Cooper Tire & Rubber Company
Q3 2019 Earnings Call Transcript

Published: 28 Oct 2019

[Operator:]

Good morning, and welcome to the Cooper Tire & Rubber Company's Third Quarter 2019 Earnings Call and Webcast. At this time all participants on the call are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I would like to turn the conference over now to Jerry Bialek. Please go ahead. Thank you.

[Jerry Bialek:]

Good morning everyone and thank you for joining the call today. This is Jerry Bialek, Cooper's Vice President, International finance 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 third quarter 2019 financial and operating results, as well as our 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 third quarter results. After that I will turn the call over to Chris for a few -- for a review of our financial performance in greater detail, then I'll return to talk about our outlook for the fourth quarter and as always we will conclude by taking your questions.Now let's talk about the third quarter 2019 results. Net sales decreased 4.5% to $704 million. Unit volume decreased 7% compared to third quarter of 2018. Operating profit was $53 million or 7.5% of net sales, a strong sequential improvement compared with the second quarter. Excluding $15 million of new tariffs in active sense for same period a year ago on products imported into the United States from China, operating profit margin would have approached the low end of our 10% to 14% target. We were pleased to deliver this operating profit improvement in the third quarter which was driven by positive trends in pricing, mix, and raw materials. As expected our volume was impacted by customer inventory actions in the U.S. as well as challenging market conditions in other regions.Americas segment operating profit margin was 11.3%. Our international segment remained challenged by conditions including 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 substantially complete and should result in a Cooper Tire Europe that is more cost competitive going forward. We are making good progress on our Global TBR sourcing footprint diversification. We are ramping up the number of tires we receive from our commercial off-take agreement with Sailun Vietnam. At the same time the construction of ACTR, our new joint venture TBR plant in Vietnam is on track with commercial tire production expected to commence early next year. Also we continue to evaluate opportunities to further diversify our TBR sourcing footprint.Speaking of TBR we are excited to have been named an outstanding supplier for 2019 by Blue Bird Corp, the leading manufacturer of school buses in the United States. Our Cooper brand TBR tires designed to deliver quality and value, our original equipment on Blue Bird school buses. We are pleased to earn this important recognition from a great customer and look forward to continuing to serve them.I should also add that our business relationship with Mercedes Benz is going well and expanding. We are proud to now have Cooper discover SRX tires as original equipment not only on the GLE model SUV but now also on the GLS last model. This is the second Mercedes Benz vehicle announced this year to feature Cooper Tires. We are excited about this opportunity and look forward to continuing to work with this luxury automaker.Before I turn it over to Chris let me comment on unit volume specifically the U.S. result which underperformed the U.S. G&A and the industry. Well we are not satisfied with this result. We remain confident that the strategic growth initiatives we are executing will make a more visible impact in 2020 as we have been communicating. As we discussed last quarter, customers make inventory adjustments from time to time which can impact selling results. As expected this continued in the third quarter. Also we do not believe our third quarter selling 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 sell out was in line or better than industry selling growth for the third quarter. Now Chris will review our financial performance.

[Chris Eperjesy:]

Thank you Brad. Starting with consolidated third quarter results sales were $704 million down from $738 million in 2018. This 4.5% decrease was driven by $54 million of lower unit volume and $7 million of unfavorable foreign currency impact which were partially offset by $27 million of favorable pricing mix. Operating profit was $53 million compared with $81 million in the third quarter of 2018 resulting in an operating profit margin of 7.5% of sales. This was achieved despite $23 million of higher net product liability expense, $15 million in costs related to new tariffs on products imported into the United States from China compared to the same period a year ago, as well as $1 million of restructuring costs related to Cooper Tire Europe's decision to cease light vehicle tire production in Melksham, England.With respect to the increase in product liability expense the third quarter of 2018 included a $31 million benefit in operating profit from lower product liability costs related to an adjustment of the company's product liability reserve model. A similar review of our product liability reserve model in the third quarter of 2019 resulted in a benefit of $4 million. This together with the normal activity and product liability expenses in each quarter including current case activity and legal fees resulted in $23 million of higher net product liability expense for the third quarter of 2019.Let me provide an update with respect to tariffs. Our expectation for the full year impact of gross expenses for all of the new tariffs remains at about $50 million. As Brad indicated earlier the Melksham transition is now substantially complete and resulted in restructuring charges of approximate 1 million in the third quarter and over 7 million year-to-date. We expect full year 2019 restructuring charges to be in the range of $8 million to $10 million. As we indicated last quarter we experienced slightly more volume and manufacturing disruption than expected with this transmission -- transition. Yet this action should more fully leverage the remaining plants in our manufacturing network ultimately benefiting Cooper in Europe and globally.Now let's take a look at our third quarter operating profit walk. Total company operating profit compared with 2018 was impacted by the following factors; $20 million of favorable price and mix, $24 million of favorable raw material costs excluding the new tariffs. This was offset by $23 million related to product liability, $16 million of volume, $15 million of new tariffs, $12 million of manufacturing, $2 million of SG&A, $1 million of restructuring, and $3 million of other costs compared to the same period a year ago. Diluted earnings per share was $0.58 compared to $1.07 per share in the third quarter of 2018.Now turning to our Americas tire operations. Segment sales for the third quarter was $602 million down 4.3% from $629 million in 2018 as a result of $51 million of lower unit volume and $1 million of unfavorable foreign currency impact partially offset by $25 million of favorable price and mix. Segment unit volume was down 8.2% compared to the same period a year ago. Our U.S. light vehicle unit volume decreased 7.7% while the U.S. TMA increased 0.7% and the total industry increased by 3.5%. Third quarter operating profit in the Americas decreased to 68 million or 11.3% of net sales compared to $87 million or 3.9% -- 13.9% of sales in 2018. Operating profit included $23 million of favorable price and mix, $22 million of favorable raw material costs excluding new tariffs. This was offset by $23 million related to product liability, $15 million of net new tariffs, $13 million of volume, $6 million of manufacturing, $5 million of SG&A, and $2 million of other costs compared to the same period a year ago.Now turning to our international tire operations. Net sales for the third quarter were $132 million down 18.6% from the third quarter of 2018. This result was driven by $28 million of lower unit volume and $6 million of unfavorable foreign currency impact which were partially offset by $4 million of favorable price and mix. Segment unit volume decreased 16.4% with unit volume decreases in both Asia and Europe driven primarily by lower intercompany shipments. In fact third party sales in Asia were flat versus the prior year.The third quarter operating loss in our international operations was $5 million compared to operating profit of $6 million in 2018. The quarter included $3 million of unfavorable price and mix and $2 million of favorable raw material costs. In addition the quarter included $1 million of lower SGA costs which were more than offset by $3 million of volume, $6 million of manufacturing, $1 million of restructuring, and $1 million of other costs compared to the same period a year ago. Moving to raw materials, our raw materials index decreased 6.9% from the third quarter of 2018. Raw material index decreased 2.9% sequentially from 161.8 in the second quarter of 2019 to 157.1 in the third quarter of 2019. This was in line with our expectations. For the fourth quarter we expect our raw material index to be down on a sequential and year-over-year basis.Now to some corporate items, other pension and post retirement benefit expenses increased $2.6 million versus the prior year. Similar to prior quarters this increase is primarily the result of lower estimated return on planned assets compared to 2018. If we had made -- as we have made strides in improving the funding status of our pension plans the portfolio is taking less risk in order to protect the funded status which results in a net increase quarterly expense. The effective tax rate was 21.0% for the quarter compared with 22.6% last year. In conjunction with the restructuring decision related to the Melksham facility the company is examining its entity structure in the region in order to assure its effectiveness from an operating and tax planning perspective. Excluding any actions resulting from this and other significant discrete items we continue to estimate the full year 2019 effective tax rate will be in a range of between 23% and 26%. The effective tax rate is based on the forecasted annual earnings and tax rates for the various jurisdictions in which the company operates. More detail on our taxes will be available on our Form 10-Q that will be filed with the SEC later today.Turning to cash flows and some balance sheet highlights, unrestricted cash and cash equivalents were $137 million at September 30, 2019 compared with $209 million at September 30, 2018. Capital expenditures in the third quarter were $50 million compared with $46 million in the same period a year ago. We expect our full year capital expenditures to range between $180 million and $200 million. As a reminder this does not include any capital contributions related to Cooper's pro rata share of its joint venture with Sailun Vietnam or other potential manufacturing footprint investments.As of the end of the third quarter the company had invested $49 million dollars in its new ACTR joint venture with Sailun Vietnam. Return on invested capital excluding the impact of the goodwill impairment charge in the fourth quarter of 2018 was 7.8% for the trailing four quarters. I want to reiterate that returning capitals to our shareholders remains an important priority for us. As demonstrated in the third quarter we are committed to supporting our quarterly dividend but we'll pursue share repurchases more opportunistically in the near-term as we balance attractive opportunities to invest in our business. I will now turn the call back over to Brad.

[Brad Hughes:]

Thanks Chris. Looking ahead we expect continued volume headwinds in the fourth quarter but we'll continue to make progress on executing our strategic initiatives including our retail expansion efforts. We expect initiatives like these and others to 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. Cooper expects fourth quarter operating profit margin to improve sequentially. Full year operating profit margin is expected to be slightly above the 5.9% we reported for full year 2018 driven by positive trends in pricing, mix, and raw materials.With respect to pricing many of our competitors recently announced price adjustments and Cooper did the same implementing adjustments that were effective October 1st. Cooper continues to monitor the industry with an eye towards remaining competitively positioned in aggregate and by product line and category. With respect to mix while we continue to see strong overall mixed trends, in fourth quarter of last year we had a strong mix of TBR business that we do not expect to repeat this year.In summary while the short-term outlook has been affected by the conditions we've described particularly tariffs on tires from China and customer inventory adjustments in the U.S. we continue to believe that Cooper is doing the right things to build our business and drive improvement which will support sequential operating profit margin improvement this year and positive momentum going into 2020. With that let's move your questions. Operator will you take the first question please.

[Operator:]

[Operator Instructions]. First question comes from Rod Lache from Wolfe Research. Go ahead.

[Brad Hughes:]

Good morning Rod.

[Rod Lache:]

Couple of questions, first I was hoping you can talk about the manufacturing cost increases and maybe what's behind those numbers. They were I think a $50 million drag in 2018 and now a couple of million dollars higher in 2019. So cumulatively quite a bit higher than what we had seen before. How should we think about those going forward, did those become a tailwind? And then secondly I was hoping you can maybe just address product liability expense, is that something that should be trending at like $11 million or $12 million a quarter, $45 million a year because it looks like it was maybe $4 million or so in this quarter?

[Brad Hughes:]

Let me take them in order Rod. The first one with regards to manufacturing cost increases, let me split this into two pieces; one is in the Americas which was about half of the 12 that we showed on a consolidated basis. Those increases were less related to volume of the units produced in the plants relative to what we've had recently and the items that contributed to that negative performance in the quarter we think will mitigate as we move into the fourth quarter when you look at it on a year-over-year basis. So yes, to a beginning of the change there in the Americas. In the international operations that cost increase that we saw that was essentially all Europe and it has to do with some of the challenges of migrating the production from Melksham into Serbia and we think that by the time we get into next year we'll start to -- we will have turned the corner and start to see the benefits of that lower cost footprint in Serbia relative to what we've been carrying this year. So that's the manufacturing cost and the product liability expense maybe I'll let Chris chime in a minute but I think directionally you're pretty close on what you were thinking about with the 4 million but go ahead Chris.

[Chris Eperjesy:]

Yeah, I mean directionally Rod I think that's correct as you can imagine trying to predict product liability expense is a very challenging exercise quarter-to-quarter so we typically don't. But you are correct in that this quarter was roughly 5 million when you adjust in terms of the actual pension liability expense which will show up in the P&L.

[Rod Lache:]

Okay, is there a way to quantify what you feel is unusual in these manufacturing increases, is that -- looks like cumulatively a pretty big increase, is this something that within a year or two you think could correct by 50 million.

[Jerry Bialek:]

I definitely think that we will begin to see improvements as we move into next year and it may take a while as both the combination of efficiencies, footprint changes, and volume increases in the plants that we have produced and the units begin to -- when all of those things begin to accumulate we should see a pretty substantial turn in terms of the manufacturing cost. Calling it precisely though Rod is, I'm not in a position to do that right now.

[Rod Lache:]

Okay, and then just lastly just a couple of housekeeping things, what was the magnitude of that customer, is it specific customer that you've called out before that had a significant inventory adjustment, so what would your volumes have looked like excluding that? And secondly a number of tire companies raised prices for light vehicle tires effective October 1, what did Cooper do and do you expect stronger price performance going forward?

[Brad Hughes:]

So we haven't narrowed it to a specific customer, we've talked about customer and that is -- and does mean plural customers in terms of the inventory adjustments because we wouldn't be as specific as any individual customer. Having said that I think the best indication Rod with regard to demand and how to think about that is the comment I made on sell out in the quarter on which we believe for Cooper based on the information we have we need to extrapolate because there's not complete data around sellout. Our sellout was up at least as much as the sell in for the industry and maybe a bit more. So as we -- as you think about that sell in and sell out dynamic, as things begin to balance out that should give you an indication.

[Rod Lache:]

And pricing?

[Brad Hughes:]

On pricing we did also announce on October 1st, we make ongoing adjustments. It is always nice to have the backdrop of what was happening in the industry last quarter with regard to announcements to go in and adjust prices. We took that opportunity and we will continue to monitor and make sure that we're staying competitive with the rest of the industry and that's an ongoing process for us.

[Rod Lache:]

Great, thank you.

[Operator:]

Our next question comes from James Picariello from KeyBanc. Go ahead.

[Unidentified Analyst:]

Hi guys, this is Jake on for James. Thanks for taking my question. So in September we saw a pretty significant step up and sell ins manned about 6% of the industry. So could you tell us how much of this you think was related to pre-buying helped the price increases and what are your consumer placement volume expectations for the fourth quarter?

[Brad Hughes:]

So with regard to the third quarter there were price announcements and that typically would have some impact on the volume. Without getting into specifics for Cooper what I would say is that anything that was affected with regard to volume is all included in the sequential operating profit margin improvement guidance that we've provided which is traditionally where we stay with regard to guidance in terms of the types of metrics. So for the industry there is pricing, there may have been some for us as we look at the fourth quarter. We're guiding to people the higher operating profit margins in the fourth relative to the third.And then with regard to our volume we do think that the backdrop is still relatively challenging. We're more confident now I think than we were even at the end of last quarter that by the time we get to 2020 these inventory adjustments in the U.S. that we've talked about will be behind us. And that we will enter 2020 with some good momentum there as that's behind us and the retail expansion initiatives we have, particularly in the U.S. will begin to flow through to the bottom line. So fourth quarter still some challenges around the globe in terms of market to market. You still have a weak passenger vehicle market in China which is impacting that market and Europe seems to be a bit weak with regard to sell due replacement volumes. So some challenges out there and we still project that we're going to see the sequential operating profit margin improvement and looking forward to 2020 where we will see more of the initiatives, we've been executing against contribute to the bottom line.

[Unidentified Analyst:]

Great, thanks. And then specifically within tariffs we saw a step up in the quarterly expense to 15 million which with your 50 million assumption implies that the tariff expense gets roughly cut in half next quarter. So could you just tell us some of the assumptions that underlie that estimate?

[Brad Hughes:]

I will let Chris confirm on what we're thinking about with regard to tariffs. I mean overall we've been talking about tariffs and when we entered the year we talked about on a belief that there was going to be pricing to offset a portion of that -- those tariffs. And while there has been some pricing as you know and as we have spoken about in previous calls. I think our expectation now is that that pricing is probably going to be delayed until some point in the future as we look at the overall market for TBR tires in the U.S. It's softer than what we are anticipating coming into this portion of the year and so the probability or the environment for pricing is different from what we thought. And when we see a pickup in TBR demand I do think that there will be opportunities for pricing but that is further out into the future than we had thought at the initial discussion that we had around tariffs. But I'll let Chris comment.

[Chris Eperjesy:]

Yeah Jake, just based on the math for the first three quarters of what we've reported your assumption is directionally correct for Q4.

[Unidentified Analyst:]

Alright, that's great and congrats on a great quarter guys.

[Brad Hughes:]

Thank you.

[Operator:]

Our next question comes from Bret Jordan from Jefferies. Go ahead.

[Bret Jordan:]

Hey, good morning guys.

[Brad Hughes:]

Good morning Bret.

[Bret Jordan:]

Can we talk about the I guess the year-over-year impact on ATD [ph] obviously you probably picked up some volume there as Goodyear and Bridgestone moved away but could you talk maybe about your volume growth there, whether you're fully penetrated, and obviously some of the new online channels that you're going through maybe tire buyer what you're seeing pick up on that channel?

[Brad Hughes:]

Yeah, so across the entire landscape when you look at it channel by channel a year ago we talked about with the announcement around tire hub that we were going to go out with an aggressive conquests program to try and sign up more independent retailers and dealers. We did that, we are starting to see some of the benefits of those sign ups now flowing through in terms of net volume increases in that part of the market. Some that are very positive looking in terms of the increases that we're seeing year-over-year, certainly a fair amount of that -- a substantial amount of benefit that we've seen in that area is supported by a ATD and we would expect for that to have even some legs on it as we go forward.So it is more than just an ATD story and we've been trying to clarify that since the outset that signing up these new independent dealers and wholesalers was broader than ATD but there was an opportunity at ATD that the team sees done and is doing so successfully. We are seeing expansion in our retail presence. We've talked about general merchandisers, we've talked about national retailers. Those efforts continue and should be able to contribute more as we move into next year. And we are seeing growth in e-commerce sales, online sales, and it continues to be exciting because not only is that a unit volume growth opportunity but the revenue and profit that we're seeing on those units particularly in e-commerce is also very strong. So we're seeing progress from all of these. Unfortunately with the inventory adjustments we've talked about for a couple of quarters we aren’t seeing it in the sell in yet. We are seeing it in the data that we have on sell out.

[Bret Jordan:]

Okay, and then a question I guess, as you brought up e-commerce what do you see in pricing as a result of obviously Amazon getting bigger in the space. I think Munroe reported last week and talked about a fairly competitive pricing environment in the Tier 2 and lower, do you see that there is general deflation in the broader market at retail or are people generally holding price online?

[Brad Hughes:]

Yes, from what we can see I mean there is two dynamics going on here. One is just in terms of the overall pricing environment as we just talked about a few minutes ago the industry has had a number of pricing actions that took place late third, early fourth quarter and while early signs are that the industry is absorbing those and digesting them I think which is a very positive sign overall for pricing in the market. The thing that you get with the e-commerce platform is more transparency with regard to volume -- with regard to pricing and consumers ability to see that pricing which I'm not sure is affecting the overall pricing levels across the industry. But with that transparency it is giving consumers more power on making decisions about where they're going to go to make their purchases which is impacting what the consumer pays but to this point we're not seeing that having a deflationary effect across the industry pricing as we see it.

[Bret Jordan:]

Okay, great. Thank you.

[Brad Hughes:]

Thank you.

[Operator:]

[Operator Instructions]. Our next question comes from John Healy, Northcoast Research. Go ahead.

[John Healy:]

Thank you. Brad, I wanted to ask just a little bit about your outlook for the heavy truck market for 2020 and was hoping you could just go over some of the puts and takes as it relates to the kind of the TBR business and just broadly speaking kind of the exposure on OE end replacement there and how we might see that impacting kind of the mix next year?

[Brad Hughes:]

Okay, so from an industry perspective you see the data as we do. The OE market has been exceptionally strong that goes back 18 months to two years. It appears that the production of units to meet the demand so you get all this backlog of orders that needed to be filled, it appears like a lot of that has been filled and that we are seeing slowing orders and that's likely to result in to slowing production in the OE end of the market. We do have some exposure there particularly on trailer volume at this point in time. I think the bus market is a little bit removed from that. So I am talking largely about commercial vehicles at this point in time. The replacement market has been down double-digits as you look at demand in the U.S. market year-to-date. We expect that that probably is going to remain weak for some period of time until all of this new equipment that's come into the market begins to get to the point which is much faster than a passenger vehicle as you know it gets into a replacement requirement for those types of tires. So we think that we are probably in for as from an industry perspective a bit of a soft patch year with regard to TBR tires in the U.S. and North America.From a Cooper perspective I think we feel a little bit more positive relative to the industry. We are not down as much as the industry is on replacement year-to-date. We have a better opportunity in OE particularly as we've introduced the Cooper brand which was specifically targeted at new parts of the TBR market in the U.S. and so we're just starting to build out that business allowing us to get into some of these OE accounts and into larger fleets with the Cooper brand while remaining strong in the replacement -- in the other elements of the replacement market with our Roadmaster brand.So we still feel quite good about our TBR business from a demand perspective even in light of what we see might be a softer industry than people might have thought a year or 18 months ago. Then let me just add just to complete the TBR story that as I mentioned in my comments we are beginning to ramp up the number of tires that we're taking from Vietnam in lieu of China which is obviously going to have a significant impact on the profitability of that business for us as we avoid the 70 point plus tariffs that are on those tires when you add up all of the tariffs that are attracted to the China tires coming to the U.S. market.

[John Healy:]

And then just on the same lines I was hoping you could talk a little bit about Europe and Vietnam. Just as you think about kind of those restructuring efforts or those changes in production, is there a way to kind of conceptualize the potential tailwinds of 2020 in terms of how much benefit there might be just with kind of the restructuring and then the realignment manufacturing?

[Brad Hughes:]

Well, we should begin in 2020 to see benefits from both of those actions. They will ramp over the course of the year. We're still moving the last pieces or last tires into Serbia right now and then we'll begin to build out the product portfolio that we're able to build in that facility so that we'll have a better market facing portfolio of products and a better cost base for both of those. But that will have to happen over the course of 2020. And similarly with Vietnam, we have the off take agreement but as we ramp up production in the joint venture that we have there ACTR that will happen over the course of the year and so I think that it's going to be later in the year that you see more of the benefit from that as the volume out of that new facility is higher coming to the U.S. So, we will begin to see it next year but certainly second half and latter part of next year will be more prevalent than the first part. Did I put you to sleep there.

[John Healy:]

Oh no, thank you guys.

[Brad Hughes:]

Thanks John.

[Operator:]

This concludes our question-and-answer session. I'd like to turn the conference back over to Brad Hughes for any closing remarks.

[Brad Hughes:]

Okay, thank you. In closing I want to thank our entire Cooper team around the globe for staying focused on executing our strategy which supports our consumers, our customers, and our shareholders. With that thank you for joining today's call and have a great day.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.