Cooper Tire & Rubber Company
Q4 2018 Earnings Call Transcript
Published:
- Operator:
- Good morning and welcome to Cooper Tire & Rubber Company's Fourth Quarter and Full-Year 2018 Earnings Call and Webcast. [Operator Instructions] As a reminder this call 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 fourth quarter and full year 2018 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 summarize the information included in the news release and in the 10-K that will be filed with the SEC later today. Please note that we will 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. Before I start the call I would like to introduce our new CFO, Chris Eperjesy who joined Cooper in December. Chris is an accomplished Finance Executive who brings three decades of global finance leadership across a diverse set of public and private companies to Cooper. We are very pleased to have him on our team and all of you will get to know him as we move forward. With that, I will begin today with a brief overview of our fourth quarter and full year 2018 financial results. After that I will turn the call over to Chris, so he can review our financial performance in greater detail. Then I'll return to talk about our 2019 outlook and we will conclude by taking your questions. Now, let's move to our 2018 results. We are pleased to have delivered results that were a bit better than the outlook we provided when we released our third quarter results. Our fourth quarter operating profit margin, excluding a goodwill impairment charge exceeded what we achieved in the third quarter excluding the benefit from an adjustment to our product liability reserve model in that quarter. Also on a year-over-year basis, revenue as well as adjusted operating profit and operating profit margin improved compared to the same period last year. Raw material costs improved sequentially but were up on a year-over-year basis by nearly 8%, slightly less than our projection. Operating profit margin improved throughout the year as our strategic initiatives began to take hold again delivering on our expectations. Unit volumes in the U.S. improved throughout the year, ending 2018 with two consecutive quarters of year-over-year volume increases. As we have discussed previously, our exit from non-strategic private brand distributor business had an impact on our 2018 U.S. volume comparisons. Excluding this impact, we would still have underperformed the total industry, but would have outperformed the USTMA with unit volume growth in 2018 compared to 2017. A word about our volume performance in Asia. We started the year strong in that region, however, beginning in the third quarter economic conditions created weakness in the OE auto market and tire industry. As a result, we told you that we expected to see a moderate headwind in our fourth quarter 2018 OE unit volume in Asia. While we did see this softness, our business performed as planned, and I'm pleased by the work from our team to ensure that we're doing comparatively well in some challenging conditions. According to the China Passenger Car Association, China's retail passenger vehicle sales were down 17% in the fourth quarter of 2018 compared to 2017. For the full year, sales were down nearly 6% year-over-year. If this trend were to continue into 2019, it could have an impact on our business. However, it does appear that Chinese government is beginning to respond with broader efforts to increase market liquidity and is potentially considering actions to stimulate the automotive industry, which we would of course welcome. Regardless, we still feel good about the long-term prospects for our Asia business, as we continue to diversify our customer base. You may also recall that at our Investor Day last May, we provided a slide showing where we thought certain key market variables were headed as we moved through the balance of 2018. As we look back on those projections, we weren't too far off. We talked about four things
- Chris Eperjesy:
- Thank you, Brad. I'm delighted to be part of the Cooper team and to join my first earnings call as CFO. Two months into the role, I'm fascinated by the industry and excited about the opportunities Cooper has to grow our business and improve profit margins. I've had the opportunity to meet several of you and look forward to interacting with further in my role. Now moving to our results beginning with the full year. Sales for 2018 were $2.81 billion, a 1.6% decrease from 2017. Net sales were impacted by lower unit volumes of $67 million, partially offset by $17 million of favorable foreign currency impact and $3 million of favorable price and mix. The company's 2018 operating profit was $165 million or 5.9% of net sales. Diluted earnings per share were $1.51 per share. As Brad noted earlier, excluding the impact of the $34 million goodwill impairment charge recorded in the fourth quarter, operating profit was $199 million or 7.1% of net sales and earnings per share would have been $2.18. This compares with operating profit of $309 million or 10.8% of net sales and diluted earnings per share of $1.81 in 2017. The 2017 results included discrete tax items of $68 million. Excluding this impact, earnings per share would have been $3.10 in 2017. Moving to consolidated fourth quarter results, sales were $770 million, up from $757 million in 2017. This 1.8% increase was driven primarily by favorable price and mix offset by lower unit volume. Operating profit was $25 million or 3.2% of sales compared with $56 million or 7.4% of sales in 2017. Excluding the goodwill impairment charge, operating profit would have been $59 million or 7.6% of net sales. Fourth quarter operating profit compared with 2017 was impacted by the following factors which are summarized on Page 6 of the supplemental slide deck. $34 million of non-cash goodwill impairment charge resulting from goodwill impairment testing in the fourth quarter of 2018. As Brad mentioned, we announced a joint venture agreement with Sailun to build new truck and bus radial tire production plant in Vietnam. The capacity created by this planned facility would decrease expected production growth requirements for Cooper's GRT joint venture in China resulting in the impairment charge. While there is an impairment charge, we are excited about this addition to our manufacturing footprint which diversifies our sourcing to protect against risk including tariffs. Operating profit also included $12 million favorable price and mix, primarily offset by $11 million of unfavorable raw material costs. Operating profit also included lower product liability costs of $6 million, $2 million of lower unit volume, higher SG&A expense of $2 million, higher manufacturing cost of $1 million, and lower other costs of $1 million. Diluted loss per share was $0.01 compared with a loss of $0.82 in the fourth quarter of 2017. Excluding the impact of the goodwill impairment charge, earnings per share in the fourth quarter of 2018 would have been $0.66. Earnings per share in the fourth quarter of 2017 including the impact of tax reform and other discrete fourth quarter tax items was $0.50. Now, moving on to our segment performance starting with the Americas tire operations. Segment sales for the fourth quarter were $664 million, up 3% from $645 million in 2017. This was a result of $21 million of favorable price and mix, partially offset by $2 million of unfavorable foreign currency impact. Segment unit volume was essentially flat compared to the prior year with the unit volume increase in North America offset by a decline in Latin America. Fourth quarter operating profits in the Americas increased to $70 million or 10.6% of net sales compared with $68 million or 10.6% of sales in 2017. The major drivers of the increase were $9 million of favorable price and mix offset by $9 million of unfavorable raw material costs. The quarter also included $6 million of favorable manufacturing costs and $6 million of lower product liability costs. These were partially offset by $11 million of unfavorable SG&A cost including increased incentive compensation cost. Other cost decreased by $1 million. You can see the full profit walk for the Americas segment on Slide 8 of our supplemental slide deck. Now, turning to our international tire operations. Net sales for the fourth quarter were $149 million, down 7.8% from the fourth quarter of 2017. This result was driven by lower unit volume and unfavorable foreign currency impact, partially offset by favorable price and mix. Segment unit volume was down 12.3% with decreased unit volume in Europe and Asia for the reasons that Brad explained. In Europe, third-party sales were up slightly year-over-year. However, this was more than offset by lower shipments to the U.S. from Serbia as we continued to execute our near sourcing strategy. Fourth quarter operating loss in our international operations was $33 million compared to an operating profit of $7 million in 2017. The decrease was primarily driven by the goodwill impairment charge of $34 million. Additionally, the segment experienced $2 million of favorable price and mix, which was more than offset by $3 million of increased raw material costs. The quarter also included $3 million of lower SG&A $6 million of unfavorable manufacturing costs and $2 million of lower unit volume. You can see the full profit walk for the international operations on slide 9 of our supplemental slide deck. As noted during the third quarter call in October, we anticipated our raw material index would be about 10% higher in the fourth quarter compared with the same quarter a year ago. Our actual index increased 7.8% from the fourth quarter of 2017 slightly less than anticipated. The raw material index decreased sequentially from 168.6 in the third quarter of 2018 to 165.1 in the fourth quarter of 2018 as shown on slide 7 of the supplemental slide deck. As Brad mentioned, raw material costs appeared to have stabilized. Therefore, we expect our first quarter 2019 raw material index to be down nearly 3% sequentially, but up nearly 3% year-over-year. Turning now to some corporate items. The effective tax rate was 96.3% for the quarter compared with 206% last year. Excluding the impair โ goodwill impairment charge the fourth quarter 2018 effective tax rate would have been 25.2%. The fourth quarter 2017 effective tax rate including the impact of U.S. income tax reform and other discrete tax items was 30.7%. The tax rate for the fourth quarter of 2018 includes the benefit of a lower blended U.S. statutory tax rate as a result of U.S. income tax reform offset by approximately $2 million of net discrete expense items related to the accrual of additional uncertain tax positions. For the full year, the effective tax rate was 29.4% compared to 60.3% in the same period the prior year. Excluding the impact of the goodwill impairment charge the 2018 effective tax rate was 22.6%. The decrease in the adjusted effective tax rate reflects the benefit of lower blended U.S. statutory tax rate as a result of U.S. income tax reform. More detail on our taxes will be available in our Form 10-K that will be filed with the SEC later today. Turning to cash flows and some balance sheet highlights. Cash and cash equivalents were $356 million at December 31, 2018 compared with $372 million at December 31, 2017. As discussed throughout 2018, we have focused on cash flow improvement actions including aligning production to demand, managing inventory levels, and other working capital actions. As a result of this focus and the strong work of our team, we're able to achieve significant working capital improvements in 2018. We improved working capital by over $20 million compared to 2017. As part of this improvement, we're able to meaningfully reduce the number of inventory units in the Americas by over 10%. We believe this positions Cooper to enter 2019 with the right level of inventory and we will continue to focus on working capital in 2019. Capital expenditures in the fourth quarter were $49 million compared with $54 million in the same period last year. Full year capital expenditures were $193 million compared with $197 million in 2017. Return on invested capital excluding the impact of the goodwill impairment charge in the fourth quarter 2018 was 10% for the trailing four quarters. Moving to return of capital to shareholders. During 2018, we repurchased over 1 million shares of the company stock for approximately $30 million at an average price of $29.65 per share. As of December 31, 2018, $193 million remains of the $300 million authorization. Since share repurchases began in August 2014 through December 31, 2018, the company has repurchased a total of 15.8 million shares at an average price of $34.11 per share. Additionally, Cooper distributed over $20 million in regular quarterly dividends during 2018. Returning capital to our shareholders remains an important priority for us. We are committed to supporting our quarterly dividend, but will pursue share repurchases more opportunistically in the near term as we balance attractive opportunities to invest in our business. We are currently evaluating the refinancing of our $174 million senior notes, which are due in December 2019, which could provide an opportunity for additional financial flexibility as well as interest rate savings. As we assess our debt, pension and other obligations relative to financing sources, we will considering -- consider borrowing more than the amount of the maturing bonds to increase the liquidity of the offering, take advantage of attractive borrowing rates and fund some very good opportunities for reinvestment back into the business. These include the previously announced joint venture with Sailun Vietnam and other potential manufacturing footprint investments. I'll now turn the call back over to Brad.
- Brad Hughes:
- Thanks, Chris. As I mentioned earlier, we are making good progress on the strategic initiatives identified at our 2018 Investor Day and I want to thank all of our employees around the world for their contributions. Cooper will continue to execute on these strategic priorities such as entering additional sales channels, making inroads into the global OE business outside of our already strong OE presence in Asia, introducing new products at a faster pace and other initiatives focused on driving growth, especially with respect to volume in the United States. We continue to build the Cooper brand and to emphasize our strong value proposition to consumers. As our brand becomes even more recognized, our retail expansion strategy becomes more important. A great example of this is an exciting new partnership Cooper has with Monro, which as many of you know is a leading growth-oriented U.S. auto service and tire retailer with approximately 1,200 retail locations across 28 states. With this new relationship, Cooper Tire will now be available in a number of Monro stores as they continue to expand the Monro retail footprint. We are excited that Cooper and Monro two organizations that share a strong commitment to the consumer to continued growth and outstanding service in the tire industry are coming together to make our great products and services available to an ever wider audience of consumers. We are very pleased to be teaming up with Monro to further our strategic initiatives. We are optimistic about 2019 as our business model was strong and our strategic initiatives are well underway. As a result, we expect the full year 2019 to include modest global unit volume growth compared to 2018, improving operating profit margin throughout the year with full year operating profit margin exceeding 2018, an effective tax rate in a range between 22% and 25%, and finally, capital expenditures to range between $190 million and $210 million. This does not include any capital contributions related to Cooper's pro rata share of the previously announced joint venture with Sailun, Vietnam or other potential strategic manufacturing footprint investments. However, there are some unique items along with typical seasonality that we expect will impact the first part of the year. These include charges related to the decision to cease light vehicle tire production in Melksham, England. We estimate that this action will result in $10 million to $15 million in restructuring charges the majority of which will occur in the first quarter. In addition recently enacted tariffs including the 10% Section 301 tariffs on tires and raw materials and the 42.16% duties on TBR tires imported from the U.S. -- to the U.S. from China. Also economic conditions in China that continue to be challenging, reflecting weakness in OE as well as the replacement tire market. As a result, we expect our first quarter 2019 operating profit margin to be lower than the first quarter 2018. We continue to expect operating profit margin to improve throughout the year and full year 2019 to be better than 2018. Again, these expectations include tariffs already in place, but do not include any rate changes or additional tariffs that are under consideration, but not yet imposed. Let me elaborate a little more regarding TBR tariffs. You may recall that in February 2017, there was a ruling by the U.S. International Trade Commission or ITC not to impose antidumping or countervailing duties on truck and bus radial tires imported into the United States from China. The United Steelworkers appealed that ruling and the U.S. Court of International Trade ordered the ITC to reconsider it. On January 30th, the ITC reversed its earlier decision. As a result, duties on TBR tires imported into the U.S. from China were implemented on February 15th. The rate for Cooper is 42.16%, which is generally consistent with most other Chinese TBR producers. Given that this decision was made just a week ago, it's not clear how the market and pricing will be impacted. As we've said before, Cooper believes that there is not enough domestic supply to meet demand for TBR tires in the U.S. and the majority of the excess supply is coming from China. We expect there will be pricing actions to help offset the cost of the tariffs; however, there may be a time lag. Given that Cooper is on LIFO accounting we will see the negative tariff impact immediately. As a result, we would expect a disproportionate impact in the first part of 2019. Let me reinforce that Cooper is committed to our TBR business. Our existing offtake agreement and recently announced joint venture with Sailun, Vietnam are steps we have taken to provide alternative capacity to help serve our TBR business around the world. We are working to maximize the units from our offtake agreement as well as to accelerate the timeline for the new joint venture in Vietnam. We are confident that our strategic plan remains the right path to achieve our goals and help drive shareholder value. Cooper has a good track record of delivering solid returns on our investments and remain confident in the strength of our business model. Overall, we believe that with industry conditions improving Cooper is well positioned for the future. We have work to do, yet are confident that Cooper will as we have for more than 100 years continue to succeed in the long-term. With that, let's move to your questions. Operator, will you please take the first question?
- Operator:
- We will now begin the question-and-answer session [Operator Instructions] Our first question comes from Rod Lache with Wolfe Research. Please go ahead.
- Rod Lache:
- Good morning, everybody. I was hoping just first of all to get a better sense of your expectations for U.S. market share going forward. If I look at the quarter, you were up about 0.5% in the market that was up 1% to 3% depending on the source and you also talked about taking some inventory down. So, are you โ I guess in a nutshell, are you thinking that some of these new accounts that you've signed up like ATD and Walmart are just not sufficient to move the needle on market share?
- Brad Hughes:
- Rod, we're โ we feel good about where we're headed with regard to our performance in the U.S. market on volume. The โ again, I hope this is the last time we're going to highlight this, but as we moved through the course of last year, we were continuing to reduce an exit from the non-strategic private label business that we have out there, and that impacted not only the year, but also the fourth quarter where excluding that we would have been above the USTMA and closer to the industry with regard to our volume increases. As we transitioned into 2019, we continue to focus on retail expansion. That's going to allow us to continue to build on the conquest program that we had in place starting last year where we were adding dealers, and again that volume will come online over time. And we are looking at other channels where we feel like we're underrepresented. We've highlighted the general merchandiser category, which is you've highlighted Walmart, but that's also Costco and Sam's Club, and we do think that we're going to make progress in that channel this year, and we're continuing to build out our retail customer portfolio. So, it's an expansion across the board where we're building on the conquest program from a year ago, we're adding on new entries and new customers in other channels. And so as we get into 2019, I think we're feeling pretty optimistic about our volume.
- Rod Lache:
- Okay. Great. Thanks for the clarification. And could you also talk about the new labor contract and whether there is any material impact on the numbers looking up to 2019?
- Brad Hughes:
- No, I'd say two things, Rod. One is, we think that the financial implications of that are fairly neutral as we look at it over the course of the next few years, and clearly, we are glad to have that behind us and have the agreement in place as we move forward with an important plant down in Texarkana.
- Rod Lache:
- Okay. Great. And just lastly, your pricing looks like it's been pretty good, but the industry still hasn't recovered the shortfall from 2017, just thinking about price mix versus the raw materials. Do you think that thereโs some momentum behind the pricing environment? Do you think that the industry continues to move towards recovering that over the course of the coming year?
- Brad Hughes:
- I think I'm going to break it into a couple of discussions here, Rod. One is on the TBR front. I think everything that we see there is setting itself up that we would anticipate that there is going to be pricing. We are already in a position where the U.S. market was likely going to be challenged from a supply perspective relative to the demand that weโre expecting for TBR tires across both the OE and the replacement markets there. You add into that some of the cost factors including the tariffs now where a lot of the tires that are being imported into U.S. are coming from China. We would expect that in that segment, there is definitely going to be some pricing action that would be our expectation and anticipation. In the light vehicle market, and again I'm focused on the U.S. here right now. I think it's going to depend a little bit. Weโve talked about this a couple of times in conferences that if we see a rise in raw material price costs, I do think that the industry will be ready to pounce on those as a reason to increase pricing at the top line, so gross pricing on the invoice. If we don't, if we continue in the stable market, we may see some pricing. However, I think the other factor here that we all need to pay attention to is that there are still a lot of promotional dollars in the market that are a carryover from 2017 where the industry attempted to price and then backed off. The backing off in some cases was a rollback of the gross price, but in many cases, it was an offset with promotional dollars which largely are still in the market and that's where we're going to be paying a lot of attention to what competitors are doing to see if there is any movement there in terms of backing off of some of that as another way to improve the average selling price.
- Rod Lache:
- Okay, great. Thank you.
- Brad Hughes:
- Thank you.
- Operator:
- Our next question comes from Chris Van Horn with B. Riley FBR.
- Brad Hughes:
- Hi, Chris.
- Chris Van Horn:
- Good morning. Thanks for taking the call. Could you elaborate a little bit, maybe the puts and takes if you will on your full year 2019 guide on modest unit volume? Maybe, could you get into a little bit more of what you're seeing regionally? And then same on the operating profit line, could you elaborate what you're seeing? It seems like you're going to see a little bit more in the back half. Is that more mix improving, new product launches, some cost reductions you might see, any more detail there would be great?
- Brad Hughes:
- Good. Yeah, Van, thank you for allowing me to elaborate on the volume on outlook here because we are calling it modest on a global basis, but that global view includes what we're looking at in China right now in the OE market, which we saw another month of vehicle sales decline for January here recently. And so we're cautious with regard to our outlook in China. We do think that from a Cooper perspective that we've got opportunity on the replacement side there for some growth and that we will likely navigate as well as anybody the OE market. But if that market continues to be soft, especially through the first half of the year that clearly was included in the way that we were looking at volumes for that market. Latin America, again there is a lot of things moving around down there both economically and politically. And so weโre a bit cautious on our outlook for that market. Europe while the team has done a really nice job in Europe of improving the mix of the products we're selling over in that market because of the production situation that we are in there and the transition that we're now going to need to make with the product that was formerly produced at Melksham that's moving into other parts of our footprint, we're really focused on having the right mix of product over there. And so it's less of a near-term volume opportunity in terms of growth in 2019, and it's more of a continuation of the strength in mix where we are focused on 4x4 and high value-add products. So you look at those three markets and we're relatively benign in terms of the outlook that we've got for 2019, which would suggest to you that our confidence around volume growth has been built off of what our expectation is in the U.S. market, where we do think that we do have a number of initiatives that are going to start to contribute this year on both in light vehicle and in TBR. So that will transition me to the bottom line profit look. Mix is clearly one of the things. Both product and geographic mix are going to be positive, as we think as we move into 2019. The other big factor Chris that I would point to is 2018 we faced a bit of a headwind with regard to manufacturing costs. Part of it was giving the supply aligned to the demand and at the same time we thought we had an opportunity to run our business more efficiently from a working capital perspective, including less finished tire inventory, which the team did a great job of addressing. And we now enter 2019 in a good position we think from both a demand and an inventory perspective. So our plant should have a better performance from a cost perspective in 2019 compared with 2018 as well.
- Chris Van Horn:
- Great. That's really helpful. Thanks for all that color. And then just my follow-up is congratulations on the Monro relationship. And just curious, is it similar to some of your other customers in terms of product lineup? And is that -- maybe if you could elaborate on the timing of it? And is it -- do you launch with a number of tires right away, or do they kind of ramp throughout the year and into next year?
- Brad Hughes:
- Well, this is -- we've actually gone a bit further than this with agreement from Monro, because we're both very excited to get this partnership going and to let people know about it. I'd say the things that I'd highlight Chris are that it's the Cooper brand. It's going to be a relatively good portfolio of products that we're expecting to start with there, and we would believe that it's going to build as we move forward and both get our feet underneath us with regard to how we're going to make this the opportunity we think it can be for both of us.
- Chris Van Horn:
- Okay. Got it. Thanks again for the time.
- Brad Hughes:
- Thank you.
- Operator:
- Our next question comes from Anthony Deem with Longbow Research. Please go ahead.
- Anthony Deem:
- Hi. Good morning.
- Brad Hughes:
- Hi, Anthony.
- Anthony Deem:
- So, few questions for me. First quarter, specifically, so if I use the index data, Chris, I think that you just shared, I'm getting to about a $5 million year-over-year headwind in raws. And when I assume a year-over-year price mix benefit percentage is sort of similar to what we saw in the fourth quarter, I'm getting to about a $10 million positive impact there. So price mix overall is $5 million positive. I'm just wondering if that's a good framework of how we're thinking about the first quarter guidance, which essentially would mean many of the other income drivers are generally lower year-over-year. Is that a good framework?
- Brad Hughes:
- I think the one thing, we capture tariffs in our raw material costs and there were tariffs in place in the first quarter that we didn't have in place a year ago, and we highlighted the ones that are in place and in effect right now as the ones that are going to affect the first quarter. So being the 301 tariffs on both tires and on material and then at least for a significant portion of the quarter on the Antidumping/Countervailing Duty tariffs that just went into place on TBR tires. And so, that's incremental to the raw material index that we talk about and are important numbers in the way that you're looking at that. Those came into play -- the 301 tariffs came in over a period of time and with different effects on it. So over the course of the year, but they were not in place in the first quarter of a year ago.
- Anthony Deem:
- So that's driving raw material costs higher year-over-year. So I think 3% was the number that was shared ex-tariffs. Is it flat or something along those lines?
- Brad Hughes:
- Well, I will go back to your original question with regard to the framework and I don't see anything fundamentally out of line with the framework you started with. I just wanted to highlightโฆ
- Anthony Deem:
- Okay.
- Brad Hughes:
- ...the other impact that you'd see in raw materials.
- Anthony Deem:
- That's fine. And I apologize if I missed this. Did you share the exact tariff impacts on operating income in 2019 that has affected your margin guidance?
- Brad Hughes:
- No, we didn't. It's factored in and frankly it would be probably premature, because, obviously, as we -- what we did try to emphasize is, that we do have an expectation that there will be pricing to offset a portion of that. So the net impact is just given the freshness of that news a little bit difficult to project at this point.
- Anthony Deem:
- Fair enough. And then, on rightsizing your inventory. So fourth quarter 2018 pretty significant drop in the balance sheet for inventory. You can blame that on some seasonality. That's what you've seen historically. But I'm wondering in terms of overhead absorption for the first quarter, specifically, is there going to be a negative impact similar to the fourth quarter?
- Brad Hughes:
- Again, I think, that as we move into 2019, we're going to be running our plants more full, right from the start, relative to what we did during 2018. And we actually even had a little bit of a turn on that in the fourth quarter, already, in terms of the manufacturing contribution. So we think we're in pretty good shape coming out of the gate, Anthony.
- Anthony Deem:
- Got you. And then, just last question for me. Just for product liability expense, that's a key variable for your earnings. I'm just curious if you can help us for 2019 modeling what the expectations are? Thank you very much.
- Brad Hughes:
- Yes. Anthony, when we, in the third quarter, announced the adjustment to our reserves of about $31 million, we indicated that the go-forward impact on our annual expense would be about $5 million annual reduction. So you'll have to adjust for not having that one-time product reserve on -- product liability reserve adjustment, but on an ongoing basis, if you look at it over time, the annual expense should be down about $5 million compared to where it had been running.
- Anthony Deem:
- And then, so just for clarification, ex that benefit, are we looking at like a $50 million run rate for 2018? Is that fair?
- Brad Hughes:
- I haven't done that math, to be honest with you. We can get back. Because with the combination of what we've guided and what's available in the soon-to-be filed 10-K, we should be able to get you pretty close to that number.
- Anthony Deem:
- I'll follow up. Thank you very much.
- Brad Hughes:
- Thank you.
- Operator:
- Our next question comes from John Healy with Northcoast Research. Please go ahead.
- Kyle Patterson:
- Good morning, everyone.
- Brad Hughes:
- Hi, John.
- Kyle Patterson:
- This is Kyle Patterson on for John Healy. Thanks for taking my question. So I appreciate the guidance that you guys gave for the full year 2019 in terms of the volume outlook. So just taking a more micro view, I was wondering, if you guys could just discuss what you've seen in the first half of Q1 in terms of industry sell-in and sell-out? And just how you would characterize industry inventory levels overall?
- Brad Hughes:
- Okay. Kyle, I think the industry data that is available out there for January as we look at it suggests that January is holding in there with a relatively decent market. We exited last year with the second half of the year in the U.S. focused most at this point with reasonably strong volume over that time frame including in the fourth quarter and from what we've seen in the industry published data that looks like it's continuing into January. And again, I know from our perspective, and I think this is a bit broader than that. As we exited last year, I think the industry, I certainly know Cooper, both our own inventory and what we are aware of in terms of the channel inventories that are Cooper, we're in pretty good position coming into the year which is nice to come -- to start the year without any kind of an overhang. In the other markets, I think generally the trends in the early part of the year are pretty consistent with the way that we exited last year. There is -- there continues to be softness in China driven by overall economic concerns and specifically some weakness in the automotive industry, although it does appear that they take -- the government there is taking some steps to try and address both the broader economic and potentially the automotive industry specifically. Latin America with some of the political changes that are underway in that -- in those markets along with some variability in the economic circumstances, we're looking at that pretty cautiously in terms of our optimism around volume growth. And then for us, Europe again, last year was -- ended up somewhat of a flattish year and that looks to be the way that we're starting this year. Our opportunity there is going to be governed a little bit by our ability to produce the tires that will be demanded. And so we're focused on making sure that we're building the appropriate mix of product to continue to move and strengthen that portfolio.
- Kyle Patterson:
- Okay, great. Thanks for the color. And then also just on the relationship with Walmart was just curious if you could provide a little more color on the evolution of that relationship? And I know there has been some expansion in that relationship on the e-commerce side. And I was just wondering if there was any movement that in 2019 we could see the relationship expanded to brick-and-mortar locations?
- Brad Hughes:
- Yes. So what we have talked about Kyle is as we have talked about the fact that their e-commerce platform we are now and have been selling tires across that platform for the second -- starting for the second half and in place for the second half of 2018. We are thrilled with the way that that's going for the most part in terms of the type of products that we're selling and the price positioning of those products that are being sold. So that's been a very good experience. The other thing that we've talked about as part of our retail expansion which is a much broader effort is general merchandise. And we highlighted it a fair amount last year, because it was a part of the market that we were clearly underrepresented in and we put a significant attention and effort around that. We haven't talked specifically about customers within that channel, we've been more focused on the channel. But we have made progress and we do think that we're going to begin to see some activity there in the first half of this year and believe that we'll build on that activity as we go through the course of this year and into next.
- Kyle Patterson:
- Okay, great. Thanks for taking my questions and good luck.
- Brad Hughes:
- Thanks Kyle.
- Operator:
- Our next question comes from Bret Jordan with Jefferies. Please go ahead.
- Bret Jordan:
- Hey good morning guys.
- Brad Hughes:
- Hi Bret.
- Bret Jordan:
- Could you give us an update, I guess, maybe where we stand with the ATD transition? And was that a positive from a unit standpoint in the end of 2018?
- Brad Hughes:
- On -- so, ATD a lot of where they're at as a company is available publicly as a result of their move through a bankruptcy proceeding to come out on the other side with a much healthier balance sheet. And while I was never -- I think I said this out loud on a previous call, a lot of things keep me up, but ATD paying us was never one of them and now we certainly feel very comfortable with what they've done to improve their balance sheet. It did create and it wasn't only with ATD and I want to continue to reinforce that. When that along with some other changes occurred through consolidation to the wholesale distribution channel in the United States, our team here looked at it and actually put a great plan in place and executed really well against a conquest program to go out and try and sign up more customers for Cooper that would be serviced through these large -- in many cases, national distributors including ATD. There is no doubt that ATD -- the business that we have through that organization benefited from this conquest program and we did grow through that. And frankly we would expect that there is additional opportunity -- again, more broadly with this conquest program as we move into 2019. Not only did it continue to sign up new customers that we didn't have even as of last year, but actually to grow the volume for a full year with the new customers that we did sign up last year. And to put it into context, we signed up about two and a half times the number of new customers in 2018 as we signed up in 2017. So, there are more customers out there that are going to be ordering Cooper products and are going to have that experience. We just think this is an opportunity to continue to build on that.
- Bret Jordan:
- Okay, great. And then in your prepared remarks I think you quipped -- you in passing said you're reviewing Americas' production component, are you looking at changing the footprint -- maybe more detail on that?
- Brad Hughes:
- Yes, in our Investor Day, what we said at that time and we had just completed the Asia review and we were well through the European review, we're going market-by-market. We have a near sourcing strategy where we want to build the majority of tires we sell into a market in or near that market. And so we wanted to go through regionally -- geographically regionally to make sure that we had the right footprint from being able to build the right kind of tires to being able to have the right levels of technology and capability in our plants, the right cost is clearly part of that. We're looking to make sure that we've got a footprint that we can support with efficient CapEx spending going forward and looking into the future. And if there -- we didn't have any changes in Asia. The Melksham announcement came out of the review of Europe and it's premature to make any remarks about what would happen in the Americas' footprint as we're looking at that right now.
- Bret Jordan:
- Okay, great. Thank you.
- Operator:
- Our final question comes from Ryan Brinkman with JPMorgan. Please go ahead.
- Ryan Brinkman:
- Great. Thanks for taking my questions. Firstly, on the margin outlook, you mentioned the guide for lower year-over-year margin in 1Q. It takes into account the wind-down cost in the U.K. Does that mean then that the outlook for higher year-over-year margin in full year 2019 also takes into account the various GAAP items including the 4Q, 2018 impairment charge? Do you expect margin to rise year-over-year on an adjusted basis? And how should we think about the potential for higher margin on an underlying adjusted basis as 2019 progresses?
- Brad Hughes:
- Yeah. When we are giving that guidance, Ryan it is on an adjusted basis. So not only -- it does adjust out the $34 million goodwill impairment charge in the fourth quarter. So the underlying business, we are expecting to have an operating profit margin improvement. We're calling it adjusted but I think it's reflective of what we believe the ongoing business looks like.
- Ryan Brinkman:
- Perfect, thanks. And then a question on China. Clearly the new vehicle production there is under significant pressure. I think the trend in production is atypically important for you there. What is happening though with aftermarket in China? How do you see the impact on replacement shipments netting out from I guess these cyclical headwinds, but also there should be some pretty good structural tailwinds there too, right, relative to their sort of recent increase in units and operation et cetera?
- Brad Hughes:
- Yeah. We really continue to feel very positively about our long-term strategic plan for Asia, which has always been that we were going to emphasize OE in a way that we aren't in other parts of the world or at least we started that emphasis there early and it is a bigger part of our business there now. But that was with the intent of building long-term, a replacement market business over there that will end up being more like it is in mature markets for all of us around the world. And so we're at a point now, I think where when you look at the replacement market over there in general for tires that it is -- we should start to see significant growth. I'm not sure we've quite seen the peak in terms of the build out of the vehicle park. We plateaued there a little bit and then it begins to age as those cars become used and passed to other consumers. But I do think that we are at a point now where we're going to start to see the pull-through in the replacement market for the growth that we've seen in the vehicle park. Certainly we believe that for Cooper, weโre at about that point. And so a big focus for us is on making sure that we've got a replacement network where we can make tires available to the people that want them in the replacement market for us in China. And again while this is a little bit of a dip in what has been a terrific market for tires particularly OE for a period of time, long-term as you look at the replacement market there, it still looks very attractive I think for the industry and I think particularly for Cooper.
- Ryan Brinkman:
- I see. Thanks. And then just lastly, do you expect tires to be included under the definition of autos and auto parts under any potential Section 232 action? And how would this layer in relative to the existing tariffs already in place on imported tires not just the recent TBR CVDs tariff?
- Brad Hughes:
- Yes. I would say, it's a good question Ryan. We've heard different views from people that we respect on both sides of that will it or will it not -- will they or will they not be included. Clearly if they were to be included our understanding is that, those tariffs are incremental. The difference on these is that, they are on tires coming from all markets unless those markets are -- those countries are excluded from the application of those 232 tariffs. And so, it would be a really substantive impact on the market in the United States. For those of us that have a footprint that's largely in place in North America, including in the U.S. to support our market here, we could become pretty popular pretty fast but it would be very disruptive for the industry for a period of time. And while we would do what we could to make sure that we're building long-term relationships, but also taking -- recognizing what the conditions are in the market at any point in time it's -- long term it's pretty disruptive if something like that were to happen. So we'll see.
- Ryan Brinkman:
- I see, very helpful. Thank you.
- Brad Hughes:
- I think that's it with regard to questions operator.
- Operator:
- This now concludes the question-and-answer session. I would like to turn the call back over to management for any closing remarks.
- Brad Hughes:
- Yes. I'm going to just make some closing remarks here quickly. Again I want to thank the Cooper team around the globe for their 2018 efforts. They delivered good results in a challenging environment including two consecutive quarters of volume growth in the U.S., good progress on both our global OE and TBR businesses, and a fourth quarter with year-over-year revenue growth and higher adjusted operating profit and margin. Looking forward we expect improvement to full year operating profit margin as we just described as we continue to progress our strategic initiatives such as our retail expansion in the U.S. which will build on the successful dealer conquest program, we had starting a year ago and continuing by expanding into new channels and by partnering with new customers. At the same time we are improving our manufacturing footprint and that includes our new TBR, JV in Vietnam. So while the industry remains challenging, we are optimistic about how we are positioned at Cooper to compete. And with that we will close it and thank you for your participation today. Thank you.
- Operator:
- The conference has now concluded. Thank you for attending today's presentation. And you may now disconnect.
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