| | Management's Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW Our worldwide net income was $22,071 million in 1998, or $17.76 per diluted share of Common and Class B Stock. This compares with the $6,920 million, or $5.62 per diluted share, we earned in 1997. Our 1998 net income includes earnings of $177 million from The Associates through March 12, 1998 and a one-time, non-cash gain of $15,955 million that resulted from our spin-off of The Associates. Excluding these amounts related to The Associates, our net income would have been $5,939 million, or $4.72 per diluted share of Common and Class B Stock, compared with 1997 net income (excluding The Associates earnings) of $6,088 million, or $4.94 per diluted share. Our 1998 net income also includes the following other one-time charges totaling $631 million, which we incurred in the fourth quarter: - $472 million for employee early retirement and separation programs,
- $86 million for writing off our net exposure in Kia Motors Company, and
- $73 million relating to the transfer of our Batavia, Ohio transmission plant to a new joint venture company formed by us and ZF Friedrichshafen AG to manufacture continuously variable transmissions.
In addition, our earnings per share in 1998 were reduced by $0.07 for the premium paid to repurchase our Series B preferred stock. For more details regarding one-time charges see Note 15 of our Notes to Financial Statements. Our worldwide revenues were $144.4 billion in 1998, down $9.2 billion from 1997. We sold 6,823,000 cars and trucks in 1998, down 124,000 units from 1997. Our stockholders' equity was $23.4 billion at December 31, 1998, down $7.3 billion compared with December 31, 1997. This reduction primarily was a result of The Associates spin-off. FOURTH QUARTER 1998 RESULTS OF OPERATIONS In the fourth quarter of 1998, we earned $1,043 million, or $0.84 per diluted share of Common and Class B Stock, compared with $1,796 million, or $1.45 per diluted share, in the fourth quarter of 1997. The one-time charges discussed above and the absence of earnings from The Associates in the fourth quarter of 1998 more than account for the earnings decline. Excluding one-time charges, our fourth quarter 1998 earnings would have been $1,674 million, or $1.35 per diluted share, compared with earnings (excluding The Associates) of $1,572 million, or $1.27 per diluted share, in 1997. Details of our Automotive sector earnings for the fourth quarter of 1998 and 1997 are shown in Table A. Table A: Fourth Quarter Automotive Sector Earnings (in millions) | | Fourth Quarter Net Income/(Loss) | | | | 1998 O/U | | 1998 | 1997 | 1997 | North American Automotive | $1,047 | $1,353 | $(306) | Automotive Outside North America | | | | - Europe | (74) | 158 | (232) | - South America | (151) | (71) | (80) | - Rest of World | (2) | (99) | 97 | Total Automotive Outside North America | (227) | (12) | (215) | Total Automotive Sector | $820 | $1,341 | $(521) | The company's net income excluding The Associates was down 2% versus 1997. Excluding one-time items, net income was $6,570 million (not shown), up 10% over 1997 and a new record. | . | Worldwide vehicle unit sales were down 2% from 1997's record, but topped 6 million units for the sixth consecutive year. | The decline in our fourth quarter 1998 Automotive sector earnings in North America is more than explained by one-time charges of $363 million. Without the one-time charges, our results in North America would have improved over our fourth quarter 1997 earnings by $57 million, reflecting primarily higher sales volume, offset partially by higher marketing costs. The decline in our fourth quarter Automotive sector earnings in Europe reflects one-time charges of $137 million, lower volume and cost associated with the Focus car line launch, offset partially by cost reductions. The earnings decline in South America was caused by one-time charges and the deteriorating economy in Brazil. Details of our Financial Services sector earnings for the fourth quarter of 1998 and 1997 are shown in Table B. Table B: Fourth Quarter Financial Services Sector Earnings (in millions) | | Fourth Quarter Net Income/(Loss) | | | | 1998 O/U | | 1998 | 1997 | 1997 | Ford Credit | $234 | $218 | $16 | Hertz | 48 | 35 | 13 | Minority Interests, Eliminations, | | | | and Other (excluding | | | | The Associates | (59) | (22) | (37) | Financial Services (excluding | | | | The Associates | 223 | 231 | (8) | The Associates | - | 278 | (278) | The Associates Minority Interest | - | (54) | 54 | Total Financial Services Sector | $223 | $455 | $(232) | Memo: Ford's share of earnings in | | | | The Associates | $- | $224 | $(224) | Hertz | 39 | 28 | 11 | Our Financial Services sector had lower fourth quarter 1998 earnings primarily because, unlike in the fourth quarter of 1997, they did not include earnings from The Associates. FULL-YEAR 1998 RESULTS OF OPERATIONS Details of our full-year Automotive sector earnings for 1998, 1997 and 1996 are shown in Table C. Details of our full-year Financial Services sector earnings for 1998, 1997 and 1996 are shown in Table D Table C: Full-Year Automotive Sector Earnings (in millions) | | Full-Year Net Income/(Loss) | | 1998 | 1997 | 1996 | North American Automotive | $4,612 | $4,434 | $2,255 | Automotive Outside North America | | | | - Europe | 193 | 273 | (291) | - South America | (226) | 40 | (642) | - Rest of World | 173 | (33) | 333 | Total Automotive Outside North America | 140 | 280 | (600) | Total Automotive Sector | $4,752 | $4,714 | $1,655 | In 1998, Ford achieved an additional $2.2 billion in total cost reductions in its worldwide automotive sector, making an unprecedented total reduction of $5.2 billion in last two years. | Table D: Full-Year Financial Services Earnings (in millions) | | Full-Year Net Income/(Loss) | | 1998 | 1997 | 1996 | Ford Credit | $1,084 | $1,031 | $1,441 | Hertz | 277 | 202 | 159 | USL Capital | - | - | 191 | One-time Actions | | | | - Gain on Sale of Common Stock | | | | of The Associates and Hertz | - | 269 | 650 | - Sale of USL Capital Assets | - | - | 95 | - Budget Rent-A-Car Write-down | - | - | (233) | Minority Interests, Eliminations, | | | | and Other | (174) | (128) | (257) | Financial Services (excluding | | | | The Associates) | 1,187 | 1,374 | 2,046 | The Associates | 220* | 1,032 | 857 | The Associates Minority Interest | (43) | (200) | (112) | Gain on the Spin-off of | | | | The Associates | 15,955 | - | - | Total Financial Services Sector | $17,319 | $2,206 | $2,791 | Memo: Ford's share of earnings in | | | | The Associates | $177* | $832 | $745 | Hertz | 224 | 168 | 159 | *Through March 12, 1998 | | | | Excluding The Associates, in 1998, 80% of worldwide net income was earned by the Automotive sector and 20% by the Financial Services sector versus 77% and 23% respectively in 1997. | 1998 COMPARED WITH 1997 Automotive Sector Worldwide earnings for our Automotive sector were $4,752 million in 1998 on sales of $119.1 billion, compared with $4,714 million in 1997 on sales of $122.9 billion. Excluding one-time charges, our Automotive sector earnings were $5,377 million in 1998 compared with$4,883 million in 1997. The 1997 one-time charge was for restructuring actions in the second quarter. The increase in operating earnings reflects primarily continued cost reductions and improved vehicle mix, offset partially by lower volume and higher marketing costs. Adjusted for constant volume and mix, our total costs in the Automotive sector declined $2.2 billion compared with 1997. Our Automotive sector earnings in North America were $4,612 million in 1998 on sales of $87 billion, compared with $4,434 million in 1997 on sales of $89 billion. Excluding one-time charges, earnings were $4,975 million, up $416 million compared with a year ago. The increase reflects primarily continued cost reductions and improved vehicle mix, offset partially by lower volumes and higher marketing costs. The after-tax return on sales for our North American Automotive sector was 5.3% in 1998. Excluding one-time charges, after-tax return on sales was 5.8%, up 6/10 of a percentage point from 1997. In 1998, 16 million new cars and trucks were sold in the United States, up from 15.5 million units in 1997. Our share of those unit sales was 24.6% in 1998, down 4/10 of a percentage point, more than explained by the discontinuation of low margin vehicle lines. Our Automotive sector earnings in Europe were $193 million in 1998, $80 million worse than a year ago. The deterioration reflected higher restructuring costs, lower export sales and costs associated with the Focus car line launch offset partially by cost reductions. Ford ranks second in the U.S. market with a combined car and truck market share of 24.6%, down slightly from 1997 as a result of the discontinuation of low-margin vehicle lines. | Ford ranks sixth in the highly competitive European market with a combined car and truck market share of 10.3%, down 1.1 points from 1997 primarily because of intense competitive conditions and limited availability of the new Focus car line during its launch. | In 1998, 16.1 million new cars and trucks were sold in Europe, up from 15 million units in 1997. Our share of those unit sales was 10.3% in 1998, down 1.1 percentage points from a year ago. In the fourth quarter of 1998, our market share in Europe was 9.4%, down 1.7 percentage points. Our market share declined because of intense competitive conditions in Europe and limited availability of our new Focus car line during its launch. Our Automotive sector in South America lost $226 million in 1998, compared with a profit of $40 million in 1997. The decline was the result of lower volume and revenue resulting from weak economic conditions and charges we incurred for employee reductions, offset partially by lower costs. We reduced production in Brazil and Argentina in the fourth quarter because of anticipated weaker demand in those markets in 1999. In 1998, 1.6 million new cars and trucks were sold in Brazil, compared with 1.9 million in 1997. Our share of those unit sales was 13.1% in 1998, down 1.2 percentage points from a year ago. In the fourth quarter of 1998, our market share in Brazil declined to 11.8%, down 5 percentage points. These declines in market share reflect new product entries from other manufacturers and an increasingly competitive market. Our Visteon operations, included in our Automotive sector, earned $712 million on revenues of $17,762 million in 1998, compared with $518 million on revenues of $17,220 million in 1997. This earnings improvement reflects primarily cost reductions and increased revenue. Visteon's after-tax return on sales in 1998 was 4.0%, up one percentage point compared with the prior year. Financial Services Sector Earnings of our Financial Services sector consist primarily of two segments, Ford Credit and Hertz. In 1998, we spun-off The Associates to our shareholders, resulting in a $15,955 million gain to Ford. For details of the spin-off see Note 15 of our Notes to Financial Statements. Ford Credit's consolidated net income in 1998 was $1,084 million, up $53 million or 5% from 1997. Compared with 1997, the increase in full-year earnings primarily reflects improved credit loss performance, higher gains on receivable sales, lower effective tax rates and higher financing volumes, offset partially by lower net financing margins and higher operating costs. Lower financing margins reflect higher depreciation expense for leased vehicles as a result of lower-than-anticipated residual values. Earnings at Hertz in 1998 were $277 million (of which $224 million was Ford's share). In 1997, Hertz had earnings of $202 million (of which $168 million was Ford's share). The increase in earnings reflects primarily higher revenues and improved profit margins in worldwide car rental operations. Review of 1998 Financial Targets We set and communicated the financial targets for 1998 shown in Table E. Our results against those targets are also listed. The Automotive sector in South America did not meet its target to break even as a result of lower volume and revenue resulting from weak economic conditions and charges we incurred for employee reductions. Ford Credit's shortfall to achieve the target to grow earnings by 10% reflected primarily the impact of lower-than-anticipated residual values. Table E: Review of 1998 Financial Targets | | Full-Year 1998 Target | . | 1998 Result | Automotive Sector | | North America | 5% return on sales | | 5.3% return on sales | Europe | Profitable | | $193 million profit | South America | Breakeven | | $226 million loss | Total Costs | Down $1 billion from 1997 (at constant volume and mix) | | down $2.2 billion | Capital Spending | Lower than 1997 | | $29 million lower | Visteon | $1.5 billion in new business Improve return on sales | | $2.3 billion in new business 1 percentage point improvement | Financial Services Sector | | Ford Credit | Grow earnings 10%+ | | Up 5% | Hertz | Record earnings | | Record (Up $75 million from 1997) | Ford ranks fourth in the Brazilian market with a combined car and truck share of 13.1%, down 1.2 points from 1997 reflecting new product entries from other manufacturers and an increasingly competitive market. | 1997 COMPARED WITH 1996 Automotive Sector Our automotive sector earnings in North America were a record $4,434 million in 1997, up $2,179 million from 1996. The increase reflected higher margins from ongoing cost, quality and vehicle mix improvements. Adjusted for constant volume and mix, total Automotive costs declined $3 billion in 1997. The after-tax return on sales was 5.1% in 1997, up 2.3 percentage points from 1996. The U.S. economy continued on a path of strong growth, low unemployment and moderate inflation in 1997. In 1997, 15.5 million new cars and trucks were sold, about the same level as 1996. Ford's share of those unit sales was 25%, down 2/10 of a percentage point from 1996. Our Automotive sector operations in Europe returned to profitability in 1997 with earnings of $273 million, compared with a loss of $291 million in 1996. The improvement reflected primarily lower operating costs (at constant volume and mix), offset partially by lower volume. In 1997, 15 million new cars and trucks were sold, compared with 14.3 million units in 1996. Ford's share was 11.4%, down 4/10 of a percentage point from 1996. Our Automotive sector operations in South America were profitable, earning $40 million in 1997, compared with a loss of $642 million in 1996. Higher earnings reflected primarily improved volume and mix, and lower material costs (at constant volume and mix). In 1997, 1.9 million new cars and trucks were sold in Brazil (the largest market in South America). Ford's share of those unit sales was 14.3% in 1997, up 4.3 percentage points from 1996. Financial Services Sector Earnings for the Financial Services sector in 1997 were down $585 million, compared with 1996. Excluding the one-time actions in 1997 and 1996 shown previously, results from operations in 1997 were down $342 million from 1996. Lower earnings at Ford Credit in 1997, compared with 1996, resulted primarily from lower net financing margins, higher credit losses and loss reserve requirements, and a higher effective tax rate; improved operating costs and higher financing volumes were a partial offset. Net financing margins decreased from 1996, reflecting higher depreciation costs on leased vehicles (as a result of lower-than-anticipated residuals). Credit losses as a percent of average net finance receivables (including net investment in operating leases) were 0.89% in 1997, compared with 0.78% in 1996, reflecting higher losses per repossession. Record earnings at The Associates reflected primarily higher levels of earning assets and improved net interest margins, offset partially by higher credit losses. Credit losses as a percent of average net finance receivables were 2.40% in 1997, compared with 2.03% in 1996. Record earnings at Hertz reflected continued strong performance in the U.S. car rental market both in terms of increased transaction volume and more favorable pricing. Ford once again ended the year with a very strong balance sheet and new record automotive cash of $23.8 billion. | Ford's common stock dividends was increased in 1998 for the 5th consecutive year as a result of the continuation of dramatic operating and cash flow improvements. Including the special distribution of $3.2 billion as part of the spin-off of The Associates, Ford's total cash distribution to shareholders in 1998 was an all-time record $5.3 billion. | LIQUIDITY AND CAPITAL RESOURCES Automotive Sector At December 31, 1998, our Automotive sector had $23.8 billion of cash and marketable securities, up $3.0 billion from December 31, 1997. This increase occurred even though we paid a total of $2.1 billion in regular cash dividends on our Common Stock, Class B Stock and Preferred Stock during 1998, and paid a special cash dividend of $3.2 billion related to The Associates spin-off. In 1998, we spent $8.1 billion for capital goods, such as machinery, equipment, tooling and facilities, used in our Automotive sector. This is down $29 million from 1997. Capital expenditures were 6.8% of sales in 1998, up 2/10 of a percentage point from a year ago. At December 31, 1998, our Automotive sector had total debt of $9.8 billion. This amount was 30% of our total capitalization (that is, the sum of our stockholders' equity and Automotive debt) at the end of 1998, compared with 21% of total capitalization at year-end 1997. Financial Services Sector The Associates spin-off primarily explains the declines discussed in this section. At December 31, 1998, our Financial Services sector had cash and marketable securities totaling $2.1 billion, down $1.7 billion from December 31, 1997. Net receivables and lease investments were $132.6 billion at December 31, 1998, down $43 million from December 31, 1997. Total debt was $122.3 billion at December 31, 1998, down $37.8 billion from December 31, 1997. Outstanding commercial paper at December 31, 1998 totaled $46.2 billion at Ford Credit, and $2.3 billion at Hertz, with an average remaining maturity of 30 days and 52 days, respectively. For a discussion of the credit and other financial support facilities for our Automotive and Financial Services sectors at December 31, 1998, see Note 9 of our Notes to Financial Statements. Automotive capital spending decreased slightly in 1998, the fourth consecutive year of decline. | YEAR 2000 DATE CONVERSION General An issue affecting Ford and others is the inability of many computer systems and applications to process the year 2000 and beyond ("Y2K"). To address this problem, in 1996, we initiated a global Y2K program to manage Ford's overall Y2K compliance effort. As part of this program, we established a global Central Program Office to coordinate our Y2K compliance efforts. We also have established a Y2K Steering Committee comprised of senior executives to address compliance issues. Ford's Y2K program has been certified by the Information Technology Association of America as meeting its Y2K best practices standards. State of Readiness We achieved all compliance objectives that we set for ourselves for 1998, including interim 1998 objectives. We expect to complete most of the remaining remediation efforts by the end of June 1999, with the rest completed in the third quarter of 1999. We have identified the following ten distinct areas for Ford's Y2K compliance efforts: Business Computer Systems: These include computer systems and applications relating to operations such as financial reporting, human resources, manufacturing, marketing and sales (including vehicle ordering), product engineering and design, purchasing and treasury. In 1997, we implemented a compliance plan focused on critical systems. By year-end 1998, all critical systems had been repaired, tested, independently verified and implemented into a production environment. In addition, we initiated an enterprise test plan for all key business processes in November 1998. As of February 28, 1999, 86% of all business computer systems were Y2K compliant. Plant Floor Equipment: We have implemented a process to assess equipment and machinery in our 180 manufacturing and assembly plants and parts warehouse facilities. We have implemented strategies to repair, replace, or develop contingency plans for all non-compliant hardware and software. As of February 28, 1999, 92% of our plant floor systems were Y2K compliant, and 85% of those systems that are critical were Y2K compliant. Suppliers: Ford has deployed, in conjunction with an industry trade association (the Automotive Industry Action Group), a process to pursue a common Y2K compliance approach with the automotive supply industry in North America. Similar actions are underway in Europe and the rest of the world. Y2K awareness and educational sessions have been made available to first, second and third- tier suppliers. Ford does business with approximately 5,000 vehicle production and critical non-production suppliers. We have asked each of these suppliers to respond to a Y2K compliance questionnaire, and a majority of them have done so. Based on these responses, the criticality of the product or service being supplied and other factors, during 1999 we will selectively audit Y2K compliance of our suppliers. Vehicle Components: Although testing continues, we have determined that the Y2K problem does not affect the onboard computer systems in our vehicles. The functionality of these systems is based generally on engine cycles or the time elapsed since the vehicle was started, not any particular date. We have surveyed suppliers of microprocessors and embedded system assemblies, and no problems have been identified to date. Recent internal global surveys to all Ford employees have substantiated these findings. Affiliates: Ford Credit, Hertz, and our other consolidated subsidiaries, as well as our non-consolidated joint ventures, have developed plans to address Y2K compliance similar to those of Ford. We have contacted and are monitoring over 200 affiliates to ensure plans are in place to achieve timely Y2K compliance. Product Development Test Equipment: This includes equipment and systems for testing vehicle emissions, safety, and performance. We are working with suppliers to replace non-compliant systems with common global test systems where needed. As of February 28, 1999, 45% of our product developement test systems were Y2K compliant, and 63% of those systems that are critical were Y2K compliant. End-User Computing: Desktop computers are used throughout Ford. Our plans to make these computers Y2K compliant include the replacement or repair of all non-compliant computers and related software, distribution of an assessment tool for end-user developed applications and the training of over 700 end-user program coordinators worldwide. As of February 28, 1999, 57% of critical end-user programs were Y2K compliant. Technical Infrastructure: We established a dedicated testing facility to repair and test our critical systems infrastructures, such as wide area networks, local area networks, electronic data centers and e-mail systems. As of February 28, 1999, 75% of our hardware, software and global communications network were Y2K compliant. Dealers: We are handling the compliance of all Ford-developed dealer systems, such as vehicle and parts ordering systems. Dealer compliance efforts with respect to other systems are being monitored by us through various dealer service providers. Physical Properties and Infrastructures: We have assessed the impact of Y2K on all building systems globally in two phases. Phase I included energy management, fire and security systems in our production facilities. We are correcting problems where required. Phase II of the program has expanded to include leased office facilities. These facilities have minimal Y2K issues. As of February 28, 1999, 82% of our plant, engineering support and owned office building systems were Y2K compliant. We are also confirming the Y2K preparedness of our energy and other utility suppliers. Set forth in Table F is a timetable showing Ford's internal target dates for compliance and the status of compliance (at February 28, 1999) for each of the areas mentioned above. We established these target dates before December 31, 1999 to allow sufficient time to perform enterprise-wide testing and further validation of our Y2K compliance. Table F: Y2K Timetable and Status as of February 28, 1999 This table shows our timing to be fully compliant with Y2K requirements by major business activity. By September 1999, all systems are targeted to be 100% compliant. | Y2K Costs We estimate that we will spend about $375 million for our Y2K compliance efforts. We will incur this amount over about a three-year period that commenced mid-1997 and will end mid-2000. Y2K compliance costs incurred through December 31, 1998 were about $155 million. Our annual Y2K costs relating to information technology have represented and are expected through year-end 2000 to represent about 10% of our total annual information technology budget. Y2K Risks The most reasonably likely worst case scenario for Ford with respect to the Y2K problem is the failure of a supplier, including an energy supplier, to be Y2K compliant such that its supply of needed products or services to a Ford or supplier manufacturing facility is interrupted temporarily. This could result in Ford not being able to produce one or more vehicle lines for a period of time, which in turn could result in lost sales and profits. We are monitoring the preparedness of utility suppliers to ensure plans are in place for uninterrupted service. Y2K Contingency Plans We have established a Y2K business resumption planning committee to evaluate business disruption scenarios, coordinate the establishment of Y2K contingency plans, and identify and implement preemptive strategies. The committee will develop detailed contingency plans for critical business processes by the end of March 1999 and will validate those plans by the end of June 1999. EURO CONVERSION A single currency called the euro was introduced in Europe on January 1, 1999. Eleven of the fifteen member countries of the European Union adopted the euro as their common legal currency as of that date. Fixed conversion rates between these participating countries' existing currencies (the "legacy currencies") and the euro were established as of that date. The legacy currencies will remain legal tender as denominations of the euro until at least January 1, 2002 (but not later than July 1, 2002). During this transition period, parties may settle transactions using either the euro or a participating country's legacy currency. The increased price transparency resulting from the use of a single currency in the eleven participating countries may affect the ability of Ford and other companies to price their products differently in the various European markets. A possible result of this is price harmonization at lower average prices for products sold in some markets. Nevertheless, differences in national value-added tax regimes, national vehicle registration taxes, customer preferences for equipment and options, sizes and types of vehicles and engines, and trade-in values may reduce the potential for price harmonization. Introduction of the euro may reduce the amount of Ford's exposure to changes in foreign exchange rates, due to the netting effect of having assets and liabilities denominated in a single currency as opposed to the various legacy currencies. As a result, our foreign exchange hedging costs could be reduced. Conversely, because there will be less diversity in our exposure to foreign currencies, movements in the euro's value in U.S. dollars could have a more pronounced effect, whether positive or negative, on us. We have budgeted up to $50 million (including contingencies) for the period from 1997 through 2003 to cover the worldwide costs of preparing for and making operational changes to accommodate introduction of the euro. Certain of our business functions have introduced euro-capability as of January 1, 1999, including, for example, systems for making and receiving certain payments, pricing and invoicing. Other business functions will be converted for the euro by the end of the transition period (December 31, 2001), but may be converted earlier where operationally efficient or cost-effective, or to meet customer needs. DISSOLUTION OF AUTOEUROPA JOINT VENTURE Effective January 1, 1999, our joint venture with Volkswagen AG in Portugal (AutoEuropa) was dissolved. This action will improve our first quarter 1999 after-tax results by approximately $165 million. Prior to the dissolution, we held a 50% interest in AutoEuropa and accounted for it on an equity basis. VOLVO On March 1, 1999, we entered into a definitive agreement with AB Volvo for the purchase of Volvo's worldwide passenger car business for a price of $6.45 billion. On March 8, 1999, AB Volvo's shareholders approved the transaction. The transaction will close following receipt of regulatory approvals. ROUGE COMPLEX On February 1, 1999, an explosion occurred at the powerhouse of the Rouge Complex in Dearborn, Michigan, completely halting production at the powerhouse. Thirty-one people were injured or died as a result of this accident. The powerhouse supplied energy and steam to the entire Rouge Complex. We own part of the powerhouse and have manufacturing plants and an assembly plant located within the Complex. Those plants supply products to various Ford manufacturing and assembly plants worldwide. Through alternative sources of power, we have resumed normal production at all of our manufacturing and assembly plants in the Rouge Complex. A significant supplier of steel to us also is located in the Rouge Complex. We do not know when that supplier will be able to fully resume its production. In the interim, we have implemented contingency plans for temporary alternative sources of steel. We have insurance, including business interruption coverage, which should limit the financial impact from the accident. NEW ACCOUNTING STANDARDS Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information," was issued by the Financial Accounting Standards Board in June 1997. We adopted SFAS 131 effective with the 1998 financial statements. Statement of Financial Accounting Standards No. 132 ("SFAS 132"), "Employers' Disclosures about Pensions and Other Postretirement Benefits," was issued by the Financial Accounting Standards Board in February 1998. We adopted SFAS 132 effective with the 1998 financial statements. Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," was issued by the American Institute of Certified Public Accountants in March 1998. This SOP provides guidance on accounting for the costs of computer software developed or obtained for internal use, and requires capitalization of certain internal-use computer software costs. We will adopt this SOP for costs incurred beginning January 1, 1999. Adoption of this standard is expected to improve full-year 1999 after-tax results by an estimated $220 million. Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities," was issued by the Financial Accounting Standards Board in June 1998. This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires recognition of all derivatives as either assets or liabilities on the balance sheet and measurement of those instruments at fair value. If certain conditions are met, a derivative may be designated specifically as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment referred to as a fair value hedge, (b) a hedge of the exposure to variability in cash flows of a forecasted transaction (a cash flow hedge), or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a forecasted transaction. We anticipate having each of these types of hedges, and we will comply with the requirements of SFAS 133 when we adopt it. We expect to adopt SFAS 133 beginning January 1, 2000. We have not yet determined the effect of adopting SFAS 133. In 1998, U.S. industry volume was 16 million units, the 5th consecutive year of industry demand above 15 million units. | Total European industry volume reached 16.1 million cars and trucks in 1998, the 5th consecutive year of increased demand. | OUTLOOK Industry Sales Volumes The company's outlook for car and truck industry sales in 1999 in its major markets is as follows: United States - between 15.5 to 16 million units, compared with the 16 million units sold in 1998
Europe - lower than the 16.1 million units sold in 1998
Brazil - substantially lower than the 1.6 million units sold in 1998
In 1998, Brazilian industry volume dropped dramatically from 1997's record level, primarily as a result of fiscal austerity measures implemented by the Brazilian government in late 1997. | 1999 Financial Targets Ford's management has set and communicated certain financial targets for 1999. While we hope to achieve these goals, they should not be interpreted as projections, expectations or forecasts of 1999 results. The financial targets for 1999 are shown in Table G. Table G: | Full-Year 1999 Financial Targets | | Target | Automotive Sector | | North America | After-tax return on sales greater than 5% | Europe | Grow earnings | South America | Improve operating results* | Total Costs | Down $1 billion from 1998 (at constant volume and mix) | Capital Spending | $8.5 billion (includes capitalized software) | Visteon | Grow earnings; obtain $2 billion of new business | Financial Services Sector | | Ford Credit | Grow earnings by 10% | Hertz | Record earnings (eight consecutive year of increased earnings) | Total Company | | Total shareholder returns | Top quartile of the S&P 500 over time. | *Because the Brazilian market has deteriorated more than expected in the first quarter of 1999, our current forecast is for worse operating results. | RISK FACTORS Statements included in this Report may constitute "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those stated, including, without limitation: greater price competition in the U.S. and Europe resulting from currency fluctuations or industry overcapacity; a significant decline in U.S. or European industry sales resulting from slowing economic growth; currency fluctuations; further economic difficulties in South America, including those resulting from Brazilian government austerity programs; a market shift from truck sales in the U.S.; lower-than-anticipated residual values for leased vehicles; problems relating to the Y2K issue; increased safety or emissions regulation resulting in higher costs and/or sales restrictions; work stoppages at key Ford or supplier facilities; and the discovery of defects in vehicles resulting in recall campaigns, increased warrant cost or litigation. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Ford is exposed to a variety of market risks, including the effects of changes in foreign currency exchange rates, interest rates and commodity prices. - Our Automotive sector frequently has expenditures denominated in foreign currencies, including the following: purchases and sales of finished vehicles and production parts; debt and other payables; subsidiary dividends; and investments in subsidiaries. These expenditures create exposures to changes in exchange rates.
- We also are exposed to changes in prices of commodities used in our Automotive sector.
- To ensure funding over business and economic cycles and to minimize overall borrowing costs, our Financial Services sector issues debt and other payables with various maturity and interest rate structures. The maturity and interest rate structures frequently differ from the invested assets. Exposures to fluctuations in interest rates are created by the difference in maturities of liabilities versus the maturities of assets.
We monitor and manage these financial exposures as an integral part of our overall risk management program, which recognizes the unpredictability of financial markets and seeks to reduce the potentially adverse effect on our results. The effect of changes in exchange rates, interest rates and commodity prices on our earnings generally has been small relative to other factors that also affect earnings, such as unit sales and operating margins. For more information on these financial exposures, see Note 1 and Note 14 of our Notes to Financial Statements. Our interest rate risk and foreign currency exchange rate risk are quantified below. Our risks related to commodity derivative positions are not material. Interest Rate Risk - We use interest rate swaps (including those with a currency swap component) primarily at Ford Credit to mitigate the effects of interest rate fluctuations on earnings by changing the characteristics of debt to match the characteristics of assets. All interest rate swap agreements are designated to hedge either a specific debt issue or pool of debt. We use a model to assess the sensitivity of our earnings to changes in market interest rates. The model recalculates earnings by adjusting rates associated with variable rate instruments on the repricing date and by adjusting rates on fixed rate instruments scheduled to mature in the subsequent twelve months, effective on their scheduled maturity date. Interest income and interest expense are then recalculated based on the revised rates. Assuming an instantaneous increase or decrease of one percentage point in interest rates applied to all financial instruments and leased assets, our after-tax earnings would change by $23 million over a 12-month period. Foreign Currency Risk - We use derivative financial instruments to hedge assets, liabilities and firm commitments denominated in foreign currencies. We use a value-at-risk (VAR) analysis to evaluate our exposure to changes in foreign currency exchange rates. The primary assumptions used in the VAR analysis are as follows: - A historical time series analysis (variance/covariance) is used to calculate changes in the value of currency derivative instruments (forwards and options) and all significant underlying exposures. The VAR includes an 18-month exposure horizon and a one-month holding period.
- The VAR analysis calculates the potential risk, within a 99% confidence level, on firm commitment exposures (cash flows), including the effects of foreign currency derivatives. (Translation exposures are not included in the VAR analysis). The model generally assumes currency prices are normally distributed and draws volatility data from the currency markets.
- Estimates of correlations of market factors primarily are drawn from the JP Morgan RiskMetricsTM datasets.
Based on our overall currency exposure (including derivative positions) during 1998, the risk during 1998 to our pre-tax cash flow from currency movements was on average less than $300 million, with a high of $350 million and a low of $200 million. At December 31, 1998, currency movements are projected to affect our pre-tax cash flow over the next 18 months by less than $325 million, within a 99% confidence level. Compared with our projection at December 31, 1997, the 1998 VAR amount is approximately $75 million higher, primarily because of increased currency exchange rate volatility and increased exposure. | |