Ford Motor Company (F) — Q2 2015 Earnings Call Transcript

Thank you, Katina, and good morning. On behalf of the entire Ford management team, I would like to thank you for taking the time to be with us this morning, so we can provide you with additional details of our second quarter 2015 financial results. Copies of this morning’s press release and presentation slides are available on Ford’s investor and media websites. Now presenting today are Mark Fields, our President and CEO; and Bob Shanks, our Chief Financial Officer. Also participating are Stuart Rowley, Corporate Controller; Neil Schloss, Corporate Treasurer; Paul Andonian, Director of Accounting; and Mike Seneski, Ford Credit CFO. Also with us is Ted Cannis, who will be replacing me as head of Investor Relations effective next week. Today’s presentation includes some forward-looking statements about our expectations for Ford’s future performance. Of course, actual results could be different. The most significant factors that could affect future results are summarized at the end of this presentation and, of course, detailed in our SEC filings. Finally, any non-GAAP financial measures are reconciled to the U.S. GAAP equivalent in the appendix of the slide deck. Our Form 10-Q is planned to be released later today. With that, I would now like to turn the presentation over to Mark.

Thanks, George. Good morning, everyone. What I would like to do is start out with an overview, and then Bob will walk us through the slides. The headline is that we had an outstanding second quarter. If you look at some of the highlights, we had the best automotive quarterly profit since 2000; the best quarter ever in North America; a second quarter record in Asia Pacific; strong continued results at Ford Credit; we roughly broke even in Europe; and we’re on track to deliver a breakthrough year that we talked about at the beginning of the year. As we rack up the numbers for the quarter, we achieved $2.9 billion in pre-tax profit, which is up 10% versus last year. Our net income was up 44% to $1.9 billion. Our operating margin, our automotive operating margin came in at 7.2%, which was up six-tenths of a point from last year. Our automotive operating related cash flow was a healthy $1.9 billion. Importantly, our global market share grew for the second quarter in a row. Our wholesale volume was up. Now revenue was flat, and that was due to the impact of the strong U.S. dollar on our international operations. And I would note that in the quarter, we had no special items. As a matter of fact, in the first half, we had no special items in the company. Now, as we go forward, we’re going to stay very focused on our three priorities, and these drive all of our folks, including myself, every day we walk in the door. It’s around accelerating the pace of progress of our One Ford plan; delivering product excellence with passion; and driving innovation in every part of our business. I believe our results in this quarter show that the plan, our people, and our processes are delivering. If we look at the first half, we racked up $4.3 billion in profit, and we expect a stronger second half. On the balance of the year, this year remains very busy. We have 16 new vehicle launches, and I’m happy to say 12 of them have been completed. Importantly, we’re delivering on quality. All regions across the globe are seeing strong progress on quality so far this year. It’s really encouraging for us to see third-party validation of the progress we’re making on bringing great quality in our products for our customers. As we look at our business units, we expect particular strength in North America, and that’s because essentially, we’re benefiting from a full supply of new products like the F-150, Edge, and Explorer. We now see the opportunity to be in the upper half of the 8.5% to 9.5% range in North American operating margin. Our new F-150 is in full production, and customers love it. We’ve also completed the launches for Ford Edge, Ford Explorer, and Lincoln MKX. In Europe, we’re equally busy. We’ve had several new products launch in the first half, including the all-new S-Max and the new Fiesta in Russia. In Asia Pacific, we fulfilled our promise of 10 new plants, with the 10th plant opening during the second quarter. Now, the balance of the year, we have four more new global vehicles to launch, and they are all on track, including the Everest full-size SUV and the Taurus sedan in Asia and the F-Series medium duty truck which is going to be built in Ohio and the Mustang GT350, which will be built in our Flat Rock plant in Michigan. Speaking of our products, we couldn’t be more pleased with the customer reaction we’re getting to our new products. In North America, the new F-150 is a smash hit; it has record transaction prices. For those of you who saw that last week, J.D. Power APEAL awards came out, and the F-150 was the award winner for pickups. AutoPacific also came out with their Vehicle Satisfaction Awards, and the F-150 received the highest vehicle satisfaction ever for a full-size pickup. Our new Edge had record sales in the second quarter; Explorer, in the second quarter, our sales were up 30%. In Europe, we’re gaining market share, led by transit. We’ve basically redone our entire Transit lineup in the last year. Our new Mondeo and our SUVs are doing well. In Asia Pacific, Escort is the fastest growing nameplate in the segment and it competes very well in the sales segment. Mustang is already the best selling sports car from a volume brand in China. Down in South America, the Mondeo now leads the segment in Argentina. While we’re delivering today and staying very focused on that, we’re also intensely focused on the future because we believe that we really are in a period of change and disruption in the industry, unlike we have seen in many, many years. You can see that manifesting itself in car sharing and autonomous vehicles, connected cars, and new mobility solutions. Rather than seeing that as a threat, we see that as a huge opportunity as a company. We’re really encouraging our organization to disrupt our own business model and to take advantage of the spirit of innovation that we have at Ford, going all the way back to our founder, Henry Ford. Our company vision is pretty simple: It’s to make people’s lives better. This is about nurturing our core business but also embracing emerging businesses whether they be products or services. Earlier this year, we launched what we call Ford Smart Mobility. This really is our plan to go to the next level in connectivity, mobility, autonomous vehicles, the customer experience, and big data. We launched 25 experiments earlier this year, and now it’s exciting because we’re moving now from experimentation to implementing a number of pilots. I assure you, as we go forward, we’re going to share more details in the coming months about the progress that we’re making. So stepping back, overall it was one of the strongest quarters in our recent history. It was a great first half. The second half is going to be even better, and we’re now more confident than ever that we’ll deliver our breakthrough year. So with that, I’d like to turn it over to Bob.

Thanks, Mark. Just in terms of process first, I'm just going to go through selected slides today, so I’ll be calling out the slide numbers of the deck that was published. So, follow me that way. Let me provide a bit of context first, and I am on slide four. If you go back to the beginning of the year, we laid out a year that was going to start slower and build momentum into the second half which we expected to be the strongest of the year and then ultimately to a breakthrough year. I have to tell you, based on the good start to the year that we had in the first quarter and what are clearly outstanding results for the company here in the second quarter, strong first-half, we are clearly on a path towards a breakthrough year which includes a good performance that will build on what we have done here in the first-half, something that we’re really, really excited about. What I’d like to do now is start going through the details. I won’t touch on the details of this slide because Mark has covered that. So, let’s just dive right into the sector results here on slide five. If you look at the upper left, you can see that we earned $2.9 billion in the quarter for the company on an operating basis. We had no special items in the quarter. We were up 10% from a year ago, and this was the third best quarter of company operating performance since we came out of the great recession. On the slide, you can see that the automotive results were strong at $2.4 billion, and financial services at nearly $0.5 billion, with Ford Credit itself just over $0.5 billion. Both sectors contributed to the performance; and as you can see below the chart, both contributed to the improvement compared with the second quarter a year ago, and both contributed to stronger results compared with the first quarter. Automotive was the big driver between the two segments but both were positive contributors. Let’s go on now and look more deeply at the auto sector on slide six. Here are key metrics, and if you start up on the upper right, you can see the $2.4 billion pretax profit in the quarter, also up 10%, and this was the best automotive profit that we have generated since 2000. Results were better than they were a year ago. They were also better than the prior quarter, and in both instances, that improvement was due to favorable market factors. The margin was strong at 7.2%. We did deliver higher wholesales, up about 2% in North America and Europe. Revenue was about flat, inclusive of just over $2 billion of adverse currency effects from translation of local currencies into U.S. dollars. If you look in the lower left, you can see the SAAR was down on a year-over-year basis about 0.5 million units; this was driven by Asia Pacific, which includes China, which we’ll talk about later. South America was down, as were Middle East and Africa. Our market share was up, as Mark mentioned. For the second consecutive quarter, it was up a tenth to 7.6%, and we saw improvements in South America, Europe, and in Middle East and Africa. Let’s now go to slide eight and let’s look at the absolute of the sector in the quarter. Let’s start with North America, which clearly was a driver of the overall performance. It was North America’s best ever quarterly profit. I’ve probably said that five times, and maybe six times if I can do it again. It was a fantastic quarter for North America. It also drove the year-over-year improvement and the quarter-to-quarter improvement. But there are actually a lot of good things that are happening in the operations outside of North America as well. Let’s look at them individually first. Asia Pacific had a record quarter for the profit. We did say potentially a breakeven result when we met with you last time, but the team did a fantastic job of delivering good cost performance in the quarter which generated the results that we see today. I want to call out Europe which even though was at about breakeven, there are a lot of positive things that we see both in the external environment in Europe but also in our performance that I’ll touch on in just a minute. If you take these operations collectively, the ones outside North America, they approached breakeven. So letting the North American profits flow through, they collectively improved versus the first quarter and also versus the year-over-year results in the second quarter of last year. We’re very, very pleased with the performance across the board, the breadth of it as well as the depth, particularly in North America. Let’s go on now and we’ll start going through the business units on the next slide which is slide nine and this is North America. North America has consistently been profitable since 2010. It’s average operating margin is over 9%, and let’s jump right to the margin. Here you can see just a fantastic result of 11.1% in the quarter. I want to highlight that North America did not benefit from positive year-over-year performance from F-150. F-150 is doing very well but it was still in the launch phase during the second quarter; we only reached full production very late in the quarter. Wholesales were down 25,000 units on a year-over-year basis in the quarter. So, this performance was a very broad-based performance which is one of the things that we feel so excited about when we look at North America. If you look at the profit, we’ve already talked about it being a record but I can do it once more, $2.6 billion; it was up year-over-year and quarter-to-quarter due to favorable market factors. Now, I’m not going to go through slide 10 which shows the details of the year-over-year but if you look at the pricing performance, it is kind of unusually; you’ll see that we had higher pricing, and that was not just F-150, that was across many products in the portfolio. We also had lower incentives. It was a very powerful quarter in terms of our pricing performance. Operating margin, I’ve touched on. Let’s go over and look at the top line. The top line was up; wholesales were up, despite the decline in F-150 that I mentioned. In terms of revenue that was also up. And that did include headwinds from exchange on the revenues that we earned in Canada and Mexico. Looking at SAAR; SAAR was up on a regional basis, and in the U.S. share was down, however, and this was due to the launch effects of the F-150. It’s not shown here but our retail share of U.S. is actually up a tenth. In terms of the full year, we continue to expect our profits going to be better than it was last year. As Mark mentioned, we clearly see the opportunity based on the first half performance to generate a return in the upper half of the 8.5% to 9.5%. Mark, any comments on that?

Yes. Let me just give some perspective on F-150 because obviously there is a lot of interest in it. First off, we are really excited and we’re seeing strong demand for the new F-150. It’s turning on our dealers’ lots more than twice as fast as the segment as a whole. As I mentioned earlier, we’re seeing record transaction prices with lower incentives versus last year. The mix is rich. We talked about the third-party awards that we were winning in that product. And basically now, we are at full production at the plants and we expect to hit normal levels of inventory by the end of the third quarter. So, we could not be more pleased and confident where we stand with the F-150.

Yes. It’s really a great performance and certainly something that’s going to drive the performance in the second half. Okay, let’s go on to the next region; we’ll talk about South America on slide 11. So looking at South America, the first thing you have to talk about is the external environment. It is very tough, particularly in Brazil. We’re not seeing any good signs from recent economic indicators. Fiscal actions in Brazil have been taken to improve the economy longer term, which probably means more pain in the short-term. So, no signs at this point of reaching bottom. Our team is managing very well and proactively in this environment, and we believe that they’re positioning our business for recovery once it does occur. But again, no signs of a bottom, and we’re not talking about a recovery today. Having said that, our One Ford product strategy is paying off; we saw strong share growth in the region and in Brazil, once again driven by the all-new car. We also saw the Fusion leading its segment once again in Brazil, and we saw the F-Series and the Cargo leading the semi-light and light segments. I’m also proud to say that in Argentina the Ford brand was again number two in terms of market share. The loss in the quarter was $185 million, which was a pretty good improvement year-over-year that was due to higher net pricing. Two elements of that: one is the fact that we’re recovering or trying to recover inflation, which is very high in the region, as well as the adverse operating exchange effects of the weak currencies. We did see positive pricing from new products, particularly the car. The results were pretty much the same on a quarter-to-quarter basis. If we look at wholesales, that was down due to the lower industries. If we look at revenue, that was down sharply as well, again due to lower industries but also exchange. In fact, about two-thirds of the overall decline in revenue is due to the weaker local currencies. If we look at the full year, we continue to expect a loss, but we expect that loss to be lower than what it was a year ago. Let’s move to slide 13 and discuss Europe. I’m actually quite optimistic about what we saw in Europe during the quarter. We nearly reached breakeven, similar to last year, as shown here. We improved on a quarter-to-quarter basis, thanks to market factors. There are several indicators suggesting positive developments, and we feel we are on a promising path towards profitability. First, in the external environment, we are observing modest yet favorable growth in the euro area and stronger growth in the UK. Industry sales are growing across Europe, despite significant declines in Russia. We’re seeing growth in Europe 20 as well, and our total wholesale volume has increased. Regarding market share in total Europe, it was up in the second quarter and also in the first half, although the latter is not displayed here. In Europe 20, it remained flat in the quarter but improved in the first half. The revenue decline primarily resulted from exchange translations. Therefore, on a local basis, we are experiencing revenue growth. I would like to highlight a few additional results. Although we won’t look at slide 14 now, in the callout box regarding volume and mix, we took a hit of about $150 million this quarter due to an increase of just 1,000 units in stock. Normally, we see a stock build in the second quarter in Europe, which we did not have this year due to plant shutdowns in the third quarter, similar to what we experienced last year. On a year-over-year basis, we sustained about a $150 million hit this quarter from the absence of that typical stock build. Several factors contributed to this: we began the quarter with a reasonable stock level, but we encountered industry strikes in Turkey, which affected our operations and limited the supply of transits back into Europe. Additionally, we launched the all-new S-Max and Galaxy late in the quarter, which constrained the supply of those products. Another aspect to consider is that this quarter, compared to the same time last year, we faced increased pension costs due to lower discount rates seen late last year, leading to higher amortization of losses related to our pension obligations in Europe. This should be viewed as a penalty for past actions; it’s non-cash. The underlying run rate of the business is actually better, and I wanted to bring this to your attention. Lastly, I should mention that last year we benefited from a one-time reserve release connected to our Cologne investment agreement, which did not occur this year. Nevertheless, we achieved the breakeven result you see today. We believe the European transformation plan is progressing well. While we need to continue enhancing our brand, products, and costs, we’re confident we’re on the right track towards profitability. For the full year, we do not expect to be profitable; we still forecast a loss, though it will be better than last year's loss. We anticipate that results in the second half will be worse than in the first half due to normal seasonal factors. With that, I’d like to turn it over to Mark to see if he has any comments on Europe.

Yes, just some perspective on the market in Europe. We remain cautiously optimistic about the continued industry growth in the second half. If you look at the channel mix, it’s fairly stable year-over-year. Commercial vehicles, encouragingly, are up more than passenger cars, and as you know, that’s a good indicator of the economy. Pricing, we’ve seen some modest improvement, but incentives obviously still remain high. It’s interesting; we’re seeing some trends in Europe that we saw during the North American recovery. In particular, we’re seeing some pent-up demand, obviously not to the same degree, but some of that pent-up demand. We’re seeing a mix improvement. When customers are ordering their vehicles, they are ordering a more well-equipped vehicle, and that’s exactly what we saw here in North America, and that’s helped a bit of the pricing environment. Overall, we’re seeing some green shoots, but still, we know we got a lot of work to do.

Let's discuss the Middle East and Africa. This is our youngest and smallest business unit, and I want to remind everyone that this region has 1.4 million consumers and is growing at about 4% to 5% annually. We are very enthusiastic about our initiatives here and the team's efforts to build a strong presence as this area begins to expand. In the last quarter, results shifted from a small profit last year to a small loss this year, primarily due to production timing differences. Most of the volume we sell in the Middle East and Africa comes from other regions, leading to long order and lead times, which creates volatility in quarterly results, as evidenced this quarter. For the full year, we still anticipate results to be roughly breakeven. There isn't much to update on regarding the Middle East and Africa today, but the team is dedicated to positioning us for significant growth in the coming years. Now, moving to Asia Pacific, there’s much excitement this quarter with a record, achieving nearly an 8% operating margin, despite a decline in industry sales, including in China. I should note that we also continued to incur growth-related costs this quarter that will yield benefits in the future. We launched the plants in Hangzhou, China, and Sanand, India, which incurred higher revenue costs in the second quarter. However, we expect substantial revenue contributions from these plants for the remainder of the year. Profit improved both year-over-year and quarter-to-quarter, primarily driven by operations outside of China. We saw noticeable advancements in ASEAN, Australia, and India, which was very encouraging. For this region, wholesale volume, revenue, and market share decreased year-over-year; I apologize for the confusion, market share did dip slightly. However, within China, wholesale volumes remained stable; our market share in the quarter was 4.7%, matching the record set in the third quarter of 2014. Overall, we achieved positive results in Asia Pacific; while there are concerns regarding slower growth in China, we still expect strong results from Asia Pacific for the full year, surpassing last year's performance. Mark, would you like to add something regarding China?

Yes, let me just give some perspective on the China market because there is obviously a lot of discussion around it. It’s clear we’ve seen a market slowdown in the industry there. We’ve seen commercial vehicles actually come down more than passenger vehicles, which again is a bit of an indicator to us. That, in turn, is putting pressure on the likely suspects around pricing. We’ve also experienced negative pricing in this market for quite some time, but it’s continuing now. We must put this market into perspective. It’s the biggest market in the world right now. By our forecast, it’s going to grow to about 30 million vehicles in the next 5 to 10 years. So we’re still very bullish on China, but it’s going to go through its fluctuations, and that’s what happens in emerging markets, and we’re going to work our way through it in a positive way and grow the business.

Let’s go on to the last of the business units, which is Ford Credit. Once again, Ford Credit had a very strong quarter. As I mentioned, it generated a profit of over $0.5 billion. It was an improvement year-over-year, and that was due to higher volume driven by consumer receivables and an increase in leasing in North America. The mix was favorable. We also saw recurrence of large insurance losses that we saw a year ago due to storms in North America. Ford Credit’s business and credit conditions remain very healthy. Our origination practices remain consistent. Costs at Ford Credit are well-controlled and very much in line with expectations. Credit losses remain at historically low levels; delinquencies also remain low; and repossessions are at historically low levels. Everything we can see in the business looks robust and very, very positive as we look at the future. In terms of our full-year guidance, we’re reconfirming that guidance, which includes the pre-tax profit that would be equal to or higher than in 2014. With that, let’s move on and look at automotive cash. We had very strong cash flow in the quarter, automotive operating-related cash flow you can see here of $1.9 billion. If you go back to the first quarter, we had some pretty large debt repayments, and we characterized most of our pension contributions in the first quarter, and we said at that time that we would not see that as we move out of the first quarter. We’re delivering on that promise because if you look at the $1.9 billion that effectively is flowing through to the change in our gross cash position other than the dividends in the quarter, which were about $600 million and that balance is the compensation related share repurchase program. We ended the quarter with $20.7 billion of cash and marketable securities; subtract from that the automotive debt of $13.7 billion, which was up a bit due to funding in Brazil; we ended the quarter with net cash of $7 billion. Liquidity was also strong at $31.7 billion. Why don’t we now move into the future and look at the business environment on slide 21? This is pretty simple. We are projecting a global GDP growth in the 2.5% to 3% range; this is driven by the U.S., China, modest growth we’re seeing in Europe, the euro areas, as well as stronger growth in the UK. There are little concerns still about South America as well as Russia. We will be watching China closely, but overall we expect pretty good growth on a global basis. Now that is not translating into growth in global automotive industry sales this year, which is unusual. That’s largely because the strong growth in China, as Mark and I both talked about, is not translating at least according to our point of view, into growth in China, and also Japan, which we haven’t talked about today; it is growing, but we expect the Japanese industry to decline in 2015 versus 2014. With that, let’s go to slide 22, and now I’ll end my comments on planning assumptions and key metrics. We are upgrading our outlook for the Europe 20 industry; we’re taking that up to 15.7 million to 16.2 million units. We are downgrading China, as Mark talked about, to 23 million to 24 million units, and all the other financial metrics are on track. We’re clearly on a track to achieve our total company pre-tax profit guidance of $8.5 billion to $9.5 billion. So, just seven words to leave you with today: outstanding quarter, strong first half, breakthrough year. And with that, I’ll turn it over to Mark.

Thanks, Bob. Let me bring this altogether. Obviously, our plan and our priorities are unchanged. We’re on track to deliver our near and long-term objectives, which have remained the same, and that’s about being in the top five in global sales, getting a better balance of profits and sales around the world, targeting operating margins over 8% globally, being in the top quartile of total shareholder returns and highly regarded by all our stakeholders. We have our three priorities that focus on accelerating our pace of progress on our One Ford plan; delivering product excellence with passion; and, of course, driving innovation in every part of our business. The way I described it is, it’s about having one foot firmly planted in today and staying riveted on the business and delivering today’s results, but also one foot firmly planted in tomorrow and taking the point of view on that future and rewinding back to the day and making sure we’re taking the decisions to maximize our success in that timeframe. We’re pushing ourselves to think, to act, and disrupt like a startup company. That really means trying to anticipate customer wants and needs in the next five, ten, and even fifteen years. The second quarter shows more proof that we have the right strategic framework, the right process, and importantly, the right team. Again, it’s one of the strongest quarters in our recent history. It’s a great first half, and we expect the second half to be even better. So with that, why don’t we open the phone lines.

Thanks, Mark. Now, we’ll open the lines for about a 45-minute Q&A session. We’ll begin, as usual, with questions from the investment community and then take questions from the media. In order to allow for as many participants as possible, please keep your questions brief, and please avoid asking more than two. Katina, can we have the first question, please?

First, can we just get back to the supply of the F-150? I guess just a little bit more detail there. I think originally you guys were expecting to have that ramped up sort of mid-summer, then I think it became late summer, and now it’s more towards the end of the third quarter. What have the issues been, and how confident do you have just surrounding the fix that’s in place to try and get that supply up there? So, that’s my first question, just an update on that.

To put it into perspective, I think we’ve always said that by the summer we would be at full production—late in the second quarter we’d be at full production, which we are. We’re on track to, as I mentioned earlier, make sure our inventory is at normal inventory level by the end of the third quarter because, you know, Patrick, there’s a little bit of a lag time as we get both plants up to production fully; we then have to shift those to our dealers and also fulfill fleet orders. We’re on track with our launch, as always. We work with our suppliers to make sure it’s successful, and we’re doing that. We’re very confident in the product, and we couldn’t be again more happy with the kind of response we’re getting with it. We expect in the second half, as we get up to stocking levels, we’ll fulfill more fleet orders, and we expect our performance in the marketplace to grow.

So it sounds like the operational stuff is well in hand. Maybe that dovetails well with my next question, which is just on the pricing, which was obviously very strong, both on the incentive side and the pure pricing. How do we think about—maybe that’s sort of a Bob question—but how do we think about that being carried over into the second half? I know that, I think you sort of launched with some of the higher trim level models, how to Dearborn first and I think some of the other stuff as less contended. But just how do we think about those numbers being carried into the second half?

If I remember correctly, in the first quarter, it was over 70% mix. I think it was a high series, and I think we’re at 50%; and I think normal rates, if you go back to the old model, was around 30%. We’ll have to wait and see where this settles out because the demand for particularly the higher series is quite strong. As you saw, probably was it this week, we launched the Limited. So we got more to come, the Limited coming in this winter; we’ve got Raptor coming next year. We’re not done plumbing every dollar of revenue we can from that product. We’re very excited about that, and the customers are demanding that. As we look at the balance of the year, we expect pricing to continue to be a strong factor in North America’s performance. We clearly expect North America to be stronger in the second half than in the first. The F-series actually did not positively contribute to the bottom line in the quarter because it was in launch phase, but we certainly expect in the third and fourth quarters on a year-over-year basis that it will be a positive contributor as we get, as Mark said, the stocks up to normal levels by the end of the third quarter—not just numbers of units but also the derivatives in the series and the mix and so forth. So, you will see strong pricing coming from North America, not just F-series but even in the quarter—F-series clearly was a factor, but there was a lot of different product lines, and we were able to generate incremental pricing opportunities in the quarter.

Just sticking with North America, can you give us a little perspective on pricing versus material cost ex-commodities? I think it was slightly negative year-over-year. If you take those two together? And also can you talk about the warranty freight positive as well, whether that was some sort of non-repeat or whether that’s a sustainable kind of improvement?

Yes, I’ll comment, and if Mark has anything afterwards, he can supplement. I’d like to go back to what I said in the first quarter because we actually got a very similar question then. I actually don’t think that’s the right way to look at it at the way you phrased the question. We clearly are seeing product costs go up as we invest in the new products, and we also see increases in the structural costs because of the investments in the plants and so forth. But we’ll get revenue for that. We just talked about for F-series, but you also get positive mix, and then if you grow the business, you get volume as well. So really, what you want to look at in terms of what’s happened to the total contribution margin of the business is to look at what you’re getting on volume, what are you getting on mix, and what are you getting on pricing relative to the product cost and some of the structural costs that you build into the business. As you can see in this quarter, that is what generated the improvement year-over-year. I’ll mention once again, that was not due to the F-150. It will come on stream in terms of the positive effect in the third and fourth quarters. That will simply add to what we’ve already seen in the second quarter. To me, it’s a broader view of what we’re doing with new products rather than just looking at the two categories you mentioned, Dan. In terms of contribution cost, we had favorable performance year-over-year on warranty as well as on freight. Duties on warranty, that was a combination of things; it was the non-repeat of some large field service actions that we had last year; we also had some supplier recoveries against some of those actions and other actions as well that might have been in different periods. I also mentioned that we got good news on freight. I think that was largely because we had a lot of premium freight last year that we didn’t repeat this year. So going forward, we expect that we’ll continue to have good performance on warranty as Mark said; the quality is extremely positive not only in North America but around the world. Field service actions happen based on the data that’s in front of us and it’s kind of hard to forecast that one. But right now, everything looks good.

Second question related to China, I mean great performance in the quarter with earnings up on flat revenue, flat wholesale volumes. Just checking, can you give us any more detail on what you’re seeing in terms of pricing? Is the pricing pressure worse today than it’s typically been? Is it worse than last year? And also, it looks like inventory is up quite a bit on a year-over-year basis; is that anything to be concerned about or are we at normal levels now? Thank you.

On the inventory, it is up, and part of that is due to as we were launching some new products and localizing, we had some bridging stocks. But as the market has come down, we’re implementing our process, which is matching production to demand. You can see that in our production for the third quarter, which is up healthily; it was up healthy. We’ve taken the appropriate actions to get the inventory in line. Overall, we feel pretty good about the inventory. In terms of the pricing environment, as we mentioned, over the past couple of years, we’ve seen negative pricing in the 1% to 4% range, and this year we probably see it in the 4% to 5% range. We’re seeing a little bit more, and it depends on region and segment. The approach from our team is—and this is, I think, the silver lining of a little bit of a downturn in China. This is the first time our team is going through a downturn in China, and we have some very experienced folks both in our operations there and in our JV partner. It’s a great learning opportunity so that when it goes down, we know how to manage through. We know that revenue in a declining market comes off fast. That’s why the big effort on cost, and that was one of the elements that drove our performance in the second quarter. Our team will stay focused on that while also launching five new products in the balance of this year to drive our top-line.

And Dan, I just want to supplement. If you look at our guidance on production in the second quarter for Asia Pacific, we originally were at 395,000 units; last year came in at 362,000. So, we’re down 33,000 units. Back to Mark’s point, this was a reflection of the team acting quickly and very proactively as we saw the softening; they took production out ASAP. That’s what we do anytime, anywhere that we see something like that happening, and the team was really staying on top of what’s happening in the marketplace and protecting the level of dealer stocks that we should have.

I just want to go back to North America, really strong quarter, 11% margins; you mentioned you have the F-150 really contribute in the second half of the year. Adjusting that, the second half margin guidance is maybe implied around 10%, which is still pretty strong, but down a bit maybe from Q2. Can you help us just walk through a couple of puts and takes around the second half outlook as compared to the second quarter?

We’re going to have a fantastic second half, and we had a really good second quarter. So, I actually kind of see the first half performance of 9.1% going up a tick as we go into the second half. That will be aided by what I mentioned earlier in terms of the F-150 contributing positively in the second half versus the first half with the launch effect. I don’t know more to say. We’re going to go from really good grade. It’s hard to parse really fabulous performance.

Also, within that, we have to look at the market, and there’s a lot of discussion around the market being at a peak. I really term it as a plateau because when you look at what’s driving the market, it’s really around replacement demand. In any mature market, about 80% of the industry in any given year is driven by replacement demand. We know the age of the car park is over 11 years old. So we think that bodes well. Within the market, we’re seeing actually incentives, and we have to watch that closely because incentives are up year-over-year when you look at the U.S. market. They have been up every month. Interestingly, incentives are up every month on cars; they are actually about even to down on trucks. That’s an area we got to stay focused on, but we expect our performance to continue to be strong in North America.

And then just my second question on Asia Pacific, and again very good results, can you remind me what went right in the quarter? I think in the first quarter call, you talked maybe about breakeven second quarter in Asia-Pac. So maybe what went right there in the second quarter, if I missed it?

Yes, I just touched on that in my comments. Itay, it’s cost performance. Mark and I were sitting here three months ago, they looked more like a breakeven type performance, but the team did, despite the production adjustments that we referenced earlier, they did a great job on cost performance. The other thing that was great about the quarter is the performance improvements that we saw outside of China. That contributed as a significant driver, supporting results in ASEAN, Australia, and India. As you know, those are areas we’ve been focused on trying to get them moving forward in a positive manner, and we got that traction in the quarter.

I just want to understand why you did not take the total company guidance up, given you had $4.3 billion in the first half, and if you set the second half—at least earlier, you set a second half stronger. What keeps you cautious from picking it quite higher into that range?

Well, I don’t think we’re being cautious. We think that the range covers the likely outcomes. If you think about the first half, we made $4.3 billion, so that gives us the opportunity to do what is at 5.2 in the second half; that’s a much stronger second half than the first half to be at the top end of the guidance. So I think we just feel comfortable that there is no need to change the guidance, and we believe at the top end that covers the potential upside we’re looking at.

Should we still think the cadence being stronger in the second half for the total company? Or has that changed given how strong Q2 was?

No, we definitely think the second half is stronger. I mean, if we just multiply the first half by two, we’re at eight, six, and we think that we’ve got, as I mentioned, clearly upside opportunity in the second half and expect to deliver that.

And my second question, can you clarify the F-150 pricing? Obviously, there is local dealer advertising at $10,000 incentive. Has there been any change month-over-month in the F-150 incentive structure? Obviously, it has created a lot of headlines.

Colin, it did generate a lot of headlines. As you know, incentives and rebates are a normal part of the competitive environment, and we use them to either encourage customers to buy more fully equipped vehicles or to finance it forward credit or to reward loyalty. But overall, when you look nationally, our incentives on F-150 are around $3,800 or so. It’s down year-over-year. That $10,000 figure that was thrown out, part of it is based on incentives that are available on all vehicles that dealers can add up to, and in some cases, some dealer associations of those a small minority of them decided to add to that. In some cases, it was $10,000, but overall when you look at our average incentive of around $3,900 and it being lower than the segment and much lower than some of our competitors, I think it reflects the strength of the product.

Just to parse by results, Bob, just to understand North America a little more. I hate to do this, but on slide 10 there is one number—the stocks positive 451; is that just a reversal of something that was unusual last year, or are we looking at something more normal?

Now, what it was, as we grew stocks by 7,000 units within this quarter, and in fact, if you go to appendix 6, it’s pretty clear. I’m sorry, we actually reduced stocks. We reduced stocks for the region; we increased stocks by 7,000, and we reduced in North America and the U.S. but had increases elsewhere. Last year, we actually had a decline. So it’s the absence of the stock reduction last year on a relative basis that’s generating the good news.

John, part of it is the industry is growing. Clearly, you expect our inventories to keep up. To Bob’s point, overall when you look at it, our inventory levels here in the U.S. are about 608,000 and that’s down from about 643,000 last year. So, our days supply are about 70, and this time last year, it was about 72. We feel good about our inventory levels.

But the number you’re talking about, the 451, that’s a non-repeat of a stock reduction last year; it was a smaller stock reduction this year.

Yes. So last year was a little bit more unusual; this year was normal. It’s really as what I’m trying to understand—

Yes.

And then staying on North America, I mean, Mark, you alluded to the medium-duty or the Super Duty launches that are upcoming in Kentucky Truck, and that’s not something getting a lot of headlines, but that could be a real big benefit above and beyond what’s going on with the F-150 on the truck side. Just to understand if you guys can talk about that a little bit and when sort of there might be a little bit of a weight in results because of that changeover and when the benefits should ultimately come because that could be a big part of the story as well.

Well, we’ll get into that more as we start talking about 2016, but focusing on 2015, obviously in the next month or so, we’re going to be launching the medium-duty truck out of Ohio. That’s a really important product because we have a lot of customers who have those products, and it drives a lot of ancillary commercial businesses across our other vehicle lines. So, we’re excited about getting that up and running. Keep in mind, that’s a product we’re bringing back and manufacturing here in the U.S.

Bob, first, a quick one. Can you tell us current capacity utilization at Changan Ford, even roughly to the nearest 500 basis points?

No, we don’t provide that information publicly. The stock level—the capacity is relatively well utilized, but Hangzhou for example, which we just launched, that’s got about 250? 250, I think in that particular plant, but we’re just launching it. We’ve got the Taurus coming later, so there’s a lot of room for us to grow into that plant.

And Mark, just a follow-up. So, I’ve checked the last four earnings call transcripts, and I searched for Ford like Apple, Google, and Uber, and actually none of them have come up in any of your prepared remarks or in the Q&A of the transcripts. I take on board fully what you said about trying to create the startup culture and disrupt yourself, and that was very evident when we toured the research facilities in Palo Alto. So can you share with us management’s and the board’s, say, high-level thoughts on whether players like Apple, Google, or Uber are emerging competitors—not just that represent an opportunity, but could they also be competitors in designing and engineering cars and the things that you do? Thanks.

We haven’t heard what Apple is doing. To my knowledge, they haven’t announced anything. But from our standpoint, you know our process, we’re always looking at the business environment. We’re seeing folks like Uber, who knows what Apple is going to do or Google is going to do? First off, we think it’s positive for the industry in terms of generating competition and innovation, and that’s what’s driving us. Sure, we could see some of those players be competitors to us; in some cases, they could be partners to us, etc. We’re looking at the whole waterfront here. We know there are many people interested in the automotive space who would like to extract some value from that. We’re very cognizant of that.

You talked in your prepared remarks about tracking in the upper half of the 8.5% to 9.5% North American margin target for the full year. It seems pretty easily attainable now; you’re already at 9.1% in the first half. At least according to IHS, you’re going to build 19% more F-150s in the back half than the first, which should help quite a bit. So, I understand there are a lot of moving pieces, not just the F-150. But does the 2Q result now introduce the possibility that you will not just be in the top half of the North American margin target for the full year, which you already are, but you might be above it?

I think it’s more appropriate for us to cover— I said on the upper half. We're always working to do better, but I think upper half is where we’re likely to land.

And this is really the same question. In last quarter’s earnings deck, you included a slide—not in this deck—that showed pre-tax results by quarter as a percentage of expected full year pre-tax profit ramping sequentially from 1Q to 2Q and then from 2Q to 3Q before it was flat in 4Q. I know the guidance today is stronger in the back half than the first half. Do you still think that results improve from 2Q to 3Q, or whether that 3Q is a greater percentage of full year pre-tax profits than 2Q?

Well, the purpose of that slide, Ryan, was to demonstrate that unlike most years where the first half is stronger than the second half—and oftentimes you will see the first quarter compete with the second quarter in terms of which one is the strongest—that was not going to be the case this year. We wanted to show that. What’s normal is the fourth quarter being the weakest and actually quite a bit weaker than most of the other quarters of the year. We felt that the fourth quarter would have the opportunity to be much stronger than normal, particularly because of the cadence of our launches. That’s still all true, and we still expect as a result, the second quarter to be strong and stronger than the first half. So, very consistent with what we’re seeing, but didn’t think it was necessary to put the chart, and since the half is over and we’ve only got two quarters to go, within the “stronger second half,” we expect to deliver that.

The situation in Europe was quite favorable, actually. It appears that pricing was the main factor affecting performance there. Can you explain what is contributing to that? I would assume models like Mondeo, S-Max, and Galaxy are key players. Are there any other factors you have been focusing on, such as channel mix, self-registrations, rental cars, or anything else? I'm trying to gain a clearer understanding. I recognize that the third quarter typically shows a seasonal decrease, but will the year-over-year pricing benefits continue as we move through the year?

Yes, you’re actually spot on in terms of what drove it; there’s one other factor I’ll mention, but yes, that’s new products doing very well. The team has been focusing on brand, the network, and customer service, and that translates into some incremental power in terms of pricing, particularly combined with the new products. The other thing that you didn’t mention that’s the factor is we’re now consolidating Russia. So somewhat similar to South America, where we’re seeing some very positive pricing as we try to offset the effects of high local inflation and weak currencies, the same thing is going on in Russia. The team is doing the same thing, so you’ve got that phenomenon also in this quarter on a year-over-year basis because of the consolidation of Russia. Everything else you said is true, and I would expect as we go into the third and fourth quarters that we will continue to see positive pricing in Europe.

So, I have a question on North America and the one on China. On North America, I would like to come back to the earnings walk on slide 10. I completely agree with your point that the increased material cost results not only in better pricing but also better mix and market share and volume. I’m just curious how you see these material costs evolve over the rest of the year? I think in Q1, it was an increase in cost of about $600 million, and now it’s about $1 billion. Obviously, more F-150s coming in also means more new materials in there. How would you see that evolve over the next couple of quarters?

I think, let’s look at it from a couple of different ways. I think you will see year-over-year increases that will start to mitigate because we had some of the products affected in the later quarters of last year. What I do think you’ll see as we go forward is that the effects will be largely mitigated sequentially. So we have what we have. Some of that will continue to show up on a year-over-year basis, but sequentially we’re kind of where we would expect to be because the launches are behind us.

And then on China, I would just like to come back on the quarter’s performance; it was obviously an incredibly strong equity income quarter for you at $400 million, which is remarkable in a flat volume environment, but also in Ford incurring all these costs from opening new plants. How sustainable do you view this performance, in light of the dynamics that you described before in China?

We expect the operations to continue to perform well. We actually expect the volume to be greater in the second half than the first half as we launch the new plant. We’ve got new product launches that Mark talked about. Some of those products, the Edge, three-row Edge, the Taurus, the Everest; those are going to be higher-margin products. I think that will show up in the results. We feel quite good about the performance in the second half relative to the first half and overall for the full year. The one thing I just want to remind you and everyone else that’s listening is when you’re looking at those equity after-tax earnings, that’s not the total picture of China; that’s just the joint ventures. Recall, I said our year-over-year results for Asia Pacific were not driven by China even though you can see that improvement at the JVs; it was driven by the operations outside. We’ve got EU imports which are consolidated, we have Lincoln which we’re investing in that’s also consolidated, and you’ve got engineering that we’re incurring on behalf of the joint ventures that they will reimburse for later, once we start building those products that we’re engineering at some point in the future, we’ll get that compensation through royalty. Looking at the total picture of China because of what’s going on in the consolidated part of our business, it was actually down slightly. We had launch balance out of Edge as Mark talked about; we had balance out of export as we’re getting ready to launch the new Explorer. We have the investments in Lincoln, and we have higher engineering for products we’re working on for the future.

I was hoping just to ask a higher-level question about China. Obviously one of the fears in the market is that just given the amount of capacity that’s coming on line, it could result in a significant deterioration in profitability for the industry. It’s happened in other emerging markets once growth in supply reaches or exceeds growth in demand. Can you give us a little more color on how does the earnings bridge look like? If you see 4% to 5% negative from pricing, what does every 1% imply for you as a headwind? And for every 1% change in volume, what does that do for you as a tailwind? How should we be thinking about the bridge and the levers you can pull to mitigate that?

1% for is $90 million to $100 million. The thing I would think about is if you look at our portfolio, we have actually a pretty rich portfolio. We have a very strong SUV lineup, the Mondeo, the Kuga, the three-row Edge, the Taurus, the Everest, which is body-on-frame utility that’s going to come off at the same platform as our Global Ranger. These are pretty high-margin products. I think that probably puts us in a good position because as you think about where the competitive pressures will be, I’m sure it will be across the industry. But there will be a lot of that particularly at the lower end of the market, particularly where you get maybe some overlap of the low end of the international brands with the indigenous brands. The place we occupy in the market is a pretty healthy place. We also have opportunities for cost reductions; the team is continuing to make improvements there. As we mentioned, we’ve got Hangzhou plant coming on, but we’re only going to man the plant to the levels of volume that we believe is appropriate and that we can deliver from the plant. As we go in, knowing the softness in the market gives us the ability to plan that very effectively. Anything you want to add?

Yes, the only thing I want to add, Rod, is when you look at the capacity coming on line at Hangzhou, as Bob mentioned, I mean it’s for products that are in pretty high demand. We’re localizing the Edge, and obviously SUVs and a seven-seater SUV is in demand; the Taurus that’s coming, a large sedan is a significant segment there that has pretty good revenues. Even the Escort we launched earlier this year and that is, as I mentioned, the fastest growing model in the segment, appealing particularly across the regions but particularly Tier 3 through 6. But across all this, as we look at the industry, look at pricing, etc., it’s not only a focus on the top-line; the team is taking a very intense focus on the costs and the costs in the industry. That is the benefit, if you will, of looking at an industry which we’re now calling flat to down and getting ahead of things. We’re working both ends.

I want to wish George Sharp farewell and hope you enjoy retirement. We will certainly miss him and his sense of history, shall I say. I want to quote a couple of things, just a little housekeeping for Bob on North America and then a broader question on China. On North America, you talked about the F-150 having no contribution. Is the way we ought to be thinking about that the volume decrement was roughly equal to the pricing less material cost contribution?

On a year-over-year basis, it did not generate, if you will, incremental profits, and that’s because the volume was lower. We also were in launch mode, so we had all the costs, the structural costs associated with the launch but didn’t have the plants producing at capacity. That will not be the case in the third and fourth quarter. When I look at the data for the third and fourth quarter year-over-year for F-150, it’s a strong positive contributor to the bottom line, all in. That’s what we’re conveying in terms of the effect it had in the first second relative to the third and fourth quarters.

Okay. So we can expect that change as we get past some of those launch costs, as well as full volume?

Yes.

And second question on China is kind of Mark. You talked about disruptive innovations in mobility, and at the same time you talked about China at some point getting to 30 million cars. I guess, when you think about where transportation could go in China, kind of ten years out. What’s the real argument for such a densely populated urban country getting to the levels of penetration you’d need for that? Are we going to look at kind of new mobility models as maybe kind of taking some of the wind out of those sales? If so, or even if not, how would you primarily with your upper-end and mid-upper-end product line in China kind of participate in those new models in China?

I think when you look at the overall size of the market, keep in mind that the Tier 3 through 6 cities, these are cities that are still growing, still cities where people are coming from the countryside and moving in. You don’t have the license plate restrictions that you do in some of the Tier 1 and 2 cities. We think a lot of that will provide the growth to that 30 million number in the next five to ten years and it will still be somewhat manageable. In terms of the overall— the mega cities, the cities of 10 million or more, there is a lot of debate around what that is going to mean to the size of the industry. Right now, there are no clear answers because you could argue that car and ridesharing increases the asset utilization which could reduce the car park, but on the other hand, more efficient utilization of those assets and a greater overall access to mobility could actually increase the total miles driven which could lead to increased vehicle sales. It will definitely increase service business, for example, with the duty cycles that these vehicles undergo. That’s what we’re looking at. As we look at these experiments and pilots, we have our team focused on this. We’re looking at some of the innovative approaches, particularly in China, which Baidu and Didi Kuaidi are implementing. As I said, you’ll see over the next number of months and years some pilots coming through, and we’re trying to create some business models out of this that can not only open up new opportunities for us but complement our existing business.

Okay. Thank you, Katina, and thanks everyone. We’re really glad that you were able to join us today.