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Cooper Tire & Rubber Company (NYSE:CTB)

Q2 2014 Earnings Conference Call

August 7, 2014 11:00 a.m. ET

Executives

Christine Hanneman – Director, Investor Relations

Roy Armes – Chairman, CEO & President

Brad Hughes – Senior Vice President, President–International Operations & CFO

Analysts

Brett D. Hoselton – KeyBanc Capital Markets

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

Operator

Good morning, and welcome to Cooper Tire & Rubber Company’s Second 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 Christine Hanneman, Director, Investor Relations.

Christine Hanneman

Good morning, everyone, and thank you for being with us today. This is Christine Hanneman and I am here with Roy Armes, our Chairman, CEO and President and Brad Hughes, Senior Vice President, President–International Operations and CFO.

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 SEC.

In association with our earnings release, we will provide an overview of the company's second 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.

We will begin this morning with Roy providing an overview. Brad will then provide 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 the call over to Roy Armes.

Roy Armes

Thanks Christine and good morning to everyone. We continued our trend of strong performance in the second quarter with EPS was $0.59 per share up 7% on sales growth of 1% compared to last year. We posted strong unit volume growth of 10% across the company, unit volume rose 9% in North America and 5% in the international segment.

You also have seen our announcement that we’ve entered into a accelerated share repurchase program that we announced this morning and Brad will explain the details of that little bit in his prepared comments. This program along with our dividend which we’ve paid for 170 consecutive quarters demonstrates our ongoing commitment to our shareholders. We’re in a strong financial and feel it is appropriate to return some of our cash to shareholders.

We don’t yet know the resolution of the CCT ownership, we believe that we’ve financial (inaudible) with all to meet all of our obligations, support our growth strategy including investment in our growth in China through CCT or otherwise along with the accelerated share repurchase to ensure a bright future for Cooper.

Now, let me just discuss just a few other details of items of note in our second quarter earnings. Second quarter operating profit was $77 million or 8.6% of sales led by strengthened North American segment, and I’m proud to say that for the six month period North America posted a record operating profit of $133 million or 11.1% of sales. This is especially noteworthy given last year’s outstanding first half performance in this segment as well as the challenges we faced coming out of 2013. And our people are focused on moving forward and I think our results reflect that.

Despite the strong unit growth, international sales and operating profit were down versus last year as a result of lower prices reflective of lower raw material costs. You’ll recall that we announced at the end January that Cooper had reached an agreement with our joint venture partner a process to determine the long-term ownership CCT. We continue to work through that process and regardless ownership outcome China will continue to be an important of Cooper’s long-term growth strategy.

And compared to the last half of 2013 and early 2014, CCT has now returned to normal production levels which help support the volume growth in the quarter. As many of know that CCT plant resumed product of Roadmaster tires earlier this year and production of all brands is ongoing with the facility at near full production levels. Our customers are responding well to the return of the Roadmaster brand and we intend to grow this business and this business segment.

We also have taken some important steps in establishing a supply chain relationship with our joint venture in Mexico and South America and for the first time we shipped product into South America from our Mexico joint venture.

Now, I want to follow up on my comments from the first quarter with respect to innovation and new product technology. A few weeks ago we announced that we will be investing almost $36 million to establish a global technical center in Findlay, Ohio. The technical center will be the company’s worldwide center for tire science technology, advanced technology and innovation and we expect that new center will accelerate research and development of advanced tire material technology that can be incorporated into new products manufactured around the world.

An example of our progress in technology is our new premium touring tire, the CS5. This tire has our new Wear Square visual wear indicator to help consumers approximate a tire's remaining tread life. We began shipping the CS5 in April and is now – it has been extremely well received by dealers and consumers and as a result we have high expectations for it in the marketplace.

Another example of success with new products is in our light truck offering. The addition of two new light truck tires and mini sizes added to existing lines over the past year accounted for a significant amount of our quarterly volume improvement in the U.S.

Now moving on, many of you are aware that in early June, the United Steel workers filed antidumping and countervailing duty petitions against certain passenger vehicle and light truck tires from China with the U.S. International Trade Commission and the United State Department of Commerce. The ITC made an affirmative preliminary determination about two weeks ago, which means that the case is now at the Department of Commerce for further investigation and determination of whether or not there is dumping and/or illegal subsidies.

We don't know what the outcome of this is going to be, but based on our past experience we know that tariffs have been disruptive to a normal market and if they’re imposed again, they are likely to be disruptive again. Tariffs are felt in the marketplace where they are being applied, but they also often affect other markets. We continue to support free and fair trade in a globally competitive market.

For those of you who may not have seen our recent management announcements, I wanted to mention that we have made changes in our international segment management structure, Brad Hughes is now President of our international operation. Brad replaces Hal Miller, who has moved into a new role of Executive Adviser and we began to search for a new CFO to replace Brad in that function and we will continue to – and he will continue to support us as CFO until his successor is hired.

Brad has had extensive international experience in his career and we are looking forward to that expertise to drive sales growth in the international segment with a goal of having international segment comprise approximately half of our total sales overtime. Also, Chris Ostrander, his role has also expanded and he is now President of the Americas operations as he has assumed market responsibility for Latin America in addition to North America. And Christine Hanneman will be handling our investor relations going forward. Her contact information by the way is on the earnings release in our website. So please direct your questions directly to her now.

With that I will turn the call over to Brad for detailed review of our performance in the second quarter.

Brad Hughes

Thanks Roy. To follow-up on Roy’s comments about new management responsibilities we will not be changing our external reporting other than to rename the North America tire operation segment. In the future, it will be called the Americas operation. Now back to the second quarter results.

We are pleased at how well the business and our teams have responded after eventful 2013. We typically see higher volume and profits in the second half of the year after building inventory in the first half of the year. So, we are very pleased that our second quarter was strong. As reported, our total company results for the second quarter included an operating profit increase of almost 11% to $77 million or 8.6% of net sales compared with $69 million or 7.8% of net sales for the same period last year. The change in operating profit was driven primarily by the following favorable factors. $67 million from lower raw material costs, $13 million from higher unit volume, $10 million from favorable SG&A and $7 million from lower manufacturing costs. This was partially offset by $85 million of unfavorable price and mix, almost all o which was pricing.

You may recall that we mentioned in the first quarter that North America pricing would be down year-over-year in the second quarter due to price reductions we took late in the second quarter last year, the third week of June to be more specific. We have now (left) those reductions for the second half pricing versus raw material should be less of a factor assuming no tariff is imposed.

Reviewing our segment performance, I will start by providing some detail on North America. Segment sales for the second quarter was $639 million, a 3% increase compared with last year. Unit shipments rose 9%. Total light vehicle tire shipments for the U.S. were up 7% during the second quarter compared with an estimated increase of 3% for the industry and an increase of 4% reported by RMA members. In the quarter, our U.S. passenger car tire unit sales increased 4%. Light truck unit volume in the U.S. increased 20% versus last year as a result of a significant number of new product introductions over the past year that are now showing meaningful sales volume. Much of the increase has occurred in our house brand products in line with our strategic initiative to shift our mix in the house brands.

In addition supply has improved as we are becoming more experienced with our ERP system in the U.S. Commercial truck tire sales in the U.S. of Roadmaster brand rose 6% in the second quarter compared with the year ago. Total industry shipments within this category as reported by the RMA were up 12%. You may recall that we had supply issues that significantly impacted sales of TBR tires primarily in the second half of last year into early 2014. Those issues have been resolved and we reintroduced the Roadmaster brand in the second quarter. We are regaining our position with 90% of our top 30 customers and expect to continue to make progress in the second half.

Second quarter operating profit in North America rose 10% to $65 million or 10.1% of net sales reflecting strength in all geographic reporting areas. Key drivers of the increase were $35 million from lower raw material cost, $8 million due to higher unit volumes, $7 million in lower manufacturing costs and these positives were partially offset by $41 million from unfavorable price and mix.

Our raw material index was 199 which was 11% lower than the same period in 2013 and down 1% sequentially from the first quarter. We expect the third quarter raw material index to be about flat compared with the second quarter. The longer term raw material outlook for costs is for cost that generally trend higher with periods of volatility. As a reminder, in the U.S. we used the LIFO accounting method charging the most recent cost against sales, which in turn impacts profits more quickly than other inventory accounting methods.

Now turning to our international operations: Net sales in the International segment were $327 million down 8% from a year ago as lower pricing due to lower raw material cost offset higher volume in both Europe and Asia. Total international segment shipment volumes after the elimination of intercompany shipments within the segment increased 5%. European unit volume increased as a result of growth in Western Europe particularly in the U.K. as those economies are recovering. That increase was partially offset by volume declines in Russia and Eastern Europe driven by the instability in the political environment. Growth in our Asian operations was driven by increases in passenger car tires and TBR shipments.

International segment operating profit for the second quarter declined to $26 million or 8.1% of net sales compared with $29 million or 8.3% of net sales last year. Lower price and mix of $46 million was offset by $37 million of favorable raw material costs and $5 million from unit volume increases.

I would now like to cover a few other items beginning with income tax accounting. Our income tax expense in the second quarter was $26 million and is based on forecasted annual earnings and tax rates for various tax jurisdictions. The effective tax rate was 36.6% for the quarter which is higher than our projected rate for the year because of a change in our annual forecast of those geographic mix of earnings. We expect the full year effective tax rate will be in the range of 30% to 35% and more detail on our taxes is available on our form 10-Q that will be filed with the SEC.

Total selling, general and administrative costs were $71 million or 8% of net sales in the quarter. This is down from $81 million or 9.2% of net sales a year ago, approximately half of the improvement is the result of the absence of cost related to the then pending merger including accruals for stock based liabilities. We expect SG&A as a percent of net sales will be in the 7% to 8% range for the full year, this is higher than our previous forecast as a result of the following factors:

Firstly, a lower net sales denominator even though our units are up, pricing is down due to lower raw material costs. We are also flowing through the higher stock based liability accrual from marking to market higher stock place at the end of the second quarter and lastly we expect to have higher professional service lease related to some special projects this year.

Cash flows and balance sheet highlights: Cash and cash equivalents of $327 million at June 30, 2014 compares with $244 million at June 30, 2013 and $336 million at March 31, 2014. Cash provided by operating activities was $10 million during the second quarter, accounts receivable were $497 million increased from the March 31, 2014 balance of $462 million.

Capital expenditures in the second quarter were $36 million, we believe capital expenditures for the full year will range from $175 million to $185 million, this estimate is up $10 million from our previous forecast as we now plan to accelerate plans to convert production capabilities to meet increased demand for higher margin product lines.

Our balance sheet remains strong and we have ample liquidity, as Roy mentioned earlier today we announced that we have entered into an accelerated share repurchase agreement. Under the ASR the company will repurchase $200 million of its common stock. We will receive approximately 5.6 million shares at the inception of the ASR, which is approximately 80% of the number of shares expected to be purchased based on the closing stock price yesterday. The final number of shares looked to be repurchased will be based primarily on Cooper’s volume weighted average stock price during the term of the transaction, which is expected to be completed by February of 2015.

The company intends to fund the ASR initially with cash on hand through existing credit facilities. We will also continue to look at our capital structure and we will determine whether we see a benefit to arranging some longer term financing to support our future needs. Again, this could be affected by the outcome of the CCT ownership process and we still do not know the valuation or the outcome of that process. Even with that uncertainty, we entered into the ASR agreement based on the strength of our balance sheet and the strength of our business.

Regardless of the outcome at CCT, we feel, we have ample financial flexibility to fund our dividends and the new ASR fund their ongoing business strategies including our growth plans and prudently fund our attention and other obligations.

With that I will turn the call back over to Roy.

Roy Armes

Thanks Brad. With our strong first half performance and commitment to continued execution of our strategic plan, Cooper has solid momentum moving into the second half of the year. As we enter our seasonally strong second half, we expect the tire market to grow in North America and Asia and to continue its recovery in Western Europe. We expect continued volatility as well in Russia and Eastern Europe. We believe that while the global tire markets will remain highly competitive and underlying economic conditions will vary across markets, Cooper will meet or exceed industry unit volume growth rates in our largest markets this year and house brands will be a key contributor to that growth. Or efforts to drive cost efficiencies at our plants will continue companywide as these programs have shown promise to make our plants even more competitive in the future.

And as mentioned earlier, we are moving forward with the process of determining the future ownership of CCT and regardless of the outcome, we feel comfortable entering into a new accelerated share repurchase program to return additional cash to our shareholders.

So with that what I’d like to do now is turn it over to the operator to start the Q&A Session of our teleconference. So operator if you get the first question please.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Brett Hoselton of KeyBanc. You may begin.

Brett D. Hoselton – KeyBanc Capital Markets

Good morning, gentlemen.

Roy Armes

Hi Brett.

Brett D. Hoselton – KeyBanc Capital Markets

Oh and ladies, welcome.

Christine Hanneman

Good morning.

Roy Armes

Thank you for recognizing Christine.

Brett D. Hoselton – KeyBanc Capital Markets

Yes, I apologize. Couple of questions here and then I think I’ll circle back. But first I guess simplistically, it looks like your North American volumes were up 9%, international volumes were up 5%, but yet your overall volumes were up 10% and I’m just, how do I think about that?

Roy Armes

Brett, the difference there is we do have intercompany eliminations and year-over-year that’s where the balance of the difference is. Yes, we had higher eliminations a year ago than we have this year and so what’s flowing through to the consolidated result is that 10%.

Brett D. Hoselton – KeyBanc Capital Markets

Okay, that’s fine. And then, thinking about operating income sequentially if I look at 2009 to 2012 that four year period of time sequentially your operating income improved from the second quarter to the third quarter, I calculated an average of $34 million, but it ranges from $20 million to $40 million. My question is, as you think sequentially from the second to the third quarter, what would you say will be the one, two or three major puts and takes that might alter that normal sequential improvement that might cause it better or worse than it has been during that normalized period of time let’s say?

Brad Hughes

Let me start Brett because every year is different and even if you have done something to try normalize for example the circumstances last year, the year before that we had the situation at the Findlay plant which was just resolving itself in the second quarter as we moved into the second half of the year. So – each of those years seem to have a unique factor even 2011, we were on, you may recall that we had gotten out of whack with pricing in the market by trying to get ahead of it a little bit as pricing was rising. There are some unique factors in each one of those years. Having said that, on the relative constant that we always had even when things are rather normal, as I would describe them to be this year is, we end up starting to ship out of the inventories that we build in the first half of the year including winner tires on. So we end up shipping more tires than we were producing and that is driving the largest portion of the favorability seasonally in the third quarter and maybe even better said in the second half of the year relative to the first half of year. So, I think that we – we don't see anything right now that's going to effect that. As we get later into the year on or as there becomes additional information available around what’s going to happen with the IT, with this new tariff, sorry not the ITC, but with this new potential tariff that could be disruptive as we mentioned earlier. But right now we do expect to see a more normal seasonal improvement in the second half of the year as we were seeing over a longer period of time and the period you are looking at.

Roy Armes

Yes Brett, I think Brad has kind of nicely walked through that I think, it all depends on what you want to call normal now. We are expecting to normalize there, but there has been so many changes over the last few years. If you just look at last year for example, we basically had very limited, no TBR tires for example in the second half with what went on with our joint venture in China which will make it – will make a difference this year compared to last year. So, it all depends on what you want to call normal. We are hoping that we can get back to what we would consider the normal seasonality rates and performances of business there for the rest of the year.

Brett D. Hoselton – KeyBanc Capital Markets

And Brad you mentioned, and by the way Brad congratulations on your new assignment. How do we think about your longer term expectations for inventory levels? If I look for example, from the first quarter of 2008 to fourth quarter of 2012, your turns average from 1.8 turns here at the second quarter I calculated that you are running it around 1.2 turns so you are below where you kind of historically been before that disruptive 2013 year and so my question is how should we think about inventory turns or you going forward. It sounds like obviously you are going to go into seasonally strong period inventories are probably come down, should they normalize back to kind of 1.8 turn level at some point in time or do you see the structural reason to run at higher inventory levels?

Roy Armes

Brett let me start with that, and let Brad answer that, I think if you look back we do typically build inventory in the second quarter to support the peak season in the third quarter as you mentioned there. And there was another element here given the earlier issues that we had with the ERP deployment and its impact on fill rates, we certainly are running a bit higher to try to address that and I think some of the reports that are out there, people have been or some of the analysts have been talking with our customers and we are getting our fill rates back to normal or even in some cases a little better than what we were before. But having said that, those are some factors that weighing into this but we feel comfortable basically where we are I think we are going to continue to monitor this and adjust it based on demand and market dynamics, but I think it's reasonable to say that we are going to get this back to a more normalize level as these – as we resolve some of these issues that we are dealing with coming out of last year.

Brad Hughes

I think that that’s right that we are going to get back closer to the normal type turn level that you would have seen historically. There are some minor changes in the way that we are sourcing tires around the world that overall could affect a little bit on our inventories and it would move them a touch higher, but I don't think it's anything that would be material enough at this point that people need to go back and start adjusting their model. So, I think that what you will see Brett is that we will start to come back in the line with what you would have recognized as more of the historical turn rate.

Brett D. Hoselton – KeyBanc Capital Markets

Excellent. I will circle back around. Thank you very much.

Roy Armes

Thanks Brett.

Operator

(Operator Instructions) Our next question comes from Bret Jordan of BB&T Capital Markets. You may begin.

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

Hi good morning.

Roy Armes

Hey Bret.

Brad Hughes

Hi Bret.

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

Couple of quick questions and I guess one I am sort of forward looking on the R&D with the big investment and the incremental facility here if you can sort of give us a feeling for what, how to think about R&D as a percentage of revenues in the next year or two versus where it was maybe for this quarter and then I have follow-up on the Investor Day you are talking about, re-penetration maybe if there is any update as far as where we stand as far as incremental OE volumes?

Roy Armes

Well I would say, let me answer the OE volumes first that's the pretty easy one. There is nothing out there that we are in a position to communicate this point in time Bret and I think we are assuming – we are continuing on with our OE business as we see it today. We will continue to evaluate that as opportunities present itself, but there is nothing really to communicate beyond where we are at today.

Secondly, on your question about R&D, we are still going to be below the industry average as a percentage of sales on our spend and it’s going to be in that 1% to 1.5% range is, so what we’re forecasting as this thing ramps up we’ve been lower than that, we’ve been lower than 1%, we’ve been higher than 1% just depends on sales product introduction and those type of things, so that would be the ballpark that we are targeting.

Brad Hughes

And then Bret, just to build or punctuate that a little bit, we have made announcements that our important initiatives for us going forward both with the global tax center here Findlay and with the Asia Tax Center on (inaudible) in China, but all of that is built into the projections that we were sharing on Investor Day, so its built into the 8% to 10% operating margin on expectation and for anything that’s picked up in SG&A it still built into that, we provided that time and we would still be saying that as we look forward 5% to 7% on SG&A as a percent of net revenue.

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

Okay, great. Thank you.

Operator

Thank you, our next question comes from Brett Hoselton of KeyBanc, you may begin.

Brett D. Hoselton – KeyBanc Capital Markets

Hi, that was fast. If CCT, if I’m remember the agreement correctly from earlier this year there’s some deadlines in there one of the ones I recall is in, I thought it was in August 11 deadline to accomplish the valuation. I’m wondering it sounds like it’s not quite done yet but I presume that you are quite confident that it’s going to be done by August 11, I mean it’s just a few days away.

Roy Armes

Yes, Brett. We are still targeting that date, we are still going through some final issues that we are resolving with our partner and we are still targeting that August 11, now whether anything comes out of that that would cause an extension or not we would communicate if that happened, but right now we are targeting August 11 as a completion.

Brett D. Hoselton – KeyBanc Capital Markets

And then, is it your intention to say anything about it, in other words announce anything or is that more of a, will get the valuation we may not make any sort of public announcement?

Roy Armes

Our plans are to disclose the outcome of our discussions and where we’re with this process. So, to the level of detail, we’ve worked that out until the final agreement with our partner and get the evaluation, but we’re planning to disclose.

Brett D. Hoselton – KeyBanc Capital Markets

And then, switching gears, the tariff, it seems like it might be a real opportunity if a tariff is put in place for you to maybe re-gain some market share or take some price increases and that would be fairly favorable for you. How do you think about, if assuming a tariff to put back into place what do you think your response might be? Do you think you will be more volume oriented or more price oriented?

Roy Armes

Yes it think I would start up just putting in the context of first of all Brett, we still support free and fair trade and secondly we are not sure what’s going to happen or what the potential outcome is going to be here. But we are going to continue to monitor this and adjust as necessary. But the third thing I would say is we have been moving and shifting our mix to a higher end product, an example would be broad line and base rated categories where we have been move exposed in the past, we are 25% or 30% less exposed today than we were before. So we are shifting out mix to a more away from the lower end. But in any case, any event such as these tariffs, they do have a disruptive effect on the market at least initially until adjustments can be made in the business and I guess we are just going to have see at this point in time, but if you look at what happened with the tariffs, the 421 tariffs, yes, there were some pricing because of the demand of more the domestic products. But at the same time we saw other countries enter into the market and pick up a lot of slack on these import because during that period of time of the tariffs, imports continued to increase. They came from other countries. So I think we are going to have to step back and monitor this and look at it and see what makes sense for us overall.

Brett D. Hoselton – KeyBanc Capital Markets

Yes, and then one follow-up question. As far as the share repurchase, your thoughts on why you chose to go as an ASR as opposed to maybe ongoing share repurchase plan?

Brad Hughes

Brett, the principal reason was, we have a great deal of confidence in where we are at right now from liquidity standpoint and from a business performance standpoint and so we thought at this was the best step forward. Obviously there is different accounting treatment for this that we will provide on more near term improvement, we believe and so that was part of effect as well. But until we see what happens with CCT, we thought that this was the appropriate step at this point in time given what we knew about the business today and where we think we are going.

Roy Armes

And we also given the confidence we have in the business going forward Brett, we really felt this was a much stronger commitment for our shareholders to do an ASR versus any other method.

Brett D. Hoselton – KeyBanc Capital Markets

Roy, Brad and Christine thank you very much.

Roy Armes

Thanks Brett.

Operator

Thank you. Our next question is comes from (Inaudible) you may begin.

Roy Armes

Colin?

Unidentified Analyst

As the potential for the tariff changed the way you view the best possible outcome for CCT?

Roy Armes

No, we think we are on a path that on August 11, our partner will get the option of put or call at that point in time. So, we don't see that having an impact. We haven’t noticed that as being any impact as we speak today Colin.

Operator

Thank you. I am showing no further questions at this time. I’d like to turn the conference back over to Roy Armes for closing remarks.

Roy Armes

Thanks operator. Just a summary on closing remarks here, I would say again that I and we as a company are very pleased with our results following the termination, the merger at the end of last year and I think this is truly continued evidence that we move forward. And we are confident about our business model and value delivered as evidenced by our commitment to accelerate the share repurchase program regardless of the outcome of the CCT and discussions as going on there. And the confidence that we have in our people and organization to continue delivering excellent business results going forward. So, we think we are positioned very well to deliver a strong second half of 2014 and that's barring any significant disruptions in the market and the economy and we still expect to perform at or better than the market. So, I think this strong performance is indication that we are moving things forward and we are moving forward in much quicker than I think most initially thought.

So, with that I really appreciate the time and attention and if you have another questions or comments, certainly Christine will be available to answer any follow-up questions. Thanks again.

Operator

Ladies and gentlemen this concludes today's conference. Thank you for your participation. Have a wonderful day.

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