Goodyear Tire & Rubber Co (GT) 2006 Q3 法說會逐字稿

Good morning. My name is Tonya, and I will be your conference operator today. At this time I would like to welcome everyone to the Goodyear third-quarter 2006 earnings release conference call. (OPERATOR INSTRUCTIONS). Thank you. I would now like to turn the call over to Mr. Darren Wells. Sir, you may begin your conference.

Thank you, Tonya. Good morning, everyone, and thank you for joining us for Goodyear's third-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 have not already obtained the presentation, it is available now on our website, investor.goodyear.com. We filed our third-quarter Form 10-Q this morning, and this morning's discussion will be available for replay after 3:00 PM Eastern standard time today by dialing 706-634-4556 or on our website at 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 will turn the discussion over to Bob.

Well, thanks, Darren, and good morning, everyone. We appreciate your interest as always in our Company. Normally I would begin our quarterly calls by highlighting key results for the quarter and progress against our seven key strategic initiatives. This morning I will most certainly cover these areas; however, I want to begin by addressing the current steelworkers strike giving our perspective, our business goals and the actions we are taking.

The tire and rubber industry is and will be very competitive. Our progress over these past few years has been driven by a series of business model changes, revenue initiatives -- for example, our award-winning product portfolio -- solid cost reductions and refinancing actions. Last September in New York we presented our plan to reduce an additional $750 million to $1 billion in costs over three years. This year we stated our plan now exceeds the $1 billion figure. Our four-point cost savings plan included -- first, continuous improvement with estimated savings of $350 million to more than $450 million; second, footprint reduction with estimated savings of $100 million to more than $150 million; third, Asian sourcing with savings estimated in the range of $150 million to $200 million, and fourth, selling, administrative and general savings in the $150 million to more than $200 million range.

In June we announced that in North America we were exiting the wholesale private-label business. This change in our go-to-market model clearly generated a need to reduce North American capacity. I would emphasize to you that we remain fully committed to these strategies and to our goals. Therefore, we intend to deliver outstanding value to our customers. We intend to be competitive on all areas of our business and competitively advantaged to the number of key areas such as high impact and new product capability. We intend to continue making the right decisions for the future of this Company. Reducing our cost structure is imperative to making our intentions a reality, and we intend to make them a reality.

Our resolve to come out of the negotiations with the steelworkers with a globally competitive position cannot be compromised, and it won't be compromised. At Goodyear our customers' needs are the catalysts for our strategies. To ensure that we are meeting their needs, we have recently taken a set of actions that we defined in our contingency plans in anticipation of possible strike event, and I want to just enumerate these actions.

First, we are going to continue supplying tires and Engineered Products with salaried associates and temporary workers staffing our union facilities and they are now ramping up. We're going to run our nine union plants full, and we will import tires from our global network of plants. Second, ongoing communication with our key customers on product supply is a daily event, and we will be matching those product supply discussions, of course, with their demand requirements. Third, as you have seen, we have draw down our revolver to ensure a solid cash position for the Company and for North America. Fourth, direct communication with the steelworker associates on our current offer will be accelerated.

The direct communication with our associates is a significant step. It is driven in large part by an overwhelming number of requests by our union people to see details of the most recent proposal that we put on the negotiating table with their leadership. As a result, our current offer will be available on our website at www.goodyearnegotiations.com later today.

It includes our proposals on productivity, benefits and job security. We have specifically included all of the details of the offer so that its contents are crystal clear.

We felt it was important for everyone to understand what is on the table as the lives of Goodyear's people are being impacted daily. We appreciate the contributions of our steelworker represented associates and the role that they have played in helping Goodyear in improving its business these past few years. Our goal quite simply remains one of getting a contract that is fair to Goodyear and fair to our workers and keeps our business competitive. We hear from many of them about the hardships that they are facing and their confusion around what is on the table today. We believe it is only fair that they have all the facts in front of them to guide their future decisions. Rich will comment in a few minutes on the financial impact of the strike, and clearly the strike is a cash positive event for Goodyear initially. However, we have incurred approximately $30 million to $35 million a week in lost operating income.

It is not our intention to take this proposal and break it down financially for your models. We will certainly do that when we get a ratified agreement and the contents of a proposal become a contract. While I am disappointed in where we are currently, we will work to negotiate a contract that positions Goodyear competitively against our future business realities. We remain ready and willing to return to the bargaining table to accomplish this objective and to get our associates back to work.

I will now transition to comments on the third quarter and update you on the progress we continue to make on our key strategies. I will then turn the call, as we usually do, over to Rich for a more detailed review of our results, and then I will come back and make some remarks about our outlook for the remainder of 2006.

Despite record raw material costs and a weak North American market that is off a full 5% year-to-date in consumer replacements, we demonstrated in the third quarter the strength of our business model changes and our successful product portfolio. We achieved third-quarter sales of $5.3 billion, a record for any quarter and earnings, excluding restructuring costs -- and I will say that again, earnings excluding restructuring costs -- of $78 million or $0.44 per share. Segment operating income was off 5% year-over-year in the quarter.

We announced another key action in our efforts to reduce our high-cost higher manufacturing capacity with the plant closing of the plant in Tyler, Texas. This decision, tied very directly to our previously announced exit from certain segments of the wholesale private-label tire business in North America, reduces our high-cost capacity by 9 million units and creates an estimated $50 million in annual savings. When we combined that decision with the second-quarter announcements of plant closures in the UK and New Zealand, we will have cumulatively reduced our high-cost capacity by 14 million units compared with a 2008 target which we have set with you last September of 15 to 20 million units, and we set that up as part of our four-point cost savings plan.

I will mention highlights for the quarter. They include the all-time record sales of $5.3 billion per quarter, which represented a 6% increase over third-quarter 2005 when you adjust for businesses we have divested in the second half of last year. Our global revenue per tire increased 8% despite tough margin conditions throughout much of the world. Our strategy of targeting higher value market segments -- by the way, the profitable segments -- offset 4% lower volume, and much of that volume decrease was anticipated as part of our previously announced strategic exit of certain segments of the private-label business in North America. All five of our tire businesses achieved record sales, and three of those businesses also had record segment operating income.

Continued high demand for our Signature branded products in North America resulted in market share gains in key targeted and profitable consumer segments. After a challenging first half, our European Union business achieved year-over-year improvements in sales, units and segment operating income and grew market share. That represents a significant momentum shift for the EU.

Another significant item to note here is that it has snowed already in both Western Europe and Eastern Europe, and that is big news in our business, good news for our profitable winter tire business, and we expect a strong winter tire sales season in both Eastern and Western Europe.

In total, our international tire businesses once again performed very well, increasing sales by 10% and growing segment operating income as well. Raw materials reached what we anticipate is a peak rate of increase in the third quarter, up almost 17% compared to last year. And if we translate that into dollar terms, that is about $250 million. We were successful in offsetting $225 million of that increase with price and mix. In our judgment, a very good performance given tough market conditions.

I want to identify an ongoing challenge and how our strategies respond to that challenge. The tougher than expected industry environment in the first half, particularly in North America, continued in the third quarter. As I said earlier, year-to-date the North American consumer replacement industry is off 5%. As we shared with you last quarter, in only four years of the last 50 has the consumer market declined more than 3%.

You will recall from our second-quarter call I referenced that as it shows people appear to be driving less and waiting longer to replace tires. We are seeing a similar trend in the third quarter with miles driven per vehicle, likely down compared to both the third quarter of 2005 and the second quarter of this year. And I will make some comments in the outlook section of my presentation here this morning about how we see this going forward. Things will improve we feel slightly.

Now let me talk about how we are dealing with our challenges in the near-term. As always, with an intense focus on our seven strategic initiatives. In a few minutes, Rich will elaborate on our Cash as King strategy as part of his comments, but I would like to focus first on product leadership because of the important role that world-class products are playing in our market gains, and then I will comment on our four-part cost reduction strategy.

Last quarter I told you about the introduction of our Eagle ResponsEdge with carbon fiber high-performance tire in North America. Last week we were honored when this tire was recognized by Popular Mechanics magazine at the SEMA Show with an Editor's Choice Award for outstanding design and innovation. Of the 17 awards that Popular Mechanics extended at the show, Goodyear's Eagle ResponsEdge was the only tire to be honored, the only tire.

In addition, it was announced in New York City on Monday that the Eagle ResponsEdge with carbon fiber earned the prestigious Best of What's New Award from Popular Science in the automotive technology category. This honor singles out our newest offering in North America as, and I quote, "100 Most Innovative Products of the Year" and we made that list. And the list was compiled from literally thousands of products reviewed. Again, this was the only tire honored, and you can find the results in the December issue now on newsstands.

Finally, on the product award front in North America, while I cannot mention the name of this highly respected independent consumer publication, our Dunlop SP Sport 5000 was named the top choice in test results of performance all-season tires, and our Goodyear UltraGrip, a winter tire, was named the top performance winter tire in the November issue. And again, you can certainly find it on your newsstand.

These and other awards are ongoing proof that our strategic focus on innovative new products is paying off. Customers are responding with their purchase decisions, and we have improved both our mix and our revenue per tire in each of the first three quarters of 2006 by executing very intensively on our market-backed product-led strategy.

We also continued to launch new products in our international businesses in the third quarter, extending our popular Excellence line into more of Asia and Latin America and launching several new commercial truck tires in Europe and Latin America. I can assure you here that more exciting new products are on their way for 2007.

I would like to now provide a quick update on our four-point cost-saving strategy before Rich takes you through a more detailed look at the businesses.

We are aggressively focusing on achieving our updated target of more than $1 billion in cost savings by 2008 and have made considerable progress to date, and I want to share with you some of the progress that we have made.

First reducing footprint. As I mentioned earlier, we're targeting high-cost higher capacity reductions of 15 to 20 million units with estimated savings of $100 million to more than $150 million. The three plant closures -- Tyler, Texas, Washington in the UK and New Hutt, Zealand announced to date represent about 14 million units of high-cost capacity and when complete will result in combined savings of about $85 million annually.

Second, SAG savings. So far this year, our SAG costs are nearly $100 billion lower than they were last year. We continue to make significant progress on reducing SAG costs globally. SAG, as a percent of sales, has declined to 13.4% year-to-date in 2006 and is down more than a full point versus last year. Our leadership team is very focused on increasing our SAG spend efficiency and implementing structural change.

Third, Asian sourcing. We continue to make significant progress in our Asian sourcing initiative. We are sourcing raw materials, capital equipment and low value-added tires from China. As we said on the second-quarter conference call, this year we will source more than $200 million from China, but expect this number to grow to over $500 million next year. We are targeting savings of between $150 and $200 million by 2008 from this initiative.

Fourth, continuous improvement. In the area of continuous improvement, and you can read this area as overall productivity including Six Sigma, lean manufacturing. In that area we are making progress on initiatives like using alternative materials to counter the impact of high natural rubber prices and accelerating our investment in our results from Six Sigma and lean process improvement. Frankly, we have made a considerable amount of progress in this area, but recognize that we have more work to do.

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

That concludes my comments on our financial results and progress on our strategies, and I will come back at the end of the meeting to share our perspective on the outlook for the remainder of the year, and of course, we will answer your questions.

Now I want to turn the call over to Rich for a more detailed look at the operating results for the quarter.

Thanks, Bob, and good morning, everybody. Bob took you through the quarter highlights which I will elaborate upon, but let me reiterate upfront that our third-quarter performance from a strategic perspective and from our financial results demonstrates the underlying momentum in our business. Strong operating income in a tough global market, foreign businesses with significant earnings growth and execution against cost reduction programs which we previously articulated are further examples of our Company striving and succeeding in hitting its targets.

Our North American Tire business remains a work-in-progress, but like other parts of our business where we delivered on our objectives, our intention is to do the same with this business and we're committed to it.

Now before reviewing third-quarter results in more detail, I want to first comment upon the financial impacts of the strike. Now the strike impacts three areas in particular -- our customers, our liquidity and our earnings -- and I will comment on each.

First and foremost, our customers. Our North American production compared to pre-strike levels is at nearly 50% in aggregate. Today our nonrepresented plants are producing the bulk of our tires. To supplement this, we have already hired and are continuing to hire temporary workers who will be fully trained to produce products we are proud to sell. While I'm not going to quote numbers here, production from our striking plants continues to increase daily. In addition to increasing production in striking plants, we have both increased and redirected production from our global manufacturing footprint to supplement the supply of product to customers. We will continue to take actions to increase supply, such as further increasing imports from Goodyear factories worldwide. There are advantages to being a global corporation, and being able to redirect production is one of these advantages that we fully intend to utilize.

The second area, which is second only to customers, is cash. Remember one of Bob Keegan's seven strategies is Cash as King. While always relevant to Goodyear, Cash as King takes on new meaning during a strike. As you are aware, the company drew down nearly $1 billion of our existing credit facility in October to ensure we have adequate liquidity in the event of a prolonged strike. At the end of the third quarter, we had approximately $1.3 billion in cash and approximately $1.6 billion in available credit lines.

Subsequent to the drawdown, our cash position is approximately $2.3 billion and is expected to be higher by year-end. In addition to this action, our focus will remain on cash generation and preservation throughout the strike. As you can surmise, we anticipate our cash position to increase as the initial impacts of the strike are cash flow positive since decreasing inventories in Accounts Receivable levels will more than offset decreasing payables.

If the strike were to continue for an extended period of time, certainly our cash flow would be negatively impacted, and there is the potential for lower inventory and receivables to trigger some level of repayments under our credit facility.

Now subsequent to drawing upon our existing credit lines, both of the leading credit rating agencies, S&P and Moody's, took actions to highlight the uncertainty that the strike creates for our cash flow. We would expect these agencies to revise their actions should the strike be settled in the near-term.

Finally, relative to the impact on earnings, the financial impact of the strike is highly dependent on the duration. Since we cannot predict the duration of the work stoppage, we are unable to provide guidance on the total impact to our results. During the initial weeks of the strike, we estimate the negative impacts on our operating income to be approximately $30 to $35 million per week. This impact reflects primarily unabsorbed overhead resulting from idle capacity in our North American Tire and engineered products businesses. This impact will be reduced as production increases. And from a reporting perspective, please be aware that the negative earnings impact from the strike will be reflected in earnings in the period they occur.

So this should provide you with some insight into the impact the strike has on our Company. To address this, a world-class business continuity planning process is in full force to mitigate the negative implications and most importantly to serve our customers.

Now I will discuss our third-quarter results in a bit more detail. While our third-quarter results were weaker overall compared to last year, the weakness was primarily centered in North America where weak market conditions continued to challenge our business. Outside of North America, each of our business units matched or beat last year's operating income, despite challenging market conditions and significantly higher raw materials.

Looking first at the third-quarter income statement, as Bob indicated, sales increased 5% to an all-time record of $5.3 billion. Sales increased 6% year-over-year when adjusted for businesses we divested in the second half of 2005. The sales growth was achieved despite weak industry volumes in North America and tough competitive environments in several of our key international markets.

Now the sales increase was achieved despite a 4% drop in tire units sold compared to last year. In North America unit volume dropped nearly 12%. The decrease was a result of the continued weak industry demand I just mentioned and our strategic decision to exit the wholesale private-label business. Of the 4% total volume reduction in the quarter, over two-thirds was due to the private-label decision -- the private-label business in North America.

Now despite the weak industry, demand continues to be strong for our Signature Goodyear products. Excluding North America, volume increased nearly 2% in the third quarter. Both EU and Eastern Europe, along with Latin America, posted volume gains in the quarter behind strong consumer demand, while Asian volume declined, primarily due to strong pricing discipline and our strategy to drive a richer mix. Our revenue per tire increased 8% compared to last year, driven by a combination of price increases in the face of higher raw materials cost and improvements in mix that came from our focus on growing our high-end branded product sales. Our strategy of targeting higher value segments of the market helped us again this quarter to mitigate the impact of overall lower sales units.

Our gross margin for the quarter was 18.1%, which included approximately $7 million of accelerated depreciation charges primarily related to the announced closure of our New Zealand plant, as well as the positive impact of a supplier settlement for approximately $10 million. This compares to gross margin of 20.3% in the third quarter of 2005. The reduction in gross margin versus 2005 reflects the impact of higher raw material cost that were not fully offset with price and mix and higher manufacturing costs due primarily to volume reductions in our North American business.

Raw materials costs increased nearly $250 million or 17% in the third quarter. This increase remains reflective of our key raw materials being at or near record highs. During the quarter, price mix increased by approximately $225 million, offsetting all but approximately $25 million of the raw material increase, again reflecting our ability to price and mix up with our key products globally.

Segment operating income for the third quarter was down approximately 5% or $17 million when compared to 2005, which included $8 million from divested businesses. North American Tire alone was $39 billion below last year, again including $8 million from the divested businesses. Meanwhile, our other business units combined grew segment operating income by $22 million in the quarter, which included a $10 million benefit of a supplier settlement. In a few moments, I will review each of the business unit's results in more detail.

The results for the quarter also include after-tax restructuring charges of $126 million or $0.71 per share, of which $107 million was related to the plant closure of our production facility in Tyler, Texas. This closure, which was announced on October 30, was recorded as part of our third-quarter results since the closure decision related to our June announcement to exit the wholesale private-label business in North America. Total annualized savings from the third-quarter restructuring actions are estimated to be $70 million, of which the Tyler closure represents approximately $50 million. We reported a net loss of $48 million or $0.27 per share in the third quarter. This number includes the restructuring expense I just mentioned, accelerated depreciation charges of $7 million or $0.04 per share, and the benefit of supplier settlement for $10 million or $0.06 per share.

Now turning to our cash flow through the first nine months of the year, total cash flow was nearly $600 million below last year, primarily due to operating activities. Keep in mind three significant items here.

First, we had higher pension contributions of $100 million. Second, the prior year reflected some significant insurance recoveries of nearly $200 million that were non-recurring. And third, we had the purchase of our remaining interest in South Pacific tires of nearly $100 million this year compared with proceeds from asset sales in the prior year. The remaining reduction is explained by higher inventories and lower income. Cash used for working capital purposes was approximately $100 million higher year-to-date than last year, primarily driven by inventory. Accounts Receivable levels increased driven by record sales, but were more than offset by higher Accounts Payable which reflected higher raw materials costs and improved payment terms from our suppliers.

Prior to the beginning of the strike, inventories increased nearly $200 million compared to last year, primarily in North America. Working capital levels are expected to return to normal levels by year-end. During the first nine months of the year, capital expenditures were up approximately $65 million from the year ago period as we continued to invest to increase our capability to supply the growing demand for higher value-added tires.

Now taking a look at our balance sheet, our cash position decreased by approximately $250 million compared to the second quarter. Accounts Receivable increased by $370 million in the quarter, driven by record sales primarily related to winter tire sales in Europe. Increased receivables were partially offset by lower inventory of approximately $70 million and higher Accounts Payable of approximately $30 million.

Now I want to take a minute to update you on Legacy costs and liabilities. As we have done in the past, on slide 13 we provide our expectations for 2006 pension and postretirement expense and pension funding. In addition, we are providing our estimate of the unfunded pension amount at year-end 2006. As we indicated in our second-quarter call, we expect it to be about $2.2 billion compared with $3 billion at the end of 2005. This reflects the contributions we are estimating for this year, which is based upon the new pension legislation enacted in the third quarter.

Our unfunded position will improve substantially this year. This will result in reduced pension expense in 2007 of $50 to $60 million, most of which will benefit our North American Tire operations. With pension legislation that was passed, funding levels will be toward the low-end of our guidance for 2006. Pension funding in 2007 will be slightly higher than 2006, which will result in an additional reduction in both the unfunded position and pension expense as we look into the future. We expect funding levels in 2008 to be only $200 to $250 million.

Now in addition to the improvement in our unfunded pension, we have been discussing with United Steelworkers potential approaches to retiree health care. As part of Goodyear's proposal to the USW, we have proposed setting up a trust fund or a VEBA to fund retiree health care going forward. The USW benefits represent a substantial portion of Goodyear's total postretirement projected benefit obligation.

The proposed trust would eliminate Goodyear's obligation related to the USW work force while providing secured funding to protect benefits for USW members. We won't get into the specific details on how the $660 million contribution would be made at this point but would provide more details once an agreement is reached. We believe this proposal works well for both Goodyear by reducing Legacy costs and obligations and for the USW by ensuring a strong level of benefits into the future for their members.

All other parts in any agreement would need to be evaluated in the context of the entire agreement rather than in isolation. Goodyear will only accept an agreement that helps us to continue to drive our key strategies. I would like to emphasize that the VEBA and all other elements of the proposal are at the proposal stage, and nothing is final until we reach a comprehensive agreement with the USW.

Now we will discuss each of our business segment results for the third quarter. Starting with North America, the third quarter was a continuation of trends we saw for the first six months. The first is record or near record high raw material costs hitting our P&L. Now the recent decrease in certain commodity prices will not impact our operating results until at least the first quarter of 2007 given the lag time between when raw material is purchased and when it is recorded as cost of goods sold.

The second trend is weak consumer demand. The key consumer replacement market declined 3.5% in the quarter, bringing the year-to-date total to a decline of 5%, down only slightly from the 6.6% market decline as of June 30. As you may recall, I have noted that only four times in the past 50 years had the market experienced an annual decline of 3% or more. The decrease in gas prices at the pump have seemingly returned some demand in the quarter, but not at a pace sufficient to significantly change the weak replacement demand we have been seeing this year. For Goodyear, of course, our decision to accept the wholesale private-label business has amplified the negative volume impacts on our business as private-label sales units declined more than 1.6 million units in the quarter.

And finally, the third trend was the ongoing competitive pricing environment where the volume versus price equation remains increasingly relevant in the weak demand market.

Now offsetting these challenging elements continued to be the strong demand for our branded products, particularly our Signature Goodyear products. Despite the weak volumes in the quarter, sales increased 3% compared to the third quarter last year, posting a record for sales in any quarter at over 2.4 billion. Excluding the businesses we divested in 2005, sales increased over 5% in the quarter. Operating income decreased $39 million in the quarter and was primarily driven by the following items. $70 million was related to lower volume, of which $20 million was related to a 12% reduction in units driven by weak consumer replacement markets and our decision to exit the wholesale private-label sector of the market. The remaining $50 million relates primarily to unabsorbed overhead costs at our factories due to lower production volume. While $5 million of the decrease was related to unrecovered raw material costs, it should be noted that revenue per tire was up 9% in the quarter as price mix increased nearly $105 million.

Now this significant increase nearly offset our raw material increases of approximately $110 million in the quarter. Now offsetting these headwinds of reduced volume and raw material increases was a $20 million reduction in selling, general and administrative expenses resulting from executing against our cost reduction initiatives. More than half of this decrease resulted from structural changes implemented in the business this year with the remainder of the decrease coming from lower discretionary spend.

And finally, the strong performance of our off-highway and chemical businesses, supplemented by the impact of divested businesses, accounts for the remaining difference in third-quarter operating income. Although our third-quarter earnings were down versus '05, the reduction was largely driven by unfavorable market conditions and strategic decisions related to our business model. Our core cost reduction and market growth strategies remained intact during the quarter.

Turning now to our European business, the third quarter represented a reversal in trends from the first two quarters of 2006 as we saw year-over-year improvements in units, sales and operating income for the first time in 2006. Sales for the quarter increased 12% to a record for any quarter, which included a favorable impact from foreign currency translation of approximately $60 million. Our sales volume in the quarter increased over 2%, driven by a 6% increase in consumer replacement sales volume where we increased our share of market during the quarter. The increase in volume was largely driven by the sale of winter tires.

Due to changes in German legislation promoting the use of winter tires, the industry increased significantly as we expected. While winter tire industry sales increased by more than 8%, our volume increased significantly more than the market, particularly in the high-performance segment of the winter tire market.

EU's operating income was a third-quarter record, increasing slightly by $1 million compared to last year. While competitive pricing pressure and inflationary cost increases from raw materials and energy costs continued to negatively impact our results, higher production volume and cost reductions in both manufacturing and SG&A somewhat mitigated their impact. And while we noted the improvements versus the first two quarters of 2006, competitive pricing pressure resulted in a continuing inability to offset raw materials cost increases through improved price and mix. As we continue to face this headwind, our focus consequently remains on cost reduction programs.

As an example, through the first half of the year, we faced year-over-year headwinds from our conversion costs of over $30 million. In the third quarter, we were able to reverse this trend with conversion costs coming in below last year. Our team in Europe has done an excellent job in reducing operating costs through structural changes, like closing our Washington UK manufacturing plant earlier this year, and also by driving increased productivity.

We also continued to make significant progress in reducing our SG&A expense in the third quarter. We initiated two new restructuring plans in the region in streamlining our SG&A organizations in Germany and Iberia. Through the first half of the year, we had reduced SG&A spending by $30 million. In the third quarter alone, we nearly matched that total. We are making significant progress by reducing structural costs through backoffice consolidation, productivity improvements and watching our discretionary spend very closely.

Turning to our Eastern European business unit, the region achieved all-time record sales and earnings in the third quarter. Sales increased 9%, had strong price and mix improvements of approximately $40 million, along with a nearly 4% volume increase, pushed sales higher. The volume growth in the quarter was driven by consumer demand for winter tires, particularly in central Europe. Segment operating income was $77 million, which was a 20% increase over last year. Significant price mix gains in the quarter more than offset the impact of higher raw material costs, representing the first time this year that price and mix gains exceeded the negative impact of higher raw material costs in the region. Price increases implemented throughout the past year, along with mix improvements to our 4x4 and winter tires, lifted revenue per tire by 8% compared to the third quarter last year. Lower SG&A spending in the quarter offset conversion cost inflation and unfavorable foreign currency movements.

Our business in Latin America posted strong sales growth of nearly 10% compared to the third quarter of 2005. Sales volume increased over 6% in the quarter, driven by strong OE demand. Segment operating income for the region was $77 million in the quarter, matching last year's results. The strong sales in the quarter, along with the benefit of foreign currency translation, modest price mix improvements and good cost controls, helped to offset significantly higher raw material costs. Our business remained strong in the quarter despite generally weak economic conditions in the region.

In the Asia-Pacific region, sales increased 7% compared to 2005, posting a record sales in any quarter, despite a 6% decrease in tire units as we focused on a richer product and customer mix. Strong price and mix drove a 17% increase in revenue per tire compared to last year, more than offsetting the impact of lower volume. Operating income was also a record for any quarter, increasing 17% or $4 million compared to last year as improvements in price and mix more than offset lower volume and higher raw material costs. We continued to see strong topline growth in China and India throughout the quarter, which was masked by some continued weakness in other parts of the region.

Our Engineered Products business posted lower sales in the quarter compared to last year due to the anticipated reduction in military sales. The lower military sales were partially offset by strong growth in our industrial business. Engineered Products' operating income increased $4 million in the quarter; however, this included a $10 million improvement from a supplier settlement. Adjusted for this settlement, the lower profit in the quarter was driven by a decrease in sales volume. The lower sales volume resulted from weak orders in North America in the back half of the quarter. Now this weakness appears simply to be a timing issue as demand for our products has been strong to start the fourth quarter.

Although most of our comments concerning the strike have focused on our tire business, let me say the Engineered Products business is also managing through the strike. As with our tire business, the Engineered Products organization has focused on meeting customer expectations by continuing to provide the best products and services in the industry.

Now earlier Bob reviewed the progress we have made against our four-point cost savings plan. I would like to highlight a couple of points regarding our progress on our structural costs. We have made significant changes to benefit plans in both the UK and Brazil this year, resulting in annualized savings of about $7 million. These changes provide our associates with benefits equal to or better than the market and are helping Goodyear remain competitive, especially when competing against low-cost Asian competitors. This will continue to be an area we will focus on improving as we move forward.

We also reduced our headcount by over 3500 people in 2006 through both attrition, restructuring and asset sales. And excluding the unfavorable impact to volume, we have offset the impact of wage increases, energy increases and general inflationary costs in our factories. Our productivity initiatives, while admittedly not yet falling to the bottom line, are offsetting record conversion cost headwinds.

Now we have done all this while growing sales, introducing new products, winning product awards and getting ready to introduce more new products in 2007. We understand our road is not an easy one, but we have witnessed the positive results of having all Goodyear associates focused on common goals. This will enable us to win in what is the relentless global tire industry.

Now I will turn the call back to Bob.

Well, thanks, Rich. Before we open the call to questions, I want to just take a couple of moments here to discuss our outlook for the balance of the year.

While the third-quarter market conditions improved compared to the first half of the year, we must say they remain volatile. We are continuing to keep a close watch on key economic indicators and staying in intimate contact with our dealers so that we have better visibility of market trends. Overall -- and I think my next two points will be key points -- overall we expect market conditions to continue to improve in North America through the end of the year as pent-up demand from delayed consumer purchases is released. So our thesis here is pent-up demand being released. This expectation is based in large part on the recent decline in gas prices in North America.

In Europe, point number two, we expect the strong winter tires sales to continue through the fourth quarter, driven both by the aforementioned German legislation changes which Rich mentioned and this year's early snowfall in both Western and Eastern Europe, which as you know is critical for us.

Taking a more detailed look at our expectations, in the fourth quarter in North America, we expect the consumer OE market to be down approximately 10% as the OEs cut back on production and the commercial OE market to be up approximately 6%. The consumer replacement market in North America is expected to be down approximately 2%, less than it has been thus far this year, while the commercial replacement market is forecasted to be down approximately 4%.

In Europe, for the fourth quarter, we expect the consumer OE market to be flat to up 1 and the commercial OE market to be up 5 to 7%. The consumer replacement market in Europe is expected to be up 1 to 2%, while the commercial replacement market is forecasted to also be up 1 to 2%.

For raw materials we continue to see as you do quite a bit of uncertainty in the market as we look forward to 2007. Following year-over-year increases of 14% in the first quarter and 16% in the second, 17% in the third quarter, we expect the impact of raw materials on our financial results peaked in the third quarter, and the full-year impact will be an increase of 15 to 16%, which is the same projection we provided last quarter.

We are also reaffirming our interest expense estimate for the year of between $425 and $450 million with more emphasis on the high end of the estimate due to our revolver draw. While we have not changed our earlier estimate of capital expenditures, that being approximately $720 million, this number may be lowered based on actions we take related to the strike here in North America.

We continue to see segment operating income from our businesses outside North America in aggregate improving for the full year. While, as Rich mentioned, the North American Tire and Engineered Products segments' operating income are expected to be down compared with 2005 with the steelworkers strike having a significant impact on fourth-quarter earnings for both those businesses.

That concludes our formal remarks, and Darren, I think with that, we will open up the discussion to address your questions.

Okay. We will extend slightly the Q&A session this morning, but I would ask that everyone please keep it to one question. Operator?

(OPERATOR INSTRUCTIONS). Saul Ludwig, KeyBanc.

Thanks for the more detailed information. The question concerns cash. If there were not a strike, Goodyear typically generates around $400 million of cash in the fourth quarter, and then you consume about that much in the first quarter. That would be sort of the normal run-rate.

Let's assume the strike sort of goes until the end of the year just for hypothetically speaking. How would that change that cash generation in the fourth quarter and cash consumption in the first quarter?

Well, I think we will have Darren respond to that. Maybe Rich and I can then elaborate.

Yes, I think what we will see going into the fourth quarter is, as you would expect, our working capital is dropping, not only for seasonal reasons but also related to the strike.

As we use up inventories, our lower receivable balance this year is the tire selling season slows down in the fourth quarter. You quite rightly pointed out that during the first part of the year we would expect not only would our receivables grow as sales grow seasonally, but we would also start to ramp our inventories back up as our production increases, as our ability to produce increases, and as we would normally ramp up production for seasonal needs.

So I think that the seasonal pattern would remain the same. Obviously a lot of dependencies here are based on how quickly we ramp up production, how much sourcing we can do from overseas, and obviously those also impact the borrowing base facility, the amount of cash we have available under the revolver.

Would the $400 million that you generate in the fourth quarter be increased because of the strike and the $400 million that you consume in the first quarter be accentuated to a greater amount again as the strike were settled and you would be in a rebuilding process?

I think so. Without quantifying the deltas here, you can assume that we have built more cash in the fourth quarter and we would use more cash perhaps in the first quarter.

Himanshu Patel, JPMorgan.

If you were to straight line raw materials cost from where they are today, do you have a sort of ballpark estimate on what your P&L raw materials impact would be for '07?

I think Bob made the comment in his last remarks that as we look into '07, we certainly see some uncertainty in terms of where raw materials prices go. I think, though, if you look at how things are playing out, we kind of hit a high-water mark here in the third quarter of our raw materials. We would expect them to come down a little bit in the fourth quarter, and given that we purchased raw materials over the course of the past months at lower prices, we would expect that to be lower in the first quarter again. So I think we can tell you directionally we would expect to see some benefits into '07, but we have not quantified that.

Okay. And then second quick question, you mentioned some white-collar benefit changes, or I am not sure maybe it is blue-collar as well, in Europe. Are there a whole lot of white-collar benefit change opportunities in the North American business that you may or may not have done so far?

Well, we have made some changes, and I will simply say here on the call this morning that we are continually looking at all possibilities. Obviously we want to have programs that are fair and competitive, and we are also looking at opportunities to reduce our cash spend.

So we are looking at those. But we have made some changes. We have changed for recent hires I think from January 2005. We have changed our pension plan from a defined benefit to a defined contribution plan, and there have been other changes in terms of increasing co-pays, etc. But we are continually looking at that space for other opportunities.

Okay. Maybe I could sneak in one last one. Bob, the $15 to $20 million capacity reduction target, you know you are already obviously bumping up to the low end of that. It sounds like even if to get to the high end of that, all you need is maybe one sort of medium-sized plant or so. I'm just wondering how do you view this number now now that your sort of three-quarters of the way through getting it? Is it sort of a conservative estimate, or do you still feel pretty comfortable that when all is said and done, it will end up being about 15 to 20 million units lower capacity?

Well, maybe I could broaden the question, and then we will get more specific. But let me broaden its first. When we talked to all of you in New York last September and we mentioned that over three years we have reduced our cost structure by $750 million to $1 billion and then we came back earlier this year and we said, gee, given market realities and the capability that we think we see in our Company, we are going to increase that number and did not give you specifics but certainly in excess of $1 billion. I think that is point number one, and that is the context for what we're doing in terms of capacity.

I would certainly say at this point we are continually pushing the envelope in terms of our costs. Why? Because that is what we do. And also because the market is pushing the envelope for us in terms of what we must do. So I would say at this point we feel confident of the numbers we have, and we're looking to push the envelope above those numbers. Rich, you might have another comment, but that is -- (multiple speakers)

No, I think -- the only thing I would add is that that number was a global number, and as we have said in the past, there is high-cost capacity remaining in other parts of the world. Our aggression in addressing those certainly isn't diminished as we look to the future.

I think just to elaborate on Rich's point, you can see that from the plant in the UK and the plant in New Zealand. It might not have been at the top of people's lists as they have looked at us. Well, we are taking the opportunities as they become available to us.

Rod Lache, Deutsche Bank.

This is [Amit Maratra] for Rod Lache. I just wanted to know can you guys talk about what the impact will be from a decline in Class 8 truck production next year?

You mean specifically relative to the new EPA (multiple speakers) environment?

Right. I guess people are expecting between a 30 to 40% decline in Class 8 truck production in 2007.

We have not given specific numbers on that. We certainly, as we said, we will see a decline. We expect that decline to be limited to 2007, and I think that is a key point as you build your models. We expect that to be limited to 2007, and the percentages you state are probably order of magnitude reasonable. Rich, has a comment here.

I would just said add one thing because we certainly get that question often and the industry decline is coming and it will have an impact on us. But I would also say strategically in the past you have heard us talk about why aligning ourselves with the fleets is so important because as the OE side declines, the pipeline based on this service and the value proposition we have put out to all the fleets out there, I think we have a business model there that allows us to direct more of our product into the replacement market, as well as having suffering some of the losses in the OE business. So that pull-through and that value proposition we have put out there, I think is going to help us particularly during this downturn.

Okay. And can you just comment on sort of the pricing environment in Latin America? I think margins in the third quarter are lower I guess if you look back, at least the lowest it has been in 2006 and some in 2005 except for the fourth quarter. Is pricing getting a little more competitive there, or is it mostly raw materials?

I think what we see in Latin America is not just limited to the price. I think again let's broaden our thought to what is happening with currencies and what is happening with pricing. From a currency standpoint, probably you like us did not predict what was going to happen in terms of revaluations in Latin America. And with re-evaluations comes a more difficult pricing environment per se. But people are doing quite well like we're doing quite well in Latin America. But the revaluations there are certainly acting as a bit of depressant on price per se on Latin America. That obviously will play out differently here over time.

And just finally quickly, the sale of the tire fabric business that you guys announced in September, you said that the savings for that next year would be significant. Is there anymore color you can offer in terms of the magnitude of the savings we can expect next year from the sale of that business?

I think we want to clarify here because we may have a misconception. Darren, would you just comment?

Well, first of all, we announced the sale of our fabric business, which we said at the time we had intended to close by the end of this year. I think that we are still working our way through regulatory approvals and so forth, so that sale has not closed yet.

We would expect savings from the sale, and part of that is the fact that we believe we will be able to under our supply agreement purchase fabric for less than we were able to produce it for. So we will generate some savings there. We have not quantified that savings at this point.

Okay. I just wanted to ask one last question. With the contract proposals, the $660 million contribution to the VEBA, is that new? Because I know in a solidarity alert previously the union has alluded to sort of trust fund and have spoken to that. So is the concept new, or is that $660 million new in terms of a contribution?

This is part of the ongoing discussion and dialogue that we have with the steelworkers at this point. So the concept is not new in our discussions, and the amount of money is just represented by our current proposal.

John Murphy, Merrill Lynch.

It is actually [Jim Leeds] as John is traveling today. (multiple speakers). I wanted to ask a little bit more about the VEBA contribution, trying to gain some comfort regarding whether that is really enough to fund the obligation or it is really a starting point in negotiations. I know in the earnings release you say that the contribution would eliminate the portion of Goodyear's postretirement healthcare obligations related to the steelworkers, and I think my gut tells me the right way to look at that would be the cash cost as opposed to the footnote under-funded portion of it.

Now I understand that in the benefits that you pay on an annual basis, there is also non-union employees, healthcare and salaried healthcare in there. The thing that might help us get a little better understanding regarding the 660 and how that plays into the funding of the healthcare obligations would be a little bit about the demographics of the steelworker workforce. I don't know if there is anything available regarding maybe retirees to actives, or if you could describe or characterize for us maybe the age of the actives, is it skewed closer to retirement age or have you been hiring workers that are maybe just a little bit younger. That may be helpful. I don't know if there's anything you can add there but.

Jim, let me just kick off here, and then Darren may have some comments as our expert in this area. Remember, we have a proposal. As I said early on, we are trying our best not to lead you to take that proposal and to incorporate it into all your financial models. I will say that from a demographic standpoint, obviously we have a workforce where the average age is in the mid-40s. So if that helps, I don't know if there's anything else you would like. Because we clearly feel with the concept, we have a win-win here in terms of both the benefits stream going to our associates and an attractive situation for our Company.

Yes, let me preface this by saying that we would expect that once we do have a ratified contract that we would come back and provide quite a bit more detail on the contract, including quite a bit more detail on the VEBA and the way this healthcare obligation breaks down. And we are not providing that sort of detail today. But I think you've gotten some of the right takeaways there, one of which is that our proposal would eliminate Goodyear's obligation while providing secured funding to protect the benefits from the point of view of the steelworkers. We believe that what we proposed would work well for both Goodyear by eliminating that obligation and reducing our Legacy costs, but would also work well for the steelworkers by ensuring a strong level of benefits into the future. So we're proposing something that will provide a strong level of benefits for both the current active and current retirees going forward.

Okay. And I reading that right, though, that in saying eliminating the postretirement healthcare obligations, that is more on the cash flow side?

Well, I think you can look at it both ways.

[Bill Shear], [Shear Capital].

It is Neil. Real quick, guys. I have an opening comment. As an investor, I want to congratulate everybody for a good job during the third quarter. I also want to tell you that you've have got my support to do what is needed with the workforce to make the company competitive. Because I have seen enough industry leaving North America; I want to see tires continue to be made here. Real quick on the sale price with the raw materials coming down, are the sale prices of retail tires staying firm, or are we seeing some slippage?

Well, remember here the reduction in raw material costs has not hit anybody's financial statements today. So I think we -- I will just speak for our Company -- we are still recovering the increases that were taking place during Q1, Q2 and Q3, and as you see, we are not quite offsetting the escalation in raw material prices with price mix, although we are doing a fine job of getting close to offsetting. So that would be my comment. Rich, anything else?

I would just say again in the quarter looking at a 17% increase in raw materials, some 250 million and only not recovering $25 million of that, I think really says that our ability to price out there still exists and our ability to price we would say is directly correlated to the products that we are putting out in the marketplace. As long as we continue to do that, I think even in an environment where raw material prices go down, we would certainly intend to price for value on our products. So clearly we will see some pressure going forward, but again we put the right products out there, we think we can get the price for it.

A little one. The Engineered Products sale, you did not really mention it. Is that still going on?

Yes, I would say just as a summary here, we started that marketing process in the second quarter. We are very pleased with how that marketing process is progressing, and there is significant interest in Engineered Products at this point.

And my last question is just on the chemical business, years ago we used to break out as a separate segment and generate significant profit. If we looked at the third quarter and we broke out the chemical business from the North American Tire, what would the North American Tire look like on a segment operating income basis?

When we sold part of the Wingtack -- well, we sold the Wingtack business in that chemical business. We integrated in North America and made it part of its and our other business' supply base, and at that point forward, we have not broken it out of North American Tire. I think we have been pretty consistent in that from that point forward.

I will say the business is still performing very well. Our strategy of keeping and not selling that business was because we thought we could drive it in a more cost-effective way, and I would tell you we are really executing ahead of that plan. So it clearly is providing us a benefit, although we don't break it out.

Thanks. Good job.

Neil, thank you very much. Thanks for your comments. Maybe I just conclude the call here with a very quick comment. Just, we thank you for your time this morning. We are obviously focused on what we feel are the right strategies for our business, and we are tactically and executionally now doing much better as a company. And we just thank you for your ongoing interest in the Goodyear Tire & Rubber Company. Thanks, everyone.

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