Q3 2019 Earnings Call

Good morning, welcome the Cooper tire and Robert Companys third quarter 2019 earnings.

Call and webcast. This time, all participants on the call our in listen only mode.

Later, we'll conduct question answer session and instructions will follow at that time.

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I would like to turn the conference over knowledge or in Jerry Brown. Please go ahead. Thank you.

Good morning, everyone and thank you for joining the call today.

This is Jerry biologic, Cooper's Vice President International Finance and Treasurer.

I'm here today, with our Chief Executive Officer, Brad Hughes, and Chris <unk>, Our Chief Financial Officer.

During our conversation today, you may hear forward looking statements related to future financial results and business operations at Cooper tire and rubber company.

Actual results may differ materially from current management forecasts and projections.

Different says maybe a result of factors over which the company has limited or no control.

Information on these risk factors and additional information on forward looking statements are included in the earnings release, we issued earlier this morning under the company's reports on file with the FCC.

During this call we will provide an overview of the company's third quarter 2019 financial and operating results as well as our business outlook. Our earnings release includes the linked to a set of slides that summarizes information included in the news release and in the 10-Q that will be filed with the FCC later today.

Please note that we will reference certain non-GAAP financial measures on this call.

The link slides include information about these measures and a reconciliation to the most directly comparable GAAP financial measures.

Following our prepared remarks, we will open the call to participants for question and answer session.

Now I'll turn the call over to Brad.

Thank you Jerry and good morning, everyone I.

I will begin today with a brief overview of our third quarter results. After that I will turn the call over to Chris first few for a review of our financial performance in greater detail now were turned to talk about our outlook for the fourth quarter and as always we will conclude by taking your questions.

Let's talk about the third quarter 2019 results net sales decreased 4.5% to $704 million unit volume decreased 7% compared to third quarter of 2018 operating profit was $53 million for 7.5% of net sales a strong.

The sequential improvement compared with the second quarter.

Excluding $15 million up new tariff synaptic since the same period, a year ago on products imported into the United States from China.

Operating profit margin would have approached the low end of our 10% to 14% target.

We were pleased to deliver this operating profit improvement in the third quarter, which was driven by positive trends in pricing mix and raw materials.

As expected our volume was impacted by customer inventory actions in the U.S. as well as challenging market conditions in other regions.

Americas segment operating profit margin was 11.3%.

Our international segment remained challenged by conditions, including the China, New vehicle market, Andy week replacement tire market in Europe .

The process, a phasing out light vehicle tire production at our Melksham facility is substantially complete and should result in a Cooper tire Europe that his work comp cost competitive going forward.

We're making good progress on our global TBR sourcing footprint diversification, we're ramping up the number of payers. We received from our commercial off take agreement with say Loon Vietnam at the same time, the construction of E. Ctr, our new joint venture TBR plant in Vietnam is on track with commercial tire pro.

Adoption expected to commence early next year.

Also we continue to evaluate opportunities to further diversify our TBR sourcing footprint.

Speaking of TBR, we're excited to have been named and outstanding supplier for 2019 by Bluebird Corporation, the leading manufacturer of school buses in the United States are Cooper brand TBR tires designed to deliver quality and value our original equipment on Blue Bird School buses we are.

We used to earn this important recognition from a great customer and look forward to continuing to serve them.

Should also we had that our business relationship with Mercedes Benz is going well and expanding we're proud to now have Cooper discover <unk> SRX tires as original equipment not only on the Jie Li model S. UBI, but now also on the Gls model. This is the second Mercedes Benz vehicle announced this year to feature.

Your Cooper tires, we are excited about this opportunity and look forward to continuing to work with this luxury automaker.

Before I turn it over to Chris Let me comment on unit volume, specifically, the U.S. result, which underperformed the U.S.T.N. eight and the industry.

Well, we're not satisfied with this result, we remain confident that the strategic growth initiatives, we are executing well make a more visible impact in 2020 as we have been communicating.

As we discussed last quarter customers make inventory adjustments from time to time, which can impact selling results as expected discontinued in the third quarter.

Also we do not believe our third quarter selling performance is indicative of underlying demand for our products while industry sellout data is not complete with the information. We do have we believe Cooper sell out was inline or better than industry sell in growth for the third quarter.

Now Chris will review our financial performance. Thank you Brad starting with consolidated third quarter results sales were $704 million down from 738 million. In 2018. This 4.5% decrease was driven by $54 million of lower unit volume and $7 million of unfavorable.

Foreign currency impact, which were partially offset by $27 million, a favorable price and mix.

Operating profit was $53 million compared with $81 million in the third quarter of 2018, resulting in an operating profit margin of 7.5% of sales. This was achieved despite $23 million of higher net product liability expense $15 million and costs related to new tariffs on products import.

It it into United States from China, compared to the same period, a year ago as well as $1 million of restructuring costs related to Cooper tire Europe's decision to see Ses light vehicle tire production in Melksham, England.

With respect to the increase in product liability expense. The third quarter of 2018 included a $31 million benefit in operating profit from lower product liability costs related to an adjustment of the company's product liability reserve.

It's similar review of our product liability reserve model in the third quarter of 2019 resulted in a benefit of $4 million. This together with the normal activity and product liability expenses in each quarter, including current case activity in legal fees resulted in $23 million of higher net product liability expense for the third quarter of two.

I wasn't 19.

Let me provide an update with respect to tariffs our expectation for the full year impact to gross expenses for all of the new tariffs remains at about $50 million.

As Brad indicated earlier, the Melksham transition is now substantially complete and resulted in restructuring charges of approximately 1 million in the third quarter and over 7 million year to date, we expect full year 2019 restructuring charges to be in the range of 8 million to $10 million.

As we indicated last quarter, we experienced slightly more volume and manufacturing disruption than expected with this transmission.

Transition yet this action should more fully leverage the remaining plants in our manufacturing network ultimately benefiting Cooper in Europe and globally.

Now, let's take a look at our third quarter operating profit walk total company operating profit compared with 2018 was impacted by the following factors.

$20 million, a favorable price and mix $24 million, a favorable raw material costs, excluding the new tariffs.

This was offset by $23 million related to product liability $16 million, a volume $15 million of new tariffs $12 million manufacturing $2 million of SGN, a $1 million of restructuring and $3 million of other costs compared to the same period a year ago.

Diluted earnings per share was 58 cents compared to one dollar and seven cents per share in the third quarter of 2018.

Now turning to the two our Americas tire operations.

Segment sales for the third quarter were $602 million down 4.3% from $629 million in 2018, as a result of $51 million, a lower unit volume and $1 million of unfavorable foreign currency impact, partially offset by $25 million, a favorable price and mix.

Segment unit volume was down 8.2% compared to the same period a year ago.

Our us light vehicle unit volume decreased 7.7%, while the USPI may increase 0.7% and a total industry increased by 3.5%.

Third quarter operating profit in the Americas decreased to $68 million or 11.3% of net sales compared to $87 million or 3.9% of 13.9% of sales in 2018.

Operating profit included $23 million, a favorable price and mix $22 million, a favorable raw material costs, excluding new tariffs.

This was offset by $23 million related to product liability $15 million net new tariffs.

$13 million of volume $6 million of manufacturing $5 million of SGN, a and $2 million of other costs compared to the same period a year ago.

Now turning to our international tire operations net sales for the third quarter were $132 million down 18.6% from the third quarter of 2018.

This was all result was driven by $28 million lower unit volume and $6 million of unfavorable foreign currency impact, which were partially offset by $4 million a favorable price and mix.

Segment unit volume decreased 16.4% with unit volume decreases in both Asia, and Europe , driven primarily by lower intercompany shipments.

In fact third party sales in Asia were flat versus the prior year.

The third quarter operating loss in our international operations was $5 million compared to operating profit of $6 million in 2018.

The quarter included $3 million of unfavorable price and mix and $2 million a favorable raw material costs. In addition, the quarter included $1 million of lower SGN, a costs, which were more than offset by $3 million of volume $6 million manufacturing $1 million of restructuring the.

As of other cost compared to the same period a year ago.

Moving to raw materials, our raw material index decreased 6.9% from the third quarter of 2018 raw material index in decreased 2.9% sequentially from 161.8 in the second quarter of 2019 to 157.1 in the third quarter of 2019.

This was in line with our expectations for the fourth quarter, we expect a raw material index to be down on a sequential and year over year basis.

Now to some corporate items other pension and postretirement benefit expenses increased $2.6 million versus the prior year similar to the prior quarters. This increase is primarily the result of lower estimated return and plan assets compared to 2018.

If we had made as we have made strides in improving the funding status of our pension plans. The portfolio is taking less risk in order to protect the funded status, which results in a net increase quarterly expense.

The effective tax rate was 21.0% for the quarter compared with 22.6% last year in conjunction with restructuring decision related to the Mosul Melksham facility. The company is examining its entity structure in the region in order to sure its effectiveness from an operating and tax planning perspective exclude.

Adding any actions, resulting from this and other significant discreet items. We continue to estimate the full year 2019 effective tax rate will be in in a range of between 23 and 26%.

Effective tax rate is based on the forecasted annual earnings in tax rate for the various jurisdictions in which the company operates.

More detail on or taxes will be available on our Form 10-Q that will be filed with the FCC later today.

Turning to cash flows and some balance sheet highlights unrestricted cash and cash equivalents were $137 million at September Thirtyth 2019, compared with $209 million at September Thirtyth 202018.

Capital expenditures in the third quarter were $50 million compared with $46 million in the same period, a year ago, we expect our full year capital expenditures to range between 180 and $200 million.

As a reminder, this does not include any capital contributions related to Cooper's pro rata share of its joint venture with Salen, Vietnam or other potential manufacturing footprint investments.

As of the ended the third comp quarter, the company had invested $49 million and its new east Ctr joint venture with say Loon Vietnam.

Return on invested capital excluding the impact of the goodwill impairment charge in the fourth quarter of 2018 was 7.8% for the trailing four quarters.

I want to reiterate the risk that returning capital to our shareholders remains an important priority for us as demonstrated in the third quarter, we're committed to supporting our quarterly dividend, but will preserve pursue share repurchases or opportunistically in the near term as we balance attractive opportunities to invest in our business I'll now turn the call back over to Brett.

Thanks, Chris looking ahead, we expect continued volume headwinds in the fourth quarter, but we'll continue to make progress on executing our strategic initiatives, including our retail expansion efforts, we expect initiatives like these and others to drive more meaningful improvements in our business starting in 2020.

We have work to do but we remain confident about the future and where we're headed.

Cooper expects fourth quarter operating profit margin to improve sequentially full year operating profit margin is expected to be slightly above the 5.9%. We reported for full year 2018, driven by positive trends in pricing mix and raw materials.

With respect to pricing many of our competitors recently announced price adjustments and Cooper did the same implementing adjustments that were effective October onest.

Cooper continues to monitor the industry with an eye toward remaining competitively positioned in aggregate and by product line and category.

With respect to mix, while we continue to see strong overall mixed trends in fourth quarter of last year, we had a strong mix of TBR business that we do not expect to repeat this year.

In summary, while the short term outlook has been affected by the conditions. We've described particularly tariffs on tires from China and customer inventory adjustments in the U.S.. We continue to believe that Cooper is doing the right things to build our business and drive improvement, which will support sequential operating profit margin improvement this year and positive moment.

I am going into 2020.

With that let's move to your questions. Operator will you take the first question. Please.

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This time, we'll pause momentarily to assemble the roster.

First question comes from Rod Lache from Wolfe Research go ahead.

40 right.

Couple questions first.

I was hoping you can talk about the manufacturing cost increases and maybe what's behind those numbers. They were I think a $50 million drag in 2018, and now couple of million dollars higher in.

2019th of cumulatively quite a bit higher than what we've seen before.

How should we think about those going forward does become a tailwind and then secondly.

Hoping you can maybe just address product liability expense.

Is that something that should be trending at like 11 or $12 million the quarter 45 million year, because it looks like it was maybe 4 million or so and this quarter.

Yes, let me take them in order ride the first one with regard to manufacturing cost increases.

Let me split this into into two pieces one is in the Americas.

Which was about half of the 12 that we showed on a consolidated basis. Those those increases were less related to volume.

The units produced in the plants relative to what we've had recently and the items that contributed to that that negative performance in the quarter. We thing I think will mitigate.

And as we move into the fourth quarter. When you look at it on a year over year basis. So.

Yes two.

Beginning of the change there in the Americas in the international operations.

That that cost increase that we saw there's essentially all Europe .

And it has to do with some of the challenges of of migrating the the on production from Melksham into Serbia, and we we think that by the time, we get into next year. We'll start to have we will have turned the corner and start to see the benefits of that lower cost footprint in.

Serbia relative to what we've been carrying this year.

So thats the manufacturing costs and the product liability expense, maybe I'll, let Chris chime in a minute, but I think directionally, you're pretty close on on what you were thinking about with the 4 million buckle at Chris Yes, I mean directional Rod I think thats correct. As you can imagine trying to predict product liability expenses as the very challenging exercising quarter to quarter quarter to quarter. So we took.

We don't.

But you are correct and that this quarter was roughly 5 million when you adjust.

In terms of the the actual pension liability expense, which will show up in the piano.

Okay.

Is there a way to quantify what you feel as unusual and these manufacturing.

Increases so is that looks like cumulatively, a pretty big increase is this something that.

Within a year or were to you think could correct by 50 million.

I definitely think that we will begin to see improvements as we move into next year and it may take a while as that both the combination of efficiencies footprint changes and volume increases in the plants that we have produced in the units begin do when all of those seem to begin.

Late we should see a pretty substantial odd turn in terms of the manufacturing cost calling it precisely though rod is on I'm not in a position to do that right now.

Okay, and then just lastly.

A couple of housekeeping things.

What was the magnitude of that customer is a specific customer that you've called out before that.

Had a significant inventory adjustments so what what would your volumes have looked like excluding that and secondly, a number of tire companies raise prices effect for light.

Vehicle tires effective October one what it Cooper do and do you expect stronger price performance going forward.

So with we haven't narrowed it to a specific customer we've talked about customer and that is good and does mean plural customers in terms of the inventory adjustments because we wouldn't be as specific as any individual customer having said that I think the best indication ride.

With regard to demand and how to think about that is the comment I made on sell out.

In the quarter on which we believe for Cooper based on the information, we have and we need to extrapolate because as you know theres not complete data around sellout.

Our sellout was up at least as much as the cell and for the industry and maybe a bit more.

So as we as you think about that sell and sell out dynamic is things begin to balance out on that should give you an indication.

And then Brian .

Yes on pricing, we did also announced on October Onest.

We we make ongoing adjustments. It is always nice to have the backdrop of what was happening in the industry on last quarter with regard to announcements to go in and adjust prices on we took that opportunity on and.

We will continue to monitor and make sure that we're staying competitive with the rest of the industry and I.

And that's an ongoing process for us.

Great. Thank you.

Our next question comes from change Pecoriello from Keybanc go ahead.

Hi, guys changes Jay comp on for James Thanks for taking my question.

So in September we saw for a pretty significant step up and sell in demand up about 6% for the industry. So could you tell us how much of this do you think was related to pre buying ahead of price increases and what are your.

Consumer replacement volume expectations on fourth quarter.

So the the with regard to the third quarter, there were price announced Benson and that typically would have some impact on on the volume on without getting into specifics for Cooper.

I would say is that anything that fit was affected with regard to volume is all included in the sequential operating profit margin improvement guidance that we've provided on which is traditionally where we stay with regard to guidance in terms of the types of metrics. So on.

For the industry. There is pricing there may have been sun for us as we look at the fourth quarter were were.

On guiding to people that higher operating profit margins in the fourth relative to the third.

And then with regard to our volume we do think that the backdrop is still relatively challenging we're more confident now I think than than we were even at the end of last quarter that by the time, we get to 2020. These inventory adjustments in the us that we've talked about will be behind us on and and that will enter 2020 with.

From there as that's behind Us and retail expansion initiatives, we have particularly in the US we'll begin to flow through to the to the bottom line. So.

On fourth quarter still some challenges around the globe in terms of market to market. These you still have a week.

Passenger vehicle market in China, which is impacting that market in Europe seems to be.

This week with regard to sell on that or do a replacement volumes. So some challenges out there on we still project that we're going to see this sequential operating profit margin improvement and are looking forward to 2020, where we see more of the initiatives, we've been executing against contribute to the bottom line.

Great. Thanks, and then specifically within tariff.

We saw a step up and the quarterly expense to 15 million.

Which with your 50 million assumption of implies that the tariff expense cuts roughly cut in half next quarter. So could you just tell us some of the assumptions that underlie that estimate.

Well, let Chris confirm on the what we're thinking about with regard to tariff semi overall.

We've been talking about tariffs and when we entered the year.

We talked about on.

Belief that there was going to be pricing to offset a portion of that those tariffs and while there has been some pricing as as you know when as we spoken about in previous calls I think our expectation now is on that that pricing is probably going to be delayed until some point in the future as we look at the overall market for team.

Our tires in the us on its softer than what we are anticipating coming into this portion of the year and so the probability or the environment for pricing is different from what we thought on and when we see a pickup in TBR demand I do think that there'll be opportunities for pricing, but that that is.

Further out into the future than we had bought at the at the initial.

Discussion that we had around tariffs, but I'll, let Chris comment, yes, just based on the math for the first three quarters of what we've reported your assumption is directionally correct for Q4.

Alright, thats, great and congrats on the great quarter guys. Thank you.

Our next question comes from Bret Jordan from Jefferies Go ahead.

Hi, guys wondering why Brett.

Can we talk about that the I guess year over year impact on Eightd.

Obviously, you probably picked up some volume there as good year in Bridgestone moved away, but could you talk.

Maybe about share volume growth, there, whether you're fully penetrated and.

Obviously, some of the new online channels that you're going through maybe tire buyer.

What you're seeing pick up in that channel.

Yes, so on.

Across the entire landscape when you when you look at it channel by channel.

A year ago, we talked about with the announcement around tire hub.

That we were going to go out within and aggressive conquests program to try and sign up more independent retailers and dealers. We did that on we are starting to see some of the benefits of those sign ups now flowing through in terms of net volume increases in that part of the market on.

Some some that are very positive looking in terms of the increases that were seeing year over year, certainly on a fair amount of that.

I see a normal.

A substantial amount of of benefit that we've seen in that area is supported by Eightd on and we'd expect for that to have even some legs on it as we go forward. So it is more than just in Eightd story, and we've been trying to clarify that since the outset that signing up these new independent dealers in wholesale.

Of course on was broader than Eightd, but there was an opportunity to eightd that the team sees dine in and is doing so successfully we are seeing.

Expansion in our retail presence, we've we've talked about general merchandisers, we've talked about national retailers on those efforts continue and and should be able to to contribute more on as we move into next year and we are seeing growth in e-commerce sales online sales and in it.

Continues to be exciting because not only is that a unit volume growth opportunity, but the the revenue and profit that we're seeing on those units, particularly in E. Commerce is also very strong. So we're seeing progress from all of these unfortunately with the inventory adjustments, we've talked about for a couple of quarter.

Yes, we are seeing it in the cell and yet we are seeing yet in the data that we have on sell out.

Okay, and then a question I guess as you brought up ecommerce what do you see in pricing as a result of obviously Amazon getting bigger in the space I think Monroe reported last week and talked about it fairly competitive.

Pricing environment in the tier two and lower do you see that Theres general deflation in the broader market at retail.

Or are people generally holding price online.

From what we can see them Theres two dynamics going on here. One is just in terms of the overall pricing environment. As we just talked about a few minutes ago that the industry has had a number of pricing actions that took place late third early fourth quarter Ondemand and while it's early signs are that the industry is absorbing those.

And digesting them, I think which is a very positive sign overall for pricing in the market. The thing that you get with the ecommerce platform is more transparency.

With regard to volume with regard to pricing and consumers' ability to see that pricing, which I'm not sure is affecting the overall pricing levels across the industry on but with that transparency. It is giving consumers more power on making decisions about where theyre going to go to make their purchases.

Hi, which.

He is impacting with the consumer pays but I had to this point, we're not seeing that having a deflationary effect across the industry pricing as we see it.

Okay, great. Thank you.

Thank you.

Again, if you have a question. Please press Star then one.

Our next question comes from John Healy Northcoast Research go ahead.

Thank you.

And one that as just a little bit about your outlook for the heavy truck market for 2020 and was hoping you could just go over some of the puts and takes as it relates to that.

The kind of as a TBR business and just broadly speaking kind of the exposure on OEE and replacement therein, and how we might see that impacting kind of the mix next year.

Okay. So on from an industry perspective on it you see the date is as we do the OE market has been exceptionally strong that goes back 18 months to two years. It appears that the production of units to meet that demand.

We had all this backlog of orders that needed to be filled it appears like a lot of that has been field and that we're seeing slowing orders and thats likely to result into slowing production in the Ole we ended the market.

We do have some exposure there, particularly on trailer.

Well I assume at this point in time, I think the bus markets a little bit removed from that's I'm talking largely about commercial vehicles at this point in time on the replacement market has been down double digits. As you look at demand in the us market year to date on we expect that that probably is going to remain weak for some.

Period of time until all of this new equipment that come into the market begins to get to the point, which is much faster than a passenger vehicle as you know.

It gets into a replacement requirement for those types of tire. So we think that we are probably in for as from an industry perspective, a bit of a soft patch here with regard to TBR tires in the us in North America from a Cooper perspective on I think we feel a little bit more Pos.

Got it relative to the industry, we are not down as much as the industry is on replacement year to date, we had.

A better opportunity in Oh, we particularly as we introduced the Cooper brand, which was specifically targeted at new parts of the TBR market into us and so we're just starting to build out that business, allowing us to get into some of these OE accounts and into larger fleets with the Cooper brand.

While remaining strong in the replacement Mark in the other elements of the replacement market with our Roadmaster brand. So we still feel quite good about our TBR business from a demand perspective, even in light of what we see might be a softer industry than people might have thought by year 18 months ago, and then let me just add just to complete the.

TBR story that on as I mentioned in my comments, we are beginning to ramp up the number of tires that we're taking from Vietnam in lieu of China on which is obviously going to have a significant impact on the profitability of that business for us as we avoid the 70 point plus.

Tariffs that are on those tires when you add up all of the tariffs that are attracted to the China tires coming to the us market.

Great and then just on those timelines I was hoping we could talk a little bit about Europe and Vietnam, just as you think about.

Kind of those restructuring efforts are those those changes and production is there anyway to kind of conceptualize the potential tailwinds at 2020 in terms of how much benefit there might be just with.

The restructuring and realignment manufacturing.

Well, there's on it we should begin in 2020 to see benefits from both of those actions on they will ramp over the course of the year, we're still moving the the last pieces or last tires into Serbia right now and then we'll begin to build out the product portfolio that were able.

The build in that facility, so that will have a better market facing portfolio, our products and a better cost base for both of those but that will have to happen over the course of 2020, and similarly with with with Vietnam on we have the off take agreement but.

As we ramp up production in the in the joint venture that we have there a ctr on that will happen over the course of the year in so I think that it's going to be later in the year or that you see more of the benefit from that as the volume out of that new facility.

Is higher coming to the us so should we will begin to see it next year, but certainly second half in latter part of next year will be more prevalent in the first part.

It I put you to sleep there.

Thank you guys.

Thanks, Jeff.

This concludes our question answer session on like the turn the conference back over to Brad Hughes for any closing remarks.

Okay. Thank you in closing I want to thank our entire Cooper team around the globe, we're staying focused on executing our strategy, which supports our consumers our customers and our shareholders with that thank you for joining today's call and have a great day.

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