MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Generation of Revenue, Income and Cash  Our Automotive sector’s revenue, income and cash are generated primarily from sales of vehicles to our dealers and  distributors (i.e., our customers). Vehicles we produce generally are subject to firm orders from our customers and generally are  deemed sold (with the proceeds from such sale recognized in revenue) immediately after they are produced and shipped to our  customers. This is not the case, however, with respect to vehicles produced for sale to daily rental car companies that are subject  to a guaranteed repurchase option or vehicles produced for use in our own fleet (including management evaluation vehicles).  Vehicles sold to daily rental car companies that are subject to a guaranteed repurchase option are accounted for as operating  leases, with lease revenue and profits recognized over the term of the lease. When we sell the vehicle at auction, we recognize  a gain or loss on the difference, if any, between actual auction value and the projected auction value. Therefore, except for the  impact of the daily rental units sold subject to a guaranteed repurchase option and those units placed into our own fleet, vehicle  production is closely linked with unit sales and revenue from such sales. Most of the vehicles sold by us to our dealers and distributors are financed at wholesale by Ford Credit. Upon Ford Credit  originating the wholesale receivable related to a dealer’s purchase of a vehicle, Ford Credit pays cash to the relevant legal  entity in our Automotive sector in payment of the dealer’s obligation for the purchase price of the vehicle. The dealer then pays off the wholesale finance receivable when it sells the vehicle to a retail customer. (See Note 1 of the Notes to the Financial Statements.) Our Financial Services sector’s revenue is generated primarily from interest on finance receivables, net of certain deferred  loan origination costs that are included as a reduction of financing revenue, and such revenue is recognized over the term  of the receivable using the interest method. Also, revenue from operating leases, net of certain deferred origination costs, is  recognized on a straight-line basis over the term of the lease. Income is generated to the extent revenues exceed expenses, most  of which are interest and operating expenses.  Transactions between the Automotive and Financial Services sectors occur in the ordinary course of business. For example,  Ford Credit receives interest supplements and other support cost payments from the Automotive sector in connection with  special vehicle financing and leasing programs that it sponsors. Ford Credit records these payments as revenue over the term  of the related finance receivable or operating lease. The Automotive sector records the estimated costs of marketing incentives,  including dealer and retail customer cash payments (e.g., rebates) and costs of special financing and leasing programs, as a  reduction to revenue at the later of the date the related vehicle sales are recorded or at the date the incentive program is both  approved and communicated. Excess Capacity. According to CSM Worldwide, an automotive research firm, in 2004 the estimated automotive industry  global production capacity for light vehicles (about 74 million units) significantly exceeded global production of cars and trucks  (about 60 million units). In North America and Europe, the two regions where the majority of revenue and profits are earned  in the industry, excess capacity was an estimated 17% and 13%, respectively. CSM Worldwide projects that excess capacity  conditions could continue for several more years. Pricing Pressure. Excess capacity, coupled with a proliferation of new products being introduced in key segments by the  industry, will keep pressure on manufacturers’ ability to increase prices on their products. In addition, the incremental new  capacity in the United States by foreign manufacturers (so-called “transplants”) in recent years has contributed, and is likely to  continue to contribute, to the severe pricing pressure in that market. In the United States, the reduction of real prices for similarly  contented vehicles has become more pronounced since the late 1990s, and we expect that a challenging pricing environment  will continue for some time to come. In Europe, the automotive industry also has experienced intense pricing pressure for  several years for the same reasons discussed above, which has been exacerbated in recent years as a result of the Block  Exemption Regulation. Consumer Spending Trends. We expect, however, that a decline in, or the inability to increase, vehicle prices could be offset  by the spending habits of consumers and their propensity to purchase over time higher-end, more expensive vehicles and/or  vehicles with more features. Over the next decade, in the United States and in other mature markets, we expect that growth in  spending on vehicle mix and content will grow at least as fast as real GDP per capita. The benefits of this to revenue growth in  the automotive industry are significant. In the United States, for example, consumers in the highest income bracket are buying  more often and are more frequently buying upscale.  Although growth in vehicle unit sales (i.e., volume) will be greatest in emerging markets in the next decade, we expect that the  mature automotive markets (e.g., North America, Western Europe and Japan) will continue to be the source of a substantial  majority of global industry revenues over the next decade. We also expect that the North American market will continue as the  single largest source of revenue for the automotive industry in the world in the next decade. 2 2 Key Economic Factors and Trends Affecting Automotive Industry