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The Goodyear Tire & Rubber Company

Q2 2008 Earnings Call

July 31, 2008, 10:30 am ET

Executives

Patrick Stobb – Director of Investor Relations

Robert Keegan – Chairman and CEO

Mark Schmitz – Executive VP and CFO

Darren Wells – Senior VP, Finance and Strategy

Analysts

Rod Lache – Deutsche Bank

Himanshu Patel – JPMorgan

Kirk Ludtke – CRT Capital Group

John Murphy – Merrill Lynch

Saul Ludwig – Keybanc Capital Markets

Operator

Welcome everyone to the Goodyear second quarter 2008 conference call. (Operator Instructions) I would now like to turn the conference over to Patrick Stobb, Director of Investor Relations.

Patrick Stobb

Joining me on the call are Bob Keegan, Chairman and CEO; Mark Schmitz, Executive Vice President and CFO; and Darren Wells, Senior Vice President, Finance and Strategy.

Before we get started, there are a few administrative items I would like to cover. To begin, the webcast of this morning’s discussion and the supporting slide presentation are now available on our website at investor.goodyear.com. A replay of this morning’s discussion will be available at noon today by dialing 706-645-9291 or on our website at investor.goodyear.com. The last item, we filed our Form 10-Q earlier this morning.

If I could now direct your attention to the Safe Harbor Statement on Slide 2 of the presentation. I would like to remind that our discussion this morning may contain certain forward-looking statements based on current expectations and assumptions that are subject to risks and uncertainties that can cause actual results to differ materially. These risks and uncertainties are outlined in Goodyear’s filings with the SEC and in the news release we issued this morning. The Company disclaims any intention or obligation to update or revise and forward-looking statements, whether as a result of new information, future events, or otherwise.

Turning now to the agenda: On today’s call, we will provide an overview of the second quarter results and discuss other related business maters, including a recap of our June 26th investor meeting. For reference, the investor meeting presentation is also available on our website. The presentation provides a very good overview of the Company together with a comprehensive review of our business growth strategies. We will follow this discussion with a review of the financial results and a summary of our latest industry outlook before opening this call to your questions.

Now, I will turn the discussion over to Bob Keegan.

Robert Keegan

Our strong second quarter and first half performance demonstrates the successful execution of our strategies, despite the significant economic challenges we are facing, particularly in North America.

In the quarter, robust revenue growth in our International operations, especially in emerging markets, more than offsets the continuing weakness of the North American market. Our core strategy to invest in our emerging market businesses has resulted in a profitable and growing set of businesses. Revenue contribution from the International businesses was approximately 60% of our global total for both the second quarter and the first half.

We remain confident in our ability to manage through the challenging near-term business conditions and are focused on maximizing current business performance. At the same time, our long-term investment strategy, highlighted for investors at our June 26 meeting, positions us to capitalize on available and attractive market opportunities. Our second quarter performance was assisted by the contingency plans that we put in place last December to address the type of macro conditions we see in our markets today. These plans included an intense focus on cost reduction, an adjustment in our production volumes in the U.S. and Europe, full utilization of our innovative new product engine to further drive price mix improvements, and leveraging our purchasing capabilities to realize better input costs.

In addition to our contingency actions, our ability to continue to perform well overall despite current business conditions can be attributed to the business model we have created over the past five years. It has significantly improved our competitive capabilities in several respects, and I’ll mention those. Our business model is grounded in the ability to introduce innovative, differentiated, and marketable new products that consumers' desire and to do it a faster pace than anyone else in our industry. Second, we have reduced our exposure to the economically sensitive consumer segments of the business, for example, exiting certain segments of low-end private label tires and as another example focusing on segments of the OE business that return higher margins and increase consumer loyalty. Third, we have successfully focused on the emerging markets as a source of continuing top line and margin growth. Fourth, we’ve continued to lower our structural costs, including our move toward a more competitive and compressed manufacturing footprint. Five, we have strengthened our balance sheet and liquidity position to enable us to fund future profitable growth initiatives. With this improved business model in place, Goodyear now has the foundation to navigate through the current weak business conditions.

I’d like to now cover our major achievements during the second quarter. We achieved record sales of $5.2 billion, which represents an increase 6.5% compared to prior year. I’d ask you remember here that the year ago period revenue of $4.9 billion included $186 million in revenue from the now divested T&WA business Therefore, our sales growth increase would have been 10.6% if we were to exclude the sales related to the divestiture of the T&WA business from the prior year results.

Income from continuing operations increased 159% to $75 million. Despite the reduction of production units that we indicated at our June 26 meeting with you New York and the resulting unabsorbed overhead, segment operating income grew to $330 million driven by EMEA, Asia, and Latin America. We maintained our positive trend of price mix improvements with price mix more than offsetting raw material increases and price mix more than offsetting raw material increases by an amount of $125 million.

Revenue per tire increased by 9%. Year-over-year revenue per tire has increased for 15 consecutive quarters. We raised our 4-point cost savings target to more than $2 billion. We announced our plan to close a high cost manufacturing facility in Australia and with that closure we will complete the footprint reduction actions under our 4-ponit cost reduction plan. We also announced a plant closure of our mixed center in Tyler, Texas, which now completes the shutdown of that manufacturing facility. We laid out plans for the relocation and expansion of our Dalian China plant, which includes our first commercial truck tire capacity in China. As planned, we refinanced our European securitization program, increasing the size by € 175 million and extending the maturity from 2009 to 2015; you’ll recall that this represents our lowest cost financing. This action reduces our near-term maturities by nearly half than 2009. Now you can reference the detail on Slide 26 in the appendix.

We were recognized as Number 16 in a Forbes Magazine list of America’s Most Respected companies. This is a consumer-driven ranking that measures the overall respect, esteem, and admiration consumers hold towards the world’s largest companies, and obviously a powerful motivator for both our associates and our customers. We held an investor meeting on June 26 in New York City during which we demonstrated the depth and capability of our leadership team as all our business unit leaders and many of our functional leaders presented, responded to your questions, and interacted with investors. We provided investment plans aimed at capitalizing on the attractive market opportunities that we see in front of us; and we addressed the impact of current economic challenges on our Company, especially in North America, and our initiatives to counter them. The meeting generated significant interest among a broad group of investors with nearly 400 participants globally. The resulting positive and supportive third party feedback relative to our strategies was encouraging.

I would like to spend a few minutes recapping the key points from the New York meeting. We focused our attention on five key areas that will help take our business, our business platforms to the next level. First, we plan to maximize our presence in high-value-added tire segments. Market growth in these segments has been, is now, and will continue to be significant.

For those of you who are joining us for the first time today, HVA refers to tires that incorporate one or more characteristics related primarily to tire diameter, construction, and performance. They are packed with technology. Due to the technical complexity of HVA products, margins are higher, in the range of $10 to $20 per tire more than those not meeting the HVA criteria. Goodyear has been successful in the HVA segment primarily because of our ability to differentiate our products based on brand strength, technology, and innovation, and the ability to deliver through our industry-leading global distribution network. We plan to continue capitalizing on these core strengths.

Second, we plan to build on our capabilities in emerging markets where industry growth and conversion to HVA tires present favorable trends and frankly opportunities for us. Third, we are driving improvement in supply chain efficiency both to reduce inventory and to fill rates for our customers. Fourth, as I mentioned earlier, in June we raised our cost savings targets under the 4-point plan to more than $2 billion. Finally, we plan to increase our capital investments to take advantage of the high return opportunities that exist in our markets.

Our announced investment plan covers modernizing existing plans for HVA tire production, expanding capacity for growth in emerging markets, improving our supply chain to reduce both our costs and are working capital investment, and increasing cost efficiency in both production facilities and in back office operations. Through these planned investments totaling $1 billion to $1.3 billion per year, we will create significant HVA capacity and incremental margin. This new HVA capacity will increase on average 8 million units per year or in 32 million units over the next four years and will help us to generate both increased price mix and improved manufacturing flexibility, efficiency, and product uniformity. As I said in New York, given the current economic challenges, our pace of investment can be altered to account for changes in outlook as we work to maintain a positive corporate cash flow.

Now we are acutely aware of the macroeconomic situation that we find ourselves in, both in the U.S. where this economic slowdown started and around the globe. These are themes we addressed head on in our June meeting with you. In the U.S. we are seeing the early stages, and I emphasize here the early stages, of a trend toward less gas consumption and fewer miles driven, clear signs that the state of the U.S. economy and higher oil prices are impacting consumer behavior.

In the second half of this year, we continue to expect challenging business conditions, somewhat more challenging than in the first half. Raw material costs will be substantially higher, volume weakness and inflation concerns will remain and, as a result, the impact of product cuts and the associated unabsorbed overhead in our income statement will be higher. While we see some weakening in our International markets, those businesses continue to perform well for us.

We have placed an intense focus on mitigating the negative impact of these pressures and that focus manifest itself in several ways. First, the Company is, and remember here we have a track record in this respect, the Company is successfully offsetting raw material costs with price mix improvements. To date, our outstanding new product engine, our steady stream of new high-value-added product introductions has enabled us to generate richer, next, and improved market share in our targeted market segments. These are and will remain attractive segments.

For example, Goodyear has introduced a number of leading HVA technologies in North American and in Europe and has now extended those technologies into Asia and Latin America. The commercial segments line up of FuelMax and Duraseal technologies, which many of you saw in New York, are also having a positive impact on revenue and most importantly margin. As preferences in the U.S. market evolve toward more fuel efficient vehicles, we have been moving aggressively on that front as well.

Goodyear is positioned on six of the top eight most fuel efficient vehicles available in North America today. FuelMax is providing significant fleet savings to our commercial customers. We believe the European market is a good proxy for what lies ahead in the U.S. market. Despite smaller vehicles and higher fuel costs in Europe, HVA trends there are well ahead of the U.S. market. Goodyear’s engineers today are well aligned in the development of the next generation of players.

Point No. 3, we continue to drive efficiency changes throughout the organization as we look to achieve our 4-point cost reduction plan with the target, as we’ve mentioned, now exceeding $2 billion. We have reduced our production volumes in the U.S. and European facilities and of course the potential exists that additional reductions may need to be made to manage inventory levels.

Finally, our purchasing efforts have been aggressive in addressing challenges on four fronts. First, we are leveraging our technical capabilities to reduce material usage and where possible. For example, substituting synthetic rubber for natural rubber or vice versa depending on where the cost advantage currently resides. Second, we are working to reducing our supply chain costs. Third, we continue to drive low cost sourcing; and fourth, we are focused on manufacturing initiatives that will significantly reduce energy consumption in our facilities. So in summary, as we manage through the economic downturn, we will continue to do the right things.

Q2 was a good quarter [inaudible] by our strength in overseas markets. We continue to grow the Company profitability; and the North American market is proving difficult at many levels, particularly as it relates to the weakened demand environment, yet our second quarter results keep us on track to achieve the remainder of our corporate next stage metrics. As we said at the New York investor meeting, the current environment in North America only impacts the timing of our delivery on those commitments, not the achievement of those commitments themselves.

Our business model changes have positioned us to better face the challenges of an economic downturn and to emerge as a stronger and leaner competitor.

I’ll now turn the call over to Mark for his comments about the corporation and segment results. Mark.

Mark Schmitz

In my comments today, I will discuss the Company’s second quarter results, building on many of Bob’s comments, followed by review of segment information, the balance sheet, and cash flows. As Bob mentioned, we’re pleased with our second quarter results which contributed to a strong first half for Goodyear. The strength of our global brands and outstanding growth in our International businesses once again help the Company grow profitability despite significant challenges related to higher raw material costs and a weak demand environment in North America and to a lesser extent in parts of Europe. The Company’s year-to-date 2008 results reflect a continued progress against a well balanced set of strategies aimed at near-term performance and long-term profitable growth.

Turning first to the income statement, net sales in the quarter grew to a record $5.2 billion, an increase of 6.5% over the prior year. This percentage increase would’ve been 2.6% if we were to exclude the sales related to the divestiture of the Tire and Wheel Assembly business from the prior year results. Price and mix improvements and favorable foreign currency translation were offset partially by lowered unit volumes primarily in North America and Europe. Gross margin was 19.9% for the quarter, which is a half point improvement from the prior year, continuing the good gross margin results we saw in quarter one.

Segment operating income increased to $330 million, which was 6.3% of sales in the quarter. Selling, administrative, and general costs increased by $43 million. The higher level of SAG can be attributed primarily to foreign currency translation which increased SAG costs by $46 million. Income from continuing operations was $75 million or $0.31 per share in the second quarter versus $29 million or $0.14 per share in the prior year. Reported income from continuing operations in the 2008 quarter included after tax expenses of $87 million or $0.36 per share for rationalization and accelerated depreciation charges. These related primarily to the announced closure of our Somerton Australian tire manufacturing plant. A list of significant second quarter items for this year and last year, including per share amounts, can be found on the last page of our earnings release and in the appendix of the slight presentation.

The next slide provides the primary factors that drove the $20 million year-over-year improvement in segment operating income. To being with, foreign currency translation provided a benefit of $35 million in the quarter, primarily in Europe and Latin America. Price and mixed improvements in excess of raw material cost increases was a favorable $125 million in the quarter. This price in mix benefit reflects the success of our pricing actions as well as continued momentum in our strategy emphasizing HVA products.

While confident in our price and mix strategy, it is noteworthy that raw material costs as they affect our P&L will escalate considerably for the remainder of the year. We reported previously that quarter one raw materials had increased by only about 1% due in part to a spike in prices in natural rubber purchased in the second half of 2006 and the lag effect of [inaudible] inventories hitting our P&L. In the second, our raw material increases year-over-year is approximately 8.5%. Obviously by keeping pace with price and mix, we have absorbed this increase and then some. We had given guidance that raw material costs increases for the full year will be in the range of 10% to 12%. This implies that the second half increase will be far larger than those we’ve seen in the first half. We are focused on continuing to drive price and mix improvements, but there’s no denying the second half will be more challenging.

With respect to our 4-point cost savings plan, we made continued progress with realized savings of $190 million in the quarter. These positive factors were partially offset by a $3 million unit sales decline, which reduced segment operating income by $37 million compared to the previous year. As a reminder, this amount reflects the average margin on the loss units and does not include the impact of unabsorbed overhead related to lower production volume. Not withstanding this volume decline versus last year and the underlying soft markets, particularly North America, we increased revenue per tire by 9%. The estimated income of inflation other than raw materials was significant at $191 million. Inflation was more pronounced in the quarter, particularly as it affected wages, indirect materials, and energy costs.

Transitional manufacturing costs at North American Tire were at about the same level of last quarter; and when coupled with unabsorbed overhead due to volume reductions amounted to $46 million. If you recall, transitional costs include cost related to factory modernizations, conversion to HVA products, and training of our $13 per hour workforce.

The remaining unfavorable variance of $56 million relates primarily to higher manufacturing costs in our International businesses, including unabsorbed overhead from production cuts and certain non-recurring costs in Europe. The negative impact of the weak demand environment on our retail business was also a factor.

With regards to progress on our 4-point cost savings plan, two-and-a-half years into the four-year plan, we’ve achieved more than $1.4 billion of cost savings. This places us on a confident path to achieve our targeted savings, which we recently increased to more than $2 billion. We’ve realized improvements in each of the four areas during the second quarter, including our continuous improvement initiatives high cost footprint reductions, low cost sourcing, and SAG cost reductions. This includes incremental steelworkers productivity savings, primarily due to the hiring of additional $13 per hour labor.

At our investor meeting in June, we announced our plan to close the Somerton Australia tire plant, which brings our total reduction in high cost footprint to our target of 25 million units. The achievement of this goal is a significant accomplishment for the team. We also recently announced our intent to close the mix center of the Tyler Texas facility which remained opened after we discounted tire production in quarter four of last year.

We remain committed to our previously announced next stage metrics and we continue to make good structural progress towards achieving the remaining goals. As we said in June, due to the economic environment in North America, the achievement of the remaining targets will take longer than we would’ve liked; but when the market recovers, we are confident we will be there.

Turning to segment results, North America reported profits of $24 million in the quarter, which compares to $53 million in the 2007 period. The 2008 profit level was based on revenue of $2.1 billion and following with 18.3 million units representing year-over-year declines of 6% and 12% respectively. The sales in the quarter would be up by 2% if we excluded sales of $186 million related to the divestiture of the Tire and Wheel Assembly business from the prior year’s results.

The demand environment weakened significantly during the quarter as consumers drove fewer miles bought fewer cars, and consequently purchased fewer tires. Published U.S. government data have shown a 2.4% reduction year-to-date in highway miles driven. During the second quarter, the U.S. consumer replacement market declined by 3%, and consumer OE declined by 20%. Industry volume for commercial placement in OE were also weak, declining 9% and 10% respectively. The impact of the lower industry volumes was significant as we sold 2.5 million fewer tires compared to the previous year.

North America has lowered production schedules judiciously as it looks to control inventory and manage for cash. As we said at our investor meeting on June 26, we plan to cut production in North America by about 8 million units this year, about three-fourths of these cuts are expected in the second half. We will reevaluate this level if conditions change.

Raw material cost increases accelerated in the quarter as did general cost inflation effecting wages, indirect costs, and the costs of energy in our plants. Raw materials alone experienced double digit increases compared to the prior year. Price and mix more than offset the higher raw material costs, providing a net benefit of $48 million in the quarter. Once again, we saw improvement in our mix of high-value-added tires driven in part by the continued growth in Goodyear-branded products. These factors contributed to a 12% increase in revenue per tire in the quarter.

We continue to see roughly the same level of transitional manufacturing costs we experienced last quarter in the area of $30 million. In addition, while the unabsorbed overhead in connection with tire production at our Tyler plant virtually ended in quarter two. The amount, roughly $15 million, was replaced by unabsorbed overhead associated with production cuts. Unabsorbed overhead flows through inventory which takes about 60 to 90 days before impacting our results; although in certain circumstances, such as significant changes in production, these costs are expensed in the period incurred.

Looking to the second half, we expect unabsorbed overhead in each of the remaining quarters of the year will be significantly higher than the cost we realized in he second quarter. The year-to-year comparison was negatively impacted by loss profits of $4 million due to the divestiture of our Tire and Wheel Assembly business in 2007.

Altogether, we see progress with the results achieved by North American Tire in quarter two as we made further steps toward our strategy goals in a difficult environment. We have reduced structural costs, exited businesses, repaired the balance sheet, and improved [inaudible]. Over time the transitional costs we are experiencing will diminish, markets will recover, and our movement toward high-value-added products will continue to feed a powerful mixed engine.

Now turning to Europe, our results came in strong with growth in both sales and earnings for the period. Revenue per tire, excluding currency, increased by 6% reflecting favorable share in our strategic segments and premium brands. Before moving to the details, let me remind that you we combined our two European businesses into one strategic business unit, Europe, Middle East, and Africa or EMEA in the first quarter of 2008. Operating income in the quarter increased 20% despite a 4% decline unit volumes. A price and mix improvement more than offset raw material cost increase which contributed to earnings growth by approximately $40 million in the quarter.

Foreign currency translation was also favorable as the euro strengthened more than 15% against the U.S. dollar in 2007, reverse is 2007, sorry. Negative factors impacting the quarter included a weaker industry demand, which had a direct impact on our volumes, compared to the prior volume decline by almost 1 million units. Consumer replacement and OE volumes were both lower due to softer demand and to a lesser extent, our decision to selectively focus on sales in the more profitable high-value-added market.

Commercial volumes were mixed with OE volumes up strongly year-over-year and replacement demand softening. Consistent with our remarks at the investor meeting in June, we lowered our European production expectations for the year, primarily at the lower value end of the product range. Inflation negatively impacted both transportation and SAG costs. Additionally we incurred certain nonrecurring operational expenses including a strike in Turkey.

Overall, EMEA is performing very well and remains an impressive success story for the Company .Recognizing weakened market fundamentals, we are maintaining balanced optimization for the second half.

Latin American Tire reported another excellent quarter with growth in sales and profits of 25% and 14% respectively. Second quarter segment operating income was $103 million on sales of $572 million. Volumes were about equal to the previous year as growth in Brazil and Venezuela, for the most part, balanced declines in Mexico which has slowed primarily due to its connections to the U.S. market. Favorable price in mix more than offset higher raw material costs and helped drive a 13% increase in revenue per tire.

Foreign currency was favorable, primarily due to the strengthening of the Brazilian real which has continued to appreciate against the dollar. Similar to the other regions, cost inflation was significant related primarily to energy, transportation, and wages. We continue to be very pleased by and optimistic about the performance of our business in Latin America. This business enjoys a combination of high growth, favorable operating margin and the lowest SAG in working capital ratios among our SBUs. Our challenge now is to make the business grow faster and we expect to do so with an unprecedented pace of new product introductions in both consumer and commercial tire markets.

Finally, Asia Pacific Tire report outstanding performance in the quarter, rounding out an impressive first half. Second quarter sales and operating income improved 20% and 27% respectively. Segment operating income strengthened from the previous year to 10.1% sales. Performance was driven by an 11% volume increase, primarily due to continued growth in China. Demand was not uniform throughout the region as we are seeing economic weakness in some areas, primarily Australia and New Zealand. Further benefits were derived from favorable price and mix versus higher raw material costs and to a less extent foreign currency translation. These positives were partially offset by higher costs related to increased marketing, business expansion, and cost inflation.

Our operations in China are expanding as we look to grow our presence in retail, manufacturing, and sourcing. We announced plans to relocate and expand our manufacturing capabilities in the region, including increased consumer, high-value-added capacity and Goodyear’s first commercial truck capacity in China. The region continues to prefer very well with excellent prospects.

Turning to the balance sheet, we finished the second quarter with nearly $2.1 billion in cash, which is $1.4 billion lower than the cash balance at year end. The lower balance reflects debt repayments of $750 million made in the first quarter as well as seasonal increases in our working capital. In addition to seasonal factors, increases in inventory reflect higher raw material costs and weaker unit volume primarily in North American and Europe. We continue to maintain a relatively high cash balance primarily due to the anticipated viva [inaudible], which we’re optimistic will be approved.

Total debt at June 30, 2008, was just under $4.1 billion compared to $4.7 billion at the end of 2007 and almost $5.5 billion at June 30, 2007. The reduction compared to year end 2007 resulted from $750 million of debt repayments executed in the first quarter. Net debt stands at $2 billion. I would also highlight that we’ve recently completed the refinancing of our European accounts receivable securitization program that was mentioned at our investor meeting in June and was completed on July 23. The size of the securitization program, which is an on balance sheet program, was increased by € 175 million to € 450 million while extending maturity from 2009 to 2015.

In addition to increasing our borrowing capacity overseas, this program continues to be a primary source of liquidity for our European business and is one of our lowest cost sources of debt. It also reduced our need to raise debt at the corporate level thus improving our balance sheet efficiency. Additionally, we expect to secure financing to support our relocation and expansion project in Dalian China during the third quarter.

Turning to cash flow for the first six months of the year, operating cash flow used by continuing operations was $215 million or almost $300 million favorable to last year. Cash flow from operations improved as a result of increased earnings and lower pension contributions, partially offset by higher working capital needs. We contributed $162 million to our global pension plans in the first half of the year versus $265 million in the first half of 2007. We’ve also reduced our expected 2008 contributions to our global fund plans to a range of $300 to $350 million from the previously indicated $350 to $400 million.

Working capital as a use of cash increased in the period compared to last year, primarily as a result of increase in inventories seen on the previous slide. We intend to keep a very tight check on our finished goods inventories and will manage production aggressively for the remainder of the year. Capital expenditures were $476 million through June 30th, as we have executed our investment plans explained at the investor meeting in June.

In summary, our quarter two and first half results reinforce the effectiveness of our strategies demonstrating our ability to improve the business in difficult times. Our structural cost reductions, stronger balance sheet, and richer product brand customer and geographic mix all work in our favor in this period of economic uncertainty. You can expect us to continue to drive mix, price, cost reductions, and high return investments in an aggressive though balanced way that meets both short-term performance requirements and longer-term strategic goals.

Now I’d like to turn the call back over to Bob.

Robert Keegan

Well thank you, Mark, and before we open up the call to your questions, I’d like to summarize our updated outlook for the industry in 2008. Overall the outlook for industry unit sales in 2008 has weakened. In North America, we now expect the consumer replacement market to be down 2% to 3% during 2008. Our forecast for the consumer OE market is now down 15% plus anticipating lower builds as the OEs manage inventories derived from slower sales. Our forecast for commercial OE has been revised to down 5% to 10%, and this industry has a tendency to fluctuate more than the replacement based on a smaller number of units than the industry faced. Our forecast for the commercial replacement market is now down 2% to 4%.

In Europe, for the full year our forecast for the consumer replacement market is now down 1% to 3%. For the consumer OE market, our forecast remains unchanged at up 1% to 3%. For the commercial replacement market, our forecast is now down 4% to 6% and our forecast for the commercial OE market is now up 8% to 10%.

While we continue to see considerable uncertainty and volatility in raw materials, much as you do, driven primarily by the volatility of oil and natural rubber pricing, while our expectations for raw materials remains the same as we communicated in New York last month, that is up 10% to 12% for the year, the volatility we see may mean we’re moving toward the higher end of that range, but the range remains in place. Consistent with our Q1 call, we expect interest expenses in the range of $320 million to $340 million.

For modeling purposes, we held our tax rate guidance at approximately 25% of International segment operating income. Our tax rate may vary depending on factors such as the release of valuation allowances against deferred tax positions and the mix of foreign earnings among low and high taxed rate jurisdictions.

Now I wanted to provide you with a concluding comment, we remain confident in our ability to manage through the challenging near-term business conditions and are focused on maximizing current business performance. Clearly here, we’ll continue to think creatively and aggressively about new initiatives to counter the current market weaknesses. At the same time, our long-term investment strategy highlighted for investors at our June 26 meeting positions us to capitalize on the available and attractive market opportunities that we’ve identified.

So we thank you very much for your interest in Goodyear, and we’ll now open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Rod Lache with Deutsche Bank.

Rod Lache – Deutsche Bank

Can you just first of all tell us whether there’s been any change to the timing of the [Viva] settlement and is there any risk at this point to that?

Mark Schmitz

Let me kick off and, Darren, you might have a comment on this as well. The judge asked for additional information, Rod as I think you know. That information was provided. There was a hearing that was held on 23rd of June and that’s where we stand at this point. I’m sure the judge will consider what he’s seen in terms of all the information, including this additional information and come forward. From our standpoint, and this is the standpoint not only of Bob Keegan but also our attorneys, we sill remain confident in this area.

Rod Lache – Deutsche Bank

You’re expecting that around the Q4 timeframe?

Darren Wells

Rod, I think that the decision itself could come anytime, but I think we’re starting to look like the savings will start in Q4.

Rod Lache – Deutsche Bank

How much higher would you expect the unabsorbed overhead to be in the second half and also just on the headwind side, non raw material cost inflation was bigger this quarter than it was Q1. Can you address that the outlook for that?

Mark Schmitz

First of all on the unabsorbed overhead question, Rod, we can’t give you very specific guidance on that right now, and I’ll tell you why. The accounting rules get a little bit complex here, they cross a threshold in terms of volume cuts that significant. They start recognizing unabsorbed overheard as period costs rather than flowing it through inventory. Now it is going to be more significant, I mean even it flows through inventory the way it has the last couple of quarters, it is going to be more significant than what we’ve seen. But it’s very difficult to provide specific guidance on it.

Let me just add to that to say that it’s not more cost in total, I mean if it flows through as a period cost as opposed to inventory, in fact it will benefit some future period and essentially just be an acceleration of cost recognition.

Then the question on inflationary impacts other than raw materials, yes, I mean we’ve definitely seen it. I think all our competitors have seen it. We’re seeing it in the economy at large. Some of this is really to understand as you see the impact of fuel prices on transportation costs, some it’s a little bit more subtle such as the impact on cola in our waste settlements. So we’re seeing it, but I think we understand it. We’re able to deal with it.

Rod Lache – Deutsche Bank

Can you quantify the total impact of the 8 million units of unabsorbed overhead? I understand it might be a period cost or built into inventory, but what’s the hit in totality? Secondly and lastly, just comments on the outlook for pricing versus raw materials as you get into the back half of this year, due you believe that you’d be able to set I guess looks like double digit raw material costs inflation in the back half, would you be able to mitigate that with pricing?

Mark Schmitz

Rod, I probably can’t give you the specific answer that would satisfy you completely, but let me just kind of repeat what we’ve seen here in quarter one and quarter two where we did see additional unabsorbed overhead amounting to I think it’s was $15 million in quarter one and about the same, $16 million in quarter two. In quarter three and quarter four, it is going to be somewhat larger than that; and that’s about as much as I can tell you right now.

Rod Lache – Deutsche Bank

Pricing?

Robert Keegan

Let me one do thing, I want to correct. I’m told I said June 23rd and not July 23rd on the latest hearing on the Viva, it was July 23. If you’re in my position, it probably seems like it was a month ago, but it was July 23rd. From the standpoint of pricing, Rod, what we will say is we think that we have demonstrated our ability to contribute significant amounts of price mix over time. As I said, we’ve had 15 quarters in a row where we’ve had great performance and certainly it would be our intention to continue that process particularly with the significant inflation that we’re seeing, as you correctly mentioned, and Mark just commented, not only in ROS, but in other areas as well. So I say look to our, look to what we’ve done and I think we’ve created a track record here that’s pretty admirable in that area. Again, we do that through outstanding marketing, outstanding products and outstanding new products and we intend to continue that.

Operator

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

Himanshu Patel – JPMorgan

In North America on price mix, you mentioned that the contribution for revenues was about $149 million and looks like the operating income line it was pretty strong, about $107. That sort of implies that you converted that at about $0.70 on the dollar, and that I think is almost a 20-point change versus what you were doing in the last two quarters. Does that mean that mix has started to soften or does that really mean that the rate of price increases has really started to improve much more?

Darren Wells

I think what you’d say in both quarters is that we had significant contributions from price and mix. Clearly in this case, we’ve had a lot of drop off in the OE business and drop off not as deep in replacement relatively speaking, and that’s a helpful factor for us. It helps us with mix as well. But I really, I would caution you against drawing too many conclusions there given the number of moving pieces. So I don’t think you’re suggesting anything that we’ve seen as a trend, but we continue to drive both.

Robert Keegan

Particularly, Himanshu, remember you’re looking at a quarter and if you look at the half, you’ll see some different movements and we tend to look at the quarter but also at the half of the past 12 months and that what’s kind of guides our assessment of what we’ve been doing and what’s been happening in terms of market dynamics and therefore what we have planned for and execute next.

Himanshu Patel – JPMorgan

One of, I think you revised down the European market outlook, it looks like the exit rate of volumes on both commercial and consumer for the industry in Q2 in Europe was considerably weaker than maybe what the total quarter was. I’m just thinking, if we get into a situation where the second half demand outlook gets a lot worse, can you just at a high level talk about your labor flexibility in Europe? Can you adjust production as fast and as cost effectively as North or is the business structure different there?

Robert Keegan

Himanshu, just to provide context here, in terms of the market, in Europe, we had a very strong, this is an industry comment here, strong industry in April and weakness in both May and June. You probably heard that on other calls that you’ve had. That hasn’t surprised us, but a little more negative than we expected. So naturally we’re looking at the second half from a contingency standpoint going back to what I mentioned, the contingency plans that we were talking about at December of last year, certainly covered from a European standpoint a macro possibility that we find ourselves in this situation. I think our team has reacted very appropriately to that weakness and they will continue to do so.

Relative to labor flexibility, and Mark, I know you’ll make a comment here to elaborate, but in Europe, we’ve got a fair amount of flexibility relative to variable labor and labor is in fact a variable cost.

Mark Schmitz

Just to expand on that comment from Bob, the implication of that is that the unabsorbed factor for European production cuts probably isn’t as large as we see from North America. Recall so in that regard, Himanshu, that we’ve got a fair amount of our production in Europe coming from the East and in general, we’ve got factories there that are more flexible, i.e., have a higher proportion of variable versus fixed cost.

Himanshu Patel – JPMorgan

I’m sorry, Mark, so you said the unabsorbed overhead that could result in Europe from lower volumes would be lower than it would in North America for a comparable volume decline?

Mark Schmitz

That’s exactly right.

Himanshu Patel – JPMorgan

Then another question, Slide 11, the last bar other, $56 million negative, I’m sorry, you ran through some of the components. Can you give us a little bit more granularity on what’s in there and which geography it’s in?

Robert Keegan

Well a little more granularity. I mean we certainly see additional costs of both lower volumes outside of the U.S. and manufacturing complexity related to conversion to high-value-added products and there are some other factors in there as well. For example, lower earnings in our retail business in North America would be buried in that as well.

Darren Wells

The only thing I would add, Himanshu, is we have a couple of what you classify as nonrecurring items is your non one-timers. There in there as well in Europe. We had the strike in Turkey, for instance, is for about $5 or $6 million and we had the cost of a wage settlement in one of our French plants that’s about $5 million, so a couple of things in there that go into the manufacturing cost lines. We kept them in other in order to portray the North American manufacturing cost cleanly.

Himanshu Patel – JPMorgan

Then last question, guys, the issue on freight costs, anyway you can help us with guidance on that? I mean should we just look what’s happening with diesel cost and assume your business will move in tandem or do you have any sort of contracts in place? Is this sort of stepped in over several quarters, or how do we think about that going forward?

Robert Keegan

Himanshu, I just mention that, I talked about our purchasing activities and we’re looking to procure certainly at rates of inflation below the market. But what we saw in the first half was virtually at market rates, maybe slightly below. So I think a reasonable assumption is slightly below the market for the second half of the year.

Operator

Your next question will come from the Kirk Ludtke with CRT Capital Group.

Kirk Ludtke – CRT Capital Group

Bob, you mentioned the trends during the quarter in Europe and I was curious if you could go through the same type of analysis, the trends and replacement demand in the other three regions and then if you got on any thoughts on how July is going, that would also be very helpful.

Robert Keegan

Well let me kick off by just saying that if I went through the other regions, let me start with North America. Remember, there are always ups and downs by month here, but certainly from a volume standpoint, you see the industry data in the forecast there that we provided. We’re continuing to see pretty consistent weakness in consumer replacement and of course OE speaks for itself with our forecast. I won’t give you any insight that’s useful for July probably except to say: trends are continuing as best as I know at this point.

From an Asia standpoint, volume was strong driven by China and the other emergent markets in Asia and then that’s offsetting to some degree some weakness in Australia and New Zealand as those economies overall have some problems. But we anticipate that we’re going to continue to see good growth. I would caution here that you’re hearing today that maybe China is slowing a bit, and we hear those same comments. What we see is if the GDP in China goes from 11% to 8%, it is still significant growth for us, particularly in the segments and products that we’re delivering, so we feel pretty good there.

Latin America, as you know, is a tale of a couple of different economies. Brazil is booming and Mexico being as it is so associated with North America is having some issues, and we’re seeing those comments that I’m making would apply to both consumer and to the truck business overall. So, Kirk, I’m trying to give you a very quick rundown, but that would be a quick rundown on volumes.

We don’t see anything happening in July that’s particularly or dramatically different than what we saw coming into July.

Kirk Ludtke – CRT Capital Group

That’s very helpful. Also, you mentioned some of the year-over-year changes for the first half, and I think you mentioned them in North America. I didn’t catch them, but could you give us those again and then also is there a way to do the same thing for Europe so we can kind of back into what it means for volumes in the second half.

Mark Schmitz

Kirk, you talking to the industry volumes for the quarter?

Kirk Ludtke – CRT Capital Group

Yes, if you could give us the comparable numbers from Slide 20 for just the first half year-over-year?

Robert Keegan

I think there would say that for the first half, if you took the consumer replacement business in North America, it’s off about 1%. The European business is off about 4%, and these are rough, but order of magnitude they’re decent numbers for you to work from in the first half. [Inaudible] business in North America off about 17% and these are industry, this is all industry number and Europe is up 2%. Kirk, does that give you kind of what you need?

Kirk Ludtke – CRT Capital Group

Yes, do you have the same numbers for commercial?

Robert Keegan

Commercial in North America for the first half, the replacement would be down 5%, Europe would be down 8%, and then commercial OE North America would be down approximately 20% and Europe would be up 14%. So in Europe, it’s important to remember here, Europe, the OE businesses are strong at this point in time and continue strong, unlike North America. That’s the fundamental difference that you guys want to be thinking about and certainly our people thinking about.

Kirk Ludtke – CRT Capital Group

Then just to check my math a little bit, does your full year material cost increase guidance translate into about 17% increase year-over-year in the second half?

Robert Keegan

It wouldn’t be far off. Just to track this because I think this would be helpful. If you looked at first quarter, our raw material costs were up 1%, second quarter 8.5%, so you can force the rest of the year and you’re going to be at a number in the ballpark of that 17%.

Operator

Your next question comes from the line of John Murphy with Merrill Lynch.

John Murphy – Merrill Lynch

On your outlook for the OE business in North America, it looks like you’re looking for something that we are with the big production cuts that we’re seeing, I was just wondering with the capacity cuts that we’re seeing at GM and potentially Chrysler given your large share there, might there be some more restructuring actions that you might take for the future, or is this really just good news that they’re cutting capacity and you shift this mix over to the replacement market?

Robert Keegan

Well it’s a bit of both, John. I mean part of that mix is shifted over to replacement with the associated higher margins; and it part, we played that out so far this year and now if we see further cuts, those will be cuts that we can’t just migrate into the replacement business. That’s why we said in North America, we’re taking 8 million units out of our production here for the here, at least that’s our current estimate.

John Murphy – Merrill Lynch

So your current actions encompass the 700,000 units of capacity that GM is cutting on the trucks?

Robert Keegan

It’s a current number.

John Murphy – Merrill Lynch

Got it. Then I apologize, but my line dropped for a second after when you were talking about the North American market, but on Slide 14, I was just wondering, you mention that sales were up 2% ex the TW&A sales. Does that impact buying or units at all there, it doesn’t have any impact, right, it’s just on the sales line?

Robert Keegan

It’s strictly a revenue line item. No impact on units.

John Murphy – Merrill Lynch

Then on the transition cost that you’re mentioning in North America that were about $30 million in the quarter, you said those were going to be larger in the third and fourth quarter each greater than $30 million.

Robert Keegan

No, John, just to correct that, no. If we gave you that impressions, it’s not accurate. Darren, why don’t you comment?

Darren Wells

John, I think the, you need to break down the North American manufacturing into four pieces, and that’s one of them. You say $34 million bad news for the quarter in conversion costs in North America and what you saw there is about $30 million worth of the transitional manufacturing costs, which is about the same as we reported in the last quarter. You would’ve seen about $16 million in what we refer to as unabsorbed overhead and it’s that $16 that is expected to grow in the second half of the year. Now in addition to that, a couple of other components, you’ve got about $46 million of structural cost improvements in the quarter, which means that there’s about $34 million of bad news unexplained and that is explained by higher inflation that has not been offset by efficiency actions. So, yeah, I mean several different pieces there, but the part that’s going to increase second quarter to second half is that $16 million of unabsorbed overhead.

Operator

(Operator Instructions) Your next question comes from the line of Saul Ludwig with Keybanc.

Saul Ludwig – Keybanc Capital Markets

What did you say that raw material costs increase was in North America this quarter?

Mark Schmitz

I probably didn’t say for North America per se, but we did say that the raw material increase for Goodyear was 8.5%.

Saul Ludwig – Keybanc Capital Markets

Could you tell us what it was for North America?

Mark Schmitz

I can’t tell you exactly, but it was a little bit higher than that and the reason for it what was that remember that the rest of the world has a bit of a currency hedge as a result of much more raw material big price of dollars.

Saul Ludwig – Keybanc Capital Markets

Could you bring us up to date on the [Hall] situation in France, and wouldn’t that result in some additional reduction of high cost capacity if you are successful in achieving what you set out to do in France?

Robert Keegan

Well let me go back to what we set out to do in France. Saul, just for everybody, I think you’re talking about the Amiens facility.

Saul Ludwig – Keybanc Capital Markets

Yes.

Robert Keegan

What we set out to do in France is what we’ve done in many other locations. We think we’ve got a plan and a strategy there that will help those two facilities in Amiens and stay vibrant and become profitable and those are moving those plants to HVA production, and we’re willing to make investment to do that. One of the plants has signed on from a union standpoint, the other one has not at this point to that. Our plan remains our plan. We only have so many degrees of freedom in terms of trying to improve the profitability of those plants. That’s where we are today. So your reaction to that could be: Well what if the other union never cooperates and we play out our plan. As I said, we only have one plan that will work for her for the Company and for the employees of that plant, which will continue to provide jobs.

Saul Ludwig – Keybanc Capital Markets

What happens come the end of the year let’s say no progress?

Robert Keegan

That’ll we’ll play out our plan. It is a binary plan. We’re ether going to make new investment that create high-value-added product with the kinds of competitive cost structure that we need or we are not.

Saul Ludwig – Keybanc Capital Markets

Would that plant be subject to being eliminated if they don’t want to play ball?

Robert Keegan

I’m saying in effect that what we’ll do is, and we’re doing that today, I’ve got to take production out of that plant. That process is engaged today.

Saul Ludwig – Keybanc Capital Markets

Darren, could you tell us what led to the on FX being a $6 million positive versus a $12 million negative when it’s been a negative number almost every quarter?

Darren Wells

I think it really is relative currency movements and principally in Latin America, Saul. So if you a lot of our Latin American affiliates will have receivables there in U.S. dollars. So as the Latin American currencies move that’ll give you different directions as those receivables are [inaudible].

Saul Ludwig – Keybanc Capital Markets

But it’s been moving positively for the last two years, in other words…

Darren Wells

In this case, we’re not principally talking about the real which has been only moving in the positive direction, other currency. So if you look in the Q, you’ll probably see Chili and Columbia mentioned specifically.

Saul Ludwig – Keybanc Capital Markets

How do you think about that number going forward, is that likely to be a positive number?

Darren Wells

Yes, I think it really is going to depend on the movement of those currencies. Those operations will continue to have U.S. dollar receivables that have to be rebalanced.

Robert Keegan

We certainly don’t consider ourselves experts at forecasting currency movements. We try to play out our plans for any eventuality and be flexible.

Saul Ludwig – Keybanc Capital Markets

Bob, I wonder if you could talk about the goal of getting to 5% margin in North America, that number has been an elusive number for many, many companies for a long time. You’re tracking it 1%. What has to happen to get there and is that achievable in the next few years?

Robert Keegan

Well, Saul, we think it is. I mean as I said earlier, we are not going to back away from that number. We think it’s achievable. In fact, we would’ve made huge progress towards that number this year had we not had the weak and very weak economy that we have and weak OE etc. We think as Rich Kramer described at the June meeting that we execute against those plans, we’re going to do just fine and the 5% is definitely within our sight.

Saul Ludwig – Keybanc Capital Markets

You think that’s doable by 2010?

Robert Keegan

Well I’ll say it’s within our sights, that exact time, if you want to precise timing, depends upon the economy. But the things that Rich talked about, our marketing capability, our supply chain capability, the investments that we’re going to be making in North America to provide HVA product, those are the things that are going to really make a difference for us.

Saul Ludwig – Keybanc Capital Markets

Just finally, in the manufacturing conversion costs, which cost you $34 million in North America, how much help did they get from lower pension expense, meaning other things would’ve been a bigger negative?

Mark Schmitz

In the neighborhood of $10 million year-over-year accrued.

Saul Ludwig – Keybanc Capital Markets

Finally, have any trouble getting [inaudible]?

Robert Keegan

Well I’ll tell you, we work at it but it’s had no disruptive impact on us at all. We continue to evaluate the situation. But from our standpoint, it hasn’t disrupted production. Like I said, our purchasing people are doing a great job.

Patrick Stobb

This concludes today’s call. Thank you again for joining us today. If you have any further questions, please do not hesitate to give me a call.

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Source: The Goodyear Tire & Rubber Company Q2 2008 Earnings Call Transcript
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