Earnings Call Transcript - GT Q1 2020

Operator, Operator

Good morning. My name is Keith and I'll be your conference operator today. I would like to welcome everyone to Goodyear's First Quarter 2020 Earnings Call. I will now hand the program over to Nick Mitchell, Senior Director of Investor Relations. Please go ahead.

Nick Mitchell, Senior Director of Investor Relations

Thank you, Keith. Thank you everyone for joining us for Goodyear's First Quarter 2020 Earnings Call. I'm joined here today by Rich Kramer, Chairman and Chief Executive Officer, and Darren Wells, Executive Vice President and Chief Financial Officer. The supporting slide presentation for today's call can be found on our website at investor.goodyear.com. And a replay of this call will be available later today. Replay instructions were included in our earnings release issued earlier this morning. If I could now draw your attention to the Safe Harbor statement on Slide 2. I would like to remind participants on today's call that our presentation includes some forward-looking statements about Goodyear's future performance. Actual results could differ materially from those suggested by our comments today. The most significant factors that could affect future results are outlined in Goodyear's filings with the SEC and in our earnings release. The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. Our financial results are presented on a GAAP basis and in some cases a non-GAAP basis. The non-GAAP financial measures discussed on the call are reconciled to the U.S. GAAP equivalent as part of the appendix to the slide presentation. And with that, I'll now turn the call over to Rich.

Rich Kramer, Chairman and CEO

Great. Thank you, Nick. And good morning everyone. I hope our call here today finds all of you as safe and healthy as you can be and for your families as well and I hope you're all working through this pandemic as best you can. Now during my time at Goodyear, we've managed through the effects of the Great Recession, the European debt crisis, the early 2000s recession and 9/11. And it's not an exaggeration to say that we're in the midst of a crisis of historic proportions. Our business was first affected by COVID-19 in China, but over the course of the first quarter the impacts became widespread. As a result, our first quarter volumes fell 18% and segment operating income fell into negative territory due to the effects of lower volume and unabsorbed overhead. The impact of this crisis spans well beyond the economic outcomes presenting both personal and societal challenges that are simply unprecedented. And I'm truly amazed at the way our associates rose to the challenges. In a matter of weeks we fundamentally changed the way we work to ensure the health and well-being of our associates. We closed our corporate and regional offices and instituted work-from-home protocols around the globe, ensuring that our associates remain engaged and connected with digital tools. These same tools have helped us stay in constant contact with our customers and suppliers allowing us to quickly adapt to the changing market conditions and maintain the continuity of our business. Our goal is first-class service and support for our customers and consumers during these trying times. We've also modified operations at our company-owned retail stores to safeguard our associates and align our staffing to meet market demand without sacrificing our commitment to keep health care professionals, first responders, grocers, and our fleet customers road-ready. In the U.S., our Goodyear auto service and commercial tire service center locations responded to the COVID-19 challenges by creating a zero-contact service offering. This allows us to limit personal contact and do our part to keep critical workers and supplies moving. To further advance this effort, we're offering free Department of Transportation inspections to U.S. commercial fleets and free tire services to essential workers. Members of our fleet services team have also been working hard to keep our fleet customers up and running, and the impact can be seen in our results as shipments of commercial replacement tires were up more than 10% in the U.S. during March. Goodyear and its associates have also stepped up to support our communities through donations of personal protective equipment to the medical community and also through supporting our local health systems and food banks. As just one example, our engineers in Luxembourg utilized the capabilities of our 3D printers to produce parts for protective face shields, helping to supply for those on the frontline. While we remain focused on serving our customers and communities, we've also taken a number of operational and financial actions in response to the crisis to safeguard our business. Through our 122-year existence, Goodyear has always faced adversity head on and emerged stronger than ever. I'm confident that we will overcome the impacts associated with this crisis as we are taking the necessary steps to protect our company. The most significant of these actions was idling production across the majority of our global manufacturing facilities and chemical plants. This ensures that we can protect our associates and help mitigate the effects of the steep drop in industry demand. I would like to extend my gratitude to our plant teams for their hard work to idle these facilities quickly and safely. We've also taken several other actions to further reduce our costs and to preserve cash in the current environment, which we shared with you in our pre-release and which Darren will cover in more detail today. I can assure you that we will continue to manage our business prudently as we move ahead. While America’s and European businesses are just now experiencing the most severe contraction, our business in China has entered into what we believe is a recovery phase. Goodyear-Pulandian is operational and fully capable of producing to demand. The plant is not yet running at full capacity, but is able to meet the needs of our customers. Our plant leaders have implemented several procedures to help our associates stay safe. Our commitment to protecting our team has been recognized by the Dalian government as a benchmark for virus prevention measures. As we survey the landscape, we see several encouraging signs in China. In the OE channel today, essentially all of the major OE plants in China are up and running. While we're expecting the OEMs to ramp up slowly due to existing dealer inventory, new car sales are gradually increasing off the lows seen in February. We're also seeing the nomination process for OE fitment starting to return to pre-COVID-19 levels. Fundamentals are also improving in the replacement channel. Essentially, all our distributors were open for business just three to four weeks after the curve flattened in China. Our dealers opened on a more gradual trajectory, but they are now mostly all open and serving customers. These favorable developments leave us cautiously optimistic that the volume recovery phase has begun in China, and we're positioning our business there and around the world for the recovery. As we think about bringing the majority of our workforce outside of China back to the workplace, our top priority remains safeguarding the health and well-being of our associates. Our leaders are working to implement measures recommended by the Centers for Disease Control and Prevention and other leading authorities, including attention to personal hygiene, enhanced disinfection, visitor protocols, and physical distancing. We're implementing a phased approach to restart production based upon regular assessments of local market conditions and inventory levels across each product segment. Our supply chain and procurement teams are working non-stop to ensure we have adequate breadth and depth of the required raw materials so that we can move quickly once we see the relevant market signals. At this point, our key suppliers remain online or have adequate inventory to meet our needs as our plants reopen. Earlier this month, we reopened some of our chemical plants and had begun a limited ramp up of our commercial truck tire manufacturing facilities in the U.S. and Europe. Earlier this week, we began to reopen tire production in most of our consumer factories in Europe, as well as in Ireland and Turkey. While market visibility remains somewhat limited, our assessment of sellout trends and customer signals suggests that demand in our Western markets will begin to recover over the next couple of months. In light of this view, we expect to have the vast majority of our manufacturing facilities up and operating by the end of May. Still consumer sentiment remains low globally. Our fleet customers are deferring capital investments, and we anticipate truck ton miles will decline in the second half of the year. Thus, we know we need to be realistic with our expectations for the remainder of the year. While the majority of our attention over the last several weeks has been directed to the situation at hand, we're also continuing to focus on our strategic priorities. To this point, I'm pleased by the early progress we've made with our efforts to align our distribution in Europe. We've secured agreements with nearly all of our targeted first full-service distributors, ensuring market coverage across the region. Even amid the COVID-19 disruption, we are already beginning to see evidence of improvement in the value of our brand in the marketplace. We've proven the strategy is highly effective in the U.S., and I'm confident we can repeat that success in Europe. The challenges brought on by difficult market conditions like those we're experiencing today reinforce the importance of having a strong distribution network that ensures our route to market. In the U.S., TireHub combined with our retail and commercial service centers is doing just that. If you're like me, I suspect much of what you're buying today is purchased online and delivered. Similarly, we're seeing a significant increase in online sales at goodyear.com in the U.S. There are two points to think about here. First is the value of a business built upon digital connections and through the infusion of data-enabled services. COVID-19 has solidified this growing trend, including for tires, as we've noticed our online direct-to-consumer business grow in this down market. Second, integral to my first point, is the increasingly important role of supply chain in our industry. Think of the supply chain in terms of the role that the last mile plays with respect to enabling the e-commerce delivery process and also the need for services and fit-for-purpose tires for those last-mile fleets and vehicles. Also think in terms of the need for dealers and distributors to operate with lower inventory levels during this crisis, thus putting a premium on tire manufacturers' on-time supply. It's about having the right tire in the right place at the right time, now more than ever. The investments we've made in our e-commerce platforms, mobile installation capabilities, and our aligned distribution initiatives like TireHub are allowing us to stay connected and relevant with our customers even when they're sheltered at home. As the importance of e-commerce grows, we should benefit from the head start these investments have provided over the competition. Now, in addition to these market-facing initiatives, we've continued to make progress against our objective to increase the competitiveness of our manufacturing footprint. Last year, we announced a significant modernization and restructuring of two of our manufacturing facilities in Germany. I'm pleased to say that we remain on track to generate at least $60 million of conversion cost savings from these projects by 2022. As you know, we also set a goal of obtaining a similar amount of savings from restructuring plans we were evaluating in the Americas. The tentative bargaining agreement we reached to close our manufacturing facility in Gadsden, Alabama would position us to deliver on these targeted improvements. This action will further align our manufacturing capabilities with the segments of the market that are growing. There is no question that in the near term, trends in our business will be shaped by the COVID-19 pandemic. However, we know mobility will resume and tires will be in demand. Our team is experienced in dealing with market volatility, and I'm very confident that we will continue to take the necessary actions to protect the company during this crisis while also positioning our business for long-term success. I want to re-emphasize my appreciation to the members of the Goodyear team who are working hard to support essential businesses, our customers, and our communities. On behalf of the 63,000 associates around the world who make up the Goodyear family, we're committed to doing our part as we make our way through the crisis and begin the recovery. Now I'll turn the call over to Darren.

Darren Wells, Executive Vice President and CFO

Thanks, Rich. As you seem to tell from our press release on April 16 and from our release earlier today, we've taken dramatic steps over the last six weeks to respond to the disruption caused by COVID-19 and to reduce as much as possible the financial impact it has on the company. We quickly shut down production in the U.S. and Europe and worked with suppliers to stop the flow of raw materials and other supplies to reduce expenses and avoid tying up capital in inventory unnecessarily. We then evaluated all other categories of expense, including marketing, research and development, and salary payroll. While we have plenty of experience as a team with cost cutting and general belt tightening, we had to add some plays to our playbook to deal with this level of decline in business activity. This included reviewing the roles of 9,000 salaried associates and furloughing approximately 2,000 of them for the entire second quarter, furloughing another 6,000 for part of the quarter, and reducing and deferring pay by 10% to 30% for those who are working. With only a week's worth of planning, we've reduced our payroll spend by nearly $65 million for the second quarter, taking advantage of the government income replacement programs to ensure our associates are supported. In addition, we cut marketing and other administrative and general expenses by $75 million for the second quarter. Simultaneously, we were working on ensuring our cash and liquidity position was protected to the greatest degree possible. This resulted in a number of actions to preserve cash, including reducing our capital expenditures by over $100 million, deferring investments in distribution, suspending our dividend, preserving over $110 million between now and year-end, and leveraging government relief efforts to defer payroll and other tax payments, an improvement of $60 million for this year in the U.S. alone. In addition, we continue to work with our core bank group to complete the refinancing of our $2 billion asset-based revolving credit facility, which we closed on April 9. Proceeding with the refinancing of this facility amid the COVID-19 disruption was a testament to the resilience of our team and the support of our lenders. I'd like to express my sincerest appreciation to both. The renewed credit agreement extended the maturity to 2025. We also obtained favorable adjustments to the calculation of the facility's borrowing base, enhancing our ability to utilize these facilities during times of lower inventory and receivables. This adjustment amounted to approximately $350 million at the end of the first quarter. The other key non-price terms and conditions remained effectively unchanged. In addition to these near-term actions, there are a couple of other key developments I want to highlight that are going to be important as we start to plan for the post-shutdown recovery. First, as Rich mentioned, we're continuing to make progress on restructuring initiatives that will improve our manufacturing footprint. In our previous calls, we outlined a series of steps we've taken in our Gadsden, Alabama manufacturing facility over the past 12 to 15 months in response to declining demand for small rim diameter tires. Last week, we reached a tentative bargaining agreement with the United Steelworkers to close this facility while providing appropriate support for the displaced associates. On a combined basis, the actions taken in Gadsden over the last year are anticipated to generate approximately $130 million of manufacturing cost improvements for Americas business units in 2021 when compared to 2019, improving the competitive position significantly. This tentative bargaining agreement remains subject to approval by the members of the local union. Second, we're also seeing some favorable developments in the commodity markets that should help mitigate the impact of lower volume later in the year. While this situation is different than we experienced during the Great Recession, historically, our raw material prices drop significantly during difficult demand environments with any corresponding decline in pricing occurring more gradually and on a lag. This could offset some of the impact of lower volume in economic downturns. Slide 10 illustrates the benefit we saw during the Great Recession between the first quarter of 2009 and the second quarter of 2010; we experienced a benefit of more than $700 million from lower raw material costs after taking into account the impact of price changes. At spot prices, our modeling suggests our commodity cost would be $50 million to $100 million lower in the second half compared to 2019, with most of that benefit coming in the fourth quarter. Turning to review the first quarter, while our results were significantly affected by the severe decline in global tire demand and our decision to suspend production, to protect our associates and avoid building unneeded inventory, our results reflect a few strengths of our business model. First, our business is deemed essential in the U.S. and most other parts of the world. That means that even while our factories are closed, our retail locations, warehouses, commercial truck service centers, and other customer-facing assets continue to operate, ensuring that we can support our customers even during the stay-at-home orders. Second, and related to this, our replacement business continued to generate revenue during late March and April lockdowns. While replacement volume was low, it never stopped and it started to recover over the last two weeks even though auto production has not. Third, our commercial truck tire business remained particularly critical, with replacement volumes through March only slightly below last year's levels as large fleets worked to keep essential goods on store shelves. Together, these attributes mitigated the volume decline that we experienced during the first quarter and leave us better positioned to navigate the current environment. Turning to Slide 11, our first quarter sales were $3.1 billion, down 15% from last year, primarily driven by lower volume but also impacted by unfavorable foreign currency translation. These effects were partially offset by improvements in price mix. Unit volume decreased 18%, replacement tire shipments declined 16%, and OE unit volume decreased 21%. Our commercial replacement business was the strongest performer with volumes declining just 3%. Our segment operating loss for the quarter was $47 million, down $237 million from the year-ago period. This decline can be largely explained by lower volume, lower factory utilization, and costs related to temporarily shutting down our manufacturing facilities. Segment operating income includes the impact of approximately $65 million for lower factory utilization and period cost directly related to shutting down our manufacturing facilities in March. Our results were also impacted by discrete charges of $472 million primarily related to two items. The first was the establishment of a valuation allowance on deferred tax assets for foreign tax credits driven by the expectation of lower near-term income in the U.S. The second was a $182 million non-cash goodwill impairment charge reflecting the expectation of lower income in our EMEA business. After adjusting for these items, our loss per share totaled $0.60. The step chart on Slide 12 summarizes the change in segment operating income versus last year. The impact from lower volumes was $120 million, reflecting a decline in shipments of approximately 7 million units. In addition, production cuts resulted in a $70 million decrease in overhead absorption. This included both the impact of production cuts taken toward the end of 2019 and the effects of suspending production at the majority of our manufacturing facilities in March. $50 million out of the $70 million of conversion costs are related to our first-quarter operations. Price/mix was flat, reflecting continued benefits from our pricing actions, particularly in the Americas, which were offset by unfavorable mix. Raw material costs increased $13 million driven by lower synthetic rubber and carbon black prices. The benefits of lower feedstock costs were partially offset by the impact of unfavorable transactional foreign currency and higher feedstock costs. Inflation of $38 million offset an equal amount of cost savings. Cost savings opportunities were adversely affected by the decline in volume. The $57 million decline in the other category includes several unique items. First, suspending production at our manufacturing facilities resulted in a $15 million write-off of work-in-process inventory. Second, we experienced lower factory utilization at our Gadsden manufacturing facility even before the shutdown due to ongoing work-to-transition SKUs to our other plants in the U.S. This dynamic resulted in us expensing about $10 million of production costs incurred in the first quarter. Third, earnings declined by $8 million in our other tire-related business. The decline was driven by weaker results in our chemical and retail operations. Turning to the balance sheet on Slide 13. Despite the disruption, our balance sheet at the end of the first quarter was stronger than a year ago with net debt down approximately $100 million. As of March 31, 2020, and pro forma for the refinancing, we had total liquidity of approximately $3.6 billion, including $971 million of cash and cash equivalents, also above our year-ago levels. Slide 16 summarizes our cash flows. We used $561 million of cash during the quarter for operating activities, primarily reflecting seasonal working capital. Turning to our segment results beginning on Slide 17. Americas volume decreased 13% to 14.5 million. The U.S. and Canada began to see significant volume declines during the month of March, while Brazil remained steady. Shipments of commercial tires were relatively stable, with units down less than 3%. In the U.S., we increased our share of the commercial truck tire market, increasing our replacement volume by 5%. This performance includes a double-digit increase in March, as we benefited from our efforts to keep our warehouse operations and commercial truck service centers open to help keep our fleet customers up and running. Americas operating results for the first quarter will break even after being ahead of last year through February. The decline was driven by lower volume and lower factory utilization, including approximately $30 million of period charges associated with shutting down our manufacturing facilities in March. These factors were partially offset by improvements in price/mix and favorable raw material costs. Turning to Slide 18. Europe, Middle East, and Africa's unit sales were down approximately 20%. Both consumer OE and replacement shipments fell around 20%, primarily reflecting the approximately 30% decline in industry shipments in March. Our replacement sales were also impacted by expected declines related to actions we were taking to restructure our distribution across Europe. Similar to the Americas, demand for commercial replacement tires was relatively stable, with industry shipments declining only 1%. Against this backdrop, we were able to deliver modest growth, with our commercial replacement volume increasing about 1%. EMEA segment operating loss of $53 million was down $107 million from the prior year's quarter, driven by reduced volume and higher conversion costs, including the impact of lower factory utilization. Period costs and other charges totaled approximately $20 million. Turning to Slide 19. Asia-Pacific tire units totaled 5.2 million, down approximately 24% from the prior year. Original Equipment unit volume declined more than 30%, driven by lower industry demand in China and India. Replacement tire shipments decreased 17%, also reflecting lower industry demand in China. Segment operating income was $6 million, $41 million lower than last year. This decline primarily reflects lower volume and reduced price/mix, including the impact of competitive conditions in our consumer OE business. These factors were partially offset by favorable raw material costs. Turning to Slide 20, I wanted to provide just some thoughts on topics that should be helpful to you when creating your forecasts. Given the limited visibility we have into vehicle production or replacement demand, it's difficult for us to provide you with an accurate projection of industry volumes for the year. However, we assume the largest volume declines will occur in the second quarter and that they will be approximately 50%, with April down close to 70% from a year ago. Overhead absorption will continue to be adversely affected by reduced plant production. We're currently planning production down almost 25 million units versus the second quarter of 2019, or about two-thirds to reflect expected second-quarter demand and to reduce inventory. Reducing production during the current plant closures is more efficient than running factories at reduced levels later in the year, which should provide some benefit as business levels recover. The guidance we provide on our modeling assumptions page for calculating the impact of production changes is still a good approximation. However, the impact of the second quarter will be essentially immediate rather than our normal lag of approximately three months to account for the accounting treatment of low utilization. Additionally, our other tire-related businesses are also significantly affected by the weakening economic environment. Traffic and volume at our retail locations is low, and the sharp drop in business and leisure travel is adversely impacting our aviation business. Furthermore, our chemical business is feeling the effects of the decline in tire production. In total, the year-over-year earnings decline in our other tire-related businesses is expected to be about $150 million during the second quarter. When thinking about our cash flow for the second quarter, some unusual dynamics related to the sharp slowdown in industry demand will impact our working capital flows. As a result of lower sales and lower production in the second quarter, we expect to experience declines in our accounts receivable and inventory balances, which will act as a source of funds in the period rather than the traditional use of funds. This is normal in a recession. However, we expect these benefits in the near term will be more than offset by the reduced accounts payable, given that we have not been purchasing any raw materials. Therefore, we anticipate working capital to be a use of funds for the second quarter. When combined with losses expected in the quarter, we could use around $1 billion of cash in Q2. Ramping back up after Q2, by itself, should not be a big cash drain, and we continue to expect working capital to be a significant source of cash in the second half of the year. Also, we now expect working capital to be a source of cash for the full year, although the amount will depend on how much inventory we need to have at year-end. Turning to Slide 21. You'll see we've updated several of our other financial assumptions. As previously disclosed, our CapEx guidance has been updated to reflect the actions we've taken to align our capital spending plans with current market demand and to preserve cash. Depreciation and amortization is expected to total approximately $775 million, down slightly from our previous forecast. This revision reflects the adjustments we've made in our capital spending plans and the impact of foreign currency translation. We've increased our estimate of restructuring payments by $50 million to reflect the impact of the plant closure of our Gadsden, Alabama manufacturing facility. Lastly, we expect our cash taxes to total approximately $60 million, which includes the $30 million we paid in the first quarter related to income earned in earlier periods.

Operator, Operator

We'll now open up the line for questions.

Operator, Operator

We'll go first today to Rod Lache with Wolfe Research. Please go ahead.

Darren Wells, Executive Vice President and CFO

Good morning, Rod.

Rod Lache, Analyst

Good morning. A lot of information. And I appreciate the detail. So hoping you can just give us some help with some of the bridging items that you talked about for Q2, which obviously is going to be the toughest quarter of the year. So if I think about volume, last year you did 37.5 million units in the second quarter?

Darren Wells, Executive Vice President and CFO

Yes.

Rod Lache, Analyst

I'm assuming that if you cut that in half, you end up with about 18.7 million units, and typically the impact per tire volume is around $17, which would amount to $300 million. Separately, just for my understanding of the accounting period, it seems there is a $25 million reduction in output from the plant, with an average of $12 per tire, adding another $300 million on top of that. Am I correctly considering these two items?

Darren Wells, Executive Vice President and CFO

Yes, Rod, the modeling assumptions still hold true. The volume will be distributed across various geographies, and each geography has its unique characteristics. However, it seems like you are calculating things in the right direction.

Rod Lache, Analyst

Yes, okay. And separately, you have $150 million from the other businesses that wouldn't be included, and it sounds like there are $140 million in savings. These appear to be the major bridging items, if I understood correctly. Regarding the working capital, your comment about the $1 billion use, was that strictly for working capital, or does it refer to the overall $1 billion use?

Darren Wells, Executive Vice President and CFO

Definitely. So Rod, regarding the income modeling you were discussing, we've calculated that combining the operating losses with the working capital could lead to a cash use of about $1 billion in the second quarter.

Rod Lache, Analyst

Yes.

Darren Wells, Executive Vice President and CFO

But it's only a small part of that is working capital.

Rod Lache, Analyst

Okay, that makes more sense. Can you provide an overview of the significant volatility in the commodity market, particularly oil? It seems that all oil derivatives have seen substantial declines. The figures you mention in dollar terms are influenced by the volume assumptions and purchases you're making. Can you share the percentage declines on a spot basis and what your strategy is to take advantage of these changes? When should we expect to see this?

Darren Wells, Executive Vice President and CFO

Yes, Rod, I believe your comment is valid. If we examine the oil derivatives, particularly carbon black and butadiene, we see significant declines in their prices over the past few months. For instance, we purchased carbon black for $40 in the fourth quarter, and the current spot price is $17 per barrel, reflecting a 50% decrease. Butadiene has also dropped from around $0.40 to approximately $0.25 per pound. Consequently, we have observed these substantial reductions. We are considering current spot prices and contemplating the potential benefits in the second half of the year. However, this benefit is somewhat limited because we are not actively purchasing materials at the moment. We had materials available during the shutdowns, and as we begin to ramp up production, we will resume buying materials; however, the significant purchases will not happen until the third quarter, meaning we may see some benefits in the fourth quarter. The crucial question revolves around the materials' prices in the third quarter, which is when we will actually make those purchases. We anticipate that it will take some time for material prices to rise again, and we have projected some benefit, estimating it to be between $50 million and $100 million when excluding the impact of currency fluctuations.

Rod Lache, Analyst

Okay, I think I understand. But basically, I'm considering the proportion of raw materials as a percentage of COGS. Are we anticipating a weighted average decline of nearly 50% that would benefit us significantly in 2021?

Darren Wells, Executive Vice President and CFO

If I compare carbon black and butadiene to the fourth quarter, we're looking at a reduction of around 50%, but it will take time for that to reflect in our cost of goods sold. Other commodities haven't experienced the same level of impact. For example, natural rubber was priced at $0.60, and it's currently $0.50, so the decline isn't as significant there. Therefore, I wouldn't estimate a 50% reduction even if current prices remain stable. We anticipate that by 2021, when the benefits of increased production materialize, material costs will likely rise again. It's difficult to predict how quickly that will occur.

Rod Lache, Analyst

Okay, got you. All right. Thank you.

Darren Wells, Executive Vice President and CFO

Yes.

Operator, Operator

Our next question is from Ryan Brinkman with JPMorgan. Please go ahead.

Ryan Brinkman, Analyst

Hi. Thanks for taking my question. And thanks for the update on the raw materials tailwind just now. How are you thinking though about your ability to capture those raw materials savings and of price/mix? I think earlier the industry and Goodyear had complained of an inability to fully recoup the effect of sharp raw material cost inflation, thinking specifically of the 2017 timeframe. Going forward, how do you expect this dynamic to work in a period of sharp raw material deflation? Do you think it is easier, as one might imagine, to not cut price to the full extent of input cost deflation than it is to raise prices to the full extent of inflation, or while capturing the benefit, you may be unusually challenged by the magnitude of expected industry volume headwinds and related unabsorbed extra cost?

Rich Kramer, Chairman and CEO

No. Ryan, I think it's a very relevant question and certainly one we're thinking through. If you look into the previous downturns and what we've seen is the benefits of lower feedstock really more than offset the pricing pressure that comes on the lower feedstock prices as well as soft demand. So net-net what we've seen is a benefit during these periods. Yes, the impact on price ultimately happens, but it occurs gradually and sort of on a lag basis. As we see that, we believe the situation of being able to capture the benefits of the lower feedstock in this downturn is something that we can do.

Ryan Brinkman, Analyst

Okay, that's helpful. Thank you.

Operator, Operator

And our next question is from Armintas Sinkevicius with Morgan Stanley. Please go ahead.

Rich Kramer, Chairman and CEO

Sure.

Armintas Sinkevicius, Analyst

I was hoping you could maybe walk us through the working capital dynamics here and how that flows from the first quarter into the second quarter? And then the second question is the decremental margins here in the quarter were quite high. How should we think about that into 2Q?

Darren Wells, Executive Vice President and CFO

Yes. Two things are happening here. First, regarding the working capital, in the first quarter, it behaved as expected for a softening environment, with a decline in receivables. Sales softened, but our inventory remained relatively stable, and our payables were also steady. This reflects a typical first-quarter working capital build based on seasonality, appearing quite normal. Moving into the second quarter, we anticipate a decrease in inventory due to the production cuts reflecting demand. Receivables will decline as sales decrease as well. Typically, we have around 90 days of payment terms from suppliers, which helps finance our inventory. However, since we are not currently purchasing materials for production, by the end of the second quarter, we expect to have paid most of our suppliers, resulting in much lower payables. This is a temporary situation. As we resume material purchases, payables will adjust back to normal levels, contributing to our expectation that working capital will generate significant cash in the second half of the year. Overall, we expect working capital to provide at least a modest source of cash for the full year, influenced by the rapid and extended shutdown we experienced. Regarding margins, the key difference in margin behavior between Q1 and Q2 relates to how we account for unabsorbed overhead. Normally, when we cut production, there's a lag through inventory before it impacts margins. In this instance, we were affected in Q1 by production cuts made in Q4, with reduced production in Q4 carrying through to Q1 sales. However, the production cuts in Q1, which exceeded 15% of factory output, are being recognized immediately. As a result, we are experiencing the impact of both Q4 and Q1 production cuts simultaneously. In Q2, our production cuts will exceed the volume decline, which poses challenges due to a projected loss of sales of around 18 million units against a lost production of 25 million units, creating an additional 7 million units of unabsorbed overhead that will affect Q2. Fortunately, this unabsorbed overhead will not be an issue in the second half, which is a positive outcome.

Armintas Sinkevicius, Analyst

And my other one just real quick. The actions you took here seem sometimes proactive with the dividend and the CapEx, but as we're moving through these numbers it look like they were acting that you had to take. How should we contextualize you being proactive with regards to the back in person these are actions that you have to take?

Darren Wells, Executive Vice President and CFO

Yes, I think that we've spent a lot of time on cash flow modeling, all of which has confirmed that we've got the resources to manage through this year. But it also helped us focus on fighting actions to keep improving the situation given the uncertainty we've got in how the recovery is going to look. Those are all prudent measures for us to take given the fact that there is going to be significant operating losses in the second quarter and some uncertainty regarding volume recovery that ultimately will become clearer. We started the quarter with cash and available credit of $3.6 billion. We're talking about a use of cash of around $1 billion in the second quarter. In the second half of the year, whatever happens from a volume and earnings perspective we'll have a significant source of cash and working capital. We want to be conservative; we know this is a time to manage the business for cash and to ensure that the balance sheet and our cash and liquidity position are solid. You can view those actions as being appropriate and proactive to make sure the situation is one that we're able to comfortably manage our way through.

Rich Kramer, Chairman and CEO

I would just add to Darren’s comments. I completely agree with him and I think it really goes into a bucket of prudence. Even if we go back to the Darren's comments about the high fixed costs that we see in the second quarter, we saw a very similar situation when we went through the Great Recession where we saw a deep production cut, not as deep as they are now, but deep demand falling off and production cuts. The flow-through cost of sales with the sales of our product becoming period cost that lasts for a quarter or two and then we get back to a normalized production. We believe that will happen again. Having gone through the Great Recession, we recognize the timing of how these things come back; that situation begs a degree of prudency.

Armintas Sinkevicius, Analyst

Great. Much appreciated.

Operator, Operator

Go ahead, James Picariello with KeyBanc.

Rich Kramer, Chairman and CEO

James.

James Picariello, Analyst

Good morning, everyone. Could you please discuss Goodyear's performance regarding consumer replacement buy-ins in the U.S. and Europe, especially in light of the company's recent developments? What were the key factors affecting your performance compared to the market?

Rich Kramer, Chairman and CEO

So, James, if I miss anything, please feel free to jump back in. In the U.S., we had one of our strongest fourth quarters in the consumer business, which includes our share position. Looking at Q1, we started off well in January and February. However, considering our size and presence in the U.S., a couple of factors come into play. Our higher shares are mainly on the coasts, particularly the East Coast and the Midwest. We experienced a slightly weaker winter, which affected our share due to reduced volume. Additionally, the COVID impact was significant in regions like the East Coast, the West Coast, and the Midwest, particularly in places like Detroit where we have a strong presence. Another factor was that Walmart, which is a key partner for us, closed all its auto centers and redirected those resources to their stores, which also affected us. I see these challenges as temporary. When I reflect on our business model and our new product lineup, I believe we're encountering a unique situation rather than a consistent trend.

James Picariello, Analyst

Got it. No, that's really helpful. And then just on the Gadsden closure, can you talk about maybe the timing of $130 million savings over this year and next? And how should we think about the volume inefficiencies related to that closure over the next 12 plus months or Q2, just 2Q and 3Q? How should we think about that? Thank you.

Darren Wells, Executive Vice President and CFO

Yes. So James, I think what we've chosen to do here is just to focus on the savings we're going to get in 2021 from that improvement in our footprint. The way that is going to play out this year has some real uncertainty around it because of the uncertainty around how our production is going to ramp up and the other factories. I would say there's some uncertainty as to how much benefit we're going to get this year. I think there will be some in the second half, but most of the savings will really benefit us in 2021.

Operator, Operator

And our next question is from Itay Michaeli with Citi. Please go ahead.

Darren Wells, Executive Vice President and CFO

Morning, Itay.

Rich Kramer, Chairman and CEO

Hey, Itay.

Itay Michaeli, Analyst

Hi, good morning. Thank you. So, maybe just two questions looking beyond Q2, maybe one for Rich, one for Darren. Rich, what do you make of the potential kind of longer-term implications of the crisis, particularly around the risks of your lower vehicle miles traveled, more able to work from home? And then maybe, Darren, can you just kind of talk about a little bit directionally perhaps where you expect your gross or net debt and the year and how you're thinking about leverage for the company beyond the immediate crisis?

Darren Wells, Executive Vice President and CFO

And Itay, I think it's a good question. I see some of the things that we have are somewhat transitory on our way back to some semblance of normality. I'm thinking about that from the perspective of clearly the trends that we're seeing people are going to be more conscious of their personal health; people's comfort with e-commerce certainly was happening, but it's grown even more as people are realizing what they can actually get delivered to their homes, including tires. Also, we see the value of a supply chain being even more important. All of this reinforces our existing business model and trends. However, I don't really think the trends around shared mobility will change or the trends around EV and AV. I think we're going to have a bit of a pause as we work through this, not unlike what we did during the Great Recession. But I think we come back and I think this disruption actually adds more focus as to how we address the mobility world moving forward. I don’t think it’s going to be exactly the same, but I believe the trends will continue to be favorable for Goodyear.

Rich Kramer, Chairman and CEO

Okay, thanks.

Darren Wells, Executive Vice President and CFO

So Itay, I think there are a lot of variables here. We expect to generate some cash and working capital, which is beneficial to us. The biggest impact on where our net debt ends up year-end is going to be the losses generated in this period. We've cut a lot of costs, but there are still many more costs than we are earning money to pay for. The losses we incur during this period are effectively going to need to be borrowed. Our balance sheet leverage is above the levels we target; we will work to address the impact this year brings in 2021.

Rod Lache, Analyst

Thank you for the follow-up. I'm trying to understand what needs to happen to achieve breakeven free cash flow, excluding working capital. It seems like there are many factors involved. From this quarter's capital statement, I noticed a $290 million burn, not including working capital. Your CapEx is projected to decrease by $25 million each quarter, and you're expecting savings of around $140 million per quarter starting in Q2. This might reduce the burn to about $120 million per quarter, which appears to require selling an additional 4 million tires at approximately $30 each to cover that. Am I on the right track with this thinking? Do you have any broad insights on how operations could reach breakeven in the latter half of the year?

Rich Kramer, Chairman and CEO

So Rod, I think you're getting to the right point which is the volume recovery is going to be an important consideration for what it takes to work our way to breakeven excluding working capital. I think as we look at volume trends, we recognize that there is going to be some cash usage in 2020. By moving to an environment where we get back what we think of as some meaningful recovery in volume we believe we can run the business without using cash.

Rod Lache, Analyst

Right, but it sounds like primarily in your mind it's the first half that you’re concerned about?

Rich Kramer, Chairman and CEO

Yes, it's primarily March through June; that’s the area where we’re using cash, and this cash is effectively going to be borrowed.

Operator, Operator

Okay. Thank you very much for that.

Rich Kramer, Chairman and CEO

Great, thank you. Thanks your attention today and as we open up the economy I hope everybody stays safe. Thank you.

Operator, Operator

That concludes today's program. Thanks for your participation. You may now disconnect.