O-I Glass, Inc. /DE/ Q3 FY2022 Earnings Call

Hello, everyone, and welcome to the O-I Glass Third Quarter 2022 Results Conference Call. My name is Sam, and I'll be coordinating your call today. I will now hand you over to your host, Chris Manuel, Vice President of Investor Relations to begin. Chris, please go ahead.

Thank you, Sam, and welcome everyone to the O-I Glass third quarter earnings conference call. Today, our discussion will be led by Andres Lopez, our CEO; and by 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 call are available on the company's website. Please review the safe harbor comments and our disclosure and use of non-GAAP financial measures included in those materials. Now I'd like to turn the call over to Andres.

Good morning, everyone. I appreciate your interest in O-I Glass. Last night, O-I announced a strong third quarter adjusted earnings of $0.63 per share, which exceeded prior year results as well as guidance. As illustrated on the left, all key measures improved. Segment operating profit and adjusted EPS increased nearly 10%, margins improved 60 basis points, and financial leverage was down more than a full turn. Earnings benefited from higher selling prices, which more than offset cost inflation. As expected, sales volume was up slightly amid record low inventories and capacity constraints in key markets. As we work to commission much-needed new capacity, we did incur some additional costs which were mostly offset by solid operating performance and benefits from our margin expansion initiatives. In addition to a strong performance, we delivered on a number of key transformation initiatives during the third quarter. First, Paddock achieved a fair and final resolution of its legacy asbestos liabilities, and the trust was founded in July. O-I has reached an inflection point, and for the first time in decades, we are focusing all of our strong cash flow on efforts to increase shareholder value. Second, we also completed our $1.5 billion portfolio optimization program in August, which helped reduce debt and prefund our expansion investments. Finally, our leverage ratio is now in line with our 2024 Investor Day target, well ahead of schedule, and net debt was the lowest level since the O-I Mexico acquisition. Recognizing our significant progress, both Moody's and S&P upgraded our credit rating during the quarter. We have updated our business outlook reflecting a strong year-to-date performance and good momentum heading into the fourth quarter. As you may recall, we did raise our full year earnings and cash flow outlook during an investor conference in September. We now expect full year earnings will be at the high end of that guidance range and cash flow should be in line with our updated outlook. Despite elevated macro uncertainty, we are encouraged by our performance and expect continued progress in 2023 and beyond. A bit later, John will discuss our business outlook as well as key themes for 2023. Let's move to page four as we review recent sales volume trends. Our shipments increased nearly 1% in the third quarter. Volume was up around 4% in Europe and down almost 2% in the Americas. In Europe, demand was strongest in the Southwest and North Central markets across multiple usage categories. In the Americas, shipments were down mostly due to elevated asset maintenance and repair activity in Brazil and North America. With that said, the shipments were up double digits, and spirits and non-alcoholic beverages were the strongest categories across the Americas. Global shipments were up nearly 2.5% year-to-date, about 4% in Europe and 1% in the Americas. On the right, we have provided the latest Euromonitor consumption projections for the 2023 to 2025 period. As you can see, glass is expected to grow nearly 2% to 4% across the markets that we serve and should be in line or exceed the overall packaging growth rate in those markets. The strong growth projections further support the favorable mega trends we have discussed in the last several calls, leading to the strongest glass fundamentals we have seen in decades. As I've mentioned earlier, we are capacity constrained across several key markets. Our expansion investment program will add much-needed new capacity over the next few years. In fact, the first phase of our Canada expansion project is now in production, and more capacity will be enabled in Canada and Colombia in the first half of next year. Let's turn to page five. On top of the strong recent performance, we continue to advance our transformation. Segment margins are up 100 basis points year-to-date, reflecting a strong net price realization and very good progress on our margin expansion initiatives. As noted, our expansion projects are progressing well as we capitalize on the strongest glass fundamentals in 20 years. All MAGMA development efforts are advancing well, and we have made very good progress on key MAGMA innovations such as the modular batch system, which is critical for greenfield expansion. The team is excited and preparing for our first MAGMA Greenfield in Kentucky, which remains on track for mid-2024. Likewise, we are preparing our new ULTRA lightweighting solutions for full-scale market trials starting in the fourth quarter of this year. Our ESG and glass advocacy efforts are also progressing well. As discussed, we wrapped up our portfolio optimization program and Paddock resolved its legacy asbestos liability. Overall, we're making excellent progress on our key strategic objectives. I encourage all of you to take a look at our updated sustainability report, which can be found on the company's website. You can see a few highlights on page six. We are already more than halfway to our 2030 emissions reduction target and are implementing technologies such as gas oxy furnaces with heat recovery to further reduce CO2. Renewable energy now represents more than 27% of our energy source, a 14 percentage point increase from 2020, and we are well on our way to our 2030 goals. Likewise, we are expanding recycling collection sites, and our recent green bond held on numerous projects to expand recycling initiatives. MAGMA and ULTRA will also provide significant sustainability benefits in the future. Overall, we're making solid progress. Glass is already the most sustainable packaging solution, and I believe you will be hard-pressed to find many industrial companies with so many levers to improve their sustainability position. Now I'll turn it over to John to review financial matters starting on Page seven.

Thanks, Andres, and good morning, everyone. O-I reported third quarter adjusted earnings of $0.63 per share. Results exceeded guidance and increased nearly 10% from the prior year despite headwinds from foreign exchange, divestitures, and interest on funding the Paddock Trust. Segment operating profit was $266 million, up from $243 million last year as margins increased 60 basis points to around 16%. Favorable net price increased segment operating profit by $48 million as higher selling prices more than offset elevated cost inflation. Shipments increased 0.5%, while the net effect of higher sales volume and a change in mix was a slight benefit. Finally, operating costs were up modestly. The Americas reported $130 million of segment operating profit, which was about flat with the prior year on an adjusted basis. Earnings benefited from favorable net price. The combined impact of 1.8% lower sales volume and favorable mix was about flat. Higher costs reflected elevated asset project activity and unplanned downtime, which were partially offset by our margin expansion initiatives. While performance was solid across the segment, we have been focused on addressing future customer agreements to restore margins in North America. As previously discussed, we are taking proactive measures to rebalance our network, improve mix, and enhance earnings. In Europe, segment operating profit was $136 million, up $44 million from the prior year on an adjusted basis, as margins reached 20%. Higher earnings primarily reflected very favorable net price. Results also benefited slightly from the combination of 3.6% higher sales volume and a change in mix. Finally, operating costs were down about $5 million, mostly reflecting the benefit of a subsidy received in Italy to help mitigate the impact of elevated energy costs net of an insurance recovery in the prior year period that did not repeat this year. The chart provides additional details on non-operating items. As noted, our effective tax rate was at the high end of our guidance range due to regional earnings mix and discrete tax items in the quarter. Yet again, the company delivered strong earnings and margin improvement despite a highly volatile macro environment. Let's turn to page eight. We continue to make very good progress on our financial priorities, which are well aligned with O-I's strategic objectives that Andres discussed. Our cash flow outlook has improved over the course of the year and cash conversion is set to exceed our original expectations. We have taken action to optimize our structure, improve the balance sheet, and reduce our risk profile. As shown on the bottom chart, our total financial leverage approximated 3.6 times at the end of the third quarter, which is in line with our 2024 Investor Day target, well ahead of schedule. Given an increasing interest rate environment, we intend to further reduce leverage to below 3 times over the next few years, and we will continue to review our capital allocation priorities. In summary, our balance sheet is in the best position in years, and we are committed to further improvement. Let's discuss our business outlook. I'm now on page nine. Overall, our outlook has consistently improved over the course of the year, including our increased guidance provided in September. Year-to-date results have exceeded our original expectations, and we have good momentum heading into the final stretch of the year. We now expect fourth quarter adjusted earnings will range between $0.28 and $0.33 per share. Results will likely be down some from last year, mostly due to headwinds from foreign exchange, divestitures, and additional interest on funding the asbestos trust. However, earnings should be up on an adjusted basis. Our fourth quarter outlook has improved from prior guidance given the third price increase we implemented in Europe. As previously communicated, sales volumes will be down a little given a challenging prior year comparable. Keep in mind, inventories are at record low levels, and we are constrained in several key markets until new capacity is commissioned. We now expect our full year 2022 earnings will approximate $2.20 to $2.25 per share, which is at the high end of our recently increased guidance range. Furthermore, we continue to expect 2022 free cash flow will approximate or exceed $200 million, which is in line with our improved outlook shared in September. As we round out 2022, we are sharing some preliminary themes on 2023. I'm now on page 10. Despite elevated macro uncertainty, we remain optimistic and expect continued progress in 2023. Starting in January, strong net price will benefit from ongoing price increases amid continued cost inflation and annual adjustment formulas that pass on much of the inflation we incurred in 2022. Sales volume will likely be flat or up low single digits as we begin to commission new capacity. While it is unclear if we will face a recession, our modeling indicates the potential volume impact is modest overall, especially given our oversold position in key markets. Like in 2022, we will have higher costs due to elevated project activity that will be partially offset by continued benefits from our margin expansion initiatives. Naturally, results will be impacted by higher interest rates given rising interest rates as well as foreign exchange headwinds. Overall, we expect 2023 earnings will be in line or likely up from 2022, which represents a strong double-digit improvement from adjusted levels when considering foreign exchange and Paddock interest. Next year's free cash flow should be modestly below or potentially comparable with current year levels as capital expenditure investments in our current expansion plan will likely peak in 2023. Finally, we anticipate continued progress on the balance sheet and financial leverage to be in the low threes by fiscal year 2023. This preliminary outlook reflects our best view of macro conditions and the many levers we have to help manage through elevated market uncertainty, as we have done since the inception of the pandemic. Let's turn to page 11. Of course, we face many macro uncertainties, including a challenging energy situation in Europe or a potential recession, yet we remain confident. O-I is a much more agile and resilient company as we continue to navigate elevated market volatility. We have the strongest balance sheet in years, and cash flow conversion is up significantly following the resolution of legacy asbestos-related liabilities. O-I serves the global food and beverage market, which is more recession-resistant than many businesses. Likewise, our business mix has improved over the years as we shift to more attractive end-use segments, and U.S. mega beer now represents only 3% of global volumes. Importantly, we are significantly oversold in key markets across Latin America and Europe, which provides a buffer from potential recession volatility. O-I is well positioned to manage Russia natural gas curtailments as we enable energy switching capabilities across half of our EU network by around year-end. While Russia has curtailed liquefied natural gas, EU storage levels are around 94% across the continent and ahead of schedule, reflecting very good efforts to reduce gas consumption. Finally, we have consistently demonstrated improved agility amid significant market disruption since 2020. Now back to Andres.

Thanks, John. In summary, we are pleased with our third quarter results and continued progress executing our transformation. The company is performing well, and our business outlook continues to improve. In fact, the company has either met or exceeded the expectations for 11 consecutive quarters. Importantly, O-I is a much more capable, agile, and resilient company, and we expect continued progress in 2023 and beyond. Finally, I believe O-I represents an attractive investment opportunity as we reduce our risk profile, execute our transformation program, enable profitable growth, advance breakthrough innovations like MAGMA and ULTRA, and further leverage our sustainability position to win in the new green economy. We are confident this strategy will create value for all stakeholders. Thank you. And we are ready to address your questions.

Thank you. Our first question comes from Ghansham Panjabi from Baird. Ghansham, your line is open. Please go ahead.

Thank you, operator. Good morning, everybody. I guess first off on the backlogs in Europe and in Latin America that you called out, is obviously being strong as you head into 2023. Can you just give us a bit more color in that in terms of sizing of that backlog and the visibility you have associated with it?

Yes. So when we look at the markets in Europe, Italy and France specifically are importing a significant amount of ware from various places within Europe and other places. So that provides a buffer, as we move forward in case of some changes in demand. Now that situation, Ghansham, is also present across other markets. So when we look at the North America market it is importing 1.4 million to 1.6 million tons every year. And when we look at Brazil or the Andean countries, it's the same; those two markets are importing. So that situation of what you call the backlog is present in multiple markets that are very important for us. And when we add up all those imports, that's more than 2.5 million tons. And then we mentioned in a previous call that there is a dislocation of supply happening as a result of the conflict between Russia and Ukraine, and that's more than 1 million tons, more than 5% of the capacity in Europe, and that's also adding to that. So it looks to us that we have a pretty good buffer coming out of all those factors as we go forward into 2023. And as a result, we're pretty confident that our pricing position will be very constructive as we go into the following year.

Yes, I would just add, Andres mentioned we got about at least a 5% oversold position in Europe. We're probably looking at double digit oversold positions across Latin America also.

Okay. Perfect. Thank you for that. And then in terms of the margin expansion initiatives, the $50-plus million that you're anticipating for 2023, are the drivers any different than what you've seen in the last couple of years? You've been pretty consistent with that sort of level. I'm just curious if there's anything different for next year.

They're the same. Some of the initiatives are going to or addressing or improving the top line. Some of them are pursuing year-on-year productivity. At this point, we are more mature in terms of our capability to drive those. So we are more and more confident we can achieve what we've been achieving in the previous years. So it's a pretty systematic approach across the organization that is delivering those results.

Perfect. Thanks so much.

Thank you.

Our next question comes from George Staphos of Bank of America. George, your line is now open. Please proceed.

Thanks. Hi, everyone. Good morning. Thanks for the details. You mentioned this, I think, a couple of quarters ago, again, we really appreciate the clarity on the material guys and the guidance, the early guidance on slide 10. On operations, that’s where I wanted to spend my time first. Can you talk about the unplanned downtime that you saw in the Americas? What caused that? What was the effect of that? And then relatedly, we're seeing the capital spending bump up into 2023. What are the key categories and buckets in terms of what's driving that?

Okay. So there are several drivers of unplanned downtime. One of them is unexpected issues that need repair. So we address them right away. But the other part comes from the challenges offered by the supply chain. As you know, it's difficult to get materials and equipment. They get delayed. So every time we get enough equipment to be able to deal with a given repair, we are very proactive moving forward and repairing even if that repair wasn't in the forecast. So that's what makes it unplanned. But it's the right thing to do. As we go forward, we are counting on an improvement, and gradual improvement of that supply chain situation. And as that happens, then we expect a higher number of repairs in 2023 as things normalize. And that, obviously, drives the CapEx, but also the inflation that we saw in capital equipment along the year that continues into the following year, driving up the CapEx number.

Yes. Let me quantify a couple of those elements. In the Americas, we experienced around $15 million in higher operating costs due to planned maintenance activities, mainly in Brazil, where we completed a significant furnace rebuild. This also includes costs from additional new capacity we are working on, as well as unplanned downtime. The $50 million increase was partly offset by roughly $5 million from margin expansion initiatives, which reflects the changes in operating costs in the Americas. For next year's capital spending, we are estimating between $725 million and $750 million, of which $275 million to $300 million is allocated for expansion initiatives. A significant portion of this will focus on projects in Canada and Colombia, which are our two major projects. We also plan to work on larger projects as we move into 2024, details of which were shared in a chart during our previous conference. We have 11 different projects planned over the next couple of years, covering those activities. The remaining amount involves about $450 million for maintenance spending. This year, we spent approximately $375 million, aligning with historical averages. However, we anticipate a slight increase due to catching up on maintenance activities caused by supply chain delays and enduring cost inflation in capital expenditures.

I wanted to delve deeper into that point. Are there any concerns regarding the unplanned outages you are experiencing? You have been putting stress on the furnaces and operating at a high rate, so are the unplanned outages increasing? Should we be worried about that from your perspective? Additionally, could you provide more details on how the MAGMA mile markers are progressing? You mentioned everything is on track, but what should we focus on or hold you accountable for in 2023? Thank you.

The issues I mentioned that are causing unplanned repairs occur every year, so it's not unusual. When they arise, we address them and move forward. We are very proactive at this stage. Whenever we have the chance to improve an asset's condition, we take it. However, there is nothing really concerning aside from the routine activities we need to continue to keep everything in very good shape.

Given the challenges with supply chains, we’ve been focusing more on smaller projects to maintain our assets in good condition. These projects occur more sporadically, which can lead to unplanned downtime. They provide a temporary solution but are reflected as expenses rather than capital investments. This indicates a slight shift in how we are allocating funds.

We are performing well with MAGMA and making significant progress in developing Generation 2 and 3 technology. Currently, we have three pilot centers testing components of this technology: one at the innovation center, another in Streetor, Illinois, and a third in Holzminden, Germany. We are on track to meet the timelines for our first line in Kentucky.

All right, guys. I’ll turn it over. Thank you.

Thank you.

And our next question is from Mike Roxland of Truist Securities. Mike, your line is now open. Please go ahead.

Thanks, Andres, John, Chris. Congratulations on another strong quarter. Just following up on George's question, aside from some of the unplanned downtime, are there other issues, John, that you mentioned regarding closing the margin weakness in the Americas? Can you also elaborate on some of the initiatives you're pursuing to restore margins in that region? And quickly in Europe, how sustainable are those 20% margins?

In the Americas, around 55% of our business consists of long-term contracts, compared to about 30% in Europe and roughly 75% in the Americas. Many of these contracts include price adjustment provisions. While we can quickly pass on energy costs in North America, most other expenses are adjusted annually through a price formula that is expected to take effect around January of next year. This results in a lag in cost recovery in the Americas compared to Europe, impacting margins and overall performance next year. In Europe, we have a long-term structural strategy regarding our energy contracts and believe we have strong procurement positions for energy over the long haul. This positions us well for future margins in Europe, particularly given the current high energy risk and cost environment. However, for competitive reasons, we are not extending our strategies beyond that.

Yes. And I think it's important to highlight that the work on the margins in Europe has been going on for several years. So what we see today is the product proposal work. The margin expansion initiatives are contributing, the mix improvement is contributing, and also what we've done over the last year on their current inflation, the very high inflation that we're facing is, we have very strong capabilities in procurement, we have very strong capabilities in commercial, and we are planning well ahead of time. And that gave us the confidence last year that we were going to fully recover inflation, protect the margins, and even have a positive net price. It is the same position that we have today. We are very confident, and we are going to perform well in 2023 for the same reasons.

Got you. That's very clear. Just one quick follow-up on MAGMA capacity. Of the new capacity you're bringing online in Kentucky, can you talk about how much of that capacity is already committed to customers and how much you might be reserving for spot volume? The reason I'm asking is that one of your peers is planning to increase capacity by about 400,000 tons by 2024. So with Kentucky coming online and starting production in mid-2024, do you have 80% committed, 90% committed? Should we be concerned about any increased competition from one of your larger peers?

Yes. So there is no concern about placing that capacity in the market. There are two big blocks driving that demand. One is the fragmented market that is all supplied primarily through imports. That's 1.6 million tons. Once we have capacity in the country to be able to supply that with MAGMA, which is a very good fit for that, it will be a natural fit. So there is no issue with that. We have a growth plan in that market. It's a multiyear plan, and MAGMA is a part of it. Now we will supply spirits customers out of that too, which we have long-term agreements. So that will be secured. And that capacity is going to be right where the demand is. So it's going to be very close to demand and still going to be in a unique position versus other capacities that might be available in the country.

Got it. Thank you. Good luck at the balance of the year.

Thanks, Mike.

Thank you.

And our next question comes from Anthony Pettinari from Citi. Anthony, your line is now open. Please go ahead.

Hi, good morning. I was wondering if it is possible to say what percentage of net capacity you're bringing online in 2023 as a percentage of your current footprint? And then just from a high level, all of the beverage can makers are canceling projects and shutting down plants in some cases. Are you seeing any of this weakness or do you think glass is just rapidly gaining back share? Just wondering if you could talk about what you're seeing on a high level from in the U.S., Brazil and Europe?

Yes, Anthony, I'll touch base on the first one. Over the next three years, part of our expansion program, we're adding capacity to support about 6% growth over a three-year period. We believe, on a run rate basis, we're installing capacity that equals about 1.5% additional new capacity in 2023, but it might be between 1% and 1.5% realized because we're implementing it and rolling it in. Now, we go into 2024, we're going to see more coming online. It's probably our peak new capacity onboarding in that period of time with it starting to trail off a little bit in the subsequent period there. So, Andres, do you want to touch base on the second part?

Yes. So as we shared before during the Investor Day and in some of the previous calls, aluminum cans and glass play in different lanes. So our growth is driven by premium products in spirits, wine, food, non-alcoholic beverages, and beer. And their growth is driven by carbonated soft drinks, energy drinks, sports drinks, bottled water, and hard seltzers. So what's happening to the aluminum industry at this point is related to their position versus those segments, which are different from the segments that are driving our growth. So for our purposes, those two things are separate. That's why we are growing the way we're growing, and you see our performance the way it is.

Okay. That’s helpful. I will turn it over.

Thank you.

And our next question comes from Mark Wilde of Bank of Montreal. Mark, your line is now open. Please go ahead.

Thanks. Good morning. Andres. Good morning, John.

Good morning.

Any way to help us size the cumulative impact on container prices over in Europe once this third price increase is in? Just order of magnitude, what would it do to the cost of a wine bottle if we stack all of these increases on top of each other?

You know, what I can indicate for you, we are not providing forward guidance per se on the current price increase that we have in the marketplace. But if you look at our European numbers in the third quarter, they were up about 18% on a year-over-year basis. That's the cumulative effect of the price increases that we have year-to-date. Obviously, the third price increase would be additive to that to give you a sense of the direction that we have going on here.

Okay. That's helpful. And then, Andres, just for my follow-on, I'm kind of curious, you mentioned the ULTRA light-weighting initiative. Is there any way to quantify the savings from both a cost standpoint, but also just what it does to the weight of the container?

Yes, I can share the target with you. We aim for a weight reduction of up to 30%, which is quite significant. We're already seeing some of the bottles from the innovation center, and it's impressive how light they are. This will have a substantial impact not only on costs but also on sustainability, as CO2 emissions per container will decrease. We plan to start the first commercial trial production at the end of this quarter and will collaborate with the customer during the first quarter of next year to prepare for the commercialization of the first container under these new conditions. I can't disclose exact cost reduction targets at this time, but a 30% weight reduction is quite impactful.

One thing I would add to it is that, another real benefit, Mark, is that as you lightweight and you have furnace pull, right? You can actually get creep capacity out of this so that you'll have more capacity out of any individual furnace because you're using less product in each bottle. So that's another way for us to be able to support the really good growth on a pretty low capital intensity basis going forward.

Okay. That’s helpful. Thanks, John. Thanks, Andres.

Thank you.

And our next question comes from Kyle White of Deutsche Bank.

Hi, good morning. Thanks for taking the question. On volumes, was there any noticeable difference in how demand or volumes trended throughout the quarter? We've seen some other packaging peers talk about a slowdown later in the quarter, but it doesn't seem like you're seeing anything of that nature.

So the cadence was positive along the quarter. July was softer, if you will, August and September were stronger. And as we look at October, we're seeing that in line with our expectations. Obviously, as you know, the current quarter when compared to prior year, that was an out-of-pattern year will be lower, but it's higher than pre-pandemic levels. So it's about 2% higher than the pre-pandemic level. So our volumes are just fine.

Got it. And then on Europe, how much of your energy needs there is already secured for next year? And where are you at regarding the strategy of switching 50% of your capacity to oil versus natural gas? And then longer term, do you think there could be any potential opportunity for share gains from maybe some smaller players that aren’t as protected from the higher energy costs going forward?

We are doing very well in preparing our capacity to handle various fuels. We plan to have 50% of our capacity ready by the end of the year, and that progress is on track. The natural gas situation in Europe has improved significantly since our last call. The measures to reduce consumption have been quite effective, and the milder weather is helping to balance storage levels. Additionally, the increase in liquefied natural gas handling capacity is benefiting the supply. As a result, storage levels are quite high, exceeding 90% and even reaching the high 90s in some countries. Overall, the situation looks much better than before, and we are prepared with capacity.

Regarding the energy contracts, we adopt a long-term strategy for our agreements that were secured for 2023 prior to the current market conditions. Therefore, we are in a strong position. For competitive reasons, we do not disclose specific figures. However, even with this favorable situation, we face significant inflation through indirect costs and other factors. It is essential for us to achieve good net price realization to offset these challenges, including inflation in areas like SG&A, interest, and capital expenditures. We closely manage our net pricing on a cash basis to ensure we maintain robust cash flow, which is vital for supporting our investments in the company.

Yes. There is something that we don't mention very often, which is, how is our position with customers evolving? When we look at our position from a quality service perspective and overall performance with our customers measured through Net Promoter Score, it has been improving significantly over time. And we are, in some places, in some markets at very high levels at this point. So there has been a solid evolution in our relationship and service with customers, which puts us in a good position going forward.

Sounds good. I’ll turn it over.

Thank you.

And our next question comes from Gabe Hajde from Wells Fargo. Gabe, your line is now open. Please go ahead.

Andres, John, Chris, good morning.

Good morning.

I was hoping you could help us understand or compare and contrast what a recession might look like. Some patterns seem consistent with 2008 and 2009, while others are different. The inflation affecting consumers is for different reasons compared to the strategy O-I used about 14 years ago. Can you explain why you think the negative impact might be limited to 1% to 3%? I appreciate that the market declined by a similar amount during the global financial crisis. However, if we look critically at the situation, with consumers facing significant inflation, why might we not see a similar drop in volumes as we did in 2008 and 2009 compared to your current projections?

Okay, let's discuss the situation in 2008 and 2009 compared to now. There are several reasons for the differences. First, regarding pricing, we are currently aligned with the market, whereas back then we were not. This change profoundly affects our position. The fundamentals driving glass demand today are strong across all markets, which is a significant departure from the perception of glass being in a long-term decline during that time. The current drivers of demand in various markets are not heavily influenced by GDP, as seen with the trend of localization of global brands that is occurring worldwide. Additionally, Europe faces a supply situation with over 1 million tons of capacity, highlighting the importance of securing supply for everyone involved. In several key markets for O-I, there is a considerable import of ware exceeding 2.5 million tons, specifically in key locations such as Italy, France, North America, the Andean region, and Brazil. Furthermore, glass has proven to be resilient to shifts between on-premise and off-premise consumption, and during a recession, home consumption is expected to rise, which benefits glass. Lastly, our current pipeline of new business opportunities totals 1.7 million tons, which is noteworthy compared to previous years. Overall, many of these conditions and others are markedly different from what we experienced in 2008 and 2009.

I would like to add two points to that. Firstly, over the past ten years, we have seen an improvement in our shift towards more premium categories, which are often viewed as affordable luxuries. Even during challenging times, people are likely to purchase items like a bottle of bourbon, which has shown steady growth over time. In fact, during 2008 and 2009, these same categories experienced growth while more mainstream products faced declines. Moreover, as noted previously, mainstream beer only constitutes 3% of our global volume, and it was the category most affected during the global recession of 2008 and 2009. Therefore, our exposure is somewhat lower in this area.

No, I appreciate the thorough answer. We tend to agree with you. I just want to tee some of that. All right. And then can you quantify for us, given that you take a mile-type thing on the '23 view, just where corporate expense you expect that to land this year and sort of if there's something, I guess, maybe nonrecurring in nature there, why it would be down next year? And then the, I guess, rebuild activity if you can quantify that for us just to help us kind of build the bridge.

Corporate expenses this year are elevated, expected to be around $220 million, which represents a $50 million increase compared to last year. There are two primary factors contributing to this. First, management incentives are up by about $30 million due to a good year. Second, we are experiencing about $20 million in cost inflation, notably in insurance costs. Additionally, there are approximately $60 million in elevated R&D costs included in this figure for higher MAGMA and ULTRA costs. These costs will persist for a few years, but once Gen3 and ULTRA are commercialized, we anticipate some reduction. It's important to understand the trend in corporate expenses. For next year, we expect a reduction of about $25 million to $30 million just from adjusting management incentives. We will provide more details on the overall corporate expense situation during the year-end call. Regarding rebuild activity, we are likely returning to a more typical level of around 12 to 14 furnaces a year.

Thank you. Good luck.

And our next question comes from Arun Viswanathan from RBC Capital Markets. Arun, your line is now open.

Great. Thanks for taking my question. I guess I just wanted to ask first on the earnings bridge. So you called out about $0.25 of headwinds. And then you've also discussed price mix, volume, and price and then volume mix and so on as potential tailwinds. How would we kind of parse that out? I guess, is it mostly volume mix as the variable factor? Or what would you say is kind of the biggest uncertainty if you look forward into '23?

As we look to 2023, the key factor will be net pricing in this environment. Volume and mix are expected to be somewhat flat, leading to a more muted impact in that area. Therefore, net pricing remains the most significant lever we have, while other factors are more variable. The pace of cost inflation is always challenging to predict. We anticipate elevated cost inflation, though not at the levels we saw in 2022, but still substantial due to the persistent higher costs flowing through the value chain, including raw material and labor costs. This uncertainty is one of the key concerns. Regarding volume, we provided a sensitivity range indicating that recessionary pressures could impact us by 1% to 3%. While we do not foresee those pressures currently, we wanted to highlight this sensitivity within our current perspective.

And just to clarify, so do you believe that 1% to 3% or say or some kind of in the low single-digit range is the more long-term growth rate that we should expect in the glass containers? Is there anything that would maybe push that up as far as substrate conversion or anything else? And then the other question I had was, when do you expect that $700 million plus of CapEx to kind of come down? And if so, what level do you think that is really sustainable over the long term? Thanks.

Yes. Yes. As far as long-term growth, don't equate the 1% to 3%, that's our sensitivity to any type of recessionary pressures. But if you go to page four of the materials, we give the projected long-term growth, which is anywhere from, say, 2% to 4% of sales volume growth in applicable markets that we operate in, okay? So that we believe is the long-term growth rates. And in fact, we've been growing at about 0.5% this last quarter. But the feeling behind it is still low single-digit type of demand environment out there, just obviously we're capacity constrained in that regard. And as far as the CapEx, obviously, 2023 will be the most elevated environment for the expansion capital. That's the biggest driver there, but we aren't giving views on CapEx levels, for example, in 2024 yet.

And our next question comes from Adam Josephson from KeyBanc. Adam, your line is now open. Please go ahead.

Andres and John, good morning. Thank you for taking my questions. Earlier, Anthony inquired about the demand for cans versus glass. You noted that cans are used for soda, sparkling water, hard seltzer, and energy drinks, and that the consumption of these products is being influenced by price increases and declining disposable incomes. I'm still a bit puzzled as to why demand for premium products appears to be holding up better than that for soda and sparkling water, especially if we're facing a recession. It seems like premium products would be more adversely affected than soda. Can you clarify this dynamic for me and share what gives you confidence that the demand for premium products will remain strong compared to soda?

Consumers of premium products are generally able to afford them and tend to maintain their preferences for these products during a recession, which has been observed in previous economic downturns. There has been considerable effort to determine if customers are switching to lower-tier options, but early indications do not clearly show this shift. The trading down typically occurs at the lower tier, where pure commodity products and slightly elevated options might see some transition due to consumer sensitivity to pricing. Furthermore, it’s important to note that the mainstream beer segment has faced ongoing demand challenges. Our growth performance has been significantly impacted by this category over the years. We have emphasized diversifying into expanding areas, particularly premium products like food, non-alcoholic beverages, and premium spirits. As a result, the share of mainstream beer in North America has decreased from about 40% to 13%, and globally it's down to just 3%. Consequently, as we look ahead, the segment that is most vulnerable is shrinking. Additionally, in the United States, there are imports reaching as high as 1.6 million tons annually. We acquired a distribution organization, OIPS, through our partnership with Vitro and have been developing it effectively, which allows us to tap into volumes we previously did not have access to. This development is favorable for our performance as we navigate through these challenging times.

Thanks, Andres. John, regarding the Italian subsidy, I wasn't aware of a subsidy in Italy. Can you explain why you received it? Were you anticipating it? Do you expect further subsidies? I would appreciate any details you can provide.

Yes, we were aware of a potential subsidy going into the third quarter, but it wasn't fully quantified or confirmed until later in September. The subsidy amounted to about $13 million, which was approximately $6 million higher than our initial estimate. However, we also faced at least $10 million in additional cost inflation in Europe. As a result, the overall impact is less significant compared to our original guidance. Historically, Italy has provided various credits and has mechanisms like white certificates to manage these incentives, helping to encourage development and expansion within industries. This isn't unexpected as it's part of legislative measures in Italy. In our previous quarterly call, we noted that despite the rising energy situation, we had strong support from governments like Italy and elected officials in France for our industry. So while the subsidy was a bit larger than we anticipated, the cost inflation was also considerable.

Thanks, John.

And our next question comes from Jay Mayers from Goldman Sachs. Jay, your line is now open. Please go ahead.

Hi, everybody. Thank you for getting me in here. I was wondering if you could just kind of decompose the minus 2% shipment number in the Americas. How much of that was these unplanned downtime impacts versus outright just demand in Latin America/Brazil and North America? I mean, you do note that you have maintained a sold-out position in Latin America, no comment on North America. Is there anything fundamentally you're seeing from a demand perspective in North America?

Yes. I would say that there are two primary drivers for the 2% down. It was down in Brazil, where we had, as I mentioned earlier, a large furnace rebuild. So that was the driver for that, the sole driver for that. In fact, if it wasn't for that, there's strong double-digit demand backed up in that marketplace. So whatever we can produce, we can sell in that market. And then the other reason was in North America, I think it was a combination of two factors. One is we did have some incremental unplanned downtime. Same situation; inventories are relatively low; if there's a little bit of lower production than anticipated, that impacted sales. The only area where we saw a little bit of weakness across our global network in the quarter was in beer in North America, and that was probably fundamentally from a demand standpoint, a couple of percent down from what we anticipated. But it wasn't a major driver of the overall performance for the company.

Looking at Brazil and the Andean region, the market is characterized by customers' focus on growing premium products. This category has been quite small, but there is a significant opportunity ahead. Customers are focusing on premium products and are localizing global brands in these markets. There is a shift occurring from returnable containers to one-way containers, particularly glass, due to convenience for certain consumption occasions. This transition is progressing well, and users are embracing our containers for both affordability and sustainability. Overall, user numbers are increasing in these regions, but we are currently limited by capacity. Our inventories do not aid in increasing capacity, but we are working on adding incremental capacity in those markets.

That's helpful. Thank you. And then, John, just a quick follow-up. On some of the leverage comments you made targeting kind of low threes by the end of next year, but it did sound like you were talking about longer term getting below that three number. Can you talk a little bit about just kind of how you're thinking about long-term leverage on the business? Like what is the right number? And why is it that number?

Yes. We believe that being a strong BB corporation is advantageous, especially in a rising interest rate environment. Our target for leverage is decreasing, and we consider mid to low threes to be a suitable range. However, with the current higher interest rates, we believe that maintaining leverage below 3 times is the best approach for the company. This strikes a good balance between capital allocation for value creation and maintaining a healthy balance sheet while being conscious of the interest rate environment. We are also focused on having an appropriate spread in our interest rate funding position.

Thank you very much.

Thank you.

And there are no further questions. I would like to hand the call back to Chris for any closing remarks.

Okay. This concludes our earnings call. Please note that our year-end call is currently scheduled for February 1, 2023. And remember, make it a memorable moment by choosing safe sustainable glass. Thank you.

This concludes today's call. Thank you for joining; you may now disconnect.