Earnings Call Transcript - GT Q4 2020

Operator, Operator

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 fourth quarter 2020 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star and one on your telephone keypad. If you would like to withdraw your question, press the pound key. I’ll now hand the program over to Nick Mitchell, Senior Director, Investor Relations. Please go ahead.

Nick Mitchell, Senior Director, Investor Relations

Thank you, Keith, and thank you everyone for joining us for Goodyear’s fourth quarter of 2020 earnings call. I’m joined here today by Rich Kramer, Chairman and Chief Executive Officer; Darren Wells, Executive Vice President and Chief Financial Officer, and Christina Zamarro, Vice President, Finance and Treasurer. 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. With that, I’ll now turn the call over to Rich.

Rich Kramer, Chairman and CEO

Great, thank you Nick, and good morning everyone. Good to be with you today. As you saw in our news release this morning, the fourth quarter was an outstanding conclusion to a truly unprecedented and challenging year. Our segment operating income in the quarter was $302 million, up 25% from last year. Our volume improved sequentially, reflecting a modest uptick in global industry demand compared to the third quarter, as well as improvements in market share in several of our businesses. We also continued to benefit from execution on cost savings initiatives, including actions we’ve taken to improve our structural costs. At the same time, we saw improvements in both price mix and raw material costs. These factors helped us deliver significant earnings growth and margin expansion during the quarter. In addition, we delivered $1.2 billion in free cash flow, our highest fourth quarter cash flow since 2011 after a strong Q3. I’m incredibly proud of our team’s ability to persevere and finish the year strong. The prospects of fourth quarter earnings growth and this level of cash flow frankly were not something we had imagined six months ago, or even three months ago; yet with the determination to win with our products in the marketplace and a relentless focus on cost and cash, we finished the year on a high note with our businesses well positioned for continued recovery. Each of our strategic business units contributed to this outcome. In the Americas, our commercial business continued to perform well. Volume increased 7% as we benefitted from significant share gains in both OE and in replacement. The momentum we have with our commercial customers is a testament to our market-backed approach to developing products and services that help owner-operators and fleets of all sizes maximize uptime and lower operating costs per mile. We believe we can build on this strength in 2021. Chart tonnage, freight rates and Class A truck orders are trending favorably in the U.S., suggesting we are likely to see accommodative industry conditions. We also see a significant benefit from recent customer wins, including Ryder, Albertsons, Dart, and Pepsi Mid-America just to name a few. We are expanding our suite of digital tools and fuel-efficient products to help us continue winning with fleets in the new year. We recently introduced Fleet Central, an interactive tool designed to help fleets lower costs and make faster and more informed decisions regarding their tire and maintenance needs. Later this year, we will roll out the Fuel Max LHD2 and the Fuel Max RSD. The Fuel Max LHD2 is a drive tire designed for long-haul fleets looking to lower fuel costs and reduce their carbon footprint. This tire offers low rolling resistance that meets Phase 2 greenhouse gas emissions and fuel efficiency standards. The Fuel Max RSD will allow us to differentiate our product portfolio further. This tire is designed for regional haul carriers that demand fuel efficiency for highway travel but also require robust durability and traction to navigate city routes. These types of customer-backed products combined with an increasingly digital-based service proposition will help us advance our strong industry-leading proposition. Turning to the Americas consumer business, our OE volume increased 6%, outperforming the industry for the fourth consecutive quarter. While I’m pleased with our recent performance, I’m even more excited about the gains we expect in our OE business in 2021 and beyond. Winning the right fitments, such as the award-winning 2021 Ram 1500 TRS, which is equipped with Goodyear Wrangler Territory all-terrain tires, allows us to strengthen our brand and build customer loyalty, both of which are key drivers of demand in the replacement market. As you’ve heard from us in the past, it’s these types of platforms that generate the highest customer loyalty in replacement. We’ve demonstrated that we can maintain our competitive advantage in the all-important light truck category on electric fitments as well. The Goodyear Wrangler Territory MT off-road tire was selected to be fitted on GM’s new EV Hummer, a strong win for our consumer OE business and a nod to how we are transforming our capabilities to meet customers’ changing needs. Turning to our U.S. consumer replacement business, while lower demand in the mass merchant channel continued to impact our absolute results, our relative performance in the U.S. improved with our share in targeted segments increasing more than two full points compared to the third quarter. Outside the mass market channel, we grew share with customers. The award-winning Eagle Exhilarate and Assurance WeatherReady, along with customer favorites such as the Assurance Max Life, were instrumental in our ability to perform well in other retail channels. Our new product rollouts will continue in 2021. This month, we will introduce the Comfort Drive, a premium tire designed for the commuter touring category, a segment that accounts for half of the consumer replacement tires sold in the U.S. The Wrangler Workhorse power line will debut later in the year as well. This product line is designed for those who rely on hardworking dependability for their tires to get the job done. Shifting to EMEA, our commercial business delivered another impressive quarter. By tailoring our products to the needs of our commercial customers and building a fully integrated service business, we have been able to grow share for two consecutive years. We expect to maintain this strong momentum in 2021 by strengthening our mobility solutions offering, expanding our service network, and broadening our reach with small and medium fleets. I’m excited to say that we’re off to a terrific start as well. In January, Ryder selected Goodyear as its sole mobility partner in Europe, becoming the latest fleet to recognize the substantial value of our end-to-end mobility solutions. Now turning to the consumer segment, our OE business is beginning to see the impact of higher win rates on targeted fitments, particularly on EVs. Our volume increased 16% in a relatively flat market. Winning with customers who place tremendous emphasis on tire technology and performance demonstrates our capabilities. We continue to see strong win rates for future fitments. OEMs are recognizing the commitment we have made to developing tires that will help them transform their portfolios to more energy-efficient and eco-friendly vehicles while delivering performance capabilities consumers demand. For example, Volkswagen selected the Goodyear Efficient Grip Performance and the Goodyear Ultra Grip Performance for its ID3, its first vehicle to be designed exclusively for electric mobility. Both tires will feature our proprietary sealant technology. Mobility solutions like these have helped us secure a leadership position in electric mobility; in fact, EVs now account for approximately half of our OE development projects in Europe. In EMEA’s consumer replacement business, the continuation of consolidating our distribution footprint has temporarily affected our volume; however, the changes were necessary and will enhance the value of our brands and our products over time. We continue to see positive effects on the value of our products in the market and in our results as a result of this initiative. This momentum increases our confidence that we will deliver on our goal of increasing our margins by $2 to $4 per tire over the coming years, and we saw improvements in our share compared to Q3, momentum we believe will carry forward into 2021. Turning to Asia-Pacific, our consumer replacement business continued to be the highlight, outperforming the industry and turning in its highest quarterly volume ever. Once again, we benefited from strong growth in China where we increased replacement units by more than 10%. This growth is supported by the work we’re doing to transform distribution. Last quarter, we announced a pilot for an app-based direct-to-retail distribution model in China. In 2021, we expect to add approximately 600 new branded retail stores across Asia to support future replacement growth, with more than half of the locations planned for China. We’re also continuing to enhance our product portfolio to ensure we meet the evolving needs of the consumer. This year, we will launch the Goodyear Assurance MaxGuard to capture growth in the mid-SUV segment. Turning to Asia’s consumer OE business, where 2020 was impacted by the discontinuation of some high-volume fitments in China, we see a very different story in 2021. In addition to the favorable impact from higher light vehicle production this year, we expect to benefit from a strong OE pipeline. We are focused on being on platforms with high replacement pull. This will help drive strong replacement demand in the years ahead. While it’s important that we focus our efforts on the opportunities that lie ahead, we cannot lose sight of all that we accomplished to position Goodyear for recovery. We increased our OE pipeline, winning fitments representing more than 9 million units, we made it easier for consumers to buy our tires by launching Goodyear Mobile Install in new U.S. markets and doubling our fleet of service vans, we expanded our commercial fleet services and added significant fleet accounts, and we continued advancing our future mobility capabilities. We know there’s been a lot of public focus around the experience being accumulated with regards to connected tire technology. Our primary focus hasn’t been around these statistics, but given the interest, we went back and calculated our accumulated connected miles, and it’s a large number. As of year-end, we have over a billion miles of data on connected tires and no plans of slowing down this learning. I’m very satisfied with the solid progress we’ve made in the second half of this year. I’d like to thank each and every Goodyear associate for their sacrifices and commitment throughout the year and for the strong fourth quarter finish. We have good momentum as we enter into 2021. Now I’ll turn the call over to Darren.

Darren Wells, CFO

Thanks, Rich. You can see from our results and from Rich’s remarks that the fourth quarter reflected a combination of continued industry recovery and strong performance by our team, including on market share, cost efficiency, and cash generation. Our consumer OE business continued to gain momentum, building on our share gains in the third quarter. We discussed in 2019 our expectation that our OE share would begin to recover by 2021 after the declines we were seeing at that time. This recovery started earlier than we expected and will continue given the fitment wins that we’ve had over the last several years. Our replacement share improved sequentially as the impact of last year’s customer store closures in the U.S. continues to improve and the impact of actions to address our distribution network in Europe begin to dissipate. We also continued to see the impact of restructuring actions in our manufacturing footprint. We delivered net cost savings of $70 million for the quarter. Finally, despite strong cash performance in Q3, we’ve delivered historically strong Q4 cash and working capital improvements, leading to positive cash flow for the full year and one of our highest levels of cash and liquidity. Overall, I’m very pleased with our performance for the quarter. While we continue to face a high level of uncertainty, we’re encouraged by the trends in our markets and in our business as we enter 2021. Turning to Slide 9, our fourth-quarter sales were $3.7 billion, down only 2% from the prior year. Our unit volume declined 5% versus a decline of 9% that we saw in the third quarter. Our segment operating income for the quarter was $302 million, up $60 million from a year ago. Our reported segment operating income included two items that were excluded from our adjusted earnings per share: first, a $34 million benefit from a legal settlement, and second, a $13 million charge for the establishment of an environmental reserve associated with a closed facility. After adjusting for these and other items, earnings per share on a diluted basis were $0.44, up from $0.19 in the prior year. The step chart on Slide 10 summarizes the change in segment operating income versus last year. The impact from lower volume was $40 million, reflecting a decline in unit sales of $1.9 million. Reduced factory utilization in the third quarter compared to a year ago resulted in a $32 million decrease in overhead absorption in Q4 results. Production in the fourth quarter was flat compared to 2019. Price mix improved $33 million, and overall material costs declined $25 million compared to a year ago. Note that we benefited to some degree from the three to six-month lag as raw material costs moved through our inventory. Recent raw material price increases will catch up some over the coming quarters. Cost savings of $103 million more than offset $33 million of inflation. Savings associated with the closure of Gadsden totaled $33 million, consistent with the third quarter. Foreign currency translation negatively impacted the results by $5 million driven by weaker currencies in South America, primarily the Brazilian real. The $9 million increase in the other category includes the benefit of a legal settlement of $34 million, which more than offset lower earnings in our other tire-related businesses and the establishment of the environmental reserve of $13 million. Turning to the balance sheet on Slide 11, net debt totaled $4.5 billion, a decline of more than $300 million from the prior year. Slide 12 summarizes our cash flows during the quarter and for the year. We generated $1.1 billion of cash flow from operating activities in 2020. Capital expenditures were $647 million. Free cash flow totaled approximately $470 million for the year, up about $30 million from the prior year despite pandemic-disrupted earnings. Working capital inflows exceeded our expectations in the fourth quarter. Since the beginning of the pandemic, driving cash flow and ensuring strong cash and liquidity have been our top priority, and results over the last three quarters reflect that focus. Turning to Slide 13, we had total cash and available liquidity of $5.4 billion at year-end. This is over $900 million higher than at the end of 2019 and marks the highest liquidity level in recent history. Turning to our segment results beginning on Slide 14, unit volume in the Americas declined 6%, an improvement from the nearly 10% decline in the third quarter. Replacement volume was down 9%, driven by our consumer business. While the adverse impact of lower sales through Wal-Mart’s auto care centers was less in Q4 than in Q3, it continued to drive the year-over-year decline in our volume relative to others in the industry. Our commercial replacement volume, on the other hand, increased 9% driven by strength in the transport industry and growth in our fleet business. OE volume was up 6%. Segment operating income for the Americas totaled $190 million or $38 million higher than last year. Excluding the impact of the one-time legal settlement and the environmental remediation reserve, the Americas segment operating income would have been $169 million, still up $17 million from the prior year. The benefits of our cost-saving actions and prudence in price mix contributed meaningfully to the earnings growth. Savings associated with the closure of Gadsden were $33 million for the quarter, and our aviation and off-road earnings remained down from the prior year. Turning to Slide 15, Europe, Middle East, and Africa’s unit sales totaled $12.4 million, down 5% from a year ago. OE volume increased 16%, reflecting the impact of several new fitment launches as auto production was essentially flat during the quarter. Replacement volume fell 11%. Lower volume in our consumer business more than explains the decline in replacement volume. Our commercial replacement business performed very well driven by continued momentum in our fleet business. EMEA’s segment operating income increased $31 million to $69 million. The increase was driven by lower raw material costs and improvements in price mix. Turning to Slide 16, Asia-Pacific’s units totaled $7.8 million, down 2% from the prior year, and a significant improvement compared to the third quarter. This sequential improvement in our volume was driven by our consumer replacement business which increased 5% in the latest period. While our business in China remained a growth engine, we also grew consumer replacement volume outside of China during the quarter. Our OE business results year-over-year continue to be affected by discontinued fitments in China. Segment operating income was $43 million, down $9 million from the prior year’s quarter driven by lower earnings in our other tire-related businesses. Turning to our outlook items on Slide 17, while markets have recovered considerably since the middle of last year, we continue to face a high level of uncertainty. Despite these uncertainties, we wanted to share with you some thoughts on how we’re currently thinking about the business during the first quarter. First, we expect volume will be similar to what we experienced in Q4 with overall levels below 2019, reflecting lower auto production and continued softness in vehicle miles traveled. Second, we expect our production levels to be about 3 million units higher than last year, positively impacting our fixed cost absorption. Third, we expect to see continued improvements in price mix. While we still expect our raw material costs to be lower than the first quarter of 2020, the year-over-year benefit will be significantly less than in the fourth quarter. Slide 18 summarizes several of our full-year financial assumptions. Based on current spot price, we would expect our raw material costs to increase $125 million to $175 million net of cost savings, largely in the second half of the year. Our planned capital expenditures total about $850 million, which includes some catch-up for the investments that were deferred as a result of the pandemic. Given the industry recovery in the second half of last year and the resulting impact on our inventory levels, we’ll need to reinvest in working capital in 2021. At this point, we expect to reinvest around half of the cash we pulled out of working capital last year. Rationalization payments are expected to be similar to last year’s levels as we complete the plans we’ve announced in Europe and the U.S. to strengthen the competitiveness of our manufacturing footprint. We expect our book tax rate will continue to be very sensitive to small variations in income, so hard to estimate with any precision. At this point, we anticipate paying cash taxes of $125 million to $150 million, which includes payments deferred from 2020. Last year, we suspended our quarterly dividend in response to COVID-19 and expect this suspension to continue while the impact of COVID-19 persists. Finally, you’ll find several updated reference slides in our presentation. Slide 20 contains updated modeling assumptions that will be useful as you develop your forecasts. The most significant changes compared to the prior year’s version are in the section on volume sensitivities, reflecting the impact of lower industry volume in 2020. Slide 21 provides an updated percentage breakdown of our raw material costs by commodity. Note that our overall spend in 2020 was significantly impacted by lower production. Slide 22 provides an update on the percentage of our consumer business made up of large rim diameter tires. You’ll notice the significant increases in the percentage of 17 inches and above in our OE businesses. Now we’ll open up the line for questions.

Operator, Operator

We’ll take today’s first question from Rod Lache with Wolfe Research. Please go ahead.

Rod Lache, Analyst

Good morning. Was hoping you might be able to talk a little bit about what you’re seeing in terms of price and mix, and in particular just the supply-demand impact of these tariffs on the four Asian countries. They accounted for at least a quarter of U.S. replacement supply in the past couple of years, so how do you see that starting to trickle through the market?

Rich Kramer, Chairman and CEO

Rod, maybe I’ll take it in two pieces, one just to give a few remarks or some thoughts on the tariffs, and then talk a little bit about the pricing environment - obviously a relevant question. I would say as we think about it, leveling the playing field in the U.S. is really no question a good thing for the health of the domestic tire industry, and I know you know it, going back to the last tariffs we saw in 2014, you could go back and look at the numbers; there was a clear benefit to the U.S. industry. I think there is a bit of a distinction because, back to 2014, we did see much of the import volume quickly shift out of China into a lot of the other Southeast Asian countries, as you know, many of which now are the ones who are actually the ones subject to the potential anti-dumping and countervailing duties and tariffs, so I think as we look at this and given that history, the benefits of these more recent tariffs potentially may be longer-lived and may have a bit longer life. Just as you think about it, there’s just simply fewer locations and places to put those tires to send them back into the U.S. Taking a step back, we think that the industry is doing pretty well. We see good recovery in demand. Demand is running ahead of supply, particularly in the premium product; that’s a good thing for us, and as you see in the fourth quarter, the positive benefits that we got of price and mix, and we see that even relative to what we see are higher raw material costs coming in next year. Then if you just take a step back and look at what’s happened to price or how we’re thinking about price and what we’re seeing, I should say right now, in 2020 we did see a net recovery of price mix versus raw materials, building on that momentum that we kind of saw in the second half of 2019 - that’s a good thing, but I’d also remind you and everyone else we’re still not fully recovered from those high raw material costs we saw in 2017 and 2018, so really a net positive and really important evidence in what we’re seeing, that that cycle is kind of turning around to help us recover all those raw materials. Again, you see it in our price per tire ex-FX was up about 3%, so good outlook on the replacement side. Remember, the OE business has some RMIs that could have an impact as well. Then if we just look around the globe, we’ll start in the U.S., the PPI was up about 1% in Q4 versus the prior year - always a good sign, and then as we look around, we saw nine of 10 of our consumer tire manufacturers out there, the ones that we monitor, they’ve announced price increases since November of about 5% to 8%. We announced up to 5% on our consumer replacement business effective December 1. Then if we go to the commercial side, we saw more than half of the truck tire manufacturers that we track, they’ve also announced price increases of that same amount, about 5% to 8% since November, and we’ve announced up to a 6% price increase that was effective November 1. Then if we switch to Europe, remember we’re in the summer selling season right now, and we’ve seen several tire companies there announce price increases as they start selling those tires. Relative to us, we implemented a price increase of about 2% on both summer and all-season, effective December 1, and also in the truck business, as the truck business, as Darren and I both referenced in our remarks, is very robust in Europe and right now, and we’ve had some pricing actions there as well. Then if we just broadly speaking look at emerging markets, we do what we always do there, is use price to offset weak currencies and raw materials. I’d say a pretty constructive environment all round.

Rod Lache, Analyst

I was hoping just secondly you’d be able to touch on what you still think you need to do longer term to achieve competitiveness. You’ve kind of referenced the low-cost country versus high-cost country manufacturing - is that something that you see getting executed over the relatively near term, and if you can just remind us what kind of cost savings you’ve got between Gadsden and Europe restructuring as you look out to 2021.

Rich Kramer, Chairman and CEO

Our manufacturing costs for consumer tires are significantly higher than the industry median, which is a competitive challenge we are working to resolve. The restructuring efforts in Gadsden and our factories in Germany, specifically in Hanau and Fulda, represent an important initial step in addressing this cost issue. We've begun to see the benefits from these efforts in the latter half of 2020, with Gadsden contributing around $33 million in savings per quarter. As we transition into the first and second quarters of 2021, we expect to realize the complete benefit. From the German restructuring, we anticipate savings in the range of $60 million to $70 million. When we combine these two initiatives, we are looking at nearly $200 million in improvements when comparing 2022 to 2019. This represents a significant positive shift. Additionally, we are making progress with expansions in some of our lower-cost factories, including those in Slovenia and Mexico. We are committed to enhancing our cost efficiency through further investment, including automation and optimizing production in our existing facilities, as well as expanding our most efficient plants. We believe we are moving in the right direction, but there is still more to be done.

Rod Lache, Analyst

Thank you.

James Picariello, Analyst

Hey, good morning guys. On the 2021 outlook, do you expect global industry volumes to be down in the first quarter, or does the color you provided relate to Goodyear’s? And Darren, you mentioned volumes similar to the fourth quarter - was that a reference to the year-over-year comp? Just given the full reopening of your largest North America replacement customer, should we expect sustained sequential improvement through the year in terms of the company has regained share and eventual volume outperformance? How should we be thinking about that? Thanks.

Rich Kramer, Chairman and CEO

Let me share our thoughts on the industry looking beyond the first quarter. Our previous comments about Q1 referred to the anticipation that our volume would still be somewhat lower at the start of the year compared to 2019 levels. We believe we will perform better than we did in 2020, especially considering the impact of the pandemic that took hold last March. When examining consumer replacement in the U.S., it's complicated due to the surge in imports we experienced in the latter half of last year. In 2020, consumer replacement volume in the U.S. decreased by 7%, while member volume dropped around 12% to 13%, and non-member volume increased by about 15%. Most of this variation occurred in the second half of the year, meaning that the first half comparisons are fairly balanced, and we anticipate good recovery relative to 2020 levels. As we approach the second half of the year, the analysis becomes more challenging. We expect members, including ourselves, to see volume improvements in the second half, but we anticipate non-members to decline due to pre-buying before the tariffs. Therefore, if we were to summarize the overall industry outlook, it appears somewhat flat when combining member and non-member performance. We expect significant improvement in the first half, while the second half remains less certain, likely presenting a decline when factoring in the import effects. This perspective informs our previously shared Q1 assessment, noting a good recovery from 2020, while still falling short of 2019 levels. Regarding other industry factors, in consumer OE, our outlook is likely similar to market expectations. We anticipate recovering most, if not all, of the 2020 decline throughout 2021, as consumer OE was down 19% last year. Commercial replacement volumes were up about 1% last year, and we expect single-digit growth this year, indicating a positive trend. In commercial OE, which faced the greatest decline of approximately 30% last year, we expect to recover about half of that based on current production forecasts. In the European market, consumer replacement volumes were down 12% last year, and we expect to regain over half of that drop this year, though not in full. Consumer OE in Europe decreased by about 25%, and we project recovering over half. Meanwhile, commercial replacement in Europe was down about 7%, which we expect to fully recover, and in commercial OE, after a decline of 18%, we foresee a full rebound, indicating a strong recovery in the commercial sector. Overall, the consumer recovery in Europe may be slower compared to what we anticipate in the U.S. To recap our Q1 outlook, we expect a decline that is directionally similar to what we noted in the fourth quarter.

James Picariello, Analyst

Got it, that’s super helpful. Thank you for all that color. As we think about your TBR OE business, would you venture to say that the margin profile of that business is higher or at least in line with the margin profile of your consumer replacement mix?

Rich Kramer, Chairman and CEO

Our modeling of margins for commercial original equipment tires is essentially aligned with that of commercial replacement tires, so there isn’t a significant distinction. While these are different products with varying margin characteristics, we generally treat them as similar. In contrast, margins for consumer original equipment tires tend to be lower than those for replacement tires.

Darren Wells, CFO

And James, part of the reason for that, remember, is a lot of those tires on OE are being spec’d by our fleet customers, so there is much more integration between what happens at the fleet level and then what gets pulled out of OE. Our customer sort of flows right through, where OE are essentially two different customers.

James Picariello, Analyst

Got it. Yes, just given the strong industry production backdrop for this year, I just wanted to ask about TBR. My one follow-on, your other tire-related businesses, I think amounted to about $150 million headwind for the full year. Aviation will be the ongoing headwind that sustains - no surprise, but how much of the $150 million do you think can be recaptured in 2021? Thanks, guys.

Rich Kramer, Chairman and CEO

I think our view here is given the continued challenges in aviation, we’re probably looking to recover something on the order of half of the $150 million that we lost in 2020, and then would expect the remainder of that to come back over the coming years. But the aviation industry, I think we’ll probably have a three or four-year outlook for a full recovery.

James Picariello, Analyst

Understood, thanks.

Victoria Greer, Analyst

Good morning. Two questions for me, please. Firstly on the Q1, could you just give us a little bit more detail around the absolute amount you’d expect of a raw materials headwind in Q1? You mentioned that you expect the Q1 price mix versus raw to be positive but less of a tailwind net than it was in Q4. Could you talk us through a bit the different drivers that you’ll have in Q1 versus Q4? Then a second question really around inventory levels. We know the industry has been running production pretty high to catch back up in the second half of 2020, it seems like that’s been the case for you as well. You were expecting to rebuild some inventories in Q4, but I guess looking at the working capital inflow you had, that probably happens more in 2021. Could you talk a bit about, firstly, where you think inventories are now, both for your own business and then also into the dealer channels? Is there still catch-up needed there? Thanks.

Darren Wells, CFO

Let me ask Rich to start by discussing our view on channel inventory.

Rich Kramer, Chairman and CEO

Yes, sure. There’s a lot to cover, and those are all valid questions. From the perspective of channel inventory, let’s break it down between the U.S. and Europe for clarity. In the U.S. during Q4, we experienced what I would characterize as modest re-stocking by our wholesalers and retailers. Sell-in was roughly at last year's levels, but sell-out declined by about double digits. This decline included, but is not limited to, the effects of the pre-buy of Asian tires mentioned earlier. Additionally, we see evidence of inventory growth among U.S. TMA members. Our third-party distribution inventory was down compared to the previous year, consistent with the reduction in sell-out observed, which correlates with VMT, a reliable indicator for balancing supply and demand over time. We expect some recovery in this area as we transition into 2021. In Europe, our third-party channel inventory, specifically among retailers, was lower at the end of December compared to the prior year, primarily driven by the usual seasonal decline in winter tire inventory. However, this represents a notable shift from the significant 13% decrease we recorded at the end of Q2. We've noticed a re-stocking trend beginning in the second half of 2020, suggesting we are in good shape overall at this point. However, it’s important to address your question, which I’ll pass back to Darren. One key matter we're focusing on is replenishing inventory this year. Demand remains strong, so ensuring our plants can meet this demand while rebuilding inventories is the central challenge we face in 2021. Darren, perhaps you can provide some numbers and insights on our approach to this.

Darren Wells, CFO

I think it's reasonable to say that the channels have begun to address their inventory issues, but we haven't had the opportunity to do the same with ours. You are correct to mention that we had intended to rebuild some of our inventory in the fourth quarter, as we stated during the third quarter call, but that did not materialize. Consequently, we concluded the year with approximately $700 million less inventory than the previous year. Our strategy is to recover about half of that. Ideally, we would have preferred to make some headway in the first half of 2021. This accounts for the majority of the $450 million to $500 million discussion. I want to revisit your question about raw materials, but Victoria, did that address your inquiry regarding inventory?

Victoria Greer, Analyst

Yes, that’s clear on the inventory, thanks.

Rich Kramer, Chairman and CEO

Raw materials for the first quarter are coming off a fourth quarter where we had a $25 million benefit in raw materials. This $25 million benefit in the fourth quarter was composed of $75 million to $80 million in benefits from raw material feedstocks, largely offset by adverse transactional foreign exchange, particularly with the Turkish lira and the Brazilian real, which increased costs in those regions. Therefore, our net benefit from raw materials was $25 million. We anticipate that both that figure and the figure after accounting for currency effects will amount to around $10 million to $12 million in the first quarter, likely representing about half of the benefit we experienced in the fourth quarter. Does that address your inquiry? Victoria?

John Healy, Analyst

Thank you. Wanted to ask a big picture question, just about the EV market. I know you guys highlighted the success and the momentum you had there, but I was hoping you could spend a little bit of time educating us a bit more about what is it about the R&D that you’ve put into place, or what’s going on specifically that you guys think is allowing you to garner some good share opportunities there, and any way you could kind of frame for us how you think you’re doing relative to the market on the EV side of things?

Rich Kramer, Chairman and CEO

John, to answer your last question, I believe we are performing very well. You’ve heard about some of the successes we've achieved over time, and we noted one of those in today's call. It’s important to view this as a combination of factors. First, our core tire technology is supported by an excellent team of engineers and scientists dedicated to solving these challenges. One significant issue with electric vehicles is rolling resistance, and I am confident in stating that Goodyear leads the way in rolling resistance across all markets globally, including Asia, Europe, and the U.S. Our expertise in areas such as tread compounding and material use adds value when addressing the complexities of electric vehicles. However, it’s not just about rolling resistance; we also need to consider the added weight of the batteries, the durability required due to the increased torque on the tires, and the sound levels, as tire noise becomes more noticeable without engine noise in electric vehicles. Our foaming tire technology and various other innovations help meet these requirements. Additionally, we must enhance the ride and handling characteristics to align with consumer expectations for electric vehicle performance. Overall, it’s the integration of all these factors that positions Goodyear as a leader in electric vehicle technology. Furthermore, the evolution towards integrated and intelligent tires will showcase our capabilities, as evidenced by our billion miles of data collected from connected fleets to optimize tire performance in conjunction with vehicles. Those first adopters will primarily be electric vehicle manufacturers and operators. Thus, when comparing us to competitors, it’s not just about building plants and manufacturing tires; we focus on integrating these elements to create value for our customers, addressing their needs, and developing products that support their future. That’s our perspective on the electric vehicle market.

John Healy, Analyst

Great, and then just one follow-up question for me on pricing, maybe specifically on the U.S. replacement market. I think you guys mentioned nine of 10 manufacturers raising prices. With the industry inventories being in a lean position and with the tariffs coming, do you think there’s an opportunity for further price increases in 2021, or do you think that the industry has already turned the page for what 2021 pricing might be for replacement units?

Rich Kramer, Chairman and CEO

John, hard first to comment about the industry. I will say that given our outlook on raw materials, which is for raw material cost increases principally in the second half in the range of $125 million to $175 million, if today’s commodity spot prices hold, the pricing actions that we took at the end of the year would generate enough pricing to cover about half of that cost in Q3 and Q4. There is more that we would have to do in order to fully offset raw material costs, so mathematically I think that’s it. I think what we’re focused on is continuing to manage raw material costs with price and mix - that’s how we’ve handled it in the past and that’s how we would expect to continue to handle it.

John Healy, Analyst

Great, thank you guys.

Operator, Operator

Your next question is from Ryan Brinkman with JP Morgan. Please go ahead.

Ryan Brinkman, Analyst

Hi, thanks. I’d like to ask about the current situation in Latin America. I remember that before you incorporated that reporting segment into the Americas, your focus was mainly on commercial tires, and you had a strong franchise with historically high margins in that region. There has been a downturn since then, but recently we’ve been hearing from some suppliers who have reported this quarter that the outlook for commercial truck production has improved significantly, possibly due to stronger agricultural commodity prices. I’m curious if you are observing the same and if that might be a positive factor for you.

Rich Kramer, Chairman and CEO

Yes Ryan, I would say we’re pleased with the way Latin America is shaping up, and I’m very pleased with how hard our team is operating. As you know, Latin America has been in what would be, I think, lightly described as a pretty difficult economic circumstance for a really elongated period of time. In that environment, I would tell you a couple things. One, in our passenger business, we continue to mix up to larger rim diameter tires and continue to expand our distribution throughout the region. We have more points of sale, we’ve been adding in each year over the course of the last few years. We’ve completely redone our product line there, and I would tell you that business is going very well. On the commercial side, a very similar story, that the industry has rebounded a bit. Our product line has been completely revamped. Our product performance, I think is leading in the industry and is broad-based across all the Latin America regions, and we also continue to expand our distribution points and notably continue now in a region that was a little bit harder to do it, are really moving ahead with some of the fleet solutions that you hear us talk about in North America and Europe. I would say we feel very good. If you asked me what’s the biggest challenge, I would still say it’s the economy, getting the economies to recover down there. But in that environment, I would say I’m very pleased with the way the team’s executing.

Ryan Brinkman, Analyst

Okay, thanks. Then just lastly, there have been a lot of questions already on price mix versus raw - most of mine are answered, the potential for future price increases, etc. But I guess I’d just like to ask around that in a little bit of a broader way. Obviously this past year has been very exciting from a macroeconomic perspective. There’s been a lot of inflation already in financial and real and alternative assets and increasingly in commodities, but it does seem that economists are more debating what the outlook is going to be for consumer prices, with some not projecting as much of a rise. I don’t know how you feel about that. We all have our own opinions. You pushed through some price increases already, the tariffs will help, the industry generally has a good track record of passing on costs long-term, but there was that softer period back in ’17 and ’18, so I don’t know - I just thought to check in with you, generally how you think the industry is positioned relative to what seems to be more inflation in input costs relative to consumer prices generally. Is this going to be the gating factor for your earnings over the next couple of years as the price mix versus raws trends, potentially?

Rich Kramer, Chairman and CEO

I appreciate you mentioning 2017 and 2018, as that was a time when we didn't recover raw materials, both for us and the industry. Looking at the bigger picture, with the vaccines being distributed and herd immunity progressing, despite the challenges posed by variants, I believe we see improvement ahead. This suggests that consumer behavior and spending, which have been restrained, may shift as we move beyond vaccinations. People are eager to travel and engage in activities again, which will benefit Goodyear and our sector as vehicle miles traveled increase, even if at a gradual pace. Additionally, we're observing demand outpacing supply, particularly in the premium segment, and this is influenced by low inventory levels not just in our industry but across various sectors. Coupled with the raw material inflation anticipated later this year and the ongoing release of stimulus funds, consumers are poised to spend. All these factors create a constructive environment for us. However, we need to monitor how this unfolds since the previous year has shown us that trends are rarely linear. Overall, I'm optimistic about the future, but our immediate focus must remain on overcoming the virus and ensuring safety. There's potential for positive developments ahead.

Ryan Brinkman, Analyst

All right, very helpful. Thank you.

Emmanuel Rosner, Analyst

Hi, good morning everyone. I wanted to start by asking about free cash flow, specifically regarding the near-term outlook and how we should view it in the long term. It appears that based on your current projections for this year, there is a need for investment in inventory, ongoing restructuring, and a catch-up on capital expenditures. Should we expect free cash flow to be a reasonable use in 2021? Moving forward, how should we approach the projections for free cash flow and its recovery according to your business plan?

Rich Kramer, Chairman and CEO

Emmanuel, looking ahead, I believe your assessment is correct regarding the need to reinvest $450 million to $500 million in working capital in 2021. You are right to point out that this will lead to some cash usage in 2021. Additionally, if we consider the longer term and set aside working capital, even before the pandemic, in the 12 months leading up to Q2 last year, we sold just under 150 million tires and generated $700 million in segment operating income. Adding back $800 million in depreciation and subtracting $100 million in corporate costs brings us to a cash flow that meets our guidance for this year, excluding working capital and restructuring payments. We have implemented actions that will lower our breakeven point. The restructuring efforts in Germany and Gadsden, Alabama are expected to reduce this breakeven point by over 6 million units, aligning us with our current volume levels. As we see volumes increase beyond current levels, it should create opportunities for generating positive cash flow even with the slightly higher capital expenditures we have planned, considering our overall cash flow outlook.

Emmanuel Rosner, Analyst

Great clarity, that’s very helpful. Could you please summarize the expected benefits of these restructuring actions for this year and next, particularly in terms of discrete actions, their impact, and the timing of some of these lower cost points?

Rich Kramer, Chairman and CEO

The first restructuring action in the U.S. involved the closure of the Gadsden, Alabama facility, which was effectively completed in the second quarter of last year. As a result, we achieved full savings of about $33 million per quarter in Q3 and Q4. We expect to continue realizing a similar amount in Q1 and Q2, which will represent the complete run rate savings. We will anniversary that in Q3 this year, so we do not anticipate any additional savings in the second half, as we will have already received the full savings from Gadsden. The cost savings from our restructuring in Europe will be more focused on this year and 2022. Although we haven't provided exact timing, we expect savings of $60 million to $70 million in relation to 2019, mostly comparing to 2020. We need to distribute that between 2021 and 2022 when accounting for the savings from factory restructuring in Germany. Additionally, since 2020 was an unusual year for tracking cost savings due to the significant measures taken to address the pandemic-induced shutdown, it remains a top priority for us to maintain cost efficiency. However, when looking at 2021, despite the benefits from the restructurings, our traditionally reported net cost savings, adjusted for inflation, will likely appear negative for the full year because of the one-time nature of the savings actions in 2020. In the first quarter, we will show solid net cost savings, as the temporary pandemic-related actions did not truly begin until Q2. However, in Q2 and Q3, we will experience some cost recovery compared to pandemic levels, which will make the net cost comparison that was favorable in 2020 look less favorable in 2021. We will still achieve savings from the restructuring, but it's important to keep this in mind as you model the cost savings year-over-year for 2021.

Emmanuel Rosner, Analyst

Great, thanks for the color.

Operator, Operator

This will conclude today’s Q&A session, and also conclude Goodyear’s fourth quarter 2020 earnings call. We want to thank you for your participation. You may now disconnect, and have a great day.