Earnings Call Transcript - F Q2 2022

Operator, Operator

Good day, ladies and gentlemen. My name is Chad, and I will be your conference operator today. At this time, I would like to welcome you to the Ford Motor Company Second Quarter 2022 Earnings Conference Call. Please also note, today's event is being recorded. At this time, I would like to turn the call over to Lynn Tyson, Executive Director of Investor Relations. Please go ahead.

Lynn Tyson, Executive Director of Investor Relations

Thanks, Chad. Welcome to Ford Motor Company's Second Quarter 2022 Earnings Call. With me today are Jim Farley, our President and CEO; and John Lawler, our Chief Financial Officer. Also joining us for Q&A is Marion Harris, CEO of Ford Credit. Today's discussions include some non-GAAP references. These are reconciled to the most comparable U.S. GAAP measures in the appendix of our earnings deck. You can find the deck, along with the rest of our earnings materials and other important content, at shareholder.ford.com. Today's discussions also include forward-looking statements about our expectations. Actual results may differ from those stated. The most significant factors that could cause actual results to differ are included on Page 22. Unless otherwise noted, all comparisons are year-over-year. Company EBIT, EPS, and free cash flow are on an adjusted basis, and product mix is volume weighted. Looking at our IR calendar, we have two upcoming engagements: Tomorrow, BNP Paribas will host a fireside chat with John Lawler and Kumar Galhotra, President of Ford Blue; and on August 10, at their Auto Conference in New York, JPMorgan will host a fireside chat with Ted Cannis, CEO of Ford Pro. Now I'll turn the call over to Jim Farley.

Jim Farley, President and CEO

Thanks, Lynn. Hello, everyone. The Ford team delivered a very solid second quarter in a challenging environment where we saw supply chain disruptions, a lot of new economic headwinds, and uncertainty as a whole. Importantly, we achieved these results as we advance the Ford+ plan, which is the biggest opportunity to create value at Ford since we scaled the Model T. At the core of Ford+ are three fundamental promises to our customers: distinctive and breakthrough products and experiences; an always-on relationship with Ford every day, every hour, every minute; and ever-improving post-purchase user experiences powered by software. Today, I'll give you an update on Ford+ and the early results of our decisions to reorganize the company into three distinct segments: Model E, Ford Blue, and Ford Pro. Now let me start with the progress we're making to lead the electric vehicle and digital revolution. What's lost in the industry's arms race of claims regarding capital invested, the number of top hats we all have, and the promises of future leadership is one fundamental question: who is and will be the best positioned to design truly distinctive and appealing products that people actually love? That's the question. Now we've been overwhelmed with the demand for our first-generation EVs, the Mustang Mach-E, the Lightning, and the E-Transit. These products are in the market now, and we have strong multi-year order banks. We're selling them as fast as we can make them. And you can't say that about many of the EVs coming to market now. We believe that these great new products will enable us to grab an outsized share of the rapidly growing EV market, combined with our healthy and vibrant shares of our ICE and growing hybrid markets. This month, we expect to produce 14,000 EVs globally. That's significantly higher than just a few months ago, and we have a clear path to reach a run rate of 60,000 EVs by the end of next year. That will lead to a foundation to two million by late 2026. In fact, our anticipated growth rate in EVs through 2026 is more than twice what we expect for the global EV industry in total. Now securing the raw materials to produce batteries at scale is critical to our plan. It's estimated that at best, 50% of all raw materials required to meet the combined announced targets for all EV OEMs is actually available, 50%. And this is why speed to securing supply is so critical and strategic. Diversifying our battery chemistries to increase our flexibility, supply, and profit is also crucial and will support different customer use cases. Last week, we announced a series of MOUs and agreements to fulfill our ambitious needs that I covered, and we are working to complete definitive agreements where necessary. Our Model E team moved quickly to capture these opportunities. To summarize, we've added battery chemistries and secured contracts, delivering 60-gigawatt hours of annual battery capacity to support fully the 600,000 units of that 2023 run rate of capacity. We now have lithium-ion phosphate, or LFP, battery packs coming for the Mach-E sold in North America next year and for Lightning in early 2024, creating more capacity for these high-demand products. We secured 70% of the battery capacity needed to support two million units by the end of 2026, and we struck a new deal with CATL on strategic cooperation for global battery supplies as well as deals for direct sourcing of critical battery raw materials in the U.S., Australia, Indonesia, and more locations. We have a plan to localize 40-gigawatt hours per year of LFP capacity in North America by 2026. These deals are a strong start as we fortify our EV supply chain that's aligned with our sustainability and human rights principles. Now let's talk about the progress we're making in building out an always-on relationship with customers and that ever-improving user experience enabled by software after the customer buys a vehicle. Now, along with product execution, these are really the relevant sustainable advantages we see to create, in today's hyper-competitive market, a difference where the real competition is not legacy OEMs, but pure-play EV companies, including emerging Chinese players. For example, more than 55,000 Ford customers have already driven nearly 10 million miles with BlueCruise, our hands-free L2 system. That’s just one year after the capacity was launched, and we started OTA-ing this to our vehicles. We're using the data we get through BlueCruise to continue to improve the customer experience. You can imagine a significant ADAS revenue and profit stream being created by giving customers the ability to work, watch a film, or even take a nap during a long trip in their Ford. While the financial benefits of ADAS are clear, as is our Ford Pro services stack, they're relatively small now, but we're rapidly increasing the number of digital vehicles on the road as well as attach rates for the enabling services. Over time, much of the SaaS revenue will be deferred on our balance sheet, providing an annuity-like revenue stream that is highly accretive, something this company and this industry has never seen. Now before I turn to Ford Blue, let me talk briefly about our connected EV dealer model in the U.S. Changes in the market have compelled Ford and our dealers to revisit how customers shop, buy, and own, and how they will do this going forward. We're moving fast as the transition to these digital EV platforms allows us to help our dealers provide a better customer ownership experience post-purchase, and in turn, enables them to expand the revenue and profit pools, expanding and improving their returns. We're working with our dealers to create a retail model better than what's offered by any traditional OEM and better than the startups who are now scrambling to develop sales and service networks to support customers in an attempt to sustain and grow share. In the U.S. alone, if we can help our dealers increase service loyalty by just 20 points, that's $2.4 billion in incremental revenue for them every year. Since March, we've conducted more than 30 workshops in the U.S. and Canada, reaching hundreds of our dealers. I have personally been involved in many of these meetings. What is clear to me, but not yet visible to the market, is that our dealers are embracing this change. They know the competitive threat is real, and they want Ford and their dealership to lead and win. We have more to share as this develops. Now turning to Ford Blue. The team is motivated by this sharpening focus on our ICE and hybrid products. We've added new talent and leadership to drive performance and focus in our trucks, our great family lineup, and our enthusiast vehicles we're so proud of. We've revealed new vehicles like the Bronco Raptor, the Bronco Everglades, the F-150 Raptor R, which my kids think sounds great. In the third quarter, we'll unveil an all-new seventh-generation Mustang at the North American International Auto Show in Detroit. It is a stunning car, and I'm so excited to share it with the world. This fall, we'll be introducing an all-new Super Duty pickup, the workhorse at Ford, and it sets a standard in our industry. There's much more to come. Our design center is filled with new products and derivatives that will further strengthen our hit vehicles in the ICE and hybrid franchises like F-150, Bronco, and Maverick, as well as the brand-new global Ranger that’s launching in Thailand and our new Everest. In short, our hottest and freshest lineup in recent history is getting even better. In the commercial vehicle market, Ford Pro, our industry-leading global business, is leading the change into an electric software-driven world. Other OEMs are talking about large numbers of future electric orders. We're actually taking orders for manufacturing and selling commercial vehicles now. Through the second quarter, we've sold more than 3,000 E-Transits in the U.S. That's a market share of 95% in the full-sized electric van market. In fact, our next two competitors combined sold just 159 vehicles. Beyond the vehicles, we're also rolling out our Ford Pro charging commercial solutions and the very exciting and fast-growing e-telematics software solutions. In Europe, where we continue to be the leading commercial vehicle brand, we've already received 8,000 orders for our two-tonne E-Transit, and our new one-tonne E-Transit custom goes on sale next year. Our Ford Pro software business is growing quickly. Telematics subscriptions globally have grown over 40% sequentially for the last two quarters. Turning to quality, we made solid progress in initial quality, as you've seen in the recent J.D. Power's IQS study, and our launches have improved. However, we continue to be hampered by recalls and customer satisfaction actions. This affects our cost but more importantly, it falls short of our most fundamental commitment to our customers. Quality is our number one priority. In fact, we recently brought on Josh Halliburton from J.D. Powers to head quality. The team is focused on three critical areas: prevention, detection, and remediation. We've instituted more robust engineering sign-off processes for the vehicles that are in the product development factory as we speak. We're driving much more frequent alignment with our supply base on quality. When identified issues arise, we take actions quickly to resolve them to protect our customer's experience, including by making much more frequent use of over-the-air updates. We have more work to do in this space, and we will keep you updated. Overall, we're pleased with the progress this year, but we are not nearly satisfied. We remain clear-eyed and determined to move with speed and determination on a Ford+ transformation. The underlying strength of our business supports our 2022 adjusted EBIT guidance range of $11.5 billion to $12.5 billion, unchanged from April. Before I turn it over to John, I want to end with this. There's context that's critical to how we think about implementing our Ford+ plan. Traditionally, the auto industry has cut costs, often indiscriminately, as an effect from lower auto demands through economic softness and shift in customer preferences. What we're undertaking at Ford is totally different than that. We're reshaping virtually every aspect of the way we've done business for a century. We're doing that for a new industry based on new technology, new skills, and new promises for customer value. And yet, cost reduction will happen in our ICE business because that's primarily what Ford is made up of today. We're modernizing to eliminate unnecessary costs, redesigning work, and strategically investing across all of our auto businesses, ICE and hybrid, EVs, and Ford Pro, while at the same time, transforming every function that supports them. Sweeping strategic change generates interest and speculation in the media, which we understand. However, we're going to comment on Ford+ actions we're taking and how they're going to strengthen our company on our own schedule. John?

John Lawler, Chief Financial Officer

Thanks, Jim. During the quarter, on an adjusted basis, we delivered EBIT of $3.7 billion, an EBIT margin of 9.3%, and free cash flow of $3.6 billion. Our cash conversion in the quarter was very strong, lifting our first half to 50%, with the target range of 50% to 60% that we set out at Capital Markets Day. We ended the quarter with strong cash and liquidity of $29 billion and $45 billion, respectively. These numbers include our stake in Rivian, which was valued at $2 billion at the end of the quarter. In Q2, we also successfully renewed our $17.2 billion sustainability-linked global credit facilities, which include a new $1.75 billion 364-day revolver, providing additional working capital flexibility. Our strong balance sheet is a solid foundation for continuing to invest in our Ford+ priorities. Our results this quarter reflect the improved earnings and cash flow potential of our business, along with leverage created from disciplined capital allocation and a much more focused business model, including our industrial footprint. The tough choices we made during the global redesign to de-risk our business and exit unprofitable markets and products are paying off. From 2018 to 2021, our markets outside North America consumed nearly $9 billion of free cash flow. This year, these markets are collectively expected to be free cash flow positive. We are confident in the underlying strength of our business and our ability to fund all the calls on capital, especially those fundamental to growth and value creation. We can achieve this while maintaining the financial flexibility to navigate external uncertainties. As a result, we're increasing our regular quarterly dividend to $0.15 a share beginning this quarter. This returns us to the prepandemic dividend levels. Now let me touch on the performance of our business units. North America delivered $3.3 billion of EBIT and a margin of 11.3%. Both of those measures were up year-over-year. An 89% increase in wholesales and strong net pricing and mix more than offset higher commodity costs and inflationary pressures. South America continues to benefit from our global redesign efforts, delivering its fourth consecutive profitable quarter. In Europe, we posted a modest profit as a large increase in wholesales helped us reach just above breakeven EBIT. The underlying trajectory of the region continues to improve. However, the adverse effects of the near-term supply chain disruption are dampening its overall results. In China, we posted a loss as the local economy and auto industry were significantly disrupted by pandemic-related restrictions and lockdowns. Lincoln continues to be a profit pillar for the region, gaining share in the quarter along with commercial vehicles. Our International Markets Group continues to be sustainably profitable as a result of its restructuring efforts. In Mobility, we are progressing our in-market pilots for moving goods and moving people and remain committed to autonomous driving. Finally, Ford Credit delivered another strong quarter, with EBT of $900 million reflecting strong lease residuals and credit loss performance. Now let me share our current thinking for the remainder of 2022. For the full year, our guidance is unchanged. We expect to earn between $11.5 billion and $12.5 billion in adjusted EBIT, which is up 15% to 25% from 2021. This reflects 10% to 15% year-over-year growth in wholesales and assumes that semiconductor availability continues to improve. We project to generate adjusted free cash flow of $5.5 billion to $6.5 billion, with a significant portion coming from automotive operations. Relative to adjusted EBIT on a year-over-year basis, our range assumes significantly higher profits in North America, collective profitability in the rest of the world, strong but lower Ford Credit EBT, projected to be in the $3 billion range, and modest improvements in Mobility and Corporate Other. Other key assumptions include strong order banks and pent-up demand for our new and iconic products, continued strength in pricing, which includes the benefits of pricing actions taken during the year, commodity headwinds of about $4 billion, which we expect to offset with improvements in net pricing and mix, a continuation of broad-based inflationary pressures, and we now expect the full effect to be about $3 billion, which is up $1 billion from our estimate last quarter. We expect auction values at Ford Credit to remain strong but decline in the second half as the supply of new vehicles improves. EBT will be strong but lower, reflecting primarily lower credit loss reserve releases, fewer return-off-lease vehicles, and more normalized credit losses. Our results in the quarter, full-year outlook, and commitment to medium-term targets together demonstrate the power of Ford+ as we invest aggressively to drive growth and value creation. Before we turn it to Q&A, let me provide a quick update on our new financial reporting. As we shared in March, starting in the first quarter of 2023, we will have three new business segments: Ford Model E, Ford Blue, and Ford Pro, and will no longer report a combined automotive segment. With Ford Next, which is formerly Mobility and Ford Credit, this will bring our total reportable operating segments to five. This change will not be a simple pro forma exercise. It's much more fundamental. These are true segments with both operating and financial accountability, giving you added transparency on our business. To help you prepare for this change, we plan to hold a teach-in early next year prior to releasing our 2022 results. We will use our revised 2021 results as a template to reflect the new segments. As part of the teach-in, we also plan to cover the business rationale, mechanics of the new reporting structure, and how our earnings disclosure and SEC filings will change. When we report our fourth quarter and full-year results for 2022, they will be based on our existing reportable segments, and we target to share, at the same time, results that are revised to reflect the new segments. If you have any questions about this, please don't hesitate to reach out to Lynn and the rest of the IR team. So that wraps up our prepared remarks. We'll use the balance of the time to address what's on your minds. Thank you.

Operator, Operator

And the first question will come from John Murphy from Bank of America.

John Murphy, Analyst

I wanted to ask a somewhat mundane question first on the outlook and then get into some pricing secondarily. But first, John, when you look at it, the seasonality of Ford's earnings traditionally is higher in the first half and lower in the second half. There's timing of cost and volume that usually drive that. Why do you think it's going to be different this year? One of the big things that might be developing as we get later this year into early next year is that raw materials seem like they may be easing and fading, but the price/mix opportunities seem like they will be pretty strong. So that might help late this year and early next year. But just curious if you can comment if there's some change in the seasonal pattern so we can be comfortable with our estimates in the second half or your outlook in the second half.

John Lawler, Chief Financial Officer

Yes. So John, it is different, right? Ever since we've had COVID and coming out of COVID, the patterns just haven't held. When you look at the second half versus the first half, I think that would be the best way to help kind of frame this up. We do see continued volume, mix, and pricing being strong on a half-over-half basis. And of course, we do expect to see commodities improve a bit as well in the second half on a half-over-half basis. Volume, pricing, and mix are estimated in the $3 billion range, and commodities could be around $0.5 billion. However, the inflation that we're seeing will continue to run through. We're seeing that across the board from material costs, freight, fuel costs, etc. So we see that continuing, and that's up, as I said in my remarks, versus what we had talked about at the end of the last quarter. FMCC is going to be down slightly half-over-half, let’s say, eight-tenths to $1 billion as they approach $3 billion for the year.

John Murphy, Analyst

That's very helpful. Jim, regarding the higher trim levels or special editions like the Ford Raptor, those F-150 Raptors are impressive trucks. You included it in the slide deck, and I look forward to driving one soon. It seems like there's a significant opportunity for Blue, and a potential Model E for these high-trim special editions. What do you see as the opportunity for mix moving forward in both divisions? How are you planning to pursue that? It seems like a sustainable strategy beyond the current supply/demand imbalance that's benefiting pricing.

Jim Farley, President and CEO

Thank you, John. We have always excelled on the truck side for those derivatives, and now we see opportunities to expand that capability across our entire lineup. Ranger is a great example, as we are launching it in Thailand. We have just introduced Raptor and Tremor, and there is much more we can do. Mustang is about to be released, and Maverick is our most affordable vehicle, showcasing the exciting possibilities we are exploring in our design studio. We also have Broncos, with high-end versions and various options, including the popular Everglade. We believe that on the electric side, we can refresh models like the Mach-E without needing to change the body. We are completely overhauling our human-machine interface and implementing over-the-air updates for all our EVs, imagining all the exciting features we could introduce with Mustang Mach-E. This presents us with a sustainable advantage which we excel at. However, the challenge we face is complexity; Ford is currently too complex. As we pursue these developments, we need to reduce our complexity to align our bill of materials with the competition. While we are pleased with our pricing power and fresh lineup, we are not satisfied with excessive complexity in our business. Thus, as we add these derivatives, we plan to significantly limit complexity in our Blue business, which will be a key focus for us in the coming years.

John Murphy, Analyst

Jim, if I could just follow up real quick on the Model E side to create a performance version of like the Mustang Mach-E might theoretically cost a lot less, but you might still be able to charge as much as you might on that delta on a Blue vehicle. Is that correct? And could we see sort of these specials or trim levels potentially garner even higher variable margin as we move into the Model E world? Is that a fair statement or not?

Jim Farley, President and CEO

I think the way we look at this, yes, good question. The days are kind of over where you have to change the upper body to build a supercar or create an off-road car; those days are over. We don't have to do that anymore with these digital products, with EV propulsion, with the motors, the software. We can really take our vehicles and make very different kinds of vehicles off of the same body engineering. That is a complete game changer for us in terms of capital intensity, meaning lower. I’m glad you brought that up because I try to emphasize this. We have to be really careful in our industry, and I'm constantly talking about this with our leadership team. We can't have the complexity of top hats that we do on our ICE business. We have an opportunity as we go digital with these EVs to simplify our body engineering and focus the engineering on what customers value. It's not a different fender; it's software, digital display technology, and self-driving systems. Of course, it’s going to be, in some cases, more powerful motors.

Operator, Operator

And the next question is from Adam Jonas from Morgan Stanley.

Adam Jonas, Analyst

Jim, the Bronco Raptor, so badass. I don't know if I put in an order now if I'll get it by the end of the decade, but maybe I'll try. Jim, this is one of the most positive Ford calls I can remember in a long, long time. Does Ford have too many people?

Jim Farley, President and CEO

As I mentioned earlier, we definitely have too many people in certain areas, and that’s a fact. Some of our skills are no longer relevant, and there are jobs that need to be redefined. We are facing many new job requirements that we've never encountered before. We are fundamentally reshaping our company across all divisions. In our ICE business, we aim to simplify operations. It’s essential that the skills we possess and the tasks we undertak are as efficient as possible. We recognize that our costs at Ford are not competitive, which is why we are unsatisfied. However, I want to stress that in my 40 years of experience, we often cut costs indiscriminately in the past. That’s not the approach we're taking at Ford now. This is a unique transformation, focusing on reconfiguring the company, enhancing skills, investing in new technologies, and reducing spending where possible. Yes, I believe it's common for companies to have excess personnel. We just need to assess workflows and determine how to proceed moving forward.

Adam Jonas, Analyst

I appreciate that, Jim. Just one follow-up on the dealers. They're doing exceptionally well. Their new gross margins have more than tripled, and in many cases, they're earning more from selling the product than what you make on it. They're simply watching products arrive and they're already presold. I know you've dedicated significant time to pricing at Ford. Is there anything that can be done to adjust pricing? When I ask the dealers why Ford or your competitors aren't increasing some of the invoice prices, they often don't have an explanation and say things I find hard to believe, like that you can't or aren't moving quickly enough or that the necessary systems aren't in place. What are we overlooking?

Jim Farley, President and CEO

We've implemented significant pricing changes, which is evident in our financial results. We closely track our dealers' retained margin in relation to MSRP, and both our pricing and margin are competitive within the industry. Your question seems to address a larger issue regarding how our retailers will adapt as we evolve the company. With electric vehicles, dynamic pricing is essential due to our new ordering system, which provides certainty in orders while still needing to adapt to price fluctuations. While I'm not diving into specifics, we believe we have a solution for this challenge. Looking at dealer margins, we recognize that our competitors include dedicated EV companies and Chinese manufacturers who are entering the market. To stay competitive, we need to cut $2,000 from our distribution costs. We estimate that a third of this reduction can come from a low inventory model, where customers order vehicles directly, allowing us to ship once their order is confirmed. This approach could yield approximately $600 to $700 in savings. The remainder will come from optimizing selling, SG&A, and advertising expenses. We currently have three tiers of marketing, which we think we can streamline to save another $600 per vehicle. We're also planning to shift towards a simplified e-commerce platform that we currently lack. This will provide our e-customers with a consistent and straightforward purchasing experience, whether online or in the dealership. Additionally, we intend to invest in innovative post-purchase marketing as a distinguishing factor, setting us apart from other EV companies. I foresee dealer margins remaining competitive, but their composition will inevitably change. Does that clarify things for you, Adam?

Operator, Operator

The next question will come from Rod Lache with Wolfe Research.

Rod Lache, Analyst

So pricing has been a massive tailwind, and it looks like mix is becoming pretty powerful now too. Can you just talk to us a little bit about the interplay between affordability and volume? Just especially in the environment that we're in right now and with still a lot of inflation on the horizon, do you think demand can return at this level of price? Are you willing to forgo volume to sustain contribution margins?

John Lawler, Chief Financial Officer

Yes. Thanks, Rod. We have seen strength in pricing due to the volume that we can produce as an industry and us at Ford relative to the demand that's out there. So, that has been a tailwind. In the quarter, we saw quite a bit of a tailwind from mix as well. Affordability is something that we keep in front of us all the time with the credit company. We're very thoughtful about where it's headed from the standpoint of the consumer being able to afford vehicles, etc. We have not seen demand come off at this point. However, if we increase volumes through the second half of the year, as some of the chip constraints ease, we do have provisions in our second half for increasing incentives as volumes come back. We've always said the relationship between volume and pricing is going to remain dynamic. As volume comes back, you will see some pricing come down. The question for all of us is how we're going to manage stocks, how we're going to move to the build-to-order process, and how we will change the dynamics to not have as much of a push system and have a more natural demand system that fulfills timely demand. So I think that's the question for all of us, and we must maintain discipline as we head into an environment where we could potentially see demand come off and/or higher supply, leading to lower prices.

Rod Lache, Analyst

That makes sense. And then just secondly, can you provide any color you can on what's happening from a supply chain perspective? Any thoughts on whether this Europe natural gas situation is something that is a major concern for you? Lastly, any detail on the $3 billion of cost inflation in North America? It looked like a large number. Was there anything unusual in that number?

John Lawler, Chief Financial Officer

No, there wasn't anything unusual, Rod. I'll start with that. It's across the board. It's in the areas you would expect, material costs going up. We're seeing increases in freight. It's just driven by the inflationary pressures we're seeing in the economy. Nothing unusual.

Jim Farley, President and CEO

On the supply chain, I'd characterize it this way: chips are still an issue, and transparency is still an issue. In the second quarter specifically, we faced challenges due to the Shanghai shutdown, which affected our North America manufacturing system. The team did a great job. We had daily calls, worked through every issue, built a digital model of our supply chain to monitor all parts. We got through it. It just feels like what's next. We're planning for everything that could happen. The next possibility of the energy crisis in Europe has been considered. We have approximately 550 active suppliers in what I would call high-risk countries like the Czech Republic, Germany, Hungary, Austria, and Slovakia. The risk is between now and mid-'23 when they can manage through the energy issues. We have about 130 suppliers for our North America vehicle production in that list, and we've established a 30-day buffer stock. We are doing everything we can with the things we know. We also have labor shortages and various moving parts. Suppliers have been working nonstop during COVID, and machine maintenance, along with other elements, shows the stress in the supply chain. Their costs have risen too. We're working through that. We're well-prepared for scenarios we can predict, but it's always a new day.

Operator, Operator

The next question will come from Emmanuel Rosner from Deutsche Bank.

Emmanuel Rosner, Analyst

My first question, I was hoping to ask you about the topic of EV profitability. So Jim, during the quarter at an investor conference, I think you essentially gave some pretty good color on where Ford is standing right now. And I think you spoke about the cost of the Mach-E being a disadvantage of $25,000 to $27,000 versus a similarly equipped vehicle from Tesla. I guess my questions would be, how do you plan on offsetting this over time? What is the strategy going forward? Should we worry about large losses from EVs in the near term over the next few years as the EV volumes increase materially?

Jim Farley, President and CEO

Thank you, Emmanuel. I'll say there won't be much guesswork at Ford because we will financially report our businesses independently. It will all be transparent for everyone to see. At Ford, it will be extremely clear. I don't want to get into specifics as this is such a material topic. We need to discuss it without rushing. I'll tell you that in the quarter, our announcement for bringing LFP to North America is a big deal from a profit standpoint. This is an important chemistry on our roadmap for profitability. We will be installing 60 to 40-gigawatt hours in North America; that's substantial. We will not wait until that installed capacity is here; we’ll bring those batteries to our highest volume vehicles next year. Distribution, the size of your battery, and engineering for lower labor content are critical factors. This is an important topic we need to address further in future communications.

John Lawler, Chief Financial Officer

In segmentation reporting, you'll see exactly where we're at between the five businesses. We know how important that is. So when we have our Capital Markets Day early next year, we'll unpack that with more detail, as Jim said, where we can spend time on it and give it the attention it deserves.

Emmanuel Rosner, Analyst

Okay. That's fair. Let me ask you a separate topic then. One of the hardest things for investors here is to gauge performance sensitivity for a downturn scenario as consumers come under more pressure, and recession risks increase. What could that do for not so much volume, because obviously, the auto industry has been operating at low volume for a while, but pricing? Any thoughts you could share, either based on history or in the current context, on how to flex down vehicle pricing in a downturn scenario?

John Lawler, Chief Financial Officer

We’ve spent a lot of time on this, as you'd expect, modeling scenarios and looking at what that means for the business, as well as what we should do today to address those issues if a recession arises. If you step back and look where we're at today compared to our past, heading into what could be a potential downturn, we are in stronger shape. We have three years of pent-up demand and a very strong product lineup, which is a positive. We're also at a point where incentives are quite low, in the single digits versus what would normally be in the high teens right now in the cycle. As volume or demand decreases, some pricing will need to be readjusted. But it's crucial that we are thoughtful about that, internally and within the industry. Our ICE product is more profitable now as we've exited unprofitable vehicles. We’ve de-risked the business. The fact that between 2018 and 2021, we burnt through $9 billion of free cash flow overseas is no longer our situation. This year, we expect that our overseas markets will be free cash flow positive. We're evaluating scenarios and getting ahead of potential issues as Jim said we must do, as it is a new day every day.

Operator, Operator

The next question will come from Colin Langan from Wells Fargo.

Colin Langan, Analyst

I just wanted to circle back to the first question going from the first half to second half. The outlook dividend point is about flat. You highlighted, I think, volume. The commodities are over $1 billion in Q1 and Q2, and you highlighted around $1 billion to Ford Credit. That totals about $3 billion in good news. You didn't quantify the bad news; it doesn't seem like that bad. Any sort of framing it, is that $3 billion inflationary cost predominantly in the second half? Is that what you're thinking?

John Lawler, Chief Financial Officer

Yes. So Colin, let me clarify. It's really hard to hear you. It's quite static-y. But Ford Credit will be about $3 billion in total profits for the year, down half-over-half. That’s a headwind. The inflationary costs on a half-over-half basis are a headwind as well. When you walk through this, yes, there will be volume. We said volume in the second half will be up roughly in the low 20 percentage range versus the first half. Volume and pricing improvements will be the tailwinds; however, there will be headwinds surrounding FMCC profits and different inflationary pressures increasing in the second half. Exchange will also affect us in the second half versus the first half.

Colin Langan, Analyst

Okay. And to follow up, I know you clearly are going to give more details on the EV perspective and how you're going to assess things. But you're talking a pretty dramatic increase in raw material costs. I think even in your comments, you indicated that only about 50% of the materials are going to be available to produce all the EV targets, which could imply that prices of raw materials will remain high. Should you be thinking about pulling back on some of the EV investments if the economics at this point are unclear?

Jim Farley, President and CEO

No, we don't plan on pulling back. If anything, the first generation of products has inspired us to go faster. I would emphasize how we view this change in our industry; it's not merely a change in propulsion but something bigger. It's a movement toward vehicles dependent on software updates that get shipped to them. We now have genuine experience creating the first shippable software for these cars, with ADAS being the most prominent. We are also shipping telematics to customers through Ford Pro, with driver coaching and energy management. Our attach rate for charging now on our E-Transits is the most significant share; it's around 30-plus percent. Services linked to these vehicles thanks to the software present a substantial revenue opportunity for us. Regarding the base walk to 8%, we’re not going to detail that here, but LFP carries a significantly different exposure to raw materials compared to an NCM cell. Diversifying our chemistry strategy is vital for our profitability. However, the most crucial point is that our investments are not just in electric cars; we're investing in digital products. We can keep these vehicles longer as we don't have to upgrade the upper bodies, considering they are software-enabled vehicles. There’s so much we can do to alter the profitability profile. We must solve the battery cost issue, and we can't wait to dive into this further.

Operator, Operator

And the next question will come from Joseph Spak from RBC Capital Markets.

Joseph Spak, Analyst

I want to discuss the $3 billion of other inflationary costs, which is $2 billion higher than before. I know you’re working to offset it. Are you assuming you will offset that difference in the guidance? Also, could you tell us how much of that was already incurred in the first half?

John Lawler, Chief Financial Officer

So it's $1 billion higher than what we discussed previously, Joe. We're looking at about $3 billion for the year. Our teams are focused on offsetting those inflationary costs. We're not completely there yet, but we have the rest of the year to address this, and it's a key priority for our team. It's a vital part of what we're doing. So we're estimating $3 billion for the year, compared to our earlier estimate of $2 billion. We've seen around another $1 billion come through, and this is across the board.

Marion Harris, CEO of Ford Credit

Joe, this is Marion here. Thanks for the question. You're thinking about it correctly. If you go back to pre-COVID, our balance sheet was quite a bit larger; we were at about $145 billion at that point. We were running at about $2.5 billion, $2.6 billion in EBT. That was our normal level, and our balance sheet is somewhat smaller now. What you're seeing is a more normalized level of profits. We're back at our pre-COVID reserve level. We are not releasing reserves, and related to lease residuals, that's pretty much worked its way through its book. You're seeing more normal performance.

Operator, Operator

And our final question of today will come from James Picariello from Exane PNB Paribas.

James Picariello, Analyst

Just for commodities, at current spot rates, just as a theoretical exercise, if we take into account the lagging effect to your P&L, can you just think about maybe directionally just what the commodities impact would look like for next year at current spot rates?

John Lawler, Chief Financial Officer

Yes. I think we do see it coming off some. Part of what complicates the situation is as we go through a year, we lock into contracts, and they roll. That protects us from increasing prices, but it also has a lag effect when prices come down. We will have to manage that as we progress through the year. Really, it's going to depend on what occurs in the overall macroeconomic environment. If we enter a recessionary period, we should see prices fall quicker, as we've seen before. Otherwise, they will decrease more moderately. So we're planning and evaluating both scenarios from a spot standpoint. It's good news as we move through next year, but we can't simply take those spot gains and transfer them through everything because we have contracts locked into a rolling basis throughout the year.

James Picariello, Analyst

Understood. And then just with respect to the cadence for the second half, how should we be thinking about the quarterly volume in the back half? Can you provide color on Ford's progress in shipping the inventory, which I think totaled 53,000 entering the quarter?

John Lawler, Chief Financial Officer

Yes. So 53,000 entering the quarter. The team reduced that down dramatically. We're now down to 18,000 at the end of the quarter, and we'll work to get those out over the second half of the year as we can free up chips that impacted us. For the second half, we said volumes would be up in the low 20 percentage range compared with the first half. But that growth rate is greater in overseas markets than in North America. The Ranger launching in IMG and volume coming through in the second half are expected to grow at a quicker rate in Europe. China was depressed from a volume standpoint in the second quarter due to the shutdown. Volumes for Q3 will be lower than those of Q2 because Q4 is expected to show improvement as chip supply increases towards year-end. This framing will help as we manage through the second half.

Operator, Operator

Ladies and gentlemen, this concludes the Ford Motor Company Second Quarter 2022 Earnings Conference Call. We thank you for your participation. You may now disconnect. Take care.