Good morning. My name is Nicky, and I will be your conference operator today. I would like to welcome everyone to Goodyear's Third Quarter 2022 Earnings Call. Today on the call, we have Rich Kramer, Goodyear's Chairman and CEO; Darren Wells, CFO; and Christina Zamarro, VP, Finance and Treasurer. During this call, Goodyear will discuss forward-looking statements and non-GAAP financial measures, which involve risks and uncertainties that could lead to actual results differing from those statements. For more information on significant factors that could impact future results, please refer to the disclosures section of Goodyear's Third Quarter 2022 Investor letter and their SEC filings, available on their website at investor.goodyear.com, where a replay of this call will also be accessible. A reconciliation of the discussed non-GAAP financial measures to their comparable GAAP measures is included in the investor letter. I will now turn the call over to Rich Kramer, Chairman and CEO.

We released our third quarter results. Okay. All right. We'll go back. We'll say again. Thanks, Nicky. Again, good morning, everyone, and thanks for joining us. Now yesterday, you saw that we released our third quarter results after the market closed in a new updated format. We're always looking for ways we can enhance our process and that has led us to introducing our first-ever quarterly investor letter. It replaces our typical press release, slides and prepared remarks and puts all that information in one place, so we can focus on your questions during our conference call. So thanks again for joining our call today. And with that, let's open up the line and have some questions.

We will take our first question from Rod Lache with Wolfe Research.

I would like to ask a few questions about pricing and competition. I understand from your announcement that you believe the current weakness is partly due to an inventory correction. You also mentioned that you're taking some downtime to prevent inventory build-up. Given that context, can you provide some insight into your perspective on pricing discipline? Do you think the industry will aim to support prices to offset inflation? Is that still the overall direction of the industry? Additionally, regarding the competitive landscape, I assume you are monitoring currency fluctuations and freight rates, as we are. What are your thoughts on the competitive situation, particularly in North America?

Yes. Rod, I'll start, and I know Darren is probably going to jump in here as well. There's a lot there. Listen, I would say, the industry is certainly facing the same headwinds that we have out there. I mean you saw by the numbers, our raw material cost increases plus energy plus transportation plus labor plus everything is sort of impacting anyone. And you look at our performance, on a trailing 12 months, we're about $2.3 billion of price that we got to offset all those costs. In North America, we've essentially offset raw material and those other costs. On a total company basis, we didn't quite do it, but we did pretty good. And I think that environment of those inflationary costs are still going to be with us. That's particularly true in Europe, where we see energy costs going up dramatically as a consequence of the war. So I think that landscape is there for everyone. And I would suggest to you that everyone faced with that same issue has to offset those costs through a combination of recovering them in the marketplace through price as well as taking cost actions, which, again, you saw us do already in Europe with the Melksham closure, with some actions in South Africa. And it'd be safe to say, we're not done, as we think about what we're going to be doing. So I would say, yes, I think that there is an acknowledgment of what price and mix has to do in the marketplace to deal with the environment we're in. And I'll just maybe say from a North American perspective, business is still good. Our product line is winning in the marketplace. That's particularly true in light truck. Our OE wins are very strong. And I would say that from a competitive basis, we've been gaining share in our key segments. And it's the best tire market in the world right now. So we feel pretty good about where we are in North America.

So Rod, there was one underlying question there, and I want to make sure I got it right. But it felt like you were probably you're also looking for any insight into how the factors that are at play in the market are affecting us relative to how they might be affecting our competition, particularly some of those cost factors. Was that...

Yes. That's right.

Let me highlight a few important points. Our competitiveness in manufacturing has been significant for us. Historically, our factories have been located in higher cost areas compared to our competitors, which put us at a cost disadvantage on a per tire basis. However, our restructuring efforts in manufacturing have mitigated that gap. Additionally, the reduction of Russian capacity has helped to further narrow that gap this year since some of that capacity was used for exports, improving our competitive stance. Another factor that enhances our competitiveness is that energy inflation is primarily affecting Europe, while we have less exposure there compared to some of our key competitors. When we evaluate other factors like wage inflation and transportation costs, we haven't observed any significant differences between ourselves and the competition. Overall, while some factors have worked to our advantage, others seem to have a neutral impact.

How about FX, Darren? Is that U.S. dollar strong?

Yes. I think it has clearly impacted our international earnings and affected the transactional exchange that influences our raw material costs. We've managed our pricing strategy well, so I'm not sure how significant the issue of transactional exchange really is. While the effect on our overseas earnings is not negligible, there are a few factors to consider. First, if there's a time for the U.S. dollar to be strong, it can be beneficial since weaker European earnings mean the weaker euro doesn't affect us as greatly, and we've observed that. Additionally, Brazil, one of our largest markets where our team has performed well, has seen the real appreciate against the dollar. This increase in the value of Brazilian earnings has offset some of the negative impacts from the euro and other currencies.

Okay. But you're not seeing that as a competitive issue in the U.S. just vis-a-vis Asian imports or anything like that but...

No. I think the questions about Asian imports are notable, and we've provided some specific details about this effect in our investor letter. It’s a bit challenging to interpret right now because there was a slowdown in Asian imports last year when transportation was difficult and container ships were congested at ports. This created an artificial slowdown, which we discussed in relation to the U.S. TMA data in the Americas section of the investor letter. Similar effects have been observed in Europe as well. We have seen periods where the backlog on water led to a rapid influx of imported tires, followed by a decline. The fluctuations in import volumes and their impact on the lower end of the industry seem to stem more from transportation dynamics rather than anything else. It's important to note that the weaker Asian currencies against the dollar could influence the lower end of the market, although we haven't seen significant effects yet. Moreover, this isn’t an area that particularly affects us. If any impact is to occur, it seems likely to happen in the future, but we haven't observed it significantly to date. Additionally, the volatility in volumes for non-industry member imports is challenging to interpret due to its significant fluctuations.

And just really quick, if I could fit this in. At one point, Rich had talked about the comps on nonstandard inflation, like things like energy and freight would start to get easier as we kind of close out this year and enter next year. Do you have line of sight on when that part of the excess inflation really starts to look more neutral at this point, or not yet?

I believe we need to approach this situation carefully due to several factors contributing to pressures in the fourth quarter. A significant aspect of this is the anticipated increase in energy costs in Europe. In our Europe, Middle East, and Africa business, the outcome heavily depends on these energy costs. However, we assume that these costs will exhibit some seasonality, likely moderating as we progress through winter. We can discuss the longer-term outlook in more detail later. For transportation costs, we have reached a peak in ocean freight, and these costs are beginning to decline. As we move into the fourth quarter, we expect to see a peak in inland freight, which is projected to decrease in the first half of next year. Therefore, we anticipate several non-raw material costs peaking and then improving in the first half of next year. Regarding raw materials, if today’s spot prices hold, we expect to start seeing relief by the middle of next year, moving toward a neutral position for these costs. Overall, I am optimistic about the industry’s setup and our potential to recover some margins by mid-next year, which I believe supports the optimism expressed regarding the evolution of costs.

Our next question from Emmanuel Rosner with Deutsche Bank.

I was hoping you could maybe first give us a little bit more color on the dynamics around the free cash flow outlook for the rest of the year, in particular the larger working capital draw than previously expected. And I guess related to this, I think in the early in the year, you had sort of like shared with us some sort of an essentially free cash flow scenario that was result in to sort of breakeven free cash flow under certain assumptions and scenarios with the larger working capital but somewhat lower CapEx, where would you shake out?

Yes. The key point is that the changes we've made in our financial assumptions show no significant difference from what we shared at the end of the second quarter. There is a bit more working capital due to inflation in inventory and accounts receivable, resulting in some overall working capital inflation and a slightly higher level of inventory units. We've reduced our investment levels, and there are a few other minor items as well. Overall, it remains neutral compared to the cash items we discussed at the end of the second quarter.

Okay. And can you just discuss how to think about these working capital dynamics as we, I guess, move into next year, Darren?

Yes. If we consider the outlook for free cash flow for next year, it will ultimately be influenced by the economic environment. However, we do not anticipate utilizing significant cash for working capital next year. The second half of 2021 and the early part of 2022 represented a unique period for rebuilding working capital, which we've experienced in the past, such as after the Great Recession. This type of situation has not occurred otherwise. Therefore, we do not expect to see similar usage. Additionally, if we experience any decline in the economic environment, that often leads to periods where cash flow improves as volumes and working capital decrease. Overall, we are optimistic about our free cash flow setup. In a stable volume environment, we won't have to rebuild working capital, creating an opportunity to generate cash. Even in a softer environment, we typically manage to generate cash. Regardless, we are committed to ensuring that our planned investment levels, CapEx and otherwise, align with the current environment and our long-term balance sheet targets.

Okay. I appreciate this information. Regarding the second topic, you mentioned that at current spot prices, you expect $300 million to $400 million of raw material headwinds year-over-year in the first half of 2022, which is very helpful. Is your current pricing sufficient to offset this? Or assuming that tire prices remain unchanged, will the pricing be enough to cover these raw material costs next year?

Yes. Emmanuel, I believe that what we have implemented will significantly help cover our raw material costs. It's a broad observation, but we anticipate continued pricing support through our raw material index agreements with the original equipment manufacturers in the first half of next year. There will likely be areas globally where we face costs that we'll need to address. If we look ahead to the first half, we expect raw material cost increases between $300 million and $400 million, primarily in the first quarter. Out of that, we might be facing approximately $250 million to $300 million in the first quarter, which is still considerably less than half the increase we experienced in the third quarter. We expect a similar trend in the fourth quarter. As we transition into the first half, it's important to note that we'll effectively be anniversarying about half of the pricing adjustments made in 2022. With half of the pricing adjustments and less than half of the raw material cost impact, I feel we are in a favorable starting position. That said, each of our businesses has unique conditions. While we remain cautious about energy costs in Europe, we feel optimistic about managing the other cost increases moving forward.

We will move next with James Picariello from BNP.

So as we think about the fourth quarter sequentially, despite the challenges in Europe, right? It sounds as though America's volume should trend flattish year-over-year, which should be up sequentially and then in Asia, continued healthy growth year-over-year and quarter-over-quarter. So if volumes are up sequentially, price/mix versus raws sustain at a similar strong rate to the third quarter. Are these factors enough to offset the additional inflationary pressure in the fourth quarter to drive sequential SOI growth?

Yes, I believe we are positive about the performance of our businesses in the Americas and Asia. A significant portion of the fourth quarter discussion will revolve around the situation in Europe. The production cuts we are implementing are aimed at preventing excess inventory and avoiding cash tied up on the balance sheet, as well as not carrying over surplus inventory into next year. Given the recent decline in demand in Europe, we are proactively making adjustments now. There is uncertainty regarding demand in Europe for the fourth quarter, and this may lead to unabsorbed overhead, which could have an impact in the fourth quarter that may extend into the first quarter. This is the main area of concern as we approach the fourth quarter. We have several businesses performing well, but one is dealing with the uncertainties currently faced in Europe.

And James, I would just add to Darren's comments, maybe building a little bit of what I said before. We've seen these environments multiple times. Certainly, in the last 3 years have put us to the test again. But we're putting a lot of focus, a lot of discussion on price and mix as well as we should. The team has done a tremendous job executing it. If we would have said we would have gotten over $2 billion of price/mix at the beginning of the year, you probably wouldn't have believed us. So the team has done an excellent job being able to manage through the situation. I think as you think about Europe and you think about working capital and cash flow, we know that we've got some potential headwinds as we work through Europe. We've taken some actions, and we're going to continue to focus on not only getting value of the product in the marketplace but also looking at the cost structure over there as we see some of the changes around energy costs, around what's happening in some of the geographies there to make sure that we're going to use this as an opportunity to set ourselves up for some of the upside that Darren talked about earlier. So it's good to talk about volume price and mix, but just remember, we're focused on the cost equation there as well.

Is there any way to estimate what the absorption headwind could be in Europe? Would it still follow the general guideline of $13 per tire for 1.5 million units?

I believe the production cuts in Europe pertain mostly to our consumer business. Now that we've adopted the investor letter format, our modeling assumptions are included in the supplemental slide deck, which can be found in the Financial Reports section of our website. For the EMEA consumer segment, we assume $8 to $12 per tire in overhead absorption, considering the varying production costs in Europe. If we take the midpoint of $10, we're looking at a reduction of about 1.5 million units from production, amounting to around $15 million. Some of this impact will be felt in Q4, while some may be retained in inventory for Q1. This is how we can frame the situation.

Yes. No, that's really helpful. And then just lastly, as you think about Europe's energy inflation, a $33 million headwind in the quarter, it sounds as though this likely does run higher or at least we know that your net inflation runs higher in the fourth quarter. Just maybe clarify, if you could clarify, what does that quarterly run rate look like at the energy inflation line? And does this carry over through the first half of next year, get worse? Or possibly get better through mitigation efforts? Just how do we think about that Europe energy inflation?

Yes. Just to mention that the $33 million we saw in Q3 more than doubled the energy cost for the EMEA business. We expect it to potentially worsen in the fourth quarter. Our energy costs are typically locked in a few months in advance, so as long as energy prices remain stable, we anticipate similar increases in the first half of next year before we start to anniversary the increases from Q3. There is a good chance that energy costs may decrease in the middle of next year, and we are considering that. However, we expect to continue experiencing pressure in the fourth quarter and into Q1.

And we will take our last question from Itay Michaeli with Citi.

Just a couple of follow-ups. Darren, going back to the free cash flow. I just want to make sure, just to clarify, do you expect the full year to kind of be around breakeven? Could we get a bit of a use just I know there's a couple of moving pieces on the working capital, CapEx and rationalization payments. So I just want to revisit that. And then maybe 1 for Rich as well. Hoping you could just expand a bit more on some of the EV OE fitments that you won in the quarter.

Okay. Yes. So I think the question about cash flow that you're asking, Itay, refers to the 2022 free cash flow issue?

Yes, the full year. Yes.

Yes. I believe the assumptions we've outlined in our investor letter consider our goal of protecting the balance sheet while not increasing our net debt. This mindset is important to us given our long-term balance sheet objectives. As we progress from the second to the third quarter, there are four changes in our financial assumptions related to cash flow. Two significant changes are that working capital has increased in usage from about $300 million to a range of $300 million to $500 million, with an approximate midpoint increase of $100 million. Conversely, our capital expenditures have decreased from a range of $1.1 billion to $1.2 billion down to $1 billion to $1.1 billion, also a decrease of $100 million. These two factors essentially balance each other out. Additionally, our cash income taxes have decreased slightly, with a tighter range, while rationalization payments have increased a bit, which also offsets each other to some extent. Overall, while some elements have evolved during the year, the overall picture remains largely unchanged. You also asked about our success with EV fitments this quarter.

We have continued to have success securing OE fitments. This success comes from our ability to partner with original equipment manufacturers to address their most challenging issues related to vehicle performance, handling, and sound quality. Our teams are consistently delivering solutions that meet highly demanding specifications, and we are pleased with our margins. The demand for our products remains strong, particularly for the vehicles we are involved with. Geographically, our wins have been well-balanced, with significant achievements in China, including both international and local manufacturers seeking to secure supplies for electric vehicle fitments. Our European business is also thriving, especially as German automakers transition from internal combustion engines to electric vehicles, which is providing us with increasing market share. In the U.S., we continue to win in the electric vehicle sector, collaborating with both established manufacturers and new start-ups, particularly in the light truck segment where we have a strong presence. The addition of the Cooper brand and the entry of electric vehicles into the light truck market are further enhancing our fitment successes. Overall, we are on track, and while the percentage of electric vehicles is currently small, we anticipate growth in this area. Our positioning and profitability align with our goals, and the demand trends are encouraging. Additionally, we plan to introduce intelligent tire features for key electric vehicles in the future, which excites us for what lies ahead.

And it looks like we have a follow-up from Emmanuel Rosner with Deutsche Bank.

Yes, I was hoping to take advantage of your brand-new format to ask a few more questions, if that's okay.

Yes.

First of all, regarding demand, your remarks and the shareholder letter mentioned some sequential softening, particularly on the replacement side in certain areas. Can you discuss what you are observing on the ground? Additionally, while Goodyear is building some unit inventory and plans to continue doing so towards the end of the year, are dealer and distributor inventories also on the higher side?

Yes. Well, Darren you can start, and I'll jump in. Go right in.

No, I think we've seen a couple of different things. Generally, the situation has been evolving in both the U.S. and Europe. Our trade inventories have been decreasing, which partly relates to the earlier comment I made about the increase in imports, as imports were difficult to get into the markets for much of the last year. There is some repositioning happening here, and I wanted to highlight that connection. What we are observing is a reflection of some warehouse space being adjusted to accommodate the imports that were ordered last year and began arriving over the summer. Our trade partners had no choice but to make room for those tires, and they now understand that there is better supply in the industry. They have adapted to us being reliable suppliers and have normalized their stock of some of our brands.

No, Darren, I think you said it right. Emmanuel, if you look back at last year in the U.S., we experienced a significant restocking, which was beneficial. However, as Darren mentioned, the shelves are adequately stocked now. Supply is more consistent, although the carrying cost of inventory has increased slightly, and we are seeing an influx of new tires from Asia. So, Darren, what we are observing is a normalization where we are going through cycles of resupplying, destocking, and importing. Once this stabilizes, I believe our business will continue to perform well. Our channel inventories are in a strong position and are not overstocked with Goodyear tires at the moment. This bodes well as we approach the end of 2022 and head into 2023. In Europe, there are some challenges with demand, leading distributors to take a cautious approach, but our channel inventories are better positioned in terms of volume and stocking compared to the end of the second quarter. We feel confident about our situation there too. I want to emphasize a point Darren has discussed often; during challenging times or economic slowdowns, we prioritize cash flow and working capital. We do not produce tires that are unnecessary, as we do not want excess inventory. Our goal is to generate cash. Historically, a slowing economy tends to enable us to generate more cash, and we are maintaining that mindset right now.

Okay. That's helpful information. I have one final question for Darren. Do you believe that the annualized SOI for the second half is a good basis for modeling 2023? If so, what would be the key factors to consider as we transition from the second half of this year into next year?

As we progress through the second half of the year, we have experienced some reduction in dealer stock volumes. This reduction seems tied to a one-time need for dealers to accommodate incoming imports, and I don’t expect this to repeat next year. This could potentially create a more favorable volume environment, especially in the Americas and Asia. Europe, however, is harder to predict due to its macroeconomic conditions. Nonetheless, I anticipate that 2023 could see ongoing recovery in OE production, leading to better replacement setups if dealer stocks are reduced and continue to recover. While there may be some recessionary effects, they typically result in only a 2% to 3% decline in vehicle miles traveled and replacement tire consumption. Regarding costs, we expect to see continued increases in the first half of next year, but a decline in raw material prices is on the horizon, barring energy costs in Europe. We will also be experiencing a lot of the increased costs from the past year, such as ocean freight and labor, begin to normalize. Therefore, by the middle of next year, we anticipate costs to come down, which typically offers an opportunity for margin expansion once vehicle costs drop. We have a positive outlook concerning volume and margins as we approach the second half of next year. We are also focused on enhancing OE profitability as we have encountered costs beyond raw materials that haven't been reflected in our agreements with OE customers and fleets. We have been having productive discussions in this area that could yield benefits next year, unlike this year. Additionally, by the middle of next year, we should fully realize Cooper synergies. In the third quarter, we saw about $25 million in benefits from these synergies, which translates to a run rate of around $100 million annually. Our goal is to reach an annualized figure of $250 million by mid-next year, which contributes to our optimism. The first half of next year will have its challenges, but by mid-next year, the combination of volume, cost adjustments, and Cooper synergies could provide a positive outlook.

Thank you. And this does conclude our Q&A session as well as our conference call. Thank you for your participation. You may disconnect at any time.