The Goodyear Tire & Rubber Company (GT) Earnings Call Transcript & Summary

Good afternoon, everybody, and thank you for joining us for this session with Goodyear as part of Deutsche Bank's Global Auto Industry Conference. My name is Emmanuel Rosner, and I'm the senior U.S. autos analyst at Deutsche Bank. Goodyear is one of the largest tire makers in the world with a market-leading position in the U.S. We are very pleased to host Goodyear's CFO, Darren Wells; as well as Christina Zamarro, who is VP of Finance and Treasurer; and Nick Mitchell, who's Senior Director of Investor Relations, for a discussion with us this afternoon. The format for this session will be some remarks by Darren, updating the latest situation and latest trends he's seeing at the company and in the industry. And then we will turn to a fireside chat around some of my prepared questions, but also and mainly questions from all of you on the call. [Operator Instructions] So with that, thank you so much for being with us and, Darren, over to you.

Okay. Listen, thank you, Emmanuel. And thanks, everybody, for taking time today. I did want to just take time to kick off today, just to try to give a little bit of an update. We've been nearly 45 days since our Q1 earnings call, and a lot of that call was focused on what our expectations were for the second quarter and a little bit of what our thinking was for the year, particularly in the area of cash flow. Now I wanted to take a minute just to give a little bit of update, just -- it's a quick-moving environment, so we're learning things every day. And I think there are some things that probably played out a little bit different than we might have expected at the end of April. And I wanted an opportunity to just comment on those as a way to provide you a little bit more information and transparency, but also as a way to inform the questions that you may want to ask for the rest of the session. So appreciate the opportunity to do that. If I were to start out with just a little bit of a picture of how volume has played out. You'll recall that in our first quarter earnings call, the view that we gave of the second quarter was that we expected that to be the trough of volume during the coronavirus disruption, and that we thought that the -- our volumes might be down somewhere in the neighborhood of 50% for the quarter as a result of that. And I think in the end, that indication of 50% probably still holds. So I think we'd still say something very similar today. I think the character of that 50% is probably a little bit different. And generally speaking, I think we feel and have experienced a little bit better replacement volume. And a little bit worse OE volume, and I think that's particularly true in the North American market. So I think we've continued to feel good about the recovery process in the replacement business, and that is true in sales, it's true in the way the industry has recovered. We're in the U.S. We saw May replacement down about 33% from a year ago after being down close to 50% in April. So continuing to see some good trends there. I think maybe even more importantly, we've seen trends in retail recover at a very good pace. And if I look at the 7-day moving average at our retail stores in the U.S. at the end of May, our retail store sales were only down about 5% from where they were a year ago. So that says that May is recovering. In the end of May, we started to get back very -- within shooting distance of where activity levels were a year ago in terms of sell-out to consumers. And so I think that is a good indication. As I said, the downside for us has probably been slower-than-we-originally-expected OE start-up. And I think that's been well published, well written about. And that's just the fact that there really weren't a lot of vehicles built in May than we had originally expected that there would be. I think fortunately, production is ramping up. And so hopefully, June and July see OE volumes getting back to normalized levels or more normalized levels. Yes. So I think that is -- it's probably been the -- that's balanced out a bit the benefit we would have gotten from a little bit better replacement volume. I think for us in the U.S., and we mentioned this on the first quarter call as well, but I think the other element for us in our U.S. replacement business is that Walmart has not reopened their automotive centers as quickly as we had originally hoped for. They've continued to focus on some of the other departments in their stores. We still expect there to be a reopening of those service centers. But Walmart automotive represents a significant part of our replacement business in the U.S. So having that distribution channel close down certainly was more painful for us in May than we had expected it to be. And also made up for some strong performance that we had in some of our other channels. So I think that's -- it's a little bit of an update on volume. I don't think a lot of specifics to add to that in Europe and Asia. Although I will say that our progress in Europe on making the changes in our distribution continues to go pretty well. So I think if anything, we've seen that process go very well during the disruption. I think we're now at a place where we have agreements with all of our full-service distributors, so the distributors that we're moving our business to in Europe. So I think we have some -- from a top line perspective, I think, overall balanced story, but some good signs in the replacement business. If I then touch on production, because I think when we did our first quarter earnings call, I think we articulated the plan to cut our production significantly in the second quarter, not only to reflect the loss of sales in the second quarter, but also to reduce inventory levels from levels that were inflated at the end of the first quarter. And to realign those with something that made more sense, given where volumes are today. And our intention is to continue to do that. In fact, I think at this point, we had said our second quarter production will be down something like 25 million units from a year ago. I think, in fact, we're probably going to be over 26 million units in reduction, which, given that our sales forecast hasn't changed, that takes our inventory down even a little bit more. And I think that is -- our managing inventory, along with managing costs have been important elements, helping us do what we can to improve our cash position. And I'll say that along with that working capital management, our cost management has continued. So the cost actions that we took and articulated for the quarter, not going to update those, I think those still remain sort of directionally correct. The $65 million reduction in our salary payroll for the quarter, partly manufacturing, partly SAG, and then $75 million of other SAG reduction that we plan for the quarter, and I think we're going to deliver on those cost savings. So I think we continue to feel good about that. And if I take the working capital or the production cuts and the inventory management and add to it the cost reductions and continued good experience, working with our customers and keeping our receivables and collections on track. I think we're in a position now where our cash usage in the second quarter is going to be less than we originally had expected or what we had expected at the end of April. On the first quarter call, we said that we could see a use of cash in the quarter of up to $1 billion, and after which we would expect to have working capital as a source of cash in the second half. So we expected second half to be cash flow positive, but after a significant usage in the second quarter, I think our view today is that our cash use in the second quarter is now likely to be more in the range of $700 million to $800 million. And I think increasing confidence that we're going to be on the low end of that range, so something more approaching the $700 million use of cash. And that does reflect a lot of work and a lot of improvement in working capital, particularly inventory and receivables, along with the continued focus on costs. So I think, overall, we think we're in a better position in terms of our balance sheet in the second quarter. Doesn't change our view that working capital will be a source of cash for us in the second half. So I think we've just done an overall better job of flattening that curve. So flattening the use of cash that we have in the middle of the year and putting ourselves in a better position at the end of the quarter. So I think other than -- I think maybe I'll leave it there, I expect we'll get some questions in terms of price and raw materials, and I think those would be good questions to get. And we continue to watch what's happening there. But Emmanuel, maybe just -- let me stop there and maybe let you get started with the questions that you have in mind and the questions that people on the call are submitting to you.

Yes. Perfect. That's a very detailed update. So I appreciate it and certainly addressing some of the questions that I had written down. Just a point of clarification, to be completely clear. So the upside to the free cash flow burn expected in the quarter, to the extent that volumes overall were sort of like still in line, I guess, what's the main driver of the upside?

Yes. So I think the additional production cuts that we took in the quarter were certainly hopeful. So to the extent we took out an additional 1 million units or so in production, that's reducing the amount of inventory that we're carrying in the quarter, right? So I think certainly see some benefits in inventory. I think the fact that we've been able to work with our customers in order to keep customer payment patterns in a fairly normal position has certainly been helpful. We obviously work to support our customers. And the fact that some of their replacement business has recovered a bit better, probably in the end, helpful there. So I think good focus on managing our inventory, good focus on collections and managing receivables with the customers. Both of those, I think, have been important contributors for us. And I think the management of our manufacturing cost has also been good. I think there's probably been a little bit of an upside surprise. Our manufacturing cost tends to be fairly sticky, and the variable cost doesn't all go away when volume goes away. But our team, I think, has done probably a better job than even what we were expecting, keeping manufacturing cost low during this period of low production.

Great. And then to be clear, your expectation would still be for working capital to be positive in the second half, despite a good management of the receivables in this quarter.

Yes. Yes, still looking for working capital to be positive in the second half.

Perfect. A few questions from the investors on the call. Point of clarification in regards to Walmart not opening their service center. You mentioned other channels that made up for that.

Yes. So I'm not -- I don't think that -- there aren't any channels that are going to be big enough to make up for that. So I mean, overall, that is a negative for us. We have seen though, in a couple of our other channels, we've seen very strong performance. And I think our retail stores, company-owned retail stores have been in that category. I mean their performance, I think, has been very strong. The other channel that's performed very well for us has been our e-commerce channel. So that's direct, over-the-internet sales to consumers. And so I think we look really at that. In the month of May, we were up 50% from a year ago in online sales. So I think that's a channel that's working very well. Obviously, it's a reflection of changing consumer preferences. So in this environment, shopping online is making a lot more sense to people, even people who may not have been used to shopping for tires online. And I think it's -- additionally, it's supported by the mobile fitment option that we offer in some markets. And the selection of mobile van fitting at consumers' homes, that has risen dramatically during the last couple of months. So that's an offering that I think we always felt confident in it, but that is a channel and offering that is -- we are sort of seeing dramatic increases during the recovery phase here. So I feel good about that. Walmart still remains our -- certainly our largest single channel. So that's going to continue to be a hit for us. I think we feel that as they get those centers reopened, that volume is going to come back. But it could be a hit for us in Q2.

Understood. Then another follow-up on your remarks from an investor. So you're working down your inventories a little more aggressively, I guess, in the quarter. Can you talk about what your expected inventory levels would be at the end of the quarter, in terms of number of tires or normalized days of inventory?

Yes. So I think the -- what you'll see is that we will have taken the opportunity to work our inventory down to the point where not only will it have adjusted for lower selling rates, but we actually should see a decline in our DSI or days sale -- days of sales in inventory by the end of the quarter. So I think we're looking at this not only as a near-term cash action, but I think we are looking for opportunities here to figure -- to take this opportunity to change the way we run our manufacturing ticket so that we are able to improve customer service levels at lower levels of inventory. And that is one of the benefits of having some extra manufacturing capacity, is we can actually -- we have time to do more changeovers. And therefore, we can do shorter production runs, and we don't have to -- we can get around to production of individual SKUs more frequently. And therefore, there are 2 benefits: one, that allows us to have quicker reaction to customer orders and therefore, better customer service, which I think we're excited about. And it allows us to have that better service level at lower inventories. And so we're resetting our system in order to do that. The challenge, of course, is going to be to try to keep that benefit or that lower sales -- days of sales in inventory and the higher customer service levels as we get back to pre-COVID volume levels. And I think we've got some business process changes that are going to allow us to do that, and that's certainly our target. But I think you'll see that step down in days of sales in inventory for the second quarter.

Okay. Great. One just additional point of clarification from the investors. Have you heard any time line around when Walmart channel comes back on line?

Yes. So that's still, I guess, work in process. So they're -- I think there have been some stores reopened, but it's a large number of locations. And I think it's still to be determined how quickly we get to all of those locations being open again. Yes, so I think a lot of that is going to play out during the month of June and July. So I think by the time we get to our second quarter earnings call, we're got a lot clearer view of that.

Right. So maybe shifting gears a little bit, a few questions from investors around commodity prices. So can you quantify the -- your updated raw materials outlook? I'm just reading here the question, but since your first quarter call, all of your key commodities have seen significant price increases other than synthetic rubber. I know you wouldn't be buying much commodities in the second quarter, but I guess just an update on your raw materials.

Yes. So I mean it's a fair question. And I think we -- when we were looking at the situation at the end of -- when we did our first quarter call, so end of April, we were looking forward and saying, okay, based on where commodity prices are, we were expecting two things: one, we were expecting that when the industry started buying commodities again, those prices would rise again. And I think that is what we've seen happen. So I don't think we were ever expecting the commodity prices to stay where they were because I think part of why they were where they were is that there wasn't really any significant demand for them. I do -- but we also said that even given that, we were expecting that we could get a $50 million to $100 million benefit in the year from lower raw material cost, excluding foreign exchange impact. And I think, in fact, our view right now is probably that we would be at the high end of that range as we look at what we expect to buy and the prices that we expect to buy in that in the coming months. So I think we continue to see that benefit, although I think most of that benefit will come in our cost of goods sold in the fourth quarter, so later in the year by the time it runs through our inventory. So I think that's the update. So if I put everything together, I think we're still expecting to get that benefit, notwithstanding the fact that there have been some commodity prices that have recovered some over the last 40, 45 days.

Okay. Great. And I guess beyond that, how much raw materials tailwind do you think is possible during this cycle? Historically, you've pointed out multiple times that you're able to capture a lot of debt back. Is it still the same this time around?

Yes. So I think that we're -- we came into this disruption at a point where there had been a number of price increases in the industry, including the 5% increase that we announced for the beginning of the second quarter. So there continued to be price increases announced, even though raw material costs have been dropping in the second half of '19. And obviously, we're feeling like that -- at this point, we have not seen any different indicators relative to that. So I think -- and in fact, I think we've seen the April PPI for tires was up year-over-year. So we're seeing that in the -- sort of seeing that in the macroeconomic data as well. So pricing -- all the -- the indications have all been that there have been a number of price moves, and those most recently have been up, even though raw material costs have been down. And while I think the move in raw material cost historically when raw material costs have dropped like this, and I guess, we'll see where they shake out as tire manufacturing ramps back up, but to the extent they're down, I think this is a part of the cycle where typically we've had an opportunity to recapture some of the margin that we lose when raw materials go up. And I think that is -- it's a perspective that I've had on this. And it's a perspective I continue to have. I think there is going to be an opportunity here for us to recapture some of the margin that we were sort of unable to achieve during the period of rising raw material cost.

Okay. On the cost savings, so you mentioned in your prepared remarks being on track for about $140 million or so from the cost actions during the quarter from payroll reduction, all those things. How should we think about that on a go-forward basis? Are these all more on the temporary side? Or can some of these savings be maintained over the rest of the year?

Yes, yes. So I guess I'll take the 2 pieces separately on this. So we've got $65 million of salary payroll reductions that we took in the quarter, and then $75 million of other SAG reductions that we expected for the second quarter. And a lot of these cuts, as you can imagine, were taken on fairly short notice. And with the idea of trying to preserve cash during the course of the second quarter and during the course of the disruption at a time when we really didn't understand how the recovery was going to shape up. So I think there are a lot of those cuts that are temporary in nature. And I think we're expecting to see the -- a lot of the salaried staff return to work as we get into the third quarter. And in fact, that has been the plan. That plan hasn't changed. I think the question is going to still be out there, though, as we develop our operating plan for the second half. And as we look out over the course of the next 12 to 18 months, the question is going to be what the volume outlook is likely to be? And what costs are going to be appropriate given that volume outlook? And I think that is still a work in process for us. And I think we realized that if -- the longer the recession persists, the more it's going to demand of us in terms of finding ways to be more cost effective. The $75 million in other SAG, I would say, at least the marketing costs that are embedded within there, which is a significant part of it, are cost that would normally come back as volume comes back. So I do think as volume recovers, you will see some of that cost come back. However, to the extent that volume recovery takes longer, then I think that we will keep -- some of that cost will -- we would plan to keep fairly tight reins on. So it's something that we can flex a bit. So I think that it's a question of we're continuing to evaluate ourselves. We'll be able to have more conversation about it. When we get to our second quarter call, our second half plan will be finalized by then. But I think we're -- I think maybe I'll stop there because it's very much still a work in process for us, trying to plan out what the rest of this year looks like and what the first half of next year might look.

Yes. For sure. I had a question on your market share. So again, with your performance in the U.S., consumer replacement tires lagged the industry quite a bit in the first quarter. There were I think a lot of good, sort of like ad-like reasons for it. But are you seeing something that's sort of like more structural there? Was it really just things like geographical mix, payback from Walmart or things like that? And anything that you can comment on in terms of second quarter market share so far.

Yes. So -- and if I just stick to the U.S., I think you've mentioned the 2 most significant factors for us in the first quarter. And I think those 2 are going to continue to be the most significant factors in the second quarter. And that is geographic mix. And the Northeast is one of the markets where we have the highest penetration. So the fact that the Northeast was most affected by the shutdown hurt us disproportionately. And the fact that the Walmart auto service centers, which is a very significant piece of our distribution, were shut down, in March and then for most of the second quarter, is going to hurt us. So I think first half of this year, those are, by far, the most significant effects. I would say it comes out in 2019 where our market share performance in the U.S. was pretty good. So I don't -- I think we were coming in on a fairly strong footing, but it definitely had a couple of impacts there that are pretty significant and a little bit unique to us. And I think we'll find a way to get -- as we move past those impacts, I think there's going to be opportunity for us to recover. In Europe, I think the story there, largely the changes that we were making in our distribution and how that affected our sales into distribution channels as we are reducing sales to some of the distributors with whom we are not going to have long-term, full-service distribution agreements and shifting more of our business to our full-service distributors. As we go through that process, sell-in is affected. I will say this, and I think it's actually a pretty good indication, as we look at the sell-out market share in Europe for April, Goodyear, we actually -- our brands gained share in terms of what was sold out to consumers, even in a period of time where our share does not look very good in terms of what's being sold into distribution. So that says the demands for the brands are still there. If the aggregate of all of our distribution channels, if that inventory is coming down, that process will end. And what will really determine longer-term volume is going to be that pull by consumers in terms of sellout. So I think we're continuing to see good demand for our products among end users. And I -- as I said earlier, we're feeling good about the transition process we're going through, moving to more aligned group of distributors.

That's great color. I want to lump a few questions that we're getting on your free cash flow together in maybe 1 long question. So you've added a decent amount of leverage during this downturn. What do you see as likely timing to start generating positive free cash flow and paying down some of the debt? Is there any potential to accelerate it through, I guess, either exiting some regions or selling assets? There is some investor asking whether it would make sense to consider selling some retail stores or a part of the reselling organization?

Yes. So I guess just I'll hit the last point first. I think we continue to feel like the -- there is a lot of benefit to us and maybe increasing benefit of having the support from a lot of our retail footprint because those are opportunities for us to have a trusted point of service for consumers, which obviously, our touch-free service offering has been an important element. I think we have a lot of trust with the consumers. And this is a period of time where that trust in a pandemic environment is very important. And we've seen sort of good traffic coming back to our stores. So I think we're feeling like that is important for us and has been important for us during this disruption. So I don't think anything about the current environment makes us feel like those are less important. So I think keeping those distribution points out there is -- that's a good thing. So I don't think we look at anything here that is significant that we would be focused on in terms of asset sales. I guess there are always adjustments that can be made. But I think really, when we're looking at what we need to do to repair the balance sheet after adding leverage during the course of this crisis. I think we are certainly focused on what it takes to get back to positive cash flow. So we're starting to generate some of our own cash. And I think part of the -- some of the actions that we've taken, including cutting back on our CapEx, including suspending our dividend, those are all in the direction of setting us up to be able to generate some cash, even if volumes take a while to recover. So I think -- I do think that we will -- that we'll have an opportunity to generate cash. I think the actions we were talking about regarding inventory and working capital are going to continue to be an opportunity for us. And our working capital to sales was lower, if we look back 2013, 2014 than it has been in the last few years. I think we see an opportunity to move back toward those levels, so to get some cash out of working capital. And I think as we look to generate that cash, obviously, our earnings can rise, and that will help us deal with higher leverage than we're ending up with right now. We'll generate some cash, and that will allow us to start to pay down some of the incremental debt that we've ended up having. And I think those are going to be enough to move us in the right direction, certainly. Not that we -- I think we will continue to focus on our balance sheet target. And to some degree, how quickly we feel we need to deleverage is going to be influenced by how quickly the economic and volume environment recovers. So if the economic environment recovers more slowly and that is allowing us to make less progress then that's something we'll have to take into account. But I think what we really feel good about is that unlike when we exited the Great Recession, this time we are exiting with higher debt, but we don't have any real issues on legacy obligations. So in other words, our pensions were fully funded or effectively fully funded and derisked. So we don't have expanding pension or other retiree obligations to worry about. All we've got to focus on is effectively the debt-to-EBITDA on the balance sheet. So I think we feel relatively good from that perspective.

That's great. Listen, I think we're out of time, but I really, really appreciate all the transparency, all the latest update, new information, your insights. I want to thank all Goodyear team for setting this up and participating in the Deutsche Bank Autos Conference. Thank you to all the investors on the line for your great questions. Stay tuned for the next round of presentation, Cooper Standards and Spartan Motors that are on track 1 and 3, respectively. And again, Darren, thank you so much for being with us.

Thanks, Emmanuel.

Buh-bye.