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Executives

Glen Ponczak - Director of IR

R. McDonald - Chief Financial Officer and Executive Vice President

Stephen Roell - Chairman of the Board, Chief Executive Officer, President and Chairman of Executive Committee

Analysts

Colin Langan - UBS Investment Bank

David Leiker - Robert W. Baird & Co. Incorporated

Colin Rusch - ThinkEquity LLC

Patrick Archambault - Goldman Sachs Group Inc.

Brian Johnson - Barclays Capital

Patrick Nolan - Deutsche Bank AG

Christopher Ceraso - Crédit Suisse AG

Brett Hoselton - KeyBanc Capital Markets Inc.

Michael Lew - Needham & Company, LLC

Ravi Shanker - Morgan Stanley

Vivek Aalok - JP Morgan Chase & Co

Timothy Denoyer - Wolfe Trahan & Co.

Johnson Controls (JCI) Q1 2011 Earnings Call January 20, 2011 11:00 AM ET

Operator

Good morning, and thank you for standing by. [Operator Instructions] I would now like to turn the call over to Mr. Glen Ponczak. You may begin.

Glen Ponczak

Thank you, Kathy, and good morning, everyone. Thank you for joining us. Before we begin this morning, I want to remind you of our forward-looking statements. Johnson Controls will make forward-looking statements in today's call pertaining to its financial results for fiscal 2011 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, mixes and schedules, energy and commodity prices, the strength of U.S. or other economies, currency exchange rates, cancellations of or changes to commercial contracts, changes in the levels or timing of investments in commercial buildings, as well as other factors discussed in Item 1A of Part 1 of the company's most recent Form 10-K filing, which was filed November 24, 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'm joined this morning by Steve Roell, who is our Chairman and Chief Executive Officer. Steve will provide an overview of the first quarter. That will be followed by a review of the business segments and the financial results by Bruce McDonald, Executive Vice President and Chief Financial Officer. After those presentations, we'll take some questions and answers and conclude at noon, Eastern Time. And with that, I'll turn it over to Steve.

Stephen Roell

Okay, well, thank you, Glen. Good morning. I'd like to start with three general comments. The first is the fact that we're just very pleased with the financial results in the quarter. The headline in our press release this morning highlights the fact that the sales earnings were at record levels. I think it's important to note that in the first quarter last year, we were already moving beyond the recovery phase.

If you look back, last year's results were at a record level. So now I think that provides some additional context in terms of the double-digit increases that were achieved by all three businesses and the momentum that we have.

In the past, I've talked about the value of our diversification in the context of business mix, geography and customer base. Clearly, we continue to benefit again from that diversification. Our global presence and capabilities and the diversity of the markets that we serve, particularly MDE, will continue to be a major factor of our success throughout the year.

Finally, as we look across our businesses, we see increasing demand in the form of higher build schedules, double-digit growth in new business orders and backlogs, as well as the demand for new technology. I'm even more confident the decision that we discussed with you at our fall analyst conference to invest aggressively in our growth initiatives for 2012 and beyond is the right decision.

So I feel good about where we are. Sometimes, at this stage of the year, there's a lull. But I would tell you that this is probably the first time in a long time, even going back in when we had a more robust economy, that coming out of the first quarter, we feel as good as we do.

I now want to shift to the PowerPoint slides. And I'll walk you through a couple of slides with you, and then Bruce will go through the business in more detail. First of all, sales of $9.5 billion were up 13% from Q1 of last year. I should note that if we were to adjust for foreign exchange, that 13% would be 15% up year-over-year. We saw a good double-digit growth across all three businesses, with Automotive Experience up 12%, Building Efficiency up 13%, Power Solution up 21%.

Our segment income was up 31% from $406 million to $533 million. Highlighting that also is the fact that Automotive Experience had a 100 basis point improvement on margins, and BE had a 70 basis point improvement. Our net income of $375 million compares to $288 million last year. It's up 30% when we exclude the non-reoccurring tax benefit that was in last year's quarter. So the headlines that you're seeing out there, I know you're sophisticated enough to know that our earnings were up 7% on a GAAP basis, but the true momentum in our business from the standpoint of our net income was 30%. And that resulted in our EPS growth from $0.43 a share last year to $0.55 on a diluted share basis this year.

In terms of momentum, solid growth in Building Efficiency backlog and orders. We highlighted that in our press release, and I think it clearly is evidence of continued market share gains. Our backlog was up 13% at the end of Q1. I think Bruce is going to go through and talk to you more about how that plays out by region. But we saw good growth across our businesses. The strong order month, after a very strong fourth quarter last year, we're up 17% again in Q1. We wanted to highlight the fact that our chiller shipments were up double digits. We can tell you that in North America -- for North American customers, I should say, was up 20%. In Asia, our demand for chillers, both small and large capacity chillers, was up 53%. So a good demand in our business, and we continue to see that momentum that began in the middle of last year.

In terms of our Power Solutions business, accelerating production in both our SLI and AGM batteries. Wal-Mart, as you recall, we were awarded 5.3 million incremental units last year, about 25% of those launched in the quarter ended June, and the rest of them launched in the quarter just ended. As Bruce will go through with you, I think the interesting part about our Power Solutions business was the growth that we saw across all our aftermarket businesses, both in Europe and in North America, as well as the OE increased volume. We've talked to you in the past about the fact that we are increasing our AGM capacity to meet the demand we see in Europe. We'll talk to you more about that as the year plays out. But clearly, we began to put some of that capacity in place.

And finally, across all three businesses, we continue to benefit from the strength and the position we have in Asia, and of course, particularly in China.

In terms of 2011, as the press release indicated, we're providing you today with an increased or revised projection for fiscal 2011 in terms of our revenue projection and EPS. It's driven by -- the revenue sales is driven by our automotive acquisitions, higher automotive production levels, and finally, higher unit volumes in our Power Solutions business.

We continue to invest to support the growth opportunities. We've made that point in our fall management meeting. We're adding to our Building Efficiency sales force, engineering and service capabilities. We continue to invest in technology and innovation across all three of our businesses. We're investing probably more than we have in the past in terms of emerging market infrastructure. And as an example, I can tell you right now that as we look at China, it's clear to us that China, in the decade, and the question is not if, but when, will probably represent a 30 million unit production market for the industry. And so we're just looking at what we need to do to be in a position to support that business.

And then, as you can see, we increased our capital expenditure projection. Bruce will talk more about that, largely tied to Power Solutions. And some of the investments that we believe are required to support the growth opportunities there.

We did announce several acquisitions. We're going to give you a little bit more guidance, which we provided in the press release. Clearly, one was Michel Thierry. We completed that in the first quarter. And then Hammerstein and Keiper, we've announced, and Bruce will go through and give you the timing of that.

I'd just like to reiterate why we did those. If you go back to Dave's presentation at the Analyst Meeting, he highlighted the need to improve and increase our technical capabilities and components. And clearly, these are world-class companies with engineering and operations and quality standards that certainly will add to our future business. We also recognize the fact that there are certain OEs who are sourcing components as opposed to complete seats, and this gives us the opportunity to provide value in both of those sourcing alternatives, if that's the case. But the key thing is the fact that both these companies that we've described, Hammerstein and Keiper, are world-class companies with tremendous mental capability.

So with that, I'm going turn it over to Bruce, who will cover each of the businesses. Bruce?

R. McDonald

Okay, thanks, Steve. Let me start on Slide 7 on Automotive Experience. So we look at our auto business. We've delivered another very good quarter with solid results in all geographic regions. Just focusing on sales, you can see our sales were up 12% in Automotive or 14% on a constant currency basis. What we really look for is -- to put our sales performance in perspective is how we do versus our production schedule, and that really demonstrates how we're taking share.

So in North America, our sales were up 9% versus a production increase of 7%. In Europe, if we exclude currency, we were up 13% versus an estimated increase in production of about 7% as well. And in Asia, you can see very strong revenue performance, up 49%, reflecting a number of new vehicle launches, predominantly in Korea and Japan. And in China, our business, as you know, is mainly nonconsolidated, but you can see here the sales up 37% to just a shade over $1 billion. And that 37% compares to an increase in passenger car sales of about 25%. So again, good performance in that region.

Just a recap on our business in China. I think we touched on in our press release, but we now have 24 joint ventures with 47 manufacturing facilities and a 45% market share in that critical market. The top line, the Chinese performance really benefits our equity earnings. I'll touch on that when I go through the financial statements. But we do expect to see significantly higher equity income flowing through for the balance of 2011 here.

Just turning to segment income. You can see at $177 million we're up 46% versus last year. And we're pleased with the profit conversion rate that we're seeing on incremental volumes. Here, we're really seeing the benefit of both our restructuring initiatives, but also better manufacturing capacity utilization. Partially offsetting this were higher net engineering costs in the quarter. So our engineering expenses were up about $20 million year-on-year, primarily in Europe. So when we look at our European results, it's sort of being penalized with a exceptionally high level of engineering costs, which is largely timing-related.

In our European business, you can see -- if you sort of look at the margins, geographically, North America, 6.7%. That's up 130 basis points year-over-year. Asia at 10.4% is up over 400 basis points versus the prior year. And Automotive Europe at breakeven is down about 50 basis points or about $11 million.

In Europe, we are continuing to experience some inefficiencies associated with problematic launches, distressed suppliers and supply shortages, particularly in electronics area. But we remain confident that these issues are going to start to trend lower through the balance of the fiscal year here.

Looking at the production forecasts that we have for the balance of the year. And I remind people that these are fiscal year. So the 12.5 million, uplifting North America about 12.5 million units, which is right on top of CSM. And in Europe, we increased our outlook for production from about 17.6 million units to 18.3 million.

Flipping to Building Efficiency here. Sales were up 13% to $3.4 billion. We saw good revenue strength in all of our segments. In North America, revenues -- and that's a combination of both systems and service, revenues were up 8%. And Global Workplace Solutions, up 21%. And very strong growth in Asia, particularly in the China market, where we're up 31% in aggregate. We continue to see very strong order activity. As Steve indicated earlier, we're up 17% a the quarter. Maybe just to give you a bit of color in terms of the geographic split of that, and I'll strip out currency here. But the Middle East sort of led the way with our orders were up 128%. We're up 56% in Latin America, 18% in Asia, 10% in Europe and 7% in North America.

If you take North America and split that between systems and service, systems was up double digit, our service business is up about 5%. So that's been the one area that's been the flattest. We are pleased to see that we are at least starting to see growth in our service business in North America. In North America, we continue to see good growth in the energy solutions line of business. And the institutional markets remain fairly robust. The market that was particularly strong in the quarter for us was actually the government sector.

Looking at segment income. At $139 million we're up 34% versus last year. Here, we saw strong profit growth in most geographic regions and across all of our lines of business. On a year-over-year basis, Steve indicated our segment margins were up 70 basis points to 4.1%, despite the investments that we're making here in our sales force, product development and the emerging market infrastructure.

If you look over on the right-hand part of the chart, our backlog, you can see we had a record backlog. It's never been this high before. So at $4.9 billion, it was up 13% on a year-over-year basis. That number, if you take out currency, it's about the same, 13%, so that's a good number. This is the second consecutive quarter that our backlog has been up over at a double-digit rate. And it really demonstrates the momentum that we have in our business. If you look at our sort of pipeline data, we expect to see our backlog be at a double-digit level as we trend through the year here.

Just one comment on the bottom of the slide here. We are going to be making some changes to our segments within Building Efficiency for SEC reporting purposes. So when you see our 10-Q and future filings, we're actually going from having six segments in Building Efficiency to five. So here, what we'll be doing is pulling out Asia and showing that as a separate segment. And that really just reflects the fact that, that business is becoming a larger and larger piece of the pie. And we'll be putting Europe and UPG into other, where Asia was previously. And as appropriate, when we talk about our financial results, we will call out our North American residential business and other geographic territories when it's appropriate.

In terms of Power Solutions, our business had a very strong quarter. Sales were up 21% to $1.6 billion, and you can see from a volume perspective, up about 19%. I would note that the quarter, we benefited from the Delkor acquisition. If you were to strip that out, our volumes were still up a very robust 13%. You can see here on the aftermarket side, volumes up 20%. In the quarter, we do have the full kind of run rate of the incremental volumes associated with the Wal-Mart win that we've talked about on previous calls.

In terms of OE, the volume's up 17%, reflecting the higher global automotive production levels, but also market share gains through the year. In Asia, our volumes continue to grow, up 168%. That has Delkor in it, and also reflects the strong growth that we have in China. In China, we have opened our second manufacturing -- or we will be opening our second manufacturing facility here in February. So that's going to ramp up throughout the course of the year. Just to remind the audience, that facility is going to have a capacity of 8 million units. That's kind of the run rate that we'll be at by the end of 2011. And next month, we'll be starting the construction of our third manufacturing plant, which will be in Western China.

In terms of the segment income, at $217 million, up 20% versus last year. Here, we're really just benefiting from a combination of higher unit volumes, a slightly richer product mix, and we're just starting to see the beneficial impact of the lead recycling center that we ramped, with the ramping up here in Mexico. So that came online in the quarter. It's still obviously well below its mature level. It's about one or two quarters away from getting to the full run rate benefit of that facility.

So maybe now flip over to the financial highlights here. So with all of our businesses growing at double-digit rates here, our sales were up 13%, or 15% if you exclude foreign exchange, as Steve indicated earlier. The increase, obviously driven by the higher volumes in all three of our businesses, share gains in the aftermarket side and Power Solutions, and then Building Efficiency, as I talked about earlier, just the momentum that we're seeing in that business with the return to double-digit growth.

In terms of gross profit, you can see we've picked up about 10 basis points compared to last year, so good success there. That increase reflects really the benefit of some of our manufacturing initiatives and better capacity utilization.

In terms of SG&A, despite the fact that we are making a lot of investments in the areas Steve covered earlier, you can see our SG&A as a percentage of sales declined by about 60 basis points to 9.9%. The key areas for us here is really ramping up our expenditure on innovation activities, emerging market infrastructure and some of the capacity initiatives that I'll talk about later in Power Solutions.

Equity income, up to $66 million, so a 25% increase there over the year. So start to see the benefits of the volume in China and our automotive joint ventures. And in addition there, we do also have some joint ventures in our Power Solutions in some regions of the world. They continue to perform very well for us. Just looking at our segment income. We're really pleased to see our segment, if you just look at segment income as a percentage of sales, an 80 basis point improvement from 4.8% to 5.6%.

So flipping over to Slide 12. In terms of net financing charges, $35 million in the quarter, which were comparable to year-ago levels. Both periods actually benefited from net foreign exchange gains. And as we sort of take into the remainder of the year here, we expect net financing costs on a quarterly run rate basis to sort of approximate $45 million to $50 million. That really starts to reflect the interest expense that we're going to see with the automotive acquisitions, as those close here in the second and third quarters.

In terms of our tax rate, it was a clean quarter. We had 19% effective tax rate, which is consistent with our guidance. And if you strip out the one-time benefits versus last year, our underlying rate was 18%. So just exactly in line with our guidance for the year. Our tax rate is marginally higher, one percentage point. Income attributable to noncontrolling joint ventures, or what was formerly called minority interest, there's a charge of $28 million versus $16 million last year. That's a higher expense because of the improved profitability in our Automotive and Power Solutions consolidated joint ventures. And then lastly, earnings per share, $0.55 or 28% higher than the previous year.

Just flipping over to Page 13, I'd just like to take a minute and really talk to the financial implications of the two automotive metals and mechanisms, the acquisitions that we've announced earlier. These acquisitions are especially strategically significant for us, as Steve laid out, in that when you take these two businesses combined with our existing metals and mechanisms operations, position Johnson Controls as the leading global supplier in this critical component area.

Both the businesses, Hammerstein and Keiper/Recaro, are predominantly European. They do have a presence in Asia and North America, but the bulk of their business is European-based. And our plan, these aren't cost synergy stories. These are growth stories. And so we plan, very shortly after closing, to really ramp up our investment in these businesses to both cross-sell our product lines to complementary customer base. Both these customers, these businesses have a very good position, some customers that we're underrepresented in. But importantly for us as well is really aggressively growing these two businesses in North America and Asia in particular.

With regards to the timing of transactions, we have received EU approval on Hammerstein, and we anticipate closing on that acquisition here at the end of January or early February. For Keiper/Recaro, we're really just in the very early stages of our discussions with the regulatory agencies, and our expectation is that, that transaction will close in mid-Q3. So if you take those timings, then the impact for us this year is approximately $700 million in revenue, and we expect these to be neutral to earnings per share. So there is going to be some operating income associated with these businesses that'll be offset by our ramping up our investment in product development and the geographic expansion that I talked about, and also the interest expense associated with these acquisitions. In terms of the purchase price, about $950 million. And that will obviously be spread here between Q2 and Q3. That assumes a Euro rate of $1.35.

For 2012, now we'll start to see the full year impact of these acquisitions. The sales impact will be about $1.4 billion, and the earnings accretion in 2012 will be about $0.10. That's still not kind of where we see the run rate. I think when we get this business out to 2013 and beyond, it's $0.20 to $0.25 accretive in terms of our numbers. So very strong growth stories here and really position our auto business to build their backlog, as we get into the 2012 to 2014 type timeframe.

Then lastly, I'll just touch a few minutes on our revised guidance. So with the terrific first quarter here, it's nice to be able to share an improved outlook for the balance of our fiscal year here. So in terms of our revenue guidance, you can see we're nudging that up from $37 billion to $38.5 billion. So we're going up from 9% to 12%. The drivers here, about half of that being the automotive acquisitions. The remainder is the higher production assumptions in North America and Europe and a pickup in aftermarket volume in Power Solutions.

In terms of earnings per share, we're increasing our range from $2.30, $2.45 to a new range of $2.50 to $2.55. And the drivers here, really, are the incremental volumes, a continued focus on our cost base, but also an acceleration of some of our growth investments, particularly on the Power Solutions side, where we are capacity-constrained almost in every region throughout the world. So we've got a lot of debottlenecking of our factories. We're incurring some inefficient transportation costs. And we'll be ramping up our investment in some of the bottleneck areas in AGM and our capacity in Asia and North America.

In terms of the -- we're introducing Q2 guidance here of $0.52 to $0.54. And I'd just remind everyone, you can see the asterisk here, we do expect to incur some acquisition and integration-related costs. We haven't yet quantified those, but some of those will flow through in the second and third quarter. These numbers that I have provided here exclude those costs.

In terms of segment margins, you can see we ticked that up a little bit by about 10 basis points. Our range Automotive is unchanged at 4.5% to 4.7%. Here, what we're really seeing is the impact of the acquisitions that is slightly dilutive, and so that's really offsetting the beneficial impact of the higher production volumes. In Power Solutions, we're increasing our range by 20 basis points to 13.6% to 13.8%. And in Building Efficiency, we're increasing our range by about 10 basis points to 5.7% to 5.9%. The real driver in Building Efficiency being better operational efficiencies, particularly in Asia and North America systems business.

In terms of financing charges, you can see we're increasing our range by about $10 million here, and that's really associated with the costs associated with the acquisitions. Our capital expenditure forecast we're increasing by $200 million to $1.4 billion. About 2/3 of the increase is capacity expansion in Power Solutions. Here, we are -- as I said earlier, we're taking up our capacity in Korea, in North America. And these are levels higher than we sort of planned going into the year. And also in AGM. In AGM, we continue to see that market develop. We expect to increase our capacity by 2014 from 3.6 million units this year to 11.2 million units by 2014.

So when we talked at our Analyst Meeting, we talked about putting capacity in place for just over 7 million units. So it's a 50% increase in our European capacity. We also expect this year that we will start to begin construction on some North American capacity. We have not yet sized that here. So some of that spend will flow through here.

In terms of AGM, a lot of investment ramping that business up and developing some of the market channels, particularly in the aftermarket side. That capacity won't be in place for 2012. It's really investment we're putting in place to expand our business in 2013 and beyond.

In terms of our balance sheet. You can see why our debt-to-total capitalization we're now forecasting to be around 22% versus the 15%. That's all attributable to the borrowings that we're going to take on associated with the auto acquisitions. Our free cash flow remains unchanged at $1.2 billion. Our higher level of net income will be offset, will basically fund the increased level of capital investment.

So just before -- I guess sort of the key financial takeaways here is really double-digit top line growth in all three of our businesses; very strong momentum in Building Efficiency with our backlog continuing to show an upward trajectory; and revised upward guidance in terms of 2011 and significant margin expansion; the fact that we're increasing our level in investment, both organic and M&A; and also, that our balance sheet continues to be underleveraged, which gives us the capacity to increase our investments further in the future to deliver superior shareholder value.

So with that, Glen I guess will open things up for questions.

Glen Ponczak

Yes. And before we start, I'm told we have a lot of people on the call. So to give everybody a chance, maybe if we can keep it to one, your best question, and maybe a quick follow-up. And with that, Kathy, we'll open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Brian Johnson of Barclays Capital.

Brian Johnson - Barclays Capital

I will talk about European seating. You said $20 million of engineering cost. Add that back in, that would imply roughly maybe a 100 basis point margin. I guess the question is what is it going to take to get this into the 4%, 5%, 6% margin range? When's that going to happen? And how do these new acquisitions help get you there?

R. McDonald

Well, Brian, this year, if you sort of go through the numbers, those acquisitions are going to be dilutive to our margins in 2011. They'll probably come in at, say, 2.5% to 3% prior to the integration and acquisition costs that I referred to. Next year, those acquisitions will start to be accretive to our margins there. But the drivers for getting our European margins up to the level we just talked about are really unchanged from last quarter.

As I indicated in my comments, we are still experiencing some launch difficulties, some supply shortages and distressed supplier costs. So we need to -- those need to drop away. And we're pretty confident, in terms of the run rate, that that's going to happen by the end of this year. But secondly and more importantly is really getting the European industry volumes back to the levels that they were prior to the downturn. I mean, we've talked in the call before about the fact that we structured our business down as much as we did in North America because we felt that there was really no fundamental reason why the market wasn't going to recover the level that it was before. So we just need some of that tailwind behind us.

Stephen Roell

Clearly, Brian, we know that there's opportunities to improve our operations also. We have to acknowledge that, that both from a quality standpoint and operations, we can do a better job in here, and that's going to be a key. Longer term, as we think about those margins and maybe the profitability of the European acquisitions, we've been consistent in how we describe our criteria for looking at acquisitions. And I would tell you that the two, or the three, if you want to look at Michel Thierry, all three of those will be achieving their return on capital investment, the targets we've set, in that third or fourth year. So maybe as you start to model longer out, I would start just thinking in that context.

Brian Johnson - Barclays Capital

And have you made any management changes in Europe to sort of give you greater confidence that the launch costs and some of the cost overruns are behind you? Or is it just refocusing the team you have there?

Stephen Roell

I think we got a real good team there. I'll start with that, okay? We have made some changes, but the changes were really more along having a dedicated structure that managed components. So what we did do is we now have our component business, metal, trim and foam, we have that as a separate business, separate global business unit. But I think we have a good team. We have to bulk up the team, and I don't think it's a matter of changing the team. I think we're trying to add some additional middle management, and I think we're getting some good middle management in the acquisitions. That's the other thing, I guess, I would describe to you.

R. McDonald

Yes, let me add to that. With some of the quality issues that have occurred in the industry, there is, for sure, a heightened expectation and demand in terms of quality performance. And so that is an area that we've brought in some external talent and is an area that we are bulking up.

Operator

Our next question comes from Ravi Shanker of Morgan Stanley.

Ravi Shanker - Morgan Stanley

Bruce, did I just hear you say that the engineering costs will be an issue for all of 2011 and something that goes away towards the end of the year?

R. McDonald

No, I didn't say that. The engineering costs are really just timing-related. They tend to be lumpy by quarter. What I was referring to there was some of the launch difficulties, the distressed supplier costs, the supply shortages that we're having. Those costs, we expect to trend down as the year goes on here.

Ravi Shanker - Morgan Stanley

So you didn't raise your auto margin guidance despite higher production estimates. Does that have something to do with the timing of these recoveries? Are you actually implicitly raising your estimates in North America and Asia, but then Europe's going to be weaker because of the acquisitions?

R. McDonald

Yes, well, the acquisitions are dilutive in this year. So if you think about the -- let's say we had not have had the acquisitions. We probably would have upwardly revised our margins in auto by 10 or 20 basis points. So the acquisitions sort of just dilute that.

Ravi Shanker - Morgan Stanley

And if I can just sneak in one more. The increase in the accretion of FAS 2012, is that because of cost synergies? Or is that just you growing the top line in these new businesses because you're obviously part of a bigger company now?

R. McDonald

It's really the latter. This one is really all about revenue growth, not cost savings.

Stephen Roell

There are some, but they're minor in contrast. And I would tell you that both these businesses came with good backlogs.

Operator

Our next question comes from Tim Denoyer of Wolfe Trahan.

Timothy Denoyer - Wolfe Trahan & Co.

Quick question on the -- a couple of battery-related questions. You mentioned that the Mexican smelter would take another one or two quarters before you're seeing the full run rate. Are we at roughly 1/3 of that run rate in the current quarter? Or can you give a little more quantification of that?

Stephen Roell

Tim, I think the way that you start the battery plant's a little bit different. I think, I would tell you yesterday they hit the run rate that they need to. But -- in terms of the amount of smelting they did. But it's a consistency level of that. So I would say it ramps up, but there's points in time where you actually hit the run rate that we're looking for down the road, and we come off. So it's just a function of how we stabilize the production over time.

Timothy Denoyer - Wolfe Trahan & Co.

And with lead prices up to, I think, around $2,700 a ton at this point, is there any change, or what is the change, I guess, versus your estimate of, you said in the past 200 to 250 basis points of margin potential from both of those, the smelters? How does that look today?

Stephen Roell

Yes, we haven't updated that. Tim, I would just tell you that as the price goes up, we're very happy we've made those decisions to invest and build those two smelters. We have not gone back and quantified revised guidance to what that delta would be based on that change.

Glen Ponczak

Yes, but that will go up and down, Tim.

Stephen Roell

Yes.

R. McDonald

I mean, but that order of magnitude, like $2,200 versus $2,700, it's not going to be significant.

Timothy Denoyer - Wolfe Trahan & Co.

And then just one more quick one in terms of -- do you expect the margin impact in batteries in the second quarter as the new China plant ramps up?

Stephen Roell

The China plant's going to ramp up gradually over the remainder of the year, Tim, so we're bringing on the lines almost on a monthly basis. But some of those are going to come on, I mean, really, it's literally April, May, June, July and August. So it's going to be that kind of a ramp up, Okay?

Operator

Our next question comes from Pat Archambault of Goldman Sachs.

Patrick Archambault - Goldman Sachs Group Inc.

I had just a question on working capital, which I think increased, I think it was $473 million. I know that it's been hard to -- it's sort of gone in either direction historically. But that seemed like a pretty big number. I think that maybe some of that is inventories with Wal-Mart. Can you give us a sense of what was behind that number? And just given everything you have going on, is working capital going to be a continued cash investment for the next couple quarters?

R. McDonald

Yes, Pat, it's Bruce here. I would say, almost without exception, we always have a working capital build in Q1. Last year was very abnormal. And let me just give you some of the underlying factors. First of all, last year, we were coming off a, obviously, a very poor year, year-over-year. Our bonus plan, which are based on year-over-year profit improvement, paid out zero last year. And I'm talking about 2010. 2009 payment that would have been made in the first quarter of 2010, it paid out zero this year. If you look at our overall incentive compensation across the company, probably a couple of $100 million. So that's half of the delta, and that always happens. Secondly is our battery business, we always build inventory in the first quarter to support the seasonality in demand. And last year, we didn't have to do that because we had excess battery capacity. So that's a very normal pattern. So those are really the two factors. Our working capital performance is very much in line with our internal plans. It just looks funny versus last year because that was so abnormal.

Patrick Archambault - Goldman Sachs Group Inc.

And is there, for instance, with the Wal-Mart business, was there any impact from that in terms of having to build up inventories ahead of that contract, or concurrent with it?

R. McDonald

No, not really.

Operator

The next question comes from David Leiker of Robert W. Baird.

David Leiker - Robert W. Baird & Co. Incorporated

On Building Efficiency, Bruce, you didn't give an organic number. I'm assuming that's because there's not much difference than the up 13%?

R. McDonald

You mean organic...

David Leiker - Robert W. Baird & Co. Incorporated

Revenue x currency?

R. McDonald

Yes. Currency was not an issue, so it was 13% with or without currency.

David Leiker - Robert W. Baird & Co. Incorporated

So this is really, this is the second quarter you've got a double-digit revenue growth there.

R. McDonald

Yes.

David Leiker - Robert W. Baird & Co. Incorporated

Europe is still coming through. You've got, the order intake is pretty strong. Yet your guidance for the full year is 8% to 10%. That 8% to 10% seems relatively conservative at this point. Is there something we're missing?

R. McDonald

Well, I think at this point in time, our orders are trending better than our expectations. And I'd say just because Building Efficiency is sort of 2/3 of our profitability is in the second half of the year, I think we just want to wait another quarter before we decide, before we kind of make a call on how the year's going to play out there.

Stephen Roell

Yes, I think the sad combination with what we think will come out of this year in terms of backlog, David, but that's really what we're trying to gauge. But I think we're pleased. I think -- this is still a market which hasn't fully recovered yet. We're outperforming it. If you look at the AIA data yesterday, it was mixed. It's trending up, but it wasn't in the institutional base. So we continue to gain share in it. I believe we can by adding the sales force that we have. But I think we just want to see a little more of the order demand here the next three to six months and then we'll have a better feel.

David Leiker - Robert W. Baird & Co. Incorporated

And then if we look at that business longer term, what do you think your revenue growth there is on a long-term basis? Right around that 10% number?

R. McDonald

We've talked about 10% to 15%.

Stephen Roell

15%, yes.

David Leiker - Robert W. Baird & Co. Incorporated

And then one last housekeeping item here. If we look at your Building Efficiency business sequentially Q4 to Q1, there's a seasonal drop there. But it looked like the drop in profits relative to revenue was a little bit mismatched relative to the past. Is there something that we're missing there, or is that pretty normal, do you think?

R. McDonald

Well, like I said kind of earlier, about 2/3 of our profitability's in the second half. But we always see it down. So this is our weakest quarter, particularly on the service side. I guess I haven't really looked at is there anything abnormal, like Q4 to Q1 this year versus the past. Maybe we can follow up with that one with you, David.

Stephen Roell

The only thing I can think of David, something that Bruce has, is the GWS sales growth, okay, was probably, the 21% was a strong number for us versus historical norms. But I think the key, and I know some people are looking at the first half versus second half, as Bruce mentioned, the service is a major element. As we start doing all of our truck-based service and our other work, a lot of that is scheduled, and it's done in the April through summer timeframe. So that really is what helps us tremendously. Plus, it's just how much work we do on contracts, given the weather. That just picks up in that timeframe. So that's just historically what's there. The key to BE, though, I'm going to tell you, is while we'll see recovery in North America, the key is the strength we're seeing in those emerging markets. Bruce talked about the Middle East and, certainly, Asia. Those are the two that are really helping us and are expected to, if you look at Global Insight.

Operator

Our next question comes from Himanshu Patel of JPMorgan.

Vivek Aalok - JP Morgan Chase & Co

This is Vivek Aalok for Himanshu this morning. I have one question for you. How does the M&A pipeline look like now? And I wanted to know where will these acquisitions be? Will they be in the autos or will they be in Power Solutions?

Stephen Roell

Are you talking about future acquisitions?

Vivek Aalok - JP Morgan Chase & Co

Yes.

Stephen Roell

Yes, I think, historically, and I'll stay by this, I've always said that our -- over the mid to long term, we expect about 80% of our M&A activity to be in the BE business unit. We knew these opportunities exist in Automotive. It's going to take us, in the organization, some time here to really focus on the integration of those acquisitions. So I would tell you that, in terms of Automotive, I wouldn't expect any more activity than what you've seen this year. Longer term, and we're struggling, to be honest with you, regarding identifying large acquisitions. We've made several approaches. We've had assets which are not available. And so, as I indicated in some recent conferences, I don't believe you're going to see a mega transaction from us in the Building Efficiency side. It will likely be smaller transactions, maybe even up into the $300 million, $400 million range. But that's what I would expect over the midterm.

Vivek Aalok - JP Morgan Chase & Co

And just lastly, can you discuss the climate for OEM pricing pressure now relative to last year? Do you see any big change?

Stephen Roell

No, we really don't. I think the only thing I would tell you, maybe not so much as to last year, but if you look back to two, three years ago, it's a much different climate. I would say there's a lot more cooperative effort, a lot more focus on pricing related to cost reduction efforts. But I just talked to our people this morning regarding what they see in Europe, in particular, and we would tell you the pricing pressure is very similar, but the cooperative level and the nature of it, it's not as contentious, and it's certainly much more of a cooperative aspect.

Operator

Colin Rusch from ThinkEquity.

Colin Rusch - ThinkEquity LLC

I just want to follow up on both the acquisition and the Building Efficiency. Can you talk a little bit about what you're seeing in China? There appears to be a pretty meaningful opportunity to roll up a fragmented escal [ph] market. How far along are you in evaluating targets, developing partnerships? And what are you expecting in terms of policy adjustment as China rolls out long-term policy targets over the next several months?

Stephen Roell

Really, it's been Automotive. I don't think they've done a whole lot on the energy side. I think the escal [ph] market's a very immature one. I mean, right now, we're building out our capabilities in China. The market right now isn't really established for an escal [ph] market right now, Colin.

Colin Rusch - ThinkEquity LLC

And then secondly, just in terms of looking at and rationalizing electricity supply chain. Do you expect to make any technology acquisitions? Or see the need to develop new technologies to harmonize the communication between grid applications and building operating systems, notably in automated demand response or in the building protocol translation space?

Stephen Roell

Are you talking about smart grid? Is that what you're asking?

Colin Rusch - ThinkEquity LLC

Yes, smart grid is basically SCADA systems and operating systems. It looks like there's a lot of work to do in marrying those things up.

Stephen Roell

Some of the targets we have would be in that area. But again, they're a small company. And we think it would be by just the nature of it.

Operator

Our next question comes from Chris Ceraso of Credit Suisse.

Christopher Ceraso - Crédit Suisse AG

A couple of questions on the acquisitions. First, with an increase, it seems, in vertical integration, does this improve the potential margin for that product line, that being seating and interiors in general? And then also on the acquisitions, you mentioned that it's primarily Europe that you're growing for top line growth. But what does the cost footprint look like? If these are mainly European assets, is it mainly a European cost base?

R. McDonald

Yes, in your first question about the margins, yes, these will be accretive to our margins longer-term. And I think once we've had a chance to integrate these businesses and firm up some of our initial thoughts here, we can talk -- I think we'll be in a position to talk about that in a lot more detail. Probably in time when we have our analyst meeting next fall. With regard to the footprint, the manufacturing footprint, it's true the businesses are European-based, but they do have a pretty good low-cost footprint each of them. So the technical resources are primarily in Germany, but from a manufacturing point of view. And metals tend to be -- obviously, there's a lot of transportation penalties. So you can't push it way into the East. But I would just say our view of the footprint of both of these businesses is that it's very good. And we don't see a -- our expectation is there's not a lot of refootprinting that we would want to do with these businesses.

Christopher Ceraso - Crédit Suisse AG

And then just one quick one on the SEC change with the reporting. I understand that resi is a small business, it's the bottom of the market, arguably, and that's kind of a highly volatile segment. Do you feel like you're giving up some transparency here to the investment community? And also, Europe, which has kind of had some struggles, it seems that combining those two kind of mask some sort of problem areas. What's your thought on that, Bruce?

Stephen Roell

Well, this is Steve. Let me talk about that. I think -- that's not our intention. As Bruce mentioned, I think, in his comments, it's our intention, Chris, that we would go through and continue to highlight those businesses in our commentary. Okay? So you should be hearing from us in terms of residential and Europe. Right now, we feel good about both those. Both those businesses are expected to be good contributors in our year over 2011 performance. So there certainly was nothing on our part in terms of trying to hide transparency. We'll be talking about those businesses with you. Okay?

Operator

Michael Lew of Needham & Company.

Michael Lew - Needham & Company, LLC

On the Asia systems and the services front, what's the current blend or mix between services and systems revenues? And also, could you comment on the type of growth rate we should expect in the near term? I mean, should we expect an acceleration beyond the 30% plus type, given the additional headcount that's being added to harvest that region?

Stephen Roell

Now you're talking about Asia specifically?

Michael Lew - Needham & Company, LLC

Yes.

Stephen Roell

Okay, I guess let me talk about China. China, because of the nature of the market, is very much of a new construction market, okay, with systems and chillers being the large proportion of our volume. The culture, and it'll morph more and more over time into a service business, and we're planning for that. But right now, the preponderance of what we do in China is exactly that. If you go to Japan, it's sort of counter, okay? Think about a very mature market. There our retrofit and service capabilities are critical to us. So we talk about the retrofit market being the primary driver of Japan. That's how we contrast those two markets.

Michael Lew - Needham & Company, LLC

And can you comment on any activity ongoing in Korea?

Stephen Roell

Well, Korea's a good blend. We've got a nice footprint there. And I guess I would say that Korea is probably a good blend of two of those. There's still construction activity, retrofit, and we do have a service capability there. So it's probably in the middle.

Michael Lew - Needham & Company, LLC

And one last question. On Power Solutions, last quarter, you highlighted the need to import from the U.S. and Europe to fulfill the demand in China. Is that still the case now, given that the China manufacturing facility is now in operation?

R. McDonald

We'll be -- our expectation is we'll be doing that all year. So for that...

Michael Lew - Needham & Company, LLC

All year?

R. McDonald

Yes.

Stephen Roell

Yes.

R. McDonald

Because the demand is ramping up faster than our manufacturing capacity. And it's likely we have some of that even into 2012.

Stephen Roell

I think what -- to be honest with you, what's catching us, though, is the demand in the U.S. is stronger than what we thought. So it's making that equation a little more complex. And that's why, as Bruce mentioned, we're putting some more form and fill [ph] capacity into the U.S. this year, because our ability to ship from here is getting tight.

Operator

Our next question comes from Rod Lache of Deutsche Bank.

Patrick Nolan - Deutsche Bank AG

It's Pat Nolan on for Rod. On the Power Solutions business, you usually see seasonally that revenue come off in the second quarter and then kind of recover in the fourth quarter. Is demand strong enough that we're going to see less of a drop-off this year?

R. McDonald

I think so. I think so.

Stephen Roell

Yes, the only reason I'm hedging on that is demand was so strong in the quarter just ended, and that's making me think. Certainly, our demand is going to be stronger than last year, but there's going to be a drop-off. It just doesn't maintain it, but I think...

R. McDonald

I think, though, one thing, Steve, is we have struggled to ramp up our capacity. And so our customers typically stock up inventory. And I think if you were to look at the cost of the inventory of the channels, that we're probably lower than normal. So that's why I think we'll probably see less of a drop off.

Stephen Roell

And I guess the other thing that would contribute, if the weather continues like what it's going to be tomorrow here. It's been battery weather. But it's difficult for us. But we had such a strong first quarter because of demand, that's the only thing I'm worried about, Bruce. But I guess, Pat, we'll have to see, okay?

Patrick Nolan - Deutsche Bank AG

And just one housekeeping. On the Power Solutions business, was there any notable lead impact on the revenue change year-over-year in the first quarter?

R. McDonald

A little bit, but nothing really significant.

Operator

Our next question comes from Colin Langan of UBS.

Colin Langan - UBS Investment Bank

Can you comment on the sequential performance in Building Efficiency on the sell side? It actually was quite good relative to the normal seasonal performance. Is there any business from Q4 pushed into this quarter or is it just this far backlog?

R. McDonald

No, it's not, Colin. There's nothing like you referred to. I think the issue, and I think maybe Steve touched on earlier, is just the GWS growth was particularly strong. I think if you probably stripped out that 20% -- I think we said GWS was up 21%. If you strip that out, probably not as stark as your comment.

Colin Langan - UBS Investment Bank

And just following up on Power Solutions. You had a 14% margin this quarter and the guidance is for a bit lower for the full year. I mean, is that just normal seasonality? Or is that some of the costs of the new capacity being added?

R. McDonald

It's normal seasonality. Our Q1 volumes, because we're building up. Our manufacturing's running sort of flat out trying to build up stock here, it's our best quarter, usually.

Colin Langan - UBS Investment Bank

You talked a lot about the opportunity in China for Power Solutions. I mean, what is the size of that revenue today? And is that all consolidated, or is that all through joint ventures?

R. McDonald

Yes, China is -- in Power Solutions, our China business is 100% consolidated, 100% owned, so it's fully consolidated. And roughly speaking, it's about $400 million today.

Stephen Roell

How many units, Bruce?

R. McDonald

6 million, 6.5 million, something like that.

Stephen Roell

So when we talk about the fact that our second plant's going to have 8 million and the one in the West is going to have 6 million, that'll give you -- that's all new capacity, give you an idea of the growth.

Operator

Our next question and our final question comes from Brett Hoselton of KeyBanc.

Brett Hoselton - KeyBanc Capital Markets Inc.

I wanted to ask you about your European margins. I was just kind of going through my prior notes, and I think you've been very consistent in the expectation that improved volumes and lower costs are going to -- like launch costs and so forth, are going to allow you to improve your margins. And again, in the past, I think you've said that you'd like to get back up to that 6% to 7% range in Europe. So it sounds like what you're suggesting here is your costs are expected to tail off towards the end of this year. And so that sounds like it's going to be largely eliminated in 2012. And then I'm looking at projections for production kind of ramping up to that $20 million to $21 million range by 2012, 2013 timeframe. Which all seems to imply that your European margins should reach that 6% to 7% goal possibly in that 2012, 2013 timeframe. Am I thinking about that correctly?

Stephen Roell

I think you're being a little aggressive on the time frame, Brett. I'm not suggesting that -- I don't we believe our forecast -- that we'll see Europe return to that level by that timeframe. It will be later than that. We probably have those kind of projections out in the 2015 timeframe. And that will be a more realistic goal, I think, at that point.

R. McDonald

Okay, I think we're going to have to wrap up from a timing standpoint. Again, thank you all for attending and your interest. It was a good quarter for us. I think in terms of the momentum we have in our business, we're confident about the remainder of the year. And I look forward to talking to you, either in person or on the conference call next quarter. Thank you very much.

Operator

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

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