Ford Motor Company (F) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Joe Spak. I head up the automotive research effort here at RBC Capital Markets. And this afternoon, we're very pleased to have with us a great roster of executives from Ford Motor Company: Tim Stone, Chief Financial Officer; Hau Thai-Tang, Chief Product Development and Purchasing Officer; Gary Johnson, the Chief Manufacturing and Labor Affairs Officer; and Lynn Tyson, Executive Director of Investor Relations. The format for today's call is fireside chat. I prepared a number of questions that go into a bunch of different areas, including recent second quarter results, the redesign effort -- the global redesign effort, some products, production, classification and the balance sheet. But I do encourage investors to get involved in discussion as well and ask questions. [Operator Instructions] So with that, Ford team, welcome, and thanks for joining us today.

Tim, let's start off with us diving back in a little bit to the second quarter results and particularly in North America where we saw an $800 million year-over-year cost benefit in the second quarter. But as you indicated, that consists of some structural austerity savings as well as some lower costs related to the volume. And that's obviously net of some issues as well such as higher warranty and it seems like commodities as well. So if we look at the company as a whole, I know you said structural was about $1.8 billion. The net cost savings, I think, was $1.1 billion. Given the importance of North America as a region, it seems fair to assume a similar relationship holds. So what does that mean for the North American run rate going forward? It seems like it's at about that $1 billion pace. But maybe you could help us understand how much austerity cost savings were in the quarter. When does some of that come back? How does it come -- some back? And maybe some examples of some temporary cost savings that can become more permanent ones.

Great. Well, thanks for having us today. We appreciate it. And as it relates to the $1.8 billion you mentioned, $1 billion of that -- over $1 billion, that was in costs, as you said. And that was from suspended production, onetime cost actions like produced marketing as an example, and that was offset by higher material costs and regulatory costs as well as higher warranty, as we did say it will be up for the year. But we have been and we'll continue to focus on all the different fitness initiatives you've been hearing us talk about as well as redesign as a priority. How we've had to respond to COVID has forced us to even take a sharper look at our fitness and our redesign, how and where we work, the number of people working from home or -- is resulting in reduced travel as it is for everyone. So we're looking at ways to plan differently for the future, which we believe will have a favorable impact on cost. But relative to Q2 specifically, we certainly did accelerate our cost actions. North America was no exception. It was a huge impact in North America, you said, including going beyond those tied to volume. And some of this will fall through into the third and fourth quarter, and that's factored into guidance. But for 2021, we really don't have, at this point, a better view of how things will develop. We'll start our planning process, as you expect, later over the next several months. But that will also depend to a large extent on what's happening with the virus, what's happening with the macro environment, as an example. But as we continue to say, I know at this point, you want to see it and we do, too, we continue to drive execution. But we believe our targets of 8% for the company and 10% for North America and 6% for Europe are achievable. And there's a bunch of levers that are going to drive us toward that profitability, the top line and EBIT improvements from a rich mix of products certainly as we have the SUVs and CVs and trucks. Many of them new coming up, the global redesign and the portfolio refresh. And then as you know, we have a lot of opportunity to improve and get better leverage from our material costs and our warranty costs, for certain; in most areas, structural costs. So we'll do -- we'll achieve those targets while we're still investing in a long-term opportunity. So you heard us mention that even with the deconsolidation of Argo, for example, we expect to still sustain our level of investment in autonomy, as an example, but also our connectivity opportunities for customers and mobility services as well, and of course, in addition to the cycle plan.

And Joe, we did mention -- we actually gave you a little bit more detail this quarter on some of the run rate benefits of the global redesign. So for example, in South America, they've taken out a significant number of heads. That will obviously carry forward benefits in Europe. They've reduced their facilities by 6 down to 17. They took out over 7,000 heads last year. More heads will be coming out this year. Those benefits obviously are sticky and will accrue into the future.

Great. Maybe as you think a little bit about the back half here, Tim, you implied the hit from the F-150 launch, which got pushed to the fourth quarter, was greater than the benefits from lapping UAW, which was about a $600 million hit. If we look at what IHS has in their forecast, and we understand that they're not always correct, they've got it about -- F-150 about 78,000 units lower, which if you assume a high variable profit assumption on those vehicles, would kind of be closer to that $1 billion view. So help us think about, is that sort of somewhere within that $600 million to $1 billion sort of range you're thinking about? And also, when you talk about the F-150 downtime, is that strictly a volume-related impact? Or does it also consider some of the launch or marketing costs associated with it?

Okay. All of that will be factored in, certainly. But the downtime, as we ramp down changeover 2 plants and then ramp back up, normal successful launches we're accustomed to doing is meaningful for the F-150, our highest volume and most profitable product. So we're intently focused, Gary and his team, Hau and his team, everybody across the company, frankly, ensuring we have very successful launches of the F-150, the Bronco Sport and the Mustang Mach-E this fourth quarter and then getting ready for the launch of the 2-door, 4-door Bronco in the first half 2021. These are great examples of us completely transforming the portfolio and will help us accelerate as we go into 2021. Really, there's a lot of work to do as we -- on the fitness and redesign side of the overall business, of course. So it's a big cost for us for sure. The F-150 changeover and the $600 million, we're saying more than that. So the UAW charges last quarter -- last -- a year ago Q4 were $600 million, and we're going to say that -- we're saying that the F-150 would be more than that. That's factored into the loss expectations for the fourth quarter. At this point, we're not saying anything more.

Okay. You mentioned the Bronco launch and some of the program profitability and how that's important to sort of getting to 10% EBIT margins in North America over time. You've had -- you've been showing a slide really for a while, I think, that shows about a $1.5 billion profit improvement from new products in Michigan Assembly and Hermosillo. I think the Bronco is the last big piece of that. But the other thing that's happened, I think, since you first started showing the slide is maybe industry volume expectations are a little bit different. So if you think that $1.5 billion is still valid, maybe you can give us a little bit of sense as to what type of volume assumptions were you planning for with the Bronco to hit that number. And I guess a final question on that is Jim Hackett sort of talked about having this high-class problem that demand's off the charts, and I think sort of sets you guys up for some higher production already. So how would you think about if that high-class problem does occur, meeting higher volume, would it still be in those facilities or can you produce elsewhere?

Great. So the $1.5 billion is still valid. But like the guidance we provided for the back half of the year, it assumes no meaningful change in the economic environment, continued steady improvement in the global automotive supply base and no further meaningful COVID-related disruptions. So beyond that, I don't know, Gary, if you want to jump in on the -- how we might -- how might we get more production capability?

Yes. It's been an interesting couple of weeks, Joe, since we did the unveiling of Bronco, and Hau's team, there's a lot of credit marching through. Yes, we've already been asked to look at potential upside, which what we can do internally in Michigan Assembly with line speeds, what we may do from a different change in the mix between that and the Ranger. It's early days and we're working through that, also looking at the supply base reported on with those mix rates we're doing. But we've already started that process. The next morning after the unveiling, the first phone call came in, "Gary, will come even more." So we're working through that as we get into the first quarter of 2021 and work our way through the rest of launch and then stabilize the system with more volume on.

And Joe, when we first showed that slide, it was early in 2019 and it was just Michigan Assembly, right? So it was just Bronco and Ranger. And on that slide, we set basically a full run rate in 2021. Obviously, this is pre COVID. That's about 200,000 units. So when we added the Hermosillo and Baby Bronco to that, we actually didn't refresh that number. But to Gary's point, I don't think a minute went by before he was being asked to say what could be done on volume.

And just to be clear, the reason that number wasn't updated even though you added Hermosillo is just out of conservatism? Or did something -- is there an offset to not changing numbers despite adding that facility?

Well, we actually thought that the estimate of the change in EBIT was going to be more relevant at this point in time than necessarily counting units. So it's the change in EBIT between the 2 manufacturing facilities once you got rid of the passenger vehicles and then put the new products in.

Okay. Gary, while we're sort of piping on manufacturing, obviously, this has been a very challenging quarter and I think still continues to be a sort of challenging time. Maybe you could give us a quick status update of where we are sort of globally from a production standpoint at Ford and some of the changes you've had to make under COVID and the impact to productivity and costs. And again, back to Tim's comments earlier, how can or when would do some of those fall away?

Yes, Joe, great question. So we started on the journey for the COVID with China in the first part of the year. And we put together our return-to-work playbook, and we've proven that out in Europe, proven it out in North America. We stabilized the volume when we came back after some plants being down between 6 and 8 weeks later in May. And we can see that it's making an impact with our union discussions, our ability to meet our volume. I think we've talked about we've exceeded the numbers by -- 95% of the schedule has been on track. In the last few weeks, it's in the 98% to 98.4% and working through it. So the really great thing about it is our people are being held safe. If I look at the discussions Hau and I have had with some of the experts in the medical field, our plants are probably safer than most places outside the plants and how we protect our employees from what they're going through from a protocol standpoint. So we're on track. Everything is back up running full-bore. We're watching the supply base and also making sure our safety protocols are on track. But every region across world is back to running full production.

And from a supplier standpoint, have there been any shortages? And do you -- could you plan on like keeping a little bit higher inventory than sort of normal just-in-time to compensate that?

Yes. The hotspot for us is Mexico. So we had some issues out of Mexico. We just had some issues last week, so we're watching that day-to-day. We've stabilized in Europe, stabilized in China. But right now, the high content area for medical and support in the North America plants is critical for us. And we've got some exceptions to run more volume in Mexico. We have increased our inventory, but we're, right about now, about 2 weeks ahead of the schedule from an inventory standpoint minus some critical suppliers who are hanging on. So it's 90.4% volume in [ miles ] is incredible work, and we're going to continue to put that through the rest of third and fourth -- and third quarter.

Great. So maybe we could flip over to Europe since it came up on the call. Your costs have been pretty neutral for the year despite $1 billion in redesign savings. I know that's sort of being offset by some of the compliance costs. Is the net of those 2 really sort of being pretty flat really the best way to sort of think about that? And how does that dynamic play out into '21 when you might have some incremental cost savings from, as Lynn mentioned earlier, some of the -- where you are in the run rate? But I think the other thing that happens in Europe next year is the compliance gets a little bit tougher because you can't omit some of the vehicles that are the worst spenders.

Yes, Joe. So I think, first and foremost, Lynn touched on it, the Ford Europe team have done a fantastic job of restructuring their business since 2018 -- the end of 2018. They've taken out significant capacity. We've exited Russia. We've closed plants, and we've reduced the workforce dramatically. And that's the enabler for the $1 billion of savings. We're using that to not only offset the higher regulatory costs that you mentioned that's a function of the more stringent CO2 requirements as well as the change with the WLTP test procedure. But keep in mind, for all of the investors, that we're also reinvesting these efficiencies to transform our product portfolio and really improve the mix. So we're playing to our strengths. We're investing in more commercial vehicles. At the same time, on the passenger vehicles, you are seeing a shift from the traditional, I'll call it, sedans and hatches to utilities, which have higher material costs but they also -- versus the outgoing product, but they also have significantly better margins. So the other thing I'll mention is we're investing heavily in technology. We're connecting all of our vehicles. We're putting in a new electrical architecture that will give us the ability to really transform the business model and deliver incremental value to our customers with connected services and over-the-air updates. So all of these actions will improve the business and support our long-term EBIT margin objectives for the region.

So you mentioned some of the actions you've taken. I think you're -- you reduced your footprint by about 6 facilities. Tim mentioned earlier that things are even under further review here, sort of evaluating the world post COVID. I know you're sort of limited in what you can say in terms of announcements in Europe until all the proper constituents are notified. But is there scope for further consolidation in Europe because you still have that $5 billion sort of cash number hanging out there in redesign?

Yes, Joe, as I mentioned in the past, I know our redesign approach is a bit different in that we didn't announce a bunch of initiatives and at one time, rather, we're trying to take a more thoughtful approach to say, we think our redesign initiatives would be about $11 billion in charges and about $7 billion in cash over a several-year period. As a result of that, we only share things as we've actually made the decision, therefore, taking a charge and share the kind of cash -- downstream cash ramifications. So based on the work we've done, it's been great work by the European team, the South American team, for example. But in Europe, in particular, we're on track based on the initiatives that have been underway and announced to reduce the workforce by another 2,500 people by the end of the year. And that will take -- it's the 12,000 in total, including Russia, 2,000 in Russia. And we expect the European [ presell ] related expenses to be down by about 20% at the end of 2020 versus end of 2018 and further reduce our structural costs, including that, and improve our market equation in the first half of 2020. So that all adds up to what we said on the call, which is we're on track to deliver by the end of this year roughly $1 billion of structural cost actions since we -- they were announced in the third quarter 2018. But beyond that -- and of course, the facility reductions, as you mentioned, 6 facilities -- down 6 facilities to 17. So beyond that, there's not much more to share at this point. But we're as passionately focused on redesign as ever, and Europe is not exception.

Maybe just a good place to squeeze in a question from an investor which relates to redesign but also South America where you've done a lot of hard work. I think the loss narrowed this past quarter but still a loss, I think, as you pointed out on the call. What else can -- is sort of under consideration for that region and is an exit even on the table?

Yes. So as I mentioned, we share these actions as we make the decisions, so I don't have anything more to share at this moment. But we have done a lot of redesign, restructuring work in South America already. We've phased out unprofitable vehicles, focused production in Pacheco heavy trucks business, discontinued the Fiesta production, ceased operations in São Paulo manufacturing plant. We phased out Six Sigma -- sorry, Sigma engine production and adjusted man capacity in São Paulo facility. So -- oh, and restructured the dealer network to better serve customers there and improve viability for the remaining dealers. So total headcount's been reduced by about 44% over the past 3 years, including about a 20% reduction of the management team in 2019. So a lot of activity already in South America. We're looking at further opportunities, for sure. As I said, we're looking at Europe, South America and around the world for redesign or restructuring opportunities, make sure they're the best design for the opportunities that are ahead of us. But again, nothing, unfortunately, additional to share or announcements at this moment.

Right. Joe, we -- this is in our disclosures. There are tax and incentive structures in South America that are different than we have in other regions. And obviously, as you're considering footprint and timing, you have to take those things into consideration.

Right. Any scope with the size of those tax considerations?

No.

We're getting a bunch of inbound questions, I guess, on balance sheet, capital priority, dividend forecast. So let me try to sort of consolidate here because I think they're all related. But I guess, one, what is the -- what's sort of the official dividend policy here now or course you're restating? What type of cash levels and free cash flow outlook are sort of needed? And I guess as it relates to -- and what is, I guess, the general sort of capital priority now for Ford? Is it really getting the balance sheet improved and potentially trying to get back to investor grade?

Yes. So first of all, let me start with our balance sheet is strong, $39 billion in cash, $40 billion in liquidity. We repaid roughly half of our $15 billion -- $15.4 billion of revolvers we drew down in March. So the balance sheet is strong. And what we'll continue to do is focus on generating more cash and more free cash flow and then evaluate opportunities to pay down debt, as an example, pay down remaining revolver as an example, and make investment decisions as well that are appropriate for the long-term success of the business. As it relates to the dividend, and -- we'll reinstate the dividend when it's appropriate to do so, of course, with the Board approval, and similarly for the anti-dilutive share repurchases.

Okay. Well, maybe let's turn the conversation to product a little bit. So to start, I guess no one really knows if it's especially true, proves everyone sort of gets the volume assumptions wrong. But it does look like we're looking at a global buy outlook over the coming years that's lower than maybe what we thought pre-COVID. How does that make you reassess your capital priorities, CapEx spend or sort of timing of any product launches?

I mean prioritizing the allocation of capital toward the product portfolio is one of the most important things we do on behalf of customers to make sure we're building differentiated products and services. And the team -- the whole -- everyone on this call works together to do that. I want to make sure we're generating -- investing in high return on capital investments and the right differentiated products for customers. So that's not new. We certainly have a heightened focus on it, making sure that we're -- from a strategy standpoint, the right fresh product set for our customers. And like the F-150, the Mach-E and the Bronco are great examples of that.

Joe, specific to the vehicle portfolio itself, certainly, we're scrutinizing where we allocate capital. We want to make sure that each of our vehicle lines where we choose to compete are going to be -- have a compelling, I'll call it, where to play and how to win. We are stress testing the assumptions using our data analytics capabilities to look at a realistic market equation call. And we're also looking at our historical performance in that segment or region as well as any political and economic risk as a result of -- post COVID. So that's kind of the normal approach that we're using. You'll see us continue to leverage partnerships to help us become more efficient with our capital spending as well as engineering expense. So a great example is what we're doing with VW around commercial vehicles and pickup trucks as well as battery electric vehicles in Europe. In terms of mobility, we are looking at, again, trying to stretch our dollars there and partnering. So VW's investment in Argo AI is a great example of this to help us both co-fund that effort. And we know, based on everything we're seeing, that's probably going to be more capital-intensive than we all anticipated initially. And then the last thing I'll mention is the teams are really stepping back and looking at the future and considering all of these disruptive forces and really stress testing what's going to differentiate Ford and Lincoln going forward and only in those areas where we choose to do that ourselves. And traditional attributers that are really basic expectations now and no longer brand differentiating, we will outsource to the supply base and leverage their expertise and their resources. So that's essentially the approach we're taking around capital allocation for our product programs.

Great. Maybe just to follow on, like in conversations we've had in prior years, you've sort of -- you really sort of talked about this idea to reduce some of the complexity on the models and the platforms and some of the savings associated with that. Now is maybe not sort of the best time to sort of bring it up given sort of the low volume quarter, but can you update us on sort of some of those initiatives or maybe what's been done and how much more can be done?

Yes. Well, we made tremendous progress. So just to sort of go back in time a little bit, when Mulally joined Ford, I think we had over 30 platforms all around the world. And under his leadership with ONE Ford, we reduced it by a factor of 3 from 30 down to 10. Today, we're working towards 5 flexible architectures, so another 50% reduction, and that's a huge enabler for us to capitalize on engineering efficiency and increased commonality and scale. At the same time, we're looking beyond just the underpinning or the platform, and we're looking at the top hat parts, if we will, and trying to leverage that for more commonality as part of our modular catalogs that we're doing. And that is helping us not only reduce the engineering expenditure but also speed up time to market. The products that you see hitting the market this calendar year really are a reflection of that. So Bronco, Bronco Sport, Mach-E are all coming off these 5 common architectures. So it's allowing us to be faster to market, be more engineering efficient and then drive efficiencies for material costs, not only with us but with our suppliers as well. So it's great. In terms of monetizing it, we previously -- a couple of years ago, we had dimensioned the fitness-related savings, and they were very significant in, I think, my recollection that 80% of it was really enabled through material costs, engineering and capital efficiencies, which are all really enabled by this flexible architecture and modular catalog approach.

Okay. It seems like -- you mentioned the Mach-E and the Bronco. And it seems, taking a step back at Ford's undergoing a little bit of a brand strategy shift here, right, you're leveraging the Mustang brand, leveraging the Bronco brand equities, almost start trying to have a family of Bronco underneath, it seems, like with the products you've announced and potentially future Bronco product, is that accurate and I guess purposely done? And I guess the F Series is sort of -- already is sort of own brand, but are there other -- is there other sort of brand equity you see at Ford that you'll be able to leverage, potentially Lincoln? What's the plan with that brand?

Yes. I think it's -- as you noted, it's really an intentional choice by us. We have really strong iconic brands that probably we were guilty being somewhat too purist with, in the case of Mustang, as an example. And I think we've seen from other folks up the street that they've done a really good job of leveraging their strong brands across multiple nameplates, and the reception we've gotten on both Mach-E and the Bronco family of vehicles has been phenomenal. I think it really reinforces the equity that we have there. So F-Series is another great example. Transit is a great example. We have multiple vehicles with -- under the Transit brand umbrella. And then even within -- across products, you can -- series, Raptor is a fantastic example. A great success with F-150. We've extended it to Ranger. It's been a big hit there, so certainly, there's more that we can do there. So yes, it's something that we will continue to embrace, and we think it's a huge opportunity for us to play to our strengths. With respect to Lincoln, yes, they're coming off a fantastic year that new products, Aviator, Corsair has been really well received. And even during the COVID time, we're seeing increases in market share, just really rejuvenate the Lincoln brand, and we're very excited about how we can continue to leverage that and compete in a very lucrative, high-margin premium segment.

Yes. I was going to say, I know a couple of people who are waiting for you to take their money for that Bronco Raptor. So...

Yes, I know, 170,000 people, as a matter of fact, yes.

You mentioned Transit, and I think Ford has actually, in the past, shown some pretty interesting stuff with sort of the commercial van opportunity. I remember being down in Miami for the Argo AI day, sort of showed really sort of the convergence of everything that I think Ford is trying to do sort of -- but centered around that commercial van opportunity. It seems to be a little bit underappreciated, maybe the opportunity by the investor community. I think internally, you seem very excited about it. So maybe you can sort of spend sort of a quick second on it because like I said, it does seem like it's really the convergence of everything you're sort of talking about: connectivity, electrification and -- but potentially elements of autonomy as well.

Yes. You're spot on, Joe. So it's a huge business for us. We're dominant globally with Transit in the commercial van business but also with F Series and the commercial truck business in North America. And as you stated, we think that the transformation that's going to be enabled by the combination of electrification, increasing levels of autonomy as well as connectivity and, call it, more broadly, connected services is going to happen first with commercial vehicles because those customers will benefit -- will be the first to benefit from those efficiencies and productivity improvements. So we're very excited. We did a hybrid Transit in the U.K., and we learned a lot from that engagement. We spend a lot of time with our commercial fleet customers where Ford is by far the most dominant player in terms of market share. They really understand their business and then how we can really make them more productive with the incremental capabilities enabled by connected vehicles as well as electrification. And we're super excited. So we want to build on that dominance. Transit is the #1 full-size Boston van segment leader with 37% market share. In North America, if you add in the E-series van, our market share goes up to 47%. So it just shows you how dominant we are. So it's not a surprise that among the first battery electric vehicles we're going to introduce will be an F-150 and the Transit. They also will have our new electrical architecture, which allows us to do -- not only connect and provide access to the data for the customers but also do over-the-air updates. So we can do things like flashing incremental features and attributes, do prognostics to keep them on the road and increase their uptime. So we're super, super excited in that space.

So maybe just to follow up there. And I guess we won't hold you to it, but by what year, maybe first in Europe and then in the U.S., do you think cities will only allow zero-emission vehicles inside the cities?

Well, we're starting to see that now, right? And even I mentioned the hybrid vehicle, hybrid Transit in the U.K., but as many in your audience knows, inside the Ring Road in London, there's a congestion charge. And so when we launched that product, we looked at between the fuel economy savings, the savings on the surcharge, the congestion surcharge daily plus the incentives that the government was giving for zero-emissions vehicle. The payback of buying one of those products was less than 2 years. And that's before any incremental productivity from connected services and those types of things. So we're seeing it in places like Norway, a lot of cities in the Netherlands. Other places in Europe are already announcing very draconian restrictions into city centers. And we believe that, that trend will extend into the green states in the U.S. and then certainly in places like China as well.

Since we're on the topic of electrification, I think I'll leave it open to you or Tim. But one of the things you mentioned on the earnings call is that you're sort of halfway through your, I think, $11.5 billion electrification effort, which is targeted through 2020. So that implies about $3 billion over the next few years. I'm not sure that's exactly the split, but if you just sort of straight-line it, that's about the number. But is that really just the beginning? Because you've talked about some of your electrified product. Maybe you haven't sort of shown us all of it, but it seems like you're still in the earlier innings of electrifying the portfolio. So how do we think about what that spend needs to be to -- as you sort of move through the rest of the portfolio? Is it about $2 billion, $3 billion a year? Or do you start to gain some efficiencies on that spend as well?

Yes. I think when we announced that, I think the time horizon was through 2022, so -- which seems like it's only a couple of years away, right? So we are about halfway on that journey of that original $11.5 billion we've announced, products like Mach-E, F-150, Transit that we've talked about. We also included as part of that our -- all of our hybrids as well -- full hybrids as well as plug-in hybrids, which we believe are going to play a key role during this transition phase to help people migrate towards eventually full-battery electric vehicle. And then beyond that, certainly, we will do more products that we're not ready to announce yet. But we don't want to get ahead of our skis or over our skis. We have a lot of work to do to launch these products well. And we think the market -- we're targeting the segments where we know we're going to be strong, commercial vehicles, pick-up trucks, performance vehicles with the Mustang Mach-E, and we'll see where the market proceeds in terms of acceptance and demand.

And we also have territory in China, right?

Yes. Territory in China is also in the marketplace there, yes.

And then is the -- any update on the Mach-E orders?

Yes. It's been going really well. Obviously, we took a different approach with the Mach-E. We had a higher reservation amount. But so far, it's been -- the -- the first edition models have been sold out. They were, in fact, sold out the first week of availability here as well as in Europe. I think at the end of June, we were -- we asked customers to basically convert their reservations into orders, and we've seen a really good conversion rate. We think we have sufficient reservations to basically fill our '20 calendar year production. We were conservative with our estimates in terms of capacitizing the supply base, especially with batteries. So very confident that first year will be fully subscribed, and then we'll see where we go from there.

On the topic of batteries, which sort of have been a little bit more focus of late, other than the capital efficiency, which I think Jim Hackett alluded to on the call, is there a strategic reason for not having tighter control over the cells and sort of just being a taker there?

Yes. There are. I mean -- so capital -- the capital intensity is clearly key components, and everybody knows, Tesla, I think, has gone on record to say they've spent about $5 billion on their Gigafactory. We know the GM LG spending is about $2.5 billion for the new facility that's going into Lordstown. For me, as both running product development as well as purchasing, it's something we think very deeply about. This is an intentional choice on our part. If you study the supply base and you look at what it takes to have an optimum loading in a battery plant that's very capital-intensive, you need somewhere between 100,000 to 150,000 vehicle volume to load up that factory efficiently. A lot of that depends on what sort of kilowatt hours and range you're targeting. But on average, 200 to 300 miles of range, that's about the volume you need. We don't have that volume initially to justify that capital expenditure. The substandard scale in the initial phase is further exacerbated by the fact that you're supplying these products globally, and in many markets, there are local content requirements. In China, the licensing agreements, you have to basically partner with a Chinese battery supplier. In the U.S. now with USMCA, it has to be localized in North America. So there's not -- there's insufficient scale for any one OEM other than somebody who's a full-line battery electric manufacturer like Tesla to justify that spending. Working with our suppliers, we can leverage cross-OEM scale to allow them to operate very efficiently. It gives us the ability to access the latest technology and innovation across multiple suppliers. So I know exactly what the state-of-the-art is from the Korean suppliers, the Japanese suppliers, the Chinese suppliers. And I'm able to compare notes across them maybe better than they can. So we don't believe we're disadvantaged in terms of access to technology, battery chemistry, energy or power density based on all of the competitive intelligence we have. And then, of course, we have the competitive tension with dealing with multiple suppliers, which allows us to drive the costs down. And in fact, I know from what I've read and what's been announced that we have the same pricing forecast in terms of material cost improvements as GM and Tesla would measure dollars per kilowatt hour. The last one, and this is a really important part, is the battery chemistry will change over time. We know there's a lot of money being invested in solid state. So the question you have to ask yourself is if you have access to all of the batteries you need and you're not disadvantaged by technology, function nor cost, why would you think in billions of dollars when you know that battery landscape is going to change in terms of chemistry? We've seen -- I'll use Toyota as an example. They've invested to vertically integrated nickel metal hydride batteries for their hybrids. And after spending over $1 billion to do that, the technology shifted to lithium-ion, and they were among the last to switch over. I don't want to put Ford in that position. So yes, the capital intensity is a big consideration, but there are many other very legitimate strategic regions. Now as our portfolio battery electric vehicles increase and we have more volume and scale, would we revisit? Absolutely. But right now, we think this is the right choice for us.

Are your vehicles -- your electric -- your BEV vehicles being built flexible enough such that if chemistry does change mid-product cycle, it will be able to accept new or different batteries?

Yes. I mean to an extent. So if it goes to solid state, maybe not. But certainly, we work with all of our suppliers to project changes in battery chemistry. We try to understand what that means to the physical shape of the battery arrays and then other interactions like with the power electronics and cooling. And that's in our business plan assumptions in terms of how much more energy and power density we would expect to get over the cycle of the vehicle life as well as cost improvements.

Yes. Tim, maybe going back to the balance sheet here. So you have your $20 billion cash, $30 billion liquidity target. A question coming in is what's -- the balance sheet, like you mentioned, still has a lot of cash. And I think after you repaid the revolver, I think the -- even the net debt is sort of -- it looks like it's back down to -- or closer to sort of prior levels. But what is really the plan for the balance sheet going forward? Because seems like investors are concerned that there can be some calls on the free cash you might be able to sort of generate here going forward given -- including redesign and maybe some other items as well.

Yes. I mean I just want to emphasize again because I think it's something we've been proactively doing is managing the balance sheet well so that we feel comfortable with our cash position and confident enough to repay half the revolver after [ being ] products and pulling it down in March. So $39 billion to $40 billion of liquidity, as you said, roughly 0 net debt. We're going to continue primarily focusing on the strategy to the vehicle portfolio's fitness global redesign to bolster free cash flow. That's primarily what we're going to be focused on thereafter from a balance sheet standpoint. As we came up earlier, we'll definitely look at opportunities to continue to pay down debt, certainly pay it obviously when due. The line of credit, pay those down to 0. We'll consider that over time. We'll also look at other opportunities to ensure we feel very confident in our cash and liquidity position. As you said, we have, over time, about $5.6 billion, if you go to the $7 billion in total, of future cash for redesign, for example. That will be over the next several years. So it's not necessarily a 2021 focus but over the next several years. We have investments we want to make in autonomy and connectivity and commercial and the product portfolio in general. And we're going to be focusing on generating free cash flow to not only have a strong balance sheet, put us in a position over time to reinstate the dividend, but be feeling very confident each step of the way in the balance sheet that we have. The guidance -- only guidance we've given short term is for free cash flow to be higher than EBIT in the third quarter given the working capital dynamics, reaching near full production at the end -- second quarter, but we're not all the way. And then similarly, in the fourth quarter, because of the launches which are launched primarily, the F-150, working capital will play out such that free cash would be less than EBIT. So as I said, negative free cash essentially since EBIT was guided to be a loss.

Meaning free cash burn greater than the EBIT costs.

Correct.

Okay. Yes, that's what -- I'm glad we got through sort of capital in that because that was another question. Maybe one clarification. I think on the call or on the slide, you sort of mentioned deconsolidating Argo. But I think you said the spend won't change. What do you mean by that, that the dollar amount that you will incur is basically the same even though you're only taking half the loss? And I guess implicit is that the spending at Argo increases, which makes sense on that because I guess the workings would be [ valued ] as well, but is that what...

Yes, essentially that's right. And so in the second quarter, recall, we had already deconsolidated Argo as of June 1. So 1/3 of the quarter was already reflecting the, say, roughly 40% ownership stake in Argo. And thereafter, that will be the case for all of Q3. And we're saying from an absolute dollar investment level standpoint, despite the deconsolidation, it will be a similar level. So similar absolute dollar level of investment in autonomy. That's because it's not just Argo, it's not just the self-driving solution. It's software. It's the full go-to-market activities and so forth we talked about on the earnings call.

Yes. And Joe, we believe we have the largest urban testing footprint right now in autonomous vehicles, right? So we have the engineering, all the additional product design that's going into it, all the additional technologies aside from the self-driving system. And that all sits in the Mobility LLC, which is fully consolidated.

Right. So is it possible to sort of break out how much of the spend Argo was versus the entire autonomous effort?

So if you go back and look at the Mobility line, over the last 2 years, AV LLC was roughly half of that, and Argo was less than half of that number, was less than half of the AV LLC number.

Okay. Maybe some questions on Ford Credit. I think in the beginning of the year, you talked about auction values down about 5%. Then in the first quarter, there was an indication that it could be worse than that. Auction values is about -- are held in. I think you're still saying down about 5%. It might even be actually a little bit better than that. But can you talk us through because -- I guess, one, did that further write-down never really happened in the second quarter? And then two, can you just walk us through the profitability trends and targets and loss provisions as we think about the remainder of 2020?

Sure. So let me start out with just saying that Ford Credit, I think, demonstrated itself throughout this crisis and certainly over the course of time what a differentiated value it is for customers and for our business. And to your questions on the business profitability, for example, it was profitable in the second quarter. We are saying that it will have a lower profitability than in third quarter of '19 -- fourth quarter of '19, but nonetheless -- as was the case in second quarter, but nonetheless profitability. I think that reflects that the team has been managing through the current circumstances. And our auction values came back well. It was down 2% year-over-year. As you said, for the back half -- for the full year, sorry, we're still expecting about a 5% decline in auction values just based on third-party estimates, informed by third-party estimates. But the prudent actions we took in the first quarter helped that we had adequate reserves, for example, as we navigate through the second quarter and all the macro uncertainty that we have, and the portfolio was strong.

Okay. A couple of investor questions coming in. So -- and I think we sort of touched on some of this, but maybe you could address more directly. How are Ford's powertrain mix shifts, meaning hybrids, plug-in [ metal ] electric vehicles and battery electric vehicles going forward? And what is the cost inflation with doing this initiative?

Yes. I mean that's a hard one to guess. I think everyone has seen a lot of external projections around the inflection point. And I think most of the times, those forecasts are basically talking about the number of new product offerings. So it's a supply-side look rather than a demand-side look. So if I can predict demand, I'd probably have a different job. But I think, certainly, we are reducing our capital expenditure on internal combustion engines. We are driving for more commonality and reducing the complexity. And then we're shifting our focus, as we talked about earlier, to doing more battery electric vehicles and electrified vehicles. So that's certainly our intention. We talked about the $11.5 billion, and we will increase that as we go beyond 2022. The actual demand, I think, is going to be a function of a government policy, both on the demand as well as supply side in terms of what incentives and things like tax rebates, those types of things or even access to HOV lanes. It's going to be a function of customer education and acceptance and awareness. I think range right now is something that people are still struggling with. They're overbuying more than they actually need because it's just a comfort level to help with the anxiety of switching over. But I think we'll settle on a more optimum position there, and that will help the costs. And then certainly, the costs will continue to improve as we build up scale and technology advances. So all of those things will play a key part of it. We are certainly going to help drive and accelerate that transition over time. That's our strategy.

So Elon Musk recently said that the goalpost on [ battery electric vehicles ] are moving, and he thinks 300 is sort of the right level. What's sort of Ford's -- 300 miles a range. What is sort of Ford's view on the optimal mile range for consumers to be comfortable with battery electric vehicles, maybe not so at this point?

Yes. I would tend to agree with him, Joe. I think 300 is quickly becoming kind of the target, the bogey that everyone's targeting. The one thing I would say is we have -- I mentioned we have a lot of -- our vehicles are connected, among the first for all of our hybrid vehicles. And we know from just monitoring driver behavior that on average, our customers drive about 17 miles a day round trip. So they don't -- if we deliver 100 miles a range, we could probably satisfy the 90th percentile customer, but it's -- people are preparing for that worst-case scenario. I'm going to drive to visit my grandmother in Chicago for Thanksgiving. So saying that the customers have to understand, and they will with time, is unlike an internal combustion vehicle with a large fuel tank. As you drive and burn off that field, the vehicle becomes lighter and more efficient. If I give you a big battery, you're carrying that cost, that space that it's occupying plus that mass, that weight around with you all the time. And if you're only driving 17 miles a day, you're preparing for a worst-case scenario. It would be like Apple making this phone last week. They could technically do it. We just wouldn't want to carry it around. They've landed on a form factor that will get us through the day, and you can charge it up overnight and you're good to go the next day. I think the same thing will happen. And I suspect the answer will probably be around that 300-mile range.

We didn't really touch on China very much, but I'd be remiss if I didn't sort of mention there seems to be some good progress there. Pre-COVID, I think there were some comments about a 50% improvement in the loss this year, further in 2021. The environment's changed, but are those still valid targets? And really, what are the biggest drivers towards the improvement in China? I know a lot of the low-hanging fruit in this organizational stuff, I think, was done. So is it really more mix and volume from here?

Yes. I think given the current environment, we're not going to be updating any forecast on China. But as you said, the China team has made great progress. It's a result of a number of different actions the team's been taking throughout this year and leading up to this year: the volume mix, localization, Corsair and the Aviator and a cost discipline focus. China was the only region to have a gain in wholesales this last quarter, up double digits, and benefited from the launch of Escape and Corsair, strong commercial vehicle sales. And then Corsair's the first locally produced product. And Aviator is launching now, as I said, but that contributed to a 12% increase in sales in the quarter, so it's great progress. But that's a highly attractive brand for customers. And then China had a second consecutive quarter of share gain, up to -- 20 basis points to 2.5%, and that's the highest market share test since the third quarter of 2018. The team's clearly has some early signs of momentum but certainly making great operational execution progress. And this commercial vehicle strength was based on 34% recent sales at JMC, our JV partner, and another 40 basis point share gain. So as is other regions, China is going to continue to focus on cost discipline and has done a really great job navigating its [indiscernible] bit and delivering for customers and employees safe manner throughout COVID. The cash flow, by the way, it's important to note that with the localization, you get some function change in working capital improvement and, of course, CapEx efficiency. So again, we're not providing any specific color on forward-looking commentary on the profitability profile or cash flow profile for China, but the team is making really strong progress.

Okay. Gary, I know now you're in charge of labor affairs as well. The -- there's been reports of some higher levels of absenteeism in the plants. I was wondering, a, what are you seeing from a Ford perspective, whether that sort of caused any constraints or impacted the cost of production? And b, just maybe in general, if you could sort of comment on sort of dealing with the labor union during such time of distress.

Yes, Joe, great question. I'll say, any other OEMs and even our supply base have been struggling with the absenteeism, which came back up in May here in the U.S. Part of that is also heat-related. You got the CARES Act. We've had record tenders in the month of July. Our union partners have been fantastic with the UAW and bringing more temporary employees in to help us cover absenteeism. But I'd like to explain to a lot of people who aren't used to work in a plant, it's like working 10 hours a day in a treadmill going 300 miles an hour with a mask on in 95-degree weather, you got 90 minutes of breaks. So what they're doing to provide product for our customers is incredible. Like I said, we're about 98.4% of volume the last 3 or 4 weeks came out the great gate in May pretty good. And the union relationship is really good. Rory Gamble heads the UAW International Union. We talk every couple of days. We're working on what we can do to improve it, how do we support our employees and protect our employees for being safe. And we had task force meeting with GM and Credit for every 2 weeks now. We are doing it every day during the period that makes more helping each other from a consistency standpoint and protecting the UAW employees. So we're on the right track. As temperature is still down a bit, it helped. But we have enough temporary employees now to help us get through that peak. So we see it stabilize and going for the rest of the summer going to the fall.

Right. Well, the -- a couple of weeks ago, there was an announcement that Ford had with Intel and I thought had a couple of interesting elements. One, you mentioned this is the first time Ford's committed to, I guess, active safety technology from them for the entire life cycle of your next-generation vehicles. So be curious to know what sort of changed internally that caused you to go that route. And the second is that the Mobileye, well, it sounds like it's going to be displayed on the center screen, kind of like an Intel Inside branding, if you will. So can you just walk us through that decision process to give a supplier, a Tier 2 one at that, such recognition? And does this -- does you dealing directly with a Tier 2 here, should we read anything into that in terms of how you are dealing with different suppliers, specifically you dealt with Tier 1s?

Joe, I'm sorry, you cut out in the first part of your question for me. Can you just repeat? I heard the second part.

Yes, sorry. So related to the Ford-Intel announcement. And so the first question was that it said you committed to the technically entire life cycle of the vehicle, which I think was the first time you've done that. So the first part of the question was what changed that caused you to do that to commit to that technology for the entire platform life?

Yes. So I'd say that the engineering spending to develop a driver system is quite high. So when we do it, our intention is to -- is not to change it for the life of the vehicle. We just wouldn't be able to make the business case to switch. The phenomenon of us, I'll call it, disintermediating the supply base and working directly with select Tier 2 is something we've been doing, especially as we shift towards new technology where -- whether it's a computer vision system in the case of Mobileye or CPUs in the case of a SYNC infotainment system or compute platform, is we're finding that oftentimes, the Tier 2 suppliers are the ones that really are driving this state-of-the-art in terms of technology. By working directly with them, we can understand the competitive landscape and what the state-of-the-art is and how future-proof it is. The Tier 1 suppliers are basically playing the role of the integrator. So by us working directly with select Tier 2s, we can oftentimes not only understand the technology landscape better but get -- achieve better cost and value in them. We basically direct that Tier 2 to the Tier 1, if you will, who plays the role of the integrator. Mobileye is the recognized leader for computer vision systems. This -- the co-branding strategy is probably not dissimilar to what we've done in the past in terms of partnering with Sony or B&O, Harman Kardon for audio system or even Microsoft, the first-generation SYNC. It gives us an opportunity to create value for both companies as well as form a long-term strategic partnership.

Great. Well, with that, everyone, I think we're at the half hour or so. Tim, Gary, Hau and Lynn, want to thank you very much for joining us today. I really appreciate your time and insightful answers. I think with that, we're -- operator, we're ready to close the call. But thanks again to the Ford team.

Thank you very much.

Thanks, Joe. We really appreciate it.