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Edited Transcript of GT earnings conference call or presentation 26-Jul-19 1:30pm GMT

Q2 2019 Goodyear Tire & Rubber Co Earnings Call

AKRON Jul 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Goodyear Tire & Rubber Co earnings conference call or presentation Friday, July 26, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Darren R. Wells

The Goodyear Tire & Rubber Company - Executive VP & CFO

* Nicholas Edward Mitchell

The Goodyear Tire & Rubber Company - Senior Director of IR

* Richard J. Kramer

The Goodyear Tire & Rubber Company - Chairman of the Board, CEO & President

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Conference Call Participants

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* David J. Tamberrino

Goldman Sachs Group Inc., Research Division - Equity Analyst

* James Albert Picariello

KeyBanc Capital Markets Inc., Research Division - Analyst

* John Michael Healy

Northcoast Research Partners, LLC - MD & Equity Research Analyst

* Rod Avraham Lache

Wolfe Research, LLC - MD & Senior Analyst

* Ryan J. Brinkman

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

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Presentation

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Operator [1]

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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 Second Quarter 2019 Earnings Call. (Operator Instructions)

I will now hand the program over to Nick Mitchell, Senior Director, Investor Relations.

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Nicholas Edward Mitchell, The Goodyear Tire & Rubber Company - Senior Director of IR [2]

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Thank you, Keith, and thank you, everyone, for joining us for Goodyear's Second Quarter 2019 Earnings Call. I'm joined here today by Richard Kramer, Chairman, 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 the call are reconciled to the U.S. GAAP equivalent as part of our -- of the appendix to the slide presentation.

And with that, I will now turn the call over to Rich.

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Richard J. Kramer, The Goodyear Tire & Rubber Company - Chairman of the Board, CEO & President [3]

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Great. Thank you, Nick, and good morning, everyone. During today's call, I'll share some highlights of our second quarter operating performance and discuss the progress we are making with several of our initiatives. I'll also take a few minutes to highlight the recognition that our teams and products are earning around the globe.

Darren will follow with a review of our financial performance and an update on the steps we're taking to mitigate the impact of the raw material cycle and the global OE slowdown. He will conclude by offering some insights into how we're thinking about our business going forward.

Our U.S. business continued to perform well in the period as we maintained the momentum from recent quarters. In all, our U.S. consumer replacement volume increased 4%. This growth was well balanced as shipments increased across all our major distribution channels, including retail, wholesale and mass merchants.

I'm pleased to say that we accomplished this while increasing our revenue per tire relative to last year, which is a testament to the strength of our brand and our product offering. We continue to excel in the all-important, high-margin premium segment of the market. Shipments of large rim diameter tires increased by 9%. This growth was more than double the industry and came on top of a strong performance in the previous year.

We benefited from the increasing premium supply aided by the ongoing ramp-up of our newest manufacturing facility in the Americas, which remains on track to provide 3 million more tires by the end of 2020. Our fill rates are improving and back orders continued to decline, allowing our dealers and aligned distributors to better meet the high level of demand for our best-in-class products in the market.

Our U.S. commercial replacement business maintained the momentum it gained earlier in the year. We continued to increase market share in the second quarter despite taking additional actions to increase the value we are capturing in the marketplace.

U.S. commercial OE shipments increased nearly 20% in the quarter on top of a similar gain in the previous year, far outpacing industry trends. These impressive results reflect the strength of our fleet solutions offering and commercial product portfolio.

We're also seeing better manufacturing performance at our commercial truck tire plants. While not where we need them to be, our efforts to improve the productivity of these facilities are paying dividends with output increasing and conversion cost per unit declining.

During the quarter, we successfully launched goodyeartrucktires.com, our commercial e-commerce website, making another first for our company and for the industry. This new platform better positions us to meet the changing needs of commercial truck fleets and owner operators and enhances the online competitiveness of Goodyear's commercial tire dealers.

In Latin America, industry trends remained volatile, reflecting slowing economic growth and volatile exchange rates in the region. In Brazil, our largest market, volume declined 2%, with weakness in our consumer OE and commercial businesses more than offsetting modest growth in our consumer replacement business.

Our business in Europe, Middle East and Africa turned in mixed results. Our commercial business continued to perform in the EU during the quarter despite economic growth slowing in many countries in the region. Notwithstanding this environment, truck miles driven remain supportive in the Eurozone, allowing us to leverage our industry-leading fleet solutions offering and successful launches of the KMAX GEN-2 and FUELMAX GEN-2 commercial tires for the drive and steer wheel positions.

Turning to our European consumer replacement business. Industry demand remained sluggish in the quarter. This backdrop negatively affected EMEA's overall consumer replacement volume, especially in Western Europe. However, we were able to gain share in the period.

Despite the weak environment, channel inventory of both summer and winter tires remained below a year ago as dealers are managing inventory, consistent with demand trends. This dynamic, along with the investments we've been making to enhance our product portfolio, leave us well positioned for when the markets turn.

Transitioning to our operations in Asia Pacific. Trends in China continued to have an outsized influence on our overall performance in the region. Earlier in the second quarter, we saw what seemed like some positive indications in both OE and replacement. As the quarter progressed, these positive signs moderated.

Our results were also impacted by the downturn in the Indian auto industry, which has been impacted by a slowing economy and tighter credit conditions. Our overall shipments in India fell by more than 10% driven by lower vehicle production.

At the beginning of the year, we indicated that a challenging macroeconomic environment for the industry would limit our performance in 2019, especially through the first 6 months of the year. Given these factors, our results do not reflect the true long-term capabilities of our assets, our people and our brand.

Our product portfolio, distribution network, retail presence and brand are all stronger than ever. While we wait for the environment to improve, we are investing, innovating and forming strategic partnerships to build a stronger business capable of winning today and in the future.

Product innovation and vitality are top on our list. We're investing in our product portfolio guided by our market-backed approach to innovation and design. We have good momentum on several fronts. Our engineers continued to raise the bar on what is possible in the areas of product design, compounds and performance, and the advancements are not going unnoticed.

Earlier this month, a leading independent tire review website among auto enthusiasts selected the Goodyear Eagle F1 SuperSport as the top all-around, ultrahigh performance summer tire. It earned this designation by offering superior wet handling without sacrificing performance in dry conditions. On wet pavement, the Eagle F1 SuperSport beat the closest competitor by more than 2 seconds, an impressive feat given the short lap test tracked. It did so while essentially matching the capabilities of the top competitors on a dry track.

Our racing operations are leveraging the technology and knowledge that went into building this world-class performance tire. The team is developing a new range of tires for the FIA World Endurance Championship, including the Le Mans 24-hour race, supporting Goodyear's return to the European and international sports car racing circuits.

We are having a lot of success outside of Europe as well. Our product lineup in the U.S. has never been stronger, and it's not just the professionals who have noticed the quality and performance and characteristics of our tires that we're bringing to market. Positive consumer feedback recently propelled the Goodyear Assurance MaxLife to the top ranking and the standard touring all-season category on a leading e-commerce website. And more recently, the Goodyear Eagle Exhilarate received positive ratings from testing conducted by the e-tailer in the ultrahigh performance all-season category. The Eagle Exhilarate sets a new standard for wet traction performance.

Customers are embracing more than just our tires. Consumer feedback on our newest customer-facing business is also encouraging. Our e-commerce platform on Goodyear.com and Roll, our new innovative retail concept, are receiving 5-star feedback from consumers. More importantly, consumers are spreading the good word to their friends and family. Roll's average Net Promoter Score is on par with those seen in best-in-class retailers outside the tire industry, which is not the norm for our industry. We're still in the test-and-learn phase, but the positive feedback reinforces that we're on the right path.

With our product portfolio where it needs to be, we've taken steps to strengthen our consumer OE business as well. We expect to start seeing the benefits from these steps over the next 2 years, with increased volume and better margins driven by enhanced product technology. Our continued focus on quality, technology, brand, value proposition and collaboration is driving increased win rates in the segments that we are targeting.

Vehicle trends, including the shifts toward electric vehicles, are making tire design and production for OE more difficult and reducing the number of relevant competitors for OE business. These trends play to our strength as a global leader in tire technology and will deliver the volume growth Darren will take you through in a few minutes.

Earlier in the year, our global consumer OE team was recognized by Ford and General Motors. Goodyear was the recipient of GM's Supplier of the Year award and Ford's World Excellence Award for achieving the highest levels of excellence in the industry as an original equipment supplier. This marked the second straight year that GM bestowed this honor on Goodyear.

Additionally, our U.S. consumer OE business ranked highest in the performance sport category in J.D. Power's U.S. OE Tire Consumer Satisfaction Study. Our ability to develop great products provide outstanding customer service and help solve problems is why OEMs want to do business with Goodyear. We are committed to exceeding expectations as a supplier and achieving the highest levels of excellence in quality, cost, performance and delivery. This commitment will sustain our position in the industry.

Ensuring adequate supply of premium tires is crucial if we're going to fully capture the benefits of our industry-leading product portfolio and expanding OE pipeline. The ramp-up of our newest manufacturing facility in the Americas remains on track. In Europe, we started expanding our manufacturing facility in Slovenia, and we announced plans to modernize our plants in Fulda and Hanau, Germany. In total, these projects will bolster our global support of premium tires, better positioning us to respond to our customers' rapidly changing needs and deliver the high-quality products they demand.

Last but not least, we are diligently working to gain additional efficiencies throughout the organization. Most notably, our manufacturing teams are working to reduce our conversion costs. Our European restructuring program will significantly decrease our cost structure in the region as we curtail production of tires for the declining less profitable segments of the market.

We are boosting the productivity of our plants by investing in new equipment that allows for further automation of the tire building process. We have an opportunity to gain additional benefits from our plant optimization program by empowering and enabling our teams to deliver stronger and attainable performance over time. Maintaining our cost competitiveness is crucial to our long-term success, and we're committed to driving productivity gains across our manufacturing footprint.

We operate in a cyclical industry with macro factors often greatly influencing our performance over short periods. I'm encouraged by the fact that several of the external factors that have significantly impacted our business in recent quarters are beginning to moderate. Looking forward, I'm really excited about the prospects for each of our strategic business units.

From the beginning of my time as CEO, I've emphasized that we are running our business for the long term. Now that we are in another industry down cycle, the second of my tenure and the third of my career at Goodyear, it's clear that our long-term approach is the right one. Our conviction in that philosophy is unwavering.

Certainly, we must operate our business today based on current market realities. At the same time, we are responding to changes we anticipated in distribution and retail and in behaviors and expectation of consumers. These shifts in mobility and transportation and their impacts on our business are already upon us and will continue to evolve. These factors both inform and define our long-term focus. We will continue to navigate through the volatility of our industry while maintaining our vision and strategy for the future. Ultimately, Goodyear's success will not be defined by short-term performance during a down cycle, but by our global leadership in a rapidly changing world of mobility.

Now I'll turn the call over to Darren.

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [4]

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Thanks, Rich. While second quarter results were a bit disappointing, with both volume and price and mix below where we wanted to see them, the first half overall was consistent with our expectations. We knew that a number of macro factors would be working against us through the first half. These included higher raw material costs; a stronger U.S. dollar; weak OE volume, particularly in China and India; and increasing energy and wage inflation in Europe. Results for the second quarter were affected by these factors while also being impacted by weaker-than-expected European replacement industry volumes.

While the first half results were unfavorable versus the prior year, our expectations for the second half are better. I'll come back to this in a few moments. But overall, raw material cost increases will not be a big factor in the second half. Our volume outlook is more favorable, and we expect faster progress on price/mix than we saw in the last couple of quarters, and we should see some meaningful working capital improvements.

In addition to factors impacting the second half, there are a couple of key positives I will also highlight as we look out over the next couple of years. First is the benefit from cost reductions we have underway. These include the manufacturing footprint restructuring actions we have announced in Europe. Second is a significant inflection in our OE volume after a decline of 2 million to 3 million units this year. This inflection is based on the fitments that we've won over the last 18 months. I'll come back to these future opportunities here in a few moments, but first, let me review the results from Q2.

Turning to Slide 9. Our second quarter sales were $3.6 billion, down 5% from last year, reflecting the impact of unfavorable foreign currency translation and lower volume. These effects were partially offset by improvements in price/mix. Unit volume contracted 4%, driven by a 12% decline in consumer OE shipments. The reduced OE volume is consistent with the drop in vehicle production across the regions, most notably in China and India as well as the strategic actions we are taking to improve our portfolio in the U.S. and Europe.

Continuing the trend from the first quarter, replacement shipments were relatively stable, with weakness in EMEA and Asia Pacific, largely offset by growth in the Americas. EMEA's performance reflects weak industry sell-in trends, especially in the summer category. Asia Pacific's decline was more than explained by weak consumer replacement shipments in China. Solid growth in the U.S. consumer replacement market once again drove the increase in the Americas.

Segment operating income for the quarter was $219 million, down $105 million from a year ago. This year-over-year performance was consistent with our first quarter results, with several of the same factors driving the variance. Our results were influenced by certain significant items. And after adjusting for these items, earnings per share on a diluted basis were $0.25.

The step chart on Slide 10 summarizes the change in segment operating income versus last year. The impact of lower volume was partially offset by improved overhead absorption from increased Americas production in prior quarters. Raw material costs increased $81 million, reflecting transactional currency headwinds, an increase in non-feedstock costs related to stricter enforcement of environmental regulations in China and higher commodity prices. Keep in mind, we have a 3- to 6-month lag as these impacts move through our inventory and into cost of goods sold.

We delivered $35 million of price/mix improvements as the benefits from our pricing actions were partially offset by negative mix in the Americas, which I'll expand on later with my comments on the second half. Cost savings of $59 million more than offset $48 million of inflation. Inflationary headwinds continued to be the strongest in EMEA.

The negative effect of foreign currency translation totaled $11 million. The other category was driven by weaker results from our other tire-related businesses, including our U.S. chemical operation, and includes our share of startup losses in TireHub, which I'll also come back to in my comments about the second half.

Turning to the balance sheet on Slide 11. Net debt totaled $5.8 billion, up from $5.4 billion a year ago, reflecting share repurchases in late 2018 as well as higher working capital, including inventory that is above targeted levels, particularly in Asia.

Note that we reduced production in the second quarter by about 1.1 million units, and we will reduce third quarter production by a similar amount versus previous year to address these inventory levels. Our liquidity profile remains strong, with approximately $3.4 billion in cash and available credit at the end of the quarter.

Slide 13 summarizes our cash flows. Net cash generated by operating activities were $73 million, down from $305 million last year. Capital expenditures were $180 million, down $14 million.

Turning to our segment results, beginning on Slide 14. Americas volume of 17.1 million units was down about 1% compared to the prior year. Solid growth in replacement shipments and commercial OE volume in the U.S. was offset by weakness in consumer OE, reflecting weaker vehicle production and the impact of choices we've made on OE fitments.

Segment operating income was $134 million, down $20 million from last year. The decline was driven by higher raw material costs and reduced earnings from third-party chemical sales. These factors were partially offset by improved factory utilization, including at our new Americas plant.

The Americas first half 2019 results were negatively impacted by supply constraints, which we described in detail on prior calls. We made good progress addressing these issues during the first half of the year and are in a better position to deliver stronger mix gains in the second half.

Turning to Slide 15. Europe, Middle East and Africa's unit sales totaled 13.3 million units, down about 6% driven by weaker light vehicle production and lower replacement industry demand during the quarter. Note that we gained share in European consumer replacement during the quarter.

Second quarter 2019 segment operating income was $44 million, significantly below last year. This decrease was driven by lower volume, increased material costs and unfavorable foreign currency translation, partially offset by improved price/mix.

Turning to Slide 16. Asia Pacific tire units totaled 7 million in the quarter, a 6% decline from the prior year. Consumer OE volume declined 11%, reflecting weakness in the Indian and Chinese auto industries. Consumer replacement tire shipments fell 2%, driven by continued challenging environment in China and actions we've taken to raise prices in part of our distribution channels. Outside of China, our replacement volume grew.

Segment operating income was $41 million, a $29 million decrease from last year. The decline was driven by lower volume, higher raw material costs and higher conversion costs, primarily due to lower factory utilization.

As I mentioned in my introductory comments, our expectations for results in the second half are better as puts and takes are beginning to balance out. The first key reason for these expectations is that the increases in raw material costs are largely behind us. At today's price levels, raw materials will be up slightly in the third quarter and it will be effectively flat in the fourth quarter.

Given most of the materials have been purchased or contracted at this point, the level of uncertainty in raw material costs between now and year-end is limited. The moderation of raw material cost allows the benefit of our past pricing actions and our improving mix to hit the bottom line.

The second key reason for a better second half outlook is an improved volume expectation in our consumer business. After a first half that saw decreases in both consumer OE and replacement, we expect to see increases in both businesses in the second half. This is partly driven by industry dynamics, including an easier comparable in international automotive production. And partly, it reflects the improved confidence we have in our product lineup, product supply and relatively lean channel inventories.

The third key reason is increased benefit from mix, particularly in our U.S. consumer business. We have experienced 3 quarters of negative mix in our U.S. replacement business, not driven by product mix, but driven by sales through lower-margin channels. As we discussed previously, part of this was the result of priority supply commitments we have to some of our lower-margin customers, and part of it reflected sales through channels that have higher distribution costs.

Another part was the equity losses from TireHub, which have previously been treated like other distribution costs and included in mix. These losses reflect not only TireHub's status as a startup company, but also costs incurred to build out their distribution footprint for future growth, so not really a reflection of cost of ongoing distribution. These losses have now been broken out separately.

We expect to improve in each of these areas during the second half. This means the negative year-over-year impact that we've seen of $20 million to $30 million per quarter in the first half should be $20 million to $30 million positive by the fourth quarter.

Now while it isn't our practice to give long-term view points as part of our quarterly earnings remarks, I want to come back and provide a couple of data points to help you think about the opportunities that we see as we're developing our plans beyond 2019. There are 3 factors I want to highlight related to our future outlook. And when I refer to the future here, you can think about the next 2 to 3 years.

The first is our work to continue to improve the competitiveness of our manufacturing footprint. You saw the announcement we made in March related to our German factories. This will improve our earnings by $60 million to $70 million as it's completed, with the full benefit expected by 2022.

While we're not in a position to make any further announcements today, we are working on a significant restructuring plan to reduce low-value, high-cost capacity in the U.S. This plan should have savings at least as high as the actions in Germany and be on a similar timetable.

The second factor is expected growth in our global OE portfolio. I mentioned earlier, we are at an inflection in our OE volume after a decline of 2 million to 3 million units this year. This inflection is based on the fitments that we've won over the last 18 months and the momentum we see as we enter the second half of the year. There are 2 parts to this.

First, we have largely completed the work we set out to do to exit low-margin fitments, many of which were on sedans and other vehicles that are in secular decline. Second, our win rate on the fitments for which we've been bidding has been significantly higher over the last 18 months than we've experienced in recent years, up from about 1 out of 3 historically to over 50% in the last 18 months.

When we reflect on the reasons for this increasing success, we see multiple factors. First, the vehicles on which we're bidding are more challenging. We've been told by OE customers that some of our competitors, particularly those with less technical capabilities, have had difficulty meeting the required performance in technical specifications, specifications that continue to get more and more difficult.

Perhaps, this is most evident in the emerging area of electric vehicles. The weight and torque associated with these powertrains makes tire design much more complicated. This reduces the number of capable suppliers and has resulted in our win rate being nearly 2 out of 3 on electric vehicles last year.

Taken together, these trends give us confidence that at current third-party auto industry projections, our global consumer OE volume in 2022 would increase by approximately 20% or over 7 million units compared to this year, with 2/3 of this added volume coming from electric vehicle tires that have revenue per tire 15% higher than traditional fitments. So we're really excited about our OE business.

The third factor I want to cover related to our future outlook is the recovery of the cyclical impact of raw material costs on our margins over the last 2.5 years. Slide 19 is the slide we've used before to compare the current cycle to the prior raw material cycle early in the decade. While this cycle has been longer than the prior cycle, we're starting to make progress and still believe that either through a decline in raw material costs that might accompany an economic slowdown or by increased pricing that might accompany further escalation in raw materials, we will see a recovery in margins in the coming years as we've seen in prior cycles. I don't see anything that would change that point of view. We are continuing to work on our forward plans, and we'll share more with you as they develop, but we continue to see a lot of opportunity to create value.

Before we open it up for questions, I'll just mention a couple of small changes to our 2019 financial assumptions. We're now expecting cash taxes to be approximately 25% of pretax operating income, the high end of the previous range, and are expecting capital expenditures to be between $850 million and $875 million, down from a prior projection of $900 million.

Also note, our industry growth assumptions have been revised down broadly for Western Europe. Industry assumptions for the U.S. are unchanged other than a reduced expectation for commercial replacement, reflecting a further decline in low-cost imports. Our modeling assumptions page is unchanged from our first quarter call so continue to use these assumptions as you develop your projections.

Now we'll open up the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from John Healy with Northcoast Research.

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John Michael Healy, Northcoast Research Partners, LLC - MD & Equity Research Analyst [2]

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I wanted to talk a little bit more about your excitement on the OE business. The 20% number, I don't know, 3 years from now is a big bogey. So I was hoping to understand what sort of global auto production assumptions are maybe in there. But also, for the company, what geographies are you winning the OE business in? Because my guess tells me it's not just the U.S. So I was hoping to understand just big picture standpoint what are the assumptions that go into the excitement on OE?

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [3]

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John, I think it's a fair question. I want to make sure that we're clear on the fact that we are using third-party projections for OE volumes, which, as they stand today, have about 2% to 3% annual growth between now and 2022. So obviously, the -- that level of growth is what's built into the numbers. So -- and that would have an impact on the numbers, but I think we feel like anyone can do work trying to figure out where they think the industry is going. So better to let people take their own of point of view on that.

But this is -- we try to be transparent about the assumptions here. And so we do assume some steady growth in order to deliver the 7 million-plus units. However, I think we're going to see some growth whatever assumptions that you make, and I think that's a reflection of a couple of things.

And we talk about the higher win rate where over the last 18 months, we've had a win rate over -- well over 50% on the bids that we've submitted, where, for several years prior to that, our win rate was more like 1/3. So we're seeing a very significant change, and I think 2 points on that.

One is I think we see some trends that are moving back in the direction of larger tire producers with greater engineering capability because that's the difficulty of the fitments, and that is something that will help the companies that have made the bigger investments in R&D.

Second thing is obviously, we're taking full advantage of that trend and making sure that we're winning at least our fair share out of the fitments that are going to go to the more technical and capable companies, and I think particularly seeing a lot of win rates, very high win rate on electric vehicles. And there, we're getting the business awarded on 2/3 of the fitments, which gives you an idea just the differential in capability that now exists as we're bidding on these fitments.

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John Michael Healy, Northcoast Research Partners, LLC - MD & Equity Research Analyst [4]

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Great. And then I just wanted to ask on the U.S. business, kind of foreshadowing events to come there. When might we realistically think about hearing the update on that? Do you think we'll have details on a plan before year-end? And anything you can add there?

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [5]

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Yes. No. John, I think we'll probably have to just leave the U.S. restructuring comments with what we've said, and that is that we're -- we are working on a significant restructuring. We will -- once that plan is finalized, we will make further announcements, do some further communication. Obviously, we feel good about the track record we have, delivering this kind of initiatives and the savings associated with them. But there is inevitably some uncertainty in timing given the steps that we have to take prior to announcing something.

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John Michael Healy, Northcoast Research Partners, LLC - MD & Equity Research Analyst [6]

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Sure. And then just one final question for me. As it relates to capital allocation, just your priorities there. When I kind of do my chicken scratch model here, I have you guys still free cash flow positive for the year and was wondering if that is an assumption that you guys feel like that you can state. And then if you had to utilize the balance sheet to pay the dividend, would that be something that you guys would do, assuming tougher macro environment maybe in 2020 or 2021 where maybe EBITDA isn't where it is today or where -- a step lower given macro factors?

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [7]

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Yes. So John, I think the first point that I'll make is that we do take protecting the balance sheet very seriously, and improving and reducing our leverage is something that is a strategic focus area for us going forward.

Having said that, I make the same conclusion that you offered that even at the run rate of our operating income over the last 12 months, I think given the other assumptions, we still feel like we will generate enough free cash flow to more than cover the dividend. So I think at this stage, we've got the money to cover the dividend, so the -- not really a -- there's not really a question of increasing borrowing in order to maintain it. So I think we're generating enough cash at today's earnings level to still cover it.

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Operator [8]

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Our next question comes from Ryan Brinkman with JPMorgan.

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Ryan J. Brinkman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [9]

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Now relative to the $15 million of equity income losses in TireHub showing in the other SOI driver category, can you talk about how long the startup costs are expected to last? And beyond that, can you remind us, should we think about -- how should we think about that line item going forward? I thought maybe TireHub itself was designed to operate neither at a profit nor a loss but simply to enable your and Bridgestone's core business to improve profit via better volume, mix/price. Or should we be modeling some sort of loss there going forward?

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [10]

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Yes, yes. So Ryan, I think there is not a need to model an operating loss in any sort of permanent sense, just to be clear. So I think what we're looking at here is a couple of things. And maybe just preface this by saying that we continue to see TireHub as a significant strategic asset and a big enabler for what we want to do to achieve distribution alignment and deliver on the initiatives we have to make the tire-buying process easier. So we feel, if anything, even more strongly about that today than we did a year ago when TireHub was starting up.

And TireHub is building momentum. So we're feeling very good about what they've been able to deliver and the fact that we've retained our customers, and they have done a really good job executing on customer deliveries.

Now having said that, we are focused on making sure they are making the significant investments that will enable them to grow in the future. So -- and that's making sure that they've got distribution footprint everywhere we need them to support our distribution. I think we have good alignment with our partner on that idea that we want to make sure that we're getting everything that we can out of what is a very strategic asset.

And so the fact that they're making these significant investments in the future right now for that growth, in addition to continuing in having some startup costs, I mean it's a company that's only a year old, has led us to think, okay, this is not really a representation of the ongoing cost of TireHub as part of our distribution.

And while I could take different points of view given that all of our other distribution costs are embedded in our normal price/mix calculation, it could take points of view that would either exclude it or include it. I think at this point, we've broken it out in order to provide some additional transparency.

But as with several of the other factors that have been impacting our mix calculation over the last 6 months, we see this one improving in the second half and continuing to improve thereafter. So I think that in the first half, TireHub, we've experienced about $15 million, which you see in the slide for the second quarter. We had about $10 million impact from equity losses in the first quarter, so $25 million year-to-date, and that's certainly something we expect to improve on in the second half.

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Ryan J. Brinkman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [11]

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Okay. And then lastly from me. With raw materials now bound to be a slightly lesser headwind for the year, how are you thinking about the outlook for pricing and for price/mix to raw material spread? Maybe you could comment, too, in your response, on the reasons, again, you think it is taking as long as it is to recover the higher raw material cost via greater pricing.

And whether -- in any of your benchmark and analysis, do you believe that other global tire manufacturers have had the same degree of profit headwind from this gap between price/mix and raw materials that you have, both in the most recent quarters and maybe since this driver began to turn negative in 2Q '17? And if there is a disparity, what can you do to close that?

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [12]

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Yes, yes, so I think that -- I guess the first point is this is something that in most ways is an equal opportunity offender in that there's very good evidence that everybody has experienced a great degree of this, and the industry's margins have reflected that. So I think it is an industry problem.

Now I would also say that there are a couple of things that are a bit unique for us that make this a bigger challenge in this cycle, and maybe the most significant one is the strength of the U.S. dollar. And we do -- since a lot of these materials are purchased or benchmarked in dollars and our local operations are buying them in local currency, that does make the raw material headwind look larger as we do those calculations in local manufacturing facilities. For companies that are not denominated in U.S. dollars, that would look less significant.

We have also had, I think, a -- and I -- harder to tell, but we've certainly had an impact from higher cost of and reduced availability of supply for some petrochemical inputs in China as a result of increased enforcement of their environmental regulations.

And again, it's a little bit tough to tell, and we refer to those as non-feedstock costs, and those have been significant for us this year. I think the -- we took advantage of opportunities to go after low-cost supply. We did that in a significant way, to the extent we did more to take advantage of that. Then as that low-cost supply becomes less available, that may be a bigger hit to us.

But again, very difficult to find the transparency to figure out who's done more or less of that, but it's a significant impact for us. But overall, I think the industry has had this effect. There is and has been more evidence of increases in revenue per tire over the last 9 months. So as we look at this chart, we see improvement. And I think that unless raw materials take another step down, I think there's a lot of -- yes, there's continued reason that over time, we're going to have to work to recover them.

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Richard J. Kramer, The Goodyear Tire & Rubber Company - Chairman of the Board, CEO & President [13]

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Yes. I'll just jump in, Darren. I think well said. I think the other point is we have been here as a company and as an industry before. And I think our track record shows that over time, between price/mix, we're able to recover those raw materials. And I don't think anything's changed in our viewpoint that we can, other than we're in that part of the cycle. And it's, as Darren mentioned, it's lasting a bit longer than it has in the past.

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Operator [14]

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Our next question comes from James Picariello with KeyBanc Capital Markets.

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James Albert Picariello, KeyBanc Capital Markets Inc., Research Division - Analyst [15]

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So just focusing on the U.S. commercial replacement market. Obviously, you've taken your industry assumption down there. We all know what's going on from a tariff standpoint for the industry and what the impacts are there with some of the price increases have been. How would you assess the underlying demand relative to this down 7% to 11%? How much of this is just the pricing, causing folks not to buy and -- yes.

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Richard J. Kramer, The Goodyear Tire & Rubber Company - Chairman of the Board, CEO & President [16]

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Yes. I think the simple way to think about it, and we've seen this particularly on the consumer side in years past, we've talked about it extensively if you go back in time, the same things happening here in the commercial business now, and that's really the impact of the tariffs. So as pre-buys were done ahead of tariffs, you'd see sort of the industry being artificially stronger in some periods and now coming down on others as part of, let's say, pre-buys ahead of tariffs and all those types of activities of that are, let's say, less than normal.

I think the real point that we'd stress here is the markets that we play in, particularly the premium markets on the commercial side, we actually see continued strength in there. On the OE side, there, we did see orders peak last summer. Those builds are just working their way down. They're still pretty robust. That's taking up some of our capacities. As that -- those orders come down, we're going to see more product availability on the replacement side. And there, we still see freight conditions really robust.

So I think there's sort of 2 different ways to think about that. One is the overall around the tariff impact and one is the industry that we play in. And there, it's been certainly steady state and it's been actually very good for us.

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James Albert Picariello, KeyBanc Capital Markets Inc., Research Division - Analyst [17]

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Got it. Appreciate it. And then just following up, returning to the TireHub equity loss dynamic, down $10 million in the first quarter, down $15 million this quarter. I just want to make sure I understood Darren's comment that by the fourth quarter, equity income becomes a $20 million to $30 million positive per quarter and prospectively.

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [18]

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No. Yes. So James, the -- 2 different things. So 2 -- and one thing is that we do expect our mix as part of our price/mix calculation to go from what has been $20 million to $30 million negative in Q1 and Q2 to being $20 million to $30 million positive year-over-year by the time we get to Q4. Now that is exclusive of the TireHub equity losses. We also expect the TireHub equity losses to be less in the second half than they were in the first half.

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Operator [19]

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Our next question comes from Rod Lache with Wolfe Research.

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Rod Avraham Lache, Wolfe Research, LLC - MD & Senior Analyst [20]

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Just was hoping you can help me with just squaring a couple of things. The numbers missed consensus by quite a bit for the quarter. Price/mix and other accounted for a lot of that. So as you talk about the positives that you see into the second half, I was hoping you can maybe just address those 2 areas. So you just mentioned that mix goes from being a $20 million, $30 million negative to becoming a $20 million to $30 million positive by Q4. You're currently running at a price/mix of mid-30s on a year-over-year basis. Does that mean that we get to something like $50 million to $60 million potentially positive year-over-year by the end of the year?

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [21]

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Yes. So Rod, I think that a couple of things are going to happen because certainly, we're going to get the boost from stronger mix. So we're going to go from having -- effectively, in the first half, we had what we're achieving on price minus $20 million to $30 million of mix in order to get to our net price/mix. So if you take that price/mix for the second quarter, obviously, that number -- the price part of that number is a lot bigger than the $35 million.

As we get to the second half, we're going to have that positive mix. I will say, we will start to anniversary some of the pricing actions. So absent any further pricing actions, then we might get a little less for price but significantly more for mix. And I think you net those 2 together, the price/mix will be stronger in the second half than what we see in the first half.

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Rod Avraham Lache, Wolfe Research, LLC - MD & Senior Analyst [22]

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Okay. So certainly moderate that a little bit because of the comps on pricing, but it sounds like better than what you're seeing right now, so maybe north of $40 million. And you're suggesting that the raw material has kind of flattened out. So just that one factor will improve your exit kind of run rate of SOI by maybe -- by at least $40 million, I would think, correct me if I'm wrong.

And can you talk about how we should be thinking about that other line? And the chemicals business has been kind of a tricky thing to model on a quarterly basis. How should we be thinking about other on a year-over-year basis?

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [23]

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Yes. So we've got -- so we -- Rod, I think effectively, what's going to happen and what will happen with chemical as well is just as we're going to anniversary some of the positives on pricing, we're going to anniversary in the second half some of the negatives in other and including the lower income in chemical, which -- and chemical wasn't good at the end of last year either. So by the time we get to this year, it's an easier comp and less of an impact.

So I think that there are some elements there that are still reality, but I think if you take the chemical business and you take the TireHub equity losses, which I already said are going to be less of an impact in the second half, you take those 2 together, you got a couple of the major drivers in other that are going to be better in the second half.

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Rod Avraham Lache, Wolfe Research, LLC - MD & Senior Analyst [24]

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Yes. I guess what I'm driving at is people want to extrapolate from whatever numbers they're seeing right now and there are a lot of moving parts. So as we think about how you're exiting the year, is it -- is there any reason to believe that you would not be -- and I know you're not really giving guidance, but you are providing enough of the moving parts to kind of triangulate to something, like a segment operating income in the low $300 millions as you get to the fourth quarter versus the low $200 millions right now. Is there any reason or anything you see at this point looking forward that would -- that we should be taking into account as we're adding these pluses and minuses up?

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [25]

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No. I mean, Rod, I don't -- I haven't heard anything you said that I disagree with. And I think when we look at Slide 17 in the presentation deck, what I think -- what I -- certainly what it feels like here is the second half puts and takes are pretty balanced in terms of the things that would be affecting our income year-over-year. And we have a couple of net positives that we see in the second half and that is volume and price/mix versus raws.

And then we've got a couple of things I will put in the negative category, which is -- because we are taking some -- we took some production cuts in Q2, taking some more in Q3, so unabsorbed overhead is net negative. And the -- we won't get -- we got $50 million effectively onetime benefit from a settlement related to Brazil VAT that was split between Q3 and Q4 last year. So that $50 million doesn't repeat. So that's a net negative looking year-over-year.

But I put all those things together and it feels fairly balanced where through the first half, there are a lot more things on the negative side on the ledger than on the positive side, and that's kind of what we experienced. But I think that's one of the reasons that we feel very comfortable saying the second half is going to feel much better.

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Richard J. Kramer, The Goodyear Tire & Rubber Company - Chairman of the Board, CEO & President [26]

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Yes. And Ron, I think that's your point. Run rate basis second half is better than the first particularly as you look at exit rate.

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Operator [27]

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(Operator Instructions) We'll go next to David Tamberrino with Goldman Sachs.

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David J. Tamberrino, Goldman Sachs Group Inc., Research Division - Equity Analyst [28]

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A lot of questions, couple of follow-ups from other conversations earlier you had. On the price versus raws, with raw materials coming down, is it going to be tougher to hold onto price within the marketplace?

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Richard J. Kramer, The Goodyear Tire & Rubber Company - Chairman of the Board, CEO & President [29]

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Listen, I'll start, Darren. I know you want to jump in on raws as well. But as we look at it, David, I mean we're continuing to see the benefit from the pricing actions that we took last year. And we're also -- we continue to fine-tune our pricing, particularly in the U.S. using some analytics that we're doing.

So I think if you look at that and you look at the new product portfolios that we've put in place, I think the basis for the value proposition that we have out there is pretty strong. And I don't think that the changes in raw material, given the increases that we've seen now for 3 years running -- remember, we had about 19% increase in '17, 6% last year, looking at another 6% this year. So the moderations that we're talking about are certainly beneficial first half, second half, but there's still a substantial amount of raw material that we need to recover out there.

And I think as the earlier question said, I don't think we're alone in that. So I think it's really about putting the value proposition out there and getting paid for it. And we actually feel pretty confident about that in the U.S., in Europe and frankly in China as well. And when we look at things like channel inventories, which are in really good shape in the U.S., in Europe going into the winter season, I think all those things would say that we feel pretty good about where we stand relative to the market and relative to volumes in the second half.

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David J. Tamberrino, Goldman Sachs Group Inc., Research Division - Equity Analyst [30]

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Okay. But are there indexation costs you have with some of your OE customers, some of your larger fleet buyers as again spot rates or spot prices for a lot of the commodities that have large inputs into your tires have come down?

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Richard J. Kramer, The Goodyear Tire & Rubber Company - Chairman of the Board, CEO & President [31]

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So you wouldn't necessarily see all that coming through in the second half. That would -- those clauses take time to go into place. So yes, those will come in, but also we'll -- some of the things that I just spoke of. And I think that's not the headwind that we would say is a big one that we're looking at right now. I'd say net-net, it's a benefit to us as these raws go down versus the detriment.

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [32]

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Yes. No, I think, David, I think right now, I mean raw materials have moderated, but they have not come down dramatically. We've had some commodities, particularly synthetic rubber, that has gotten less expensive. We've had carbon black and natural rubber that have gone the other way a little bit in the first half. So the -- not a strong direction.

I think either -- in this cycle, we will see a stronger direction down in raw materials, and that -- if we really -- if we get into a more significant downturn economically, I think that's what we would expect. And that would give us -- in the past, that has given us an opportunity to recapture our margin or the economy will sustain itself.

And in that case, I think we might see raw materials turn the other way, and the work that has to be done to increase prices to offset those raw materials would have to start again. So I think it can play -- I can see it playing out either way. And in the past, it has played out each of those ways at different times. But I think the situation right now is -- has not given enough relief to really restore industry margins.

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David J. Tamberrino, Goldman Sachs Group Inc., Research Division - Equity Analyst [33]

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Okay. And then I wanted to follow-up on your OE business wins. I don't think I caught where regionally you've been winning. I think you said you've been very strong on electric vehicles that -- in China, there was locals, there was JVs, there was European customers where...

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [34]

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So listen, a very good question, and John -- I think John did, in fact, asked me that, and I may not have answered it. So the -- first of all, our win rates have stepped up significantly in all 3 regions of the world. So I would say the same -- we see the same dynamic in each region. We see the electric vehicle trend and the wins in electric vehicles being much more weighted toward the markets where electric vehicle introductions are being done in higher numbers, and that is effectively Europe and China, to much greater degree than in the U.S. But our -- the step-up in win rates has been significant across all 3 businesses.

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David J. Tamberrino, Goldman Sachs Group Inc., Research Division - Equity Analyst [35]

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Okay. And is that inflection starting in the back half of the year? Because again, I was surprised by the favorable volume outlook in every region for the second half. I mean is that actual orders from replacement channels and OEMs? Is it inflection and consumer demand for GT-branded tires? Or is it just the easy compares that you're looking at?

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Richard J. Kramer, The Goodyear Tire & Rubber Company - Chairman of the Board, CEO & President [36]

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Yes. No. So I think when we look at the OE business, David, in the second half, I would call it more easy compares than anything else as we're going to be able to start deliver some volume growth because we felt a lot of the reduction occurred at the end of last year. So I think where -- that's where we see some -- our growth in terms of our global OE volume.

For replacement, I think there's a number of factors there. I think as we get in Asia, there is an easier comparable. But as we look at the U.S. and Europe, I think we see very lean channel inventories, and we see very strong product line up on our parts and we've got good momentum and market share. So I think we're feeling good about the replacement volume on the -- on more a basis of sort of fundamental strength rather than just comparables.

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David J. Tamberrino, Goldman Sachs Group Inc., Research Division - Equity Analyst [37]

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Okay. And then just lastly, Darren. I think early in the year, you said with regards to the full year SOI kind of hard to see improvement in the year. First half, obviously a little -- much weaker. I know Rod -- and you kind of went through some of the puts and takes in the back half. But I mean should we be -- it seems like it should be down year-over-year, but it'd still be above $1 billion. Is that the right way to be taking your commentary today?

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [38]

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Yes. So I think, David, I understand the question, but I think I'm going to stick with the comments that I made.

I mean, through the first half, I mean, we're down close to a couple hundred million. And as we look out the second half, we see a much more balanced picture and, in fact, a lot of things that we are feeling good about, they're going to feel a lot better. But I guess I'll stop short of giving any particular prediction for what the outcome of that is because I think there are still some variables out there.

I do think it feels good and gives us confidence that we don't have the raw material cost variable in the second half because we've effectively bought or contracted for most of what we're going experience. Yes, so I think that gives us an opportunity to be more confident. And hopefully, you're hearing in today's call the confidence that we do have.

I mean the second half is going to feel a lot better and can get us moving in a much better direction. We knew the first half is going to be tough. We're going to have to get through it. Now we get to transition into the second half. We're feeling good about the second half. And as we exit the second half, I think we'll look out at what the OE portfolio is going to do for us, and I'll say that a lot of that does come in 2021, 2022. So we're looking at a 2-, 3-year outlook. But it gives us a really nice point of optimism that we know it's going to start to rebuild our volumes, start to allow us to grow and start to provide some additional benefits on top of the restructuring costs that we're delivering and on top of any recovery that we can get on price versus raws.

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Operator [39]

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And it appears we have no further questions and we have reached our allotted time frame. This will conclude today's Goodyear's Second Quarter 2019 Earnings Call. You may now disconnect, and have a great day.

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Darren R. Wells, The Goodyear Tire & Rubber Company - Executive VP & CFO [40]

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Thank you.