The Goodyear Tire & Rubber Company (GT) Q2 2013 Earnings Report, Transcript and Summary

Good morning. My name is Tony, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Goodyear Tire & Rubber Company Second Quarter Earnings Conference Call. [Operator Instructions] I would now like to hand the program over the Damon Audia.

Thank you, Tony, and good morning, everyone. Welcome to Goodyear's second quarter conference call. Joining me today are Rich Kramer, Chairman and Chief Executive Officer; and Darren Wells, Executive Vice President and Chief Financial Officer. On today's call, Rich and Darren will provide perspective on our results and outlook for the remainder of the year. Before we get started, there are few items I need to cover. To begin, the supporting slide presentation for today's call can be found on our website at investor.goodyear.com. 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. Today's 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 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. The financial results are presented on a GAAP basis and in some cases, on non-GAAP basis. The non-GAAP financial measures discussed on the call are reconciled to U.S. GAAP equivalent as part of the appendix to the slide presentation. With that, I will now turn the call over to Rich.

Thank you, Damon, and good morning, everyone. Thanks for joining us today. This morning, I want to start our call with a comment on our team's outstanding performance over the past 3 months. This performance resulted in the highest second quarter segment operating income in Goodyear's 115-year history. Record second quarter segment operating income in both North America and Asia Pacific, and year-over-year volume growth, which gives us confidence as we go into the second half of the year. In what remains a tough global economy, our team delivered in the quarter. As I review the performance of each of our businesses this morning, you will see evidence of the disciplined execution of our strategy roadmap. We're delivering market-rack innovation and award-winning products, meeting customer needs and differentiating ourselves from the competition. We're winning in profitable market segments, focusing on the areas that have the potential to deliver the best returns and profitable growth for Goodyear and for our customers. We're making progress toward our goal of being the best supplier in the industry. We're delivering more value for our customers by driving more efficient and productive operations through our operational excellence initiatives. We're executing on our significant capital investments, driving higher profitability and delivering the returns we targeted. And most importantly, we're executing our plans with strong commitment and alignment by our team. As pleased as I am with the quarter, you've heard me say many times that we're not running our business for 1 good quarter. Our long-term objective is to achieve sustainable consistent earnings and cash generation, while providing the most innovative products to our customers with increasing efficiency and reliability. Our results are clear validation that our strategy is working. We're making the right decisions in building our businesses and we're seeing consistent, repeatable improvements in our results. Before going into more detail on the quarter, I'd like to share some observations based on what I heard from our customers during my recent travels to our many markets around the globe. Their candid feedback is always valuable and instructive, and this time was very consistent. I heard repeatedly that the value of the Goodyear brand is as strong as ever and continues to pull customers into their stores. The Goodyear brand is a differentiator, that's what they tell me. They told me that our products have a value proposition that resonates with consumers. Consumers recognize the value of Goodyear products even as new tire brands enter the market. And in Europe specifically, I heard that our leadership in tire labeling is a competitive advantage and is making a difference at the counter. It's clear that, just as magazine test influences winter tires sales, high-label scores have a positive impact on purchase decisions for summer tires. I also heard from our customers that they want even more of our branded products, making reliable supply a critical factor in their ability to serve their markets. This came through loud and clear as the #1 area of focus. It's an area where we continue to make improvements to deliver the best customer service in the industry. And in my visits with truck tire customers, I heard specific examples of how our solutions are driving value, as measured by lower cost per mile. These customers praised the performance of our products and our cradle-to-grave service model, which is driving value for them and competitive advantage for us. Now whenever I travel to visit our customers, I'm reminded that this is where the game is won. This is where our market-rack approach begins in retail stores and fleet service centers, where tires are actually bought and sold. It's the best way to understand what we're doing well and equally, if not more important, what we can do even better. On balance. I'm pleased with what I've heard and I'm energized about the opportunities ahead for Goodyear to win. Turning to our second quarter results, segment operating income was a record $428 million, the best second quarter performance in the company's history. 3 of our 4 regions showed increased volume, with North America being the outlier. We see volume stabilization as a positive sign, especially in Europe. Combined with the solid execution of our key how-to's and our strategy roadmap, higher volume and the decrease in raw material cost helped us deliver our strong performance in the quarter. In North America, we delivered a record $204 million in segment operating income by driving our strategic initiatives. Our initiatives around efficiency helped reduce cost and increase cash, while we continue to introduce innovative products. For example, in June, we launched the new Eagle Sport All-Season, a performance tire that is already drawing accolades. One auto magazine said the engineering behind the new Eagle's performance is close to rocket science. While another one called it a potential game changer. Terrific handling and responsive grip in dry, wet and snow, led one reporter to claim that it will "Likely become the tire of choice for many of us." Now those are the kind of reviews we want to see. We're also excited about the launch of the new Wrangler All-Terrain Adventure with DuPont Kevlar. This tire for light trucks and SUVs delivers great off-road traction and toughness, as well as a quiet ride on the highway. It's another innovative product that renews the long time trust and quality of the Wrangler family of tires. Clearly, we continue to set the pace for new product introductions in the industry. Another area of strength is our original equipment business, where we increased volumes in the quarter and continue to win fitments on new vehicles in targeted segments. We are the primary OE tire on America's top-selling vehicle, the Ford F-150 pickup, and on the 2014 Chevy Impala, which a leading consumer magazine recently rated the best sedan on the market. And looking ahead, we have a full pipeline of OE fitments, which reinforces our selectivity strategy. When I became CEO in 2010, the most common question I was asked was, "When will North America be profitable?" The business has now posted 13 consecutive profitable quarters and 16 straight quarters of year-over-year segment operating income improvement. Our segment operating income margin in the second quarter was 9.3%, making it the fifth straight quarter with at least 5% earnings to sales. Those strong second quarters are partially due to the seasonality of our business. We believe our performance is another indication that North America is solidly on the path of sustainable value creation. Finally, on North America. You will have seen that we reached a tentative agreement on a new label -- labor contract with the United Steelworkers. Though we will not discuss the details of the agreement until after it is ratified by the USW membership, we believe we will be able to sustain our competitive position and be ready to take advantage of opportunities when demand begins to accelerate. Now turning to our Asia Pacific business. We delivered record earnings in the quarter with segment operating income of $91 million, a 28% increase over the same quarter a year ago and the second consecutive record-breaking quarter. Our business in China continues to grow faster than the industry and is focused on Premium segments, delivering a strong return on our investments in the region. The third quarter rollout of innovative new tires, such as the Assurance Triple Max, the motor trend tire of the year in China, will further strengthen our brand across Asia. I can tell you, this tire is a hit with our OE and our replacement customers we're very pleased with this rollout. Now our entrance into the commercial truck tire business in China continues to gain strength. Truck tire production in our state-of-the-art Pulandian facility has given us a distinct advantage with fleets in the world's largest truck tire market, where demand for our best-in-class products continues to grow. Looking ahead, our focus in this growth market remains on developing and expanding our truck tire distribution. We remain positive on Asia as a source of growth in both the consumer and commercial segments. We're also very pleased with our results in Latin America, as our business increase its operating income by more than 40% over last year's second quarter. We've always said that the Latin America region will have periods of volatility, driven by political and economic events. This is certainly one of those periods affecting Brazil, Venezuela and Argentina in particular. As I've also said, our management team is well equipped to deal with these issues as evidenced by our second quarter results. The Latin America market remains a key growth market for us. We continue to invest in the region and introduce new products to support the growth of premium tires in our well-established distribution network. The modernization of our factory in Americana will enable us to make more high-technology tires to serve the region in the future. Though our business in Europe, Middle East and Africa showed signs of recovery in the second quarter, we are still experiencing weak conditions in Europe. Headwinds in much of Europe continue to have a dampening effect on the automotive businesses directly affecting consumer demand. With that said, we are seeing progress even amidst the sluggish economy. EMEA had higher volumes and year-over-year segment operating income improvement, reversing the trend of the past 5 quarters. Improved earnings reflect the strong performance of our summer tire portfolio, which stood apart from the competition in the important magazine tire tests. This year, Goodyear and Dunlop tires claimed 27 wins in 39 summer tire tests published by the most respected automotive magazines in Europe. Our test winners included Goodyear EfficientGrip Performance and Eagle F1 Asymmetric 2 and Dunlop's Sport Blue Response and Sport Maxx RT. One influential publication described the Blue Response as a top class summer tire without any weaknesses. These outstanding test results further validate our strategy, the market-back innovation and these products differentiates our brands and creates value in our targeted market segments. Another continuing bright spot is our commercial truck business in Europe, where we have a great product portfolio and a strong fleet service proposition. We're seeing consistent year-over-year growth and market share gains in both mature and emerging markets, especially in Russia, where we've been able to deliver value for fleets where it matters most, reducing their cost per kilometer. In both consumer and commercial truck, we are seeing the benefit of our strong label grades, which demonstrates our ability to deliver top performance in both traction and fuel economy. In consumer tires, Goodyear has the highest rated label portfolio in the industry, with more BA-rated products than anyone else. This is a tremendous achievement and delivers on our promise to lead the industry in tire labeling. Increasing our share in profitable market segments and taking advantage of growth opportunities in emerging markets are 2 aspects of our profit improvement plan in Europe. We're starting to see the results of the plans implementation and expect further progress with stabilized volumes. Looking ahead to the second half of the year, we anticipate some volume growth in mature markets and we plan to capture our share of this growth concentrated in our targeted segments. Clearly, the global economy is taking longer to improve than most, including us, had anticipated. Now that said, we remain optimistic over the long term that volume will return to more normalized levels and that the trade will restock their inventory. We continue to believe in our MegaTrends and the migration to high-value added tires, a trend that has not slowed down much, even in this downturn. Tough decisions, disciplined behavior and commitment to our strategy are paying off. During the quarter, we delivered record earnings, our cadence of new product introductions remains vibrant, we had strong cash generation and our cost-reduction initiatives are taking hold. Though we take the long-term view, our success in the second quarter increases our optimism about the future. We now expect 2013 segment operating income of about $1.5 billion, which is the high end of our prior full year estimate. We also expect an acceleration of volume growth in the second half. But remember, the tire industry is defined by volatility. A great quarter doesn't define success, and a lower quarter doesn't preclude it. Our long-term objective is to create a business that delivers sustainable, consistent earnings and cash generation, while providing the most innovative products to consumers and customers, with increasing efficiency and reliability. That's what we're all about. That's our destination. And our performance this quarter was a significant step on that journey. Now I'd like to turn the call over to Darren.

Thanks, Rich. As Rich discussed, our strong second quarter performance is a reflection of successful execution, despite continued soft volumes in many of our key markets. This execution is particularly notable in 3 areas. First, in the continued management of price/mix versus raw materials. We continue to succeed in winning business in more Premium segments of the market, driving favorable mix and gaining share in many of these segments. Second, in working capital management. Our team has consistently driven down our working capital percent of sales, while maintaining and improving our service levels, and supporting growth in our customers businesses. Finally, we've executed in cost efficiency. This performance ranges from improving our start-up costs in our new China factory, to driving down our SAG spend, to reflect the market conditions in EMEA, to ensuring we control factory costs in North America as we build a richer and richer mix of tires. Overall, we're very pleased with our Q2 results and we're confident that our teams continued execution will position us to grow earnings and cash flows as the soft markets begin to recover. Turning to the income statement on Slide 8. Our second quarter revenue decreased 5% to just under $5 billion. Although volumes improved, revenue per tire declined 2% compared with the prior year, excluding the impact of foreign exchange. This reflects the impact of substantially lower raw material cost on contractual pricings and OE, and on pricing a replacement. The remainder is explained by year-over-year declines in our third-party chemical sales and a 1% reduction due to currency translations. We generated gross margin of 21.4% in the quarter, up 180 basis points from the prior year. Selling, administrative and general expense decreased $6 million to $691 million during the quarter. Excluding discrete items, our second quarter tax rate as a percent of foreign segment operating income was about 25%. For the full year, we now expect income tax expense as a percent of foreign segment operating income to be approximately 25% versus our prior guidance of 25% to 30%. Second quarter after-tax results were negatively impacted by certain significant items. A summary of significant items can be found in the appendix of today's presentations. Turning to the segment operating income step chart on Slide 9. You can see the progression of operating income compared with the prior year. We reported $177 million of reduced raw material costs during the quarter, which were offset partially by price/mix. Higher volumes, improved operating income by $11 million, while production cuts taken in Q1 resulted in $47 million of additional unabsorbed overhead during the quarter. Cost savings of $106 million more than offset general inflation of $68 million. As I said, we're very excited about the successes we've achieved in delivering improved cost efficiency. This includes a focused effort in material substitution, in designing tires for lower weight and in how we work with our suppliers. These are complemented by some early successes in how we manage and prioritize improvement efforts on the factory floor. All of these areas have significant opportunities for the future. Notwithstanding our enthusiasm about our execution on cost savings, I want to point out a couple of unique items that made Q2 and the first half better than the second half is likely to look. First, in the second quarter, there was no expense for profit-sharing in North America, given the contractual cap on profit-sharing had already been achieved. The provisions of the new agreement will determine what expense will apply going forward. Second, in the second half last year, we benefited from a significant favorable adjustment to our product liability accruals in North America resulting from improved claim experience over time. This is unlikely to be as significant this year. So good progress on cost, but a couple of unique items in the second quarter and first half. Turning to the balance sheet on Slide 10. At quarter end, our inventory stood at $3.1 billion, down 20% from the prior year and 3% below year-end 2012. This reflects the success we had in reducing our working capital, despite seasonal requirements and a weak selling environment. Our net debt totaled $4 billion. Compared with a year ago, our net debt increased $451 million, reflecting nearly $900 million in payments to reduce our unfunded pension obligation, offset in part by strong cash generation. Turning to Slide 11. I want to provide a quick pension update. Slide 11 shows the impact of this year's actions to fully fund our U.S. salary plans on our contributions, expense and unfunded position going forward. In addition to our funding action, we have also seen increasing interest rates through June 30, which if they remained at these levels through year end, would decrease our unfunded amount by another $400 million. On the following slide we've expanded our pension sensitivity analysis to show the potential impact interest rates can have depending on where they end of the year. Slide 13 shows free cash flow from operations. During the second quarter, we generated $357 million of free cash flow from operations, improving $138 million versus the prior year. Over the last 12 months, our free cash flow from operations was $1.4 billion, after investing $1.1 billion of CapEx. The significant cash flow positive has been our continued progress on reducing our seasonal working capital usage during the year. In addition to focusing on our working capital as a percent of sales at year end, we've set goals this year focused on reducing seasonal working capital during the course of the year, driving down our average working capital as a percent of sales. In the second quarter, our 12-month average working capital as a percent of sales improved to 14% from 17% in 2012 and 19% in 2011. Through year end, our outlook has improved, so we now expect working capital to be neither a source nor a use, even after significant reductions in working capital in 2012. Moving to individual business units. I'll start with North America. North America reported an all-time record in segment operating income of $204 million. While unit volumes were down 3% and results were impacted negatively by $40 million of higher unabsorbed overhead, the North America team delivered strong price/mix versus raw materials and effectively controlled costs to deliver another great quarter. Two other points on North America results. While price/mix for the quarter was $76 million negative, partly attributable to our raw material cost past-through arrangements with our OE, fleet and OTR customers, mix remained favorable. Second, as I mentioned before, we did benefit from a reduction in profit-sharing expense of $13 million versus last year's second quarter. The steady delivery of improved results in North America has been remarkable in such a low-volume environment. And the fact that our return on sales is now significantly exceeding our 5% threshold, it means there is substantial economic value being created by this business, giving us the motivation and the right to want to grow this business. We're really excited about the opportunities we see in North America as industry volumes recover. Europe, Middle East and Africa delivered segment operating income of $51 million in the quarter, which compares to $19 million in Q2 2012. Q2 is the first quarter of the year-over-year earnings growth after 5 quarters of declines, showing some stabilization as we implement our profit improvement plan. European industry volumes in the second quarter began to show signs of stabilization, although at low levels, with the consumer replacement industry increasing 4% and commercial replacement increasing 5%. In the Consumer business, the growth is mainly driven by higher summer tire volumes, as the summer season was delayed in Q1 by late winter weather. This was offset partly by a slow start to preseason winter sales. In OE, we saw a minor increase in consumer and a 3% reduction in commercial truck. Our volumes were up 400,000 units year-over-year, which is the first increase in 6 quarters. You recall we discussed in April, a 3-point profit improvement plan for EMEA. This plan included increasing our share in targeted segments, growing in emerging markets and improving our cost structure. We made progress in each area during Q2. EMEA performance in Q2 reflects progress made to improve our value proposition in our consumer tire business. Our summer sales have been successful and we continue to gain share in high-performance summer segments, driven by our magazine test winning products and our industry-leading label grades. In addition, as in the first quarter, our Truck business continued to deliver strong year-over-year earnings improvement, driven by strong product and service propositions, and continued growth in our share in emerging markets. Although our cost performance was negatively impacted by low-production volumes, we saw solid steps forward in our process to close the Amiens factory in France, and in our efforts to drive an additional $75 million to $100 million in productivity over the next 3 years. These actions, along with our continued investment in industry-leading products and technology, will help us return our EMEA business to its historical margins. In Latin America, total unit volumes increased 4%, representing the second consecutive quarter with year-over-year growth. Excluding the impact of exiting the bias truck business in certain countries, total unit volumes increased 9% with the growth driven largely by our Replacement business. Latin America sales increased over 5% versus the same period in 2012, driven by favorable volume and price mix, offset partially by $50 million of foreign exchange impact, mainly related to the devaluation of the Venezuelan bolivar and the weakening of the Brazilian real. Second quarter operating income was $82 million, or $24 million above the prior year level. The improvement was mainly driven by strong price mix of $52 million, lower raw material cost and increased volume. These benefits were offset partially by cost inflation and unfavorable foreign currency translation. The continued improvement in our Latin America business demonstrates our team's ability to manage the volatility in Venezuela after the February devaluation, and to make progress in transforming our business model in Brazil. Our Asia Pacific business reported record segment operating income of $91 million for the quarter. The $91 million represents a $20 million increase year-over-year, reflecting our growing business in China and $9 million of lower start-up expenses associated with our new facility in Pulandian. Unit volumes in Asia Pacific were 5% higher versus prior year, driven by the businesses in China and the ASEAN countries. While we remain confident in our ability to deliver strong return on investment in Asia, the second half will be challenged by the slowing economic growth in several markets and weakening currencies in key countries such as Australia and India. Turning to Slide 15. You can see our 2013 industry outlook for North America and EMEA, which is unchanged from our call in April. On Slide 16, we've updated our full year modeling assumptions for 2013 and added an outlook for the third quarter. Notably, full year volume assumptions are in line with prior guidance, reflecting a slow but steady volume recovery in developed consumer replacement markets. Our unabsorbed overhead outlook is consistent with these expectations, with no adverse impact in Q3 and unchanged guidance for the full year. Turning to Slide 17, you'll see other key assumptions for 2013. We've refined our assumptions for a few items. In particular, we're now showing interest expense of $395 million to $415 million, due to improved cash flows year-to-date and interest rates remaining low. Given the improvements in our working capital, we now expect it to be neither a source nor a use of cash for the year. Also, we now expect our capital expenditures to be about $1.1 billion, the midpoint of our prior range. Before we go to Q&A, I'd like to again highlight our strong performance in managing price/mix versus raw materials, our strong cost performance and our continued delivery on cash flow. These successes give us confidence in delivering the high end of our prior earnings range and building momentum going into 2014. With that, we'll open up the call for questions.

[Operator Instructions] We'll first move to Rod Lache with Deutsche Bank.

It's actually Pat Nolan on for Rod. A couple of questions. You've previously talked about that your goal was to freeze and then fund the remaining defined benefit pension you have in the U.S. Assuming you're successful in doing that, could you just discuss the sources of funds you'd consider using to fund the pension?

Yes. So Pat, the pension strategy that we announced in February was a combination of prefunding and derisking plans once they're frozen. And obviously, we completed a transaction in Q1 that fully funded the U.S. plans that we'd previously frozen, and that was done with debt financing. So yes, I guess that demonstrate that debt financing is certainly an alternative. I mean the benefits of this strategy reduces the overall volatility of our pension plans, which have been a long-term drag on shareholder value, allows us to improve our cash flow and make it more predictable going forward, which opens up some increased flexibility for us. And ultimately, allow shareholders to benefit from the improving results in the underlying tire business. The step we've got next is to freeze the remaining plans. And I can't comment a whole lot about that further at this stage. But until that occurs, we're not in a position to consider further funding actions. You saw that we also had an increase in interest rates through the first half, that relative to the numbers on Slide 11, would reduce the unfunded amount by another $400 million. So if we take the position that we're in and consider that it's something that could occur over time, I think the sources could be a combination of things. And certainly, we're continuing to drive in areas like working capital to focus on generating cash in the business itself. So I think the timing of those actions is going to determine how much of it would be able to be from free cash flow from operations that we're generating internally versus other sources we might consider like the debt raise we did in Q1.

That's helpful. Can you also touch on your CapEx going forward? The guidance came down slightly for this year, but does CapEx trend down over the next several years as we get through the Chinese expansion and capacity?

Yes. So Pat, we spent about $500 million through the first half, and that's essentially in line with the signal that we've given for the year of $1.1 billion. We'll continuously evaluate capital expenditure levels, thinking about industry outlook, thinking about technology requirements to keep our product line as innovative and strong as it is today, and then thinking through our capital allocation priorities. But you're right in pointing out that we have major projects in Chile and China that are going to be effectively completed this year. We haven't announced any other new projects of this size and scale, although we are focused on things like expanding and modernizing our facility in Americana, Brazil. But we continue to go through our planning process. Once we've gone through that process, we'll provide you some more information on future plans as we typically do.

If I could just sneak in one more. Your North American replacement volume down 5%, that appears to be a little bit below what the industry did in the quarter. Can you just discuss how you think you performed relative to the industry? Was there a mix factor, maybe the high end underperformed the overall market or was there a CV mix that impacted that?

No, Pat. I would tell you that we're pretty pleased with North America results overall, it's probably the best way to answer that question. In terms of replacement volumes, obviously, we saw, certainly, an improvement from where -- from an industry perspective, where Q1 was to Q2. So we're seeing some stabilization as we go forward. I would continue to tell you that we really have a very disciplined approach to managing volume, price and mix, certainly versus raw material as well. And our North American business, in its totality, I think is a very good example of that as we look forward. Also thinking our North America business, remember on the replacement side, there's a lot of different channels in the business that we sell to. And obviously, we don't go through those in particular, on the call. But when I look at it, broken down by the channels, we're certainly making progress in the places that we want to. So I'm very pleased with that. And really, as we look on to the second half of the year, we see an industry outlook that's better. I referenced a number of new products on the call, we're seeing a very good take-up of those products already in July. And also, we had some destocking in some of those channels in the past, which we don't really expect to see again. So overall, I think we're in a pretty good position.

Next, we'll move to Itay Michaeli with Citi Group.

Just wanted to chat on raw materials here initially. I think, last quarter, the view was that as volume starts recovering in the second half of '13, that raw materials cost will probably start to go up. I think we've actually seen volume stabilize, but raw materials continue to go down. Can you talk about your latest outlook there, in terms of how much the recent move in raw materials may be impacting your financial results this year? Maybe how much it may impact it next year? Just your overall view as well, in terms of the price dynamics in response to the recent tailwind in raw materials?

Yes. Itay, you have a good memory. And I'm glad because that is our long-term view. I think, Darren, you can break it down a little bit more granular for him.

Yes. I think we continue to see low raw materials prices today, reflecting both the macroeconomic weakness and continued weakness in tire industry volumes. Our long-term expectation is what it is, and that is as volumes recover, we'll see an upward trend in raw materials. In Q2, raw material costs were down $177 million or about 9%. And we continue to expect for the full year, that raws will be down about 10% for us or around $800 million. Now this outlook is consistent with the guidance from our Q1 call. And although you'd look and say, well, natural rubber that we buy is down 6% or 7% since April, and butadiene is down as well. On the other side, there are some materials like carbon black that are actually up from where they were in April. So it is a bit of a mixed bag over the last 3 months. And when we look at our international businesses, given the currency -- a number of currencies have weakened versus the U.S. dollar. In those businesses, we're actually seeing a lot less benefit from raw materials and in fact, can be some increases depending on where the currencies are. So that has -- that, in the international businesses, that changes the picture a bit because with weaker currencies and markets, I can mention Brazil and Australia and India, as 3 examples of that. That drives the cost of raw materials in local currency back up, even if they're relatively flat as we look at them in U.S. dollars. But I continue to see that -- as we see the volume start to increase, as we go into the third and fourth quarter, I think that's generally been the trigger of raw materials going up. I'll say that volume -- we look back to 2011, it took a couple of quarters from the time volumes started to head down, before raw materials started to go down. And so the timing won't necessarily be concurrent. In the past, it's been within a quarter or 2, raw materials start to react. And so I think something like that is a reasonable expectation. So it may take a bit of time, but the raw materials will react to volume.

Very helpful. And then just a question on volume in the U.S. It seems that, versus some of your competitors, you probably have greater exposure to the first replacement sale, maybe a car, it's 3 or 4 years old. And presumably that business maybe at a trough today, just given where the SAR was a few years ago, would you agree with that view? And then can you maybe tell us or compare how the profitability on a first replacement tire sale compares to your overall profitability in the North America replacement market?

Itay, I think that's a pretty accurate statement. And I think, really, part of our strategy being on first replacement and second replacement, and really linking that to our selectivity strategy from an OE perspective is really pretty much in line with what we've been talking about in the past. And as we've migrated away from private label, that private label is obviously where you're getting into probably beyond third, fourth and fifth replacement on OE vehicles -- or excuse me, on replacement vehicles. And that's a part of the market that really is in that sort of 4 for 99 market, where it's really tough to make money. So describing ourselves as linked to first and second replacement, is exactly how we are managing the business and the profitability there is frankly much, much better than it is at the low end of the market.

Absolutely. And then maybe one last quick housekeeping. Darren, it seemed like the incremental margin as implied by the year-over-year volume of $11 million on the slight increase in volume was fairly higher than usual. Is that just sort of a mix issue there?

No. I mean, Itay, it's a good thing to point out because I think what you're seeing there is we've got some volume increases in some higher-margin segments and geographies. So we've got good growth in some areas in commercial truck, still some growth in large mining tires, which is helpful. And we see some strong growth in both Asia and Europe, where we've got some higher-margin tires. Where in places where we've had some weaker volume, we've actually been on the lower margin end of the spectrum. So maybe a little bit of the law of small numbers, but certainly something there that demonstrates our focus on our targeted market segments.

Next we'll move to Aditya Oberoi with Goldman Sachs.

I had a question on Europe. It seems from your commentary that you believe that demand is kind of stabilizing. Just curious, are you seeing the demand stabilizing just because dealers have started to put back inventory on their shelves? Or is it that the end demand or the sellout has started to improve?

Yes. So I think that, clearly, we have seen a cycle of some destocking in the channels. So -- and we've separated into summer tires and winter tires, but we've seen, last year, a very weak summer season. This year, we've had certainly a better product lineup and better value proposition, so our sales in the second quarter were better. And that's helped as our dealers have sold those tires out into the market, that has kept summer inventories in better shape. I think for winter tires, and we're just starting into the winter tire selling season now. We do see that dealers have come off 2 weak winter seasons. And not surprisingly, early preseason sales in June were pretty slow. But inventories in the channel, because of the late winter weather we got in the first quarter, and because dealers have delayed their ordering a bit in Q2, have left the channels in better shape than they were a year ago. And we're starting to see some sales in July improving in winter. And I think that, that does partly reflect the fact that inventories are in better shape. Obviously, winter weather is going to be a key for us here in the second half, but I think we're real confident in our value proposition. So if you take that summer and winter together, you'd say, clearly, we look and say, part of the significant weakness that we saw in Europe during 2012 and early this year was some element of dealer destocking. And obviously, once that's done, it's done. But I think that there is also some stabilization in the sellout and that is ultimately what we need. We need to sell -- not only sell the tires in an industry, we need to sell them out to retail or out to consumers, I think we are seeing some better stability there.

Got it. That's very helpful. And if I may, one more here. On North America margins, obviously, adjusting for some of the 1 x items you mentioned, it still seems a very strong quarter from a North American standpoint. How should we think about, like, are there any peak margins or margins that are the new target for Goodyear? Like I know, historically, you've targeted 5 and now we are already touching double-digit pretty close to that. So is there a new normal for North America that we should be thinking about?

Adi, we haven't put out any new guidance of what you would say the new normal for North America. We're very pleased with the progress we've made. As we've said in the past, we're creating value in a business that hasn't done so for a long period of time. That remains our focus. And I think that's how we're going to continue to manage the business going forward. If we have a new target for North America, we'll give that to you at another time. But right now, we're just focused on driving the value proposition that we've spoken of, hopefully, consistently over the last number of years and you're seeing the results of that right now.

[Operator Instructions] Meanwhile, we'll move to Ravi Shanker with Morgan Stanley.

Can you just talk a little bit more about the position with labeling in Europe? What are your current position as in terms of what percentage of your product actually have AAs and ABs and so forth? Where you are versus the competition? Also, are you seeing any change in customer behavior in your stores with people coming in and asking for specifically for a higher label tires?

So on the first part of the question, I think, Ravi, I would point you back to a slide that we have that shows our labeling portfolio versus unnamed competitors. And I think that's probably the best gauge that we would give you of how we stand. And what you'll see on that page is that we do have the best labeling portfolio in Europe for summer tires right now. So that's, I think, the best place for you to look there. In terms of customer behavior. As I mentioned earlier, I've been out visiting our customers, talking to consumers. And I would tell you that as we look at the consumers coming to the counter, I mentioned this in my remarks. Just as consumers coming into stores in Europe really value the magazine test for winter tires, it's almost a directory to say, which tires they want to buy and consequently, which tires the dealers want to stock. We're seeing a migration to that very similar in terms of labeled tires. As the consumer gets to the counter, and as the purchase decision has to be made, those label scores have a significant and increasing impact on purchase decision of the consumer. I would say that that's a trend that's probably still a bit nascent, that's going to expand. And we're seeing it more in the Germanic countries than in Northern Europe today, in Southern Europe, where I think the economies are a bit tougher. It's probably less relevant today. But ultimately, I think it will become a bit more pervasive. But I can tell you from direct discussions with our customers out in the field, it is -- I think, some of them have been surprised at some of the consumers coming in fairly well educated on label scores and consequently, making that a real element of their purchase decision.

Next, we'll move to Brett Hoselton with KeyBanc.

Darren, you kind of talked a little about European margins and potential improvement there. I guess, what I'm wondering is, did you have a particular time frame in mind? And was there some specific actions that you were looking to make or take to see that improvement?

Yes. So Brett, I think the way that we look at our European business, we're starting today with profitability over the last 12 months, a little over $200 million. And we've got in mind our 3-point improvement plan. And I think the 3 areas that we're focused on are those 3 areas. And the first one is achieving better share in targeted market segments. And I'll say that the big progress we made in Q2 is clearly in the high-performance summer segments. We were gaining share on those segments, that's exactly where our high-labeled portfolio, we were just talking about on the prior question, that's where it hits the market. And that's where the magazine test have really helped us. So those high-end summer fitments. Second thing, yes, we're continue to grow in emerging markets. And emerging markets that we can serve a lot better today, given the soft volumes in Western Europe. So that frees up supply that we can send into supplying emerging markets that we have underserved in the past. So I think both of those, you'll see coming through in terms of margin improvements in Europe. The third point, and one that we can't get around, is the fact that we do have to improve our cost structure in Europe, given the kind of volumes that we're running at and the closure of the Amiens, France facility is an element of that, which would, by itself, add $75 million to our earnings in Europe. In addition to that, over 3 years, so that's this year, next year and the year after, we're targeting another $75 million to $100 million of cost savings over and above inflation to deliver improved margins for Europe. So I think you take -- where were running today, add the $75 million for Amiens, add another $75 million to $100 million for the additional productivity that we're able to generate. And then add to that, the margins we're able to achieve through the mix from targeted market segments and the growth in emerging markets. And I think that's the -- as we look at the next 3 years for European business, that's the growth path that we're looking at.

And then as we think about the margins, basically, for the overall business, I mean, North America as an example, what, 9% segment margin is very, very good margins relative to your target of 5%. So you certainly met that target and exceeded it. But you talked about raw materials potentially moving back up at some point in time here. And I guess what I'm wondering is, how do you think the industry is going to react from a pricing standpoint, as raw materials move back up? Do you anticipate that the industry is going to try to maintain those margins by raising prices or do you think that, that might result in some margin compression?

Brett, I think, obviously, we'll talk from our perspective. And I said this earlier in the call, and we have a very disciplined strategy that we've been executing in terms of balancing volume, price and mix versus raw materials. We have a good track record of doing that. And I think you should expect us to continue doing that moving forward.

It appears we have no further questions at this time.

Okay. Thank you, everyone.