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Johnson Controls Inc. (NYSE:JCI)

F4Q09 (Qtr End 9/30/09) Earnings Conference Call

October 27, 2009 11:00 AM ET

Executives

Glen Ponczak - Executive Director, Investor Relations

Stephen A. Roell - Chairman, President and Chief Executive Officer

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

Analysts

Richard Kwas - Wells Fargo Securities, LLC

Michael Lew - ThinkEquity

Brett Hoselton - KeyBanc Capital Markets

Brian Johnson - Barclays Capital

Rod Lache - Deutsche Bank

Christopher Ceraso - Credit Suisse

David Leiker - Robert W. Baird & Co., Inc

Itay Michaeli - Citigroup

Michael Coleman - Sterne Agee

Colin Langan - UBS

Operator

Welcome and thank you for standing by. At this time all participants are on a listen-only mode until the question-and-answer session of today's conference. (Operator Instructions) I would now like to turn the call over to Mr. Glen Ponczak. Thank you. You may begin.

Glen Ponczak

Thank you Diane and good morning everyone and thank you for joining us. 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 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 of, or changes to commercial contracts, liquidity, changes in the levels or timing of investments in commercial buildings, the ability to execute on restructuring actions according to anticipated timelines and 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, 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.

I am joined this morning with, by Steve Roell, our Chairman and Chief Executive Officer who will give us an overview of the quarter followed by Bruce McDonald, the Executive Vice President and Chief Financial Officer, who will give a review of the results of Q4 followed then by some questions-and-answers.

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

Stephen A. Roell

Okay. Thanks Glen. Well good morning and thank you for joining us. We saw many of you in New York on October 13 and I think what you will find today is the results that we announced, and very consistent in what we described you at that point. But I am going to go through and just give you a couple of highlights and comments.

As we look at the fourth quarter, I've got five points I wanted to review with you. The first is the fact that current quarter was fairly benefited by the continued government stimulus around the world. Certainly a number of European countries, China with its support from a tax standpoint for consumers and of course the U.S., with the cash for clunkers. But I think also in that regard you'd have to also look at some of -- I am sorry we had some interference of the phone call.

So to go back, the comment I was about to make was the fact that even despite the fact that there was good stimulus throughout the world we still saw pockets of weakness as evidenced by the fact that the U.S. automotive that was down 21% year-over-year in the quarter.

There are signs of growth in emerging markets. Bruce and I spent some time in South America in August and we were pleased to hear the outlook in that country and Brazil relative to all three of our businesses. Obviously there is still good growth in China and we're optimistic about what we're hearing in the Middle East in terms of just the amount of work that's being now brought to bid in Saudi and are building efficiency growth.

We did see a return of normal battery stocking patterns which happens at late summer early fall for the winter season, aftermarket in North America units were up 8%. We published the fact that they were up 1% overall obviously what the offset is, is the weakness and still the build schedules but we did see the return to normal stocking patterns in the aftermarket.

We do continue to see high interest in energy efficiency and sustainability projects in terms of our bidding activity, I'll come back and talk a little bit later about that. The U.S stimulus AARA funding though is still very weak.

We do see some awards in the Federal side and State side but my comment in terms of slowest is particularly evident in the education market, where things have been very, very weak in terms of awards.

Some other Q4 highlight, we did see strong demand for performance contracting that's part of our solutions offerings and building efficiency. That's where again we would see the focus on energy.

The building efficiency AARA funding stimulus projects were worth about 2.7 that we've been bidding on. We believe there'll be meaningful revenue in late 2010. By contrast when you talked to you last quarter there were 2700 projects and about $800 million that was visible to us. So we are seeing bigger projects, putting in the words, of thus far have been very weak and it will be a late 2010 benefit for us.

As you're all aware, I think most of you, we were awarded about $299.5 million Federal grant from the DOE for the building of our domestic lithium ion manufacturing facility which we've announced to be in Holland, Michigan that took place in the quarter. We were again the largest recipient of funds from that from the DOE awards.

We did couple of new lithium-ion battery agreements. We highlighted this document Jaguar Land Rover and Volkswagen, we have development contracts.

And then finally Bruce will go into much more detail but we were successful late in the quarter with a conversion of the $805 million of debt to equity. And Bruce will go into that in more detail.

In terms of awards and recognition, I did want to call out the fact that in Newsweek, we were noted as the -- ranked as the number 11th Greenest Large Companies. That ranking pretty much looked at the S&P 500 and we were recognized well from the standpoint of our product offerings as well as the fact what we do internally at JCI relative to energy efficiency and greenhouse gas emissions control.

And then there are two other awards I wanted to call out, were WalMart and Advanced Auto which in both cases pertained to our power solutions business and the fact that we continue to be recognized for our performance by both of those strong customers.

Turning to the numbers for the fourth quarter, our sales were 7.9 billion that compared to 9.3 billion in 2008. Just to give you two elements of that, we had foreign exchange contributed 243 million of that delta and lead was another 216 million.

Our segment income was 514 million. We were profitable in all geographic regions of automotive experience and in fact, North American profits in the quarter were ahead of those of fiscal Q4 of 2008.

Our power solutions group, as Bruce will go through, recorded a record quarterly results with a strong quarter, with good demand. Our net income of 339 that yielded $0.52 per diluted share compared to $0.73 I Q4 of'08, very much in line of what we guided.

And with that, I'm going to turn over to Bruce who will walk through the businesses and the financial detail.

R. Bruce McDonald

Okay thanks Steve. Okay just starting with automotive, we were extremely pleased with our results here in the automotive in the quarter.

If you look at our fourth quarter numbers I think it really demonstrates the success of our restructuring initiatives and our ability to take cost out of that business. The fact that we're able to be profitability at these depressed levels I think it speaks volumes of our restructuring activities.

If you're looking at the revenue side, we're down 12% on a constant currency basis with double digit declines in both North America and Europe.

Again excluding currency, our sales were generally better than the production levels in the markets that we're operating in generally -- mainly attributable to the launch of new business award. And specifically in North America our sales were down 12% versus a production decline of 21%.

In Europe, our sales were down 12% versus an estimated production decline of 13%. The market in China continues to be exceptionally robust. In the quarter, our sales in China were actually up mainly through the unconcluded joint ventures were up 62% and that compares to an industry production increase of about 77%. So, that was sort of skewed towards smaller vehicles.

Earlier this year we committed to getting our auto business to a breakeven run rate by the end of the fiscal year. And I'm proud to report on behalf of our automotive experience division that we are sort tracking ahead of that goal.

In the quarter our segment income was 77 million which compares against 147 million in 2008. And while our profitability continues to be adversely impacted by lower volumes, the RC and the benefit of the restructuring initiatives and I think if you look at the Q4 results that demonstrate a $91 million sequential quarterly improvement versus our third quarter level.

As Steve indicated, we were profitable in all geographic regions in North America. We had a return on sales of 2.7%, in Europe it was 1.4%, in Asia 4.3 %. Our profitability in Europe continues to be a little bit negatively impacted by high engineering and launch costs. We have a lot of our backlog flows through in Europe.

We're also seeing some signs of distress in the supply base and late in the quarter we started to experience some manufacturing inefficiencies as running into components part and part shortages in the supply chain.

Flipping over to building efficiencies, our sales here of 3.3 billion were down 13% on a constant currency basis. Kind of a mixed bag if we look at the various businesses, our North American systems business was down 8% and that's really reflecting the fact that our exposure to the institutional markets, which -- healthcare, government education were tended to be a lot more resilient than the office retail and lodging sectors where we're under exposed.

Our service business was down 15%, though we did see PSA or as contracts with scheduled service growth. We continue to see customers define discretionary maintenance and an equipment retrofit.

And now we're still seeing delays with our solutions business associated with clarification of the AARA funding guidelines. We did see a strong order intake in our solutions business in the month of September and we are hopeful that carries on here into the first quarter.

Excluding the impact of exchange, Europe and the rest of the world were down 15 and 17% respectively. In Europe, most declines are really heavily skewed towards Eastern Europe, Russia and our residential businesses.

Let's look at our backlog in the quarter. We were down 9% at 4.3 billion on a constant currency basis that's 9% as well. So a little bit of a degradation versus where we were in the second quarter.

If you look at the details of our backlog, we did see an increase in the solution side and our reduction in North American market was lower single-digits, so low double-digits in other parts of the world.

In terms of our profitability, we're down 56% to 138 million, though that includes $105 million residential warranty charge here in North America. If we stripped that out, our underlying segment income declined by 23%.

Let's sort of look at the various businesses, pre the warranty charge, our North America residential business was profitable on the quarter, with about 4% return on sales. We saw year-over-year improvements in our profitability in both systems, our North American systems business and global workplace solutions. But this was more than offset by declines in our businesses in Europe, the Middle East and Latin America.

Now as we go into 2010 for building efficiency, our backlog is about exactly in line where we thought it would be. And we've guided to a 3% revenue growth for building efficiency in 2010.

I just like to remind everybody that we at our analyst meeting, we did talk about the fact that our revenue growth is going to be back-end loaded. So as we go into the Q1 and Q2 of fiscal 2010, our expectation is that, we're going to start off the year with revenues in, down about 10 %. That's we're going to enter 2010 and we expect then to see substantial improvement in our revenue flowing through the year.

If I turn to power solutions, as Steve indicated, we had a record quarter. We never made -- our profits have never been strong. If we look at the sales side, down 17%. If you back out lead and foreign exchange, our sales were roughly comparable to last year and reflect that global increase in our volumes about 1%.

Globally our auto aftermarket business we saw 5% unit growth. That really reflects both new business awards and the cessation of destocking activity that we saw earlier in the year.

If you look -- the OE side of the business which comprises about 20% of our business, sales were generally down in line with the industry production levels.

In terms of our segment income, the record 194 million, that really reflects strong operating performance in our business and a better product mix, i.e. more aftermarket volume. I would note that the year-over-year improvement is somewhere inflated by the fact that our year ago numbers were depressed by a lag in recovering commodity costs of 15 to 20 million.

Let's go now to the financial highlights, and as I cover the next two slides, I am going to really talk to the -- I put in here the shade -- shaded comp of our reported results. But I'm going to talk to 2009 excluding items and compare that to 2008 excluding restructuring charges so that I can talk to the operational and financial trends in our businesses.

So looking at the top-line, our sales were about 7.9 billion or 15% below last year. Out of that 15% decline, about 2% is due to foreign exchange and another 2% is due to lower lead prices. So underlying decline is 11% and that was really driven by lower auto production levels and the revenue softness in building efficiency.

On the gross profit line, I am pleased to see here the 60 basis point improvement to 15.9%. And that really reflect the success that we've had taken down our manufacturing footprint and flexing our factory costs.

You'll recall I think last quarter we talked about our margin was being negatively impacted in building efficiency by legacy copper hedges and discounting associated with some of our activities that reduced our inventory levels. So those were where we weren't factoring in the quarter, that's behind us now.

In terms of SG&A, 761 million, down 10% versus last year. Here we're seeing the benefit of our restructuring actions. But you are also seeing us maintain our investment with some of our key growth initiatives.

Then lastly on this page, maybe a comment on equity income of 27 million which is down slightly from last year's 31 million. And here what we've got is the strength of our Chinese joint ventures show a strong benefit versus prior year levels. But that was offset by two factors: one, higher levels of investment in our staff to joint venture where we are developing our lithium iron battery technology, and then some charges for some plant closures in a non-consolidated North American automotive joint venture. Those are the two factors that pushed it to year-over-year decline.

Going over to slide 10 then, a comment maybe on net financing charges of 72 million which were about $18 million higher than prior year's. That increase is really a 100% attributable to the higher cost coupons associated with the convertible debt that we issued this year. I am going to talk a bit about that in my next slide but with the completion of our exchange offer, our expectation is that quarterly net financing charges to be in that $50 million to $55 million range as we go into 2010.

There were several non-recurring tax items in the fourth quarter which I've summarized in the appendix and I don't plan on going through here in my remarks. You can go through those and if there is any questions we would be happy to take them. But from an underlying rate perspective we were 22.7% in the quarter and that compares to 21% in Q4 of last year. And as we talked about at our analyst meeting as we go into 2010, combination of a better geographic mix of our income and some of our tax planning initiatives, our expectation is our rate for next year is going to be about 20%.

Then lastly on minority interest, we had a benefit of 3 million in the quarter versus a charge of 4 million last year. That reduction is really attributable to lower levels of profitability in some of our North American automotive joint ventures.

Our earnings per share, stripping out the items, was $0.52 per share, which is actually a 100% improvement over Q3, though it's a 29% deduction versus last year.

On slide 11 here, maybe just talk a little bit about the early exchange offer, before I get into the details on our balance sheet, cash flow and liquidity. As you'll recall that back in March we issued 852.5 million of both convertible bonds and mandatory convertible equity units. We issued those at a time when our access to capital was limited and in the fourth quarter we decided we would take an action to entice those holders to convert that at high cost debt into equity.

So we were pleased to see that in the quarter, our exchange offer was successfully completed. We got over 99% of our convertible bonds, converting to equity and then 90% of our equity that's converted into equity. So on a net basis we took a 111 million charge associated with that transaction in the fourth quarter and the net impact on our balance sheet was over about a $700 million reduction in our net debt.

The economics of this transaction were pretty compelling, the annual interest savings were about 70 million a year. So we took a $111 charge and we saved $70 million a year for the next two and half years so, pretty compelling transaction.

Just going through our balance sheet little bit of detail here, with the completion of the exchange offer and our Q4 cash flow, quite frankly our balance sheet's never been in better shape. We have a $2 billion revolver which backstops our commercial paper program and that's undrawn, it matures in -- a little bit more than two years from now.

On liquidity cushion which we define as our -- all of the sources of liquidity that we have as compared to our peak intra-month cash requirement is an excess of 2.5 billion. We have a very few debt maturities that come due in the next year about 125 million that we do have about a $1 billion in 2011.

We continue to see strong investor demand for commercial paper. I think I talked about this at our analyst meeting overnight paper we're sort of issuing that 40 to 50 basis point range.

Our cash flow in the fourth quarter was 404 million and we define cash flow here as operating minus investing activities. I guess I would remind folks that included in that number is $90 million discretionary contribution to our U.S. defined benefit plan or pension plan. Ex that item our cash flow was nearly 500 million in the quarter.

Our net debt to capitalization was 26% versus 34% at the end of the third quarter. And our business as I think generally performed well again this quarter in terms of their working capital management which was a source of about 212 million. And I think if you look at our inventory in particular, in 2009 we have reduced our overall inventory position by over 27%, so a good accomplishment by our business teams.

CapEx in the quarter was 118 million which is less than half of what it was in Q3... sorry, Q4 of last year. We continue to see the benefits of better capacity utilization in both automotive and power solutions. And as we indicated in New York a couple of weeks ago, we expect a modest increase in capital expenditure next year into that 650 to 675 million range.

Then lastly on the 2010 outlook, I guess a sort of key message here is we're really not changing our guidance versus 2010. I guess we would acknowledge we are encouraged by the recent positive production trends in the auto business here in North America in particular which is benefiting both our auto business and power solutions. Though we are little bit cautious because we are just waiting to see some signs that this consumer demand for -- and vehicle starts to pick up. So we have little bit of I think a cautious outlook versus some of the external analysts. We're just going to wait and see how consumer demand reacts in the next couple of months here.

So with that, I will turn it back over to you, Steve.

Stephen A. Roell

Okay, fine. Just a couple of wrap up comments regarding the 2010 outlook and this is again consistent with what we discussed with you in New York.

First of all as Bruce would indicate our markets are beginning to stabilize. We are seeing increasing benefits from our cost improvements restructuring activities that we -- that took place throughout 2009. Our strategies and offerings will continue to look how we can take advantage of the global growth megatrends around energy efficiency, sustainability in the emerging markets.

As Bruce indicated, we have good financial strength in our balance sheet right now. We will continue to look for ways we can accelerate our investments to grow both organically and through acquisitions. And the primary focus for 2010 and beyond is to go back and drive that sustainable powerful growth that we discussed with you.

As Bruce indicated I think we are looking at markets in a realistic manner. We are looking for more indicators of signs from the consumers. We again are looking at what we can do to drive our results. And that's around our cost structure and how we can gain share and grow in the markets that we anticipate in.

So with that Diane we are going to open it up for questions -- Q&A. So we know we have got a number of people in the queue. So we will go ahead and turn it to you.

Question-and-Answer Session

Operator

Thank you. We will now begin the question and answer session, (Operator Instructions). Our first question comes from Rich Kwas, Wells Fargo. Your line is now open.

Richard Kwas - Wells Fargo Securities, LLC

Hi, good morning guys.

Stephen Roell

Good morning Rich.

R. Bruce McDonald

Hi Rich.

Richard Kwas - Wells Fargo Securities, LLC

Question on auto, 2.2% margin, very strong showing given your guidance for 2010, 1.3 to 1.6% margin. Realizing the business is seasonal, how should we think about that going forward? It seems like the guidance is fairly conservative and I know your comments were that you want to be conservative at this point. But just some more color on that would be helpful.

Stephen Roell

Well Rich, this is Steve. Let me start. I think that we are talking about a recovery I the auto build in fiscal '10, but I think if you look at even the first quarter of the one that we are currently in, our first fiscal quarter, production estimate to be down 6% year-over-year. So what we are saying is that we expect to see that the build up 13-14% but we are going to start in whole the right out of the box. So I think as Bruce indicated we just want to see where the consumer is and if we see stronger demand then we hope you are right. Then we hope we are overly conservative but right now it's going to be a latter half for the year.

Richard Kwas - Wells Fargo Securities, LLC

Okay. And then on the Steve on the distressed suppliers in Europe or I guess Bruce. Is that picking up steam or what do you think you are in term of seeing the stress there right now?

R. Bruce McDonald

I would say -- I wouldn't maybe say it's picking up steam but it just keeps on going, I guess. We are not really seeing a lot of that -- I think North America that's improving and people have adjusted their cost base. Production is back to normal but I think in Europe there is a little bit lot more pressure in the tier two, tier threes than we've seen before.

Stephen Roell

It's not a huge issue, I would put, it's 15 to 20 million a quarter type number for us.

Richard Kwas - Wells Fargo Securities, LLC

Okay. And then just last question Steve, you talked about, earlier in the year you talked about the stimulus benefit kind of thinking about at over a three year timeframe let's say 2010-2012. I think in last week talked about their benefit, they think the benefit to them is going to be more in 2010 and 2011. Given what you're seeing at least on the bidding activity and kind of how the timing in these projects are playing out. Is there any change to that kind of three year timeframe in terms of the bulk of the revenue coming online?

Stephen Roell

No Rich, I think that's still -- because I think what you'll find is that there are projects that are, I would call, shovel ready. But even for the school market I think that we're going to find out that as it's awarded, it's going to take time for it to trickle down to get the funding done, to get the construction complete. So I think 2010, '11, '12 are clearly I would expect maybe 2011 to be the peak.

R. Bruce McDonald

Maybe just our exposure of the educational market in particular and that's going to -- that would be in the laggard.

Stephen Roell

If we look at our orders in the quarter, we did see a bump in the federal side. That's where one of our stronger markets enters the new order's book in the month on the quarter but we've not seen it as I have indicated in education whatsoever so far.

Richard Kwas - Wells Fargo Securities, LLC

Okay. Great, that's helpful. Thank you.

Stephen Roell

Thanks.

Operator

Our next question comes from Michael Lew, ThinkEquity. Your line is now open.

Michael Lew - ThinkEquity

Hi good morning and thank you for taking my questions.

Stephen Roell

Hi Michael.

R. Bruce McDonald

Hi Michael.

Michael Lew - ThinkEquity

Hi. You've indicated that in building efficiency business you are bidding on 3,300 projects attributed to the stimulus. But you mentioned there is also delays of projects related to potential eligibility, how much do you estimate that pool of opportunity to be?

Glen Ponczak

Well it's Glen here, Mike. I mean think you think about it, we've identified a $12 billion opportunity and we're bidding on about something approaching 3 billion right now. So the bulk of the opportunities is still yet to come by.

Stephen Roell

And the biggest piece of that opportunity when we earmarked, there were four elements, here is the federal, state, education and renewables and that the part that was the largest was the education piece, Michael we've been talking about. That's the one that's really a laggard.

Glen Ponczak

That was like a $5 billion piece Mike.

R. Bruce McDonald

Just Mike, maybe just to help you out on the delayed comment. What we're seeing is jobs that we have been working with our customers on and we're sort of at the advanced stage and expecting to receive an order. Once the AARA funding came out, people have sort of put the brakes on those and said, wait on a minute, I want to make sure I might be eligible for this government funding, for part of this project. So I'm just going to slow walk the order process here.

That's what we've -- so I'd say in the short term while we have a lot of work in our auto activity in our pipeline, our orders were -- it was a negative too and we don't expect that to continue for much longer.

Stephen Roell

Let me describe that to you, we have what's called a pipeline and yet for those of you that don't know that definition, that's work that we're currently bidding on which we're waiting for an award. At the end of the year, our fiscal year, our pipeline activity in our service segment which should be primarily around performance contracting and retrofit was up 13% year-over-year.

So, as we indicated, we are seeing the work in just in terms of renewable and solutions and retrofit activity that's tied to AARA or just in general. And so we're seeing that kind of a bump.

Just to kind of finish that comment, our systems pipeline is not about 4%, which again I think, if you contrast, people -- some people are talking about in terms of the decline in systems activity, the 4% is probably somewhat what we're seeing and expect to see in our order pattern. So that s why Bruce mentioned we'll be little bit weaker in the first quarter probably to some of these flows but as we get to the latter half part of the year we've got several things we think that will help.

Michael Lew - ThinkEquity

Okay. And also quickly on the emerging growth area in lithium ion you talked and you mentioned the Jaguar and Volkswagen, are these exclusive contracts and when would you anticipate to begin delivering products?

Stephen Roell

Michael, we haven't been able to disclose that level of detail yet. So stay tuned on that.

Michael Lew - ThinkEquity

Okay all right. And one last question, automotive experience you've been working on like on some potential opportunities and providing seats into commercial aerospace industry. I mean there is a tremendous opportunity there given the backlog of over 7000 personal aircraft between Airbus and Boeing. Can you comment on the progress being made there and do you anticipate moving forward on this opportunity this fiscal year in 2010?

Stephen Roell

Well I would guess, two ways to describe. We've been doing some research. We've been doing with some of the airlines in that regard. I wouldn't expect it to be significant part of our business going forward okay.

Michael Lew - ThinkEquity

Okay, thank you.

Operator

Our next question comes from Brett Hoselton, KeyBanc, your line is open.

Stephen Roell

Hi Brett can you hear us?

Brett Hoselton - KeyBanc Capital Markets

Yes I can, Steve, Bruce, Glen. Couple of questions here. First of all you mentioned something about, I think it was part shortages in the automotive experience group. My question is if I understood that correctly, what's short, why and do you think this is a major or just a minor issue? I mean one of the concerns that we have is during this ramp up you are going to end up with some part shortages which might cost some disruptions in the supply chain and --

Stephen Roell

Yeah.

Brett Hoselton - KeyBanc Capital Markets

Sounds like you might be seeing a little bit of that?

R. Bruce McDonald

Yeah I think this I wouldn't say as a comment that's specific to Johnson Controls. I mean I am sure you've read recently that with -- Chrysler had to shut down one of their Jeep facilities, because they had some part shortages from one of their suppliers.

I would tell you in terms of us, it's probably the biggest areas in the electronics side where we are seeing some component shortages in that part of our business.

Stephen Roell

So this isn't a function of distressed suppliers who are creating disruption. This is really just overall demand for electronics.

Brett Hoselton - KeyBanc Capital Markets

Okay. And then switching gears over to the building efficiency side, bidding on 2.7 billion in the stimulus projects, it sounds like there is a wide range of outcomes there. And I am wondering as we look at your building efficiency expectations for 2010, should we consider your guidance to be kind of pessimistic, realistic, optimistic with regards to the bidding on these stimulus projects?

Stephen Roell

Realistic Brett. Brett, I think it's realistic. I think there is a part Brett that was that -- the hardest thing is not -- it's just the timing of all these projects.

Brett Hoselton - KeyBanc Capital Markets

Got it.

Stephen Roell

Okay and that's why we've decided -- and it's proven out. I mean we've been describing the fact for sometime that it has been slow and we expect it to be later than maybe most people though it would be. And that s what it's panned out. And so I think we've been very realistic in terms of how it's going to go from shovel ready project to something that can actually be done.

Brett Hoselton - KeyBanc Capital Markets

Okay great. Gentlemen thank you very much.

Stephen Roell

Thanks Brett.

Operator

Our next question comes from Brian Johnson, Barclays Capital. Your line is open.

Brian Johnson - Barclays Capital

Good morning.

Stephen Roell

Hi Brian.

Brian Johnson - Barclays Capital

Back to the building efficiency and sort of the cadence through fiscal year 2010, within the services being down how of that was technical services, how much of that was some of the other things you do? And how do you expect the service line to develop in North America through the year?

R. Bruce McDonald

Well within services, there's really four main buckets. There's a normal service business, we do technical services. That business holds up pretty well. There's project related work and that's very discretionary, down double-digit and there is a solutions business in there which is up. And there is retrofit, replacing equipment is broken and that's down double-digits.

So that's kind of four elements in there. The one that's I'd say really shut down the fastest on here was the project work early in this year. And so we expect to start to see sort of favorable year-over-year comps.

Stephen Roell

In fact, we're starting to see that in our pipeline Bruce. Okay,

R. Bruce McDonald

Yeah.

Stephen Roell

So in our pipeline, we're starting to see the project work come up. So that's a good sign. That was a -- we didn't expect that in the fourth quarter and that was probably the biggest surprise of our pipeline activity.

Brian Johnson - Barclays Capital

Okay. And that's pipeline that's not in backlog. Is that correct?

Stephen Roell

That's right. Pipeline means it's work that we're bidding on that once awarded it will go, it will be an award that will go in the backlog.

Brian Johnson - Barclays Capital

Okay. So and the technical services, you said holding up early in the year that had actually had ticked down on a year-over-year and on a sequential basis. Is that now firming?

Stephen Roell

Let me try to describe that to you. We described that it was weak. Remember we described, Brian that's being tied to a number of retail customers, okay? We're putting that off. They have not come back but what we're saying is it hasn't changed.

Brian Johnson - Barclays Capital

Okay.

R. Bruce McDonald

Stabilized.

Stephen Roell

Stabilized yeah.

Brian Johnson - Barclays Capital

Okay. And in terms of residential shipments, what's your best guess around when those might pick up?

R. Bruce McDonald

Well it’s a tough one, though, our outlook for the next year as we talked about in New York is we're forecasting about an 18% increase in new construction starts. So we expect to see -- it's a very seasonal business as you know from the second half year, so I guess the real evidence of the strength of that market is where you're going to see in our third quarter.

Stephen Roell

We'll start seeing that probably March, April, probably April would be the date, we normally would start to see that the demand pick up, that's sort of the date that we watch in that month.

Brian Johnson - Barclays Capital

So more reasons, our building efficiency is going to be a back end loaded event.

Stephen Roell

That's correct.

Brian Johnson - Barclays Capital

Okay. Thanks.

Operator

Our next question comes from Rod Lache, Deutsche Bank, your line is now open.

Rod Lache - Deutsche Bank

Good morning everybody.

R. Bruce McDonald

Hi Rod.

Rod Lache - Deutsche Bank

Just also to follow up on building efficiency, did you say earlier that your pipeline for performance contracting was up 13% and systems pipeline up down 4%. Is that right?

Stephen Roell

That's correct except, I didn't say -- what I would only clarify is that with our all of our service captions okay, which would be our project work solutions and our retrofit was up 13%.

Rod Lache - Deutsche Bank

Okay.

Stephen Roell

And then you are correct, systems was done four.

Rod Lache - Deutsche Bank

Okay but based on your comment on sales it sounds like your bookings versus billing is still somewhat negative. Are you seeing are you expecting to sort of a bottoming of backlog around the first quarter based on that early read on the pipeline?

R. Bruce McDonald

In Q1 or Q2.

Rod Lache - Deutsche Bank

Okay. And then can you repeat again you ran through this pretty quickly; the automotive experience regional margins, you said Asia was 4.3% and also on auto experience, can you talk about what the consolidated proportion of your backlog would be and whether that's changing in terms of kind of the mix of products business, electronic, interior or however that's changing?

R. Bruce McDonald

Yeah Rod, if you look on slide the slide that has the auto numbers on it, we actually did put our we said we -- yeah slide six. Here is sort of the cadence of our 2.5 billion backlog we said 70% of it's consolidated, 30% non-consolidated. And then we show you here is how it flows through the years if you look at the numbers 93% of our backlog is outside of North America. And roughly evenly split between Europe and Asia.

Rod Lache - Deutsche Bank

Okay. And can you repeat the margins?

R. Bruce McDonald

I said -- this is for Q4. So, North America was 2.7, Europe was 1.4 and Asia was 4.3.

Rod Lache - Deutsche Bank

Okay. And then just lastly was there has there been any difference in sort of the composition of business within the backlog? Is it less seating more electronics, how is that changing at this point?

R. Bruce McDonald

More in seating.

Rod Lache - Deutsche Bank

More in seating?

R. Bruce McDonald

Yeah, heavily skewed toward seating.

Rod Lache - Deutsche Bank

Okay, great, thank you.

R. Bruce McDonald

Okay thank you.

Operator

Our next question comes from Chris Ceraso, Credit Suisse. Your line is now open.

Christopher Ceraso - Credit Suisse

Thanks, good morning.

Stephen Roell

Hi Chris.

Christopher Ceraso - Credit Suisse

So it seems relatively clear that maybe there is some upside potential on the margin, in the automotive business but let's talk for a second if we can about the building business. You're guiding the 5.6 to 5.8% on the margin for next year. It's a relatively tight range. Where would you say the risk is there to that number? What has to go wrong for you to miss on the downside on the margin in the building business?

R. Bruce McDonald

I guess I would say we're clearly forecasting a pickup in the revenue in the back half of the year. So if the economy turns out to be a lot worse than I guess folks are expecting, then we probably would see less of a pick up in that -- second half and that would be detrimental to us, probably the biggest single area.

Stephen Roell

Just it was probably residential Bruce but we try to -- we've out stepped (ph) that in terms of the elements, I think we've been pretty comfortable with it. But to the extent that residential, I can't imagine would -- to get worse than where it is today that would be other one. But we try to look at our -- this we've done from a cost standpoint and I think we feel comfortable with what the margins side of that, because we're controlling a lot of it.

I guess you could only say Chris there could be some further softness in service which would be our higher margin business but the fact that it's stabilized gives us pretty good comfort there. So we try to figure out where the risk could be, I think we are okay with that number.

Christopher Ceraso - Credit Suisse

Okay. And then just a couple of housekeeping items you mentioned on the equity line Bruce that some of it was a closure charges at a JV, how much was that? And then how much do you -- what are you spending on investment? What is the drag on the equity line some of the investment in the battery business? And is that going higher as we go forward?

R. Bruce McDonald

Well the charge on the equity line in auto was around $5 million something like that, our share of it, the total charge is obviously greater. In terms of the -- we haven't never broken out the results of our joint venture separately but the cost is increasing. It's a headwind for us as we go into 2010.

Christopher Ceraso - Credit Suisse

Okay. Is it big enough that you're going to see your equity income like that over time or is that going to stay positive?

R. Bruce McDonald

I just think it will -- what you will see is that'd sort of be flattish because the gains that we're making elsewhere getting offset with higher investment in the business.

Christopher Ceraso - Credit Suisse

Okay. And then just the last housekeeping item, there was 18 million in Q4 under the heading of Effective Dilutive Securities, is that something that we need to dial-in in subsequent quarters or is that a one time thing in Q4?

R. Bruce McDonald

I am not sure I understand what -- what page are you referring to Chris?

Christopher Ceraso - Credit Suisse

I have to go back in the press release. I will follow up with you.

R. Bruce McDonald

I think what we might have said is the -- I made a comment when I talked about financing charges that there is about $18 million increase in the quarter versus last year. That is all due to the higher coupon on the mandatory and convertibles, now that those have been exchanged, that goes away. That's why our interest run rate goes from the mid 70s down to 50 to 55 range.

Christopher Ceraso - Credit Suisse

In other words, it was in the back of the press release, there is 18 million financing cost related to convertible senior notes. So that's a one-timer?

R. Bruce McDonald

Yeah.

Christopher Ceraso - Credit Suisse

18 million?

R. Bruce McDonald

Yeah.

Christopher Ceraso - Credit Suisse

Okay that's good. Thanks.

R. Bruce McDonald

Chris, give us a call and I'll take you through that in more detail.

Christopher Ceraso - Credit Suisse

Okay. Thank you.

Operator

Next question comes from David Leiker, Robert W. Baird. Your line is open.

David Leiker - Robert W. Baird & Co., Inc

Good morning.

R. Bruce McDonald

Hi David.

David Leiker - Robert W. Baird & Co., Inc

Just I don't know if you probably touched on your analyst day or not, keep it there but this warranty charge in the residential, I mean that's a good number relative to the revenue line in that business. I just want to get a better understanding of what's going -- what that was about?

Stephen Roell

There were two elements to it, David, first it was a triple of a warranty reserve, okay, pushed back to part -- more of a accounting policy matter, okay. That was about 29 million of that number. And the rest of it had to do with basically a single item where the best I can describe to you, it was an application of film that was intended to be anticorrosive and ended up having a problem for us in high humidity areas. So we think we've got a favorable box but that sort of pertains to it round the clock.

David Leiker - Robert W. Baird & Co., Inc

So that's something that had over several years.

Stephen Roell

I think its three year period, Okay.

David Leiker - Robert W. Baird & Co., Inc

Okay. And the stimulus funding for this 2.7 billion that you are bidding on now, what magnitude of that revenue base you think you could see in the back half of 2010? Is that a couple of hundred million dollar item or is it something that could push more than that?

Stephen Roell

I hope it's more than that, David. We have settled a lot that we thought we had the right to 25% of that. We are bidding on that 2.7, we should see that start to flow into our backlog and how it executes it depends on the size of the job in each of the job.

R. Bruce McDonald

I think as we stand we right now we have about 60 or 70 million of AARA's orders in our backlogs. So we don't lose, we don't have to get very much more to get the 200 million you are referring.

Stephen Roell

Yeah it should be stronger than that.

David Leiker - Robert W. Baird & Co., Inc

And then 2.7 stuff that you are bidding and get awarded and startup before the end of 2010?

R. Bruce McDonald

I would hope so.

David Leiker - Robert W. Baird & Co., Inc

Okay. On the power solutions side, if I'm doing my math correctly your margin here in the quarter is well above what your mid term target is. And that how of that is the seasonality in this quarter? Can you just get me explain that a little bit?

R. Bruce McDonald

I guess the margins are typically that this is our strongest seasonal quarter in terms of our mix shipment. So that helps us. The lead assumption that we made our 2010 guidance based on was about 2100 a ton in the quarter. We were in I think 1900 was the sort of average. So when you sort of normalize back, that takes things down.

And quite honestly, I would say our shipments in this quarter we were surprised that the strength on the aftermarket side and OE was we have got a lot of pull through here with the OE restocking in North America.

David Leiker - Robert W. Baird & Co., Inc

Okay.

R. Bruce McDonald

We have done -- I mean we can make, I mean that business is very capital intensive and it is very sensitive to demand. We have a high and also incremental profit pull through in that business. So if once the volume does start to pickup here in the OE side of the business, I mean this is kind of the level of profitability that business can crank out.

Stephen Roell

David, we should also say that level right now is above 2300.

David Leiker - Robert W. Baird & Co., Inc

Yeah, I know.

Stephen Roell

So again what we have seen along is, it doesn't impact our profitability but it is going to impact our margins, highly.

David Leiker - Robert W. Baird & Co., Inc

Yes, I understand that and then on the manufacturing side and batteries business, where are you in rolling out your manufacturing strategy across the globe, how much that has been done and what's left to go?

Stephen Roell

You talking about PowerFrame, David?

David Leiker - Robert W. Baird & Co., Inc

PowerFrame, correct.

Stephen Roell

It's been done for quite sometime in North America, I think sensibly done in Europe. And still is the next phase of China and South America come after that.

David Leiker - Robert W. Baird & Co., Inc

Okay. So there's still some upside from that as well?

Stephen Roell

Yes. Let me throw one more, just on your first question, remember too, there was a 15 to $20 million negative commodity hit in 2008 as well.

David Leiker - Robert W. Baird & Co., Inc

Right. Okay. Sure. And then in the last item, here is debt to capital, historically I think you've talked like 30-35% was your targeted debt to capital number. Have you in light of what's happened over the last year changed that assumption in terms of what normal debt to capital number is for you that you're comfortable with?

R. Bruce McDonald

No, I think that's still the right long term. I guess I would tell we got little bit nervous in the back then March April timeframe when the market got so tight. And access to CP was a question. But no that's still the right level of leverage for us.

David Leiker - Robert W. Baird & Co., Inc

Great thank you.

Operator

The next question comes from the Itay Michaeli from Citi, your line is now open.

Itay Michaeli - Citigroup

Great thanks, good morning.

R. Bruce McDonald

Good morning.

Itay Michaeli - Citigroup

Want to just clarify one thing on the auto experience margin Bruce. I think at the meeting you referenced that you can get to a 3% level at a 10.5 million North American production. Just want to clarify is that a sort of all else equal achievable in fiscal '10 or is that more of the fiscal of a '11 target with the incremental backlog you get in fiscal '11?

R. Bruce McDonald

Well we just need to be careful here because I know a lot that would get a lot of questions about -- asking about production level and margin levels, if you look at the -- I talked about where we were from a regional basis here. When we said, we talked about being in the next 3% range globally in 2011. That's what we said we saw and that was based on Europe being in that sort of low -- sorry North America being in the low 10. So we are pretty comfortable about it.

But if you look at just this quarter the issues for us our European business is at 1.4% right now. We got to work our way through the launch issues, we got a lot more upside operating leverage because that business is much larger when the volumes in Europe pick up.

Stephen Roell

We've talked about our margin aspirations being at 6 to 7% when we get to sort of normalized production levels. And we're comfortable we can get there in all three geographic regions in all of our product lines. So as we start to ramp I think we feel really good about this.

Itay Michaeli - Citigroup

Right so that's helpful. And then just going to commodities for a second, I think I also referenced 90% of your business has indexing in place. Is that a similar percentage for the auto experience business or is that for the auto...

Stephen Roell

That's just an auto...

Itay Michaeli - Citigroup

Okay that's great and then one last housekeeping. Bruce, can you just remind us what the pension contribution assumed in the fiscal '10 cash flow?

R. Bruce McDonald

About we're making discretionary expenditures of about 100 to 125 million in U.S. on a global basis pension contribution in that 250 range.

Itay Michaeli - Citigroup

Okay great. Any product maybe increasing that, it may be an opportunistic use of cash or you're likely kind of stick to that, that target throughout the year?

R. Bruce McDonald

We'll probably going to -- I mean at t point in time we're going to going to stick with it but the circumstance has changed. We may re-look at it. But that's where we see it right now

Itay Michaeli - Citigroup

Great, thank you.

Operator

Our next question comes from Ravi Shankar, Morgan Stanley. Your line is now open.

Unidentified Analyst

Thanks. You had said that your production expectations for 2010 reconciled with on the auto side and certainly some analysts are well above your expectations. I know that we definitely are. If it does seem that you are conservative and the level of production is much higher, I mean are you prepared for that and especially I mean do you think that T2 and T3 supply base is prepared for that?

Stephen Roell

Yeah. I think it depends on that. But I am sure, if I don't know what the estimates are but we have the ability to flex pretty very well and it goes up without having much cost. So that's actually we've been issued to us whatsoever. But again I would just caution, we are looking at a fiscal year. I think people may be looking at calendar year. So I would just ask to make sure that you look at your estimates probably that you look at that as well okay.

Unidentified Analyst

Right absolutely. And also I think you had said that on the building efficiency side for 1Q, did you say revenue was probably going to be down 10%?

R. Bruce McDonald

Yeah.

Unidentified Analyst

So can you also help us on the auto side, I mean what you are seeing there in terms of cadence of production?

R. Bruce McDonald

Well as Steve talked about, earlier in the call, we're looking at 6% decline in Q1.

Stephen Roell

That's the industry.

R. Bruce McDonald

In North America only.

Stephen Roell

Yeah. North America only is down 6 % year-over-year in our fiscal Q. And what we've said is for the full year, if you recall we expect it to be up I think close to 13% is what our number is, even if I -- Glen now okay.

Glen Ponczak

Correct.

Unidentified Analyst

Got it. And finally on the cash flow, it looked like even after you adjust for the pension contribution, cash flow is probably a little soft in the quarter compared to last year at least. Did it come in line with your expectations? And do you think like working capital is going to be an issue going forward?

Stephen Roell

I think if you look at our cash flow and adjusted for the pension contribution we did this year and the fact that our -- the shortfall is really at all driven by the lower earnings. So came in about where we expected it. I was pleased to see the working capital performance during the fourth quarter. Even if you look for the full year I think we did a nice job like I said in my comments our inventories came down by 27% this year, so we're pretty lean there. And we're in good shape.

Glen Ponczak

Yeah, I think Ravi if you look at it just at the three units of cash flow that we look at our operations to manage, which is receivable inventory and payables. We saw basically a $400 million working capital, positive cash generation from those three working capital units. And I always like when I see receivable and inventory being the big contributors.

Unidentified Analyst

Got it, thank you.

Operator

Next question comes from Michael Coleman, Sterne Agee, your line is now open.

Michael Coleman - Sterne Agee

Hey good morning.

Stephen Roell

Good morning, Michael.

Michael Coleman - Sterne Agee

Going back to the building efficiency margin what -- within that 5.6 to 5.8, what are you assuming in terms of material cost or an inflation assumption?

Stephen Roell

Well I struggle to answer that question. What I can tell you is that our biggest commodity exposure if that's where you want to go, is would be on copper and aluminum. And we're probably about 60% hedged on those two commodities.

So, we don't really have a lot of exposure. The other thing I would just remind you is that the cycle time between when we bid and get a contract awarded and then subsequently execute it and complete it is it's not like a five year automotive contract for work. It s a long period of time. It will be in the 8 to 10 months type timeframe. So, we're not hanging out there with a lot of inflation risk. We can re-price it in sort of the next jobs, next bids that we make.

Michael Coleman - Sterne Agee

Okay.

R. Bruce McDonald

I don't think I don't you know just a comment Michael, I'm not worried about inflation their terms believe me, we spend a lot of time talking about what it could be in 24 to 36 months when the economies do recover.

Michael Coleman - Sterne Agee

Okay, thank you.

R. Bruce McDonald

Thank you Mike.

Operator

Our next question comes from Colin Langan, UBS, your line is now open.

Stephen Roell

Hi Colin.

Colin Langan - UBS

Hey how are you? I just had a question on the building efficiency side. I thought last quarter you gave guidance of some margins there should be flat in Q4. Has anything changed this quarter or we're obviously surprised why the margin came down a bit even adjusting for the warranty and construction.

R. Bruce McDonald

I think probably the biggest surprise for us would have been Europe was considerably softer than we were expecting going into the quarter.

Stephen Roell

And I would say, it's too ironic that we saw some softness, when Bruce walked through it, we saw a softness in a number of our international markets. And yet I the same markets where as we look at some of the activity in terms of quoting and building experience in South America, that we expect to be a good contributors to us. Globally that is the same view of that, although there is a short term weakness in some of those markets, there's going to be good single growth for us in 2010 and should represent double digit growth for us going forward. So I think Bruce, that's where I can't think of few much else other than really that the European offices.

R. Bruce McDonald

Right.

Colin Langan - UBS

Okay. And then on the, when I look at auto experience, your sales were down I think in North America 11% which I think is a lot better than the production year-over-year. But the industry I think was closer to 20. Is that a reflection of your better customer mix or is that new business trends? What's really driving that better than industry performance?

R. Bruce McDonald

It's a little bit of a product mix. I think we're pretty strong in the CUV sector. And I'll just go down, our sort of flat platform of where we were significantly better than last year. We were fortunate we have some good exposure on some programs that did well in the marketplace.

Stephen Roell

And I think if I look at the customers that had stronger build in the quarter Ford clearly was one, Toyota the other, and we'll represent both of those two major OEs.

Colin Langan - UBS

I know last year you gave a comment you said about 50% of your business in North America was transplant half that growth (ph), I mean is this sustained this year or is it actually more shifted to transplants?

R. Bruce McDonald

It's comparable, because this year, for the first time, a transplant volume was -- on the past transplant volumes they started to gain share year-over-year, this year the transplant production was down at a comparable level with three. So we're still in that 50:50 mix plus or minus a percentage or two.

Colin Langan - UBS

Okay. And thank you very much.

Glen Ponczak

We are going to wrap it up here Diane so no further questions. I will turn over to Steve.

Stephen Roell

No, that's fine. Bruce and I appreciate the questions and if there is anything else that we haven't answered that you'd like to, have us respond to. Please go through Glen will get back to you.

Again we feel good about the quarter. We feel good that business has stabilized and we look forward to hitting back at the first quarter and the next year. We just hope that and feel good about where our businesses are and where they are performing. So thank you very much.

Operator

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

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