GOODYEAR TIRE & RUBBER CO quarterly report, Q1 FY2018

Goodyear Tire & Rubber Company — Q1 2018 Form 10-Q

Reporting period: Three months ended March 31, 2018. Unaudited consolidated results; comparisons are with Q1 2017 unless otherwise noted. Amounts are in U.S. dollars.

Financial performance

Metric	Q1 2018	Q1 2017	Change
Net sales	$3,830 million	$3,699 million	+3.5%
Segment operating income	$281 million	$390 million	−27.9%
Segment operating margin	7.3%	10.5%	−3.2 percentage points
Income before income taxes	$113 million	$239 million	−52.7%
Net income attributable to Goodyear	$75 million	$166 million	−54.8%
Diluted EPS	$0.31	$0.65	Down $0.34
Operating cash flow	$(389) million	$(286) million	$103 million more cash used
Capital expenditures	$248 million	$271 million	Down $23 million

Cost of goods sold was 77.7% of sales versus 74.6% a year earlier; the corresponding gross margin was approximately 22.3% versus 25.4%. Selling, administrative and general expense was 15.4% of sales versus 15.6%. Interest expense declined to $76 million from $87 million. Other expense increased to $37 million from $8 million, including higher non-service pension costs and one-time and transaction-related items.

Worldwide tire unit sales were 39.0 million, down 2.5%. Net sales benefited from $166 million of favorable foreign currency translation and $64 million of improved price and product mix, offset by lower tire volumes and other tire-related sales. Raw material costs rose approximately $73 million year over year. Management cited approximately $75 million of cost savings, including $20 million from raw-material cost measures.

Segments and material changes

• Americas: Sales of $1,929 million, down 1.5%; operating income of $127 million, down 41.2%. Higher raw-material costs, weaker price and mix, lower volume, conversion costs and new-plant start-up costs weighed on results.
• Europe, Middle East and Africa: Sales of $1,330 million, up 7.3%, largely from currency translation; operating income of $78 million, down 22.8%. Units fell 5.4%, and raw-material costs increased.
• Asia Pacific: Sales of $571 million, up 13.7%; operating income of $76 million, up 4.1%. Unit sales increased 4.5%, led by original-equipment demand in China.

Management attributed the $109 million decline in total segment operating income primarily to $73 million of higher raw-material costs, $20 million of lower tire unit volume, $16 million of lower price and product mix, and $10 million of lower income from other tire-related businesses. Lower selling and administrative expense and favorable currency translation partly offset these pressures.

Balance sheet, debt and liquidity

• At March 31, cash and cash equivalents were $837 million, down from $1,043 million at year-end 2017. Cash, cash equivalents and restricted cash totaled $888 million.
• Current assets were $6,488 million and current liabilities were $4,941 million. Total assets were $17,580 million; total liabilities were $12,618 million.
• Debt and capital leases totaled approximately $6,259 million, including $332 million of notes payable and overdrafts, $327 million due within one year, and $5,600 million of long-term debt and capital leases. This compares with approximately $5,729 million at December 31, 2017.
• Total credit arrangements were $8,735 million, with $2,439 million unused, versus $3,196 million unused at year-end. Thirty-nine percent of debt carried variable rates, averaging 3.84%.
• Operating cash use reflected a $449 million working-capital outflow, including substantial receivables and inventory use, and $106 million of rationalization payments. Financing provided $399 million, including $492 million of net borrowings. Investing used $248 million, primarily for capital expenditures.

Goodyear amended its $400 million second-lien term loan in March, extending maturity from 2019 to March 2025. The company reported compliance with applicable material covenants; its first-lien availability plus defined available cash was $1,548 million, above the $200 million threshold at which a financial covenant would apply.

Outlook, commentary and notable items

• For 2018, management expected tire unit volume to increase approximately 2% versus 2017, reflecting the planned transition of volume to TireHub; unabsorbed fixed overhead costs were expected to be about $55 million lower.
• Expected 2018 cost savings were approximately $130 million, more than offsetting general inflation. Based on current spot rates, currency translation was expected to benefit segment operating income by approximately $40 million.
• Based on current raw-material spot prices, raw-material costs were expected to increase approximately $50 million for the full year, excluding cost-saving measures; price and product mix net of raw-material costs was expected to be a $25 million headwind. Management cautioned these estimates could change with commodity prices.
• Expected 2018 cash needs included approximately $1.0 billion of capital expenditures, $335–$360 million of interest expense, $200 million of restructuring payments, $135 million of common dividends, $25–$50 million of non-U.S. pension contributions, and a $100 million working-capital use. Management said liquidity was adequate for 2018 operating and investing needs and debt maturities.
• On April 16, 2018, Goodyear announced a planned 50/50 U.S. tire-distribution joint venture with Bridgestone, TireHub, expected to close in June subject to approvals. The company planned to transition approximately 10 million units of annual sales to TireHub and other aligned distributors.
• Q1 included $37 million of rationalization charges; the related liability was $149 million at quarter-end and expected to be substantially used within 12 months. A one-time $9 million pension-accounting charge was recorded, and $4 million of TireHub transaction costs were included in other expense.
• The Tax Act transition-tax obligation was provisionally recorded at $84 million, with a separate $20 million reserve for potential foreign withholding taxes. Goodyear said a possible valuation-allowance release could produce a one-time tax benefit of up to $25 million if positive evidence persists.

Risks and contingencies

• Management cited weak demand in key U.S. and European markets, higher raw-material costs, global competition, currency movements, tariffs, labor disruptions, and economic or supply-chain shocks as risks. Commodity prices are volatile, and the company said it does not currently hedge commodity prices.
• Goodyear had approximately 50,000 pending asbestos claims at March 31. Recorded gross asbestos liabilities were $169 million, with a $115 million insurance receivable; the company said additional costs could be material but could not be reasonably estimated.
• Approximately 840 former Amiens, France employees asserted claims totaling €120 million ($148 million). Goodyear intends to defend the claims and said any ultimate payment could not be estimated.
• Recorded environmental liabilities were $47 million. Workers’ compensation liabilities were $243 million, with reasonably possible excess exposure estimated at approximately $30 million.
• Off-balance-sheet guarantees and other commitments totaled approximately $83 million. The company also disclosed that about $850 million of subsidiary net assets, including $155 million in cash, were subject to restrictions on transfers between countries or entities.
• Adoption of the new lease-accounting standard was expected to materially affect the balance sheet because of significant operating lease commitments. The company reported effective disclosure controls and no material change in internal control over financial reporting.

Important facts for investors to verify

• Whether the projected 2018 volume, savings, currency, commodity-cost and cash-flow assumptions were achieved, especially given raw-material price volatility and weak demand.
• How the decline in segment operating income and margin developed by region, and whether price and product mix kept pace with cost inflation.
• Whether working-capital use, borrowing and unused credit availability changed materially after quarter-end; review borrowing-base terms, variable-rate exposure and debt maturities.
• The TireHub closing, operating ramp-up and sales-volume transition, including effects on Goodyear’s distribution economics and customer reach.
• Changes in asbestos, Amiens labor, environmental, workers’ compensation and tax exposures, including insurance recoverability and the provisional Tax Act estimates.