AKRON—A very weak replacement tire market in North America coupled with rising raw material costs led Goodyear to post “disappointing” profits in the second quarter.
Goodyear posted record sales of $5.14 billion in the quarter, up 3 percent from the prior period's $4.99 billion. But the gains came mostly from improved pricing and product mix as the firm lost about 2.4 million units in volume—a 4.3-percent decline.
Net income fell 97.1 percent to $2 million from $69 million primarily on restructuring charges.
“The second quarter provided quite a mix of highlights and challenges for the company,” Chairman and CEO Robert Keegan told analysts during a conference call. “We posted strong sales, but disappointing profit results in the quarter.
“Those results primarily are a function of the challenging market conditions that we faced. At the same time, the progress we have made implementing our strategies continued to deliver significant gains.”
For the first half of the year, sales rose 2.4 percent to $10 billion from $9.76 billion last year, but net income dropped 44.5 percent to $76 million from $137 million a year ago.
North American Tire (NAT)—Goodyear's largest and erstwhile struggling unit—posted a slight gain in sales to $2.34 billion in the quarter, but volume slipped 7.9 percent to 23.3 million units.
A 10.7-percent drop in consumer replacement volume was partially offset by increased share of higher-value branded products, the firm noted. Goodyear also posted a decline of 300,000 units from the sale last year of its North American farm tire business to Titan International Inc.
Segment operating income also was slashed to $6 million from $55 million the prior year. Goodyear said the sharp decline was because of lower volume, divestitures, higher manufacturing costs and price mix improvements not offsetting higher raw material costs.
For the first half, NAT posted a 3.3-percent gain in sales to $4.58 billion despite a 7.3-percent drop in volume. Segment operating income was down 25.8 percent to $49 million from $66 million last year.
Operating margin in the segment also fell to 0.3 percent in the quarter and 1.1 percent for the half.
Goodyear wants that figure up to 5 percent by 2008, but the quarterly result is down from 1.9 percent in the first quarter and 1.8 percent for 2005. Total segment operating income fell 15.5 percent to $267 million from $316 million.
Still, investors seemingly weren't discouraged by the earnings report as Goodyear's stock closed Aug. 4 at $11.79, up 72 cents on very high trading volume.
Analysts pointed out that—discounting the restructuring and rationalization charges—Goodyear would have posted a profit of about $65 million for the quarter, above Wall Street expectations.
A major caveat, however, is that these charges are hardly rare occurrences for the cost-cutting tire maker.
“Given the ongoing nature of Goodyear's rationalization, associated charges may be viewed more as operating items as opposed to one-timers,” said analyst John Murphy of Merrill Lynch.
Indeed, Mr. Keegan said during the conference call that he intends to cut costs by 2008 beyond the $750 million to $1 billion goal he outlined last September.
“We have intensified that cost focus and have subsequently raised the bar of our cost reduction to more than $1 billion by 2008,” he said.
Those cuts will continue to come from the same areas previously identified. They include continuous improvement such as Six Sigma and lean manufacturing, reductions in Goodyear's manufacturing footprint, and selling, administrative and general (SAG) expenses and increased Asian sourcing.
Mr. Keegan pointed out that its restructuring moves this year already add up to 13 million of the 15 million to 20 million tires Goodyear wanted to remove by 2008.
Goodyear said it would close its plants in Upper Hutt, New Zealand, and Washington, England, plus draw down its private label manufacturing by 8 million units.
The private label tires are made in five North American plants, all of which are represented by the United Steelworkers union. Goodyear is in talks with the union for a new three-year contract.
Reducing this capacity “would require a corresponding reduction in tire manufacturing capacity in North America,” Goodyear said in filings with the Securities and Exchange Commission (SEC).
Goodyear also sourced more than $200 million in low-value tires, raw materials and capital equipment from Asia and plans to increase that to $500 million next year, Mr. Keegan said.
Overall, Goodyear hopes to cut $350 million to $450 million through continuous improvement; $100 million to $150 million from footprint reductions; $150 million to $200 million with Asian sourcing; and $150 million to $200 million from SAG.
“We've got a very difficult environment,” Mr. Keegan told analysts. “We've picked up the intensity…. Frankly, our culture has recognized the need here to be aggressive on costs. So from footprint through SAG through legacy, you're going to see significant changes in what we're doing, and we're more confident in our ability to take significant costs out.”
Regardless of the firm's cost-cutting moves, two major challenges Goodyear faced in the quarter were beyond its control. Mr. Keegan pointed to very sluggish demand in the replacement market—particularly in the low end of the spectrum—and skyrocketing raw material costs. Unfunded pension requirements and high long-term debt continue to drag on the firm as well.
The consumer replacement market is off 6.5 percent year-to-date, Mr. Keegan said. He added the market only has been down 3 percent or more in four of the past 50 years.
Customers are waiting longer to replace tires because they have less disposable income, they're only replacing the most worn tires instead of all four and they're driving less.
“The history indicates that such behavioral changes are likely to be temporary,” he said.
For the full year, Goodyear expects this market to be down 3 to 4 percent.
The cost of raw materials also plagued the tire maker, growing 16 percent or $210 million over last year.
“Prior to this year we've been able to overcome raw material inflation through two primary initiatives, price mix improvement and raw material productivity in the form of improved purchasing processes and lower-cost material substitution,” Mr. Keegan said. “During the first half of the year, our ability to move pricing higher to offset the rising cost has been challenged, particularly in our Western European business.”
To combat both of these challenges, Goodyear plans to work with its dealers to cope with the market, further reduce costs and reduce inventory to keep a strong cash position, he said.