Johnson Controls, Inc. F1Q09 (Qtr End 12/31/08) Earnings Call Transcript

Jan.16.09 | About: Johnson Controls, (JCI)

Johnson Controls, Inc. (NYSE:JCI)

F1Q09 Earnings Call

January 16, 2009 11:00 am ET

Executives

Glen Ponczak – Director, Investor Relations

Stephen A. Roell – Chairman and Chief Executive Officer

Keith E. Wandell - President and Chief Operating Officer

R. Bruce McDonald – Executive Vice President and Chief Financial Officer

Analysts

Patrick Archambault - Goldman Sachs

Richard Kwas - Wachovia Capital Markets

Christopher Ceraso - Credit Suisse

Himanshu Patel - JPMorgan

Brian Johnson - Barclays Capital

Rod Lache - Deutsche Bank

Operator

Welcome, and thank you for standing by. All participants are in a listen-only mode until the question-and-answer session of today's conference. (Operator Instruction) I would also like to remind participants that the conference is being recorded. If you have any objections please disconnect at this time.

I’d now like to turn the call over to Mr. Glen Ponczak.

Glen Ponczak

Good morning, everyone, from a very frigid Milwaukee. Before we begin I want to remind everyone that Johnson Controls, Inc. will make forward-looking statements in this presentation pertaining to its financial results for fiscal 2009 and beyond that are based on preliminary data and are subject to risks and uncertainties. All statements other than statements of historical fact are statements that are or could be deemed forward-looking statements and include terms such as outlook, expectations, estimates or forecasts. For those statements the company cautions that numerous important factors, such as automotive vehicle production levels, mix and schedules, financial distress of key customers, energy prices, the strength of the U.S. or other economies, currency exchange rates, cancellation or changes to commercial contracts, liquidity, the ability to execute on restructuring actions according to anticipated timelines and cost, as well as other factors discussed in item 1A of part two of the company's most recent Form 10-K filing could affect the company's actual results and could cause its actual consolidated results to differ materially from those expressed in any forward-looking statement made by or on behalf of the company.

We are pleased to be joined this morning by our Chairman and Chief Executive Officer, Steve Roell, who will give some overview comments and take a look at the first quarter. Keith Wandell, our President and Chief Operating Officer, will follow with a review of the business results for each of our three businesses. And then Executive Vice President and Chief Financial Officer, Bruce McDonald, who is nursing a sore throat and some little bit of laryngitis, will give us a financial review and we hope that his voice holds out through the entire call. That will be followed at the end with questions and answers.

And with that I'll turn it over to Steve.

Stephen A. Roell

Good morning. It clearly was a very challenging quarter for us and it became more apparent and evident as we went through the quarter that the depth and the duration of the U.S. economic slowdown and recession was going to be greater than what we initially had expected as well as the fact that it extended into the global markets.

So with those leading comments, let me just start with the financial results for the quarter. Our sales of $7.3 billion were down 23% from last year. Keith will go through the various segments but clearly you will hear a combination of volume declines, of commodity pass through, as well as exchange.

Our segment income was a loss of $48.0 million and that’s excluding the Q1 non-reoccurring, non-cash items and again, at the end of the session Bruce will go through that in more detail.

Our net income was a loss of $82.0 million, which resulted in a $0.14 per share diluted share loss versus $0.39 profit that we recorded a year ago in Q1.

On the next page I just decided to use this exhibit to illustrate the extent of which we saw the deterioration of the U.S. automotive market. This chart depicts the U.S. seasonally adjusted annual rate of sales. So this is really sales to the consumers and if you look you can begin to see the slowdown that occurred in the first part of calendar year 2008, but then you can see the last months of October, November, and December, just how fast and to what extent and extreme the fall-off and the slowness in sales took place.

If you look at the 2008 full-year sales from the industry were 13.2 million units. That was down 18% versus the prior year and that represents the lowest level since 1992.

On the next page we go then from sales to automotive production and this is looking at the period going back to 1951 through 2009. When we revised our estimates and pulled our guidance, I should say really in early December, we indicated that we thought the 2009 North American production level would be as low as 9.2 million units.

You can see from this chart that that’s the lowest level since 1983 and, in fact, you have to go back to 1963 to find the second year that begins to proximate what we are talking about in terms of the weakness in production in North America this year.

I think I did this, I know most of you follow the automotive industry but there are some who do not, so I just wanted to put this in context just as a starting point for discussion.

The next chart talks about international markets and clearly what did surprise, I think, most analysts was the extent at which Europe deteriorated in the first fiscal quarter. The European market had been very stable through August 2008, and then if we look at the quarter just ended, Western European car registrations were down 26% year-over-year. It was the worst quarter since 1993 and it was obvious that Eastern Europe was not exempt.

If you look at the graphs on the right, what this illustrates is that Q3 was 5.6 million units and that period includes the summer shutdown in the European market. You can see how it deteriorated in Q4 down to 5.1 million units and how it is going to continue to decline in the first calendar quarter, or our second fiscal quarter in 2009.

I’m sorry, that is not correct. Is this calendar year 2009? That’s fiscal year, okay.

So then if we also go back to the rest of the international markets, the China market was down 2% year-over-year as that market began to soften as well.

In terms of the building markets, we did begin to see some softness in the commercial new construction markets in Q4 2008. The greatness weakness, as we look into 2009, is going to be in the office, retail, and lodging segments and to some extent in the industrial manufacturing group. Some of the data we have seen from a forecasting service called Global Insight has indicated that as much as 80% of the softness in 2009 will be confined to these four vertical markets.

I say that only because our volume is heavily concentrated in the institutional sector, basically federal, state, local governments, healthcare, and education, and those segments are expected to remain the strongest during this 2009 time frame.

We did see new construction slowdowns and deferrals in the Middle East, primarily due to low oil prices and higher vacancy rates but as I look at the rest of the world, we have really seen very few cancellations or deferrals.

We can highlight a few things in maybe the Thai market, but for the most part and certainly the U.S., we have really not seen cancellation of construction projects in any of our backlog.

U.S. housing starts were down 47% year-over-year in the quarter. We continue to try to seek bottom in terms of the housing starts, and of course, the existing home sales were also impacted and declined in the quarter.

So that’s the environment. In terms of what actually we have taken I will go back to the September time frame, when we announced that we were taking a $495.0 million restructuring charge. Just a few things about that. That includes thousands of work force reductions. In fact, as you will note in our Q2, it’s over 9,000 positions that are being eliminated throughout the world. Includes 21 plant consolidations or closings. You can see those by the various businesses that we have.

From the standpoint of payback, we have indicated that we expected to have the payback in 2.5 years. Obviously the $495.0 million costs are spread out through the next four quarters.

In terms of an update on that, on the far right-hand side, the plant closings are on schedule. We do expect that the actions will start to add to our earnings and be accretive starting in Q2 2009. Although, as we noted when we announced the charge, the biggest benefit will be in fiscal 2010.

Obviously we are not pleased at having to take the restructuring, as we indicated back in September, but we do recognize that we were able to take the chargea few things about that. that that we were taking a $495.0 mil and of course, existing home sales were also impacted and decline. Many of our competitors are not able to do so from the cash aspect. This, we believe, will improve our competitiveness greatly as we exit the recession in 2010 and beyond.

We have taken some additional actions. I am just going to call out a few of those. We have, as you would expect, general hiring freezes on throughout our businesses. We have frozen the wages of almost all of our bonus-eligible people. Just by virtue of how annual bonuses are calculated, the corporate executives and employees, as well as our automotive employees, will not earn an annual bonus in 2009. We are looking at flexible work hours in some of our businesses, relative to four-day weeks.

And in terms of liquidity preservation, Bruce will talk a little more about these, but clearly we are gunning down in terms of our capital spending. We maintained our dividend, which we thought was important for our shareholders for 2009. We did not increase it, though. And we also, as you recall coming into the fiscal year, had indicated that we were going to make pension contributions. We have scaled that back and, again, Bruce will highlight that in his discussion.

There are some positives and I think from our standpoint we continue to invest in innovation. We think it’s critical, just of how we provide value to our customers and I will share a few things with you. We continue to gain share. While I am not going to go into much detail, we had a good quarter in terms of new business awards across a variety of OEs.

Our Building Efficiency backlog in absolute dollars is up 7%. We continue to see growth in our pipeline in terms of new order opportunities. We have been awarded several new contracts in Power Solutions and I will highlight one of those. We didn’t highlight this, but we also began adding to our sales force back in September, in the Building Efficiency side, to take advantage of what we saw were growth opportunities in the government sector and those opportunities existed even before the current stimulus package that was announced yesterday.

Just an example of innovation. Some of you, I know, had a chance to attend the Detroit auto show. At that show we highlighted a concept vehicle that was there. It was called the RE3. And that is an important show for us. Despite the fact that the attendance will be down at the auto show, we still have almost 3,000 customer representatives who come through from their engineering departments to view our technology.

There are three [inaudible] to comment a little bit more about that. If you look at the upper right-hand side, it is a conversational arrangement. It’s more evident when you look at the lower-left and you can see how the front seat can actually move back to the back a little bit and provide conversation to both the person in the rear seat as well as in the front. It’s a slim seat design, stadium folding.

The left photo also shows a unique and creative way of how we can package a lithium ion battery in the center console, which frees up the rear road space and allows for seating of five, which has been a major hurdle for a number of the OEs as they design vehicles for lithium or for any type of a hybrid battery application.

We have expanded storage, extended cluster, which includes a traditional gauge cluster, along with a seven-inch color touch panel display. And you will notice that there is a wing seat armrest and controller on the driver’s side that enables some of the controls we moved from the center stack to the seat.

I call this out only because this just is an illustration of the types of packing and creativity we can bring and innovation to the OEs as they think about the design of the interior of their vehicles.

As I mentioned, we have on the next page, a couple of new customer wins in Power Solutions. The one we can talk about today is O’Reilly Auto Parts. More than 1,000 new outlets, a full line of automotive super-start batteries, including the Optima high-performance automotive battery, where shipments will commence in February. We were very pleased with that customer’s confidence in us going forward to supply them with our product.

I want to talk just a minute in Building Efficiency about federal government opportunities. In December 2008 we were named as one of several companies in the U.S. that the U.S. Department of Energy will source relative to an $80.0 billion energy efficiency program for federal buildings.

I have talked to several of you in the past about the fact that I think that we have been awarded a lion’s share, a high portion of what’s been awarded for the DOE and DOD already in 2007,2008 and beyond. Just to illustrate some of those, we are filing this year the Lawrence Livermore National Labs contract, which is a $12.0 million contract. We were also awarded an Oakridge National Lab contract in Tennessee for $89.0 million.

And then we just have several of these recent federal government contracts for the DOD, including Fort Stewart, Lackland Air Force Base, and you can read the rest.

I think the point is that as you look at this, these are broad-spaced, broad-scoped contracts, often times including renewable energy, water conservation. We get to deploy our HVAC York equipment, our Metasys building automation systems, and often times we get a long-term service arrangement as well.

So starting to look forward then, we can then highlight some of the comments that have been made by President Elect Obama. I chose a quote that he made on January 8. If you will go to the middle portion of that quote it talks about the fact that, “We will modernize more than 75% of federal buildings and improve the energy efficiency of 2.0 million American homes.”

Many of you probably saw in the initial American Recovery and Reinvestment bill the proposals that were highlighted in the Wall Street Journal this morning. There clearly are opportunities for us relative to the funds that would be targeted for government and school building energy efficiency.

And one of the important things there is how well we are advantaged. We think they are going to want to deploy and get benefits associated with these spendings. What that requires is that we are pre-qualified under a number of different government procurement processes. They include the ESPC for the Department of Energy, a lot of the different contracting vehicles for the Corp of Engineers, as well as the GSA.

We have a long history of successful projects with the federal government, we have a dedicated government business unit, we have increased our sales force, as I mentioned to you, and from the standpoint of the branch network reach, given the fact that we have 165+ branches throughout the U.S., we are in a position geographically to respond to local opportunities.

So just to finalize my comments, I think that the important thing as we think about the current environment is that we, number one, align our cost structure to the realities of the market. We recognize that there is going to be a period of time here where our costs and profits will be under pressure, so we have taken the steps, we believe, to get our cost structure in line.

We also think, though, that we need to do that in concert and consistent with our long-term goals and that is important to us and that is the way we have been making these decisions. We want to protect our liquidity and I mentioned some of the steps we are taking and Bruce will talk a little more about them. And I think we are in a great position to benefit from the global mega trends, whether it be energy efficiency, sustainability greenhouse gas reductions, as well as our positioning and market share gains in emerging markets.

We think it is extremely important from our standpoint to be in a position to gain share, to monitor this economic cycle as strong as we can, improve our competitiveness, and enhance our leadership position.

So now I will turn it over to Keith and Keith is going to walk through the three business units and give you the highlights from the sales and segment income standpoint.

Keith E. Wandell

I will probably walk through each one of the three businesses and sort of give you high-level highlights of what occurred in each one of our businesses, starting with Building Efficiency. From a revenue perspective revenue was down quarter-over-quarter from $3.2 billion to $3.1 billion, which is 5% roughly, but without currency in there our sales were actually up 1%. And there were really some puts and takes in all of that.

Number one, we continue to see a depressed residential demand for our unitary products. Demand was down about 18% quarter-over-quarter on top of an already depressed level from a year ago. And in our technical services, the services that we provide out of our fan-based service work, repair, replacement and that kind of thing, was down about 2%, particularly in the labor and material area where we see people sort of pulling back a little bit maybe on some preventative maintenance kind of services.

On the other hand, our North American systems business was up 5% and really was flat in the rest of the world, and our solutions business, you know, the energy efficiency and performance contracting work was up over 20%.

And again, that’s really driven by the demand for energy efficiency solutions as well as our performance contracting work that institutions are turning to to fund some of their projects. So overall, relatively flat performance in a tough, tough market.

From a segment income perspective, we did see double-digit improvements in both North America systems and services, 12% and 30% respectively. And in our North American services our margins were up over 100 basis points and I really think that’s a tribute to all the work we’ve been doing around best business practices and really sharing practices across our network and really driving efficiencies and productivity gains. And I think that is going to serve us well as we go forward here.

We did have lower European profitability, mostly due to the impact of currency and some volume.

Our backlog is $4.7 billion, which is up 7% quarter-over-quarter and excluding FX, is up 8%. And again, just to reiterate, we continue to see fairly good strength in the federal, healthcare, and higher education vertical markets where we really tend to be the strongest in the markets that we serve.

Moving to Power Solutions, revenues were down 32% quarter-over-quarter. It was $1.7 billion in revenue to $1.1 billion. And really there were three significant impacts, I would say to the revenue number: lower lead prices being the largest, lower volume, and then some currency because of our strong position in Europe and the sales that we have there.

When you think about the volume though, our OE production was lower, our OE production was down, our batteries that were sold to our OE customers was down approximately 30% quarter-over-quarter in both North America and Europe. And those batteries, the OE portion of our business makes up about 24% of our revenue.

In terms of the after-market customers, our volume was also down, I think impacted mainly by two things. Number one, I think our customers, as lead ran up in the last year, the bill prices went up and even though we have seen some retraction in the L&E and the like, our customers have become a little more cautious about managing their inventories and so we are seeing some of that as they have sold off their inventories.

As well as we think that approximately 30% to 40% of the after-market batteries that are sold are really sold as a preventative maintenance purchase and we do think there are some folks that are putting off those purchases and we will really just create what we think is some kind of demand in the future.

In our Automotive business revenues were down from $4.6 billion to $3.1 billion, about a 32% decline. Sales were down 25%, including the impact of currency. And really we saw declines across all geographies, customers, and product segments. And Steve mentioned earlier, while we clearly saw that coming in North America, the big surprise has been just the rapid drop-off in production in Europe.

Our North American sales were down about 23%, production was down about 26%, and in Europe our sales were down 41% while production was down 24% and certainly some of that is due to the effect of foreign exchange.

And from a segment income perspective we went from $78.0 million last quarter to a loss of $219.0 million. And again, just strictly attributable to the volume and loss of contribution margin and we saw losses, really, in all geographic regions.

In our Automotive business we are continuing to execute our restructuring initiatives. We feel good about where we are on those. We are continuing to rationalize our footprint and capacity and we really believe that when the volumes respond, as they will at some point in time, that this is going to serve us very well.

Stephen A. Roell

When you were going through the Power Solutions piece on volume, I think we need to go back to the segment income. You didn’t really have a chance to comment on that.

Keith E. Wandell

The segment income was down 70%, from $133.0 million to $40.0 million. And again, it’s just reflective of the volume drops, the lead volatility, lead went from approximately $3,200+ on average per ton last quarter in 2009 to about $1,251 so a drop of about $2,000. That impacts us. And we did have a non-recurring lead inventory issue related specifically to spent cores that we purchase in the market to have tolled through our secondary smelters, which impacted us about $50.0 million. But once again that is a non-recurring event.

I apologize for skipping over that. With that I will turn it over to Bruce McDonald.

R. Bruce McDonald

I am going to talk about our first quarter financial highlights and I am going to exclude the non-recurring charges. I will come back and talk about those in a couple of minutes here.

Reflecting on the difficult economic environment that we are facing, our sales were down 23%. If you back out exchange that was down about 17%, with only our Building Efficiency business up on a year-over-year basis.

As Keith indicated, our North America systems business, performance contracting, and global workplace solutions businesses were higher versus last year. Power Solutions sales were down 30%, reflecting dramatically lower lead pass-through prices and about 13% lower unit volumes.

In Automotive our sales were down 32% and if we take out exchanges, that down about 25%.

If we look at the gross profit line you will see we are down about 300 basis points versus last year and that is really due to lower factory absorption and some of the difficulties that we have had adjusting our cost base in our European Automotive operations.

If you think about our business in Europe, it’s very difficult to flex direct labor quickly and that probably cost us about $40.0 million in the quarter, and that is something that we have to get after here as we go through the balance of our fiscal year.

Turning down to SG&A you can see we are down about 10% versus the prior year. We continue to aggressively attack our cost base but we continue to protect investments in some of our key longer term growth initiatives.

Steve talked about our restructuring program earlier on but maybe I can provide a few specifics here. So far we have completed about 30% of our planned 9,300 headcount reductions and all of our plant closings are either on or ahead of schedule.

If you go to Slide 19, you will see net financing charges were $56.0 million so they are about $13.0 million below the level of a year ago. In here we benefited from lower interest rates but we also have some favorable foreign exchange. It was a pretty volatile quarter and we don’t expect the level of volatility that we saw in the currency markets to continue, so on a go-forward basis our net financing charges should probably in line with approximately [inaudible] levels.

If we look at our tax rate and strip out the one-time items, our tax rate increased to 24% versus the 21% that we had guided to. I am going to comment on taxes a little bit later and from an operational point of view we lost $0.14 this year.

I would like to spend a minute on Slide 20 and talk about the $526.0 million of non-recurring, one-time charges. You can see where all the charges have been reflected in the financial statement and I would like to highlight the fact that these are all non-cash charges and don’t affect our liquidity.

The charges are comprised of three items. First, we recorded a $152.0 million charge against the equity investment in our North American residential HVAC business. As you know, the North American residential market is severely depressed and it’s currently running at about 70% below its peak level. As a result of that downturn we were required to revalue our equity investment.

Longer term we continue to like the fundamentals of the North American residential market place and we are confident that we are reaching the point of the bottom and that better days are ahead. But we have to take that charge, really reflecting the conditions in the market place right now.

Secondly, we wrote off some fixed assets in our Automotive businesses in Europe and North America, which in aggregate were $110.0 million and these charges really represent lost fixed assets for programs where we don’t expect to make money, given the current depressed industry volumes.

Lastly, we recorded a $300.0 million tax valuation allowance adjustment against our deferred tax assets in several foreign jurisdictions, primarily in Europe. I will comment on the next slide on tax in a little more detail.

In 2009, with this volatility in our income statement, our taxes are going to be quite volatile as well so I would like to spend a few minutes and take you through a few of the items here.

First of all with respect to the deferred tax valuation allowance, these really were triggered by the downturn in our outlook for auto business in Europe. Right now we are anticipating industry volumes in Europe are going to be down about 30% and as a result of that there are some countries in Europe where we no longer have a history of profitability and according to FEN 48 new accounting guideline we are required to set up reserves against deferred tax assets when the financial outlook changes in a significant manner.

I would like to point out, however, that unlike our other write-offs for tax purposes, these things can come on and off and you will recall a couple of years ago we had some fairly significant releases of valuation allowances because of deferred tax assets and so we expect these to come on and off as our history of profitability is restored.

The other point I would make is while we have fully reserved against losses in some of our European jurisdictions, that will provide us a positive rate benefit on a go-forward basis.

Secondly, here in 2009 we are upping our tax rate from 21% to 24%. This is really due to two things. One, a mix change in where we’re making our income in 2009. And secondly, we have losses in some European countries that we won’t be able to tax benefit so that provides a bit of short-term upward pressure.

And lastly, the erosion on our profitability does provide us with some tax planning opportunities and we expect, beginning in our second quarter, to start to be able to implement some of those and we will probably over the balance of this fiscal year generate about $200.0 million to $250.0 million of non-recurring benefits.

So we have taken a $300.0 million charge in Q1, we expect to recover most of that through one-time benefits in Q2, Q3, and Q4.

Turning to our balance sheet, I would like to talk a bit about our cash flow. We ended the quarter with a debt to total capitalization of about 34.8%. Historically we experienced a working capital outflow in our first quarter, and in Q1 that was about $520.0 million, or about $200.0 million higher than last year.

As we look out into the balance of this fiscal year we do expect to see our revenues decline and as a result of that we anticipate that cash flow from working capital will be a source of cash for us for the year. However, offsetting that is going to be the cash flow that we have, the outflow that we expect on the restructuring program that we talked about previously. So net-net it should be a neutral for us for the full year but it is an outflow in Q1.

Going to capital expenditure, we have guided to a number of $600.0 million to $650.0 million for the year. That’s what we said in December. You will see in Q1 we spent about $268.0 million so our capital expenditure is very heavily skewed towards the first half of the fiscal year.

There are a couple of other things I would like to point out here in Q1. In the first quarter we had about $70.0 million of acquisitions and investments in some equity joint ventures. We don’t see that recurring in the balance, we don’t see anything significant in the remainder of our fiscal year.

Secondly, with respect to pensions, we made about $100.0 million of contributions in the first quarter and, again, we don’t expect to see any discretionary pension funding in the balance of the fiscal year.

And third, in the quarter we paid about $50.0 million of off-balance sheet debt. Our current level of off-balance sheet debt is the minimum. We generally have a policy of putting all of our debt on our balance sheet but there is a small amount out there that we repaid in the quarter. And again, that won’t be recurring.

So if you take those three items in aggregate there is about $225.0 million of cash flow associated with those things.

Our overall liquidity position is strong. Even though our ratings were recently lowered by Standard & Poor’s, the important thing to note is our short-term ratings were not affected. We continue to have a short-term A2/P2 rating with all three of the rating agencies. We continue to be able to access the commercial paper market, which is highly liquid. Overnight borrowing costs are in the 1.5% range. We have got $3.0 billion of liquidity with minimal debt maturities in the next couple of years.

Lastly, we did withdraw our guidance in December and it’s not our intent to reinstate it at this point in time. We continue to operate in extremely volatile economic environments and a lot of uncertainties remain. If I step back and look at where we are right now, we are making great progress in our restructuring plans, continuing to invest in the areas that are going to benefit us in the long term.

As we go into the second quarter we are guiding to a loss of a similar scale for the operating loss that we had in the first quarter. We do anticipate that both Building Efficiency and Power Solutions performance will sequentially improve but being realistic, the second quarter is going to be a tough one for Auto business.

In North America production is going to be down about 46%. Europe is extremely weak in our second quarter. But I think we have got actions in place. Some of our businesses are seasonal and we are highly confident that we will return to profitability beginning in our third quarter.

With that I will turn it back over to Glen.

Glen Ponczak

We are ready to take questions and answers.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Patrick Archambault - Goldman Sachs.

Patrick Archambault - Goldman Sachs

On the win in Power Solutions, which I think might have come from Exide, can you quantify what the size of that is in dollar terms, once it fully ramps up, and secondly, can you tell us what that one was based on? Was it price competition, service capability, or any other factors you can shed some color on.

Glen Ponczak

The volume of batteries or the size of the contract was not disclosed. And I guess I would tell you if you want to know what the decision was based on maybe call O’Reilly. That’s probably more appropriate.

Stephen A. Roell

We are not out lowering prices to take volume. I can at least make that comment to you. So I would like to think it was a combination of our technology, our cost position, as well as the fact that I think we’ve got a very good reputation in the industry relative to our service.

Patrick Archambault - Goldman Sachs

On the cash flow, it seems like debt increased by $670.0 million for the quarter. Did you draw on your revolver or any of your bank facilities? Where did the issuance come from?

R. Bruce McDonald

We financed our outflow here in the first quarter, which we expect to be seasonal, so we expect that to come down in the balance of the year, with commercial paper. We haven’t drawn on our bank line.

Patrick Archambault - Goldman Sachs

I know you don’t have guidance but can you give us a bit of a breakdown of the outlook for the components, non-res construction business, how you see it trending? I think if I remember, you had it flat in your previous guidance. Possibly that has come down. I think that was in North American. And then I would ask a similar question for Europe, just how you expect that to play out. And I understand that within that some of the markets are different. But a little more color on that would be great.

Stephen A. Roell

Probably the best way to describe it you is going back to my comments, if you look at the forecasting services, when they look at new construction, their view is that the softness is going to be pretty well concentrated in the lodging, manufacturing, retail arenas.

And as I mentioned I think as much as almost 80% of it is concentrated in that. So that then talks about where the strength is. And as Keith mentioned, when we look at our backlog and look at our pipeline, we continue to see good growth in the federal market, higher ed, and also in the school market.

Now part of that is a function that we are driving our results based on what we call solutions, which isn’t going to be real obvious in terms of new construction awards. That’s really energy savings investments and paybacks. That’s why we added 100 sales people since last year.

So I think when I tell you where we’re going to see the increase, it’s going to come from the existing building market in the service arena, primarily solutions.

When it comes to Europe, Europe is not that advanced in the concept of performance contracting. So Europe will be softer for us. I think we see that right now. We see Europe softening, we see China softening but we still expect growth in the Chinese market, and even though we mention that we see softening in the Middle East we will still see year-over-year growth.

Patrick Archambault - Goldman Sachs

I guess the concentration of the weakness, has that sort of changed in the recent quarter because of fiscal stimulus which is going to make the federal side, and perhaps other segments, relatively more attractive. How much of a role has that played?

Stephen A. Roell

I think from the stimulus standpoint we can only see it in two ways. We see it in the federal government buildings and we would see it education. From the stimulus standpoint I am optimistic that we will see it, I just think we are going to see it very late in the fiscal year. We are not going to see it obviously in second and third quarters.

I do think we are well positioned to take advantage of it when it does happen, as I mentioned, because of the way we are qualified under the contracting vehicles that exist for the federal government.

Maybe the last thing that we haven’t talked about, which would be worthwhile mentioning, is our GWS business. We have seen a real surge of quotations and interest coming out of the life science arena that we haven’t seen before. We have strength there. I think in the past we have talked about the fact that in our facilities management business we do have a high concentration of life science. But I guess I would tell you that we have seen probably our largest backlog, it’s not in the numbers we report to you, in terms of pipeline. But our pipeline there is as strong as it’s ever been.

So GWS should be a good area of growth for us as we look at secured business going forward this year and next year.

Patrick Archambault - Goldman Sachs

That’s excluded from the backlog number that you report to us, correct?

Stephen A. Roell

Right.

Operator

Your next question comes from Richard Kwas - Wachovia Capital Markets.

Richard Kwas - Wachovia Capital Markets

Could you discuss the restructuring, back in September you announced this restructuring program. If I recall correctly you were assuming a 12.5 North American unit production and I think you were expecting that Europe was going to be relatively flat over the next couple of years. Given the decline in volumes over the last quarter or so, do you anticipate having to up the ante with the restructuring program, and are there any restrictions under your debt covenants to do more restructuring.

R. Bruce McDonald

First, let me comment on the debt covenant. We have no debt covenant other than a minimum net worth covenant, $1.3 billion and our equity is at $8.3 billion right now. So we really don’t have any debt covenant issues that we have to comply with.

With regard to the restructuring, I would say right now, you are right, we did phase the restructuring program on a higher volume level than we are currently operating at, and we recognize that we probably need to do more than we initially set out to do. But at this point in time we are not in a position to comment further on it.

Richard Kwas - Wachovia Capital Markets

But it’s probably likely you will have to do something additionally. Looking at 2010 you’re not expecting necessarily that North American unit production is going to get back to the level that you thought it was going to be for fiscal 2009 or 2010.

R. Bruce McDonald

I think it’s probably more around the SG&A side of things than the plant closure side of things.

Stephen A. Roell

I think it’s important to note that we are contemplating another restructuring charge. What we are doing is we’re looking at our SG&A costs and just to give you a feel for it, in North America today we have our SG&A costs at what they were when we were producing the same level back in 1997. And that’s when our sales were in that 5.0 million unit level in the U.S.

Keith E. Wandell

And in addition to that, even prior to the announcement of the restructuring, the prior three or four years, we had done a lot of restructuring, just sort of internal to the ongoing financial performance of the business. So there has been a lot more done even than just this sort of bigger announcement that was made last year.

R. Bruce McDonald

I think the other things is clearly our customers, especially in North America are almost inevitably going to do some downsizing. As you know, some of our plants are 100% dedicated to those and to the extent our customers make announcements, we will respond accordingly.

Richard Kwas - Wachovia Capital Markets

On the supplier front, certainly in the auto sector, tier 2, tier 3, coming out of the show there is a lot more commentary about real near-term risks. What are your thoughts on that over the next 60 to 90 days, on your tier 2s and how healthy are they?

Keith E. Wandell

We have publicly stated that approximately 35% of our supply base is financially distressed. And so it is an issue. And I think we have a good process in place for how we are managing that.

We are doing a couple of things. Number one, we have a very aggressive in-sourcing process in place where we have sort of excess capacity internally, be it injection molding, or be it metal stamping, or whatever, where we are very rapidly bringing a lot of that work in-house, which is really a double benefit to us. It helps with our overhead absorption as well as typically it is at a lower cost to us.

And then secondly we are going through a work-out process and we have a complete organization in place that is really helping us move a lot of parts from financially-distressed suppliers to other more healthy suppliers.

And so I would tell you that right now we are pretty well ahead of the curve but it is a concern for us, and it’s an even bigger concern for the car companies. You can just imagine the number of suppliers that they have and how many of those are financially stressed. So this is a big issue for the entire industry.

Richard Kwas - Wachovia Capital Markets

After-market business softness with inventories, and pulling back on inventories with some of your key customers, do you anticipate that continuing in the near term? Do you think you’ve seen the worst of it or what’s your sense for that right now?

Keith E. Wandell

I think in terms of the inventory management, I think we’ve probably seen the majority of it. The thing about the battery business is there is a very imperfect forecasting capability, when you think about all the different SKUs and the different battery types that go into vehicles, we might have a forecasting inaccuracy of anywhere to 80% to 100% in any given month on any given part number. So typically what you do to offset that is you layer in inventory, both in our system as well as at the customer. Because the customer is trying to obviously make every sale they can make when the customer comes in the door.

And so like I said, with the price of lead going up over the last year, they have become more sensitized to that so they have sort of scaled back their inventories, and we think we have seen the bulk of that.

The other thing I did mention, though, was that we do believe there has been a deferral, if you will, of sort of the preventive maintenance kind of purchases that occur with batteries and we think at some point in time that will level out as well and there should be some pent-up demand there.

Stephen A. Roell

I wanted to add a comment, another thing we can acknowledge is that at least in Europe we saw in December, we saw the after-market customers come back. So I think that lead has now been fairly level for probably the last 90 days and that’s sort of helping out a little.

Operator

Your next question comes from Christopher Ceraso - Credit Suisse.

Christopher Ceraso - Credit Suisse

In some of the segment EBIT data, can you give us a feel for how much was the hit from the customer bankruptcy? And was it in the GWS area?

R. Bruce McDonald

I think it was $7.0 million or $8.0 million.

Christopher Ceraso - Credit Suisse

And as you look forward, there was a comment in here about starting to feel more of the accretion from restructuring as we roll forward over the next couple of quarters. Can you give a feel for the magnitude of that as we move through Q2, Q3, Q4?

R. Bruce McDonald

I don’t have that in front of me. But we’ll touch on that next quarter.

Stephen A. Roell

I think we did describe what the 2010 impact was.

R. Bruce McDonald

Next year it’s $0.20 to $0.25, the accretive year-over-year benefit. What we did say is Q1 restructuring is a net negative to us here. In the second quarter it’s a positive. Off the top of my head I think it’s $0.03. But I can’t remember the cadence as we go into Q3 and Q4.

Stephen A. Roell

And the $0.20 to $0.25 was accretive over what we expect 2009 to the interest benefit.

Christopher Ceraso - Credit Suisse

Were there any favorable customer settlements or raw material recoveries in the Auto sector? The contribution hit there on the revenues was a bit better than I might have expected even though the loss was bigger.

Stephen A. Roell

No.

Christopher Ceraso - Credit Suisse

Any change or slowdown in your bidding activity? I know there was a little bit of a slowdown in your backlog, which was up 7 versus last quarter up 12. What’s going on a little further out in the pipeline?

Stephen A. Roell

Looking at the pipeline I guess there are two things we saw. Probably on the service side the activity stayed strong driven by solutions, as I mentioned. And the big vertical markets that are helping us are the federal government and higher education.

When we look at the systems side there is mixed bag. I would tell you that’s probably where we’re seeing some of the slowdown. Probably flatness in healthcare and higher ed in the systems side.

But we’re seeing still good growth in a couple of areas you wouldn’t expect. Actually in the U.S. commercial real estate market, that office market, we’re seeing our bidding activity up. We’re seeing government up and we’re seeing airport construction activity up.

Operator

Your next question comes from Himanshu Patel – JPMorgan.

Himanshu Patel - JPMorgan

Are you seeing any increased signs of in-sourcing from the European car makers? I’m in particular thinking about the German OEMs, they’ve been pretty adamant about not reducing headcount and obviously volumes are plummeting across Europe. Have you seen any signs of things that were previously outsourced that are now being brought back in-house?

Keith E. Wandell

We have not. At least in the parts and components that we’re supplying. Whether it’s in other areas I don’t really know, but we’ve really not seen that.

Himanshu Patel - JPMorgan

On Europe auto, my understanding at the start of the year was that you were reluctant to cut too deeply into permanent manufacturing headcount despite the volume weakness in 2009 because you knew you had a large backlog coming on stream in 2010. Where does your thinking on that stand now? Has your medium-term outlook for perhaps overall European industry volumes weakened sufficiently that you would consider deeper restructuring on the manufacturing side in Europe even though you do have an uptick in backlogs next year?

Keith E. Wandell

When we looked at the overall restructuring we did include quite a bit of restructuring in Europe as well as North America. I think where the disconnect might be here is where we had engineering support for the increased launch load that was coming up. But in terms of plant rationalizations and headcount reductions, Europe was the biggest hit. And we’ve really taken a lot of SG&A as well as direct folks out in Europe and are continuing to do so.

Stephen A. Roell

You may remember, when we talked about engineering, we actually had four programs that were being engineered in the U.S. We opted not to increase engineering in Europe at that time because number one, we couldn’t hire them fast enough. We’re doing it out of India, out of the U.S. That’s where we flex in terms of the European to meet that backlog you referred to.

Himanshu Patel - JPMorgan

Lastly, just a ballpark of your Building Efficiency division, how much of that is the federal government?

Stephen A. Roell

I would have to go back and look at how much that is. I can tell you that the pipeline of opportunities before any stimulus here, we have about $300.0 million of work that we’re working on right now. In terms of pipeline opportunities alone.

But from a sector standpoint, healthcare and education are our two largest segments. Federal would be bigger than probably office. But the combination of state, local, and federal would be our third largest segment.

Operator

Your next question comes from Brian Johnson - Barclays Capital.

Brian Johnson - Barclays Capital

As we think about the restructuring, especially as to Europe, it looks like detriment margin was up over 20%. When we think about restructuring is it just going to keep detriment margins in that 20% range or could we actually see it being added to the bottom line, that is taking detrimental margins down to 10% or 12%?

R. Bruce McDonald

I think one of the issues that I touched on and maybe you didn’t pick up on it is that in Europe, as things have turned down so quickly, where we’re struggling is completely flexing our direct labor.

In North America we are able to lay people off very quickly. In Europe, in several counties, you have to continue to pay people, or give them notice. If you look in the first quarter the negative impact of that, i.e. not being able to take out fixed labor in line with production, was about $40.0 million. That’s not a long-term structural problem but it’s something we have to flex our labor down. We just can’t do it as quickly. So that’s why the degradation in our margins, or the negative contribution to margin in Auto Europe is worse than you probably would have liked to see.

Brian Johnson - Barclays Capital

And when do you think you hit the point where paid staffing is in line with the Europe production rate?

R. Bruce McDonald

That’s a hard question to answer because we have to respond to our customers and right now in Europe customers aren’t taking plants out, they’re taking a week out of their schedule or operating three days a week, or taking shifts out. And as long as our customers do that, we have to basically follow.

Brian Johnson - Barclays Capital

And do you have flexible-work-week agreements with your work force in Europe and if so about how much would that cover?

Keith E. Wandell

We really don’t but we’ve been very successful in our employees cooperating with us in that respect.

Operator

Your last question comes from Rod Lache - Deutsche Bank.

Rod Lache - Deutsche Bank

The Automotive business in Europe, down 41%. Obviously some currency impact there. But at the same time I believe there was some ramp up in the backlog this year so could you talk about why that seems to be declining more than the production decline? And also in that region, is the 30% decline that you mentioned earlier, is that for Q2 or is that your expectation for the upcoming fiscal year?

Keith E. Wandell

I think the 30% was in auto battery. That was for Q1.

Rod Lache - Deutsche Bank

Did you not say on your comments on the deferred tax asset write-down that you were expecting a European decline of something like 30%?

R. Bruce McDonald

Yes, for the year.

Rod Lache - Deutsche Bank

And what is your expectation for this upcoming quarter in production?

Keith E. Wandell

We don’t have an update for that.

Stephen A. Roell

At Q1, that 4.2 was really the production for our fiscal Q1. I don’t have Q2. We can get something for you.

R. Bruce McDonald

You were asking about the 41%. Maybe I could just provide a bit more color there. A couple of things in Europe. One, we saw particularly harsh volume reductions in the manufacturers that are export-geared. So you take someone like Volvo or BMW for example. Their production is down much more than the industry.

Secondly, General Motors [inaudible] is a big customer for us. They did a little bit of inventory destocking so they were down probably more than the aggregate. And obviously tough foreign exchange in there.

Rod Lache - Deutsche Bank

And to Keith’s comments about the distressed suppliers, do you have an estimate for what that cost you last year and any way to put any parameters around that this year and would it be greater in Europe or greater in North America at this point.

Stephen A. Roell

First of all, I don’t think it’s a big number for us. The biggest cost for us last year was really the capital associated with bringing BusTek in-house. That’s the way I would describe it to you. And I would say since then, as Keith described the insourcing, BusTek’s been a great source for us in terms of being able to move production for injection molding into the plastic operations. We have been able to restructure that significantly. In terms of reducing the number of plants, the number of people. But we like what we have right now in terms of injection molding in the U.S.

But I would not attribute at this stage any significant cost at all to what we’ve incurred in terms of supporting distressed suppliers. It’s not a big number.

I want to make a comment about Europe, and I’m going to be a contrarian here, but if I think about European Automotive and the outlook, there are all kinds of forecast about why Europe will be weak for a longer period of time and they particularly point out the fact that they went into the recession later. But I have to look at it from a consumer standpoint and if I think about European consumers, they don’t have credit card debt, they don’t have the housing problem in Germany and France, the unemployment levels are not historically out of balance. In fact, they were improving and today are lower than what they were a year ago.

So I have reason to believe that Europe could actually lead us out of this thing if we can get the consumers there about going forward. Quicker than the U.S. That’s just my sense. But they don’t have the 401(k) issue that we have here. So I’m optimistic that Europe could actually lead us out. We’re not planning for that but I think we could come up with a scenario that says Europe could rebound for us.

Rod Lache - Deutsche Bank

How are you sizing up the stimulus opportunity for Building Efficiency? Is there like a market share of that business and sort of a big picture number that you are targeting at this point?

Stephen A. Roell

We could sit here and talk about $15.0 billion of that stimulus which would be within our scope, but all we’re going to do right now is really organize ourselves, take advantage of it, as I mentioned making sure that we’re on the lists that are qualified to move quickly, to take advantage of it, and working on our relationships. Both at the federal as well as the state levels.

Glen Ponczak

Thanks everybody for your interest and participation. I will be available in my office for the balance of the day if you have additional questions.

Operator

There are no further questions in the queue.

Operator

This concludes today’s conference call.

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