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Johnson Controls (NYSE:JCI)

Q2 2011 Earnings Call

April 25, 2011 11:00 am ET

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

Michael Cox - Piper Jaffray Companies

David Leiker - Robert W. Baird & Co. Incorporated

Colin Rusch - ThinkEquity LLC

H. Nesvold - Jefferies & Company, Inc.

Brian Johnson - Barclays Capital

John Murphy - BofA Merrill Lynch

Brett Hoselton - KeyBanc Capital Markets Inc.

Ravi Shanker - Morgan Stanley

Himanshu Patel - JP Morgan Chase & Co

Timothy Denoyer - Wolfe Trahan & Co.

Operator

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

Glen Ponczak

Good morning, everybody, and thank you for joining us. Before we begin, I'd just like to remind you of our forward-looking statements. The Johnson Controls will make forward-looking statements in this call and in the documents that you received this morning 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 are or that 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, customer or supplier disruptions, energy and commodity prices, the strength of the U.S. or other economies, currency exchange rates, cancellation of or changes to commercial contracts, as well as other factors discussed in Item 1A of Part 1 of the company's most recent Form 10-K, could affect the company's actual results and 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, our Chairman and Chief Executive Officer, who will give an overview of the quarter. Bruce McDonald, Executive Vice President and Chief Financial Officer will come afterwards to give you more in-depth look at our business results and an overall financial review. And we'll conclude the call with questions and answers ending sometime around noon Eastern Time.

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

Stephen Roell

Okay, thanks, Glen. Good morning. Well, actually on the call this morning, I'd like to start by first discussing our financial results for the first half of our fiscal year and the progress that we're making on various growth initiatives. And then I think we'll turn our attention to the second quarter performance, and both Bruce and I will have some comments on that. And then finally, we'll talk about the outlook for the remainder of the fiscal year, including what we know about global automotive production schedules and their impact on our results.

So first of all, focusing on the first half. Clearly, all 3 businesses have performed very well. Automotive Experience sales are up 19% with segment income up 37%. Again, I'll tell you about the first half, the first 6 months. Our Power Solutions sales, 20% higher than the prior year. The segment income up 25%. And finally, Building Efficiency had a great first half with sales increasing 15% and income up 30%. Those numbers are on plan and slightly ahead of the guidance that we've provided you coming into 2011. Our business diversification and global presence remains a key strength of our company, and I know I continue to talk about that. As you can imagine, given some of the events in the automotive industry, clearly having the Power Solutions and Building Efficiency segments are going to be important to us.

Turning to the first half results, specifically for Automotive, a couple of highlights I wanted to make. Typically we talk about our backlog, our 3-year backlog, when we meet with you in October. But I thought I'd at least give you some idea that in the first 6 months, we've booked roughly $800 million of new business. That's net new business. It's a good mix of seating, interior systems and electronics. It's more geographically distributed than in the past 2 years and really represents, again, the major market share gains that we're getting across the globe.

If you recall back at the Analyst Meeting back last fall, we talked about the importance of strengthening our component capabilities. Well, in the past 6 months, we've announced the acquisitions of Michel Thierry, Hammerstein and Keiper Recaro, with a total acquisition value of approximately $1.2 billion. Each of those businesses had strong backlogs and we project that by 2014, they'll add roughly $3 billion to our sales and generate $0.50 per share to our earnings in that timeframe -- at that time. When we complete the acquisitions, our market share of our global seating, metals and mechanisms will be about 27%. And as our press release indicated, we expect to close in the Keiper Recaro transaction in the June, July timeframe. Previously, we thought we could be closing that in May. It's been delayed due to -- just the regulatory review, nothing unusual.

Shifting to Building. A strong first half of new awards has resulted in a record backlog, the first time that we've enjoyed a backlog in excess of $5 billion. And if you recall, we talked about the fact that we would expect to see recovery in emerging markets, particularly in the Middle East and Asia, as we look at the next 4 years. Emerging market orders are up over 30% in the first half with a strong pipeline of new orders still in each of those regions.

In terms of our future growth in 2012 and beyond, we continue to invest in our sales force, our front-liners, product offerings, as well as information technology and infrastructure. We'll talk more about that when we get into some of the -- I'm sure the questions from the analyst. We recently announced the acquisition of EnergyConnect, which will close in Q4 of the fiscal year. It pertains to demand response. Many of you may not know that term. It basically is where it allows commercial building owners to take advantage of variable pricing programs offered by utilities. It's a rapidly growing market we believe our field organizations can take advantage of to help our customers lower their costs.

Turn to Power Solutions. We continue to highlight 3 areas of strategic investment. The first is Start-Stop vehicles with our AGM batteries. If we look at just what's happened since the July timeframe of last year, we've committed to roughly $420 million in capital investments. The most recent was an investment in North America. We took that and received the approval from our board in March. And right now, we're reassessing the investments that we're going to need for the China market. And again, this is just the beginning of those investments because as you can imagine, we still are not really putting in place capacity for the aftermarkets in any of those markets. Because of the complexity of those batteries and technology from a process and the capital intensity, we're projecting that revenues are going to increase by roughly 2x out of the SLI volume that they're displacing, and earnings will be roughly 3x out of the SLI equivalent.

The second category that we talked about within Power Solutions is vertical integration. We've launched production in our Mexican lead recycling facility, and that facility is near its capacity right now. We started construction in South Carolina, the lead recycling plant there, and expect that to be completed by mid-2012. When both those facilities are completed, just to remind you, it represents about 150 to 250 basis point margin expansion. And so we believe that's what the run rate will be by mid-2012, and we'll have roughly 50% of our recycling needs will be met by our internal operations.

And then finally is the rapidly growing demand in China, our investments there. We have launched production at our second plant. We began that production in December. It'll ramp up through the summer months. It can be fully operational by -- in the July timeframe. We commenced construction of our third China plant very recently, and we continue to estimate that over the next 4 years, we'll invest roughly $450 million in investments related to China expansion, which will lead to roughly 3 million units.

Just to focus real quickly on the second quarter. Bruce will go through this in much more detail, but our sales were $10.1 billion. There's a 22% increase over the same quarter a year ago. It's the first time I believe that we've actually exceeded $10 billion in a quarter. Our segment income of $557 million compared to $427 million a year ago, up 30%. That yielded net income of $383 million, up again 31% over the prior year, and our EPS was $0.56 per diluted share versus $0.43 per share in Q2 of '10. Maybe just 1 comment I would like to make. There were several newswires incorrectly commented on commodities being a factor in the quarter. I just want to highlight that we do not believe that commodities were a factor in the quarter. We believe our pricing actions and our supply contracts allowed us to recover that. And so you'll find nowhere do we highlight or do we attribute commodity increases to any of our margins. That got out in an early newswire. And for some reason, it's found itself in the 2 or 3 other ones. It's just not the case. We want to clarify that and make sure it's not coming from Johnson Controls.

In terms of the second half of fiscal 2011, we're expecting strong performance from Power Solutions and Building Efficiency. We've got good visibility, given their backlogs and the momentum in those 2 businesses. And as you'll note, we increased our full year guidance for Building Efficiency with revenues up 15% now versus the previous guidance of 8% to 10%. Automotive Experience, we have the uncertainty surrounding the extent of the production interruptions in the upcoming quarter and that recovery. We'll talk more about that later in our comments. Bruce is going to -- got a couple of slides, so he'll address that.

Our capital investments, we continue to make investments for the future. Our capital expenditures are now projected at $1.4 billion. That's consistent with what we guided to last quarter. And as I mentioned earlier, we do continue to make SG&A investments in our sales force, in our service providers, advertising, innovation. That will continue, and that's where some of the margin pressure that you're seeing is coming from. It's just the fact we need to make those investments to keep our growth targets in 2012 and '13.

So with that, Bruce, I'll turn it over to you for more discussion on the quarter.

R. McDonald

Okay, thanks, Steve. And so let me just start out with Automotive Experience, which had another very solid quarter and those results were actually much higher in all geographic areas. So just looking at the top line, you can see sales here up 25%. And currency really wasn't a factor in any of 3 businesses. So on a constant currency basis, sales were up 25% as well. 1 of the ways we look at sales is, to put it in perspective is look at how we perform on a geographic basis versus the underlying production build schedules and here is really good results in the quarter. So in North America, our sales were up 22% versus a production increase of 16%. In Europe, our sales were up 26% versus the 2% increase in production levels there. And in Asia, which for us is primarily Japan and Korea, sales improved by 37%, where they're reflecting a lot of new vehicle launches, particularly in Japan. In China, which as you know, is primarily a nonconsolidated joint ventures for us, we had a very good quarter again. You can see here sales up 31% to just under $1 billion, and that would probably compare to a passenger cars sales increase in the quarter, about 13%. So real solid performance, all geographic regions and very strong results in light of the build schedules that we saw on a global basis.

In terms of segment income for the quarter and these exclude the acquisition-related costs, and I'll talk to those later of about $0.05 a share. But excluding those, segment income in Auto up about 31%, $247 million versus $189 million a year ago. And as we've talked about in previous quarters, we are investing in innovation and growing our backlog, as Steve commented on earlier. Just to put things in perspective, higher engineering costs, which are primarily European-based right now were about $25 million increase year-over-year.

In terms of our geographic margins, you can see overall our margins improved by about 20 basis points to 4.7% in AE [Automotive Experience]. If you look at it geographically, good movement here. North America margins at 7.2% were up about 50 basis points versus last year. In Asia, 8.5% compares to 6.7% in the prior year. And in Europe, we were 2% in the quarter, down from 2.4% last year, but obviously a significant improvement versus the break-even type levels that we saw in Q1.

In Europe, some of the margin degradation continues to be some of our operational difficulties that we're having there, containment costs, some of the supply base issues that we've talked about before. Those costs, while still significant, are starting to trend lower, and we have -- we think some of the production slowdown that we expect in Europe is going to give some of our launch teams some relief, so we think -- we're fairly confident in terms of those costs continuing to trend lower in the third and fourth quarter here.

In Asia, our margins were -- obviously we talked a little bit about the Japan impact earlier. For the quarter, revenue wasn't that significant, about $0.02 per share. Really, the only impact that we saw in the quarter was our Asian results lower volumes because the situation in Japan was virtually an elimination of production from March 11 onward. Anyway, the impact about $0.02 a share and that's going to escalate, and I'll talk more about Japan in later slides.

Let's flip it over to Building Efficiency. Here we saw sales up 18%. On a constant currency basis, it would have been 16%. We saw revenue strength in all segments. North America was up 7%. As we've noted here, Europe was up 7%. GWS, our Global WorkPlace Solutions business, up 27% and Asia up 31%. We don't talk about it here on the slides in terms of residential but just to give a little bit of clarity there, that business has continued to perform very well for us. In the quarter, our residential business was up 20%.

If you look at our order activities we talk about it over on the right-hand side of the slide, up 21% in the quarter. If -- pretty, a real mixed bag in terms of results, but good momentum in all geographic sectors. So the Middle East, up 125%; Latin America, up 44%; Asia, 27%; North America, 13%; and you'll see that Europe, we saw a slight decline 2% in our orders. Let's really spend a minute on North American orders, where our business is being favorably impacted by our exposure to the institutional sector and the investments that we're making in our energy solutions business. Those are particularly strong sectors for us and really letting us outperform the market. If you sort of deep dive into the institutional market side, the strength really in the quarter was in state and local government, education and healthcare. That's where the real benefit came. So great performance in our North American business plus 13% versus some of the new construction numbers that are much, much lower.

In terms of segment income for the quarter, $132 million. It was up 27% versus last year. Strong growth in all geographic regions and across most of our product lines really driven by the higher volumes. On a year-over-year basis, our margins improved by 30 basis points to 3.8% despite some of the investments that Steve talked about that we're making in sales force, product development, emerging market, infrastructure and things like that. And then on the residential side, that business was up about 15% in the quarter.

If you look at the backlog, you'll see that at the end of the quarter we had record backlog, first time over $5 billion, at $5.1 billion in the quarter, so that was up 18%. This really represents good sequential movement on a quarter-over-quarter basis, and it's the third consecutive quarter we've had double-digit growth in our backlog. So I think clearly the momentum in Building Efficiency is picking up.

Turning to Power Solutions. We had another very strong quarter. You can see sales up 19%. If you look at the unit volumes are up about 18%, and aftermarket was up 18%, and that obviously shows we're starting to see the benefit of the full year impact of the Wal-Mart business that we won last year. We'll have 1 more quarter of sort of year-over-year growth in Wal-Mart. But we get into our fourth quarter, the impact becomes much, much lower on a year-over-year basis. In terms of the OE sector, you can see up about 16%, really reflecting higher production levels, but also market share gains that we've made on a global basis. If you look at Asia in the quarter, our volumes were up about 163%, and that really reflects the growth in China, but also the acquisition of a Korean joint venture that we did -- we completed a couple of quarters ago. As Steve indicated before, the second manufacturing facility in China did start production in this quarter. It's a slow ramp up, but we do expect that operation to be operating up to its full capacity on a run-rate basis by the end of 2011. That's an 8 million unit facility. And in the quarter, Steve indicated as well, the third manufacturing facility we've broken ground there.

Our investments in the key growth initiatives are on track. The second smelter positively impacted our margins. We had a little bit of a headwind overcoming some of the start-up costs of our new manufacturing facility in China. But overall, everything's going as expected. Our AGM investments are playing out like we thought. And as we noted here on the -- earlier in the presentation, we are announcing today plans to invest in our first AGM facility here in North America. That will actually be a conversion of an existing facility and it'll provide us about 6.8 million units of capacity here. And as we talked about in our press release, over half of that volume has already been committed to by our OE customers. So we feel good about our ability to fill that facility up between now and the end of the year. And as Steve talked to earlier, we expect to sort of finalize our Chinese strategy from a manufacturing perspective here before the end of the year.

So overall, we feel good about the income here up 33%, higher volumes, richer product mix, margin expansion through vertical integration in the smelters, all played out just as we expected and delivered 130 basis points of margin expansion in the quarter.

So now, flip to Slide 14. We'll go through some of the financials. And as I talk to the numbers, I'm going to talk about the adjusted results. The adjustments that we're making here, first to back out the acquisition-related costs, we talked about -- we don't have a firm handle on what those were, so those were excluded from our guidance last quarter, that was about $0.05. And in the prior year, we had a clean quarter with the exception of a $0.03 nonrecurring tax charge associated with the elimination of Medicare Part D subsidies. But if we look at our overall revenues, up 22% to $10.1 billion. The increase, as we've talked about, was broadly based and really driven by higher volumes in each of the 3 businesses and improving automotive production build in Europe, North America and Asia.

If you look at our gross profit, you can see we're down about 20 basis points to 14.5%. This really reflects some of the investments that Steve talked about, a little bit of a more adverse product mix here in the quarter. This is not something that we expect to continue. Our expectations for the second half of the year will begin -- we will show margin expansion like we did in the first quarter here.

If you look at SG&A, we're pleased to see that we have some good leverage on the top line growth. So SG&A if you look at it as a percentage of sales decreased by about 60 basis points to 9.6% from 10.2% last year, and that's obviously inclusive of a lot of the investments we're making in innovation, emerging market, infrastructure and some of the long-term growth initiatives that Steve talked about in BE.

You can see equity income up about 20%, $61 million. Here's where you see is really the benefit of the improving top line performance in our Chinese automotive joint ventures. And then from an overall segment point of view, where you'll see our margins up about 40 basis points to 5.5% versus 5.1% a year ago.

Flipping the page to Slide 15, financing charges of $46 million, up 3% versus prior year levels. And as we indicated in the last quarterly call, our expected net financing costs are somewhere in the $45 million to $50 million range. That sort of reflects the debt issuance that we did in this quarter and factors in the higher borrowing levels associated with the 2 major acquisitions that we have closing here between now and the balance of the year. So $45 million to $50 million is sort of the run rate on a go-forward basis here.

On the tax line, a clean quarter. The rate was 19% consistent with our guidance and last year, on a cleaned-up basis for the Medicare issue was 18%, so slight uptick in tax just like we got it to at the beginning of the year. If you look at income attributable to noncontrolling interests or formerly minority interest, there you can see a higher charge, and that really reflects just the improved profitability of our consolidated joint ventures in Automotive and Power Solutions. And then lastly, diluted earnings per share up 30% to $0.56 in the quarter.

So turning to Slide 16, I'm just going to spend just a minute on Japan and talk you through what we know and what we're seeing. And first of all, before I get into the impact to the company, clearly, our thoughts and sympathies go with the Japanese people who've lost so many of their family members and friends and loved ones. For us, in terms of looking at our employees, we're very pleased to be able to report that all of our employees and their family members have been accounted for, and we'd really like to -- Steve and I would really like to thank our teams in Japan for their support and beginning to support the recovery process, the long recovery process, particularly in the northern part of the country. Just by way of background in terms of Johnson Controls, 1 of our strengths has been our long-standing relationships with the Japanese and the Japanese OEMs in North America and Europe. If you look at our overall exposure to Japan, our sales for 2011 prior to the tsunami and earthquake here was revenues of about $900 billion...

Stephen Roell

Million.

R. McDonald

Sorry, $900 million, and our exposure to Japanese transplants in North America, Europe and some of the emerging markets is about $4 billion, including our exposure through some nonconsolidated joint ventures. So pretty heavy impact to the Japanese customer base.

From a sort of where we -- what we're hearing from our customers, I caution you that the situation remains very dynamic. But here's sort of the latest of what we know based on discussions with our customers and the production release information that we have. So in Japan, in particular, we expect production will be down 50% in the third quarter to just a shade over 1 million units. And in North America -- and then the expectation here is that some of the supply issues in the electronics chains will improve and will get back to sort of pre-crisis levels here in the fourth quarter. In North America and in Europe, we are seeing production interruptions at all of our Japanese OE customers. So where we're seeing the biggest hit is on Japanese customers in these regions. We are seeing some small sporadic-type cuts in some North America and European customers but I would tell you that generally speaking, we have less visibility with the North American, European customer base.

Just to put sort of the magnitude of some of these cuts in perspective, we have about 250 just-in-time delivery facilities in our automotive chain on a global basis, about 50 of them we anticipate will be impacted in the third quarter. Obviously, as many of you know, the critical issue is in the electronics supply chain where the Japanese suppliers produce a substantial portion of silicon wafers, chemicals used in lithographic plates and some of the resins used to manufacture PC boards. The impact it's going to have on us, Johnson Controls, is it really impacts our ability to supply -- obtain microcontrollers, and these are what we would use in our seat controls, clusters and displays, body controller modules, telematics products and some of our specialty products like HomeLink and Compasses.

So if you get to the financial ramifications on Slide 17, here is what it sort of looks like to us. In the second quarter, as we've talked about earlier, relatively minor impact of a couple of cents a share. But as we get into the third quarter here, you'll see the impact is about $0.16 to $0.18, and the current expectation is that, and I'll say current expectation and it's not clear, is that we expect sort of to get back to kind of a neutral level for the company. A lot of -- and then you look at when the volume as we bleed down some of the dealer inventory is going to be picked up. For us, that falls into our fiscal 2012 year. So our expectation is that pretty much most of the loss/profitability that we see here will be picked up in the first half of 2012.

So if you just sort of factor the impact of the Japan situation into our guidance, here's kind of our latest look. So we're increasing our full year revenue guidance by $1 billion to $39.5 billion. That will be a record for us, abut 15% versus last year. The main drivers here are the increase in the outlook for Building Efficiency, where we're taking our top line growth up 15%. Previously, we're at 8% to 10%. Slightly stronger euro, we're using the $1.40 here. Our previous guidance is $1.35, and that's going to obviously be offset by a slight delay in the timing of the Keiper Recaro acquisition. That's going to cost us a couple of hundred million and the $500 million impact is sort of the revenue side of the Japan situation.

In terms of our earnings per share outlook, we have a reduction here of down $2.40 to $2.45, and that obviously is inclusive of $0.18 to $0.20 of Japan. So were it not for the Japan, we would have been talking today about upping our guidance to $2.58 to $2.65, but we're factoring that in. We're going to see the benefit of that flow through in the first half of 2012. And I'd just remind people that our guidance still excludes the acquisition and integration-related costs for both Hammerstein and Keiper Recaro. Steve said we're not sure if Keiper's going to close at the back half of Q3 or early Q4. And we obviously have a range for that number, but we don't know what the final number is going to be.

So just sort of wrapping things up, I think for me the key financial highlights for us, the key takeaways would be double-digit top line growth in all 3 of our businesses, accelerating momentum in Building Efficiency where we saw 21% growth in orders and 18% growth in our overall revenues. And I'd put that against the backdrop of what is still in the very early stages of a recovery in the mature markets here, increasing our lever in investment, both organic and M&A. And so we talked about some of the acquisitions and then the expansion and some of the Power Solutions investments. Strong balance sheet, still very conservatively capitalized with the capacity to increase investments to deliver shareholder value. And obviously the Japan impact, while being quite a weight for us to carry around for the next quarter or 2, that we expect to be fully offset in 2012. And then lastly just a note, we do plan on hosting an Analyst Day here at the end of June, June 27 here in Milwaukee. That's really going to be a Power Solutions deep-dive. We're going to spend more time on the new technologies and just give the investment community more insight into some of the investments that we're making in that business.

So with that...

Glen Ponczak

Yes. Cathy, we're ready to take some questions. Just before we begin the Q&A, we tend to get a lot of folks on the queue to ask a question here. So if I could ask you please to ask your best question, and if you've got a second question, hang up, get back in the queue so that we can give the most -- a lot of people a chance to ask theirs?

Stephen Roell

Glen, if I can just make 1 more comment. We were very particular, trying to make sure that with our fiscal year, a lot of the industry, automotive industry companies, are not fiscal year ended September there. They're calendar years and they're talking about recovery within the calendar year. Please those of you that -- I'm sure the majority of you on the line know our fiscal year. So the recovery of Japan falls into our fiscal year. When we talk about 2012 first half, we're talking about starting in October.

Glen Ponczak

Right.

Stephen Roell

Just to clarify that, okay?

Glen Ponczak

Okay. Go ahead, Cathy?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Colin Rusch from ThinkEquity.

Colin Rusch - ThinkEquity LLC

On the AGM batteries, can you talk about when the replacement cycle will start to play out and if you're looking at any competitive technologies that may be a real threat to you in either North America or Europe?

Stephen Roell

Well, let me start. I think if you think about the fact we're just beginning to populate the OE production schedules right now, Colin, I think you could probably project 3 years out would be the replacement cycle to start. So it could be as quickly as 2014, '15 that we're going to have capacity in place for the replacement market.

R. McDonald

Keep in mind, maybe 1 other data point there, Colin. It's Bruce here, is we have been making AGM products for quite some time. The optimal product and flat plate products for Daimler in Europe for 8 or 10 years now. So we do know how long the AGM products tend to last. The replacements are very consistent with SLI in terms of the life and durability. We think, based on initial testing, that the demands that Start-Stop will put on the battery will make it consistent with the existing lead acid. So it's going to ramp up, but 3 to 4 years will be typical, we think.

Stephen Roell

And then I guess the second part of your question, Colin, had to do with is there other competitive technologies that are coming in? We don't see anything right now. The EFB [enhanced flooded batteries], that flooded battery was initially thought to be something that could compete, but I think as we see more and more application applied to AGM or Start-Stop, I think it's clear that, that the current technology we have is going to win out over that.

Colin Rusch - ThinkEquity LLC

Great, thanks a lot guys.

Stephen Roell

Thanks, Colin.

Operator

Our next question comes from Brian Johnson of Barclays Capital.

Brian Johnson - Barclays Capital

Just wanted to go into some of the dynamics around both the margin and just the op income within Building Efficiency and perhaps how the SG&A is playing into that. Could you just remind us, I know the Q will -- maybe given some more details about how the Building, the GWS growth might have driven the margin? And then secondly, should we get some -- should we remain comfortable that as the product side of the Building Efficiency grows that you actually will see increased operating income in the product-related segments growing faster than sales?

Stephen Roell

Yes, let me try it a little bit and Bruce you jump in. Let me -- GWS was a factor in the quarter in terms of just the mix.

R. McDonald

It was about 40% of the growth in the...

Stephen Roell

It was that. And so there was a little bit more of the impact of the cost fall-throughs or flow-throughs. But Brian, I just want to talk a little bit about -- I referred to the G&A investments. Let me just give you a little color behind those. If you look at our -- just our Solutions business, in the past 12 months, we've increased our sales force from a little over 900 in the U.S. to a little over 1,200. And then we've added roughly another 100 people in Asia and Europe as we began to put that capability in place. So if you were to just take those 400 people times pick an average salary range between probably closer to $125,000 of all support costs, now there's $50 million of annual run rate right there that doesn't flow -- it's going to show up in our secured volume and next year even more so. So there's an example of where we're investing where we believe we think we can make some great strides in growth in both lighting and solutions. That's weeding down the margins. The other areas would be information technology. We're going to be investing as a corporation probably close to $1 billion in IT over the next 5 years. Now that's not all BE obviously, but also that has affected that. Over the latter part of that timeframe, we'll get a tremendous payback from that, but it's not part of the investment that we're making right now. We just have the cost spread over 5 years. In terms of the products side, Brian, really it's not really products. It's really, I guess more of the contract side, but where we get our higher margins and through service and through our contract work. And clearly, that's where our backlog is. So as the backlog continues to grow and that momentum you see in terms of the $5.1 billion, that will help our margins. Okay? Bruce, anything else you want to add to that?

R. McDonald

No, I think you covered most of the points.

Stephen Roell

Okay. Brian, does that -- anything else on the follow-up on that?

Brian Johnson - Barclays Capital

Well, on the product equipment side itself, you noticed that the chiller shipments increasing. Is that accretive to margins?

R. McDonald

Yes, that helps, Brian. Just to sort of put that into perspective, if we look in the quarter, our chiller shipments were up 21% on a global basis. If you look at our chiller orders though, they're up -- we have a big backlog growing here. So, I mean, just to give you an example, see North America, our chiller orders were up 33%; Asia was 40%; Middle East over 100%; Latin America 40%. So we -- a lot of demand on the equipment side that will help us, because that's when we do get economies of scale through better manufacturing utilization. But I mean in the quarter we had BE. Sort of looking at our underlying margins, it actually came in line with our plan. We're up 30 basis points. Our guidance for the year is 60% to 70%. So I mean we feel good about the guidance that we're out there with 60% to 70%. I just saw some notes out there this morning where people had margins up 100, 150 basis points on a quarter-over-quarter basis. It's just not indicative of the guidance that we've given, which is inclusive of the investments that we're making to grow the business. And I just think you've got to step back and say, we got a $15 billion business in the quarter. We're growing at 18% on the top line and the profitability is growing at 27%. So I think we need to put that in perspective that that's pretty good business.

Stephen Roell

Yes, that's good point, Bruce. And yes, I apologize, Brian, you're right. I just want to go back on the products cycle. I have a tendency to think about controls products as opposed to the large chillers. And clearly, the growth in the Middle East and China, a lot of -- a good portion of that is in fact the large equipment and that will help us.

Brian Johnson - Barclays Capital

Right. And you mentioned servicing contract is in the backlog. Is that in the capital B backlog that you just disclosed, which I thought was mainly products and equipment sales?

Stephen Roell

No, the backlog is largely contract work. Very little service, I should mention that, but it is on a contract...

R. McDonald

Retrofit.

Stephen Roell

Retrofit, yes.

Brian Johnson - Barclays Capital

Retrofit. So that would include product-related sales?

Stephen Roell

Yes, right.

R. McDonald

Yes.

Brian Johnson - Barclays Capital

Okay, thanks.

Stephen Roell

Thanks, Brian.

Operator

Our next question comes from Himanshu Patel from JPMC.

Himanshu Patel - JP Morgan Chase & Co

Just 2 questions. When you guys look at the forecast from CSM, it looks like they've sort of taken 400,000 units of production out of North America and Europe each in the kind of calendar Q2 and put it in the calendar Q4. I'm just curious as you talk to the OEMs, is that consistent with what you're hearing from them at this stage?

R. McDonald

I think the Q -- I think, we have a lot better visibility in Q3, so maybe I'll just limit my discussions on that because I think it will be the same thing for Q4. I think we have very -- the Japanese customers are being very forthright, letting us know kind of in advance what their plans are and I'm sure you've seen in the press what some of their plans are. I would tell you on some of our other customers, and I don't want to name any in particular, we still get things like over the weekend, the revised schedule take a day out of the next week or something like that. So I think, and I don't want to be critical because I think they are grappling to try and figure out what the impact is and I'd say, as time goes on, Himanshu, it's getting worse. And so I guess I wouldn't be surprised if a month from now, people have a lot more visibility on when some of these components are going to run out and whether there are allocations that sort of we've been told some of us are on allocation with some critical components in Japan, whether they stick. I think the fourth quarter outlook is very heavily dependent on some of these facilities coming back online. And so I guess that's probably the biggest bet that you would need to make about Q4.

Himanshu Patel - JP Morgan Chase & Co

And then, Steve, just a follow-up on your point on the kind of SG&A and sales force investment in Building Efficiency, I appreciate the color on headcount there. Can you give us some context on just when the rate of growth on this investment starts tapering off? Just so we sort of get a sense of when operating leverage in the Building Efficiency business sort of start accelerating from where we are here.

Stephen Roell

Yes, I think maybe the way to think about it, Himanshu, is as we -- we may continue the rate of growth in SG&A, not the rate of growth but the magnitude, but it will get weighted down by the growth of the business and the benefits from the investments we are making, okay? That's how I guess I would describe it. We'll have to give you, Himanshu, the best way we can provide that to you is through our guidance and margins. And so I would expect -- we'll see margin improvement forecast when we sit down in October and give you that guidance. We'll try to give you some color maybe for a couple of years in that business at that time.

R. McDonald

I think, Himanshu, if you go back to the guidance that we gave at our Analyst Meeting in October when we talked about Building Efficiency, it's not going to snap back in the next year or 2. So we've talked about our intermediate guidance in terms of margin expansion being in the -- I think the range is like 40 to 60 basis points. That's kind of the number that we're thinking about here in at least for I'll say '12 and '13.

Stephen Roell

And these investments, just the ones I've mentioned here, probably worth 60 to 75 basis points this year. So it'll -- we'll begin to weight it down as a percentage of the margin improvements, but we're looking for benefits from those as well. So I'm not answering your question, Himanshu, I realize. But I guess I would tell you, you should expect to see our margin guidance pick up. We still have that mid-range target of trying to get to the 10% ROS x GWS, and so we're trying to figure out how to gap from where we are today to that as quickly as we can.

Himanshu Patel - JP Morgan Chase & Co

Thank you.

Operator

Our next question comes from Ravi Shanker from Morgan Stanley.

Ravi Shanker - Morgan Stanley

So just on the European auto margins, it was good to see that bounce back a little bit this quarter. Just want a sense of where you think we are now in terms of those costs and when do we get back to those, the near-term 3% level that you were talking about and maybe the longer-term 4% to 5% margin levels. Is that something that gets derailed because of the Japan situation? Or is that something that happens in...

R. McDonald

Yes, I guess I would start off by answering if you back out the impact of Japan, then I think what we would have said is we probably have 50 to 60 basis points of margin expansion per quarter here for the next couple of quarters. What I don't have, Ravi, and we can maybe follow up with Glen is, I don't have the sort of Japan hit quantified between Asia, North America and Europe how we cut out segment. I'd have to sort of come back and cut the revenue and the earnings to give you a provision. But all things being equal, we would have thought we'd have seen our margins going to say 2.5%, 2.6% in Q3, in the low 3s in Q4, and that obviously would have compared pretty favorably about last year where we were at 2.4% in Q3 and then we are sort of -- a small loss in Q4.

Stephen Roell

I think 1 of the things that's weighting us down right now, Ravi, is we've got a lot of containment costs. I've talked to the people that I've met with on the road and those are going away. We've got -- we're incurring right now some exorbitant freight and containment costs just insuring supply. We overwhelmed our metal capabilities in Europe, and we can see that beginning to improve. We put a lot of investment in the quality side in our organization. That was the capacity building I mentioned last quarter, and I feel good about the progress we're making. So I think, as Bruce mentioned, we'll start to see step-up quarter-by-quarter. And I think a year from now, you'll see us improving in our European operations.

Ravi Shanker - Morgan Stanley

Just another quick 1. How much of the $800 million incremental backlog in auto comes from the new acquisitions?

R. McDonald

None.

Ravi Shanker - Morgan Stanley

Thank you.

Operator

Our next question comes from Tim Denoyer from Wolfe Trahan.

Timothy Denoyer - Wolfe Trahan & Co.

Can you comment on some of the longer-term implications of Japan and maybe higher fuel prices as well in terms of -- are you seeing any change to just-in-time production philosophy? And are you seeing higher safety stocks or potentially some more domestic production in North America?

Stephen Roell

Tim, no, not yet. I think it's too soon to see that. I think what I would expect to see is just that we have -- if I'm an OE, I guess I'd want to make sure I understand the Tier 1 and the Tier 2 or 3 programs relative to just continuity of supply. I think that's what I would expect, but I don't think it'll change the JIT [just-in-time] philosophy, okay?

Timothy Denoyer - Wolfe Trahan & Co.

Okay. And in terms of -- you mentioned, you talked about raw materials earlier in the call, that it was not an impact. Are you expecting any impact in your guidance going into the second half?

Stephen Roell

No, we've done some revisions. We know there's some pressure, but it's no different than what we described when we came into the year. I'm looking at side-by-side comparisons of what we thought the world would look like back in October for steel, chemicals, resins and others. It's really virtually unchanged.

Timothy Denoyer - Wolfe Trahan & Co.

Great, thanks very much.

R. McDonald

Thanks, Tim.

Operator

Brett Hoselton from KeyBanc.

Brett Hoselton - KeyBanc Capital Markets Inc.

You didn't specifically provide us with segment margin guidance for the full year 2011. I'm wondering if you could either maybe give us some specifics or maybe some directional thoughts as to where Building Efficiency, Power Solutions and Automotive Experience margins might be versus your prior guidance?

R. McDonald

Yes, I'll take that 1, Brett. What we talked about on our last call was for Power Solutions margins. We talked about them in that 13.6% to 13.8% range, and that's unchanged. In BE, we talked about margins being 5.7% to 5.9%, which was up about 70 basis points midpoint. That's unchanged. And so the impact for us is really going to come out of the auto space where we were talking about margins being that 4.5% to 4.7%. So if you sort of just do the math, you end up taking about -- I'd have to get back, I can't do the math on my head. But it all comes out of auto, sales and the earnings all come out of auto. We don't think that the impact for Power Solutions is significant. We don't supply Toyota and our exposure in the battery side to the Japanese customers is not as significant as it is in the OE side on the Automotive Experience side. So -- and then Building Efficiency, again, very little. There'll be some impact in terms of -- our business there is primarily service based, about $400 million in Japan and overall, maybe a little bit of disruption in the short term but again, nothing significant.

Stephen Roell

The only thing I would add to Bruce's comments were on the Automotive side, where we're getting hit in electronics is a little bit higher contribution margin than our other business, okay?

Brett Hoselton - KeyBanc Capital Markets Inc.

Okay. Thank you. On the Building Efficiency side, obviously a significant increase in sales guidance. Normally, you'd see a little leverage there, I would think. Is it primarily the disruption in Japan that's maybe offsetting some of that leverage? Or is it a mix shift? Or why would you not raise your margin expectations on that side of your business?

R. McDonald

Well, I would say if you look in BE, what we've done is we have -- we are seeing higher on -- if you look at the balance this year, we are seeing a higher outlook in copper. Copper is higher than we originally forecast. We've passed long pricing increases that go. We did 1 price increase in the fall with another 1 that kicks in here in April 1. So some of the -- obviously, if we price our way out of it, it kind of inflates our costs and that inflates our revenue, it doesn't help the bottom line. The other thing, Brett, is the GWS growth has been stronger than we anticipated, just sort of extra -- some new business coming on quicker than we thought and share of wallet gains out of our existing customers. And so with that business being lower margin and the overall total, it can kind of offset some of the benefits you're referring to.

Brett Hoselton - KeyBanc Capital Markets Inc.

Thank you, Bruce. Thank you, Steve.

Stephen Roell

Thanks, Brett.

Operator

The next question comes from Peter Nesvold from Jefferies.

H. Nesvold - Jefferies & Company, Inc.

So you quantified the impact of fiscal third quarter from the production cuts as roughly $0.16 to $0.18. 1 thing that was not clear to me is all of that revenue, that potential impact from revenue and so there's no overhead absorption, headwinds discounted into that number.

R. McDonald

No, I would tell you that for us, if you just look at the -- how we calculate that number. It's primarily revenue based. We figure that we can probably flex our labor at about 60%. So in other words, it was not a 1-for-1 reduction just because some of the timing of the cuts. So just to give you an example, for instance, Toyota here in North America has announced they're going to shut down Mondays and Fridays. So we feel we can flex 100% there. But Tuesday, Wednesday, Thursday, we're going to work 4-hour shifts, and so it doesn't make sense to bring people in for 4 hours and send them home. We'll use that time for training or maintenance on the facility or things like that.

H. Nesvold - Jefferies & Company, Inc.

Okay. And then just as a follow-up to that. It looks like there's pretty big, pretty good symmetry between the revenue or the EPS impact expected in fiscal 3Q and then the add back for fiscal '12. So it sort of sounds like whatever overhead absorption, headwinds you encounter on the way down, you're able to recapture that lost margin on the way back up pretty efficiently as well. Is that a fair characterization? Or do you anticipate some other kind of overtime costs as you rebound production to make up for this lost revenue?

R. McDonald

I think, I mean, labor is quite a small component. So the inefficiency, I think we feel pretty good about being able to offset, so it's not a significant number.

Stephen Roell

Yes, probably not as capital intensive as you might be thinking of some people with heavy machining capabilities, okay?

R. McDonald

Yes.

H. Nesvold - Jefferies & Company, Inc.

Great, thanks a lot.

Operator

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

David Leiker - Robert W. Baird & Co. Incorporated

Bruce, Steve, on Slide 11, on Building Efficiency, when you go across the different subsegments within that, there's pretty wide range of revenue performance. Can you characterize for us somehow where those different subsegments are in terms of cyclical rebound and demand versus how much of that is secular growth in those different areas?

R. McDonald

Yes, I guess, probably better to talk about orders geographically than the revenue, because that's more of a leading indicator. So let's start with the Middle East where we said our orders were up 125%. Now Middle East is a small, but rapidly growing sector and it is all about -- our business there is pretty broad based to the Dubai, UAE, Qatar, Saudi. So there I wouldn't classify it cyclical rebound, I would talk about it as generally the economies are performing well there and there's a huge demand for infrastructure spend. So this is really what's driving the equipment side of our business, they tend to be very large market for large tonnage chillers. In Latin America, again, the markets there have performed fairly well. Our orders are up 44%, again, large chillers and refrigeration equipment, big vertical markets down there would be food processing, but markets are growing strongly there with the -- and we expect that to continue with some of the investments in the Olympics and the World Cup. In Asia, 27%. Again, a lot of equipment in that market. So the markets there continue to -- really didn't go down at much of a downdraft, just performing very well and our growth is really, China being the biggest market of growth, it'd really be driven by the investments that we're making to expand into some of the Tier 2 and Tier 3 cities. North America...

Stephen Roell

I'll take North America to give you a break, Bruce, okay?

R. McDonald

Okay.

R. McDonald

North America, that increase there, I guess I would say we see that as a recovery mode, but primarily driven off the retrofit. We see control systems are up double digit, as well as equipment. Equipment much stronger. And the product subset of that is strong. I think, David, I can tell you color wise there, we continue to see strong demands. We indicated in the U.S. from state and local governments, education, healthcare. The only market that we've seen really weaken is the federal market. And if I were to show you, go back and look at our pipelines, I'd tell you the same thing is true. That we see a little bit of softness in the federal market, the good strength out of the school market, which haven't been there, healthcare and state and local governments. So those continue to be good markets for us, but those are all recovery modes. But again, we're not as definitive on the new, we call it the new construction market as much as we're seeing the demand recover in project work. And then in Europe, seeing some signs of recovery. I think it's more our performance. We've underperformed in that market for several years. We don't see much recovery per se in the European market itself, okay, as we...

David Leiker - Robert W. Baird & Co. Incorporated

Okay, great. And then I had just 2 quick questions here on Power Solutions. The aftermarket volumes of up 18%. How much -- what would that number be, excluding Wal-Mart?

R. McDonald

Well, don't have it at my fingertips but we'll follow that 1 up.

Stephen Roell

Well, I'd like to get that number if I could for you, because I want to make sure it's not that much. What we saw, David, while he's looking for that, pardon?

Glen Ponczak

About 1 million units in the quarter.

R. McDonald

Yes, we'll need to get you a number, David.

Stephen Roell

But we saw strong growth across the basin. David, it was very unusual this month because typically if there's weather-related factors, you see the demand pick up in our aftermarket channels in the month of January. We got surprised, because it stayed strong in February and it stayed strong in March. And so we were -- we actually had performance matters trying to supply in that timeframe.

Glen Ponczak

David, it's less than half of the increase in North America, quite a bit less.

David Leiker - Robert W. Baird & Co. Incorporated

Okay, great. And then 1 last item, as you convert this plant SLI to AGM here in North America, what's your incremental capital on that versus putting up a new plant?

R. McDonald

Well, that's a tough 1. But I guess here is how I'd probably tell you to think about it is, if we were building a new plant from scratch, like, let's say, in China, it'd be about 8 million units and I'd say the cost would be somewhere in the 180 to 200 range, something like that. To convert a similar size to AGM is probably in the 150 to 170 range depending on -- and would have about that 6.8 million units of capacity. So there's just a big -- the battery takes 3x as long to form, so it's investment.

Stephen Roell

Yes, what you would see if you were to walk into 1, David, you would see a formation line that just -- the formation process is just like slow motion. It just takes so much longer because of the requirements of that power of that battery, okay?

David Leiker - Robert W. Baird & Co. Incorporated

That's about the same then?

Stephen Roell

Yes, and I think that's also, people ask about how defensive is this business. It's going to be very hard for someone to come in here with the volume and the capital that's required here to participate in this industry right now.

R. McDonald

Yes, about the same investment, but less capacity, right, 6.8 versus 8. I think that's 1 of the reasons why I think we're having the Power Solutions Analyst Day. We really want to do a deep dive on the AGM technology, the competition, the applications that the demand that we're seeing for beyond Start-Stop because that's significant, and then just our outlook on a regional basis and our competitors and the investment portfolio. So that's really what we're going to spend our time on at the end of June here, David.

David Leiker - Robert W. Baird & Co. Incorporated

Okay, wonderful. Thank you very much.

Operator

Michael Cox from Piper Jaffray.

Michael Cox - Piper Jaffray Companies

Thanks a lot, guys. My first is on the Japan and potential that this flows into your fiscal fourth quarter, the neutral expectation. How optimistic do you view that in light of the situation as it stands today?

Stephen Roell

The best I can do is tell you there's the uncertainty is the best we can see. I think the problem that we have right now is that we pretty much know what our situation is. What we have a hard time knowing is exactly where the OEs are in terms of the rest of their supply chain. And we also can't really speak very, very effectively to what kind of workarounds we've been able to achieve. So I think we're going to learn a lot more as Ford, GM, and some of these other companies report, but right now we just don't have good visibility into the entire supply chain like they do. So we've given you what we know and try to key off what we heard from the OEs.

R. McDonald

I think the 1 thing I'd maybe add to that is to the extent, I mean obviously our critical assumption here is the timing of those -- of some of the electronics plants coming back online. So that you'd have to make you're own guess. But to the extent that some of the Japanese manufacturing is down in Q4, our fiscal Q4, you would expect to start to see some substitutional buying patterns in the marketplace. So some people are going to wait for a specific Japanese vehicle, other people are going to switch over to a European or a North American-produced vehicle that is of similar size and characteristics. So it's hard to model that out. But that's probably -- inevitably some of that is going to happen and that will start happening in our fourth quarter as dealer inventories become very tight.

Operator

Our final question comes from John Murphy from Bank of America Merrill Lynch.

John Murphy - BofA Merrill Lynch

I'll keep it to 1, I promise. Just on the launch schedules. You said 18 vehicles were launched in the quarter with your customers. I'm just wondering if you could put that in context relative to the last couple of years where launch schedules have been relatively low versus maybe back when launches were normal and what you see going forward. Because I think what we're hearing from a lot of suppliers is the launch schedules sound like they're pretty heavy right now and are depressing margins a little bit and then a couple of years out, it might ease. Just curious about that.

Stephen Roell

Let me start with 1 comment. The 18 are really the very large, okay, ones that were launched. We're launching over 100, 120 this year is how many launches we have, which would be a combination of brand new, as well as remakes or renewals, okay? But the launch schedule is heavy and again, ours is heavily skewed towards Asia and Europe right now. Bruce, do you want to add anything anymore?

R. McDonald

Yes, the 18 that we refer to our new programs for us, not replacements. And so I think you...

Glen Ponczak

When you look at the backlog, of course, we're launching 1.1 billion this year, 1.4 billion next year, 1.7 billion the year after that.

Stephen Roell

And last year, we launched in large number as well.

Glen Ponczak

So it's sort of with us for a while.

Stephen Roell

I think we were hoping we're behind the complexity, but we have 1 or 2 programs which really bit us and that's really where we're incurring our high cost, okay? If we didn't have those 2, we probably wouldn't be talking about containment costs in Europe, to be honest.

John Murphy - BofA Merrill Lynch

Great.

Glen Ponczak

Now we'll turn it over to Steve for some final comments.

Stephen Roell

Yes, if I could just make some final comments. I think the reason I started out this call talking about some of the longer-term strategic investments is just to ensure that the story that we've been talking to you about and our projections for our businesses remain intact. We feel very good about the long-term growth prospects. We continue to see good momentum in our Power business and BE as highlighted by their backlogs and just the growth we've experienced. We're going to have to manage through the -- obviously, the issue that we have in the automotive build on the uncertainty. But I can hardly wait to get to the other side of this when we're talking about having to build the -- get the production levels scale back up to meet the demand and to replenish the dealer inventories. I think we're going to be there quicker than it'll seem, and we're anxious to be on that side of it. And we'll have a very good story as we go into 2012. And so with that, thank you very much for your interest, and Glen will be available for questions the remainder of the day. Thank you very much.

Operator

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

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