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Goodyear Tire & Rubber (NASDAQ:GT)

Q2 2011 Earnings Call

July 28, 2011 10:00 am ET

Executives

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

Darren Wells - Chief Financial Officer and Executive Vice President

Gregory Fritz - Vice President of Investor Relations

Analysts

Rod Lache - Deutsche Bank AG

Patrick Archambault - Goldman Sachs Group Inc.

Itay Michaeli - Citigroup Inc

Brett Hoselton - KeyBanc Capital Markets Inc.

Himanshu Patel - JP Morgan Chase & Co

John Murphy - BofA Merrill Lynch

Operator

Good morning. Welcome to the Goodyear Tire and Rubber Company's Second Quarter Financial Results Conference Call. [Operator Instructions] I will now hand the floor to Greg Fritz, Vice President of Investor Relations. Thank you. Mr. Fritz, you may now begin.

Gregory Fritz

Thank you, Christina, and good morning, everyone. Welcome to Goodyear's second quarter conference call. Joining me today are Rich Kramer, Chairman and CEO; Darren Wells, Executive Vice President and CFO. Before we get started, there a few comments I would like to cover.

To begin, the webcast of this morning's discussion and the supporting slide presentation can be found on our website at investor.goodyear.com. Additionally, a replay of this call will be accessible later today. Replay instructions were included in our earnings release issued earlier this morning.

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. These risks and uncertainties, which can cause our actual results to differ materially, 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 to the agenda. Rich, will provide a business overview including second quarter highlights and accomplishments. After Rich's remarks, Darren will discuss the financial results and outlook before opening the call for your questions. With that, I will now turn the call over to Rich.

Richard Kramer

Thanks, Greg, and good morning, everyone. And please join me in welcoming Greg Fritz, our new Vice President of Investor Relations. I know some of you have already been working with Greg, and we're certainly glad to have him on board. So Greg, welcome to the team.

So today, we're very pleased to report outstanding second quarter results, highlighted by record sales, a significant increase in segment operating income and the continued successful execution of our strategy. The most impressive results were delivered by our North American Tire business, which delivered earnings of $137 million, marking its most profitable quarter since 1998.

In total, all of our businesses continued to make solid progress in achieving price/mix improvement through innovative product offerings in targeted market segments. This is consistent with the strategy we shared with you earlier in the year.

In April, we reiterated our belief that our strategies and objectives were the right ones, and our first quarter results provided evidence of progress. We are very pleased that our second quarter results indicate that we are executing our plan and staying on pace to hit our targets.

Now as I usually do, I'll cover a few topics before turning the call over to Darren and then taking your questions. First, I will call attention to some accomplishments that were important to Goodyear's outstanding second quarter results, then I'll share my thoughts on the strong performance we saw in our North American Tire business and try to put it in context. And finally, I'll provide a perspective on the second half of the year and our longer-term outlook, touching on the challenges and opportunities that lie ahead.

The first accomplishment I'd like to highlight in Q2 is our top line performance. We achieved total sales of $5.6 billion, the best quarterly total in our company's history. Likewise, 3 of our 4 regions achieved record second quarter sales.

The second accomplishment is our execution on price and mix, which more than offset significantly higher raw material costs. As we've previously discussed and demonstrated, price/mix improvement has been an effective and necessary response to unrelenting raw material cost headwinds. All 4 of our regions fully offset raw material cost increases in the quarter. And I'll make further comments about price/mix performance in a few moments when I discuss our North American business.

The third accomplishment is maintaining our focus on pursuing sales in targeted market segments. Our revenue per tire grew 18% from a year ago. While the industry volumes were weaker overall, there remained strong demand for our premium innovative products in both emerging and developed regions.

Additionally, we are continuing our focus on operational excellence. Across our global footprint, we are improving our ability to make more of the right tires, leading to a richer product mix and increased customer service levels.

Our efficiency in eliminating low-value tires and moving products from Union City to our other plants facilitated closure of that factory ahead of schedule. This action is also consistent with our plan to reduce high-cost capacity, which we detailed for you in previous calls.

Our new products also were critical to further accomplishments in the quarter. In Latin America, high-technology Fuel Max and Aquamax tires were launched across the region. I know it's been an extremely hot summer for many of us. Europe is already preparing for the winter driving season. Goodyear and Dunlop will continue their leadership in winter tires, with more new products being introduced this year to build on the existing portfolio of award-winning products.

Our European business also delivered significant year-over-year and quarter-over-quarter improvement driven by successful price/mix performance. By keeping our focus on targeted summer tire market segments and getting off to a fast start in winter tire sales, we were not significantly affected by softness in the southern European markets.

We continue to see strong growth for our innovative products in any of targeted market segments, including commercial truck, and we'll keep adding to our portfolio of award-winning tires.

In China, Assurance Fuel Max was named Auto Trend Magazine's Tire of the Year, topping all competitors and becoming the publication's highest-rated tire ever. Fuel Max received perfect grades in 9 of the 10 performance categories. That's outstanding for us. Our growth in Asia is being supported by an expanding retail presence in China as we opened 64 new retail stores in June alone.

In 2010, Goodyear was named both Retail Brand of the Year and Employer of the Year in China and our expanding retail presence fortifies both these positions.

Now much of our recent commentary about our Asia Pacific business has focused on our new factory in Pulandian, China. And I'm happy to report a significant accomplishment for our team there. In June, the first tires for public sale were manufactured in this facility. Crossing that threshold was an important step for our operations, for our presence in China and for our opportunity for growth in the region.

Our new Pulandian facility will double our capacity over our existing factory, providing the basis for continued growth consistent with our strategy of winning in China.

But perhaps the quarter's most significant accomplishment and best illustration of how we are executing our plan is in North America. The momentum that was apparent in the first quarter continued over the past 3 months. Segment operating income was $137 million, which corresponds to a 5.7% segment operating margin, a level we have not seen in North America in more than a decade.

We achieved these strong results by focusing on new innovative products for our key targeted market segments. For example, the newest generation of one of our most popular consumer tires, the Assurance TripleTred All Season, hit dealer shelves in the quarter. In fact, this week we launched a 16-city ride-and-drive tour for customers who needed to experience the new TripleTred. We're very proud of it. We have sold more than $22 million Assurance tires since we launched the sub-brand in 2004, and we expect that the new Assurance TripleTred All Season will build our mass success.

Now in addition, we continued addressing our business portfolio by shifting to in-demand branded products and being selective about OE shipments to ensure that we receive an appropriate return. Also, we are well positioned for the rebound of the Commercial Tire segment with a full portfolio of business solutions.

In the month of June, our fleetHQ service program got 22,000 immobilized trucks back up and running, the highest monthly total since the program's inception 3 years ago. We also have introduced important new products such as innovative wide-base tires that help reduce fleet operating cost. These Super Singles offer both the fuel efficiency of Fuel Max Technology and the puncture resistance of DuraSeal Technology.

Now during the quarter, we also priced proactively for the value of our products to address increasing raw material cost. These results will be difficult to repeat in the second half because of increasing raw material cost challenges and uncertain economic conditions. Now as we said repeatedly, we are confident that we can offset increasing raw material costs overtime with price/mix, but we expect periods where we cannot recover these increases as they occur. As a result, we believe that our Q1 earnings are more indicative of our current earnings run rate in North America.

Now as pleased as I am about our exceptional results in North America, and more importantly the initiatives driving them, the level of earnings in the second quarter is not yet sustainable. It is more reasonable to expect progress toward our 2013 earnings target of $450 million will be made with steady but smaller steps.

So looking at our businesses in total, we are seeing execution of our strategies with measurable results from our focus on price and mix, progress on North America's path to sustain profitability, continued strength in Europe and successful activation of our investments for future growth in Asia and Latin America, improvements in operational efficiency and success with innovative products in targeted market segments.

I believe that these outstanding results are further confirmation that we're on the right path toward not only the 2013 targets but toward our long-term objective of creating sustainable economic value.

In the second half of 2011, we expect the global tire industry to continue to grow, but recent trends have affected our outlook somewhat. We see the recovery in developed markets remaining sluggish overall, driven in large part by 2 things. The first is a genuine macroeconomic concern relative to the prevailing debt issues in both the U.S. and Europe, which is having a discernible impact on confidence among customers. The second is a more balanced relationship between sell-in to the dealer channel versus sell-out to end users. Well, the data is not entirely available, and transparency here is difficult, the trend seems to have emerged. While sell-in was stronger than sell-out during the first quarter, we are now seeing lower sell-in volumes. The balance seems to be shifting toward meeting consumer demand and away from inventory restocking, a trend perhaps not surprising, given the existing economic uncertainty. This is a trend we will watch in the near term, but since consumer demand has not yet returned to pre-recession levels in mature markets and since dealer inventory does not appear high, clarity in the economy or other positive catalysts should improve demand over the long term.

Now relative to emerging markets, we see higher structural inflation and the resulting effect on growth rates. Of particular importance to us is the strength of the real in Brazil, which continues to bolster the import market, putting pressure on domestic manufacturers in many industries, including tires. We saw the impact of these factors on segment operating income margin in the region this quarter. Now to be clear, we still see growth opportunities in Latin America and emerging markets. However, these dynamics remind us that volatility remains despite an optimistic future.

Now balanced against some of these challenges is continuing strong demand for our high value-added branded products, which in many cases remain in short supply. We see industry growth scenarios such as consumer OE tires, particularly as the Japanese automakers continue their recovery from the effects of this year's natural disasters; European winter tires as harsh weather last year and increased winter tire legislation have dealers preparing for high consumer demand; and in commercial truck tires in North America, as the transportation industry continues its recovery.

I'll also remind you that, while higher volumes may indicate a healthier industry, our focus on targeted market segments leads us away from volume, simply for volume's sake. We will stay disciplined in our approach to price/mix and focus on selective profitable segments. That's our strategy, and we're going to stick to it.

Now we're facing substantial raw material cost increases in the second half of the year as well. These are conditions that we're now familiar with and show no signs of abating. That said, we remain focused on price/mix as a way to address these raw material cost increases. Darren will provide financial details of the anticipated raw material cost impact in the second half of the year.

Now while the volatility we see over the second half of 2011 is a reality of our industry, we remain confident in long-term opportunities. The growth of HVA tires in mature markets will continue, and the strong GDP growth in emerging markets will sustain the expansion of the middle class and, subsequently, the need for tires. I will reiterate that we believe in focusing on targeted market segments where we can drive value for Goodyear and our customers. We believe in operational excellence in everything we do as a source of competitive advantage, and we believe that innovation in our products is the key element that differentiates our tires and, in fact, our company, from the competition.

So there are significant challenges ahead. We are very pleased with our second quarter results. They offer further validation of our strategy, reward our execution and strengthen the confidence in our plans, our products and our people. We are on the right path, and we firmly believe that we are on track to reach our 2013 targets.

So I appreciate your attention, and now I will turn it over to Darren to take you through the financial details. Darren?

Darren Wells

Thanks, Rich, and good morning. As you've heard this morning, we generated a significant increase in segment operating income during the second quarter, despite having to manage through a substantial increase in raw material costs. On our Q1 call, I pointed out that raw materials were rising at a rate well beyond our historical ability to offset them with price/mix. Needless to say, I'm very happy with the price/mix improvement of $554 million that we achieved compared to the prior year, far more than we've ever achieved in a quarter. This substantial increase was the result of several factors.

First, we realized the benefit of our price increases. Given the sizable increase in raw material cost inflation, this has been critical to our results and reflects the strength of our brand and product offerings.

Second, our targeted segment strategy drove improved mix during the quarter. Our product mix was favorable in all regions as we were able to deliver more of the tires consumers we're shopping for.

And third, we saw a continuing recovery in the commercial truck markets, which added to our ability to achieve price/mix.

To put our performance in perspective, we now nearly offset raw material cost increases that we've seen over the trailing 4 quarters in aggregate. As we consistently maintained, the timing of price/mix actions and raw material cost increases are not always directly in-sync, and I'll stick to that statement. But I've also said that we're confident in our ability to offset raw materials over time. Q2 adds to our solid track record in this respect.

Turning to the income statement. Our second quarter revenue increased 24%, despite a 2% decline in the entire unit volume. The revenue increase was largely due to improved price mix, which explains 14 percentage points of our revenue growth on a year-over-year basis. Favorable other tire-related revenue in foreign currency explains the remainder of the year-over-year improvement.

Coming back to unit volume. We saw uneven trends during the quarter. As Rich explained, U.S. consumer demand softened as dealers worked through some of the first quarter pre-buy. EMEA consumer unit volume, on the other hand, continued to show growth during the second quarter, driven by early ordering of winter tires. We maintained our gross margin percent of sales, despite the adverse impact of year-over-year increase in raw material cost.

Selling, administrative and general expense increased $83 million to $753 million during the quarter. Foreign currency translation accounted for $57 million of the year-over-year increase. As a percentage of sales, SAG declined 140 basis points to 13.4% during the quarter.

We reported segment operating income of $382 million, which I'll discuss more in a minute. Excluding discreet items, our second quarter effective tax rate, as a percentage of Foreign segment operating income, was about 22%. For the year, we continued to expect our effective tax rate to be about 25% of Foreign segment operating income.

Second quarter after-tax results were impacted by certain significant items including restructuring and debt rebates. A summary of this can be found in the appendix in today's presentation.

Turning to the segment operating income step chart. You can see the benefit of price/mix at $554 million compared with raw material cost increases of $428 million. In addition, during the second quarter, we generated cost savings of about $78 million, net of the USW profit sharing program. Our second quarter savings are consistent with our plan for 2010 to 2012 and keep us on track to achieve $1 billion in savings over the 3-year time period.

Out of the $78 million in savings, $47 million was the result of efforts to substitute lower-cost materials in our compounds and to reduce the amount of material required to produce each tire. Our cost savings largely offset an $80 million impact of inflation in the second quarter.

Higher production levels continued to drive lower unabsorbed fixed cost versus the prior year. The benefit of $39 million was generated on incremental year-over-year production of 3 million units in Q1 after one quarter of inventory lag. This result, coupled with the first quarter of unabsorbed fixed cost improvement of $81 million, puts us on track toward full year improvement of at least $175 million.

Much of this has already been realized through the first half of the year, and we currently expect the remaining improvement will be spread about evenly over the next 2 quarters.

Favorable foreign currency translation, driven by weaker dollar, resulted in a $28 million benefit for the year -- from the prior year. And as anticipated, pension expense continues to improve in our North America business in the second quarter. Lower unit volume had an unfavorable impact of $12 million.

The other category primarily reflects higher advertising, startup costs for our new factory in China, the sale of the Latin America Farm Tire business and higher transportation costs. These increased costs were partially offset by the non-recurrence of last year's $20 million adverse ruling in a 6-year-old product liability case.

As I've done for the last few quarters, I want to take a moment to discuss our sales and unit volume for the Global Consumer and Commercial Businesses separately.

Our Global Commercial business continued to see strong growth. New truck production rates remained robust as markets continued their recovery. As with the case in Q1, the improved factory utilization and higher volumes in commercial truck contributed significantly to earnings improvement in North America and EMEA.

On the consumer side, we experienced lower unit volumes. This reflected lower OE production and a lower North America consumer replacement industry, which followed the strong Q1. For both consumer and commercial, you can see the higher revenue per tire driven by both price/mix and favorable foreign exchange.

Turning to the balance sheet. Our net debt increased from the first quarter, as we saw a $500 million increase in working capital. The working capital increase was mainly driven by seasonal requirements, higher unit raw material costs and a weaker U.S. dollar. But also reflected higher inventory levels, given weaker industry volume in the quarter, which gave us an opportunity to catch up on inventory to improve service levels for our customers.

We expect working capital to be in use of $300 million to $400 million of cash for the full year reflecting seasonal improvements in the second half and the benefits of our working capital initiatives offsetting much of the cash used in the first half. This slightly increased outlook reflects the opportunity to catch up on inventory.

Turning to segment results. North America reported segment operating income of $137 million in the second quarter, which compare to the income of $16 million in the second quarter of 2010. North America unit volumes were down, as industry volume per consumer replacement and OE each declined approximately 4%. Commercial industry demand continued to see strong gain, with replacement demand up 9% and OE up 57%. In addition to the benefit of price/mix of $216 million more than offsetting $131 million of raw material costs, North American earnings continued to benefit from ongoing reductions in unabsorbed overhead and lower pension expense. Higher year-over-year production levels in our plants in Q1 resulted in North America recovering $20 million in unabsorbed fixed cost. Cost improvements were partially offset by higher USW profit sharing as a result of higher profitability levels.

Given the recent consumer industry volume trends, we were able to execute our Union City closure on July 11. As a result of this action, we expect to generate $80 million of annualized cost savings beginning in 2012, part of our recovery of unabsorbed overhead in North America. We will not see net savings in 2011, given savings are temporarily offset by product ramp-up and other transition-related cost.

Our second quarter North American results demonstrate we have the right strategy: Targeted market segments, industry being innovation and a continued focus on cost reduction. Evidence of this strategy is visible in the price/mix improvement, in the increases in branded share for consumer replacement and continued cost improvements in the quarter. Looking forward, however, we see current earning run rate more consistent with Q1, as raw material cost pressures increase in the second half, and we lose the benefit of high third-party chemical income that we had in the first half.

Europe, Middle East and Africa reported segment operating income of $126 million in the quarter, which compared to $73 million in the 2010 period. The 2011 results reflect sales of $1.9 billion, a net sales increase of 34% on a 2% increase in unit volume. Revenue per tire, excluding the impact of foreign exchange, increased 19% year-over-year.

Industry unit volume reflected strong growth in emerging markets as well as a 23% increase in the winter segment, partially offset by a 5% decline in the summer segment in Western Europe.

Consumer OE volumes increased slightly and commercial has shrunk with replacement up 12% and OE up 56% compared with the year ago. The stronger euro and other currencies versus a year ago favorably impacted net sales for the quarter by $222 million.

EMEA segment operating income increased $53 million, reflecting primarily price/mix of $199 million, more than offsetting $135 million of raw material cost increases. Strong winter volume helped support improved mix. Results were also favorably impacted by a $17 million benefit from lower unabsorbed fixed cost, driven by higher capacity utilization in our factories.

Latin America reported segment operating income of $54 million during the second quarter compared to $66 million in the prior period. [indiscernible] factors impacted our Latin America year-over-year results. As previously announced, we sold our Farm Tire business to Titan on April 1. This negatively impacted the year-on-year segment operating income comparison by $8 million, consistent with the $30 million to $35 million annualized impact we discussed on the Q1 call. Second, structural cost inflation, we were unable to offset with savings actions. And third, unique costs related to the ramp-up of our Chile manufacturing investment.

In addition, our Latin America business is experiencing some adverse market dynamics, including the strength of the Brazilian real, which has significantly increased import competition at the lower end of the market. Our team recognizes these challenges and is putting in place actions to address these market dynamics.

Our Asia Pacific business reported another very impressive quarter. The continued strong demand from China and India helped mitigate ongoing weakness in the Australia and New Zealand retail environment and softening OE demand. As a result, Asia Pacific reported segment operating income of $65 million, a year-over-year increase even with $10 million of startup expenses associated with the ramp-up of our new factory in Pulandian, China.

Foreign currency was favorable by $7 million, reflecting mainly the stronger Australian dollar. Price/mix improvements were able to more than offset raw material cost increases. Overall, we continue to be pleased with performance and opportunities we see in Asia and particularly in China going forward.

Turning to our industry outlook. We have tempered our full year expectations for North American consumer replacement demand, given some of the recent trends and overall macroeconomic uncertainties. We now expect full year industry growth will be flat to up 2%, which implies a flat second half replacement industry in North America. Our EMEA consumer replacement industry outlook remains unchanged. Our assumptions in North America and EMEA for consumer and commercial OE businesses are also unchanged from the prior quarter.

On the commercial truck replacement side, we see stronger demand trends within the North American industry, which is now expected to grow 10% to 15% in 2011. In EMEA, we expect commercial replacement growth of 7% to 11%, in line with our previous expectations.

For Goodyear, we now expect full year unit volume growth will be at the low end of the previous range of 3% to 5%.

Looking at our raw material costs over the balance of the year, we expect cost increases of more than 30%. In the third and fourth quarter of the year, we are projecting raw material cost increases approaching $600 million in each quarter. These increases will represent a substantial sequential increase from our second quarter level as the lag effect from recent raw material cost increases moves through the P&L. Our outlook for interest expense, tax rate and capital expenditures remain unchanged.

That completes my outlook comments. Overall, we feel very good about the progress we've made as a company in executing key elements of our strategy, and we feel we'll focus on the things we can control at the company while we manage through an uncertain macroeconomic environment. Now, we'll open the call up for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Itay Michaeli with Citi.

Itay Michaeli - Citigroup Inc

Just a couple of questions on pricing and mix, really 3. One, if you could break out the breakdown between price versus mix in the quarter? Two, if you can maybe just talk about the second half of the year? I mean, you guys have really beaten your own expectations for price and mix, it was very strong again. I think last quarter you thought it might be even. It was another positive quarter, so maybe you can talk about how you think about the second half of the year. And then maybe lastly, if you can also just weigh in terms of how you're thinking about pricing in general in light of some of the volume softness and macro softness we're all seeing now.

Richard Kramer

Okay, Itay, I'll start, and Darren may add something in here. So I think, relative to price/mix, as you know, we don't break out price/mix separately, but I think it's safe to say that we had strong price performance in the price/mix equation in the quarter. Relative to our second half outlook, I guess there's a lot of things happening relative to volumes as well as raw materials. And I guess maybe I'll just focus on our outlook relative to how we're thinking about raw materials. And I think the best way to frame this in the way that we think about it even strategically is that we look at our track record and our ability to offset raw material cost increases with price and mix, and we've got a very good track record if you look back at where we've been over the course of the past few years. And I think, even with the performance, we saw the timing of our price/mix actions and the raw material increases that we see, as we've often said, don't always happen in the exact same period. And we really don't feel any different about that as we think about looking at second quarter and how we think about the outlook there. And I think Darren's comments, my comments, talked about volume a bit in the second half. Clearly, we were pretty clear in our comments. We're sticking to our guidance of 3% to 5%, maybe a little bit on the lower end right now. But year-to-date we're comfortable with that number, and we're going to continue to watch volume really as it relates to some of the macroeconomic concerns out there, which we feel is probably the most significant thing pressing on volume risk right now as we look at the balance of the year.

That said, we still feel very confident in the direction that we're taking the business. Your last question about price, about how we think about price and volume over the back half of the year and price/mix and volume. I guess, Itay, the way we think about this is, we put a strategy out in March, and we're going to stick to that strategy. And that strategy is really about focusing on our targeted market segments, focusing on our branded business and focusing on innovative new products. That's where we're going to continue to focus. We're not following a strategy of volume for volume's sake. So we're going to stick to that strategy and our goal is to get value for the product innovation that we bring to the market, and it's to recover the raw material cost that we've put into the products that we sell. So we're on that path, we're going to stick to it. We expect, as we think about our long-term outlook, that there's going to be bumps in the road. The tire industry is not -- doesn't grow in a straight line, at least it hasn't since I've been in the industry. That's okay. We're continuing to deal with it proactively. It is a sign of -- a sign of that is taking our Union City plant out. So we're going to continue to do that, with a focus on cash, going forward, rather than volume. And we think we're prepared to deal with some of those bumps that come ahead, some volume disruptions we may see in the second half. So that's kind of how we think about it.

Itay Michaeli - Citigroup Inc

Now that's very helpful. And then just one more on the lags on raw material increase. Can you maybe just remind us on what those lags look like today and particularly the differences that might exist between natural rubber and synthetic?

Richard Kramer

Yes. I think our general guideline is that we get a 1- to 2-quarter lag in between the time we buy raw materials and the time that they're reflected in our cost of goods sold. For synthetics, it would generally be more like the 1-quarter lag. Natural rubber tends to be more toward the 2-quarter lag, particularly in our European and North American businesses. Latin America and Asia get natural rubber a bit quicker than that.

Operator

.

Your next question comes from the line of Rod Lache with Deutsche Bank.

Rod Lache - Deutsche Bank AG

So first of all, I was hoping you can clarify what you said about your expectations for North American margins. Are you suggesting that the 2%-ish level that we saw in the first quarter is kind of sustainable despite a higher raw material cost expectation you have now?

Richard Kramer

Well, I think, Rod, as we think about the North America results in the second quarter, I'm very pleased with what we did to get there, both tactically around how we had to react to some of the cost headwinds, which the raw material cost headwinds that we saw, and while still driving some of the strategic initiatives that we have. So I think the first quarter was demonstrative of the capability that we're building in North America. So clearly, we saw those positive developments as we look at it. Now we also said that we had very good price/mix performance versus the raw material headwinds in the quarter. That said, Rod, I'll go back to what I said, we've got a very strong track record of offsetting those raw material cost increases with price/mix but not necessarily every time in the same period. And I think that's what brings us a back to say that -- as we think about the tactical execution, the strategic capability that we're building, we feel more comfortable going back and saying Q1 is really more indicative of the run rate that we see for North America at this time on our way to the strategic -- the targets that we've put out there going forward. That's how we think about it.

Rod Lache - Deutsche Bank AG

So you're not necessarily commenting on the second half necessarily on that 2%. Am I hearing you correctly?

Richard Kramer

Yes, I think, Rod, the way -- the best way we think about it is looking to Q1 as a run rate. But it doesn't deter our confidence in terms of our capability to get to our targets, and it also doesn't deter our confidence based on what we've done in the past relative to our ability to offset raw material cost headwinds with price and mix.

Rod Lache - Deutsche Bank AG

And just on the pricing question, are you seeing evidence that the industry is working to offset this recent increase in butadiene prices that you've been seeing? And maybe you can just give us some feel for what you would see as the second half pricing on a year-over-year basis, if there were no additional changes from here, just relative to that $600 million year-over-year raw material cost inflation that you were talking about?

Richard Kramer

Yes, Rod, I think we don't comment on what the industry is doing. We just look at what we're doing, and our focus is, again, on recovering the raw material costs that we have in our products through price/mix and drive that through the new products and with our leading innovation, those products, going forward. That's what we can control. Those are the things that we focus on. And again, we can't predict quarter-to-quarter exactly how price/mix versus raws is going to come out, but we know, over time, that we can cover it.

Rod Lache - Deutsche Bank AG

Okay. And just lastly, just hoping you can just comment on the maybe unusual things that happened in the quarter, and for example is Europe. European mix, unusually strong for this part of the year, just given winter tire starting early as -- the chemical business, unusual this period; and obviously the inventory building that's occurring, is that now kind of behind us?

Darren Wells

So Rod, I think the points you made are the right ones. There were some things that helped mix in the quarter, no question. In Europe, the fact that winter orders have started earlier than they have in past years, that's helpful. The fact that the Commercial Truck business has been strong in North America and in Europe, also helpful for mix. And the fact that OE was down a bit, given that the OE margins tend to be lower, also a little bit of help on mix, and we have to understand the impact of that going forward. But I think good mix performance even beyond those factors, but those factors helped. The chemical profitability in North America in the second quarter and, in fact, the first half, contributed to some earnings improvement. We don't consider that something that's going to continue. So that's one of the comments we made, just to confirm that. And I think we're now at a point where we're much for comfortable where our inventories are. I think we talked about over the last 3 or 4 quarters, the fact that our inventories were below where we really wanted them to be, and it was putting pressure on service levels. We had an opportunity to catch up a bit and rebuild some inventories, so the opportunity to serve customers and meet orders, going forward, should be better. Yes, it's better aligned with where our target inventory levels are. Having said that, we're not looking to increase inventory as we go forward here. So I think, going forward, if -- we're going to have to be tracking our production with sales levels. I mean, that's, I guess, I think that's the question you're asking, yes, but that's the way we look at it now.

Operator

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

John Murphy - BofA Merrill Lynch

I just wanted to follow up on this inventory line of questioning. I mean, it looks like, historically, the second quarter has generally been the high point of inventory, and you've worked off in the third and the fourth quarter a little bit of that. I mean, is there the potential that you could see some benefit from inventory workdown on cash flow? And also just curious on the other working capital items, if there might be some benefit as we go through the third and fourth quarter?

Richard Kramer

So, John, I think the point you're making is the right point. The middle of the year tends to be the high point in our working capital and particularly in our inventory. And we would expect the same this year. As we look and gave our outlook in the sense that, yes, that we expect working capital to be in use of $300 million to $400 million of cash this year. We've used a lot more than that through the first half. So that says, yes, we do expect to work down inventory and reduce working capital from here through the end of the year. And that is a typical pattern for us. We look at working capital overall. I think the place where the increases come is clearly in inventory. Our receivables have continued to be good. Accounts payable has continued to be a contributor to working capital improvements. But as we look at the rest of the year, clearly there's going to be a lot of focus on our working capital initiatives and not just counting on seasonality but looking for ways that we can improve our working capital practices to continue to get that cash back to the balance sheet.

John Murphy - BofA Merrill Lynch

Okay, so there's no reason that the seasonal factors or seasonal pattern that we've seen historically would change dramatically.

Richard Kramer

No, I think you're still going to see that working capital reduction between now and the end of the year.

John Murphy - BofA Merrill Lynch

Got you. Then second question, on the outlook. As we look at the changes that you've made as North American replacement being a little bit weaker than you'd expected previously and commercial replacement being a little bit stronger, that would sort of indicate that the mix in aggregate for the year on the margin would be slightly better than you had expected before. Just curious, is that a fair characterization? Because it seems like that's explicitly what you'd assume from this as how it's changing outlook.

Richard Kramer

Yes, John, I understand what you're saying. I think you do have to think about the fact that OE volumes will be coming back some in the second half as we recover from the Japanese events. And having that OE volume higher tends to work against mix.

John Murphy - BofA Merrill Lynch

Got you. But, I mean, relative to your previous forecast, though, I mean, you would presume that mix would be a -- based on this, will you presume it would be a little bit better?

Richard Kramer

Yes, if you're looking at the full year outlook, I think it's fair.

John Murphy - BofA Merrill Lynch

Okay, and then just to follow up on that a little bit. In the consumer replacement North America, with this weakening of volumes relative to your expectation, is there any pressure on the price hikes that the industry or Goodyear is passing through? Are they still going through just fine? And conversely, is there maybe a little bit more pricing power in commercial replacement because demand is improving relative to your expectations for the industry and Goodyear?

Richard Kramer

Yes, I think, John, the best way we can talk about our price/mix is really looking at whether our price and our mix is sticking in the marketplace. It's just looking at the performance in the quarter. I think that's probably pretty indicative of what's happening in the market. And the comments you've made about our consumer replacement outlook, I think, are accurate on point. I'd still let you know, from a mix standpoint, while we are seeing some softening, we still see real strong demand for our branded products: the Assurance lines, the Eagle GTs, the Forteras and what-have-you. So while certainly there's some softness particularly maybe on the lower end, I want to be clear that there still is good demand out there for our premium products. And that's a positive thing for us both for volume and for mix as we look out over the second half. Now clearly, we're going to keep an eye on what happens over the second half. I think, if we look at year-to-date, our North America business, our business overall, is pretty well in line with expectations of where our volume is. The uncertainty we see is really some of the reactions both by dealers or our customers and then consumers and how they think about what's happening about the whole uncertain macroeconomic situation that we're all living through right now. And I think we're seeing that trickle in a little bit, and what we have to manage is what does that ultimately do for us over the second half. We still feel good about the business, we still feel good about where it's going. But as I said earlier, we're going to stick to our strategy of selected or targeted market segments. We're going to stick to premium products, and we're going to manage our business that way. We're not going to go back toward -- to inventory builds or selling tires for volume. We're going to focus on cash, we're going to focus on winning in our strategies, our targeted market segments. That's how we're going to react as we move forward. And to reiterate the point, to the extent we get a little bump in the road along the way or some bump in the road, we're going to work our way through it. That's the tire business, that's what we do, and I think we're well positioned to do it, and our track record says that we know how.

John Murphy - BofA Merrill Lynch

So, Rich, just to follow up on the pricing now specifically, in the quarter, was it -- was price hikes sticking better than you would have expected? And was that a big benefit in the quarter? I'm just trying to understand how the pricing power is developing because it seems like it's actually much better than we -- than most people would have expected.

Richard Kramer

Yes, again, I can only speak to our business. And I think our strategy, our pricing actions that we've taken have been very successful thus far, and I think that's why you see the results in the second quarter.

John Murphy - BofA Merrill Lynch

Got you. And then just lastly on Lat Am, it sounds like you had a little bit more competition from imports. I'm just trying to understand the competitive environment down there, because it seems like that's pressuring the business little bit. Is there anything changing as far as the domestic manufacturing base down there that would pressure you? Or is this purely a currency issue that's making imports more viable for the time being?

Richard Kramer

John, it's a relevant question, a good question. And Darren and I actually were just down there and had really a hands-on look at what's happening in the business. So Darren, maybe elaborate a bit more on what we saw in the environment we're seeing.

Darren Wells

Now it's a fair question. And I think, the last couple of quarters, we've had, call it unique events, that have affected Latin America results adversely. And again this time, the earnings from the Farm Tire business, which was a profitable business down there, have been pulled out because it was sold on April 1. And we do have some cost for the ramp-up of our manufacturing plant in Chile, which has begun building saleable tires. The -- yes, so we do have a couple of those things going on, but a couple of other things that are real factors here. One is there is a significant amount of inflation in wages, in energy cost, and really, I guess, costs of all type, beyond raw material cost. And that's a real factor for us, and it's running at levels that are beyond what we're typically able to offset with improved efficiency. And that's putting pressure. And that wage pressure does contribute to the overall cost of manufacturing products there, and that's true for Goodyear. It's also true for other industries. So it's true for the whole tire industry there, and it's true for other industries. And in addition to the inflation, the currency factor compounds the situation and makes imported products much less expensive and again has really started to challenge some of the manufacturing that takes place within Brazil, in particular, right now. I think what we see ourselves doing -- and first of all, to be clear, our team has dealt with a lot of volatility over time in the Latin American markets, and they've dealt with a lot of changes as the Brazilian market matures and has gone through this long period of stable growth. And we're confident they're going to be able to deal with this as well. Ultimately, we've got a strategy of being in targeted market segments, and that's true in Latin America as well. And as is the case in other parts of the world, the import competition issue is much more a factor at the low end of the market as the high end. And so our ultimate goal here is going to be to be in the segments of the market in Latin America where our technology and our products have the best value proposition. And that's where we're going to be focused. But ultimately, our team is good at this. They deal with volatility, they're able to continue to produce good results even through challenging times, and we've got confidence that they'll to continue to do that going forward.

John Murphy - BofA Merrill Lynch

So the 8% to 12% operating margin that we saw in the first and second quarter -- the second and first quarter, is that the kind of the travel rate we should be thinking at? I mean, you guys typically have been in that 15% to 16% range for the last couple of years down there. I'm just trying to understand if we're seeing something that might be lower than that 15% to 16 range structure rate.

Darren Wells

So I think a couple of things have happened to address that directly. One, the inflation in raw material costs, even to the extent we're able to offset it with price/mix, that inflationary pressure tends to mathematically drive margins down. So compared to history, there's clearly a couple of points of margin decline that's just related to passing through raw material cost. If we then take the impact of the Farm Tire business, there's probably, given the sales and earnings that we've given up there, another point or so that we've given up as a result of that. So I think that there are couple of things there that have created some -- some decline in margin that, I guess, are a bit artificial. But the business environment there has put some pressure on for now, and we're looking for our team to come back and deal with that and get back to levels of profitability that are consistent with our history down there. And we're confident they're going to be able to do that.

Operator

Your next question comes from the line of Himanshu Patel with JPMorgan.

Himanshu Patel - JP Morgan Chase & Co

Two questions. Rich, I think you spoke a little bit earlier about Goodyear's inventory, so I'm wondering, in North America, whether you could offer just some anecdotal color on industry inventory levels on the commercial side as well as the consumer side.

Richard Kramer

Well, I mean, if I start with consumer, I think that when we look at inventories right now, I think we see them in pretty good shape, meaning they're not excessive, Himanshu. If we go back to what we've seen, we saw consumer replacement, strong industry in the first quarter, and we saw that really a result of both restocking and perhaps buying ahead of some of the price increases that were coming. And that was, again, building up from what were very low channel inventories over the past, call it 18 months prior, would have you coming out of the great recession. So we saw a little bit of building, and again we saw slower volume growth in the second quarter. So we see more of an equilibrium between sell-in to the channel and sell-out of the channel for consumer. And again, the way I think about that, the way we view it, is we kind of try to equate it to what's happening on sell-out. And if we just think about this from a longer-term perspective, sell-out has really, in North America in particular, has really not gotten back to the levels that it was before the great recession. So yes, we've seen positive sell-out, but true consumer demand has not yet really snapped back to where it was pre-recession. So the second half of that is we look at dealer in inventory. They're pretty much in-line, perhaps buying to sell at this point rather than buying to stock. So if we see some kind of improvement in consumer -- end-consumer demand, which we do think we'll see, the timing is a little bit harder to predict, I think that, that demand will flow back through the channel and back to the manufacturers, in this case, ourselves. So we feel pretty good about where it is right now. The issue I would again point to end-consumer demand rather than the channel. On the truck side, truck inventories are a little bit harder for us to see. Channel inventory is hard to see. There's no real metric other than how we work with our customers to see it. I would just point to demand remains very, very strong. You saw the percentage overall in our truck business, it went up almost 40%. Strong OE growth as well. And I know you follow it very closely, you follow some of the OE manufacturers and some of the situations they're seeing. So we see the truck business still remaining very strong, and I guess that demand is also probably a good indicator of where their inventory levels are.

Himanshu Patel - JP Morgan Chase & Co

Would it be too much of a generalization to say that there's still a little bit more catch-up that probably needs to happen on commercial inventories as opposed to consumer?

Richard Kramer

I think it's a reasonable observation to make. As I mentioned, my only hesitation is I don't have the real good data to support that. But certainly, that's what we see. That's what we feel.

Himanshu Patel - JP Morgan Chase & Co

Okay. And then if I could shift to the North American replacement business. And I'm sorry, I missed some of the earlier comments, so you may have talked about this already. But your replacement volumes were, I think, down 5%. And it looks like, from the data we have, that the U.S. market RMA data was down about 6% on replacement. I guess that's better than market, but I would have thought it would have been maybe even more better than the market, given your relatively low presence in private label and low-end tires. Was there a considerable or material weakness in high-end branded tires as well this quarter for the industry that could explain that?

Richard Kramer

To my earlier comment, Himanshu, I think what I talk to our business about everyday is making more of the right tires, because the right tires, those high-end tires, remain in-demand for us. So there's really not any weakness in what we're seeing in our premium branded tires. In fact, as you point out, we actually continue to gain share there. I think you also have to look back a little bit to Q1 and see the strong growth we had in Q1 and sort of balance those two off over the first half. But specific to the question, we're not seeing any kind of slowdown in the premium products.

Himanshu Patel - JP Morgan Chase & Co

So maybe this is just a little bit of timing around price increases or whatever, and maybe we should look at the first half kind of on a blended basis?

Richard Kramer

Yes, exactly. I mean, we were strong first half, slower second half, balances okay, with a view on the second half that we're watching closely because of the sort of macroeconomic concerns we have out there.

Himanshu Patel - JP Morgan Chase & Co

Okay, great. And then I -- just a housekeeping item. Any way you could help us with just a unit volume mix inside of your North American consumer OEM business of Japanese transplants?

Richard Kramer

We haven't ever really talked about sort of shared account on each of those businesses, but I would say we're somewhat balanced. Our focus is really on getting the right fitments across all the manufacturers. That's where it's been, that's where it's going to be, that's part of our selectivity strategy. And that's why, Himanshu, because we are balanced across that, including the JOEMs, that we did see our consumer OE volumes go down. So we were impacted a bit from it, but certainly, we see some of that coming back in the second half.

Operator

Your next question comes from the line of Patrick Archambault with Goldman Sachs.

Patrick Archambault - Goldman Sachs Group Inc.

Just more generally on -- I wanted to talk about the pace at which you think you can build from 2% margins in North America in the back half. Just generally, if you could maybe just go over, again, remind us some of the initiatives that you have in place and sort of the timing. I mean, on the call, you obviously talked about the closure of your one high-cost plant that would probably be more of a 2012 impact. I think we've -- other things you've mentioned in the past have clearly been more flexibility and work rules and then eventually some additional capacity outside of the U.S. So maybe we can just go over that.

Darren Wells

So, Patrick, I guess, 3 things that we'd point to. And we're very consistent with the walk that we showed in our investor meeting back in March. If we take it from the, just call it the first quarter run rate, we're going to be 2 big discrete items. One is the $80 million in savings that you're suggesting for Union City, which we'll get in 2012. Second thing is that pension expense will continue to improve as we fund the pension. And you saw some benefit from that. Now we expect more benefit from that in 2012 and 2013. And the third thing is getting the remaining part of the unabsorbed overhead benefit. As we fill the factories up, we've still had some unabsorbed overhead carrying into this year, so 2012 will look better in that respect. So if you take those 3 things together, those are -- and I think the good part is that those are all cost-related and are going to take us a big part of the way from where we are today to where we target in 2013. Along the way, we still have volume, price and mix that we'll continue to focus on. I mean, those are going to be important for us as well, and our strategy of offsetting raw material cost with price and mix over time is always going to be a piece of the equation. But I think those 3 costs pieces are a big part of the walk from here to there.

Patrick Archambault - Goldman Sachs Group Inc.

Okay. And actually just one last one on -- there's been a lot of questions on the demand piece in the U.S., and I understand the restocking concept. But how do you guys assess the level of pent-up demand that's out there? I mean, I think the last time you had mentioned Tred levels at some of your dealers were still at extremely low levels. And I understand that miles driven have slowed, and there's this restocking issue. But one would think that there would be sort of a pent-up demand that would provide a pretty meaningful offset to at least some of the macro issues that we're seeing right now.

Richard Kramer

Yes, I think, Patrick, I think we look at a variety of different things. For instance, we look at the miles driven trends, gas consumption trends, and we've seen those sort of see-saw from a big down coming out of sort of '08, '09, toward improvements last year, toward the last few months, which really last month reported, I think, is May. So we've seen some volatility there again. So that's one indicator of how we think about pent-up demand and what's there. We also look at GDP, because as we said, GDP certainly is an indicator of -- a good indicator that follows where consumer industry demand is, so we look at that. And when you -- and then again to your point, we look at, in our retails stores and some of the dealers that we see, we get a view of things like tread depth, such things like someone coming in to buy 1 tire or 2 tires or 4 tires, whatever it might be. So we have a pretty good pulse on what's happening out there. And I think, I believe you would sort of 2 things to think about. One is maybe a repetition of what I said earlier, and that's that we really haven't seen a big snapback in a robust consumer demand. We think it's there, we think it's going to come for the reason you say, that there has to be pent-up demand there. The second thing is, because we haven't seen that demand come back as strong, we know that people have to replace tires. So even though we might not see the strongest we like, you can only drive on your tires so long so that core demand is out there, and it's sort of annualized itself from when people put it off to now when they have to replace it, it's just a question of how fast are they going to replace it. And that's a bit of a function of the economy, it's a bit of a function of confidence, which is a little bit troubling today. It's a function of those things. But our view long-term is that demand is still there, and when it comes, there is going to be an uptick and a good supply opportunity for us. And I think we're positioning ourselves well to supply that demand with the right tires in the right segments of the market.

Operator

Ladies and gentlemen, due to time, the final question comes from Brett Hoselton with KeyBanc.

Brett Hoselton - KeyBanc Capital Markets Inc.

First, I want to make sure that I understand how you're characterizing price/mix-versus-raws relationship in the back half year. Coming out of the first quarter, it seems like you're very confident that price/mix was going to be able to offset raws. It sounds like, going into the third quarter and the fourth quarter, while you think you're eventually going to be able to offset those high raw materials, it sounds like it's unlikely that you're going to be able to offset those raws in the third quarter and the fourth quarter timeframe. Is that a fair characterization?

Darren Wells

Yes, so Brett, I guess, historically when we've seen raw material inflation at the levels that we're seeing right now, we've only recovered about 2/3 of it in that quarter via price/mix. The second quarter gave us a new high watermark on price/mix as we more than offset $428 million in raw material costs, and even in North America and Europe where it tends to be tougher, we offset raw material costs. And so that's a new high watermark. We feel great about that, but one quarter doesn't make a trend. And we know the bulk of the raw material cost increases are coming in the second half. And with raw material cost increases approaching $600 million year-over-year in Q3 and Q4, that's more than we could have offset even with the second quarter best-ever performance in price/mix. So we have to look -- we look at that, we understand what we've done, and we understand what's happened historically, and we also understand that we've had a very strong second quarter. But while our goal remains to recover raw material increases over time, I got to stick to this statement: it doesn't mean that we can offset the increase in the same period in every case.

Brett Hoselton - KeyBanc Capital Markets Inc.

And then I'm thinking about tire shipments in Asia, in particular. The current trends that you're seeing today, do you think that's kind of indicative of where you maybe see the remainder of the year is going to be?

Richard Kramer

Yes, I think it's a fair way to look at it. And when we talk about Asia, Brett, it's really an amalgamation of a lot of different markets over there, clearly. China and India, for example, remain very, very strong. If we go to sort of Australia and New Zealand, we see weak consumer -- we see a weaker economy, weak consumer demand there, we're feeling part of that. So softer volumes in Australia, New Zealand, stronger volumes in the places you'd think. So I think it's a fair way to frame it for yourself.

Brett Hoselton - KeyBanc Capital Markets Inc.

And then finally, we've had a number of truck OEMs talking about a shortage of tires, reducing their ability to produce trucks. I'm wondering, is this a problem at Goodyear? Or is it more kind of industry in general, maybe some of your competitors? Does it potentially represent an opportunity in the back half of the year for Goodyear?

Richard Kramer

I think, if you look at the truck growth that we saw in the quarter, you see that robust demand from the OEs, the truck OEs, coming back to us. I would say we're supplying our customers, we're doing it very well, but we're also doing it in the context of our strategy to make sure we're selling the right tires in the right places and the right brands. And that's how we're looking at it right now. We are, I think our customers would tell you, that we're a good supplier, and there's more demand out there. And that's a good thing for us as we go forward. Okay, I think that breaks up -- wraps up the call. Everyone, we appreciate your attention. Thanks very much.

Operator

This concludes today's conference call. You may now disconnect.

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