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Cooper Tire & Rubber Co. (NYSE:CTB)

Q2 2010 Earnings Call

August 5, 2010 11:00 am ET

Executives

Curtis Schneekloth - Director of IR

Roy Armes - Chairman, President and CEO

Brad Hughes - CFO

Analysts

Rod Lache - Deutsche Bank Securities

Ravi Shanker - Morgan Stanley

John Murphy - Bank of America Merrill Lynch

Himanshu Patel - JPMorgan

Tony Cristello - BB&T Capital Markets

Derrick Winger - Jefferies & Co

Saul Ludwig - KeyBanc Capital Markets

Operator

Good morning. My name is Tania and I will be your conference operator today. At this time, I would like to welcome everyone to the Cooper Tire and Rubber Company’s Second Quarter Earning Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. I would now like to turn the call over to Mr. Schneekloth. Please go ahead.

Curtis Schneekloth

Good morning everyone. Thanks 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, you may hear forward-looking statements related to the future financial results and business operations of Cooper Tire. Actual results may differ materially from current management forecasts and projections as a result of factors over which the company has no control. Information on these risks and additional information on forward-looking statements are included in the press release in the company’s reports on file with the Securities and Exchange Commission.

With me today are Roy Armes, Chairman, Chief Executive Officer and President, and Brad Hughes, who serves as Chief Financial Officer and Vice President. 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’ll open the call to participants for a question-and-answer session.

Today’s call will begin with Roy providing an overview of the results. We’ll then turn it over to Brad for discussion on some of the detail by segment and comments on other matters. Roy will then summarize and provide comments on our outlook. Now let me turn the call over Roy Armes.

Roy Armes

Thanks Curtis and good morning to everyone. Before we get into the review of the operations, I’ll mention that the impact of the 8-K we filed regarding re-statement of our financials will be covered a little bit later in the call by Brad Hughes. The re-statement is to comply with financial accounting and reporting requirements and it has no effect on the company’s assets, cash flow or net income. It also does not have a cumulative impact on the amount of earning per share available to common shareholders. This is also, there’s also no change to the operating performance result of any of Cooper’s joint ventures or the international segment.

Now with all that said, let me now start in with our comments on our operating results.

During the second quarter, we had a net income attributable to Cooper Tire & Rubber Company of $0.70 per share or $44 million. This amount includes $25 million of benefits related to discontinued operations and restructuring charges of $7 million, primarily related to the closure of the Albany, Georgia facility. This compares with a prior year second quarter loss of $13 million or $0.11 per share, which included $37 million of charges related to discontinued operations and $9 million of restructuring charges. Excluding discontinued operations, restructuring charges and adjusting for the non-recurrence of a $10 million pension curtailment benefit in 2009, net income attributable to the company was approximately $3 million better than the prior year.

Year-over-year results were impacted most significantly by volume improvements and increased raw material prices. We continue to have impressive growth in the top line as unit shipments increased 16% and revenues increased 27% on a year-over-year basis for the quarter. This is a result of our successful efforts to position the company for growth. We’re also pushing ahead in our efforts to improve our cost structure. The net benefit of improved leverage and manufacturing results were positive during the quarter versus the prior year. We operated at very high utilization rates during the quarter as we continued with the most aggressive volume ramp up in the company’s history.

We continue to be excited about the opportunities for Cooper going forward, but with that said, let me present our overview of the operations. On a consolidated basis, sales for the second quarter increased over the prior year’s second quarter by 27% to $804 million, driving the top line growth were significant volume increases and positive pricing and mix compared with the second quarter of 2009. We continued the positive sales trends started in the second half of 2009 and our volume performance was again ahead of the industry in the United States. This is the result of aligning ourselves with market demands through several different actions that we’ve taken. We’re benefiting from some of the positive industry trends that are occurring currently and have also launched new products that are achieving very solid market acceptance.

The international operations were also very positive in delivering a 13% growth in unit sales compared to the prior year. Operating profit for the second quarter was $34 million, compared with operating profit of $41 million for the same period last year.

Results for the quarter when compared with the prior year were driven by improved volumes which contributed $27 million and increased utilization and manufacturing capacity of $23 million. Partially offsetting the improvements were a negative net price and mix to raw materials relationship of $51 million and the non-recurrence of a $10 million benefit recorded during the prior year’s second quarter for the curtailment of pension related costs. Our international segment again provided strong results delivering $21 million in operating profit, an increase of $2 million over the second quarter of 2009.

We’re confident that we are focused on the right priorities to drive profitable growth, and as our June first price increase takes full effect, it will help to deal wit the challenge of the elevated raw material cost. At the same time, we’re pushing our plans to efficiently meet strong demand for our products while continuing to attack costs.

Now Brad’ going to go through and provide you with more detail on the individual segments and some of the other financial matter associated with the business. So, Brad?

Brad Hughes

Thanks Roy. I'm going to start with some detail on the North American Tire Operations. North American segment sales were $575 million, that’s an increase of 35% compared with the second quarter of 2009. The top line increase was driven by higher volumes on a year-over-year basis in improved pricing and mix. Supporting this improvement were healthier industry conditions, continuing new product success and growth in channels where we earned or represented. The improvements were across many of our product segments and distribution channels.

Low levels of inventory continue to exist across the industry supply chain. In the Unites States replacement market, our unit shipments of total light vehicle tires increased 25% in the second quarter, compared with the same period of 2009. This is about 3.5 times the 7% total light vehicle shipments reported for the total industry by the Rubber Manufacturers Association or RMA and significantly higher than the estimated 9% increase in total light vehicle shipments for the RMA members during the quarter.

The momentum at our top line continues to build on the performance improvements that began in the second half of 2009. Operating profit for North American Tire operations of $20 million decreased by $8 million when compared with the same period in 2009, excluding the one-time benefit from freezing our pension benefits that occurred in 2009, profits were unchanged year-over-year. Increased sales volumes in the North American segment improved operating profit by $19 million, compared with the prior year. The net effect of price and mix compared with raw materials was a negative during the quarter. Raw material costs were $83 million higher and price and mix offset about $43 million of this increase.

Underlying commodity costs, including natural rubber and oil were significantly higher than a year ago, but did begin to moderate during the quarter. The underlying raw material index was up approximately 45% on a year-over-year basis, and as a remainder, the last-in-first-out or LIFO accounting method which we use in the United States charges most recent costs against sales, impacting profits more quickly than other inventory accounting methods.

The net impact from our operations during the quarter was a positive $10 million. We benefited from running our plants at higher utilization rates during the quarter which contributed $23 million.

In 2009, during the second quarter as we’ve spoken about already, we recorded a one-time benefit in our North American operations of $8 million related to the freeze of our pension benefits. The remaining $5 million offset reflects primarily additional costs that we incurred during the quarter as we were aggressively ramping up production. The total companies selling, general and administrative costs were 6.7% of net sales during the quarter, which is inline with our target of 6% to 7%. These costs when combined with products liability and other costs were roughly even with prior year levels.

Let me summarize the operating profit walk up to compare the second quarter of 2010 with the second quarter of 2009. The total decrease in North American operating profit was $8 million. The key drivers of this were $43 million from higher price index, $19 million from higher volume, $18 million from improved manufacturing cost including better utilization, $2 million in lower restructuring costs, and these positives were offset by the $8 million non-recurrence of the pension benefit and $83 million of higher raw material cost.

Now turning to our International Tire Operations. The international segment had net sales of $312 million, up 21% from the second quarter of 2009. This was driven primarily by a 24% increase in our Asian volumes while European volumes were about flat the increased sales in Asia included significantly higher exports of both light vehicle and truck tires. The growth was especially strong in passenger tire exports to Europe, the US and Africa, and truck tire exports to the US and Southeast Asia. Domestic sales light vehicle tires were also robust.

Operating profit for the international segment was $21 million, an increase of $2 million from last years operating profit of $19 million. The improved profits resulted from positive price and mix of $36 million, increased volumes of $8 million and better production utilization and manufacturing cost of $3 million. Other costs, including currency impacts were favorable by $3 million. These positive indications were offset by higher raw material cost of $48 million.

The positive momentum in our international operations will continue to grow their contribution to our overall result, and we are very pleased with the achievements to date and direction we are heading. Results can of course be impacted by many of the same factors as North America, but we are excited about our future opportunities around the globe.

Let me provide you with the key underlying factors in the form of an operating results walk-forward for the International operations, comparing last year’s second quarter to this quarter. The net improvement was $2 million. That included improvements of $36 million from price and mix, $8 million from higher volumes, $3 million from improved manufacturing and leverage, $3 million from lower other costs and currency impacts, partially offset by $48 million from higher raw material costs.

I would now like to cover a few other items starting with income tax accounting. Income tax expenses recorded in the second quarter from continuing operation was approximately $1 million and was computed using a forecasted multi-jurisdictional annual effective tax rate. This tax expense also included discreet items during the quarter. More detail on our taxes is available in our Form 10-Q that will be filled with the SEC. This includes a discussion on the discreet tax items that affected the quarter. Our taxes and related accounting continue to be effected by tax holidays in certain jurisdictions, the normal reversal of some deferred tax assets and the valuation allowance we carry against certain of these deferred tax assets.

In 2010 as we generate taxable income, we will continue to benefit from allowable tax holidays and tax credits in addition to using other tax strategies to minimize tax expense and taxes payable as appropriate. In recording tax we are required to estimate an annual effective rate that is applied at quarterly earnings. At this time we believe that the company’s full year forecasted effective tax rate will be in the 17% to 27% range. In projecting this annual effective rate, it is important realize that it is based on forecasted earnings by cash jurisdiction, some of which are still effected by tax holidays or credits.

We have $27 million of anticipated tax refund receivables recorded at June 30, 2010. These rates relate primarily to the 10-year specified liability losses carry-back including interest. We anticipate collecting 14 million of these in 2010. The total amount of the tax refund is just slightly higher than we had previously discussed and the collection is expected to extend into next year.

Turning to cash flows, net cash provide by continuing operations from operating activities was $59 million during the second quarter. The generation of cash during the quarter was driven primarily by operating profits and an increase in accounts payables balances. Inventory balances increased reflecting the normal seasonality of the business as we build inventories ahead of the peak selling season in the third quarter.

During the quarter we received $18 million, owed in relation to the final settlement of the sale of Cooper-Standard Automotive Group. As part of the settlement of this matter, we were also released from other certain liabilities. These amounts are reflected in discontinued operations.

Balance sheet highlight includes cash and cash equivalents of $379 million at June 30, 2010, which was $77 million higher than June 30, 2009, and $48 million lower than December 31st, 2009. The higher balance compared with last year is driven primarily by improved operating results during the first half of 2010. The decrease from year end is the result of higher inventory balances.

Accounts receivable of $459 million increased from the June 30, 2009 balances of $367 million as sales increased. Inventory balances have remained low as demand has remained strong. At June 30th, 2010, inventory was at $388 million compared with $377 million at June 30th, 2009.

Almost all of the short-term notes payable, $156 million relate to partially owned ventures in the People's Republic of China, whose operations are included in our consolidated balance sheet. These are typically refinanced as they become due with an ongoing goal of converting a portion to long-term instruments and refinancing of these balances continues to be on plan.

As a reminder in December 2009 we repaid $97 million of matured parent company debt. On July 27th we filed an 8-K announcing that we would file amended financial statements. The amendment is necessary to comply with accounting regulations related to the valuation and method of disclosure of a non-controlling shareholders interest of our related joint ventures. This change has two parts: First, the way we account for currency translations related to the joint ventures, and second, the accounting for non-controlling shareholders interest due to the existence of a put option as Cooper Chengshan Tire.

We filed the amended financial statements earlier today. Cooper Chengshan, CCT and the put option related to that, the put option related to CCT will expire on December 31st, 2011, and has been disclosed previously in the footnotes to the financial statements included in our 10-K filings. These changes have no impact on the company’s assets cash flow or net income. It also does not have a cumulative impact on the amount of earnings per share available the common shareholders.

Liquidity and a few words about our credit facilities, we have two primary parent company credit lines to provide sources of liquidity. The first is a $200 million asset back to revolving credit facility which expires in November of 2012.

We also have an accounts receivable securitization program for up to an additional $125 million that expires in September of 2010. Both facilities remain undrawn with approximately $35 million of the line used to back levers of credit the amount that can be borrowed is subject to the availability of working capital that can be pledged. These two credit facility do not contain any significant financial conveyance until availability is reduced to specified levels.

We have renegotiated a 364-day extension of the accounts receivable securitization at current market conditions, the limits in convenience remains the same. Additionally, we have unsecured annually renewable credit lines in Asia a total $200 million, of which approximately $136 million remains available. These credit lines do not contain material financial covenants. All related borrowings are due within one year and are included in notes payable on the balance sheet. During the second quarter, Standard & Poor's raised its corporate credit rating and other decoratings on Cooper to double B minus from B.

CapEx, capital spending in the second quarter of 2010 was $30 million. We currently believe capital expenditures for 2010 will range somewhere between a $110 million and $120 million, including initial investments in our ERP systems. This will keep spending close to depreciation levels. And now I will turn it back over to Roy.

Roy Armes

Yeah, thanks Brad. Before taking your questions, let me give you some other thoughts about the quarter and our outlook for 2010. During the second quarter, elevated raw material cost represented a significant challenge which we address with a June 1st price increase that will take full effect for the third quarter. We expect that raw material costs will continue to be elevated, but stable during the remainder of the year. We continue to identify ways to efficiently add capacity to meet the strong demand for our products and this includes adding capacity at our existing plants without significant brick and mortar.

For the first six months of 2010, we achieved a 30% increase in revenues over the same period in the prior year. We expect growth rates in 2010 will vary by region as developing markets including the PRC present more robust opportunities for improvement, and mature tire markets are expected to grow as near historical growth rates. The recovery and demand for the global tire industry began in the second half of 2009 and will present more challenging comparables for growth during the second half of 2010. We expect that demand in the second half this year will continue to be strong for our products. Our direction is guided by our strategic planned imperatives of improving our global cost structure, profitability increasing the top line and enhancing our organizational capabilities.

Now to summarize, we had a very strong quarter for sales, we’re running our plants at very high utilization rates. We have additional benefits to be gained from the already announced price increases. Our balance sheet remains very solid and we are excited about the new products in our pipeline that present opportunities for us to growth. We’ll need to successfully execute our plans and continue with the intent to prudently manage resources to drive forward the momentum built over the last several quarters. We’re confident about our abilities and have a proven history of successful execution and these factors in industry conditions leave us cautiously optimistic toward future results.

With that, I'd like to thank everybody for attending the conference. That does conclude our prepared remarks and comments. So what we like to do now operator is open this up for Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Rod Lache.

Rod Lache - Deutsche Bank Securities

I had a couple of questions. First of all, just on pricing. Is it possible that the average transaction prices in North America declined a bit sequentially from the March quarter to the June quarter? Was there some mix effect there? Could you just talk a little bit about also how much of the June price increase was reflected in the quarter? And then, any comments you can provide on what’s happening with pricing in your international segments.

Brad Hughes

Okay Rod, a couple of comments. One is, with regard to the mix effect sequentially, there was a modest impact in the second quarter related mix. We did have a very strong quarter with regard to some of our Starfire products, our opening price position in the quarter, particularly as the price increases were being implemented. And so that had a modest impact on the sequential mix effects compared with the first quarter.

With regard to the pricing, up to 7.5%, that was announced for effect on June 1st, and begins to be implemented during the month of June. The full impact of that will be in effect as we enter the third quarter starting in July and that’s consistent with what we’ve been communicating up until now. Internationally, we continue to react to changes in the markets and there were pricing actions in Asia specifically during the quarter to address raw material price increases there.

Roy Armes

Rod, we had multiple price increases from our Asia business to offset some of the material costs, and as it relates to North America, they are up to 7.5%. We historically have seen somewhere around that 40% of that being netted out as price increases of that total price increase. We expect to see that and right now, our expectations will be a little stronger than that going forward and we should see that full impact in the third quarter.

Rod Lache - Deutsche Bank Securities

Any thoughts on how we should think about because you are gaining some new coverage on your accounts in the opening price point, how should we be thinking about mix prospective? And then also, my last question would just be related to the outperformance that you being achieving in North America in particular relative to the industry, it sounds like your alluding to the fact that the comparables, they come a little bit more difficult as you look forward. Was some of that outperformance that we’ve seen up until now related to inventory building from some new accounts? Is there the potential that just because the comps become very difficult on a volume basis that we wouldn’t see outperformance prospectively relative to the market?

Roy Armes

Let me answer part of that, Rod, and we’ll kind of work backwards with your questions there, because we had a lot in there that I think is important questions. Let me just talk little bit about the industry itself. The expectation for the industry is going to be for the full year in that 4% to 6% range. We’ve been saying since early on that we’re expecting somewhere around that 5% range, maybe on the high side six, on the low side about four. We are expecting it to come in right around 5%. If you look at the first half of the year, industry is up about 10% in the light vehicle category. So just mathematically, you can see the second half being year-over-year about flat compared to last year, maybe up slightly is what our expectations would be. That’s one comment I would make.

Secondly, we have outperformed the market quite a bit in the first half. We saw a little bit of a slowdown here in June, in July and the industry in general. We do believe that in the first half, there were some of the sales that were driven into inventory because the supply chain had been very low on inventory. In our estimations would be the industry, the supply chain industry is down about 30% in inventory levels. So there was some replenishing that was going off. I don’t know what percentage was there. I think some of that, because of the uncertainty and volatility in the economy right now, there’s probably been some back off of that inventory replenishment. And then the consumer sell-through was the rest of it. And I don’t know what the percentage would be in that particular case.

I think there are still low inventories in the industry. I don’t think they’ll comeback to the level they’ve been to historically, but they are continuing to look at how much inventory I say, they being our dealers and our supply chain, wants to build in the process, waiting for the economy to recover at a faster rate. So I think that’s some general comment. I think it might answer a few of your questions. You’re other questions, Rod; would you repeat the first couple?

Rod Lache - Deutsche Bank Securities

Well, just on that, I guess my question was, in the context of a tougher comp. do you think that Cooper Tire specifically would continue to outperform the market? Clearly, it’s going to be tough for the overall market to continue in this space, but would you be doing better? And then I also asked about the outlook (inaudible).

Roy Armes

Right now our anticipation is that we can outperform the industry, even with the year-over-year tougher comps, I think with our product lineup that we have out there, what we’ve been able to do to penetrate different channels and different geographic areas, I do believe we can outperform the industry. That’s one comment I’d make. Right now we are doing everything we can to get our capacity at a level so that doesn’t become the constraint for us. So, having said all that, we are still expecting to outperform the industry.

Brad Hughes

And then Rod, with regard to mix, sequentially there’s two things: One is, we probably had a little bit higher mix of lower price tires in the second quarter and then in addition to that flattening back out, we’ve got the winter tire season coming towards us and there will be higher shipments of winter tires which are at the higher end of that, particularly in the third quarter.

Operator

Thank you. Our next question comes from [Brett Holston].

Unidentified Analyst

Setting out the 10-Q in front of me, I calculated the tax rates at around 8.5% on an adjusted basis. Now, that may be wrong but I am thinking, it’s obviously significantly below the 17% to 27% range that you’ve been talking about. What would be the one or two or three reasons it was so far below?

Brad Hughes

Well, we had some discreet items during the quarter, Brett, in multiple operations. In China we had some credits that we were able to take advantage of and then there were a couple of smaller discreet items that affected the US tax rate during the quarter. Again, we continue to as we did last quarter calculate the annual effective tax rate in that range of 17% to 27%, but we were able to take advantage of a couple of credit situations, both in China and in the US during the quarter that reduced that a bit.

Unidentified Analyst

And as we think about the tax rate moving into the third and the fourth quarter, and given that you were 16.5% in the first quarter on an adjusted basis and let’s say 8.5% in the second quarter. The 17% to 27%, should we think about that as being the rate for the third and fourth quarter or is it going to be towards the upper end of the range because you reported much lower taxes in the first and the second quarter?

Brad Hughes

Yeah. Again, that’s an annual effect. And so, in order to get there, the second half of the year is going to have to be a little bit higher than what we had in the first half.

Operator

Your next question is from Ravi Shanker.

Ravi Shanker - Morgan Stanley

Roy, if you heard you right, did you say that you’d typically get about 40% of the announced price increases and you expect that to be higher this time around? Any particular reason why that would be the case?

Roy Armes

Well, first of all the capacity is constrained and the demand is still strong and as a result of that we see a little bit higher leverage there yeah we do typically seeing that 40% range of that averaging up to price, and this time around we believe that its going to be a little bit stronger than that.

Ravi Shanker - Morgan Stanley

Did you see any prebuying ahead of the price increase?

Brad Hughes

Yeah, in fact in May our price increase went out in June and we saw a very strong May, and then we did expect a slow down in June for that very reason, and that happened. And there is a little bit of slow down in July not to the extent of June, but we are anticipating that it’s still the second half this year, it still be a strong second half.

Ravi Shanker - Morgan Stanley

And can you give us your outlook on your raw material index?

Brad Hughes

Let see.

Roy Armes

Yes, we can do that certainly and I would like to get everybody on the same page where the raw material index has been. So, I will start with the first quarter this year. For reference purposes, actually I will start with the first quarter of 2009 to make sure everybody is on the same page. Q1 2009, it was at 154, Q2 137, Q3 147, Q4 168. Starting in 2010 in the first quarter then it was at 181, second quarter we came in at 198 and our outlook is that during the third quarter, raw material prices will have stabilized and will be somewhere plus or minus a couple of points from 200.

Ravi Shanker - Morgan Stanley

And finally, the benefits from the manufacturing efficiency was a little weaker than I expected in the quarter. Anything in particular going on there?

Roy Armes

Yeah, I think that is, probably a question on lot of peoples mind Ravi, so let me try to explain it. There was some improvement as you might recall last year we had some production down days in curtailment because of just the industry being pretty slow. This year the ramp-up started in the second half of last year. I say ramp-up, the demand increase was significant in the second half of last year and went right into this year, so we adjusted. We began adjusting our manufacturing operations that was driven by this demand, we moved our Texarkana facility to a 24/7 operation from a five-day operation, we’ve been increasing our mold levels in all US factories since the beginning of the year. We have had a little bit of additional complexities as a result of the Albany consolidation. We’ve had to ship more equipment than we have planned into our US operation from Albany.

We’ve been hiring and training some new people for production and these are all really strained and stretched our manufacturing operation. But from my experience I would tell you, all of these are very manageable parts of running a manufacturing operation, and there’s no hidden issues out there that we are not aware of. So from our standpoint, we see and expect continued improvements in our manufacturing operation through the third quarter and the fourth quarter. And if you look at the improvement year-over-year, still $18 million worth of improvement in our manufacturing efficiencies, but we’ve got it constrained, or not constrained, we’ve got it stretched and strained right now, but there are items that we feel are very manageable. So we are pretty confident about the continued improvement throughout the rest of the year.

Ravi Shanker - Morgan Stanley

So any particular on how you see some of those headwinds coming off or possibly getting worse as volumes pick up from here in the coming quarters?

Roy Armes

You said headwinds for…

Ravi Shanker - Morgan Stanley

I am talking about those higher costs that you just mentioned in terms of the manufacturing and running the extra shift and such?

Roy Armes

I think we will just see continued improvement through the third and the fourth quarter in those overall efficiencies. I mean that’s the best that I can say at this point in time.

Operator

Your next question is from John Murphy.

John Murphy - Bank of America Merrill Lynch

Just maybe to follow-up on the Roy, I mean what level of utilization or capacity utilization do you think you are running on in the quarter, and as we look forward in the third and fourth quarter, will we be at that same rate and can you operate more efficiently at a higher margin at that same utilization rate?

Roy Armes

Well, I am going to joke about this to start with, John, but I feel like we are running at about 120% utilization rate. But we are really, if I put a number on it, where it’s 90% plus utilization rate at this point in time. If you talk to our factory guys they would certainly feel like they have been stretched and strained over the last several months here. Now having said that, I do think that we will continue to improve and get more efficient in the third and fourth quarter as we get these molds in place, get the equipment in place, we are making a lot of changes here, and once we get our people, the hiring and training of our people takes a little time to get them situated such as we get consistent output there. And we are going to have a lot of that done here in the third quarter. At the same time we are looking for ways to continue to expand the capacity in our operations across the globe to be able to support the North American market. So that’s what are plans are at this point in time is to continue deep again. These things are very manageable from my experience in the manufacturing operations. Unfortunately, or fortunately, whichever way you want to look at it, the demand came on pretty strong in the second half of last year and has continued here in the first half of 2010. So, we are continuing to struggle to get up to speed with that, it’s going take a little time to smooth that out.

John Murphy - Bank of America Merrill Lynch

And any impact on fill rates, because for you or maybe even throughout the industry are you seeing fill rates dropping off a little bit?

Roy Armes

Yeah, the feedback that we are getting is that fill rates are lower than what they have been historically, and that’s the same case for us. We are seeing right now with a little bit of a slowdown in June and a little bit of pick up in July over June, but still fairly slow. We have been able to improve some of the fill rates, but they are below our historical levels. And we’ve built a little bit of inventory but we haven’t build as much inventories we need to get back to the fill levels that our customer are used to. So, we are going to continue to push for that even with the lesser or the softer market as we are seeing it right now. We think that’s going to continue to improve for the rest of the year and we are not going to be able to build as much inventory during the second half here as we would like to.

John Murphy - Bank of America Merrill Lynch

And then maybe lastly just about on the market share gains you seem to be making here in North America, I mean obviously some of your competitors are not just aftermarket tire guys, they are supplying to the OE market, and as new vehicle production continues to ramp up, they seem to be getting some of their tires pulled into the OE market which means they can’t sell them in the aftermarket. It seems like a phenomenon that will likely, depending on your opinion where new vehicle volumes go, likely to continue. Will that continue to create room for you in the aftermarket to continue to gain market share as their tires are getting pulled into contractually into the OE market?

Roy Armes

You know John, I think there is probably a little bit of that that we can benefit from, but you know, I wouldn’t say that’s the biggest part of this. I think the biggest of our growth is two fold: One is, the number of channels that we are now penetrating in some of the geographic areas, specifically talking about North America, and then secondly, the new products that we have out there have been very well expected and we’ve been successful with those. And then, if I look at Asia and China specifically, we were going through our second expansion in our operations over there in 24 months to try to keep up with the demand there. So, we’ve got those things working for us and then these other pieces with the OE business picking up, I certainly believe that we can somehow fall from that, which is positive for us. But I don’t think that’s a bigger share of it.

Operator

Our next question comes from the line of Himanshu Patel.

Himanshu Patel - JPMorgan

Can you explain to us a little bit, just the mechanics of how price hikes flow through? You mentioned the 40% realization number. Does the actual realization of a price hike change over a period of three months, meaning, let’s say it takes about three months to get a price hike sort of fully into the system. Is it sort of 40% realization month 1, month, 2, month 3 or is it sort of different in the first month versus the last month?

Curtis Schneekloth

Himanshu, it’s Curtis here. And there is a little bit of difference between month 1 and month 3 in your example. Where, typically by the second month or third month, you are going to have the full thing in. But I will say that the majority of it comes on right away when we have got that data in there. So, an example of the June 1st price increase, the majority of that would have come on sometime on June.

Himanshu Patel - JPMorgan

And then just going back to, Roy, your earlier comment, you have been I think signaling for a few quarters now that Cooper could continue to outperform industry volumes. But just a magnitude of outperformance this quarter is I think kind of a more essential question, your kind of 3.5 x in the industry. Can you more specifically comment on just your ability to continue outperforming at that pace in the second half? I mean do you think that there is something abnormal about doing 3.5 times better than the industry? Or is that something you think you can do in the second half as well?

Roy Armes

I don’t want to comment on what we can do and can we stay at that pace. The second half of the year is certainly a much tougher year-over-year comp, but more importantly to that Himanshu, is just the fact that we are trying to get our capacity up where we can continue to do well and satisfy our demand from the supply that we have available to us. So in the end, I think we are still going to outperform the industry. I think 3 or 3.5 times, the industry is a pretty strong outperformance and that’s a huge range there. So, I wouldn’t go out on the limb saying that in this second half I think there’s a few constraints that would keep us from doing that. At the same time, I feel pretty confident about what our ability is to outperform the industry for the remaining of the year, as well as for the full year.

Himanshu Patel - JPMorgan

And then lastly, if you could just kind of step back and comment a little bit on just what’s going on with industry volumes? I know year-over-year data is still looking positive, but I you just kind of look at mid-April through June sequentially the industry was sort of flattish. I think historically we’d see sort of mid-teens sequential rise during that period. You would think over that period and you sort of pull ahead, ahead of the June 1st price that would have been captured. So, I’m curious, do you actually see the consumer kind of softening here? Do you think that was partly an explanation for why volumes have been soft in the last couple of months in addition to maybe some pull ahead?

Roy Armes

Yeah I think when you look at both June and July from what we are seeing, it’s easy to draw I think a conclusion that consumers have softened. I’ll call it the sellout, particularly what we are seeing at the retail level. We don’t think that’s a permanent situation talking with our customers, I think our customers are still fairly optimistic for the rest of the year, although there is a little caution in there as well, maybe not a much caution as we have seen in the past, but a little caution in there that this is a temporary slow-down, that’s something that we see as being permanent. A lot has to do I think with just building the consumer confidence in the economy in this recovery will do a lot for releasing some of that pent-up demand. We all believe that there is still pent-up demand out there for replacement tires.

Himanshu Patel - JPMorgan

And last question, if you just kind of had to do an over-under from your seat on sort of how the last three months in your business when you issued to the manufacturing stress, obviously price realization issues on raw materials and volume. Can you just kind of give us a sense on what sort of wind, better and what you had expected at the start of the quarter and kind of what came in little bit worse than which you had thought?

Roy Armes

Well I think, it’s probably easy to say that our volumes were better than what we had expected for the second quarter. If you look at the price mix, I think I would like to go ahead of the curve a little bit more on the pricing, the June 1st, but there was a lot of other dynamics that were playing on that, but probably the most difficult thing for us was seeing this whole raw material pricing not stabilize, I think quarter-over-quarter we are looking at about a 45% increase in raw material cost compared to our index. That was much more difficult the offset, even with the volume and price mix that we did have out there.

Curtis Schneekloth

Operator, we’ll take one last call.

Operator

Thank you. Your final question comes from the line of Tony Cristello.

Tony Cristello - BB&T Capital Markets

One question, Roy, when you look at the Albany $75 million to $80 million targeted benefit, did you think of that number is still on track or have some of the inefficiencies with molds, moving things around and stress on the production created a little bit of a headwind in terms of achieving that ultimate goal?

Brad Hughes

Tony, it’s Brad. I think we’re still on track to deliver that range, somewhere in that range on the overall implications of taking the Albany volume and redistributing that into the footprint and have been very favorable to our efficiency in North America, principally in the he U.S. There’s a lot going on as a result of that Roy alluded to the movement of the equipment, the introduction of new molds as we’re ramping up into the 24/7 operating on pattern at Texarkana. We’ve got some new products that are coming online at the same time and some of the challenges of getting the people in place and train so that they can reach their ultimate efficiency. But overall, we’re confident that that’s still going to be the type of number that we deliver.

Roy Armes

I’ll tell you what, what I would to add to that is what we’re doing with these factories? The three factories that we have are really ramping at unprecedented levels. I mean, what we’re trying to bring on stream is lot faster than what we’ve done in the past. So, there was some unprecedented levels of ramp up in trying to increase that capacity based on this demand is what’s been constraining or stressing the operations.

Tony Cristello - BB&T Capital Markets

If I go back and look at the June quarter of last year, the utility and the efficiencies line, I guess you had a positive benefit of $14 million, if I do the math, it looks like June quarter this year, it was probably a 5 million or so drag. As we move into the third quarter, I'm assuming that that is still going to be somewhat of headwind as you are continuing to ramp up and try to get more utility out of your facilities. Is that a fair assessment?

Roy Armes

You’re saying a headwind that we would have a negative impact on.

Tony Cristello - BB&T Capital Markets

Yeah, there’s still some negative impact. You haven’t fully put everything in place where you needed to be and that’s still going to sort of work a little bit against you in Q3.

Roy Armes

Yeah. It will probably work a little bit against this, but I think we’re going to gain some tailwinds as we get through this as well, because I think these things are much more manageable than maybe some of the things we’ve dealt with a few years ago. But I think that would be a good observation, there would be a little bit of headwind in this in the third quarter.

Tony Cristello - BB&T Capital Markets

And then maybe just one last question, just a little bit bigger picture. You’ve gone through probably one of the best periods in terms of the volume, a replacement that you’ve seen for your business in sometime, and I'm just wondering as we step back and look out into the next year, two or three years, what is it that Cooper can do to sort of continue to build itself and maintain a really solid level of demand and production and as you anniversary some of these really tough comparisons.

Roy Armes

Well I think, probably the first thing that we’ve got to do, we feel optimistic about the demand that we’re seeing, the feedback we’re getting from our customers, the product plans that we’ve laid out for the next few years and we think that they are going to continue to be successful. I think our biggest challenge is going to be bringing on the right kind of capacity to support that demand. I'm saying bringing on the right kind of capacity globally and we’re looking at the various options of being able to do that. We are confident enough that we think we can go out and use some of cash to invest into that capacity. Again we in a mature market here in North America that we got opportunities and we are showing that we can do that, be it channels in geographic areas. We are in the fastest growing market in China and actually that market is growing faster than we are bringing on capacity. So, we are going to look for some options there as we go forward. So we are still, we still think we’ve got some opportunities out there to continue with the solid growth.

Curtis Schneekloth

Operator, we will take one last question. Thank you.

Operator

Your final question comes from Derrick Winger.

Derrick Winger - Jefferies & Co

Did you mention your bill of building on your lines?

Brad Hughes

We did and against the lines in North America we’ve used about $36 million, $35 million to support some lines of credit, and then we’ve got about a $136 million available on the lines in Asia.

Derrick Winger - Jefferies & Co

So what’s the total that’s available?

Brad Hughes

So the total that’s available is, I mean, I depends at points in time on the, on the working, it is available against the lines in the US. But right now the total that’s available is around $250 million, $275 million.

Derrick Winger - Jefferies & Co

So the $136 million plus and another $130 million something, gives around $270 million of that total there.

Brad Hughes

I am just being little bit conservative on the amount of inventory that’s available to back one of the lines. It could be a bit higher than that.

Derrick Winger - Jefferies & Co

Okay, it will be in the queue right?

Brad Hughes

Yes.

Curtis Schneekloth

One last question.

Operator

Your next question is from Saul Ludwig.

Saul Ludwig - KeyBanc Capital Markets

Roy, would you expect the price cost which was a negative roughly $40 million, how much might that get close in the third and fourth quarters?

Roy Armes

Right now with the price increases we have out there, Saul, if the material costs do stabilize although it is at these higher levels, we are expecting that to be on the positive side for the remainder of the year.

Saul Ludwig - KeyBanc Capital Markets

You mean where price more than trumps that cost in the third and fourth quarters?

Roy Armes

Yes.

Saul Ludwig - KeyBanc Capital Markets

That will be very good. Next question, not to throw on that manufacturing issue, but I think that lot of people are spooked by that and I think that’s part of why the stock is actually the way it is. You know in the first quarter your manufacturing cost benefit was $10 million. Now in the second quarter, it was negative five, I assume that had to be little bit of surprise to you and you wouldn’t have expected that to be happening. And you explain that’s because of the potency with which you had to ramp up production, hire new people and costs associated with that. When we get to the third quarter, is that still going to be a negative number on a year-over-year basis and if so, how much or can do anything about that?

Roy Armes

I think we still got some work to do there to get this thing smoothed out, but our first priority is to getting up to a level where we can satisfy the full demand that’s out there, Saul. So, right now with everything we are doing, we are going to still be at ramping up molds right through the end of the year. And trying to get to a point where our run rate is much more stable going into 2011. So yes, I think we can anticipate going into the third quarter. We are still going to be strained or stretched in the manufacturing operations. At the same time, we are going to continue to see improvements. Now I don’t know what that number is at this point in time, but we are going to and expecting to see improvements. My experience has been these things when you get into this where you a have spike in demand like that, it starts to strain the operations and it is just a matter of time of getting these things smoothed out when you’ve got all the working pieces that are going on at the same time.

It’s just going take us some time there. If you look at the equipment that we are moving into some of these operations from our Albany facility, this equipment that we hadn’t originally planned on thinking at least that we didn’t need those in those operations, with the demand like it is we have had, and it shows up in our restructuring cost as well, because we are beginning to ship some of that equipment out of Albany into the factories that we hadn’t originally planned on. So that’s still going as we speak.

At the same time, we are going to be putting along additional capacity in different parts of our footprint globally to support the North American demand with supply that is going to take place here in the second half into next year as well. So, it is going to take us some time to just smooth this out. But I think these things are still from experience very manageable parts of a manufacturing operation.

Saul Ludwig - KeyBanc Capital Markets

And then finally, internationally last question. International profits were colored roughly $20 million a quarter. In the back end of last year your international profits were quite strong. Are you going to be able to do as well or will you be under pressure in your international results to where you were earning $30 million, no $35 million. But you were earning a lot more money in the back end of last year, $30 million and $27 million internationally. Are you going to able to close GAAP from where you were in the second quarter?

Brad Hughes

Saul, it is Brad. The international, we were affected very similarly to the effect in the US with regard to the price raw material relationship. And as we expect sequentially in the US just to kind of expand on what Roy was saying, I mean sequentially we expect improvements compared with the second quarter in the third and fourth. As suppose I think your question was year-over-year I think we were talking compared with the second quarter. But similarly in the international operations, we are expecting that we will see an improvement in that relationship that are going to help us to improve profits compared with what we have in the second quarter.

Roy Armes

Well again, I thank everybody for attending the call today, we feel very comfortable and confident that our second quarter was very solid with the sales growth that had, the utilization rates that we have. The performance to the market that we’ve had in this first half and we still remain optimistic in the second half going forward while a bit cautious because of the volatility of the economy. But in general, we are feeling pretty good about how we are positing the company. The things that we are doing of the understanding that we have on the issues and things we got to deal with inside our business. They are very manageable. So with that said, we are looking forward a good third quarter and good fourth quarter. Thanks again.

Curtis Schneekloth

Operator, we are done.

Operator

Thank you. This concludes today’s conference call. You may now disconnect.

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Source: Cooper Tire & Rubber Co. Q2 2010 Earnings Call Transcript
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