GOODYEAR TIRE & RUBBER CO quarterly report, Q2 FY2014

Goodyear Tire & Rubber Co. — Q2 2014 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2014. Unaudited consolidated results. Goodyear manufactures tires and reports through North America, Europe, Middle East and Africa (EMEA), Latin America, and Asia Pacific segments.

Financial performance and position

Metric	Q2 2014	Q2 2013	Six months 2014	Six months 2013
Net sales	$4.656 billion	$4.894 billion	$9.125 billion	$9.747 billion
Goodyear net income	$213 million	$188 million	$162 million	$221 million
Net income available to common shareholders	$213 million	$181 million	$155 million	$206 million
Diluted EPS	$0.76	$0.67	$0.58	$0.79
Total segment operating income	$460 million	$428 million	$833 million	$730 million
Segment operating margin	9.9%	8.7%	9.1%	7.5%

Q2 sales fell 4.9%; higher tire volume was offset by lower sales in tire-related businesses, weaker price and product mix, and unfavorable currency. Tire unit shipments rose 2.7%, led by replacement demand; original-equipment volume declined.
Q2 cost of goods sold was 75.9% of sales versus 78.6% a year earlier; selling, administrative and general expense was 15.0% versus 14.1%. Segment income improved as lower raw-material costs outweighed lower pricing and mix.
For the first half, sales declined 6.4% and common net income fell to $155 million from $206 million. The decline reflected higher Venezuela currency remeasurement losses, rationalization and pension charges, and higher interest expense, partly offset by improved segment income.
Segment performance diverged: Q2 EMEA operating income rose to $117 million from $51 million; North America was $208 million versus $204 million. Latin America declined to $59 million from $82 million, and Asia Pacific to $76 million from $91 million.
Six-month operating cash flow was negative $1.134 billion, versus negative $462 million. It included $1.257 billion of pension contributions and direct payments and $608 million of cash used by working capital. Capital expenditures were $441 million; investing cash flow was negative $421 million; financing cash flow was positive $376 million.
Cash and equivalents were $1.637 billion at June 30, down from $2.996 billion at year-end, primarily reflecting U.S. pension funding. Unused credit availability was $2.236 billion, down from $2.726 billion.
Total debt and capital leases were approximately $6.755 billion, plus $7 million of notes payable and overdrafts; year-end comparable amounts were approximately $6.235 billion plus $14 million. Current liabilities were $5.025 billion against current assets of $8.038 billion. The filing reports 39% of debt at variable rates, averaging 5.47%.
Q2 net income included a $20 million benefit from settlement of indirect tax claims in Latin America, comprising $3 million in segment income, $9 million in interest income, and $8 million in interest expense recovery.

Material changes and notable items

On April 1, 2014, mandatory convertible preferred stock converted into approximately 27.6 million common shares. This increased shares outstanding; no further preferred dividends are payable.
Goodyear contributed $1.167 billion to fully fund its hourly U.S. pension plans, including $907 million in discretionary contributions. The plans were frozen to future accruals effective April 30, 2014. The substantial funding was a major use of operating cash.
The company closed its Amiens, France manufacturing facility and is exiting the EMEA farm tire business. It expects approximately $75 million in annualized savings after closure and $40 million to $50 million of savings in 2014; $21 million was realized in the first half.
Six-month foreign-exchange losses included a $157 million Venezuelan bolivar remeasurement loss, versus $115 million in the prior-year period.

Outlook, risks and contingencies

Management expected 2014 tire unit volume to increase 2%–3% versus 2013. It expected 2014 raw-material costs to be about 5% lower than 2013, based on then-current spot prices, but revised its expectation for net raw-material costs and price/product mix to slightly negative, primarily due to weaker off-the-road tire mix.
Management expected cost savings to more than offset inflation and additional advertising, marketing and R&D spending. It expected a favorable $50 million–$75 million impact from changes in unabsorbed fixed costs, toward the higher end of that range.
For 2014, the company expected capital expenditures of $900 million–$1.0 billion, interest expense of $415 million–$435 million, global net periodic pension cost of $150 million–$175 million, and pension contributions of approximately $1.3 billion. It did not expect working capital to be a significant source or use of cash.
The updated 2014–2016 capital plan included approximately $1.5 billion of growth capital spending, up to $450 million of share repurchases through 2016, increased common dividends, and $800 million–$900 million of debt repayments and pension funding. The board declared a $0.06-per-share dividend payable September 2, 2014; future dividends remain subject to board approval.
Venezuela remains a significant uncertainty: currency controls restrict remittances, imports and pricing; government controls and operating issues may weigh on results. Goodyear recorded the bolivar at the SICAD I rate, while the SICAD II rate was approximately 50 bolivars per U.S. dollar at June 30. Applying SICAD II would have caused an estimated additional remeasurement loss of approximately $270 million. Management expected Venezuela-related factors to reduce Latin America 2014 operating income by $40 million–$60 million versus 2013.
Goodyear commenced arbitration seeking dissolution of its global alliance with Sumitomo Rubber Industries. A resolution or exercise of minority exit rights could require a payment to acquire SRI’s interests; the company did not expect a material adverse effect but the outcome is uncertain.
Recorded contingencies include $47 million for environmental matters, $308 million for workers’ compensation, and $317 million for general and product liability and other tort claims. The company reported approximately 73,900 pending asbestos claims; it noted that excess costs may be material but could not reasonably estimate them. Other disclosed exposures include a Brazilian indirect-tax assessment of approximately $42 million and Greek labor cases with potentially substantial claims.
Goodyear maintained a roughly $2.4 billion valuation allowance on U.S. deferred tax assets at January 1, 2014. Management said it was reasonably possible that sufficient evidence might permit release of all or a significant portion during 2014; certain foreign valuation allowances could also decrease by up to $105 million within 12 months.
Principal risks include raw-material volatility, foreign exchange and interest rates, high debt and financing access, emerging-market conditions, labor matters, litigation and tax assessments, and the ability to execute capital and restructuring plans.

Investor verification priorities

Track operating cash generation, working-capital needs, cash balances, and available credit after the large pension contributions.
Verify debt reduction progress, financing availability, covenant compliance, and the effects of variable-rate debt.
Assess whether forecast volume, raw-material savings, pricing, and cost reductions translate into sustained segment-margin improvement.
Monitor Venezuelan exchange rates, currency remittance approvals, import access, and related remeasurement exposure.
Check delivery of Amiens and farm-tire restructuring savings and the remaining restructuring obligations.
Follow pension funding and expense, deferred-tax valuation-allowance judgments, and material litigation or arbitration developments.