from the line of Kyle White from Deutsche Bank.

I think you mentioned headwinds in regards to your volumes on food, specifically in the United States, as at-home consumption wanes. Do you have a sense of how much incremental food volumes you gained throughout the pandemic, that could potentially pose a headwind going forward as at-home consumption wanes?

So food went up during the pandemic double digits, right? It was a very strong peak because of that at-home consumption. What we're seeing right now is that, that peak obviously came back down because the on-premise channel is already open. However, we're keeping important gains versus pre-pandemic levels. So at this point, we're seeing between 3% and 4% incremental volume versus those levels. So premium food is quite healthy because of the focus of consumers on premium products, and this is happening across all categories.

Yes. And the studies we've looked at and reviewed indicate that, that is a longer-term trend is that some level of premiumization continued at-home living focus is going to be there. So most project some form of continuation of that type of demand structure.

Your next question comes from the line of Salvator Tiano from Seaport Research.

Firstly, can you provide in the Americas refiner print on your shipments by region, by more specific regions? And also why despite that shortfall, what data points give you confidence that demand is actually very strong even though shipments were down 2%?

Yes. So in the U.S., I'll give you a few data points. When we look at both channels on-premise and off-premise through Nielsen data and CGA statistics, we're seeing interesting performance, for example, in beer, which is up like 2%, spirits is up like 13%, and premium wine around 10%. So what that means is, even with the channel rebalancing, the demand for those products is quite good, and those products are very well aligned with glass. Domestic beer decline has improved. We are at half the rate we used to be out of a small base. So the impact is going down in our system, and international beer brands and premium beer are mostly offsetting that decline. Now we continue to diversify away from domestic beer, and we've been successful doing that. That's why we're seeing the growth in food, as an example. And as I mentioned before, the imports from China are lower than before, so that's also increasing local supply. When I look at the Andean countries, Mexico, Brazil, in those markets there is very solid performance across all categories. Mexico, in particular, is showing strong local demand for food and non-alcoholic beverages. But then exports for beer, tequila, and non-alcoholic beverages out of Mexico are quite strong. In the Andean region, beer performance is strong due to premium beer and global beer brands, and one-way glass is growing. Also, food is strong out of the Andean countries driven by exports. In the case of Brazil, we're seeing good performance of returnable glass back to pre-pandemic levels, which is 40% of the total beer category. We're seeing new products in returnable glass in Brazil, which is a very good indication of how premium products are important for these markets. One-way glass is up at 9% of market share compared to 6% or 7% before, so it's increasing. Premium products are 22% higher than pre-pandemic levels. So those markets are doing really well. We are limited by capacity, but as we explained before, part of the 3-year plan we are adding capacity to all those markets to take advantage of these opportunities.

Okay, great. And my second question is on your CapEx plan. I thought that your strategic investments would be more geared towards 2023 and '24. In terms of your strategic CapEx number, almost $300 million is 40% of strategic CapEx, you said you would spend over the 3-year period. So did something change? Did you decide to spend more capital upfront because you're seeing opportunities?

No. This is very much in line with, I believe, what we laid out during Investor Day. What we're going to do is we're going to see CapEx ramp up here in 2022, peak in 2023, and ebb off in 2024 on the strategic capital side. I think what we're referring to is the sales volumes that we're realizing are going to ramp up, I mean, more back-end loaded as the capacity comes online in the 2023 and 2024 window. So this is all consistent with the planning; nothing has changed. And the thing I would add too is that, I guess, also consistent with what we said in Investor Day is that the portfolio optimization activities are also front-end loaded here so that we anticipate having the cash in-house on those transactions before the cash goes out for the CapEx that we spend on the strategic capital side.

Your next question comes from the line of Alton Stump from Loop Capital.

I just wanted to ask, it was pretty clear from your press release and also comments this morning that you had to walk away from some lower margin business here in the U.S. during the third quarter. Is that a short-term impact? Or how much longer do you think that can last where you're not going to be able to satisfy a portion of your customer base?

Yes. The margin management that we did was primarily due to inventory shortages and supply chain issues and the strong ramp-up after markets reopened again. We're seeing in certain categories in certain parts of the geographies, we just don't have the inventories that we would ideally have for that original mix of business. So what we're doing is managing the mix of our business to capitalize on the strong demand for glass. This is a transitory issue, but it's not something that goes away in one quarter, for example.

Your next question comes from the line of Arun Viswanathan from RBC Capital.

Hello?

Laurence, let's move to the next one.

Your next question comes from the line of Adam Josephson from KeyBanc.

I have two questions, one about earnings and another regarding your cash flow outlook. John, just a month ago, you mentioned that earnings would be at the high end or slightly above the range of $0.47 to $0.52. It ended up being significantly higher than that, and I assume this wasn’t driven by volume since inflation clearly isn’t improving. Can you clarify what contributed to this substantial outperformance compared to what you indicated last month, excluding volume?

Yes, yes, sure. Yes, exactly. The numbers proved out to be better than we were anticipating that this pointed to September being a good strong month for the business. In particular, what we saw was very good labor efficiency. The quality performance of the business was very, very good and a number of asset projects that we had underway actually wrapped up a little bit earlier and at a lower cost at the end of the day than we originally intended. So very good operating performance across those major levers towards the end of the quarter.

Got it. Regarding free cash flow, if I estimate a free cash flow projection for this year, it looks like it could be over $260 million, perhaps around $280 million. Capital expenditures and working capital might result in a $300 million year-over-year decrease, meaning if earnings see a slight increase, we could expect flat or minimal free cash flow. Please correct me if I'm mistaken. Looking ahead to the next two years, while capital expenditures are expected to decrease somewhat, they may still be around $640 million. I'm curious if you could share your expectations for actual free cash flow, not adjusted for cash flow, over the next three years. Am I on the right track with my thinking, or am I overlooking something?

We are not going to provide specific numbers for 2022 and 2023 at this time. However, we anticipate that reported free cash flow will decline slightly over the next couple of years. We expect it to stay positive, but the dip will occur due to strategic capital investments before it starts to increase again. As we have mentioned before, we believe that the extra strategic capital will be fully supported by the portfolio optimization steps we are taking, such as the sale of the Le Parfait business announced today. We estimate that these actions will result in an additional EBIT run rate of about $50 million to $60 million as we enhance our margin management and work towards a more sustainable growth path driven by MAGMA in the long term.

Your next question comes from the line of Mike Roxland from Truist Securities.

Just quickly on the revenue optimization initiatives you mentioned and how that is impacting pass-throughs. Obviously, the company has done a lot of work around upgrading its sales, marketing and innovation capabilities. The company is obviously going through analyzing each account to make sure it receives the profit value for the Ford products. So just wondering, can you talk about what you've done specifically in the quarter and how the revenue authorization missions actually benefited the pass-through?

Yes. So as you mentioned, this is one of the margin expansion initiatives. It is really about leveraging the capabilities we built over the last few years to improve our top line. What happens in the third quarter is really the product of the work that we've done over the quarters. And frankly, over time, setting up things to be able to capitalize better on the top line opportunities. We have quite sophisticated tools in place. At this point, we have processes that are also very well established. So there are lots of rigor and discipline around the top line. And that's what helped us with Q3.

Yes, for clarity, our margin expansion initiatives include three major projects: revenue optimization, which we are discussing here. In the quarter, we realized benefits estimated between $5 million and $10 million that contributed positively. This area has consistently performed well. On the cost side, we also improved our factory performance and engaged in cost transformation related to SG&A, which provided additional benefits. However, we also faced challenges, such as freight, which was approximately a $10 million headwind this quarter. When we account for these factors, we achieved about $10 million in net margin expansion initiatives from those three areas, after considering the freight costs. We aim to ensure that we're assessing a net benefit for the organization.

Got it. Just a quick question about mix management. John, you mentioned the inventory tightness and your expectation for correcting this mix management. Are you moving away from certain businesses that aren’t profitable right now, considering the supply chain and your customer accounts? Are you deciding not to continue with customers who aren’t providing appropriate value for your products, leading to a potential permanent shift in your focus towards higher quality offerings than in the past?

Yes. So yes, that's the focus. We're giving priority to margin and return. As we navigate through all these various challenges, that is a very important criterion we're using to define what is a priority for us.

Yes. I think you got all of the above going on. There are some places where you're looking at the inventories, right, and saying, 'Hey, I don't have that specific inventory, and I'm going to shift away to this other category because you do have the inventory' and some that are permanent changes in mix. I mean, in North America, we've commented over time, we've actually transitioned about 35% of our beer capacity to other categories over the last several years—spirits to wines, to food categories and things like that. And that is always ongoing to make sure that we can continue to shift our capacity to better margin business.

Your next question comes from the line of Gabe Hajde from Wells Fargo.

I wanted to comment on the inflation question, I guess, from a couple of different angles. The first is I'm assuming the answer is yes, but have you guys gone through the total cost of ownership calculations taking into account a new baseline of where raw materials are today? I'm kind of thinking about, obviously, aluminum that's almost doubled when we include aluminum premiums, warehousing, etc. Again, I'm kind of asking in the context of these dual control policies that China might be putting into place that could imply kind of structurally higher aluminum costs going forward. To the extent that it makes glass packaging a more cost-competitive alternative, is that something you guys have been looking at? And I guess, corollary to that, MAGMA in theory should improve that even more. What has been the initial customer response been since you guys kind of announced this aggressive expansion?

Yes. So let me just give you one perspective on that, and John can complement. One of the advantages of glass is that the supply chain for glass is mostly local. And that has two very important impacts. One is cost, the other one is environmental. When you look at the dynamics that you described, they're related to global supply chains that are very large in nature, that support those substrates that are demanded from multiple places and are creating those pressures. But that's not the case with glass. As you know, we melt glass in the same facility in which we convert to containers. So our supply chain is very integrated with very important implications on cost and sustainability.

Yes. As far as how do we go in pricing and how do we look at the opportunities in the marketplace? We clearly price based upon market. We are not a cost-plus producer. So clearly, we look at the competitive landscape across opportunities to make sure that we price accordingly to get value relative to the competing opportunities. And then the other question you had was what has been the initial customer reaction been on MAGMA. I would say it's been very good. With the intent to expand our business, I think that's been very well received by customers. In many markets, we've talked about for some time as we run against capacity constraints. So everybody is very, very encouraged that we're working on new opportunities. I think they responded very well to the capabilities that we're laying out with MAGMA because it just fits so well with the market realities that all of our customers are facing in today's world.

And then one more aspect on MAGMA. MAGMA will help glass production and supply to become even more local because we can co-locate or near locate. We can also scale down that capacity to follow growth but at the same time, protect the economies of scale, which is a significant change for the industry.

I think this will be the last question, Laurence?

Yes, sir, we have a follow-up question from Ghansham Panjabi from Baird.

Thanks a lot for letting me hop back in the queue. This is Matt Krueger again on Ghansham. Understanding that the tight capacity situation can mitigate the opportunity here a little bit. But I wanted to touch on what you're seeing in the hard seltzer market. We're starting to see some marketing campaigns and advertising come out with glass as a packaging substrate in that market. And obviously, there's been a lot made about the slowdown there on the can side of things. Can you just talk about what your penetration level is in the hard seltzer ready-to-drink market and maybe what you see the opportunity being moving forward across your business?

Yes. So the hard seltzer category is only an upside for glass. Our current share is very, very small. However, the attributes of glass, which makes it very good for branding, is a perfect fit for what is going on in that category, which there is a significant proliferation of presentation confusing the consumer. That's one of the things that we're seeing customers doing, and that's why they need products. Now the category is slowing down; obviously, that's lower demand than previously expected by the suppliers that are supplying currently that category for the most part. Now when it comes to where the capacity of cans goes and the capacity of glass, it's very important to highlight what we brought up during Investor Day. Glass and aluminum cans play in different lanes of product categories. The products that are driving the demand for aluminum cans are products in which we are not present. So if anything, we see this as an upside for us if we get into them, but there are several other categories that are really driving the demand for glass, and in particular, they move towards premium in all those categories.

All right. Thanks. That concludes our earnings call. Please note that our fourth quarter and year-end call is currently scheduled for February 2, 2022. And remember, join team glass by making a memorable moment in choosing safe, sustainable glass. Thank you.

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