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Bayerische Motoren Werke AG  (NASDAQOTH:BAMXF)
Q3 2018 Earnings Conference Call
Nov. 07, 2018, 4:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Good afternoon, ladies and gentlemen. I would like to welcome you all to our telephone conference for the third quarter results. With us today is Harald Kruger, Chairman of the Board of Management and Nicolas Peter, our CFO. First, Harald Kruger will give you an update on the business performance during the third quarter of 2018. Nicolas Peter will then take you through our financial results. Afterwards, we will have time for a Q&A session. Mr. Kruger, please go ahead.

Harald Kruger -- Chairman

Good afternoon, ladies and gentlemen. The BMW Group has two firm principles. We take a long-term approach and we chart our own course. That is what has made us strong. Securing our Company's future is the top priority in all that we do. This is especially true in volatile and challenging times like these our industry is currently experiencing. Thanks to our financial strength, we are able to invest in new technologies and services. This year alone, we will be channeling another EUR1 billion into upfront investments in future mobility. At the same time, we are gearing the whole Company to be future-orientated, efficient and flexible in terms of our structures, processes and know-how. In recent weeks and months, our business environment has become a lot more difficult, but steering through headwinds while maintaining our course is part of the BMW Group's success story.

The current situation is certainly unique. We are seeing an accumulation of challenges on the geopolitical, trade and competition fronts and all of them vary from one region to another. Let me give you a few examples. The planned CO2 targets for the EU from 2030 onwards; the trade dispute between U.S. and China is straining the entire global economy; the possibility of a no deal Brexit remains with all its implications for companies such as ours. We are also having to make higher provisions for goodwill and warranty activities. The BMW Group has successfully completed the changeover to the new WLTP test procedure. But in the European markets, we are now facing supply distortions and high pressure on prices. All of these challenges are affecting our business in parallel and at a very intensive level.

As a result of these factors, we had to adjust our guidance for 2018. But our targets remain ambitious. Our strategy NUMBER ONE > NEXT sets clear priorities for the coming years. We remain focused on the following key areas: First, systematic electrification of all brands and model series; development of autonomous driving; third, expansion of mobility services and through the planned joint venture with the Daimler Group; and fourth, strategic development of our global production network. Today, the BMW Group is a much more global Company than it was 10 years ago. Our customers in the three main economic regions have different wants and needs. We are therefore stepping up our commitment in Europe, Asia and the Americas. In Europe, we are offering solutions for sustainable mobility in cities. In Germany, we are supporting the federal government and municipalities in their efforts to improve urban air quality with the effective measures. In Germany and Europe, we are forging ahead with e-mobility and production of battery cells.

And here I can give you three examples. First, we will be building the all-electric BMW i4 and the iNEXT in Munich and Dingolfing, respectively, from 2021. On the World Flight of our Vision Vehicle, we demonstrated that the iNEXT is much more than just a car. We have signed a contract worth more than EUR4 billion with CATL for delivery of battery cells. A new plant will be built in Germany in Thuringen. We have presented our proposal for a technology consortium with Northvolt and Umicore to the European Commission. We want to produce battery cells in Europe and establish the entire value chain for cell manufacturing.

Now to our second region, Asia. The BMW Group is widely respected in China. We are now taking our local footprint to the next level. We will be the first foreign car maker allowed to expand its share in a Chinese joint venture and we plan to increase our stake in the venture with Brilliance to 75%. BBA will be investing more than EUR3 billion in its plants in Shenyang over the next few years. In 2020, we will start building the first fully electric BMW in China. This iX3 will be exported from there. It will be the first model to come with a fifth-generation electric drive train, one that does not use rare earth.

And finally, the third region is the Americas. The United States is our second home. The BMW Group is not only the largest net exporter of vehicles from the U.S. We also create a total of almost 70,000 direct and indirect jobs in the U.S. In recent years, we have invested nearly EUR9 billion in our largest plant located in South Carolina. Another EUR600 million will follow up to 2021. At the end of this year, a completely new vehicle concept, the BMW X7 will start rolling off the production line in Spartanburg. Many customers in North America, China, Russia and in the Middle East are eagerly awaiting this, the biggest X model. The X7 is another building block in our offensive in the fast-growing luxury segment. It has received very positive reviews in the media, especially for its design. The X7 will have its world premier in LA in three weeks' time.

Ladies and gentlemen, no matter what region the BMW Group is active in, wherever we go we are a positive force for growth and prosperity. This will be also the case from June 2019 in Mexico and later also in Hungary. Thanks to our flexible -- highly flexible production network, we are able to balance out many market fluctuations and custom barriers. We continually target long-term growth with our attractive and technologically diverse portfolio. Because our products are more desirable than ever, from January to September of this year we sold more vehicles than ever before in this nine-month period. This applies to both the BMW Group and the BMW brand. The BMW Group is segment leader. Rolls-Royce also posted significant gains. BMW Motorrad remains on par with the previous year. MINI slightly below.

On the electrification side, we are right on track to sell more than 140,000 vehicles this year. There are now over 313,000 electrified BMW Group vehicles on the roads worldwide. The BMW 3 Series is our most successful model, with more than 15 million sold. The new generation sets new standards for connectivity, especially with its range of digital services and driver assistance options. This offers our customers a new level of sheer driving pleasure. Production is currently ramping up at the Munich plant. Next year, the 3 Series will also be rolling off the production line at our new plant in Mexico and in China.

Our model offensive continues at full speed. The almost completely renewed BMW X family will also play a significant part in this. The new X3 is a hit with customers, with sales up more than 60% in the third quarter. The new X4 has been available since July. The new X5 will be released this month. And next year, this will be joined by M models of the X3 and X4, as well as X3 and X5 plug-in hybrids. All these models will strengthen our leading position in plug-in hybrids. The first 8 Series Coupes are being delivered to customers right now. Last week, we released the first pictures of the 8 Series convertible. We will be launching this model in spring of next year. In 2019, the 8 Series Gran Coupe and the corresponding M models will complete the new 8 Series range in the luxury segment. As you can see, we will continue to generate strong product momentum over the next few years.

Ladies and gentlemen, the global environment is likely to stay volatile for the foreseeable future and the level of complexity will remain just as challenging. The growth forecast for both the global economy and the Eurozone has been lowered for 2018. The BMW Group has more than 100 years of experience in dealing with change. We do not shy away from any challenge. We work toward solutions and pave new roads to success. We are investing in our business in this direction and winning new customers for our four premium brands. We are on track to meet our adjusted targets for the current year. I would like to clearly emphasize we remain a profitable, reliable Company and we will continue to lead our Company into the future. Thank you.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you very much, Harald. Nicolas, please go ahead.

Nicolas Peter -- Chief Financial Officer

Ladies and gentlemen, good afternoon. The increasingly difficult market environment in the third quarter has impacted earnings development across the entire automotive industry, including at the BMW Group. In September, we therefore, adjusted our forecast for 2018. In line with this new guidance, earnings for the first nine months are on track to reach our goals for the year.

Group earnings before tax for the year to the end of September totaled EUR7.88 billion. Although lower than the previous year, this is still our second best nine-month result ever. The EBIT margin of 7.6% in the automotive segment is also on course to meet our adjusted guidance of at least 7% for the full year. We are tackling the current challenges and concentrating on our operating business, as well as gearing up for the future. Gearing up for the future remains our absolute priority.

As previously announced, we will be investing a total of around EUR1 billion more in research and development of new technologies this year. As communicated at the beginning of the year, the R&D ratio increased to 6.9% in the third quarter. We knew from the start that 2018 was never going to be easy. In addition to high upfront investment in future projects, we are also facing currency and commodity headwinds in the high three-digit million range as expected. These already challenging conditions, intensified even further over the course of the summer.

The WLTP transition had thrown the European market completely off balance. We had our vehicles certified early, ahead of the deadline, but have still not been able to isolate ourselves from the overall market development. We made a conscious decision early on not to follow every price war. The BMW Group responded immediately to these changes and we adjusted our production volumes accordingly. Thanks to this careful planning, we were able to reduce our inventories by nearly 20,000 units in the third quarter. The trade dispute between the U.S. and China is straining the global economy. With different production locations worldwide, not all competitors are equally affected. The volatile trade situation also unsettled customers in the third quarter.

As previously announced, we have increased our provisions for warranty costs and goodwill significantly to ensure that we are appropriately covered in this area. On the cost side, we began implementing countermeasures early on. In addition to prioritizing more strictly, we also decided on a number of short and long-term measures in recent months. In light of the challenges I referred to, additional efforts will be needed to support our profitability targets.

Ladies and gentlemen, let's take a look at the Group financial statements for the first nine months in more detail. Revenues for the year to the end of September totaled EUR72.46 billion, slightly lower than the previous year due to currency translation. Adjusted for this effect, revenues rose by 1.5%. In view of the factors I just mentioned, pre-tax earnings were in line with our expectations, reaching EUR7.88 billion at the end of September. The figure for the third quarter was EUR1.85 billion. Regardless of these challenging external conditions, the BMW Group remains on course for the future. Upfront investments in continued development of e-mobility and autonomous driving will be essential for tomorrow's success.

Research and development expenditure for the year to the end of September increased accordingly to around EUR4.45 billion as planned. The R&D costs recognized in the income statement were nearly EUR400 million higher year-on-year. The R&D ratio for the first three quarters rose to 6.1%. Capital expenditure for the same period reached EUR2.89 billion, with a CapEx ratio of 4%. This mainly reflects product and structural investments for the new X3, as well as preparations for the launch of the X5 and the X7. As planned, capital expenditure will increase once again in the fourth quarter with the start of production of our new 3 Series and 8 Series models. At Group level, the EBT margin currently stands at 10.9%.

Let's take a brief look at the individual segments. The Automotive segment saw a slight increase in deliveries in the first nine months of 2018 to more than 1.83 million vehicles. Adjusted for currency translation effects, segment revenues rose slightly by 2.9%. The unadjusted figure was on par with the previous year at around EUR62.63 billion. Here we are also feeling the effects of the difficult pricing situation in Europe due to the WLTP transition. Higher expenses for warranty and goodwill activities have raised our cost of sales. As previously mentioned, R&D costs will also be significantly higher than the previous year. Higher tariffs resulting from the current trade tensions, has put earnings under further pressure.

The Automotive segment's operating earnings for the third quarter decreased to EUR930 million. As a result, the figure for the year to the end of September was also lower at EUR4.73 billion. As I already mentioned, the EBIT margin of 7.6% for the year to the end of September is in line with our new guidance.

Ladies and gentlemen, please allow me one personal remark at this point. As you know, we do not adjust our figures as a matter of principle. If you want to discuss comparability, we can take a closer look at the individual profit effects in Q3, which you can also find in the quarterly report, during our Q&A session. The financial result benefited from our BBA joint venture business in China, which increased by 11.7% year-on-year. Pre-tax earnings in the Automotive segment totaled EUR5.35 billion for the first nine months of 2018.

Let me say a few words about the cash flow statement. Our free cash flow mainly reflects lower profits. For the year to the end of September, it nevertheless amounted to around EUR2.04 billion. In the third quarter, free cash flow amounted to about EUR100 million. Despite the difficult conditions, we are still targeting a free cash flow of EUR3 billion for the full year. But here I must emphasize, in light of the current challenges, this will not be an easy task.

In the Financial Services segment, our business with retail customers continues to perform well. At the end of the third quarter, we managed a total of 5.14 million contracts. This is 4.4% more than at the start of the year. China in particular posted significant growth of almost 17% in its total contract portfolio. The number of new financing contracts rose significantly in the third quarter with a slight increase on the leasing side. At EUR1.7 billion, pre-tax earnings for January to September were slightly lower year-on-year, reflecting the negative impact of currency translation effects, among other factors. As expected, the risk situation remained stable overall. In Europe, as in the previous quarter, residual values trended slightly downward in a number of markets. In North America, on the other hand, used car prices made a slight recovery. In Asia, we continued to see stable development.

Let's move on briefly to the Motorcycle segment. Despite the model changeover in the midsize class, deliveries remained at the same high level as the previous year. Operating earnings were at EUR208 million. The EBIT margin was 12.5%. Ladies and gentlemen, conditions remain challenging for the automotive industry. Trade barriers, the transition to WLTP, the debate over emissions and their respective levels, all these factors are hampering our business environment. The BMW Group responded promptly, of course, and has launched both short and long-term measures within the Company. We are strengthening our sales side with targeted programs. At the same time, we are stepping up countermeasures on the cost side. Thanks to our flexible international production system and high level of capacity utilization, we are able to adapt quickly to new situations. We are watching trade development, in particular, very closely. If conditions deteriorate significantly, effects on our guidance cannot be ruled out.

Against this background, our outlook for the full year is as follows. Group earnings before tax are expected to show a moderate decrease from the high level of the previous year. This adjusted outlook does not reflect any positive earnings effects that may result should the planned mobility services joint venture receive regulatory approval and close in 2018. In the Automotive segment, deliveries are expected to be slightly higher than the previous year, with an EBIT margin of at least 7%. Revenues are now forecast to be slightly lower year-on-year. In the Motorcycles segment, we should see a slight increase in deliveries, with an EBIT margin in the range of 8% to 10%. And in the Financial Services segment, we are aiming for a return on equity above our target figure of 14%.

Ladies and gentlemen, you know that the BMW Group has always been reliable and transparent. We remain true to our values even in these challenging times. We openly acknowledge risks and take appropriate action. We are facing a highly volatile environment as we enter the final quarter of the year. We cannot rule out that several of the factors I mentioned may continue to impact our business beyond 2018. However, we will see positive impetus next year from our rejuvenated product lineup.

There will be new generations of several key models. At the end of the year, our plants will be ramping up the successor to our successful 3 Series. Further 8 Series models will also go into production before the year end. In recent months, the new X3 has also successfully ramped up at three separate plants. With the X5 and X7, we have two more vehicles with high contribution margins ready to go. We expect these to give us fresh momentum in the next year. The entire automotive industry is currently confronted with challenging conditions. The BMW Group is and will remain a high performance Company. Even in turbulent times, we never lose sight of our long-term goals and continue to stay the course. Thank you.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you, Nicolas. And now ladies and gentlemen, the line will shortly be open for questions. Please wait for some technical advice.

Questions and Answers:

Operator

(Operator Instructions) The first question is from Tim Rokossa, Deutsche Bank. Your line is now open.

Tim Rokossa -- Deutsche Bank -- Analyst

Yes, thank you very much and good afternoon everyone. It's Tim from Deutsche Bank. I would like to raise two questions, please. The first one is that your messaging on volume and cash flow for Q4 sounds quite a bit more cautious than for example that one of your Stuttgart-based competitor. Can you help us understand what you see there in trends? Is Europe still WLTP impacted or is the underlying demand and pricing also simply weaker? Is China weaker or what exactly do you see there?

And secondly, Nicolas, I would like to pick on your personal remark. Even including the additional provisions, you would have ended the quarter below your 8% to 10% margin corridor, around 7.6% or so. We get the more cautious measures on Q4. Next year, you have a very strong product lineup, but variable costs will probably go up for everyone considering what's going on in the regulatory side. Does that mean we should say goodbye to your 8% to 10% margin corridor for sometime now or do you still plan to return to that with the countermeasures that you spoke about? Thank you.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you very much, Tim. We start with Nicolas, please.

Nicolas Peter -- Chief Financial Officer

Tim thanks for your question and remarks. As you know, we remain an ambitious Company and we set ourselves a very ambitious target and we are still committed to an EBIT margin of 8% to 10%. On the other hand side, if we reflect -- and it's a little bit too early to give a very precise indication regarding 2019. And on the more challenging side, we have to assume that some trade conflicts will continue, in particular between U.S. and China. There is uncertainty about the Brexit outcome and then we have some regulatory requirements, which force us to further invest in technology. On the currency and commodity side, we forecast to see some headwind in the mid-three digit area. And of course, we will continue to invest in our future, in particular, in e-mobility and autonomous driving. On the other hand side, we have as you rightly said, a really very, very strong product portfolio, with the X5 definitely a profit champion in our product portfolio. The X7 will contribute in a significant way, the X3 now being available produced in three plants. And not to forget, on the one hand side, the 3 Series still one of our most important volume models and the 8 Series in the top segment. So, we will balance those positive and more challenging effects in the weeks to come and we will come up with a clear guidance for the year 2019 in the first quarter.

Second topic, free cash flow. And on one hand side, I definitely believe we have taken the right approach in Q3 to reduce our production and our inventories by approximately 20,000 units in this very, very volatile environment. Very difficult to forecast exactly how in particular the European market will develop. In China, we have seen a strong month on our side in October, despite an overall market in China being relatively weak. And in Europe, we still feel the impact of the WLTP changeover, with some of our competitors being at more than minus 50%, minus 60% in major markets and others, plus 20%, which is indicating that the market is not in balance. And on top, we have of course, due to the fact that in Q4 we are planning the ramp-up of the 3 Series in our plants, the X5, we have higher investment scheduled and planned in the fourth quarter 2018. Having said this, still we aim for the EUR3 billion, but this is not a walk in the park.

Tim Rokossa -- Deutsche Bank -- Analyst

Thank you very much.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Good. Thank you very much, Tim. Next question please.

Operator

The next question is from Patrick Hummel, UBS. Your line is now open. Please go ahead.

Patrick Hummel -- UBS -- Analyst

Yes, thank you. Good afternoon gentlemen. Two questions. First one, I know this is not the 2019 guidance day today, but just to get a bit more granular understanding about the things that you have under control. Can you just help us with your updated thoughts on R&D? I think you said a year ago that the 7% level is sort of the peak, and then from here we should see normalization, meaning a negative trend in the R&D ratio, is that still what you see today? And can you elaborate a little bit more on the additional cost efforts you are going to take, in which area those will be?

And my second question, you had a couple of things in the third quarter in BBA that were impacting profitability negatively, some dealer measures and the ramp of the X3. I was just interested, can you share what the actual underlying profitability in the joint venture would have been without those two sort of non-recurring items? Thank you.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you very much, Patrick. Nicolas?

Nicolas Peter -- Chief Financial Officer

Patrick, first of all, R&D -- R&D ratio, as mentioned, we will be around 7% in 2018 and our guidance is still valid that in 2019 we would see a decrease in this ratio, too early what exactly will be the ratio for 2019, but there will be a decrease with this regard. Other cost areas, as you can imagine, we have, on an ongoing basis, efforts in all areas to increase our efficiency and reduce our spending levels. This, in 2018, amounted to between lower and mid three-digit positive impact on the cost side, so a significant effort which was already delivered in 2018. And we have short-term measures, which I would say more of the classic style, you can imagine. But also very important, some more medium- and long-term oriented actions we are taking, in particular, in order to reduce the complexity in our product offering. Here we definitely believe we can, in a certain way learn also of some of the new entrants in our business. So, this is definitely something we are working extremely hard on it and we have, I would call it a 360-degree program running since a couple of months.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

BBA?

Nicolas Peter -- Chief Financial Officer

So next topic, Patrick, BBA. You are absolutely right, the profitability at BBA was impacted by exactly the two elements you have mentioned. We believe, in particular, due to these trade issues, May and June, the profitability of our network was impacted in a negative way, and to be honest, I don't think it's not only our profitability, all other networks were impacted as well. And for us, it's extremely important to keep a dealer network, which is running full steam, highly motivated. And we have decided therefore to make some extraordinary payment to our dealers, which we believe, looking at our results in August, September and October, October is significantly up, also thanks to the X3, has proven to be absolutely right.

Patrick Hummel -- UBS -- Analyst

So quarterly run-rate, just to follow up, of EUR200 million (ph) plus is still a realistic assumption going forward?

Nicolas Peter -- Chief Financial Officer

Yes.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you very much. Next question please.

Operator

The next question is from Arndt Ellinghorst at Evercore. Your line is now open. Please go ahead.

Arndt Ellinghorst -- Evercore ISI -- Analyst

Good afternoon everyone. Two questions, please. One for Harald Kruger and one for Nicolas Peter, please. The first one, Harald Kruger, would you be open to a significant increase in collaboration with Mercedes, given the change of leadership at Mercedes and Daimler more broadly and the huge pressure for the industry overall, wouldn't it be time to really step up collaboration between Mercedes and BMW? And here I am specifically asking about areas such as EV platforms and combustion engine?

And secondly, for Nicolas Peter, please. In the past, you have been talking a lot about the opportunities to restore pricing. And I think we all appreciate that you have been taking out production to protect and hopefully improve your pricing in the market. Now, you have a new Head of Sales and all of that, but it's become a bit quiet regarding the opportunity to improve both component mix and also pricing in the market. Could you be a bit more granular what the opportunity is and -- if we finally get into a positive pricing environment after years of negative pricing? Thank you.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

So thank you very much, Arndt. We start with Harald and then Nicolas.

Harald Kruger -- Chairman

Arndt, concerning the question on the cooperation with Mercedes possible, I mean, we are in very serious talks about finalizing our cooperation on the mobility services side, not knowing if we can conclude it this year or is it maybe next year, but this is also one area where we cooperate definitely strategically, because we believe we can create a win-win partnership on both sides for bringing a strong player into the mobility services world, where we add strength from both companies. For example, we are quite strong in the charging area. And Mercedes with mytaxi is quite strong in that area. So that's why we are working together and the idea of this one creating a strong mobility services provider and for sure, making it more profitable and sharing costs on these sites, yes, so creating this. So that's the strategic opportunity we follow up very seriously.

On the question of, is there potential other areas for strategic co-operations, in principle, you can say this is to be discussed. On platforms, it's definitely very difficult, because mainly timing wise, normally it doesn't fit, because sometimes one company needs the cars in 2021, the other company is in 2024 and then you have so many delays that you can't bridge it. So in principle, that is difficult. But if there is a win-win opportunity, we definitely will take a look at it. But in principle, Arndt, it's always quite difficult to find win-win cooperation, but we focus clearly first on what we do with kits with our mobility services. That's the first thing we would like to close.

Nicolas Peter -- Chief Financial Officer

Arndt, definitely at pricing, our profitability per unit is still one of the top priorities we have in our organization. Maybe to reflect on what we have discussed earlier this year and maybe starting with the volume development. If you remember, we have said we will grow slightly. From a global perspective, we will grow slightly in Europe, in the U.S. and we will grow a little bit higher, between 5% and 10% in China. If you look at 10 months later, this is exactly where we stand, exactly where we stand, so we have seen a slight growth. From a global perspective, we have seen growth in all regions around the globe and a more significant growth in China. And if you look month by month, and this is part of this effort, probably, our volatility in the sales number has been among the lowest in the industry and this is definitely supporting pricing. Why have we been one of the lowest in terms of volatility? Because we were ready with WLTP in time and we had, by the way, since early July, most of our cars compliant with Euro 6d as well.

Having said this, I see further opportunities? Why? Because we are in the process of launching a very important -- from a profit perspective, extremely important models. 2019 will be the first year where we have full X3 availability around the globe, including China. First year with full X5 availability and we are launching the X7. Of course, what impacted in a negative way the development in 2018 was in particular the trade tension between U.S. and China. Why? Because in particular, cars with high profit margins were impacted, X models shipped from U.S. to China. So, despite the fact that we had increased prices in China between 7% and 8%, there was overall still a negative impact on profitability.

Arndt Ellinghorst -- Evercore ISI -- Analyst

Just maybe before you move to the next question, I think what I am trying to find out is, you are referring to external sectors, left, right and center and we all understand those, because we discuss them with all the companies. I think we are trying to find out what has gone wrong, if anything, in your own assessment of your business. So what has gone wrong at BMW, in addition to the more sector-related headwinds or are you just a victim of the market?

Nicolas Peter -- Chief Financial Officer

Arndt, if you look region by region, in U.S., we are on course as planned. And as I said, a little bit -- as I said in my speech, we have seen even -- and this is thanks to -- also thanks to our, I think, efforts in the sales and financial service area, we have seen used car prices, we see the value going slightly in the positive direction. Have we been able to forecast the WLTP issue in Europe and the fact that our competitors were not ready, and by September 1, I don't think so, and of course this trade issue which popped up in end of May and was implemented 6th of July is an additional factor. Having said this, we have to deal with those challenges and with those factors and this is exactly what we are going to do. And, therefore, I think we have, in particular, based on the strong product momentum, also have reasons to be optimistic that in term with regard to pricing power, we will see further positive development.

Arndt Ellinghorst -- Evercore ISI -- Analyst

Okay, thanks.

Harald Kruger -- Chairman

And Arndt, one extension to the question on the cooperation, because you asked on net figures (ph) only, and from the BMW perspective, we are definitely following strategic cooperation, think about three items we are currently focusing on. The one is the MINI cooperation with Great Wall, where we setup a new joint venture. Then the second one was Toyota on fuel cells strategy, or for example, the third one on autonomous driving with other partners, first and second tier suppliers. And this is one of the approach, because I believe in strategic co-operations that you can be faster and that you can share costs, that you can maybe deliver the better standard together, so as a BMW Company, we follow up strategic co-operations even outside the Daimler cooperation, which we will do on the mobility services.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Okay. Thank you very much, Arndt. Next question please.

Operator

The next question is from Daniel Schwarz of Credit Suisse. Your line is now open. Please go ahead.

Daniel Schwarz -- Credit Suisse -- Analyst

Yes, thank you very much. One question regarding the warranty costs, the EUR679 million, is that more than you expected with the profit warning earlier on in September and are you going to book more extra warranty costs in the fourth quarter? And on back of that, do you believe that going forward that the regular provision for car will structurally be higher in 2019 and beyond?

And the second question just regarding the dividend, or the dividend policy. Would you be comfortable with increasing the payout ratio if reported earnings are depressed due to mostly one-off effects in 2018 and is the main driver for the dividend decision, the reported earnings or the free cash flow?

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you very much, Daniel. This question will be answered by Nicolas.

Nicolas Peter -- Chief Financial Officer

And Daniel, maybe let's start with the dividend payout. We will stick to our dividend payout ratio of 30% to 40% and we will take, as always, the final decision once we have our final result for 2018. Provisions of EUR679 million were not higher than expected with the profit warning end of September. Of course, there are always several reasons in this area, warranty provisions. However, there is one major topic, which is the EGR module in certain of our diesel cars. Those single cases didn't post a significant risk to our customers. Nevertheless, we decided in end of October to increase our recall, which is based on what I would call precautionary and voluntary basis. So we are recalling, from a global perspective, 1.6 million cars, mainly in Europe and in China -- sorry not China, in Asia, in Asia, China is not a diesel market, in Asia.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Okay. Thank you very much, Daniel. Next question please.

Operator

The next question is from Dorothee Cresswell, Barclays. Your line is now open. Please go ahead.

Dorothee Cresswell -- Barclays Capital -- Analyst

Hi, there. It's Dorothee Cresswell from Barclays. Thank you for taking my question. The first is around the R&D capitalization. How are we meant to interpret the increase in the capitalization rate? And could it be that you are working on more R&D projects that qualify for that accounting treatment, because they are more likely to come to fruition? And then my second question is around China. You have obviously committed to, I think, a EUR3 million CapEx increase at BBA. I was just wondering how quickly that will allow you to reduce the earnings impact from the hiked U.S. import tariff -- or sorry, the hiked tariffs on U.S. imports? Thank you.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you very much. Nicolas, please?

Nicolas Peter -- Chief Financial Officer

Dorothee, if we look year-on-year, after nine months, we are with our capitalization ratio slightly below 2017. Our forecast for the full year is that we will be approximately plus minus on the same level as the previous year, meaning around 40%. The higher ratio in Q3 was planned and is in particular due to the fact that we are ramping up now, of course with projects qualifying like the X5 and the 3 Series, as well the 8 Series and the X7, which all of them are very, very profitable cars.

China (multiple speakers) So China, first of all, those EUR3 million, of course, will be spent over couple of years. The outlook for BBA in 2018 is definitely positive, also based on our strong sales results in the previous months. So, we stay optimistic. The 5 Series continue to sell very well with low discounts. The start of the X3 was very, very positive and we will take a final decision in the coming weeks together with our joint venture partner, which model to localize next in China.

Harald Kruger -- Chairman

And Dorothee, one extension to that one, for example, some of the investment will be, we are localizing the X2 in China next year and that will be another product which is localized and where we spend some CapEx.

Dorothee Cresswell -- Barclays Capital -- Analyst

Thank you.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you very much, Dorothee. Next question please.

Operator

The next question is from Horst Schneider of HSBC. Your line is now open. Please go ahead.

Horst Schneider -- HSBC -- Analyst

Yes, thanks for taking also my questions. Horst from HSBC here. First of all, this morning in the press call, you mentioned already that the FX burden will be next year in the magnitude of EUR500 million, or you said mid-three-digit million euro amount. I wonder if you can be a little bit more specific on other cost changes. I mean, that is an item you should have already now good visibility on. Should we also plan here with roughly EUR500 million burden next year?

Then you also mentioned regarding 2019 the importance of the 3 Series, but it reminds me a little bit to the 5 Series, where we saw not that much volume tickup, just because the design has not really changed. So, how important is the 3 Series in your planning then for rising profits in 2019? And last but not least, my question on pricing, you always say that pricing in Europe was slightly negative, could you be a little bit more specific, how negative was it and is it now improving in the fourth quarter?

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you very much, Horst. So we start with the importance of the 3 Series and the 5 Series with the Chairman, with Mr. Kruger.

Harald Kruger -- Chairman

Horst, I'll start with the 5 Series, very clearly, three messages. The 5 Series is the segment leader. It's ahead of everyone in the world. The 5 Series extended rebase in China is clearly leading its segment. When you look into the past, there was sometimes Audi and others. So the 5 Series long rebased China is clearly a segment leader. The 3 Series was always its segment leader and we sold 15 million (ph) 3 Series in the past. The reception we had at the Paris Motor Show was very positive. It was very positive. The dealers are looking forward to it. There's a huge step, one from the design side, but also, as I mentioned in my speech, on the digital services side, on the connectivity. It would even drive better than the 3 Series before, which is always a challenge for us. So I am clearly optimistic, and we will launch 3 Series in plant Munich now, it will come to the market in March next year and then we will launch in Mexico and China. And then in China, you should be aware that we always have a long rebase 3 Series again, so specific for the Chinese market. And then there is a huge customer potential there as well. So overall I am, on the 3 Series, optimistic with the three locations we have and then especially -- and 5 Series is definitely the market segment leader since one and a half years.

Nicolas Peter -- Chief Financial Officer

Horst, maybe starting with FX burden, and not only talking about FX, but also about commodities, this is what I said this morning. Both together will be in the mid 3-digit area negative. I've mentioned already in the last couple of weeks one other item. If you look at the trade tension between the U.S. and China, this had an impact close to EUR300 million -- or will have an impact of close to EUR300 million in 2018. If you assume that this was a six-month impact, because it kicked off 6th of July, you can easily, let's say, calculate what-- in which magnitude we might see an impact in 2019 under the condition that there is no positive development between U.S. administration and the Chinese government.

If we look to pricing, and I think we have to look at volume mix market, the development we have seen in the third quarter and low three-digit impact coming from this area, and this was mainly due to, on one hand side, the WLTP issue in Europe and in China to the change in pricing related to the change in tariffs early July.

Horst Schneider -- HSBC -- Analyst

Sorry, you have not answered two of my questions. What is now the outlook for price in Europe Q4 and I asked about other cost changes in 2019, not about the foreign exchange impact?

Nicolas Peter -- Chief Financial Officer

Horst, other cost, 2019 guidance is as always in concrete numbers is due in the first quarter 2019. As I have already mentioned, we have on one hand side, the ongoing trade topics. We have some requirements to invest in technology in order to reduce further CO2 emissions. I have mentioned the currency and commodity headwinds. And I've already answered the question regarding research and development ratio will go slightly down. Nevertheless, of course, we will continue to invest, in particular, in e-mobility and autonomous driving. And how will Q4 develop? Well, if you look at the October numbers, in particular, in some of the major European markets, you definitely see that the market still is not stable. We've seen in major markets some of our competitors with minus 50%, minus 60% in October, others with plus 20%, more than 20% in the same period. This is an indicator that the market is still not in a balanced position. And Horst, we assume that this can continue or can have an impact into the first half of 2019 as well.

Harald Kruger -- Chairman

Maybe to add, there are also opportunities, because you need to have in mind that we are having, especially on the high-end of our portfolio, more products in 2019 like the new X7, like the new 8 Series, there is the new X5. There is also cars coming with higher contribution margins into the market where we can balance some effects.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you very much, Horst. Next question please.

Operator

The next question is from Dominic O'Brien of Exane. Your line is now open. Please go ahead.

Dominic O'Brien -- Exane -- Analyst

Hi, guys. Thanks for taking my question. And just two questions from me. The first one on product cycle and you have obviously got a busy launch schedule coming up. So can you just give us an idea of the impacts the product cycle will have on working capital, on free cash flow and earnings over the next six months or so? And by that I mean will there be any notable working capital drag or higher CapEx spend or launch costs that we need to be aware of in any particular quarter? My second question is just on investment spending. You said the R&D spend should sequentially decrease in 2019 as a percentage of sales. How should we think of that for CapEx as well? Thank you.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you, Dominic. Nicolas, please?

Nicolas Peter -- Chief Financial Officer

Dominic, as I said, it's definitely too early to comment in detail 2019 regarding free cash flow for the next three months. Our ambition is clearly to achieve the EUR3 billion for the full year. Having said this, this is what I have mentioned in my speech. This is definitely not a walk in the park. On the other hand side, we have delivered positive free cash flow in Q3 as well and we have a good momentum from our various most important markets. And as I said, R&D will decrease in terms of ratio next year. And CapEx, it's I think definitely too early, but you have seen our CapEx ratio very, very stable over the last couple of years. So from today's perspective, there is no reason to assume that this will be very different in 2019.

Dominic O'Brien -- Exane -- Analyst

Okay. So quickly, just to follow up sorry. So there isn't a one particular quarter where the sort of product cycle changeover will have, I guess, one big notable impact?

Nicolas Peter -- Chief Financial Officer

No, it's definitely not anything we can -- if you look, our launch calendar is very balanced across the different quarters, so nothing to be mentioned at this point in time.

Dominic O'Brien -- Exane -- Analyst

Thank you very much.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Thank you very much. So, ladies and gentlemen, we have time for one more question. The last question please.

Operator

The next question is from Stephen Reitman of Societe Generale. Your line is now open. Please go ahead.

Stephen Reitman -- Societe Generale -- Analyst

Yes, good afternoon. I have two questions, please. First of all, on production, you mentioned that obviously you have been adjusting production to keep inventories under control. In the third quarter, you mentioned the figure of 20,000 units. Looking at your production in the third quarter, I figured that your production in China was up about 28,000 units, so I think you are up 25% in actual terms. And you are also -- there is a gearing up in the U.S. for X5 and the like. So clearly, the big production cut was in Europe, with WLTP, as you mentioned. What are you expecting for the fourth quarter?

And my second question is on the 3 Series. You mentioned obviously the importance of this model. You are bringing this on to your CLAR platform now. So what does that mean in terms of reducing complexity, reducing diversity costs and so are there improving impacts on margin on that as well, please? Thank you.

Nicolas Peter -- Chief Financial Officer

So Stephen, first starting with production, adjusted production in Q3, 20,000. We have already taken measures to adjust in Q4 slightly as well. And you are absolutely right that this is mainly related to the situation in Europe, as the overall trend in China is very, very positive. And with the momentum of the X models, we are positive for the U.S. market as well. And if we talk about, let's say, production adjustment, there is maybe one other market we should mention, which is Turkey, a very complicated market environment, so this is one -- outside Europe, one other market where we had to adjust production, not only in Q3, but in Q4 as well. Nevertheless, we will see growth in terms of sales from a global perspective as planned in Q4 as well.

And your second question was about cost improvement. It's always a balance, while on the one hand side, definitely, we see cost improvement. On the other hand side and Stephen I think you know it very well, we have to add costs, in particular, to fulfill the regulatory requirements around the world, which are becoming more and more challenging. Having said this, we believe that the 3 Series will definitely be a car which will add not only in terms of segment development, positive segment development, but also in terms of profitability from 2019 onward.

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

So, ladies and gentlemen, thank you very much for joining us today. I wish you a pleasant day. Bye-bye and thank you very much.

Duration: 61 minutes

Call participants:

Maximilian Schoberl -- Senior Vice President, Corporate and Governmental Affairs

Harald Kruger -- Chairman

Nicolas Peter -- Chief Financial Officer

Tim Rokossa -- Deutsche Bank -- Analyst

Patrick Hummel -- UBS -- Analyst

Arndt Ellinghorst -- Evercore ISI -- Analyst

Daniel Schwarz -- Credit Suisse -- Analyst

Dorothee Cresswell -- Barclays Capital -- Analyst

Horst Schneider -- HSBC -- Analyst

Dominic O'Brien -- Exane -- Analyst

Stephen Reitman -- Societe Generale -- Analyst

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