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Goodyear Tire & Rubber Company (NASDAQ:GT)

Q4 2008 Earnings Call

February 18, 2009 09:00 am ET

Executives

Patrick Stobb - Director of Investor Relations

Robert J. Keegan - Chief Executive Officer

Darren R. Wells - Chief Financial Officer

Damon J. Audia - Senior Vice President of Finance

Analysts

Rod Lache - Deutsche Bank Securities

John Murphy - BAS-ML

Himanshu Patel - J.P. Morgan

Patrick Archambault - Goldman Sachs

Operator

At this time, I would like to welcome everyone to the Goodyear fourth quarter and full year 2008 earnings release conference call. (Operator Instructions) At this time I will turn the conference over to Patrick Stobb.

Patrick Stobb

Good morning everyone and welcome to Goodyear’s fourth quarter and full year conference call. Joining me on the call are Bob Keegan, Chairman and CEO; Darren Wells, Executive Vice President and CFO; and Damon J. Audia, Senior Vice President of Finance & Treasurer. Before we get started, there are a few items I’d like to cover.

To begin, the webcast of this morning’s discussion and the supporting slide presentation are now available on our website at investor.goodyear.com. A replay of this call will be available later this afternoon. Replay instructions can be found in our earnings release issued this morning. The last item, we plan to file our 10-K later today.

If I could now direct your attention to the Safe Harbor Statement on Slide 2 of the presentation. Our discussion this morning may contain forward-looking statements based on our current expectations and assumptions that are subject to risks and uncertainties that can cause actual results to differ materially. These risks and uncertainties are outlined in Goodyear’s filings with the SEC and in the news release we issued this morning. 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.

Turning now to the agenda, on today’s call Bob will provide full year highlights followed by a strategy update. Darren will follow with a review of the financial results and discuss 2009 outlook before opening the call to your questions. That finishes my remarks. I will now turn the discussion over to Bob Keegan.

Robert J. Keegan

Good morning and thank you for joining us on the call this morning. Needless to say, we are in the midst of very interesting times. Today’s economic uncertainty, the new economic realities of the world, and the implications for our industry and for Goodyear are extremely challenging. We know that. Macro improvements may not come quickly and we understand that.

These realities have certainly impacted overall consumer spending, tire industry demand and are reflected in our results, and will be reflected in the significant actions we are announcing today.

The global economic slowdown has increased both in severity and geographic scope throughout the year. By year end it had a significant impact on volume in each of our major business units. The fourth quarter decline was the most dramatic, especially in our overseas operations.

We want to ensure that the many positive actions that we took and the results that we achieved in 2008 are not overshadowed by the global economic decline. So let me briefly highlight some of the key achievements for the year.

Global revenue for tire increased 8%, that’s excluding foreign exchange. Price mix offset full year raw material increases of approximately 13%, thanks to some strong early pricing actions and solid mix improvements. We reported record revenue in three of our regions, EMEA, Latin America, and Asia Pacific.

Our share of market for Goodyear branded products continues to increase in all major markets. Our Latin America and Asia Pacific businesses reported record segment operating income. We made significant progress against our four-point cost savings plan, generating more than $700.0 million in savings in 2008 alone. That’s $700.0 million in 2008 alone.

We completed major restructuring actions during the year, including shutdown of our Tyler, Texas, mix facility and our Summerton, Australia, tire plant and we are closing 92 retail locations in the U.S.

We completed the implementation of the VEBA trust. As you recall, that’s our innovative approach to dealing with the health care costs of our United Steel Workers Retirees of the U.S.

We aggressively curtailed tire production beyond indicated demand changes to better manage our inventories. We recorded total segment operating income of approximately $800.0 million. The decrease from prior year reflects the industry volume decline and the associated higher operating costs related to production cuts, which when combined impacted our segment operating income by more than $600.0 million.

Remember that for Goodyear, through three quarters segment operating income was up 5% from 2007 despite slowing economic growth. This performance has evidenced the power of our core business model and the strategic drivers we’ve implemented over the last several years.

We were named by Fortune magazine as the world’s most admired motor vehicles parts company and named by Forbes as one of America’s most respected companies, and additionally, we were on its list of most trustworthy companies in America.

Our progress in 2008 provides us a base from which to address what we expect to be a challenging business environment again in 2009, particularly in the first quarter. We are now dealing with new economic realities. GDP estimates for North America and Europe would indicate that these major economies contracted in the fourth quarter.

The U.S. GDP decreased at an annual rate of 3.8%. The Euro zone GDP dropped 1.5%, the worst drop since the Euro was established. In Germany GDP declined 2.1%, the worst such decline since reunification of the country in 1990.

North America is facing persistent market trends. Despite relief in gas prices in the U.S., consumers continued their trend of driving fewer miles. Miles declined in the U.S. for the 13th straight in November with a drop of 5.3%. By the way, that’s our most recent data. Recent fuel purchase data indicates a decline is likely to continue with December and January. This is unprecedented.

Consumer demand for automobiles weakened significantly during the quarter, as you are well aware, despite extremely aggressive sales incentives indicating little hope for a rapid recovery. The SAR for the year finished at 13.2 million units, down from 16.1 million in 2007.

As you will see on the next chart, the historical data provides us with confidence for a tire market recovery. During the one to two year period following previous recessions, in 1974, 1975, 1991, and 2001, the industry experienced a snap-back in demand and that demand spike occurred because the temporarily depressed buying behavior of consumers and dealers during the recession built a pent up demand for our products. That demand was released following the recession as consumers and truck fleets bought the tires or vehicles they had deferred and dealers replenished their inventories.

In Europe rapid deterioration and economic fundamentals drove a significant volume decline in the fourth quarter in both consumer and commercial markets. In Latin America Brazil experienced a 28% decline in auto unit production. The impact of the economic downturn, although hitting Asia Pacific late, has been rapid and intense in Q4 driving sharp declines in both car and tire sales.

The economic environment was the obvious catalyst for our disappointing fourth quarter earnings. These are truly extraordinary times that require extraordinary actions and these actions will be the focus of the balance of my comments this morning as we at Goodyear are aggressively adjusting our plans to the new market realities.

It is very clear to us at Goodyear that given the likely 2009 economic environment, our intense focus on the seven strategic drivers that we established in 2003 remains a solid strategic foundation. We are not creating a new path, rather we will be taking a proven path to the next level. We will be taking a proven path to the next level. In fact, I would say our seven strategic drivers resonate operationally today even more than they did back in 2003.

As we continue to face ongoing economic challenges, these seven strategic drivers define the progress we’ve made, define the direction we will take, and define the results you could expect. As I have continually said, everything we accomplish starts with leadership and I emphasize leadership because success against our other six drivers simply is not possible without outstanding leaders in place throughout our company.

During 2008 we continued to strengthen our leadership team, making several key appointments at the top levels of our company. For example, naming Darren as CFO and Damon as Senior Vice President of Finance and Treasurer, from inside our ranks, and bringing Joe Ruocco to Goodyear from General Electric to head our human resources organization. We continue to blend outstanding talent from both inside and outside the company.

And in addition to these key corporate appointments, we have made other significant moves to strengthen our strategic business units around the world. I’ve said it often but it bears repeating, in my opinion by game-tested leadership team is the best team in the industry and we’re getting better.

With leadership as our core, let’s talk for a few minutes about how our focus in three specific areas will keep us on our proven path towards success. These areas are top-line growth encompassing new product leadership, building our core brand strength, and leveraging our industry-leading distribution network, lowering our costs, aggressively aligning our cost structure with today’s lower industry volumes, and managing for cash.

I would first like to emphasize the top line and the success of our new product engine and our outstanding dealer network because of their criticality in today’s environment. Our industry-leading new product engine has delivered an unprecedented number of innovative, differentiated, and award-winning new products at a pace previously unattainable in our industry.

I said initially when we partnered with Sandia National Labs to fully develop this capability that we would get much better. Well, we have. As a result, we have been able to drive a richer more profitable product mix and improve our revenue per tire, consistently offset volatile raw material costs with improved price mix, increase the market share of Goodyear branded products, and introduce new products that have had dramatic revenue and margin impact and that have consistently gained overwhelming endorsements from independent third-party sources.

Most recently both Goodyear and Dunlop brand tires dominated the results of the critical European winter tire test that consumers rely on to guide their purchase decisions. And most significantly, our new product offerings have energized our network of tire dealers.

Let me give you a recent example. At our annual North American dealer conference in Washington, D.C., earlier in February—which, incidentally I would mention was attended by more dealers than our 2008 meeting—at that meeting we introduced 12 outstanding new products for the consumer tire segment alone. We also launched four new commercial products that targeted specific performance needs for a variety of truck applications. Our dealers were enthusiastic and hugely supportive of these product line additions.

Now we knew what our attitude was going to be, going into the meeting. However, there was no way to fully know what the dealers’ mindset was going to be, given current business conditions. It very quickly became clear that they shared the same calm and confident determination that together we can deal with whatever the economy presents. I was impressed.

The new product introductions that have now become the public face of the new Goodyear put an exclamation point on their confidence. Dealer after dealer commented that our unprecedented focus on innovative new products in a down market provides them with both the products and the associated marketing tools to capture an increasing share of consumer purchases and further strengthens our position for the future.

The highlight of the conference was the introduction of the Assuarance Fuel Max tire, a mid-tier offering with fuel savings technology that means consumers can potentially save 2,600 miles worth of gas over the life of the tire when compared with our previous, and as you all well know, successful Assuarance tire.

This increased fuel mileage is achieved without compromising performance. Think about it this way. This tire provides 27% less rolling resistance so it rolls easier requiring less power and that 27% equates to a 4% overall improvement in highway fuel economy. So over the life of the tire you essentially get 2,600 free miles. That’s effective innovation.

The mid-tier positioning of this product was an enormous emotional connection for the dealers in the current environment, and while Fuel Max may have been the highlight, the full breadth of new product launches had our dealers engaged and excited. This is not just the North American statement on new products. I’m simply using North America as an example.

Our global offerings are unmatched in the industry. Globally we will introduce one in fifty innovative high-impact new products in 2009. And our dealers in other regions of the world are equally supportive and appreciative of those efforts. During challenging economic times new products, strong dealer support, and innovative marketing programs will be the core revenue generating strengths for Goodyear.

To address costs let me briefly summarize what we have accomplished to date in building a more competitive company and then I will provide specifics relative to our forward plans.

Since implementing our four-point cost savings plan in 2005, we have taken out $1.8 billion in gross costs from 2006 to 2008. As you will recall, at our June 2008 investor meeting in New York City, we began increasing this target as challenging business conditions dictated more aggression in reducing costs.

Over the past few years we eliminated approximately 25.0 million units of capacity, including the recent closure of our Summerton, Australia, plant. We continue on our strategy to have over 50% of our total capacity in low-cost countries by the 2012 time frame. Incidentally, by year end 2008 we were at 43%.

We also drove significant reductions in our global workforce as we scaled staffing to better match our business needs, a process that has been ongoing for the last five years. Since the middle of 2008 we have eliminated more than 5% of our global workforce, or almost 4,000 jobs. Then I will have to say later about 2009.

We completed the implementation of the VEBA trust. We realized structural savings from our Steelworker contract in the U.S. with the ability to hire $13.00 an hour labor under a two-tier pay structure. We have driven a low-cost sourcing model utilizing our Shanghai-based purchasing organization and we implemented a salaried pension benefit freeze in the U.S. as we migrated to a defined contribution retirement plan for salaried associates.

Our new plan cost actions are nothing less than an attack on our cost structure with the intent of driving our break-even point considerably lower. We are raising our four-point plan total to $2.5 billion by the end of 2009. We will do this by reducing our global workforce by nearly 5,000, so for mid-year 2008 to the end of 2009 we will have taken out almost 9,000 jobs.

Implementing a global freeze on salaries, and that means no merit increases for 2009. Lowering our manufacturing costs through a combination of shortened work weeks, reducing manufacturing personnel and reduced third-party sourcing.

For example, just last week we initiated a process of one of our plants in Latin America to reduce the staffing levels by more than 400 employees. Here in the U.S. we have had a good cooperation with the Steelworkers’ leadership in addressing capacity issues.

In December union membership at our Buffalo, New York, plant approved an agreement that allowed a staffing reduction of 150. Last week we reached a tentative agreement with the local Steelworker leadership in our Danville, Virginia, plant to reduce capacity and to reduce the workforce there in excess of 400 people. That agreement will be voted on by the membership tomorrow. And I’m simply giving you examples here of a multitude of actions that have been and will be taken.

And by increasing our continuous improvement efforts through lean manufacturing and Six Sigma, delivering increasing purchasing savings, eliminating non-essential discretionary spending with tight controls on indirect spend, and continuing to close under-performing retail stores.

In addition to these four-point cost plan actions we are aligning our manufacturing capacity with demand to reflect lower industry volumes. We plan to reduce manufacturing capacity by an additional 15.0 million to 25.0 million units over the next two years. Please note that although headcount reduction and plant footprint rationalization carry significant upfront costs, they do generate a rapid payback of one to two years. We will certainly want to fully leverage these cost reduction actions when global tire markets rebound, as they inevitably will.

Our focus on managing cash has guided our actions over the past few years. Considering the current environment, we are in a much better position today as a result of past initiatives and I will list several.

We completed a series of debt transactions that have spread our maturities to a point where the only significant maturity we have between now and 2011 is approximately $500.0 million in December 2009. Our efforts to recapitalize have provided operating flexibility and increased available liquidity, which is critical in today’s environment.

We completed a highly successful equity offering in 2007. I previously mentioned the VEBA agreement that eliminated more than $1.0 billion in liabilities from our balance sheet. We completed the sale of non-core assets, including our engineered products and fabric businesses. And I might add we sold those businesses at attractive prices.

As market conditions deteriorated last year we were quick to execute a series of existing contingency plans, including cutting tire production by approximately 30.0 million units in 2008, curtailing capex and other discretionary spending.

As you know, we have consistently maintained a high level of cash and available liquidity. As you would expect, our new actions on cash indicate that we will continue to manage aggressively. We are implementing targeted inventory cuts made possible by significant improvements in our global supply chain. We anticipate these cuts to reach over $500.0 billion, or approximately 15% of inventory.

We are also adjusting our capex plan downward and now expect spending $700.0 million to $800.0 million in 2009 and we are pursuing additional non-core asset sales.

While we believe these actions are appropriate and address the business challenges as we see them today, flexibility in this uncertain global economy is an imperative. We recognize that. Similar to last year, we are preparing contingency plans beyond the initiatives I outlined. We are fully prepared to implement those actions if market conditions should further deteriorate.

As economic challenges persist we remain confident in Goodyear’s ability to drive performance. And that confidence derives from a proven track record based firmly on the strength of our strategies, now more than ever the continued success of our products in today’s marketplace, our dedication to driving our innovative global new product engine, and the strong marketing programs and network of successful dealers we wrap around our products, the significant actions we are taking to improve our cost structure, and our absolute focus on managing for cash.

Goodyear is focused on the strategies that will improve both our short-term and our long-term competitiveness.

I will now turn the call over to Darren for a more detailed review of business performance and then we will come back and take your questions.

Darren R. Wells

Before I get into the details of the quarter’s results, I will make a few summary comments and then address operating results, the balance sheet and our outlook for 2009. As you review the fourth quarter results think about two factors we have discussed with you over the last several months that negatively impacted Q4 and will impact Q1 2009 but should improve beginning in Q2.

First, the double hit to earnings from production cuts, which reflect not only lower sales but also address our aggressive management of inventory levels. In the fourth quarter we reduced production by 17.0 million units versus a drop in sales of about 10.0 million units.

Second, the peak of the raw materials cycle. As we have indicated previously, our raw materials cost increases, as they hit the P&L, spiked in Q4 and will peak in Q1 2009. The fourth quarter reflects an increase of about $350.0 million, or 28%, versus a year ago. On the positive side, pricing mix continued to provide significant benefits, reflecting performance of our new products and strong market programs.

Liquidity remains solid but cash flow for the year was weaker than targeted, mainly due to the severe decline in fourth quarter industry volumes. While our business will remain challenging until volumes recover, as you heard Bob say, we continue to take aggressive actions to deal with the difficult market conditions, to lower our cost structure, protect cash flow, and deliver value to our customers.

Given the impact of the quarter, I would like to spend some time on global industry volumes. In the fourth quarter a weak demand environment got even weaker and spread beyond North America and Europe to include Latin America and Asia. All of our businesses in North America and Europe saw double-digit declines for the quarter. Latin America and Asia were also impacted by weak demand. In Latin America commercial and consumer OE demand declined an average of over 20%. We also experienced significant declines in replacement. In Asia consumer industry volumes were down 7% in OE and down 15% in replacement.

The significant drop in industry volumes, when compared to the prior year, drove global unit sales lower by nearly 10.0 million units, or a reduction of 19%. As Bob mentioned, this had a significant impact on our results due not only to the margin on lost sales, which was over $150.0 million for the quarter, but also the impact of unabsorbed fixed costs, which was over $200.0 million. The combined impact of these two factors of over $350.0 million explains the majority of the year-over-year decline in segment operating income for each of our business units.

Looking at the income statement, sales were down about 20% for the fourth quarter, reflecting the drop in unit volume across all business units and adverse currency movement, given the strengthening of the U.S. dollar. These factors were partly offset by a 9% increase in revenue per tire.

Also impacting sales was the divestiture of our tire and wheel assembly business which contributed sales of $158.0 million in the 2007 period. Lower gross margin, segment results, and the loss from continuing operations all reflected lower volumes as well as higher raw material costs.

SAG was down 18% from a year ago reflecting cutbacks in response to the deteriorating environment as well as decreased compensation-related costs and the benefit of foreign exchange. Note that the fourth quarter after-tax results included rationalization-related costs totaling $49.0 million, along with other significant items. The appendix to the presentation includes a summary of these items for this year and last year.

The segment operating loss for the quarter was $159.0 million. The decline from the prior year reflected the impact of lower volume of $154.0 million and the double hit from unabsorbed overhead of approximately $213.0 million, related to 17.0 million units of production cuts.

The spike in raw materials of $350.0 million in the quarter more than offset strong price and mix performance of $263.0 million, a net of $87.0 million negative. To keep this in perspective, the price mix performance still represents the second highest quarterly performance on record.

Cost reductions under our four-point plan totaled $205.0 million, a strong pace which should provide significant net benefits as general inflation rates come back down.

We would expect many of the same challenges to exist in Q1 with weak volume, associated production cuts, and peaking raw material costs all impacting results before improving in the second quarter.

As Bob indicated, we have again raised our targets for our four-point cost savings plan through a series of new cost actions. We now target $2.5 billion by 2009. We also increased our targeted high-cost footprint reductions by 15.0 million to 25.0 million additional units over the next two years. The savings from these reductions are incremental to the four-point plan.

We will intensify our focus on actions to improve cash flow and lower our break-even point. How far we need to go will be determined by the duration of the downturn but what you will see from us immediately is targeted inventory reductions which are enabled by our improvements in supply chain, including optimized warehousing and improved forecasting. We plan to reduce our inventory by over $500.0 million, or about 15%, by the end of the year.

We also see reduced capital expenditures. We plan to delay plant expansions and the related spend to match market demand. We will defer equipment upgrades, given reduced demand, and our ability to redirect unused high-value-added OE capacity to meet high-value-added replacement demand.

2009 capex is now planned between $700.0 million and $800.0 million, compared to nearly $1.1 billion in 2008, a reduction of $300.0 million to $400.0 million.

Finally, as Bob mentioned, we are pursuing the sale of excess real estate and smaller non-core businesses that even in this environment could result in additional cash flow.

Looking at the balance sheet, there are several key points I would make. First is the elimination of $1.1 billion of retiree health care obligations that were transferred to the VEBA when we funded that plan back in August. Second, as with many companies, the impact of last year’s market performance increased our unfunded pension obligations.

Overall, the position or our international plans improved slightly so I will focus today on the U.S. pension plans. While liabilities for the U.S. plans remained relatively unchanged versus 2007, the 32% loss on our portfolio resulted in the unfunded amount rising to over $2.0 billion compared with a shortfall of about $600.0 million a year ago.

While we announced almost two years ago the freezing of our defined benefit plans for U.S. salaried associates, these legacy obligations will remain a challenge until we see a recovery in plan investments.

As a result, pension expense in 2009 will increase significantly for North America. These costs will impact North America earnings by $200.0 million to $225.0 million in 2009 compared to 2008. In addition, contributions will increase approximately $50.0 million in 2009 and will increase another $200.0 million for 2010.

I would point out that there is the potential for additional pension relief legislation that may reduce this funding obligation and improve the near-term cash picture.

The third point on the balance sheet is that it reflects the receipt of $284.0 million out of the $360.0 million that we had invested in the reserve primary fund. This fund froze withdrawals following the Lehman bankruptcy. The remaining investment of about $71.0 million is classified as other current assets on the year end balance sheet. We have taken a $5.0 million reserve against the potential losses on the remaining balance.

Fourth, you will see both the liability for the Entran II litigation and the associated settlement fund, previously shown as restricted cash, have now been removed from the balance sheet as we made our final payment in the fourth quarter.

Finally, despite the second half production cuts, inventories remain high given the weak sales environment and the impact of higher raw material costs. As I said, we will continue to take actions this year to manage inventories in line with demand.

Despite these factors we saw our cash balance increase and our debt decrease versus September. Net debt was up versus a year ago reflecting the VEBA settlement, higher working capital, and capital investments.

Our maturity profile remains strong and we will continue to monitor capital markets for financing opportunities. But as we have said before, we plan to run our business so our near-term maturity, $500.0 million due in December, can be satisfied from existing cash and liquidity if necessary.

Turning to the segment results, North America reported a segment operating loss of $193.0 million in the quarter, which compares to segment operating income of $40.0 million in the 2007 period. Revenue was down 15% but would have decreased only 9% if we were to exclude sales of $158.0 million related to the divested tire and wheel assembly business from the prior year results.

The impact of lower industry volumes I mentioned previously was significant as we sold 3.6 million fewer tires in North America compared to the prior year with half the decline coming in the consumer OE business.

The Goodyear brand continues to gain share in the replacement market amid this market weakness, given the success of our new products, strong marketing initiatives and dealer support. While we continue to see a slowing trend in mix improvement, as consumers are tending to be more cautious in the current economic environment, we still achieved a 10% increase in revenue per tire in the quarter.

Price mix performance overall was strong but did not keep pace with the dramatic increase in raw material costs in Q4. Price mix did exceed raw material costs increases for the full year. This is an impressive result considering it was achieved in a weak demand environment while gaining in branded market share.

As in the third quarter, North America experienced significant impact from unabsorbed fixed costs due to production cuts, totaling 6.0 million units. These unabsorbed costs totaled $116.0 million in the quarter for NAT, including $84.0 million of costs for fourth quarter production cuts recognized immediately under FAS 151.

In response to lower demand, North America has reduced its production schedules by running facilities at lower output levels and by shutting down production at several facilities for week-long periods, as allowed under our contract with the United Steelworkers.

As Bob outlined, we have also been working on other initiatives with the USW. These changes have been planned and executed in a manner that focuses on protecting service levels for our customers.

Overall, North America continues to make progress in terms of new products, marketing, and supply chain, but that progress must continue at an accelerated pace to meet the challenges of today’s environment.

Europe, Middle East, and Africa results also reflected the weakening demand environment and the impact of significant production cuts we took in the quarter. Both sales and earnings declined when compared to the prior year. As a result of weak industry volumes in both western and eastern markets, EMEA sold nearly 4.0 million fewer tires and saw sales drop by $500.0 million compared to 2007.

The impact of currency translation negatively impacted sales by $226.0 million, reflecting the reduced value of the Euro and the British pound compared to the U.S. dollar. Market share improvements provided a partial offset.

The operating loss of $32.0 million in the quarter primarily reflects lower sales along with unabsorbed fixed costs of about $67.0 million from the 6.0 million units of production cuts.

As we have said in the past, the impact of these costs is not as high in Europe, Middle East, and Africa as it is in North America given greater flexibility in many of the EMEA plants.

Revenue per tire increased 5%, helping drive strong price mix improvement, although not enough to offset the spike in raw materials. Overall, despite the tough quarter, EMEA performed well in 2008.

In Latin America the impact of the weak demand environment and sharp decline in the Brazilian real were significant. Unit sales declined 26%, or 1.5 million units, in Q4 when compared to the prior year.

Despite the spike in raw materials, Latin America’s price mix more than offset the cost increases, a net benefit of approximately $26.0 million. Segment operating income for the year was a record for the region. The lower earnings level in Q4 reflects the impact of lower volumes and the $20.0 million of unabsorbed fixed costs relating to production cuts of 2.5 million units.

Similar to North America and Europe, we expect market conditions in the region will remain challenging in 2009. Latin America is taking aggressive action to manage inventory and to reduce structural costs in step with the environment, including the changes in production shifts Bob mentioned earlier.

The economic slowdown also had an impact in our Asia Pacific results, although the impact began later. The impact of lower industry volumes resulted in an 11% decline in unit sales compared to the previous year.

Fourth quarter operating profit was $17.0 million, which was well below the prior year result, but full year segment operating income was a record. The impact of lower industry volumes and unabsorbed fixed costs associated with production cuts of 2.3 million units accounted for the majority of the decline.

Price mix benefits were significant but not sufficient to offset raw materials in the quarter. Foreign currency translation was also unfavorable, primarily due to a 25% decline in the Australian dollar. Actions to reduce cost helped offset the decline.

So in each of our businesses we saw the significant impact of weak replacement sales and significant OE production cuts, along with a strong impact of higher raw material costs. But in each business we also saw strength. Strength in our brands and our products, which along with cost improvements provide opportunities as markets recover.

I want to turn now to our outlook for 2009. Considering the current state of the global economy and the high level of uncertainty we see in our end markets, we can’t provide a meaningful industry volume outlook for the year. What I can tell you, however, is the environment we see in Q1 seems similar to the environment in the fourth quarter of 2008.

In response to the continued weakness, we plan to cut production by nearly 12.0 million in the first quarter and will continue to monitor market demand and react as needed.

Our projections for raw materials will be limited to the first half of the year. During this period we expect raw material costs to increase about 15% to 18% when compared to the prior year. As indicated in my opening remarks, Q1 raw material costs will represent the highest increase we’ve seen. We expect Q2 to show increases but at a more modest level. Beyond that point, the second half should reflect decreasing raw material costs, assuming prices remain where they are today.

For modeling purposes, we expect interest expense in the range of $315.0 million to $335.0 million for the year and we continue our tax expense guidance at approximately 25% of international segment operating income.

While the environment remains volatile, we remain very confident in the seven strategic drivers and confident that we have the right plans and actions in place to move the business forward. But we are always extremely cautious, cautious about competition and cautious about the environment. That’s the right balance for today’s markets.

Thanks for your interest in Goodyear this morning. Bob, Damon, and I will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Rod Lache - Deutsche Bank Securities.

Rod Lache - Deutsche Bank Securities

On the $500.0 million inventory reduction that you spoke about, are you expecting that to be implemented in the first half or is that over the course of the year and how much of that is related to your expectations for commodity declines as opposed to production cuts?

Robert J. Keegan

That $500.0 million is over a year and it’s the result of what we’ve been talking about for the past two years, significant improvement in our supply chain capabilities, frankly, in the company. And most of that is not due to commodities, although that’s a piece of it as commodity prices are expected to come down. Most of that is driven by significant unit reductions, particularly in North American tire and [inaudible].

Darren R. Wells

The only thing I would say is what you will see in the balance sheet is that the inventory for raw materials was up over $100.0 million during 2008 so that probably would help to mention the fact that it will come down but it won’t be the largest piece of the pie.

Rod Lache - Deutsche Bank Securities

And do you have any thoughts on what the associated overhead absorption impact would be of that and how that compares to the impact that you had in 2008?

Robert J. Keegan

Just to mention that, on a tire-for-tire basis, it will look, I think, very similar to what we experienced in the results of the actions we took in 2008.

Darren R. Wells

The only thing I would say is that as we take personnel out of our manufacturing organization, there is an element of the unabsorbed fixed cost that does relate to people and so as we take those cost reduction actions, and certainly as we start to take actions against the 15.0 million to 25.0 million units of capacity reductions, that will start to lead us down a path of reducing that unabsorbed overhead.

Rod Lache - Deutsche Bank Securities

And on cash flow, can you talk about with the capex reduction, this inventory reduction, is it your expectation that you can manage the business for positive free cash this year and you mentioned also the debt maturities. What is the status of the Sumitomo put? Is that exercisable later this year?

Robert J. Keegan

Let’s start with the Sumitomo put because you can take that as a separate consideration here. You probably recall that in 2003 we extended the initial agreement, partnership agreement, that we had with Sumitomo and we extended for five years, essentially, at that point, to September 2009. And at this point in time, our feeling is that the partnership is working well, it’s working well from a technology standpoint, a purchasing standpoint, and we would anticipate that there would not be a put in 2009. Because I think both parties are getting significant benefits, driving significant benefits from the relationship.

But remember, we did extend this in 2003 for five years.

Damon J. Audia

Just to the point, on running the business from cash and what expectations we might have for cash flow in 2009, the environment clearly makes it more difficult to generate cash. There is no question about that. I think what you see from us is actions in inventory, reductions in capex, looking at opportunities for asset sales, so that we put ourselves in the best position that we can, in terms of cash flow, but in the end the environment is going to have an influence and partly it will be the operating environment throughout the year and I think partly there will be questions around when the recovery comes, does that bring with it some working capital increases. And those are all things that we are going to look to minimize the amount of cash that we use on those factors, we’re going to take the right actions to manage for cash. But in the end the environment is going to be an influencing factor.

Rod Lache - Deutsche Bank Securities

Inflation obviously had been swamping cost savings for most of this past year and it looks like you’re starting to catch up now. Any thoughts on inflation versus savings for 2009?

Robert J. Keegan

I think your comment to that is take raw materials out of the equation and just look at what we’ve called general inflation which hit us to the tune, I think in 2008, of about $690.0 million. And even a somewhat significant rate in the fourth quarter. We are expecting clearly that general inflation will, given this economic situation, will be mitigated and decline a bit and so we will be able to carry more of the gross savings that we talk about through 2009 and into 2010.

Operator

Your next question comes from John Murphy - BAS-ML.

John Murphy - BAS-ML

Just wanted to touch on the capacity reduction. It’s a pretty big incremental step here, greater than 10% of your unit shipment. I was just wondering if you could parse out what regions it’s in, if it’s mostly focused in North America, really where it is, and if it really represents any change in direction. Are you getting out of any further segments at the lower end? Is there anything going on there strategically?

Robert J. Keegan

We won’t make any specific comments here about regions. Obviously we have negotiations around the world that take place this year and next year so we have got to work our way through those, so I would simply say, I won’t specify regions, but you can assume that if you look back at what we did in taking the 25.0 million out these past few years—and by the way, we took Huntsville in the U.S. out before that, which was an incremental 7.0 million—so we kind of look at it internally as we’ve taken out 32.0 million in the past 6 years. 32.0 million units of capacity.

We have generally addressed high-cost capacity. Remember our manufacturing cost goals are centered on take out high-cost capacity, replace that with low-cost capacity, as I mentioned in my remarks. And by the way, also built capacity to be able to deliver high-value-added products.

So I think you can assume that’s the case. But we are working on 15.0 million to 25.0 million over this time frame and I think we’ve got a track record over these past few years that says, a) we know how to do it, we’ve done it in the right areas, and we’ve done it for the right strategic reasons.

John Murphy - BAS-ML

And on inventory, how do you see inventory in the channel? Is there a lot of excess that you think needs to be worked on in the channel in addition to what you’re trying to cut on your balance sheet? And as you and a lot of other industry players are working down inventory, do you expect any incremental pressure potentially on price as we work through this process?

Robert J. Keegan

In terms of dealer inventories, it’s interesting that in both North America and in Europe, and this is information as of yesterday, we think dealer inventories are in pretty good shape. This is for the replacement consumer business. I cannot say the same in either North America or in Europe for commercial truck tires. Their inventories are high because of the magnitude of decline that we’ve seen in those areas over the past quarter to two quarters in Europe and a longer period of time in the U.S. We’ve seen some pretty significant declines. You can see those in the sales figures, from us and from the rest of the industry.

So dealers have been working the consumer product down and doing so pretty effectively, that’s our view. And remember, we’ve got pretty good insight because of our scale, into that. But in the commercial truck area, dealers still have inventories to work off, which is going to affect all the manufacturers, including us, as we go into 2009.

In terms of pressure on price, which was your second question, I think we’re not going to speculate here. We will simply say that we have a situation today of dropping demand. We’ve got some inventory issues in truck. And those would point to concern. On the other hand, we’re going to keep moving with the strategy that we have used over these past few years and our new products will substantiate that.

Over the past five years I think we have achieved over $900.0 million, or $3.5 billion of positive price mix, with about $940.0 million in 2008. Where one could have argued the economies have started to soften.

So we will keep on that track and we now have the competitive position of the products and the dealer relationships to make that successful. Even with some downward pressure and concerns to the overall economic situation.

John Murphy - BAS-ML

On capex, what we’re looking at is really a near-term thrifting as opposed to something, a structural efficiency that you’ve found. Is that a correct characterization as we step through 2010 and 2011?

Robert J. Keegan

I think the way we look at that is frankly we say, “The market has changed. A fair amount of our capex was pointed towards increases in annual unit sales and high value added.” And we may still see some increases over time, in the short term in some particular market segments. But overall, we don’t need to spend the capex today. We can defer it and we’re not giving up very much market opportunity because that opportunity isn’t there today. It will be there in subsequent years. So it’s not a huge kind of capital allocation efficiency that we found in the capex area.

Operator

Your next question comes from Himanshu Patel - J.P. Morgan.

Himanshu Patel - J.P. Morgan

On Slide 18, I’m just looking at the general cost inflation figure for the quarter at $192.0 million. Can you speak to when that figure should turn positive? Could it be as early as Q1 on a year-over-year basis or should we just think of Q1 as being negative but maybe to a less severe extent than what we saw in Q4?

Darren R. Wells

The inflation that we see in the fourth quarter results, as you might imagine, it does represent some lag from the time when the production costs were incurred. So you can think of that as being more of a reflection of where inflation rates were in the second quarter or third quarter. And that will work its way through the system.

I think for some areas of cost, and particularly in directs and energy, we should see lower inflation rates in the first quarter results. But there will still be some inflation pressure flowing through. And that, as you might expect, we would expect that that would ease up as we go through the year.

Himanshu Patel - J.P. Morgan

I’m just looking at price mix gains in the fourth quarter for North America it was about $79.0 million versus about $100.0 million year-over-year in Q3 and Q2. I know this number is a little bit volatile so I don’t want to read too much into it, but can you give a little color on what’s going on there? Was there a comp issue? Was it more mix-driven? And I am specifically referring to the moderation in the gains in price mix, and if it’s not mix, does that imply it was pricing?

Darren R. Wells

I think there are going to be multiple factors involved there but certainly a piece of it is the fact that volumes are so much lower so less opportunity to gain on price mix, we’re selling that many fewer tires.

What we saw was price increases continuing to flow through. You know, our last announced price increase was September 1 in North America so we got the benefit of that, the benefit of the two other price increases we announced during the year. So we continued to see that benefit but just on a lower volume base.

Robert J. Keegan

I would also mention here, just to make sure we’re as open with all of you as we always are, because I know you’re thinking about what are consumers doing, are they trading down from premium product a bit.

What we’re seeing is a fair amount of strength in the mid-tier in North America. The mid-tier still encompasses a significant amount of high-value-added, or HVA product, and our new products, including the Assuarance Fuel Max, are directed right at that mid-tier. Frankly, the mid-tier is where the high volumes are. And we are seeing strength in that area and obviously we are expecting, over time, that there’s going to be some pressure on the premium product.

Frankly, it’s just driven by the overall economy but premium products are holding up pretty well. And the mid-tier here is growing and we feel we’ve got the product lines now. I wouldn’t have said that a year or two ago. To go after that, but those are HVA products, as I mentioned.

Himanshu Patel - J.P. Morgan

If the current level of end demand were just to be straight-lined, can the inventory correction that needs to be done pretty much be done by the first half or even the first quarter? I’m trying to get more granularity behind the earlier comment that the inventory reduction figure is sort of for a full-year number.

Damon J. Audia

I would say the way we would talk about it today is to say that that’s over the full year. Don’t expect that the vast majority of that is going to be out in the first half. As Darren mentioned in his outlook, we are going to take further production cuts in the first quarter but those production cuts will contribute to the 500.0 million, they won’t realize the 500.0 million.

Himanshu Patel - J.P. Morgan

On Slide 7 you have some useful data there and just long-term U.S. consumer replacement demand. If you look at the late 70s it looks like peak-to-trough was negative 20%. Where are you thinking this cycle plays out? Is your starting assumption that maybe we are going to see something similar to that?

Robert J. Keegan

I would say this, that as I mentioned in my comments, frankly, flexibility right now is an imperative. And in terms of our view of the future, we are looking very hard at the next quarter, the next half, and the next year, and what we see is a weak economy over that time frame.

My point was simply to say that people need tires, people are going to drive, people want mobility, people are going to come back at some point, but I’m not going to speculate as to the point in time.

But we know from the history that when there is a bounce-back it’s likely to be a significant bounce-back because there is pent-up demand being created. Behaviors we’re seeing include the fall of buying new tires, in some segments. So in and of itself, that creates pent-up demand.

But it’s a challenging economy and we’re just going to play this with very flexible planning on our part. I mentioned contingency plans and I’m very grateful that we started those just over a year ago for 2008.

Operator

Your final question comes from Patrick Archambault - Goldman Sachs.

Patrick Archambault - Goldman Sachs

On the revenue per unit growth rates in both Asia and Latin America, obviously those were still up pretty strongly for the quarter. Can you give us a little color on what the trends are there? Is that pricing, is that kind of a trading up trend in terms of mix that maybe has some legs to it versus the mixed trends that seem to be moderating in both Europe and North America?

Darren R. Wells

You clearly saw a strong impact here on our price and mix in the quarter and I think there’s evidence in the trends there of strong improvement in both areas. What I would point out is from a pricing perspective, this revenue per tire is measured excluding foreign exchange, so this is a local currency move. So to the extent that some of these markets have experienced devaluation, there is an element of pricing to offset devaluation that will boost the revenue per tire, so you do see an element of that.

But you also see a good product position, a lot of new product launches, and continued improvements in mix. So all of those are factors but when you see the fact that the revenue per tire was up in the fourth quarter more than it’s been in prior quarters, I think there was an element of exchange in that.

Patrick Archambault - Goldman Sachs

Maybe if we could dig into the pricing issue a little more. Can you give us a sense of how pricing traditionally has trended with capacity utilization in the industry and I know you are doing your best to take out excess capacity but I assume that for the entire market it’s down quite a bit. What levels are associated with a deterioration of price discipline historically and if things are different this time around it would be interesting to hear why pricing might hold up as well.

Robert J. Keegan

I would say that your comment is right relative to the history. We do a lot of data collection and data analysis and I wish I could say that we could just extrapolate from that data to conclusions about 2009 and 2010 with regard to price. We can’t. So the history is some guide but not a perfect guide because think of the products, the innovation that we and others have brought to the market. The products are totally different.

I think the other thing that we should look at are just the fundamentals. A fair amount of capacity has come out of North America these past few years and we’ve highlighted that on other calls. That’s a fact of the way the industry has dealt with a demand and capacity here in the U.S. and we have contributed to that decline in capacity. What we have seen recently, and this is public information of course, we have taken some capacity out but around the world and even in North America, so have other manufacturers.

So I think as I look at it I see us all trying to deal with the demand stress that the markets are under today. So I think those are key factors.

The third factor is that innovation has played a role here and people pay premiums for innovation. And that continues to be as core to our strategy as anything we ever talk about.

So I think those are the points I would ask you to think about, but it would be about as specific as I would get on the subject. That’s how we think about it.

Patrick Archambault - Goldman Sachs

Your other income was significantly negative. I believe it was a loss of $83.0 million for the quarter. And while your segment income came in close to a lot of people’s expectations I think one of the divergences in EPS was from this other income line. Can you tell us what that was? I assume there was some non-recurring stuff in it. Can you just break that out a little more for us?

Damon J. Audia

The two primary drivers in that account are the foreign currency exchange and then remember at the course through last year we had much higher interest income in 2007 versus 2008 as we put money in to pay off the high cost debt and also the funding of the VEBA in the middle of the year.

Patrick Archambault - Goldman Sachs

So interest expense is not a net number then, so interest income actually rolls through the other bucket.

Damon J. Audia

Correct.

Operator

There are no further questions in the queue.

Patrick Stobb

Thanks for joining us today. That concludes today’s call. As always, if you have any follow up questions, please don’t hesitate to give me a call.

Operator

This concludes today’s conference call.

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Source: Goodyear Tire & Rubber Company Q4 2008 Earnings Call Transcript
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