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Cooper Tire & Rubber Company (NYSE:CTB)

Q3 2011 Earnings Conference Call

October 31, 2011 11:00 AM ET

Executives

Curtis Schneekloth – Director, IR

Roy Armes – Chairman, President and CEO

Bradley Hughes – VP and CFO

Analysts

Rod Lache – Deutsche Bank Securities

Elizabeth Lane – Bank of America/Merrill Lynch

Hamanshu Patel – JP Morgan

Ravi Shanker – Morgan Stanley

Brett Hoselton – KeyBanc Capital Markets

Saul Ludwig – NorthCoast Research

Operator

Good morning. My name is Patrick, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cooper Tire Third Quarter 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)

I would now like to turn the call over Curtis Schneekloth to begin the conference sir.

Curtis Schneekloth

Thank you Patrick. Good morning everyone and thanks for joining the call today. My name is Curtis Schneekloth, and I serve as the company’s Director of Investor Relations. To start with I would like to remind you that during the 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 forecasts 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. The press release contains a link to a set of slides that are a summary of information, included in the press release and 10-Q.

These slides available on coopertire.com 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 comments, we’ll open the call to participants for a question-and-answer session.

The call begins with Roy providing an overview of our results. He will then turn it over Brad for a discussion on some of the details by segment and comments on other matters. Roy will then summarize and provide comments on our outlook and open it up for questions and answers.

Now let me turn the call over to Roy.

Roy Armes

Thanks Curtis and good morning to everyone. We successfully navigated a challenging environment during the quarter, and improved our results from the second quarter. While we are happy that we are able to move forward in most parts of our business, we continue to believe that there are still opportunities for meaningful improvements. Of course a rebound in the economy could help, but we are optimistic about our ability to continue with our momentum.

And before I provide an overview of the results for the quarter, I want to make a comment regarding our contract with our employees at our (inaudible) location, who are represented by local 207L of the United Steelworkers. The contract is due to expire tonight, however, negotiations with the Union is continuing, and our objectives include reaching a fair and competitive agreement with our employees, ensuring both the short and long-term availability of great products for our customers and protecting the long-term interests of our business. There is always uncertainty around such negotiations with a variety of different possible outcomes, but as a result we don’t plan to publicly comment on the content or the status of the negotiations, but when there is something more to report, we plan to communicate appropriately.

Now consolidated sales were up 19% from the third quarter of 2010, reflecting higher prices and increased volumes. Net sales were a record for any quarter, and were over $1 billion for the first time. Overall our volume growth in the United States was higher than the industry in the third quarter, and demand for our products was particularly strong in the Ultra High Performance, light truck and commercial tire product lines. We performed generally in line with the industry for the broad line and value tires, but these product lines were weakest for the industry.

We believe that pent up demand exists for broad line and value tires, and we can benefit when this one is released. It is just extremely difficult however to predict when and how this demand will manifest. Unit volumes were up 1.3% for the North American segment, and 2.3% for the international segment. Within the international segment, both Asian and European volumes increased.

Operating profit for the third quarter was $47 million compared with $67 million for the same period last year, and the North American segment’s operating profit was $17 million or 2.3% of net sales, while the international segment operating profit was $30 million or 7.2% of net sales.

We have commented during the second quarter conference call that we believe margins would improve in the second half of the year compared with the second quarter, and we were able to achieve that improvement in the third quarter. Of course we believe we still have opportunities to improve beyond this level.

Higher sales volume improved profits by $5 million compared with the same period of the year ago, and also improving profit were $12 million of lower selling, general and administrative costs reflecting primarily incentive costs and $5 million of lower restructuring costs. Improved price and mix of $158 million during the quarter was more than offset by $194 million of higher raw material costs. Higher manufacturing costs decreased results by $6 million as we produced a more premium mix of tiers and curtailed production to balance inventory levels and demand.

During the third quarter we had net income attributable to Cooper Tire & Rubber Company of $0.27 per share of $17 million. This compares with the prior year third-quarter net income of $45 million or $0.71 per share. Due to the fact that the Company has a valuation allowance against the U.S. deferred tax assets, the tax provision for the quarter was impacted by $8.9 million of additional expense because of the timing of credits and deductions. These items are expected to be largely offset with the anticipated fourth quarter release of the majority of the U.S. valuation allowance.

And for the nine months ended January 30, 2011, the company reported net sales of $2.9 million, an increase of $440 million, or 18% from the same period of 2010. The Company reported net income of $0.71 per share from continuing operations on a diluted basis for the nine months ended September 30, 2011, compared with $1.21 for the same period of 2010.

Now I would like to ask Brad to go ahead and provide details on the individual segments and some other financial matters. Brad.

Bradley Hughes

Thanks Roy. And just for clarification, Roy was just covering the results for the nine months ended September 30, 2011. I will start with some details on North American tire operations. The segment’s sales were $765 million, an 18% increase compared with the third quarter of 2010. the top line increase was driven by stronger pricing and mix and higher unit volumes. Unit sales for the North American segment increased 1.3% compared with the prior year third quarter. Cooper's total light vehicle shipments in the United States increased by 1.1%, compared with total industry shipment increases of 0.2% as reported by the Rubber Manufacturers Association or RMA, and also better than the estimated 2.1% decrease in total light vehicle shipments for RMA members during the quarter.

Year-to-date, Cooper’s light vehicle shipments are down 0.9%, compared to a decrease of 0.5% for our industry. Our commercial truck tire business continues to be a bright spot. Commercial tire shipments of the Roadmaster brand were up 52% and now account for about 3% of our North American unit shipments and 6% of net sales. Our UHP product line sales during the quarter were up more than 27% from the prior year.

The segment's operating profit was $17 million for the third quarter, or 2.3% of net sales. This is a decrease of $38 million compared with the same period in 2010. Let me summarize the operating profit walk forward and key drivers before providing more detail. Operating profit in the quarter benefited from $75 million of higher price and mix, $6 million in lower SG&A costs, including incentive compensation cost, $4 million in lower restructuring costs, $3 million lower other costs, and $1 million from improved volumes.

These positives were offset by $123 million in higher raw material costs, and $4 million in higher manufacturing costs. Favorable pricing and mix of $75 million were more than offset by $123 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%, after which we made a few selective price adjustments in certain lines during June to ensure that we were competitive.

We have announced another price increase effective December 1 for up to 5%. The underlying raw material index of 276, was up approximately 38% on a year-over-year basis for the quarter. this is a 3% sequential increase from the second quarter. As a reminder, the last in first out or LIFO accounting method, which we use in the United states charges the most recent costs against sales impacting profits more quickly than other inventory accounting methods.

Significant increases in the cost of synthetic and natural rubber during the year are the primary drivers of these increases. Our purchasing strategy at Cooper continues to place a priority on securing an adequate supply of raw materials, followed closely by purchasing at close to or better than our competitors. We now expect raw material cost to remain at elevated levels, but to be lower sequentially by an amount less than 5% during the fourth quarter compared with the third quarter of 2011.

Raw materials have shown signs of stabilization but these costs remain inherently volatile. Our manufacturing facilities are doing a good job of adjusted to changing conditions, and we continue to find ways to improve our underlying costs. During the quarter, higher manufacturing costs decreased results by $4 million as the operations produced a more premium mix of products and balanced production with inventory levels and demand requiring production curtailments.

This demand for premium product mix inflated our operating cost as we currently manufacture those products at higher cost facilities. We continue to push for cost reductions and quality improvement in all of our operations. These efforts have been very successful over the last few years, and we believe will contribute meaningful incremental results over the next couple of years.

This segment’s selling, general and administrative costs were $6 million lower than the prior year. the improvement was driven by reduced incentive-based compensation. Products liability costs were flat with the same period of 2010.

Now turning to our international tire operations, the International segment had net sales of $422 million, up 30% from the third quarter of 2010. this was driven by price and mix improvements and a 2.3% increase in shipment volumes for this segment. Increased sales volumes of 2.2% for Asia, included intercompany shipments that support both the European and North American operations. Increases were strong for both domestic and intercompany light vehicle volumes, and for export sales of commercial truck tires.

The ongoing impact of exiting bias tires was not significant during the quarter. European volumes increased by 12% as supply became available to meet demand for our products in those markets. The following were underlying factors impacting operating profit for the international operations. This operating profit walk forward compares last year’s third quarter to this year’s. the net increase was $9 million.

Profits benefited from $81 million of improved price and mix and $4 million of higher volume. These improvements were partially offset by $71 million from higher material costs, $2 million in higher manufacturing costs and $3 million in higher other costs including currency effects. Unallocated corporate charges were $1 million during the third quarter, down from $7 million in the same quarter of 2010. this reduction was primarily the result of lower incentive related costs.

I would now like to cover a few other items starting with income tax accounting. Income tax expense recorded in the third quarter from continuing operations was approximately $17 million, and was computed using the applicable effective tax rate determined using forecasted multi-jurisdictional annual effective tax rates. This tax expense included $8.1 million of discrete tax expense items during the quarter including the US 2010 provision to return adjustments, and the UK rate change impact on deferred tax assets. More detail on our taxes is available on our Form 10-Q that will be filed with the SEC.

Our taxes and related accounting continued to be affected by remaining tax holidays in certain non-US jurisdictions, with generally lower tax rates in non-US jurisdictions, the normal changes in some deferred tax assets, and the valuation allowance, which 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 credits and other tax strategies to minimize tax expense, and taxes payable as appropriate.

Excluding discrete items, the effective tax rate for the quarter was 23%. At this time, we believe that the company's full year effective tax rate on a normalized basis will be in the low end of the 20% to 30% range we have been communicating for 2011. In conjunction with the company's ongoing review of its actual results and anticipated future earnings, the company reassesses the possibility of releasing all or a portion of the valuation allowance currently in place on its US deferred tax assets.

Based upon this assessment, the anticipated release of the majority of the valuation allowance should occur in the fourth quarter of 2011. The required accounting for the release will involve significant tax amounts and impact earnings but not cash.

At September 30, 2011, the US valuation allowance was approximately $171 million. As Roy mentioned earlier, as the company has a valuation allowance against its US deferred tax assets that tax provision for the quarter was impacted by $8.9 million additional expense because of the timing of credits and deductions. this amount is inclusive of a portion of the $8.1 million in discrete items I mentioned for the third quarter. These items are expected to be largely offset with the anticipated fourth-quarter release of the majority of the US valuation allowance.

We have $16 million of anticipated tax refund receivables recorded at September 30, 2011 a portion of these relate to the US 10-year specified liability loss carry backs. We

collected $3 million of these receivables in October. The collection of the remaining $13 million is expected to occur upon completion of the IRS audit currently in progress.

Now turning to cash flows, cash and cash equivalents of $91 million at September 30, 2011 were $256 million lower at September 30, 2010. During the first quarter of 2011, the company invested $134 million to increase ownership levels and support future growth at affiliated operations in China and Mexico. Working capital increases during the first nine months of 2011 reflected both higher finished goods, unit inventory levels, which increased 28% from December 31, 2010, and the higher costs of raw materials.

Typically inventory is built during the first half of the year for sale during the second half of the year. the company feels the overall inventory levels are within an acceptable range based on current demand trends. Inventory levels are expected to reduce during the fourth quarter consistent with historical seasonal trends. Going forward production can be adjusted as necessary to maintain an appropriate availability of tires.

Balance sheet highlights include accounts receivable of $555 million, increased from December 31, 2010 balances of $414 million. The increase is related primarily to the growth in net sales and increased selling prices. With the peak sales season occurring during the third quarter, it is normal to have receivables that are generated for collection after the quarter end.

Almost all of the current notes payable balance of $139 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 longer-term instruments.

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 backed revolving credit facility, which expires in July 2016. We also have an accounts receivable securitization program that expires in June 2014.

This facility has been increased to a limit of $175 million. Both facilities were undrawn at September 30 with approximately $67 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 $231 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 third quarter of 2011 was $38 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 recent years, and reflects both the investments in the ERP system and capacity expansions.

Spending will be relatively close to depreciation levels of approximately $130 million. 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 light vehicle tires in September 2012.

We believe it is likely the tariff will be allowed to expire as originally designed. At expiration the tariff on tires imported from China will decrease from 29% to 4%. We are currently exporting between 3 million and 4 million light vehicle tires a year from China into the US on which we are paying these additional charges. On balance, we believe we are well positioned to handle the changes. The cost advantage of tires produced in China has narrowed as both a result of US manufacturing becoming more efficient and Chinese production costs rising. The costs include labor inflation, exchange-rate changes, ocean freight costs and other factors.

Cooper has specifically added to our low-cost manufacturing in Mexico and improved our US plant efficiencies and we now have a more competitive and flexible manufacturing footprint. While we expect there to be some form of pricing pressure, we believe we are well positioned to adapt to the situation.

I will now turn it back over to Roy.

Roy Armes

Yes, thanks Brad. Now before taking your questions, let me give you some other thoughts about the quarter and our outlook. We were pleased to show signs of improvement in the third quarter, and this includes better than industry volume performance in the US, solid growth out of our international operations, and margins that while still lower than we want but are improved from the second quarter.

The industry is still facing two significant headwinds, dampened consumer demand and high raw material costs. But we are optimistic about our ability to successfully compete. They have been receiving great feedback on many of our recently launched products and believe that this is confirmation of the technology and value we bring to the customer. The continued strengthening of our product portfolio will help balance our exposure to the broad line tire category, and we continue to believe that pent-up demand for broad line tires exist, but it is difficult to predict when exactly that demand will manifest itself.

We expect raw material costs to remain at elevated levels and to be marginally lower sequentially by less than 5% during the fourth quarter from the third quarter 2011. We are seeing signs of stabilization in raw material – on raw material costs, but this area remains inherently volatile. Our manufacturing costs were higher during the quarter compared with the same period a year ago, primarily as a result of manufacturing at below optimal levels for cost absorption as we adjusted production downward to maintain appropriate inventory levels while producing a more premium product mix.

This demand for premium product mix inflated our operating cost as we currently manufacture those products at higher cost facilities. While we are never pleased with an increase in manufacturing costs we have demonstrated in recent years an ability to achieve competitive costs while delivering high quality products. We continue to believe meaningful results will be yielded from our focus in this important area over the next couple of years.

And we continue to see progress and positive signs in many parts of our business. These include the excellent reaction to our products around the globe and the continued development of our manufacturing footprint. We will also continue to search for additional sources of capacity that fit with our long-term strategic direction and make sense within the current economic environment. The success of our efforts to strengthen the business has positioned us to benefit in the future and improve shareholder returns.

I want to thank everybody for attending the conference call here. That concludes our prepared remarks. Now we would like to open it up for a Q&A session.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Rod Lache.

Rod Lache - Deutsche Bank Securities

Good morning everybody. can you hear me?

Roy Armes

Yes.

Bradley Hughes

Hi Rod.

Rod Lache - Deutsche Bank Securities

I guess first question is just there was that price increase in March, there is another one in December, and you did comment on some really strong performance in kind of the high year end ultra high-performance and commercial truck tires in the quarter, but we did notice that just doing the divisions, it looks like your average transaction prices declined sequentially from Q2 to Q3, could you just talk a little bit about what happened there, how much of this just in the quarter was just kind of temporary pricing adjustment sort of corresponding with what the market is and just give us a sense of how we should be thinking about sequential average transaction price improvement as you go from Q3 to Q4, presumably some of those are eliminated when you are implementing the December 1 price increase?

Roy Armes

Yes, I think that is a fair observation Rod, particularly sequentially. But if you look at it, the third quarter is typically where we do some of our promotions. Take the money and ride has been out there for the last few years, but if you look at the year-over-year third quarter our revenue per tire is up 17% year-over-year and that is a more comparative base. But we have run some promotions here in the third quarter that has helped our volume and I think that has an impact on it.

Rod Lache - Deutsche Bank Securities

Can you help us to mention what that might be just to help us calibrate you know the kind of the sequential walk from Q3 to Q4 if those promotions aren’t continuing?

Curtis Schneekloth

Rod, it is Curtis here. and it is going to be a mix of whether those promotions continue or not. You are right in bringing up that there was a price increase back in March of an average impact of 8% to 9% within May and June just at a few selective lines for pricing the mix. So we were competitive in those lines.

And then we have got a price increase going in of up to 5% in the US December 1. So we have done all that. We have also had to run some programs as we do traditionally during the third quarter. Roy had mentioned take the money and ride. There were some other ones that we started in the third quarter mix, and into the fourth quarter a little bit. At this point in time, I don’t think we are in a place where we want to necessarily quantify on a per tire basis, because we don’t quantify things on a per tire basis, but how much of that will continue into the fourth quarter, but it won’t be all of it.

Rod Lache - Deutsche Bank Securities

Okay. so presumably the price benefit maybe greater than just the benefit of that December 1 price increase I assume. Can you talk a little bit about also the sequential benefit from China from the tariff reduction on September 26, is that something that we can quantify just on a sequential basis, and then lastly your net debt right now it was less than half a churn on your last 12 months EBITDA, and obviously volume is not at such a strong level. Could you just talk about your priorities for cash moving forward?

Bradley Hughes

Hi Rod, it is Brad. In order the question on the benefit from the tariff, we will benefit on the tires that we will be bringing into the market during the fourth quarter. During the fourth quarter there will be less tires that we are importing on a seasonal basis than in the prior nine months on average over the first three quarters. But that will still be tires coming in and that will begin to pick back up in the first half of next year compared with the fourth quarter and although those tires will benefit from the reduction in tariff that occurred in September.

Regarding cash, we are expecting as we move into the fourth quarter that we will see our traditional seasonal working capital changes, which include further reduction in inventory, and the liquidation of accounts receivable that we will see some positive cash generation during the fourth quarter.

Rod Lache - Deutsche Bank Securities

Right, good. Could you talk about what your priorities would be for use of cash going forward?

Bradley Hughes

Yes, we continue to look at the same priorities. As you know we have been investing in our business, in our ability to grow the business particularly in markets overseas, and we will continue to monitor those types of opportunities along with other actions including investing in the business here, looking at opportunities that are more directly affecting the shareholder, but as we talked about in the past our priority right now is how we can invest on growing the business.

Rod Lache - Deutsche Bank Securities

But at this point you are not looking to invest all that much more than depreciation, is that right?

Bradley Hughes

That is correct. I mean as we look at the balance of this year and even looking forward to next year the guidance we have given is $140 million to $160 million this year. I think next year we probably would be looking at what something more in line with what our original guidance was 2011, $150 million to $170.

Roy Armes

And then, and Rod, this is Roy that will also include the investment we are making at ERP, which is still an incremental piece right now to the overall business, incremental investment piece.

Bradley Hughes

Now, if there were any unique transactions that came along that would obviously be incremental to what that base investment plan, but we don’t have anything at this time that we are announcing. But to the extent that there were an opportunity out there that could possibly be over and above our base plan. And then just to quantify, the benefit that we see from the tariffs is about $1 million to $2 million for the quarter.

Rod Lache - Deutsche Bank Securities

Okay. All right. Thank you.

Operator

Your next question comes from John Murphy.

Elizabeth Lane - Bank of America/Merrill Lynch

Good morning. This is Elizabeth Lane on for John. Just wanted to ask a quick question on the international tire business because it looks like shipments in Europe were very strong, and I know that Goodyear mentioned on Friday that they had higher winter tire sales in the quarter in Europe. Is that what really drove the performance for Cooper as well, or are there other products that were particularly strong there?

Curtis Schneekloth

Liz, it is Curtis here, and winter tires were definitely strong. There was a little earlier season for winter tire orders this year from which it benefited. But that wasn’t the only product that we were strong in. There are several product lines that we had good sales and good volume. I think most people are trying to get to whether we would see a fall off in that volume in the fourth quarter after such a strong third quarter, and I love to see how the winter tire season plays out, but our strength was not just in winter tires in Europe.

Elizabeth Lane - Bank of America/Merrill Lynch

Okay, that was exactly what I was trying to get to on 4Q. and just one quick one on SG&A, as production increases, would you expect to see some variable costs creeping back in or most of those cuts pretty much staying in place in the near term?

Roy Armes

I think that where you see us traveling right now is relatively indicative of where we’re going to be. The only caveat I would put on that with SG&A is with regard to some of the incentive–based compensation reductions that we saw in the third quarter, those are done, and now into the base end, and we wouldn’t expect those to come back. But we wouldn’t expect those to decrease further as we go forward.

Elizabeth Lane - Bank of America/Merrill Lynch

Okay, great. Thanks very much.

Operator

Your next question comes from Hamanshu Patel.

Hamanshu Patel - JP Morgan

Hi, good morning guys.

Roy Armes

Hi Hamanshu.

Hamanshu Patel - JP Morgan

You know, just because we don’t have all the details on the sub segments, can you just directionally help us with just how bad is the broad line segment doing right now at an industry level. I think you mentioned UHP was up 27%, your commercial volumes were up I think 50% some, when you think of kind of the low end of the market can you just put some ranges around sort of how much down was it in the third quarter, and then associated with that if you would adjust for seasonality, does it feel like the low end has stabilized sequentially?

Curtis Schneekloth

Hamanshu it is Curtis here, and the broad line segment was down roughly 9% on a year-over-year basis for the quarter. And we were pretty close to that performance. I would say we would classify industry volume as stabilizing, which is really good after the second quarter. so that is where we are right now in terms of the industry. We have seen strength in the UHP tires and the SUV tires, and even the light truck tires for Cooper at least. So that is where we are at with it right now.

Hamanshu Patel - JP Morgan

Curtis, would you guys say the broad line has also stabilized?

Curtis Schneekloth

I would say it is stabilized relative to where it was in the second quarter. It is still unfortunately the weakest tire segment in the industry right now.

Hamanshu Patel - JP Morgan

Okay, back at I guess at a investor day I think in April of ’09 and there was some discussion at that point about the kind of fully landed cost advantage of a Chinese made tire exported into the US versus a US manufactured tire. I forgot where those numbers were, I think it was somewhere around $10 per tire or so. Can you just update us on sort of what your estimate of that cost advantage is today? I presume it is compressed because of labor inflation in China and transportation cost and all these things, I’m wondering if you could just give us a sense on where that cost advantage is now because it seems like that is perhaps the bigger kind of risk of sort of the pricing deterioration that may or may not happen post tariff expiration?

Bradley Hughes

Yes, it is probably better not to think of it in dollar terms given how much raw materials and some of the other costs have moved from that time frame. But on a percentage basis, it has declined and is probably more in the range of 10% to maybe 15% for a landed tire from China right now moving towards 10%.

Roy Armes

Hamanshu, I think in fact when you would have first referenced that it would have been closer to that 15% to 20% range. Now it is in that 10% to 15% range as Brad had mentioned, and if you are making the right decisions about how you are sourcing and how you are shipping, you can make up for a lot of that 10% in how you do it.

Hamanshu Patel - JP Morgan

So, it is 10% to 15% moving to 10%, and that is fully landed inclusive of transportation cost and everything.

Roy Armes

Yes, but exclusive of the special tariff.

Hamanshu Patel - JP Morgan

Correct. Okay, and then lastly I am wondering if you guys could comment a little bit on just the kind of outlook on two areas, how do you see manufacturing costs progress into the fourth quarter, is that a headwind do you think still in Q4, and then lastly you obviously did some production cuts in the third quarter, what is the state of inventories right now in your view?

Roy Armes

First of all Hamanshu on the manufacturing cost, we were impacted by a couple of things, the more premium product that we were building one, and secondly just the curtailments trying to adjust our inventories. We don’t see that as being significantly worse in the fourth quarter than the third quarter for sure, which as we think our inventories are better in line.

I think the caveat there Hamanshu is really around where the demand goes in, and right now we are not expecting some huge decreases in demand. But it is still weak from a consumer standpoint. So we’re not expecting our manufacturing cost to be worse in the fourth quarter, our inventories are in line with where we expect them to be. We will continue to reduce them throughout the fourth quarter.

Hamanshu Patel - JP Morgan

Okay. But it sounds like from your perspective, there is still some risk of incremental production cuts in Q4 should the demand picture soften up a little bit from here?

Bradley Hughes

Yes, I think that is a good assumption. That is what we are watching very closely. I think the good thing is we have got some pretty good flexibility in our manufacturing to be able to move up-and-down with where the demand is or where we wanted to manage our inventories. One of the things we are trying to avoid is getting such a low inventory like we did in 2008 and 2009. we missed some of the upside demand, pent-up demand that was out there. So I think we have got a pretty good balance right now. We’re going to continue to maintain that through the fourth quarter.

Hamanshu Patel - JP Morgan

Okay, great. Thanks guys.

Operator

Your next question comes from Ravi Shanker.

Ravi Shanker – Morgan Stanley

Thanks. Good morning.

Roy Armes

Good morning.

Ravi Shanker – Morgan Stanley

A couple of questions, Roy just comment on the overall pricing environment in the industry. I know you guys and some of the others have a price increase coming up in 4Q, but it seems to be smaller than what the whole industry did in the first half of the year, so is that just a function of where raw materials are and or is more reflective of maybe consumers pushing back a little bit on price increases. And the other question is Brad, or Curtis, if you can just give us some color on product liability in 4Q, what that looks like?

Roy Armes

Yes, Ravi, on the pricing side, I think we still see some pretty good discipline in pricing within the industry and with the customer base. Are they pushing back, yes, I mean that is always something that we have to deal with, it ultimately gets back to how the consumer is going to see this, and can they afford to purchase the product at the prices at the prices that we have out there.

I think what you see in this third-quarter like we mentioned before, there are certain promotions that are going on like ourselves, which has been historic. I would say historic certainly for the last two or three years, where we had a special on the take the money and ride, which is a rebate program. You will see those type of things out there, but barring that from our viewpoint the pricing has been pretty consistently disciplined from our viewpoint. And you want to talk about the…

Bradley Hughes

And then regarding, this is Brad, Ravi, regarding products liability for the fourth quarter, again we encourage people to look at that on a full year basis, and so I’m assuming that you are doing that. for the fourth quarter, obviously any particular case might move in a direction during the fourth quarter, up or down. we are not expecting anything particularly unique in the fourth quarter, and so I think that we will continue on the trend that we have seen for this year, which if you look at you just need to make sure that when you are comparing this year to last year, you adjust for the one significant case we had a year ago, being the tow [ph] case, and also excluding the savings that we had on some of our legal fees, because we don’t have insurance in place for that any longer. So, I think steady as it goes is what the message should be for the fourth quarter.

Ravi Shanker – Morgan Stanley

Thank you.

Roy Armes

Thank you.

Operator

Your next question comes from Brett Hoselton.

Brett Hoselton – KeyBanc Capital Markets

Hi good morning Roy, Brad and Curtis.

Roy Armes

Hi Brett, how are you doing?

Brett Hoselton – KeyBanc Capital Markets

Brad I was hoping you will talk about tax rate into 2012, after the reversal do you still anticipate 20% to 30% tax range, do you think it moves up a little bit, what are your thoughts there?

Bradley Hughes

I think for the balance of this year 23% is what the effective tax rate was for the third quarter, excluding some of the discrete items. Again for this year at the lower end of that range, I think that we'll probably start the year at 20% to 30% as a range for next year. At this point I would think that it might be towards the upper end of that range given our outlook at this point in time. But we'll have a better feel for that once we get through with the valuation release, and have a better outlook on next year.

Brett Hoselton – KeyBanc Capital Markets

And then Roy, how do you think about inventory levels is, what measure do you use, is it an either a specific dollar amount, inventory turns, how do you look out at it and is there a range that you try to stay within?

Roy Armes

Yes Brett, what we do, I'm going to talk right now. We've got the several metrics of measuring our inventory, but the one that I was referring to earlier was really around the volume of inventory, the unit volume we have in inventory because we're also trying to match that with having the fill rates that our customers are expecting.

And that's why we didn't have a very good balance of that in 2008 and 2009, and we come back and we're looking at that now, because we got a different business model that we had in 2008. And I think we're now able to manage that little closer to get the kind of fill rates that our customers are expecting. So that's kind of how we're looking at it. And we range that so if we go above that, we adjust our production, if we go below it, we adjust the production to manufacture more and it – we have a lot more flexibility to adjust to the demand today than what we did a few years ago.

Brett Hoselton – KeyBanc Capital Markets

Thank you very much gentlemen.

Roy Armes

Okay. Thanks Brett.

Operator

(Operator instructions) Your next question comes from Saul Ludwig.

Saul Ludwig - Northcoast Research

Good morning guys.

Roy Armes

Hi Saul.

Saul Ludwig - Northcoast Research

Roy, you mentioned that you are making your broad line tires in your lowest cost plants and you are making your high-end tires at your high cost plants. Does that – that doesn’t sound right is there anything that could be done to change that?

Roy Armes

Saul, it doesn't sound right, because that wasn't what we said. What we're doing here is we're balancing our whole manufacturing footprint and we have families of products that we're building in different parts of the world to try to match the demand and match the competitiveness that we really need in whatever product category.

So, we actually are structured internally to manage the sourcing appropriately and make the right kind of tradeoffs depending on – and that’s really what we've tried to do the last several years with our manufacturing footprint to build in that flexibility.

Saul Ludwig - Northcoast Research

Okay. Now a broader question, you know, your goal has been to get to a 6% to 8% margin, what do you think are the critical things that has to happen to bring that about. I am not saying when are you going to get there or to predict that but from your own thinking what has to change from where we are today to where they have to be to achieve those margin targets?

Roy Armes

Well, I think Saul to start off with, I think our first priority in going back a few years ago when we put our strategy together was to get the right kind of footprint, manufacturing footprint a competitive and sustainable manufacturing footprint that would help us continue to improve, and we have been continually improving in efficiencies and productivity and cost inside our operations.

That’s the first thing, I think the second thing has a lot to do with the products that we’re taking into market, which are much more the premium upscale and a good example is the A/T3 that just got some top rating in some of the customer magazines. You got the A/T3, and you got the UHP which is also a good premium tire for us, and you can see the kind of performance that we're having there. So, that’s got to be part of our mix as well. So, I think, when you start looking at those two things particularly I think it's an important part of how we continue to grow our margins. We have confidence with and we’ve been able to show that now both on improving our cost structure and improving our manufacturing operations and delivering very good products to market, our customers are very satisfied with. And I think those are two big ones, there are other things, but those are the two big ones.

Saul Ludwig - Northcoast Research

And then finally just a question for Brad, two parts question. One, at CKT where you had a certain tax holidays because all of those tires were exported, but after I think it is April next year, you can now sell those tires in China if you like, does your tax situation at CKT change with the changing of the requirements as to where you shift the tires? And then the second question which is not exactly related to that, how many dollars did you spend this year in tariff payments and were those tariff payments offset with price or were you in a negative price versus tariff situation?

Bradley Hughes

On the first part of the question Saul, you're right beginning on about the little before the middle of next year we are able to start selling tires from the CKT facility into the domestic market. The lower tax rate that we've had in place there does also roll off and we begin to pay a normalized tax rate for the China market out of that facility next year.

On the second question, well I can't speak to the total amount of tariff that we pay because we don't talk about the number of tires specifically that we're bringing in from a particular facility. We clearly have been paying those tariffs and will benefit from not only the reduction that occurred recently but the further reduction all the way down to 4% that we're anticipating in September of 2012.

The way that we've managed that from a business perspective I think as we've discussed with all of you before is that we priced across the portfolio so that in aggregate we've reached the right business equation for the tires we're selling, and the tires we're producing, including the incremental costs that are coming through the tariffs. That doesn't mean that we've achieved the pricing to cover that on an individual tire-by-tire basis.

Saul Ludwig - Northcoast Research

But in the aggregate it sounds like you think you've covered the tariff, and then when the tariffs go away next September and they go to zero or go to 4% there I assume would be some modest price givebacks to those people that are buying your Chinese tires. They know that you're not paying the tariff. So would you just expect to maintain the same relationship that you currently have this year or do you think you can pick up a little bit?

Roy Armes

Well, as we mentioned earlier, we are expecting some pricing pressure that will be associated with the tariff going away, and we're going to have to monitor how much we can maintain with regard to the pricing that's not only for those tariffs, but the pricing that's occurred along with the substantial movements in raw materials over the last two years. So, there's been a lot of movement and one thing we know we'll do is benefit from the reduction in the tariff and we'll have to monitor what happens on the pricing side.

Curtis Schneekloth

Saul, it is Curtis here. I want to make one comment around a misperception that may exist out there around the way we price on the tires that are coming in from China. Some people expect that we set a separate price because the tires are coming from China and that's not the case. We price our tires on a portfolio regardless of where it's…

Roy Armes

Based on the competitive…

Curtis Schneekloth

Based on the competitive landscape out there. So, those people are not incurring an additional tariff in and of themselves on those tires.

Saul Ludwig - Northcoast Research

And finally, Brad, you mentioned about the tax rate in China going to normal rate. Does CKT now after April or so, does it quantify as if the Chinese operating company and whether you export the tires or sell them in China? Is that irrelevant that your tax rate in China then moves to a normal rate and what is that normal rate in China?

Bradley Hughes

It does move and it moves to about 25%.

Saul Ludwig - Northcoast Research

Great. Thank you.

Roy Armes

Go ahead. We have time for one more question operator.

Operator

Sure. Our last question comes from Brett Hoselton.

Brett Hoselton – KeyBanc Capital Markets

Hi, good morning.

Roy Armes

Hi Brett.

Brett Hoselton – KeyBanc Capital Markets

Is there a material difference between the relationships, the 10% to 15% that you are talking about between Chinese import tires versus here? Is there a material difference between the landed cost of your Mexican manufactured tires versus your US manufactured tires and what might that differential be?

Roy Armes

Well, I think when we, before Brett, when we were talking about the landed cost from China, there was a reference I think to the US manufacturing but, really we’re leveraging our Mexico operation to help with offsetting some of that differential as well. And we feel going forward that that’s going to be a strong part of our business and our US manufacturing base has gotten a lot more competitive, so all of this has helped squeeze that curve of landed cost.

Curtis Schneekloth

Brett it is Curtis here, you may recall that our long-term strategy is to develop near-source high quality, low cost operations for each region. So when we speak about that, we’re talking about Mexico as a lower cost to help support the US operation. We’re talking about China for China and for Europe, you'd be looking for something in maybe another part of Europe, but it doesn’t always mean that you're going to be sourcing tires for the US from China.

Brett Hoselton – KeyBanc Capital Markets

And as a result of change in the tariff, do you anticipate any material shifts in where you are shipping tires to, in other words do you see increasing capacity here in North America and decreasing exports from China to the US, or something along those lines?

Roy Armes

I think Brett, we can – I think it's safe to assume that we're going to continue to look at where is the best place to manufacture for the different markets, and we could expand to Mexico, we have expanded even in our US operations. We've invested there. If you recall, when we shutdown Albany, we were able to expand in those operations.

So, having said that, we've got a group here as I mentioned earlier that's constantly looking at this to make sure that we're satisfying each one of the markets and that we're producing in the right location.

Brett Hoselton – KeyBanc Capital Markets

Thank you very much gentlemen.

Roy Armes

You know, I just like to make some closing comments here. We feel very good about our quarter. It's consistent with what we said in the second quarter and what we said we were going to deliver. We feel very good about our manufacturing footprint and how that flexibility is turning out, and we've been putting that together for the last few years. Our new products have certainly been successful.

We've been investing in growth, and we got a strong balance sheet. I think when you add all of these up, we're very optimistic about our ability to continue the momentum that we have going here. I think there are some things that we watch and the risks that are out there, particularly as it relates to raw material cost, consumer demand, just the overall economy and things that are going on there that we can't control so much of. But overall we feel very good about the direction and the strategy that we’ve put in place. So, with that, we thank you again for all your attention and your interest in Cooper Tire.

Operator

And this concludes today's conference call. You may disconnect at this time. Thank you.

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