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Cooper Tire & Rubber Co. (NYSE:CTB)

Q2 2011 Earnings Call

August 4, 2011 11:00 am ET

Executives

Curtis W. Schneekloth – Director, Investor Relations

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

Bradley E. Hughes – Vice President and Chief Financial Officer

Analysts

Patrick Nolan – Deutsche Bank Securities

Ravi Shanker – Morgan Stanley

Vivek Alok – JPMorgan

Brett Hoselton – KeyBanc Capital Markets

Saul Ludwig – KeyBanc Capital Markets

Operator

Good morning. My name is Lacy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cooper Tire Second Quarter 2011 Results Conference 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. Mr. Curtis Schneekloth, you begin your conference.

Curtis W. Schneekloth

Good morning everyone and thank you for joining our call today. My name is Curtis Schneekloth, and I serve as the company’s Director of Investor Relations. To begin with I would like to remind you that during our conversation today, you may hear forward-looking statements related to the financial results and business operations of Cooper Tire.

Actual results may differ materially from current management forecast and projections. Such difference 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 press release, and 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 our Chief Financial Officer. In association with the press release which was sent out earlier this morning, we will provide an overview of the company’s quarterly operations and results. Press release contains a link to a set of slides that are a summary of information, included in the press release and in 10-Q.

These slides are intended to help investors and analysts quickly obtain information and they are available like coopertire.com. They will not be used as a focus of today’s call. 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 the overview of our results. You will then turn it over Brad for discussion on some of the details by segment and comments on other matters. Roy will summarize and provide comments on our outlook afterwards.

Now let me turn the call over to Roy.

Roy V. Armes

Thanks Curtis and good morning. First of all I want to see upfront that this was not the result that we expected for the second quarter given the strength of the market during the first quarter. Industry demand drop more sharply and more quickly then any one anticipated, but having said this we’ve taken the appropriate actions in response to the change circumstances and in our view our underlying business fundamentals remain strong.

Barring any further significant softening to volumes or other unforeseen events such as spikes in raw materials cost et cetera. We expect our margins to improve in the second half of 2011 compared to the second quarter. Now what I'd like to do is to provide you with an overall summary of our business results.

Consolidated net sales were $922 million for the quarter an increase of 15% reflecting higher prices that offsetting 9% reduction in volumes. Demand for our products was strong in several areas including UHP or Ultra High Performance tires, light truck tires and commercial tires.

Year-to-date we are quadruple that industry growth in UHP tires and have grown commercial tire business by over 50% compare to 9% growth by RMA members. Unfortunately weakness in the broad line segment offset these positives. Unit volumes were down 8% for the North American segment and 9.7% for the international segment. In North America the segment performance for the first two months of the quarter was weaker than industry but rebounded to outperform the industry in June.

Within the International segment Asian volumes decreased while European volumes increased. Decreases in Asian volumes were the result of facing out less profitable bias products weakness in the domestic Chinese truck and bus tire market and our decision to prioritize profit over volume and certain export markets.

While volumes during the quarter were lower than expected, there were several positive developments. The negatives were really isolated to broadline tires in the US and the decrease is related to protecting our margins in the international business. We continue to be very optimistic regarding the medium and long-term prospects for the company as we benefit from the actions we have taken to strengthen the company, and there were several reasons for this optimism including the new products we have launched that are receiving very positive reviews, our continued attack on cost and the investments we have made to strengthen our manufacturing footprint.

Operating profit for the second quarter was $24 million compared with operating profit of $34 million for the same period last year. The North American segments operating profit was $4 million or 0.6% in net sales while the International segment operating profit was $23 million or 5.9% of net sales.

And compared to the prior year, lower volumes reduce to total company results by $14 million and products liability costs were $12 million higher. Higher raw material costs of $194 million were only partially offset as we were able to successfully recover a $184 million through improvements in price and mix.

Positive during the quarter included improved manufacturing efficiencies, which lowered cost $13 million and selling, general and administrative and other costs were lowered by $7 million at 5.3% of net sales.

Restructuring costs were $7 million lower and the net impact of these changes was to lower operating profit by $10 million for the quarter compared with the prior year.

During the second quarter, we had net income attributable to Cooper Tire & Rubber Company of $0.18 per share or $12 million and this compares with a prior year second quarter net income of $44 million or $0.70 per share, which included $25 million of income from discontinued operations.

Income from continuing operations was $14 million during the quarter down from $25 million in the prior years second quarter.

For the six months ended June 30th, 2011 we had record sales of $1.8 billion, which generated operating profit of $56 million or 3.1%, and this compares to net sales of $1.6 billion and operating profit of $67 million or 4.3% for the same period of 2010.

Now, Brad will provide you some details on the individual segments and other financial matters.

Bradley E. Hughes

Thank you, Roy. I will start with a detail on our North American Tire Operations. The segment sales were $667 million or 16% increase compared with the second quarter of 2010. The top line increase was driven by improved pricing and mix partially offset by decreased unit volumes.

In the Unites States replacement market, our unit shipments of total light vehicle tires decreased by 11.9% in the second quarter, compared with the same period of 2010. This was a larger decrease than the 6.8% reported for the total industry by the Rubber Manufacturers Association, or RMA, and also larger than the estimated 5.4% decrease in total light vehicle shipments for RMA members during the quarter. This decrease reflected primarily lower sales experience during April and May in broadline tires. We responded to the industry conditions and had better than market performance in June.

Reviewing the situation with broadline tires, we believe that the following occurred. First, during March and April dealers and wholesalers purchased in advance of price increases that were going to be implemented by multiple manufactures. Second, gas prices increased a level that effected consumer sentiment and demand for tires resulting and reduced purchases by consumers from the dealers.

The increased gas prices affected consumers who would typically purchase broadline or value tires more quickly and more significantly and other consumers. Wholesalers and dealers reduced purchases from tire manufactures to manage their inventories. Typically, circumstances such as I just described resulting postponed demand rather than a structural reduction to demand.

While we have been successfully gaining ground in premium, light truck, and commercial truck tires we still have a large exposure to the value and broadline segments of the market. We took a number of actions to address our performance in broadline tires and believe that we are back in position to perform at or better than industry for this segment. Our rebound in industry volumes will likely be linked to improvements in consumer sentiment.

Year-to-date Coopers light vehicle shipments are down 1.9% compared to a decrease of 0.8% for the industry.

Our business in the commercial truck tire where it continues to be a bright spot commercial truck tire shipments were up 58% and now accounts for around 3% of our North American unit shipments and about 6% of net sales for this segment there are also indication that there will be strong season for winter tires.

The segments operating profit was $4 million for the second quarter or 0.6% of net sales this is a decrease of $16 million compared with the same period in 2010.

Let me summarize the operating profit walk forward and key driver before providing more detail. $103 million from higher price in mix, a $11 million from lower manufacturing cost, $7 million unit lower restructuring cost, and $5 million in lower SG&A and other costs were offset by $119 million in higher raw material costs, $12 million in higher products liability costs, and a $11 million from lower volume. The favorable pricing and mix of a $103 million were more than offset by $119 million of higher raw material costs. The last price increase we implemented in the United States was in March for an average impact of 8% to 9%.

During the quarter we adjusted pricing for a limited number of tires to maintain a competitive position. This is not unusual.

The underlying raw material index of 267 was up approximately 35% on a year-over-year basis for the quarter. As a reference point, this is a 12% sequential increase from the first quarter. As a reminder, the last in first out or LIFO accounting method which we use for cost flow in the United States charges the most recent costs against sales impacting profits more quickly than under, other inventory accounting methods.

There have been significant increases in the cost of natural and synthetic rubber as the primary drivers of these increases. Our purchasing strategy at Cooper continues to place a priority in securing an adequate supply of raw materials followed closely by a need to purchase at prices close to or better than our competitors.

We now expect the third quarter raw material index will increase sequentially by less than 5% and based on current commodity prices, we expected that the fourth quarter will then be relatively flat.

Our manufacturing facilities are doing a good job of adjusting to changing conditions and we continue to find ways to reduce costs. These reductions lowered manufacturing costs by $11 million. We continue to push for cost reductions and quality improvements in all of our operations.

These efforts have been very successful and we believe will continue to contribute meaningfully to the incremental results over the next couple of years as we evolve and expand our approach. Our production volumes during the quarter were higher than the prior year period.

The segment’s selling, general and administrative cost were $5 million lower than the prior year. The improvement is primarily the result of reduced incentive based compensation and lower professional service expense. The $12 million increase in products liability cost was partially the result of insurance reimbursements that were collected in the second quarter of last year. This had a $6 million impact on the quarter.

You will recall that we informed you that we no longer have this type of insurance.

Lower volumes reduced operating profits by a $11 million.

Now turning to our international tire operations, the International segment had net sales of $396 million up 27% from the second quarter of 2010, this was driven by price and mixed improvements partially offset by lower volumes.

Decreased sales volumes of 8% for Asia included intercompany shipments that support both the European and North American operations. The primary drivers of the decrease were the continued exit from bias tires, weakness in the domestic Chinese truck and bus tire markets, and our decision to prioritize profit over volume in certain export markets.

The European volumes increased by 6% as supply became available to meet demand for our products in those markets.

Despite the drop in overall volumes for our Asian operations there were several underlying positive trends including growth in the premium products and brands that we are focused on for the future. We also believe that robust opportunities for growth continue for this segment.

The following were the underlying factors impacting operating profit for the international operations. This operating profit walk forward compares the last year’s second quarter to this quarter. These factors were very similar to those of the North American operations.

The net increase was $2 million. We have $81 million from improved price and mix and $3 million in lower manufacturing costs that were partially offset by $75 million from higher raw material cost, $4 million from lower volume and $3 million in higher other costs.

I’d now like to cover a few other items starting with income tax accounting. Income tax expense recorded in the second quarter from continuing operations was approximately $1.6 million and was computed using the applicable effective tax rate based upon forecasted multi-jurisdictional annual tax rates. This tax expense also included $1.2 million of discrete tax benefits during the quarter.

For more detail on our tax situation, you can refer to our Form 10-Q that will be filed with the SEC. Our taxes and related accounting continue to be effective by remaining tax holidays in certain jurisdictions that generally lower tax rates in non-US jurisdictions, the normal reversal of some deferred tax assets and a valuation allowance we carry primarily in the US against certain of these deferred tax assets.

As we continue to generate taxable income, we will benefit from allowable tax holidays and tax credits in addition to using other tax strategies to minimize taxes expensed and taxes payable as appropriate.

Excluding discrete items, the effective tax rate for the quarter was approximately 18%. At this time, we continue to believe that the company's full year effective tax rate will be in the 20% to 30% range for 2011. In conjunction with the company's ongoing review of the its actual results and anticipated future earnings, the company reassesses the possibility of releasing the valuation allowance currently in place onto its US deferred tax assets.

Based upon this assessment, the release of the large majority of the valuation allowance, is likely to occur during 2011. The required accounting for the release will involve significant tax amounts and it will impact earnings but not cashed in the quarter in which it is deemed appropriate to release the reserve.

At June 30, 2011, the US valuation allowance was approximately $170 million. We have $25 million of anticipated tax refund receivables recorded at June 30, 2011 a portion of these relate to the 10-year specified liability loss carry backs. We anticipate collecting or applying to taxes payable, approximately $11 million of these receivables during the balance of 2011. The collection of the remaining $14 million is expected to occur upon completion of the standard IRS audit currently in progress likely in 2012.

Turning to cash flows, cash and cash equivalents of $138 million at June 30, 2011 were $241 million lower than June 30, 2010. During the first quarter of 2011, the company invested $134 million to increase ownership levels and affiliated operations in China and Mexico to support future growth. Working capital increases during this period primarily reflected unit inventory levels, which increased 30% higher and higher costs of finished goods resulting from increases in raw material costs.

Cash and cash equivalents at December 31, 2010 were $413 million. Typically, inventory is built during the first half of the year for sale during the second half of the year. For the balance sheet, highlights include accounts receivable of $478 million, which is an increase from the December 31, 2010 balance of $441 million – I’m sorry $414 million, the increase is related primarily to the growth in net sales and increased selling prices.

Almost all of the current notes payable balance of $136 million relate to affiliated 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.

Liquidity a few words about our credit facilities, we have two primary parent company credit facilities to provide sources of liquidity, the first is a $200 million asset back revolving credit facility, which has been extended and now expires in July 2016. We also have an accounts receivable securitization program that we have extended to expire in June 2014.

This facility has been increased to a limit of $175 million. Both facilities were undrawn at June 30 with approximately $32 million of the lines used to back letters of credit. The amount that can be borrowed is subject to the availability of certain assets that can be pledged. These two credit facilities do not contain any significant financial covenants until availability is reduced to specified levels.

Additionally, we have unsecured annually renewable credit lines in Asia of which approximately $191 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. Capital spending, CapEx in the second quarter of 2011 was $47 million, we believe capital expenditures for 2011 will range from $140 million to $160 million, including investments in an ERP system. This is slightly higher than the previous years, and reflects both the investments in the ERP system and capacity expansions.

It is down slightly from recent guidance for this year as we have reacted to market conditions. Spending will be relatively close to depreciation levels. Before turning it back over to Roy, I would also like to provide a little information around what we expect to happen as the special US tariff expires on Chinese products in September 2012.

While we can't guarantee, it will be reduced. We do expect the tariff will be allowed to expire as originally designed. This means the tier up on tires imported from China will decrease from 29% to 4% at that time.

We are currently exporting between three million and four million light vehicle tires a year from China into the US. When the tariff drops, we will no longer have to pay the additional duty on those tires. The cost to produce and ship tires from China to the US has risen since the tariff was implemented due to changes in the exchange rate, labor inflation and other factors. We have made significant strides in our competitiveness over the last couple of years including in our US plans.

We have also increased capacity at the near source, low-cost Mexico facility. We are involved with an (Inaudible) of controlling positioning. With the tariff expiring, we will also have additional opportunity to ship tires from China to the US. On balance, we believe the work we have done has positioned us to successfully handle the changes coming with the expiration of the tariffs.

I'd now turn it back over to Roy.

Roy V. Armes

Yeah. Thanks, Brad. Before taking your questions, let me give you some other thoughts about the quarter and our outlook. The industry is currently being challenged by two forces, it's the drop in consumer demand and increased raw material costs. These challenges are not new to the tire industry and we have historically found ways to successfully address the issues they present and while these factors may continue to put pressure on the industry in the short-term, we are optimistic about our ability to successfully compete and we're confident the actions we put in place will have positive impacts that will translate into increased value for our shareholders.

We continue to position ourselves to take advantage of the opportunities to grow profitably including launching a record number of new products in 2011 and our Cooper Zeon RS3 UHP or ultra high-performance tire has recently been recognized by a prominent consumer testing organization as one of the best available on the market. This is confirmation of our ability to deliver outstanding technology while providing the great value consumers have come to expect from Cooper. As mentioned earlier, we have continued to grow in the areas of UHP, light truck and commercial tires and we're still targeting growth for our International segment, which we expect will eventually account for about 50% of our revenues. While we continue to shift our mix to more premium tires, we will continue to aggressively compete in the broad line area where we have traditionally delivered greater value and quality.

The progress we're making in some areas is camouflaged in part by tough industry conditions, particularly in the value segment of the market. Replacement tire demand has historically been resilient and these pull backs are temporary in nature. We can’t tell you when the demand will recover, but we can be confident that the continued focus we have on reducing cost while delivering excellent quality will place us in a great position to compete when it does return.

While we have added capacity with our current inventory levels and projected demand, it is likely we will reduce our previously planned production in the second half of 2011 reducing our prior goal of producing 10% more tires in 2011 versus 2010. Our first step would be to eliminate production driving premium cost. The actual levels of production will be depended going forward on the demand for our tires.

We do expect raw material cost to remain at elevated levels and to be sequentially higher by less than 5% during the third quarter from the second quarter of 2011 and we believe the raw material index will be flat during the fourth quarter.

We’ll also maintain our focused efforts to reduce costs while delivering high-quality and believe meaningful results will continue to be yielded over the next couple of years. And as I mentioned, borrowing any further significant softening to volumes or other unforeseen events, we believe the work that we’ve done will deliver better margins in the second half of 2011 as compared to the second quarter.

Now to summarize, we are facing challenges that continued to improve our underlying business operations and our focus is on efforts that will further improve shareholder returns and we remain optimistic about our opportunities to successfully implement tactics to profitably grow the top line and improve our global cost structure and improve our organizational capabilities.

So with that, I want to thank everyone for attending the conference call here. That concludes our remarks, and what we would like to do now is open it up for Q&A session.

Question-and-Answer Session

Operator

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

Patrick Nolan – Deutsche Bank Securities

Good morning, actually Pat Nolan for Rod.

Roy V. Armes

Hi Pat.

Patrick Nolan – Deutsche Bank Securities

Just a couple of questions. Maybe you can help us think about how we should think about how your volumes should track versus the industry in the back half. Do you lag the industry at least on the light vehicle side pretty significantly, I know, part of that is your sector mix, but I mean I think most industry forecast are for a flat slightly up industry in the back half in North America. I mean, how significantly do you think you’ll lag that in the back half?

Roy V. Armes

Well, first of all Pat, we are not expecting ourselves to underperform the market. I think the segment here; the broadline segment is one that really surprised all of us very honestly. When you look at high gas prices, you look at the miles driven being down and the ones that are in that that are purchasing in that segment have basically really retreated, and there is growing pent-up demand in that segment. I don’t think those customers have gone away. I just think they has they do not have the money to spend for those sag regardless of what the price of the tires really are.

So we think the pent-up demand is continuing to grow there more so may than in other segments or at a higher percentage in other segments, so it’s really going to be dependent upon when that recovers and it’s very difficult to predict at this point in time.

Bradley E. Hughes

Pat, I will also like to add some focus to the comments that were made during the prepared script about. We took action during April and May, or after April and May when we saw those results. And we saw some better performance in June. So we have already reacted to the situations we wouldn’t expect that would be off quite as much as we were in the second quarter.

Patrick Nolan – Deutsche Bank Securities

And maybe just a follow-up on the volume side. I know there has been some inventory destocking, has the sell-out on the broadline segment’s been materially worse than the other segments of the market or is it been more of an inventory destocking was more significant than the other segments?

Roy V. Armes

Well, I think it’s a combination of both, but actually talking with our customers, I think the consumer sell-out in that category is definitely down, and I think the belief is that consumers are trying to adjust to these higher gas prices. They’ve decided to wear those tires or use those tires a lot longer. You can see that the gas consumption is down, the miles driven is down, and I think it’s heating that segment a lot higher than in other categories.

Patrick Nolan – Deutsche Bank Securities

And just lastly on pricing. You guys, revenue per unit, a lot of your new product launches are more towards the higher end of the market, and I guess the mix of your overall sales is moving towards that as broadline is weaker. All else being equal, assuming you get no further price increases sequentially. Is your revenue per unit going to increase going forward just based on your product mix or should we be thinking about x-pricing is pretty steady?

Roy V. Armes

We’ve been very successful with the new products that we have launched and there has been a lot in that premium segment. So we would expect that our revenues per tire would go up as a result to that. Now, we are not vacating the broadline category because it is a good volume segment for us. But I think going forward with the products that we’re putting out there in the premium segment that we’re putting out there, you should expect revenues per tire to increase.

Bradley E. Hughes

Just a couple of other adds to that. One is the growth in the commercial tire segment that we’re experiencing and then the seasonally driven winter tire will also in the near-term effect that. So, overall, I think that that will continue to the higher prices per tire, higher revenue per tire.

Patrick Nolan – Deutsche Bank Securities

I’ll get back in the queue. Thank you.

Operator

Your next question comes from John Murphy.

Unidentified Analyst

By this is actually [Elizabeth Blaine] for John. You mentioned that UHP, light truck and commercials were highlights in the quarter, what percentages of sales is from these products and what’s the outlook for the segments in both North America and your international market?

Curtis W. Schneekloth

Elizabeth, it’s Curtis here. We don’t have not hysterically broken out what percentage of the mix those are, other than for commercial tire, we’ve been saying that they are roughly 3% of the volumes and 6% of the revenue (inaudible) in North American. Globally, they are much higher percentage of the overall portfolio as we have the strength and age. And specifically, Chinese market for TBR tires. Going forward, especially with the recognition we’ve received on our ultra high-performance tires UHP tires, we certainly expect growth in that area, but it is starting of from a small percentage of our portfolio.

The light rack is a larger percentage of our overall portfolio. We’ve historically done very well with that in the United States where the couple brand drives a really good recognition for the products we have out there. We continue to expect expansion in that line, primarily because we’ve been adding capacity over the last year to 18 months, and that line was capacity constraint for a while, there has been solid demand for it. So, while we don’t break it out by product for you, all three of those should be growing in the future.

Unidentified Analyst

Okay, great. And given that your last price increase was in March and many of your competitors have implemented more recent price increases. Does it seem likely that in the next quarter, we should have maybe even another small increase announced or it’s a demographic that you cater to pushing back on price increases more than that of your competitors?

Roy V. Armes

We were a little bit earlier out with that price increased in some of our competitors, and so that price increase that we had is generally consistent with the some of the price increases you saw from competition that came in later. We will continue as we always do to monitor the competitive environment and our profitability and determine when and if it’s appropriate to prices, we go forward.

Unidentified Analyst

Okay, thanks. And just one last quick one. You stated that it’s likely that you’ll reduce prior goal for production growth in 2011 versus 2010. At what point in the year do you think you will have a more concrete view of before you picture?

Bradley E. Hughes

I think probably, Elizabeth, in this third quarter depending on what happens in the market that’s the wildcard, because we have added capacity as we’ve said before and as a result of some of that added capacity we’re going to produce more product, but as I mentioned nobody anticipated this downturn so quickly in the market. So but I would say in the third quarter we should have a better feel for how the year is going to shape up in that case.

Unidentified Analyst

Okay, great. thanks very much.

Operator

Your next question comes from Ravi Shanker.

Ravi Shanker – Morgan Stanley

Good morning, thanks so much.

Roy V. Armes

Good morning Ravi.

Ravi Shanker – Morgan Stanley

Hey so you guys outperformed the industry in June. Can you talk about what do you saw in July I mean are you seeing any sign that the demand for the April and May are coming back.

Roy V. Armes

While we don’t talk about July specifically for Cooper on industry data is not released yet. And so we can’t comment on the industry as well.

Ravi Shanker – Morgan Stanley

Directionally even…

Roy V. Armes

Ravi when we have said and we pointed out in the call was the release of the pent up demand is likely to coincide with some kind of improvement in the overall economy and consumer sentiment and July that headlines were real positive to the consumers out there.

Ravi Shanker – Morgan Stanley

But you don’t think that the gas prices coming upward kind of give people the reason to replace those if they have to.

Roy V. Armes

I don’t think we are in any position right now to comment further on that Ravi.

Ravi Shanker – Morgan Stanley

Got it and did you – you said you made some competitive adjustments in 2Q I’m assuming that means prices cuts anyway you can mention it for us?

Roy V. Armes

Well, Ravi when price increases in March, we were trying with that price increase we were trying to anticipate where material cost were going at that times we built that into that price increase which was a little more aggressive and earlier than we would normally go out there.

But having said that we with the downturn in the broad line category we wanted to make sure that we were competitive in certain segments and we went back and looked at some of those and in some cases we did make some adjustments to get more competitive but we still have the biggest share of that price increase from March still in the market.

Ravi Shanker – Morgan Stanley

Okay and finally did you undertake any unusual cost savings actions in 2Q in response to the lower volumes that may come back in the back half?

Roy V. Armes

Ravi there was nothing that would have gone proud out on a walker I would call out going forward that was unusual in terms of that cost savings. It is part of our continued focus going forward, we continue to put resources on it and we continue to adapt the difference ways to look at funding cost savings. So going forward we have more out there that we believe we are going to be able to deliver to bottom line is going to take some time and effort to get it. But we are that’s part of our D&A at Cooper, we are going to continue to work on cost.

Bradley E. Hughes

And I think some of that was evident when you look that our manufacturing efficiencies in the second quarter as well. That’s part of the continuing effort that we have gone on.

Ravi Shanker – Morgan Stanley

Thank you.

Operator

Your next question comes from Himanshu Patel.

Vivek Alok – JPMorgan

Hi, this is Vivek Alok for Himanshu Patel this morning. I had a quick question on raw material index and your outlook on pricing for the raw material spread in the second half. I see the guidance is less than 5% increase in raw material index in third quarter. What are the key drivers I see this (inaudible) gone up when material prices have been down. Are there any other commodities that that led you to increase your raw material index guidance up for the third quarter and would be expand the price mix of the raw material spread to widen thoroughly in the second half?

Roy V. Armes

We won’t comment on the price mix to raw material spread in the second half of the year. The synthetic rubber was the biggest driver of the increase sequentially into the third quarter. We also included in our outlook that during the fourth quarter we thought it would be flat sequentially from the third quarter.

Vivek Alok – JPMorgan

Okay and secondly on SG&A, I saw that SG&A came down very significantly this quarter. How should we think about this number going forward is it because of the lower volume in this quarter or because of additional step that you took during the quarter?

Bradley E. Hughes

While the SG&A I think around 5.5% or so 5.3% which is a little bit below what we typically target 6 to 7% of net sales. I think we will still continue to look for that 6 to 7% of net sales quarter-to-quarter it could be below that.

Vivek Alok – JPMorgan

Okay thanks a lot.

Operator

Your next question comes from Brett Hoselton.

Brett Hoselton – KeyBanc Capital Markets

Good morning Roy, Brad and Curtis.

Bradley E. Hughes

Hey Brett how are you doing?

Brett Hoselton – KeyBanc Capital Markets

Doing all right. Let’s see North American volumes what do you think the primary driver was for the improvement from April and May to June?

Roy V. Armes

I think it was principally that we performed better in the broad line by segment and while continuing to have strong performance in the other categories that we’ve been performing well in April and May. So I mean in April and May it was broad line and that’s what we most of the rebound compared with that period going into June.

Brett Hoselton – KeyBanc Capital Markets

You think that was attributable primarily to some of pricing actions that you took or would be attribute it more to you know something on the lines of getting back into the ordering mode after our pre buy?

Roy V. Armes

I think there were a number of actions that we took on to address Cooper specific issues that helped and then there was a little bit of market reaction but I think it was largely in response to the actions that we took specifically.

Unidentified Company Representative

And remember Brett that our price increase was in March, so there would traditionally be a little bit of pull forward in, before that. So April would suffer from that March pull forward.

Brett Hoselton – KeyBanc Capital Markets

You know. That would make sense.

Bradley E. Hughes

As we look at Q2.

Brett Hoselton – KeyBanc Capital Markets

Yeah. Now as you look at China, is there any way that you could possibly, you’ve given three different reasons for the decline. Is there anyway that you could possibly kind of portion those out, I mean is the majority due to one factor or another factor or is it spread evenly across the three factors?

Roy V. Armes

The largest majority of it I would say, right now that I would point to is probably bias, but that’s not to say the others are factors in there. The bias tires are not of a, not very high margin typically, Brett. and so, as we move forward, we’re going to look to move into more premium mix over there and we’ll be exiting those over a period of time here. The other ones, we mentioned that there was some weakness in the domestic Chinese TBR demand, but that’s really relative weakness. So there is still strength there and opportunity to grow and we’re excited about those opportunities.

Brett Hoselton – KeyBanc Capital Markets

Can you maybe explain a little bit more about your decision in terms of the export profitability that factor?

Bradley E. Hughes

Well, we’re always looking at whether or not that we want to grow profitably. and so we continually monitor where we’re at from a profitability position, as we looked at some of the export business in order to compete, it was not making sense for us, and so we chose to reduce the volumes that we were sending into those specific export markets. particularly as we look forward and anticipate that as the demand rebounds in the domestic market, we’ve got an opportunity to improve overall the mix of the business that we’re selling over there.

Brett Hoselton – KeyBanc Capital Markets

Okay. And then as we look at your North American margins, obviously fairly weaker in the second quarter, or very weak in the second quarter, a little bit weaker in the first quarter than in prior quarters. as you look out over the next few quarters or even in the 2012, typically you guys have been kind of mid, maybe even nearing high single-digit margins in North America, now you’re 0.6% in 2000 or second quarter. What are your thoughts Roy, as you kind of look out over the next say year, I mean is this a business that can rebound backup into that 5% range or do we think it’s potentially permanently imperative and going to be in the single digits.

Roy V. Armes

Brett, I feel confident that it is one that can rebound here. I think we’re, if you look at our pricing and our LIFO methodology is not always in sync. so it’s hit us pretty hard particularly in the second quarter here, but I don’t have any other belief that things going forward as soon as economy turns around and the industry begins to pick back up why we shouldn’t be able to recover from where our historical levels have been

Brett Hoselton – KeyBanc Capital Markets

Thank you very much gentlemen.

Roy V. Armes

Thanks, Brett.

Operator

Your next question comes from Saul Ludwig.

Saul Ludwig – KeyBanc Capital Markets

Hey, good morning guys.

Roy V. Armes

Hey, Saul.

Saul Ludwig – KeyBanc Capital Markets

You know, you had this gigantic surge in inventories here in the second quarter and you’ve talked about lowering your production rates in the second half of the year to bring those inventories more into balance. You did have $11 million of favorable operational cost efficiencies in the second quarter. What's likely to happen in the back end of the year, as you may not be covering all of the fixed cost in production? Does this present an issue where manufacturing costs might go a negative year-to-year in the back half of the year, because of lower production and working off inventories?

Roy V. Armes

Well, I think Saul, I mean, if we could predict what the industry and the demand is going to be, obviously we could give you a little better answer on that. But as it stands right now, it's very unpredictable.

One of the things that we are going to do from lessons learned in the past is, try to maintain our inventory level at above where we are right now, and any kind of increase beyond that we are going to adjust production to be able to manage that.

And let me tell you the rationale behind that. If you go back to 2006 and 2007 where we come out of 2006, and we had a demand-supply curve that was way out of balance. I mean, the demand was much higher than the supply.

We get into 2008 the latter part of 2008 second half or second quarter through the rest of 2008 and even into the first part of 2009, we were finding ourselves cutting inventories significantly because the demand had dropped off.

And in the middle of 2009, things picked up to a point where all of a sudden we’re out of capacity again, and we don't have the inventory to address the market. And then we were straining through 2009 and 2010 right into the first quarter this year, and then all of a sudden the demand drops off significantly and we’re sitting here with building this inventory, which we had planned on doing.

So as a result of some of that, we were going to maintain a inventory level that when this industry bounces back, we think we’re going to be in a pretty good position to be able to respond better than what we had before. So, we're going to maintain a certain level there, and if demand or volume stay off in the industry our inventories start to increase, we’ll have to adjust our manufacturing on that. But it's just very difficult to predict right now.

Saul Ludwig – KeyBanc Capital Markets

You think you'll still have manufacturing efficiencies then year-over-year in the third and fourth quarters?

Curtis W. Schneekloth

Saul, its, Curtis here. I think it's entirely possible. We’re still seeing improvements. One big difference from what you're comparing to is we used to have four plants, we now have three. So that is a different set up that we’ve had in the past.

Saul Ludwig – KeyBanc Capital Markets

And Roy or Brad, could you comment on the product liability? $6 million or the $12 million increase could be explained by the insurance recovery that you had last year, but even then a $6 million increase year-over-year is a pretty large number compared to historical patterns.

Is there some product issue here that's causing product liability expenses to be much higher? And how should we think about the year-over-year product liability expenses going forward from this point?

Bradley E. Hughes

Well, I reinforced the guidance that we provided coming out of last year, which is that I would encourage you to look at this more on an annual basis rather than quarter-to-quarter, because there can be variations in terms of what's going to happen in the individual quarter, and the full year will be more representative.

And what we told you at the end of last year is, take out the one unique case we have last year, assume that you're not going to have any insurance for coverage this year, and then we’ll get the normal trend if that we have with regard to product liability costs over time.

And if you factor that into what you're looking at for this full year, that will still give you a pretty reasonable representation of where we think we're going to come out.

Saul Ludwig – KeyBanc Capital Markets

Help me with those numbers, because I don't have them right off the top of my head. What should we look for year-over-year product liability?

Bradley E. Hughes

We haven't provided a specific number. The two adjustments that you would need to make are to back the one case that we had in the second quarter of 2010 out of last year, which was for about $22 million and then to not assume that we'll have any insurance recoveries this year, which is on an annual basis and for the quarter, $6 million.

So make those adjustments and then look at the historical trends that you've seen in the cost progressions and you'll come up pretty close.

Saul Ludwig – KeyBanc Capital Markets

Okay. And then I don't know whether this answers your capital allocation question, but here is the stock down almost 30% today, down 50% since the beginning of the year. Does the stock buyback ever enter the equation in terms of using some of your cash?

Bradley E. Hughes

Saul, as we've explained in the past, it's always on the list of alternatives that we're looking at. We've then focused on growing the company and looking for ways to expand our capacity and as you know, we've made investments in China and Mexico to secure the sourcing to help support that growth.

We continue to look at other opportunities to grow the business as well. But currently we will continue to look at on other ways to return money to shareholders. When we’re making decisions about how we're going to spend our cash.

Saul Ludwig – KeyBanc Capital Markets

I was just wondering as you look at that is there certainly the stock price where it happens to be at any point in time, is in the hopper of alternatives. It's now such a time where that seems to ratchet up higher on the priority question?

Curtis W. Schneekloth

It will continue to be a consideration, and we're going to wait that of with the other investments in use of our cash at this point. And that's the best that we can tell you at this stage.

Saul Ludwig – KeyBanc Capital Markets

Okay, and then just my final question. Looking at the international side of the equation, where you made about $23 million, where do you think the second half the pattern should look like there, should be maintain roughly there is level of earnings or should they tend to get much better?

Bradley E. Hughes

We can’t provide specific guidance, we have historically not provided specific guidance on where profitability is going to be, but if demand holds up, we don't see any reason why we can’t continue to perform well in the international segment and we do believe that as the markets either remain strong as they are in Europe for our products and return a little bit of strength that we’d seen previously in China on the commercial truck side. Previously there is real opportunity for growth there both on the revenue and the profit side.

Saul Ludwig – KeyBanc Capital Markets

Great, thank you very much guys.

Curtis W. Schneekloth

Thanks Saul.

Roy V. Armes

We'll take one more caller. Operator?

Operator

Your final question comes from (inaudible).

Unidentified Analyst

Good morning gentlemen.

Roy V. Armes

Hi, Alan.

Unidentified Analyst

I just want to start off one of the questions to follow up on the inventory side of things. And when you look at the level of inventory and I understand the rationale is not just sort of repeat what happened when you sort to have a shortage of inventory and demand spike. But when you talk about the mix and obviously going into 3Q, 4Q there is a much higher demand for winter tires. Is the mix of inventory from a finished good standpoint today appropriate for that? Are you going to have to them build inventory to meet the demand at the end of the year and have to work down some of the inventory you have now possibly at lower prices?

Roy V. Armes

We’ve been preparing as we always do seasonally to be ready for the winter tire season. And so that's already built into our production plans and our planning levels for inventory. As we look at the levels right now one of the things that we do look at is trying to make sure that we are at the appropriate level of inventory to maintain, what we believe at the right levels of fill rate for our customers. We do have some ranges around that that we will make sure that we will make sure that we stay within.

At this point we don't see any reason to make significant changes to the way that we're going to run our inventory as we progress into the second half of this year and into the first part of next year.

Curtis W. Schneekloth

Alan, it’s Curtis here. The comments around inventory really need to be taken into contact to the seasonality of the business that we typically have. So you typically will still see us build inventory up through that first half of the year and release it through the second half of the year. I think Roy was more speaking to the overall ranges within that pattern.

Unidentified Analyst

Hey guys, its Tony. I just wanted to also follow up, when you think about the brand and you talked about some initiatives to sort of better position the HP, UHP categories for even the small, what steps can you take from what is relatively small mix of your business to really grow, I mean you’ve been associated with your distribution and your dealer networks for a very long period of time as the sort of go to broadline entry point brand and there’s been periods of time where when you move away from that or sort of refocus it has a ripple effect in your dealer networks. So can you may be give a bit more color of what should you do on an environment where your main categories under pressure, but yet you want to still grow the other one?

Curtis W. Schneekloth

Yeah. I think Tony the big difference here now is that we would – we've spent last few years and even continue to do that today with our broadline category beefing that up with new product introduction. So we did what we had plan to on strategy, because that’s still a core part of our business and it's going to stay a core of our business. At the same time we recognized that we’ve got the technology and innovation that we could lever to get to some of these other premium products to help balance on our portfolio. So I wouldn't say that that’s our absolute focus, I think what's happened here is, we haven't done anything to that UHP product, before when we get into trouble to your point as we spent everything and all of our time on higher end premium mix product and we just totally ignored the broadline category. That's not been the case here.

And UHP, we have done anything for five or six years and when we refresh our product line, we went the broadline first and then we start moving through that whole portfolio. And as a result of that we've been able to put out some very good products there. Now, what we are also doing at the same time is to back up our advertising and promotion and commercials and those type of things to really support that brand going forward.

Clearly we've got to have a good mix between our premium brands and our broadline category, but we're not – we don't think we've lost focus on the broadline category. And I would argue that we’ve just about traded out that whole line up with refresh products between the Cooper brand and Mastercarft brand over the last few years.

Unidentified Analyst

Okay, that’s helpful. Maybe if one last follow up, If you or Curtis mentioned that the PBR segment in China and it was sort of relative weakness. I’m just trying to understand sort of on a relative basis to what and is there some underlying issue there from a macro standpoint that we maybe it’s starting to surface that, it’s stages albeit it’s something we should think about down the road?

Bradley E. Hughes

Well, I think it's relative to the high rates of growth that we've experienced in the past in China, and there is a macro environment on issue there that you’re probably well aware of where the Chinese government has taken a number of actions to try and slow the economy. And some of those have affected the commercial truck business or segments within that. And it is starting to affect the number of tires that we've been selling.

Having said that, we continue to see relatively strong demand and we had times have been capacity challenged there especially as we are moving out of bias and into radial and as we get more capacity coming online we’ll be growing there. The market is there.

Curtis W. Schneekloth

Yeah, which Tony, is we announced that capacity increase sometime ago, but we have been constraint there. We should have that finish by the end of the year and going into the first quarter, we got more flexibility with upside volume.

Unidentified Analyst

Thanks, guys. I appreciate it.

Curtis W. Schneekloth

Alright, thanks.

Roy V. Armes

Operator that will be the end of our call today.

Operator

Okay. Do you have any [further] remarks?

Roy V. Armes

No.

Operator

Thank you for participating in today's conference call. You may now disconnect.

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