form10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________ to ________________

Commission File Number: 1-3950


FORD MOTOR COMPANY
(Exact name of registrant as specified in its charter)


Delaware
38-0549190
(State of Incorporation)
(IRS Employer Identification No.)
   
One American Road, Dearborn, Michigan
48126
(Address of principal executive offices)
(Zip Code)


(313) 322-3000
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
T Yes                            £ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer T
Accelerated filer £
Non-accelerated filer £
Smaller reporting company £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
£ Yes                            T No


As of October 27, 2008, the registrant had outstanding 2,318,003,459 shares of Common Stock and 70,852,076 shares of Class B Stock.

Exhibit index located on page number 64.
 


 
 

 

PART I. FINANCIAL INFORMATION
Item 1.  Financial Statements
FORD MOTOR COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF INCOME
For the Periods Ended September 30, 2008 and 2007
(in millions, except per share amounts)

   
Third Quarter
   
First Nine Months
 
   
2008
   
2007
   
2008
   
2007
 
   
(unaudited)
   
(unaudited)
 
Sales and revenues
                       
Automotive sales
  $ 27,733     $ 36,270     $ 103,907     $ 115,006  
Financial Services revenues
    4,312       4,808       13,178       13,333  
Total sales and revenues
    32,045       41,078       117,085       128,339  
                                 
Costs and expenses
                               
Automotive cost of sales
    24,999       33,238       100,450       104,135  
Selling, administrative and other expenses
    4,574       4,904       16,974       15,828  
Interest expense
    2,382       2,733       7,339       8,210  
Financial Services provision for credit and insurance losses
    399       194       1,341       374  
Total costs and expenses
    32,354       41,069       126,104       128,547  
                                 
Automotive interest income and other non-operating income/(expense), net
    (244 )     (216 )     (344 )     672  
Automotive equity in net income/(loss) of affiliated companies
    13       51       109       262  
Income/(Loss) before income taxes
    (540 )     (156 )     (9,254 )     726  
Provision for/(Benefit from) income taxes
    (462 )     162       (811 )     467  
Income/(Loss) before minority interests
    (78 )     (318 )     (8,443 )     259  
Minority interests in net income/(loss) of subsidiaries
    51       62       262       205  
Income/(Loss) from continuing operations
    (129 )     (380 )     (8,705 )     54  
Income/(Loss) from discontinued operations (Note 8)
                9       34  
Net income/(loss)
  $ (129 )   $ (380 )   $ (8,696 )   $ 88  
                                 
AMOUNTS PER SHARE OF COMMON AND CLASS B STOCK (Note 9)
                               
Basic income/(loss)
                               
Income/(Loss) from continuing operations
  $ (0.06 )   $ (0.19 )   $ (3.89 )   $ 0.03  
Income/(Loss) from discontinued operations
                      0.02  
Net income/(loss)
  $ (0.06 )   $ (0.19 )   $ (3.89 )   $ 0.05  
Diluted income/(loss)
                               
Income/(Loss) from continuing operations
  $ (0.06 )   $ (0.19 )   $ (3.89 )   $ 0.03  
Income/(Loss) from discontinued operations
                      0.02  
Net income/(loss)
  $ (0.06 )   $ (0.19 )   $ (3.89 )   $ 0.05  

The accompanying notes are part of the financial statements

 
2

 

Item 1.  Financial Statements (Continued)

FORD MOTOR COMPANY AND SUBSIDIARIES

SECTOR STATEMENT OF INCOME
For the Periods Ended September 30, 2008 and 2007
(in millions, except per share amounts)

   
Third Quarter
   
First Nine Months
 
   
2008
   
2007
   
2008
   
2007
 
   
(unaudited)
   
(unaudited)
 
AUTOMOTIVE
                       
Sales
  $ 27,733     $ 36,270     $ 103,907     $ 115,006  
Costs and expenses
                               
Cost of sales
    24,999       33,238       100,450       104,135  
Selling, administrative and other expenses
    2,740       3,016       8,804       10,314  
Total costs and expenses
    27,739       36,254       109,254       114,449  
Operating income/(loss)
    (6 )     16       (5,347 )     557  
                                 
Interest expense
    462       563       1,475       1,720  
                                 
Interest income and other non-operating income/(expense), net
    (244 )     (216 )     (344 )     672  
Equity in net income/(loss) of affiliated companies
    13       51       109       262  
Income/(Loss) before income taxes — Automotive
    (699 )     (712 )     (7,057 )     (229 )
                                 
FINANCIAL SERVICES
                               
Revenues
    4,312       4,808       13,178       13,333  
Costs and expenses
                               
Interest expense
    1,920       2,170       5,864       6,490  
Depreciation
    1,596       1,620       7,544       4,599  
Operating and other expenses
    238       268       626       915  
Provision for credit and insurance losses
    399       194       1,341       374  
Total costs and expenses
    4,153       4,252       15,375       12,378  
Income/(Loss) before income taxes — Financial Services
    159       556       (2,197 )     955  
                                 
TOTAL COMPANY
                               
Income/(Loss) before income taxes
    (540 )     (156 )     (9,254 )     726  
Provision for/(Benefit from) income taxes
    (462 )     162       (811 )     467  
Income/(Loss) before minority interests
    (78 )     (318 )     (8,443 )     259  
Minority interests in net income/(loss) of subsidiaries
    51       62       262       205  
Income/(Loss) from continuing operations
    (129 )     (380 )     (8,705 )     54  
Income/(Loss) from discontinued operations (Note 8)
                9       34  
Net income/(loss)
  $ (129 )   $ (380 )   $ (8,696 )   $ 88  
                                 
AMOUNTS PER SHARE OF COMMON AND CLASS B STOCK (Note 9)
                               
Basic income/(loss)
                               
Income/(Loss) from continuing operations
  $ (0.06 )   $ (0.19 )   $ (3.89 )   $ 0.03  
Income/(Loss) from discontinued operations
                        0.02  
Net income/(loss)
  $ (0.06 )   $ (0.19 )   $ (3.89 )   $ 0.05  
Diluted income/(loss)
                               
Income/(Loss) from continuing operations
  $ (0.06 )   $ (0.19 )   $ (3.89 )   $ 0.03  
Income/(Loss) from discontinued operations
                      0.02  
Net income/(loss)
  $ (0.06 )   $ (0.19 )   $ (3.89 )   $ 0.05  

The accompanying notes are part of the financial statements

 
3

 

Item 1.  Financial Statements (Continued)

FORD MOTOR COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET
(in millions)

   
September 30, 2008
   
December 31, 2007
 
   
(unaudited)
       
ASSETS
           
Cash and cash equivalents
  $ 24,894     $ 35,283  
Marketable securities
    16,907       5,248  
Loaned securities
          10,267  
Finance receivables, net
    100,883       109,053  
Other receivables, net
    7,529       8,210  
Net investment in operating leases
    29,179       33,255  
Retained interest in sold receivables
    154       653  
Inventories  (Note 2)
    12,048       10,121  
Equity in net assets of affiliated companies
    3,065       2,853  
Net property
    30,253       36,239  
Deferred income taxes
    3,032       3,500  
Goodwill and other net intangible assets (Note 4)
    1,805       2,069  
Assets of discontinued/held-for-sale operations (Note 8)
          7,537  
Other assets
    12,316       14,976  
Total assets
  $ 242,065     $ 279,264  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Payables
  $ 20,358     $ 20,832  
Accrued liabilities and deferred revenue
    62,931       74,738  
Debt
    156,793       168,787  
Deferred income taxes
    2,514       3,034  
Liabilities of discontinued/held-for-sale operations (Note 8)
          4,824  
Total liabilities
    242,596       272,215  
                 
Minority interests
    1,458       1,421  
                 
Stockholders’ equity
               
Capital stock
               
Common Stock, par value $0.01 per share (2,304 million shares issued)
    23       21  
Class B Stock, par value $0.01 per share (71 million shares issued)
    1       1  
Capital in excess of par value of stock
    8,910       7,834  
Accumulated other comprehensive income/(loss)
    (571 )     (558 )
Treasury stock
    (183 )     (185 )
Retained earnings/(Accumulated deficit)
    (10,169 )     (1,485 )
Total stockholders’ equity
    (1,989 )     5,628  
Total liabilities and stockholders’ equity
  $ 242,065     $ 279,264  

The accompanying notes are part of the financial statements

 
4

 

Item 1.  Financial Statements (Continued)

FORD MOTOR COMPANY AND SUBSIDIARIES
SECTOR BALANCE SHEET
(in millions)

   
September 30, 2008
   
December 31, 2007
 
   
(unaudited)
       
ASSETS
           
Automotive
           
Cash and cash equivalents
  $ 10,607     $ 20,678  
Marketable securities
    11,477       2,092  
Loaned securities
          10,267  
Total cash, marketable and loaned securities
    22,084       33,037  
Receivables, net
    4,623       4,530  
Inventories (Note 2)
    12,048       10,121  
Deferred income taxes
    333       532  
Other current assets
    4,756       5,514  
Current receivable from Financial Services
    1,177       509  
Total current assets
    45,021       54,243  
Equity in net assets of affiliated companies
    2,466       2,283  
Net property
    30,027       35,979  
Deferred income taxes
    6,992       9,268  
Goodwill and other net intangible assets (Note 4)
    1,796       2,051  
Assets of discontinued/held-for-sale operations (Note 8)
          7,537  
Other assets
    5,826       5,614  
Non-current receivable from Financial Services
    2,520       1,514  
Total Automotive assets
    94,648       118,489  
Financial Services
               
Cash and cash equivalents
    14,287       14,605  
Marketable securities
    5,735       3,156  
Finance receivables, net
    103,796       112,733  
Net investment in operating leases
    25,838       30,309  
Retained interest in sold receivables
    154       653  
Equity in net assets of affiliated companies
    599       570  
Goodwill and other net intangible assets (Note 4)
    9       18  
Other assets
    5,492       7,217  
Total Financial Services assets
    155,910       169,261  
Intersector elimination
    (4,009 )     (2,023 )
Total assets
  $ 246,549     $ 285,727  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Automotive
               
Trade payables
  $ 15,154     $ 15,718  
Other payables
    3,152       3,237  
Accrued liabilities and deferred revenue
    25,036       27,672  
Deferred income taxes
    2,728       2,671  
Debt payable within one year
    1,282       1,175  
Total current liabilities
    47,352       50,473  
Long-term debt
    24,856       25,779  
Other liabilities
    32,622       41,676  
Deferred income taxes
    736       783  
Liabilities of discontinued/held-for-sale operations (Note 8)
          4,824  
Total Automotive liabilities
    105,566       123,535  
Financial Services
               
Payables
    2,052       1,877  
Debt
    130,960       141,833  
Deferred income taxes
    3,534       6,043  
Other liabilities and deferred income
    5,280       5,390  
Payable to Automotive
    3,697       2,023  
Total Financial Services liabilities
    145,523       157,166  
Minority interests
    1,458       1,421  
                 
Stockholders' equity
               
Capital stock
               
Common Stock, par value $0.01 per share (2,304 million shares issued)
    23       21  
Class B Stock, par value $0.01 per share (71 million shares issued)
    1       1  
Capital in excess of par value of stock
    8,910       7,834  
Accumulated other comprehensive income/(loss)
    (571 )     (558 )
Treasury stock
    (183 )     (185 )
Retained earnings/(Accumulated deficit)
    (10,169 )     (1,485 )
Total stockholders' equity
    (1,989 )     5,628  
Intersector elimination
    (4,009 )     (2,023 )
Total liabilities and stockholders' equity
  $ 246,549     $ 285,727  

The accompanying notes are part of the financial statements.

 
5

 

Item 1.  Financial Statements (Continued)

FORD MOTOR COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
For the Periods Ended September 30, 2008 and 2007
(in millions)

   
First Nine Months
 
   
2008
   
2007
 
   
(unaudited)
 
       
Cash flows from operating activities of continuing operations
     
Net cash (used in)/provided by operating activities
  $ 3,269     $ 13,242  
                 
Cash flows from investing activities of continuing operations
               
Capital expenditures
    (4,875 )     (4,215 )
Acquisitions of retail and other finance receivables and operating leases
    (36,932 )     (42,827 )
Collections of retail and other finance receivables and operating leases
    32,278       34,509  
Purchases of securities
    (49,881 )     (9,085 )
Sales and maturities of securities
    47,852       14,805  
Settlements of derivatives
    1,753       716  
Proceeds from sales of retail and other finance receivables and operating leases
          705  
Proceeds from sale of businesses
    6,293       1,236  
Cash paid for acquisitions
    (13 )      
Transfer of cash balances upon disposition of discontinued/held-for-sale operations
    (925 )     (83 )
Other
    421       185  
Net cash (used in)/provided by investing activities
    (4,029 )     (4,054 )
                 
Cash flows from financing activities of continuing operations
               
Sales of Common Stock
    663       152  
Purchases of Common Stock
          (31 )
Changes in short-term debt
    (4,422 )     (2,558 )
Proceeds from issuance of other debt
    27,565       24,018  
Principal payments on other debt
    (32,768 )     (32,457 )
Other
    (531 )     151  
Net cash (used in)/provided by financing activities
    (9,493 )     (10,725 )
                 
Effect of exchange rate changes on cash
    (136 )     64  
                 
Net increase/(decrease) in cash and cash equivalents from continuing operations
    (10,389 )     (1,473 )
                 
Cash flows from discontinued operations
               
Cash flows from operating activities of discontinued operations
          16  
Cash flows from investing activities of discontinued operations
           
Cash flows from financing activities of discontinued operations
           
                 
Net increase/(decrease) in cash and cash equivalents
  $ (10,389 )   $ (1,457 )
                 
Cash and cash equivalents at January 1
  $ 35,283     $ 28,896  
Cash and cash equivalents of discontinued/held-for-sale operations at January 1
          (2 )
Net increase/(decrease) in cash and cash equivalents
    (10,389 )     (1,457 )
Less: cash and cash equivalents of discontinued/held-for-sale operations at September 30
           
Cash and cash equivalents at September 30
  $ 24,894     $ 27,437  

The accompanying notes are part of the financial statements

 
6

 

Item 1.  Financial Statements (Continued)

FORD MOTOR COMPANY AND SUBSIDIARIES

CONDENSED SECTOR STATEMENT OF CASH FLOWS
For the Periods Ended September 30, 2008 and 2007
(in millions)

   
First Nine Months 2008
   
First Nine Months 2007
 
   
Automotive
   
Financial Services
   
Automotive
   
Financial Services
 
   
(unaudited)
   
(unaudited)
 
Cash flows from operating activities of continuing operations
                       
Net cash (used in)/provided by operating activities
  $ (7,242 )   $ 8,088     $ 5,932     $ 5,247  
                                 
Cash flows from investing activities
                               
Capital expenditures
    (4,815 )     (60 )     (4,176 )     (39 )
Acquisitions of retail and other finance receivables and operating leases
          (36,932 )           (42,827 )
Collections of retail and other finance receivables and operating leases
          32,643             34,545  
Net (increase)/decrease of wholesale receivables
          2,058             2,027  
Purchases of securities
    (33,430 )     (16,721 )     (1,428 )     (7,657 )
Sales and maturities of securities
    33,676       14,176       1,469       13,336  
Settlements of derivatives
    1,063       690       748       (32 )
Proceeds from sales of retail and other finance receivables and operating leases
                      705  
Proceeds from sale of businesses
    2,595       3,698       1,079       157  
Cash paid for acquisitions
    (13 )                  
Transfer of cash balances upon disposition of discontinued/held-for-sale operations
    (925 )           (83 )      
Investing activity from Financial Services
    9                    
Investing activity to Financial Services
                (8 )      
Other
    144       277       (20 )     205  
Net cash (used in)/provided by investing activities
    (1,696 )     (171 )     (2,419 )     420  
                                 
Cash flows from financing activities
                               
Sales of Common Stock
    663             152        
Purchases of Common Stock
                (31 )      
Changes in short-term debt
    56       (4,478 )     (69 )     (2,489 )
Proceeds from issuance of other debt
    116       27,449       189       23,829  
Principal payments on other debt
    (456 )     (32,042 )     (617 )     (31,840 )
Financing activity from Automotive
                      8  
Financing activity to Automotive
          (9 )            
Other
    (206 )     (325 )     207       (56 )
Net cash (used in)/provided by financing activities
    173       (9,405 )     (169 )     (10,548 )
                                 
Effect of exchange rate changes on cash
    (64 )     (72 )     342       (278 )
Net change in intersector receivables/payables and other liabilities
    (1,242 )     1,242       (777 )     777  
Net increase/(decrease) in cash and cash equivalents from continuing operations
    (10,071 )     (318 )     2,909       (4,382 )
                                 
Cash flows from discontinued operations
                               
Cash flows from operating activities of discontinued operations
                16        
Cash flows from investing activities of discontinued operations
                       
Cash flows from financing activities of discontinued operations
                       
                                 
Net increase/(decrease) in cash and cash equivalents
  $ (10,071 )   $ (318 )   $ 2,925     $ (4,382 )
                                 
Cash and cash equivalents at January 1
  $ 20,678     $ 14,605     $ 16,022     $ 12,874  
Cash and cash equivalents of discontinued/held-for-sale operations at January 1
                (2 )      
Net increase/(decrease) in cash and cash equivalents
    (10,071 )     (318 )     2,925       (4,382 )
Less: cash and cash equivalents of discontinued/held-for-sale operations at September 30
                       
Cash and cash equivalents at September 30
  $ 10,607     $ 14,287     $ 18,945     $ 8,492  

The accompanying notes are part of the financial statements

 
7

 

Item 1.  Financial Statements (Continued)

FORD MOTOR COMPANY AND SUBSIDIARIES

NOTES TO THE FINANCIAL STATEMENTS

NOTE 1. PRINCIPLES OF PRESENTATION AND CONSOLIDATION

Our financial statements are presented in accordance with generally accepted accounting principles ("GAAP") in the United States for interim financial information and instructions to the Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X.  We show our financial statements on both a consolidated and a sector basis for our Automotive and Financial Services sectors.  All intercompany items and transactions have been eliminated in both the consolidated and sector basis financial statements.  Reconciliations of certain line items are explained below in this Note, where the presentation of these intercompany eliminations or consolidated adjustments differ between the consolidated and sector financial statements.

In the opinion of management, these unaudited financial statements reflect a fair statement of the results of operations and financial condition of Ford Motor Company and its consolidated subsidiaries and consolidated variable interest entities ("VIEs") of which we are the primary beneficiary for the periods and at the dates presented.  The operating results for interim periods are not necessarily indicative of results that may be expected for any other interim period or for the full year.  Reference should be made to the financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2007, updated in our Current Report on Form 8-K filed on June 2, 2008 ("2007 Form 10-K Report").  For purposes of this report, "Ford," the "Company," "we," "our," "us" or similar references mean Ford Motor Company and our consolidated subsidiaries and our consolidated VIEs of which we are the primary beneficiary, unless the context requires otherwise.  All held-for-sale assets and liabilities are excluded from the footnotes unless otherwise noted.  See Note 8 for details of held-for-sale operations.

Presentation of Balance Sheet

Deferred Tax Assets and Liabilities. The difference between the total assets and total liabilities as presented in our sector balance sheet and consolidated balance sheet is the result of netting of deferred income tax assets and liabilities.  The reconciliation between total sector and consolidated balance sheets is as follows (in millions):

   
September 30, 2008
   
December 31, 2007
 
Sector balance sheet presentation of deferred income tax assets:
           
Automotive sector current deferred income tax assets
  $ 333     $ 532  
Automotive sector non-current deferred income tax assets
    6,992       9,268  
Financial Services sector deferred income tax assets*
    191       163  
Total
    7,516       9,963  
Reclassification for netting of deferred income taxes
    (4,484 )     (6,463 )
Consolidated balance sheet presentation of deferred income tax assets
  $ 3,032     $ 3,500  
                 
Sector balance sheet presentation of deferred income tax liabilities:
               
Automotive sector current deferred income tax liabilities
  $ 2,728     $ 2,671  
Automotive sector non-current deferred income tax liabilities
    736       783  
Financial Services sector deferred income tax liabilities
    3,534       6,043  
Total
    6,998       9,497  
Reclassification for netting of deferred income taxes
    (4,484 )     (6,463 )
Consolidated balance sheet presentation of deferred income tax liabilities
  $ 2,514     $ 3,034  
__________
*
Financial Services deferred income tax assets are included in Financial Services other assets on our sector balance sheet.

Ford Acquisition of Ford Motor Credit Company LLC ("Ford Credit") Debt.  In connection with our Registration Statement (No. 333-151355) filed on Form S-3 and the related prospectus dated June 2, 2008 and the prospectus supplements dated August 14, 2008 and October 2, 2008, we issued shares of Ford Common Stock from time to time in market transactions and used the proceeds therefrom to purchase outstanding Ford Credit debt securities maturing prior to 2012.

As of September 30, 2008, we issued 88,325,372 shares resulting in proceeds of $434 million.  During the quarter, we purchased, with $270 million of cash, debt securities of Ford Credit with a carrying value of $305 million and recorded a gain on extinguishment of debt in the amount of $35 million in Automotive interest income and other non-operating income/(expense), net.

On our consolidated balance sheet, the debt is no longer reported in our Debt balances.

 
8

 

Item 1.  Financial Statements (Continued)

NOTE 1. PRINCIPLES OF PRESENTATION AND CONSOLIDATION (Continued)

On our sector balance sheet, the debt is still considered outstanding as it has not been retired or cancelled by Ford Credit.  Accordingly, on our sector balance sheet, the $305 million of debt is reported as Financial Services debt.  Likewise, included in Automotive marketable securities is $305 million related to Ford's purchase of the Ford Credit debt securities.  Consolidating elimination adjustments for these debt securities, and a related $7 million of accrued interest, are included in the Intersector elimination lines on the sector balance sheet.

Presentation of Cash Flows

Trading Securities.  Beginning with our statement of cash flows for the period ended March 31, 2008, we changed the presentation of cash flows to separately disclose the purchases of trading securities and the sale and maturities of trading securities as gross amounts within Cash flows from investing activities instead of Cash flows from operating activities of continuing operations.  This change is in response to our election to apply the fair value option to our available-for-sale and held-to-maturity securities upon adoption of Statement of Financial Accounting Standards ("SFAS") No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – including an amendment of FASB Statement No. 115 ("SFAS No. 159") on January 1, 2008.

Wholesale and Other Finance Receivables.  The reconciliation between total sector and consolidated cash flows from operating activities of continuing operations is as follows (in millions):

   
First Nine Months
 
   
2008
   
2007
 
Sum of sector cash flows from operating activities of continuing operations
  $ 846     $ 11,179  
Reclassification of wholesale receivable cash flows from investing to operating for consolidated presentation (a)
    2,058       2,027  
Reclassification of finance receivable cash flows from investing to operating for consolidated presentation (b)
    365       36  
Consolidated cash flows from operating activities of continuing operations
  $ 3,269     $ 13,242  
__________
(a)
In addition to vehicles sold by us, the cash flows from wholesale finance receivables being reclassified from investing to operating include financing by Ford Credit of used and non-Ford vehicles.  100% of cash flows from wholesale finance receivables have been reclassified for consolidated presentation as the portion of these cash flows from used and non-Ford vehicles is impracticable to separate.
(b)
Includes cash flows of finance receivables purchased from certain divisions and subsidiaries of the Automotive sector.

Ford Acquisition of Ford Credit Debt.  The $270 million cash outflow related to our acquisition of Ford Credit's debt securities is presented differently on our consolidated and sector statements of cash flows.  The cash outflow is reclassified from Automotive purchases of securities within Cash flows from investing activities on our sector statement of cash flows to Principal payments on other debt line item within Cash flows from financing activities on our consolidated statement of cash flows.

NOTE 2. INVENTORIES

Inventories are summarized as follows (in millions):

   
September 30, 2008
   
December 31, 2007
 
Raw materials, work-in-process and supplies
  $ 4,367     $ 4,360  
Finished products
    8,722       6,861  
Total inventories under first-in, first-out method ("FIFO")
    13,089       11,221  
Less: Last-in, first-out method ("LIFO") adjustment
    (1,041 )     (1,100 )
Total inventories
  $ 12,048     $ 10,121  

Inventories are stated at lower of cost or market.  About one-fourth of inventories were determined under the LIFO method.

 
9

 

Item 1.  Financial Statements (Continued)

NOTE 3. IMPAIRMENT OF LONG-LIVED ASSETS

Automotive Sector

Based upon the financial impact of rapidly-changing U.S. market conditions during the second quarter of 2008, we projected a decline in net cash flows for the Ford North America segment.  The decline primarily reflected:  (1) a more pronounced and accelerated shift in consumer preferences away from full-size trucks and traditional sport utility vehicles ("SUVs") to smaller, more fuel-efficient vehicles as a result of higher fuel prices; (2) lower-than-anticipated U.S. industry demand; and (3) greater-than-anticipated escalation of commodity costs.  As a result, in the second quarter of 2008 we tested the long-lived assets of this segment for recoverability and recorded in Automotive cost of sales a pre-tax impairment charge of $5.3 billion, representing the amount by which the carrying value of these assets exceeded the estimated fair value.

The table below describes the significant components of the second quarter 2008 long-lived asset impairment of the Ford North America segment (in millions):

   
Ford North America
 
Land
  $  
Buildings and land improvements
    698  
Machinery, equipment and other
    2,833  
Special tools
    1,769  
Total
  $ 5,300  

Financial Services Sector

During the second quarter of 2008, higher fuel prices and the weak economic climate in the United States and Canada resulted in a more pronounced and accelerated shift in consumer preferences away from full-size trucks and traditional SUVs to smaller, more fuel-efficient vehicles.  This shift in consumer preferences combined with a weak economic climate caused a significant reduction in auction values for used full-size trucks and traditional SUVs.  As a result, in the second quarter of 2008 we tested Ford Credit's operating leases in its North America segment for recoverability and recorded a pre-tax impairment charge in Selling, administrative and other expenses on our consolidated income statement and in Financial Services depreciation on our sector income statement of $2.1 billion, representing the amount by which the carrying value of certain vehicle lines in Ford Credit's lease portfolio exceeded the estimated fair value.

NOTE 4. GOODWILL AND OTHER NET INTANGIBLES

Changes in the carrying amount of goodwill are as follows (in millions):

   
Automotive Sector
   
Financial Services Sector
       
                   
   
Ford North America
   
Ford Europe
   
Volvo
   
Total
   
Ford Credit
   
Total Company
 
Balances at December 31, 2007
  $ 89     $ 37     $ 1,360     $ 1,486     $ 18     $ 1,504  
Changes in goodwill:
                                               
Goodwill acquired
                                   
Other disposals
    (1 )                 (1 )     (9 )     (10 )
Dealer goodwill impairment*
    (88 )                 (88 )           (88 )
Effect of foreign currency translation and other
          (2 )     (65 )     (67 )           (67 )
Balances at September 30, 2008
  $     $ 35     $ 1,295     $ 1,330     $ 9     $ 1,339  
__________
*
Based on our expected reduction of our Ford North America dealership base, we recorded an other-than-temporary impairment of our investment in our consolidated North America dealerships.  We recorded the $88 million impairment of our investment in the first quarter of 2008 by writing down the related goodwill to its fair value of $0.

 
10

 

Item 1.  Financial Statements (Continued)

NOTE 4. GOODWILL AND OTHER NET INTANGIBLES (Continued)

Other Net Intangibles

The components of net identifiable intangible assets are as follows (in millions):

   
September 30, 2008
   
December 31, 2007
 
   
Gross Carrying Amount
   
Less: Accumulated Amortization
   
Net Intangible Assets
   
Gross Carrying Amount
   
Less: Accumulated Amortization
   
Net Intangible Assets
 
Automotive Sector
                                   
Distribution networks
  $ 322     $ (104 )   $ 218     $ 335     $ (103 )   $ 232  
Manufacturing and production incentive rights
    271       (118 )     153       297       (74 )     223  
Other
    191       (96 )     95       199       (89 )     110  
Total Automotive sector
    784       (318 )     466       831       (266 )     565  
Total Financial Services Sector
    4       (4 )           4       (4 )      
Total
  $ 788     $ (322 )   $ 466     $ 835     $ (270 )   $ 565  

Our identifiable intangible assets are comprised of distribution networks with a useful life of 40 years, manufacturing and production incentive rights acquired in 2006 with a useful life of 4 years, and other intangibles with various amortization periods (primarily patents, customer contracts, technology, and land rights).  Pre-tax amortization expense, excluding the effects of foreign currency translation, was as follows (in millions):

   
Third Quarter
   
First Nine Months
 
   
2008
   
2007
   
2008
   
2007
 
Pre-tax amortization expense
  $ 27     $ 32     $ 77     $ 80  

Excluding the impact of foreign currency translation, intangible asset amortization is forecasted to range from $95 million to $105 million per year for the next three years, and $20 million to $30 million per year thereafter.

NOTE 5. VARIABLE INTEREST ENTITIES

We consolidate VIEs of which we are the primary beneficiary.  The liabilities recognized as a result of consolidating these VIEs do not necessarily represent additional claims on our general assets; rather, they represent claims against the specific assets of the consolidated VIEs.  Conversely, assets recognized as a result of consolidating these VIEs do not necessarily represent additional assets that could be used to satisfy claims against our general assets.

The total consolidated VIE assets reflected on our September 30, 2008 and December 31, 2007 balance sheets are as follows (in millions):
 
   
September 30, 2008
   
December 31, 2007
 
Automotive Sector
           
Cash and cash equivalents
  $ 938     $ 742  
Other assets
    5,088       5,599  
Total assets
  $ 6,026     $  6,341  
                 
Financial Services Sector
               
Cash and cash equivalents
  $ 4,407     $ 4,605  
Finance receivables
    61,513       60,361  
Net investment in operating leases
    12,232       17,461  
Total assets
  $ 78,152     $ 82,427  

Ford Credit uses special purpose entities ("SPEs") that are considered VIEs for most of its on-balance sheet securitizations.  Ford Credit's FCAR Owner Trust retail securitization program ("FCAR") issues commercial paper externally.  On occasion, we purchase the debt issued by FCAR.  At September 30, 2008, the asset-backed securities of FCAR supported $9.8 billion of FCAR's asset-backed commercial paper held by external investors and the remaining $1.1 billion was held by Ford Credit.  Further, Ford Credit repurchased $2.5 billion of asset-backed securities from FCAR during the third quarter of 2008 and FCAR used the proceeds to pay off maturing FCAR commercial paper.

 
11

 

Item 1.  Financial Statements (Continued)

NOTE 5. VARIABLE INTEREST ENTITIES (Continued)

We also have investments in other non-securitization related entities determined to be VIEs of which we are not the primary beneficiary.  The risks and rewards associated with our interests in these entities are based primarily on ownership percentages.  Therefore, we do not consolidate these entities and we account for them as equity method investments.  Our maximum exposure at September 30, 2008 and December 31, 2007, respectively, was $424 million and $357 million for our Automotive sector and $148 million and $76 million for our Financial Services sector.  Any potential losses associated with these VIEs would be limited to the value of our invested capital or equity rights and, where applicable, receivables due from the VIEs.

NOTE 6. JOB SECURITY BENEFITS RESERVE AND EMPLOYEE SEPARATION ACTIONS

Automotive Sector

Job Security Benefits Reserve

We are required to pay most idled unionized hourly employees in North America a portion of their wages and benefits for a specified period of time ("Job Security Benefits").  We expense in Automotive cost of sales Job Security Benefits expected to be provided to our hourly employees at facilities that will be closed or at which shifts will be eliminated or, in the case of some Automotive Components Holdings, LLC ("ACH") plants, sold (see Note 18 of the Notes to the Financial Statements in our 2007 Form 10-K Report).

The Job Security Benefits reserve includes an amount for benefits expected to be provided in their present form under the current International Union, United Automobile, Aerospace and Agricultural Implement Workers of America ("UAW") and National Automobile, Aerospace, Transportation and General Workers Union of Canada ("CAW") collective bargaining agreements.  The Job Security Benefits provided to our hourly employees are expensed when it becomes probable that employees will be permanently idled.  The following table summarizes the activity in the related Job Security Benefits reserve:

   
Reserve (in millions)
   
Number of Employees
 
   
First Nine Months 2008
   
Full Year 2007
   
First Nine Months 2008
   
Full Year 2007
 
Beginning balance
  $ 817     $ 1,036       8,316       10,728  
Additions to Job Security Benefits reserve/Transfers from voluntary separation program (i.e., rescissions)
    77       232       728       2,220  
Voluntary separations and relocations
    (239 )     (311 )     (2,764 )     (4,632 )
Benefit payments and other adjustments
    (129 )     (140 )     (1,821 )      
Ending balance
  $ 526     $ 817       4,459       8,316  

Included in "Benefit payments and other adjustments" above is a $344 million decrease in the third quarter of 2008, primarily due to a reduction in the number of employees in the reserve as a result of three ACH plants whose employees are no longer probable to be permanently idled.

The reserve balance above takes into account several factors, including the demographics of the population at each affected facility, redeployment alternatives, and recent experience relative to voluntary redeployments.  Due to the complexities inherent in estimating this reserve, our actual costs could differ materially.  We continue to expense costs associated with the small number of employees who are temporarily idled on an as-incurred basis.

Separation Actions

The costs of voluntary employee separation actions are recorded at the time of an employee's acceptance, unless the acceptance requires explicit approval by the Company.  The costs of conditional voluntary separations are accrued when all conditions are satisfied.  The costs of involuntary separation programs are accrued when management has approved the program, the affected employees have been identified, and termination is probable.

 
12

 

Item 1.  Financial Statements (Continued)

NOTE 6. JOB SECURITY BENEFITS RESERVE AND EMPLOYEE SEPARATION ACTIONS (Continued)

UAW Voluntary Separations.  The following table summarizes the activity in the related separation reserve, with the expense recorded in Automotive cost of sales:

   
Reserve (in millions)
   
Number of Employees
 
   
First Nine Months 2008
   
Full Year 2007
   
First Nine Months 2008
   
Full Year 2007
 
Beginning balance
  $ 225     $ 2,435       1,374       26,351  
Voluntary acceptances
    222             1,832        
Payments/Terminations
    (297 )     (1,912 )     (2,440 )     (21,587 )
Rescissions and other adjustments
    14       (298 )     (61 )     (3,390 )
Ending balance
  $ 164     $ 225       705       1,374  

The ending balances shown above represent the cost of separation packages for employees who accepted packages but have not yet left the Company, as well as employees who accepted a retirement package and ceased duties, but who will remain on our employment rolls until they reach retirement eligibility.  Excluded from the table are 3,389 acceptances during the first nine months of 2008 of voluntary retirement incentive packages, the costs for which are included in pension and other postretirement employee benefits ("OPEB") separation costs.

Other Employee Separation Actions.  In the second quarter of 2008, we announced plans to reduce salaried employee costs in North America by 15%.  We completed those actions by the third quarter and recognized pre-tax charges in the United States of $65 million and $78 million for the third quarter and first nine months of 2008, respectively.  In 2007, we completed our previously-announced North American salaried employee reduction and incurred $154 million of pre-tax charges in the United States through the first nine months of 2007.  These charges are reported in Automotive cost of sales and Selling, administrative and other expenses and exclude costs for pension and OPEB.

In addition, we had pre-tax charges for other hourly and salaried employee separation actions outside the United States. We recognized $70 million and $28 million for the third quarter of 2008 and 2007, respectively, and $108 million and $280 million for the first nine months of 2008 and 2007, respectively.  These charges are reported in Automotive cost of sales and Selling, administrative and other expenses and exclude costs for pension and OPEB.

Financial Services Sector

Separation Actions

In 2007, we recognized pre-tax charges of $45 million in Selling, administrative and other expenses for employee separation actions.  The majority of these actions were associated with Ford Credit's North American business transformation initiative (i.e., the consolidation of its North American branches into its seven existing business centers).  These charges exclude costs for pension and OPEB.

NOTE 7. INCOME TAXES

Generally, for interim tax reporting we estimate one single tax rate for tax jurisdictions not subject to a valuation allowance, which is applied to the year-to-date ordinary income/(loss).  However, we manage our operations by multi-jurisdictional business units and thus are unable to reasonably compute one overall effective tax rate.  Accordingly, our worldwide tax provision is calculated pursuant to Financial Accounting Standards Board ("FASB") Interpretation No. 18, Accounting for Income Taxes in Interim Periods, which provides that tax (or benefit) in each foreign jurisdiction not subject to valuation allowance be separately computed as ordinary income/(loss) occurs within the jurisdiction.

SFAS No. 109, Accounting for Income Taxes ("SFAS No. 109") requires that the provision for/(benefit from) income taxes be allocated between continuing operations and other categories of earnings (such as discontinued operations or other comprehensive income) for each tax jurisdiction.  In periods in which there is a year-to-date pre-tax loss from continuing operations and pre-tax income in other categories of earnings, tax provision is first allocated to the other categories of earnings.  A related tax benefit is then recorded in continuing operations.  Included in Provision for/(Benefit from) income taxes are tax benefits of $630 million for the third quarter of 2008 and $1.3 billion for the first nine months of 2008 related to these intraperiod allocations.

Also included in third quarter 2008 Provision for/(Benefit from) income taxes is a $94 million tax provision that represents a correction to amounts that were incorrectly recorded in Accumulated other comprehensive income for the periods beginning with the fourth quarter of 2006 related to foreign deferred tax assets.  We have not restated our prior-period financial statements because we have concluded that the effect of correcting for this item and other immaterial out-of-period adjustments is not material.

 
13

 

Item 1.  Financial Statements (Continued)

NOTE 7. INCOME TAXES (Continued)

Uncertain tax benefits are recognized in accordance with FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 ("FIN 48") on a more-likely-than-not standard.  At any point in time, Ford's cross-border transfer prices are being evaluated by multiple governments around the world.  Over the next several months, bilateral discussions are expected to occur between the United States and a major trading partner.  It is reasonably possible that the total amount of unrecognized tax benefits related to these unresolved transfer pricing disputes may significantly increase or decrease in the next twelve months as a result of these discussions; an estimate of the reasonably possible change cannot be made at this time.

NOTE 8. DISCONTINUED OPERATIONS, HELD-FOR-SALE OPERATIONS, OTHER DISPOSITIONS, AND ACQUISITIONS

Automotive Sector

Discontinued Operations

Automotive Protection Corporation ("APCO").  Our North American operation APCO was sold in the second quarter of 2007.  Third quarter and first nine months results for this discontinued operation are shown in the table below (in millions):

   
Third Quarter
   
First Nine Months
 
   
2008
   
2007
   
2008
   
2007
 
Sales and revenues
  $     $     $     $ 13  
                                 
Operating income/(loss) from discontinued operations
  $     $     $     $ 2  
Gain/(Loss) on discontinued operations
                      51  
(Provision for)/Benefit from income taxes
                      (19 )
Income/(Loss) from discontinued operations
  $     $     $     $ 34  

Held-for-Sale Operations

Jaguar Land Rover.  During 2007, we committed to sell our Jaguar Land Rover operations in order to focus on our core Automotive operations and to build liquidity.  At December 31, 2007, we classified the assets and liabilities of these operations as held for sale on our balance sheet.  On March 25, 2008, we entered into a definitive agreement with Tata Motors Limited pursuant to which we would sell all of our interest in Jaguar Land Rover for $2.3 billion, subject to customary purchase price adjustments upon completion (e.g., relating to working capital, cash, and debt), and agreed to contribute up to about $600 million to Jaguar and Land Rover pension plans.  In the first quarter of 2008, we recorded a pre-tax impairment charge of $421 million reported in Automotive cost of sales related to the disposal of these operations.

On June 2, 2008, we completed the sale of Jaguar Land Rover.  At the time of the sale, we received $2.4 billion in cash proceeds and recognized a second quarter pre-tax loss of $106 million, reported in Automotive interest income and other non-operating income/(expense), net.

During the third quarter, we received $132 million in cash, which reflected final settlement of purchase price adjustments and recognized an additional pre-tax loss of $30 million reported in Automotive interest income and other non-operating income/(expense), net. With this, our pre-tax loss is $136 million.

The assets and liabilities of Jaguar Land Rover that were classified as held-for-sale operations at December 31, 2007 are summarized as follows (in millions):

   
December 31, 2007
 
Assets
     
Receivables
  $ 758  
Inventories
    1,530  
Net property
    2,246  
Goodwill and other net intangibles
    2,010  
Pension assets
    696  
Other assets
    297  
Total assets of the held-for-sale operations
  $  7,537  
         
Liabilities
       
Payables
  $ 2,395  
Pension liabilities
    19  
Warranty liabilities
    645  
Other liabilities
    1,765  
Total liabilities of the held-for-sale operations
  $  4,824  

 
14

 

Item 1.  Financial Statements (Continued)

NOTE 8. DISCONTINUED OPERATIONS, HELD-FOR-SALE OPERATIONS, OTHER DISPOSITIONS, AND ACQUISITIONS (Continued)

As part of the transaction, we will continue to supply Jaguar Land Rover with powertrains, stampings, and other vehicle components.  We also committed to provide transitional support, including engineering, information technology, accounting, and other services.  Ford Credit will provide financing for Jaguar Land Rover dealers and customers during a transition period, which can vary by market, for up to 12 months.

ACH.  On April 14, 2008, ACH completed the sale of its glass business to Zeledyne, LLC.  The sale included the Nashville, Tulsa, and VidrioCar plants, along with the research and development, engineering, sales and aftermarket operations in Tennessee and Michigan.  These facilities continue to supply Ford with automotive glass products.  As a result of the transaction, we recognized a second quarter pre-tax loss of $285 million reported in Automotive interest income and other non-operating income/(expense), net. This loss was comprised of asset write-offs of $149 million, long-term contractual restructuring obligations of $104 million, and $32 million of transaction costs and other related expenses.

During the third quarter of 2008, the sale agreement between Ford and Zeledyne, LLC was amended resulting in an additional $19 million pre-tax loss reported in Automotive interest income and other non-operating income/(expense), net. The third quarter loss is primarily related to changes in long-term contractual restructuring obligations.  With this, our pre-tax loss is $304 million.

In the second quarter of 2008, we disclosed that we expected the sale of the Milan plant, which produces fuel tanks and bumper fascias, would be completed by the end of this year.  Accordingly, at June 30, 2008, ACH classified the assets and liabilities of the Milan plant as held for sale in our balance sheet.  We also recorded a pre-tax impairment charge of $18 million in the second quarter of 2008, which represented the excess of net book value of the held-for-sale assets over the expected proceeds based on June 30, 2008 conditions.

During the third quarter of 2008, deteriorating domestic economic and industry conditions significantly reduced the probability of selling the Milan plant within the next 12 months, although negotiations are ongoing.  Accordingly, at September 30, 2008, the Milan plant has been reclassified and reported as held and used.  The pre-tax impairment charge of $18 million previously recorded in the second quarter of 2008 continues to be reported in Automotive cost of sales.

Other Dispositions

ACH.  During 2008, ACH terminated the non-binding agreement for the sale of the business at the Sandusky plant, which primarily produces lighting components, and the Saline plant, which primarily produces cockpit modules, instrument panels, door trim, and floor console products.  Neither of these businesses were classified as held for sale at September 30, 2008.

Financial Services Sector

Discontinued Operations

Triad Financial Corporation ("Triad").  In 2005, Ford Credit completed the sale of Triad.  Triad specialized in automobile retail installment sales contracts with borrowers who generally would not be expected to qualify, based on their credit worthiness, for traditional financing sources such as those provided by commercial banks or automobile manufacturers' affiliated finance companies, primarily through non-Ford dealerships.  In 2005, Ford Credit recognized a $4 million after-tax gain on disposal of discontinued operations. For the nine months ended September 30, 2008, Ford Credit received additional proceeds primarily based on better-than-anticipated securitized portfolio performance, and recognized a $9 million after-tax gain in Income/(Loss) from discontinued operations.

Other Dispositions

Nordic Operations.  During the second quarter of 2008, Ford Credit completed the creation of a new legal entity and transferred into it the majority of its business and assets from Denmark, Finland, Norway, and Sweden.  By the end of the second quarter, Ford Credit had sold 50% of the new legal entity.  As a result of the sale, Ford Credit reduced Finance receivables, net by $1.7 billion, and we recognized a pre-tax gain in Financial Services revenues of $85 million, net of transaction costs and including $35 million of foreign currency translation adjustments.  Ford Credit reports its ownership interest in the new legal entity as an equity method investment.  The new legal entity will support the sale of Ford vehicles in these markets.

 
15

 

Item 1.  Financial Statements (Continued)

NOTE 8. DISCONTINUED OPERATIONS, HELD-FOR-SALE OPERATIONS, OTHER DISPOSITIONS, AND ACQUISITIONS (Continued)

PRIMUS Financial Services Inc. ("PRIMUS Japan").  In April 2008, Ford Credit completed the sale of 96% of its ownership interest in PRIMUS Japan, Ford Credit's operation in Japan that offers automotive retail and wholesale financing of Ford and Mazda vehicles.  As a result of the sale, Finance Receivables, net were reduced by $1.8 billion, Debt was reduced by $252 million, and we recognized a pre-tax gain of $22 million, net of transaction costs and including $28 million of foreign currency translation adjustments, in Financial Services revenues.  Ford Credit reports its remaining ownership interest as a cost method investment.

Primus Finance and Leasing, Inc. ("Primus Philippines").  During the second quarter of 2008, Ford Credit completed the sale of its 60% ownership interest in Primus Philippines, which is Ford Credit's operation in the Philippines offering automotive retail and wholesale financing of Ford and Mazda vehicles.  Ford Credit also completed the sale of its 40% ownership interest in PFL Holdings, Inc., a holding company in the Philippines that owns the remaining 40% ownership interest in Primus Philippines.  As a result of the sale, we recognized a pre-tax gain of $5 million, net of transactions costs and including $1 million of foreign currency translation adjustments, in Financial Services revenues.

AB Volvofinans ("Volvofinans").  During the third quarter of 2007, Ford Credit sold a majority of its interest in Volvofinans, an unconsolidated subsidiary that finances the sale of Volvo and Renault vehicles through Volvo dealers in Sweden.  As a result of the transaction, we received $157 million as proceeds from the sale, and recognized a pre-tax gain of $51 million reported in Financial Services revenues.

NOTE 9. AMOUNTS PER SHARE OF COMMON AND CLASS B STOCK

The calculation of diluted income per share of Common and Class B Stock takes into account the effect of common stock equivalents, such as stock options and convertible securities, considered to be potentially dilutive.  Basic and diluted income/(loss) per share were calculated using the following (in millions):

   
Third Quarter
   
First Nine Months
 
   
2008
   
2007
   
2008
   
2007
 
Basic and Diluted Income/(Loss)
                       
Basic income/(loss) from continuing operations
  $ (129 )   $ (380 )   $ (8,705 )   $ 54  
Effect of dilutive senior convertible notes (a)
                       
Effect of dilutive 6.50% Cumulative Convertible Trust Preferred Securities ("Trust Preferred Securities") (b)
                       
Diluted income/(loss) from continuing operations
  $ (129 )   $ (380 )   $ (8,705 )   $ 54  
                                 
Basic and Diluted Shares
                               
Average shares outstanding
    2,280    
2004
      2,236       1,931  
Restricted and uncommitted-ESOP shares
    (1 )     (1 )     (1 )     (1 )
Basic shares
    2,279       2,003       2,235       1,930  
Net dilutive options and restricted and uncommitted-ESOP shares
    (c)     (c)     (c)     12  
Dilutive senior convertible notes (a)
                       
Dilutive convertible trust preferred securities (b)
                       
Diluted shares
    2,279       2,003       2,235       1,942  
__________
Not included in calculation of diluted earnings per share due to their antidilutive effect:
(a)
538 million shares and the related income effect for senior convertible notes.
(b)
282 million shares and the related income effect for Trust Preferred Securities through August 2, 2007.  As of August 3, 2007, following the conversion of about 43 million of our Trust Preferred Securities, 162 million shares and the related income effect are not included in the calculation.  For further discussion of the conversion, see Note 16 of the Notes to the Financial Statements in our 2007 Form 10-K Report.
(c)
28 million, 19 million, and 26 million contingently-issuable shares (primarily reflecting restricted stock units) for the third quarter of 2008, third quarter of 2007, and first nine months of 2008, respectively.

 
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Item 1.  Financial Statements (Continued)

NOTE 10. FAIR VALUE MEASUREMENTS

We adopted SFAS No. 157, Fair Value Measurements ("SFAS No. 157"), on January 1, 2008.  SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The fair value should be based on assumptions that market participants would use, including a consideration of non-performance risk.

In determining fair value, we use various valuation techniques and prioritize the use of observable inputs.  The availability of observable inputs varies from instrument to instrument and depends on a variety of factors including the type of instrument, whether the instrument is actively traded, and other characteristics particular to the transaction.  For many financial instruments, pricing inputs are readily observable in the market, the valuation methodology used is widely accepted by market participants, and the valuation does not require significant management discretion.  For other financial instruments, pricing inputs are less observable in the marketplace and may require management judgment.

We assess the inputs used to measure fair value using a three-tier hierarchy based on the extent to which inputs used in measuring fair value are observable in the market.  Level 1 inputs include quoted prices for identical instruments and are the most observable.  Level 2 inputs include quoted prices for similar assets and observable inputs such as interest rates, currency exchange rates, commodity rates, and yield curves.  Level 3 inputs are not observable in the market and include management's judgments about the assumptions market participants would use in pricing the asset or liability.  The use of observable and unobservable inputs is reflected in our hierarchy assessment disclosed in the tables below.

Our fair value processes include controls that are designed to ensure that fair values are appropriate.  Such controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and reviews by senior management.

The following section describes the valuation methodologies used to measure fair value, key inputs, and significant assumptions.

Cash Equivalents – Financial Instruments.  We classify highly liquid investments, with a maturity of 90 days or less at the date of purchase, including U.S. Treasury bills, federal agency securities, and commercial paper rated A-1 / P-1 (or higher) as cash equivalents.  Prior to the adoption of SFAS No. 157, we carried cash equivalents at amortized cost, which approximates fair value.  Effective January 1, 2008, we measure financial instruments classified as cash equivalents at fair value.  We use quoted prices where available to determine fair value for U.S. Treasury notes, and industry-standard valuation models using market-based inputs when quoted prices are unavailable, such as for government agency securities and corporate obligations.

Marketable Securities.  Our marketable securities portfolios include investments in government securities, corporate obligations and equities, and asset-backed securities with a maturity of greater than 90 days at the date of purchase.  Where available, including for U.S. Treasury notes and equities, we use quoted market prices to measure fair value.  If quoted market prices are not available, such as for government agency securities, asset-backed securities, and corporate obligations, prices for similar assets and matrix pricing models are used.  In certain cases, where there is limited transparency to valuation inputs, we may contact securities dealers and obtain dealer quotes.

Concurrent with our adoption of SFAS No. 157, we elected to apply the fair value option under SFAS No. 159 to our financial instruments, including marketable securities, loaned securities, and those classified as cash equivalents.  SFAS No. 159 permits entities to measure certain financial assets and liabilities at fair value.  The fair value option may be elected on an instrument-by-instrument basis and is irrevocable.  Unrealized gains and losses on items for which the fair value option has been elected are recognized in earnings at each subsequent reporting date.  This election resulted in a cumulative after-tax increase of approximately $12 million to the opening balance of Retained earnings.  Prior to the election of SFAS No. 159, we classified our securities as trading, available-for-sale, or held-to-maturity.  The unrealized gains and losses for available-for-sale securities were recorded in Accumulated other comprehensive income/(loss), and the unrealized gains and losses for held-to-maturity securities were not recognized.

 
17

 

Item 1.  Financial Statements (Continued)

NOTE 10. FAIR VALUE MEASUREMENTS (Continued)

Derivative Financial Instruments.  As part of our risk management strategy, we enter into derivative transactions to mitigate exposures.  Our derivative instruments include interest rate swaps, currency swaps, currency and commodity forwards, currency and commodity options, and currency futures.  The vast majority of our derivatives are not exchange-traded and are over-the-counter customized derivative transactions.  Substantially all of our derivative exposures are with counterparties that have long-term credit ratings of single-A or better.

We estimate the fair value of our derivatives using industry-standard valuation models, including Black-Scholes and Curran's Approximation.  These models project future cash flows and discount the future amounts to a present value using market-based expectations for interest rates, foreign exchange rates, and commodity prices, and the contractual terms of the derivative instruments.

We include an adjustment for non-performance risk in the recognized measure of fair value of derivative instruments.  The adjustment reflects the full credit default spread (“CDS”) applied to a net exposure, by counterparty.  We use our counterparty's CDS when we are in a net asset position and our own CDS when we are in a net liability position.  At September 30, 2008, our adjustment for non-performance risk (relative to a measure based on unadjusted LIBOR) reduced derivative assets by $14 million and $52 million for Automotive and Financial Services sectors, respectively; and reduced derivative liabilities by $14 million and $88 million for Automotive and Financial Services sectors, respectively.

In certain cases, market data is not available and we use management judgment to develop assumptions which are used to determine fair value.  This includes situations where there is illiquidity for a particular currency or commodity, or for longer-dated instruments.  For longer-dated instruments where observable interest rates or foreign exchange rates are not available for all periods through maturity, we hold the last available data point constant through maturity.  For certain commodity contracts, observable market data may be limited and, in those cases, we generally survey brokers and use the average of the surveyed prices in estimating fair value.

Retained Interests in Sold Receivables.  We retain certain interests in receivables sold in off-balance sheet securitization transactions, including residual interest in securitizations and restricted cash.  We estimate the fair value of retained interests using internal valuation models, market inputs, and our own assumptions.  The three key inputs that affect the valuation of the residual interest cash flows include credit losses, prepayment speed, and the discount rate. The fair value of residual interest is estimated based on the present value of monthly collections on the sold finance receivables in excess of amounts needed for payment of the debt and other obligations issued or arising in the securitization transactions.  The fair value of the residual interest in securitizations and the cash reserve account is determined using a discounted cash flow analysis.

 
18

 

Item 1.  Financial Statements (Continued)

NOTE 10. FAIR VALUE MEASUREMENTS (Continued)

The following table summarizes the fair values of financial instruments measured at fair value on a recurring basis at September 30, 2008 (in millions):

   
Items Measured at Fair Value on a Recurring Basis