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Goodyear Tire & Rubber (NASDAQ:GT)

Q4 2012 Earnings Call

February 12, 2013 9:00 am ET

Executives

Gregory A. Fritz - Vice President of Investor Relations

Richard J. Kramer - Chairman of the Board, Chief Executive Officer and President

Darren R. Wells - Chief Financial Officer and Executive Vice President

Analysts

Rod Lache - Deutsche Bank AG, Research Division

Itay Michaeli - Citigroup Inc, Research Division

Aditya Oberoi - Goldman Sachs Group Inc., Research Division

John Murphy - BofA Merrill Lynch, Research Division

John M. Healy - Northcoast Research

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

Ravi Shanker - Morgan Stanley, Research Division

Operator

Good morning. My name is Kevin, and I will be your conference operator today. At this time, I would like to welcome everyone to The Goodyear Tire & Rubber Company Fourth Quarter Earnings Conference Call. [Operator Instructions] I would now like to hand the program over to Greg Fritz, Goodyear's Vice President of Investor Relations.

Gregory A. Fritz

Thank you, Kevin, and good morning, everyone. Welcome to Goodyear's Fourth Quarter 2012 Conference Call. Joining me today are Rich Kramer, Chairman and CEO; and Darren Wells, Executive Vice President and CFO. On today's call, Rich and Darren will discuss our fourth quarter results, 2013 outlook and review the pension strategy we announced this morning.

Before we get started, there are a few items I need to cover. To begin, the supporting slide presentation for today's call can be found on our website at investor.goodyear.com. A replay of this call will be available later today. Replay instructions were included in our earnings release issued earlier this morning.

If I can now direct your attention to the Safe Harbor statement on Slide 2. Today's presentation includes some forward-looking statements about Goodyear's future performance. Actual results could differ materially from those suggested by our comments today. The most significant factors that could affect future results are outlined in Goodyear's filings with the SEC and in the earnings release. The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

The financial results presented are on a GAAP basis and in some cases, a non-GAAP basis. Non-GAAP financial measures discussed in the call are reconciled to the U.S. GAAP equivalent as part of the appendix to the slide presentation.

With that, I will now turn the call over to Rich.

Richard J. Kramer

Thank you, Greg, and good morning, everyone. Thanks for joining us today. Today I'll discuss our fourth quarter and full year results, elaborate on significant progress we have made, comment on the areas where we face challenges and discuss our plans to address these challenges. I'll also provide some perspective on the year ahead. But let me say upfront that overall, I'm particularly pleased with our fourth quarter and full year results and the execution of our strategy. The exception, however, is Europe as its economy continues to worsen despite some recent financial stability.

Now before I get started, let me provide some context. Industry volumes in 2012 were a challenge throughout the year, and in particular, mature markets were close to levels that we saw during the great recession. In the U.S., the economy improved, lifting OE sales, but replacement volumes remained depressed. In Europe, economic weakness continued, and consumer sales, which had been resilient in 2011, became increasingly weaker throughout the year. Though Latin America and parts of Asia were stable, growth was not robust, and some of our key markets, such as Australia, were extremely weak. That provides the backdrop for both our success and our challenges in 2012.

Overall, our segment operating income for 2012 was just over $1.2 billion, marking the second year in a row and only the third time in the company's history that we've reached that level of performance. Now in addition, we delivered strong cash results for the year as our progress on working capital helped generate $700 million of free cash flow from operations. These positive results were driven by strong performance in 3 of our 4 businesses.

In Latin America, we delivered solid fourth quarter results that reflect a stabilizing business. Investments in our operations in Brazil are helping reenergize the business in our most important market in the region. In addition, our businesses outside Brazil delivered historically strong results. Our focus on asset utilization and investment to increase our production capability in the region is aligned with our strategy to mix up in the faster growing premium market segments where our brand, our technology and our innovation have the most value.

Asia Pacific delivered record segment operating income of $259 million for the year. Weakness in Australia, our largest business in the region by revenue, created a challenge for both the top line and for earnings. Offsetting this weakness was solid performance in the ASEAN countries and strong growth in China. We're beginning to see the benefits of our strategic investments in China, which supports our focus on premium segments, where we continue to increase share by growing faster than the industry.

The highlight of our 2012 performance came from our North America business. A record fourth quarter pushed our full year earnings to $514 million, beating our 2013 target of $450 million a year early. In addition, the business delivered a margin of 5.3%, marking the first time in more than 10 years that North America has achieved that level. Also, we're recovering our cost of capital. Not only are we generating profit, but we are creating economic value.

As you know, returning our North America business to profitability is one of the key strategies on our strategy roadmap. We delivered these results in NAT through disciplined delivery against the key how-to's. For example, we focused on market-back innovation. By reenergizing our brands through the simplification and complete rejuvenation of our Assurance, Eagle and Wrangler product lines over the past 4 years, our product portfolio is the best in the industry. These are tires that consumers want to buy and customers want to sell. We targeted profitable segments. By making choices on where to play, supported by deep analytics, we identified those segments of the market that offer profitable volume growth and where our value proposition is a competitive advantage. As a result, we achieved improved price mix and grew share in these key segments.

Another illustration of winning in targeted market segments was in the original equipment business. We partnered with key OE customers, rather than pushing volume for volume's sake. Today, Goodyear is not only on 7 of the top 10 selling vehicles in the United States but also has a profitable OE business. We make strides in operational excellence as well, becoming a better supplier for our customers while simultaneously reducing inventory and improving efficiency. Our North America supply chain is a clear competitive advantage and, going forward, will only continue to improve.

Credit for executing our strategy goes to our North American team, led by Steve McClellan. At our annual North America Dealer Conference 2 weeks ago, our customers praised the team for its consistency and the clarity of its plan and for the integration of the business's goals with those of our dealers. Our team has never been more closely aligned with our customers and their business.

I'm proud of our progress in NAT, whose turnaround is comparable to any in the auto industry. In 2009, this business lost more than $300 million. In 2012, we delivered record earnings but more importantly, built the foundation of sustainable economic value creation in line with our strategy. And while we clearly have momentum, it's not enough. We're not focused on 1 year of earnings. We're focused on results delivered consistently over the long term.

So in addition to driving the key tenets of our strategy, we must continue to focus on productivity improvements, and we must address the ongoing volatility from our existing defined benefit pension plans. We will address both of these issues as we drive toward consistent value creation.

Now even with the success in North America, our 2012 results were tempered by ongoing challenges in Europe. During the fourth quarter, it became increasingly clear that the effects of the European economic crisis will be felt for an extended period of time. While recently, there has been some stabilization, we believe there has yet to be a comprehensive and lasting solution to the euro crisis. The resulting slow economic growth will continue to dampen consumer demand. This is particularly evident in the European auto industry, where vehicle sales are at 20-year lows. Multiple plant closures announced by European automakers point toward weak forward projections, which will inevitably impact the automotive supply chain. As this economic weakness continues, we see an environment where supply in many industries, including tires, will exceed demand.

Relative to our business, EMEA saw full year volumes decline of 16% or about 12 million tires. Consumer sellout continued to be weak amid high unemployment and economic uncertainty. Dealers reacted to the weak consumer demand and their already high inventories by reducing their orders even more, resulting in continued inventory destocking in the region. In addition, another milder-than-normal beginning to winter affected industry demand for winter tires, a traditional strength for Goodyear. The adverse industry environment was further complicated by internal challenges we had in providing the service our customers deserve and due to a high cost structure that's not flexible enough yet to handle the economic volatility.

Now recognizing these challenges and our overall outlook on Europe, we are implementing a profit improvement plan to return Europe, Middle East and Africa business to its historical margins. We're taking aggressive actions now to rebuild our earnings power rather than waiting for the pace of growth in the region to accelerate. Our plan in Europe is focused in 3 areas: first, in increasing share in our targeted market segments; second, accelerating growth in emerging markets; and third, driving productivity improvements in our supply chain, including our manufacturing facilities. I'll provide some color around each one.

First, we must win in Europe's profitable market segments. In many of these segments, including ultra-high performance and Run On Flat, for example, Goodyear has traditionally enjoyed a competitive advantage because of technology leadership, innovation and success in the magazine tire tests. We must continue to lead these segments and leverage our leadership in the newly implemented tire label ratings to further distinguish our winning products from the competition. Led by our lineup of newly released Goodyear EfficientGrip and Dunlop Blue Response products, Goodyear has the highest rated label portfolio in the industry, with more Ba-rated tire products than anyone else. This is a tremendous achievement delivering on our promise to lead the industry in tire labeling.

Now second, building upon our existing brand strength, we will increase our commitment to growth in emerging markets in the region. Growth in these markets creates opportunity for both consumer and commercial truck tires, supported by our leading brands and technology. We're confident that winning in these markets will lead to improved profitability in the region.

And finally, we are committed to productivity improvements throughout our operations in Europe. We're targeting $75 million to $100 million in productivity gains with further back-office consolidation, increased factory utilization and operational excellence initiatives that will improve factory output, reduce wastes and unnecessary losses in our factories and improve the supply of premium tires to customers in our targeted market segments. Our productivity improvement goal is in addition to the $75 million in expected earnings improvement from the announced closure of one of our manufacturing facilities in France. The passenger tires produced in this plant are low-value tires that are neither in demand nor consistent with our strategy. Additionally, the high cost of this plant's operation has affected our competitiveness in this region for an extended period of time.

While this profit improvement plan will take place over a 3-year time frame, we're confident in making steady progress over that time and beginning to see the results in 2014. Similar to our improvement plan in North America, we will leverage our brand strength in targeted market segments while improving our productivity and customer service. And keep in mind that North America's turnaround was accomplished without the advantage of growing emerging markets.

We already have begun executing a plan to rebuild our business in EMEA in a way that is consistent with our strategy roadmap and has the power to create sustainable results for the long term. We believe in the market opportunities in Europe and remain confident in our ability to deliver improvement in EMEA. The successful execution of our transformation in North America is proof positive that we know how to do this.

Now let me turn to another challenge we are addressing, the significant impact of record-low interest rates on our pension liability. As you know, this is an issue that many companies are facing. Despite the benefits of both our contributions to our pension plans and the strong performance of our portfolio last year, our unfunded liability has continued to increase. Our unfunded pension obligation has driven unexpected volatility in our earnings and cash flow for many years, at times overshadowing significantly improved operating performance and disrupting operating cash flow projections.

As you know, we've taken steps in the past to address legacy obligations, including establishing a VEBA trust to remove retiree health care obligations, freezing our salary pension plans and moving associates into 401(k) plans. We intend to proactively address the persistent risk posed by our unfunded pension obligations just as we addressed other benefit obligations that threatened our long-term strategy. We are announcing a pension funding strategy today, which Darren will discuss in detail during his remarks. Our goal is to drive consistent, sustainable value creation over the long term. By addressing our chronic, unfunded pension obligation, we will free up our business to drive further shareholder value.

Regarding our expectations for 2013, I'd like to start by revisiting the key -- the 3 key targets that we identified in March of 2011. First, we set a segment operating income target of $450 million for our North American Tire business. We reached and surpassed that goal 1 year early despite declining industry volume and higher-than-expected pension costs. Second, we set our global segment operating income target at $1.6 billion by the end of 2013. Since setting the bar at that level, we have delivered consecutive years of at least $1.2 billion in a slow growth cycle, something that we've never done before. With that said, given the continued weakness in Europe, we are adjusting our outlook. We expect total segment operating income to be between $1.4 billion and $1.5 billion this year, still a 12% to 20% increase over 2012 and record levels for our company. Finally, we targeted break-even cash flow in 2013. We have delivered strong cash performance over the past 2 years and continue to target positive cash flow in 2013.

We feel very positive about the progress made in our North American, Latin American and Asia Pacific businesses in 2012, and are confident in our ability to continue delivering improved profitability. We believe the fundamentals of our business are strong and that the megatrends shaping the tire industry play to our strength. We believe our strategy roadmap is clear. And despite challenges in Europe, we believe we are positioned to deliver positive results over the long term. And while we anticipate that growth in the global tire industry will continue at a modest pace in the near term, we still believe that a return to a more robust tire industry growth is not a question of if but when, and we'll be ready for it. We continue to make the necessary adjustments to our business now but to be prepared when the cycle continue -- when the cycle returns upward. We are confident in the fundamentals of the tire industry and in our ability to continue our positive momentum.

Now I'll turn the call over to Darren.

Darren R. Wells

Thanks, Rich. We have quite a bit of material to cover today, so I'll keep my fourth quarter remarks brief to leave more time to discuss our pension strategy, our 2013 outlook and your other questions.

Turning to the income statement on Slide 11. Our fourth quarter revenue decreased 11% from last year to $5 billion. The decline primarily reflected a 7% reduction in unit volume and lower third-party chemical sales due to the year-over-year decline in butadiene spot prices. EMEA volumes accounted for about 80% of the overall unit volume decline. Revenue per tire increased 1% compared with the prior year, excluding the impact of foreign exchange, and we continue to benefit from mix improvements, reflecting our ongoing focus on profitable market segments.

We generated gross margin of 18.7% in the quarter, a 340-basis-point improvement versus the prior year despite lower volumes. Improvement was largely driven by continued strong price mix performance as we continue to see the benefit of lower raw material costs. Gross margins also reflected strong cost savings.

Selling, administrative and general expense decreased $17 million to $707 million during the quarter. Foreign currency translation and lower advertising expenses more than accounted for the decline in SAG.

Excluding discrete items, our fourth quarter tax rate as a percent of foreign segment operating income was about 21%. As in 2012, we expect 2013 income tax expense as a percent of foreign segment operating income of approximately 25% to 30%. Fourth quarter after-tax results were impacted by certain significant items. A summary of significant items can be found in the appendix of today's presentation.

Turning to the segment operating income step chart on Slide 12, you can see the comparison of operating income compared to the prior year. Favorable raw material costs and price mix were significant drivers of the year-over-year improvement during the fourth quarter, and we're in line with the outlook we provided in October. Lower volume reduced income by $57 million, while production cuts resulted in $119 million of additional unabsorbed fixed costs during the quarter, even after Union City closure savings. Cost savings of $106 million more than offset general inflation of $63 million. This significantly exceeded our $3 billion -- 3-year $1 billion cost savings goal.

The other category includes higher pension expense and a $15 million benefit from other tire-related businesses primarily related to third-party chemical sales. The year-over-year improvement in chemical earnings was attributable to the low level of earnings we reported in 2011. We expect to see this impact reverse in the first quarter as we reported strong chemical earnings in Q1 of 2012. We expect to see a negative year-over-year variance of approximately $25 million for other tire-related earnings in Q1.

Turning to the balance sheet on Slide 13, our net debt totaled $2.8 billion. Compared with a year ago, our net debt increased $376 million. The increase included costs related to debt refinancing and notes prepayment and also reflected the lease of a new headquarters facility as debt on the balance sheet.

Year-end unfunded pension obligations increased to $3.5 billion from $3.1 billion a year ago. While our portfolio returns exceeded our 8.5% return assumption, lower discount rates and increased life expectancy assumptions more than offset the returns. As Rich mentioned, we've announced a strategy to pre-fund and de-risk our U.S. plans. I'll discuss that plan in more detail in a moment.

I'd like to highlight our year-end inventory, which was just over $3.2 billion. We aggressively reduced our production schedules to balance our supply of tires with a challenging demand environment. We've made strong progress not only in reducing inventory on the balance sheet but also in reducing unit inventory levels, which are down approximately 4 million units from 2011 year-end levels. While these production cuts adversely impacted earnings in 2012 and will have a carryover effect in Q1 of 2013, they protect our cash flow and mean the future volume recovery will drive increased production volumes and lower unabsorbed overhead.

Slide 14 shows free cash flow from operations. During 2012, we generated $701 million of free cash flow from operations. This cash flow was used primarily for contributions toward our unfunded pension obligation. In addition, we also reduced our gross debt position and made payments toward restructuring activities.

Moving to individual business units, I'll start with North America. North American Tire reported segment operating income of $116 million in the fourth quarter compared to $21 million in the prior year. North American unit volumes were down 5%. Lower volume in Consumer Replacement, Commercial Replacement and Commercial OE were offset partially by increased volume in Consumer OE. In the fourth quarter, North American Tire realized a raw material cost benefit of $150 million. Our price mix was lower by $11 million, partially attributable to our raw material cost pass-through arrangements with OE customers. North American Tire's fourth quarter manufacturing costs reflected higher unabsorbed overhead of approximately $65 million as we've lowered our production levels in response to the softer industry environment. Consistent with prior quarters, we realized approximately $20 million in savings from the closure of our Union City factory in July 2011, bringing our full year savings to approximately $80 million. North America's full year segment operating income totaled $514 million, the highest ever achieved in North America, and a recovery of over $800 million over the last 3 years. This is important: North America's segment operating income margins, at over 5%, now result in a return on invested capital that adds economic value for shareholders and starts to make growth in the North America business an attractive investment going forward.

EMEA results in Q4 reflected the trends that we've seen over the last 3 quarters. While our revenue per tire remained solid and we benefited from lower raw material costs, our overall results were weak, the result of significantly lower volume and the impact of high manufacturing cost structure in a weakening economic environment. While some of our volume weakness relates to declining industry volumes, a part of the volume decline reflects the need to improve our value proposition. This value proposition includes our service levels, supply chain flexibility and our cost structure. As you heard from Rich, our technology continues to lead the industry with summer tire label grades that are best in class. While actions to improve our service levels and our supply chain are well under way, it's clear we need to make a substantial improvement in our cost structure and our manufacturing flexibility.

Given the weakness in the European industry, the closure of Amiens is critical to ensure competitiveness. As Rich mentioned earlier, we are taking additional actions in the areas of targeted market segment growth, accelerating our emerging markets presence in the region and improving our productivity. These actions, along with our continued investment in industry-leading products and technology, will help us return our EMEA business to its historical margins even if recovery in industry volumes are slow.

Unit volumes in Latin America decreased just under 1% during the quarter. Excluding the impact of exiting the bias truck tire business, total unit volumes would have increased 4%. Total replacement volumes increased 2% during the quarter, driven by our Consumer Replacement business. The strength in our replacement units was partially offset by a 6% decline in Commercial OE. Despite the strong Replacement volume, total Latin American net sales in the fourth quarter were $541 million, increasing 9% versus the prior year. Unfavorable foreign currency translation and the sale of the bias truck tire business more than accounted for the decline. These reductions were partially offset by improved price mix. Operating income was $61 million during the quarter, $13 million above prior year level. The improvement was mainly driven by favorable price mix of $35 million, which was offset partially by cost inflation.

Unit volumes in Asia Pacific were 5% higher than a year ago, given strong growth in China and recovery from the 2011 flood in Thailand. Our Asia Pacific business reported segment operating income of $57 million for the quarter. Excluding the Thailand flood impact and Pulandian start-up costs, our earnings were up about $6 million versus prior year, reflecting solid price mix and favorable raw material costs. Overall, we continue to be pleased with our performance and see further opportunities in Asia, particularly in continuing to gain share in China and in executing a turnaround in Australia as we adjust our business model to current market realities.

Before turning to the outlook, I'd like to take a moment to discuss the pension strategy that we've announced this morning, which is summarized on Slide 16. As Rich highlighted earlier, we've taken many actions to eliminate our exposure to legacy obligations. Today, we're announcing our intent to pre-fund and de-risk our plans as they are frozen. The frozen salary pension plans currently account for approximately $1 billion out of our $2.7 billion U.S. underfunded position. We expect to use debt financing to raise funds for these accelerated contributions.

Skipping to Slide 20, we summarize the implications of our pension strategy. Pre-funding our U.S. salary plans would result in improved operating cash flow, reduced volatility in our pension funded status and the impact that funded status has on leverage, earnings and cash flow. While pre-funding itself will be neutral to overall leverage, our goal is to pre-fund and de-risk our pension plans, more closely aligning our financial results with the performance of our tire business.

As a precursor to accelerated funding actions, we've put in place derivatives to reduce our exposure to market movements during 2013. Slide 22 shows our sensitivity to discount rate changes, incorporating the effect of these hedges. As you can see from the analysis presented, we maintain the majority of the benefit of an interest rate increase while significantly limiting our exposure to an interest rate decrease during 2013. These actions reduce our exposure to market volatility going forward as we move to execute our pension strategy.

Turning to Slide 23, you can see our 2013 industry outlook for North America and the EMEA. In the Consumer business, we expect Replacement markets to be flat to up 2% in both North America and EMEA. In OE, we continue to see positive trends in North America and expect industry demand will increase approximately 5% in 2013. In EMEA, we expect to see the softness continue into 2013 and expect industry shipments to decline another 5%. Turning to commercial truck, we expect both North America Replacement and OE demand equal to 2012 levels, although we expect the first half of the year to show some softness before improving in the second half. In EMEA, we expect Commercial Replacement demand to increase about 5% after a soft 2012. In OE, we expect demand to be flat to up 5% for the year.

On Slide 24, you'll see the modeling assumptions behind our 2013 segment operating income expectations. While our segment operating income expectation is a record level for Goodyear, it represents a 12% to 20% increase over our 2012 segment operating income, which is below our $1.6 billion target, driven by EMEA and the recently announced devaluation in Venezuela. As we implement our profit improvement plan for EMEA and work our way through the impact of the devaluation in Venezuela, the $1.6 billion should be achievable, just not in 2013. Outside of EMEA, we're clearly ahead of plan -- that plan that we set out 2 years ago.

We are well ahead of our plan on North America, which at the time was by far our most challenged business unit. In addition, we've delivered far better cash flow over the last 2 years than we expected and remain on target to deliver positive cash flow in 2013. We'll achieve this with 30 million to 40 million fewer units than we originally planned to sell in 2013. But from that perspective, the fundamental earnings power of our business is substantially ahead of plan, despite pension deterioration, the delay in completing the restructuring plan for consumer capacity in Amiens, France, and despite dramatically weaker volume and lower manufacturing capacity utilization, and despite adverse currency effects.

In EMEA, we are taking actions to address deterioration in that market. These actions, combined with the growth opportunities we see in emerging markets and the opportunity from pent-up demand across many mature markets, positions us well for continued earnings growth as we move beyond 2013.

With that, we'll open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from the site of Rod Lache from Deutsche Bank.

Rod Lache - Deutsche Bank AG, Research Division

Just a couple things. First, on your volume expectations for North America and Europe, you said 0% to 2% for Replacement. Wondering what does that imply for Goodyear? Is it similar? Just over the course of this past year, you had some underperformance both in -- in both of those regions.

Richard J. Kramer

Well, Rod, I think from our North America businesses, as we look ahead, we don't see a robust industry in terms of what the economy is doing here, but we still see sort of the GDP type of growth in the economy, and that's going to drive the volume forecast that we see.

Darren R. Wells

Yes, so I guess, Rod, if you look at our -- I mean, our view is that we'll have low-single-digit growth this year. I think if you match that up with the industry outlook, you're going to find it's pretty well in line.

Rod Lache - Deutsche Bank AG, Research Division

Okay. Can you comment also on raw materials. If spot prices stay where they are right now, how would you see that going forward?

Darren R. Wells

Yes, so I think the answer on this is a little bit longer answer, Rod, because I think if we just said that raw materials remain flat for the remainder of the year, there would be a raw material cost decline in the neighborhood of $800 million. Yet the difficulty is that we do -- I mean, we do see some recovery in industry volume this year, but to the extent volumes start to increase again, we would expect that raw material costs would start to increase also. And that's effectively what we've had to take into account as we look at what our performance looks like during the year. Because we are expecting some improvement in volumes even at low single digits, us and the industry. And I think that to go along with that, we have to expect the raw materials are going to start to increase again as well. And as you know, our expectation over time is that raw material costs are going to continue to rise.

Rod Lache - Deutsche Bank AG, Research Division

Okay. And just lastly, a little clarification here on the pension funding. What discount rate are you using right now? What's the rate of return on your assets that you're assuming? Is that current discount rate a good proxy for the underfundedness just given that you're planning to shift more towards fixed income? And can you just lastly add a little commentary on why are you making these changes right now? Did something serve as a catalyst for that?

Richard J. Kramer

So, Rod, I'll start, and I'll let Darren go through the discount rates with you as well. But I think as we think about this -- I'll just personalize it a little bit. I've been here now about 13 years. In the early part of the last decade, we were about $2 billion underfunded. And after we put in literally billions of dollars into our pension plans and doing a lot of things like changing the benefit structures that we had, moving to 401(k)s, freezing the salary plans and the like, we end 2012 with an unfunded domestic pension plan of about $2.7 billion. In other words, after putting a lot of money in, it's gotten even worse. And we know why that is, discount rates and the like. So we take a step back and concluded ourselves that we need to address the volatility we have here. As you know, it's volatile to our earnings, to our leverage, to our cash flow and ultimately, to our stock price. And as we think about the strategy roadmap that we've put out, as we think about the destination of where we want to go to create value over the long term to improve shareholder value, we think that this is very much consistent with that. So that's sort of a view into the thinking of what we're doing here. But, Darren, you could -- you can elaborate on the discount rates.

Darren R. Wells

Yes. So, Rod, the -- at the end of the year, the average discount rate for the U.S. plans is about 3.7%, which compares to about 4.5% at the end of last year. We obviously -- I think given the movement in the bond markets, discount rates have probably risen a bit earlier -- early this year. But at year end, it was 3.7%. We continue to assume -- for the purposes of our pension expense estimates for 2013, we're assuming portfolio returns at 8.5%. So that has not changed. I will tell you that as we execute the pre-funding actions, we will adjust that. As we pre-fund, we will shift the portfolio more toward fixed income, which means that assumed return will come down. But as we execute those actions, there are a number of assumptions that we'll have to provide you to update for those funding actions. So what you've got right now is 2 things. You've got sort of our normal pension assumptions going into the year. So you've got our required contributions, which are around $300 million. And you've got our pension expense, assuming we don't do anything beyond what we've done right now, which is just the hedging transactions that we talked about. As we implement pre-funding, those assumptions are going to change. But since the pre-funding is not done, we've given you the baseline assumptions, and we'll update you as we need to.

Rod Lache - Deutsche Bank AG, Research Division

When you say fixed income, moving toward fixed income, I'm presuming you're not assuming entirely fixed income. Do you have some ratio in mind of what asset allocation should be?

Darren R. Wells

Yes, so, Rod, I think we'll take a pass on that right now, and we'll come back as we execute that. But I think the closer we get to fully funded, the closer we're going to be to being fully invested in fixed income. And I think the ultimate idea is that once the plans are fully funded, that we would have an asset portfolio that would be made up of bonds that would closely mirror the bonds that are used to calculate our discount rate. So that if there was a move in the interest rate curve, the gain on the asset would offset any loss related to discount rate and vice versa.

Operator

We'll go next to the line of Itay Michaeli from Citi.

Itay Michaeli - Citigroup Inc, Research Division

Just first, 2 clarifications on Europe. One, are any of the savings from the French closure, to get $75 million, contemplated in the 2013 SOI target, or is that mostly a 2014 event?

Richard J. Kramer

No, Itay, that is not going to be achieved in 2013. That's one of the things I think we concluded as we went through the fourth quarter, is what the status of that situation is. Obviously, we made some changes to that with -- to what we were on plan to do with our announcements in early January -- or late January, I should say. And the impact of that sort of pushes out the benefits we're going to get beyond 2013.

Itay Michaeli - Citigroup Inc, Research Division

That's helpful. And then the $75 million to $100 million of additional productivity over the next 3 years, should we think about that as a gross savings that could be offset with some inflation, or is that sort of a net-of-inflation savings number we should be modeling?

Richard J. Kramer

Our target is that's gross savings. That's as we look at -- excuse me, the $75 million is net savings, I'm sorry, excuse me. But the goal that we have is to drive those programs to take our European business back toward its -- toward the historical profit margins that we've seen in the past.

Darren R. Wells

Yes, so when you look at cost savings actions overall, Itay, you're going to -- you heard the view that as we look at cost savings going forward, we're going to at least offset inflation. You should look at those -- that $75 million to $100 million of productivity actions in Europe as being over and above inflation.

Itay Michaeli - Citigroup Inc, Research Division

That's great. And then go back to volume, the Q1 outlook is still sort of weak, and you do expect improvement throughout the year. Can you talk about what you're assuming for dealer stock situations, restocking, destocking in both North America and Europe throughout 2013?

Richard J. Kramer

I think, Itay, as we talk about North America, we said now for a number of quarters that as we look at what we see, we see low inventory in the RMA manufacturing inventory, we see low inventory in the channels, which continues to point toward an opportunity for a rebound. So inventories are low. As volume comes back, we think there's going to be an opportunity for restocking. As we said, it is not a question of if but when. But as we plan the year, we see the opportunity for it happening. However, as we talked earlier, our growth rates in North America continue to be in that low-single-digit rate. For Europe, we continue to see higher inventories still, as we said in our remarks. Because of the low -- weak economy there, dealers continue to sort of take a wait-and-see attitude. The sort of weak start to the winter again resulted in dealers still having higher inventories than we'd like. So it's very hard to get insight into exactly what inventories are across Europe. But I would tell you, our view right now is it's still higher inventory levels, and that's certainly played into our volume outlook and our adjustments to our outlook on Europe for 2013.

Operator

And we'll go next to the line of Aditya Oberoi from Goldman Sachs.

Aditya Oberoi - Goldman Sachs Group Inc., Research Division

Guys, I had a question on your guidance for segment operating income. At the midpoint, it implies $150 million cut, and that is driven by a couple of -- 2 or 3 factors. Can you bucket how much of an impact is due to Venezuela and how much is EMEA and then how much is Europe?

Darren R. Wells

Yes, so, Aditya, I think the -- what we've done -- first of all, I guess on the Venezuela situation, obviously, that's one that's -- it's a very recent effect, so that was just announced at the end of last week. So we've tried to take that devaluation and work it into our foreign exchange expectations for the year. So the foreign exchange impact that we expect for the year is a negative impact of $40 million to $60 million, a significant part of that driven by the situation in Venezuela. But I'll say that we're internally [indiscernible], we're still evaluating Venezuela, so not easy to pin that down with any precision at this point. But you can certainly assume that there is some element there. I think the impact beyond that is very focused in EMEA, and I think we look at that, we look at where we've been over the last 3 months, we -- I think we were still, even as late as October, continuing to work on a plan that would get us to $1.6 billion. And what we saw as we went through November, went through December and went through January, was -- rather than recovering, rather than Europe recovering, it, in fact, continued to get even weaker. So we were seeing very significant slide there in volume, very weak winter season, so the environment there getting even tougher. And what became clear is we were going to have to take another approach to the situation in Amiens, France, which we announced at the end of January. But clearly, if we'd been able to complete the restructuring and sale of that factory, then that would have given us an opportunity for benefits in 2013. As it is now, the -- we've begun the consultation process on a plan to close that factory in its entirety, so both the Consumer and the Farm Tire production. But that process is going to take us longer, so we won't get the benefit in 2013. I think we take all of that and add to it the continued weak outlook for auto production in Europe. And we see a number of things that are going the wrong direction, so you can tell that a lot of the impact we're looking at here does relate to Europe.

Aditya Oberoi - Goldman Sachs Group Inc., Research Division

And that's helpful, guys. And one more, if I may. You guys did a good job in constraining or pulling back on inventory versus where you guys were in the recent past. Do you think it could weigh on your sales? Because historically, we have seen like having tight inventories at dealer level has impacted your sales and market share in the past.

Richard J. Kramer

No, I think we actually feel very comfortable how we've managed our inventories. And I think what I'd point toward is the improvements we made in the element of our strategy around operational excellence as we've -- as we made progress on our internal processes and forecasting and the like, we've actually been able to improve our supply to our customers while maintaining lower inventories through the process changes we've made, and that's one of our focus, to make that a sustainable improvement to how we manage the business. So of course, inventories may move around as we see -- when the industry does come back, we'll adjust a little bit accordingly. But at the end of the day, our goal is to run our business on lower inventory while improving our service levels. And I would say particularly in our North America business, we made tremendous progress on that in 2012.

Operator

We'll go next to the line of John Murphy from Bank of America.

John Murphy - BofA Merrill Lynch, Research Division

This pension stuff is really interesting, and the timing sounds pretty good from a borrowing standpoint. I'm just curious, as we look at the $2.7 billion underfunded, looks like you got $1 billion that is frozen at this point. Is that sort of the target of the capital or the debt raises, the $1 billion? Or if there's a big appetite, would you be more opportunistic and maybe do something even larger? Just trying to understand how big this effort might be.

Darren R. Wells

Yes, no, John, I think you -- yes, I mean, you picked up on the right point there, which is the fact that we see this as a 3-step process: first is to freeze the plan; second, to pre-fund it; and third, to de-risk the asset portfolio or the investments related to it. And right now, the only -- the part of our pension plans that are through step 1 or the freezing step is that $1 billion. So that's effectively what's eligible for the pre-funding step as we sit here today. Having said that, I mean, our view is that we should take the step of freezing in our other plans as well. Obviously, that will require discussions with our workforce and some additional steps that will take some time, so that hasn't happened yet. We're obviously anxious to do that as quickly as possible, but the -- for right now, what we'd be looking at is the $1 billion of the unfunded amount that's in frozen plans.

John Murphy - BofA Merrill Lynch, Research Division

Okay, that's great. And then just a second question, as we look at the SOI increase year-over-year in 2013, it's about $150 million to $250 million, which is a big increase. And you guys are kind of indicating that Europe is not going to be so great on a year-over-year basis. I'm just curious as we look at the 3 other major regions where you think that real strength or increase year-over-year will be, will that be really North America, Asia Pac or Lat Am? I'm just trying to understand where you see that big positive year-over-year increase.

Richard J. Kramer

Yes, John, we don't -- obviously, we don't give guidance on each of the -- each of our SBUs, but I think as we looked at the $1.6 billion target, I have to say all of our businesses were really on path to achieving the sort of the goals that we set out for them. So I think we see certainly a continued, sustainable progress in North America. As we said on the call, our Asia business, led by the growth in China and our new factory there, presents us with excellent opportunities. We're growing there faster than the industry and gaining share in the segments that we want. And we got some headwinds in Australia, but we're managing them, and hopefully, we'll see some upside. And in Latin America, we're stabilizing our business there. We've seen improvements in Brazil, and obviously, that's a great market and a great place where our brand and our distribution is still a big asset for us. So to those 3 businesses, really, we still see the same things we saw before. It's really a question of what Darren went through in Europe around a weak economy, weak -- weaker volumes, a tougher auto industry and the impact that's going to have on our volumes and unabsorbed overhead. That's really where we stand.

Operator

We'll go next to the site of John Healy with Northcoast Research.

John M. Healy - Northcoast Research

Question for you, Darren, on cash flow. I think in the slides, you mentioned working capital would be neutral to the use of about $100 million. I hope you can give us a little color on how you get there, with the thought that volume increases low single digits and the thought that with volume gains, maybe raw material prices go up a bit. Are there some things working in the background that are making you guys more efficient at kind of managing the working capital of the business and maybe how you think about working capital longer term as you guys enter this next phase of, hopefully, industry growth.

Darren R. Wells

Yes, so, John, yes, I think it's a fair question. And as we look at this, the fact that we're -- we look to use anywhere from $0 to $100 million this year, obviously, it's not part of our long-term outlook. I mean, our long-term outlook has been that working capital should be neither a source nor a use. However, I would say in the last couple years, and in 2012 in particular, we did very well and, in 2012, generated a significant amount of cash from working capital. If I take the long-term perspective, I would say we have consistently driven down working capital as a percent of sales, and that is what we plan to continue to do. We're going to continue to work on that rhythm. I would say that for much of the last 5 years, significant amount of progress has come in working on our accounts receivable and working on our accounts payable. I think with the work that we're doing in operational excellence, we see some opportunity in inventory, and that's where I think I see some of the forward opportunity. We've essentially delivered some of that in our North American business, and that's been -- as Rich said, that's a part of the story. We've delivered it in North America, and we've maintained and improved our service levels. There are other parts of the world where our supply chain processes are not as advanced and where we have that same opportunity. So I think we're looking at being able to continue to drive down inventory levels, and that's going to allow us to continue to drive down working capital as a percent of sales as a long-term matter. Having said that, 2013, with the volume increases that we're looking at and the fact that raw materials may come back, I think that that's what led us to the view that there may be a modest use of cash there in 2013.

John M. Healy - Northcoast Research

That's helpful. And then I was hoping you guys could give a little bit more color on the environment in Australia. I know you called it out earlier in the prepared remarks, but maybe just also on the competitive environment there, how the [indiscernible] and just your thought process on when that market may turn.

Richard J. Kramer

So, John, Australia is a business where basically our business is all retail at this point. As you may remember, we closed a number of factories over the past few years, and by and large, the retail business that we have there is really being impacted by the economy. As you're I'm sure aware, the non-mining economy in Australia is very -- is a very difficult one right now, and that's what we're feeling. In addition, Australia is a market that gets a lot of imported tires, so a lot of that market is certainly receiving some of the volumes from other parts of the world, which also adds another headwind to our challenge there. That said, our retail presence there is significant. We feel the value proposition that we have and that we're going to improve is going to put us at a competitive advantage in the region. We've taken a lot of actions to do that in terms of new products, in terms of how we go to market there and in terms of significant cost reductions, both within our stores and within the supply chain in Australia as well. So the environment there I think will remain tough. I think to a large degree, it's going to be contingent on the Australian economy at large, but we're not going to wait again for the economy to improve to drive improvements in our business. Long term, we see it as a good business. Near term, we're going to continue to work hard to get to an improved position at this point. Now, John, also say -- well, I'll leave it at that. I'll leave it up to your [indiscernible]. That's it.

Operator

Moving next to the site of Brett Hoselton from KeyBanc.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

I wanted to ask you a little bit about Europe and some of your thoughts there. I guess, specifically first of all, increasing market share, what segments are you thinking about in terms of your potential market share increases there?

Richard J. Kramer

Yes, I think, Brett, I think we -- I highlighted, and I think Darren may have commented as well, we play very well in the premium segments there, ultra-high performance, Run On Flat, winter high performance, 4x4, all these segments, and those are opportunities where our technology really plays traditionally, and we're going to continue to go after those markets. Now in addition to that, the new opportunity in Europe is in tire labeling. And as I made a remark -- as I made comments in my remarks, that as we look at the summer portfolio, the high-performance summer portfolio that's out right now, our Goodyear brand and Dunlop brand products are really doing fabulous. I'm extremely pleased with the team and how they put together the technology, industrialize it and have these products to market to lead the industry in the best labeled portfolio in the industry right now. That's a huge win for us. And when we talk about -- in our strategy, we talk about technology being an advantage for us and really the megatrends playing up to technology increases plays to our advantage, I think labeling is really the proof point of why we think that and what we're capable of doing.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

And as you think about your comment regarding European margins returning to historic levels based on the actions that you're looking to take here, can you talk a little bit about how should we think about your operating income progressing from 2012 to 2013 in Europe? Do you expect it to improve? And then in terms of returning to historic margin levels, is that kind of in line with the 3-year restructuring that you're looking to do, or is that more of a "we think it's going to take 2 years," or is it 5 years? How do we think about the timing there?

Darren R. Wells

Yes, so, Brett, I think you've picked up the right point in terms of the productivity plan. Yes, so we've got a couple of things going on. I think, base income level for 2012 was $252 million premium. We've said that we will have some modest volume growth in the Consumer Replacement business, but overall, not a lot of volume growth in Europe, so there's not a lot of volume in 2013. And I think we've said that the savings -- or the profit improvement from the restructuring plan in Amiens is something that won't affect 2013. And I think we look at the productivity as $75 million to $100 million over 3 years, so there may be some modest amount there achieved in 2013 but not a lot. So I think you can look at this and say that a lot of the actions that we're taking are going to affect 2014, 2015, to the extent there is some volume recovery in 2013, and that's helpful. But that's the thing that is going to be most helpful in the near term.

Brett D. Hoselton - KeyBanc Capital Markets Inc., Research Division

And then just finally here, the growth in the emerging markets, I believe that's a European comment, and it's -- I think you're thinking Eastern and Central Europe or some of the regions or countries in that area. Is that correct?

Richard J. Kramer

Yes, no, you're right on, Brett.

Operator

And we'll take our final questions from the line of Ravi Shanker with Morgan Stanley.

Ravi Shanker - Morgan Stanley, Research Division

A follow-up question on the share. You have been giving up share in North America the last few quarters to focus on segments that you really want to be in and to boost the price mix. So when you're talking about future share gains, are you referring to just the segments you are in or versus the overall market?

Richard J. Kramer

Yes, I think, Ravi, our strategy is to focus on profitable volume. So we've often said, not volume simply for volume's sake. And our volume weakness that you refer to is reflected in a number of factors really on an overall basis, reflecting our weighting toward more mature markets and as you rightly pointed out, our choice to leave certain of those businesses. So I'm very pleased, I have to say, with the disciplined strategy that the teams have implemented and executed, and particularly in North America. We've made some very good choices both on the Replacement side and the OE side to drive our profitability. And as we've always said, our goal is to win in those targeted market segments where our value proposition delivers value for ourselves, for our customers and for our consumers. That's where we're going to focus. And by definition, that hasn't been at the low end of the market, which is why we exited some of those opening-price-point tires. That said, we're very cognizant that volume in total is not something that we can take our eye off of and we won't, but again, our focus will not be on simply volume for volume's sake.

Darren R. Wells

No, the only other thing I could add there, Ravi, is the fact that we did see share gains in the Goodyear brand at the end of the year. We're continuing to get -- continuing to build the value of that brand. So it's other area -- other tires outside the Goodyear brand that have driven some of the volume losses.

Ravi Shanker - Morgan Stanley, Research Division

Understood. If I can also ask a question on Amiens, obviously, you've had difficulties with that facility for a while. Are you now and do you have a greater degree of confidence now that you'll be able to close it this time around compared to what happened the last couple years?

Darren R. Wells

Yes, I think, we worked -- as you know, we worked for 3 years on a plan that would've closed Consumer production in that factory and preserved the jobs in Farm Tire production by selling the factory. That plan was rejected by the majority union in the factory. So we announced on January 31 that we'll now pursue a full closure of the Amiens North facility and that we're going to exit the Farm Tire business in Europe. So that -- in some ways, it's unfortunate because I think there was an opportunity there. But the fact is that this is, in many ways, a more direct approach. And I think we're not happy with where we've ended up. But the fact is we're going to go through the required consultation process, which has begun. We had an additional works council meeting today in Paris. We can't completely estimate the timing of the plan, as we've talked about, but we're going to move our way through the process, and today's meeting was another step in the process. So I think we're confident in the plan that we've laid out. We are taking care to present plans that support the employees and limit the social consequences of the closure as much as possible. But this is the -- really, the only option we have left, and we're going to move our way through it.

Ravi Shanker - Morgan Stanley, Research Division

And finally on the pension, I apologize if you touched on this before, but what's the timing on the debt freeze, and are you planning to do that through a convert or some other method?

Darren R. Wells

Yes, so the comment was that we're going to use the debt capital markets. We can't comment any further than that.

Gregory A. Fritz

Okay, I think that wraps up the call. We appreciate your attention today. Thanks very much.

Operator

And this concludes today's program. Have a great day. You may disconnect at this time.

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