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The Goodyear Tire & Rubber Co. (NASDAQ:GT)

Q2 2009 Earnings Call

July 30, 2009; 10:00 am ET

Executives

Bob Keegan - Chairman, Chief Executive Officer & President

Darren Wells - Executive Vice President & Chief Financial Officer

Damon Audia - Senior Vice President of Finance & Treasurer

Patrick Stobb - Director of Investor Relations

Analysts

Himanshu Pattel - JP Morgan

Rod Lache - Deutsche Bank

John Murphy - Bank of America/Merrill Lynch

Saul Ludwig - KeyBanc

Itay Michaeli - Citi

Kirk Ludtke - CRT Capital Group

Operator

Good Morning. My name is Ashley and I will be your conference operator today. At this time, I would like to welcome everyone to Goodyear’s second quarter 2009 financial results conference call. (Operator Instructions)

I would now like to turn today’s call over to Director of Investor Relations, Patrick Stobb. Sir, you may begin your conference.

Patrick Stobbs

Thank you, Ashley and good morning everyone. Welcome to Goodyear’s second quarter conference call. Joining me on the call are Bob Keegan, Chairman and CEO, Darren Wells, Executive Vice President and CFO and Damon Audia, Senior Vice President, Finance and Treasurer.

Before we get started, there are a few items I would like to cover. To begin, webcast of this morning’s discussion and supporting slide presentation can be found on our website at investor.goodyear.com. A replay of this call will be accessible this afternoon. Replay instructions were included in the earnings release issued this morning.

The last item, we plan to file our 10-Q later today. If I can now direct your attention to Safe Harbor Statement on slide two 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 our 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 quickly to agenda. On today’s call, Bob will provide a strategy update and market overview. After Bob’s remarks, Darren will review the financial results and discuss outlook before opening the call to your questions. So, that finishes my remarks.

I will now turn the call over to Bob.

Bob Keegan

Thanks, Pat and good morning everyone and thank you for joining us on the call this morning. There’s little debate as to the severity of the economic and industry downturn we have experienced over the past three quarters.

However, despite conditions that have had a significant impact on our performance attributed to weak industry demand and escalating raw material costs, we had what I would call a respectable and encouraging second quarter. We are starting to see some positive signs of economic stabilization and recovery although still fragile at this stage and varied around the globe.

Global Tire industry demand remains significantly below levels prior to the recession as most major economies continue to struggle. I will comment on our current perspectives concerning several key drivers of our business. In the US, the key miles driven indicator increased slightly for the second consecutive month in May after a record 16 straight months of decline.

The growth was a modest 0.0007% following a 0.006% gain in April. Miles driven for the year are still down 0.008% from a year ago, a total reduction of 10 billion miles. Businesses in the U.S. and Europe have aggressively managed inventories reflecting the drop in both current economic activity and their future expectations.

This dramatic inventory adjustment, combined with the economic slow down in autos and construction, has had a severe impact on commercial trucking and therefore, on our truck tire business. This slide has exceeded our low end expectations with the ATA or American Trucking Association index, which measures commercial freight tonnage posting in June a 13.6% drop year-over-year, the largest decline of the current cycle.

Cash-for-Clunkers Programs in Europe have stimulated new car sales this year. The U.S. program should begin to stimulate sales during the second half, and I would just remind you that that program is relatively modest compared to the European programs, at least as defined at this point. The Asian economies led by China have shown signs of a faster and more robust rebound.

For China, the tire markets, led by the consumer OE market, are beginning to resemble pre-downturn conditions. This activity has clearly resulted from the government’s aggressive stimulus programs. Our Q2 results strengthened compared to the first quarter as our strategic actions continued to have the desired effect on our top-line, our cost savings and our cash generation.

This progress is a reflection of our market oriented business model and the accelerated actions we have taken over the past year. Today, we are a leaner, more efficient company. We have expanded both our capabilities and our competitiveness globally and have substantially reduced risk in our business. Credit in large part goes to the leadership teams that we have assembled at Goodyear.

Our teams have proven their capabilities with strong performance in prior difficult conditions. They have demonstrated resilience throughout this downturn and have not taken their eyes off of our ultimate goal of being positioned to take full advantage of an inevitable tire market recovery.

I would like to make an additional comment about an announcement we made recently in naming Rich Kramer, our Head of North American Tire and past CFO, as COO of the company. This was a move to further strengthen our capabilities globally.

The Board of Directors and I’ve been impressed with the performance processes, depth of analysis, decisions and actions led by Rich and his team during the downturn and the progress that was being made in the business prior to the tire market collapse in North America. All of our businesses will benefit from Rich’s perspective and his leadership.

We also announced Wednesday the addition of Dave Bialosky to our leadership team as General Counsel, replacing the retiring Tom Harvie. Dave comes to us from TRW Automotive where he held the same post. We are pleased to have an individual of Dave’s ability and experience joining our team at Goodyear. In Dave, we found a successor who could contribute immediately and continue the strong and innovative leadership that Tom Harvie provided throughout his career.

Our leadership team continues to make the right decisions and take the right actions consistent with our seven strategic drivers, as we work to improve our top-line, cost and cash performance. I’ll give you my perspective on each of these.

Our top-line second quarter achievements were significant. We successfully launched 19 new products, raising the total through June to 42 and putting us well on our way to meeting our global objective of more than 50 new product launches this year. Maintaining our world class new product focus during very difficult industry conditions is something you now expect from us.

Innovative products define our company, our brands and our future, and the consumer continues to pay a premium for our product and innovation. Our focus over the past six years has been on the top two market tiers, premium and mid tier. We originally charted the new product road map that addressed the premium segment and we have executed against that plan flawlessly. Our early success at the premium end of the market has created a halo effect as we now introduce new products into the high volume mid tier market segment.

Given the economic downturn, this year we have concentrated on the mid tier, highlighted by the launch of the Assurance Fuel Max Tire in the US. We are commanding good margins with this product, aimed at a much larger addressable market segment with features previously not available in the segment. As a result, we have sales and market share momentum in the market’s current suite spot.

Goodyear is pioneering the way open innovation is allowing us to bring relevant technology to the market at a pace unmatched in our industry. Here we define open innovation as working with third parties like Sandia National Labs or strategic suppliers on technology.

The new product engine that has become the face of the new Goodyear has continued to deliver category leading award winning products that are exceeding the markets expectations. Our new products sent absolutely the right message to our dealers that we are fully committed to innovation and will continue to provide them with relevant technology during recessionary times, when new products provide them with a much needed and powerful differentiator.

These top-line initiatives helped Goodyear’s performance in the second quarter. Despite tough year-over-year sales comparisons due to weak industry demand, we continue to make progress. Compared to Q1, our Q2 sequential sales increased nearly 12%, reflecting higher volumes.

We continued our strong market share performance. For example, in North America the Goodyear brand gained share in the consumer replacement market for the fourth consecutive quarter. Our revenue per tire increased 1.1% excluding foreign currency translation. As in the first quarter, this revenue per tire increase would have been several points higher if it were not for the dramatic industry weakness in commercial truck.

The benefit of price mix, the segment operating income for the quarter was $127 million, which more than offset higher raw material costs of $119 million. Our quarterly profits in Asia Pacific of $57 million were a record for the region in any quarter, driven by growing volumes in China and in India.

In China, our Wrangler high performance all weather tire was recently recognized by Motor Trend as the SUV Tire of the year. The article said, “Wrangler, which features smart tread, silent block and silent armor technology has achieved excellent ground breaking results on both dry and wet surfaces, a clear choice for best tire.” You may recall that the Goodyear Assurance tire was the tire of the year in China last year.

In the U.S., more than 500,000 Fuel Max tires have already been shipped in 2009, exceeding our original estimates. This tire continues to create a buzz because of its unmatched technology and value proposition in the mid tier market. It’s the right tire, at the right time and in precisely the right place in the market. Not to be outdone, the EfficientGrip tire in Europe is pushing the boundaries of wet performance and rolling resistance as early sales also exceed our expectations.

As we look at costs in the second quarter, we continue to track toward our targeted four point savings of $2.5 billion over four years. Despite market driven downtime in our factories that limited the available opportunities for manufacturing cost savings, we achieved $200 million of cost savings in the second quarter. That is $200 million of cost savings in the second quarter alone.

Our 2009 cost plans included the reduction of 5,000 jobs globally. Through the end of June, this annual target has been achieved with 5,500 positions eliminated. These reductions were in addition to the 4,000 jobs that were eliminated in 2008, primarily in the second half. We’ll continually reassess our total labor requirements as a function of market conditions.

In May, we announced that we are planning to discontinue consumer tire production at a plant in Amiens, France. This will eliminate high cost capacity of approximately six million units. In July, we then announced plans to discontinue tire production at our plant in the Philippines, which is a high cost plant relative to our other Asian plants. This action will reduce capacity by two million units.

Leading into labor negotiations with the United Steelworkers in the U.S., we were able to secure unprotected status of our Union City, Tennessee plant that gives us the ability to close that facility if market conditions warrant. As part of our discussion in Union City, we were able to reduce staffing levels by 550 positions and move to a five day operation.

This follows previously announced reduced staffing levels in including salary positions at three other U.S. plants in Danville Virginia, Topeka, Kansas and Buffalo, New York. With these decisions behind us, we are now focused on our ongoing negotiations with the Steelworkers and have mutually extended our contract deadline to August 15, while we work productively through other issues of competitiveness.

In summary, for our cost structure I’ll make four comments. Number one, by year end the four point plan will have generated $700,000 of savings in 2009, raising our four point cost savings to $2.5 billion over the life of the plan. This significantly surpasses the savings forecast in our original plan.

Number two, over the past four quarters, we have eliminated more than 9,000 positions globally and four point cost savings of approximately $695 million. Number three, clearly cost savings momentum will continue in the second half of this year as many of our first half actions will generate additional efficiencies. Number four, beyond 2009, our plan targets the reduction of 15 million to 25 million units of inefficient capacity that we announced in February.

Our focus on managing cash has further intensified given current economic conditions. You saw us take aggressive actions in 2008 at the onset of the downturn. Well, we’re continuing with more aggressive initiatives in 2009, consistent with the plan that we announced to you in February.

Several years ago, we made a strategic decision to focus on building an advantage supply chain. Venturing outside of the tire industry to recruit top-talents, who could create big changes, big improvements. The results of these efforts and the potential implications for the future have become very obvious to us, but they’re perhaps not as visible to you. So let me help.

This is a critical performance driver for us. We’ve been able to drive our inventories lower during the downturn while improving fill rates. What you wouldn’t have visibility to, is the way the progress that we’ve already made will translate into an ability to operate efficiency at low inventory levels once tire markets rebound. That’s a huge advantage for us in costs, in working capital, in fill rates and ultimately, and in dealer satisfaction.

Goodyear retailers know today that, we have the processes and the systems in place to deliver tires to them much quicker and in a more timely and reliable matter. That allows them to keep their inventories lower than previously required. Naturally, they love their newfound ability to reduce their investment in inventory.

An advantage supply chain such as we are building maximizes cash for both Goodyear and for our customers. It’s a classic win-win proposition, and we plan to fully leverage this competitive advantage. Let’s quantify our progress year-to-date.

At the beginning of the year, we developed plans for an inventory reduction of more than $500 million or approximately 15% of inventories. Thanks to our supply chain management. Total inventory levels at the end of the second quarter are $680 million below their levels at year end 2008. This was accomplished despite our normal inventory build from January through June.

As indicated at the end of the first quarter, we’ll adjust our CapEx plan downward given the erosion of market demand to a total between $700 million and $800 million in 2009. Our CapEx spending is on target through the first half. We successfully completed our billion dollar bond transaction which helped reduce risk and bolster our liquidity in an uncertain market.

We’re continuing to pursue the sale of non-core assets, which includes our decision to pursue offers for our European and Latin America farm tire business. We were able to reduce corporate risk by navigating successfully through bankruptcies at Chrysler and General Motors.

These bankruptcies were not material to our results as we’ve been paid for virtually all receivables and we continue to provide our valued customers with the tires they need. While the receivables risk is now off the table, other risks remain which we are working to manage just as effectively.

In summary, we continue to focus intensely on improving our businesses and in doing so, we’ve developed the capability to quickly recognize and then act upon changing market conditions. Let me briefly summarize why we believe we are poised to compete strongly when the world’s tire markets recover. I will do so by summarizing the powerful catalyst we’ve put in place to create an advantage.

First, we have an outstanding and continually improving leadership team that has aggressively made the right decisions effectively managing investments and risks to keep our strategy on track. Second, our industry leading new product engine has delivered innovative, award winning and category leading new products and is now expanding in a major way into the high volume profitable mid tier. We have market momentum despite the industry volume reset.

Third, we have made major advances in developing an advantage supply chain and we are seeing the results of that work today. In fact, multiple customers globally are today saying Goodyear is easy to do business with. This is a hugely positive statement for a company in the tire industry. Our dealer relationships are very, very solid today.

Fourth, our intense efforts to drive costs out of the business coupled with our cash is king mindset are helping us to permanently lower our cost structure, enhance margins and improve our operating flexibility. Also, as we look beyond the downturn, the prospects for our industry remain positive. The number of drivers globally will continue to increase, driven primarily by emerging market growth.

Although tire purchase deferrals have increased throughout the down cycle, tires are non-discretionary purchases. When customers choose to replace tires, they’re continuing to reward product innovation and strong brands. The continuing strength of market trends that favor an improved high value added product mix is a perfect fit for our strategy.

So, although the current economy will continue to be challenging for the remainder of the year, we are encouraged at this stage of recovery that our intense focus on our goal of emerging from the downturn in a position of strength has helped us get significantly more competitive today.

I will now turn the program over to Darren for review of our businesses and our outlook, and then we will take your questions. Darren.

Darren Wells

Thanks Bob. I will start this morning with a few summary comments before moving on to address our operating results, the balance sheet and the outlook for the rest of 2009. Despite continued weak industry volumes, which were a lot like we saw in Q1, our second quarter results strengthened compared to last quarter.

The improvement in revenue and segment operating income reflected strong price mix performance, driven by the top line initiatives that Bob discussed. As we indicated on last quarter’s call, the increase in raw material costs moderated in Q2 after peaking in Q1. So price mix performance was once again able to more than offset raw material cost increases.

As in the past few quarters, we continued to see the double hit to earnings from production cuts, which reflect not only lower sales, but also our aggressive management of inventory levels. In the second quarter, we reduced production by about 10 million units compared with a year ago, consistent with the plans we discussed during our first quarter conference call.

Our results also reflected increasing benefits of net cost savings, which are flowing to the bottom line given today’s low cost inflation. This savings also had to overcome increased pension expense of nearly $50 million in North America, the result of portfolio losses in 2008, which impacted cost of goods sold significantly for the first time in Q2 given a one quarter lag in inventory.

Our cash actions drove strong cash flow performance in the quarter. The second quarter is normally a period of seasonal cash usage, but we had positive cash flow this quarter, the result of strong working capital management. This cash generation, along with our $1 billion notes offering, has strengthened our solid liquidity position even further.

The significant drop in industry volumes when compared to the prior year drove global unit sales down by nearly 8 million units or a reduction of 60.5%. Looking at the income statement, sales were down approximately 25% from the prior year, reflecting lower unit sales and adverse currency movement given the strengthening of the US dollar versus a year ago.

As I mentioned, price mix improvement, driven by our top line initiatives, favorably impacted sales. Decreases in gross margin and operating income as in the last two quarters were driven by lower volumes and the associated unabsorbed fixed cost in our factories. SAG was down significantly from a year ago reflecting aggressive cost cutting and personnel reductions, lower advertising and the benefit of foreign exchange.

Note that the second quarters after tax results were impacted by rationalization related costs totaling $116 million along with other significant items including a book loss of $43 million from our Akron camper sale. If you recall, this sale is part of our plan to develop a new leased headquarters adjacent to our innovation center in Akron.

The appendix includes a summary of these items for this year and for last year. Going into more detail on this quarter’s segment operating profit, you see the impact of some of the same factors with the impact of weak markets more than explaining the year-over-year decline. Price mix of $127 million offset raw cost material increases of about 9% or $119 million.

The price mix was favorable, despite an adverse mix impact, driven by two factors. First, the weaker commercial truck business; declining more rapidly than our consumer business and second, the consumer OE business holding up better than the high value replacement business in our international markets. So, both those impacted mix for the quarter.

Our aggressive cost cutting continued in the quarter with savings from our four-point plan of about $200 million, which is providing significant net benefits to our cost structure as general inflation rates are down compared to the high inflation we experienced last year.

One note on the step-chart we provided in the slide presentation. Our unabsorbed fixed costs at $251 million has been presented both before and after the benefit of restructuring actions taken over the last year. As you would expect, these savings from restructuring in our factories are reflected as part of our four-point cost savings plan.

If we look at the specific drivers of cost savings in the quarter, we saw results in each of the categories of our four-point plan raising the year-to-date total to $345 million. We saw a higher level of savings this quarter from continuous improvement initiatives in our factories.

The higher savings was possible given factory utilization was higher than we saw at the end of last year, providing an increased opportunity set for our lean manufacturing and other process improvement initiatives. Benefit from high cost footprint reductions has now reached our target of $150 million.

Our future plans, including announced actions in France and in the Philippines totaling 8 million units of capacity will provide benefits once those closures are complete. The timing for the remainder of the additional 15 million to 25 million units has been discussed as over the next two years.

I can tell you we are re-evaluating the specific timing of the remaining actions to insure they’re consistent with meeting market demand and to insure we make targeted customer service levels. We’ll confirm the timing of those additional plans once they’re finalized.

Finally, we also saw the significant impact of actions to reduce SAG, with structural savings of about $70 million bringing our total to-date to about $320 million. We remain confident in our ability to achieve the full $700 million savings in 2008.

Looking at our balance sheet, you can see the benefit of our focus on managing for cash. Normally, Q2 would be a period of cash usage, even in a stronger economic environment. So, the fact that we generated cash in the quarter is a significant point. Our inventory is down $350 million or 12% from the end of Q1 and $680 million or 19% from year end 2008, which exceeds the target of $500 million that we set for the full year.

This reduction stems from improvements in our supply chain, in combination with lower raw material prices. We’ve also been successful working with our customers to insure strong receivable collections. The challenge going forward will be to hold onto these improvements in both areas as demand returns. We are not changing our target for the full year, but will continue to reassess our inventory targets as the second half demand becomes clearer.

In addition to positive cash flow, our liquidity at June 30 benefited from a successful billion dollar bond offering. A portion of the proceeds of the offering will be used to satisfy our December 2009 debt maturity. The offering enhances our financial flexibility and further extends our maturities.

Given these improvements, which bring cash and liquidity to more than $4 billion, we feel very comfortable with our position. One area of added focus for us however, recently is a growing cash balance in Venezuela.

We have a strong business in Venezuela. However, like other manufacturing companies, we’ve experienced delays in obtaining approvals from the central bank to pay suppliers. This has resulted in a growing cash balance, about $290 million at the end of June. We continue to work with the Central Bank to resolve this issue, but the timing remains uncertain.

One last point on liquidity, we had previously said our receivables exposure to GM and Chrysler would be as much as $60 million to $80 million during the quarter. Given the approach taken with suppliers in these bankruptcies and our team’s work with the customers, our loss on receivables, as Bob mentioned, if any, will not be material.

Moving to the business segments, in North America, we continued to see significant year-over-year reductions in industry volume across all tire segments, with OE industry volumes declining by levels consistent with last quarter. Replacement volumes, while down, declined by less than in Q1.

Given the weak industry volumes, we sold about 3.5 million fewer tires in North America compared to the prior year, primarily driven by lower consumer OE volume. Consumer replacement volumes, although still down compared to last year, benefited from a significant increase in market share, particularly in the Goodyear brand. This was our fourth consecutive quarter of increasing share.

North America reported a segment operating loss of $91 million in the quarter, which compares to segment operating income of $24 million in the 2008 period. The decline is more than explained by lower volumes, including unabsorbed fixed costs. North America also saw increased pension expense of nearly $50 million.

Again, this is the first quarter to show the increased costs related to last year’s losses on our pension portfolio, as these costs are lagged through inventory. Pension costs more than offset the savings from the implication of the VEBA retiree healthcare trust last year. Solid price mix of $38 million more than offset higher raw material costs, which were up $35 million.

This outcome can be attributed to the success of new products, strong marketing initiatives and continued dealer support. Revenue per tire was up by 5.9% in the quarter in North America. As in the previous two quarters, North America experienced a significant impact from higher unabsorbed fixed costs due to production cuts versus last year totaling four million units.

Unabsorbed fixed costs totaling approximately $95 million in the quarter, and totaled about $95 million in the quarter, including about $60 million of costs for second quarter production cuts, which we recognized immediately under FAS 151. Continued actions on cost structure, including significant restructuring actions, provided benefits in Q2, particularly in SAG, but will contribute further to results going forward as the full impact is recognized.

In Europe, industry volume weakness continued, just as it did in North America with a couple of differences. First, consumer OE volumes have been aided in Europe by stimulus efforts driving OE demand primarily the low end of the market. Second, the commercial truck business remains even weaker with volumes below even our recent expectations.

EMEA sold three million fewer tires this year reflecting weaker industry conditions. Our brands continue to perform well in key segments, particularly the high performance winter tire segment, were our tire were the clear winners in last year’s German Auto Industry magazine test.

We also continued to gain share in key Eastern European markets. Despite our strength in winter tires, sales declined $631 million, reflecting lower unit sales, although 35% of the decline in sales was negative impact from currency.

In addition, revenue per tire decreased 4.5%, reflecting the mix impact from lower commercial volumes, which have a higher per unit revenue that consumer tires. If viewed individually, both the consumer and the commercial businesses saw increased revenue per tire. At a constant mix, revenue per tire would have been more than eight percentage points better.

This adverse mix resulted in price mix continuing to fall short of fully offsetting raw material costs increases. This shortfall, along with lower volumes, explained the results for the quarter.

The team in Europe, Middle East, Africa has responded to this tough environment with significant cost reduction actions including the announced shutdown of consumer tire production in one of our plants in France and actions to centralize back office functions, both of which will deliver significant savings once fully implemented.

In Latin America, we reported segment operating income of $73 million. The combination of a 14% decline in unit sales and the related unabsorbed fixed cost drove the decline in segment operating income versus the prior year.

Sales are also impacted negatively by currency. The environment in Latin America has improved somewhat recently, with the most notable strength being the consumer OE business, particularly small vehicles being sold under government stimulus programs in Brazil.

In the quarter, price mix benefits more than offset higher raw material costs and revenue per tire increased 3.5%. As with Europe, this number would have been higher if not for the weak commercial truck and agricultural tire markets. The most challenging situation our team in Latin America has to manage is the political issues resulting in trade barriers and currency controls in countries like Venezuela, Argentina and Ecuador.

These barriers not only create cash and balance sheet challenges, but also hurt volumes and disrupt our business. Our team is continuing to work productively with local authorities while at the same time reducing the cost structure to better match the lower volumes the trade barriers create. So we see some pluses and some minuses to the environment in Latin America. Fortunately, we have a team with a proven track record of delivering results despite this volatility.

Our Asia Pacific business reported record segment operating income of $57 million despite lower volumes, reflecting strong price mix and cost saving actions. While volumes remain down year-over-year, it’s hard to generalize the state of the markets in the Asia Pacific region. Asia Pacific is really three separate stories. Both India and China, have displayed a degree of resilience through the global downturn.

A recovery in auto sales and infrastructure growth together with government incentives, that help to reduce the deficit down cycle in these countries. Australia and New Zealand markets remain the weakness with industry environment similar to what we’ve seen in North America and Europe; and traditional Asia falls somewhere in between the two.

Strong price mix performance of $18 million, more than offset a minimal increase in raw material costs, as Asia has benefited more quickly from declining raw materials given its proximity to natural rubber supply. Our Asia Pacific team has also maintained its focus on improving cost structure. You see this with the announced closure of the aging factory in Las Pinas, Philippines.

This action, following on the heels of the closure of our plant in Australia, substantially improves the manufacturing base in the region. We continue to invest in other facilities including the relocation and expansion of our factory in Dalian, China to deliver the increasing high value products being demanded in the Asia markets.

In some ways, Q2 felt like a continuation of the first quarter, with weak volumes across all business units, production cuts and continued uncertainty in the markets. In some very important ways, however, it was different, with some signs of market recovery emerging together with some relief in raw material costs.

Critical for our business is the continued action that we’ve taken to deal with the downturn and prepare for a recovery by improving our cost structure, by continuing to use our new products to improve share and deliver on price mix and by continuing to take actions to manage the risk associated with today’s unpredictable environment.

Turning to our industry outlook, the market environment will continue to significantly impact our performance in Q3. Economic uncertainty makes it hard to give a clear outlook for the industry, but here’s what we see for the third quarter.

We expect demand to remain weak, similar to what we experienced last quarter with a few notable exceptions. These include in North America, an expectation the consumer industry will be slightly better, led by OE. For EMEA, although the consumer industry will be similar to Q2, risks remain, primarily in the winter tire market.

In Latin America, although political issues pose a risk, we expect Q3 will be slightly better than Q2. Finally, in Asia Pacific we anticipate growth in the emerging markets, with continued weakness in Australia and New Zealand. Similar to prior quarters, we’ll continue to cut production as we balance inventory requirements with weak industry demand, expecting to cut it by 4 million units compared with last year’s production.

The impact of raw materials will turn favorable in the second half of 2009. We expect raw material costs to decline by 15% to 20% in the third quarter with further reductions expected in Q4.

For modeling purposes, we expect interest expense now in the range of $330 million to $350 million for the year, which is higher than our prior estimate due to the impact of our bond transaction. We continue our tax expense guidance at approximately 25% of our international segment operating income.

Thank you for your interest in Goodyear this morning, and Bob, Darren and I will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Himanshu Patel – JP Morgan.

Himanshu Pattel - JP Morgan

I am wondering if you can comment a little bit on the inventory situation. Bob, I think in the last quarterly call, you had mentioned that inventories in most segments were coming inline except in commercial tires.

Where would you characterize the situation now and on that same point, is the $4 million unit production cut for the third quarter, does that anticipate any further inventory destocking or is that just effectively moving inline with what you expect sales to do?

Bob Keegan

Himanshu, first just a point of clarification; you mean inventories out in the market. I think what we are seeing in commercial. I will start with North America, is those inventories are starting to work their way down, but we still see a challenge here over the balance of the year, but they’re working their way down, certainly and we can see that in the variety of different customers that we monitor.

In Europe, the decline in commercial has been somewhat more dramatic, but again, now starting to work itself down. You can see that by quarter-to-quarter improvements overall and what we are seeing in commercial at the replacement level and the OE business has a long way to go in both Europe and North America to work their inventories down on both trucks and subsequently of tires. Darren, you might comment on the impact there on production schedules.

Darren Wells

Himanshu, the way to think about it is that we are going to continue to work on inventories. During the first half we benefited from strong inventory controls, but also the decline in raw material costs. Raw material costs have started to go back up.

So obviously, that has got an impact on inventories, but as you think about our production, the production cuts that we are taking have been and will continue to be a combination of factors, one being lower sales, but the other being our desire to continue to drive down the number of units inventory.

Himanshu Pattel - JP Morgan

Okay and then Darren, on slide 14, the global EBIT walk, when does that general cost inflation line item flip to be a favorable year-over-year? Could that happen in Q3?

Darren Wells

Himanshu, the cost inflation has come down dramatically, but you have to keep in mind that the cost inflation is not just a reflection of cost in the U.S., but it includes inflation factors in other parts of the world. So, while you have seen, producer price industries and other indicators in the U.S. actually turn negative, in other parts of the world, that’s not true. So I think we will be looking for inflation to stay fairly modest. I am not sure we have a prediction as to when or whether it might actually flip around.

Bob Keegan

Just in perspective, I think, Darren, we can say that the first half general inflation was about 1.5% increase and that trailed off a little bit in the second quarter as compared to the first quarter. So, we would anticipate and hope that we are dealing with pretty manageable numbers there.

Himanshu Pattel – JP Morgan

Then last question for me, Bob any comments on the ITC ruling?

Bob Keegan

Really no. Obviously, controversial area. Obviously, it has not been signed by President Obama at this point. You could presume it will be or won’t be, but I can guarantee you there’s tremendous activity in Asia right now, in terms of shipping product into the North American markets as you would suspect.

Himanshu Pattel – JP Morgan

I guess my question is, I mean if some sort of tariff does get imposed. How do you view that affecting your business? Is it as simple as saying that should help your North American business or would there be some offsets where maybe a lot of those tires from China end up in other geographies and maybe that hurts Europe or Latin America?

Bob Keegan

I think like any of these things, it’s the reason. Darren mentioned in his comments that we’re struggling like everyone in Latin America with some of the protectionist activities. Obviously, what’s going to happen is play out on a global scale and the Chinese are going to produce the tires and those tires are going to find their way in the markets.

Possibly they’re also going to shift manufacturing location for tires going around the world, in other words, tires not going from China to the U.S., but other places in China. Chinese really own the tire plants producing tires in other locations, Indonesia, Malaysia might come to mind, coming here into the US. So, it is never as easy as people that look at these things at a very high level assume. There’s going be tremendous change in product flows if this becomes reality.

Operator

Your next question comes from Rod Lache - Deutsche Bank.

Rod Lache - Deutsche Bank

First of all, I was just hoping you might have the raw material costs on just an absolute dollar basis. What was your raw material cost in the quarter?

Darren Wells

Rod, the break down of raw material costs for us, historically what you have seen is it’s been about 40% of our cost of goods sold. That’s what we saw in 2008. I think what you’d see in year is that percentage has come down some, as we have gone through this decline in raw material costs. It’s a modest decline.

So, I think your starting point is going to be where we’ve been in the past, which is 40%. It is probably coming back down more toward where we would have been prior to 2008, which is closer to 35%. So, you are going to be somewhere in between those two.

Rod Lache - Deutsche Bank

So, 35% to 40%, something like that.

Bob Keegan

Well, as Darren mentioned with a lot of volatility here. If you look at individual components, significant components like for us butadiene, we saw huge declines, I think 50% over a six month period and then in the last three or four months an 50% and 80% increase.

So, obviously, that’s affecting the percent of the total, but collectively Darren, I think 35% to 40% is a good estimate as we would have.

Rod Lache - Deutsche Bank

It just looks like; your non-raw material costs of goods sold is down pretty dramatically on a year-over-year basis. Just trying to back into numbers here, could you tell us what the FX impact was on the cost of goods sold line?

Darren Wells

You are going to see there an impact that’s going to be on cost of goods sold, it’s going to be similar to the sales line. So it’s not going to differ that much. We saw our sales, the impact of foreign exchange on sales of about $369 million.

Bob Keegan

7% plus.

Darren Wells

What you’ll see is cost of goods sold affected by foreign exchange by a little over $300 million.

Rod Lache - Deutsche Bank

Any color on the outlook for SG&A in the back half of this year?

Bob Keegan

I think the color would be, in this environment, we are going to continue to monitor everything we spend even more closely than we’ve done historically. We’ve obviously taken out activities that we though we’re not value creating. We’ve taken out a tough stand a bit on advertising generally, except for supporting new products.

We’ve supported new products as fully as we think we should around the globe, and we’ll continue to do that. So I think from that standpoint, a lot of change in the first half that will probably ameliorate a little bit as we go into the second half.

Rod Lache - Deutsche Bank

I guess three other points, was hoping you could provide some color on what your primary objectives were out of these labor negotiations. How your pension performance has done year-to-date? Just lastly, just to clarify, did you say there was a $230 million cash benefit from what’s happening in Venezuela or a detriment to you in terms of cash flow?

Bob Keegan

Let’s take that one first, and then we’ll back up.

Darren Wells

Rod, the comment was that the amount of cash in Venezuela has increased. As we’ve continued to produce tires there, but we haven’t been able to pay suppliers. So the cash balance in Venezuela has gotten up to $290 million. So that was the point on Venezuela. It wasn’t a point on cash flow per say, it was a point on where the cash balance has gotten to at this point.

Bob Keegan

Then we will backup, Rod, on your last three points. On the labor negotiations, we’ll just say that overall, our policy is not to discuss these negotiations as they’re on going. I think that’s good solid policy. We’re not going to deviate from that.

Obviously, what we’re doing here is we’re addressing other issues to create a more competitive manufacturing and supply network for us in North America. That’s as much detail as we’re going to convey at this point. Then the next point was pension?

Rod Lache - Deutsche Bank

Yes.

Darren Wells

Rod, second quarter pension performance was quite positive. Through June, we were at positive 6.5% on our U.S. plants.

Operator

Your next question comes from John Murphy - Bank of America/Merrill Lynch.

John Murphy - Bank of America/Merrill Lynch

In the quarter, price mix of positive 127 was better than we were looking for, and it looks like it is approaching $400 million positive for the first half of the year given what went on in the first quarter. As we look at what’s going on in the second half this year and your push into this mid tier part of the market. Do you expect to continue to see that to be a positive in the second half of the year of the same magnitude, or will that diminish overtime?

Bob Keegan

I’ll make an overall comment here John. That generally if you look at, what we’ve done over the past 5.5 years. So if you track from ‘03 through ‘08, and then into ‘09. We have delivered positive price mix. We intend to do that, we’ve got the product lines to do that. Frankly, we think we have the pricing strategies and the pricing courage to be able to make that happen. That’s a bit of what you saw certainly during the first half.

As we get more competitive, we’re going to continue to deliver that kind of price mix led by, or maybe better said, anchored in our new product capability and innovative capability. As I said, it creates a halo effect throughout our entire product line. So that from a high level is what I would say there. Darren, any comments in terms of price mix with any more specificity in the second half?

Darren Wells

Yes, I think a couple of things you will want to think about John, as you consider that. One is that the expectation of the U.S. OE business coming back, which generally is, if it comes back more quickly that’s a negative mix impact for us, because we don’t have the margin on those units that we have on replacement units.

The other one to continue to watch out for is just how consumer behaves versus commercial. So particularly in our international business units, the commercial business staying so weak as it has in Europe is a negative mix factor for us. So you have to keep those two things in mind as we look at the second half.

John Murphy - Bank of America/Merrill Lynch

Darren, you sort of led me into my second question. As we look at the potential for a big up tick in production volumes on the OE side, particularly in North America, we’re expecting better than 30% in the fourth quarter this year.

I know you guys don’t make great margins on those OE tires, but as those tires theoretically ramp up, will those create a reversal of the unabsorbed overhead that we’re seeing in the first half this year? I’m not looking for guidance, but I’m trying to understand. Even though the margins there might not be that great, the volume should help the unabsorbed overhead, right?

Bob Keegan

John, the response is yes, it will help. We’ll have lower unabsorbed overhead as those markets start to come back a bit.

John Murphy - Bank of America/Merrill Lynch

Lastly, working capital was a positive in the first half of this year, which is a little bit unusual and obviously had to do with the inventory management, which is great. Should we expect to see the second half to be positive like it is typically sort of on a seasonal basis, or have you gotten a lot of those benefit in the first half this year?

Darren Wells

The seasonal trend, as you pointed out, is not the same seasonal trend that we’ve seen historically. So we’ve been able to contain our working capital levels and keep inventories in line, keep receivables in line.

In addition to taking advantage of the fact that raw material costs have come down and their value in inventory is lower. The challenge for the second half is to manage the inventory receivable levels as we look for markets to potentially recover, whether it is second half of the year or beyond that, that’s going to be our challenge.

As we’re managing them in a very weak environment, we have to also manage working capital as the markets recover. So I think it’s fair to say that, if the working capital hasn’t gone up as much, there’s less opportunity from a seasonal perspective, but I still see opportunity as we look at what we can do in driving down the number of units in inventory.

Certainly, we’re not all the way there on the commercial truck business. We still see inventory needing to comedown to address the market environment we’ve got today, and we’ll continue to focus on what our supply chain can do to allow us to operate with lower units in our consumer inventory.

Bob Keegan

We’re not officially going to change our inventory target. I think that’s important to say, but yes, you can accuse us of being conservative on that target at $500 million.

John Murphy - Bank of America/Merrill Lynch

Just lastly, real quick on the USW contract, it sounds like you’ve made a lot of progress on operating agreements, headcount reduction, getting Union City unprotected. What’s left on the table? It seems like to me, the only other major issue really out there is potentially retiree benefits or pension. Is that something that’s being negotiated right now, or are there other big items that are out there that I am missing?

Bob Keegan

John, everyone on the call is going to look at me at this point, because I’m going to give you the response you don’t want to hear, but again, I’m not willing to say anything with anymore granularity than I said. Because I think you’ll understand, we’re in the middle of those negotiations.

I will simply say those things that can improve our competitiveness are on the table and we’re having good, productive discussions and the extension of the contracts to August 15, is a good solid move that I think just portrays, we’re having good conversations, but I’m not willing provide any more granularity at this point.

Operator

Your next question comes from Saul Ludwig - KeyBanc.

Saul Ludwig - KeyBanc

I appreciate the comments that you made about mix and its impact on price mix as we look forward, I think those are very relevant. If we had a constant mix, how was your average price in the second quarter compared with the first quarter? Has there been any degradation in pricing, and do you expect any degradation in the third quarter from the second quarter levels again, on a constant mix basis?

Bob Keegan

Saul, we don’t break out, traditionally, price and mix, but I think we can say that in this environment it varies around the world. If one were to just look at price in the price mix, price is a contributor to the price mix positives that we’re seeing. Because the question maybe or I can interpret it as is this all mix? It’s a combination of price and mix. They’re both significant contributors on a year-over-year basis. If you look at Q1 to Q2…

Saul Ludwig - KeyBanc

Any degradation in price?

Darren Wells

We’ll keep price and mix together, Saul. I understand your question it is very hard for us to break those apart in a meaningful way. I think as we moved into Q2, as we’ve seen most of the degradation in volume in North America was OE versus replacement, that the fact that gave us a very high mix of replacement that is a beneficial thing for us.

As we look in Europe, certainly they’re hurt by the fact that commercial business is down very severely. In fact, the OE business held up better, so that was working against them in Europe and that’s why you saw from us that in our European business we had our revenue per tire year-over-year down about 4%, but in fact, if we had kept the mix constant, it would have been up about 4%.

So, we saw a huge impact there from the mix of business which is partly commercial truck, also includes agriculture OTR and some other non-consumer tires. So, we’ve got some major drivers there. So, I think that’s where we will leave the comments for now.

Saul Ludwig - KeyBanc

The $4 million production cuts in the third quarter, will they will if this same proportion geographically as what we saw in the second quarter?

Darren Wells

I think the production cuts are going to be reflective of where we see the markets. So, as you might expect, we are going to have production cuts that are going to match up with where the volume is needed. So, I think you can make some judgments about where we see the industry, where others see the industry and you can assume we are going to follow what’s going on in the market place and work back through our production schedule.

Bob Keegan

For both consumer and commercial.

Saul Ludwig - KeyBanc

Finally, the performance you had in Asia was outstanding, congratulations on that in particular. We’ve now seen, and you commented that part of that had to do with you saw raw material cost cuts earlier there than elsewhere in the world. Now we have seen this, a little up tick in natural rubber prices and as you talked about already Bob, can this level of earnings in Asia be sustained or is this a second quarter little [fluke], if you will, on the upside?

Bob Keegan

Well, I would start the response, Saul, by saying look; we’ve had continually improving and outstanding year-on-year performance in Asia Pacific for sometime. We are doing this today with frankly, weak markets in Australia and New Zealand. They look more like the other western markets of Europe and North America.

So they’re going to get a boost when those markets comeback, which they inevitably will, too. So, I see this natural so much as a raw materials question but more a market capability question, and they have done a very nice job in Asia.

You can see it by remember, we are restructured our entire manufacturing network in Asia with I lot of activity over this past three years. We have got our cost structure down, and we will continue driving that down.

So I think they have room to play, both on cost and certainly from a market standpoint. Because although China and India are doing better, we still in Asia are down in volume Asia Pacific totally are down in volume year-over-year. So we’ve got a lot of room to continue to move there from an overall standpoint.

Operator

Your next question comes from Itay Michaeli - Citi.

Itay Michaeli – Citi

Great. Thank you. I just have a couple of follow up cash flow questions. First on pension, I know you mentioned your performance in the quarter, but do you have a better sense of what the minimum contributions we should be thinking about here over the next couple of years? Does it have to ramp up back to $600 million, $700 million that we saw earlier in the decade, or any sense there?

Damon Audia

For 2009, we’ve kept the guidance at $325 million to $375 million and as we look forward into 2010, what we have said is we expect it to be up approximately $200 million from that number in 2009. Now, what we do know is there was some relief from the IRS on the discount rate selection for at year end 2008.

That would positively impact the 2010 contributions or reduce them, but given all of the other variables, that can have change throughout 2009. We haven’t changed the guidance, but I guess at this point, I will tell you that $200 million is probably the high end of incremental contributions.

Itay Michaeli – Citi

Then just on the cash flow for the remainder of the year, could you help us out with what you are thinking the cadence might look like? Does Q4 still look better than Q3, or is it perhaps more smooth given the puts and takes around inventory?

Darren Wells

Yes, I think that you’re right to think about the seasonality potentially being different this year, I think it’s a fair point. Because normally we would see very significant outflows during the first three quarters and I think inflow in the fourth quarter, some of it driven by lower inventory, but a lot of it driven by lower accounts receivable based on seasonal sales pattern.

I think we are going to continue to work down inventory, we are going to continue to focus on that and try to run our business with lower units of inventory. We have gotten a lot of benefit from lower raw material costs in the first half so in some ways, where raw material prices go, we will have some influence over where inventory for raw materials is the rest of the year.

I think we would still look for some level of seasonality in terms of receivable balance and inventory for the fourth quarter. So, it is more muted than it would have been in a year when there has been a bigger build in the middle of the year, but I think we’ll still see some seasonal impact there.

Itay Michaeli – Citi

Great, and then just lastly, a bigger picture question on CapEx. It looks like you are able to preserve margin here on $700 million to $800 million of CapEx, but if you think about the next couple of years, do you think you can sustain that level and still return to say, mixed mid single-digit operating margins, or do we probably have to trend back up to north of $1 billion?

Bob Keegan

I won’t be precise here, but certainly, the $700 million to $800 million, we don’t see that as a sustainable level We are able to do that because frankly, demand is down, and so we don’t have the same requirement for modernization and move the high value added tires at the same pace that we had before, but that trend is clearly upward, so it is going to put pressure on our CapEx expenditures overtime.

Operator

Your next question comes from Kirk Ludtke - CRT Capital Group.

Kirk Ludtke - CRT Capital Group

With respect to volume, I wasn’t quite sure what the guidance was for the third quarter with respect to in Asia in aggregate.

Darren Wells

I mean for the second quarter, what we saw in Asia, as Bob mentioned was we have some strength returning for China and India, but we have very weak markets in Australia and New Zealand. Then we’ve got the rest of traditional Asia somewhere in between the two. As we look forward, we’re looking for the region in aggregate to see growth.

I think the color behind it is we see a lot of that growth being driven by the strength in China and India. The recovery in Australia and New Zealand I think we’d expect to be slower, so we would still expect those markets to be fairly weak, but take a market in aggregate, our indication was we see Asia Pacific strengthening.

Kirk Ludtke - CRT Capital Group

So third quarter versus second quarter, you think it is positive.

Darren Wells

Yes, I think we are looking for Asia Pacific to return to year-over-year growth in industry volumes.

Kirk Ludtke - CRT Capital Group

Then with respect to materials, the guidance is pretty clear for the third quarter, down 18%. Fourth quarter also down year-over-year, but you’re not sure what the percentage change is going to be in the fourth quarter?

Bob Keegan

There are clearly still some variables out there that could influence the fourth quarter. The view that I would offer you is that based on everything we know today, the percentage decline in the fourth quarter would be a bigger percentage decline than Q3.

Kirk Ludtke - CRT Capital Group

Then with respect to pension, of the pension of 425 of pension expense for the full year, how much did you actually expense in the first half?

Bob Keegan

Pension expense for the first half?

Darren Wells

It’s about half of that.

Kirk Ludtke - CRT Capital Group

So it is half, even though you only recognized the incremental pension expense in the second quarter?

Bob Keegan

Yes.

Kirk Ludtke - CRT Capital Group

Same thing for funding, did you fund about half of the 325 to 375?

Darren Wells

Yes Kirk, I think year-to-date pension contributions were about $170 million, so about half.

Kirk Ludtke - CRT Capital Group

Then Bob, you mentioned that there’s an increase in Asian tire imports, I guess in anticipation of the President potentially signing this legislation. Do you think that impacts pricing in the second half, or is that in segments that you don’t compete in anymore?

Bob Keegan

I really can’t, I’d be speculating about that. The reality is we know that there’s a lot of product coming in right now, which is totally natural given the expectation. In terms of its impact on pricing, I’m not going to speculate on that.

Kirk Ludtke - CRT Capital Group

Lastly, with respect to FX, what was the impact on, I know it was a negative for sales, but what was the impact at the operating income line?

Bob Keegan

Yes, the impact at the operating line was not as significant for us. The reason, is if you look for instance in Europe, where some of the most significant impact is on the top line, because the operation is on an EBIT level pretty close to breakeven, it’s not seeing a big impact from currency. Not a big factor.

Patrick Stobb

Alright, thanks, Kirk. Thanks for everyone for joining us today. We appreciate that and this is Pat. If you have any follow-up questions, please feel free to give me a call. Thank you. Ashley, if you can close the call.

Bob Keegan

Thanks everyone.

Operator

This concludes today’s Goodyear’s second quarter 2009 financial results conference call. You may now disconnect.

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Source: The Goodyear Tire & Rubber Co. Q2 2009 Earnings Call Transcript
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