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

Johnson Controls (NYSE:JCI)

Q1 2012 Earnings Call

January 19, 2012 11:00 am ET

Executives

Glen Ponczak -

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

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

Analysts

Alexander E. Potter - Piper Jaffray Companies, Research Division

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Ravi Shanker - Morgan Stanley, Research Division

Rod Lache - Deutsche Bank AG, Research Division

Itay Michaeli - Citigroup Inc, Research Division

Kelly A. Dougherty - Macquarie Research

John Murphy - BofA Merrill Lynch, Research Division

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Joseph Spak - RBC Capital Markets, LLC, Research Division

Patrick Archambault - Goldman Sachs Group Inc., Research Division

Operator

Welcome, and thank you for standing by. [Operator Instructions] Today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would now like to turn today's call over to Mr. Glen Ponczak. Sir, you may begin.

Glen Ponczak

Well, good morning. Thanks, Kim. Welcome, everybody. Before we begin, just want to remind you that Johnson Controls will make forward-looking statements in this presentation pertaining to its financial results for fiscal 2012 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 and forecast.

For those statements, the company cautions that numerous important factors such as automotive vehicle production levels, mix and schedules, energy and commodity prices, the strength of U.S. or other economies, currency exchange rates, cancellation 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, 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 today by Steve Roell, Chairman and Chief Executive Officer of Johnson Controls, who will give an overview of the quarter; followed by Bruce McDonald, Executive Vice President and Chief Financial Officer, who will give details of the business unit results and the financial review. That'll be followed by question-and-answers, and we will end at noon, Eastern Time.

With that, turn it over to Steve.

Stephen A. Roell

Okay. Thank you, Glen. Well, good morning, and thank you for joining us. Before I go into the financials, I just wanted to spend some time talking about the business environment and give you some sense for what we see not only in the quarter that just ended but sort of what we anticipate going forward for the full fiscal year.

Now let's start with the automotive industry production levels. In the quarter itself, production levels in North America and China were very consistent with what we expected. The growth of 16% in North America, China being flat, I'll come back and talk about that. If there was any surprise in the quarter, just a slight surprise with the European production being down slightly. We didn't expect a 4% decline. But in general, I would tell you that the quarter from a production standpoint really was not a cause of any of our concerns in the quarter itself.

So now I'll turn to the full fiscal year. The guidance that we've provided to you for North America and China remains. We don't see any reason to adjust that. And therefore, the only -- I guess I would like to talk about this China. You'll hear 2 differing estimates for China production, one being flat, one being up 8% to 10%. And that difference is whether you're looking at the total industry, including trucks, or whether you're just looking at the passenger car element. Since we're only impacted by the -- participate really in the passenger car side, that segment is expected to be up 8% to 10%, and that's consistent with the guidance that we provided at the beginning of the fiscal year.

Where there has been a change in our guidance is obviously in Europe where we are concerned about production levels. And we reduced our industry projection for the fiscal year down to 19.6 million units from the 20.1 million that was in our plan. So all in all, that's really how we look at it. But the key thing from our standpoint is that given the stronger consumer confidence levels, we feel good about the outlook for the North American production as well as China.

The next item we'll talk about is weather, and I hate talking about weather, but it does have an impact on us, particularly in our battery business. The mild weather that we've experienced this winter is not just in North America but also, Europe is experiencing extremely mild conditions. We're able to track with 7 of our largest aftermarket customers what's happening at the point-of-sale. And while we saw some softness beginning in November, the big decline took place in the month of December where their point-of-sale was down almost 15% in the month of December. It stayed mild obviously in the first half of January. We're just now getting cold weather. It's probably going to be too late to generate major restocking for our customers. Typically, they will restock in January and February. But when we get this far into a winter, the likelihood of a restocking is not very high. And so that's really more of a second quarter impact for us, and that's really why we took -- one of the reasons why we took our second quarter guidance down was because there will not be a restocking in the second quarter. So we could lose as much as 600,000 units, we believe, in North America in the second quarter.

The other factor that we talked about in the quarter is also the lower sales of our residential furnace units. It had some impact probably related to weather, but we acknowledge that we probably underestimated the impact of the end of the tax credits. This wasn't a factor for our year-over-year results, but our plan had assumed that we would have more demand in our residential business. And of course, that's a hit also to our margins because our residential business is a higher-end margin business for us in BE.

Some other leading indicators at the macro level. Recently, we've been tracking Architectural Billings here in North America. They've trended up last quarter. That's true with both commercial and the institutional segments, so we feel good about that. We see that also in our pipeline in terms of bidding activity.

We're encouraged by the improvement in the U.S. Consumer Confidence Index the last past 6 months compared to the last 2, because we believe that supports and gives us more confidence about the auto demand over the next 6 months.

Bruce will talk more, but clearly we had to adjust our forecast for the euro, and that had an impact and does have an impact to us for both the quarter -- the upcoming quarter and the full year. And the final item I guess would be commodities, where we see most of the commodity pressure being mitigated right now from what we had assumed at the time. Lead is declining and of course, the impact on lead is primarily its impact on our top line at Power Solutions, not our bottom line. So I just want to give you sort of a sense for what we see in terms of some of the major macro elements that impact our business.

Then turning to the numbers, our sales in the quarter were $10.4 billion, a record level, up 9% from 2011. Our segment income of $598 million was up 12% over last year's quarter. We continue both those elements to benefit from our strong backlogs in Automotive and Building Efficiency, and those results are consistent with the guidance we provided back in October.

Our net income of $410 million compares to $375 million, and that resulted in earnings per share of $0.60 per diluted share versus $0.55 last year and the fiscal quarter. We do believe, if you look at our individual businesses, that you'll identify the fact that all of our businesses outperformed the underlying markets, and we believe we gained, therefore, significant share in each one of our business segments.

Just a few more comments about the first quarter itself. Significantly higher profit in automotive in Europe due to the acquisition impact of metals and a higher improvement in Asia. We launched 48 significant programs, and that -- we just bring that up to you just to give you some of the other growth we're experiencing and the complexity and challenges that presents to us. We probably will launch over 500 programs this year. Some of those aren't as significant. These 48 pertain to 48 major programs.

We had a higher North American metal start-up cost. We'll go into that, more detail later. But that was a disappointment for us, we didn't see that coming into the quarter. To try to mitigate future concerns about quality in our launches, we've hired over 306 Six Sigma Black Belts and quality experts over the last 6 months, and we think those will begin to have a dramatic impact in terms of the new product launches going forward.

From a Building Efficiency standpoint, we continue to do very well in what really has to be described as a very sluggish commercial building market. We continue to see good growth. Our backlog is at record levels at $5.3 billion. And then we do acknowledge that there's lower residential HVAC market demand. And I think we'll hear that from the industry participants as the calls come out throughout the quarter.

To try to protect ourselves from an earnings standpoint, we have taken some pretty dramatic actions at Building Efficiency to reduce our SG&A. From what we had originally planned, we probably have reduced our costs by roughly $150 million. But at the same time, we've been able to sustain and maintain our investments in new product technology and sales force expansion.

From a Power Solutions standpoint, the quarter itself was good, in-line performance despite really what I described as of soft demand at the end of the quarter and unseasonably warm weather. We've talked about that already. I do want to make mention the fact that the investments related to our AGM expansion, vertical integration in China, those investments are on track and performing according to plan.

Looking at the 2012 outlook, Bruce is going to go through in more detail the finance -- the financial numbers, but I just wanted to give you just a couple highlights. We think our story, our future growth and profitability story, is very much intact. We do understand we've got some short-term challenges related to the weather and some of the currency issues. But if we look at it from the standpoint of our investments, we're maintaining our investment levels in terms of our CapEx.

I want to remind you that we're spending -- spent $1.7 billion this year to drive what we believe will be ongoing growth in 2013 and '14 and improve our margins. Over 70% of our CapEx in fiscal 2012 will be tied to those type of categories as opposed to maintenance.

We continue to invest and support the record level of Automotive Experience new business awards and launches. We continue to invest to improve our information technology to support that future growth. And more importantly, we're investing in innovation and engineering to ensure that we can not only perform well in terms of new product launches and designs, but also that we can provide more value to our customers.

So then I'm going to turn it over to Bruce, who will go through the first quarter and give you more highlights by business unit.

R. Bruce McDonald

Okay, thanks, Steve. Starting out here with Automotive Experience, we saw a pretty solid quarter against, I guess I would say, a backdrop of modest improvement in global production volumes. On a regional basis, our sales were up 15% in each of the 3 major geographies.

In North America, our 15% compares to an estimated 16% increase in production. We slightly underperformed the market, mainly because of our exposure, which is quite high to the Japanese customers.

In the quarter, sales to our Japanese customers are only up about 4%. So our exposure to Japan continues to be a bit of a headwind because we just haven't seen the inventory restocking in North America.

In Europe, our 15% compares favorably to the 4% decline in production. If you back out the impact of the acquisitions and currency, what you would see is an underlying revenue increase of 4% against that minus 4% for the industry.

And then in China where our sales are primarily through nonconsolidated joint ventures, we're up about 10% to just over $1.1 billion. And that again compares to Chinese passenger car volumes in the quarter, which we think were flat.

Turning to our segment income, we improved by 10% to $194 million. We continue to benefit from higher volumes, the accretive impact of the acquisition and improvement in our European quality containment cost.

In Europe, if you just look at our European numbers overall, we had a $21 million year-over-year swing in our profitability. Our margins were just below 1% versus a breakeven level last year.

In Asia, you can see our margins coming in a little bit north of 15%, up about 500 basis points versus last year. Here we continue to benefit from exceptionally strong performance in our Chinese joint ventures in particular.

And then lastly, in North America, we experienced a downturn in our margins. This really reflects the start-up costs associated with our North America metal footprint.

Going into the quarter, as Steve indicated, we did expect to see a headwind associated with the start-up of that facility. They were somewhat higher than we had anticipated in our guidance. We're going to talk to the fact that those costs are on the right glide path, but they're going to continue on here for the next couple of quarters.

Lastly, we did include the -- we had some questions in terms of the impact of Thailand. And as we indicated throughout the quarter, the impact has been pretty modest for us, about $0.01 a share. So just put that in for the questions that are out there.

Turning over to Building Efficiency. You can see here, sales up 4%. We saw revenue growth in most of our major segments. In Asia, sales were up 13%. Global WorkPlace Solutions, up double-digit, 10%.

If you look at North America in aggregate, we are up 2%. That would be systems up 4% and our service business relatively flat. Middle East, which is a, I'd say a lumpy market, we're up 27%. Europe, we're down 2%. Latin America, we're down 18%. And then in our residential business, our sales were down 19%, with unit shipments being down 26%. That's sort of the headwind that we were talking about, that Steve was talking about in his section, the extreme softness in the residential market.

We look at our order intake, we're up 2% in the quarter excluding currency. Geographically, kind of a mixed bag here. Asia continues to be very strong, and so in Asia that is up 17%; up 6% in North America; flattish in Europe; and then we were down in Latin America and the Middle East. The Middle East really down 40%. We had a tough year-over-year comparison and the size of our order intake there tends to be fairly lumpy. So it's not really indicative of our business performance, just the timing of large orders on a year-over-year basis.

As indicated earlier, our backlog was up 8% to $5.3 billion. That's a record level for us. In terms of our segment income at $133 million is about 4% lower than last year. Margins were comparable to the year-ago levels in North America systems and Global WorkPlace Solutions but lower in our service business and in Asia.

I'd just remind folks that we are up against a pretty tough year-over-year comp in Asia. Last year, in the quarter, our Asian income was up 65% on a year-over-year basis. So down slightly from last year, but we had a tough comparison there.

In terms of the margins for BE in the quarter, they were actually in line with our expectations. Most of the year-over-year decline was due to the timing of some of our investments in infrastructure and the launch of Panoptix. Our business did a nice job actually of offsetting some of the revenue softness with SG&A reductions.

Turning to Power Solutions, our business performed very well in the quarter despite some significant headwinds, which I'll get to later on. Sales were up 4%. If you look at our unit volumes, we were actually down 1%.

Aftermarket volumes, which are primarily soft due to the weather here, were down 1%. And as Steve indicated earlier, we saw most of the year-over-year decline happen in the latter part of December.

We're starting to see some of the benefits in terms of product mix as our AGM business continues to grow. Then lastly, with regards to our China plant which has been shut down since September, we originally forecast that the facility, we were hoping, will be open for the beginning here, the second quarter. That plant remains closed, and we're in discussions with the Chinese authorities. But at this point in time, it's uncertain when and if that facility's going to come back online this year. And the guidance that we're going to provide later on assumes the facility is closed for the remainder of the year. So that's the worst-case scenario.

In terms of our segment income here, you can see a nice increase to 25%, up to $271 million. Here, we saw very strong margin performance as we benefited from the investments in our vertical integration. That's smelting, the higher mix of AGM batteries. And then we had an equity income benefit that we expected and was included in our guidance, about $0.02 a share associated with the increased investment that we made in our separator joint venture business in the quarter. Partially offsetting this, of course, was the impact of the Chinese plant being shut down for the full quarter and the consolidation of our hybrid battery business, which depresses our margin.

Turning over to Slide 10 in the financials. So just a little bit of more color here. So as we said at the top of the call here, sales up to $10.4 billion, 9% year-over-year increase. Currency really wasn't a factor. If you back out the year-over-year currency differences, our underlying growth was about 10%. So not really much of an issue.

In terms of our gross profit, you can see about a 10 basis point year-over-year decline here. Here, we basically saw the benefit of our higher volumes, offset by our business mix. In other words, our automotive business, which tends to have the lowest gross margin, was a bigger piece of the pie this quarter than it was last year. That sort of depresses our margins on a reported basis. In addition, as Steve indicated, the softness of our residential business depressed our margins by about 10 basis points as well in the quarter.

In terms of SG&A, you can see an 11% increase. The SG&A as a percentage of sale ticked up about 20 basis points. Here we're really seeing the impact of the SG&A coming on our automotive acquisitions and the investments that we're making in innovation, emerging market infrastructure and some of our IT investments.

Equity income, you can see a big year-over-year increase from $66 million to $120 million. There's really 3 things driving this increase. One is the increased profitability of our automotive joint ventures in China; secondly, the equity income benefit of a couple cents a share that I talked about in Power Solutions; and then third, in the prior year, we had equity losses on our hybrid business flowing through this line. Those losses are now consolidated, so don't flow through the equity income line.

And then lastly, from a margin point of view, you can see about a -- we had 10 basis point improvement in our margins, up to 5.7% in the quarter.

Turning to Slide 11, maybe just a few comments here on financing charges. You can see a fairly large year-over-year increase from $35 million to $49 million. This is really an impact of comparable interest rates, but really, higher debt levels associated with the acquisitions and capital investments that we've made on a -- that have grown significantly on a year-over-year basis.

If you look at our effective tax rate, it's at 19%. That's consistent with our guidance and our effective tax rate last year. In terms of income attributable to noncontrolling interest or minority interest, it's higher by about $7 million, from $28 million to $35 million. That's really attributable to higher levels of profitability on our Automotive and Power Solutions consolidated joint ventures.

Maybe just spend a bit of time here on the balance sheet and our cash flow in the quarter. And maybe the first thing I just point out is we did make about $350 million of pension and post-retirement funding in the quarter. Those flow through as a use of cash within our operating activities and also show as an outflow in terms of working capital. So you really need to adjust those to sort of get an apples-for-apples comparison in terms of how our businesses are performing.

If you make that adjustment, our cash provided by operating activities more than doubled in the quarter to $250 million from about $130 million last year. If we look at our working capital, and we really define our working capital as being trade working capital, so it's inventory, receivables and payables, we saw a 40 basis point improvement in trade working capital levels versus where we were at the end of last year. So we're pleased to see an improvement there.

And then lastly, if you just look at our total working capital outflow, we typically have an outflow in the first quarter. This year, it was $380 million. Last year, it was $450 million. Again, I'm adjusting for the retirement contributions here. So we are pleased to see that, that outflow was less this year than last year, and we continue to focus a lot of our energies on driving improvement in our working capital management.

In terms of our capital investment, you can see we had a major increase here, $500 million -- nearly $540 million, or nearly double the level of last year. That's basically the run rate associated with the $1.7 billion that Steve referred to in his slides earlier. And then I would just point out that also, within our cash flow, we have $100 million outflow associated with the increase in the ownership stake that we have in our Power Solutions separator joint venture.

So let me just now talk to our guidance and some of the factors affecting our guidance in a little bit of more detail here. And I'd like to really comment on which one of these impact the second quarter and which ones impact the full year. And I've also tried to use kind of the size of the arrows here to relocate -- to indicate the relative magnitude of each of these factors.

So let me just go through them, and Steve touched on some of these, but let me just touch on some of them in a little bit more detail. So first of all, in terms of Power Solutions weather-related volumes, we aren't going to see the winter stocking -- restocking that we normally anticipate. That's going to be a fairly significant impact to the second quarter, but it has no impact at all in the second half of the year.

In terms of the Shanghai closure, that is going to be another significant impact here for the second quarter. The impact as we go further through the year becomes less and less because we're able to offset the closed -- the existing Shanghai facility with volumes that are coming online in our 2 other facilities in the region. So it becomes a diminishing issue for us as the year progresses and probably won't be a factor as we go into 2013.

In terms of the metals start-up, I talked about this one earlier. Here we thought we'd have some headwinds that would go away in the first quarter. We expect to see those trend into the second and possibly into the third quarter. But we're on a glide path, so those should be substantially gone by the second half of the year.

In terms of the European production volume, it's a relatively small impact in the second quarter and the second half. Same situation in terms of the euro. I just point out the euro alone is worth about $0.04 in terms of our reduction in guidance here.

In terms of the residential HVAC demand, we expect that to continue to be a headwind for us. In the second quarter, the impact becomes lesser in the second half of the year, largely because of some new business wins that we have, and we're comparing against better year-over-year comparables.

And then lastly, well, obviously, we're doing a number of things to offset some of these headwinds through cost reduction initiatives, pulling forward some of our best business practice projects and things like that. Those will accelerate over time. So obviously, they're going to have some impact here in the second quarter, and that grows as we go throughout the balance of the year.

So when you sort of look at it all-in-all, net position here for the second quarter, it's about a $0.10 to $0.12 headwind. And as we get into the second half of the year, largely speaking, our cost reduction initiatives are going to offset most of the headwinds here. So we're only looking at a $0.01 to $0.02 per share deterioration in the second half of the year.

In terms of our revised guidance on the last slide here, our sales we now expect to be up 7% to $43.5 billion. Most of that softness would be associated with the euro. In terms of our EPS guidance, let me first talk about full year, we're lowering that to $2.70 to $2.85, which would still represent a year-over-year increase of 13% to 19%. And we're introducing guidance of $0.52 to $0.54 for the second quarter, many of the factors explaining that second quarter outlook I touched on the previous slide here.

In terms of net financing charges, you can see we're taking that up about $10 million in terms of range. That really reflects the impact of the bond issuance that we did in late November. We termed out about $1.1 billion of our debt. We just thought that was a prudent thing to do to take advantage of historically low interest rates and also reduce our dependency on short-term borrowings in the event we saw deterioration in the financial markets associated with the situation in Europe. In terms of our CapEx outlook, we're maintaining that at $1.7 billion.

So just before we get into the questions, I think kind of the financial highlights would be strong double-digit top line growth in the quarter, and we expect to see continued growth here for the balance of the year. Our margins, although they're a little bit short of expectations, are up year-over-year, and we expect to see those ramp up in the second half of the year in particular.

We do have some near-term challenges, but I think our cost reduction initiatives are ramping up so that we're going to minimize the impact of those as we exit 2012. We're starting to see some improvements in our working capital position, and we're continuing to invest in some of the long-term growth initiatives. Our capital expenditure plans are on track, and we continue to deploy capital in areas like the separator joint venture where we can generate long-term shareholder value.

So with that, I'll turn it back to Glen and we'll open things up for Q&A.

Glen Ponczak

Hey, Kim, we're ready to take questions. [Operator Instructions] All right, Kim, we're ready to start.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from John Murphy with Bank of America, Merrill Lynch.

John Murphy - BofA Merrill Lynch, Research Division

One question, first on the Shanghai battery, your shutdown or the continuation of the shutdown of that plant. I'm just curious, as you look at your other plants and your ability to make up that capacity or buy them elsewhere, just curious what your comfort level is that you might not run into the same sort of regulatory or quota issues on lead processing at those other plants? And how much more capacity can you add to those other plants to really make this up?

Stephen A. Roell

Yes. I guess let me start. John, this is Steve. We're pretty confident about the fact we're not going to run into any other issues in the plants that we've launched. They're vastly different locations, number one. Okay? And we're in the midst of putting that capacity on board. I don't see any issue there. Both plants we have are permitted, and the volumes are -- the additional capacity is already being put in place. So I think it was very specific to that location right now, John.

John Murphy - BofA Merrill Lynch, Research Division

Okay. And then just maybe 2 very simple housekeeping questions. If you could just give us your European exposure on the auto business by automaker. And the other housekeeping is you guys reduced your pension discount rate in the U.S. from 5.25% to 5%, and this was in the 10-K. That seemed like it was a pretty small reduction relative to what the Moody's AA Index did, which was down at least 75 basis points for measurement point to measurement point. Just curious, what was the driver of what -- it was a pretty small decline in that discount rate. Just a very small technical question.

R. Bruce McDonald

Yes, I'll take the discount rate one.

Stephen A. Roell

I'll take the other one.

R. Bruce McDonald

John, I think -- we obviously work with both our actuarial advisers and with our auditors in terms of setting our discount rate. And I think if you look at the change -- I mean, our year-end, we set our discount rate with the year-end -- our year-end measurement dates are as of September. So I think when you look at the September-to-September movement, maybe a little bit different than the December-to-December. The other factor is you have to look at the duration of the -- in addition to taking the AA corporate standard, you have to look at your expected duration of your liability curve. We tend to have a fairly young workforce, so our liability curve tends to be a little bit longer than the index. So that gives us a little bit of benefit. Those would be the 2 factors.

Stephen A. Roell

John, this is Steve. Let me just do the best I can on this European exposure. First of all, we've got broad exposure in Europe. Our largest customer is Volkswagen followed by Mercedes. But we do a fair amount of volume with Opel, Volvo, probably disproportionate. We do most, if not all, of Volvo's business. We do a fair amount with Ford, and we also have exposure in Renault and Peugeot. Where we don't have -- where we're underrepresented would be in probably Fiat and Dacia, which are -- if you look at the 2 OEs, which are probably under some pressure and probably where -- if you look at some of the IHS forecasting, they're forecasting some further softness. We don't have much exposure to those 2 OEs.

Operator

And our next question comes from Kelly Dougherty with Macquarie.

Kelly A. Dougherty - Macquarie Research

I just want to see if we can get a little bit more detail on the guidance. Are you sticking with the segment revenue assumptions and the margins assumption you previously had?

R. Bruce McDonald

No. What we'll do, Kelly, is we cannot -- I don't have the exact segment splits at the top of my fingers here. But what I can tell you is in terms of our overall margin guidance for the company, we guided to up about 60 to 80 basis points, and now we would be up 40 to 50 basis points. So that's kind of the magnitude of the overall position. And I think what you'll -- and Glen, you can follow up with Glen, but what you're going to see is we have lower margins than we thought in automotive, slightly softer margins in BE associated with the downturn in the residential business. And then our margins in Power Solutions will be stronger than we guided to.

Kelly A. Dougherty - Macquarie Research

Great, that was very helpful. And then just a bigger picture question. A lot of times, we get asked that the Start-Stop opportunity seems, in some ways, too good to be true. There's commanding market share, you've got very tight capacity, not too strong of competitors. So how do you think that plays out over the next quarter? Do you expect new entrants to come into the market to add to capacity and give you a bit more better run for your money? Or is your relationships, access capital, things like that, that much stronger than everybody else's?

Stephen A. Roell

Well, we've looked at that, Kelly, trying to see who could come in and compete, and we don't see a lot of competition. This is a very capital-intensive investment as we've indicated to you. So that's going to be a limiting factor in some cases. We don't see anybody migrating from the industrial base into the automotive sector. That would be one other option, but we don't believe that's going to happen. So at this point in time, we're still being pressured to put in more capacity, particularly into China. So if anything, we're not seeing any of the OEs behave like they have other sources in mind. Rather it's just more pressure on us at this stage.

R. Bruce McDonald

One of the other advantages that we have is our strong OE relationships. Because you have to remember, this is an OE business right now. It's going to migrate into the aftermarket. And when we look at our relationships through that channel versus a lot of our competitors, that's another big advantage that we have.

Operator

And our next question comes from David Leiker with Baird.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Just to follow-up on that, Steve, as we look at the AGM batteries, can you give us an update on where you are on the capacity that you're putting in place, the timing for that and what the ramp is for the volumes?

Stephen A. Roell

Well, I'd have to go back...

R. Bruce McDonald

It -- well, you may have it.

Stephen A. Roell

I think, David, by the end of the year, it's something like 7 million units or something. We exited '11 in the 3 million, 3.5 million, something along those lines. And then it ramps on through 2014 to get to the 21 million.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Ultimate target there I think, was it like $18 million or something?

R. Bruce McDonald

Yes. Just to be clear on that one, I think if you look at our -- the numbers Glen quoted was our volume. If you look at our run rate, I think we'd hope to be exiting the year just a shade over 11 million.

Stephen A. Roell

11 million is what I recall.

R. Bruce McDonald

And that in the following year, our production capacity by the end of the year goes up to 17 million or 18 million.

Stephen A. Roell

And just remember, a lot of the production we're putting in place is still European. It's with Hanover. We're just now getting our capacity put in place in Toledo here in the U.S.

R. Bruce McDonald

The only challenge that we -- I'd say challenge that we have versus our plans, David, would be in China. And there, the situation that we have in our Shanghai plant was when where we were hoping to introduce AGM. That obviously is being reconsidered. So at this point in time, we still don't have an answer in terms of where we're going to invest in China for the AGM products. So that's the only thing we haven't gotten our minds around.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then, Steve, just one other item here. I mean, we got several quarters in a row here where the margin items have been a bit bumpy along the way, and you do a great job of explaining the reasons along the way. We're starting to get some calls, questions from investors, whether this bumpiness in margins, the shortfall in margins is more than the normal case for JCI as opposed to nearly a history of very stellar performance on that. How can you give some comfort to folks that we're just running through a patch here of some choppiness, and there's light on the end of the tunnel there?

Stephen A. Roell

Yes, that's a very fair question. David, I guess I would highlight a couple things. First of all is the fact that we've put more resource and leadership into different roles. I indicated in the past that we did hire a new COO at Automotive. And we have hired the researchers, which is probably more critical, in terms of getting our quality experts and our Black Belts into the design phase. So I think the stabilizing or design, the standardization of product is probably one of the critical items. I guess the second thing is I would do -- would point to is the fact that we -- I'm sure we underestimated the impact of launching the magnitude of what we have. And I think now we've looked at program by program, we have metrics, we have our what are called SBB teams to help in the launch process in place. And I think I just feel much more comfortable that in terms of the complex product we're launching, and in terms of the amount of oversight and monitoring that we have and kings [ph] of reviews, I just feel we've increased our discipline significantly. I do understand the concern that you raised though, David, okay, that we've had a lot of lumpiness. And it's come from the standpoint of -- let me give you an example, and this -- I don't mean to sound this like an excuse. But if we look at the North American, the launch that Bruce referred to, 2 very successful programs from an OE perspective, one with Toyota, one with Ford. Both of them ramped up and requested significantly higher volumes than what we originally designed for the launch of those 2 products. So we went from a 5-day full bore to a 7-day, all-out. And we were incurring as much as $4 million a month of just overtime -- excuse me, of premium freight which is now down to $400,000. But if you can get a picture, $4 million a month of just premium freight, which doesn't include the overtime, the demands on maintenance and things of that nature. We had to actually locate part of that production to a second facility to take the pressure off. Now that all happened in the quarter. If you look at the customer standpoint, we met their delivery. We met their quality. We were able to do all of that but at a very high price internally from our standpoint. That's not going to repeat itself. But I do understand the fact that these things do spike, and it looks strange from the outside world. But that's really what transpired. The good news was the demand and the fact we were able to respond to it at a very high penalty from our standpoint.

Operator

Our next question comes from Itay Michaeli with Citi.

Itay Michaeli - Citigroup Inc, Research Division

Just a question, Bruce, maybe on European auto margins for the year. I think at the Investor Day, you guided to maybe somewhere in the mid-4% range. It looks like from the FX and production cuts you made to your assumptions, the impact there may not be more than 20 to 40 basis points, by my math at least. So I mean, do you think we can still kind of hit a 4-plus percent margin in Europe auto this year?

R. Bruce McDonald

I don't have the margins broken out by region here. I mean, we kind of tend to do a deep dive in terms of our forecasting in the sort of February, March-type time frame. So what we tend to sort of do here is just kind of like a variance analysis to sort of see where we're at. We can pull something together, but I just can't answer that on the call right now.

Itay Michaeli - Citigroup Inc, Research Division

Okay. So a new -- just one quick follow-up. The free cash flow guidance you've previously hatched, we assume that, that sort of moves down commensurate with the revision in earnings. Or is there anything special going on there, either up or down?

R. Bruce McDonald

Yes, it'll go down with the earnings. And then obviously, we -- I'd say we used about $100 million of that free cash flow to increase our ownership in the Power Solutions separator business in the quarter. But yes, I think if you just look at our free cash flow guidance, it's ticked down with the earnings.

Operator

And our next question comes from Alex Potter with Piper Jaffray.

Alexander E. Potter - Piper Jaffray Companies, Research Division

My first question is regarding the impressive profitability coming out of the Automotive Experience business in China in the quarter. You had mentioned it was up 500 basis points on a year-over-year basis. It's up even more than that on a sequential basis. Was wondering what drove that significant increase and whether some of those drivers are going to be in place in the medium to long-term, or if this was kind of a one-time thing?

R. Bruce McDonald

Yes, Alex, when I -- just to be clear, I want to make sure you don't misinterpret what I said, is our margins in Asia were up 500 basis points. And what you kind of have to think about there, Alex, is in Asia, we have sales and revenue in Korea, in Japan, but a very small amount of revenue in China. And what we're benefiting from is the fact that we have an awful lot of nonconsolidated joint ventures in China. So what tends to happen is as those 9 consolidated joint ventures improve their level of profitability, and we pick up income and essentially no sales, and so it has a very -- it kind of skews the margins, I guess you'd say. So it's sustainable, but it's attributable to different factors than you'd think.

Alexander E. Potter - Piper Jaffray Companies, Research Division

Okay. So at any rate, the improvement there was coming, for the most part, from increased productivity in those Chinese JVs and there's no reason to believe that, for some reason, they're going to become less productive?

R. Bruce McDonald

That's correct, and it's productivity and it would be driven by volume growth. So like we said in the quarter, our sales in China were up about 10%. For the year, our expectation in China's sales will be in the mid-teens up. So...

Alexander E. Potter - Piper Jaffray Companies, Research Division

Okay, sure. And then I guess my last question here is regarding some of the cost cutting measures you had mentioned that you took here in the quarter in Building Efficiency. I was just wondering if you could elaborate on that, maybe try to quantify what some of the impact might be, whether they're recurring, whether that was just one-time in the quarter.

Stephen A. Roell

A lot of it is slowing down our investments in certain areas, okay, where we could. So we had planned to, let's say, build some our sales organizations in some of the foreign markets. We'd look at the opportunities and decided that's not the best investment this stage. We've slowed down the timing of some of our IT investments. Those ones come to mind from my standpoint, Bruce.

R. Bruce McDonald

Yes. And then looking, obviously, at consolidation opportunities and where we can be more efficient, things like that. We're working on initiatives to move a lot of our back office stuff to lower-cost countries, and we're sort of seeing what we can do to pull those forward. In terms of magnitude here, I think we're looking to cut a couple hundred, maybe $250 million out of our SG&A versus kind of what we saw -- that's the whole company, not just Building Efficiency. That's kind of the sort of size of the prize that we're going after here to deliver our guidance here.

Operator

And our next question comes from Joseph Spak with RBC Capital Markets.

Joseph Spak - RBC Capital Markets, LLC, Research Division

Question on the Chinese battery. I'm assuming you guys are still importing into China to sort of help meet that demand. So can you give us an order of magnitude as to sort of what that benefit is from shifting to importing batteries to be able to sort of produce in the other Chinese plants?

Stephen A. Roell

I mean, the bottom line, Joe, is it's sort of breakeven at best when you're importing, and you make a profit when you're making them domestically. Right? And that plant is certified for about 2.8 million units. Right? So that's -- if you think of -- if you level loaded it there, it's 1.5 million units or so that there's no profit on versus where there should be.

Joseph Spak - RBC Capital Markets, LLC, Research Division

Okay. And then maybe just back to European automotive margins. I realize you had the year-over-year profit increase, about -- the 1% margin. But you also, this year -- or you said that you had some accretion from the deal which you didn't last year. So can you just give us a sense of what's going on, on the core European business, if you will, from a margin perspective?

R. Bruce McDonald

Yes. I think what I said is we had some benefit associated with -- the acquisitions are accretive to our margins. So what you've seen in auto Europe is, as you sort of look at the pluses and the minuses, you'd see a benefit associated with the acquisition, you'd see a benefit associated with this reduction in our quality and containment-type cost. Then you would've seen a negative associated with higher net engineering costs. Those would sort of be the 3 big movers.

Stephen A. Roell

I guess -- just for the audience, I guess, the other thing I would tell you is that one of the things we haven't discussed in detail is we're making good progress on the integration of the metals operations. We incurred or benefited greatly from some of the purchasing synergies that we identified as part of the transaction. But we are lagging in other parts of it, particularly around the engineering integration. So we did not receive the -- did not benefit as much as we thought we would in the first half here. Let's put sort of part of the second half too as we've now got a weekly cadence in place. The Program Management Office has been strengthened, and we feel that the second half will benefit from achieving some of the synergies that we originally thought we would get in the first half.

Joseph Spak - RBC Capital Markets, LLC, Research Division

All right. One last quick one if I could sneak it in. Can you quantify what the metals impact in North America was in the quarter and how we should think about that going into the next?

R. Bruce McDonald

Yes. I'd say it was probably a headwind for us of say $0.05. And our expectation was that it was maybe going to be $0.03. So a couple cents of disappointment.

Joseph Spak - RBC Capital Markets, LLC, Research Division

And should that sort of like get cut in half next quarter? Or how should we think about it?

R. Bruce McDonald

It's going to be $0.03 or $0.04 in the next quarter, and that should largely be behind us by then.

Operator

And our next question comes from Chris Ceraso with Crédit Suisse.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

I wanted to focus on the Building business for a minute. I know you don't have the detailed breakdown of the expected revenue in margin by segment, but it would seem that this one in particular looks like it's trailing what you had expected with revenues up 9 to 11, very slow revenue growth here in the quarter, backlog that's up plus 8 versus your plus 9 to 11 prior guidance, and margins that are I know seasonally weak in Q1. But looks like it's kind of in line to behind a year ago, when for the full year you're calling for some margin expansion. It just seems that this segment seems to systematically disappoint. What's the explanation?

Stephen A. Roell

Well, let's think about some of the revenue side. I guess I would tell you that had we had the residential piece, I think we would have had different metrics on the first quarter. That's the first item I guess I would say, Chris, okay? So the residential hit on that dramatic was against our -- was different than our guidance, okay? The second thing is I think that our backlog is not moving as quickly as we thought. It's Building, which is fine. But if you look at it, when I say it's not moving, it's not executing -- the churn rate is not as strong. I don't think it's anything unusual. I think we looked at that to make sure that in fact there wasn't a postponement of projects. We've seen none of that. We've seen no cancellation. But we do see, for whatever reason, a slower execution of that backlog. Let me give you a different positive. It does address some of your concerns, but if I look at the pipeline, which is probably further my standpoint, probably the biggest indicator of the health of the business, the pipelines are up strong in both service-type work that we're quoting on, construction-type work. Solutions has not grown as much. But the other 2 are strong double-digits. So I still could see the good growth. I think we'll see that turn. And I think from the standpoint of the SG&A actions we're taking, you're more likely to see us be able to hold our guidance in terms of the margin improvement that we expect in that business in 2011 -- 2012.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

I'm sorry, Steve, I missed that last comment. Are you saying that you think for the full year it's more likely now that margins will be flattish instead of up?

Stephen A. Roell

No. That we'll be able to hold the guidance that we gave you earlier. Okay?

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Be able to hold it, okay. Okay. And then the Europe volume in Auto, you've got now down 3.5%. That seems to be a fair bit stronger than the latest numbers out of CSM, which are calling for down 8.5% on your fiscal basis. What's the difference? Is it all customer exposure? Or why are you more optimistic?

Stephen A. Roell

No, Chris, it is. If you look at it, the biggest exposure from some of the estimates out there that call for a further reduction point to bigger reductions at Dacia and Fiat. And we don't have that much exposure in Europe.

R. Bruce McDonald

And to some of the Russians.

Stephen A. Roell

Russians. We don't have that exposure, okay?

Operator

Our next question comes from Rod Lache with Deutsche Bank.

Rod Lache - Deutsche Bank AG, Research Division

On the Building Efficiency, just a follow-up. Could you just talk a little bit more about what's behind the North American service margins decline? And the $150 million SG&A action that you described, is that something that's already reflected in the Q1 margins? Or is that something we would expect to see prospectively?

Stephen A. Roell

It'll build as the quarter goes up. Some of that margins, as Bruce mentioned, some of that cost-reduction offset the softness in the residential. I think it'll -- our objective is to really hold our SG&A cost. We have 2 segments of SG&A cost. We have one which is tied to 4 initiatives, like our Innovation and Panoptix. And then we have the rest of the SG&A. We're trying to hold that SG&A below last year's level from a run rate, and we're doing that right now. So that's what gives me that confidence. The North American service business itself in the quarter, I can't -- this is a tough quarter from a service standpoint. It's not our largest quarter by any stretch. What we're monitoring is our renewal rates of our service business, our truck-based fleet, and looking to grow the project work, which we're seeing more demand for in terms of our pipeline. So I still feel good about the business as it plays out.

Rod Lache - Deutsche Bank AG, Research Division

Okay. And just secondly, you described a few unusual items in the Automotive Experience business in North America, the metals ramp and some unusual freight and things like this. I'm assuming that you're not -- you're no longer expecting the margins for the full year to be flat in North American Auto Experience. When you add up all of the unusuals together, can you give us a sense of how big a drag that is and how you see that sort of -- the trajectory of that over the course of the year?

R. Bruce McDonald

Yes. I think, like I said, I don't have the breakdown, the geographic breakdown, Rod, in terms of Europe, North America and Asia, in terms of our outlook. But clearly, like I said earlier in the Q&A here, we do expect our margins to be lower in AE than we guided to. I just don't have -- I wish I could answer your question, but I just don't have the details here on the call. But you're right in your comment. I just can't quantify it. I mean, we're not looking for -- we're basically saying that the industry's levels are going to be the same as our outlook, so we're not changing that. And the only thing that we've talked through here is the fact that the metals launch was more difficult than we thought in Q1 by a couple cents a share, and we're going to have a headwind of that of $0.03 or $0.04 a share going into the second quarter here. So if we take that, you're talking $0.05 to $0.06 of extra cost, which equates to somewhere between $50 million and $60 million of earnings hit on the North American business. So it's definitely going to pull their margins down. I just don't have all the -- there's some other moving pieces, Rod, but in orders of magnitude, that's probably what we're looking at.

Rod Lache - Deutsche Bank AG, Research Division

Do you -- just one last thing. Do you happen to have the acquisition costs from Q1 of last year in Europe? You were amortizing an unusually high acquisition expense.

R. Bruce McDonald

Well, in the number that we're comparing to in our call here, we only closed on the relatively small fabric, Michel Thierry acquisition in the first quarter. The metals acquisitions, one happened in Q2 and one happened in Q3. So from that perspective, they don't really -- they're just -- we call those out at separate line items, and we'll definitely do that when we talk to our second and third quarter numbers.

Operator

And our next question comes from Ravi Shanker with Morgan Stanley.

Ravi Shanker - Morgan Stanley, Research Division

In North America, you said that JSV [ph] production was a headwind in 1Q, probably driven by the Thailand impact. Do you have a sense of what that production ramp looks like over the next couple of quarters and if that's going to be something that helps you out from the industry in a big way?

Stephen A. Roell

You're talking about the replenishing of inventories in Japanese dealers and things.

Ravi Shanker - Morgan Stanley, Research Division

Exactly. Yes.

Stephen A. Roell

The only thing I can -- let me try if I understand the question right. If you look at the build schedules that we have, they're out there for the second, third and fourth quarter. They're up, I'm going to say, 8% in North America. But if you look at it, Ravi, to your point, there's some vastly different OE performance. Basically, the North American OEs are flattish to slightly down in the next 3 quarters. The growth is really going to be accruing from the Japanese suppliers. So Japanese exposure in the next 3 months should benefit those players, and we think we will because of that.

R. Bruce McDonald

Yes. I think, I only know -- I've got the Q2 outlook for us, Ravi. I don't have the Q3 and Q4. But if I look at the second quarter here, our second quarter, we're looking for the Japanese production to be up about 17%. So as I said in my comments, if you look at Q1, our sales to our Japan customers in North America were up about 4%. And as we look into the second quarter, we should start to see some benefit relative to the industry.

Stephen A. Roell

Yes. I've got a little more information, Bruce. I can tell you that if you look at the second half build, GM, Ford and Chrysler are all expected to be anywhere from 4% to 16%, whereas Toyota will be up 73%. So the growth in the quarter, in the second half, is almost -- it's all attributed to Toyota and Honda. A little bit to Volkswagen.

Ravi Shanker - Morgan Stanley, Research Division

Got it. And also, just quickly on the equity income, I think you cite in your release that the separator JV income was kind of onetime-ish in nature. So what kind of run rate can we expect for that line next couple of quarters?

R. Bruce McDonald

Yes. The balance, that was about $20 million, a couple cents a share. That was something that we knew about within our guidance. So that's the amount that's nonrecurring, Ravi.

Ravi Shanker - Morgan Stanley, Research Division

So what, $100 million would be regular [ph] going forward?

R. Bruce McDonald

Give or take, yes.

Operator

Our next question comes from Patrick Archambault with Goldman Sachs.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

I just had a question on pricing in seating. I guess, maybe 2 parts to it. Number one is how would you characterize the pricing environment? Number two, it sort of is notable that it sounds like you've had to bear the cost of some of these increased orders on short notice that have been put to you by some of your customers in an environment where production estimates seem to be going up and not down in North America. What kind of a measure do you have against continuing to sort of shoulder that kind of premium freight if indeed things went up a little higher? And in general, back to my first question, I can't help but notice that there was another large seating manufacturer at the Detroit Auto Show that also pointed to weak margins in the seating segment. I mean, is this an industry which still has capacity issues which is preventing the kind of leverage that you need to get the right kind of pricing for these contracts? Or have things changed?

Stephen A. Roell

Let me try, Pat, on both points. I guess, first of all, I would describe the pricing environment as not really changing, okay? It's pretty much what it has been for the last year. So I don't see any increased heightened pressure from our customers in that context. If I go to the item with metals, that's an unusual situation where you have 2 programs that take off the way they have and where we have to respond in that fashion. It just so happens that -- I wouldn't point it to capacity, although the plant that we had that was dedicated to those 2 facilities, we just undersized given the original expectations. That's unusual. That doesn't happen very often. But I wouldn't characterize that as a capacity issue in the industry or capacity issue that's going to impact us as we go forward. If demand continues to improve, we've got enough capacity throughout our organization now, particularly with the metals acquisitions to be able to respond and take advantage of it. So we would -- unlike what I described to you in North America regarding what we had to run into, I would say that we'll clearly benefit from higher volumes.

R. Bruce McDonald

Yes, and I would just -- maybe to help you out there, if you look at our longer-term guidance for Auto, it's 7% to 8% of ROI. That's what we're sort of looking for. And as we look at the new programs and the capital associated with new programs and our bidding activity, that's where they're coming in at. So when we look into our backlog, we feel confident that we can get there. I just think many of the issues that we're grappling with are too many of them, are things that we just got to do a better internal job.

Stephen A. Roell

Yes. I think maybe what Bruce is really saying, I want to maybe get close on the wrap up here, is to say that really, a lot of what we're experiencing are things that are under our control. We can improve this. We get the integration done, get that completed, we get the improvements that we're expecting from a quality perspective. When I talk to the leadership in the Automotive group, they're very confident about achieving those goals that we once set, which was being able to get to a 7% or 8% margin, get to a 25%-plus return on assets. That's still what we're marching to every day. And we do experience some of these hiccups and more so than usual recently, but we feel confident we're putting things in place to get the processes and the discipline what we need to be.

Patrick Archambault - Goldman Sachs Group Inc., Research Division

And if I could just ask one, just housekeeping one as a follow-up just on BE, you had -- I'm sorry if I cut you off in terms of Auto there, but I wanted to sneak this one in before the end of the call, in terms of non-res expectations, you had given out I think 1.5 in U.S. and 1.8 for Europe during your Analyst Day. Is there any kind of new outlook there that you can provide to us for that end market?

Stephen A. Roell

It's interesting. I would say it may have deteriorated a little bit, Pat, but not in the scheme of things, okay? And where I'd be looking to see that, it would be in the pipeline bidding activity and the fact that it's actually a little bit stronger than what I thought. I can't point to that being a factor at this stage.

Glen Ponczak

We're out of time here. Steve, do you have some final comments?

Stephen A. Roell

I think maybe to wrap up, just a comment. We recognize we had some certain short-term challenges. I've been involved in the C-Suite here for 20 years, and we've never guided lower except we pulled our guidance back in 2009. So this is sort of new for Bruce and I to go through and guide lower. We recognize the short-term challenges to our original expectations, but our fundamental growth story, it remains intact. We continue to invest to achieve our long-term growth. Our profit and margin are firmly our objectives, and that's what we're committed to. And that's really what we want to convey to you today.

Glen Ponczak

Okay, thanks everybody.

Operator

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

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

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

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

Source: Johnson Controls' CEO Discusses Q1 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts