Earnings Call Transcript - F Q3 2020

Operator, Operator

Good day, ladies and gentlemen. My name is Holly, and I’ll be your conference operator today. At this time, I would like to welcome you to the Ford Motor Company Third Quarter 2020 Earnings Conference 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. I would like to turn the call over to Lynn Antipas Tyson, Executive Director of Investor Relations. Lynn, I hand it to you?

Lynn Antipas Tyson, Executive Director of Investor Relations

Thank you so much Holly and welcome everyone to Ford Motor Company’s third quarter 2020 earnings call. Presenting today are Jim Farley, our President and CEO; John Lawler, our Chief Financial Officer and also joining us today for Q&A is Marion Harris, CEO of Ford Credit. Jim will have some opening comments, John will talk about our third quarter results and then we'll turn to Q&A. Our results discussed today include some non-GAAP references. These are reconciled to the most comparable U.S. GAAP measures in the appendix of our earnings deck, which can be found along with the rest of our earnings materials at shareholder.ford.com. Today’s discussion includes forward-looking statements about our expectations and actual results may differ from those stated. The most significant factors that could cause actual results to differ are included on slide 23. 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. A quick update on our IR events over the next weeks. On Monday, November 02, Credit Suisse will host a fireside chat with John Lawler, Marion Harris and Kumar Galhotra, Ford's President of the Americas and our International Markets group and then on November 10, Stuart Taylor Executive Director of Enterprise Connectivity will participate in Deutsche Bank's auto tech virtual conference. Now, I'll turn the call over to Jim Farley, Jim?

Jim Farley, President and CEO

Thanks, Lynn, and hello everyone. I want to express how honored I feel to be the CEO of Ford. My family has been connected to Ford since 1916 when my grandfather began working in Highland Park, Michigan. That marked a significant improvement in our family story, and many others have similar experiences with Ford. We truly are a family company, from Bill Ford's leadership down to our factory workers. I am highly motivated to foster a vibrant and growing Ford, positively impacting generations to come and benefiting all our stakeholders. We have put together a talented leadership team, consisting of dedicated Ford veterans who know the business and new colleagues bringing different experiences and skills to the table. We intend to keep enhancing our team with critical capabilities in marketing, technology, and more. In recent months, I've had discussions with many of you, and I believe our current plan aligns well with your expectations. We're dedicated to creating a Ford that grows profitably and generates sustainable free cash flow, driven by our automotive business. Our capital will be allocated to the highest priorities to ensure sustainable value creation. The plan we introduced to our team and stakeholders on October 1 is straightforward. We will operate like a challenger, earning every customer through exceptional products and services, ensuring rewarding ownership experiences. We are swiftly turning around our automotive operations by improving quality, cutting costs, and restructuring underperforming segments. We will experience growth in the right areas, directing more capital, resources, and talent to our most promising businesses and vehicle franchises. We aim to incubate, scale, and integrate new ventures, some of which utilize new technologies, including our self-driving systems, while expanding our leading commercial vehicle business with strong margins and a range of software services that foster customer loyalty and generate recurring revenue streams. We are also committed to leading the global electric vehicle movement, leveraging our strengths and scale. Regarding electric vehicles, we are developing completely new electric versions of the F-150 and Transit, our top commercial vehicles. These key vehicles drive Ford's commercial vehicle business, and we are electrifying them, making them truly capable work vehicles with unique digital services to enhance productivity and uptime for our important commercial clients. The electric Transit will be unveiled next month, and we are excited to share this news for our global markets. We believe there will be significant demand for our fully electric commercial van and pickup, representing the largest profit opportunities in the market, and we are prepared to seize this chance. Additionally, our pricing, productivity, capabilities, and cost of ownership will present strong appeals to our customers. Ford is leading the development of the electric Transit and F-150, backed by our unmatched dealer network, which ensures reliable service and excellent uptime for our clients who possess extensive knowledge of their needs. In the coming weeks, we will also deliver the first Mustang Mach-E units to customers in the US and Europe, with strong reservations for this vehicle. Our plans also include selling it in China shortly. In my three decades in this industry, I have never been more excited about one of our retail vehicles. After driving the Mach-E for 1,000 miles, I can genuinely say that our engineering team has created an outstanding driving experience, integrating advanced technology and ingenious cloud-enabled services at an accessible price point. You will witness our strategy for electrifying leading commercial vehicles and iconic high-volume products rapidly unfold at Ford. We are also expanding our electric vehicle manufacturing capabilities globally, with four plants in North America, including a new carbon-neutral factory currently under construction at the Rouge plant. We have finalized an agreement with Unifor, the Canadian Auto Workers Union, allowing future electric SUVs to be produced by our team in Canada. As we implement our plan, I commit to maintaining transparency, including clear, measurable key performance indicators so you can monitor our progress objectively. We will share more details about our financial targets in the spring. Now, let me provide a brief update on our strong third quarter and what we anticipate in the fourth quarter. Our results reflect the benefits of our decision to invest capital in our strongest franchises, which includes pickups, a range of utilities worldwide, commercial vehicles, and iconic passenger vehicles. Additionally, we experienced higher-than-expected demand for new vehicles during a quarter when inventories were low due to earlier pandemic-related factory shutdowns. This situation contributed to a favorable pricing environment. These elements, coupled with the best performance from Ford Credit in 15 years, resulted in a total company adjusted EBIT margin of 9.7%, a 490 basis point increase from last year. Consequently, we generated $6.3 billion in adjusted free cash flow. Throughout 2020, even during the industry-wide halt due to COVID-19, while prioritizing our team's safety, we have been methodical in preparing for the high-quality launch of the 2021 F-150, which is versatile enough for various uses. We are excited about the Bronco Sport, one of many Broncos to come, and the all-new all-electric Mustang Mach-E. We even utilized unanticipated downtime to further validate our preparations for these crucial launches. I'm pleased to report that we are in excellent shape for these launches, with software and hardware engineering completed and supplier readiness looking strong. Currently, all-new F-150s are rolling off the line in Dearborn, with production soon starting in Kansas City. We are beginning to build the Mustang Mach-E and the Bronco Sport early this week. Before I pass the call to John, I want to thank all of you for being here today. Despite our strong third-quarter figures, we recognize we still have challenges to address in our automotive business, including warranty costs that remain unacceptably high. I will remain transparent and focused on delivering value to both our customers and shareholders, demonstrating our commitment to improving this business and our plan over time. Now, John, please take us through the details.

John Lawler, Chief Financial Officer

Thanks Jim. First let me say what an honor it is to be the CFO of this great company and you know I really can't remember a time when we've had this much opportunity to transform and grow our business and so it's incredibly exciting and delivering on that potential is an important responsibility all of us have to our customers and to our stakeholders. Now to be clear, our transformation and growth plan is predicated on delivering an 8% or better adjusted company EBIT margin and consistently generating free cash flow so we can invest in accretive, high-return products and services. My initial priorities to help drive this are one, help our team fix or dispose of underperforming parts of our business so we can allocate capital to its best and highest use and two, further strengthen our balance sheet. We will make the tough decisions to improve our financial flexibility and ensure that we have the resources to build and grow our business. Now let me summarize the third quarter. As Jim mentioned, we had a strong quarter delivering a 9.7% company adjusted EBIT margin. That margin was driven largely by higher-than-expected vehicle demand, positive net pricing, and favorable mix as inventories were limited because of the virus-related shutdowns in the first half of the year. North America and China benefited from growth in both wholesales and revenue, while Europe, South America and our international markets group were still affected by COVID-related industry declines. In addition, our performance continues to benefit from our portfolio of refreshes as we reallocate capital to our franchise strengths. Ford Credit also contributed, turning in its strongest performance since 2005, generating $1.1 billion in earnings before taxes with help from strong auction values. Now before I talk about the rest of our business, let me put our record $6.3 billion of adjusted free cash flow in perspective. Not only does it reflect the strength of our EBIT in the quarter, but as we indicated last quarter, working capital recovered sharply as we rebuilt production to full capacity after a shutdown, largely driven by supplier payables. In the third quarter, the payable build was completed and this was worth about $4 billion. The strong cash flow in the quarter gave us the confidence and ability to make a second payment on our corporate revolver, which we did on September 24. We fully repaid the entire $15 billion facility and we ended the third quarter with a strong balance sheet including nearly $30 billion in cash and more than $45 billion of liquidity, providing us with the vital financial flexibility we need. Looking at North America, despite the difficult backdrop of COVID, the Ford team executed well operationally. We optimized incentives for lower dealer stock levels, maximized production, and skillfully managed supply chains to meet stronger-than-expected customer demand. The region delivered an EBIT margin of 12.5% as it benefited from top-line growth of 8%. EBIT improved by $1.2 billion supported by $900 million in net pricing and $400 million in favorable volume and mix. The improvement in volume and mix reflects the effectiveness of our team focusing on Ford's franchise strengths. A few examples include the S-series. The S-series gained 1.7 points to a share of more than 35% in the US. Our mix of trucks and vans increased one point to 57%. Our utility mix increased three points to 35% with a very strong showing from the Explorer and the mix of cars declined four points to just under 8%. In total, North America share increased one point to 13.6%. In Europe, EBIT declined $300 million in the quarter and that was driven by lower volume and about $400 million in costs related to our Kuga PHEV battery supplier issue. Those expenses included pulling costs required to comply with the EU's new CO2 emissions standards this year. We said earlier that we anticipated meeting those new standards based on our product roadmap and the Kuga PHEV was a key part of that expectation. We're working closely with our supplier to remediate the situation and minimize any inconveniences to our customers. We plan to notify our customers in the coming days on how and when we will repair their vehicles and had it not been for the Kuga issue, Europe would have been profitable for the third quarter. Since Europe began its sweeping redesign of the regional business in 2018, the European team successfully rationalized the manufacturing footprint, shifted resources to our leading position in commercial vehicles and dramatically lowered structural costs. This year the Europe team is on track to deliver $1 billion of annual structural cost reductions. Relative to mix, our commercial vehicle mix share increased by 50 basis points to 15.1% for the quarter and SUVs accounted for more than 30% of our vehicle mix in Europe, nearly 9 points higher than a year ago. Turning to China, wholesale shipments in China were up 22%, marking the second consecutive quarter of year-over-year growth that reflects strong sales of SUVs and commercial vehicles. Our mix of SUVs increased 13 percentage points to 36%, driven by locally built Ford Explorer, Escape, and Lincoln Aviator and Corsair, with Lincoln delivering its best-ever quarterly sales in China; over 65% of Lincoln vehicles are now produced locally following the introduction of the Corsair and the Aviator in the first half of 2020. Commercial vehicle sale mix increased five percentage points to 45%, reflecting strong JMC sales, which were up 38% versus the prior year, demonstrating continued strong demand for light trucks, vans, and pickups. Overall, the team delivered a third consecutive quarter of year-over-year share gains and marked the second consecutive quarter of year-over-year improvement in EBIT, the best performance in three years. In South America, we are mitigating the ongoing pressure from inflation, currency and the industry's structural challenges. Profitability in IMG also benefited from the work the team has done to lower structural costs. Ford Mobility, which is building fourth-generation autonomous test vehicles with the latest self-driving technology, generated its first AV-related revenue from a fleet operations pilot in Austin, Texas, and at the same time, we are strategically expanding our Spin scooter business in the US, the UK, and Germany, generating strong revenue growth. Before taking your questions, I'll briefly comment on the fourth quarter, which assumes no meaningful change to the current economic environment, continued steady improvement in the stability of the global automotive supply base, and no further significant COVID-related disruptions to production since the third quarter. Our guidance for adjusted company EBIT for the fourth quarter is between a loss of $500 million and breakeven. We recognize this is a big change both sequentially and year-over-year, so I want to step through the key sequential drivers. First, we expect a reduction in wholesale of about 100,000 units associated with the F-150 changeover. This volume effect is a result of our measured production ramp-up plan to ensure that every vehicle we wholesale is gate released with the highest possible quality for our customers. The approximate 100,000 unit impact in the fourth quarter will far outweigh the effect of our UAW ratification bonus in Q4 of last year, which was worth about $600 million. Second, we also expect higher structural and other costs from the manufacturing launch activities for the Mustang Mach-E and the Bronco Sport, as well as advertising launch activities for the new products, including the all-new Bronco brand, and higher material and other costs. We expect EBIT from Ford Credit to be lower sequentially driven by strong but lower auction values and lower disposal at auction. With this fourth-quarter guidance, we now expect full-year adjusted company EBIT to be profitable for the year. Other elements of our guidance for the year are unchanged, with the exception of capital expenditures. We now expect a lower level for this year down between $1.2 billion and $1.7 billion versus $7.6 billion in 2019, reflecting continued efficiencies. Before we move to Q&A, I want to leave you with my key takeaways from the quarter. We had better execution; our restructuring is paying off. These things intersected very nicely with the stronger-than-expected demand. We know there's more to fix and we're carrying on a clear plan to do that, as Jim mentioned. Our balance sheet is solid with nearly $30 billion of cash and over $45 billion of liquidity. Now operator, let's open the line for questions.

Operator, Operator

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

John Murphy, Analyst

Thank you for the information and congratulations to Jim for leading the call. It's interesting to see the early developments. I have a question regarding the strength in the third quarter. Clearly, there has been excellent execution and a strategy around volume, mix, and pricing that benefited from favorable industry conditions. Once we transition from the F-150 in the fourth quarter, which might affect your first quarter next year, how much do you anticipate a reversal in those three key factors? Considering your current production and your shift towards a richer mix, how much of these benefits do you think can be sustained into 2021, or at least on a run rate basis as we move into next year?

Jim Farley, President and CEO

When you look at that, it's a bit difficult given going down in the first half and then coming back up and the launches we have for the quarter and so from a cost standpoint, we're going to continue to focus on making sure that we can really leading into what we need to do to improve the business, improve the underperforming parts of the business. As far as mix and the top line, we saw some strength there. We have wind at our back due to the strong demand with the short supply, so we’ll continue to expect to push on our strengths of trucks, SUVs, and atomic nameplates. But as far as a run rate and what we see into 2021, we're not ready to talk about that at this point and we'll come back and will have more to say on that early 2021.

John Murphy, Analyst

How much do you think is transitory due to market factors? While the industry volume appears to be relatively strong compared to peers, it doesn't seem particularly impressive in absolute terms. It suggests there is a stronger underlying demand for a better mix than we anticipated 12, 18, or 24 months ago. As you focus on improving this mix with better products, do you notice anything specific in the market, particularly in the third quarter, that indicates a positive trend?

Jim Farley, President and CEO

Yes, there is a positive. We see strength there. The question is, there was an imbalance in supply and demand and that gave us some tailwind, but we also are seeing over time as we've made concerted efforts to shift into our strengths of commercial vehicles and trucks. So we do see strength there as far as how far that extends and what that looks like we're not ready to comment now, but we do see strength there.

John Murphy, Analyst

Okay. And maybe just one last question on lease deferrals, how many leases did you defer in the second quarter that came back in the third quarter or might come back in the coming quarters and sort of envision when you see auction values I should say being very strong. How long do you expect that to continue because it just seems like there's a lot of positive news on these lease deferrals as well as what's going on in these vehicle markets that's helping out now just Ford Credit but the core new vehicle businesses as well.

Marion Harris, CEO of Ford Credit

Hey John, so this is Marion Harris. We did a bunch of payment extensions for loans and leases, but if you're referring to lease deferrals for lease-ins where our unit comes back to auction, we didn't really do many of those and we had a pretty big inventory of used vehicles going into the third quarter and as we sold those units into an improving market, that's really what was the real benefit for Ford Credit. If you were talking about payment extensions though, we extended about 11% of our retail loan and lease portfolio and of that about 99% of those have already made a payment and we're back to pre-pandemic levels of extensions.

John Murphy, Analyst

Okay. So as far as what you're selling into the auctions right now, it's normal run rate of these returns flowing into record auctions and no ebbs or flows or pulls by you?

Jim Farley, President and CEO

That's correct. We're back at a normal inventory.

Operator, Operator

And our next question will come from the line of Rod Lache with Wolfe Research.

Rod Lache, Analyst

Congratulations on the performance in the quarter. I hope it is the sign of things to come. I had three questions for you; number one, Jim you’ve talked about 10% margin target for North America for some time and now you’ve shown that you can get there obviously Q4 this one phase will be a bit challenging, but could you talk a little bit about what you're thinking about as the timeline for getting to that kind of a target more sustainably?

Jim Farley, President and CEO

On North America, I think it's really important for us to be clear. The turnaround on automotive operations in North America needs to absolutely be at 10% plus. As you can see from the pricing and mix, I think Ford is the strongest brand in the US industry mainstream brand on pricing and mix. Our issue in North America is cost and growth. On cost, it's really isolated to material cost, which is tied to that higher pricing, and warranty. Our warranty costs in the last few years have increased $1 billion to $2 billion depending on the year and that is not okay. So although it moderated in the quarter and we have taken a lot of actions on craftsmanship and long-term durability, we have a much bigger ambition to improve the quality of our vehicles. We have taken a lot of countermeasures; they will take time. I'm happy to discuss more if you'd like, but I'd say our North America 10% is really a cost journey for us because on the gross side, we have a whole new Bronco lineup coming and our brand new S-series coming. These are fantastic opportunities for us on the top line for the next many years to come. So our journey to get to 10% is a cost.

Rod Lache, Analyst

I noticed that the warranty cost moderated a bit, at least the cost inflation moderated. Is that a sign that things are finally peaking?

Jim Farley, President and CEO

We have more work to do, that's all I'll say. We are not satisfied with the quality of run rate and maybe coming down but that's not what we're targeting. We're targeting a fully competitive level of warranty spend on coverages, and that's got lots of zeros next to it. To do that, Rod, there are a couple of things the team has decided to double down on. For suppliers who ship us bad parts, we're going to have punitive financial repercussions. If there are bad shippers for multiple times, we put more resources in our plants for supplier quality. We have more resources dedicated and a ton of transparency on quality issues that are open for more than 30 days in the company. That's a key metric that we drive our management team to. So those are the types of changes we've made and I wouldn’t say this quarter is anything that we're proud of.

Rod Lache, Analyst

And just to clarify, Jim, you didn't really provide a timeline on getting to a sustainable 10% or better margin. You said that you've got visibility on the revenue side and you still have work to do on the cost side. So is there a line of sight for you on that? It seems like the product side and the revenue side for North America looks pretty powerful as you look out to next year.

Jim Farley, President and CEO

Yes.

Operator, Operator

Our next question will come from the line of Emmanuel Rosner, Deutsche Bank.

Emmanuel Rosner, Analyst

Jim and John, first congratulations on your new roles and Jim every encouraged by your commitment to transparency and measurable improvements. So I guess in that spirit, when we look at your performance in the quarter, besides for the stronger demand pricing mix which you commented on, are you able to point us to measurable areas of underlying improvement that you’ve seen whether it is on these material freight. You spoke a little bit about warranty on the structural side, anything that's really bearing some fruit that you're excited about or should we think about it more as an opportunity for the future?

Jim Farley, President and CEO

When you look at the cost performance for the quarter, it's really evident if you look at what we talked about with Europe; all the restructuring they've done, the headcount reductions, they're now approaching and they will approach this year a billion dollars in structural cost reductions. We saw that flow through and that's going to continue to come through. What the team has done in South America in restructuring the business down there, getting out of low profitable vehicles, selling the Bernardo plant, and all the actions they've taken on their structure and headcount, that's going to continue to flow through. We saw good performance out of the International Markets group this quarter. They were profitable and most of that was driven by structural cost reductions. As far as what we saw here in North America, I think with the strength that we had in demand and the short supply, we saw the effectiveness of our team focusing on Ford's franchise strengths.

Emmanuel Rosner, Analyst

So I guess to get a little bit of color on what needs to be done on the warranty side and quality side, what is being done or can be done? I don't need a quantification, but just in terms of what does it require to get the material and freight, you show that's down, it looks like this is probably one of the two largest markets on the cost side here?

Jim Farley, President and CEO

On the material cost side, it's kind of everywhere. A good example, we have a proximity key in your pocket to unlock the door on all four doors of the F-150. When we look at the vehicle usage data, we found that people don’t use the proximity sensor for the front two doors. We do not need a proximity sensor in the rear two doors. Our jack on the F-150 looks like it'll last about 50 years. That's not the case for our competitors. So it's everything from the way we package our features, the actual bill of material, and the team has been working through all these opportunities since February. We made progress but we need to make a lot more, especially with the more expensive launch vehicles. The real enabler is going to be complexity reduction; we've been talking about complexity reduction as a company for quite some time as a key fitness for the leadership team, but we have a lot more work to do on complexity reduction and that will be a huge enabler for not only our manufacturing operations but also our material cost.

Emmanuel Rosner, Analyst

And then finally, there was no specific guidance on free cash flow for the fourth quarter. I think in the last earnings call, there was a comment about how EBITDA would be better than the EBIT and the fourth quarter being worse than fourth quarter EBIT. Any sort of sense you can give us on this quarter's free cash flow and whether there will be some of the timing on the eCapital payback from the strength that we've seen in the fourth quarter?

John Lawler, Chief Financial Officer

In the quarter, we got payables back to what we would say is a normal run rate and so from a standpoint of the guidance on the cash flow for the fourth quarter, it's going to frankly have said with EBIT; it's going to be driven by EBIT. So we haven't given a specific number on that and at this point, I'm not sure we're going to do that today.

Operator, Operator

Our next question will come from the line of Adam Jonas with Morgan Stanley.

Adam Jonas, Analyst

Thanks everyone. Jim, I've got a few questions for you. I think you mentioned that EVs look great financially, specifically when you're looking out they seem to line up well financially. Could you elaborate on that? My understanding is that EVs present a really great opportunity to decomplexify the vehicle, even allowing for the expensive battery cost. So things that you can remove from an EV and that way you can design a lot more efficiently relative to the spiderweb of complexity of the internal combustion mechanisms. Is that correct in that assumption and I just didn’t know if you could add some color to that hypothesis?

Jim Farley, President and CEO

I guess the three key messages for our electrification strategy are; first, we're going after very large addressable markets and profit pools and we're playing to our strengths. The second is to turn battery electrics into a digital opportunity, which is quite important for the company to transition as well. Related to the cost, initially several years ago, when we made these investments and decisions, the profitability of the vehicle was really challenging. What we found since then, once we started to look at the real cost of CO2 of our internal combustion engine, we started to look at in commercial terms offering bidirectional charging, bringing charging to the job site. We started to realize that there's a lot more revenue opportunity, a lot lower cost in marketing because of the connected services and of course, the cost of our battery—we used kind of a temporary overcapacity situation to get very competitive costs and also cherry-picked the best chemistry out there. All of that kind of came together to provide a much more compelling financial picture for these first cycle products. That's what I was referring to when you look at all-in comparison to ICE. Also, the revenue opportunity—when we got into the commercial world of electrification, I think our eyes were very open and informed by the aluminum investment in F-150; people are willing to pay in the case of light weighting, more than just light weight fuel economy. It’s a commercial vehicle for towing and payload. When you think about bringing energy to the job site or bidirectional charging for small medium-sized businesses, it becomes a game changer for them in terms of revenue. I hope that makes sense.

Adam Jonas, Analyst

Yeah, it does and you seem to have expressed a lot of enthusiasm toward the software services, the data opportunity for the company. Could you be specific on what services get you most excited and when that could be material?

Jim Farley, President and CEO

Great question. It starts with the talent. We attracted Alex Purdy from Deere, who went through the whole Deere journey moving to software and data. We attracted Gil, who is now our data analytics lead; we've had the talent onboard for enough time. We really understand the opportunity. The opportunity first came, Adam, with internal efficiencies within the company. You can imagine with our warranties, the data codes off the vehicle instantaneously having AI models analyzing all those data codes; how exciting that is for our frontline engineers. How exciting it is to have that data be available to all of our engineers on the actual bill of material and its usefulness for a company that has very expensive billing material. But then it became pretty clear when we got outside of Dearborn to the opportunity on services, such as over-the-air updates that are really relevant to the customer. In the case of commercial, they run their businesses off these vehicles, and so dynamic routing, telematics, driver coaching to drive more economically—the people that have our small fleets just love this because they haven't had that data before, and we can see a day, not too distant in the future, with a full lineup of pure battery electric commercials. We have a whole service business and that service business is charging, small enterprise solutions, small medium-sized businesses, repair, and more affordable repairs and upgrades of these physical vehicles. That’s what we’re busy doing. That’s our double transformation—one is to transform our automotive operations and the other one is in a way to disrupt ourselves.

Operator, Operator

And our next question is going to come from the line of Ryan Brinkman with JP Morgan.

Ryan Brinkman, Analyst

Thanks for taking my question, which relates to the upcoming F-150 launch. Can you remind us of the timing and the impact you expect both in terms of the profit or margin headwind from the lower production during the changeover as well as the benefit to sales mix or pricing subsequent to the rollout of the new version and how should investors think about execution risk during the launch? Can you talk about your confidence level there and steps that maybe you're taking to mitigate the risk?

Jim Farley, President and CEO

I'll answer the last question first on the product launch. We’ve spent a lot of time on these launches. It's very important as you understand and making sure we have all the design and engineering ready to go. We've made all the checkpoints, and suppliers are ready, manufacturing is ready, and we've started that production. We haven't discussed what we expect from a pricing standpoint or what we expect from a margin standpoint of the new truck, and I don't think we want to talk about that today, but we did talk about the fact that we are taking a very pragmatic ramp-up plan to make sure that we deliver these with quality, and that's leading us to have wholesales on a sequential basis down about 100,000 units and that's what's impacting the fourth quarter. But getting any deeper than that, I'm not sure we're going to get into that today as far as the pricing and cost impact of the vehicle.

John Lawler, Chief Financial Officer

And as far as the launch to complement John, we are so excited about this new F-150's all-new powertrains that deliver best-in-class towing and payload—it’s the best F-150 we have ever had. The technology and customer feedback have been incredible. We’ve completed the design phase, the engineering phase, and Howard and the team did a great job. We finished supplier readiness and manufacturing readiness. My whole leadership team and myself went to both plants personally to review the launches a couple of times, and we are now in high production starting the ramp-up curve at Dearborn and Kansas City. We expect to start soon. I think we don't know until we begin getting up that ramp curve what we're going to see, but I’d say one of the things that will complement the Ford team is how Linda and the whole team used COVID. During the COVID shutdown, we didn't stop with the quality assessment of the launch and there was a lot of work done on the software especially. This is all-new electrical architecture. There’s a ton of new software, and we used that downtime to really prove out our capability. We’re a long way from declaring victory. It's a daily huge global team working on the F-150 launch but we work through the launch so far; we've made a lot of progress as a team and now we're into mass production. So stay tuned.

Ryan Brinkman, Analyst

And then lastly wanted to ask about the strong net pricing that you've been enjoying in Europe and South America. Can you talk about how you think your net pricing is tracking relative to the industry in those regions and is the pricing strength more a function of the success of your company-specific product launches or are there other more macro factors that play—for example, as OEMs work to offset lower FX in South America etcetera? Where are you in terms of your product life cycles in these regions and how should we expect pricing to track going forward?

John Lawler, Chief Financial Officer

If you look at Europe, we’ve had a strong shift into our SUVs as we talked about earlier and with that has come pricing power relative to the other vehicles. We expect that to continue in Europe. Down in South America, the team has been aggressive, and you're seeing products shift there driving some of the net pricing; the strength in pricing because we're getting out of low profit, lower end vehicles and being very focused on driving towards higher margin products like Ranger and some of the other strengths that we have in the region. We're going to see that continue through and in Europe, they're managing through revenue management looking at everything we're doing. We’re doing the same thing here in North America. It's a focus we have, and a lot of it is being driven by our strong mix. We are seeing some pricing for product as new product coming out and that's flowing through as well. We’re very focused on driving the top line as best we can, but equally and more focused on getting the cost right.

Operator, Operator

Thank you. Our next question will come from the line of Mark Delaney, Goldman Sachs.

Mark Delaney, Analyst

Jim and John, you spoke to having urgency in achieving your goals, and included in that is the electric F-150 and Transit as a few of the several electrified models that Ford is planning to bring to market over the next two years. I was hoping to better understand if the company plans to go beyond its $11.5 billion investment target in electrification as previously articulated and does Ford plan to increase in particular the number of models compared to prior expectations?

Jim Farley, President and CEO

I think the simple way to look at it is, we're kind of in the first inning of this transition of the industry to battery electric future and we're deep into planning for the second cycle of those products. Competitive reasons, we're not going to share the cycle plan, but you can imagine that we're getting more and more excited about the electric future. Now we have some great ICE products and we think that market will still be robust, but we're making our bets on iconic retail vehicles and electric is definitely something that we’re more and more excited about, and our capital is following. We don't want to just be one of the many OEMs to transition to electric; we want to lead the electric change. That's why we're committed to Paris. That's why we're standing with California, and that’s our capital. We feel that the way we're doing it at Ford is the most important message, which is commercial and work. Those customers run their business on these vehicles. They’re more attentive to cost of ownership; the vehicles are of higher utilization and therefore the lower cost of ownership of operation is more important to them and they’re especially interested in the data. Although we could talk about general investment levels, the key message from Ford is more the segments that we’re investing in, and that this is not a propulsion story, it’s an investment in the digitization of our business.

Mark Delaney, Analyst

Thanks, and you commented that because of the total recall, you're going to have a CO2 compliance cost this year. Are you anticipating a similar level of cost in the fourth quarter as was realized in the third quarter, and maybe more importantly, can you discuss if you think this issue will be resolved and is there risk to any of your other hybrid or electric products?

John Lawler, Chief Financial Officer

From a cost standpoint, as I said earlier, it's about $400 million for the quarter. We do expect some costs in the fourth quarter somewhere between $100 million to $200 million. So that's the impact we see as it is today and it does also include the impact of the pooling effort that we're going to have to undertake for our passenger vehicle in Europe.

Jim Farley, President and CEO

The battery used in the Cougar PHEV is not problematic, so the potential issue is around the supplier.

Operator, Operator

And our next question will come from the line of Brian Johnson with Barclays.

Brian Johnson, Analyst

Thank you and congratulations to the new Ford team. I want to drill down on the European CO2 compliance strategy both on the light vehicle side and the LCV side. So first on the LCV side, which of course has two different standards, is that on track and when can we expect an MEB-derived LCV platform for Europe?

Jim Farley, President and CEO

First of all, we have a great plan for Europe. We were on track for our CO2 target this year until the Cougar PHEV situation came up with the supplier late in the year. As I mentioned today, it's a bit new news; it's maybe not as dramatic as a $100,000 retail off-road, but the electric Transit is a really big deal for Ford Motor Company. We're number one in the US, we're number one in Western Europe and we think electrifying this product has been really key and it will be a key part of our CO2 compliance announcement. We continue to see more city restrictions; many of our small medium-sized business owners are now asking for all-electric solution, and we also think the quality of the product will be a benefit for our European customers as well. The Mach-E will be sold in Europe next year in volume, so we have a great plan next year with the Mach-E and we have a number of hybrids coming out next year in Europe and mild hybrids could be specific. We really have a great lineup in Europe of over 20 models, but the leadership team is really excited about Europe as the commercial vehicle business and electrifying our high-volume vans.

Brian Johnson, Analyst

I would concur on that. So moving over to the light vehicle passenger car and CV market. It struck some as a split of the pandemic with many viewing plug-in hybrids as a transition and million-plus unit global EV platforms as the way to go. A) what's your thinking on that strategy and B) as we go into '21, '22, can you flex between BEVs and plug-in hybrids or even move to a more consolidated BEV platform for Europe?

Jim Farley, President and CEO

I think the flexibility between battery electrics and plug-ins is not very high. So we're really locked in as we should be. So I wouldn’t—this is not like vehicle mix or something like that. All the battery supplies are slightly different and the lead time for changing battery capacity is a lot longer than most other major components in the vehicle. So I would think about those capacities in terms of flexibility very differently than I would traditional ICE powertrains.

Brian Johnson, Analyst

Okay. And finally, can you disclose or can you disclose who the pooling agreement is with and will it become a public record at some point in the EU?

Jim Farley, President and CEO

We're not going to do that today, thanks.

Operator, Operator

Our next question will come from the line of Dan Levy with Credit Suisse.

Dan Levy, Analyst

Jim, I wanted to start out on a strategic question, on how you plan to balance the near-term industrial recovery; it's been a long cycle longer-term transition to EV. How does that view the interplay of those two? Is the pace of EV development regardless of the pace of near-term recovery, or should we look at the pace of EV development by the extent of near-term recovery? So if you’re outperforming on your near term, you can accelerate on EV as per the recovery? What's the interplay and near-term recovery in your EV development?

Jim Farley, President and CEO

First of all for Ford, our plan is very simple—turnaround automotive operations, modernize the company and in a way disrupt ourselves, launch high-growth businesses like our services business or customer-facing EV business. Our calls on capital are much more complicated than just EV end vehicles. We have 15,000 software engineers at Ford right now and that will grow. So our capital calls, our software, the credit company obviously, but increasingly it’s these services businesses. We need talent, we need cash and capital to support them. It's all funded essentially by our core automotive operations. The turnaround of automotive operations is not just a stakeholder journey. It's actually the lifeblood of our future because it funds everything. So how we look at it is getting our automotive operations overseas to profit and then a solid sustainable return dealing with the issues of passenger cars in Europe and South America and India—the three problem areas we've had in automotive—and getting our North American operations to 10% plus is an absolute minimum for the company to fund not just the electrification journey, but the move to services, data, and software.

Dan Levy, Analyst

So help me understand; as you have these larger capital calls, presumably you have profitability that is needed, because then it’s nice to have in terms of your investment. Does the pace of recovery at all impact the way that you accelerate or decelerate spend on those?

Jim Farley, President and CEO

These are great questions. If you don't mind, this is such a fundamental question you're asking. It's such an important question for Ford. I don't think the third-quarter earnings is the right venue. We need to take our time and go through this with you and all of the key stakeholders at Ford, and I think you'll find it for all of us to be a lot wiser if we just take more time and we have specifics for you.

Dan Levy, Analyst

Just a follow-up on the comp factors of growth; your focus on top-line growth is also clear at the same time you’re likely willing to further sacrifice some of what we can call global quality of more commoditized passenger car volume. So my question is; we’ve already seen some structural volume decline in North America related to passenger cars in Europe as well, but could you give us a sense of maybe how much more we might expect to see volume decline in the coming years related to more commoditized products? Or maybe said differently, which region do you think there is more way to go in moving more commoditized type volume?

Jim Farley, President and CEO

Thank you for your question. It’s a very important one for us. After several years of making really tough choices, we now have the opportunity in North America to grow, and I’ll emphasize again, that is something to note. Our share of SUVs grew; our mix of SUVs grew; our car share is declining almost to below 10% now, and our North America share increased one full point in the quarter. We have Bronco we’ve never had before; we have Mach-E that we’ve never had before, and we’re really excited about the profit potential for all those vehicles. So here we are on the eve of Ford Motor Company being able to execute well and grow in North America. When you look outside of North America, the growth that matters for us is commercial vehicles in Europe. The key growth metric for us in China allows us to grow again. We just localized the Explorer and the whole Lincoln lineup; we haven’t sold as many Lincolns as we did in September in 25 years and it’s because of China. So we have a huge opportunity to grow China and we have an opportunity to grow with export models coming from Mahindra, and I have to say we haven’t talked a lot about this, but leak it out and that is we have some really exciting affordable products for North America that are going to help us grow profitably. I think what you’ll see is China and North America growth opportunities, and the rest of the world will really focus on where we can win with Ranger and the commercial vehicles in Europe, and you’ll see us continue to grow these services businesses along the way. If there’s one message you’ll get from Ford from this leadership team, it’s that we’re really trying to think everyone—asking everyone to think about growth at Ford is more than volume growth. We want to grow our software business, our services business.

Operator, Operator

And our last question for the day will come from the line of Joseph Spak with RBC Capital Markets.

Joseph Spak, Analyst

Maybe just two quick ones since we touched on a lot. I realize you are not talking about free cash flow for the fourth quarter, but Ford Credit EBT year-to-date is $1.7 billion, and distribution is $1.1 billion and I think you committed in the past to defending all that out. So should we expect a catch up in the fourth quarter?

Jim Farley, President and CEO

I'm not sure, but I'm quite clear on the catch-up. I think that we've been distributing from Ford Credit on a regular basis throughout the year, so I wouldn't expect there to be anything out of the ordinary there.

Marion Harris, CEO of Ford Credit

Joe, the distributions from Ford Credit are going to reflect profit after tax, balance sheet size, and leverage; it’s going to be what it’s going to be.

Joseph Spak, Analyst

And then just lastly, John, I saw in the media that you made a comment about how it's too early to talk about the dividend reinstatement. I realize ultimately it's a board decision, but I'd like to set this up I guess to Jim and John in each of your opinion: should Ford give any dividend over the coming years given the transformation you’re talking about? And if so, what are really the parameters you're looking for in reinstating that?

Jim Farley, President and CEO

Thanks for the question. I don't think this is the time to have that discussion. I think we need to have that framed up in our total capital strategy and calls on capital and where we're headed as a business, and I think next spring would be the time to do that.

Operator, Operator

Thank you. That will conclude today's Ford Motor Company third quarter 2020 earnings conference call. We do appreciate your participation. You may now disconnect.