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Cooper Tire & Rubber (NYSE:CTB)

Q1 2014 Earnings Call

May 02, 2014 11:00 am ET

Executives

Bradley E. Hughes - Chief Financial Officer, Vice President and Treasurer

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

Analysts

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

Rod Lache - Deutsche Bank AG, Research Division

Bret David Jordan - BB&T Capital Markets, Research Division

Operator

Good morning, and welcome to the Cooper Tire & Rubber Company First Quarter 2014 Earnings Call and Webcast. [Operator Instructions] As a reminder, this conference call is being recorded. I'd now like to turn the conference over to your host, Mr. Brad Hughes, Cooper Tire Chief Financial Officer. You may begin.

Bradley E. Hughes

Thank you, operator. Good morning, everyone, and thank you for being with us today. I am Brad Hughes, Cooper Tire's CFO. And with me today is Roy Armes, our Chairman, CEO and President.

To begin, I would like to remind you that during our conversation today, you may hear forward-looking statements related to the future financial results and business operations of Cooper Tire & Rubber Company. Actual results may differ materially from current management forecast 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 U.S. Securities and Exchange Commission.

In association with our earnings release, we will provide an overview of the company's first quarter 2014 operations and results. Our earnings release includes a link to a set of slides that summarizes information included in the news release and in the 10-Q that will be filed with the SEC. These slides are intended to help investors and analysts quickly obtain information. They will not be used as a focus of today's call.

Following our prepared remarks, we will open the call to the participants for a question-and-answer session. As a reminder, questions may also be directed to our email address, which is investorrelations@coopertire.com.

We will begin this morning with Roy providing an overview. He will then turn it back over to me for a detailed review of our quarterly results. We'll wrap up with Roy providing commentary on our outlook. And then, we'll take your questions.

With that, I'll turn it -- turn the call over to Roy.

Roy V. Armes

Yes. Thanks, Brad, and good morning. As I said in the press release we issued earlier today, Cooper is indeed off to a strong start in 2014, which, I'm proud to say, is our 100th year in the tire business. It was a great start to this milestone year in the company's history, with outstanding profit performance of $81 million in the first quarter, which is a bit over 10% of net sales.

In fact, this represents the second-best operating profit for our first quarter in our company's history, topped only by the first quarter of 2013 a year ago, when we set an all-time first quarter operating profit record for the company. Obviously, this year, we were up against that very tough comparison from last year, and we're pleased with our achievement, especially coming out of the challenges that we experienced in 2013.

We generated net income of $0.71 per share or $45 million in the first quarter, which was down from $56 million or $0.87 per share for the same period last year. Cooper maintained a strong balance sheet, ending the first quarter with $336 million in cash, which was down a bit from our position at the end of December. And this is typical of our seasonal pattern for working capital. And as expected, while first quarter sales were $796 million, down 8% from a year ago, our volumes are recovering.

In North America, Cooper's total unit shipments were up by 5% in the first quarter compared to a year ago, and our total light vehicle tire shipments in the U.S. increased 7% compared with the Rubber Manufacturers Association member companies, which were up 1%, and total industry shipments, which were up 5%.

These are signs that Cooper has moved on, and we're moving our business forward in the right direction. Our people around the globe have done a great job of adapting very quickly and refocusing on our business priorities. We still have work to do, but I'm proud of the people and their ability to leverage our strengths during times of change and staying focused on our future.

As we celebrate our centennial, the contribution of our people certainly comes to the forefront. And I want to thank all Cooper employees around the world, past and present, for the role they have played in our success throughout all these years. I also want to thank our customers, whose loyalty and commitment to Cooper is very much valued and appreciated as we commemorate 100 years in the tire business.

Moving back to our discussion of the first quarter. As anticipated, we did experience some lingering effects during the quarter, resulting from the events of 2013, but their impact was much diminished compared to the third and fourth quarters of last year.

Our transition to SAP through our ERP initiative did have an effect on distribution costs. And we also incurred professional fees to support continued ERP deployment in the North American segment. And we're effectively working through this transition and believe that ERP will ultimately be of great benefit for Cooper once we are in a position to realize its goal of having real-time access to accurate and consistent data across our entire or total enterprise. This will allow us to run a more efficient business and continue to be one of the best companies to do business with.

Beyond ERP, we also experienced some residual effects in our International segment from last year's labor disruptions at CCT facility in Rongcheng, China. Sales volume in Asia decreased 4%, driven by reduced passenger car tire and medium truck tire shipments, including intercompany shipments, of which our Roadmaster tires are a part. As you know, the CCT plant restored production of Roadmaster tires earlier this year. But as Brad will explain, due to timing, we saw an impact on our volumes in the first quarter.

I would be remiss if I did not mention the team at CKT, our wholly-owned facility in question in Kunshan, China. They did a great job in picking up production to fill in when we experienced the situation at CCT. So a big thank you goes out to those folks.

Today, operations at CCT are normal, and production of all brands continues with the facility at near-full production levels. Our customers are responding well to the return of the Roadmaster brand, and we're looking forward to being in a position to build this business going forward.

You'll recall that we announced at the end of January that Cooper had reached an agreement with our joint venture partner regarding a process to determine the long-term ownership of CCT. The process begins with an independent valuation of the business, and Cooper and the joint venture partner are moving forward with this process. Regardless of the ownership outcome, China is and will continue to be an important part of Cooper's long-term growth strategy.

Now before I turn it over to -- turn the call over Brad, I want to put an emphasis on the importance of continued innovation in new products and the vital role this has played in the success at Cooper. We're excited about our technical and product development teams and their ability to deliver a flow of new products that are recognized throughout the industry for performance and value.

And at the end of the first quarter, we introduced what we consider to be the very important new product for 2014, a new, premium touring tire called the CS5. We believe the CS5 is Cooper's best passenger touring tire ever. This tire offers innovative technology and compound and design and features our new Wear Square visual wear indicator, which is a convenient gauge that helps consumers approximate a tire's remaining tread life.

Our sales and marketing teams are moving forward with launching this innovative product in the marketplace now. And you can expect to see and hear more about this exciting new product, including on consumer television advertising throughout the year.

I also want to talk about our continued focus on making our plants even more competitive and efficient throughout our global manufacturing network. Our teams have done a great job focusing on quality and plant safety while addressing opportunities to reduce costs and improve efficiencies.

For example, you may have read about the funding Cooper's going to receive from Mississippi to assist with investments we're making to modernize equipment at our Tupelo facility. Our goal with such efforts and others is to make all of our plants even more competitive in the marketplace.

Now with that, I'd like to turn the call over to Brad for a detailed review of the performance in the first quarter. Brad?

Bradley E. Hughes

Thanks, Roy. As reported, our total company results for the first quarter included an operating profit of $81 million or 10.2% of net sales compared with $97 million or 11.2% of net sales for the same period last year.

North American segment operating profit was $69 million or 12.2% of net sales, and the International segment operating profit was $23 million or 7.5% of net sales. The change in operating profit was driven by the following factors: $67 million in the lower raw material costs; $11 million for manufacturing cost efficiencies; $8 million from higher unit volumes; $2 million in lower products liability charges, which were offset by $96 million of unfavorable price and mix; $5 million of higher SG&A costs; and $3 million in higher other costs.

Reviewing our segment performance, I will start by providing detail on the North American Tire Operations. Segment sales for the first quarter were $563 million, a 6% decrease compared with the first quarter of 2013.

Unit shipments for the North American segment increased 5% compared with the first quarter of 2013. In the first quarter of 2013, North American volume was negatively impacted by inventory adjustments made by certain U.S. customers and by the effects from the ERP system implementation and cutover in the U.S.

Total light vehicle tire shipments for the U.S. were up 7% during the first quarter as compared to a quarterly increase of 5% reported for the industry and an increase of 1% reported by our RMA members.

In the quarter, Cooper's U.S. passenger car unit volume increased 4%, and the light truck segment increased 20% compared to a year ago. Commercial truck tire sales at the Roadmaster brand were down over 90% for the quarter compared with a year ago. In comparison, total industry shipments within this category, as reported by the RMA, were up 8%. The decrease in Roadmaster sales is attributable to the earlier labor issues at CCT.

While production of Cooper brand products at CCT resumed in the first quarter, the time to ramp up production, coupled with the shipping time to the U.S., resulted in minimal sales volume of Roadmaster brand tires in the first quarter. An increasing supply of Roadmaster tires will be available going forward.

North American segment operating profit, as I said, was $69 million for the first quarter or 12.2% of net sales, decreasing $3 million from the first quarter of 2013. Let me summarize the key drivers of the decrease in the form of an operating profit walk-forward: $50 million from lower raw material costs; $10 million due to higher unit volumes; $10 million in lower manufacturing costs; $2 million in lower products liability charges, offset by $70 million from unfavorable price and mix; $1 million higher SG&A costs; and $4 million in higher other costs.

Our raw material index in the first quarter was 200, which was 11% lower compared with the same period in 2013, reflecting primarily lower prices for natural and synthetic rubber. The first quarter index was down 4% sequentially compared to the fourth quarter of 2013. We expect the second quarter raw material index to be about flat sequentially compared to the first quarter.

With periods of volatility in raw material prices, Cooper's purchasing strategy continues to place a priority on securing an adequate supply of raw materials purchased at prices that are close to or better than industry competitors.

As a reminder, in the United States, we used the last in, first out or LIFO accounting method charging the most recent cost against sales, which, in turn, impacts profits more quickly than other inventory accounting methods.

Manufacturing cost efficiencies were $10 million favorable in the first quarter. Sales volume reductions in the first quarter of 2013 required production adjustments at the U.S. facilities. Such adjustments were not required in the first quarter of 2014.

Other operating costs increased $4 million compared to the first quarter last year, reflecting increased distribution costs associated with carrying higher inventory levels through the quarter.

Now turning to our International Tire Operations. Net sales in the International segment were $310 million in the first quarter, down 9% from a year ago. Segment shipment volumes decreased 2% compared to the same period last year.

Cooper's European operations sold 5% fewer tires in the first quarter of 2014 compared with the same period of 2013. This decrease was more than explained by reduced sales of lower price point tires, including the impact from exiting an arrangement to sell an entry-level brand exclusively through a large real -- retail chain.

Cooper's plant in Serbia continues to convert much of its production to traditional Cooper brands. Cooper's unit volumes in our Asian operations declined 4% compared with the first quarter last year. The decline was driven by reduced passenger car tire and medium truck shipments, including intercompany shipments, reflecting primarily the lingering effects from the earlier labor disruptions at CCT.

I'll echo what Roy said about the resolution of the long-term ownership of CCT. Regardless of who owns CCT, China remains an important part of our business today and will remain an important part moving forward. Total International segment shipment volumes, after elimination of intercompany shipments within the segment, decreased 2% compared to the same period last year.

International segment operating profit for the first quarter of 2014 was $23 million or 7.5% of net sales compared to $30 million or 8.8% of net sales from the same period last year. The operating profit walk-forward for our international operations includes $22 million from lower raw material costs; $2 million in lower manufacturing costs; $1 million from lower SG&A, offset by $30 million from unfavorable price and mix; and $2 million from lower unit volumes.

I'd now like to cover a few other items, starting with income tax. Our income tax expense recorded in the first quarter was $23 million and is based on forecasted annual earnings and tax rates for various tax jurisdictions. The effective tax rate was 30.4% for the quarter. We expect the full year effective tax rate will range somewhere between 29% and 35%. More detail on our taxes is available in our Form 10-Q that will be filed with the SEC.

Consolidated or total company selling general and administrative costs were $66 million or 8.3% of net sales in the first quarter. This is up from $61 million or 7.1% of net sales in the same quarter a year ago. The higher costs were driven by increased professional fees, including costs to support the company's new ERP system in the U.S.

Lower net revenue also contributed to the increase in SG&A as a percentage of net sales. We continue to believe that SG&A for the full year, as a percentage of net sales, will be in the 5% to 7% range, although towards the higher end of that range, as we continue to invest in our brands and in our distribution capability.

Now turning to cash flows and balance sheet highlights. Cash and cash equivalents of $336 million at March 31, 2014, were $62 million lower than December 31, 2013. Cash used in operating activities was $28 million during the first quarter. The decline in cash and cash equivalents followed our regular seasonal pattern for working capital. The company typically built inventory during the first half of the year for release during the peak of third quarter selling season.

Accounts receivable of $462 million increased from the December 31, 2013, balance of $360 million, which is, again, consistent with the typical increase in accounts receivable expected in the first quarter based on sales patterns.

Net property, plant and equipment was $975 million at March 31, 2014, compared with $974 million at the end of 2013, as capital spending was about equal to depreciation and amortization.

The notes payable balance of $25 million relates to our operations in Mexico and China. These are typically refinanced as they reach maturity with an ongoing goal to convert a portion to long-term instruments.

Liquidity. A few words about our credit facilities. We have 2 primary parent company credit facilities to provide liquidity. The first is a $200 million asset-backed revolving credit facility, which expires in July 2016. We also have an accounts receivable securitization program with a limit of $175 million. It expires in June 2015. Both facilities were undrawn at March 31, 2014.

The amount that can be borrowed is reduced for the amounts used to back letters of credit and is subject to the availability of certain assets that can be pledged. These 2 credit facilities do not contain significant financial covenants until availability is reduced to specified levels. The company's additional borrowing capacity at March 31, 2014, was approximately $266 million.

Additionally, we have unsecured annually renewable credit lines in Asia, of which approximately $368 million remains available. These credit lines do not contain material financial covenants, and all related borrowings are due within 1 year and are included in the notes payable section of the balance sheet.

CapEx. Capital expenditures in the first quarter of 2014 were $40 million. We believe capital expenditures for the full year will range from $165 million to $175 million.

I'll now turn it back over to Roy.

Roy V. Armes

Yes. Thanks, Brad. With our strong first quarter performance and commitment to continued execution of our strategic plan, Cooper has solid momentum moving into the second quarter and the rest of 2014. Our truck and bus radial tire volumes in the U.S. are expected to rebound, as production of all tire brands has been restored at CCT.

Our efforts to drive for cost efficiencies at our plants will continue in North America, Europe and Asia, and these programs have shown promise to make our plants even more competitive in the future. We're projecting some growth for Cooper Asia, as the economy there expands, although it may be at a slower pace than in prior years. Cooper continues to rapidly broaden our points of sale in Asia.

Growth is also expected in the U.S. and North America. And in Europe, we'll likely see a continuation of current trends as the economy is expected to display a modest recovery.

Cooper believes that while the global tire markets will remain highly competitive and underlying economic conditions will likely continue to vary widely across markets, we'll meet or exceed industry unit volume growth rates in our key markets this year, including house brands.

As mentioned earlier, we are moving forward with the process of determining the future ownership of CCT. And once this is established, we'll continue to address our capital deployment options to deliver value to our shareholders.

We look forward to expanding on the topics we've addressed today and having more detailed discussions regarding our future plans when we host an Investor Day event on May 15 in New York. And this event, which is by invitation, will include presentations by me and Brad, as well as by other members of our executive leadership team. The event will be webcast live on May 15, beginning at 8:30 a.m. Eastern Time. And just refer to the news release issued earlier today for detailed webcast information.

Now with that, I think it's time to get on with the questions that you might have. So operator, if you'll take the first questions, please.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Brett Hoselton of KeyBanc.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

I want to kind of start off with just inventory levels. If I kind of look back at inventory levels in the first quarter over the past, I don't know, 5 or 6 years, it seems like you've generally run kind of in that mid-300 to maybe as much as 500. But in 2013, you bumped up to the mid-600 range. And you're kind of now in the low 600 range. I think last year, you maybe carried a little bit more inventory because of the lockout and so forth. So I'm kind of wondering, where do you think inventory levels will normalize for your company?

Bradley E. Hughes

Brett, I would say that the inventory levels that we're carrying right now are within the range that we would typically manage to in the first quarter. Again, it's not just a matter of where -- it's also a matter of where we see demand going. And we may be at the higher end of the range that we'd be managing to, but we're comfortable with where we're at right now when we look at the demand going forward.

Roy V. Armes

And Brett, there was a little bit of a run-up in the inventory as well. As we get prepared to -- as we ramped up CCT to get that production going and shipping product here, particularly on the TBR side, as we start those products now, are starting to flow out to our customers. We were building some inventory as a result of that. And we have our typical inventory build as well, getting ready for a peak third quarter, which is typical in the industry as well.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

And then, as we think about kind of sequentially, as we move into the next quarter and so forth, how do we think about manufacturing in terms of a component of your operating profit lock? And again, I'm kind of thinking sequentially from the first to the second to the third quarter, is that -- are you operating at a pretty high level of capacity utilization at this point in time? Is there some incremental benefit there, or is it potentially a headwind?

Bradley E. Hughes

Well, last year -- Brett, I'll make a couple of comments and then Roy can follow on. But I think there's 2 important things to think about with regard to our manufacturing. A year ago on -- with the circumstances we had around the inventory adjustments, the ERP cutover on some of the industry demand dynamics, we had a fair number of production curtailments that we outlined over the course of last year that were a drag on our manufacturing cost efficiency activity. And we see volume recovering this year, as we said in the past. In addition to that, we have a number of cost reduction initiatives underway that have been and we believe, will continue to contribute to reducing our overall manufacturing cost. So as I look at 2014, I would expect our manufacturing cost to be a positive story.

Roy V. Armes

Yes. And I think, having said that, our utilization rate is still very high. We intend to continue to run at those levels for the better part of the year, other than some normal downtime maintenance, downtime type of things that we would have. But certainly, running full out as compared to last year.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

And then, just one final question. In terms of the valuation, where are we at for the CCT entity? Where are we at in terms of selecting an entity to value that? And are you planning on making some sort of announcement when you finally do select somebody? Or should we look for an announcement when you finally can determine the valuation? How do we think about what you intend to communicate as you go through that process?

Bradley E. Hughes

All right. So I -- it won't be a blow by blow as we go through. What we can say is that we are progressing towards the process that was laid out inside of the agreement. And as something -- if something material develops that requires or indicates that we should be communicating it with the investment community, we certainly will. But at this point, we would say that we are progressing towards the process that was outlined in that agreement and probably leave it there.

Operator

Our next question comes from Rod Lache of Deutsche Bank.

Rod Lache - Deutsche Bank AG, Research Division

I was hoping you might be able to comment a little bit about 2 things. One is the price mix versus the raw materials, which was a little bit adverse in the quarter for you. Just what are you seeing in terms of just general market conditions, the effect of, I guess, low-cost imports? And is that kind of stabilizing? And on the flip side, you're actually outperforming, particularly in North America, the light vehicle side, even with some of the volume constraints. What do you -- is it -- is that largely a pricing factor? Or is there -- are there other things that you see coming in with new contracts, or things along those lines that would help you support outperformance on the volume side?

Bradley E. Hughes

On the price mix, Rod -- I'll start. On the price mix, from an industry perspective, we see things stabilizing, whether it's looking at what the implications -- and this was more in the volume part of your question, but I think it's -- it does contribute to the price mix discussion as well. The impacts from the Chinese tariffs going away and some of the Chinese manufacturers trying to regain their position in the U.S. market, that initial reentry into the market is stabilizing, both from a volume and a price perspective. And that while we had been watching pricing catching up with the reduction in raw material costs that continued through '13 and into the first quarter of '14, that as well seems to be stabilizing. And so what you're seeing in our numbers is just kind of the last bit of that catch-up right now. And as we look forward, it does appear to be relatively stable. If raw material prices continue to decline, you may see a bit of market activity, but it looks like things have leveled out of that. Maybe Roy wants to comment on the volume?

Roy V. Armes

Yes, I think that's a good assessment on the price mix in raw material. We are seeing some stabilization. Well, it's been so volatile over the last several years. It's a risk to even talk about it stabilizing at this stage. But I think, Rod, we're -- that's what we're seeing. If you look at the North America -- second question, pricing market share and how we've outperformed there, we were, last year, holding off on any kind of pricing to make sure that -- we were doing some promotions and things like that versus invoice pricing, if you would, changes. This year, we work with our customers to find out where it's best to get us positioned and being able to make sure that we had the right pricing to be able to be effective in the marketplace. And we did adjust our pricing, Rod, to some degree, to be able to match where our product is positioned and where we can be most effective in the marketplace. Now having said that, even with that, we had some very good margins for our North American business.

Operator

Our next question comes from Bret Jordan of BB&T Capital Markets.

Bret David Jordan - BB&T Capital Markets, Research Division

Question on the SAP. You said there was some incremental cost in Q1. Could you give us an idea what the magnitude was and sort of where we are in the process of completing the SAP?

Bradley E. Hughes

So we talked about $4 million of incremental other costs compared to our prior year, and most of that is explained by the higher distribution costs that we're incurring in the U.S. right now. With regard to where we're at with ERP, we've made really good progress. At a point in time in the third and fourth quarter last year, it was actually affecting our efficiency to ship units and our ability to meet demand. We are essentially over that at this point, and we're shipping to be able to meet the demand out there for the most part. But it is with -- at this point, a little bit higher cost and we think that, that will diminish as we go through the year.

Bret David Jordan - BB&T Capital Markets, Research Division

Okay, great. And then a question on raw material visibility, that sequential decline of 4%. I think in mid-March, you were seeing a sequential decline of 3% for this quarter, and so a lot changed in the last couple of weeks. Is that something that you really have to sort of close the books on the quarter before you see what the full raw material impact was? Or is it something that changes so quickly that you can get a 30% swing in a matter of weeks?

Bradley E. Hughes

Well, I don't know if it's quite as dramatic. The -- we were looking at about 3%. The 4% is actually a round-up from about 3.6%, I think, if I recall the specific numbers correctly. And so I don't -- it's just not that quite as far apart as the 30% might suggest. We usually have, for the next quarter out, reasonable visibility. But again, you can see -- I mean, natural rubber continued to move lower throughout the quarter. And so that was one of the contributing factors. But I wouldn't suggest that it was a real big miss in terms of what we were estimating. There's a bit of rounding that's in there when we're talking to whole percentages.

Bret David Jordan - BB&T Capital Markets, Research Division

Okay. And then one last question, I think follow-up on the last question. You're saying you're seeing pricing stabilizing from a manufacturers-to-the-channel standpoint, the deflation? I mean, it seems like some of the Chinese manufacturers were passing through a lot of those lower raw materials costs. But you're seeing things getting a footing here?

Roy V. Armes

Yes, I think that's safe to say at this point in time. What we're seeing right now, Bret, is it looks there is some stabilization there. One other thing I want to follow-up on Rod Lache's question about pricing and market share, Rod, if you're still on. One of the things that we have noticed in our product, our new products are performing very well in the marketplace as well to help us outperform the industry. And they're -- as you see, our North American business has some pretty good margins there. It's a result of our new products that we've introduced and we've got out to the marketplace, as well as those new products being more of a premium segment, addressing the premium segment versus the lower end.

Operator

I'm not showing any further questions in queue and would actually like to turn the call back over to management for any further remarks.

Roy V. Armes

No, I don't think we have anything here. We're very proud of our quarter, very proud of our people that's really come on strong after our challenges in 2013. And we're very excited about -- as we move forward in our business and all the possibilities and opportunities that we have in front of us. So we're feeling very optimistic at this point in time.

So with that, thanks, again, for attending the call. And if you have any other questions or comments, certainly feel free to call Brad, Brad Hughes and -- with some follow-up questions, or come to our investor website and we'll try to get answers back to you, okay? Thanks a lot, operator, and thanks for attending the call today, to our investors and analysts.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.

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