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

Oct.23.07 | About: Johnson Controls, (JCI)

Johnson Controls Inc. (NYSE: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

JonathanSteinmetz - Morgan Stanley

Bryan Johnson - Lehman Brothers

Brett Hoselton - KeyBanc Capital Market

Operator

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

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

Denise Zutz:

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

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

Before I turn the call over the Steve, I do need to provideyou with our Safe Harbor Statement, which indicates that Johnson Controls is makingforward-looking statements during this call pertaining to our financial resultsfor the year 2008 and beyond, that are based on preliminary data and are subjectto risk and uncertainties.

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

For those statements, the company cautions that numerousimportant 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, laborinterruptions, as well as those factors discussed in the company's most recent10-K filing dated December 2006, could affect the company's actual results andcould cause it's actual consolidated results to differ materially from thoseexpressed in any forward-looking statements made by or on behalf of thecompany.

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 callthis morning. I could just thank them for their contribution to our recordresults this year.

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

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

And I think if you look across to our market you'll see thatwe 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 theexcess of our diversification in our business model. Those of you who wouldhave the PowerPoint can look at the slide that shows our earnings. In that pieif you look at it, you'll see that Building Efficiency is now representingalmost 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 aboveaverage shareholders returns, using the year ended 9/30 of '07. Our one yeartotal shareholder return was 67% compared to the SNP 16%.

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

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

Many of you are aware of the fact that we were named as oneof 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 oursuccess in terms of providing solutions to our customers.

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

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

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

Also then in July we announced a strategic partnership withthe number one automotive battery manufacturer and brand in China, BaodingFengfan. 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 furthergrowth opportunities in the future.

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

Turning to Automotive Experience. As we announced couple ofweeks ago in New Yorkat the analyst meeting, our backlog looking at the 2008-2010 period is now atroughly $3.9 billion, an increase of 11% over the prior year. We also announcethe 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 certainlyour sustained improvements in Europe. Europe was a major element of our 2006 performance andfairly in 2007 they continue to perform well. So now if I look forwarded to2008 and beyond, lot of these or the comments that we made at New York analystmeeting, but just some of the highlights.

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

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

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

And then finally as Bruce will describe, we ended the yearwith a very strong balance sheet. We have the financial wherewithal to be ableto continue to invest best in growth platforms, and we think that’s critical tous 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 hewill review some of the business performance in the fourth quarter.

Keith Wandell

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

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

Increased customer demand for energy efficient and greensolutions is a global trend we are seeing more of. And also there is a globaltrend around the increasing demand for one-stop solutions; equipment, controls,and services. And specifically for JCI in 2007, our cross selling initiativegenerated 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 theone-stop shopping solutions. In terms of our specific Q4 performance, saleswere up 15% from $3.1 billion to $3.6 billion. And in all global regions, bothsystems 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. Segmentincome was up 23% from $257 million to $360 million, driven by higher volumeand really cost structure improvements that are underway, have been underwayfor sometime, specifically the branch network redesign for both North Americaand Europe.

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

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

So as we continue to consolidate our product engineeringefforts and generate the synergies around that all the way through the supplychain paying dividends for us. In our manufacturing operations, we reduced ournumber of plants by roughly one-third around the world. We’ve consolidatedoperations, have driven productivity improvements. We’ve also implemented ourBBP process which has been well established in battery and automotive now forsome years, and we are seeing tremendous upside and benefits from thoseinitiatives as well.

Our commercial backlog as Steve, mentioned is $4.2 billionup 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 andoffice buildings, as well as the rest of the world.

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

We are seeing, as Steve alluded to, an increase incommitment and demand for hybrid technology from many of our OE customers. Over20 hybrid vehicle announcements were made at the 2007 Frankfurtauto show. And Steve mentioned as well, we have 12 development contractsunderway 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 halfof that was driven by increases in lead cost that we passed through on thesales line. There were also higher unit shipments specifically in Europe,driven by our OE customers, offset a little bit by the lower OE and aftermarketin North America.

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

From a segment income perspective, we were up 7% from a $150million to a $161 million, again driven by the improving operationalefficiencies 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 marketenvironment perspective, the industry vehicle production, North America was up roughly 4%, while cars were down 2, light truckswere up about 8%. Europe was up an estimated 3%, Japandown 9, and Chinaup roughly 25%. We are also glad to see that the commodity prices with regardsto steel, foam, chemicals and resin has stabilized toward the latter part of thisyear.

In terms of our Q4 performance, sales were up from $4billion to $4.2 billion, up about 3%. In North America, sales were up 2%, whileour sales for the Detroit3 were slightly lower. That was offset by higher sales to the transplants in North America. Europe was up 5% and China on anunconsolidated sales basis was up 48%.

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

Europe, Steve mentioned had a continued strong performanceand a nice five year trend there, and Asia was flat as our growth investmentsin China that Steve talked to related specifically to the Chery orders, maskedthe 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 startingup on Slide 9, I'll just we reiterate that we are extremely pleased with ourrecord earnings here in the fourth quarter, which came in at the top end of theguidance that we provided three months ago.

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

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

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

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

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

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

Looking at SG&A expenses, we are up about 7% versus2006, we back out the impact of foreign exchange and take in the considerationof about $40 million higher net engineering cost, than our underlying SG&Alevels were basically flat versus the year ago.

We did increase our SG&A levels to fund some of ourgrowth initiatives in Building Efficiency. Generally speaking those were offsetby 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 thelevel that we’ve been running at over the last couple of quarters, but it’s apretty significant reduction versus the exceptionally strong $40 million thatwe recorded in 2006.

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

For the quarter, as Keith talked about, our Chinese jointventures were essentially flat on a year-over-year basis with improvedperformance that our matured joint ventures offsetting start-up investments infive of the new JVs we formed this year. As we go forward into next year, we doexpect to start to report positive year-over-year comparisons in our equityline, as a result of the Chinainvestments coming on stream.

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

Looking to Slide 10 then. You see net financing charges dropfrom $77 million to $68 million; a $9 million reduction really as a result oflower year-over-year borrowings. If you look at interest rates, the interestrate 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 younote in the detailed notes, the financial statements that were with ourearnings release, we did have three non-recurring items flowing through our taxprovision in the quarter, but on overall basis these numbers netted out tonothing. So there's a pick up in the two charges and they netted out to zero inthat 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 overthe last couple of quarters, you will see minority interest was actually anincome item for us in the quarter. That basically means that we're making lotsof money in our joint ventures on a year-over-year, and now that’s really dueto the consolidated joint ventures what supply to Tundra in Texas and launchcost Sheriff's office of our consolidated Southeast Asian operations.

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

Just looking to our balance sheet, you will see may be thefirst thing to point out would be that we had cash on hand of about $650million, which is something that we usually don’t have. To just point out thatat the end of the year we had repaid all of our commercial papers, so we had noshort-term debt readily available to pay down.

And from an economic perspective it just makes sense for usto stockpile cash in advance of two bonds that we've got maturing in the secondquarter 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 thatwe’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 endedthe year with a net debt-to-total capitalization of about 29.7%, which was inline 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 areinvestment ratio versus our depreciation and amortization of 1.1:1. Most ofthe capacity projects that we had in place for Power Solutions have come inon-stream as was expected. And as we talked about at our analyst meeting in New York a couple ofweeks ago, we do expect CapEx to trend down to about 1:1 in 2008.

We had good working capital performance in our fourthquarter, really reversing the disappointing result that we saw in Q3. And ifyou 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 topline.

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

Now as you will see in the notes to our financialstatements, our FAS 158 charge to equity was about $75 million. That really reflectsthe robust level of funding that we have in our defined benefit plans. Justlooking in to the outlook for 2008, we are not making any changes as I am sureyou would expect. We are forecasting 10% sales growth next year toapproximately $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 seeinterest expense drop by about 40 million. So it’s the continuation of the sortof the trend that you saw at Q4, and we are looking for tax rates to be equalto this year 21%. And from a balance sheet perspective or cash flowperspective, 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 inour New Yorkmeeting, but just to give a little bit more clarity. We are forecastingearnings per share of 35% to 37%. Take the midpoint. Sorry $0.35 to $0.37 pershare. Take the midpoint there, that's roughly 28% to 29% year-over-yeargrowth. So, we are expecting to start off the year very strong.

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

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

Steve Roell

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

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

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

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

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

Question-and-AnswerSession

Operator

Thank you. We'll now begin the question-and-answer session.(Operator Instruction). First question today comes from Robert Barry withGoldman 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. Itlooks like indeed your billing efficiency backlog was up year-on-year, but itwas down slightly on a sequential basis, and I was just wondering if you couldgive 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 theyears, 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 thefourth, 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 weare 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 ordersin Building Efficiency as well. Can you give us any kind of quantification onhow those are tracking?

Steve Roell

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

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

Pat Archambault -Goldman Sachs

Is it growth rate that’s up but perhaps papering off alittle bit in North America or is it kind ofkeeping 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 anythingwe would point. You know there are different elements that are growing atfaster rates. I think if we looked at it, we saw a good growth typically inhealthcare side. And surprisingly, the manufacturing sector was the other onethat 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 ofyour 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 heavilyweighted towards the school education, (inaudible), healthcare, officebuildings probably not as much of manufacturing certainly not in lodging andretail. So as you think through some of the things you are reading about Dodgefor 2008, some of the markets that are weaker we have highlighted particularlylodging and retail. We don’t have that higher penetration in. So may be to thatextent, but then I think that we are seeing it broad based. Here's an exampleoffice market vacancy, office building vacancy right now, it’s at a veryreasonable rate. I think it's 12.5% to 13%, and that’s pretty - there's noissue there.

Pat Archambault -Goldman Sachs

Okay, and just a last quick on batteries. I mean, eventhough margins are under pressure from an absolute point of view, myunderstanding is you've definitely been able to hedge raw material cost eitherthrough pass-through arrangements or I guess official hedging program. I mean,at what point does this inflation become a problem where I can actually startto eat in to the absolute level of profitability on a per unit basis? Is thatsomething 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'veseen so far is because lead is such a large percent of the cost of a batterylike in excess of 70 right now, our competitors are generally, in a fairly weakfinancial position from a global perspective, and I think there's been a lot ofdiscipline in the marketplace, passing on lead price increases to the endconsumer.

And I guess our expectation is that that's going tocontinue. I would tell you though, we are probably seeing what the level of thecost reduction -- the cost increases that we are passing through. I think weare seen our customers put a little bit more emphasis on their inventory leveland de-stocking to some extent which we think is sort of a factor in the marketbeing 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 AmericaSecurities. Thank you, your line is open.

Jairam Nathan - Bancof AmericaSecurities

Hi thanks. If I look at your automotive experience margins,it looks like you probably did like 6%, like maybe 7% margins in Europe thisquarter, and 2.5% in North America. And I'mjust kind of thinking if that is higher than what you've guided to for the wholeyear? And just wondering why can't this be sustainable or are there anyone-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 someof the - your numbers are little bit off there. For the fourth quarter, ourmargins for auto in North America were just abit over 4%, our European margins were 5.4% okay, so it’s not quite aspronounced as you indicated.

North America we had anexceptionally strong quarter. There were a number of commercial settlements. We’vemade a lot of progress in terms of taking down our cost base and as we’vetalked about before, by looking our auto business, we generally give away orstart the fiscal year giving away our price reductions effective in thebeginning of our fiscal year October 1 and then our cost reduction activitiestend 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 wesequentially improve. So you can't really look at Q4 and sort of fast forwardinto Q1 and say what are the changes?

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

Jairam Nathan - Bancof AmericaSecurities

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

Bruce McDonald

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

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

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

So, I guess I'll tell you to kindof make a long story short, here is where we really pushed the accounts payableline. 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, butwe don’t expect to give it back either.

Jairam Nathan - Bancof AmericaSecurities

Alright, thank you.

Operator

Next question comes from ChrisCeraso 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 onthe margins in the building efficiency business if my math is right, it lookslike 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 softerthan we thought it would for a quarter, was there anything that held you backthere, is it function of currency or was there something that came out a littlebit softer than you thought it would be in a quarter?

Steve Roell

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

Keith Wandell

I guess, so it would say, I thinkthat our personal residential business is a little bit softer than we thoughtcoming up the quarter. That was interest rate to be how much of businessportion 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 youexpect for the year, did you say that we started seeing positive comparisonsversus '07?

Bruce McDonald

Yes, we’ll start to see positiveyear-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 firstquarter?

Bruce McDonald

Yes.

Chris Ceraso - Credit Suisse

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

Keith Wandell

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

Chris Ceraso - Credit Suisse

Okay.

Keith Wandell

I mean if I look at the year weare up about $25 million, so I can't think of that, it's off the top of myhead. I mean, one of the things I guess, I can think of from last year is wewere amortizing New York back some of the New York intangibles of specificallyassociated with the backlog and that’s behind us now, so we have someamortization probably $6 million or $7 million in a quarter that’s not theiryear-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 knowwhat that number is off top of my head. I think it might be a little bit higherthan that.

Chris Ceraso - Credit Suisse

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

Keith Wandell

On a cash basis our tax isrunning 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 HimanshuPatel 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 youmentioned the number of commercial settlements in the North American autobusiness in the quarter. Can you sort of quantify how big that was?

Steve Roell

Himanshu, there is nomisunderstanding. Those are typical. Still, we don’t make you think of that'sunusual. If you look at every quarter in the fourth quarter of our fiscal yearin automotive we have those commercials. That's not unusual. We don’t want tomislead you on that okay.

Himanshu Patel - JP Morgan

Was it dramatically larger thanthe 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 arealways commercial issue resolutions at the end of the year. It was probably thequietest year-end that we've had in sometime.

Steve Roell

That explains part of the cyclicalnature of the months. Okay, the business plan.

Himanshu Patel - JP Morgan

Okay, and then it sounds like youexited this year at sort of a low 4% margin in that business and the full yearwas about 1%. You guys, I think you have talked about 100 bips of marginimprovement every year on that. That comment just seems fairly conservativenow. 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 thinkthat by '09 the business could be back at the 4% to 5% margin level?

Steve Roell

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

Bruce McDonald

I guess if you think about itHimanshu, we’ve talked about Europe margins been fairly flat here for nextcouple 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 backloggrowth is skewed to Europe in '010 so that business going to stay pretty flatand that's obviously the biggest source of earnings right now North America wewas talking about that business tripling in probably next year.

I would tell you the absolute Q4little bit better than we were expecting here, but we feel real good about thatbusiness picking up sequentially here. Then Asia, for the year roughly abreakeven for us and again that's when we expect to see some small improvementbut the just the size of North America, sorry, Europebeing flat it kind of mutes the overall margins for us.

Himanshu Patel - JP Morgan

No, I get that but, I think yourcomments earlier were that just in North America interior business would see ahundred 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 cautionanymore Himanshu that you can use the fourth quarter that's all I can reallysuggest, okay.

Steve Roell

Yeah, the other issue like justfor the understanding everyone listening, the other issue in addition to whatBruce discussed why you can't really look sequentially in this businessrelative to margin is that typically fourth quarter is when we typicallyexperience a lot of engineering recoveries with our customers. So we have thosediscussions go on and so that recovery where it tends to be lower in the firstpart of the year and tends to be higher in the fourth quarter too.

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

Himanshu Patel - JP Morgan

Okay, then separately in the GMlabor contract there were some talk about potentially considering in-sourcingcertain businesses have you guys sort of thought that through or is that notsomething that even concerns you guys right now?

Bruce McDonald

Well, I don’t think that, atleast in terms of the business, that we're associated with that. We think thereis 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 issort of (unbound) that over the last several years. We just need to stayfocused on been a good supplier and having good relationships and deliveringbest value to the customers that we can I think that we should be okay in thatarea.

Himanshu Patel - JP Morgan

Okay and then, Bruce, I think youhad 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 inthe SG&A line?

Bruce McDonald

Well we've talked about - there’sbeen higher and higher level of engineering cost in '08 it's because we've donea 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 RodLache 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 lastquestion on the engineering spending have you given any color on what youroverall 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 preparedRod. We don’t have any information here.

Rod Lache - Deutsche Bank

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

Bruce McDonald

No, we didn’t Rod but we can dothat.

Rod Lache - Deutsche Bank

Okay.

Bruce McDonald

I mean…

Steve Roell

Rod, max it was up 12% in thequarter, 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 thebacklog, can you give us any color on the composition of the backlog? I assumeit’s shifting a little bit away from services and is that diluted to themargins going forward?

Steve Roell

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

Bruce McDonald

No it’s a [quick way] solution tothat.

Steve Roell

Solution to that, yes.

Rod Lache - Deutsche Bank

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

Bruce McDonald

Our margins and our backlog aregenerally up.

Rod Lache - Deutsche Bank

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

Steve Roell

While, first of all, the savingstend to sort of increase as the year goes on because the way we layered intothe plan, I mean, we layered in that way because obviously, there's few whowere in the first month and then what you gain in the first month carries overin the second month etc.

But clearly, we have a betterview of what our performance gaps are in each one of our businesses. We feelpretty confident that we have a very clear roadmap and path that when we laythose numbers in then we have a fair path to get there. So we feel prettyconfident and not only in building efficiency, but in all of our businesses andquite frankly, he was talking about automotive a lot and that's by and largepart of the reason why we had improved margin in that business as well becausethese are the fruition of the efforts so its been put in place over the lastcouple of years here.

Keith Wandell

Thinking in terms of your otherquestion about where did they flow out, I mean, I don't have that here, butsome this have been little more with flow through SG&As and auto which tendto be more sort of manufacturing cost. Here at some does spoke through theSG&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 youexecute on more and you don't lose what you've already accomplished but from anexternal perspective should we be thinking that we got maybe $150 million ofsavings it's around 30% and that's $37 million a quarter, or does that rampsignificantly, 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 isthat, it will be back-end. But a few things, can he just build as the quarterpoints 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 JonathanSteinmetz 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. Idon't want to be the dead horse on the North American auto margin item, but Iguess the question I would have, sequentially was there any restructuringincrementally that would have sort of shown, sort of shine through in thefourth 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 alot of the restructuring really was in sort of the back half of last yearbeginning in first part of this year?

Steve Roell

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

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

Jonathan Steinmetz - MorganStanley

Okay. Switching to…

Steve Roell

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

Jonathan Steinmetz - Morgan Stanley

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

Steve Roell

We really haven’t seen any mixshift, we have seen an increase in sales in both of our, what we call leasttech product in Germany arein Europe, which is a very high priced andhigh margin product and as well as Optima. So, we really haven’t seen anydeterioration there.

Keith Wandell

No, I guess, Jon that’s a greatquestion, you would expect that. But, I’m just saying if a couple of customerswe’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 itfor the company as a whole? I think you gave revenue but do you have theoperating profit line?

Bruce McDonald

It was about, if you look FXversus 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 BryanJohnson with Lehman Brothers. Thank you, your line is open.

Bryan Johnson - Lehman Brothers

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

Steve Roell

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

Bryan Johnson - Lehman Brothers

Okay and what's the geographicsplit within that?

Steve Roell

Roughly, we said it’s heavilytowards Europe. Let me give you just a roughbreak out. I’ll give you five break outs okay. North America and consolidatedis about 950, North America and non-consolidated is about 75, Europe and I'lljust go back to what you have been hearing from Keith and Bruce about theengineering is 1.325 million in that three year time frame. Asia consolidatedis 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 a925 for Asia and about 75 for North America.

Bryan Johnson - Lehman Brothers

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

Steve Roell

Well I am sorry, cadence isbetween…

Bruce McDonald

He is asking breaking out the 39across '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 thinkingabout most of the Asia and all of the Asian growth being in the JVs and thathence, 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 thatreflect things moving from one column into from minority interest and equityincome?

Steve Roell

No, no. There is none of that.

Bryan Johnson - Lehman Brothers

So what we should be thinkingabout for minority interest for next year?

Steve Roell

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

Bryan Johnson - Lehman Brothers

Okay and the final question is inthe 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 beentalking about?

Steve Roell

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

Bryan Johnson - Lehman Brothers

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

Steve Roell

Well, that will show up Bryan, as equity incomebecause the less than 50% and we will have a couple of quarters where we havesome acquisition. We are going to have to eliminate our profit on the initialstocking and things like that. So, couple of quarters it will be not a heck ofa 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 morequestion operator.

Operator

Today's final question comes fromBrett Hoselton with KeyBancCapital Market. Thank you, your line is open.

Steve Roell

Hi Brett.

Brett Hoselton - KeyBancCapital Market

Hey folks, howare you today?

Steve Roell

Good.

Brett Hoselton - KeyBancCapital Market

Let's see. Iam not sure how far you are going to be willing to comment on this. You'vetalked a bit about acquisitions and my question is there is quite a number ofacquisitions, potential acquisitions circulating or discussion about them forexample, the VISTION electronics business, Goodmann Global, some ideas aboutLinux or possibly trains putting up and so on and so forth. I guess what I amwondering is, would you be willing to take any of those and suggest or statethat 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 theareas where we have interest, peers and categories. But we would never commenton a company, okay.

Brett Hoselton - KeyBancCapital Market

That's veryfair. Okay, thank you.

Steve Roell

Thank you verymuch

Denise Zutz

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

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