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Johnson Controls, Inc. (NYSE:JCI)

F2Q10 (Qtr End 03/31/10) Earnings Call Transcript

April 23, 2010 11:00 am ET

Executives

Glen Ponczak, Executive Director, IR

Steve Roell – Chairman, President & CEO

Bruce McDonald – EVP & CFO

Analysts

Rod Lache – Deutsche Bank

John Murphy – Bank of America/Merrill Lynch

David Leiker – Robert Baird

Brett Hoselton – KeyBanc

Himanshu Patel – JPMorgan

Rich Kwas – Wells Fargo Securities

Colin Langan – UBS

Chris Ceraso – Credit Suisse

Brian Johnson – Barclays Capital

Ravi Shanker – Morgan Stanley

Ethai Nicoli [ph]

Nankent Newkem [ph] – Wells Fargo Advisors

Tim Denoyer – Wolfe Trahan

Operator

Welcome and thank you for standing by. At this time, all participants will be in a listen-only mode until the question-and-answer session. Today’s conference is being recorded. If you have any objections you may disconnect at this time. With that it is my pleasure to turn over today’s call to Mr. Glen Ponczak. You may begin.

Glen Ponczak

Good morning everyone. Thank you for joining us and happy Friday. Before we begin, I’d like to remind you of our forward-looking statements. Johnson Controls will make forward-looking statements in this presentation pertaining to its financial results for fiscal 2010 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 time lines and costs, as well as other factors discussed in Item 1A of Part 1 of the Company’s Form 10-K filing, which was filed on November 24th, 2009, that 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.

Joined this morning with – by Steve Roell, Chairman and Chief Executive Officer of Johnson Controls, who will provide an overview of our second quarter 2010. And he will be followed by Bruce McDonald, Executive Vice President and Chief Financial Officer, who will give a more in depth look of business results as well as a financial performance. And that will be then followed by questions and answers.

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

Steve Roell

Thank you, Glen. Well, good morning and thank you for joining us. I guess I am going to start by just highlighting the two primary themes in our earning release, certainly the fact that we are benefiting from the recovery of the North American and European auto industry is a major driver of our results in the quarter. And I think the other theme is the fact that we are starting to see signs of – that are surfacing at the non-residential market, the building market is beginning to recover as well, and we’ll highlight some of those indicators for you.

In terms of the second quarter itself, both Power Solutions and Automotive Experience benefited from the strong automotive production levels, North America and Europe. And we’ll talk a little bit later about the fact that we now are convinced that those trends will continue into the second half of the year.

Emerging markets, demand continues to be good for all of our businesses. If you look at the Building Efficiency side, China, we continue to benefit both from an order and a sales standpoint. South America is strong force and in the Middle East while sales were negative in the quarter, down slightly from a year ago, the orders and the pipeline of activity in the Middle East is trying to pick up for us significantly.

Coming into the fiscal year one of the key elements of our projections was that we would covert on the higher automotive volumes in both Automotive and Power. And we continue to perform very well against that metric; the conversion has been strong at the high end of the range as we originally projected.

We looked across our businesses and believe that we are gaining share whether that be in the Automotive group (inaudible) sales growth compared to the industry build. We see gains obviously in the Power Solutions business and we believe we are taking share in the equipment side and security solutions side clearly in our Building Efficiency.

We ended the quarter with a strong balance sheet. During the quarter we did get past our outlook provisions for both S&P and Moody’s and our cash flows remain strong and as a result of that as we note here we will be accelerating some of our investments in growth. That’s primarily in the Power Solutions business when we talk about capital but we will be investing also in the increased sales forces in our Building Efficiency group.

In terms of the absolute numbers for the second quarter our sales of $8.3 billion were up 32% from a year ago. Our segment income was $427 million. Our net income of $292 million was a record for any second quarter. So, we wanted to highlight that. We did not highlight that in our press release, but it did beat the 2008 fiscal year second quarter, which was a record for that period of time.

Our EPS $0.43 compares of course to a loss last year of $0.16. We did call out the one item, the $0.03 charge; I think most of you are probably familiar with this by now. We had an $18 million charge from a tax standpoint related to the Medicare subsidy law change that took place. And so that’s the one single item in the quarter we call out relative to our earnings per share.

I should also note, Bruce in the past has talked about a – factored in the second half we’ll have roughly a $50 million to $100 million benefit of tax benefits. We still expect that to happen. We want to make sure that you understand that that’s not included in our earnings per share guidance for the fiscal year.

Turning to Power Solutions, just a couple of quick items for you. Our vertical integration strategies are on track. The Mexican lead recycling facility is now scheduled to start up in October of 2010. What you see in the – those of you that are looking at the Power Point, the illustration in the far right is an actual image from that site. And we also received the final permit we need to start construction in South Carolina with our another lead recycling facility. When both of those plants are complete, our in-house recycling capacity will represent about 50% of our needs. And as we’ve highlighted in the past we expect about 200 to 250 basis point margin improvement as a result of those investments.

We are expanding our investments in China in Power Solutions from a capacity standpoint. For the last 12 months we’ve been supplying China’s demand through exporting from various facilities throughout the rest of the world. That capacity the need now is equal to that. So we are going to build another plant. And we already have volume incidentally [ph] that we are selling in China that represents that additional plant’s capacity. We now project that we’ll require a plant per year for the foreseeable future just to keep up with demand in China.

In terms of the quarter one of the things must be highlighted was the fact that our aftermarket unit growth was up 9% in North America. We just want to make sure that you understand that include the addition win from Wal-Mart that we announced in February though that volume will start at best in June and probably in our fourth fiscal quarter. So, we just wanted to highlight that that 9% growth was really a reflection of just the market and the share we’ve taken at this point does not include additional Wal-Mart business.

And then finally in terms of hybrid business, a couple of highlights for you. Our lithium-ion battery assembly production launch for the Ford Transit will begin in September of 2010. That vehicle was named as Truck of the Year. In addition, we would highlight that the Mercedes S-Class Hybrid, which you probably have seen in some of the ads is selling exceptionally well, in fact three times that of the original expectation by the OE.

Turing to Automotive Experience, seeing strong growth across all geographic regions. Bruce is going to highlight some of the industry assumptions that we have, what we saw, but we are very pleased with the build. Our China expansion continues. We now have 23 joint ventures with over 40 manufacturing plants. We expect to add an additional 10 plants, manufacturing plants, some are components, some are just in time by the end of this fiscal year. Our sales for 2010 in China are now expected to be $3 billion, mostly non-consolidated. That compares to $1.9 billion in 2009.

Now, we’ve highlighted the fact that we’ve had a very heavy launch load in our automotive industry business. We had roughly 60 launches in the first quarter, we had 39 additional launches in the quarter just ended. The majority of those are – essentially the majority, more than half were really in Europe. And then we highlighted some of the launches themselves. The Ford – the seating for the Ford Fiesta and the Opel Meriva, the interior systems work was really the door, this is the 5 Series door panels for BMW. Electronics pertains to the VW Polo Cluster. And we had some hands-free phone launches for Honda. So, it’s good launch load. It’s a good thing to have that kind of business; we feel very good about it.

We feel we are gaining share. And just to highlight for you, while we don’t announce our new backlog from – until October at our annual management meeting, we can tell you that and signal to you that we expect an increase in our backlog as we look at the years 2011 through 2013, we expect some increase in our backlog when we report to you in that October timeframe.

Turning to Building Efficiency, as I mentioned, there are signs of recovery. Our orders were up 5% in the quarter. It’s the first time in fact that our orders have been up since the fourth quarter of our fiscal 2008. The strength primarily was in the rest of the world. As I mentioned we are seeing good growth in the international markets, but also North America where both our systems and services orders were up 5%.

I wanted to highlight the fact that when we look at the vertical markets in North America, we’ve talked about the fact that we had not seen a lot of demand from ARRA and despite that we were seeing education demand strong. That continued in the quarter. We continue to have strong bookings in both K12 and higher ed. We see extremely strong bookings in the government vertical markets, be it federal, state and local. I do want to highlight that our bookings in ARRA in the quarter were $143 million which essentially is more than what had been booked in fiscal year ’09 and Q1 combined. So we did see some activity pickup but I would tell you that we are seeing the growth in education with or without that ARRA stimulus.

Finally, wanted just to mention the fact that the expanding market leadership, we are seeing, as I mentioned earlier gains. We track that from a standpoint of some of our equipment shipments. We can look at some of the industry data that gives us an indication that our North American equipment unit share is growing year-over-year. And one of the ones I would point out is our residential heating furnace market share, which was 13.4% in February of ’10 compared to 6.5% February of ’09. We have that data at least.

Finally, I guess I want to talk about the outlook that was contained within our press release. We have revised our automotive production levels in both North America and Europe. We are now looking at production levels for our fiscal year – I’ll mention our fiscal year – 10.9 million, and in Europe 16.7 million units. And then given the fact of how well we’ve demonstrated our ability to convert in the high end, we felt that it was appropriate to revise our guidance higher.

That combined with the Building Efficiency showing signs of improvement gives us some confidence that as the year plays out, our second half will continue to improve and we expect our third fiscal year quarter to be – show sales growth beginning in that timeframe. Just to comment on that EPS guidance. Our previous guidance was $1.70 to $1.75 per share for our fiscal year ended in September. We’ve revised that now to $1.90 to $1.95 and I think all the assumptions that support that EPS guidance are contained in the press release that we provided to you.

So, with that I am now going to flip it over to Bruce and let Bruce go into more detail on the second quarter by business and also the financial – some of the financial detail. Bruce?

Bruce McDonald

Okay, thanks, Steve. So just flip into slide 10 on Automotive Experience. We were really pleased with our Auto results for the quarter here. I really think it shows that the progress that we’ve made, the financial momentum that we had is a result of completing the restructuring, most of the restructuring initiatives in Europe and North America.

So, if you look at sales, back out the impact of currency, they are up 66%. That really reflects both sales gains and flow of our backlog, the launch of new business, but by and large a big chunk of that is higher OE production levels. In North America you can see our sales were up about 85%. That compares versus that production increase about 72%. So they are sort of the evidence of the share gain. Similarly in Europe if we back out foreign currency our sales were up 51% versus an estimated improvement in new vehicle registrations of about 9%.

Then lastly in China, we are seeing – we continue to see the very strong growth that we saw quarter of sales, which I will remind everybody come mainly through consolidate non joint ventures, improved by 91% to $741 million. The industry sales in China were up about 78%. So all three regions substantial out performance versus the industry.

In terms of our segment income of $189 million, that compares to a large loss of $269 million last year and we are seeing really good conversion rate on the incremental volumes. And that’s really just again due to the restructuring initiatives. The top line growth that we see in China is being – it really helps our margins because it flows through as higher equity income and we saw that both in our Chinese joint ventures but also some of our non-consolidated Joint ventures in North America and Europe.

Looking at our margins by geography, you can see in the upper part of the chart here North America at 6.7%, Europe at 2.4%, and Asia at 6.7%. I think these type of numbers kind of demonstrate that the improvements that our business is making and underpin our confidence that we can get our margins in that 6% to 7% range as volumes pick up here.

In terms of our European profitability, we talked last quarter about our numbers being negatively impacted by some launch difficulties, distressed suppliers and things like that of $40 million to $50 million. This quarter those costs dropped by about 50%, so we are in that $20 million to $25 million range in the quarter. And we – remember our guys are making good progress reducing those. So we expect those to tail off over the next couple of quarters here and to start to see our European margins trend higher.

Flipping over to Building Efficiency, sales were $3 billion, which was the level of last year, but if you take out the impact of currency it’s down 4%. And as Steve mentioned earlier, our order activity picked up, so we are starting to see things looking better here. If you look at the businesses that don’t flow through our backlog, so that’s Global Workplace Solutions and our North American residential business, sales in these two segments were up 14% and 42%, respectively, and that’s excluding any impact of foreign currency again. In North America we saw revenues were down about 10%, but we were pleased to see orders pick up 5% in this region. And then lastly in Europe and Latin America, those markets continue to remain somewhat soft and we saw double digit declines in our revenue position.

Looking at segment income $104 million, we are up 16% year-over-year. That really reflects primarily the turnaround in our residential business and then good control of our costs. I point out that our numbers here – we have a bullet point here, we talk about our non-recurring charges being sort of comparable to last year in the quarter. if you recall last year, we took about $25 million – we had about $25 million of expenses that really related to some of the reorganization that we were doing in our North America residential business and our SKU and inventory rationalization actions. In this quarter, we had a comp – we have comparable charges, non-recurring type charges of about $25 million that relate to both inventory adjustments and some – a couple of larger customer bankruptcies that impacted us by, like I said, in aggregate about $25 million.

And as Steve indicated before, we continue to invest in some of our key growth initiatives like energy, our infrastructure in emerging markets in particular. Looking forward, we are confident that we are going to see Building Efficiency sales start to turn positive on a year-over-year basis here and further margin expansion beginning here in the third quarter.

And lastly in terms of the backlog, you can see in the quarter we are at $4.4 billion on a year-over-year basis about a 6% decline again taking out the foreign currency and the key sort of takeaway here is the sequential improvement versus the down 10% that we were at the end of the first quarter. So, we are seeing strong momentum in our pipeline. And our backlog we anticipate will turn positive on a year-over-year basis within – by the end of the third quarter here.

Next, moving on to Power Solutions, we had an exceptionally strong quarter with sales up 30%. As we pan [ph] to back out the impact of lead, which is about $100 million, our unit volumes you can see were up 14% with aftermarket up 9% and the OE side of our business up 44%. And as Steve indicated earlier, these numbers just reminding everyone don’t include the impact of the Wal-Mart business, which launches in our fourth quarter.

In terms of China, Steve talked about the capacity expansion that we are looking to make in that market. Our volumes were up 38% and as Steve indicated, we are filling that demand with shipments from North America and Europe. I guess I probably should point out that if you think about our growth in our business really coming from our development of the aftermarket side of that business. So, our growth strategy is building up the aftermarket side of Power Solutions to take advantage of the longer term trends, more stable trends that we see in that side of our business. Hence our – so the confidence that we can put the production capacity in place that Steve mentioned earlier.

That currency expansion in China combined with the timing of us getting the South Carolina smelters is the driver behind the uptick in our CapEx guidance that I am going to talk about later on.

In terms of segment income for Power Solutions, the $134 million, the main sort of drivers here being higher volumes. We had some lead issues that lingered on in 2009 and our business performance is very strong. We are basically selling just higher level of volume with three fewer plants than we had a year ago, so we are getting excellent conversion pull through for our manufacturing operations.

And then I would also point out that negatively impacting our segment income is the investments that we are making in our hybrid business that Steve talked about, the money that we are spending to facilitize here in Holland, Michigan, and the launch of our BMW lithium-ion production in France in the quarter here.

So maybe now I will turn over to the financial section on slide 14 and as I talked about our numbers, I am going to talk about them excluding the one time items and as Steve mentioned earlier the only item that we are calling out for this quarter is the $18 million tax charge that we took associated with the Medicare Part D subsidy elimination. So before I sort of get into the specific details, I think the key sort of takeaways from our financial performance are as follows.

First would be our top line growth. We are benefiting from both the automotive and battery. Those markets improving on the OE side as well as market share gains in all three of our businesses. And here is where you are really seeing the continuity that we had in terms of commitment to our growth initiatives. We funded those through tough times last year and we are now starting to see the benefit of those pay off. Be that the growth that we are seeing in China in all three of our businesses, some of the market share gains that Steve talked about, North American residential turnaround, those types of things.

We are also seeing significant benefit of our restructuring actions. We are seeing that in both expanded gross margins and also better SG&A control. And then the strong conversion rate on the incremental volume is really flowing through well. If you look at our top line, Steve mentioned sales were up $3.3 billion, it was 32%. Again backing out foreign exchange, the underlying increase is 27%. Obviously, that was driven primarily by the recovery in the OE side of our business in battery in Automotive, but all three of our businesses contributed here in terms of market share gains.

Building Efficiency, while we’ve bottomed out, we were still down 4% in the quarter. In terms of gross profits at 14.7%, you can see about 390 basis points of improvement versus last year and here is where we are really seeing the benefit of restructuring initiative and better capacity utilization across our manufacturing operations.

In terms of SG&A expenses the $847 million, we are up about 5% year-over-year. If we backed out the impact of foreign currency, it’s up 2%, so I think sort of takeaway is we had a 27% constant currency increase in sales, now we have a 2% increase in our SG&A cost and if we sort of look at where that 2% came, it’s been higher engineering increases in incentive compensation accruals, those were increased versus last year.

You can see again on the equity income line we have a significant improvement versus last year, $51 million. If you think about that and the two main buckets would be $20 million would be in China and the other $20 million would be North America and Europe non-consolidated joint venture in our Auto business.

Flipping to slide 15, maybe just draw you attention to a couple of line items here on financing charges of $43 million, a little bit lower than last year, really reflecting lower borrowing rate and borrowing levels. Lastly, on an underlying basis, our tax rate was 18%, which is consistent with the guidance that we gave you last quarter. And then income attributable to non-controlling interests or what we used to call minority interests was an expense this year of $23 million versus income of $12 million last year and that really is just attributable to the fact that our consolidated automotive joint ventures were profitable this year whereas last year in the quarter they were losing money.

And then if you look at the diluted earnings per share is $0.43 you can the see the magnitude of the turnaround from the sort of $0.16 loss that we had last year.

And lastly, I will just comment a little bit further on our guidance for this year. So, as Steve indicated, we are upping our guidance range by $0.20, so our new range is $1.90 to $1.95. In terms of our top line you can see we are ticking up our sales growth from 16% to 18% at $33.5 billion. Here we are seeing benefit of the higher production levels in North America and Europe, although that’s somewhat offset by our euro assumption. And you can see taking the euro down from $1.45 to $1.35 negatively impacts our top line by about $700 million. And I think even though we haven’t changed our Building Efficiency sales guidance of up 5% we just want to make sure that folks understand that we are committed to that number and we feel very confident with that especially on the basis of what we are seeing in terms of our orders backlog activity here.

In terms of our earnings at $1.90 to $1.95, here you are really seeing the impact of the conversion on the incremental revenue growth. We are seeing good focus, a good continued focus on keeping our cost down. So as the revenue grows, we are keeping our expenses in check here. And then the impact of the euro assumption on our earnings is about $0.05 a share and that flows through primarily in our Automotive European operations. That’s where most of that $0.05 of hit – that’s because that’s our biggest European business.

In terms of margins, we’ve changed our guidance here and taken our overall segment margins up to plus 330 basis points. The range is as you can see by business, Automotive we are going to be in the 3.1% to 3.3% range, which is up from 2% to 2.2% previously. In Power our range is 12.6 to 12.8%. That’s up from 11.8% to 12% previously. And BE we feel our range doesn’t need to be updated here. We are sticking with the 5.6% to 5.8%.

Capital expenditures, we are up ticking about $50 million in our range here. And that’s all due to Power Solutions. And then from a free cash flow point of view, we are going to be up about $100 million, so we got slightly higher level of earnings and a little bit offset by the increased CapEx guidance.

So, with that I will turn it back to Glen and we’ll open things up for questions.

Glen Ponczak

Teresa [ph], we are ready for questions. If I could ask everyone on the phone please if you’ve got multiple questions, if you could just ask one question and then hang up and get back into queue, in that way we can be fair to everybody who would like to ask a question. And with that Teresa, we will take questions now.

Question-and-Answer Session

Operator

(Operator instructions) our first question comes from Rod Lache from Deutsche Bank. Your line is open.

Rod Lache – Deutsche Bank

Good morning, everybody.

Steve Roell

Yes, hi, Rod.

Bruce McDonald

Hi, Rod.

Rod Lache – Deutsche Bank

Just, first of all, on Power Solutions, the comments on China growing the size of Europe over the next five years if Europe is about 30% of that business, it looks like you could be doing may be $300 million per year of growth from that and you’ve got 5 million or 6 million units coming from Wal-Mart. It sounds like that business could be looking at 10% organic growth in 2011 and beyond. I was hoping you can comment on that and – yes.

Bruce McDonald

Yes, Rod, it’s Bruce here. I think one thing you just need to be – we feel very optimistic about our growth prospects in China but I would caution you that that’s a unit comment. So when we talk about – we think the level of the – our unit forecast let’s say in a five-year timeframe from China could grow from say something like an 8 million or 9 million level that we are sort of running at now to about say a 30 million level within five years, okay? So that sort puts the magnitude of the unit sales in context. If you look though at the dollar amount, generally speaking, I would say that there is a quite a bit richer mix in Europe from a dollar point of view with AGM batteries and more extended life type batteries. So, the dollar is not going to be equal but the units are. But nonetheless that’s significant growth.

Rod Lache – Deutsche Bank

Thanks, okay, back into the queue.

Steve Roell

Thanks, Rod.

Operator

Our next question comes from John Murphy – Bank of America/Merrill Lynch. Your line is open.

John Murphy – Bank of America/Merrill Lynch

Good morning.

Steve Roell

Hi, John.

John Murphy – Bank of America/Merrill Lynch

I just wanted to ask about the backlog and you made some very interesting comments on the Automotive side or the automotive interiors. You said they were – the backlog was increasing and I know you can't mention the exact number, but I was just wondering why you think you are seeing that backlog increases? Is that because you think volume forecast are higher, are there new wins, or you are actually getting a higher percentage of wins on the business that you are bidding on and if there is change in this relationship with the automakers as you ramp up this backlog.

Steve Roell

I guess the two things I would point out is if you think about the backlog we’ve provided to you, John, is for the 2010 through 2012 timeframe. Probably the biggest changes I guess I would highlight one is the fact that, that backlog ’10 through ’12 was almost void [ph] of North American new business and now we are seeing some new programs and some shares there in North America. And secondly I guess the other one is we would expect to see more interior growth. In interior systems we had the backlog in the prior time. So that’s what you should hear from us when we come out in ’11 through ’13.

Bruce McDonald

And, John, I maybe just add a bit. When we talked about our backlog last year dropping from the $4 billion plus range to the $2.5 billion number that we disclosed a big chunk of that was cancellations and deferrals. And as you’ve seen the fortunes of our customers improve new business activity or that product development cycle is speeding up and so there is more business opportunity than let’s say there has been in the past.

John Murphy – Bank of America/Merrill Lynch

So, it’s fair to say that the logjam has been broken in North America and it’s not as though you are shifting your market share in the bidding process?

Steve Roell

I wouldn’t say that – we aren’t taking – we would take some share but it’s a combination of all that.

John Murphy – Bank of America/Merrill Lynch

Great. Thanks.

Bruce McDonald

Yes, and I think by definition that – our backlog is incremental business, so by definition it’s share growth.

Steve Roell

Yes.

John Murphy – Bank of America/Merrill Lynch

Great. Thank you very much.

Operator

Our next question comes from David Leiker from Robert Baird. Your line is open.

David Leiker – Robert Baird

Good morning, everyone. Talk about China here a little bit, your operations over there, and I see you’ve grown in scale across all the businesses. Can you give us some context how you managed that and how you make your investment decisions. And I think almost all your operations there are joint ventures and do you have any intentions of getting majority ownership or fully-owned operations?

Steve Roell

Well, David, just to remind the audience that’s listening that most of our joint ventures are with our customers.

David Leiker – Robert Baird

Right.

Steve Roell

We have a unique situation. So, when we are growing with SAIC affiliates we are really growing with SAIC of with FAW affiliates is with FAW. I think we’ve continued to gain share with them. We’re the primary supplier to both of those large OEs and then also obviously we’ve penetrated and I signed (inaudible) something in the future. We have a relationship with Cherrie [ph], with GAAC. To your broader point, I don’t believe that we are going to – it’s not our intention right now to try to take bigger ownerships in those joint ventures. We think the model works well for us. It’s provided good growth opportunity. We manage those plants. We train those managers. We run morale surveys and dividend plans around all of that – those management teams. And so despite the fact that it’s fractured and fragmented by JVs we are able to get some scale and some consistency across the whole breadth of all those different JV relationships.

David Leiker – Robert Baird

Are you getting dividends out of those operations, are you reinvesting that.

Bruce McDonald

We generally we are reinvesting, but yes we do get dividends because it’s not sort of a like-for-like, David. I guess the other thing maybe I would add is if you look at our Power Solutions and Building Efficiency businesses, those operations are 100% owned or we have a couple that we own 80%, but those businesses were really grown primarily through organic growth investments. And if you look at all three of our businesses, we have a significant presence there managing our growth strategies in those regions and that – and we talk about that as being key areas where we’ve been investing over the last three or four years.

Steve Roell

I think as an example of that would be if we were to take you to our technology center in (inaudible) you would see it’s one of the best ones we have in the world.

David Leiker – Robert Baird

Okay, great, thank you.

Operator

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

Brett Hoselton – KeyBanc

Good morning, gentlemen.

Steve Roell

Hi, Brett.

Bruce McDonald

Hi, Brett.

Brett Hoselton – KeyBanc

Why don’t you talk about your Automotive margins for a second here? First of all, what are the primary drivers for your increase in Automotive margins, is it simply the reflection of the improvement here in the second quarter or are you looking for additional significant improvements going forward, and it sounds like you might be in Europe?

Bruce McDonald

Yes, I mean there is several factors. Clearly, volume is the biggest one. We’ve talked about on incremental volume we are looking for our business to pull through somewhere between 15% and 20%, I am talking here as the industry recovers. The profitability of the business that we are launching out of our backlog again we’ve talked about that being higher than business that it’s replacing in aggregate. And then with respect to Asia, we certainly have a tailwind in the fact that our equity income is really benefiting our income and it doesn’t obviously affect our sales. So that’s accretive to our margins. Those are the main factors. You also made a comment, Brett about Europe. We had a good improvement versus Q1, but we still have – you can think about a point or so of penalty that we are dealing with associated with some of the launch difficulties and supplier shortages and things like that that I spoke about earlier. So, we are definitely anticipating that the European side of things improve further out as we go through the year.

Steve Roell

And the only thing I would add, Bruce, I think Europe’s margins are being impacted only by the launches, which are good by the way, and not like maybe the first quarter where we had more – we had a couple of launches that we had to fight through. I think now it’s just the – it’s the typical class [ph] associated with launches, the magnitude of them.

Bruce McDonald

And then secondarily we have engineering costs, so our engineering costs were up also on the quarter primarily in Europe as they support these launches.

Brett Hoselton – KeyBanc

And if you look at – and I apologize, mine is the follow on call, but if you look at the European margins, the 2.4%, you pick up let’s say 100 bps with the launch cost and distress supplier cost going away here, how do you then see yourself going from 3.4% let’s say up into that 6% to 7% range?

Bruce McDonald

Well we’ve – again, I would say we’ve talked about that really being a question of volume, Brett. I mean we’ve said that I think if you sort of go back in time, we’ve had a target of 6% in Automotive. When we did the magnitude of the restructuring here that we did in the downturn, we said look we think we can get that 6% to be closer to 7% and that we also felt that our ability to get to that level we didn’t need production to be back in that 15 million, 16 million units in North America let’s say, but rather sort of down in that say 13 million, 13.5 million range. So that’s sort of where we need to get to, to get to those levels. It’s really a question of making sure that we launch our programs in line with the targets that we have, hedge – making sure that our community costs don’t eat into our margins and we’ve talked about the fact that 90% of our business is – we’ve got full or partial indexing. And then making sure that as the industry recovers that we get that 15% to 20% profit pull through. I mean as simple as that.

Brett Hoselton – KeyBanc

Thank you, gentlemen, very helpful.

Steve Roell

Thanks, Brett.

Operator

Our next question comes from Himanshu Patel from JPMorgan.

Himanshu Patel – JPMorgan

Hi, good morning guys.

Steve Roell

Hi.

Himanshu Patel – JPMorgan

Just wanted to get a little bit more into the Power division. Two questions on that, one is the two lead recycling plants, once they come on stream how does that affect your earnings sensitivity to future lead prices?

And then the second question on Power was you mentioned there was 200, 250 bp gain from the lead plants coming on stream. How much additional margin expansion would you see from some of the elevated lithium investments you have right now sort of normalizing or I guess some revenue coming on stream to match that if we are just trying to think out three years from now to figure out sort of a normalized battery division margin.

Steve Roell

Yes, let me start, okay? I am going to go back to the investment in the vertical integration, in the 200, 250 basis point improvement; that’s assuming that lends it to today’s date. the way to think about it would be if lead goes up then clearly we benefit even more from probably the agents we would have. So it gets even – it has even a higher margin impact if you believe lead is going to skew higher. I mean when we did these transactions, these investments, we looked for a two-year payback, is what we are currently projecting on both of them. Just to give you some idea how lucrative it is. Secondly, what it does do us, Himanshu, is it does add a fixed cost element to us to the extent that at the fact lead went the other way. But we feel good about what that – those economies are even with a lead pull back. In terms of the – yes, Bruce, anything you want to that?

Bruce McDonald

No, go ahead.

Steve Roell

And on the lithium piece, I think that’s a function of really how much – how successful we are commercially in terms of support structure we have to put in place. So, I don’t – I am not in a position to give you a longer term projection of margins on that other than what I described to you on the vertical integration piece. That’s the best I can do today.

Himanshu Patel – JPMorgan

Okay, if I could just –

Bruce McDonald

I would think probably in the next two to three years, what’s happening within hybrid is probably not going to be a significance either of our margins here.

Steve Roell

That’s fair.

Himanshu Patel – JPMorgan

If I could sneak in one last one, I mean the balance sheet has come a long way. Your equity value has moved up. How are you thinking, Steve, now on acquisitions?

Steve Roell

Well, we are clearly looking at what’s out there and what we can do that will help benefit our business. We’ve prioritized, met with our management regarding some of the opportunities that we would look to. Some we believe are actionable, some are not. So, I guess I would just describe it this way. We – clearly our acquisitions are focused on technology platforms that we can grow from. I would look at all three businesses. I think longer term as I mentioned to you, I believe that BE will still have the lion’s share of our M&A activity. But it doesn’t mean that we are going to exclude opportunities in the other two businesses; that’s for sure.

Bruce McDonald

And I would say, I mean we did make a small acquisition in this quarter that you can see that from our cash flow. That’s a business that provides us with some enhanced capability to do performance contracting so on the lighting and lighting controls side of our business. And we have other I’d say small type acquisitions that are in the pipeline that you should expect to see start to flow through here in the next few quarters.

Himanshu Patel – JPMorgan

Thank you.

Steve Roell

Thanks, Himanshu.

Operator

Our next question comes from Rich Kwas from Wells Fargo Securities. Your line is open.

Steve Roell

Hey, Rich, what’s your one question?

Rich Kwas – Wells Fargo Securities

I got that fixed [ph] right here. It’s been fine. My one question is on services just in Building Efficiency as you look – that business has been down. And Bruce, what was the – what was the year-over-year change for that business, that piece of the business this quarter? Again what are you seeing right now in that front as that start to pick up at all.

Bruce McDonald

Yes, I mean for the quarter revenues were down 7% in services, okay? And our order impact – order – this is just North America by the way – and orders were up 3% and I guess, Steve, you want to comment on some of the quoting activity–-

Steve Roell

Yes, we are – Rich, the thing we’ve been highlighting the whole time is the fact that we hadn’t seen one of the smaller work –

Bruce McDonald

Project.

Steve Roell

Project type work and just the last two weeks we’ve seen a slight pick up in terms of that – when we look at our pipeline our pipeline now what we call prime or that project type work is the best it’s been in two and a half years. But it’s all happened relatively recently. So, we are encouraged by that. We are also seeing a lot of activity in terms of our – what’s call PSA, the scheduled service work, and the bidding activity there is the strongest it’s been in two years. So are just starting to see some recovery, that’s what I am really pointing to, on the service side.

Rich Kwas – Wells Fargo Securities

And just lastly, L&M, what are you seeing there, any pickup there?

Steve Roell

Not really at this stage.

Rich Kwas – Wells Fargo Securities

Okay.

Steve Roell

Not really. We are just getting. We don’t have – usually weather is the driver. This time of the year if you look at what we are doing, our service people are primarily doing that scheduled work in the March-April timeframe. The L&M usually is associated with spikes in weather. It’s one where you typically see it or just (inaudible) penetrate more accounts. And right now at this time of the year we are focused pretty much on providing that preventive maintenance work on the PSAs.

Glen Ponczak

Unless you make – it’s Glen here – you might see a little bit as well once the air conditioning season sort of comes full on and people start turning all the stuff on after being off all winter.

Rich Kwas – Wells Fargo Securities

Right, makes sense, okay, thanks.

Steve Roell

Thanks, Rich.

Operator

Our next question comes from Colin Langan from UBS. Your line is open.

Colin Langan – UBS

Good morning.

Steve Roell

Hi, Colin.

Colin Langan – UBS

Can you talk a little bit about Building Efficiency I mean you are down on average by I think more percent than the first half but you guidance is still – you still think you can do the 5%, that means second half is going to be around 11% in the second half, can you comment on the pace about in Q3 and Q4 and then what are the main drivers and how much – how dependent are you on the recovery of servicing at 5%?

Bruce McDonald

Yes, I mean may be just one sort of clarification in terms of your math there when you said down one, then we need to be up 11%. Keep in mind our business is very seasonal. More of our revenue flows in the second half. It’s not quite as bad as you are suggesting there. But nonetheless it does need to pick up. I think you need to – what gives us confidence is if you look at the business as an art [ph] flowing through our backlog that’s the residential business and our Global Workplace Solutions, we are – those businesses are up, as I said earlier double digits, strong double digits, 40% in the case of our UCG business. So we feel confident that those trends are going to continue and in the case of GWS accelerate. If you look at the other businesses that now flow through our backlog I mean there we sort of take comfort from the quoting activity we have. So, the fact that when we’re starting to see orders picking up in – that’s what happens before it turns into revenue. So, I think we feel pretty good about that. I’d say, maybe the only derail of itself there for us would be if we have an exceptionally either late start to typical wind season or a very, very cool summer. But those are one or two percent delta is not going to change the sign here.

Steve Roell

I think guys I would tell you is we are seeing good pickup in demand from an equipment standpoint and has a – fits a good forerunner. Secondly I guess I think the emerging markets are really trying to pick up when we see some of the order and the pipeline activity. The only matter I guess I would tell you, Colin that we still don’t see recovery happening at is Western Europe. That’s the one market that at this stage we are not counting on any growth in the second half.

Colin Langan – UBS

So in your 5% the servicing side is not a big portion of that growth or – I mean it takes some of the business that you already have then in the pipeline?

Bruce McDonald

Yes.

Steve Roell

Yes.

Colin Langan – UBS

Okay.

Steve Roell

Now, particularly the Solutions business. If you include that element that’s really where – we’ve got good growth in our backlog too.

Bruce McDonald

Yes.

Colin Langan – UBS

Okay. Thank you very much.

Steve Roell

Thanks, Colin.

Operator

Our next question comes from Chris Ceraso from Credit Suisse.

Chris Ceraso – Credit Suisse

Thanks, good morning.

Steve Roell

Hi, Chris.

Chris Ceraso – Credit Suisse

Couple of questions on Europe. First, the revenue there I guess was stronger than we thought it would be. Is there anything in particular that you can point to or a change in mix or a new program that came on? And then just as a point of clarification on your 16.7 build expectation for the year, just on your numbers, what was that in ’09 so I get the percent change right?

Bruce McDonald

I think that number – we’ll have to get back there.

Steve Roell

Yes.

Bruce McDonald

I think it was in the low 15s if I am not mistaken.

Steve Roell

Chris, I will send you a note on that right, I don’t remember that.

Bruce McDonald

Yes. And then – I am assuming you meant European Automotive here from the second part of your question.

Chris Ceraso – Credit Suisse

Oh, yes, yes.

Bruce McDonald

The – a couple of things. We are seeing – the OE production is – continues to be better than we are expecting in paradoxically we are even seeing most of the strengths in the A and B segments and so think about the – some of the stimulus programs that have – that were in place last year that aren’t there this year. We never would have thought we’d see the growth in the small segment. I think the other point that’s very significant for us here in Europe is a lot of – we are a very well-positioned (inaudible) of our launches. If you look at where we have strong content, our customers are gaining share in the market, the product being very well received.

Chris Ceraso – Credit Suisse

Anything in particular, you can flag any vehicles?

Steve Roell

No, I can tell you where the demand came from, the stronger demand came from Volkswagen. In our backlog Volkswagen, PSA, and Daimler [ph]. and I think if we go back, we have had this large launch load and I think part of is the business that just – that we’ve launched in the last 12 months benefiting from the high volume.

Glen Ponczak

20, more than 20 of those launches were in Europe this quarter. So, I mean we just had a lot of volume coming as a result of the new program.

Steve Roell

Right.

Chris Ceraso – Credit Suisse

Okay, thanks, guys.

Steve Roell

Thanks, Chris.

Operator

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

Brian Johnson – Barclays Capital

Hi, good morning.

Steve Roell

Good morning, Brian.

Brian Johnson – Barclays Capital

I want to talk a bit strategically about the lithium-ion battery business. You know given how fast that market is going what product demand has been since we met with – since you had your big meeting in New York. Could you give us a couple of sense of how do you look at the global potential there? You seem very well positioned in Holland, Michigan with Ford. Couple of sub questions. Is Ford rolling out faster than you think, and should we think about upside there?

And secondly on the European side, European OEMs, we got Daimler, Renault teaming up on electric vehicles. Daimler buying a German battery company. BMW doing some ventures. Are you still comfortable with that you can grow the European side of the lithium-ion battery business or are the automakers there doing an in-house based approach?

Glen Ponczak

I think I mean if you want me, let me take a shot at it. I mean I think it’s sort of all of the above, Brian. I think it’s the sort of typical characteristics of a nascent industry in that nobody quite knows maybe what the business model is and so people are taking a taste of it this way, and a taste of it that way. And so you are seeing – you know even within OEs it’s going different routes for different sort of vehicles and different levels of electrification. And I don’t know that that’s going to settle out anytime soon. So it’s sort of hard to give a prediction of what it would like in three years. I think we are all sort of figuring that as we go on.

Steve Roell

You know I think Brian, it still is – you know as Glen mentioned – this is a very immature industry. My frustration it continues to be the fact that there are so many different players or so many different chemistries or so many different types of packaging and so configurations it’s going to take a while. But that’s – it’s just characteristic of a very immature industry. I think we are going to have to watch it evolve here. But right now basically you have very few of those consortiums that have been formed. You don’t have really standards being formed. I think you have to look over your shoulder a little bit at some of the improvements being made in the combustion engines and some of the mileage efficiency that people are talking about. I don’t think at this stage if I were looking at strategically trying to size this business that I would change a whole lot with what we’ve done in the past. I think it still represents probably at the end of this decade maybe 10%, 15% of the market. I don’t think gasoline prices or government subsidy is going to make a whole lot of difference based on what I know today. It would change dramatically if you want to – if you double the gas prices here in the U.S. and it will change the ball game. We still have a hard time see how EVs themselves are economically feasible for the consumer. We have done some work, which is where we think the gasoline prices have to be to make that economic story work. And it’s a ways from where we are today. So, anyway, I am still optimistic we are going to play hard in this part of the segment of our business, we think we have some competitive advantage and relationships, but it’s just going to be one of those things where I think the stories are going to change as we play out here.

Brian Johnson – Barclays Capital

And are the European OEMs who are doing in-house are aligning with each other, are you still in the running with them [ph] for future business there or is it –

Steve Roell

Yes, we are.

Brian Johnson – Barclays Capital

Okay.

Steve Roell

Yes, we are.

Brian Johnson – Barclays Capital

So those aren’t final decisions that this is a 100% in-house sourced?

Steve Roell

No. Some points that Glen mentioned may take you from forms [ph] that we may partner in a different way with them, but, no, those opportunities still exists.

Brian Johnson – Barclays Capital

Okay, thanks.

Steve Roell

Thanks, Brian.

Operator

Our next question comes from Ravi Shanker from Morgan Stanley. Your line is open.

Ravi Shanker – Morgan Stanley

Thank you. Can you talk about the competitive environment in the auto business? I mean you said you are gaining share and the auto margins are looking pretty good as well now. Can you give it a sense of is it the pressures that you face in that business if there is any on the pricing either from your customers or from competitors?

Steve Roell

I don’t think a lot has changed from a competitive environment standpoint. We have great competitors. We compete with Lear obviously and Magna for us here that ones we would call out. But I don’t think a great deal has changed in terms of how we all behave at this stage. So I don’t sense as much difference in terms of pricing pressure. It’s probably what it always has been. It’s my sense.

Ravi Shanker – Morgan Stanley

And from the customer side, I mean in the past obviously you’ve seen as the supplier margins start getting up there is obviously a risk of price down. I mean do you see that being an issue?

Bruce McDonald

I think it’s probably fair to say that as the volumes continue to increase there is going to be and there is starting to be a bit more pressure on productivity give-backs. But I think with what the industry has been through, I think there is going to be a lot more discipline to make sure that productivity give-backs to our customers are matched to with cost down within our operation.

Steve Roell

Yes, that’s a good point. What Bruce just said is definitely and that is that I would tell you that there is just a different change right now. When we deal with some of the OEs where there would have been just an expected let’s say historically 2.5%, 3% price down, I think there is a lot more cooperative effort trying to figure out how to make that happen. So, Bruce made that comment about cost – underline will be the ‘cost’ word. That’s usually in conjunction with the OE in terms of identifying opportunities. That’s what really has changed.

Ravi Shanker – Morgan Stanley

Okay, thank you.

Steve Roell

Thanks, Ravi.

Operator

Our next question comes from Ethai Nicoli [ph].

Ethai Nicoli

Thanks, good morning.

Steve Roell

Good morning, Ethai.

Ethai Nicoli

Just a follow-up to that question, are you seeing the same cooperative effort in some of the new backlog discussions you referenced in North America? And if so, would you expect new business to really come in at more profitable rates going forward?

Bruce McDonald

Yes, I would. I mean I think for us we are going to be very disciplined in terms of the financial characteristics of business that we book. But I think when you are quoting new business I don’t think that side of the equation has changed. I mean the business model is generally speaking our customer has a target price, usually an aggressive target, and they make a sourcing decision based on somebody’s ability to hit that target and their confidence on the technology and quality and ability to hit the program milestones on time.

Ethai Nicoli

Great, that’s helpful. Maybe one quick one. Can you maybe talk about the outlook for North American auto margins in the second half of the year? It looks very good in Q2, and maybe what you are kind of embedding into the full year auto margin guidance for North America?

Bruce McDonald

Well, we are looking at – we’re – I mean if you look at our guidance we are sort of thinking that production is slightly lower in the second half than the first half, okay? And not obviously due to some of the planned shutdowns that happen every year in Europe and North America in July and August. We’ve – we are increasing our – we are continuing to increase our investment in quoting new business, so as I say our fortunes are improving in Automotive. We have asked our – our business is going to spend more money looking to grow our backlog further. That’s kind of an investment that we need to make for longer term growth. So, I think we are pretty confident. I mean we gave the range for the full year. I think we are pretty comfortable with that range.

Ethai Nicoli

Terrific. Thank you.

Steve Roell

Thanks.

Operator

Our next question comes from Nankent Newkem [ph] from Wells Fargo Advisors. Your line is open.

Nankent Newkem – Wells Fargo Advisors

Thanks. Could you share with us any thoughts from the Board perhaps on the dividend policy? You’ve now gone about 10 quarters at the same rate. With business clearly improving, can we expect some movement here any time soon?

Steve Roell

Yes, Kent,

Nankent Newkem – Wells Fargo Advisors

Yes, can we – we will revisit that as we normally do in our November timeframe. And that’s when the Board meets, that’s when we discuss the outlook, compare our outlook for the new fiscal year. If you look at our data right now, our payout ratio is about 27%. And we are pretty proud of the fact that we held our dividend when many cut them. So, I understand your – the tone of your comment. But I think we worked very hard maintain our dividend throughout a very tough year with a very high payout ratio last year. So – what you should expect from us is a revisit and September announcement in that November timeframe regarding our outlook, okay?

Nankent Newkem – Wells Fargo Advisors

Thank you very much.

Steve Roell

Thanks.

Operator

Our next question comes from Tim Denoyer from Wolfe Trahan. Your line is open.

Tim Denoyer – Wolfe Trahan

Hey, good morning, guys.

Steve Roell

Good morning, Tim

Tim Denoyer – Wolfe Trahan

I was wondering if you could provide a little more color on the two Visteon plants which Bankruptcy Court recently approved your purchase of. Has that been completed and can you give a little color on what components are built there and how you would plan to operate them a bit more profitability and–? That’s it.

Bruce McDonald

Yes – so first of all they haven’t – that has not yet been completed. I think our target completion date is the end of April, but I could be mistaken. But it’s definitely in this current quarter.

Tim Denoyer – Wolfe Trahan

Okay.

Bruce McDonald

I don’t really want to get into a lot of the details about what we are going to – how we are going to operate those plants versus how they were operated before. But we are confident that they will be accretive to our earnings in the next quarter. So they are not something that we think we’re going to lose money on.

In terms of what they are, they are interiors component. And if you sort of think about putting a couple of extra plants into our network here, we think we –- the footprint that we got with these two operations we have some good potential to launch new business in those operations where we maybe we would have otherwise had to spend capital in the future. So we have some good synergies buying those and we think we can operate those very profitably.

Tim Denoyer – Wolfe Trahan

Okay, thanks.

Steve Roell

Thanks, Tim.

Glen Ponczak

Teresa, we probably have time for one more call.

Operator

All right. We have our next question from Rod Lache with Deutsche Bank.

Steve Roell

You made it back, Rod, welcome back.

Rod Lache – Deutsche Bank

Well, full circle. There hasn’t been a lot of talk yet about raw materials on this call but obviously they’ve been aside from lead, but obviously they’ve been rising. I was just hoping you can just give us some feel for what you are seeing relative to the Automotive Experience and Building Efficiency businesses, is this a meaningful headwind at this point. And also just on the Power Solutions, based on where spot prices are currently, can you just give us some feel for your revenue expectations for this year adjusted for spot lead prices?

Steve Roell

Okay, led me start, Rod. On the raw materials side I am going to start with steel and just tell you a couple of things. First of all from the standpoint of how we lock things in we are locked in with contracts for the remainder of our fiscal year, start with that. And they are consistent with the plan and the guidance that we’ve been providing you. Now, having said that, we also recognize that steel is going to go up and as a result of our contracts, it is going to go up significantly when we end those contracts, there will be a hike. I will come back and talk to you about what we have towards our side of the equation with the OEs, but let me complete one more. We are also seeing the increase in resin prices as you would imagine and so we again have that protected through contracts.

And then let me go through and explain to you what we do on the other side. You know in some cases there is one large OE here in the U.S. where we are on their steel and resin buying, let’s just start with that. So we – no exposure from the standpoint of our contract exposure. And as Bruce has indicated, if you look across our board at the Asian OEs, the European OEs, we are fairly and very confident about our recovery of those timing by a month or two to be an issue, but we feel confident about a high recovery rate on that, contractually and just the agreements that we have with those firms. So, that’s the other side of it. We would acknowledge and we have been worried about raw material prices for some time. So, just a commentary as something that we started worrying about probably two years ago when we came out of this side of the recovery.

From a copper standpoint, our policy has been that we have six months of our forward work is hedged. Bruce, you want to talk more about that?

Bruce McDonald

Yes, we are – and it’s going to be – I mean copper, like as Steve said, we do hedge six months out. So we will have a little bit of a headwind here in the second half of the year associated with copper but not a meaningful amount. And as – if copper continues to sort of run off, then that – at least in the Building Efficiency side of the business, historically there has been a good patter of the industry passing that on through higher prices and I guess we would expect that would continue. But that would be more of a ’11 issue than a ’10 issue, Rod.

Steve Roell

Yes. I mean in terms of both Power Solutions and our assumption regarding lead, Bruce, I think we can peg it about 2200 right?

Bruce McDonald

Yes, yes, and it’s been pretty consistent for a change.

Steve Roell

Yes, that’s 2200 a metric ton just for those in the audience and it’s been plus or minus that number for probably the last four or five months.

Bruce McDonald

Yes.

Steve Roell

So, it really has stabilized. We are not seeing the upward pressure on lead at this stage.

Rod Lache – Deutsche Bank

Okay, thank you.

Glen Ponczak

Well, thanks everybody for all of your good questions. And it’s Glen here; I am available for the balance of the day for any followup. And have a good weekend.

Operator

Thank you for participating today. You may disconnect at this time.

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