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Executives

John Haudrich - Vice President of Investor Relations

Albert P. L. Stroucken - Executive Chairman, Chief Executive Officer, President and Member of Risk Oversight Committee

Stephen P. Bramlage - Chief Financial Officer

Analysts

Phil M. Gresh - JP Morgan Chase & Co, Research Division

George L. Staphos - BofA Merrill Lynch, Research Division

Ghansham Panjabi - Robert W. Baird & Co. Incorporated, Research Division

Alton K. Stump - Longbow Research LLC

Alex Ovshey Ovshey - Goldman Sachs Group Inc., Research Division

Deborah Jones - Deutsche Bank AG, Research Division

Albert T. Kabili - Crédit Suisse AG, Research Division

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division

Scott Gaffner - Barclays Capital, Research Division

Todd Wenning - Morningstar Inc., Research Division

Philip Ng - Jefferies & Company, Inc., Research Division

Owens-Illinois (OI) Q2 2012 Earnings Call July 26, 2012 8:30 AM ET

Operator

Good morning. My name is Angela, and I will be your conference operator. At this time, I would like to welcome everyone to the O-I Second Quarter 2012 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Jason Bissell, Director of Investor Relations. Please go ahead.

John Haudrich

Thank you, Angela. Good morning, and welcome everyone, to O-I's Second Quarter 2012 Earnings Conference Call. I'm joined today by Al Stroucken, our Chairman and CEO; Steve Bramlage, our Chief Financial Officer; and several other members of our senior management team.

Today we will discuss key business development, review our financial results for the second quarter, and discuss future trends affecting our business in 2012. Following our prepared remarks, we will host a question-and-answer session. Presentation materials for this earnings call can be obtained from 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 operation. A reconciliation of GAAP to non-GAAP earnings can be found in our earnings press release and in the appendix to this presentation.

I will now turn the call over to Al.

Albert P. L. Stroucken

Thank you, Jason, and good morning. O-I posted strong results for the second quarter with earnings of $0.81 per share compared to adjusted earnings of $0.59 in the second quarter last year. We have made good progress regaining manufacturing and supply-chain efficiencies. This has been most evident in our North American region, which had the largest year-over-year improvement in the second quarter of any of our segments. On the other hand, macroeconomic conditions in Europe continue to generate uncertainties, and our business in that region has been impacted by slower sales this quarter. As a result, we have implemented production curtailments in Europe to balance capacity with customer demands and to ensure that we meet our cash flow targets.

I am pleased to introduce our new Chief Financial Officer, Steve Bramlage. We welcome Steve back to Perrysburg after serving 2 years in leadership roles in our Asia-Pacific region. And for those who do not know Steve, he joined O-I in 2006 as our Corporate Treasurer and then became our Finance Lead in Europe, followed by a term as our Corporate Controller. He moved to New Zealand in 2010 to lead our operations there, and subsequently became President of our Asia-Pacific region. Steve will now review our financial results, after which I will provide an overview of our region's performance in the quarter. Steve?

Stephen P. Bramlage

Thanks, Al. It's nice to be on the call this morning and I look forward to working with all of O-I's stakeholders in my new role. I would also like to take this opportunity to thank Ed White for his first many years of dedicated service and leadership to O-I, as well as for assisting me in the CFO transition over the past month.

Now let's move to Chart 2 and review the second quarter reconciliations for sales, operating profit and earnings per share. Second quarter 2012 segment sales were nearly $1.8 billion. Price and mix in the quarter were up $82 million or more than 4% from the prior year. As in prior quarters, cost pass-through provision had a small impact on sales. These provisions are in certain customer contracts and are principally for fluctuations in energy costs. Lower sales volumes decreased the top line by $95 million this quarter. This impact was primarily due to lower sales in Europe, which were partially offset by higher sales in the North and South American regions.

Finally, currency translation had the most significant impact on the top line, reducing it by $159 million in the quarter, primarily due to a 12% decline in the euro and a 25% decline in the Brazilian real from the prior year quarter.

Moving over one column to segment operating profit. The second quarter was $266 million, up $42 million from the same period last year. Globally, price/mix improvements stayed ahead of inflation by $30 million this quarter and this has helped recapture some of last year's unrecovered inflation. Lower sales volumes impacted segment profit by $26 million in the quarter. Manufacturing and delivery costs were $49 million lower than the second quarter of last year, and were the main drivers of higher segment profit.

The primary reason for this year-over-year improvement relates to our actions to regain manufacturing and supply-chain efficiencies, especially in our North American region. In addition, the permanent footprint adjustments that we have taken in Australia over the past year have reduced fixed costs, increased asset utilization and improved the competitive position of this business versus the prior year.

Moving to operating and other costs, they were $12 million lower than the prior year as a result of global cost reductions. Lastly, lower foreign currency exchange rates reduced the translation of our operating profit by $23 million as compared to the second quarter of last year.

Finishing with the EPS reconciliation, our net income was $0.81 per share in the quarter compared to adjusted earnings of $0.59 in the prior year. Operating profit, driven by the items we just discussed, was up $0.18 from the prior year. Nonoperational items were also favorable by $0.04 a share.

Within this category, there were 2 significant items that offset each other. First, similar to the first quarter, corporate and retained costs were higher than the prior year quarter as a result of reduced earnings from lower machine and equipment sales, as well as higher incentive compensation costs. Offsetting this was lower year-over-year net interest expense due to redemptions of higher cost debt in the second quarter of 2011.

Finally, there were no items in this quarter that management considers not representative of ongoing operations. Therefore, the Note 1 table of the earnings release only shows prior year items.

Let's move to Chart 3 for more detail on our balance sheet and free cash flow. On June 30, 2012, cash was $336 million and total debt was approximately $4 billion. Therefore, net debt was $3.7 billion, a decrease of nearly $400 million from the second quarter of last year. This was due to the impact of currency translation and debt pay down. Our net-debt-to-EBITDA ratio was about 2.8x at the end of the second quarter, well below the prior year quarter and within our target range of 2x to 3x EBITDA.

Shifting to cash flow. As you recall, at the beginning of the year, we introduced an expanded cash flow metric called underlying free cash flow. This was defined as our traditional free cash flow measure, plus the add back of certain capital spending in China. This capital spending was added back since it will ultimately be funded by government agencies purchasing 2 legacy plant sites for redevelopment. This will allow us to relocate these facilities without impacting overall cash flow.

At the beginning of the year, we anticipated a $50 million capital spend in 2012 in China to begin the relocation. But we have now slowed the spending to approximately $20 million for this year. Given this scaling back of capital spending in China, we have decided to simplify our reporting and eliminate the underlying free cash flow metric and just report on free cash flow. In addition to deferring capital spending in China, we have also pruned our capital spending in other regions for the remainder of the year. These actions will maximize our financial flexibility during this period of macroeconomic uncertainty and ensure we have the ability to meet our cash flow targets for the year. At this time, and at the current exchange rates, we estimate that our total capital spending will not exceed $350 million in 2012.

Moving back to the second quarter, we generated $49 million of free cash flow, which was about $50 million less than the prior year quarter. Higher working capital levels this quarter more than offset stronger earnings and lower capital spending. You will recall that we had insufficient inventory levels in North America last year during the second quarter, so we rebuilt inventories to ensure that we could effectively service our customers.

In Europe, we also increased inventory levels in the first half of this year to ensure appropriate supply. This inventory allowed us to subsequently take several furnaces cold, and is both a cost and a cash effective way to manage production downtime and balance supply with the lower demand. Cash flow will be positively impacted as inventories are reduced in the second half of the year.

Finally, on the right-hand side of the chart, you can see that we are managing our leverage ratio down and we continue to move towards the lower end of our target range. We will continue to focus on debt reduction over the next year. Let's now move to Chart 4 to review second quarter operating profit. As previously mentioned, total operating profit was $266 million in the second quarter, up from $224 million last year. As you can see on the chart, the increase in profit this year was led by North America's much improved performance.

We have also included second quarter 2012 segment profit on a currency-neutral basis for easier year-over-year comparison, and to highlight underlying operating performance more clearly. On a currency-neutral basis, total segment operating profit in the second quarter was $289 million, a significant increase over the prior year quarter.

I will now turn the call back to Al, who will give some additional perspective on our regional business performance.

Albert P. L. Stroucken

Thanks, Steve. As you can see on Chart 4, our European operating profit was $107 million in the second quarter of this year, down $5 million from the prior year second quarter. As shown, profit adjusted for currency was up slightly. Higher prices this quarter more than covered inflation and allowed for the recovery of some of the margin erosion that we experienced last year. Offsetting these gains were lower shipment levels, which were down approximately 11% from the prior year quarter. The weakness in shipments was most pronounced during the month of May.

As we saw in the first quarter, year-over-year sales volumes continue to vary considerably by country and end market. Wine bottle shipments, especially in southern Europe, accounted for the majority of our lower volumes in the quarter. This was caused by weaker macroeconomic conditions, generally poor weather, as well as some share shift to smaller competitors due to our margin repair pricing strategy.

Beer glass container volumes were down to a lesser extent in the quarter, likely aided by the Euro Cup Football Tournament and preparations for the upcoming Olympics. Given the lower wine volumes expected in Europe for the remainder of the year, we began to adjust capacity to align our operations to customer demand. At the end of the second quarter, we idled 5 furnaces in Europe and we permanently closed a small, older furnace in the region. Further potential permanent footprint activity is under active consideration and is likely to be ready for a decision later in the second half, following the completion of the summer shipping season.

In North America, operating profit was $96 million, up from $50 million in the prior year. Year-over-year shipments were up slightly this quarter, led by good wine and spirit volumes. We are pleased with the significantly improved manufacturing and supply chain performance in this region, especially compared to our sobering second quarter last year. These operational improvements, as well as cost-cutting initiatives, have led to North America nearly doubling their profit level from the same quarter last year.

We would like to thank Miguel Escobar and his team for their hard work in achieving this turnaround, and we share our employees' pride in this accomplishment. After 20 years with O-I, Miguel has decided to return to his native Colombia to pursue another opportunity. We thank him for his many contributions to O-I and wish him well. Effective August 1, [indiscernible], who comes to us from Constellium, formerly known as Alcan Engineered Products, will succeed Miguel as our President of O-I North America.

Moving to Asia-Pacific. Operating profit was $16 million, up from $9 million in the second quarter of 2011, despite $3 million of currency headwind this quarter versus the prior year. Although the shipment levels in Asia-Pacific were down nearly 6% in the second quarter, we continue to see improved profitability and competitiveness from our Australian footprint initiative and other cost-savings measures. Nevertheless, given the continued sluggishness of the Australian wine and beer markets, as well as the fact that we are still negotiating major customer and union contracts, further capacity actions may be necessary.

To date, we have spent $25 million of the anticipated $50 million restructuring program in Australia. Additional activity to complete this program will be managed to ensure that further spending is offset by cost savings so that our cash flow goals are achieved. And finally, to our South American region, operating profit was $47 million, down from $53 million in the prior year second quarter. However, adjusted for currency, profit was actually higher compared to the same quarter last year.

Total shipments in the region were up slightly and we saw growth in Brazil largely offset by lower year-over-year beer shipments in Peru. This volume change improve was due to the introduction in 2011 of a new returnable product in the beer market, which created a spike in shipments in the second quarter last year. Overall, our second quarter performance was pretty solid in a very turbulent macro environment.

Moving to the third quarter outlook on Chart 5. We expect that 3 of our 4 regions will generate operating profit in line with, or slightly higher than, prior year. European profit levels will be down from the prior year. And let's briefly review each region. Starting with Europe. As you know, the euro has devalued substantially during this year and at current exchange rate, will result in an approximate 14% translation headwind to operating profit in the third quarter. Given this impact, as well as higher production downtime, our European third quarter segment profit will lag the prior year by a significant amount. Our current expectation is that sales volumes will be down mid- to high-single digits from the prior year, and production volumes will be down double digits as we manage inventory down.

As you recall, European operating profit in the first quarter benefited from our planned inventory build and the associated favorable cost absorption. We build inventory levels in the first quarter to support anticipated seasonal demand and because macroeconomic indicators looked stronger at that time. Now that market demand levels have declined, we have curtailed production in Europe to balance supply and demand, as well as adjust inventory levels.

Therefore, increased unabsorbed fixed costs in the third quarter are expected to offset the higher profit realized in Europe during the first quarter this year. However, partially offsetting these lower volumes, we expect that the price increases we have already achieved will more than cover inflation in the third quarter. And this will aid in recapturing some of last year's unrecovered inflation.

In summary, for Europe, unfavorable exchange rates are likely to continue to pressure our second half profit there. But however, on a currency-neutral basis, our full year profit level in Europe is expected to be flat compared to the prior year, despite the economic headwinds.

In North America, we expect operating profit to be up slightly versus the prior year third quarter. Keep in mind that we operated our North American region at a high-production rate in the third quarter of last year to replenish inventories. And this led to a very favorable fixed cost recovery. For the third quarter this year, we're planning to run this region at normal operating rates so the benefits from the fixed cost absorption are not expected to repeat. Regarding sales volumes. We expect third quarter shipments to be flat with the prior year quarter and price should also more than cover inflation.

Moving to Asia-Pacific. We expect lower consumer confidence or low consumer confidence and high personnel savings rates will continue to weigh down the wine and beer markets in Australia and New Zealand. But we should see improved earnings from our fixed cost savings measures. Overall, we expect Asia-Pacific's operating profit in the third quarter to be up slightly from the prior year quarter.

And finally, our South American region's operating profit will likely be flat in the third quarter compared to the prior year period. The impact of weaker currencies, especially the Brazilian real which, at current exchange rates, would be more than 20% below the prior year third quarter, will offset expected benefits from higher sales volume. Also, we plan to complete construction on our new furnace in southern Brazil in the third quarter and be ready to start production later this year.

In summary, currency translation headwinds in most regions, as well as lower sales and production downtime in Europe, will likely result in lower overall third quarter adjusted earnings compared to the prior year. Regarding overall sales volumes, despite challenging European market trends, we expect that stronger business conditions in other regions should lead to our global shipment levels being down by low- to mid-single digits in the back half of the year. We are seeing robust business trends in Brazil, which we expect will lead to improved volumes in South America, and we also expect steady year-over-year volume trends in our North American business.

Concluding, looking to the balance of 2012, we are confident that we will continue to see good performance from most of our regions. However, our business in Europe, like in many other countries, continues to face challenge. As we stated, we're managing supply and demand by idling capacity in Europe and as a result, the unabsorbed fixed cost associated with production downtime will pressure earnings in the second half of the year. However, we are prudently managing our business and we have greater confidence in our ability to achieve our cash generation goals.

Given our year-to-date performance and our outlook for the remainder of the year, at today's exchange rates, we now expect our free cash flow to be at least $250 million for the full year, an improvement over our initial forecast.

Thank you and I now will ask Angela to open up the lines for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question is from Phil Gresh with JPMorgan.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

So I just want to address the unabsorbed fixed cost. I think at the beginning of this year with your fourth quarter slide, you talked about a $40 million impact from underproduction. So I just kind of wanted to come back to that. You talked about $20 million unabsorbed cost in Europe in this quarter, but that's kind of making up for what happened in the first quarter. So where do you stand on a full year basis? And does that mean fourth quarter could have a more meaningful impact for underproduction.

Albert P. L. Stroucken

I would say, Phil, over a total year period, because of the weaker season that we saw in the second quarter, the actions to reduce inventory are a bit stronger than we had initially anticipated. So I would say it's in the $40 million to $50 million dollar range at this point in time, with regard to unabsorbed fixed cost for the year.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Okay. So then -- so what is the overall impact that we saw in the first half then if it was positive first quarter? Just roughly in the first half.

Stephen P. Bramlage

Phil, it was approximately $20 million to $25 million in the first half.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

On the positive?

Stephen P. Bramlage

On the positive, correct.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Okay. And then just an update on the price cost situation. I know you had initially kind of thought price would be around 5% for the full year, for this quarter is around 4%. Do you expect an improvement in price at the back half or is it a little bit lower than what you're thinking? And also, just on the input cost side and what are you thinking?

Albert P. L. Stroucken

I think it will most probably stay in that range. We might see some slight improvement because of some pricing activity that typically occurs in Latin America in the second half of the year rather than in the first half of the year.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

And your next question is from George Staphos with Bank of America Merrill Lynch.

George L. Staphos - BofA Merrill Lynch, Research Division

Two questions. First, Al, can you comment on how early third quarter shipments are trending relative to the expectation that you laid out for the year. And the second question, we're pleased to see the reduction in capital spending. And perhaps what seems to be some retrenching in your strategy in China, I don't know if you would agree with that or not, but is this a change in philosophy on capital spending or more just an adjustment given the macro environment?

Albert P. L. Stroucken

All right. With regard to early trends. Well, early trends for the quarter would only be one month. And as we have said in the past, one month is really not necessarily indicative of what you can project going forward. It looks like a pretty solid month compared to what we've seen so far in the year. I would say, if I look at the trends over the last 3 months, it's certainly influenced by the significant volume drop that we saw in May in Europe compared to last year. So the percentage of 11% that we saw in the third quarter, clearly, is not indicative of what the run rates are at this point in time. And I would say based on looking at shipping days and also potentially some weather influences, I'd say the third quarter is starting out at the same level as we have in our overall outlook for the year.

Now with regard to the capital spend. Really, the issues in China are that we are integrating the acquisitions that we've made over the last 2 years. We certainly have pulled back from our M&A activity, somewhat, until we see greater clarity in how China is going to evolve and develop. And that also has its impact a little bit on spreading out the timing of some of the investments that we had originally planned for China. So I think it is an adjustment to what we're seeing happening overall in the economy, just like other companies are doing. But we certainly keep an eye on what the evolution is going to be so that we can adjust, if that would be required as we go forward.

Operator

And your next question is from Ghansham Panjabi with Robert W. Baird.

Ghansham Panjabi - Robert W. Baird & Co. Incorporated, Research Division

Al, just given your comments on market shifts in Europe, what do you think the overall market was down in Europe as a whole for the quarter?

Albert P. L. Stroucken

I would say if you look at our volume drop in the third quarter -- in the second quarter, we think about 40% of that was due to overall economic trends. So I would say most of the volume was down about 4% in Europe. The rest of it is really pricing action. And you'll also recall that we already closed a furnace in Spain in November or December of last year, which of course is volume that's taken out of the equation, but we knew that, that was going to happen. So I would say about 40% of our drop is related to the marketplace, I would say perhaps another 40% is related to competitive pressure and 20% maybe because of we'd taken capacity out.

Ghansham Panjabi - Robert W. Baird & Co. Incorporated, Research Division

Got it. And then also, I mean I know it's early, but just looking out to 2013, right, so when you came into '12, the strategy was to recover pricing. You're obviously very successful at doing that, the market conditions maybe have changed a little bit. But what should we look forward to for 2013? Should we expect some element of price to still flow through, I mean you referenced some productivity initiatives, what are the major drivers to sort of look out for there?

Albert P. L. Stroucken

I would say we still are seeing inflation. And the next year, it may be a little bit less than what we saw this year, but not really significantly so, based at least on the indicators we have today. Now I grant you a lot of that is going to be influenced by the evolution of the European situation over the next couple of months, which may create some distortions in overall supply-demand and the basic materials, as well as in energy. But I would certainly expect us to continue with our pricing activities and pricing strategies to recover inflation as we go forward and we have -- in the whole, basically, seen also that our competitors are in a very similar position. Now we do have, and particularly in South America and South Europe, we saw that. We have a few small competitors, who are basically taking advantage of some volume opportunities that presents to them. But we'll have to work our way through that as we go forward.

Operator

And your next question is from Alton Stump with Longbow Research.

Alton K. Stump - Longbow Research LLC

I apologize if I missed this. But I think per cost run, I think as of last quarter you were still guiding to $200 million plus in the cost for the full year. Has that changed at all given the recent slide, namely in oil?

Stephen P. Bramlage

Alton, we still think we're going to comment for the full year at the lower end of that range. I think our initial guidance on global input inflation was somewhere in the $200 million to $230 million range, and so we will still guide towards that $200 million number, even with the lower rent costs that we're seeing. A lot of our cost in Europe are largely fixed for the remainder of the year.

Alton K. Stump - Longbow Research LLC

And I guess just as a quick follow-up to that, I was going to ask on the hedging front in Europe, is there any percentage that you can give us as to how much is locked in for the back half of the year, i.e., if we will benefit at all from the recent decline in oil there in the back half?

Stephen P. Bramlage

The vast majority is already locked in well over 85%, 90% is locked in.

Operator

And your next question is from Alex Ovshey with Goldman Sachs.

Alex Ovshey Ovshey - Goldman Sachs Group Inc., Research Division

Just on the operational improvement in North America. I think last year you talked to the negative impact being $20 million to $25 million and the year-over-year improvement in profit in North America is much better than that. And so was that just conservatism there on your part around what the headwind was and that's what really drove the much better results for North America or is there something else going on there?

Albert P. L. Stroucken

What we saw last year was about a $20 million to $25 million headwind, but we basically also had price improvement this year in North America, recovering some of the inflation we saw last year, which we were not recovering last year. And that was particularly true for soda ash, if you will recall, because those increases gained fairly late in the game. And then also, because of cost efficiencies and operational savings and operational OpEx, we've really been able to get a greater productivity out of our operation that we were able to achieve even in a normalized setting last year. I think those 2 factors really contributed.

Alex Ovshey Ovshey - Goldman Sachs Group Inc., Research Division

Okay. And it looks like the free cash flow profile is pretty strong, you should be within your leverage range towards the end of '12. As we you look out to '13, can you talk about what your capital allocation priorities will be in 2013?

Stephen P. Bramlage

Alex, I think it's a little bit early for us to get specific exactly on how we will allocate the capital, but there's no doubt, we do want to continue to progress lower in that net-debt-to-EBITDA range. And I would like to see us eventually evolve to a position around capital allocation where we can be a little more balanced in terms of application of the capital than we have been in the past. But while we're at the higher end of this range, we are of the opinion that the best thing we can do with the capital is apply the majority of it to deleveraging. That's the best way to add value to all capital providers at this point in time. But as we get lower, I would hope that we can evolve to something a little more balanced than we've been historically.

Operator

And your next question is from Debbie Jones with Deutsche Bank.

Deborah Jones - Deutsche Bank AG, Research Division

I'm just wondering if you guys could talk about the supply-demand balance in Brazil. And whether or not you're -- I'm assuming you're still planning your 4Q furnace add in Rio and then just what you think that might do to margins in 2013?

Albert P. L. Stroucken

Okay. Well, we -- as you know from past discussions, we have basically been priming the market by supplying volume for the Brazilian growth on an imported basis. So whatever we're putting in place today as capacity in Brazil is not going to change or offset the balance of supply and demand in Brazil. It allows us to then potentially allocate capacity that we have in other countries that used to supply to Brazil, to our other regions where we may have a need as we go forward. But the big advantage of manufacturing now locally, once we have established the demand profile is, of course, that a lot of the logistic costs will disappear. So we're still moving along. And also what we've seen from a growth rate perspective, Brazil has been very encouraging for us in the second quarter with growth rates in the high-single digits, and we certainly expect that to continue going forward. Some of the comments that we're hearing from the marketplace and from some of the brewers in Brazil as well, despite the fact there's going to be an excise tax increase is very positive for the second half of the year. So I think Brazil is marching in a good direction.

Deborah Jones - Deutsche Bank AG, Research Division

Okay. And also, Steve, I was just wondering if you could talk a recap of some of the things that you guys have done in Asia-Pac, especially in Australia and New Zealand in the last year? And kind of what you would like to see done in the next year, where you think -- or you think that margins can return to the levels that we saw back in 2010?

Stephen P. Bramlage

Okay. Well, let me answer the second one first. I think it's a little bit early for us to get specific as to where we think the ultimate margin levels should be. And that's mainly because the profile of the volume continues to evolve as the wine business structurally continues to move offshore in bulk shipping and beer grinds down for the region -- the reasons that Al mentioned a little bit earlier. So it's a little bit premature for us to set a target margin there. I think for the actions that we've already taken, we've taken out 2 furnaces in Australia, specifically over the last year. We have a little bit more work to do on that front. We are getting close to where that footprint is balanced with the current level of market demand, but there will be additional opportunities for us not only to take out a little bit of additional fixed cost, but also to drive the operating costs lower. So we are middle ending in the footprint program for Australia. But the early returns are certainly delivering what we expected to see.

Operator

And your next question is from Al Kabili with Credit Suisse.

Albert T. Kabili - Crédit Suisse AG, Research Division

Just a question on Europe on where you see your competitor capacity situation right now. Given the amount of volume that you've walked away from on the pricing initiatives, how much capacity do you think your competitors have in terms of its lack of capacity at this point?

Albert P. L. Stroucken

Well, it's of course always very difficult to predict because I don't have full insight as to what they have in their operations. But I would say, what we have observed is that the large competitors have basically stayed on course and are running their operations to optimize their profitability and cash flow in a certainly very difficult environment. Where we have seen some graft for volume has really been in the smaller competitors and they tend to be more the ones in the southern region of Europe. And I would expect that with what we did in Spain, closing down a furnace last year, as well as the volume shift that we've seen, that they're pretty full at this point in time. And I think that we are already seeing some of that also in the volume evolution over the last 3 months running average. We certainly see not the significant decline that we saw earlier. It's being tampered somewhat, which indicates to me that they're pretty full.

Albert T. Kabili - Crédit Suisse AG, Research Division

Okay. Good. All right. And then I just wanted to clarify an earlier comment on the underproduction headwind in the second half. Is it $40 million to $50 million headwind in the second half or is that for the full year?

Stephen P. Bramlage

That's a full year number. So if we were $20 million positive in the first, you've got to do the math to get it to down $40 million for the year.

Operator

And your next question is from Chris Manuel with Wells Fargo.

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

Let me start with a question regarding Europe. So I know over the last couple of years, you guys have exerted a lot of energy on cost putting in global ERP systems and improving the forecasting and that type of stuff. But as we go through the first quarter and even partly in the second quarter, you were still overproducing. So you end up kind of ahead of yourselves and you're working through the inventory, I understand, the back half of the year and have idled a bunch of these furnaces. But are you in a situation where you talked about potential for restructuring, but 5 furnaces is a pretty significant number. I mean does that -- that's like 13%, 14% of your capacity. Is that potentially along the lines of what you might -- let me ask the question this way, what would you -- how would you think about the restructuring opportunity? Is something like what you've got taken down right now seem reasonable to you? What would make it bigger? What would make it smaller?

Albert P. L. Stroucken

Well, I would say at this point in time, what you're seeing in the temporary shutdowns is, of course, a reaction to the second quarter. That's not a permanent size of the impact. So you cannot necessarily say if you shutdown 5 furnace temporarily for, let's say, half a year or for 3 months or 4 months depending on what each furnace is scheduled for, you cannot say that's taken out for the entire year. So I think that's where you have to watch out a bit in the equation. We have taken out a furnace already, completely, in December of last year. In Spain, we just shutdown the smaller furnace permanently. In central Europe, we are contemplating some other steps as we go forward. I would say, most probably, there is an opportunity for us over a period of time. It's not going to happen from today to tomorrow, to look at 5% to 7% or so of capacity that we could take out.

Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division

And then my follow-up question is with regards to cash flow and the $250 million number this year, a, is the $50 million that's anticipated coming in from the sale of property in China still coming in? I realized that's below that line. And then, b, is there anything baked into that $250 million of op cash less CapEx that you have kind of tabbed as you said here today for restructuring? Or could that potential be a use spend as we get into 4Q?

Stephen P. Bramlage

I'll answer the first one for you on the Chinese one. We have received already about $14 million, $15 million in proceeds from the Chinese government, thus far in this process. We don't have any reason to believe we will not ultimately receive what we are expecting for all of the properties. Though it's, as you can imagine, it's a relatively extended and elongated conversation and process to get there. We've actually received more than the we've spent in China thus far. As it relates to the restructuring, we had given -- I would separate the restructuring from the capital. I'm not sure those things are one and the same. We had given some guidance earlier this year that the anticipated restructuring spend for the course of the year was going to be a little bit over $50 million. We're at about $40 million or so this year. We may end up a little bit higher than the $50 million, but that will be obviously incorporated into the $250 million of cash flow guidance that we've given.

Operator

And your next question is from Adam Josephson with KeyBanc.

Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division

Just a clarification on the production downtime impacts. You mentioned there's a benefit of $20 million in the first half, a drain of $45 million-ish for the full year or so, you have a drain of $65-ish million in the second half. How would that be spread in 3 and 4Q? And how much could that number increase if you decide to idle or close more furnaces?

Stephen P. Bramlage

Most of the spread is going to be in the third quarter as opposed to the fourth, when we're looking at year-over-year. Because fourth quarter, normally for us, is a lower period of production anyway. So the way year-over-year works, you'll see most of that. Probably 2/3 of that difference in the third quarter.

Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division

Okay. And that's, again, exclusive of price cost and FX translation. Just one clarification on the free cash flow guidance, to what extent did it increase? I know you changed the language, I'm just trying to better understand it.

Stephen P. Bramlage

Yes, I know. It's a fair question. It's one I had to ask myself when I got here, honestly. So at the beginning of the year, we had gone out with a underlying free cash flow number of $250 million, and that included a $400 million global capital spending number. The way that definition of underlying free cash flow worked is, really, it was $200 million of free cash flow and then we were adding back $50 million of anticipated spending in China. And that got you to $250 million. So sitting here today, the free cash flow number has come up from the $200 million at the beginning of the year to the $250 million that we're guiding to right now. And we've eliminated that definition because of the capital spending number in China that we would otherwise be adding back has come down. The difference is not that significant and it's too confusing to try to keep track of both of them, so we'll go back to free cash flow.

Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division

And how much of that is because you're reducing CapEx?

Stephen P. Bramlage

At the moment, the capital spending number has gone down by $50 million, so the $400 million is down to $350 million.

Albert T. Kabili - Crédit Suisse AG, Research Division

So it's all the CapEx reduction?

Stephen P. Bramlage

Yes.

Operator

And your next question is from Scott Gaffner with Barclays.

Scott Gaffner - Barclays Capital, Research Division

I just wanted to reconcile the guidance for 3Q for North America. I guess I'm a little unsure how you get to higher year-over-year earnings for North America since you got sales volumes flat. And then you're sort of running at -- you said operation's running at a steady rate and you don't get the benefit of the fixed cost absorption year-over-year that you had from running all out in the third quarter of last year. Can you sort of reconcile that to how we get to improved earnings in North America in the third quarter?

Albert P. L. Stroucken

Yes. Scott, this is Al. It goes back to what I said earlier that, aside from just the operational improvements, we also have cost takeouts and cost savings that have been put in place, that are adding to the efficiencies we're getting. And then also, it's the recovery of inflation that we were not recovering last year. And due to the contracts that we have, we are getting that additional benefit this year that we didn't have last year. That's where the difference comes from.

Scott Gaffner - Barclays Capital, Research Division

And no impact from the recent increase in natural gas prices? I mean I realized you've got relatively short pass-throughs on energy cost in the U.S. But is there going to be any potential issues from that? Or maybe a month or even for the quarter?

Albert P. L. Stroucken

No. We don't really see that. Because what has happened since we put these contracts in place over the last couple of years, most of our large customers have decided to let us hedge for them. So it's a real immediate pass-through, it's not just a delayed pass-through. And I would say, today, less than 10% of the natural gas is governed by still pass-through provisions that may have a time delay.

Operator

And your next question is from Todd Wenning with MorningStar.

Todd Wenning - Morningstar Inc., Research Division

Was there any weakness in demand for Europe's export bottles for Scotch and Italian wine, for example. Or was the weakness mostly in the domestic European demand?

Albert P. L. Stroucken

What we saw overall is, in the discussions that we've had with our customer base, was that their exports were still doing pretty well. But really, domestic demand was a bit weaker because, overall, we didn't see a significant increase in volume and demand. So I would say, export is still doing reasonably well, but Europe clearly was a bit of a weaker side as well as cost.

Todd Wenning - Morningstar Inc., Research Division

Okay. Great. And have you seen any change in glass demand for North American craft beers, given the rollout of some canning lines for some of the larger craft bands?

Albert P. L. Stroucken

Not really. I'd say in the second quarter of this year, growth in the microbreweries was still above 10%. And we do not really see a change in that trend. I would say there is some effort because of the customer taste that the craft brewers are trying to go after, sometimes wants variation and wants differentiation and that's what's leading some of them to also include some cans in their portfolio. But I really would not say that, that's a significant underlying trend.

Operator

And your next question is from Chip Dillon with Vertical Research.

Unknown Analyst

This is James for Chip. First question is, is there any risk that capacity constraint in the U.S. glass container market -- are there any regional mismatches where some regions have too much capacity and others have too little?

Albert P. L. Stroucken

I would say within the U.S., we have typically been able to handle that reasonably well by shipping products from facilities that we have. We have a total of, I believe, 18 or 19 facilities in North America. So we're pretty well covered as far as that is concerned. We are seeing a stronger demand profile in general. As you could see, our volumes is pretty stable at this point in time. And you are seeing some more positive comments coming from the mega beer brands at this point in time. So I would say the market is likely going to continue to be tied and we are looking at alternatives to supply some product from other locations that we have in either Latin America or in Europe to support the growth profile that we see in North America potentially evolving in the future, rather than having to touch capital right away ourselves in the country.

Unknown Analyst

Okay. That's helpful. Switching gears a bit, O-I has not made a major acquisition in some time, are we likely to see O-I remain out of the market or is there potential that you would be looking to make a significant acquisition?

Albert P. L. Stroucken

Well, I would say for the next 2 or 3 years, we will clearly want to see how the overall economy is evolving. We've now been in a rut from the global economy for the last 3 or 4 years. And I think our focus should be on driving operational excellence and capabilities to our organization. Now should the one or the other absolute strategic opportunity come along, we will certainly take a look at it. But I'd say, at this point in time, I don't see that happening in the near future.

Operator

And your last question is from Phil Ng with Jefferies.

Philip Ng - Jefferies & Company, Inc., Research Division

Free cash flow has been somewhat depressed the last few years with a bigger reinvestment cycle and restructuring. So when I look out, going forward, you guys kind of alluded to restructuring. Will that be a big headwind again on cash flow going forward?

Stephen P. Bramlage

The way we will try to manage restructuring, Phil, will be something similar to what we've done in the Australian or the Asia-Pacific footprint here recently, where we've really tried to incorporate as much of a pay-as-you-go type of a concept as we can. So that we approach projects in such a way that they de-risk supply-chain potential problems for us. We want to avoid, obviously, what we dealt with in North America last year and pick the projects that are quick payback, relatively low risk early and use the funding that we get from those projects and then take bigger bites of further restructuring steps. So we will continue to plan for restructuring dollars as part of our free cash flow guidance. We have opportunities that make sense for us to do that. We've alluded to the study that we're going in Europe and the ongoing activity in Australia. But we will certainly try to avoid what we did in 2010, where we took a significant haircut in the global free cash flow number and kind of took a big bath approach on the restructuring all at once. It will be much more of a moderated, consistent approach.

Philip Ng - Jefferies & Company, Inc., Research Division

Okay. That's helpful. And I guess switching gears a little bit on North America. As you alluded, the market is, obviously, pretty tight now. Can you remind me of when the next round of contracts are up for renewal in North America, just for the initiative as a whole. And do you have the sense of this recent acquisition of Anchor by Ardagh would be constructive for pricing for the long term.

Albert P. L. Stroucken

I assume you're talking about customer contracts and...

Philip Ng - Jefferies & Company, Inc., Research Division

That's correct. That's correct

Albert P. L. Stroucken

Okay. I'd say that a significant amount of contracts needs to be renewed by 2014 and 2015. So '13 and '14 are the years when those discussions will heat up and take place. It's very difficult, of course, to predict on how that is going to evolve over the next couple of years, a lot of that will also depend on how demand is going to recover for the mega brands because those are clearly the volume drivers and they have the biggest impact on supply and demand. So it's evolving at this point in time. It will be a folly for me to try to be predictive at this point in time what the likely outcome is going to be and what's going to happen in the marketplace. I'd say looking back over the last 3 or 4 years, overall supply and demand in the United States has remained relatively balanced, despite a fairly weak economy. And I would assume that, that clearly is going to help during the negotiations as we go forward.

Philip Ng - Jefferies & Company, Inc., Research Division

But there wouldn't be any opportunity near term to pick up any incremental pricing, like surcharges if things do get too tight, right?

Albert P. L. Stroucken

Well, of course. I mean, again, it's all a play of supply and demand. But wherever we have contractual obligations, we cannot of course renegotiate. So that will just run its course. And then the question is going to be whether at the time of the contract renewal, can that supply-demand balance that's sufficiently tied to see whether there would be an opportunity to get additional pricing.

Philip Ng - Jefferies & Company, Inc., Research Division

Okay. And just one last final question. You guys kind of alluded to Brazil being pretty strong. I know another can maker kind of alluded to how the big beer guys in Brazil and China are slowing the conversion into cans. Is that one of the drivers that you're a little more upbeat about beer demand in Brazil?

Albert P. L. Stroucken

Well, what we have seen the first half of the year is that several of the large brands in Brazil have gone to returnable glass containers for their initiatives, for their marketing initiatives. And that of course is logical because a returnable container is the lowest cost container per transaction, so it allows the customer -- or it allows the brewers to either access a customer base more efficiently and more economically or it allows the brewers to get higher margin and compensate perhaps for some of the tax impacts that they may see from the excise tax. So we clearly see a greater willingness and a greater enthusiasm of the brewers to go to returnable, refillable containers and the only option they really have is left.

Stephen P. Bramlage

All right. Thank you, everyone. That concludes our second quarter earnings conference call. Please note that our third quarter 2012 conference call is currently scheduled for Thursday, October 25 at 8:30 a.m. Eastern time. We appreciate your interest in O-I. Again, thank you, and don't forget to choose glass.

Operator

This does conclude today's conference. You may now disconnect.

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