Ford Q1 Earnings Impacted by $400 Million Service-Action Charge

Ford accrued a $400 million charge for North America service actions in the first quarter, which raised eyebrows among financial analysts during a conference call today with top executives.

The charge covers current and future warranty and recall expenses and is a common accounting practice among automakers. However, given the recent increase in high-profile recalls, particularly General Motors’ callback of millions of vehicles over faulty ignition cylinders, industry sensitivity toward such issues has heightened.

Bob Shanks, Ford executive vice president and CFO, says the charge, which impacted the automaker’s Q1 pre-tax $1.4 billion pretax profit, down $765 million from year-ago, was a large increase from prior quarters.

“There are a higher number of recalls and units being affected (in the industry),” he says. “As that occurred, we had to look at our reserves and adjust them.”

Shanks says the automaker uses a pattern estimation model to determine how much should be placed in reserve for possible field-service actions. Reserves are kept in place to cover vehicles until they reach a certain age. Ford currently keeps reserves on vehicles going back to the ’08 model year.

If a service action exceeds $250 million, the cost to cover it is not drawn from the reserve, but rather is allowed to impact the automaker’s bottom line, he says. At the end of last year, Ford had $3.9 billion set in reserve.

“We only hold these reserves for six to seven years,” Shanks says. “When the oldest year is ready to run off, if there is anything left in reserve, we release it.”

A part of the $400 million charge will go to cover the cost of recalls involving lighting control modules for ’03-’05 Ford Crown Victorias and Mercury Grand Marquis, as well as ’01-’04 Escape CUVs that potentially could develop rusty subframes, he says.

Ford also incurred a $100 million Q1 charge for problems related to the particularly harsh winter in the U.S., which resulted in premium freight and labor costs, Shanks says.  

In a statement the automaker says while similar issues such as the warranty and service actions as well as the weather-related charges could occur in the future, “it is unusual for items like these to occur in this magnitude in the same quarter.”

The large charges were not the only challenges Ford faced in Q1. In the automaker’s home North America market it posted a $1.5 billion pretax profit, down $892 million from year-ago. In addition to the service and weather-related charges, falling sales of small cars and a drop in market share impacted Ford’s North American results.

“We delivered solid results despite several significant factors,” CEO Alan Mulally says. “We remain on track to implement our full plan in North America as we will launch three times the number of products compared to last year.”

Ford’s South American operations were another low point of the quarter, posting a pretax loss of $510 million. The issues facing Ford in South America are numerous, but chief among them are slow gross-domestic product growth, currency fluctuations, high inflation and political and social turmoil.

Chief Operating Officer Mark Fields cites Venezuela as a particularly difficult area of business, noting the country in Q1 2013 accounted for 113,000 sales compared to just 12,000 this year.

“We continue to watch the environment there and work to minimize our exposure,” he says.

Ford fared far better in the Asia-Pacific region, posting a Q1 pretax profit of $291 million, up $319 million vs. year-ago. China was the standout in the region, as wholesale volume increased 32% to 350,000 units and revenue jumped 19% to $2.6 billion.

Fields says Ford’s lineup of SUVs and CUVs, including the Explorer, Kuga and EcoSport, are driving increases in China.

“The SUV/CUV segment in China as an industry is up about 28%,” he says. “Our sales are up almost 300%. The infrastructure lends itself well to SUVs and CUVs and the demographics of our customer are very encouraging, as they are younger than the industry average. That bodes well for us going forward.”

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