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Executives

Thomas Kaczynski - Vice President of Investor Relations

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

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

Analysts

Itay Michaeli - Citigroup Inc, Research Division

Aditya Oberoi - Goldman Sachs Group Inc., Research Division

Rod Lache - Deutsche Bank AG, Research Division

Ravi Shanker - Morgan Stanley, Research Division

Goodyear Tire & Rubber Co. (GT) United Steelworker 2013 Agreement Conference August 27, 2013 9:00 AM ET

Operator

Good morning. My name is Tony, and I'll be your conference operator today. At this time, I'd like to welcome everyone to The Goodyear Tire & Rubber Company Investor Call on its newly ratified master labor contract with United Steelworkers. [Operator Instructions] I would now like to hand the program over to Tom Kaczynski, Goodyear's Vice President of Investor Relations.

Thomas Kaczynski

Thank you, Tony, and good morning, everyone. Thank you for joining us for Goodyear's United Steelworker 2013 Agreement Conference Call.

Joining me on the call this morning are Rich Kramer, Chairman and Chief Executive Officer; and Darren Wells, Executive Vice President and Chief Financial Officer.

Before we get started, there are few items I need to cover. To begin, the supporting slide presentation for today's call can be found on our website at investor.goodyear.com.

A replay of this call will be available later today. Replay instructions were included in the press release announcing the United Steelworker agreement issued this morning.

If I can now draw your attention to the Safe Harbor statement on Slide 2. Today's presentation includes some forward-looking statements about Goodyear's future performance. Actual results could differ materially from those suggested by our comments today. The most significant factors that could affect future results are outlined in Goodyear's filings with the SEC and in the 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.

And with that, I'll now turn the call over to Rich.

Richard J. Kramer

Thank you, Tom. Good morning, everyone, and thank you for joining us on the call today. When we began negotiations with United Steelworkers in late April, our goal was to build on the significant progress made in the 2003, 2006 and 2009 contracts and enable our North America business to continue its momentum. We believe our new 4-year agreement meets that goal, allowing us to enhance our competitiveness even in the midst of continuing economic challenges.

Like the past 3 contracts, this contract addresses both our operational efficiency and structural costs. The new agreement permits us to freeze legacy pension obligations for USW employees, building on our 2006 action to eliminate retiree health care obligations and our 2009 agreement to move new hires to 401(k)-type retirement plans.

In addition, the new contract adjusts our profit-sharing plan to reduce its costs and keeps wages and benefits in aggregate, consistent with the prior contract. These steps align with our strategy road map and further position our North America business to continue on its path.

As shown on Slide 4, that path is the result of a series of actions, each building upon the other. This contract is one of those actions and likewise builds on the previous agreements. In 2003, we focused on addressing unproductive capacity and reducing costs to help support the early stages of our financial turnaround. These were tough decisions around plant closure, wage and benefit reductions and other necessary actions.

In 2006, we addressed our retiree medical obligations through the VEBA, an innovative strategy soon implemented by numerous other companies. Also, we eliminated more high-cost capacity, increased labor efficiency through job reclassification and implemented a tiered wage structure.

In 2009, we improved our efficiency within the 4 walls of our factories. In that contract, we further reduced high-cost capacity, improved performance standards to drive consistent and measurable productivity gains and continued to address the pension obligations by shifting toward a defined contribution plan for all new hires.

These 3 agreements enabled us to address significant cost and productivity challenges by closing 3 unproductive high-cost plants. At the same time, we improved our flexibility to better respond to rapid and ongoing changes in the tire industry. Taken together, they helped us fundamentally change our North America business model.

And we believe our new contract with the USW addresses our major remaining structural concern, allowing us to increase the transparency to the success in our underlying tire business.

The new agreement accomplishes 3 things: first, it allows us to fund and freeze the defined benefit pension plan, moving exclusively to a defined contribution plan; second, it reduces the maximum annual profit-sharing payment, maintaining performance incentives while lessening the volatility of the previous plan; and third, it continues medical cost sharing and maintains overall wage and benefit costs consistent with the prior agreement.

In summary, we view this agreement as the next action in the continuous process and a positive step on our journey towards sustained value creation in North America.

I'd like to express my sincere thanks to Goodyear's chief negotiator, Jim Allen, who has led all of our bargaining efforts going back to 2003 and the USW's lead negotiator, Tom Conway, and their teams for the months of hard work to reach this agreement. We sincerely appreciate their efforts.

The turnaround of our North America business was a result of genuine teamwork, especially between Goodyear and the USW membership. We have seen what we can accomplish when we work together with shared purpose and common goals as one Goodyear team.

Now I'll turn of the call over to Darren.

Darren R. Wells

Thanks, Rich, and good morning, everyone. This morning, I'd like to provide you with more detail on the 3 key provisions that Rich touched on.

Turning to Slide 5. I want to discuss provisions for addressing our remaining unfunded U.S. pension plans. These plans are expected to be unfunded at year end by about $1.1 billion, based on June 30 discount rates and statutory required contributions.

Consistent with the pension strategy announced earlier in the year, our objective in this contract was to obtain the ability to freeze the hourly defined benefit plan in order to implement our previously announced strategy and reduce the exposure of our pension liability to future interest rate and equity market movements.

This objective was achieved. The contract allows us to fully fund the hourly defined benefit plan and transition participants to a 401(k) plan. A key feature of the pension provisions of the contract is the flexibility we gained in terms of timing. We can freeze the plan at any time during the life of the contract. The plan becomes frozen 90 days after it is fully funded to ERISA requirements. Once funded, we are obligated to keep the plan 97% funded on an ERISA basis.

Consistent with our announced strategy, once the hourly plans are fully funded, we'll change the asset allocation to substantially all fixed income securities. This shift in allocation is designed to ensure asset returns offset any future impact of discount rates on the plans' unfunded status.

Funding for these plans is expected to come from a combination of cash and debt financing. The timing of the funding is yet to be determined and will depend on the interest rate environment and other factors.

Current USW employees who are participants in the defined benefit plan will begin receiving company contributions to their 401 (k) plans starting with the effective date of the defined benefit plan freeze. The annual company contributions will range from $2,100 to $8,000 depending on age. USW employees who are not participants in the defined benefit plan will receive an increase in company contributions to their 401(k) plan effective January 1, 2014.

A number of factors go into the calculation of the net savings we anticipate once we take actions to fully fund and freeze the plans. These include eliminating service costs, adjusting pension asset return assumptions, reducing PBGC premiums and changing the period over which gains and losses in the plan will be amortized.

On Slide 6, we've provided one example based on a hypothetical funding date in early 2015. As shown in the example, we anticipate a net favorable pension expense impact of about $60 million by the end of the contract period. The impact on other years will depend on the timing of the funding actions.

Slide 7 summarizes changes to profit sharing compared to the prior contract. The formula under our 2009 agreement allowed for 12% of North America EBITDA in the form of profit sharing with a cumulative cap of $175 million and no specific annual limits.

Under the new contract, profit sharing has been reduced to 10% of North America EBITDA and the amounts earned are capped at $35 million per year, thus, evening out early distributions. The new agreement has a cumulative cap of $140 million over the life of the agreement.

On Slide 8, we highlight the most significant provisions related to wages and benefits under the new agreement. Under the new agreement, Goodyear has the flexibility to reduce employment levels by up to 15% at each of the 6 U.S. facilities covered by the contract, including up to 230 discretionary buyouts in 2013. The company may also offer 400 additional buyouts during the duration of the agreement.

Aside from the flexibility to adjust employment levels to reflect business conditions, there are a number of changes to wages and benefits. None of the individual items were that significant. And overall, the wage and benefit costs are consistent with the prior agreement.

Examples of these changes include a modest wage increase for the bottom 2 tiers of associates, which represent about 7% of the workforce covered under the agreement. This will help with retention issues we've had related to this group of workers. Premiums for medical plans have been modestly increased to offset a portion of medical inflation. And adjustments have been made in provisions for cost-of-living adjustments and the process in payments related to associates changing job tiers.

Overall, wages and benefits remain cost-neutral versus the prior contract before assuming any headcount reductions.

Overall, we feel that the flexibility to transition our hourly defined benefit plan to a 401(k), combined with a reduced profit sharing and retaining overall wage and benefit costs from prior agreements, the outcome of these negotiations is a positive for future financial performance.

Before we move to Q&A, we'd like to cover one additional piece of business. We're pleased to announce that we'll be holding an investor meeting this year on the morning of Friday, September 20, in New York City. Rich and I, along with other members of Goodyear's leadership team, will discuss the state of the business and the broader tire industry. We'll also take participant questions in an extended Q&A session. Conference details will be sent out later today.

We'd now like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Itay Michaeli with Citigroup.

Itay Michaeli - Citigroup Inc, Research Division

Just the first question is that you noted you would look to fund the plan with a combination of debt and balance sheet cash. Give us a little bit more detail around how much cash you'd be comfortable using for this, maybe to review some of your minimum and comfort ranges for cash going forward?

Darren R. Wells

Yes. So Itay, I think the amount of funding and the source of funds, the combination of debt or debt and cash, is going to depend on a lot of factors and including the timing of the funding. I will say that one of the things that we'll address at our investor meeting on September 20 is going to be our capital allocation plans going forward. So there'll be a number of topics covered there, but that'll be among them. And I think we'll come back and we'll talk a bit more about our thoughts around the funding of the pensions at that point. There's nothing imminent there. Obviously, we have 4 years available under the contract to make the funding. But we are -- we remain focused on eliminating that volatility.

Itay Michaeli - Citigroup Inc, Research Division

Terrific. And then just on Slide 6, a couple of questions. One is what's the assumed rate of return in the projection? Does that assume that you shift entirely or mostly towards fixed income assets? And then how would the expense dynamic perhaps change, if at all, if you were to fund the plan sooner than what you've outlined on Slide 6?

Darren R. Wells

Yes. So Itay, the sensitivities here are complex, as you can imagine given the number of different variables involved in the calculation. Yes, so we've given an example so that it's clear what all of the various impacts would be and it's clear about what financial impact we would expect from the reduction in defined benefit pension expense net of the 401(k) contributions that would take the place of that benefit plan. Not really easy to do quick sensitivities on this. Obviously, the sooner the plan is funded, the sooner the savings kick in. But there are number of different variables here. So as I said, this is -- I mean, a hypothetical example, we pick kind of the midpoint of the contract to do the example. And when we get to the point of doing the funding, obviously we'll come back and give a full set of financials based on the conditions at that time. You are right, though. To your first question, you are right to point out that there is an assumption underlying the baseline pension expense here that does assume that as the plan gets more and more funded, we shift the assets more toward fixed income. So that's part of the ongoing plan, part of the strategy we announced at the beginning of the year.

Itay Michaeli - Citigroup Inc, Research Division

Perfect. And if just quickly, just lastly, back to Slide 5. Does the definition of fully funded per the labor contract correspond to the $1.1 billion underfunded, I guess, based on GAAP? Are those 2 pretty much matched up?

Darren R. Wells

Yes, so GAAP and ERISA can be a little bit different. And as we point out here, the contract is written in ERISA terms. But the unfunded amount on GAAP and ERISA basis converge over time. So I mean, our strategy is focusing on fully funding on a GAAP basis to eliminate the volatility and financial results, getting to the transparency we want to the underlying tire business. But over time, the 2 are not significantly different.

Operator

We'll take our next question from Aditya Oberoi with Goldman Sachs.

Aditya Oberoi - Goldman Sachs Group Inc., Research Division

So I had a quick question on Slide 8 first. So the additional 400 buyouts that you mentioned in Bullet 2, which is, I think, approximately 5% of the workforce that is covered under this contract, is it in addition to the 15% that's mentioned in Bullet 1? Or is it a part of the 15%?

Darren R. Wells

No, that is in addition to the 15%.

Aditya Oberoi - Goldman Sachs Group Inc., Research Division

Okay. And when you say there's a right to offer up to 230 discretionary buyouts in 2013, do you plan to exercise it? And is it already included in your SOI target? Can you comment a little bit about that?

Darren R. Wells

Yes, so Adi, we have not announced any plans in that respect. So that's something that we still have to make a decision on.

Aditya Oberoi - Goldman Sachs Group Inc., Research Division

Okay. And that implies that it is not a part of your SOI target either?

Richard J. Kramer

Think about it as flexibility as we manage the business going forward, Adi.

Aditya Oberoi - Goldman Sachs Group Inc., Research Division

Okay, great. And I know you guys have addressed this topic before in the previous question as well. But just to get little more clarity, since you have the flexibility to fund the plan at any point in the next 4 years, is this a scenario, assuming interest rates continue to go in the right direction, that you might not even require to make any contribution, that the interest rates itself take care of most of the underfunding here?

Darren R. Wells

Yes, so Adi, the impact on interest rates on required contributions does not happen that fast. So regardless what happens with interest rates, there'll still be some significant contributions over the next several years. So I think this is -- it's a fair point. But over the next few years, almost regardless of what happens with interest rates, we're still going to be contributing numbers like the $200 million to $250 million a year to these plans that we talked about in the second quarter call. So I think, yes, the next 2 or 3 years, not much impact as interest rates rise. After that, clearly, it does have some impact and would have some impact on the overall situation.

Operator

We'll take our next question from Rod Lache with Deutsche Bank.

Rod Lache - Deutsche Bank AG, Research Division

I was hoping you can just spend a little bit of time on a couple of the lines here on Slide 6. Just the expected return on plan assets reduced line, I would assume that you have something like, I don't know, a $4 billion PBO or something like that on the -- maybe a little bit more than that on the hourly plan. Is that fair?

Darren R. Wells

Yes, so we don't have disclosure of the hourly plans by themselves, Rod. But your -- the -- I mean, they represent about 2/3 of the plans that we have in the U.S. So moving in the right direction there.

Rod Lache - Deutsche Bank AG, Research Division

So if it's in the ballpark, let's say it's $4 billion of PBO and $4 billion of assets, so every 1% change in your asset return assumptions is maybe $40 million. You're currently assuming an 8.5% return assumption. If you flip to fixed income, I would think that maybe it's 4.5% or something like that. So maybe that's $160 million effect from the reduction in the plan assets. Can you just explain how you get from something -- maybe it's not a precise explanation, but the numbers look quite low relative to what, I guess, I would anticipate from a shifting to fixed income.

Darren R. Wells

Yes. So Rod, the -- I mean, 2 things are happening here. First of all, in our baseline assumptions, at the top of the page, because of the contributions we're making, we're assuming that we're making a move toward more fixed income allocation over time anyway even if we're just making the required contributions. So by the time you get out to 2016 and 2017, in the baseline, you've already made a lot of the movement toward the -- toward fixed income, full fixed income allocation, right? So when you we take it a little bit quicker, you get there quicker, but it is not representing a move from 8.5% all the way down to a pure fixed income asset return.

Rod Lache - Deutsche Bank AG, Research Division

So this is not compared to what we've been seeing in your P&L like through 2013. There's some negative effect from that, that you're anticipating through the rest of this year and 2014 before you get to that net reduction of $38 million and $76 million and so forth?

Darren R. Wells

Yes. So if you see in the baseline, our net periodic pension costs going from $85 million in '15 to $105 million in '16, I mean, that increase is a result of assets being allocated more to fixed income and reducing the expected return on assets.

Rod Lache - Deutsche Bank AG, Research Division

Okay. All right. And then just a point of clarification on the headcount reductions, the 400 buyouts plus the 15% in each facility. Is there anything being planned and maybe can you comment, is that part of the -- just a broad comment that you made on wage and benefits being more or less neutral? Is that net of headcount reductions?

Richard J. Kramer

No, Rod. Again, these are just builds in flexibility looking to the future, so I think you've got to look at them -- look at it as a separate element.

Darren R. Wells

There's a comment on the wages and benefits being cost-neutral versus the prior contract. That is before taking into account any potential headcount reduction.

Rod Lache - Deutsche Bank AG, Research Division

Okay. And just lastly, is there any profit sharing in your P&L this year because I see that it's basically going to decline to, I guess, $35 million next year. And how are you treating the signing bonus?

Darren R. Wells

Yes. So Rod, here is the way -- if we step back from it, if we take the profit sharing we still have in our first quarter results this year, along with the upfront payments we're making for the contract, then those payments would be over $30 million this year. So next year's profit sharing, if accrued at $35 million, means '14 and '13 would be very similar.

Operator

And we'll take our final question from Ravi Shanker with Morgan Stanley.

Ravi Shanker - Morgan Stanley, Research Division

Just had a quick question. What level of leverage in the balance sheet are you comfortable once you've fully funded this pension plan?

Darren R. Wells

Yes, I mean, Ravi, what we've been working our way toward is a 2.5x leverage ratio calculated as debt plus unfunded pension to EBITDA plus pension expense or EBITDAP. And that's been our long-term target. So that's -- if you ask us what level we're comfortable with, that's the level we'd be comfortable with. We have -- we also have been comfortable making progress toward that over time, so there's no specific date that we've set for achieving that. But I think, clearly, getting to the point where pension obligations are a fixed obligation rather than one that potentially changes or is volatile gives us the ability to control much better when we are able to achieve that leverage target.

Thomas Kaczynski

Okay. Everybody, appreciate your attention today, and we're very pleased with the results of this contract. And I think it aligns very well with the destinations in our strategy road map. So appreciate the attention today. Thank you.

Operator

Thank you. This does conclude today's conference. You may disconnect at anytime, and have a great day.

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