Johnson Controls F4Q07 (Qtr End 9/30/2007) Earnings Call Transcript

Johnson Controls Inc. (JCI)

F4Q07 (Qtr End 9/30/2007) Earnings Call

October 23, 2007 11:00 am ET

Executives

Denise Zutz - VP Strategy, IR and Communication

John M. Barth - Chairman and CEO

Stephen A. Roell - Vice Chairman and EVP

Bruce R. McDonald - VP and CFO

Analysts

Pat Archambault - Goldman Sachs

Jairam Nathan - Banc of America Securities

Chris Ceraso - Credit Suisse

Himanshu Patel - JP Morgan

Rod Lache - Deutsche Bank

Jonathan Steinmetz - Morgan Stanley

Bryan Johnson - Lehman Brothers

Brett Hoselton - KeyBanc Capital Market

Presentation

Operator

Welcome and thank you for standing by. At this time all participants are in a listen-only mode. (Operator Instructions).

Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn over the meeting to Mr. Denise Zutz. Thank you. You may begin.

Denise Zutz:

Okay. Thank you and good morning everyone. We appreciate your joining us for us to review our Fourth Quarter Financial Results. Here this morning to talk with you is Steve Roell, our Chief Executive Officer.

Also joining us is Keith Wandell, President and Chief Operating Officer. Keith is going to be reviewing our business financial results for the fourth quarter, and also Bruce McDonald, Executive Vice President and CFO. Bruce will add his financial comments after Keith as well as Steve. We will then be happy to take your questions. We hope to conclude the call by 12 O'clock Eastern time.

Before I turn the call over the Steve, I do need to provide you with our Safe Harbor Statement, which indicates that Johnson Controls is making forward-looking statements during this call pertaining to our financial results for the year 2008 and beyond, that are based on preliminary data and are subject to risk and uncertainties.

All statements other than statements of historical fact are statements that are or could be deemed forward-looking statements, and include terms such as outlook, expectations, estimates or forecast.

For those statements, the company cautions that numerous important factors such as automotive vehicle production levels and schedules, energy prices, the ability to mitigate the impact of higher raw material costs, the strength of the U.S. or other economies, currency exchange rate, cancellation of commercial contracts, changes to tax rates, labor interruptions, as well as those factors discussed in the company's most recent 10-K filing dated December 2006, could affect the company's actual results and could cause it's actual consolidated results to differ materially from those expressed in any forward-looking statements made by or on behalf of the company.

And with that I’m pleased to give you Steve Roell.

Steve Roell

Well, thank you Denise, and Good morning. Before I begin, I'd like to acknowledge our employees, many of who are listening on the call this morning. I could just thank them for their contribution to our record results this year.

And at the same time I also acknowledge John Barth. John is retiring as many of you know, and this year is the last year of his leadership and certainly it reflects on his contributions to us and we want to thank John for his leadership over the years.

If I just look at 2007, I think that the results that we released this morning are consistent with the guidance that we've been providing to you. Our sales were up 7% to $34.6 billion, income form continuing operations was up 25% to $1.3 billion.

And I think if you look across to our market you'll see that we took share, our growth rates were higher than those of our competitors, largely due to our innovation quality and cost.

And I think the other thing I would point to again is the excess of our diversification in our business model. Those of you who would have the PowerPoint can look at the slide that shows our earnings. In that pie if you look at it, you'll see that Building Efficiency is now representing almost 50% of our earnings. That's basically because BE or Building Efficiency, their earnings in fiscal 2007 were up 56%.

In addition in terms of 2007, we delivered a well above average shareholders returns, using the year ended 9/30 of '07. Our one year total shareholder return was 67% compared to the SNP 16%.

In terms of the fourth quarter; again, consistent with guidance that Bruce had provided to you and he will give you more detail. Our sales of $9 billion were up by 11%, and earnings per share from continuing operation of $0.78 was up 26%.

Just a couple of highlights then in terms of the various businesses, if I start with Building Efficiency. Global market share gains in our HVAC equipment, particularly in our small chiller and large chiller segments. Our backlog a 40% increase in our Building Efficiency backlog to $4.2 billion. That’s consistent with the backlog that we needed to basically to support our 2008 guidance.

Many of you are aware of the fact that we were named as one of the four providers. Our performance contracting to participate in the Clinton climate initiative. That plays to our strength, where performance contracting has been a key of our success in terms of providing solutions to our customers.

And finally, a major residential HVAC distribution win, the most notable being the one we announced very recently regarding US Air, and the fact that they will be distribution Johnson Controls product, [York] product in Southern California.

Turning to Power Solutions. We have a number of major new OE and aftermarket batteries of customer wins this year. The ones that were most notable included Chrysler in North America, where we've won the remaining half of their business. The same is true of Daimler's business is Europe. We also won new business with BMV as well as with Volkswagon.

In the aftermarket side, probably the most notable win was a UK auto chain in Europe which we haven’t been able to name, but it's a significant win for us and it will provide upside for us in 2008 as well.

Also then in July we announced a strategic partnership with the number one automotive battery manufacturer and brand in China, Baoding Fengfan. That's strategic mark for us in terms of our entry into that market. As you know, we've been in that market since the acquisition of the Delphi battery business, and this will provide us further growth opportunities in the future.

In addition from a standpoint of '07, our involvement in hybrid plans increased significantly. We now have 12 development contracts for lithium-ion plug-in technology, and as we have announced previously we have two production contracts in hybrid technology.

Turning to Automotive Experience. As we announced couple of weeks ago in New York at the analyst meeting, our backlog looking at the 2008-2010 period is now at roughly $3.9 billion, an increase of 11% over the prior year. We also announce the fact that we were in several joint ventures which Chery to provide them. Multiple programs around seating and other interior [performance] in China.

And I think the other highlight for the year was certainly our sustained improvements in Europe. Europe was a major element of our 2006 performance and fairly in 2007 they continue to perform well. So now if I look forwarded to 2008 and beyond, lot of these or the comments that we made at New York analyst meeting, but just some of the highlights.

You know as we look we see a number of significant growth opportunities in each of our businesses, focusing on our things of comfort, safety and sustainability. We highlight those around energy efficiency and the environmental sustainability elements. Certainly hybrid vehicles as we look further out, automotive electronics is a key area of growth for us and emerging markets.

Also we are investing in new technology, around products and processes. That innovation is going to be key to our differentiation of our products as well as that for our customers. And our customer relationships continue to be one of our key focal points, which is how we provide value, and I think that’s demonstrated by the fact that we continue to grow with our major customers around the world.

I think one of our major differentiations from our competition is the discipline and the rigors we apply to our continuous improvement. Keith and I were on the phone earlier this week with over 750 of our continuous improvement leaders in a call on Monday morning with over 752 around the world. And that just really reflects just a small portion of the focus we have around that topic.

And then finally as Bruce will describe, we ended the year with a very strong balance sheet. We have the financial wherewithal to be able to continue to invest best in growth platforms, and we think that’s critical to us and again that’s a key differentiator for some of our competitors.

So with that I would like to turn it over to Keith, and he will review some of the business performance in the fourth quarter.

Keith Wandell

Thank you Steve and good morning everyone. I would like to provide a few data points around three businesses specifically related to the market environment, and then also some specific points about JCI's Q4 performance in each one of those businesses.

We will start with Building Efficiency. The global service market continues to grow around the world, and that’s a positive for us. We look at the North American construction market. The non-residential spending was up 19%, and the residential construction was down roughly the same number, about 19%. But the construction remains strong in all the key emerging markets around the world, and specifically for us in China and the Middle East.

Increased customer demand for energy efficient and green solutions is a global trend we are seeing more of. And also there is a global trend around the increasing demand for one-stop solutions; equipment, controls, and services. And specifically for JCI in 2007, our cross selling initiative generated about $200 million in incremental revenue, up from a 180 million in '06, even though that was a nine month number.

So we see the momentum continuing to increase in the one-stop shopping solutions. In terms of our specific Q4 performance, sales were up 15% from $3.1 billion to $3.6 billion. And in all global regions, both systems and services were up. Systems were up 20% and services 11%.

The North American residential market for us was down 8%, and roughly 65% of our sales in that segment are for replacement. Segment income was up 23% from $257 million to $360 million, driven by higher volume and really cost structure improvements that are underway, have been underway for sometime, specifically the branch network redesign for both North America and Europe.

It’s a process we started a couple of years ago, and it's really combining and streamlining our operations and providing new tools to improve execution and delivery in matching the right skill levels to every job.

Another cost structure improvement that has been underway and is paying dividends is our product standardization. When you look at our Air Cooled chillers, we have lieu from 15 to 9 platforms. In our water-cooled chillers, we’ve gone from 8 to 6 platforms, and our heat pump products have lieu from 10 to 7 platform.

So as we continue to consolidate our product engineering efforts and generate the synergies around that all the way through the supply chain paying dividends for us. In our manufacturing operations, we reduced our number of plants by roughly one-third around the world. We’ve consolidated operations, have driven productivity improvements. We’ve also implemented our BBP process which has been well established in battery and automotive now for some years, and we are seeing tremendous upside and benefits from those initiatives as well.

Our commercial backlog as Steve, mentioned is $4.2 billion up 14% with growth in all regions, and as I mentioned earlier specifically China and the Middle East. With regards to our commercial orders, we see strength in North America in our order activities, around healthcare, government and office buildings, as well as the rest of the world.

In our Power Solutions business, from a market environment perspective, the aftermarket demand is flat to slightly lower, and we've experienced even higher peaks for lead prices in Q4, where the Q4 average on the LME was about $3140 a ton, and this is a 164% increase over Q4, 2006.

We are seeing, as Steve alluded to, an increase in commitment and demand for hybrid technology from many of our OE customers. Over 20 hybrid vehicle announcements were made at the 2007 Frankfurt auto show. And Steve mentioned as well, we have 12 development contracts underway as well as three production contracts with hybrid vehicles.

Related to our specific Q4 performance in Power solutions, sales were up 27%. They were up from $1 billion to $1.3 billion. Roughly half of that was driven by increases in lead cost that we passed through on the sales line. There were also higher unit shipments specifically in Europe, driven by our OE customers, offset a little bit by the lower OE and aftermarket in North America.

Our Asia sales were up double-digits, as Steve mentioned we gained a foothold in Asia year and a half ago with the Delphi acquisition, and we continue to expand our operations there.

From a segment income perspective, we were up 7% from a $150 million to a $161 million, again driven by the improving operational efficiencies in our Power Solutions business as well as the higher volume. Lead, the increases in lead did have a negative impact to our margins.

In our Automotive Experience business from a market environment perspective, the industry vehicle production, North America was up roughly 4%, while cars were down 2, light trucks were up about 8%. Europe was up an estimated 3%, Japan down 9, and China up roughly 25%. We are also glad to see that the commodity prices with regards to steel, foam, chemicals and resin has stabilized toward the latter part of this year.

In terms of our Q4 performance, sales were up from $4 billion to $4.2 billion, up about 3%. In North America, sales were up 2%, while our sales for the Detroit 3 were slightly lower. That was offset by higher sales to the transplants in North America. Europe was up 5% and China on an unconsolidated sales basis was up 48%.

Our segment income was up 24% from a $148 million to $183 million, really driven by the strong performance that we've seen North America. You know a few years back we had a turnaround that we promised in Europe; deliver that. North America recently we promise to turnaround and we are in the process to delivering that. We feel real good about the work that's been done there.

Europe, Steve mentioned had a continued strong performance and a nice five year trend there, and Asia was flat as our growth investments in China that Steve talked to related specifically to the Chery orders, masked the underlying improvements that are occurring in that area as well.

With that I would to turn it over to Bruce McDonald.

Bruce McDonald

Okay thanks Keith and good morning everybody. Just starting up on Slide 9, I'll just we reiterate that we are extremely pleased with our record earnings here in the fourth quarter, which came in at the top end of the guidance that we provided three months ago.

Reflecting on both our business diversification, our geographic diversification and the successful implementation of number of our growth strategies, our sale increased by 11% to $9 billion. If we exclude them at the foreign exchange and you can see on the slide, we topped the Euro for the quarter averaging about $0.10 higher than last year. Then underlying sales growth was about 6%.

We are pleased to see the 15% growth that Keith talked about Building Efficiency, reflecting both the positive economic environment of the markets that we are operating in, and also the investment of some of the growth initiatives, cross selling in particular.

As we talked about earlier Power Solutions have 27% sales increased, ex-lead that would be about 12% versus 2006 on a year-over-year basis. And then in automotive we saw 3% sale growth, although if you back out exchange, we actually were down 2%.

Despite the fact that production volumes were up in the quarter, we actually saw negative year-over-year growth really as we exited some models earlier in the year, but also our overexposure to the light truck and SUV sectors in North America we have higher content per vehicle.

If you look at our gross profit line, you will see the 50 basis point improvement to 15.8%, and as we talked about the last couple of quarters anyway, in that material economics were really not a factor in terms of the year-over-year perspective. On a short term basis, our commodity hedging programs are working as we designed them to; and it's really helping us to insulate us from the run up in the lead prices that Keith talked to in his section.

Lead; the main issue for us in lead is the volatility on a short term basis, and we saw a lot of that in the fourth quarter where prices just in the quarter alone escalated by 30% and we ended the year at about $3450 a metric ton.

Looking at SG&A expenses, we are up about 7% versus 2006, we back out the impact of foreign exchange and take in the consideration of about $40 million higher net engineering cost, than our underlying SG&A levels were basically flat versus the year ago.

We did increase our SG&A levels to fund some of our growth initiatives in Building Efficiency. Generally speaking those were offset by reductions as we scale down our cost space on the auto side of our business. You see equity income in the quarter is basically been consistent with the level that we’ve been running at over the last couple of quarters, but it’s a pretty significant reduction versus the exceptionally strong $40 million that we recorded in 2006.

What we are really seeing in here is three things. One, some higher launch cost in some of our North American joint ventures with supplier or transplant customers, higher levels of engineering expenditure or hybrid joint venture with [fast], and then we have a couple of equity accounted for joint ventures in Power Solutions in Asia and Saudi Arabia in particular, and those businesses suffered, we don't hedge in those businesses, and those businesses suffered from the volatility and lead in the quarter and we expect that to come back here.

For the quarter, as Keith talked about, our Chinese joint ventures were essentially flat on a year-over-year basis with improved performance that our matured joint ventures offsetting start-up investments in five of the new JVs we formed this year. As we go forward into next year, we do expect to start to report positive year-over-year comparisons in our equity line, as a result of the China investments coming on stream.

And then lastly just looking at segment income of $660 million, a 50 basis point improvement in our margins and that sort of gives us constants tow guidance that we've given for continued improvement in 2008.

Looking to Slide 10 then. You see net financing charges drop from $77 million to $68 million; a $9 million reduction really as a result of lower year-over-year borrowings. If you look at interest rates, the interest rate environment was roughly consistent with last year on a global basis.

Looking at the tax lines. We had a reported tax rate of 21%, which was consistent with our guidance and the same rate as last year. If you note in the detailed notes, the financial statements that were with our earnings release, we did have three non-recurring items flowing through our tax provision in the quarter, but on overall basis these numbers netted out to nothing. So there's a pick up in the two charges and they netted out to zero in that line. So we've reported a clean 21% from an overall basis.

And then if you just look at the trend that we've seen over the last couple of quarters, you will see minority interest was actually an income item for us in the quarter. That basically means that we're making lots of money in our joint ventures on a year-over-year, and now that’s really due to the consolidated joint ventures what supply to Tundra in Texas and launch cost Sheriff's office of our consolidated Southeast Asian operations.

We also have a consolidated battery joint venture and we saw diminished profitability in that as a result of legs and recovering lead prices. And then lastly, if you look at earnings per share $0.70, up a pretty respectable 26% versus last year.

Just looking to our balance sheet, you will see may be the first thing to point out would be that we had cash on hand of about $650 million, which is something that we usually don’t have. To just point out that at the end of the year we had repaid all of our commercial papers, so we had no short-term debt readily available to pay down.

And from an economic perspective it just makes sense for us to stockpile cash in advance of two bonds that we've got maturing in the second quarter of this year, $500 million in January and $175 million in February. That you’ll see again in Q1, we’ll have elevated levels of cash, and after that we’ll return to sort of normal cash levels for us which are about $200 million.

If we therefore net cash against the total of debt; we ended the year with a net debt-to-total capitalization of about 29.7%, which was in line with the guidance that we provided at the beginning of the year. Overall, we paid down about a $700 million of net debt in the year, and exited the year $3.8 billion of borrowings.

CapEx in the quarter was $241 million building a reinvestment ratio versus our depreciation and amortization of 1.1:1. Most of the capacity projects that we had in place for Power Solutions have come in on-stream as was expected. And as we talked about at our analyst meeting in New York a couple of weeks ago, we do expect CapEx to trend down to about 1:1 in 2008.

We had good working capital performance in our fourth quarter, really reversing the disappointing result that we saw in Q3. And if you look at our working capital performance for a full year, we generated about $200 million of cash from working capital despite the 7% increase in our top line.

I would also like to point out and it shows up in one line item of our cash flow here, that our deleveraging was accomplished even after we made a $200 million equity investment in the U.S. Airconditioning joint venture, and after the adoption of [FAS 150] pensions.

Now as you will see in the notes to our financial statements, our FAS 158 charge to equity was about $75 million. That really reflects the robust level of funding that we have in our defined benefit plans. Just looking in to the outlook for 2008, we are not making any changes as I am sure you would expect. We are forecasting 10% sales growth next year to approximately $38 billion.

Our earnings per share guidance of 245 to 250 is an 18% increase over this year, excluding a one time tax items. We expect to see interest expense drop by about 40 million. So it’s the continuation of the sort of the trend that you saw at Q4, and we are looking for tax rates to be equal to this year 21%. And from a balance sheet perspective or cash flow perspective, we are forecasting free cash flow in the 1.1 to 1.3 billion range.

If we just turn to Q1, we talked a little bit about this in our New York meeting, but just to give a little bit more clarity. We are forecasting earnings per share of 35% to 37%. Take the midpoint. Sorry $0.35 to $0.37 per share. Take the midpoint there, that's roughly 28% to 29% year-over-year growth. So, we are expecting to start off the year very strong.

Our earnings growth is front-end loaded next year, really driven strong top line performance in Building Efficiency and a continuation of the recoveries that we've seen in our North American automotive operation. So you'll recall last year we had about a $50 million loss in Q1, we expect our North American automotive business to be slightly profitable here for the first quarter. So those two factors really drive a strong start for 2008.

And with that I'm going to turn things back over to Steve Roell.

Steve Roell

Sure, thanks Bruce. Well then just to summarize. In terms of the '08 outlook, as we indicated at the Analyst Meeting in New York, we have great momentum in all three of our businesses going into the fiscal 2008 period. On Building Efficiency side, we’ve got a high rate of growth, guess it should continue for us.

We ended the year with a strong a backlog. Keith reviewed the cross sale synergies that we are seeing still from the transaction with York, and we expect that to continue. But more importantly, I think we see growth across a wide variety of geographies in 2008.

Cost structure optimization which Keith also talked about is critical to our earnings improvement and our margins expansion of 2008. On the Power Solution side, it’s a business for the reoccurring revenues with profitable growth. We expect to continue to gain share in Europe and Asia, and we certainly continue to benefit from some of the investments we made in capacity in the past year.

Automotive experience sustained recovery particularly in North America, but the turn around continues. We’ve highlighted the fact that we expect to see margin expansion in the next three years. In Europe, the profitability that we’ve established, we expect to be sustained in Asia. We expect to see some continuing improvement there in Asia, as we talked about, as Bruce highlighted some of the improvements in our joint ventures in equity investments in that market.

So with that, we would expect 2008 to be a period where we would continue our track record of profitable growth, it would represent our 62 consecutive years of sales increases and 88 consecutive years of earnings increases. So we look forward to 2008 and we'll now turn over to you for questions. Jeremy?

Question-and-Answer Session

Operator

Thank you. We'll now begin the question-and-answer session. (Operator Instruction). First question today comes from Robert Barry with Goldman Sachs. Thank you, your line is open.

Pat Archambault - Goldman Sachs

Hi, it's Pat Archambault here, actually

Steve Roell

Hi, Pat.

Pat Archambault - Goldman Sachs

Good morning, a couple of quick ones on the backlog. It looks like indeed your billing efficiency backlog was up year-on-year, but it was down slightly on a sequential basis, and I was just wondering if you could give us a little bit of color on how we might interpret that?

Steve Roell

Sure. If you look at our execution on our backlog over the years, typically, our fourth fiscal year is a very strong period of execution. So, typically we would expect to see quarter-over-quarter between third and the fourth, be it period of either flatness or down. And so that’s one a typical. That’s pretty much the cycle that we go through. The key is the fact that we are up [40%] year-over-year. That’s a better reflection. Okay.

Pat Archambault - Goldman Sachs

Okay. And that makes sense. And in terms of the new orders in Building Efficiency as well. Can you give us any kind of quantification on how those are tracking?

Steve Roell

The orders were strong. We saw particularly in some of the international markets in the last quarter, and I guess also from a system’s standpoint, Keith highlighted that I think in his comments. The other thing we look at, which we don’t talk about, we don’t disclose the numbers is what we see and what's called a pipeline. And that’s really the activity that is actually preceding our orders secured. So it’s really worked that we are quoting at this point of time. And we've got a window of that and Keith and I have reviewed that.

And if we just look as an example of the North American new construction activity, we have looked at 15 vertical markets and every one of those were up year-over-year. And so, I think that lays to rest some of the concerning that we are hearing out there regarding concerns on the new construction market in the US. But we also feel comfortable given the growth that we see in the international market. So that combination gives us confidence for 2008.

Pat Archambault - Goldman Sachs

Is it growth rate that’s up but perhaps papering off a little bit in North America or is it kind of keeping pace with what you've been seeing in previous year?

Steve Roell

No, I think it’s same pace. I don’t think there's anything we would point. You know there are different elements that are growing at faster rates. I think if we looked at it, we saw a good growth typically in healthcare side. And surprisingly, the manufacturing sector was the other one that that I would tell you we probably would not have expected.

Pat Archambault - Goldman Sachs

Would you characterize that as being kind of a function of your client base which are may be doing a little bit better than the average, or is that something like you think is characteristic of the market as a whole?

Steve Roell

Well if we look at our client base, we are more heavily weighted towards the school education, (inaudible), healthcare, office buildings probably not as much of manufacturing certainly not in lodging and retail. So as you think through some of the things you are reading about Dodge for 2008, some of the markets that are weaker we have highlighted particularly lodging and retail. We don’t have that higher penetration in. So may be to that extent, but then I think that we are seeing it broad based. Here's an example office market vacancy, office building vacancy right now, it’s at a very reasonable rate. I think it's 12.5% to 13%, and that’s pretty - there's no issue there.

Pat Archambault - Goldman Sachs

Okay, and just a last quick on batteries. I mean, even though margins are under pressure from an absolute point of view, my understanding is you've definitely been able to hedge raw material cost either through pass-through arrangements or I guess official hedging program. I mean, at what point does this inflation become a problem where I can actually start to eat in to the absolute level of profitability on a per unit basis? Is that something that could happen if the pace of inflation keeps up?

Bruce McDonald

Well it's hard Pat. It's Bruce talking. I think what we've seen so far is because lead is such a large percent of the cost of a battery like in excess of 70 right now, our competitors are generally, in a fairly weak financial position from a global perspective, and I think there's been a lot of discipline in the marketplace, passing on lead price increases to the end consumer.

And I guess our expectation is that that's going to continue. I would tell you though, we are probably seeing what the level of the cost reduction -- the cost increases that we are passing through. I think we are seen our customers put a little bit more emphasis on their inventory level and de-stocking to some extent which we think is sort of a factor in the market being down slightly here this year.

Pat Archambault - Goldman Sachs

Okay I got it. All right thanks a lot guys.

Steve Roell

Thanks.

Operator

Next question comes from Jairam Nathan with Banc of America Securities. Thank you, your line is open.

Jairam Nathan - Banc of America Securities

Hi thanks. If I look at your automotive experience margins, it looks like you probably did like 6%, like maybe 7% margins in Europe this quarter, and 2.5% in North America. And I'm just kind of thinking if that is higher than what you've guided to for the whole year? And just wondering why can't this be sustainable or are there any one-time stuff in there which you think that's going to sustain next year?

Bruce McDonald

If I sort of look at our margins by geography, I think some of the - your numbers are little bit off there. For the fourth quarter, our margins for auto in North America were just a bit over 4%, our European margins were 5.4% okay, so it’s not quite as pronounced as you indicated.

North America we had an exceptionally strong quarter. There were a number of commercial settlements. We’ve made a lot of progress in terms of taking down our cost base and as we’ve talked about before, by looking our auto business, we generally give away or start the fiscal year giving away our price reductions effective in the beginning of our fiscal year October 1 and then our cost reduction activities tend to ramp up over the course of the year.

So if you look at our historic margins in North America, you typically see Q1 being the weakest and we sequentially improve. So you can't really look at Q4 and sort of fast forward into Q1 and say what are the changes?

I guess the other point I would note is, there tends to be some shut down there around Christmas and in the first quarter of our fiscal year, and that's a factor as well.

Jairam Nathan - Banc of America Securities

Okay. And lastly on the cash flow, you seem to have a benefit from accounts payable and accrued liabilities. I was just wondering is that mostly lead related, and how should we think, do you give a lot of that back next year, or in 1Q?

Bruce McDonald

Well, I would say there are a few different things flowing through there. So if we just look at for the full year now, clearly that's the elevated levels of lead impact on receivables inventory and payables. And we think that probably $200 million to $250 million would be in a sort of year-over-year impact in accounts payable.

The balance of the improvement that we saw within that lined items really represents our effort to standardize payment terms. I mean, we stock four of our taken our BBP sort of initiatives and really looking at that and trying to fly that to our working capital management and the initiatives that we have there we are really trying to standardize our payment terms in some of our businesses when we looked at the different payment terms we had; we had maybe 50 or 60 different terms and we'll try to standardize those.

We've also gone into Europe and particularly in building efficiency business most notably and where you looked at our payment terms by country and trying to align countries like say, in Italy where we would generally speaking of AR terms of 100 plus days and making sure that we had days payable consistent with that and there was a big mismatch, so that’s been an initiative that we've really been driving all year.

So, I guess I'll tell you to kind of make a long story short, here is where we really pushed the accounts payable line. We've done a good job getting to the level that we actually at year-end. We don’t expect to see sort of a magnitude of this going through into 2008, but we don’t expect to give it back either.

Jairam Nathan - Banc of America Securities

Alright, thank you.

Operator

Next question comes from Chris Ceraso with Credit Suisse. Thank you, your line is open.

Chris Ceraso - Credit Suisse

Alright, thanks. Good morning.

Steve Roell

Hi, Chris.

Chris Ceraso - Credit Suisse

A few things, first, I guess on the margins in the building efficiency business if my math is right, it looks like you came out at the low end of your range for the full year versus 6.7.

Steve Roell

Yeah.

Chris Ceraso - Credit Suisse

And it did come in a bit softer than we thought it would for a quarter, was there anything that held you back there, is it function of currency or was there something that came out a little bit softer than you thought it would be in a quarter?

Steve Roell

Well we had a strong lot of sales growth in GW, I'll answer that in a little bit dilutive for us. I mean, the only thing of note we had there was we didn't take up the (burn) cash right up of about $10 million in the quarter for a technology investment that we made as equity investment and technology played sort of different panel, we rose that investment off which was about $10 million that will be the only two things I could think of, Chris

Keith Wandell

I guess, so it would say, I think that our personal residential business is a little bit softer than we thought coming up the quarter. That was interest rate to be how much of business portion in the quarter ended?

Chris Ceraso - Credit Suisse

Okay, alright that makes sense. Can you clarify the comment that you made about equity income and what you expect for the year, did you say that we started seeing positive comparisons versus '07?

Bruce McDonald

Yes, we’ll start to see positive year-over-year comps in '08.

Chris Ceraso - Credit Suisse

I am sorry, '08 versus '07.

Bruce McDonald

Yeah.

Chris Ceraso - Credit Suisse

And that’s starts in the first quarter?

Bruce McDonald

Yes.

Chris Ceraso - Credit Suisse

Okay. What was the decline in D&A on the cash flow versus where you have been running at around 180 drops that closer to 160?

Keith Wandell

I don’t know; it's off the top of my head.

Chris Ceraso - Credit Suisse

Okay.

Keith Wandell

I mean if I look at the year we are up about $25 million, so I can't think of that, it's off the top of my head. I mean, one of the things I guess, I can think of from last year is we were amortizing New York back some of the New York intangibles of specifically associated with the backlog and that’s behind us now, so we have some amortization probably $6 million or $7 million in a quarter that’s not their year-over-year, but the rest of it I get this just a little bit of noise in there.

Chris Ceraso - Credit Suisse

And for the full year D&A, are you thinking about 750 is at the right number?

Keith Wandell

For next year?

Chris Ceraso - Credit Suisse

For '08?

Keith Wandell

Let me get back. I don’t know what that number is off top of my head. I think it might be a little bit higher than that.

Chris Ceraso - Credit Suisse

Okay, and then last one on the taxes. You've talked about the 21% and how you get there. What are you running on a cash basis and what's the expectation for '08 in terms of cash taxes?

Keith Wandell

On a cash basis our tax is running slightly below 21%, and we expect that to continue.

Chris Ceraso - Credit Suisse

Okay, great. Thanks a lot.

Keith Wandell

Okay.

Operator

Next question comes from Himanshu Patel with JP Morgan. Thank you, your line is open.

Himanshu Patel - JP Morgan

Hi. Good morning guys.

Steve Roell

Hi Himanshu.

Keith Wandell

Hi Himanshu.

Himanshu Patel - JP Morgan

Two questions, first you mentioned the number of commercial settlements in the North American auto business in the quarter. Can you sort of quantify how big that was?

Steve Roell

Himanshu, there is no misunderstanding. Those are typical. Still, we don’t make you think of that's unusual. If you look at every quarter in the fourth quarter of our fiscal year in automotive we have those commercials. That's not unusual. We don’t want to mislead you on that okay.

Himanshu Patel - JP Morgan

Was it dramatically larger than the year ago level?

Keith Wandell

Now this is Keith. It was lower. We probably had the quietest into Bruce's point and Steve's point there are always commercial issue resolutions at the end of the year. It was probably the quietest year-end that we've had in sometime.

Steve Roell

That explains part of the cyclical nature of the months. Okay, the business plan.

Himanshu Patel - JP Morgan

Okay, and then it sounds like you exited this year at sort of a low 4% margin in that business and the full year was about 1%. You guys, I think you have talked about 100 bips of margin improvement every year on that. That comment just seems fairly conservative now. Fiscal fourth quarter has a seasonal drop on the production perspective. You are already doing 4% margins right now. Is it unreasonable for us to think that by '09 the business could be back at the 4% to 5% margin level?

Steve Roell

Yeah, I think the guidance we gave out New York was for the total business. Right, that had maybe the 5% in two and three to five years, right. So, I think everybody feeling really good about the business and how it's summoned around. However, every year has its issues, right, the unexpected things so the guidance we’ve given you what we think is our best view not necessarily conservative and it's not aggressive but it’s our best view.

Bruce McDonald

I guess if you think about it Himanshu, we’ve talked about Europe margins been fairly flat here for next couple of years at the level that they are at now which is just a bit over 5%. I think they are going to learn a launch activity and most of our backlog growth is skewed to Europe in '010 so that business going to stay pretty flat and that's obviously the biggest source of earnings right now North America we was talking about that business tripling in probably next year.

I would tell you the absolute Q4 little bit better than we were expecting here, but we feel real good about that business picking up sequentially here. Then Asia, for the year roughly a breakeven for us and again that's when we expect to see some small improvement but the just the size of North America, sorry, Europe being flat it kind of mutes the overall margins for us.

Himanshu Patel - JP Morgan

No, I get that but, I think your comments earlier were that just in North America interior business would see a hundred bips per annum of margin improvement and that sort of squares to a 3% margin in '09 and you just exited '07 with North of a 4% margin in your --

Keith Wandell

I don't know how we can caution anymore Himanshu that you can use the fourth quarter that's all I can really suggest, okay.

Steve Roell

Yeah, the other issue like just for the understanding everyone listening, the other issue in addition to what Bruce discussed why you can't really look sequentially in this business relative to margin is that typically fourth quarter is when we typically experience a lot of engineering recoveries with our customers. So we have those discussions go on and so that recovery where it tends to be lower in the first part of the year and tends to be higher in the fourth quarter too.

So that’s another factor that makes fourth quarter a little bit more advantaged.

Himanshu Patel - JP Morgan

Okay, then separately in the GM labor contract there were some talk about potentially considering in-sourcing certain businesses have you guys sort of thought that through or is that not something that even concerns you guys right now?

Bruce McDonald

Well, I don’t think that, at least in terms of the business, that we're associated with that. We think there is a major concern with the in-sourcing of either seeds or interior components. That would be a very difficult thing obviously, for any customer to do that is sort of (unbound) that over the last several years. We just need to stay focused on been a good supplier and having good relationships and delivering best value to the customers that we can I think that we should be okay in that area.

Himanshu Patel - JP Morgan

Okay and then, Bruce, I think you had mentioned $40 million of higher net engineering cost in the quarter what -- was that sort of an aberration and how should we think about that for 2008 in the SG&A line?

Bruce McDonald

Well we've talked about - there’s been higher and higher level of engineering cost in '08 it's because we've done a lot of platform sort of turning overheads really skewed towards the Europe.

Himanshu Patel - JP Morgan

Got it, okay. Great, thank you.

Keith Wandell

Thank you, Himanshu.

Operator

Next question comes from Rod Lache with Deutsche Bank. Thank you, your line is open.

Rod Lache - Deutsche Bank

Hi everybody.

Keith Wandell

Hi Rod.

Rod Lache - Deutsche Bank

Just a follow-up on that last question on the engineering spending have you given any color on what your overall SG&A outlook is for '08, the percentage of sales or any other context?

Bruce McDonald

No we haven’t.

Rod Lache - Deutsche Bank

Can you?

Keith Wandell

Right now we are not prepared Rod. We don’t have any information here.

Rod Lache - Deutsche Bank

Okay. A couple of questions on the building efficiency, did you provide the impact of FX on the top and top line and operating profit line?

Bruce McDonald

No, we didn’t Rod but we can do that.

Rod Lache - Deutsche Bank

Okay.

Bruce McDonald

I mean…

Steve Roell

Rod, max it was up 12% in the quarter, so we reported 15 FX it would have been 12.

Rod Lache - Deutsche Bank

Okay. And on the operating profit line, is it pretty…

Bruce McDonald

Marginal.

Rod Lache - Deutsche Bank

Okay.

Bruce McDonald

Marginal difference.

Rod Lache - Deutsche Bank

Alright and just looking at the backlog, can you give us any color on the composition of the backlog? I assume it’s shifting a little bit away from services and is that diluted to the margins going forward?

Steve Roell

Well the reason -- there are two questions, so let me go back. The first one is, if you look at the backlog itself it’s really shifted towards systems, but remember, that we don’t run our services through the backlog, I mean our truck-based services not run through there. So I just want to be careful how I will answer your question.

Bruce McDonald

No it’s a [quick way] solution to that.

Steve Roell

Solution to that, yes.

Rod Lache - Deutsche Bank

Okay, so the backlog is shifting towards systems and then what’s the implication of that you are relative to your backlog as relative to your margins?

Bruce McDonald

Our margins and our backlog are generally up.

Rod Lache - Deutsche Bank

Okay. And then can you just comment on that, that $500 million of perspective cost saving that you've been talking about on building efficiency and, I think you said a third kind of have that roles in over the next couple of years. Is that lumpy at all, over the course of '08 or does that come in pretty steadily and how much of that cost savings would you allocate to SG&A when you kind of look at how the numbers flow?

Steve Roell

While, first of all, the savings tend to sort of increase as the year goes on because the way we layered into the plan, I mean, we layered in that way because obviously, there's few who were in the first month and then what you gain in the first month carries over in the second month etc.

But clearly, we have a better view of what our performance gaps are in each one of our businesses. We feel pretty confident that we have a very clear roadmap and path that when we lay those numbers in then we have a fair path to get there. So we feel pretty confident and not only in building efficiency, but in all of our businesses and quite frankly, he was talking about automotive a lot and that's by and large part of the reason why we had improved margin in that business as well because these are the fruition of the efforts so its been put in place over the last couple of years here.

Keith Wandell

Thinking in terms of your other question about where did they flow out, I mean, I don't have that here, but some this have been little more with flow through SG&As and auto which tend to be more sort of manufacturing cost. Here at some does spoke through the SG&A line items, well but I don't have that split.

Rod Lache - Deutsche Bank

Okay, great and just to clarify, obviously, the savings that increased over the course of the year. As you execute on more and you don't lose what you've already accomplished but from an external perspective should we be thinking that we got maybe $150 million of savings it's around 30% and that's $37 million a quarter, or does that ramp significantly, so that it's kind of back half weighted.

Keith Wandell

We are looking at each other, trying to answer the question. I think only what we can describe to you is that, it will be back-end. But a few things, can he just build as the quarter points out, okay.

Rod Lache - Deutsche Bank

Okay.

Keith Wandell

[There's way out].

Rod Lache - Deutsche Bank

Aright, thank you.

Operator

Next question comes from Jonathan Steinmetz with Morgan Stanley. Thank you, your line is open.

Jonathan Steinmetz - Morgan Stanley

Thanks, good morning everyone.

Steve Roell

Hi, Jonathan.

Jonathan Steinmetz - Morgan Stanley

Hi, just a few follow-ups here. I don't want to be the dead horse on the North American auto margin item, but I guess the question I would have, sequentially was there any restructuring incrementally that would have sort of shown, sort of shine through in the fourth quarter or they didn't show in the third? You mentioned also engineering, I'm just trying to hand on what these items could have been because I thought a lot of the restructuring really was in sort of the back half of last year beginning in first part of this year?

Steve Roell

No, that's been continuing to flow through and we also have programs drop, dropping off but sort of whole economics and few ones come in. I guess the best way to look at it is if you look at the business on full year to full year perspective. The North American automotive margin is by 1% and we've talked about that business, tripling in profitability next year.

I want to tell you is North America came out a little bit stronger than we have expected here in the fourth quarter and I think that will be a challenge for us to triple that but, we will see big margin growth in that side of the business. It just when you ran out of the whole of automotive with Europe staying flat, you get lots of margin pumping, you think from an overall perspective.

Jonathan Steinmetz - Morgan Stanley

Okay. Switching to…

Steve Roell

Just think in the Q1 as I said in my comments. In last year in Q1, we lost just a shade over $50 million and this year we're guiding in Q1 to a smaller profit. So, we’ve got, say a $50 million year-over-year improvement but we were not going to be, I mean, our margins are going to be less than a full year in the first quarter.

Jonathan Steinmetz - Morgan Stanley

Sure. Okay. Switching to the lead issue, are you seeing any ramifications down stream? I would imagine demands is pretty inelastic, but are you seeing yet any mix-shift, and if you did see that, is that a negative for you, meaning are some of the higher price batteries, substantially more profitable?

Steve Roell

We really haven’t seen any mix shift, we have seen an increase in sales in both of our, what we call least tech product in Germany are in Europe, which is a very high priced and high margin product and as well as Optima. So, we really haven’t seen any deterioration there.

Keith Wandell

No, I guess, Jon that’s a great question, you would expect that. But, I’m just saying if a couple of customers we’ve met with, and we haven’t seen that mix shift.

Jonathan Steinmetz - Morgan Stanley

Okay, lastly, just house keeping, I think you gave FX translation on EBIT for building efficiency. Do you have it for the company as a whole? I think you gave revenue but do you have the operating profit line?

Bruce McDonald

It was about, if you look FX versus last year, in the quarter it was $0.02 or $0.03.

Jonathan Steinmetz - Morgan Stanley

Okay, thank you very much.

Operator

Next question comes from Bryan Johnson with Lehman Brothers. Thank you, your line is open.

Bryan Johnson - Lehman Brothers

Hi, I have got some related questions around the interplay between equity income and minority interest. First, in terms of your backlog, total was 3.9, what’s the consolidated backlog in autos versus unconsolidated?

Steve Roell

Of the 3.9, this is Steve, the consolidated is about 2.9.

Bryan Johnson - Lehman Brothers

Okay and what's the geographic split within that?

Steve Roell

Roughly, we said it’s heavily towards Europe. Let me give you just a rough break out. I’ll give you five break outs okay. North America and consolidated is about 950, North America and non-consolidated is about 75, Europe and I'll just go back to what you have been hearing from Keith and Bruce about the engineering is 1.325 million in that three year time frame. Asia consolidated is about 625 and Asia non-consolidated is 925.

Bryan Johnson - Lehman Brothers

Okay.

Steve Roell

Bryan, going back to your first question if you look for the non-consolidated it’s a 925 for Asia and about 75 for North America.

Bryan Johnson - Lehman Brothers

Okay and what about the cadence for that across '08, '09 and '010?

Steve Roell

Well I am sorry, cadence is between…

Bruce McDonald

He is asking breaking out the 39 across '08. '09 and '10.

Steve Roell

Oh, I am sorry. I can do that. It’s roughly 0.9 is '08, 1.5 is '09 and 1.5 for '010.

Bryan Johnson - Lehman Brothers

Okay and should we be thinking about most of the Asia and all of the Asian growth being in the JVs and that hence, consolidated revenue is in something that we will be looking at?

Bruce McDonald

Correct.

Steve Roell

That’s correct.

Bryan Johnson - Lehman Brothers

Okay it seems to be declining. The second is when we go to minority interest down year-over-year, does that reflect things moving from one column into from minority interest and equity income?

Steve Roell

No, no. There is none of that.

Bryan Johnson - Lehman Brothers

So what we should be thinking about for minority interest for next year?

Steve Roell

We are looking at minority interest for next year been in around $40 million to $50 million range.

Bryan Johnson - Lehman Brothers

Okay and the final question is in the other investments non-acquisitions you had a 200 so million cash flow out, is that that distribution JV for our residential air conditioning you have been talking about?

Steve Roell

Yeah, if you look on other you’ll see a line item in here under investing other net this is outflow of $260 million, $200 million of that are investment in the US air conditioning joint venture.

Bryan Johnson - Lehman Brothers

Okay, and so when do we start seeing operating income and unconsolidated revenue from that coming through?

Steve Roell

Well, that will show up Bryan, as equity income because the less than 50% and we will have a couple of quarters where we have some acquisition. We are going to have to eliminate our profit on the initial stocking and things like that. So, couple of quarters it will be not a heck of a lot there but we will kick-in in the second half.

Bryan Johnson - Lehman Brothers

Okay. Thanks.

Denise Zutz

I think we have time for one more question operator.

Operator

Today's final question comes from Brett Hoselton with KeyBanc Capital Market. Thank you, your line is open.

Steve Roell

Hi Brett.

Brett Hoselton - KeyBanc Capital Market

Hey folks, how are you today?

Steve Roell

Good.

Brett Hoselton - KeyBanc Capital Market

Let's see. I am not sure how far you are going to be willing to comment on this. You've talked a bit about acquisitions and my question is there is quite a number of acquisitions, potential acquisitions circulating or discussion about them for example, the VISTION electronics business, Goodmann Global, some ideas about Linux or possibly trains putting up and so on and so forth. I guess what I am wondering is, would you be willing to take any of those and suggest or state that you have no interest in any of those four that I have mentioned possibly?

Steve Roell

This is Steve. I think what we did at the New York Analyst Meeting was give you sort of the areas where we have interest, peers and categories. But we would never comment on a company, okay.

Brett Hoselton - KeyBanc Capital Market

That's very fair. Okay, thank you.

Steve Roell

Thank you very much

Denise Zutz

Okay, thank you everyone for joining us, we appreciate your attention and all of your questions this morning. If you have further questions please feel free to give me a call or Glen Ponczak. Thank you very much.

Copyright policy: All transcripts on this site are copyright 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.