GOODYEAR TIRE & RUBBER CO quarterly report, Q3 FY2013

Goodyear Tire & Rubber Co. — Q3 2013 Form 10-Q

Business context and reporting period. Goodyear manufactures tires and operates through four regional segments: North America, Europe, Middle East and Africa (EMEA), Latin America, and Asia Pacific. This unaudited filing covers the three and nine months ended September 30, 2013; comparisons are with the same periods in 2012. Unless otherwise noted, amounts are U.S. dollars.

Financial results and key metrics

Metric	Q3 2013	Q3 2012	Nine months 2013	Nine months 2012
Net sales	$5.002 billion	$5.264 billion	$14.749 billion	$15.947 billion
Income before income taxes	$249 million	$186 million	$555 million	$408 million
Goodyear net income	$173 million	$117 million	$394 million	$205 million
Income available to common shareholders	$166 million	$110 million	$372 million	$183 million
Diluted EPS	$0.62	$0.41	$1.43	$0.73
Total segment operating income	$431 million	$348 million	$1.161 billion	$976 million
Segment operating margin	8.6%	6.6%	7.9%	6.1%

Q3 cost of goods sold was 78.9% of sales, versus 82.0% a year earlier; for the nine months it was 79.5%, versus 82.0%. The corresponding gross margins were approximately 21.1% and 18.0% for Q3, and 20.5% and 18.0% year to date.
Operating cash flow was negative $298 million for the first nine months, compared with negative $329 million in 2012. Investing cash flow was negative $725 million, including $734 million of capital expenditures; financing cash flow was positive $1.400 billion.
Cash and cash equivalents were $2.500 billion at September 30, up from $2.281 billion at year-end 2012. Unused credit availability was $2.374 billion, down from $2.949 billion.
Long-term debt and capital leases were $6.498 billion, including $132 million due within one year; notes payable and overdrafts were another $44 million. Total debt on these reported categories was approximately $6.542 billion, compared with approximately $5.086 billion at December 31, 2012. Interest expense was $100 million in Q3 and $287 million year to date.
At September 30, current assets were $9.069 billion and current liabilities were $5.184 billion. Goodyear shareholders’ equity was $952 million; total shareholders’ equity, including minority interests, was $1.203 billion.

Material changes versus prior comparable periods

Q3 sales fell 5.0%, while nine-month sales fell 7.5%. Management attributed the decreases mainly to lower chemical-product sales, lower price and product mix, and unfavorable currency translation; nine-month tire volume also declined.
Worldwide tire unit sales rose 1.9% in Q3 to 42.6 million, but fell 1.9% for the first nine months to 121.6 million. Replacement volume was weak year to date, particularly in EMEA and North America.
Q3 segment operating income increased $83 million, primarily because raw-material costs declined $237 million, more than offsetting lower price and product mix, higher selling and administrative expense, and higher conversion costs. Year-to-date segment operating income increased $185 million, principally on $754 million of lower raw-material costs.
Q3 Goodyear net income rose to $173 million from $117 million; year-to-date it rose to $394 million from $205 million. These comparisons include significant one-off and non-operating items, including Venezuela’s currency devaluation loss in 2013 and large debt-redemption financing charges in 2012.
Segment trends were mixed year to date: North America operating income rose to $492 million from $398 million; EMEA fell to $197 million from $214 million; Latin America rose to $231 million from $162 million; and Asia Pacific rose to $241 million from $202 million.

Outlook, management commentary, risks and unusual items

Management described developed-market industry conditions as weak but stabilizing. It expected Q4 2013 tire-unit volume to increase 2%–4%, a net benefit from raw-material costs and price/mix, lower under-absorbed fixed overhead at higher production levels, and cost savings to exceed general inflation.
For full-year 2013, management expected North American consumer replacement and commercial tire markets to be flat, with consumer OE up about 5%. In Europe, it expected consumer replacement flat, consumer OE flat to down 5%, commercial replacement up about 5%, and commercial OE flat to up 5%.
The company recorded a $115 million loss from Venezuela’s February 2013 bolivar devaluation. At September 30, it held $397 million of cash in Venezuela, where currency controls restrict remittances. Approximately $164 million of requested U.S.-dollar liability settlements were pending before the currency exchange board. Further devaluation or changes in access to foreign currency could cause additional losses.
Operating cash flow reflected $1.072 billion of pension contributions and $505 million of cash used for working capital. The pension contributions included an $834 million discretionary contribution to fully fund frozen U.S. pension plans. The company estimated 2013 global contributions to funded pension plans of $275 million–$325 million in addition to that discretionary contribution, and 2014 U.S. contributions of $250 million–$300 million.
The new four-year USW labor agreement allows Goodyear to freeze U.S. hourly pension plans and replace them with defined-contribution plans once fully funded; it also changes profit-sharing and provides staffing flexibility. Management expected the 2013 rationalization plans to reduce annual operating costs by approximately $23 million. The Amiens, France facility closure and EMEA farm-tire exit were expected to improve EMEA operating income by about $75 million annually after closure; the company expected the closure process to finish in time for a Q1 2014 closing.
Goodyear reinstated a $0.05 quarterly common dividend, with the first payment scheduled for December 1, 2013, and authorized a $100 million share-repurchase program intended to offset shares issued under equity compensation plans. Future dividends remain subject to Board approval.
Goodyear issued $900 million of 6.5% senior notes due 2021; substantially all net proceeds funded frozen U.S. pension contributions. Thirty-seven percent of debt carried variable rates, averaging 5.36%. Credit facilities and indentures contain restrictions, and the first-lien revolver’s borrowing base was $487 million below its stated $2.0 billion size. The company reported compliance with applicable material covenants.
Contingencies include $45 million of environmental liabilities, $315 million of workers’ compensation liabilities (with reasonably possible additional exposure estimated at approximately $40 million), and $302 million of general/product-liability and other tort liabilities. Approximately 74,000 asbestos claims were pending; asbestos liabilities were recorded at $141 million, with a $75 million insurance receivable. The filing says additional asbestos costs may be material but cannot reasonably be estimated.
Management identified risks from significant debt, pension obligations, raw-material and interest-rate exposure, competition, economic weakness, foreign exchange and restrictions on moving cash across borders, litigation and tax matters, and possible SRI alliance exit rights. No SRI exit-right notice had been provided as of the filing date. Disclosure controls were assessed as effective at September 30, 2013.

Important facts for investors to verify

Whether lower raw-material costs and expected cost savings can offset price/mix pressure, inflation, and weak replacement-tire demand.
How much cash and credit are practically accessible, particularly funds subject to restrictions in Venezuela and other countries, and the capacity to meet debt, pension, capital expenditure, and dividend needs.
Progress and actual costs of the Amiens closure, farm-tire exit, and other rationalization plans, including whether projected savings are achieved.
The persistence of Venezuela-related currency, remittance, and settlement risks, and recovery of the $13 million subsidy receivable.
Changes in pension funding requirements and the potential cash and earnings effects of pension, asbestos, workers’ compensation, environmental, tax, and other contingencies.
Whether the common dividend and announced repurchase proceed as described, while balancing debt reduction and other capital requirements.