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
- 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.
- Verify China demand, full-year shipment assumptions, and the effects of foreign exchange on segment results.
- Assess cash conversion and working-capital needs against planned capital spending, restructuring payments, dividends and repurchases; monitor the decline in unused credit availability.
- Confirm TireHub’s Q3 gain and investment accounting, transition of distribution volumes, and ongoing transaction or operating effects.
- 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.