Cooper Tire & Rubber Q2 2009 Earnings Call Transcript

| About: Cooper Tire (CTB)

Cooper Tire & Rubber Company (NYSE:CTB)

Q2 2009 Earnings Call

August 06, 2009 11:00 am ET

Executives

Curtis Schneekloth - Director of Investor Relation

Roy V. Armes - Chairman, Chief Executive Officer and President

Philip G. Weaver - Vice President and Chief Financial Officer

Analysts

John Murphy - BAS-ML

Rod Lache - Deutsche Bank

Himanshu Patel - JPMorgan

Anthony Cristello - BB&T Capital Markets

Saul Ludwig - Keybanc Capital Markets

Presentation

Operator

Good morning, my name is Tasha, and I will be your conference operator today. At this time I would like to welcome everyone to the Cooper Tires 2009 Second Quarter Conference Call. (Operator's Instructions) After the speaker's remarks there will be a question-and-answer session. Thank you. Curtis, you may begin your conference.

Curtis Schneekloth

Good morning, everyone, and thank you for joining our call today. My name is Curtis Schneekloth and I serve as the company's director of investor relations. To begin with, I would like to remind you that during our conversation today you may hear forward looking statements related to future financial results and business operations for Cooper Tire & Rubber Company. Actual results may differ materially from current management forecasts and projects as a result of factors over which the company has no control. Information on these risk factors and additional information on forward-looking statements are included in the press release and in the company's reports filed with the Securities and Exchange Commission.

With me today are Roy Armes, Chairman, Chief Executive Officer, and President, and Phil Weaver who serves as Chief Financial Officer. In association with the press release, which was sent out earlier this morning, we will provide an overview of the company's second quarter operations and results. Following our prepared comments we will open the call to participants for a question-and-answer session.

Today's call will begin with Roy providing an overview of our results. He will then turn it over to Phil for a discussion on some of the details by segment, and comments on other matters. Roy will then summarize and provide comments on our outlook.

Now let me turn the call over to Roy Armes.

Roy V. Armes

Thanks, Curtis, and good morning to all that's on the phone here. The second quarter was a return to profitability for the continuing operations of Cooper and this was an exciting achievement for us, especially in light of the continued difficult economic conditions. This improvement was driven by both internal efforts and stabilization in the macroeconomic environment.

Now during this period we've continued advancing our strategic plan. This plan calls for us to establish a sustainable and cost-competitive supply of tires, profitably growing our top-line, and enhancing our organizational capabilities.

We're also successful at shepherding our resources and had cash of $203 million as of June 30th, 2009, which is up $55 million as compared to December 31st, 2008, and we also were able to reduce our debt by $53 million during the first half of 2009.

While exciting in terms of the progress, we view this as part of a journey and not necessarily the goal. There can be continued difficulties posed by the global economic environment and we must continually and successfully execute changes we've identified to position the company for success.

And during the second quarter we had a net income loss of $0.22 per share or $13 million. This includes restructuring charges primarily related to the pending closure of the Albany, Georgia facility of around $9 million. We also incurred a charge to discontinued operations of $35 million related to a taxation matter which will be further explained by Phil a little bit later in the call.

Excluding restructuring charges, continuing operations had a profit of $33 million or $0.40 per share. This is a significant improvement over the prior year second-quarter loss of $22 million or $0.37 per share. Global demand for replacement tires remained weak during the second quarter of 2009 as a response to the macroeconomic factors that are affecting consumers. Certain regions around the globe including China have begun to recover, but on balance, demand for tires is still very weak.

There have been other recent indicators in the United States, our largest market, that stabilization may be occurring. June was the strongest month for tire shipments that we have seen in several months and resulted in a strong finish to the quarter for the company. Our strategic plan is a solid foundation and although we've had to continue adapting our expectations to the current environment, we’re committed to delivering results with the actions that we put in place.

The previously announced closure of our facility in Albany, Georgia, is ahead of schedule and we should now cease production at the facility by October, ahead of initial projections. We continue to estimate the restructuring charges and total will be around $120-$145 million, of which 60%-70% should be non-cash.

To date we've incurred $99 million of restructuring costs, the majority of which is non-cash. The annual savings of the closure will be in the range of $75-$80 million, primarily due to the better fixed-cost structure and the operating leverage at our remaining facilities when compared to not closing a plant. In essence, better optimizing the three remaining plants versus sub-optimizing the four US plants.

With that said, let me present an overview of the operations. On a consolidated basis, sales for the second quarter decreased over the prior year second quarter by 18% to $632 million. The largest driver of this decrease was volume as the global tire market continued to be soft. Pricing and mix were also slightly negative during the quarter and raw material costs were down significantly and the price-raw material relationship continues to be favorable.

We also continued to realize the benefits of reducing costs in our manufacturing operations and were able to absorb the costs associated with the need to curtail production to align with demand. During the quarter we were excited about our few indicators that related to the top line. These were both industry and company specific and they included June as a strong shipment month. We have also received positive feedback in the areas we're targeting to regain position and grow, and while there's no guarantee that we'll see actual growth on a year-over-year basis, it is a positive sign of what we can do by adjusting our go-to-market efforts.

Also some other indicators are solidifying new customers and successful new product introduction are a couple of other significant factors that give us more optimism about our business. As a result of these efforts, operating profit for the second quarter was $41 million compared to operating losses of $15 million for the same period last year.

The largest driver of this change were the impact of volume decreases, restructuring costs, and production curtailments offset by favorable raw material costs, manufacturing improvements, and tight overall cost controls. We benefited globally as well from raw material cost improvements of about $95 million. North America operations alone accounted for $75 million of that improvement.

On the demand side of the equation the US replacement market continued to be extremely soft, but did strengthen in June. The Rubber Manufacturers Association Estimate of industry tire shipments in the United States for light vehicles declined by 11% in the quarter on a year-over-year basis for its members, and the RMA estimated that total industry shipments including nonmember companies declined by about 13%. Cooper's unit shipments were down about 20%, and as we've mentioned in prior calls, while we don't take satisfaction in this, we expected to underperform the industry in the first half of the year and then at some point in time in the second half, close the gap with the industry, and we're beginning to see improvements in our performance in relation to the industry as we speak.

I was particularly pleased with how our underlying operations in North America continued to improve performance as investments in automation, Lean Six Sigma, and other projects mature. These manufacturing efficiency improvements were approximately $14 million during the quarter when compared to the second quarter of 2008.

We also benefited from a one-time pension adjustment of about $8 million related to a change in the estimate of our pension liability and this benefit is included in our cost of goods sold during the quarter.

As previously mentioned we curtailed production to align with demand while maintaining appropriate inventory levels. These curtailments cost approximately $23 million during the quarter, an increase of $10 million from the same quarter last year and primarily result from unabsorbed fixed overhead. We've done a good job of managing inventory levels thus far in light of these economic conditions.

On the international front, our international segment provided a relatively strong result with $19 million of operating profit, an increase of $13 million over the second quarter of 2008. Certain regions have recovered faster from the global economic downturn, and due to our global position, we were able to take advantage of those improvements. The Chinese market was particularly strong as their government stimulus took effect.

Not all markets have recovered and this could present a challenge for us going forward. The relationship between price, mix, and raw material cost, was positive on a year-over-year basis. Our two joint ventures in China and our facility in Europe are focusing on further reducing cost while maintaining quality. A continued positive for us during this period is the performance of the Cooper brand in China, which outpaced market growth.

Our balance sheet and liquidity levels continue to be positive. Our cash balance was $302 million at the end of the second quarter and we've not had to draw on our available parent-company credit lines which remain as a source of liquidity.

Our cash balance has increased $55 million as compared to December 31st, 2008, as we've said in previous discussions that we really have been focusing in this area. The results of the quarter were exciting and I'm pleased the performance of all of our Cooper employees and the reality however is that the global economy may continue to present headwinds that can affect our results.

The operating margins posted during the quarter were very solid, especially given the state of the economy and the industry as a whole. Sustaining these margins in this economic environment will be our challenge going forward.

Phil is now going to provide you with a little bit more detail on the individual segments and other financial matters.

Philip G. Weaver

Thanks, Roy, and good morning, everyone. First our North American operations, our sales during the quarter were $427 million, a decrease of 22% compared to last year's second quarter. The net sales decrease was primarily the result of lower unit volumes. Price and mix collectively for the quarter were slightly negative.

While overall volumes for the segment were down, we saw positive signs during the quarter that the overall market may be stabilizing. During the month of June our shipments outpaced the industry.

Operating profit for North American tire operations was $28 million in the quarter compared to an operating loss of $22 million during the same quarter last year. This includes restructuring charges for the closure of our Albany facility of about $8 million. Excluding these charges, the segment would have had operating profit of $36 million during the quarter.

The net sales change during the quarter was a result of lower unit volumes which had an impact of $102 million. Price and mix collectively were negative by about $18 million. The product segment with the largest decline were light truck tires. The decline was particularly acute in the private brand channels.

In the United States replacement market, our unit shipments of total light vehicle tires decreased 20% in the second quarter compared to the second quarter of '08. This exceeded the 11% decrease in total light vehicle shipments reported by the Rubber Manufactures Association, or RMA members, and an estimated 13% decrease in total light vehicle shipments for the total industry for the quarter. The total industry decline includes estimates of imports by non-RMA member companies.

Weak macroeconomic conditions are continuing to affect consumer confidence n the United States. This may be causing people to delay tire purchases which is, in turn, affecting industry demand. Recently, positive signs have emerged that the situation may be moderating and could even improve late in the year. In May, government estimates of average miles driven per day showed an increase. This is only the third month since late 2007 where miles driven were up.

RMA estimates have also improved and recently published estimates of consumer confidence have seen improvements compared to a year ago. The relationship between price mix and raw materials was a strong positive during the quarter, and on a net basis, supported about $69 million in improvement to operating profit.

We implemented three price increases during 2008 which, when combined with the current levels of raw materials, allowed us to generate positive margins. The underlying raw material index was down approximately 30% on a year-over-year basis. This added $75 million to profit compared to the same quarter a year ago.

As a reminder, the LIFO accounting method charges the most recent costs against sales, in effect more quickly affecting operating profits compared to other inventory accounting methods. We have managed raw material quantities to a more normal level during the quarter as well.

The deteriorating market conditions led to a negative volume impact during the quarter of $25 million on operating profit. In addition to this we curtailed production to match demand, and therefore incurred $23 million of curtailment costs compared to $13 million in 2008, an increase of $10 million.

We continue to improve our underlying plant operations through the successful implementation of automation, Lean and Six Sigma projects, and complexity reduction. The manufacturing and improvement in the quarter was $14 million on a year-over-year basis.

During the quarter we recognized a change in our pension liability that led to approximately $8 million of improvement in cost of goods sold. This change was related to the freeze of our US based salary pension plans as of June 30th, and this piece will not be a recurring improvement.

However, ongoing service costs for pensions will also be lower after June 30th.

Before turning to international operations, let me express the changes during the quarter for North America in the form of an operating results walk forward. This compares the second quarter of '09 to the second quarter of '08.

The total increase in North American operating profit was $15 million. The key drivers of this were: $75 million improvement in raw materials, $14 million in favorable manufacturing performance, $8 million in lower pension costs, $2 million in favorable other costs, offset by $25 million from lower volumes, $6 million in weaker price mix, $10 million in more production curtailments, and $8 million in restructuring charges.

Now turning to our international operations, sales decreased to $257 million, down 9% compared to last year's second quarter. This was a result of decreased volumes and negative currency impacts at the net sales line. Unit sales in Asia were up 1% for the quarter, an exciting development given the global markets.

This was driven primarily by the strength of the Chinese market and exports from our joint ventures there. Europe's net sales were down about 19% as the markets they compete in saw weakness. On a total basis, the segment's unit sales were down about 5%.

Operating profit for the international segment was $19 million, an increase of $13 million from last year's operating profit of $6 million during the quarter. The biggest driver of this was an improved price to raw material relationship, which provided a positive boost of $12 million. Manufacturing improvements drove another $5 million to the bottom line. Volume decreases and other unfavorable items presented an offset which together totalled $4 million.

As mentioned earlier, the Cooper brand has continued to perform extremely well in China. Our radial medium truck operations have also been very impressive in their ability to grow and outperform the market while driving margin improvements.

The joint ventures we have in Asia continue to drive out costs while improving quality. This is critical to our ability to grow in the future. Our facility in Europe faces a difficult environment and had negative headwinds, including a weak demand environment and increased other costs that they faced during the quarter. The leadership and employees at that facility continue to do an excellent job managing the business and will continue addressing marketplace challenges.

Let me provide you the key underlying factors in the form of an operating results walk forward for our international operations comparing last year's second quarter to this year. An increase of $19 million from raw materials and $5 million from improved manufacturing costs, offset by $7 million from lower price and mix combined and about $4 million of other smaller items. The drivers for most of these charges were discussed earlier on the call.

Now I'd like to turn to a couple of other items, starting with our income-tax accounting. Income-tax expenses recorded in the second quarter from continuing operations were about $1 million, and this was computed using forecasted jurisdictional annual effective rates. More details on our tax situation will be available in the 10-Q that we'll file with the SEC, likely later today.

Our tax situation continues to be complicated by tax holidays and certain jurisdictions and the establishment of a valuation allowance we carry against our deferred tax assets. This allowance was just in excess of $233 million at June 30th of '09. Due to this allowance and the application of the accounting rules FAS 109 and 1048 as they're known, we have very unusual effective tax rates.

This allowance, by the way, does not eliminate our ability to use operating loss carrybacks and carry-forwards. Therefore, in periods when we have a profit in the US we will usually be able to minimize the tax charge for this. In periods where we have a loss we intend to maximize our ability to carry back the losses to prior periods and obtain cash refunds.

We have $48 million of cash-tax refunds recorded at June 30th. During the second quarter we didn't receive any refunds, but in recent weeks we've collected $26 million. These relate primarily to the carry-back of certain specified losses, the balance of this we are currently expecting in the fourth quarter.

A couple of words on cash flows. Net cash provided by continuing operations in operating activities was $165 million in the first six months. This compares to net cash used by continuing operations of $100 million during the first six months of 2008 for a remarkable improvement of $265 million. The change in cash flow was driven primarily by changes in profitability and inventory balances.

On our cash flow statements you'll note that we grossed up the impact of LIFO on the cash flow statement to highlight the cash impact of the change in inventory.

Cash provided by operations for the quarter was $33 million compared to a use of cash in the second quarter of '08 of $48 million. Inventory was a source of cash in the second quarter of '09 as raw material prices were lower during the quarter. Our raw material quantity levels are now closer to the level we believe appropriate to effectively manage the business.

Tire sales are seasonal so we need to build these levels during the first half of the year to meet higher demand in the second half of the year. We have managed this increase in line with what we believe to be the future demand scenario that we will face.

A couple of highlights on the balance sheet. As Roy mentioned, cash was $302 million at the end of June. Inventory balances are lower as a result of the decrease in raw material prices. We do believe that our quantities of raw materials and finished goods are at appropriate seasonal levels for the market conditions. Net property and equipment is down about 12% from a year ago, second quarter numbers, as capital spending was constrained to amounts less than depreciation, and of course we had the $76 million fourth quarter write down of assets related to our planned closure of the Albany facility.

Goodwill related to the Asian operations was also written off in the fourth quarter of '08. Almost all of the short-term notes payable relate to our partially owned ventures in China whose operations are included in the consolidated balance sheet. These are typically refinanced as they become due with the goal of converting a portion of these to long-term instruments. We also reduce these liabilities when appropriate. Refinancing of these balances continues on plan and we've reduced the outstanding amount pretty significantly during the quarter.

The current balance of our long-term debt includes about $97 million of parent company debt due in December of this year and about $22 million of term loans maturing in partially owned subsidiaries in China. For additional information this, please refer to the disclosures of our credit facilities available to these operations in our quarterly report on 10-Q, which again should be filed later today.

Shareholders' equity reflects the new requirement to include non-controlling shareholders' interests rather than in a mezzanine position between liabilities and equity. Now a few comments on pension funding and expense.

In response to market conditions, we froze the salaried pension plan for US-based salaried employees, effective June 30th. This is not a termination of the plan, but it will reduce the future liabilities of the organization as opposed to maintaining the previous program.

Due to this freeze, we recognize the $10 million nonrecurring benefit during the quarter as the measure of the pension liability was reduced because of the freeze. Approximately $8 million of this flows through cost of goods sold during the quarter and about $2 million of the benefit was reflected in SG&A.

The salaried employees defined contribution plan was enhanced to provide company matching of employee contributions up to 3.5% of the participant salaries effective July 1st. Although we have $40 million of authority remaining for share repurchases and a little over $100 million for debt repurchases, for the time being we've suspended these repurchases to protect our liquidity.

A few words about our parent company credit facilities. We have two parent company lines to provide liquidity. The first is a $200 million asset backed revolving credit facility which expires November of 2012. We also have an accounts receivable securitization program for up to an additional $125 million that expires late in 2010. Both facilities remain undrawn and there's about $24 million or so of the lines which are used to back letters of credit, primarily relating to insurance. The amount that can be borrowed is subject to availability of working capital that can be pledged, and of course we have a seasonably business.

These two credit facilities do not contain significant financial covenants until availability under the lines is reduced to specified levels. As mentioned earlier we have not drawn on either facility since they were put in place. Additionally we have unsecured annually renewable credit lines in Asia of roughly $200 million in US dollars, approximately $79 million of which remains available.

These credit lines also do not contain significant financial covenants and all related borrowings are due within one year and are included in our notes payable on the balance sheet.

Switching gears, CapEx in the second quarter of 2009 was $25 million. In our efforts to conserve cash we've taken a hardline view of capital expenditures and focused on only spending amounts that are absolutely critical to the business or that provide extremely fast payback.

We continue to be conservative and cautious in our use of capital while the economic and capital market outlooks remain uncertain. We currently plan to continue with this approach towards capital expenditures through 2009. These levels will probably keep capital expenditure amounts at or below depreciation levels. We currently believe that CapEx for 2009 will range between $100 million to $110 million.

On a related note and in connection with our acquisition of Cooper Chengshan, our 51% interest, beginning January 1st, 2009, and continuing through September 31st of 2011, our partner has the right to put to us the remaining 49% ownership share at a minimum price of about $63 million. This includes the right to put various percentages of that within the window mentioned. On July 3rd we received a notification from our non-controlling shareholder that it intends to exercise a portion of its put option after it receives governmental approvals and satisfies other related conditions. If the put option is exercised, the company would purchase the 14% share for about $18 million.

Before I turn the call back over to our Chairman, I'd like to describe the change in the charge in our discontinued operations. This charge is related to a tax situation associated with a former subsidiary that we sold in 2004 in connection with the settlement of various intercompany pricing issues. Under the sale agreement, we're responsible for all tax obligations and are entitled to all refunds for the period that we owned that company.

The cash impact of this settlement consists of two parts, a refund of taxes paid in Canada of about $69 million US at today's exchange rates, and a tax obligation in the US of about $35 million. The net impact of these items would result in a gain of about $34 million. The former subsidiary is obligated under terms of the sales agreement to remit the fund to the company promptly upon receipt.

During the week of July 26th, 2009, the company was advised that the Canadian affiliate received a substantial portion of that anticipated refund, however, the funds were not remitted to the company promptly as required under the agreement. On August 3rd, 2009, Cooper Standard Holdings, Inc., the company that acquired the former subsidiary and various of its affiliates, filed voluntary petitions for a reorganization under Chapter 11 of the US Bankruptcy Code.

Based on these facts, the company does not believe that the recognition criteria related to the refund receivable of $69 million has been met and we have not recorded the receivable, and won't, until the certainty of its realization becomes assured, but we are pursuing all options to recover these monies which represent refunds of taxes paid by us under the terms of that sales agreement.

All right, those are the highlights. I'd now like to turn it back over to our Chairman. Roy?

Roy V. Armes

Yeah. Thanks, Phil. I'm getting a lot of questions here and I want to try to answer this up front that recently a petition was filed by the United Steel Workers with the International Trade Commission, asking for action to be taken against certain tires imported from China. At the heart of this request was the increase in recent years in the number of tires imported from China.

United States Trade Representative is currently reviewing a recommendation that would place a 55% tariff in year one on imported light vehicle tires from China, and in year two, it would go to 45%. In year three it would be 35%. A recommendation on this matter will be provided no later than September 2nd, 2009, to President Obama, who will then have 15 days to take action. And his decision is not limited to the recommendation that's provided here and can be modified.

As there are a wide range of scenarios that could be played out from this matter, we do not intend to discuss all the possible outcomes, and Cooper as a company imports tires to the United States from China and we're actively completing contingency plans that focuses on meeting our customers' needs while balancing the reality of what various scenarios would mean to the supply and profitability.

We believe that within our North American operations, given a reasonable period of time, we can still deliver many of the tires we're now importing.


Before taking your questions, let me give you some other thoughts about the second quarter and outlook for the remainder of 2009. Cooper's employees have been focused on how we can continually and continuously improve on building, selling, and delivering good quality tires, and this in combination with an improved price to raw materials relationship has resulted in improved operating profit and results.

Our strategic plan called for a focus on this area and we begun to show success in eliminating some of these costs. And as we align the capacity at four plants in the US to three plants, we can see a further improvement by decreasing the curtailment cost.

Our investments and facilities in lower-cost countries continue to position us for improved operating costs, greater geographic flexibility, and the ability to penetrate markets outside the United States. We've also had an imperative of top line growth in our strategic plan, and this will require us to first stop the market share losses that we've incurred and then grow where it's profitable.

We've started taking action to position the company to begin matching industry performance in the second half of the year, but to do this we plan to slow the losses that we've experienced in the private label segment.

In working with our customers, we believe that we've identified opportunities to do this. This should begin to appear in our results of the second half, and in prior calls we've talked about launching value segment tires and penetrating into geographies and channels where we're under represented and we started this process and the effects will begin to be seen in the third quarter, and finding ways to profitable growth will be essential to our future success.

We have an excellent dedicated employee base with a continuous improvement mindset culture that will help us achieve greater levels of success. We continue training black and green belts, as well as making internal changes to the organizational structure to improve operating efficiency and make the changes sustainable.

We believe the improvements we've made internally are sustainable, but our results can be influenced by external factors such as changes in raw material prices or further downturn in the global economy. And as we've mentioned earlier, we still have cash and untapped credit lines. We have, at this time, suspended the repurchase of shares and debt, limited expenses where possible, and are invested only in the items that are critical to our success.

For 2009 we continue to expect full-year industry volumes to be down in North America, probably somewhere in the range of 9%-10%. Europe will continue to face difficulties through the rest of 2009, and in China the market has already begun to recover and we believe that growth in the mid to high single-digit range is possible there.

Raw material costs are difficult to forecast, but we do not see a return to the extreme price highs of last year. Commodity prices have moderated during 2009 and may begin to increase in the second half. Raw material cost during the third quarter will be up sequentially from the second quarter, but still down on a year-over-year basis and we expect a year-over-year difference as a percentage to peak in the third quarter.

The actions we've taken and are taking will continue to advance our strategic plan and this is, I believe, because our Cooper employees have performed well in this turbulent time and remained focused on what really matters. The operating margins earned in the second quarter were solid, but we're realistic about what must be done to see continued profitability and growth and we're very cautious in our expectations of the level of future profitability because of the uncontrollable factors which impact this industry such as consumer confidence of gasoline prices, raw material cost, intense competition, currency fluctuation, and the like. But we do remain cautiously optimistic.

Now with that I'd like to thank all those attending on our conference call here. That does conclude our prepared remarks. What we'd like to do now is open it up for a Q&A session.

Question-and-Answer Session

Operator

(Operator's Instructions) Your first question comes from the line of John Murphy.

John Murphy - BAS-ML

Good morning, guys. If we look at what appears to be some pretty extreme market share losses in the first half of this year, I mean, I'm just wondering if you could put some color around where those major losses are. Is it in the private label business where you're being crowded out by some other low-end tires? I just want to understand exactly what's going on there.

Roy V. Armes

More specifically, John, it's in the private-label wholesale channel, and that is a channel that the imports are leveraging or using to be able to come in and get distribution in the country. So that's the specific area.

Philip G. Weaver

The other part of that, John, is that with our exposure to light truck, as the light truck declined faster than the market, it appears that our market share loss is faster.

John Murphy - BAS-ML

Okay. And when you think about that though, I mean, as you close Albany and switch your remaining three plants, I mean, is that a part of the market that you need to regain that market share or is that just not great profitable business so you might not fight back there and might just take a lower volume, higher profit approach? I'm just trying to understand what'll happen in there as Albany closes.

Roy V. Armes

Yeah. A couple of things there, John. We are interested in making profit on the tires that we do well so we are balancing that volume and margin equation. Secondly, though, we did introduce a value-line product that is really going at and attacking more of that loss that we had not only in the private label but in our house brands as well, and we think we've got a very good value position that we can both make money on and also gain some of that volume back, but we have been selective over the last couple of years to make sure that we profitably grow.

John Murphy - BAS-ML

Okay. And then when we look at Albany closing and thinking about the capacity underutilization on your remaining plants, where is that right now, the capacity utilization in all of your plants? Where do you think that will go once Albany is closed? And as you're talking about the $70-$80 million in savings from the closure of Albany, does that also encompass potentially any operating leverage improvements in the other plants as cap utilization rate goes up?

Roy V. Armes

Yeah. For this year, John, it does capture some of that leverage volume in the other facility so I'll answer that one first. On the other one where you talk about capacity, I haven't seen the numbers just recently here, but before we started this change we were probably in a 60%-65% range and now with our facilities we're at about 75%-80%. We expect in the second half in what we've seen from the end of the second quarter going into the third quarter here that we could be at 80% or a little north of that capacity utilization in the second half.

John Murphy - BAS-ML

And when we think about that and think about sort of the sweet spot of incremental margins, I mean it seems like 80%-90% is kind of really the sweet spot where that contribution margin should be highest. Is that sort of a fair assumption?

Roy V. Armes


Historically, 85%-90% is a good number, yeah.

John Murphy - BAS-ML

Okay. And then lastly, Phil, I mean obviously the pension plan being frozen has been a benefit in the quarter. You mentioned the service cost was going to be lower going forward. What kind of level will that be at or what's the decline that we should expect on a structural basis?

Philip G. Weaver

Well, first you have to do this in the context of knowing that it's up this year because of the amortization of the shortfall in funding and because of last year's market performance. But the freeze itself should reduce it, if I recall correctly, somewhere in the range of a net basis about roughly $3-$4 million per quarter.

John Murphy - BAS-ML

Great. So the $8 million that you got in this quarter, about half of that will continue to be repeated?

Philip G. Weaver

Well actually, they're two different things, but first of all, to clarify, the $8 million was the cost of goods sold portion. The total was about $10 million related to the freeze and that's just the remeasurement of the liability itself. That's a one-time item. But going forward, the service cost portion will be zero because obviously we've frozen future accruals. That's the piece that will be roughly $3-$4 million net per quarter lower than it would have been.

John Murphy - BAS-ML

But you did not get that $3-$4 million in this quarter?

Philip G. Weaver

No. Not in this second quarter. We will —

John Murphy - BAS-ML

Okay. So I mean, obviously, there are two different items, but the benefit will be about half of what it was for different reasons going forward?

Philip G. Weaver

Yes.

John Murphy - BAS-ML

Great. Thank you very much.

Operator

Your next question comes from the line of Rod Lache.

Rod Lache - Deutsche Bank

Good morning, everybody. I guess just first of all, it looks like average transaction prices declined by a couple bucks a tire sequentially and can you just give us a little bit more color on that? Was that price or was that just mix?

Roy V. Armes

Rod, what we did on certain sizes and ceratin segments to match competition is in some cases we did make some adjustments either on the price or promotions for the product. It's not a wholesale change. We've been very selective in making some of these changes to address some of the competitive nature of the market.

Rod Lache - Deutsche Bank

Okay. So is it your sense that maybe we're starting to see some less discipline in the market? And just strategically it had been looking like you were basically going to try to maintain price and take down capacity; is it a little bit more of a balance between pricing and capacity going forward?

Roy V. Armes

I think there's a little bit of balance there, but we don't see the discipline in pricing really dropping off that much, Rod, and let me try to explain that a little bit. One of the reasons of making some of these adjustments, as you know, we talked about the private label business earlier, and that being roughly around 45% of our volume, we made some adjustments to compete head on with some of the lower-cost competition, if you would, and that's the reason we've made those changes. And we're trying to balance that volume with pricing on specific areas where we think we needed to make some changes. But I don't see it as being a lack of discipline or the pricing at this stage. I think a lot of these have been more selective in the market than they've been across the board or wholesale changes.

Rod Lache - Deutsche Bank

Okay. It looks like clearly on a year-over-year basis your raw materials were down more than the pricing, but on a sequential basis it looks like it was actually maybe a bit of the opposite. With the raw materials going up a bit into the third quarter, can you just give a sense of how you expect those gross margins to kind of progress and what do you think kind of normalized operating margins should look like in the North American and international business going forward?

Philip G. Weaver

Rod, if I may take that one? In terms of the raw materials, first of all, taking it in pieces, we do expect that our raw materials will be up slightly in the third quarter compared to the second; on our index that we use internally, maybe in the 145-150 range. This would still be in the range of 35%-40% less than the quarter of last year.

On the pricing side of that, obviously it's difficult to tell, but as Roy said, we don't see wholesale changes coming through. This is generally the highest quarter for North American shipments so it should be more competitive from that standpoint so we don't think prices would necessarily erode there.

As far as margins, I guess it's probably a little bit too early to put a number out there, or I'm not willing to do that at this stage, but we see dramatic differences in the comps of raw materials. So pricing is indeed coming down a bit, but it's because of the huge drop in raw materials compared to a year ago.

Roy V. Armes

Yeah. And we are expecting, Rod, that the raw material costs are starting to eek back up. I don't think we'll see it to the high levels it was last year so I think from our viewpoint, anyway, really watching this pricing — raw material relationships is really important when we think that down into the latter part of the third quarter and into the fourth quarter that we'll see an uptick in the material costs.

Rod Lache - Deutsche Bank

Okay. And just last two quickly: Any thoughts on tax rate and SG&A going forward? And also, we're hearing that some of the Chinese manufacturers are ramping up exports ahead of this ruling in September. Are you doing that and what do you sort of expect as a result of that going forward? I guess it's hard to predict which direction this is going to go, but if there isn't a favorable ruling, would that have any implications for your business?

Roy V. Armes

Well, we think that it's really very difficult to call, as you said, or try to predict at this point in time. I do think that there could be some ramp up with some of the imports ahead of the decision and put some in inventory ahead of that. We're not seeing in the market where a lot of that's going — not in the market here anyway, Rod. Reasonably or rationally it could happen, but we're not seeing it at this point in time so it's really difficult for us to tell what's going to happen here. And depending on the decision that comes out, there's a multitude of things that we could do to address the issue.


But it would have an impact on the product that we have coming out of our CKT joint venture, which is 100% export at this point in time. It would have an impact there, but we have some capacity that we could fill that gap and it would just take us time to make that shift.

Rod Lache - Deutsche Bank

Tax rate and SG&A going forward?

Philip G. Weaver

The tax rate is very difficult to project because of all these valuation reserve accounting things going on. I guess I wouldn't even want to really make a substantial guess, Rod. If you do your estimates separately in Europe and then in China you can attack those. The North American one is the toughest one because if we have profitability, essentially there would be no charge because of the loss carry forwards. If we have losses we can carry those back. There's certain specified losses we can carry back 10 years and we'd actually get some benefit from that. So the range is very broad on that one.

I know that's tough. SG&A, I haven't looked lately at our total projections, but I think our spending level should not be higher than they are currently, and the extent to which we have this pension freeze within SG&A, it should be coming down.

Rod Lache - Deutsche Bank

Great. Thank you.

Roy V. Armes

And, Rod, just to close on that one there, we are trying to make sure we're maintaining this in that 6%-6.5% range.

Rod Lache - Deutsche Bank

Your SG&A in the 6%-6.5% range?

Roy V. Armes

Yeah.

Rod Lache - Deutsche Bank

Great.

Philip G. Weaver

Yeah. Year over year with some incentives that we hope to achieve it might be up a bit, but quarter to quarter I think it should be at roughly the same level. There is some seasonality in our advertising and that's a piece I just don't have in my head right now.

Operator

Your next question comes from the line of Himanshu Patel.

Himanshu Patel - JPMorgan

Hi, good morning. The negative price mix of $6 million in North America, can you just directionally tell us how much of that was price versus mix?

Curtis Schneekloth

Himanshu, we're not going to break that out for competitive purposes. If you've got some specific questions you can give me a call later on.

Himanshu Patel - JPMorgan

Okay. On the issue of pricing on the second half, Roy, I know you talked about how the ITC ruling could affect your availability and supply. Why wouldn't an ITC ruling that leads to a tariff just allow you to raise prices in the second half?

Roy V. Armes

We haven't ruled that out, Himanshu. I mean, that could happen. I think it's really right now unpredictable what they're going to come out with the ruling, but that would be one alternative for us, to try to manage the supply and demand.

Himanshu Patel - JPMorgan

And then sequentially, raw materials are creeping up, does that development give any scope for potential price increases in the second half?

Roy V. Armes

I think what we've got to do is we continue to watch this price mix raw material relationship very closely, and that obviously is important to our margins and we're going to continue to watch that. And if we see a strong uptick in that we would have to — again, it would be one of the things that we would have to consider.

Himanshu Patel - JPMorgan

You mentioned I think in the commentary that there were some signs of stabilization in the last month of the quarter in the private label segment. Just in terms of total demand, how is that continued? And if you have a look on July already, what's been going on in that space now? Has that trend continued?

Roy V. Armes

We've had some continued momentum there. I think we're continuing to see where we need to tweak our product screen and not just the product screens, but where we can tweak some of our pricing to make sure that we're doing some of the right things to drive some of the volume there, but we've seen some continued efforts there in the end of July.

Himanshu Patel - JPMorgan

You mean the overall market or Cooper's performance?

Roy V. Armes

Cooper's performance.

Himanshu Patel - JPMorgan

How's the overall market in private label doing though? Has that felt like it's bottomed out?

Roy V. Armes

Yeah, for the most part. I would say that's a good observation.

Himanshu Patel - JPMorgan

Okay. And then, Phil, on the status of the uncollected tax receivable from Cooper Standard, what's going to happen there? I mean, do you expect to become an unsecured claimant in that bankruptcy or is there a chance that that could become — could you sort of argue that somehow a super-senior tax claim and you could recover par on that? What's the initial thinking from a legal perspective?

Philip G. Weaver

Well, I'm not an attorney, but I would say we don't view ourselves as an unsecured creditor. We believe it's our money and it's rightfully due us and hope that in this process we convince those who make those judgments of that position, and we intend to collect the money, but there are a lot of uncertainties around it.

Himanshu Patel - JPMorgan

Okay. And then last question on the Albany plant closing savings. I know you gave an annualized impact. Can you just help us think through what would be the impact in the third quarter year over year or the third quarter year over year and sort of full year '10?

Philip G. Weaver

Would be rather small in the third quarter year over year because we still have not only some of the people there, but the severances continue. That would be still true in the fourth, and even some of the pension accounting can't be done until the actual settlements of people's accounts are made, which could trickle into the first part of 2010. But that should be relatively small compared to the overall charge.

So it would be small, $2-$4 million would be a rough guess in this current quarter, and then slightly larger into the fourth, but realizing the majority of the projected annualized savings in 2010 — not quite all of it, but the majority.

Himanshu Patel - JPMorgan

Okay, understood. And then lastly, I'm sorry if you covered this earlier, SG&A was up year over year by $5 million. I think there were some one-time issues there with the pension gain, but what — I think that was probably only $2 million. I would have thought directionally that number should have been down; is there something else going on there in the June ending quarter?

Philip G. Weaver

There's some incentives in there, there are mark-to-market issues on some deferred incentives that are payable in stock or cash. That's kind of a weird piece. That's about 2.5 million or so. So there's a combination of things, but it's probably those two are the biggest drives.

Himanshu Patel - JPMorgan

Incentives, you mean pricing related incentives or —

Philip G. Weaver

That are payable in company stock. And with the stock going up you have to mark those market and that results in positive or negative charges or credits each quarter.

Himanshu Patel - JPMorgan

Understood, so the stock's appreciation led to a $2 million non-cash charge in SG&A this quarter?

Philip G. Weaver

Yes. I think it was roughly more like $2.5 million, if I remember.

Himanshu Patel - JPMorgan

Okay, understood. Thank you.

Roy V. Armes

Operator, we have time for about one more caller.

Operator

Okay. Your final question comes from the line of Tony Cristello.

Anthony Cristello - BB&T Capital Markets

Thank you. Good morning, gentlemen. I guess one question I had, when you look at the industry RMA versus Cooper down 20 versus down 11, can you help me understand better how much of the ability to close the gap is going to be related to the macro improvement versus how much of closing that gap is really in your control with initiatives you have underway right now?

Philip G. Weaver

Well, first of all, the macro change, the rising tide would float the boat the same, if you will, right? So we're talking about on a relative basis being able to move with the market as compared to the first half of being down more than the market. So we do believe that in the third quarter we will start to close that gap, but by the end of the year, and now I'm talking run rate, not absolutely back to the market levels, but on a run-rate basis we expect that we will have closed that gap.

Anthony Cristello - BB&T Capital Markets

So basically, by the end of the year you're assuming you're going to be in line with whatever the industry shipment numbers are doing.

Philip G. Weaver

Yes. On a relative basis that's right.

Roy V. Armes

On a run-rate basis.

Anthony Cristello - BB&T Capital Markets

And is that function of your ability to simply fix the problems? You're talking about the wholesale, about the light truck and all those, are there other initiatives underway such as new customers or launches or anything else that will give you the ability to narrow that gap?

Roy V. Armes

Yeah. In fact, some of those have been implemented already, Tony. It's introduction of new products, repositioning of some of the products to get more competitive. We're already seeing some of the results from that and we're feeling fairly confident that as the second half goes on we'll continue to close that gap, but it's a combination of several things that we've got placed.

We also have brought on some very good new customers that we'll start to shift to in the second half as part of that initiative as well.

Anthony Cristello - BB&T Capital Markets

Okay. And is there a differential now on that wholesale side of the business because of your market share loss in terms of as you gain that traction back does that give you sort of a tailwind or an uplift a little bit in your ability to price or capture a bit more pricing or is it irrelevant relative — it seems like because of what raw materials did to such degree, that doesn't really matter.

Roy V. Armes

I would say I'm not sure that really matters. I think this is strictly a competitive issue that we're trying to address, and as we start to address our cost structure internally to become more competitive, it give us a little more flexibility, but I would say that it's not all just in that wholesale channel. The new customers that we've gotten, we've been able to get a very good mix with three new customers to be able to protect some of our margins as well.

Anthony Cristello - BB&T Capital Markets

Okay. And when you look at China, and you might have covered this, but it seems that business over there has done better. How has the profitability versus the investment looking right now over in Shenzhen? Can you give us an update on what's going on over there, how's that looking, and how should we be thinking about contribution as we enter next year?

Roy V. Armes

Well, if you want to pick a point in time, our China Asia operation is doing very well. If we look at — I'll give you a point of reference. Over the last year and a half we've made some investments there to expand the capacity in Shenzhen in this particular case, both on passenger tires as well as truck and bus tire radials. Now we slowed up on some of that investment last year because of the economic situation we're in, but we went back in on the truck and bus tire and completed that expansion, and I would tell you right now we're out of capacity there on truck and bus tire radials; so we've got to step back and look at that market and how it's performing, the economy itself, how we're performing, and take a look at some additional expansion if it's needed there, so that's a good indication of how well they're doing.

Anthony Cristello - BB&T Capital Markets

That's great. Thanks, guys.

Roy V. Armes


We have time for one more question.

Operator

Your next question comes from the line of Saul Ludwig.

Saul Ludwig - Keybanc Capital Markets

Good morning — good quarter. With your moving up in the operating rate in the third quarter, as you said, into the 80+% range, I think the unabsorbed overhead would seem to be maybe disappearing. I think last year in the third quarter you had about 9 million in unobserved overhead, do you think that sort of goes away to zero this year?

Roy V. Armes

I think that's a good possibility, Saul. There may be some still left there, but that would be the intent, yeah.

Saul Ludwig - Keybanc Capital Markets

But minor in the third quarter this year?

Roy V. Armes

Yeah.

Saul Ludwig - Keybanc Capital Markets

And your unit volume is higher in the third quarter for both industry reasons as well as your steps to close the gap.

Roy V. Armes

Yes. That's right.

Saul Ludwig - Keybanc Capital Markets

And did you start shipping to Sears yet?

Roy V. Armes

Yes. As we speak we've had some inventory there — we've been building some in parallel to finalizing the agreement with Sears and we'll now start shipping.

Saul Ludwig - Keybanc Capital Markets

So they'll come into the third quarter for the first time?

Roy V. Armes

Yes.

Saul Ludwig - Keybanc Capital Markets

And you said there's some other customers; any of a substantial nature — I mean, of the same type of magnitude as the Sears?

Roy V. Armes

No. I wouldn't go into that, Saul. I don't want to get into talking about specific customers so much, but it's a combination of multiple customers, and I'm trying to think right now — I don't know that there's any that is at that same level as Sears being we're starting from ground zero with Sears.

Saul Ludwig - Keybanc Capital Markets

When you had this $13 million improvement in your operating income internationally, what was the — if you think about Asia versus Europe, was Europe actually down and Asia up? How did that $13 million split between Asia and Europe?

Philip G. Weaver

Give us a second. Do you have another question? We'll get to that.

Roy V. Armes

The primary area of improvement was in Asia.

Saul Ludwig - Keybanc Capital Markets

Well, was it about 13 and zero in Europe or up 15 and down two or —

Roy V. Armes

Europe was relatively flat.

Saul Ludwig - Keybanc Capital Markets

Okay. So whole profits in Europe, when their volume declined 19%, that sounds pretty amazing.

Roy V. Armes

We have a wonderful team there and they are right on top of every piece of the business that they can control. We're very proud of them.

Saul Ludwig - Keybanc Capital Markets

So I guess it's the raw material cost savings that help there?

Roy V. Armes

Remember, Saul, part of our strategy was really getting focused on where our strengths were in some of the better product categories, which they've done a good job of as well.

Saul Ludwig - Keybanc Capital Markets

So your margins in Asia were pretty potent.

Roy V. Armes

They were. We had some good margins in Asia.

Saul Ludwig - Keybanc Capital Markets

Do you think they're sustainable?

Roy V. Armes

I think, Saul, there's still some unpredictability there. I think there's the stimulus that the government put in place there to kind of spur the economy. We're just a little cautious because we're not sure how long that can be sustainable. If the economy stays like it's going, yeah, I think there's some good sustainability there. I think our guys did a great job of managing margins and managing price and managing inventories — they managed the whole business very well during this period of time and I think it's starting to pay off.

Saul Ludwig - Keybanc Capital Markets

And just finally, Phil, with your balance sheet, if we think about cash outflows in the second half of the year, you go the $100 million, you're going to pay off the $97 million, you're going to have the $16 million on the put, but those are what we know about. We know about cap spending. Where do you see your cash ending the year?

Philip G. Weaver

Well obviously, we'll be projecting a lot of things to get there. We think that we'll have a healthy balance, Saul. We also during this time will have some of our own tax refunds, and we need to get our hands on the other tax refund that was part of discontinued ops. Pension funding will likely occur here in the second half and so there's a host of things.

But I think we should have some ability on a seasonable basis to squeeze a few bucks out of inventory, particularly in North America during this time, but it's hard to predict the cash balance.

Saul Ludwig - Keybanc Capital Markets

What do you think, just rationally, more or less than you ended June with?

Philip G. Weaver

I hope it's more, but I don't think we want to go much beyond that.

Saul Ludwig - Keybanc Capital Markets

I got it. Thank you very much.

Philip G. Weaver

Could I add right there so I don't confuse anyone, that's without regard to, of course, our $100 million payment that we're talking about, just to be clear.

Roy V. Armes

All right, thanks, Saul. Hey, before we close let me just try to summarize a few points that we discussed here. We did have a very good second quarter, particularly in this case, from our continuing operations driven by the favorable price mix raw material relationship that we're managing, the manufacturing improvements that we've mentioned. We've talked about the new products that we feel are doing a good job satisfying the customers' needs in basically all regions, and we've had both the North American and international segments contribute to this strong quarter, so overall we had contributions coming from all parts of the business.

And I think a big factor here besides just the raw material cost is being able to execute successfully the key initiatives that we've put in place: the automation, complexity reduction, the closure of Albany, which has happened faster than we anticipated and it's given uninterrupted service to our customers while we were making that change. We've been able to secure some new customers in some underrepresented channels. I think that's just to name a few, and our focus on the cash and liquidity is also very obvious with our cash balance being $55 million higher than the end of 2008.

When you look at the overall volume being down, our Cooper brand continued to outperform the market. We've still got some uncertainty out there with raw material costs, exchange rates, competition, consumer confidence, gas prices, and again, just to name a few, that does have sizable impact and could have sizable impact on our business.

At the same time we're remaining cautiously optimistic given there's still some volatility out there that we could face, and the economy is still fragile going forward, so I think it's going to be us staying very close to what's going on not only in the economy but in our industry, and continuing to adjust to the challenges there.

And I want people to feel confident our organization has executed well and contributed a lot to the success here that's going to help us to exit this economic environment a lot stronger than we went into it and that's a real plus. And our people should get most of the credit if not all the credit for that in recognizing that their motivation is to win in this global marketplace, and I give them a lot of credit for that.

Again, thanks for your attendance and your participation in this conference call this morning and we'll look forward to talking to you next quarter.

Operator

This concludes today's conference. You may now disconnect your line.

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