GOODYEAR TIRE & RUBBER CO quarterly report, Q2 FY2018

Goodyear Tire & Rubber Co. — Q2 2018 Form 10-Q

Business context and reporting period. Goodyear manufactures and sells tires through three regional segments: Americas, Europe, Middle East and Africa (EMEA), and Asia Pacific. This unaudited filing covers the quarter and six months ended June 30, 2018; amounts are in U.S. dollars unless noted.

Financial performance

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Net sales	$3.841 billion	$3.686 billion	$7.671 billion	$7.385 billion
Goodyear net income	$157 million	$147 million	$232 million	$313 million
Diluted EPS	$0.65	$0.58	$0.96	$1.23
Segment operating income	$324 million	$369 million	$605 million	$759 million
Segment operating margin	8.4%	10.0%	7.9%	10.3%

• Sales rose 4.2% in Q2 and 3.9% year to date. Q2 worldwide tire shipments increased 4.3%; first-half shipments rose 0.8%.
• Q2 cost of goods sold was 76.8% of sales versus 75.6% a year earlier; the first-half ratio increased to 77.2% from 75.1%. Calculated gross margin consequently declined to 23.2% in Q2 from 24.4%, and to 22.8% for the half from 24.9%.
• Q2 Goodyear net margin was approximately 4.1% versus 4.0%; first-half net margin declined to approximately 3.0% from 4.2%.
• Six-month operating cash flow was negative $84 million, compared with negative $185 million in 2017. Capital expenditures were $442 million, making operating cash flow less capital expenditures negative $526 million. Investing cash outflow was $470 million; financing cash inflow was $519 million.
• Cash and cash equivalents were $975 million at June 30, down from $1.043 billion at year-end 2017. Unused credit availability was $2.248 billion, down from $3.196 billion. Current assets were $6.569 billion and current liabilities $4.833 billion (current ratio approximately 1.36).
• Balance-sheet debt, including notes payable and current and long-term debt and capital leases, was approximately $6.347 billion, versus $5.729 billion at December 31, 2017. Forty percent of debt bore variable rates, averaging 4.08%. Interest expense declined in Q2 to $78 million from $89 million and for the half to $154 million from $176 million.

Material changes and management commentary

• Q2 segment operating income fell $45 million year over year, principally due to $34 million higher raw-material costs, $30 million lower price and product mix, $10 million lower income from other tire-related businesses, and $10 million higher research and development costs. Higher volume and lower conversion costs partly offset these pressures.
• For the first half, segment operating income fell $154 million. Key headwinds included $107 million higher raw-material costs and $46 million lower price and product mix; lower conversion costs, higher volume and favorable currency translation provided partial offsets.
• Americas operating income declined 29% in Q2 and 35% for the first half. EMEA Q2 operating income rose 25%, while first-half income was approximately flat. Asia Pacific operating income was nearly flat in Q2 and up 1% for the half.
• Management cited strong Q2 demand, particularly for consumer replacement tires in Europe and the United States, but warned of rising raw-material costs, a stronger U.S. dollar and softening conditions in China. Q2 cost savings were approximately $77 million and exceeded general inflation.
• Q2 net income improved despite lower segment income, helped by lower rationalization charges, lower accelerated depreciation and lower taxes. First-half net income declined, primarily due to lower segment income and TireHub-related and hurricane-repair expenses, partly offset by lower taxes, interest and rationalization charges.

Outlook, unusual items and risks

• For 2018, management expected tire unit volume growth of approximately 1%–1.5% and overhead absorption approximately $45 million better than in 2017; both expectations were reduced due to softer China markets. Cost savings were expected to exceed general inflation by approximately $115 million.
• Based on then-current assumptions, foreign currency translation was expected to reduce 2018 segment operating income by approximately $30 million. Raw-material costs were expected to rise approximately $190 million versus 2017 before cost-saving measures, with an estimated $165 million price-and-mix headwind net of those costs. Management cautioned that commodity-price volatility could materially change these estimates.
• Expected 2018 cash needs included approximately $900 million of capital expenditures, $325–$350 million of interest expense, $185 million of restructuring payments, $135 million of common dividends, $25–$50 million of non-U.S. pension contributions, and approximately $150 million of working-capital use. Management said liquidity was adequate for 2018 operating, investing and debt-maturity needs.
• TireHub, a 50/50 joint venture with Bridgestone, began operations July 1, 2018, after the reporting date. Goodyear expected to record a non-cash gain of approximately $285 million and an equity investment of approximately $292 million in Q3; no cash was exchanged at closing. The company planned to transition about 10 million annual units to TireHub and other aligned distributors.
• Other notable Q2 costs included $10 million of TireHub transaction costs and $8 million of hurricane-related repair expenses. First-half other expense also included $14 million of TireHub costs, $11 million of hurricane costs and a $9 million one-time pension-accounting adoption charge.
• Contingencies include approximately 49,500 pending asbestos claims, with $168 million of gross recorded asbestos liabilities and a $116 million insurance receivable. Approximately 850 former Amiens, France employees asserted claims totaling €119 million ($139 million); Goodyear said it could not estimate any ultimate payment. Workers’ compensation liabilities were $237 million, and the company estimated reasonably possible excess exposure of approximately $30 million.
• Key disclosed risks include raw-material and currency volatility, competition and economic weakness, labor disruptions, substantial debt and variable-rate exposure, borrowing-base and credit access, contingent liabilities and tax matters. The company reported compliance with applicable material debt covenants and effective disclosure controls at June 30, 2018.

Investor verification priorities

1. Track whether pricing and product mix, cost savings and productivity gains can offset raw-material inflation and the forecast $165 million net price/mix headwind.
2. Verify China demand, full-year shipment assumptions, and the effects of foreign exchange on segment results.
3. Assess cash conversion and working-capital needs against planned capital spending, restructuring payments, dividends and repurchases; monitor the decline in unused credit availability.
4. Confirm TireHub’s Q3 gain and investment accounting, transition of distribution volumes, and ongoing transaction or operating effects.
5. Monitor asbestos insurance recoveries, Amiens labor claims, other contingencies, and the potential tax-valuation-allowance release of up to $20 million described in the filing.