Owens-Illinois Inc. (OI) delivered earnings per share of 90 cents in its second quarter, falling short of the Zacks Consensus Estimate of 91 cents as well as the year-earlier profit of 94 cents.
 
The decline was due to lower revenues in Europe (the company’s largest segment), lower shipments and inconsistent recovery across North America and Europe on sluggish beer demand. These headwinds more than offset the accelerated economic recovery in South America and China, and higher selling prices implemented to combat cost inflation.
 
The reported and year-ago quarter’s EPS excludes after-tax restructuring charges and asset impairment of 5 cents and 3 cents, respectively. The second-quarter 2009 EPS was further impacted by a 3-cent charge for note repurchase premiums and write-off of finance fees, net of related interest rate swap settlements. Including these one-time items, EPS was 85 cents for the quarter under review compared with 88 cents in the year-ago quarter.
 
Total revenues dipped 5% year over year to $1.7 billion and missed the Zacks Consensus Estimate of $1.8 billion mainly due to unfavorable foreign currency translation effects. Sales decreased in all regions, except Asia Pacific, which posted a 16% growth.
 
Higher price and product mix contributed 1.3% to sales. Global shipments were down 1.8% as shipments in North America were impacted by lower volumes following the renegotiation of contracts that went into effect in January. However, excluding this impact, global shipments were up 1.7%.
 
Costs & Margin Performance
 
Manufacturing, shipping and delivery expense dropped 6% year over year to $1.3 billion in the quarter and as a percentage of revenue, declined 70 basis points to 76.8%. Gross margin upped 65 basis points to 23.5% in the quarter. Selling and administrative expenses increased 3% year over year to $125.6 million and as a percentage of sales, rose 50 basis points to 7.3%.
 
Segment operating profit dropped to $287 million from $292 million in the year-ago quarter, affected by unfavorable foreign currency translation. The foreign currency impact was $17 million, reflecting a weaker Euro compared to the U.S. dollar and the translation of the company’s Venezuelan operating results at a devalued exchange rate. However, adjusted for currency translation, operating profit increased year over year driven by a higher price and product mix, which more than offset the cost inflation of $18 million in the quarter.
 
Large-scale restructuring from the company’s strategic footprint alignment initiative is now complete. Since its initiation in 2007, the company has reduced annualized fixed costs by $213 million, which included $18 million in the reported quarter. The benefit of footprint initiative savings and overall higher capacity utilization during the second quarter more than offset other incremental costs related to the North American realignment efforts.
 
Segment Performance
 
Since the nature of the glass packaging markets calls for proximity of manufacturing locations to points of sale, the company’s segments are classified into geographical regions.
 
Asia Pacific, where the company operates in just four countries and still remains the market leader, was the only region to book overall growth in the reported quarter. Revenues increased 16% to $223.1 million and operating margin expanded 790 basis points to 13.8%.
 
Europe, the company’s largest market contributing 42% to total revenue, saw the highest revenue decline in the quarter of 10% year over year to $715.5 million.  Segment margin contracted 60 basis points to 14.6% in the quarter.
 
Revenues in North America dropped 8% year over year to $516.2 million and segment margin also dipped 140 basis points to 17%. Furthermore, revenues in South America went down marginally by 1% to $247.6 million. However, its segment margin expanded 320 basis points to 26% in the quarter due to strong growth in higher-margin businesses in the region.
 
Financial Position
 
Owens-Illinois had cash and cash equivalents of $682.3 million as of June 30, 2010, down from $188.2 million as of March 28, 2010. The company generated cash flows of $150.1 million from operating activities in the quarter, significantly less compared with $211.7 million in the year-ago quarter.
 
As of June 30, 2010, the debt-to-capitalization ratio was flat at 69.5% compared to 70% as of March 30, 2010 and 72% as of June 30, 2009.
 
During the quarter Owens-Illinois issued $690 million of 3% exchangeable senior notes due in 2015, the proceeds of which were utilized for repaying $450 million 8.25% senior notes due in 2013 and repurchasing 1.6 million shares for $55 million.
 
During the quarter, in line with Owens-Illinois’ objective to grow through strategic acquisitions and joint ventures in rapidly growing markets, the company formed a joint venture with Thailand’s Berli Jucker Public Co. to buy four plants from Fraser & Neave Holdings Bhd.’s Malaya Glass operations for $221.7 million. The purchase price included debt and minority interests, of which Owens-Illinois’ portion was $132.4 million and was funded from the above-mentioned proceeds.
 
Asbestos-related cash payments during the second quarter of 2010 were $43 million, down from $49 million in the prior-year quarter. New lawsuits and claims filed during the first half of 2010 declined 29%. The number of pending asbestos related lawsuits and claims was approximately 6,400 as of June 30, 2010, down from approximately 6,900 as of Dec 31, 2009.
 
Outlook
 
Management did not provide any guidance for the upcoming quarter or the fiscal year. However economic recovery is expected to continue, though the improvement may vary given strong growth in the emerging markets and sluggish beer demand in North America and Europe.
 
The company noted that pricing will depend on input cost trends and overall demand patterns. As its strategic footprint initiative is essentially complete, the company expects higher capacity utilization compared with the prior year. However currency trends are likely to affect results. The company has additional strategic activities up its sleeves that will deliver further growth.
 
Our Take
 
Owens-Illinois is attempting to cut down costs, improve margins and enhance free cash flows. The company should be able to pursue acquisitions, joint ventures and new plant constructions. Owens-Illinois is particularly focused on entering or expanding its presence in rapidly growing markets with existing preferences for glass. The company concentrates more on Asia Pacific and Latin America given the fact that these markets collectively represent more than 50% of global glass consumption.
 
However, the company’s substantial debt could result in a major outflow from operations. Further, the company has asbestos liabilities and may need to record additional charges in the future for estimated asbestos-related costs.
 
Overall, we believe Owens-Illinois’ low near-term revenue visibility, competitive environment and continued weakness in some end-markets will continue to undermine the company’s growth prospects and profitability.
 
Perrysburg, Ohio-based Owens-Illinois is the world’s largest glass container manufacturer for food and beverage products, including beer, wine, spirits and non-alcoholic drinks. The company commands market leadership in each of its four operating regions ─ Asia Pacific, Europe, Latin America and North America.
 
 
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