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Cooper Tire & Rubber Company (NYSE:CTB)

Q1 2008 Earnings Call

May 7, 2008 11:00 am ET

Executives

Curtis Schneekloth - Director of Investor Relations

Roy V. Armes - Chairman, Chief Exec. Officer and Pres

Philip G. Weaver - Chief Financial Officer and VP

Analysts

Rod Lache - Deutsche Bank

[Chester Lye]

Himanshu Patel - JP Morgan

Derrick Winger

Saul Ludwig - KeyBanc Capital Markets

Kurt Lutz

[Johnson Bimeds]

Operator

Welcome everyone to the first quarter 2008 results conference call. (Operator Instructions) I would now like to turn the call over to Curtis Schneekloth, director of Investor Relations.

Curtis Schneekloth

To begin with I would like to remind you that during our conversation today you may hear forward-looking statements related to future financial results, and business operations for Cooper Tire and Rubber Company. Actual results may differ materially from current management forecasts and projections as a result of factors in which the company has 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 and Chief Executive Officer, and Phil Weaver, Chairman and Chief Financial Officer. In association with the press release, which was sent out earlier this morning, we’ll provide an overview of the company’s first quarter operations and results. Following our prepared comments, we’ll open the call to participants for a question and answer session. Today’s call will begin with Roy providing an overview of our first quarter results, who will then turn it over to Phil 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. Now let me introduce you to Roy Armes, Chairman and Chief Executive Officer and President.

Roy V. Armes

Cooper earned $0.03 per share during the first quarter while facing some the most challenging economic conditions in quite some time. These challenges adversely affected our bottom line and offset some of the good improvements we’ve made in our operations. Our earnings per share for continuing operations were $0.02 per share during the quarter, and before we get started I want to make it clear that we’re not satisfied with the earnings of the first quarter and are acting aggressively to address the situation, and the economic conditions in North American certainly had a major impact on our results.

But we’re continuing to make improvements on our operations that we talked about in the past. These efforts seize all volume increases, very good order patterns, specific profitable product lines, success in implementing price increases. I think all of these provide support for our belief that results will be appreciably more favorable as the economy improves. With that said, let me present an overview of the operations.

One a consolidated basis, sales for the first quarter increased slightly over the prior year first quarter and reached the new first quarter record of $679 million. This increase was driven by the significant increase in the international segment and pricing in North America. Operating profit for the first quarter was $9.6 million compared to $29 million for the same period last year. This is a decrease in operating profit margin as a percent of net sales from 4.4% last year to 1.4% this year.

The North American segment placed higher raw material cost, weakened industry demand, and higher product liability costs. They were able to partially off-set these with improved price and mix, as well as the plant operations improving sequentially from the fourth quarter. The international segment continued to grow and deliver solid margins in the face of the increasing raw material costs and the tougher market in Europe. And for the first quarter, net income decreased by $19 million to $2 million or $0.03 per share on a fully diluted basis. Net cash used in operations was $48 million for the first quarter, and a significant portion of this use related to rebuilding the inventory levels to meet seasonal demand. Now Phil is going to provide you with more detailed individual segments in financial matters.

Philip G. Weaver

First the North American tire operation. The North American operation sales were $498 million. This was a decrease of 3.4% compared to the first quarter of 2007. The decrease was driven by lower unit volumes and partially off-set by improved pricing in May. Operating profit in our North American tire operations was $8.1 million in the quarter or 1.6% of net sales. This compares to an operating profit of $26.8 million or 5.2% in the first quarter of 2007. In the first quarter of 2008, our total light vehicle tire shipments in the U.S. were down from the prior year. The decreases occurred across all product segments, with the largest being in the area of broadline and light trucks.

You may recall that the first quarter of 2007 we had benefited from the strike of the competitor. The decreases in unit volumes were partially due to the execution of strategic decisions by the company to eliminate an associate brand and exit unprofitable lines in the house and private brand lines of our business. These decisions were made so that we could attack complexity in our own operations and decrease our exposure to unprofitable business. The majority of this decrease volume occurred in March.

Overall tire industry shipment in North America decreased during the first quarter by about 4.4%. This followed a decrease in miles driven first noted during the last quarter of 2007 that has carried through at least to February of 2008. It appears that consumers have delayed the purchase of tires, and they paid higher gas prices in a concern for the slowing economy. We believe there is some pent-up demand out there, but I cannot accurately predict when this demand will resurface.

Price and product mix succeeded the increased cost of raw materials during the quarter, as compared to last year by about $7 million. We’ve not yet recaptured all of the raw material increases that have occurred over the past few years. During the quarter, raw materials cost continued at high levels and appear to be going higher. These increases occurred in natural rubber, oil based products, and steel. Declining downward impact and other factors have driven record high raw material prices specifically in natural rubber and oil derived materials, and that coupled with the use of last in first out cost flow assumptions for our inventory accounting in North American has contributed to decreased earnings.

The LIFO accounting method resulted in the most recent cost being charged against sales and is impacted by purchases late in the quarter. During this first quarter the LIFO reserve increased by $9 million but the corresponding charge to operation, and these cost moderate the North American operations will experience lower charges to cost of goods sold than would be reported under the first-in first-out accounting method. We think this is significant.

We implemented a price increase in North America in February 2008, intended to mitigate these and other cost increases. Importantly we’ve also just announced another price increase effective July 1st for up to 8% in North America. Mix has continued to improve also. The mix improvement relates to both product and customers, specifically our Cooper brand continues to improve versus the industry.

Sales of the Cooper CS4 premium touring tire, which we introduced in 2007, has continued to be strong and has had a positive impact. We recently launched a new premium sport truck tire in North America, the Cooper Zion XSTA, to take advantage of the SUV and cross-over vehicle tire demand. This new line has also been very well received by our customers. We’re also launching the Cooper Discover CST, a premium SUV tire that will be an excellent addition to our product portfolio.

North America operations were faced with increasing challenges during the first quarter which affected the unit volume and sold and in turn affected our bottom line. At the same time, many of the initiatives that we’ve started are beginning to show results. We’re taking appropriate actions to deal with the economic situation in North America. This includes a review of spending, refocusing on projects that have the fastest payback, and we’re actively looking at new profitable businesses that we can grow. As we do this, we remain committed to our strategic direction and the goals that we had established previously. Plant operations showed sequential improvement from the fourth quarter of 2007 to the first quarter. Since this is a result of changes in the production environment that we’ve been successfully implementing and which are starting to bloom and benefit, we can see this improvement in many of the metrics that we monitor internally.

Some of the initiatives that are starting to deliver payback are in the area of sixth segment, lean and automation projects. We’ll continue to focus resources on these types of projects and expect that they will continue to deliver excellent payback. Product liability costs during the quarter were higher by $14 million compared to the first quarter of 2007. This results primarily from increased charges to resisting reserves. We do not expect increases of this magnitude to occur repeatedly in the future.

Now turning to our international tire operations. In this segment sales increased $232 million, up 27% over last year, last year’s first quarter. This was a record in the result of increase volumes and price in Asia, as well as improved pricing in Europe. Sales in Europe were up 45% for the quarter, driven by a 40% increase in unit sales. Europe experienced a decrease in unit sales as they continue to focus on profitable business and margin improvement, rather than volume growth. Operating profit in the international segment improves to $6.9 million, up from $6.1 million. This is an improvement of 13% over the same quarter last year. We continue to successfully ramp up our Cooper and Kenda joint venture in China. We will continue to increase our production levels at that facility which will help to support North American sales.

In 2008, we expect to receive approximately 2.5 million tires from the CKT facility. During the first quarter, we received about 410,000 tires from this operation. Cooper [Chin-Chan] continues to successfully expand operations while implementing project that will improve operational recessions. We also are working the strength in the presence of the [Chin-Chan] brand in both truck and bus radial, and passenger tires while improving mix. These efforts will play important parts in Cooper’s future and CKT is successfully executing a plan designed to improve margins.

Let me express these changes in the form of the operating profit walk-forward, starting with North America. Now this compares the first quarter of 2008 with the first quarter of 2007. The total decrease in North America was $19 million. They key drivers were $34 million improvement in price and mix, offset by $12 million due to lower volumes, finding $4 million in higher raw material costs and $14 million in higher product liability costs then the first quarter of last year. In total the increases of these changes led to a decrease from 5.2% operating profit margin last year to 1.6% margin in 2008 for our North American segment.

International operations improved their operating profit to $6.9 million. Key factors leading to this were about $4 million from increased volume, $9 million in improved price in net offset by $10 million in higher raw material costs and about $5 million in higher selling, general and administrative expenses as we expand our Asian operations and increase brand awareness. The drivers of most of these changes were discussed earlier in the call, but I’ll point out that start up costs in the first quarter in CKT were approximately $3 million.

Let me now discuss a few other items, starting with income tax accounts. The reported income tax expense using an aggregate world-wide forecast an annual effective rate of 32.4%. Last year our forecasted effective rate in the first quarter exclusive to discrete items was 28.8%. The change in tax rate relates primarily to the mix of earnings by jurisdiction. Flux in change in evaluations allowance due to an increase in the per tax assets. The total income tax expense reported the first quarter for continuing operations included tax expense relating to discrete items of 469,000, primarily related to the [inaudible] dividend.

Concerning cash flows, net cash issues by continuing operations was $48 million in the first quarter. This compares to net cash provided by operations of $60 million in the first quarter of ’07. The changing cash flow is driven primarily by the company intentional building of inventory to meet seasonal demands. Optimizing inventory levels allows the company to operate more efficiently and to continue with its tradition of providing customers industry leading order fill rate. A few balance sheet highlights, current assets include $107 million investment in the Korean based Kumo tire company. We exercised our put option on this investment late in the first quarter, and under terms of the agreement expect to be paid during the second quarter. During the first quarter the company was able to repurchase about 14 million of the 7 ¾% unsecured senior notes due in December 2009. These repurchases were part of the $200 million debt repurchase authorized by the board in August 2007. In total the company has authority remaining to repurchase another $105 million of debt. The board of directors also authorized share repurchases of up to $100 million.

During the first quarter, we repurchased about 803,000 shares at a cost of $14 million. In total we’ve now repurchased around 6% of the company during the last six months. This leaves about $40 million in authorization remaining for share repurchasing.

Another important point is our liquidity. In total cash and cash equivalents in short term investments for $315 million at the end of March, this is down from $396 million at the end of March a year ago, and the largest use of this cash relates to the seasonal inventory build that occurred during the quarter. By the way, the Kumo investment that I mentioned earlier is not included in this $315 million. Total gross debt to capitalization was 43% in March ’08, compared to 50% at the end of March ’07. A few words about our credit facilities, we have two primary credit facilities that are potential sources for liquidity. The first is the $200 million asset factory involving credit facility which expires in November 2012, it is used to support letters of credit and may be used for short-term borrowing when the need arises. We also have an accounts receivable securitization program for up to an additional $125 million that expires in 2010. Both facilities are undrawn, and a small portion of these lines are used to back letters of credit as I mentioned, and our new credit facilities are not currently subject to any covenants.

As a reference point, the next scheduled debt maturity for long-term debt of our parent is $97 million, due in December of 2009. We believe we have adequate sources of liquidity available to continue to operate and grow our business. With the existing cash and credit facilities, improved cash generation in the expected proceeds from [inaudible] Kumo investment, our liquidity levels are strong. Pension funding, our typical contributions to U.S. pension plans exceed the minimum risk of requirement in order to take advantage of tax benefits and maintain prudent funding levels. Of course, we reported those levels at the end of the year. Under our normal funding policy, contributions to domestic and foreign plans in 2008 would be in the range of $30 million to $35 million. We don’t see that being materially different than in the past.

CapEx in the first quarter in 2008 was $32 million. We estimate that capital expenditures in 2008 will be in the range of $190 million to $200 million. This is a bit below the previous estimate we provided as we take a more conservative and cautious approach to the use of the capital, while the economic outlook in North America has remained uncertain. Capital expenditures at Cooper Chin-Chan and the Kenda joint venture are funded from three sources; cash from operations, increased debt within those entities, and contributions from the owners. This has an impact on the amount of funding the Cooper is required to provide as we do not solely own these operations, but they are consolidated into our accounts. Capital infusions from our partners during the quarter were $4 million. We have earnings net of taxes for discontinued operations of 344,000 during the quarter related to activity for Cooper standard automotive in Holland. I’d now like to turn it back over to Roy Armes.

Roy V. Armes

Before taking your questions, let me give you some thoughts about 2008 as we see them. We continue to face headwinds in two specific areas. It’s rising in raw material costs and soft demand in the North American replacement market. But we believe that we can successfully manage through these issues. Our confidence is based on our strong balance sheet, excellent levels on liquidity, and most importantly a focus on executing on improvements in our operations. This is consistent with our strategies and we’ve not wavered in our concentration to improve, while dealing with these issues. We believe the investments we’re making will drive Cooper to be a stronger, more competitive company in the future, and our employees are more focused than ever and are committed to the strategic direction and goals that we’ve set. And as we proceed, we constantly monitor the factors that will impact us and will take action necessary to protect our business.

The execution of our plan calls for multiple steps rather than just one large step and I think we’re fortunate to be in a position of flexibility with the deployment of our capital should economic circumstance require additional adjustments. Our international segment is delivering a strong performance, both in Asia and in Europe. Asia has grown rapidly in scope and will become a greater share of our sales as we move forward. North America continues to improve operations as we implement six sigma lean in automation projects. The progress that these initiatives have made will be important building block for the future.

Even though we will be facing strong challenges for the remainder of 2008, we still believe we can exit the year with the $70 million of cost savings that we had promised. This would leave us with a run-rate of $170 million in total on what were known as the “sunrise project”. While we’ve got confidence that we can execute on everything within our control, we still need to be mindful that some of the benefits may be offset by industry performance and other economic factors. For 2008 we expect industry volumes in North America to be flat compared to 2007, China’s likely to continue strong growth in replacement tires while Europe is holding steady. Raw materials continue to surge in price during the first quarter of 2008 and we see that continuing into the near future, and it might be reasonable to expect that raw material price increase as year-over-year might be in the range of 10% to 16% and considering this increase, just like to remind everybody that we use a first-out cash flow methodology.

During the quarter, I continued to communicate with all stakeholders of Cooper, I’ve visited clients, customers, Europe, Asia, and held investor conference in New York, and in that conference we laid out our strategic direction and we still feel very committed to delivering the goals we communicated as part of that vision. And it’s even more important now to be able to continue to diversify our business portfolio globally, to provide more consistent results. And although the first quarter has been tougher than what we envision, and while there are headwinds in the second quarter, we’re making good progress towards our goals.

We have a defined plan of action that we’re executing against as the environment changes, we’ll adapt it but in the end the goal remains the same. So let me close my remarks by saying that we’re still positive about the future success for our company, even within this difficult environment the people at Cooper remain excited, energized and optimistic about the opportunities that we have before us and the initiatives that we put in place. No one at Cooper was satisfied with the first quarter results, and we’re working to deliver continuous improvement throughout the rest of 2008. So thanks for attending our conference. That concludes our prepared comments, so now we’d like to do is open it up for our Q&A session.

Question-and-Answer Session

Operator

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

Rod Lache - Deutsche Bank

Can you just talk a little bit about what you expect for your volumes for this year? Obviously, it looks like underperform deals we’re all market by quite a bit. Maybe 8 points or so, and how do you manage 2 million units of additional imports from China when demand is down here?

Roy V. Armes

Probably the first part of this on the volume. We recognize that we are down significantly in the first quarter, some of that, Rod, was due to some of the changes that we made in our business model overall that’s impacted the first quarter. Going forward, we don’t expect it will continue that kind of loss volume.

Now it’s still speculation on how the industry is going to perform for the rest of the year, but in the end we’re expecting to pick some of that volume back up as we go about through the year. Particularly with the new products that we’re introducing and some other things that we’re doing to try to compensate for some of that loss in the first quarter. Your second question is about the 2 million units. We’re staying with our plan, we got flexibility, for example to take a Saturday out of our Texarkana, some overtime that we’re working some of our operations other operations to be able to support our business and we think the overall balance, particularly, on in the second half should be sufficient to be able to deliver our volumes.

Rod Lache - Deutsche Bank

Local to voluntary volume decline that you experienced in the quarter?

Roy V. Armes

The voluntary?

Rod Lache - Deutsche Bank

You were down maybe 12% or so in volume in the quarter. What will you do with some of it that you guys said you did sort of strategically?

Roy V. Armes

I think that’s about 4% to 4.5 % instead of the total.

Rod Lache - Deutsche Bank

And can you talk a little bit about the cost savings in this lock, this European bridge that you provided North American and International. There was no mention of that $70 million. What’s happening now? What are you achieving, and how will that ramp up over the course of this year?

Roy V. Armes

I think it will be, because of the nature of these projects as they are implemented, there will be higher amounts later in the year, that’s just the way these are. We were a little bit behind in the first quarter primarily some of that being volume related, but we still think we will exit 2008 with that total in place of $170 million. This stems back to the measure that we started in 2006.

Philip G. Weaver

Rod, I would also like to remind you that, that our operating profit and loss you don’t see a separate line for those cost saving initiatives that fall into all the other lines.

Rod Lache - Deutsche Bank

But you’re thinking that the costs were roughly neutral, cost rupture was roughly neutral on the quarter. Gets better going forward.

Roy V. Armes

You talking year-over-year?

Rod Lache - Deutsche Bank

Yes

Roy V. Armes

Year-over-year there were slightly less favorable than last year.

Rod Lache - Deutsche Bank

Okay, and lastly this liability cost is a big number. Could you just address that? What’s going on with that number and the only part of it that is going to be a kind of non-recurring. What are the underlying trends that are driving that?

Roy V. Armes

Yes I don’t know that there are trends per se, but as we improve for both actual claims and try to provide some estimate on expected claims in the future, for time to time we take a look at those reserves. As said, what’s going on in on, in individual cases? The majority of this increase, which I may have to remind you is off of the first quarter of last year we were at the lowest level of any level of last year. So the change looks more remarkable than if you look at kind of as a trend line. On the other side, most of the change here was driven by three or four cases where we believe our reserves should have been increased. So while this can happen from time to time, we don’t see it happening repeatedly, and wouldn’t expect quarter by quarter to be at these levels. On the other side, cases could develop which could drive any particular quarter up.

Operator

Your next question is from [Chester Lye].

[Chester Lye]

Can you share with us what free cash flow was for the quarter? Also could you quantify the impact of forging capital and CapEx to free cash flow?

Roy V. Armes

Well maybe I can answer it this way, relative to the quarter, and I think I covered cash from operations so if you give me a second here I can get access to the others. Certainly the biggest item in the quarter was the consumption of cash related to the expected build in inventory levels. If you had been following our calls, you would know that we had service, some service decline in 2007 as a result of pretty tight inventory levels as we cranked down our inventories late in 2006 and early in 2007.

So for the quarter I would just give you the pieces here, we consumed about $48 million from outward activities. CapEx was $32 million, and paying the bond whether you include dividends they way you do it. Dividends are about $6.2 million. You can do the math.

[Chester Lye]

And working capital in general, away from inventory, was that a significant use?

Roy V. Armes

No. Inventories that drove about $92 million of that And obviously we would have cash generation without that. Part of the build is because of the ramp-up of our operations in China. Part of it is because it’s a more highly seasonal business in North America, but in North America we had about 400,000 units less inventory in the end of March ’08 than we did at the end of March ’07.

[Chester Lye]

You know following up on the product liability cost question earlier. You mentioned that you do not expect increases of this magnitude moving forward, but can you provide us with an estimate for the next few quarters for modeling purposes?

Roy V. Armes

Now it will vary of course by the circumstances in each case, but generally, and this combines our insurance premiums, our litigation costs and settlements. And that, barring any of these types of adjustments may run $18 million to $20 million range typically in a quarter.

[Chester Lye]

And on your Chad operations can you talk a little bit about how margins are tracking over there? Are they still being impacted by a loss cost, so should have with the new plants and what is your target margins for China?

Roy V. Armes

Yes, our margins for the international operations were down just slightly from last year’s quarter. As you could see, maybe 50 basis points or something. That’s in part due to timing of pricing increases versus raw material costs. I think we have solid margins that are CCT operation, we are in the start up mode at CKT and we are investing in advertising and other kind of start up costs if you will throughout China to build brand equity and establish our dealing base and so forth.

So they had a positive contribution to operating profits. I don’t want to get into the details within that segment but I think with the expansion opportunities that are on their way there and some of the price increases that are going into effect this month, we think that will continue at reasonable levels.

[Chester Lye]

My final question is about your pricing strategy compared to just recently announced the price increase effective the first of June. Can you comment about that?

Roy V. Armes

Yes. You may not have been on the call earlier, but we announced an increase that I mentioned of up to 8% July first in North America. We have other increases underway. I think May first in China and Europe.

Operator

Your next question is from Himanshu Patel – JP Morgan.

Himanshu Patel - JP Morgan

The price mix numbers that you threw out, $34 million in North America, any color you can give us on sort of the split there between price versus mix, is mix becoming a smaller or greater portion of that?

Roy V. Armes

The majority of that of course is price. But as we said we dropped certain lines and that was part of the volume decision that we discussed with Brad. So there was a more favorable mix, but the majority of that is price driven.

Himanshu Patel - JP Morgan

The 4 to 4.5 percentage points of volume decline that you attributed to voluntary exiting, does that repeat itself every quarter this year?

Roy V. Armes

If we took not other action it would, but we are taking action to replace that, which was our design all along. And the idea of course is that we’ll also have some impact, not huge, because of the volumes but some impact on the operational efficiencies of our plants.

Himanshu Patel - JP Morgan

So this is the first quarter where you did that so that you have negative comps on that voluntary exit through the end of this year?

Roy V. Armes

As we compare back to last year, after the point where we began to exit those lines, of course it will diminish.

Himanshu Patel - JP Morgan

Okay. And it this even neutral or is there a slight profit that was attached to these volumes as you exit them?

Roy V. Armes

Maybe a slight would be the right word here.

Himanshu Patel - JP Morgan

And then raw materials, you know, this rate of increase that you saw this quarter I guess $24 million is that the year of your spot price increases, you know, you seem like there are, you know, sort of the same magnitude fourth quarter and first quarter so if we think about how that flows through your P&L and one quarter lag, should we assume that in the second quarter the year-over-year inflation costs from raw materials is about comparable to what happened in the first quarter?

Roy V. Armes

We think it will be up about 6% to 8%, somewhere in that range probably first to the second and again we’re talking about not the impact on, let me say in a positive way, we are talking about the impact on our income statement because we are on LIFO in North America. What we buy directly flows through the P&L at that time. And I think that has to be kept in mind when we’re compared to some of our competitors. That experience that is in their income statement.

Himanshu Patel - JP Morgan

So that 6% to 8% sequential, do you know what that would triangulate to on a year-over-year basis for 2-2?

Philip G. Weaver

It’s a significant number up in the double digits, Himanshu. So for the year let me say it this way, I think Roy mentioned it, we think it will be somewhere between 10 and 16% year-over-year on average.

Himanshu Patel - JP Morgan

Can you give the nominal numbers for Q1, what was it on a percentage basis in Q1?

Roy V. Armes

I don’t know if I have that. Per year-over-year?

Himanshu Patel - JP Morgan

Yes.

Roy V. Armes

8%.

Himanshu Patel - JP Morgan

8, 8, okay, so you’re calling for 10% to 16% for the full year, okay. Okay then, separate question, the margins in the international business, can you kind of revisit the trajectory there? I mean they are down year-over-year. It looks like volumes are growing pretty nice, is this all start up costs though?

Roy V. Armes

A lot of it is start up costs, a lot of it are some of the transitional costs as we’re expanding. The plants in Asia, in Europe I can say volumes were down as an industry and pricing was relatively strong. Our guys, our volumes were better than the industry, although down slightly. Mostly in Western Europe, growing in Eastern Europe, and the other big part of course is the raw material of the rate of increase versus the timing of the price increases.

Himanshu Patel - JP Morgan

Do the raw mass hit you faster overseas than just because of the proximity of some of those like natural rubber and all that stuff? Does it flow through the P&L faster?

Roy V. Armes

No because we don’t use LIFO there, you cannot use LIFO there. So it actually flows through in on another inventory turn if you will.

Himanshu Patel - JP Morgan

Okay but I mean, just on the questions of margins for international, would it be unreasonable to assume that margins are still going to be sequentially improving throughout the year for international?

Roy V. Armes

I don’t think that’s unreasonable. Let me say that depends on where the prices go, particularly the oil derived items that make up about two-thirds of our raw materials.

Himanshu Patel - JP Morgan

One the speed of price increases that you and the industry are implementing. Are you seeing any sort of impact there on demand or mix or are you finding consumers are starting to trade down to some of the lower end brands or is there still pretty good receptiveness to the price increases?

Roy V. Armes

I think Himanshu, we probably should never say they are receptive but we are seeing a trade down in the consumer to lower-end price point tires. That’s one point. The second point is there is some, still maintain some very good integrity into the pricing and our ability to be able to get the pricing had we been successful at that.

Himanshu Patel - JP Morgan

Any color on April shipments?

Roy V. Armes

You know we put some things in place to be able to stimulate some of our shipments starting in the April-May timeframe and we are pleased with the response from those activities, those actions.

Operator

Your next question is from Derrick Winger.

Derrick Winger

Just a follow up on the repurchase of the debt. At what levels did you repurchase that, and with your substantial liquidity why not purchase other issues below par?

Roy V. Armes

We paid a bit of a premium on that and obviously as we closer to the maturity date that will go down. We could go after other traunches but those are pretty long and we’ve got a number of changes in our footprint and other activities here to execute on our strategic plan, so we’ve just been cautious on the near term.

Although we’ve tried to whittle down that 2009 traunche and we’ve been successful at reducing it from $350 million at issuance down to about $97 million now, and of course that has really substantially reduced any risk regarding the repayment of debt at maturity in December of ’09. One the other side, and this is not part of your question, in the share repurchase arena the past three years we’ve repurchased $250 million worth of our shares and paid out $78 million of dividends. We have remaining authority there but probably we’ll be cautious on both of these until we get a better view of where the economy is going and to conserve cash, just until we see kind of what the end of this down cycle might be.

Operator

Your next question is from Saul Ludwig - KeyBanc Capital Markets.

Saul Ludwig - KeyBanc Capital Markets

The walk on North America, I think you said 34 price mix, 24 raws, 12 volume, 14 product liability. Is that correct?

Roy V. Armes

Yes those were the key items.

Saul Ludwig - KeyBanc Capital Markets

Then there’s another $3 million I guess in a mixture of other things.

Roy V. Armes

Yes.

Saul Ludwig - KeyBanc Capital Markets

We think about the cost savings program, your productivity, improvement initiatives. With all these other things what were some of the pluses and minuses, at least if you can’t quantify them, what were they?

Roy V. Armes

Well plant operations did improve sequentially, which we mentioned and they have been improving as we’ve implemented some of these changes in the latter half of 2007. So quarter by quarter, certainly third to fourth, fourth to first have improved. We expect improvement as we continue to move forward. I think that’s an important one that we have our eye on. There’s a number of other things, some SG&A where we’ve taken out cross. So there’s a combination of things Saul, but we just didn’t want to get that granular on this call.

Saul Ludwig - KeyBanc Capital Markets

You said your North American volume and units declined how much?

Roy V. Armes

I don’t know if we gave that number.

Saul Ludwig - KeyBanc Capital Markets

Usually you do.

Roy V. Armes

It was probably somewhere around 10% or 11% year-over-year. But remember that last year one of our competitors had a strike.

Saul Ludwig - KeyBanc Capital Markets

Right, right I understand that. So when you say your raws were up $24 million, I assumed that on the prevalent number of units that in other words your raw material. If you sold 11% fewer tires wouldn’t that actually be up? But you’re talking on a comparable number on those same number of units versus a year ago?

Roy V. Armes

We’re talking about what we sold. We’re talking about the income statement.

Saul Ludwig - KeyBanc Capital Markets

Now the well the plan this year was to run your North American plant pretty full out because you were weak in your inventory levels and your service levels, I assume you must have drove your North American plants full out here in the first quarter, which would give you very good fixed cost absorption, that probably would be a positive factor on your walk. That is the question. And then do you plan to continue to run North American plants full out or are your inventories a little heavy at any given the pulse of business?

Roy V. Armes

Well you know Saul, truthfully we did run out plants full out this first quarter so your observation there is correct. And we said last year that we wanted to put about 1 million to 1.5 million units in our inventory. We’re not at that level at this point in time, we’re down about 400,000 units compared to first quarter of last year and we’re still short of the 1 million to 1.5 million that we wanted to put in inventory.

So were still moving down that path so we’re going to continue to run as we appropriately to get those inventories in line. But we are running, we are back to the fill rates that we’re accustomed to in the past. So that’s been a positive for us in the first quarter. I think the wild card here is watching the industry and how the industry performs and then in the making the appropriate adjustments in manufacturing if we need to. Otherwise our plans right now is to continue to run the factories full out.

Saul Ludwig - KeyBanc Capital Markets

On this volume decline in the first quarter. You had the product to meet, you know, you weren’t short of product. You gave up, you said, four points or so that could have been business you walked away from which would leave let’s say 7% or so decline. Absent that., are you pleased with the job your sales people are doing in moving product into the marketplace? Are you sort of missing some opportunities?

Roy V. Armes

Well let me start out with saying that I don’t ever think you can be pleased when your volume is down that much in the first quarter. But I am pleased with the response and stuff our guys are giving to get things back track, so I feel comfortable with that Saul. I think the other thing here that in our normal operating mode, we have started the production of some of our winter tires earlier this year than we did last year to be able to fill some of these orders that are starting to come in. So I think that has also helped us on the manufacturing and the volume side as well.

Saul Ludwig - KeyBanc Capital Markets

On the minority interest, you call it non-controlling shareholders income was $2.1 million. That I would assume is about half of, you know, half of the action and so in total that would have implied that the Chin-Chang and Cooper Canada would have made about $4 million. Is that kind of the right way of looking at it on an operating basis? And in Europe, the earnings there must have fallen pretty sharply.

Roy V. Armes

Well on the first point I think your logic is right, I don’t know if the math is exactly right whether you’re looking at the income statement or the balance sheet.

Saul Ludwig - KeyBanc Capital Markets

The income statement

Roy V. Armes

In Europe I think they did pretty well, frankly, given that the volumes were down.

Saul Ludwig - KeyBanc Capital Markets

I mean that your operating income was up $800,000 but the minority interest which was up $1.6 million you pull that up to 100% would be up over $3 million, that in terms of op income on the Chinese operations that’s implying that the op income in Europe would have had to been down sharply. Where am I missing the boat?

Roy V. Armes

Well probably part of it is in the elimination because part of the Chinese products are exported elsewhere, but I can tell you that operating profit in Europe was up during the quarter compared to last year.

Saul Ludwig - KeyBanc Capital Markets

And how is Europe volume, did you say?

Roy V. Armes

I think it was down slightly, but less than the market was down as a whole.

Saul Ludwig - KeyBanc Capital Markets

Then you would be down 2$ to 3% or something?

Roy V. Armes

No by merely a flat. Over the flat, just down very slightly.

Operator

Your next question is from Kurt Lutz.

Kurt Lutz

How much was the U.S. market in terms of units, and just thinking about the segments that Cooper competes in. How much was the market down in the first quarter?

Roy V. Armes

About 4.5 %.That’s overall, and the replacement market. This does not include OE.

Kurt Lutz

The U.S. consumer replacement was down 4% and so you, I’m trying to get, would you say you compete in all of those segments? So that’s appropriate number for Cooper?

Roy V. Armes

Well that’s using the entire U.S. replacement shipment numbers.

Kurt Lutz

Yes, but if you were just to exclude all of the segments that you really don’t compete in, is it, do you have a sense for what that number would be?

Roy V. Armes

These are light vehicle shipments I’m referring to. I’m not referring to off the road, or greater type tires and so forth so we think it’s an appropriate measure.

Kurt Lutz

And you’re down 10 to 11 voluntarily by 4% to 4.5% I guess. With respect to the involuntary unit declines, can you give us some color as to, you know, how much you attribute to the competitor, you know, the change in share based on the competitor strike and all factors.

Roy V. Armes

Yes it’s very difficult to get an exact measure of that unless we had a customer that we had not done business with call and say “I need tires because your competitor can’t produce them.” More typically it’s the case where we would sell to the same customer, and that customer would simply buy more from us so we can’t get a measure of the incremental piece. But we think it was a substantial piece of that remaining difference, combined with maybe timing of orders from certain larger customers. So we can’t break it down that precisely.

Kurt Lutz

But as far as you can tell, there is no other reason why you would be losing share other than.

Roy V. Armes

The availability of some of the tires, particularly our radial light truck tires, which we have began producing at a more appropriate levels here in the second quarter and that’s recovering. That’s another piece of this.

Kurt Lutz

So there was fill rate issues in the first quarter?

Roy V. Armes

In the light truck, certain light truck tire lines, yes.

Kurt Lutz

Can you give us any color as to what your fill rates were in the first quarter?

Roy V. Armes

Well overall they probably averaged around 90% but as Roy said they’ve improved during the quarter. I think they were somewhere in the high 80’s lets say, at the beginning of the year and are more like 92% or so by the end of March. Which is we’d like to keep it in that range or higher.

Kurt Lutz

And I guess you’re holding more inventory it sounds like in order to get the fill rates up?

Roy V. Armes

Well part of its seasonal, just so people understand. But we’re not quite at the inventory levels we would like to be at in order to prepare for the seasonal increase that typically occurs roughly say June first through the end of November.

Kurt Lutz

Is there, do you have a target inventory year end inventory level?

Roy V. Armes

We do and that’s 1.5 million or so above 2007 that Roy mentioned.

Kurt Lutz

That’s units?

Roy V. Armes

Units.

Kurt Lutz

You, do you know what that is in terms of dollars?

Roy V. Armes

Depending upon where we hit it exactly it could be in, somewhere in the $60 million to $70 million range. Depending upon the types of tires we get in there.

Kurt Lutz

You mentioned earlier that you think your sense is that consumers are trading down in terms of price points?

Roy V. Armes

What we’re seeing here, and these are only qualitative points, but we are seeing consumers and the data is showing us that the miles driven is down. With the gas prices like it is, we’re seeing more car, more customers not driving so much cars and SUVs, driving trucks and SUVs but driving more cars. Our customers are giving us some feedback about the lower price point tires that they are selling. I think it’s a natural reaction to the economic slowdown.

Kurt Lutz

It’s just, and that’s your expectation is that the people would trade down. I guess that would be of benefit to Cooper.

Roy V. Armes

If they don’t delay their purchases at the same time.

Kurt Lutz

I’m looking at the, kind of the midpoint of your full year material costs and increase of 10% to 16%. So I guess that’s 13% of the midpoint. For the full year you were, I guess you said you were materials were up 8% in the first quarter. So I guess the headwind picks up here in the last three quarters. Is there a, looking at this point is there a quarter where the comps are particularly tough or do you think it’s kind of equally tough in each of the next three quarters?

Roy V. Armes

Probably I would say the second, because of the, you know its first of all its nearby are more certain that is will be up versus the timing of the price increase being July one. After that you know we all know we’re either raw materials or pricing might go but I’d say particularly the second quarter.

Kurt Lutz

Be the toughest, okay.

Roy V. Armes

And especially since again we’re on LIFO, we would see that immediately when we buy it, as opposed to once the inventory turns that others would be reporting it.

Kurt Lutz

And then there was with respect of the year-over-year bridge you said price in mix, it was mostly price. Was mix positive in the quarter?

Roy V. Armes

Yes, mix was positive.

Kurt Lutz

And you did mention operational issues so I’m assuming operations were flat year-over-year?

Roy V. Armes

Improved modestly, sequentially and slightly below the first quarter of last year.

Kurt Lutz

Operations were down still year-over-year?

Roy V. Armes

Yes. As we’ve talked about in the past.

Kurt Lutz

And then I think, just as a follow up to Himanshu’s question. I wasn’t quite sure what, where you came out on, with respect to the effective, your ability to the take race on the price increases. Have you seen any trends in your ability to get price increases? Are there any, looking back over the last half a dozen price increases, you know, how have the trends been in terms of the actual take rates?

Roy V. Armes

I would say they’ve been very strong and the way the industry announces them typically is in up to a certain number. So we generally implement the price increases that we’ve designed, we just announce them in the form of the highest rate of increase, so I would say they have been implemented pretty close to, been executed pretty much close to the designed price increase. So pricing has been firm.

Operator

Your final question is from [Johnson Bimeds].

[Johnson Bimeds]

You’re talking in the second quarter sequentially about a 6% to 8% raw material increase relative to Q1.

Roy V. Armes

Yes

[Johnson Bimeds]

Okay and so when I think about the pricing actions, you don’t have anything until July, so what you’ll get in the second quarter is the benefit from the February increase versus 1Q. How much of the quarter do you think actually benefited from that increase. In other words was it mid-Feb, end of Feb. When do you really think you saw a benefit?

Roy V. Armes

I mean some of them are slightly staggered so you might think of it in terms of kind of the end of February.

[Johnson Bimeds]

Okay so we have only one month of the quarter where you actually saw it.

Roy V. Armes

Probably.

[Johnson Bimeds]

So we’ll see three eight, three months in the second quarter. Okay. On the demand side, I don’t know if you guys look at it this way, I’m just trying to understand sort of what’s happening in the middle of the market versus either the lower middle or the lower end. Do you guys track demand changes year-on-year by price points? In others words if we divvied you up into core tiles in price points asques, would there be a big difference between the sort of top core tile and you bottom core tile?

Roy V. Armes

We don’t do it in core tiles. We do it by product line.

[Johnson Bimeds]

And how would that look? I’m just trying to figure out whether at my thesis will be at the lower end people or differing driving more and deferring purchasing more, and I’m just trying to see if that is coming through in your numbers.

Roy V. Armes

We don’t have a whole lot of science to back that up, but right now that is what we believe we’re seeing. That lower end tires are more inclined, the drivers are more inclined to defer the purchase there at the moment. More pressure than the other guys.

[Johnson Bimeds]

But you’re not seeing people trade down then from the middle towards the lower.

Roy V. Armes

We are hearing some of that also.

[Johnson Bimeds]

I’m just trying to figure out which factor is going to prevail, so to speak.

Roy V. Armes

I don’t know that we have a read on that right now.

[Johnson Bimeds]

Okay and lastly, just on the product liability. You gave us a number fill to expect about $18 million to $20 million a quarter, going forward.

Roy V. Armes

Let me clarify that. That’s been about our average. Now from time to time there are specific cases that you’ve seen it over the years where in particular quarter there’s an aberration compared to that kind of rough estimate of an average.

[Johnson Bimeds]

Sure so do you have the actual numbers for 1Q ’08 versus 1Q ’07 was because you said 1Q ’07 was kind of below that trend clearly 1Q ’08 will be above it.

Roy V. Armes

Johnson what we studied in the past is that you can look at quarter over quarter, oh sorry year-over-year in 2008 each quarter will probably run about 4 million higher than it did last year.

[Johnson Bimeds]

Okay but we ran $14 million higher, do you have the absolute number for 1Q ’07 and 1Q ’08?

Roy V. Armes

Yes I do. It was about $14 million and 28.

Roy V. Armes

Yes thank you. Thanks a lot. Thank you everybody.

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Source: Cooper Tire & Rubber Company Q1 2008 Earnings Call Transcript
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