Goodyear Tire & Rubber Co (GT) 2018 Q3 法說會逐字稿

Good morning. My name is Keith, and I'll be your conference operator today. At this time, I would like to welcome everyone to Goodyear's Third Quarter 2018 Earnings Call. (Operator Instructions)

I will now hand the program over to Christina Zamarro, Goodyear's Vice President of FP&A and Investor Relations. Please go ahead.

Thank you, Keith, and thank you, everyone, for joining us for Goodyear's third quarter 2018 earnings call. I'm joined here today by Rich Kramer, Chairman and Chief Executive Officer; and Darren Wells, Executive Vice President and Chief Financial Officer.

The supporting slide presentation for today's call can be found on our website at investor.goodyear.com, and a replay of this call will be available later today. Replay instructions were included in our earnings release issued earlier this morning.

If I could now draw your attention to the safe harbor statement on Slide 2. I would like to remind participants on today's call that our presentation includes some forward-looking statements about Goodyear's future performance. Actual results could differ materially from those suggested by our comments today. The most significant factors that could affect future results are outlined in Goodyear's filings with the SEC and in our earnings release. 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.

Our financial results are presented on a GAAP basis and, in some cases, a non-GAAP basis. The non-GAAP financial measures discussed on our call are reconciled to the U.S. GAAP equivalent as part of the appendix to the slide presentation.

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

Thank you, Christina, and good morning, everyone. Before beginning my remarks, I'd like to welcome back Darren Wells who recently rejoined the company as our Chief Financial Officer. For those of you who are unfamiliar with Darren, during his prior time with Goodyear, he was instrumental in the development of our turnaround strategy during the mid-2000s and was the architect of several of our major capital structure decisions. He also served as a leader of our EMEA operations and helped to bring stability to the business.

Throughout his tenure, Darren has experienced several business cycles and can add valuable perspectives as we work our way through the current environment. With his deep knowledge of Goodyear, the tire industry and his familiarity with many of our analysts and investors, it goes without saying that we're very excited to have Darren back on the team. Welcome, Darren.

In the third quarter, segment operating income totaled $362 million and segment operating margin was more than 9%. Our global tire shipments increased by 2% on a year-over-year basis, driven by the significant gains in the Americas and EMEA.

Globally, despite significant headwinds in China, we grew both our consumer and commercial volumes led by our consumer replacement and commercial OE businesses.

During the quarter, we continue to improve the operating performance in our key mature markets, driven by the benefits of strong mix trends and solid volume growth. Our teams delivered outstanding growth in the premium segments of the U.S. and European consumer replacement channels. These gains contributed to improving momentum in our 2 largest regions as EMEA delivered operating income growth of more than 20% and the Americas turned in its best year-over-year performance since 2016.

We're pleased to see that our total operating performance was relatively stable in a period of increasing volatility. The issues that began to emerge in the second quarter have persisted into the fourth quarter, including a stronger U.S. dollar and deteriorating market conditions in China.

In addition, newly enacted emission standards in Europe, growing economic volatility in Latin America and the changing global trade environment have added incremental challenges for the overall industry. While these factors have a near-term impact on our results, the headwinds do not detract from our value proposition in the market or the continued execution of our long-term strategy. Our teams are delivering on improvements in volume and mix in our mature markets while continuing to build on our capabilities to expand our opportunities for growth.

With the strength of our products, our people, our brand and our focus on business model innovation, the current environment does not change my perspective on the longer-term trajectory of our business in the new mobility ecosystem.

Turning to Slide 4. I'll cover the performance of the Americas as well as the industry conditions in the region. U.S. consumer replacement industry sell-in demand was up 5% in the quarter, representing an acceleration versus the first half of the year. In comparison, our U.S. consumer replacement volume was up 11% and higher than the second quarter when our shipments increased 8% after adjusting for the significant impact related to the transition from ATV to TireHub.

Our transition to TireHub is progressing smoothly, and TireHub's daily sales and delivery rates continue to increase steadily. We're pleased with the team's execution and dedication to this strategic initiative.

Industry growth in the 17-inch and larger segment came in at 9% in the quarter. And once again, we grew share in this important segment, outperforming the market by over 2.5x.

Goodyear sellout volume or consumers buying at retail was up 5% in the U.S. We have now seen 3 straight quarters of mid-single-digit growth in sellout demand, which is a testament to the quality and value of our products. The strong retail demand has improved inventory turns in the channel, leaving wholesale inventory of Goodyear branded products with our distributors in excellent shape.

Just this month, Goodyear's Assurance WeatherReady reached yet another important milestone, more than 1 million tires sold. This latest achievement comes just a few weeks after the tire was ranked #1 among consumers in the grand touring all-season category. In addition, last week, a leading consumer magazine ranked the Goodyear Assurance CS Fuel Max, the highest among SUV all season tires. This is great news, and again, a testament to the quality of our products.

The strength of our product portfolio, in combination with the lean channel inventory, should enable us to capitalize on our plans to drive a richer mix and improve value proposition going forward.

Our U.S. commercial operations continue to leverage the strong freight environment, including record-setting Class A truck orders. Our commercial OE volume was up more than 30% in the quarter. Commercial replacement volume was down slightly, partially reflecting the strong OE performance and some transitory ramp-up inefficiencies in our U.S. plants.

Overall, we continue to have a constructive outlook for our U.S. commercial truck business as the drivers of the industry demand remain robust, including ton-miles, utilization rates and spot rates.

While industry conditions improved in North America, growing economic and political volatility in Latin America contributed to a more challenging backdrop in the region. These dynamics had a notable impact on our performance in Brazil, which accounts for a significant portion of our operations in Latin America.

Our total shipments in Brazil fell 2% in the third quarter, reversing the trend seen through the first 6 months of the year when volume increased in the mid-single-digit range. We saw a deterioration in both our consumer and commercial businesses, reflecting lost economic momentum in the wake of the national transportation strike, weakness in the real and uncertainty surrounding the presidential elections.

While the replacement market is softening, our consumer OE business in Brazil grew 10% during the quarter as we continue to grow our share with new platforms, particularly in the 17-inch-and-greater segment.

Additionally, as we have completed the modernization of our Americana Brazil plant, we have expanded our OE business with more manufacturers to capture growth in the coming years as the Brazilian and Latin American economies improve.

Turning now to Slide 6. Our EMEA business delivered solid performance during the quarter aided by improving industry conditions. The European consumer replacement industry grew 2%, with ETRMA numbers outperforming. In comparison, our consumer replacement volume was double the growth rate of the overall industry. Our share gains in the 17-inch-and-greater category continued in the third quarter as we delivered 12% growth, 200 basis points ahead of the industry.

EMEA's commercial truck operations delivered robust results across the board. OE volume rose 14% versus last year. Replacement shipments increased 5%, reflecting the strength of our fleet services model and favorable industry conditions.

We feel good about our relative position versus the industry during the final months of the year given our strong performance in this year's third-party winter and all-season tire tests. Our successes include the Goodyear Vector 4Seasons, which earned podium finishes in all 6 tests this year, including 3 first place finishes. In addition, our winter tires continue to be highly recognized by leading European tire magazines and the marketplace as we grew share during the third quarter in this important segment.

Now clearly, the unpredictable winter weather will affect buying patterns. Regardless, we are confident our award-winning winter products will position us to win in the marketplace.

Lastly, I'd like to acknowledge a significant win by our OE team in the region. Audi selected the Eagle F1 Asymmetric 3 SUV tire for the e-tron, its first fully electric SUV. These tires use Goodyear's sound comfort technology, which effectively reduces the interior vehicle noise by 50%. Being fitted onto the Audi e-tron is a testament to the work of our technology and engineering teams, the work that they're doing to improve handling while reducing rolling resistance and noise levels. Great job by that team.

Now turning to Slide 7. I'll cover Asia Pacific performance and provide an update on operating conditions in China. Asia Pacific shipments fell 4% as declines in China more than offset growth across the other countries in the region. We're not seeing any substantial signs that suggest industry conditions in China are likely to improve in the near term.

OE customers continue to ratchet down their production forecasts in response to softening end-market demand and elevated inventory levels. In September, passenger and commercial vehicle sales declined 12% and 8%, respectively.

While the magnitude of these declines are significant, our OE business in China is tracking in line with the view we expressed on our second quarter call. At that time, we consciously made the decision to plan for a very difficult OE environment in the second half of the year based on our analysis of market conditions. This turned out to be the correct decision and allowed us to take some offsetting actions ahead of the sharp deceleration.

The replacement market is also being negatively impacted by events currently shaping the business environment in China. We're seeing ongoing destocking activity and deteriorating retail demand. We expected a significantly weaker replacement market in China when we revised our forecast earlier in the year. However, market conditions are now below our expectations, primarily due to the weaker than expected sellout trends.

We continue to believe that the weakening fundamentals in OE and replacement channels reflect tighter credit conditions, a weak stock market and worsening consumer and business sentiment, all cyclical factors.

While China's economy has not responded as quickly to stimulus as it has in the past, we're encouraged by the government's recent actions to reduce individual income tax rates and to create liquidity through monetary easing for the fourth time this year.

It may take some time for market conditions in China to improve, but our continued investment positions us and our business to come out of the cycle even stronger.

Looking back at the quarter, I'm satisfied with our volume performance in our major markets. In the U.S. and Europe, we are regaining share and driving strong mix gains, both of which contributed to our overall performance in the quarter.

As we enter the final months of 2018, our expectations are that these trends will continue, albeit with some moderation as we face more difficult comparisons, especially in the U.S. Even with these successes, a variety of industry and macroeconomic headwinds have changed the landscape in 2018 and will continue to have an impact in 2019.

We think that it's prudent to take a more conservative view of our near-term potential given that we are in a period of increasing volatility.

While the current environment will keep us from reaching our full potential in the short run, we have a strong track record of successfully navigating through similar conditions in the past.

As we look ahead, we'll continue to leverage our strengths where the markets are healthy and take a disciplined approach to manage near-term challenges and set ourselves up for future recovery. While the macro environment has become more volatile in recent quarters, we will not abandon our unwavering commitment to pursuing growth in the industry's most attractive market segments and ensuring that we capture the full value of our brands and products in the marketplace.

More importantly, you will see us continue to challenge the industry's traditional business models in order to build on our competitive advantages. TireHub is a perfect example of disrupting the status quo to strengthen the value of our brand and enhance our value proposition to the consumer.

Additionally, just this month, we launched Roll by Goodyear, a new retail concept in 2 major markets that is designed to enable us to win with consumers. I'm confident that our strategic plan and the investments we are making are improving our long-term competitive position in the market.

Now I'll turn the call over to Darren.

Thank you, Rich, and good morning, everyone. Let me start by saying that I'm very excited to be back on the Goodyear team.

While we're going through a period of some adverse macroeconomic conditions, the underlying business fundamentals impress me as being stronger than they were 5 years ago when I did my last earnings call as CFO. Even though I'm only 30 days into my return to the role, I want to take a couple of minutes to offer you some initial impressions.

My first impression is that the current cycle of raw material cost increases has a lot in common with prior cycles. There are some differences as well, but overall, I don't see anything that should change our ability to recover margins over time. I'll talk more about this in a few minutes.

My second impression is that the tire industry hasn't gotten any easier. Even in times with pretty good economies, we find challenges that make our near-term financial results difficult to predict. For Goodyear, this means we have to continue to focus on disciplined execution of our operational excellence initiatives as well as our connected business model, making sure that we're as well positioned as possible when the current volatility settles.

My third impression is that our business is positioned with the right capabilities to navigate these challenges. I'm impressed by the progress over the past few years on multiple fronts. The company has continued to address its cost structure, continued its strategy of reinventing U.S. distribution, and it's made investments in technology that set us up for a changing automotive ecosystem.

Hopefully, you can tell how enthusiastic I am about our prospects in the coming years. That's one of the reasons I rejoined the team. However, I also realize that you're very focused on understanding our near-term results and having better visibility into how the next few quarters may play out.

Today, I'm going to focus on the fourth quarter. I should be able to come back at the beginning of next year with a full perspective on 2019. After we get to that point, we'll start to look at 2020 and beyond.

In the meantime, I look forward to continuing the dialogue I've had with many of you over the last few weeks and getting to understand your views and questions as we work through our plan for next year.

Turning back to Q3. I want to start by reflecting on where we are in the raw material cycle and how I see the similarities and differences versus prior cycles.

The chart on Slide 9 illustrates the net impact of price and raw material costs over the last 7 quarters and compares that impact to our experience during the last similar cycle, which I remember well in 2010 and 2011. Each of the lines starts in the quarter where we first saw the step-up in raw material costs. In this cycle, it was the first quarter of 2017. In the prior cycle, it was Q2 2010.

You can think of the area below and above the horizontal line as margin compression and expansion relative to the baseline at the start of the cycle. You can see that during the prior cycle, margins were compressed early on and then started to improve, ultimately taking nearly 3 years and 5 price increases to fully recover.

You also see the recovery wasn't in a straight line but we got there. I remember a lot of questions during 2011 focusing on whether the industry had changed and whether we could really get back to raw material costs. These questions were especially intense when the recovery rate dropped back down in the fourth quarter of 2011. We remain confident then, and we remain confident now that we can recover the lost margin over time, but it takes time.

This latest cycle seems to be lasting longer, which doesn't feel very good, but probably reflects a couple of dynamics that are different this time around. First, this cycle's raw material cost increase is less severe. Only about $900 million for Goodyear over 8 quarters versus the last cycle when we saw $900 million in only 3 quarters. So much quicker last time and a bigger impetus for industry pricing to move.

Second, in the last cycle, raw materials kept rising after the initial 3 quarters, ultimately increasing for 11 quarters in a row. This was another driver of industry pricing. In this cycle, raw materials flattened out after the initial 3 quarters before starting to increase again. This made pricing decisions more difficult as it was less clear which direction raws would take.

As the lines of the current cycle shows, we are recovering, and we continue to focus on getting full value for our products in a competitive marketplace. The recovery may not be a straight line, but the destination doesn't change.

Transitioning to a review of our performance during the quarter, I'll begin with the income statement on Slide 10. Our third quarter sales was $3.9 billion, up slightly from a year ago as the benefits of higher volume and favorable price/mix were substantially offset by unfavorable foreign currency translation. Segment operating income was $362 million for the quarter, and our segment operating income margin was 9.2%, both relatively consistent with prior year.

Our results were influenced by certain significant items, most notably the gain we recorded on the TireHub transaction. Adjusting for these items, we generated earnings of $0.68 per share on a diluted basis.

The step chart on Slide 11 compares third quarter 2018 segment operating income to third quarter last year. Higher volume and improved factory utilization resulted in a $35 million increase in operating income. Raw material costs were essentially flat but worse than we expected, reflecting the impact of foreign exchange on emerging markets as well as adverse costs for some inputs we source in China. And I'll talk more about this as I review the outlook for the fourth quarter.

Price/mix was lower by $10 million. This reflects the flow-through impact of pricing actions taken during the third quarter last year. This year-over-year decline was mostly offset by favorable mix.

Cost savings of $69 million more than offset the $44 million negative impact of inflation, delivering a net benefit of $25 million. The negative effect of foreign currency exchange and other totaled $18 million and $35 million, respectively.

Turning to the balance sheet on Slide 12. Cash and cash equivalents at the end of the quarter were $896 million. Working capital was in line with our typical seasonality but decreased $250 million year-over-year, reflecting an increase in accounts payable given higher year-over-year production volume and increased raw material costs. Net debt was effectively unchanged versus a year ago.

Slide 13 summarizes our cash flow in the period. Cash flow from operating activities was $60 million for the quarter, similar to a year ago, and $1.3 billion on a trailing 12-month basis. While net income was up for the quarter, it was largely a reflection of noncash gain on TireHub that's reversed out in calculating cash flow from operating activities.

Outside free cash flow, we repurchased $100 million worth of our common stock in the third quarter or about 4.2 million shares. For the first 9 months of 2018, we have repurchased $200 million worth or just over 8 million shares.

Turning now to segment results on Slide 14. Americas segment operating income was stable versus 2017. Revenue increased 3%, with higher volume and higher non-tire revenue more than offsetting unfavorable foreign currency translation.

While in the U.S., consumer replacement volumes were up 11%, Brazil consumer replacement volumes declined 6%, offsetting part of the strength in the U.S. Segment operating income reflected a $23 million benefit from this increased volume, including the impact of higher factory utilization. The benefit of higher volume was more than offset by lower price/mix, higher raw material costs and higher manufacturing costs.

One final point in the Americas. Third quarter results were impacted by 2 specific items: first, $21 million for a favorable settlement we received in a trade tax dispute in Brazil; and second, a $6 million negative impact for bad debt reserve in Brazil. So a net $15 million positive from these 2 items.

Turning to Slide 15. EMEA delivered solid volume growth, but saw relatively flat revenue given unfavorable impact of foreign currency. Winter tire sales and consumer replacement started out strong during the third quarter, reflecting low-channel inventory after robust sellout at the end of last winter. Toward the end of the quarter, weather remained relatively warm and sell-in slowed down as many distributors were waiting for increased demand in the retail channel before taking further deliveries. As always, weather will be a key contributor to our fourth quarter volume in EMEA.

Our commercial business, as Rich said, continued to deliver strong performance both in replacement and OE in EMEA. Segment operating income increased 23% during the quarter, driven primarily by lower raw material costs and positive price/mix, which were partially offset by unfavorable foreign currency translation. The translation was a function of a weaker euro and the devaluation of the Turkish lira during the quarter.

Turning to Slide 16. Asia Pacific's third quarter segment operating income was $57 million. The year-over-year decline reflects a challenging industry environment in China where our OE and replacement volumes each declined in excess of 20%. We also recorded $4 million of incremental bad debt expense in the quarter, primarily related to one of our smaller China OE customers.

Outside of China, the region saw double-digit consumer replacement growth in Japan and India. OE volume outside China was essentially flat. We see OE in India, though, as a watchout going forward. While recent weakness was a result of the national transportation strike and flooding, more recently, tightening liquidity, rising fuel costs and recent insurance regulation are creating further challenges for OE sales in India.

Despite a tough current environment, we continue to build a foundation for future growth in China. Our growing pipeline of OE fitments, including the electric vehicle segment, will help us to drive OE volume and replacement demand over the coming years.

Slide 17 updates our outlook for full year segment operating income drivers. We now see unit volume at the low end of our prior range, principally to reflect continued softening of consumer replacement demand in China and a weaker demand environment in Brazil. We also expect less benefit from factory utilization on overhead absorption as a result of this volume weakness in our key emerging markets.

We have increased the benefit we expect from price/mix to $45 million, reflecting the impact of recently announced pricing actions, partially offset by lower mix driven by the weakness in China.

While we've taken steps on pricing, we've also seen increases on our raw material costs for Q4. This takes the full year impact of raws to $270 million. The increase in raw material cost reflects the impact of currency in our emerging market locations as well as some higher input costs, particularly for carbon black and other oil-based derivatives that we source from China. We're seeing cost increases in these materials at least partly due to stricter enforcement of environmental regulations in China.

In response to this enforcement, several of our Chinese suppliers have closed plants, curtailed production and raised prices to cover the cost of unplanned investments required to meet the new environmental standards. So these increases aren't purely commodity-related, but they're still having an increasing impact on our material spend.

The last point I want to make on this page is regarding our cost outlook. This forecast is $10 million below our previous guidance and is in an area that we control. While some of this deterioration is situational and related to changes we are making in our factories to prepare for the future, we have some performance challenges that we have to overcome. This is another area that we'll come back and talk to you about when we talk about 2019.

While we will continue to look for opportunities to improve price/mix and drive additional volume, our best view on segment operating income incorporating all these factors is that we'll exceed $1.3 billion. We'll look to improve from there, but we feel like this is an appropriate expectation given the recent changes we've seen.

The focus now is on the steps that we can take to improve our momentum as we enter 2019 even as raw materials look to be higher and emerging market businesses look like a challenge that will continue into the first half.

Now we'll open the line for your questions.

(Operator Instructions) We'll take our first question from Rod Lache with Wolfe Research.

First of all, 2 housekeeping items. Can you just confirm the accounting for TireHub shipments at this point, are they still on a consignment basis? In other words, there's no benefit from channel filling there? And are you bucketing some of the big changes that we've seen in Turkish lira and peso and some of those other pretty significant moves in the raw material bucket?

Yes. So Rod, I think I'll answer your second question first and say yes, the devaluation does have transactional impact that we do put in raw materials to the extent our factories in Turkey are buying raw materials that are denominated in dollars or in non-lira currency. So you're thinking about that one the right way. And yes, to confirm, there's no benefit from moving tires into the channel with TireHub.

Yes. And Rod, by definition, that's not the purpose of it, and certainly that's not happening in the quarter. And we're pretty much through the consignment element of it as well.

Okay. And I'm just hoping you can help us with a few kind of perspective items. One is, is price and mix really accelerating to about $100 million in the fourth quarter, and we're wondering how we should be thinking about some of these things as we look out to 2019 just on a preliminary basis. If price and mix adjustments you're making right now hold, what would that mean for 2019? How should we think about raw materials? And then any other color that you could provide for us on some of the other things that you've mentioned in the past like San Luis Potosi ramp and the non-recurrence of the TireHub and cost reduction, some of those things as they stand today looking out to 2019.

Yes. So Rod, let me -- I guess the first thing I'll say is that I won't -- I'll offer you what I can on 2019. I think our plan for 2019 is something that I'm certainly still working with the team to try to better understand, so there are going to be some elements of 2019 that I won't be prepared to comment on today. But I think your point on the price/mix performance for the fourth quarter is a fair one. And based on achieving $45 million of price/mix for the full year, that does imply that the fourth quarter is going to be a big turnaround, so we're going to go from having negative impact of price/mix over the last 3 quarters to having a very significant positive effect of price/mix in Q4. And I think that is something that is a positive for us as we set ourselves up for 2019. The other positives, I guess, as we look out to 2019 that we've got some clarity on at this point is -- and I think you pointed some of these out, the continued ramp up all of our factory in Mexico and the additional units that we'll be getting out of that factory, which are both high-margin units and have a better cost structure than units that we would build at high-cost factories. The reversal of some of the impact at TireHub, so some of the hit we've taken for reduced volume in TireHub this year, obviously, that will unwind next year, and it'll provide some positives. And we'll have -- yes, I think we'll continue to have net cost savings. I think it's worth having a longer discussion about it and I'm not fully ready for that discussion yet. But we've got -- our net cost savings, yes, I think we look at it in the fourth quarter as being a bit lower than it has been the rest of this year. And that ultimately is being done for some good reasons, but that doesn't mean it's not a concern for me. And on the negative side, I think raw materials, as we look out the next year, given where raw material prices and currency sit today would be $350 million or $400 million increase. And obviously, that does include the foreign exchange effect that you referenced, and that includes our view of foreign exchanges today. I should say where foreign exchange is today rather than our view, where our raw material costs are today and a view of the changes that we're having to make related to the supply issues in China that I mentioned in my prepared remarks. So yes, fairly increasing hurdle. Yes, I think we were looking at $150 million to $175 million when Rich and Christina were out in Laguna. Now we're looking at $350 million to $400 million going into next year. Foreign exchange is also going to be a negative, and today's spot rates would be another $40 million or so. The China environment, obviously, as we look last -- this year's first half in China was pretty good. If the current conditions continue, then the first half of next year would be up against pretty tough comps in China and would continue to be a headwind. And yes, so I think a number of things there, that there are going to be challenges for next year. Obviously, against that, we're going to be working on the price/mix question as well as what we can do to grow volumes. But even on the volume front, because of some selectivity on our part, getting out of some of the less profitable OE fitments that we were on. We're facing OE volumes that even if the industry stays stable, we'd be down 2 million or 3 million units in OE -- focused on our mature markets businesses. But -- so we've got some volume there that we're going to have to look to -- frees up some tires for replacement, which is good, but it is still some volume is going to come out for us. So I think we're looking at a number of those factors, and those are all factors that we'll take into account as we pull together our overall view for '19. And we'll pull that together and talk about our view of '19 when we get past year-end.

Good. And just to clarify, if the -- on that turnaround in price and mix, is that something that kind of all things being equal, you would have 3 more quarters at sort of that level through next year? Or is there something unusual that is occurring in the fourth quarter this year that boosts that number?

Yes. I mean, we're obviously getting past the anniversary of some of the price decreases, and that's helpful. Some of the price downs that took place last year, that's helpful for Q4. It'll be somewhat helpful going forward. Well, I'm not on the point where I'm comfortable giving you a clear view of where price/mix is going to be going into 2019, but I think we're -- obviously, we are making progress there, we are continuing to deliver very strong mix and taking some continued action on price, including the price increase that we announced in the U.S. that really started benefiting us -- will start benefiting us in Q4.

(Operator Instructions) And we'll take our next question from John Healy with Northcoast Research.

I wanted to ask just a kind of a big picture question on the volume side. So 3 quarters in a row with replacement market growth in the U.S., clearly, you can point to the economy driving that, but can you help us understand what's changed? And maybe a view of how sustainable this will -- obviously not 11%, but sustained growth -- how we might expect to see growth for the next few quarters on the replacements and your level of confidence there?

John, I think I'll go back and maybe refer to questions that we got a lot last year that I suspect many remember, and that was when we saw such a robust economy relative to sentiment and consumers and VMT and everything else, and we weren't seeing the demand out, the sellout demand in the marketplace. And what we said back then, it was going to be a question of when, not if. And I think that when is now. And I think that's what you're seeing. And as you think about this year, go back to Q1, remember, our volumes were down about -- I think about 3% -- or it was $3 million, I can't exactly remember what the number was. We were down in Q1, but sellout was up 8% at that time. And what we said is that pent-up demand was going to come forward because inventory channels were emptying. And since then, just as you said, we've had a very -- in North America and in Europe, we've had very robust second quarter volumes and very robust third quarter volumes. And on top of that, what you're seeing is the channels are in good shape as well. So that speaks to where we are. As I said in my script, we've had good -- we've had mid-single-digit sellout for 3 quarters now, and that trend is where -- we're ending October, continues into October. And if you think about that, we're getting volume, we're getting sellout, channels are in good shape. And as Darren just mentioned, the benefit of our price is going to come into the fourth quarter. So you've got a lot of those things all working together right now, which is exactly the momentum that we want to take into end of year and then take out into 2019. So I think it's really the economy and the demand for our product, the demand to support VMT and tread rubber burning finally coming to fruition.

Helpful. And then I thought Slide 9 was great in terms of illustrating previous cycles and the raw increases. But when I look at that slide, you highlight the 11 quarters it took to recover the raw increase. Given the environment, the volume seems healthy and you guys seem like you expect it to continue, can that period of time in terms of recovering the raw prices actually potentially be shorter do you think than that 11 quarter time frame? And how do you think that might play out?

Yes. So let's all start on this one. And I think the fact that we're get -- our volume is recovering, market share is in a strong position. And clearly, those are things that make the job easier. We've been through, obviously, a period of time last year where volume went the other way, and that's -- that continues to be something that we have to be watchful of because we're working to recover this, but we're working to recover it in a competitive marketplace. The thing I find to be the -- requires the most thought about this particular cycle is that the raw materials have been through periods of flattening out, which makes it sort of harder to read the direction. And if we got to a point where we believe raw materials were going to go back down, and I don't think we're there, but if we got to that point, then it would raise questions about which direction pricing we'd likely take. And I think that's the biggest uncertainty for us as we move forward. But I think what we've done in the third quarter, and I think what we'll continue to work on, is going to demonstrate that -- we're committed to take in that area that we're experiencing under the line, so to speak, over the last 7 quarters and create some space above the line as we did in the last cycle, and that is the model. It is a business that has these raw material cycles, and that's how we work through them. And we're going to continue to hammer away at that.

Great. And then just one final question for me, TireHub. Any color you could give us just on how installer response has been to the launch, are you seeing good retention of the dealers that you had in your network prior, and are you seeing any big wins out there in terms of geographies or just markets where you've been maybe underserved in the past?

John, I would say it's frankly exceeded our expectations in terms of its ramp up and in terms of servicing customers. Like any startup, if you will, there's hiccups along the way. And I think on a customer by customer basis, there's probably been some out there, and we work diligently to get through that. But no customer losses, no big customer losses, and none at all really. And the process is working very well as we intended. And I think as we think about it from a strategic perspective, it's absolutely in line in what our strategies and what our intentions are. So to get off on the right foot, I think, was key for us, and that's exactly happened. In terms of growth, we never intended to have significant growth in 2018 as we ramped it up. I think as you look out into 2019 and beyond, that's where you're going to see the benefits of expanding the distribution, and it will also support some of the new initiatives that we're working on, whether it's goodyear.com and working with our partners out there, our partner dealers and our other line distributors or the new retail concept that we're testing out as well in a few markets in Washington called Roll by Goodyear. And I can elaborate on that if you like. But that's what TireHub is for, and I'd say it's on plan and, frankly, even a little bit ahead of plan.

And we can take our next question from Anthony Deem with Longbow Research.

This first one is for Darren. I'm wondering if we can get an update on your leverage ratio outlook and investment grade intention. At the beginning of this year, it was Goodyear's goal to grow EBITDA to lower the leverage ratio more so versus paying down debt. And just wondering where we sit today with you in a CFO role. Will buybacks remain a priority over deleveraging?

Yes. So Anthony, I think you've raised a good question here because, obviously, when we look at our shareholder return programs, those programs well was meant to be a reflection of our ability to generate cash. And as we go through this part of the raw material cycle, our results, our cash generation have been impacted. I would say that we are still committed to having a balance -- investment grade type balance sheet. I mean, that is a long-term objective for us. It's something that has -- I think always been part of the DNA here and has a lot to do just do with the types of companies that we compete with. So we need to have consistent access to reasonable cost of capital through the cycle. And so the investment grade balance sheet is what helps drive that. So as we've seen, obviously, our debt -- I don't know different leverage ratios available, but certainly on a debt to EBITDA basis, yes, we were having some nice improvements down into the mid-2s. And our intention was to continue to work toward a ratio of around 2x. And instead, in 2017 and 2018, because of the results, I mean the drop in EBITDA, our leverage ratio has moved back up. And I think the commitment is still there to answer your question. And I think we're going to have to balance our commitment to shareholder return programs with our desire and our strategic need to keep improving our balance sheet. So I mean, that commitment is clearly there. Yes, so I think the balance is going to have to be struck. And we've had -- so far this year, we have repurchased about $200 million of Goodyear's stock. So fairly substantial amount. I think that's something that we -- we're going to have to moderate, quite honestly, as a result of where our cash flow is and in order to do the right things to our balance sheet. We've got confidence in our business for the long term, no question. And you would have seen that in the increase that we made in the dividend recently. So I don't think it's a question of what we think we can do or the cash we can generate in the long run. But as we go through a cycle like this and given that it's difficult to predict how long a cycle like this lasts, we're going to have to take some steps to protect the balance sheet. Does that answer your question, Anthony?

Yes, that does. It's probably tough to commit to a targeted time frame I assume at this point, right, if it proves to be 2020.

Yes. Yes, I think that's fair. I mean, we're going to taking a hard look at our '19 plan and then obviously coming back to take a look at where we think we're going to be in 2020 and beyond, so we need some time to work on that. I need some time to work on that just on a personal level. Yes, so we will come back on that question. I understand the question. And obviously, we'll keep having dialogue and listening to our investors and the view points that they have.

I have a few more questions if I may. And sorry if this is already answered. Can you specify exactly how much of the $80 million raw material guide down for 2018 is related to transaction impact versus increases in the commodity and non-commodity costs? Spot pricing would suggest sort of flat to slightly lower raw material cost third quarter versus second quarters, so I'm just wondering if that's mostly FX driven.

Yes. So I think of the $80 million, about $30 million of it is foreign exchange related. There is another substantial factor here, and there is some that is a reflection of higher commodity costs. And most of the increases that are not foreign exchange related are in the categories of carbon black and some oil-based derivatives that we purchased. But within that carbon black and oil-based derivative category, you heard me mention earlier the fact that there has been a fairly significant change in the availability of supply in China. And over the last several years, a lot of the production of these materials has shifted to the point where most of it is made in China. And so if China then starts to regulate through environmental regulations or other policies start to reduce the amount of this material that's produced, a couple of things happen, both of which are affecting us. One, there are some suppliers that just stop and aren't able to make the required investments to comply with the environmental standards. And therefore, if you are a customer of theirs, you're forced to change supply. In general, you're changing supply for a higher cost supplier. The other effect is that all the suppliers in the market start to raise their prices to recoup the additional investment for those who are able to make it, recoup the additional investment in meeting the environmental standards. So it is something that pushes up those materials. And for our Asia Pacific business and even for our business in North America, we do a lot of our procurement for these materials in China. So that is playing into it, and it also plays into our outlook for raw material costs going into next year.

And I know you're not prepared to give a price/mix outlook for next year. But given the circumstances that you just described, do you see Goodyear undergoing another round of price increases maybe here in the fourth quarter?

Yes. So I think we're probably going to stand on the fact that we're going to recover the -- we're focused on recovering the impact of raw material costs on our margins and doing it over time. We have to do it in a way that fits the marketplace that we operate in. So I'm not going to point to a particular timing, but I think we're making a big step forward in Q4, and it's something that will get a lot of time and attention from us going forward.

Great. And just one last quick one. Is 5% a good estimate for the prebuy benefit for U.S. consumer replacement shipment growth? The 11%, we saw about 5% industry growth. So assuming you maintain market share, was the prebuy benefit 5%, 6%-ish?

So when you talk about the prebuy benefit, I want to make sure I'm answering the right question here or that we're answering the right question. Are you talking about the question of are there people buying tires ahead of our price increase?

Yes.

Okay.

As I understood it, there was September 1 price increase, that was somewhat expected in the marketplace in the third quarter. So I believe that you gave some opportunity for prebuy for your customers, and I'm wondering if that probably benefits your shipments.

Frankly, it's been very positive in the sense that there's really been no significant prebuys, I would say not only for us, but as we look around at our customers, our multi-branded customer, we haven't seen a lot of that from an industry perspective at this time. So I would say it's been very moderate, certainly relative going back to some of Darren's comments when we went through this before and some of these recoveries of raw material price increases in the past were expected, you might see some price through some prebuy. We saw very little of that. And again, I think that goes back to the earlier question of volumes. Sell-in volumes are good. Sellout volumes are good. Channel inventories are good. And the price increases that we put in as of September 1 have been very favorably received from our perspective. So they're sticking.

And we'll take our next question from Ashik Kurian with Jefferies.

Just following up on the previous question. I mean, did you imply there was no prebuy effect occurring from what we understand your price increases were probably effective from September 1, most of other Tier 1 same price increases are from Q4. Well, the main question I want to ask is I think last time around in 2017, your pricing was slightly out of sync with the rest of the industry which had an impact on your volumes. This time around especially for Q4, are you seeing any big distortions between your volumes and industry? Do you think both your pricing and volume development is pretty much in line with what it is for these members?

Ashik, I would say in line. I mean, again, we didn't see any significant prebuy. And I guess maybe to answer the question directly, we said industry was up 5%, our volumes were up 11% in North America, greater than 17-inch industry was up 12%, we were up 24%. And you've seen those volumes now up for -- tracking like that for 2 quarters in a row, so it wasn't the announced price increase that cause the prebuy that drove our third quarter volume to be clear. And as we said, sellout continues to be good, and that continues in October. So the volumes we had have not been -- or the incremental volume hasn't been a prebuy as we move ahead, to be clear.

And should we worry about Europe because no one has announced price increases? Is that just a reflection of the high level of inventory there or not just the market? I mean, any thoughts on how likely it is you have price increase in Europe?

So Ashik, remember, we did do a price increase in the commercial business that we talked about in the second quarter call. And again, if you want to think sort of environmentally at least from a macro perspective, here we have replacement markets in Europe in the quarter up 5% for commercial business and OE up about 14%. So volumes are good. Our business is good. Industry is good. And as we look at this, what we see is a market that's good and taking pricing on as we look at the Europe truck market. Remember, passenger is much different, particularly in the winter segments, Darren knows as well. Winter pricing -- pricing on winter tires is set earlier in the year. So as we go into that selling season, it's sort of set as we go. So we didn't expect any incremental price as we went into third quarter. Having said that, remember, we said our volumes on sell-in have been very good. We gained share in the winter markets, and we did that on the back of some excellent products out in the marketplace. We'll see sellout start to happen now in October. We would have hoped it happened in September, but the weather has still been warm, as you know, over there, so we'll see those tires coming out and getting pulled into the market and then have a restocking of the distribution ideally in the fourth quarter, assuming we see snow coming into the market. Now remember, and I said this last time, the opportunity to revisit how to recover a raw material cost will be with the new summer tires or the summer tire season that will start late in the fourth quarter as well. So we will be -- as Darren said earlier, we'll be looking closely at how we approach that market given the higher raw material costs as summer tires gets set in the market later in the fourth quarter.

One more on China. What are your views on the Chinese sellout plan? I mean, is the weakness we are seeing in selling largely destocking by the dealers you do? And if you choose, has there been underlying sellout weakness as well? And also given your high OE proportion of sales in Asia, if you do get a volume weakness, do you think you have enough demand in the replacement side to offset this?

So Ashik, you hit on both points. Clearly, we've seen the deterioration in China, and we haven't on the bottom yet as we go. And remember, as you point out, our mix in China is much higher. We're about 60-40 OE to replacement. So if you look at both markets, I'd say we leaned into the OE market in Q2. And right now, I think the orders, the OEM order books to us have kind of come to where we said they would be in our forecast in Q2. So it's been deteriorating, but we feel pretty good. And as you know, auto sales have been down 3 months in a row, September down 12%. So really pretty severe as we go. That said, I'll just comment on OE. We continue -- I'm very pleased with the win rate that we're getting on new OE business in China, particularly around EVs and particularly around large rim diameter tires with both transplants and domestic producers. So I think OE will rebound as the economy gets better in China. But clearly, the headwinds are there. On the replacement side, Ashik, I think you hit it right. What you saw was essentially credit drying up. Remember, a lot of distributors paying bank acceptances, those large even mid to small size distributors, when they don't have access to liquidity and they can't pay, you see them essentially selling tires that they have to get cash to pay down their debt, whether it's in the tire business or for other businesses they own. So we're clearly seeing less purchases going in. But there's also -- because sellout is slow, there's also a lot of inventory in the channel right now. And I think that's what has to work its way through, and that's going to come through with consumers buying cars and buying tires. And I think that's sort of a derivative of the slow economy in China that we all know about right now. And as we said in the past, the government -- the Chinese government clearly put stimulus into the economy. Our sort of rule of thumb was it took about 2 quarters to sort of turn up in our business and get volume slowing again. Despite the government reducing reserve rates, reducing income taxes, putting more liquidity in the market, we've still yet to see the benefits of that stimulus sort of hitting the end consumer to start to empty the channels and get buying going again. So it's taken a little bit longer this time. We get that, but again, I'll say it doesn't really deter our view that China is a great market and continue -- will continue to be down the road. So we'll work our way through this. And yes, less OE demand gives us more to sell-in replacement, but we need to see that sellout in replacement happen, and we're just not seeing that yet.

And we'll take our final question today from David Tamberrino with Goldman Sachs.

Darren, you've kind of danced around it a couple of times. I figured I'd ask you directly. With you coming onboard now, should we view the 2020 guidance that was previously set as off the table?

Yes. So David, I think right now I'm focused on making sure we understand where we are in the fourth quarter. And as soon as we get past the call, I mean, the work is all going to be about where we're set up for 2019. I think the question around 2020 is going to have -- is going to, to a degree, be dependent on the external environment. In the past -- if you look at the past cycle, we could say there was some very quick recovery. So over a 2-year period of time, we saw our segment operating income jump dramatically coming out of the last cycle. So I think it will be -- part of the determination is going to be where are we in this raw material cycle. And so really not going to make any definitive comments about it today other than to say that by year-end, we're going to be in a position to talk in a robust way about 2019. And once we get through the discussion and layout where we are in 2019, we're going to go to work on our view of where we are for 2020.

Okay. And on that topic, because I do really like Slide 9 and trying to fit this into prior cycles, what I was surprised by within your commentary that you didn't really address the capacity situation within the industry today versus where we were previously and the growing or recovering global backdrop from 2010 through 2013. So I'd be curious to hear your comments on how you think that overlay with a lot of capacity that's been coming online because we had a really great period from '13 into '14 into '15 with tight supply and demand, tight capacity utilization rates via tires and declining raw mats, that we had a lot of project stream with, I'd love to hear that overlay from you on capacity and how that might be different this time than the prior cycle.

Yes. No, David, I think this is the right question. And at some point in the future, I think we'd like to do a larger discussion on how we see the supply versus demand balance evolving in that 17-inch-and-above or the high-value tires. Yes, there are clearly some dynamics here that I understand that there have been a lot of new factories constructed and there are some new competitors in the market. As I look at our businesses in North America and in Europe, the performance that we're delivering right now doesn't seem to indicate a situation of oversupply and that we are getting to a point where we're going to be delivering volume and price/mix improvements simultaneously. And I think that's an indication -- also of a reasonable balance between the 2. I realize that during that time in 2013, 2014, we could have said, there was a real shortage of supply for some of the high-end products. And I think for some of that product, that's still true. The big question about how much capacity has been impacted by the additional complexity and the slower build cycle times on these higher-end tires, and it's a question I have and it's one that we want to continue to inform you and our investors about. So it may be -- I can't give you complete clarity there, but I'll say I don't see the evidence that I would expect to see of an oversupply situation.

So everyone, thank you. Appreciate you listening today. Thanks for your attention.

And this will conclude today's program. Thank you for your participation. You may disconnect. Have a great day.