Q2 2011 Earnings Call
July 28, 2011 8:30 am ET
Edward White - Chief Financial Officer, Principal Accounting Officer and Senior Vice President
John Haudrich - Vice President of Investor Relations
Albert Stroucken - Executive Chairman, Chief Executive Officer, President and Member of Risk Oversight Committee
Ghansham Panjabi - Robert W. Baird & Co. Incorporated
Thomas Mullarkey - Morningstar Inc.
Phil Gresh - JP Morgan Chase & Co
Philip Ng - Jefferies & Company, Inc.
Alex Ovshey - Goldman Sachs Group Inc.
James Armstrong - Henry Armstrong Associates
Alton Stump - Longbow Research LLC
Timothy Thein - Citigroup Inc
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Good morning. My name is Angela, and I will be your conference operator today. At this time, I would like to welcome everyone to the O-I Second Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. John Haudrich, Vice President of Finance. Sir, you may begin your conference.
Thank you, Angela. Good morning, and welcome, everyone, to O-I's second quarter 2011 earnings conference call. I'm joined today by Al Stroucken, our Chairman and CEO; Ed White, our Chief Financial Officer; and several other members of our senior management team.
Today, we will discuss key business developments, review our financial results for the second quarter and discuss future trends affecting our business in 2011. Following our prepared remarks, we'll host a question-and-answer session. Presentation materials for this earnings call are also being simulcast 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.
Unless otherwise noted, the financial results we are presenting today relate to adjusted net earnings, which exclude certain items that management considers not representative of ongoing operations. A reconciliation of GAAP to non-GAAP earnings can be found in our earnings press release and in the appendix to this presentation.
I'll now turn the call over to Al, who will start on Chart 2.
Thank you, John, and good morning. Our second quarter 2011 adjusted earnings were $0.59 per share, down considerably from $0.84 last year. Clearly, we are disappointed with these results, and our performance was unacceptable. Adding into the second quarter, we expected our earnings would be in line with the prior year despite elevated cost inflation. However, we incurred significantly higher manufacturing costs, which more than offset the benefit of higher shipments on a global basis.
Market demand has started to rebound after several years of unfavorable trends in our business. Shipments in tonnes were up more than 6% in the second quarter, driven by recent acquisitions as well as organic growth. In fact, demand was up across all key end-use categories on a global basis. This should have been a very favorable environment for O-I, given our work in the past to create significant operating leverage from improving demand. However, we incurred much higher manufacturing costs due to elevated cost inflation, production issues in North America and market challenges in Australia and New Zealand. Cost inflation accounted for most of the additional manufacturing costs. While inflation was not a surprise, energy prices in Europe have increased faster and to a greater extent than we expected adding into the year. And we have discussed this trend in detail during previous earnings calls.
We have implemented an energy surcharge in Europe to help offset the impact of the most recent spike in energy pricing. The combination of our surcharge this year and expected higher selling prices next year should fully offset the impact of 2011 cost inflation on a global basis.
In North America, poor operating performance resulted in manufacturing inefficiencies and supply chain issues. As a result, we incurred higher production and logistics costs as well as additional expenses for product loss. Challenging market conditions in Australia and New Zealand resulted in choppy, lower demand in those countries. And in response, we reduced our production to match supply with demand, which led to a higher unabsorbed fixed cost in Asia-Pacific.
As we respond with urgency to these issues, my leadership team and I are focusing on our core operations to restore high productivity level. We also need to significantly improve our ability to generate a more accurate business forecast. Serving our customers and maximizing our long-term earnings are our highest priority. Despite our disappointing operating performance, we can point to a number of positive developments this past quarter. Organic growth was 3%, excluding the impact of a much lower demand in Australia and New Zealand. We generated $97 million of free cash flow, and we acquired the remaining interest in our 7 Brazil operations from our minority partner. O-I will now fully benefit from future growth and profit improvement in the attractive Brazilian market. And finally, we refinanced debt to extend maturities and increase financial flexibility.
Looking to the third quarter, we expect shipments will be up in all regions and end uses on a year-over-year basis. As we focus on fully restoring our operating performance, we will still incur higher manufacturing costs during this transition period. And as a result, we expect third quarter adjusted earnings will improve from our second quarter results but likely lag the prior year. Looking to the full year, we have revised our 2011 free cash flow target for a number of reasons. In Australia, we are restructuring our footprint in response to changes in demand. This will result in additional capital spending and severance costs. In North America, we will rebuild inventory levels to avoid repeating significant supply chain disruptions as demand improves. And in Europe, we expect some restructuring costs as part of the purchase price for our recent VDL acquisition. And finally, we will invest in capacity expansion in South America to improve margins and support growth. As a result, our 2011 free cash flow target has been reduced from $300 million to between $200 million and $250 million.