Goodyear Tire & Rubber Co (GT) 2006 Q2 法說會逐字稿

Good morning. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Goodyear second quarter 2006 earnings release conference call. [OPERATOR INSTRUCTIONS] I will now turn the call over to Mr. Darren Wells. Please go ahead, sir.

Thank you, Dennis. Good morning, everyone, and thank you for joining us for Goodyear's second quarter 2006 results review and strategy update. Joining me on the call are Chairman and CEO, Bob Keegan; and CFO, Rich Kramer. There is a slide presentation that supports our discussion this morning. If you've not already obtained the presentation, it's available now on our website at investor.goodyear.com. We filed our second quarter Form 10-Q this morning. This morning's discussion will be available for replay after 3:00 PM Easter Time today by dialing 706-634-4556 or on our website, again, investor.goodyear.com.

Before we get started, I need to remind everyone 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. 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.

Thanks again for joining us today. Now I'll turn the discussion over to Bob.

Well, thank you, Darren, and good morning, everyone. I'll begin by setting the agenda for our meeting. First, I will provide an overview of our second quarter performance and share my perspective on the economic environment that we are currently facing in the North American tire industry. Then I want to update you on the significant progress we're making on our key strategies, in particular, our intense drive to generate profitable revenue growth, to reduce our cost structure and to improve our overall business model.

I'll then turn the call over to Rich for a more detailed review of our second quarter results. Rich will review each of our business units' results and discuss the steps our businesses are taking to overcome what is a difficult set of market conditions, including cost inflation. I will then come back and make some remarks about the outlook for our business and the industry for the second half of the year. And lastly, we'll open up the meeting to your questions.

The second quarter provided quite a mix of highlights and challenges for the Company. We posted strong sales but disappointing profit results in the quarter, those results primarily as a function of the challenging market conditions that we face. At the same time, the progress we have made implementing our strategies continued to deliver significant gains.

Let me share with you the high points of the second quarter. Sales set a quarterly record at over $5.1 billion, which represents a 3% increase over 2005. I'd remind you here that if you adjust for businesses we've divested in the second half of last year, sales increased by 5% year-over-year. We achieved the sales increase despite weak overall industry volumes by driving significant pricing and mix improvements that resulted in a 7% increase in revenue per tire. Sales of branded tires in North America and Europe remained strong in the quarter relative to the industry with share gains in each region for our Goodyear and Dunlop brands.

Our focus on cost reduction drove SAG costs down by $53 million or 7% compared to the second quarter of 2005. As in the first quarter, SAG as a percentage of sales fell and is now down to 13.7% of sales year-to-date. That represents a full percentage point better than last year.

We announced two restructuring plans during the quarter as part of our overall strategy communicated last September to investors to reduce our costs by between $750 million and $1 billion by 2008. For your information, we have intensified that cost focus and subsequently have raised the bar of our cost reductions to more than $1 billion by 2008. So that's an adjustment since our investor meeting last September.

The first of our two announced restructuring plans was a headcount reduction of 150 in our European business, resulting in expected annual savings of $10 million. Then we announced our intention to close a plant in New Zealand which will result in a reduction of approximately 2 million tires of high-cost manufacturing capacity, while saving the Company approximately $15 million annually. We also completed the previously announced closure of our plant in Washington in the UK during the quarter. This is expected to result in annual savings of approximately $20 million.

We announced two key business model changes in our North American business during the second quarter. We decided to exit the wholesale segment of the private label business. In addition, we've expanded our relationship with pilot truck stops as part of our cradle to grave strategy in our commercial business, and I will discuss both these changes in more detail in a minute.

As you've noticed, several business units posted strong results for the quarter despite challenging market conditions. Our Eastern Europe, Latin American, Asia-Pacific and engineered products businesses showed a combined 15% improvement in segment operating income compared to last year. And Rich will provide more detail on each business unit's results during his comments.

The second quarter clearly presented challenges for our Company. First, we faced a tougher than expected industry environment, particularly in North America, which overshadowed much of the progress we made on our key strategies. Year-to-date, the North American consumer replacement industry is off over 6.5%. Now, to put this decline into historic perspective, the North American consumer replacement industry has been down by 3% or more in only four years out of the past 50. Let me repeat. The consumer replacement industry of North America has been down by 3% or more in only four years of the past 50.

Now, in general, our analysis of economic and customer data shows two likely behavioral drivers of the lower market demand in North America this year. The primary factor seems to be that customers are waiting longer to replace tires. This is consistent with the volume declines being experienced only in the low end of the market. We believe this behavior relates to declining disposable income due to factors like higher gas prices, interest rates and home energy costs. Our data indicates that customers are buying fewer tires per visit, meaning they are only replacing tires that are well worn.

We also have data from our retail stores showing less tread depth on average on tires being taken off cars. An additional factor relates to consumer driving habits, which may be driven by the same macroeconomic factors. For passenger vehicles we see some evidence of fewer miles being driven per vehicle -- not fewer miles, but fewer miles per vehicle -- which could lead lower replacement tire demand. I note here that history indicates that such behavioral changes are likely to be temporary.

Now, to summarize. The recent weakness in the consumer replacement market has been seen mostly at the low end of the market. Of course, this has a significant impact on our associate brands and private label business. We believe our customers, particularly those buying value tires, have declining disposable income, which is causing delayed replacement of existing tires.

At the same time, we continue to see a strong demand for our high-value branded tires in the consumer segment. In the second quarter we achieved, as I said earlier, share gains in our Goodyear and Dunlop brands in both North America and Europe. And I will talk later about the industry growth that we expect going forward.

The second challenge we faced in the quarter was the continued escalation of raw material costs and the growing difficulty in offsetting those cost increases. In the quarter, we experienced raw material cost inflation of $210 million over last year, an increase of approximately 16%. Natural rubber prices have been the primary driver of the increase, rising more than 40% year-over-year.

Now, prior to this year, we've been able to overcome raw material inflation through two primary initiatives, price mix improvement and raw material productivity in the form of improved purchasing processes and lower cost material substitutions. During the first half of the year, our ability to continue to move pricing to higher -- pricing higher to offset the rising costs has been challenged, particularly in our Western European business, due to an increase in competitive pricing pressure in the marketplace. And Rich will have more to say about that.

And while we continued to see significant positive impacts from mix enhancement and productivity improvements in terms of material procurement usage, these factors were not enough to overcome the impact of escalating costs.

Now, let me tell you how we're dealing with these challenges in the near term with a constant focus on our seven strategic drivers. First, we're increasing our efforts to support our industry leading distribution channels, which means helping our dealers cope with the difficult market environment. Second, we continue to focus intensively on reducing our costs. These efforts are taking place throughout every area of our business. And third, we are taking the necessary actions to reduce inventories and ensure we maintain a strong cash and liquidity position. Although this means reduced factory efficiency in the short term, we know that maintaining our cash-is-king approach is the right thing to do. And Rich will talk in much more detail about that relative to our second quarter.

I want to share with you the progress we are making on our strategic initiatives relative to winning with customers and reducing our cost base. We continue to push our entire organization to drive our key strategies of delivering innovative new products, building brand strength and leveraging our outstanding distribution network.

First, let's talk about new products. So far this year we've introduced the highly acclaimed Eagle ResponsEdge with carbon fiber high-performance tire in North America. It's been very successful. We've extended our successful Assurance and Fortera tire lines into Mexico and launched the Excellence line of tires in China. In addition we have new commercial truck tires to be introduced later this year, along with several winter tires for the European market. Our pipeline of new products for 2007 looks to be even better and will provide us with more opportunities for topline growth going forward.

As a direct result of releasing new product launches, our branded products are consistently gaining share in both at North American and the key European consumer replacement markets, driving topline growth and, perhaps more importantly, improved product mix.

In Europe, we are very well positioned to take advantage of the recent German legislation that we expect will drive a strong winter tire selling season. We have the award-winning Goodyear UltraGrip 7 winter tire that we introduced last year to take advantage of that situation.

We are also targeting premium new car fitments. And perhaps over the last few weeks you've seen announcements that our tires have been selected to outfit some exciting new car models, including - and this is just an example -- the Audi Q7, the Shelby Mustang 500, the VW Eos and the new Dodge Nitro.

We continue to drive innovative marketing of our Company and our products. We've done a great job of getting the word out about our new products as evidenced, I think, by the more than 40 articles that have been published about the new high performance Goodyear Eagle ResponsEdge with carbon fiber tire that we just introduced this spring.

We're getting additional value and reach from our marketing spend through strategic partnerships as measured by independent research. We've accomplished this by using some new methods, certainly new to our industry, to reach relevant consumer groups. Our relationships with NBC during the Olympics, Fox for Major League Baseball and ESPN for the upcoming Monday Night Football season are leveraging our highly recognized blimps to provide -- and this is important -- in-program messages about our products.

We're also customizing our messaging for specific environmental factors our customers are experiencing at the moment of contact. One example of this is our partnership with the Weather Channel and weather.com, where our end market messaging and product focus changes depending on the current local weather conditions. So we're real-time. We often talk with you about our innovation in terms of products, but our marketing efforts provide evidence, I think, that an innovative approach has become part of our culture.

Now during the second quarter, we announced two significant business model changes in the North American tire business. First we announced our decision to exit the wholesale private-label business. That is, the wholesale component of the private-label business. This decision affects approximately 10 private-label brands, totaling 8 million units or around $300 million in annual sales. And this action clearly reflects our strategy to focus selectively on profitable market segments and focus our resources on building our strengths in the core brands.

The second change we announced during the quarter was the expansion of our relationship with pilot travel centers. As part of our cradle to grave strategy in the truck business, the relationship with pilot expands our service footprint for better coverage of the cycle of services and products that tie us to commercial fleets long term. We already have 14 pilot truck care centers operating today and have identified five more locations that will be operational by year-end. These make us a more attractive partner to fleets and increase our opportunity for higher-margin service revenue. So it's a key business model change for us in North America.

Now turning to cost. We remain intensively focused on reducing our cost structure as a strategic imperative for our Company. And I want to touch on some of the actions we are taking against our 4-point cost saving strategy that we introduced again at the September investor meeting. First, in terms of footprint reduction, we have already addressed 3 million units of high-cost capacity in Europe, 2 million units in Asia and are reviewing currently plans to address the 8 million units in North America that are related to our exit from the wholesale private-label business. Now if you take these together, they represent 13 million of the 15 to 20 million units which we reflected in our three-year high-cost capacity reduction target of 8 to 12%. So 13 of the 15 to 20 already represented with actions we have taken or are considering.

Our second cost strategy is our Asian sourcing initiative. We are making significant progress in our sourcing of raw materials, capital equipment and low value added tires from China. This year we'll source more than $200 million from China, but expect this number to grow to over 500 million next year. We are targeting savings in excess of $150 million from the sourcing initiative by 2008.

Third, in the area of continuous improvement, we are making progress on initiatives like using alternative raw materials to counter the impact of high natural rubber prices and accelerating our investment in lean process improvement initiatives. The results to date have been outstanding, but we're really here just hitting our stride.

Fourth, as I mentioned earlier, we are realizing significant benefits from reductions in our SAG expense, totaling $61 million so far this year toward our original goal of 150 to 200 million by 2008.

In summary, we continue to focus on our successful strategic initiatives and on long-term value creation. There are two additional points I would like to address before I turn the call over to Rich. First I want to update you on our negotiations with the steelworkers. Our contract with the union in North America expired on July 22nd. However we have agreed to operate under the terms of the current agreement on a day-to-day basis.

As you are probably aware, the steelworkers selected Michelin as the target for the current contract bargaining. And Michelin and the steelworkers have announced that they have reached a tentative agreement on July 25th -- details still to be composed. We remain confident that we can reach a fair contract with the steelworkers that will improve the cost competitiveness of our North American manufacturing base and reach an agreement that helps us win with our customers as well.

The last point I wanted to discuss is the sale process of our engineered products business. We began marketing the business in the second quarter, as we said we would on the last investor call. We're still in the early stages of the process. And I wanted to just mention here that given the size and complexity of the business, we expect the sales process to take considerable time. In the meantime, the engineered products business is performing very well, and you see that in the second quarter results.

Overall, we remain focused on our strategic objectives and achieving our next stage metrics of 8% total segment operating margin, a 5% operating margin in North America and a debt to EBITDA ratio at or below 2.5 times. We remain confident that we can attain these goals while recognizing our challenges.

Now that concludes my comments on our financial results and progress on our strategies, and I'll come back at the end of our formal remarks to share my perspective on the outlook for the second half of the year and to answer your questions. And now I'd like to turn the call over to Rich for a more detailed look at our operating results.

Great. Thanks Bob and good morning everybody. I started off my comments during our first quarter conference call by saying that the quarter reflected the benefits of our strategic drivers as well as the need to reduce our structural costs. Our second quarter financial results reinforce this statement and cement our belief in our key strategies. It remains clear in order for us to consistently deliver the solid financial results in our industry, we must be successful in each of our strategies. And while the markets in our competitive environment may provide us with additional challenges along the way, as has been the history in the tire industry, we remain steadfast in driving these strategic imperatives to deliver long-term shareholder value.

Our second quarter results were generally weaker compared to last year driven by the significant volume decline in North America that Bob referred to. Now in addition to weak market conditions pushing unit sales down, we also continued to face a difficult competitive environment in Europe as well as dealing with the impact of additional raw material and manufacturing cost inflation.

Looking at the second quarter income statement, sales increased 3% to an all-time record of 5.1 billion. Sales increased 5% year-over-year when adjusted for businesses we divested in the second half of '05. The sales growth was achieved despite weak industry volumes and tough competition in several of our key markets.

Our revenue per tire increased 7% compared to last year driven by a combination of numerous price increases over the past 15 months in the face of higher raw material costs and improvements in mix attained from our focus on growing our high end branded product sales. Our strategy of targeting higher value market segments helped us again in this quarter to mitigate the impact of lower volume.

Our gross margin for the quarter was 17.3%, which included approximately $45 million of accelerated depreciation charges associated with the previously announced closure of our Washington UK plant. In addition, the reduction in gross margin reflects the impact of higher raw material costs that were not fully offset with price and mix as well as higher manufacturing costs.

Segment operating income for the second quarter was down nearly 16% or $49 million, compared to 2005 and remember 2005 included 14 million of operating earnings from divested businesses. Our North American and European businesses combined were $76 million below last year. Again, the shortfall includes the 14 million from divested businesses. Now meanwhile, our other business units combined grew segment operating income by $27 million or 15% in the quarter.

Now in a few moments I'll review each of the businesses in a bit more detail. Net income for the quarter was 2 million or $0.01 a share and this number includes after tax restructuring expense of $30 million or $0.17 per share and again the accelerated depreciation charges of $33 million on an after tax basis or $0.19 per share.

Now turning to our cash flow for the first six months of the year, cash flow from operations was approximately $250 million below last year, driven by lower earnings, higher pension contributions and the non recurrence of some significant insurance recoveries that occurred in 2005. Now cash used for working capital purposes was similar to that used last year in total, but the makeup is a bit different. While inventories increased versus last year due primarily to lower sales volume and escalating raw material costs, we were able to offset this with better accounts receivable management and improved payment terms from our suppliers. This focus is a reflection of our focus on improving our working capital reduction -- working capital position in the aggregate.

Now for the first half of the year, capital expenditures were up approximately $30 million from a year ago. Now we continued to invest in increasing our capability to supply the growing demand for high-value tires. This is the key focus of our CapEx payments.

Now turning to our balance sheet on slide 12, you'll see a comparison between June 2006 and June 2005. Now note that despite an increase in working capital and significant pension contributions our cash balance is only slightly below the prior year and both our total debt and net debt are down. Executing against our capital structure improvement plan, again as we've reviewed with you on many past occasions, has allowed us to better absorb the cyclicality of the tire industry without significant impact to our liquidity.

Now before reviewing the SB results in more detail, I wanted to take a minute to discuss some issues on legacy cost and the related liabilities. Clearly, this has been a significant issue in the past for a variety of reasons. But as we look ahead to 2007, we see some positive implications. Now as we've done in the past, on slide 13, we provide our expectations for 2006 pension and post-retirement expense and for pension funding as well.

Now in addition, this time we are also providing our estimate of the unfunded pension amount at the year-end of 2006, at the end of this current year. And we expect it to be about $2.2 billion compared with 3 billion at the end of 2005. The substantial reduction reflects both the contributions we are estimating for this year, which is based on the expectation of new pension legislation, which after this morning's news seems highly probable, as well as a discount rate that is 75 basis points above year-end 2005, again, about where it would have been at the end of June.

Given these factors and acknowledging that the discount rate could certainly still change, it is likely that our unfunded position will improve substantially this year. Improved funding and a higher discount rate will begin to reverse a trend that so negatively impacted our earnings earlier in the decade. And it will result in reduced pension expense in 2007 of $50 to $60 million, most of which will benefit our North American tire operations. And to also say, given our current domestic tax position, the lower expense will also be a direct benefit to our 2007 net income.

Now relative to pension legislation and the news we heard this morning that now the Senate as well has passed the current bill, I'll just make a few comments to say that we're still evaluating the impact of the bill that's passed, given that it's about 900 pages and certainly while we're familiar with it, we still need to go through the final.

But I would also say we see it as positive that Congress is actually taking some action, and assuming the legislation is consistent with our prior understanding, our domestic funding will be at the low end of our estimate, which you may recall is between about $550 and $600 million. So hopefully, we're going to be able to provide you with a bit more certainty of our funding levels for the balance of 2006.

Now, I'll discuss the business segment results for the second quarter, starting with North America. Now while we are disappointed with the second quarter results in this business, we remain upbeat on the prospects for the future. Results in the quarter were largely driven by weak market conditions. But even in that environment, we see our core strategies continuing to deliver improvement across the business. The second quarter also reminds us of the need to reduce our structural cost as we see the significant financial impact that lower volumes have on our high fixed cost base.

Now, sales for the quarter increased 2% compared to the second quarter 2005. Adjusted for businesses we divested in the second half of 2005, sales increased 5% over last year. Improved price and mix drove sales higher by 125 million in the quarter, more than offsetting a $95 million negative impact of lower volume. Volume in unit terms fell about 8%. Our improved price and mix drove our revenue for tire in North America up 9% year-over-year.

Now speaking about revenue per tire, I might just take the opportunity to mention then in reflection of the continued increasing raw material cost environment, we also recently announced an up to 5% price increase effective September 1 in our consumer replacement business. The segment operating income for North America dropped to $6 million in the second quarter, down from 55 million over last year. The drop of 49 million to be explained essentially in four major areas -- 11 million of the decline was due to lower sales volume; 7 million of the decline was due to price and mix improvements of $91 million, not fully offsetting escalating raw material costs of $98 million with a significant impact being felt in our consumer OE business; 14 million of the decline was the effect of loss-profit contribution from the businesses divested in '05; and finally, 9 million of the decline was due to higher costs. Selling, administrative and general expenses were reduced by 34 million in the quarter, but were more than offset by 43 million of cost increases in other areas, particularly in manufacturing.

Now as Bob explained earlier, we are feeling the impacts of decreased demand seemingly coming from reduced disposable income, which disproportionately impacts the low end of the tire industry and consequently the low end of our business. However, the demand our signature products -- again, that's Assurance with ComfortTred and TripleTred, Fortera with Silentarmor and Fortera with TripleTred, Wrangler with TripleTred, and of course, our new Eagle with ResponsEdge. Now, the demand for these products remains strong and in fact continues to grow as evidenced by our branded share gains in this weak market. These products overall are up double-digits versus 2005, and we expect this trend to continue.

This is confirmation that our focus on targeting selected market segments with innovative products that our dealers and consumers demand is working. This also reinforces our strategy to reduce our exposure to those market segments where we cannot favorably compete while simultaneously directing our resources to those segments where we can win.

Now, relative to our consumer OE business, we remain committed to our strategy of targeting selected fitments versus a volume orientation. Our current OE business is clearly suffering from continuing raw material increases in a business segment where price increases remain challenging. We nonetheless remained focused on improving the performance of this business through product innovation, pricing and cost reduction.

Our truck business saw continued robust OE demand in advance of the 2007 environmental changes -- environmental law changes, again, but experienced a weaker than expected replacement market. This decrease appears to be reflective of an adjustment in inventory levels throughout the supply chain as global truck tire supply increases and demand somewhat moderates due to the underage of trucks on the road following over two years of a robust OE market.

Our off-highway business also continued to experience strong demand in the quarter. During the second half of the year, we again will maintain our cash-is-king approach and will be implementing production reductions in the region to bring our production schedules and inventories back in line with market demand. So despite the challenging second quarter, we remain very positive with the positive - with the progress we're making in North America.

Now, turning to our European business, our second quarter results were down versus 2005, due primarily to competitive pricing pressures in the region and to price and mix improvements being insufficient to offset decrease in raw material cost. Sales for the quarter increased 6% as reported and up 4% when adjusted for translation. While our unit volume was down in the quarter, driven primarily by our consumer OE business, price mix improvements in our key consumer replacement business drove the sales increase.

Europe's operating income in the quarter was down 27 million compared to last year. In our discussions of the first quarter results in May, we described an intensified competitive environment that prevented us from offsetting continued raw material cost increases. The situation continued in the second quarter with raw material costs increasing 48 million compared to price mix improvements of 22 million. While the environment remains challenging, we did see signs in the latter part of the second quarter, which created some optimism relative to opportunities for improved volume, price and mix.

Now understanding the implications of a changing competitive and cost landscape in the region, our European management team is certainly not sitting still. They've reacted and will continue to react both tactically and strategically to improve our business results in the near and long-term. Through the structural change and tight controls on discretionary spending, we were able to realize a $25 million year-over-year reduction in selling, administrative and general expenses in the second quarter alone.

We are also starting to see the benefits of restructuring actions taken to lower our costs in certain of our retail operations and centralize certain of our back office functions such as purchasing. We also completed the closure of our Washington UK plant on schedule and will begin to see the benefits in the closure in the second half of the year as a result of fixed cost reduction and higher utilization at our remaining facilities. And finally, the region has commenced a more inclusive review of its entire back office functions with a goal of creating efficiencies -- excuse me, and reducing duplicative costs.

Now, in addition to these initiatives, we are also excited about the upcoming winter tire selling season. New German legislation that encourages the use of winter tires in the market will create strong demand. And Goodyear, with its award-winning Ultra Grip 7 winter tire, is well positioned to benefit from that demand. As you may recall, the Ultra Grip 7 was rated as the number one winter tire in Europe last year. And we certainly expect it to test well against the competition again this year.

Turning to our Eastern European business, the region achieved record sales and earnings in the second quarter with segment operating income up 20%. While price and mix improvements were less than raw material increases in the quarter, strong volume in key growth markets, a focus on cost and the benefits of foreign exchange on our low cost structure drove the earnings increase. We continue to see Eastern Europe as a region where our market-leading position will allow us to continue to demonstrate our competitive advantage and continue to provide us with significant growth opportunities.

Our Latin America business continued to post strong results amidst weak economies in a week tire industry. Despite a 6% decline in unit volume, the region increased its operating earnings by 8% to $83 million. The driver of this increase was execution against the aggressive cost reduction initiatives, which have been advanced in view of weak markets.

Also impacting operating earnings were the benefits of price and mix and translation offset by higher material costs and the lower volumes I just mentioned. The decrease in unit sales volume in the quarter was focused in the consumer replacement segment, primarily in Brazil, where weak economic conditions and price competition were the primary drivers of the shortfall. Now looking ahead, we see continued uncertainty driven by region politics, but expect the Brazilian economy to improve later in the year as lower interest rates and other economic stimulus measures take hold.

In the Asia-Pacific region, sales increased 2% compared to 2005, posting a record for sales in the quarter despite a 4% decrease in tire unit sales. Strong price mix driven by 16% increase in high performance tire sales in the quarter more than offset the lower volume.

Operating income was a second quarter record, increasing 40% or $8 million versus the prior year, as improvement in price and mix more than offset higher raw material costs. We continued to see stronger topline growth in China and India throughout the quarter, which was masked by some weakness in other parts of the region. The second quarter also included strong performance from our off Highway business operation in the region.

On the cost side, we announced the closure of our New Zealand factory during the quarter as part of our ongoing effort to reduce the structural cost challenges within South Pacific Tire, our Australian business. While we feel we have a significant opportunity for earnings growth at SPT, our focus will also be directed to getting our costs in line to facilitate that growth. And finally, our Asian sourcing strategy continues to gain traction. We continue to meet with a qualified third party tire manufacturers and all the raw material and CapEx suppliers consistent with our low cost strategy.

Our engineered products business posted lower sales in the quarter compared to last year, again due to an anticipated reduction in military sales. However, the lower military sales were offset in the quarter by strong growth in our industrial business where our products continue to be in demand. The profit improvement in the segment was also driven by the strong performance in our industrial business, along with cost reductions, particularly in selling administrative and general expenses.

So as Bob and I have stated, we saw traction against our stated strategies of winning in our targeted market segments through topline growth and executing against our cost reduction plans. The successes were nonetheless mitigated by challenging industry conditions. But as we stated, we remain confident in our ability to drive the requisite changes in our business model to deliver shareholder value.

Now I'll turn the call back over to Bob.

Well, thanks, Rich. Before we open the call for questions, I want to take a couple of moments to discuss our outlook for the balance of this year. Given difficult market conditions, we're keeping of course close watch on key economic indicators and staying in close contact with our dealers, so that we have timely visibility to any changes occurring in the market. As we see it now, conditions in the second half of the year are expected to improve overall. And let me provide our rationale for that position.

In North America, we expect some of the pent-up demand from delayed consumer purchases to release in the balance of the year, impacting the third and fourth quarters. In Europe, we're anticipating, as both Rich and I have said, a strong winter tire sellout in the second half driven by the aforementioned German legislation changes.

Now taking a more detailed look at our expectations, I will cover the third quarter, then the full year for North America and Europe. In the third quarter in North America, we expect the consumer OE market to be down approximately 2% and the commercial OE market to increase approximately 6%. In light of the economic uncertainty, the consumer replacement market in North America is expected to be flat to down 2%, while the commercial replacement market is forecast to be down approximately 3%.

For the full year in North America, we expect the consumer OE market to decline approximately [2 to 3%], while the commercial OE market is expected to growth 4 to 5%. The consumer replacement market in North America is expected to be down 3 to 4%, while the commercial replacement market is forecast to decrease approximately 2%.

For Q3 in Europe, we expect the consumer OE market to be flat to up 1% and the commercial OE market to up 4 to 5%. The consumer replacement market in Europe is expected to grow 1 to 2%, while the commercial replacement market is forecasted to be up 1 to 2%.

For the full year in Europe, we expect the consumer OE market to be flat to up 1% and the commercial OE market to increase 3 to 4%. The consumer replacement market in Europe in is expected to grow 1 to 2% while the commercial replacement market is forecasted to be up about 1 to 1.5%.

For raw materials, we, like you, continue to see quite a bit of uncertainty in the market. Following year-over-year increases of 14% in the first quarter and 16% in the second quarter, we expect full-year increases of 15 to 16%, with the second half at or above first half levels.

Now in addition to the input that Rich has already provided on pension expense, I want to comment on earlier estimates for interest expense and capital expenditures for the year. We are reaffirming our capital expenditure estimate, although market conditions may dictate further review through the second half of the year. So we're reconfirming CapEx.

We are lowering our interest expense estimate for the year as we've been able to reduce interest expense and some variable rate data and minimize borrowing in our overseas operations. So we're lowering our interest expense. We now expect interest expense of between $425 and $450 million compared with $450 to $475 million communicated previously.

In the important area of tax expense, our tax expenses are expected to be approximately 30% of our international segment operating income. We continue to see segment operating income from our businesses outside North American tire in aggregate improving for the full year, while the North American tire segment operating income is expected to be down compared with 2005.

So that's a summary of our outlook for the balance of this year. That concludes our formal remarks. And we'll now open up the discussion to address your questions.

[OPERATOR INSTRUCTIONS] Your first question is from the line of Himanshu Patel with JP Morgan.

Hi. Good morning, guys.

Good morning Himanshu.

You guys raised the cost target to over $1 billion. Can you just us give us a little bit of color behind what areas that increased optimism is from?

Yes, Himanshu. Let me certainly kick that off, and, Rich, you may have additional comments that you'd like to make. If you take the 4 box chart everyone of those -- the quadrants of that box will contribute to the increase. But we've got a very difficult environment. We've picked up the intensity and we're learning here.

I think we've talked with you previously about the fact we've have been on a steep learning curve in the cost area these past four or five years. And we're starting to learn how to climb that curve. We're getting much better at lean process. And frankly, our culture has recognized the need here to be aggressive on cost. So it will -- from footprint through SAG through legacy, you're going to see significant changes in what we're doing and we're more confident today perhaps in our ability to take significant cost out of here. But it affect everyone in those area. Rich may you have other comments.

No. I think the only thing I would add is, as I mentioned in my earlier comments, we're in a cyclical industry. And we're getting cyclical lots of headwinds and as we said back in understand what we need do to drive this business, I think, our collective view is we need to do more and that more is going to come from as Bob mentioned from all the boxes, but again particularly think about our high fixed cost structure whether that's assets or whatever you might want to put in that bucket that's where we need to be more aggressive. And I think we're committed to doing that.

I think we saw in the -- both the first and the second quarter of this year, again, us -- from an operating standpoint, our teams really stepped up and cut SAG expense. And we've done that we feel without significantly affecting our ability to market and sell product.

But there's still more opportunity in that area, and we've taken the SAG expense for example down a full percentage point in sales, from I think 14.7 to 13.7 for the first half. Significant progress in an area where we felt we were operating pretty effectively before. So we're continuing to set lofty goals and we're hitting those goals, frankly.

I'm just wondering, you've been sitting down with the union for a few months now. Would it be fair to say that you've got a little more visibility on what you could achieve that out of the union negotiations, or are you still kind of at square one when it comes to trying to figure out where this new contract ends up landing?

Well, Himanshu, all I'll say there is clearly we're talking, we're having good -- what we feel constructive discussions with the union, and I think that's all I can say at this point in time. So we go on feeling that we will be able drive a more competitive situation just as we would have said to you on the last call.

Okay. And then on the North American profit walk, Rich, I think you had mentioned costs were $9 million higher, and that included 40 or 43 million of higher manufacturing costs offset by SG&A.

Right.

Can you go into that a little bit more, the manufacturing part?

I think in that $43 million you'll see a combination of things. One is the negative impact of some of the production cuts that we took toward the end of the first quarter and the early part of the second quarter, because remember, those get deferred and will be rolled out with inventory turns.

So some of that's in there, but again, remember, I would also refer to production cuts coming. I think you'll see more of that in the back half of the year than you will in the second quarter. The other items in there are essentially higher energy costs to run our factories, COLA -- wage increases, cost of living type of adjustments that are indexed that we have to pay. And finally, I think, as we look at I think our volumes come out quicker than we've been able to take the cost out of the factory, frankly speaking, within the second quarter.

Okay. And then lastly, on the cash flow -- and if you just try to back into the second quarter operating cash flow, it appears that working capital was a drain in the quarter but not as much as it was in the year-ago Q2. I think I did the math on that to suggest there was maybe a 63 million drain in the quarter versus 124 in the year ago. I mean, that's an improvement. How should we think about that trend going into the second half of the year?

I'd give you some positives and a negative and maybe I'll start with the negative. And that's simply our inventory, if you look at the balance, is up significantly year-over-year. I mean, that's not a flow but it's a good indicator as you look at our inventory balance and that is by and large comprised of the higher raw material costs that are sitting in our inventory from finished goods all the way through.

We do have some increased units year-over-year in there but I'm going to tell you the lion's share that is just coming from higher inventory cost -- raw material cost. Now, on the positive side, we have actually reduced our days in receivables by about three days and we've improved our accounts payables days by also by about three days. So as we think about this, in a period where we've had higher sales, we've pulled down our receivables and we've been able to get some extended terms on our payables.

So as we go back, we understand that managing our inventory in a down market is going to be very difficult to show a flat if you will or not use of cash. So our strategy is to and in fact bounded by other components that make up working capital, and in this period focused on the aggregate, and I think we did a reasonably good job of that in the second quarter. Of course, we'll continue to have to do that over the balance of the year.

Okay. Bob, one last one for you. You mentioned considerable time to get the engineered products done. Anything changed on that?

No, no. I mean, the -- I will say the marketing has been done, we're early in the process. Certainly there is expressed interest from both financial buyers and strategic buyers. So don't read that as a negative. It's just the reality of the business of that size and that complexity.

Okay. Thank you.

Thanks, Himanshu.

Thanks, Himanshu.

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

Good morning, everybody. Can you hear me?

Yes. We sure can Rod. Good morning.

A couple of questions. There is, I guess, some indication that your accounts receivable reserve declined as a percentage of those gross receivables. I would think that with this weakness in the market overall, that the credit quality of the dealers would be affected by that. Can you just address where - what's behind that and where you see that going?

Yes, Rich. Maybe you could --

Sure. Rod, I would tell you, we go through and assess the appropriateness of all our reserves including the accounts receivable one on a quarterly, if not more, basis. We're not seeing any weakness that would cause us to change that, and any movements in the reserves that you're picking up on are essentially movements that are in the normal course of our assessing that reserve, writing off accounts that we feel are uncollectible, but I wouldn't tell you, if any of those movements are a reaction or an anticipated reaction to currently what we're seeing in our dealer base.

Yes. Rod, another point here that might be interesting is that, remember, many of our dealers, and many tire dealers in general, do both service and they sell tires. And service income, people are doing fairly well with service income, and we could argue why that would be the case, but I'll just mention service income, we continue to do well with and the tire business is -- obviously is weak in the US.

I think that's right.

Yes.

Should we assume that this reserve as a percentage of gross receivable stays where it is right now?

I think Rod that our percentage is going to change based on facts and circumstances. But I think a better way to look at it is you historically look at our receivables and our dealer base, just going on my own memory, I think -- I can only think of one or two significant big bad debt write-offs that we have had that would have been outside the normal course. So I wouldn't say it's absolutely going to stay at that balance, but it could move up, it could move down but it's normal course. I just wouldn't read into it.

Right. And you guys made some comments about the inventories being high at the end of the first quarter and the finished goods is up sequentially, what's the target for where you think inventories could go?

Well, I don't think we've ever put any targets out, Rod. I think our view is, we want to balance our inventories to be consistent with the demand that we're seeing, and we want to balance those inventories equally so with the - by product demand that we're seeing. What I mean by that is our inventories in Europe are probably a little bit higher than normal, but that's in anticipation of the winter tire sellout coming in.

And as we look at the demand for our signature products that I referred to, that is something that we will continue to build to. Where we're having an issue right now is inventory, particularly on the low-end of the business, and we've taken actions exiting wholesale private label and also production cuts moving forward to address those. So I would say our concern is really service levels and managing our cash as opposed to an absolute target.

Okay. If we think a year from now, this part of the year should we just expect that the inventory levels are going to be lower than they are right now?

It would be our -- it depends on how strong the market is, et cetera. But Rod from our standpoint, we've talked about reducing our working capital overall and we've set big internal targets there. So directionally, we'd assume that we'd able to achieve our -- and improve our service levels, improve our cost, and to do that while reducing our inventory levels. I mean, that's the clear goal for our operating units.

Okay. The two other things that I wanted to ask about were, can you maybe just rank what the priorities are in these labor discussions? Is it -- is capacity reduction at the top of the priority list, or is it something related to flexibility or benefits? And there's also been some news on this dispute with General Motors on the OE supply. Can you just explain what the issues are behind that and how significant is this from your perspective?

Okay. Let me try to pick off those questions one-by-one. In terms of the union negotiation, I won't rank these because I can't rank them. We're given -- I want to preserve here the integrity of the negotiation. We've said before that there are three real categories of areas that are being discussed. One would be footprint, two would be overall productivity, and three would be legacy costs.

But I'm not Rod, in the position want to rank those. Those are areas that we're obviously engaged in and the discussions are focused on. Relative to GM, which I think is your second question, we believe that the -- by the way, we have still not been served - there's been a filing. We believe that the complaint is unfounded, mischaracterizes the relationship between Goodyear and General Motors. We're certainly supplying tires today to GM on valid contracts and remain, I would say, hopeful that we can resolve this amicably and look forward to doing so.

Okay. Can you talk about what the magnitude is of the contracts that are under dispute?

No, I cannot do that.

Okay. All right. Thank you.

Thank you Rod.

Thanks Rod.

[OPERATOR INSTRUCTIONS] Your next question is from the line of Saul Ludwig with KeyBanc.

Good morning.

Good morning Saul.

Hi Saul.

Let me lump this in one question here.

How many parts will there be, Saul, for this question?

12 or 13. On the SG&A cuts, to what extent is that people versus advertising -- that's part A. And part B in the $43 million additional cost that you had in manufacturing in North America, how much specifically was unabsorbed overhead, and what you think that unabsorbed overhead bucket is going to be in the third quarter as you try to skinny down your inventories?

Okay. Rich let me take the first one and probably take the second one. On SAG cost obviously there is a mix here of several things. There's a mix of people and you know that over the last few quarters we've reduced people in North America and in Europe. We've also cut back in other areas. Advertising is certainly a piece of this, but I would look at more generally the overall area of marketing spends as we've really gone after how we spend our marketing dollars, which would include advertising, promotion et cetera -- all our dealer relations. And we've cut back to those things that we feel really create value for us. So that's how I'd address that one.

Thank you.

And I think the intent probably of your question, Saul, are we getting at long-term cost reduction or is this kind of short-term, and we feel we're doing a good job of addressing whether a certain action and expense is driving long-term value or not. And that's what we think is mostly incorporated in that reduction of -- what do we have for the first half, 61 million, I think.

Thank you. And the second part?

Saul, in the second quarter the impact is not terribly significant. It's about $8 to $10 million again because there were not that would have hit the P&L. In terms of -- so the lion's share of that 43 million is more the cost head side of this particular volume. For the second half of the year, I don't have a number to provide you and it's going to be in large part about assessing what the demand is in the second half of the year. And as you heard Bob say, we have a view on where we think the market is going to go, but clearly we don't know exactly where it's going to go and what happens is going to dictate what the ultimate number is. Now that said, clearly we do have higher inventories than we'd like in terms of unit volume, particularly in North America, so we will have an impact in the second half. And I will tell you that impact is certainly going to be much greater than the 8 million impact that we saw in the second quarter.

Thank you very much, guys.

Thanks Saul.

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

Good morning, guys.

Hi, John.

Most of my questions have been answered but -- or asked, but one question that I have is on revenue per tire being up 9% in North America. How much of that is mix and how much of that is price increases? And actually a second question, you guys have mentioned a capital markets transaction in the past to raise cash, maybe to fund a pension plan. Just wondering where you stand on that?

Okay, John. I'll take the first part of your question. In terms of North America, with that increase; we don't split out price and mix. You can assume that the -- certainly because it's such a big number, the majority of that would be priced. But there is a significant component as well given our new products --

Okay.

-- that contributes to that 9%. Okay.

Okay.

And then, guys, the second question?

Yes. I think relative to a capital markets transaction, I think, John, as we've always said, it's something that obviously has a place as we think about how we want to drive the business forward. But we also said that being in the midst of a union contract and also our purpose of doing that offering would be to impactfully or meaningfully impact our capital structure. And certainly, given where we are today, I don't think that's a transaction that we'd be contemplating immediately.

Okay. So we're clearly at -- after negotiations are hammered out?

I think that's input but certainly there are other factors as well that we'd consider before we would - we'd ever go forward with that.

Thanks a lot, guys.

Yes. Thanks, John.

This morning's final question will come from the line of Neal Shear with Shear Capital.

In my opinion you did a great job this quarter. I think the Street was estimating your earnings to go down, and I think if you adjust it out it's a flat to up quarter. So amazing job. Very happy to be a shareholder.

Well, thanks, Neal.

I guess I'll ask the main question, and since everybody has already asked things, the hurricane season coming up, have we adjusted our plans at all to kind of have contingencies on hand in case there is another series of that are disruptive?

Well, Neal, I'll say that with Katrina and the other hurricanes of last year, I think we were well-prepared for that activity. We've got a great business continuity theme that did an outstanding job last year. And remember, we got hit like everybody in the Beaumont area. We were first up with our plans, I think we fought through the retail protection piece of that pretty well. And I think we've learned from that experience and should do even better. Let's all hope that we don't have to relive that experience in any part of either the southeastern part of the US or the Gulf Coast.

But the business continuity team did an outstanding job last year, and again, learning curves should in a position to doing even be a better job this year or in the future when some other catastrophic could hit this country.

Well, again, I just want to let you know that I am very surprised at the job you did on earnings and imagine it took a ton of work to get the numbers up to this point considering what's happening in raw materials.

Well, we're doing what we need to do, we think, Neal.

Yes. All we need to do is get raw materials up.

If you can help, we'd appreciate it.

I'd love to.

A few other things as well, but raw materials is one of them. You are absolutely right, Neal.

Well, Thank you, Neal.

Great job here.

Thank you. Let me close I think Darren -- because we have run over a bit, by saying that what we recognize we're competing in a very challenging and competitive environment with a lot of uncertainty. But we'll continue to focus on what we can influence to control our own destiny.

We'll continue to drive strategies that allow us to win with our customers and the end user, I mean, not just the dealer but dealer and end user. We will continue to drive down as Rich mentioned our high fixed cost base to our four point cost reduction plan. And we'll remain focused on our cash-is-king approach to advance the progress, frankly, that we've already made on the balance sheet. I want to thank you for your time this morning and for your interest in the Goodyear Company. Good bye now.

Ladies and gentlemen, thank you for joining this morning's Goodyear second quarter 2006 earnings release conference call. You may now disconnect.