Cooper Tire & Rubber Company
Q2 2019 Earnings Call Transcript

Published: 29 Jul 2019

[Operator:]

Good morning, and welcome to the Cooper Tire & Rubber Company Second Quarter Earnings Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded.I would now like to turn the conference over to Jerry Bialek. Please go ahead.

[Jerry Bialek:]

Good morning, everyone and thank you for joining the call today. This is Jerry Bialek, Cooper's Vice President and Treasurer. I'm here today with our Chief Executive Officer, Brad Hughes; and Chris Eperjesy, our Chief Financial Officer.During our conversation today you may hear forward-looking statements related to future financial results and business operations of Cooper Tire & Rubber Company. Actual results may differ materially from current management forecasts and projections. Such differences may be a result of factors over which the company has limited or no control. Information on these risk factors and additional information on forward-looking statements are included in the earnings release we issued earlier this morning and in the company's reports on file with the SEC.During this call, we will provide an overview of the company's second quarter 2019 financial and operating results, as well as the company's 2019 business outlook. Our earnings release includes a link to a set of slides that summarizes information included in the news release and in the 10-Q that will be filed with the SEC later today.Please note that we'll reference certain non-GAAP financial measures on this call. The linked slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures. Following our prepared remarks, we will open the call to participants for a question-and-answer session.Now, I'll turn the call over to Brad.

[Brad Hughes:]

Thank you, Jerry, and good morning, everyone. I will begin today with a brief overview of our second quarter results. After that, I will turn the call over to Chris for a few of our -- for a review of our financial performance in greater detail. Then I'll return to talk about our outlook. And as always we will conclude by taking your questions.Now let's talk about the quarter. Net sales decreased 2.8% to $679 million. Unit volume decreased 4.9% compared to the second quarter of 2018. Operating profit was $32 million or 4.7% of net sales, a sequential improvement compared with the first quarter.The Americas segment operating profit was up 16% year-over-year, despite the impact of new TBR tariffs. Our international segment was challenged by conditions within the China new vehicle market and a weak replacement tire market in Europe. The process of phasing out light vehicle tire production at our Melksham facility is nearing completion and will result in a Cooper tire Europe that is more cost competitive.We are now sourcing more tires, TBR tires from our Vietnam off take agreement with Sailun and progress on construction of our new joint venture TBR tire production facility in Vietnam is on schedule. Both actions diversify our TBR sourcing footprint outside of China. And our business relationship with Mercedes-Benz is going well.Let me comment on the unit volume, specifically the U.S result, which underperformed the USTMA and the industry. While we are not satisfied with the result, we remain confident that the strategic growth initiatives we are executing will make a more visible impact in 2020 as we've been saying. Also, we do not believe the second quarter performance is indicative of underlying demand for our products.While industry sellout data is not complete, with the information we do have, we believe Cooper sellout was in line with the overall U.S market for the first half of 2019. However, as you know, customers make inventory adjustments from time to time, which can impact sell-in results as we believe happened in the second quarter.With that, I will turn it over to Chris.

[Chris Eperjesy:]

Thank you, Brad. Moving to the consolidated second quarter results, sales were $679 million, down from $698 million in 2018. This 2.8% decrease was driven by $34 million of lower unit volume and $6 million of unfavorable foreign currency impact, which were partially offset by $21 million of favorable price and mix.Operating profit was $32 million compared to $33 million in the second quarter of 2018, resulting in an operating margin of 4.7% of sales. This was achieved despite $13 million in costs related to new tariffs on products imported into United States from China as well as $2 million of restructuring costs related to Cooper Tire Europe's decision to cease light vehicle tire production in Melksham England.Let me provide an update with respect to tariffs. Last quarter we indicated that for the full-year 2019, we expected the cost of the new TBR tariffs implemented on February 15 to be around $50 million. Our expectation was that there will be price increases on TBR tires in the U.S market to help offset these costs. While we and others implemented price increases, we have yet to see the broad industry pricing that we expected.Cooper will remain market phasing with our TBR pricing and we continue to believe that strong demand for TBR tires relative to supply will eventually result in industry pricing. However, we do not expect that pricing actions will occur as quickly as previously assumed. We're making good progress on our TBR sourcing footprint diversification. We're beginning to receive tires and are ramping up the number of tires we received from our commercial off take agreement with Sailun Vietnam.At the same time, the construction of the new joint venture TBR plant with Sailun is on track with tire production expected to commence in the first half of next year and we continue to evaluate opportunities to further diversify our TBR sourcing footprint. In early May, the U.S administration announced a further increase in section 301 tariffs from 10% to 25% on certain Chinese imports.Given that Cooper is on the LIFO accounting method in the U.S., we experienced a negative tariff impact immediately. This incremental rate increase was not included in our previous outlook. This tariff applies to both our passenger car in TBR tires imported from China as well as some raw materials. As we have updated our estimates for recent rate and sourcing changes and other variables, our expectation for the full-year impact of gross expenses for all newly implemented tariffs on fiscal 2019 is $50 million.As Brad indicated earlier, the Melksham transition is nearing completion a little ahead of schedule, which resulted in approximately $2 million restructuring charges in the second quarter. This amount was in line with our projections and we continue to expect full-year 2019 restructuring charges to be in the range of $8 million to $11 million.As we approach conclusion of this transition, we experienced slightly more volume in manufacturing disruption than expected. Yet when completed, this action will more fully leverage the remaining plants in our manufacturing network, benefiting Cooper in Europe and globally.Now let's take a look at our second quarter operating profit walk. Total company operating profit compared with 2018 was impacted by the following factors

[Brad Hughes:]

Thanks, Chris. Clearly the industry is facing some near-term challenges as we've described. Yet even with these headwinds we were able to improve total company operating profit margin from 4.3% in the first quarter to4.7% in the second quarter. And in the Americas segment, we improved profitability by 16% year-over-year even after absorbing the impact of the new tariffs.We continue to make progress on executing our strategic initiatives, including our retail expansion efforts and expect that these initiatives will drive more meaningful improvements in our business starting in 2020. We have work to do, but remain confident about the future and where we are headed. Increased U.S tariff costs and delayed timing of anticipated commercial truck tire price increases as well as weakness in the China new vehicle and Europe replacement tire markets are expected to impact the remainder of this year. The Americas segment, excluding TBR tariffs is still generally in line with previous expectations. On a consolidated basis, we anticipate improvement throughout the year in operating profit margin.Cooper is adjusting expectations for the full-year as follows

[Operator:]

Absolutely. [Operator Instructions] Today's first question comes from Rod Lache of Wolfe Research. Please go ahead.

[Rod Lache:]

Good morning, everybody.

[Brad Hughes:]

Good morning, Rod.

[Rod Lache:]

Had a couple questions. One is just kind of high level. If you divide your performance into the variable contribution items, so if you think about volume price mix raw materials and tariffs on a year-over-year basis, it was actually up $13 million year-over-year. And that was offset by the SG&A restructuring distribution and other which was a negative 14. I was hoping you can maybe talk a little bit more about how those structural costs -- those other items flow as you look into the back half of this year because you will be comping against, I think it was $5 million of higher distribution costs for distribution facility you had last year and on the West Coast. And there was a $34 million goodwill impairment in the fourth quarter which shouldn’t recur.

[Brad Hughes:]

Yes, that's correct, Rod. And I don't have exactly the math in front of me that you used, but directionally it does seem correct around the variable improvement in some of the structural things that are many of them are not going to recur as we go forward. So a couple of examples there. Within the distribution costs, there are $2.8 million, I believe, of nonrecurring insurance recoveries that we had in last year's on results that we don't have this year. So there's almost $3 million there that’s contributing to that distribution. Something else in there that's on a little less obvious on is that we are actually manufacturing more tires in the United States and Mexico for this region. And it actually moves where we reflect those distribution costs into distribution costs were some of the sea freight when they were being imported previously were not recorded in the same category. Not a huge number, but another contributor to that distribution cost there. And then as you’re correct, we began to in the second half of last year and most importantly I think the bigger piece of that was in the fourth quarter had the new warehouses online, and so began to incur some of those costs and we will not have that differences as we move forward this year. On the SG&A side, I point out that there's a couple of things that are going on in the compensation category. One is with deferred compensation related to stock shares, the price, you look at the move and the price a year-ago versus the move in the price of the shares this year and that was a negative contributor to the SG&A. And frankly a year-ago, we were on adjusting our projection for the full-year payout and incentive comp down and we did not have a similar reduction this year. So there are several things in there to your point that are not recurring as we move into the second half of this year, and we would think that we'd see a better year-over-year performance.

[Chris Eperjesy:]

Rod, this is Chris. Just one other thing I would add in terms of items that occurred last year that won't be reoccurring in the second half of the year is, you will recall in the third quarter there was a $31 million benefit related to product liability, the adjustment of our model, so that kind of rounds out all the one-time items.

[Rod Lache:]

Right, right. Okay. That's helpful. And just two other things. One is, can you just remind us on what the aggregate volume will be from the Vietnam off take agreement once that ramps? To what extent are you offsetting the million or so units that you're bringing in on commercial tires from China. And any update on what happened to the ramp from ATD, Walmart and some of the other new accounts that seem to be coming in, in the back half of last year? Wouldn't some of those accounts be ramping up inventory?

[Brad Hughes:]

Yes. So on -- first to the question on Vietnam, we haven't given specific numbers about the number of tires that we’re bringing in. We are ramping up against the commercial off take agreement that we had and that will be -- we will have more units coming from that in the second half of the year, certainly compared with the first half. But more meaningfully as we get into the joint venture next year and begin to produce there then you'll see a larger number of tires coming from Vietnam over the course of next year and we will continue to highlight that because that's a big opportunity against the tariff costs that were impact -- were incurring right now. And then with regard to the business that came online last year, we are seeing some of the benefits of that this year and as we tried to highlight in the comments previously on, we -- as we look at sellout, which ultimately determines what the sell-in will be over a longer period of time, we think that actually we are on increasing at about the same level that the market is in the U.S. Unfortunately on the timing of some inventory adjustments that we’re seeing from some customers right now is offsetting a portion of that. But we believe that over the longer-term and certainly as we get into 2020 as we get through some of those inventory adjustments, we will move around from quarter-to-quarter etcetera and we've got more impactful contributions from some of the new business that we have been putting on the books that you really start to see that contribute to the bottom line with growth.

[Rod Lache:]

Okay. Thank you.

[Operator:]

And our next question today comes from James Picariello of KeyBanc Capital Markets. Please go ahead.

[James Picariello:]

Hey, good morning, guys. Can we just kind of focus on the operating margin guidance, the revision there, going from greater than 7.1% to now 5.9%. We’ve got -- if you could help just bridge the items, so we’ve got lower volume, we’ve got raw materials look a little bit better, just curious what the major buckets are in terms of the variance. The gross tariff impact remains at $50 million, so maybe the netting of that has changed. It sounds like pricing is a bit delayed. So, yes, if you could just help walk through this variance in the full-year expectation, that will be helpful. Thank you.

[Brad Hughes:]

Yes, that’s you’ve just identified one of them, James, there which is the TBR tariffs. And again there's a lot of moving pieces in there both in the gross cost and in the pricing side, specifically the timing of one we anticipate there to be pricing. But the combination of those factors including the 301 tariff going from 10% to 25% and now a revised outlook is the one we're going to see pricing in that market, even though we continue to believe that the dynamics of that supply and demand situation will ultimately create a very favorable background for price increases, but we are moving those out. So that the tariffs including the timing for the pricing is an element of that. We are seeing a continued slowdown in the new vehicle market in China. So we've expanded that to affect the full-year, which is a little bit different from we had previously. And then, frankly, the slowness, the weakness in the replacement market in Europe is probably the third major factor that I would refer to with regard to the change in the guidance for the full-year.

[James Picariello:]

Okay. Thank you for that. How about the inventory realignment with a key customer in the U.S. Does that persist as well?

[Brad Hughes:]

The -- that’s all timing, right. And it can be one quarter, it's not necessarily just one customer on the -- that is a timing element. And I make that comment because different from what we were saying about the private brand wholesale business, which was a structural change that the way that we were going to market and which tires we were selecting to sell and to whom, we -- that is behind us. This sell-in, sell-out as inventories are adjusted from quarter-to-quarter or period to period, is really a timing and we’re trying to become more focused on the sellout and we feel pretty good about where we're tracking through the first half of the year relative to market in the U.S.

[James Picariello:]

Got it. And just a housekeeping one on the tariffs side. So the 301 tariff did step up from 10% to 25%. So what's allowing you guys to keep that gross tariff exposure to $50 million as oppose to something higher.

[Brad Hughes:]

Also -- there's a -- again, lot of moving pieces there and including the fact that we are continuing to restore certain products to new countries that are not affected by the tariffs. And so that -- the volume, which markets we are selling them into, all contribute to that. But we didn’t lose sight of the sourcing changes well within that.

[James Picariello:]

Thanks.

[Brad Hughes:]

Thank you.

[Operator:]

And our next question today comes from Chris Van Horn of B. Riley FBR. Please go ahead.

[Chris Van Horn:]

Good morning. Thanks for taking the call.

[Brad Hughes:]

Hi, Chris.

[Chris Van Horn:]

I just want to dig a little bit further into the comment around unit growth, unit volume growth for 2020. Is part of it just a reversal of maybe what you see in the back half of this year, or is there other moving pieces that we should think about on top of that or more weighted than that?

[Brad Hughes:]

Well, I think there are a couple things, but most importantly is the retail expansion initiatives that the team has been pursuing in North America, specifically on -- are going to begin to show themselves in greater numbers and have more of an impact on the total overall volume in growth next year. That combined with some changes to the -- if we get to a more consistent sell-out/sell-in type of environment, which we would expect in certain -- with certain customers next year that would also give us a little bit of a tailwind as we move into next year with regard to volume. But the most important thing is that the efforts around retail expansion are going to contribute more next year than they have to date just as we grow into those new relationships.

[Chris Van Horn:]

Okay, got it. And then, you’ve identified $8 million to $11 million of additional spent on the Melksham restructuring. Can you remind us on what you foresee that being as a benefit in the out years in terms of cost savings and controls etcetera?

[Brad Hughes:]

Yes, we haven't given specific numbers on that yet, but clearly it is going to contribute a benefit to the bottom line removing out of our highest cost facility into one of our lowest-cost facilities, Melksham to Serbia, which is going to absorb the most of that volume, that's being moved. But it's also going to put additional volume into the rest of the footprint, which will benefit our overall utilization. So, we haven't quantified that yet and you'll begin to see more of that as we get into next year obviously, but it clearly will contribute to lower costs for total company and most importantly for Europe.

[Chris Van Horn:]

Okay, got it. And then last for me, just maybe an update on the OEM launch here in the U.S. Any foreseen unexpected costs or is it going as planned, just any update there?

[Brad Hughes:]

No, going largely as planned. The relationship is very good with Mercedes. We are adding additional platforms as we move along here and continue to seemingly perform pretty well based on all the feedback that we’ve received.

[Chris Van Horn:]

Okay, great. Thanks again for the time.

[Brad Hughes:]

Thank you.

[Operator:]

And our next question today comes from Bret Jordan of Jefferies. Please go ahead.

[Bret Jordan:]

Hi. Good morning, guys.

[Brad Hughes:]

Hi, Bret.

[Bret Jordan:]

I guess just a question on the timing of the new relationships. I mean, obviously -- I guess, you expanded your volumes with ATD at Walmart and picked up Monro. As far as the fill-in as most of loading up those new relationships done and now it's a matter of selling out, or are there incremental new customers that you’re adding to the list going forward.

[Brad Hughes:]

Well, I think there's two categories here. There's -- the first category are some of the new opportunities that we started to experience through our conquest program last year when there were some changes in the distribution landscape and we went out and tried to use that as and successfully used that as an opportunity to increase the number of selling points that we had primarily with the independent dealers and retailers that are serviced through some of the large national distributors. That -- the initial selling that resulted from that is largely in place right now. And now it's a matter of growing the number of tires that we're selling through those retail points that we added last year. Again the smaller independent retailers and dealers that are serviced by those large wholesale distributors. Then you've got some of the newer larger retail, national retail general merchandiser accounts where we are adding additional opportunity to sell-in different parts of the U.S and those are still building right now. You go through the pilot phase, which can last different lengths of time depending on which one you're talking about, but seemingly we're progressing with those and those will continue to grow this year and at more importantly we really think next year is when you’re going to start to see some of that new activity show up on the bottom line.

[Bret Jordan:]

Okay, great. And then a question on -- the commentary about being more opportunistic in the near-term on the share repurchase program, is that more -- is that being more aggressive? I guess -- I think you’ve said in conjunction with a discussion about reinvesting in the business, which would theoretically take away from the buyback. What is your thought on the share repurchase going forward here?

[Brad Hughes:]

Yes. So we’ve been saying for on -- a few quarters now that that we think that there are new and good opportunities to reinvest in the business and so that will be something that we're considering to do. We obviously are going to need to continue to look at where the share price is as we look at the -- any opportunity to buy back. But for right now, we do think that there are some new and better opportunities that we've had over the last couple of years with regard to reinvesting in the business.

[Bret Jordan:]

Okay, great. Thank you.

[Operator:]

And our next question today comes from John Healy of Northcoast Research. Please go ahead.

[John Healy:]

Thank you. I want to ask a question about the Americas segment. I think you guys called out the $6 million of SG&A cost in terms of the operating income for the segment. It seems like a big number assuming, just given the relative size of SG&A for you guys. I was just hoping you could give us a little bit more color what was going on there?

[Brad Hughes:]

Right. Look, Chris, supplement this a little bit as we -- if I missed something here, but again a couple of big pieces there are

[Chris Eperjesy:]

No, that was the majority, Brad. It was the stock based comp and the overall incentive compensation and the adjustment of the accrual last year.

[John Healy:]

Got you. And then I just want to ask maybe just kind of on a broader base picture standpoint. If you look at the Americas segment and we think about ATD and Monro and Walmart, just at a surface level most of us think it shouldn’t be a really good thing for Cooper. And maybe you guys should be growing volumes and the volumes are still on the soft side. Can you help us close that gap and maybe provide a time frame for when do you think that we might be done with kind of some of this overhang of the private label business? Just trying to understand when you think is a reasonable time that Cooper should start to perform in line with the USTMA members or maybe even better than that, given some of the share opportunities?

[Brad Hughes:]

Well, I think on -- it's hard to call a quarter-to-quarter, John, but I would certainly indicate and confirm as we've been saying that we think as we get into 2020, that you're definitely going to start to see on a different level of performance as this new business begins to contribute more. Before that, it's just -- again, as you move quarter-to-quarter and you look at on sell-in activity, which is what we're measuring as opposed to sell-out activity with the numbers that the USTMA reports and that we compare ourselves to is can move up and down quarter-to-quarter based on some of the buy in and sell-out timing. We think that as we get through the balance of this year that will kind of even itself out. We’ve a lot of customers out there that and we're not alone. I would say the industry is doing a much better job of managing their inventories both for -- which will better align the sell-in to the sell-out. And so as that begins to trickle through, it will be reflective of what the sell-out demand is for our products in terms of the sell-in that we are reporting. And we think through the first half of the year, we were about the same as the industry in the U.S., and we think as we move forward with some of the new initiatives as we get into 2020 that should improve and show itself on the sell-in data that we report against [indiscernible].

[John Healy:]

Great. And then just last question for me. On the Vietnam opportunity, when you look at the TBR is it reasonable that most of those tires that you bring into the U.S can be sourced through Vietnam in 2020, or do you think you'll still be using a dual region approach to bringing those tires into the U.S?

[Brad Hughes:]

Its -- there's definitely going to be a continued transition during 2020. As we exit the year, there's no doubt that we will be in a position where the majority is coming -- assuming everything stays on track and we're well on track right now. So I should say could use the term no doubt, but we're highly confident that that by the time we exit 2020, the majority of those tires will be coming from outside of China. Whether or not we get there for the full-year, I don't know, but it's on -- everything is on track and that will be a big help next year if the current tariff environment remains in place.

[John Healy:]

Great. Thank you, guys.

[Operator:]

And our next question today comes from Ryan Brinkman of JPMorgan. Please go ahead.

[Rajat Gupta:]

Hi, good morning. This is Rajat Gupta on for Ryan. Just had a question on the manufacturing improvements bucket and the margin bridge, particularly in America, and you continued to see some good improvement there. Last quarter you had highlighted some easy compares you saw from the inventory draw down efforts. How do you feel about the inventory levels currently? And then, how should we think about benefits from manufacturing going forward, especially in the second half in this weak volume growth environment? And I have a follow-up.

[Brad Hughes:]

Okay. On the manufacturing question in specific, well one thing to note is that when you look at it on a consolidated basis as we were working our way through the tail end of the cessation of light vehicle tire production in Europe, we did experience a minor complications relative to what we thought we were going to incur. Now we are pretty much done with that. That along with making sure that we're not overbuilding China relative to the OE market cost us to adjust our production schedule there. And in combination, those did have an offsetting impact on what we're able to achieve in the Americas. As we look forward, we still think for the balance of the year when you look at it in total that we will continue to have better utilized facilities in North America, and so when we get into the second half of the year, we do see that continuing.

[Rajat Gupta:]

Got it. And then just on the margin guidance for the full-year, what kind of industry or company-specific volume expectation is that based on? I mean, is there -- could you give us a range or sensitivity as to how that margin might move if volumes come in better or worse than expectations?

[Brad Hughes:]

Well, those are global expectations, so we need to think about it globally. And as we indicated, we are now viewing that the China OE market, the new vehicle market and then the European replacement market will remain soft for the balance year -- of the year. The severity of that continuation and how that happens could have some impact on the guidance that we provided. I would suggest that if we stay in the range that we're in right now for an industry -- replacement industry volume in North America that would -- there wouldn't be any change to our guidance relative to what we've just provided. So I would say kind of as is in the Americas and continued weakness in Europe and China with the one caveat there that China if it were to continue to be really, really severe through the balance of the full-year, might have some further impact. And then, just lastly, Chris noted this earlier, last year in that 5.9% for the full-year there were two offsetting -- almost offsetting equally one timers with regard to the product liability, benefit and the goodwill write-off, $31 million and $34 million, respectively. This year, we've got not only the restructuring costs that we've indicated for Melksham of $8 million to $11 million as the range and at the new TBR tariffs that we are incurring of $50 million roughly in the profits that we are talking about, those are two pretty big hurdles to be overcome -- overcoming and still to achieve the same report of operating profit margin guidance, which just highlights that there's progress being made in the underlying business.

[Rajat Gupta:]

Got it. Makes sense. Thank you.

[Brad Hughes:]

Thank you.

[Operator:]

And this concludes our question-and-answer session. I would like to turn the conference back over to the management team for any final remarks.

[Brad Hughes:]

Thank you very much. And before we close, I want to reiterate some key points. First, as I was just describing, the new TBR tariffs in Melksham restructuring costs have negatively affected our near-term results. Excluding these, our operating profit and operating profit margin would have improved year-over-year for both the second quarter and the first half. Regarding our TBR business, we’ve sourcing initiatives well underway to mitigate the current tariff impact as we move into 2020, and we believe market conditions will be favorable in the future for pricing. In China, while there has been near-term weakness in the new vehicle market, we continue to believe that China is a strategically important part of our business given the size of the car park and the growing what should be a growing replacement market. Moving to Europe, we believe near-term softness in the replacement market will ultimately improve and the actions we've taken at Melksham will make us more cost competitive, particularly in Europe. Lastly, as we said in North America, our retail expansion plans are moving forward and we expect to see more from them in 2020. We will continue to implement our strategic initiatives, while evaluating incremental opportunities to improve our business and results going forward. Thank you for being on the call today.

[Operator:]

Thank you, sir. This conclude today’s conference. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.