Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Johnson Controls Inc. (NYSE:JCI)

F3Q09 Earnings Call

July 20, 2009 11:00 am ET

Executives

Glen Ponczak – Director, Investor Relations

Stephen A. Roell – Chairman and Chief Executive Officer

Bruce McDonald – Executive Vice President and Chief Financial Officer

Analysts

Patrick Archambault – Goldman Sachs

Colin Langan – UBS

Christopher Ceraso – Credit Suisse

[David Lichter]

[Etai McHaley]

Richard Kwas – Wachovia Capital Markets

Ted Wheeler – Buckingham Research

[Cheryl Van Winkle]

Operator

Welcome to the Johnson Controls third quarter 2009 earnings conference call. (Operator Instructions) At this time I will now turn the call over to our first speaker, Mr. Glen Ponczak. Sir, you may begin.

Glen Ponczak

Before we begin I'd like to remind you of our forward-looking statement. Johnson Controls has made forward-looking statements in this presentation pertaining to its financial results for fiscal 2009 and beyond that are based on preliminary data and 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 in schedules, financial distress of key customers, energy prices, the strength of the U.S. or other economies, currency exchange rates, cancellation of, or changes to commercial contracts, liquidity, the ability to execute on restructuring actions according to estimated timelines in costs as well as other factors discussed in the company's form 8-K which was filed March, 9, 2009, could affect the company's actual results, or could cause its actual consolidating results to differ materially from those expressed in any forward-looking statement made by, or on behalf, of the company.

I'm pleased this morning to be joined by Steve Roell, our Chairman and Chief Executive Officer who will provide an overview as well as some details on the economic environment and the outlook. He will be followed by Bruce McDonald, Executive Vice President and Chief Financial Officer, who will give a review of the business results as well as a financial review. And that will be followed by questions and answers.

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

Stephen A. Roell

Before going into the slide presentation I'd like to make just a few opening comments. In our conference call at the end of the second fiscal quarter we indicated that our markets would continue to be challenging in the near term, and that certainly was the case in the quarter.

Automotive production schedules in North America while already at historic lows were further depressed by the excessive shutdowns that took place at Chrysler and General Motors. But at the same time we now have more clarity around the future of both Chrysler and GM.

With Chrysler we've reached agreement on the amounts that were owed to us and we have been paid in full. And while we still have a few items to reconcile with General Motors, the customer has paid us for the majority of the amounts outstanding, I really would like to compliment both of the automakers on how they communicated and worked with us during their trying times.

You may recall that the central message of last quarter's communication was that we had taken the actions to improve our profitability. We were not dependent upon recoveries in our markets to achieve the results that we now have demonstrated in the third quarter as well as in the fourth quarter.

Our results in the quarter reflect our ability to take share and align our cost structure to market conditions and while the comparisons to last year are tough, I'm really pleased with our progress and the improvements in our profitability.

Our employees have made numerous sacrifices for the company and I'd like to just acknowledge their contributions and thank them.

So now if we turn to the slide, just a couple of quick references here in terms of the numbers for the quarter. Our sales are $7 billion compared to $9.9 billion in 2008. I can give you a little bit of color behind those in terms of the break out. Foreign currency was roughly $700 million, lower lead was about $430 million and then lower automotive buys contributed almost $1.5 billion of the shortfall from the prior year.

Our segment income of $282 million was $395 million higher than what it was last quarter. Building Efficiency and Power Solutions of course were profitable, but we also saw our automotive experience in Asia and Europe also contribute to our results with profits. And we had a much smaller sequential loss in North America where we lost roughly $34 million on the segment basis.

Our net income was $163 million that yields $26 per share versus $0.73 in Q3 of 2008. We concluded this with a little box in the upper right-hand side of the slide that illustrates for you the sequential improvement in Q3 over Q4 where revenues were up roughly $700 million, segment income was up $395 million and net income was up $260 million. So we wanted to just provide that to you.

In terms of some of the highlights in Q3 outside of the financials, we were awarded some immediate takeover seating and interiors business. Those programs are in Europe and we launched those during the summer programs. That's the reference to the immediate takeover is the fact that we're right now in the midst of converting those programs over to Johnson Controls.

Now we've tried to keep you updated here in terms of what we see in terms of the stimulus projects for our BE business. We're currently bidding on 2,700 stimulus funded projects worth roughly $800 million. It's up from $535 million when we talked to you late in Q2. Again, just to remind you we expect that in this quarter as well as the first half of 2010, the fiscal year, that will be largely a period where we'll be winning awards that we would expect to execute and get meaningful revenue in late 2010.

The next bullet's really in reference to some of the things you're reading regarding the cap and trade structures that may evolve. You know, clearly we've identified by some of the press regarding our ability to help our customers monitor their emissions and also help manage their greenhouse gas emissions. It's in the very early stages but we feel we've got excellent software and capabilities to help a broad range of customers in terms of how they would manage greenhouse gas emissions in the future.

The next bullet refers to the fact that we did launch our first full production of lithium-ion battery systems for the Mercedes S-Class. We believe it's the first full production lithium-ion system to be introduced. The next one, of course, we've highlighted in the past is the BMW 7 Series which we expect to see in the showrooms by the end of calendar 2009.

And finally those of you that have followed our Power Solutions business know that we have applied for the U.S. federal matching funds for domestic lithium-ion hybrid battery manufacturing. We expect to hear from the government by the end of July. Public announcements will be made in September. We fully expect to be awarded a portion of those funds. We are partnered with Ford as well as a number of world class suppliers, and so we'll be able to provide you more updates, but it probably won't be until the September timeframe.

In terms of the economic environment and the outlook we'll just highlight just a little bit in terms of the third quarter, North American Q3 production was down 48% versus last year. I've already mentioned the fact that Chrysler and GM had extended production shutdowns.

You're aware of the fact that Cash for Clunkers legislation did pass in the U.S. Its potential is probably a full forward roughly 250,000 vehicles, primarily small cars. It's a $1 billion program and I think it's well intended. I just think it will have minimal impact given the fact that we're so far down in the context of production against historical norms.

There are signs of improving credit availability to car buyers. We also have heard that we've been watching the trends in used car prices and they're trending up. So there are a couple of things that bode well. The North American auto market may have some signs of recovery, be it modest.

In Europe Q3 production was down 27% versus last year. As you're aware some of their government incentive programs are working primarily in Germany, Italy and France. The segments that are benefitting are primarily the A and B segments where we'd have good participation in those market places but just by the nature of the vehicles they have smaller content.

China continues to be a very bright spot; production was up 21% versus 2008 and the quarter, and clearly there was a sequential improvement there with very strong demand in the Chinese market in the month of June.

Shifting to building markets, overall the softening in new construction, we've seen construction numbers soften, particularly around the rest of the world in Eastern Europe, Middle East and Latin America. As we've indicated in North America, we're highly dependent on institutional building markets, the government, health care, education, and we'll probably talk more in our – as we go through our notes we'll talk more about the pipeline.

We did see maintenance and retrofit deferrals in the quarter. And so I think we had a tough quarter in the context of the market being unsettled by the stimulus and what was going to be awarded, and also just deferrals as our customers try to wait out the economic softness that they see right now.

And then finally we would tell you that there has been a delay in the energy efficiency projects in the U.S. due to just the potential for stimulus funding. We've used a quote here that came up out in the American Institute of Architects on July 13, that indicates that in their forecast they're beginning to see some moderation in the trends in design, building and architectural firms. So quote, "They are hopeful that they're nearing the bottom of the cycle."

As we've indicated, we do participate in the institutional side. These two pieces of information are part of their forecast where they're projecting that educational construction will decrease by a little over 8% in 2009. But then they're saying by 2010 the decline is only 1% or they're going to call if fractional. The same thing is true with health care where they see a decrease of only 1.5% in 2009 and less than 1% in 2010. So that sort of gives you some idea of what's being said by the AIA relative to the construction markets.

But then I want to turn it over to Bruce, and he's going to comment on the quarter itself and some of the numbers behind our financial results for the quarter and also the outlook. Bruce?

R. Bruce McDonald

Well first, let's talk about automotive. Reflecting I guess one of the worst production environments that we've seen in a generation, we're really pleased with our automotive results. Look at the top line, our sales were down 31% on a constant currency basis with significant declines in all regions across all customers and across all product segments. With the exception of China where we saw aggregate revenues, which include our unconsolidated joint ventures, sales there were up 12%.

Adjusting for currency if you look at our numbers versus the industry we generally did a little bit better than the industry levels and that really reflect the launch of new business awards. For the quarter our segment income was a loss of $14 million which represents a $261 million improvement over our second quarter results. While we continue to be negatively affected by lower volumes our third quarter results really show the benefits of the restructuring and other costs reduction activities that we've done to realign our cost base with the current market conditions.

Steve indicated earlier we committed to getting our auto business to a breakeven level by the end of our fiscal year and we're tracking generally better than our internal projections. As I noted in our last conference call, the low levels of production have helped us pull forward our restructuring activity, so we're running kind of a little bit ahead of schedule there.

In Asia we've continued to invest there and that's a real long-term growth opportunity for us. In the quarter our Asian operations report a 31% improvement in segment income to $17 million. In China our equity income in the quarter was a new record for the company, and that's despite the fact that we still have four joint ventures that are sort of in a start-up phase and aren't yet profitable.

If you look at our European auto business, we had a small profit in the quarter and that business continues to benefit from slightly stronger volumes in the A and B segment market where government stimulus programs are having a positive impact on consumer demand. So sales are still – market's still down significantly, but we are seeing an uplift in some countries in the A and B segment sector. Then lastly in North America, we had a big sequential improvement. Our loss in the quarter was $34 million.

Turning over to building efficiency our sales of $3.2 billion went down, again, 7% on a constant currency basis. If we look at the various pieces within that and our North American systems business was about 7% as the installed market – as the institutional market remains more resilient then the office, retail and lodging sectors were – generally were under exposed.

Our service business was down 11% though PSAs or those are contracts that we have for scheduled service continue to increase, and we're still seeing customers deferring routine maintenance and equipment retrofit projects.

We had a good quarter in our solutions business with that business growing again and we did start to see some of the ARRA projects flow into the backlog. Included in our numbers here for the quarter we were awarded about $25 million of stimulus orders, but generally speaking we're still seeing temporary contracting delays as the funding guidelines aren't clear.

If you exclude FX in Europe and the rest of the world our revenues were down in that 10% to 15% range. In Europe we see the declines disproportionately skewed towards Eastern Europe, Russia and our residential businesses.

On a positive note, revenues in our North American residential business were comparable to year-ago levels and it now appears as though that market's beginning to stabilize, albeit at historic low levels. In that North American residential business we've completed our footprint restructuring. We're down from three facilities to two. And we've instituted a number of initiatives that we're going to return that business to profitability even at this volume level.

In the quarter we made substantial improvement in the profitability of that business and we expect see that accelerate here in the fourth quarter. If you look at our backlog of uncompleted commercial business it was $4.4 billion at the end of the quarter, down about 6% on a constant currency basis. In looking at the pieces within that, if we look at North American aggregate we're comparable to year-ago levels, same thing in Asia and Latin America. The real soft spot for us was the Middle East where are backlog declined by significantly and represents about two-thirds of the overall reduction. So two-thirds of that 6% is Middle East of the balances in emerging markets and Europe.

In terms of the income line, segment income of a $190 million was down 37%. This is really attributable to lower volumes which adversely impact on factory absorption on the equipment side of our business and unfavorable copper hedges. In addition to that we have – we're discounting certain product lines to reduce our inventory levels, and as we get into the fourth quarter here we expect to see accelerating benefits from our restructuring initiatives. And then the negative impact of our copper hedges and some of these discounting activities are going to become a lesser issue for us and help improve our bottom line.

Turning to power solutions, our sales were down 35% and obviously adversely impacted by the lead prices and to some extent foreign exchange. If we look at on the volume side we're down 12% versus last year aftermarket down in the sort of the mid-single digits with OE volumes in North America and Europe down 34% and 29%, respectively. And in the quarter we did start shipping to NAPA which is a new customer that we announced last quarter.

Turn to the income side, you'll see income down 27% to $106 million. That's mainly attributable to lower volumes and as we've noted here these – our results include about a $15 million nonrecurring charge associated with the sale of former manufacturing facility in Europe and some associated fixed asset write-offs. So those are behind us now and they're not expected to continue.

We're continuing to invest in both our hybrid business and our Chinese operations. On the hybrid side we've recently submitted an application for a federal grant to help fund the Michigan lithium-ion battery facility. As many of you know we already have one facility up and running in France, so this is our second facility that we're talking about here.

We continue to be pleased with the strong customer interest in our hybrid systems capabilities. As Steve mentioned before, we're in production with the S-Class, with four other global production contracts and 10 development contracts currently in our backlog.

Turning over to the financial statements, if you look at the sales, down 29%, really reflecting the difficult climate that we're in. As Steve noted earlier in his comments, the majority of the reduction is due to foreign currency, lower lead prices and reduced production levels in the auto side of the business. On the gross profit line we came in strong in the quarter at 14.9% which is down only 20 basis points from prior year levels.

The modest reduction that we're seeing here I guess really reflects the benefits of our restructuring efforts and some of the manufacturing footprint actions that we've taken. You'll recall a couple quarters ago we talked about we were struggling to adjust our European direct labor to reflect the lower production levels and we sort of put those programs in place there and that's largely been addressed and behind us.

So we're pleased with our gross margin performance here in the quarter. As I mentioned, if you look at the gross margin line, building efficiency we continue to be adversely affected by both the legacy copper hedges and some discounting associated with our efforts to reduce our inventories. Both of those factors we don't expect to occur to this extent in the fourth quarter.

SG&A we're down about 10% versus last year. We continue to take a lot of cost out of our overhead base, but we're making sure that we continue to protect the investments that we have in some of our key growth initiatives.

On the equity income line, you'll see we added a large sequential improvement of $22 million versus last quarter, but at $30 million we're still a little bit below prior year levels. The strength that we're seeing in our Chinese joint ventures is more than offset by declines in our automotive joint ventures in North America and Europe.

On slide 11, if I look at the net financing charges you'll see they're at $65 million, a little bit below prior year levels. I'd just remind everybody that our results in the quarter include the higher cost coupons associated with the convertible debt that we completed in March. And another point maybe just for modeling purposes the quarterly after-tax earnings payments on those instruments are about $13 million. And they're actually added back in the calculation of fully diluted per share, and you'll see we've got that sort of reconciled in the notes to the financial statements that are included in our press release.

For the quarter if you look at our tax line our rate was 23% versus 21% a year ago. In the quarter we did have about $9 million net of nonrecurring tax benefits, so our underlying rate was about 27%, which is the rate we sort of anticipate going into the fourth quarter with.

In terms of minority interest, $4 million charge in the quarter, down from $16 million last year. Again, here the reduction is attributable to low profitably and our consolidated automotive joint ventures in both North America and Europe.

And overall you can see our earnings per share of $0.26 a cents here. There is about a $0.01 tax benefit in there. And just as we note down at the bottom of the page here, the fully diluted share count is now 676 million, again reflecting the dilutive impact of the convertible offering.

I'd just like to spend a few minutes talking about our liquidity, the balance sheet and our cash flow here in the third quarter. Now we continued to have a strong balance sheet. In the quarter we actually strengthened it.

In aggregate, just looking at our liquidity position, we have about $3 billion in committed and non-committed bank lines. And we have a peak intra-month need of about $800 billion which leaves us with a $2.2 billion cushion over our peak borrowing needs in a point in time.

If you look at our bank revolver of $2 billion, and that's what banks, backstops our commercial paper program. That facility is undrawn and that matures in December of 2011. We have very minimal debt maturities in the next 18 months, about $125 million, strong access to the commercial paper market where we're actually able to place overnight paper at rates below 1%.

Our cash flow in the quarter was good at $343 million. That's cash from operating and investing activities. And this enabled us to reduce our net debt by $245 million in the quarter. If you look at net-debt-to-total capitalization that was 33.8% versus 36.2% at the end of the second quarter, and we were pleased to see our working capital performance come in strong in the quarter with source of cash of about $130 million and now on a year-to-date basis all of our working capital metrics are in significantly better shape than they were at the end of last quarter.

Just looking at inventory as a case in point, you'll see that on a year-to-date basis, we've been able to lower our inventory position by about 23%. Capital expenditures continue to trend down. That's something that we talked about last quarter. We're just north of $100 million here. That's really reflecting some of the curtailment actions that we took as the economy toughened up here in the fall of last year.

Our full year expectation for capital expenditures continues to be in that $600 million to $625 million range. We're forecasting strong free cash flows here in the fourth quarter and expect to end the year with debt levels roughly comparable to year ago, to where we ended 2008.

Last, let me just talk about sort of what we're seeing here for Q4 in our outlook. We're not going to get into specific quarterly guidance but here's kind of the shape of what we're looking at. We expect to see our revenue pick up in the fourth quarter by about another $400 million, so we're looking around that $7.4 billion.

In automotive, we're making, as we've talked earlier, terrific progress right sizing that business and its cost structure to the current production environment. And based on the production visibility that we have today and factoring in the summer shut downs in North America and Europe, our expectation in Q4 is that we'll have a positive return on sales of nearly 1%.

In Power Solutions, as we talked about in our press release, we're expecting our profitability levels to be roughly in line with the way they were in the fourth quarter of 2008, and that will be on about 10% lower volume. So our Power Solutions team has done a nice job resizing their business to be a sort of flat year-over-year profitability level on 10% lower volumes. So when the volumes pick up, we'll be well positioned to get that incremental contribution margin.

Then in Building Efficiency, let me just sort of put it in context. If you look at our numbers here in Q3, you'll see our revenues were down 14% and our segment income was down 37%. As we look into the fourth quarter, you know, we continue to expect the revenues are going to be down by a comparable basis, but we think we're going to be able to maintain our profitability shortfall to be closer to our revenue shortfall.

We expect to see continuing, accelerating benefits from our cost reductions initiatives. The unfavorable copper hedges are going to start to roll off and some of the discounting I've talked about earlier is coming behind us here.

So to look at individual pieces within Building Efficiency, you know, we expect comparable profitability in our North America systems and service both, both – sorry, both of our North America systems and services business, GWS and Europe. And that really reflects sort of our efforts to take cost out of those businesses.

Our challenge is going to be, like we have in this quarter, the Middle East and Latin America where we're seeing significantly lower volumes and product discounting is going to continue in the Latin America segment. Our North American residential business is going to return to profitability here in the fourth quarter though we do expect it's going to be down on a year-over-year basis.

I guess overall we know that Building Efficiency is a late cycle business and I guess we feel pretty comfortable that we have growth strategies in place that's going to let us continue to outperform the markets that we're in. We're taking all the actions that we need to on a cost basis so that we're positioning Building Efficiency to expand its margins in the climate here. And with that, we'll open it for Q&A.

Stephen A. Roell

All right, we'll take questions.

Question-and-Answer Session

(Operator Instructions). Our first question comes from Pat Archambault – Goldman Sachs.

Patrick Archambault – Goldman Sachs

Hi. Good morning.

R. Bruce McDonald

Good morning.

Stephen A. Roell

Good morning, Pat.

Patrick Archambault – Goldman Sachs

I guess just on building efficiency first, maybe you could just tell us a little bit more of the growth outlook. You know your backlog is down I guess 6% ex-currency. That's more than clearly it was last quarter, but obviously that doesn't include things like global workplace solutions which are probably more stable. So can you maybe give us a little bit of help as to maybe we might think about the growth there for the next call it 6 to 18 months?

Stephen A. Roell

Sure. Bruce was giving you sort of the outlook for the upcoming quarter but let me see if I can add some color of what we're seeing. The one thing we look at is the pipeline of business and that's a primarily North America view at this stage, but what we do see in the pipeline right now are numbers that are comparable or slightly up.

And so as we look across the K through12, the educational market, the federal government type quoting that we're seeing, we're seeing good strength in that and so we expect that to really – that's the business we now look in the upcoming quarter that should execute in revenue in the next probably 9 to 12 months.

The other thing is I would tell you is we are seeing a big backlog of solutions work which is performance contracting fees. There were some big contracts that we thought we'd secure in the third quarter that are falling into the fourth, so we would expect that to help prop up our backlog in the fourth quarter.

Now having said that, I would expect that we still are going to be down year-over-year in terms of our backlog at the end of the upcoming quarter, but I still feel good about the level of bidding that we have. Probably some help that we'll get in the latter part of fiscal 2010 relative to the stimulus bill, and I think we're taking the Saudi hit right now, the hit in Dubai.

Saudi will pick up for us as we go through the year. So there's pockets of strength that we see, Pat, that I think do give us some confidence that while it'll be soft in '10, we're still going to have a fairly good year out of the Building Efficiency group.

Patrick Archambault – Goldman Sachs

Okay. The hedging impact for copper can you guys put a number around that in terms of how big it was for the quarter?

R. Bruce McDonald

No, we're not going to break that out, Pat, because it's just too sensitive in terms of our pricing strategy. So it's significant but we're not going to quantify it.

Patrick Archambault – Goldman Sachs

I guess moving onto automotive, can you remind us, are all your contracts now pretty much hedged in terms of raw materials? You said it another way. Are they written in a way that there's some flexibility if raw materials go up a lot, particularly thinking about foam and resins here? Or are there still some legacy contracts that have yet to roll off that when they do roll off could maybe provide a tailwind?

Stephen A. Roell

Yes, Pat, I guess I would tell you that, I think the last quarter we indicated that about 90% of our contracts had a commodity type paragraphs or wording in them that allowed us to either share or pass on that cost. That's still the same. There's probably one or two customers that we still have to resolve but we're negotiating with them right now.

I'm not so much concerned near-term, but it's something that we want to just make sure we get in place as we approach probably higher inflationary periods two to three years out.

Patrick Archambault – Goldman Sachs

And I guess last question on that segment, how are you thinking about the production cadence in Europe? Obviously you've had a really pretty good quarter. I think European production was up, it might have been 20% sequentially or something like that, right, from given the scrappage incentive programs?

What are you hearing from your customers? How are you thinking about how that plays out for the balance of the year with some of these incentive programs looking like they're coming to a close?

R. Bruce McDonald

I guess what we're hearing, Steve and I are actually going to be in Europe next week so we'll probably have a better read then, but what we've heard lately is that the German one in particular is doing very well and the expectations are that that's going to last through the end of the calendar year.

The program in place in the U.K. is only just started. I think it's been in place for maybe a month and a half or two months. There is some concern that the demand is pulling forward vehicles from next year but I guess I'd say it's probably too soon to tell.

And I guess the key thing in Europe is the market just dropped off so quickly in the fourth calendar quarter of 2008 that it's tough to get an accurate read on the timing of that market coming back to anywhere close to levels that it was operating, even as late as the latter part of the second half of 2008.

Stephen A. Roell

I think the key will be how the governments approach this from the standpoint of trying to protect employment and whether or not they'll extend those incentives. That we don't know. But I would believe that they're going to have to do something, whether they extend beyond the A and B segment or just extend longer the A and B, what they've offered. That will be interesting.

The one thing, Pat, that we haven't talked about that maybe we should just talk about with the rest of the players on the phone call here, we have our largest number of launches that we've ever experienced in our automotive business right now in Europe.

And we have over 30 launches that we're in the midst of that where pretty much engineering was done last year and early this year. We're in the midst of those launches. They've gone very well. But what's really masking part of our results as well in 2009 is just the costs associated with those start-ups.

So as we think forward to 2010 and 2011, having those behind us and getting more efficient is going to be a critical part of the improvement in Europe as well. We haven't highlighted that but it's probably, if you think about the backlog that we shared with you at the beginning of this fiscal year, if you recall, a lot of our launches were in fact in Europe and in Asia. It's really those launches that are coming through.

Operator

Your next question comes from Colin Langan – UBS.

Colin Langan – UBS

Can you just give a quick status of your restructuring? You only had the $15 million charge in Power Solutions this quarter. Does that mean most of your restructuring is complete at this point or is there more to come in the second half?

R. Bruce McDonald

No, the restructuring charge that we took in September and March of last year I would say were, if you sort of look at the aggregate numbers, were about 60% done in total. We wouldn't classify the $15 million in Power Solutions in that bucket.

Those really relate to, we had a former facility that was actually acquired as part of the Varda transaction. We sold it in the quarter and the cost of selling that and the environmental clean-up far exceeded our original estimates and we had to top that up.

Colin Langan – UBS

And then so you highlighted the taxes sort of impacting your earnings. Is there an earnings impact of the $15 million or is there any reason to think that's a recurring charge? Is that not one time?

Stephen A. Roell

The $15 million, Colin ?

Colin Langan – UBS

Yes, for the Power Solutions?

Stephen A. Roell

That's nonrecurring.

R. Bruce McDonald

That's nonrecurring. That doesn't affect the tax rate.

Colin Langan – UBS

And is that like a $0.02 impact on earnings that would be for this quarter?

R. Bruce McDonald

Yes, the Power Solutions, had the $15 million not occurred, yes, it would have been a $0.02 higher EPS for us in the quarter.

Colin Langan – UBS

When you take that 15 out of the Power Solutions, the margin looks like a 14% margin. Is that a sustainable margin for the Power Solutions business going forward?

R. Bruce McDonald

Yes, what you really got to watch here, Colin, is in the Power Solution side of the business we pass on the impact of lead prices. So if lead goes up, if lead doubles then we would essentially double the lead part of our selling price so our margins would look very skewed.

So what you've got here is, in the quarter, I think lead prices came down 35%. That knocks $430 million off our sales but it doesn't have any impact on our bottom line. So if you want to make it apples-for-apples, you'd have to add the $430 million back into this year's revenues and then look at the year-over-year margin basis.

But to your point on a go forward basis, if lead stays level then the 14% is a sustainable number. In fact, we think it will be better in the fourth quarter.

Stephen A. Roell

I think the guidance that Bruce gave though earlier Colin on the phone call therefore was based on absolute dollars. So what Bruce's comment was that we believe our segment income for Power Solutions will be comparable dollar-wise to what it was in the fourth quarter a year ago.

Colin Langan – UBS

And then switching over to, I guess for clarity, there are two seating and two interiors? Is that four different pieces of business or just one seating and one interior?

R. Bruce McDonald

Two pieces of business.

Colin Langan – UBS

And are there any more opportunities there? I mean obviously the summer shutdown seems like a good time to transition business over. Are you in process and discussions with automakers about taking over additional business from competitors? And could you give any color on the size of the business that you've already won?

Stephen A. Roell

Colin, there's a lot there. First of all, you're right. This is the time where you would typically see the changeover taking place. We continue to be in dialogue with OEs about additional business but again, just to remind you, any business that we're going after typically is there because of a concern over a supplier's financial viability.

We're not there to try to price the business to take that kind of conquest business in that form. We haven't sized and it would be difficult to size it in terms of what ultimately could happen. But we've talked about in the past, we wanted to let people know that at least there's some of that taking place right now in this quarter, okay?

Operator

Your next question comes from Christopher Ceraso – Credit Suisse.

Christopher Ceraso – Credit Suisse

Just a couple of items, you mentioned some of the changes that are happening with the backlog with the Middle East coming off and one of the performance contracting contracts rolling to the fourth quarter.

But if I look at the backlog and aggregate, is there other stuff going on behind the scenes that would change the mix of the backlog of business that we need to think about in terms of the expected profitability of that new business as it rolls on over the next year?

Stephen A. Roell

I guess other than the other thing we would tell you is that the European market was soft in terms of the backlog. Those were the two. We did lose some industrial refrigeration momentum in Latin America would be the other thing I could think of.

But from the standpoint of profit, to the extent that it's skewed towards performance contracting and some of the retrofit, those are typically higher margin business for us. Chris, that's the best I can do.

Christopher Ceraso – Credit Suisse

What about that on the government subsidy when that comes on? Should we expect that to be any different than the rest of your business in terms of average profitability?

Stephen A. Roell

No I don't think so, not in a [unique] way, okay? Clearly it is going to be work that we have to bid on, so it's going to follow more of the construction type margin as opposed to the retrofit, but I would expect it to have good profitability in it.

I guess I'm making that statement based on the fact that we do a lot of work for the government today under different bidding conditions and I would tell you it is comparable profitability.

Operator

Your next question comes from [David Lichter].

[David Lichter]

I know you kind of talked about it a little bit. In a more direct way, can you give us a sense in your Asia business what your revenues changed year-over-year in aggregate? I know you talked about you consolidated a number the China separately but if you put those together?

Stephen A. Roell

We'll have to get back to you because I'd have to sit down and pull together Korea and, are you talking about automotive specifically?

[David Lichter]

Yes, automotive.

R. Bruce McDonald

Yes, I've got that one. Give me a minute on that here. So if I'd look at the three pieces, so China, which is unconsolidated, grew by 12, okay. Japan was down 42 and the rest of Asia was down 29.

[David Lichter]

And that's predominantly Korea, right?

Stephen A. Roell

It's predominantly Korea. I think the number that's important to us at this stage, given the size of the business is what we get from the equity ventures in China.

[David Lichter]

Yes, absolutely. And Power Solutions as a clarification, I think you commented units are down 12%, but if we pull out flat and currency it looks like sales are down, too. Is that all price or is there a mix there with the OEM and aftermarket?

R. Bruce McDonald

It's a combination of a little bit of price but mainly mix because for generally speaking we sell for a higher selling price in the aftermarket side.

[David Lichter]

And then on the aftermarket being down 5% you picked up a lot of new programs. I'm just – it seems like some of these retailers their volumes are good and there's probably some inventory destocking, but just kind of reconcile that down 5% number with picking up some new customers there?

Stephen A. Roell

Yes, I think it is the destocking and just the inventory shifts that they've had, David, okay? We've just seen different policies from some of the retailers who have decided that they want to – well first of all we're supplying at 95% plus service rate, so to that extent they can count on us to provide them with product on a real time basis. That's number one.

Number two, I don't think we saw much weather help until probably late in the month of June. If you think, we have a very, very mild time and clearly there's probably some consumer buying patterns which have deferred the replacement of batteries. That typically happens.

I do think we've seen the end of that, though. I think that the inventory stocking at the retailers is just about the end of its extreme. They'll start stocking for the fall here as we go into the September-October timeframe. So I feel we're still clearly gaining share, and we continue to expect to do that.

[David Lichter]

And then just one last question here. I mean your automotive business, you've always had the target there historically of hitting a 5% margin. One, is that still your target eventually, and where do volumes need to go for you to get there?

Stephen A. Roell

In the last quarter we talked about the fact that our target's really 6% to 7% now. And we said we needed to get into that 13.5 plus range to get there, and I'm using North America as a base.

[David Lichter]

Perfect.

Operator

Our next question is from [Etai McHaley].

[Etai McHaley]

I just wanted to touch up on a couple of cash flow questions, Bruce. Can you just help us to walk through how we should think about working capital? It looks like you're expecting very strong free cash flow in Q4 and maybe perhaps as high as $700 million, but how should we think about that as production ramps up in general going into 2010 for all three businesses?

R. Bruce McDonald

Well, in the auto side of our business we have very little working capital. Like it's around 2% of sales, so when the customers are open, launching or ramping up production significantly or shutting down, there can be a mismatch between payables and receivables on a monthly basis. But longer term I'd say if our auto business doubles then the incremental working capital requirements that we have are about 2%. Okay? So that business doesn't use a lot of cash, nor does it throw off a lot of cash when it shrinks.

In Power Solutions this is – it's a working capital business. I mean it's working capital being in the mid-teens percent and when I'm talking about working capital here I'm talking payables, receivables and inventory, trade working capital. Payables largely offset receivables but we have to maintain, because of aftermarket business, we have to maintain a fairly large investment in inventory to satisfy our customer demands.

And then building efficiency is kind of somewhere in the middle. It's working capital as a percentage of sales may be 10%-ish. We think that's a business that we can continue to improve. The working capital uses and as we sort of go forward that's the area where we're sort of looking for more significant improvement in 2010.

[Etai McHaley]

And just following up on CapEx it looks like you're sticking with the $600 plus million for this fiscal year. Now as you win business and as recovery continues to play out, do you think you can sort of maintain at that level or might you have to go back to the $800 million level you ran in fiscal '08?

R. Bruce McDonald

No, I would say our core capital expenditure requirement in a sort of steady state right now is probably in the $550 million level and then anything kind of over and above that would be required to either get incremental growth, significant incremental growth in auto space, or some investments that we're making either in the vertical integration or geographic expansion our Power Solutions business.

Stephen A. Roell

You know, here's an example of two items we would highlight for you that we're starting the work in the quarter and it will extend into 2010. One is the fact we just broke ground in Mexico on smelter as we increase our capacity in that marketplace, and then we're also, this fall we'll be launching and expanding our production capabilities in China. So those will be two examples that are baked into our numbers that we could absorb and still be in that $600 million to $650 million range.

Operator

And our next question comes from Rich Kwas – Wachovia Capital Markets.

Rich Kwas – Wachovia Capital Markets

Hey Steve, on systems for building efficiency, are you seeing any re-pricing on contracts given the environment and customers coming back and trying to renegotiate?

Stephen A. Roell

No, that's an interesting question. We just met with our people from building efficiency the last two weeks and there's been no – re-pricing's not being discussed. You know, Rich, I'm trying to think if I've ever encountered that in the past and I can't ever think of re-pricing contracts.

Rich Kwas – Wachovia Capital Markets

And then on the auto side with backlog, I know you'll update it in October, but given the lower volumes and given the distress in the sector, do you see any rebound in bidding activity on the auto side or is that still declining?

Stephen A. Roell

A lot of our bidding activity is still what, Bruce, in Europe and Asia.

R. Bruce McDonald

Yes.

Stephen A. Roell

So there's very few programs in North America. There's a couple out there as you're probably aware of, but I'm not sure that there's a lot of new – in terms of a three-year window we have, Rich. I'm not sure we would want to portray it as a lot of new opportunity for us there, okay?

R. Bruce McDonald

I think one thing that's fair to say, though, is if you look at it within the industry a lot of the bidding that we thought was going to be bid in this year has deferred as customers are re-looking at their product plans, particularly GM and Chrysler here in North America.

Rich Kwas – Wachovia Capital Markets

So it sounds like at least outside of North America there's some activity.

Stephen A. Roell

Yes, there is.

Rich Kwas – Wachovia Capital Markets

And then Bruce, just on CapEx, just to kind of follow-up on that last question, as we think about next year it shouldn't be, even with the plant down in Mexico and the Chinese activity, there shouldn't be much change in terms of total dollars, $600 million to $650 million is a good number to think about?

R. Bruce McDonald

Yes.

Rich Kwas – Wachovia Capital Markets

And then in terms of the cadence of the cash restructuring you spent $53 million this quarter. You still have a chunk left to spend on the cash side. How do we think about the cadence for the next several quarters?

R. Bruce McDonald

I would say it's flowing out a little bit slower than I expected. I think it's going to pick up a little bit here in the fourth quarter, so it should be more in Q4 than in Q3. Some of the amounts that we have in there really relate to plants that are – they are tied to plant OE closures because with both Ford, GM, Chrysler have announced a certain number of plant closures. Some of those extend into, well into the end of – well beyond 2010, so not all of it will be spent by the end of even next fiscal year.

Rich Kwas – Wachovia Capital Markets

And what's your best guess on how much will be spent by the end of next year?

R. Bruce McDonald

You know what? We'll update that when we do our analyst meeting in October. I'll get a better feel for it.

Operator

Our next question comes from Ted Wheeler – Buckingham Research.

Ted Wheeler – Buckingham Research

Maybe on the same – question on the same theme, the cost programs, where are you on the expenses? Have you pretty much finished expensing the implementation costs for the restructurings in the various cost take outs or is there some more expense to flow through?

R. Bruce McDonald

Yes, I'll take that one, Ted. I guess the way I sort of look at it is what's sort of the net, because we're always going to have some expenses associated with the actions until they're done. To me the issue is the gross savings don't exceed the costs that we're incurring, and the answer to that is most definitely. We talked about sort of our first quarter the restructure was a net negative to us because the cost were greater than the benefit.

Ted Wheeler – Buckingham Research

Right.

R. Bruce McDonald

This quarter it's significantly higher the benefit is well in excess of the cost. I think we probably still had about had about $40 million to $45 million of non-qualifying restructuring cost that went through our numbers this quarter. That will drop and then the savings will accelerate. And that becomes a bigger and bigger...

Ted Wheeler – Buckingham Research

Yes, I was just trying to come to the point of a steady state at the end of all this. Hopefully, volume doesn't cause any issues on the downside and it comes back. But when we are at steady state you'll be – an annual run rate again is how much?

R. Bruce McDonald

We've talked about that benefit being about – for next year the benefit from restructuring, so this is year-over-year, is $0.35 to $0.40.

Ted Wheeler – Buckingham Research

Yes, and that includes the absence of cost plus benefits, is that correct?

R. Bruce McDonald

That's correct. And that, just to be clear, Ted, there is a net benefit in 2009 for restructuring.

Ted Wheeler – Buckingham Research

Yes.

R. Bruce McDonald

And I'm going to say that is in $0.10 to $0.15 range. On top of that there's another $0.35 to $0.40 next year and that's what we've talked about.

Ted Wheeler – Buckingham Research

And that's this year's $0.10 to $0.15 sounds like it's all second half?

R. Bruce McDonald

Yes.

Ted Wheeler – Buckingham Research

If you looked at it that way, with it just building up toward the run rate.

R. Bruce McDonald

Correct.

Ted Wheeler – Buckingham Research

Another question on the Building Efficiency the service of business, how do you track, or can you track the customer's willingness or propensity to scrape along at minimum levels and when do you think can you track whether they might be will coming at more normal maintenance at some point? Or is it just the kind of shut down and do minimum until we tell you later.

I mean, do you have any dialogue? Do you have any sense of what or how long that might last, this bare minimum kind of attitude?

Stephen A. Roell

No, it's hard although I would tell you that we saw – the answers we did see in the marketplace, Ted, took place probably last fall. We haven't seen it accelerate so I would tell you that at least that part I know. In terms of those who have decided to defer it's hard for me to project when they're going to go back. I'd be guessing at this stage. I just don't know that detail. I know our people are talking to those customers and looking at impact of deferred maintenance on their repairs but I can't categorize that today very well for you, okay?

R. Bruce McDonald

Yes, maybe to just give you a little bit of color there, Ted. If you look at the service business in the quarter we were down about 11% on the revenue basis.

Ted Wheeler – Buckingham Research

Wasn't that like 6% or 7% in the March quarter?

Stephen A. Roell

I think it was like 7% – I think it was 8%, Ted.

Ted Wheeler – Buckingham Research

Yes. Sorry. Sorry.

R. Bruce McDonald

Now what we did see though is if you look at the backlog within our North American service business, it was actually up marginally in the quarter. And so the backlog, what we have in backlog in the service business, is the scheduled contracts or PSAs. And then the sort of the retrofit and project work that had typically been deferred, so that stopped getting worse and actually upticked a bit, but we – then you say why is the revenue down 11% and it's the unscheduled service part that's now pulling us down.

Stephen A. Roell

I always hate to refer to weather ,Ted, okay, but I am going to in this case, and that is if you think about the weather we've had, and those of you in the Northeast understand how cold and wet it's been. This hasn't been – it took us until almost late May probably into June before we were able to do testing on air conditioning units. And so that what's that levered material is and it's really going in and actually being able to anticipate repairs or start-ups for those people that don't have scheduled contracts.

And so we didn't get any help from the weather and that was hard for us because we had to keep our workforce in place on the premise that there was going to be a normal spring, a normal summer and it has taken us forever to get there. So you are going to hear that from other OEs that have service elements as well.

Ted Wheeler – Buckingham Research

Lastly, as I look at the guidance or just the color on the fourth quarter, that the Building Efficiency profits might be comparable in decrement to revenues, which is a big improvement from what you just had. How much of that delta performance would be attributable to the copper hedging issue?

R. Bruce McDonald

I am not going to go there, Ted. I'm sorry

Ted Wheeler – Buckingham Research

I really tried. I thought you might take that one.

R. Bruce McDonald

It's like I said the copper issue is significant but it's just commercially sensitive information for our team.

Stephen A. Roell

I guess we can certainly say this, that it's – our ability to improve and achieve what Bruce described is less dependent on copper. It's more dependent on other actions and recovery in the businesses, okay? The fourth quarter, Ted, as you know, has always been – is a strong period for us anyway in the building efficiency group. A lot of work gets completed. A lot of work gets secured in this timeframe, so it's a critical quarter for us to your point, and we just feel good after having met with building efficiency group that we're going to see some better comparisons than we did in the last quarter.

Ted Wheeler – Buckingham Research

I guess another last one that would be the cost of base of residential to achieve profit at current levels? When do you think you'll get there?

Stephen A. Roell

We are there.

Ted Wheeler – Buckingham Research

You're there now. Okay, great.

Stephen A. Roell

We've got time for one short one.

Operator

Our next question is from [Cheryl Van Winkle].

[Cheryl Van Winkle]

My question was about the immediate takeover business that you won? Could you tell us when as in what month that was awarded? And then when you will start seeing the volume impact?

R. Bruce McDonald

It was awarded. I am not going to get into what month. But it was awarded in this quarter and it starts shipping in August.

[Cheryl Van Winkle]

So when you say this quarter you mean in the quarter – the April-May-June quarter.

Stephen A. Roell

Yes.

[Cheryl Van Winkle]

And it starts shipping at the beginning of August?

Stephen A. Roell

Right. Right after the shut down.

[Cheryl Van Winkle]

And just roughly what kind of size would you be talking about?

Stephen A. Roell

[Cheryl], we haven't disclosed that, okay?

Okay, so first of all again, thank you again for joining us. Glen will be available for questions and we will be able to help him. But just to recap, some closing comments for you. I think if you look at the actions we've taken in the last nine months to realign our businesses to the marketplace, and the cost structure is trying to benefit us you can see that in our third quarter results.

We feel, again, that we'll perform better than the marketplace in the upcoming fourth quarter simply because of those actions that we've taken. We feel good about our cost structure in the context of where we have it and how we'll benefit as markets recover.

So, again thank you very much and we appreciate your support and your interest by joining us today.

Operator

Thank you. That concludes today's conference. You may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Johnson Controls Inc. F3Q09 (Qtr End 06/30/09) Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts