Jul 18, 2007
Denise Zutz
[Technical Difficulty] 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.
For these statements, the Company cautions that numerous important factors such as automobile vehicle production levels and schedules, the ability to mitigate the impact of higher raw material and energy costs, the strength of the U.S. or other economies, foreign currency exchange rate, cancellation of commercial contracts, labor interruptions, the ability to realize acquisition related integration benefits and the ability to execute on restructuring actions according to anticipated timeline and cost as well as those factors discussed in the Company's most recent 10-K could affect the Company's actual results and could cause this actual consolidated results to differ materially from those expressed in the forward-looking statements made by or on be half of the Company.
Okay. So, participating in our earnings call this morning is John Barth, our Chairman and CEO; Steve Roell, our Vice Chairman and Executive Vice President; and Bruce McDonald, our Executive Vice President and CFO.
John Barth will begin with some overview comments, Steve is going to cover our business results in the quarter and Bruce McDonald is going to provide you with a review of our financial results overall. We will then be happy to take your questions this morning.
Our intent is for the call to last approximately one hour. And with that, I would now like to turn the call over to John Barth.
John M. Barth
Well, thank you and good morning everyone. And I am please to report another strong quarter with both record sales and earnings.
And our sales were up 6%, $8.9 billion. And when I look at the three businesses, building efficiency, there you saw increases in every part of the business and every region in the world.
This particular strength in North America systems and services which was up 18% and rest of the world was up 12% and global workplace solutions was up 26%. In Power Solutions, our battery business was up mainly due to… what I would say the unprecedented and then lead cost increases that was seen during the year.
Demand in North America in our battery business was slightly lower, mainly due to a lower OE production. In Automotive experience, sales were level with last year.
North America sales were tracking with production. Our European sales were up slightly mainly due to the favorable currency exchange.
Our segment income was up 14% to $573 million. And the building efficiency had significant margin increases again in all parts of the business particularly in North America systems and services with the biggest improvement in Europe where the margin improved 500 basis points over last year, and I think we indicated throughout the year that we anticipated that.
Power Solutions was fundamentally level with last year and I would remind you that last year included a $33 million insurance benefit. If we exclude that, segment income in Power Solutions was up 37%, and again, just due to the fundamentals of our… how we manage and run that business with our best business practices and operational improvement.
In Automotive Experience, we saw double digit improvement in segment income. Margin improved in Europe to a record 6%.
North America improved for the second sequential quarter. If you recall we had a slight loss in out first quarter, breakeven in our second quarter in North America in this past quarter and margin of 2.6.
I would mention that Europe… I mean I am just pleased with the 6% improvement and this was continuing to be a bright spot relative to our automotive business. Bottom line, EPS from continuing operations was $1.98 and this was slightly ahead of the $1.95 that we have had forecasted in back in April.
And so, I would like to thank all of our employees. They just continue to do what they say they are going to do and so thanks a lot.
It is just a great quarter. Then look at highlights from the quarter.
Starting with Power Solutions. We are in a process of rolling out Power frame and I remind you that is a new technology that adds both quality, again separates our capability in out battery from our competition.
But also is a… is a pretty significant in cost improvement to us. So that is now in a process of being rolled out for the balance of this year through all of our plants in Europe.
We went in a major aftermarket customer here recently in Europe and at this point unfortunately we are not at a point where we can disclose who that is and in China… first if I look at our lead asset business, there that continues to expand… you'll recall that we doubled our… our production our capability since we have acquired that Delphi battery business there and we should have some… an announcement coming soon on just some of the winds and progress that we are making relative to… improving our share in China as well as with our hybrid business… we are working very closely with our Chinese customers there and again we think we will have an announcement coming in a near term on some progress that we are making in China. Building efficiency… we've been one of four companies selected to provide performance contracts to the private and public sector, buildings in 40 cities around the world.
Five banks have committed to provide performance contracting, financing for as much as $5 billion in energy efficiency improvements and this represents a significant opportunity for us going forward and it creates an opportunity for performance contracting for the first time outside of North America. We have received a large chiller order for a 115,000 tones of air conditioning for a central cooling system in cutter, one of the largest chiller installations in the world.
And I think the… this is a testament to… I think the position that we have in the emerging markets, but more importantly relative to the technology and capability that we have in this segment of the market. And we announced a big win a few weeks ago which significantly expands our distribution in the residential market and we find this agreement with U.S.
air conditioning distributors which accelerate our presence and reach in southwest part of the United States. And in our automotive experience business we continue to win business around the world.
We have some significant wins in both Russia and Turkey which will continue to strengthen our position in these… in these markets and provide us a dominant position there. We continue to win business from the… the distressed suppliers and that represents near-term on almost immediate revenue for automotive business and we continue to have successful launches.
In the past quarter, we launched the Buick Enclave, the Fiat 500 and the new model for Kia as well as some others that… that I am sure Steve may go in to here in a little bit. Customer recognition and you can see on the right hand side of the slide there and this is something that we just are very proud of.
You can you can say a lot of things about yourself and when your customers recognize you and you continue to win awards in all three of our businesses. Again I think it is a testament to the focus that we have on exceeding your expectations.
When I look at the full year… we are still committed to a profitable… the profitable growth as our primary way of increasing shareholder value. We continue to have significant growth opportunities in all three of the businesses.
As our competitors and others, I think reshaped their businesses and defined what their near term goals and business plans will be. We continue to invest in innovation and in new technologies that helped distinguish ourselves and separate ourselves from… from the folks we bump in to everyday.
One thing that is part of our DNA, or our culture is, our best business practices and just how we drive continuous improvement throughout the company and we will just continue to focus on that. And before I turn it over here to Steve, I just saw… you don't know how proud I am of the management team and employees that we have in place.
This is really in all parts of the world. So, that's everyone is up to the challenge and doing what… what they said they were to going to do.
So, thanks a lot and when I look at 2007, this will be our 61st consecutive year of sales increases. 17th consecutive year of earnings increases, and 32nd consecutive year of dividend increases.
So, the financial strength of the Company just continues. And with that I will turn it over to Steve.
Stephen A. Roell
Okay. Thanks John and good morning.
I thought I would start with building efficiency and maybe make some comment about the industry itself first before I go to our results. Just in terms of the construction market in the U.S., the most recent data that we have is that growth in 2007 for the calendar year for the industry will be somewhere between 4% to 6%.
It's a good robust market for us. That's coming from the recent data from Dodge.
The strength appears to be in the public sector, moving away from the commercial building market, obviously because of interest rates. And the public sector plays well for us because we do have a very strong presence in the schools and the healthcare and the governmental markets, so that bodes well.
And then this morning the institute for American architects… American Institute for Architects came out AIA and talked about some of their leading indicators around the architectural services demand. And that would imply that the strength and the construction market will continue well into 2008 and throughout 2008.
So, it looks as if we are going to have a good robust North American constructional market to stay with us for the next 18 months… at least 18 months. On top of that we are seeing good continued strength in the international markets.
Double digit growth in a number of the markets such as Asia and the Middle-East. In addition to that as we've talked in the past, we believe we will benefit greatly from the increased focus on energy efficiency ingrained.
And we continue to see that in terms of driving and prospecting and new opportunities for us in our business. The residential market, so much that I can tell you that you don’t realize there.
New construction was down 24%. We continue to believe we are bottoming out, but it’s difficult to feel that at this moment, certainly, wasn’t true in the quarter.
Inventories, we believe at their normal levels due to the recent, the record North American summer heat. And so, we hope that that part of the industry will recover as we see through the reminder of this year.
Turning to our results. Our sales, as John mentioned, were up 15%, $3.2 billion up from $2.8 billion.
Good growth across all segments of our North American business, new construction retrofits, technical services. Frequent strength in the global workplace solutions business, which was up 26%, I think John mentioned that as well.
We highlight that we did secure two new programs, one with the BBC and one with Orange. I know many of you know who Orange is, but for those of you that don’t, it’s a mobile communication company, headquartered in Europe.
The contract we have is an example as in the U.K. Its over 1 million square feet, covering 24 office buildings, 23 technical centers, over 290 retail outlets.
So, that gives you some idea of the scope of some of these projects when they are secured. Our residential sales dollars were up modestly on lower units shipments.
I think that’s the theme of the industry today is. Our competition is gone up as well and identified the softness in residential.
The big news is that segment income improvement from $191 million or 43% to $274 million. A higher volume coupled with operational improvements in margin expansion across all geographic elements of our business.
I should probably point out too that when we talk about residential and how tough a market it is. Our residential air conditioning business operated the double digit margins in terms of its performance in fiscal… in our current fiscal Q3.
Our backlog remains strong, $4.3 billion up 16% over the prior year. If we look at just the U.S.
itself, even our new construction, we continue to see good demand in office and in state and local government. And in terms of the existing building the strength expands on the industrial sector, higher education, healthcare, and the federal government.
And then addition to that we called our Europe only because its backlog or its orders were up 19% as fits demand. I am now going to turn over to Power Solutions.
We talked about the fact that the production schedules were off, primarily because of lower demand in the OE market. After market, we believe from an industry prospective, was fairly flat quarter over last year.
Unprecedented increases of lead. The LME refers there is the one London metal exchange.
If you look at year-over-year, lead is up 278%, I am going to use the tonnage there, $995 per ton increased year ago to $2,546 per ton. If you look at the closing price on July 17, grew over $3,100 per ton.
That’s unprecedented and that’s creating issues for us, both in terms of how we are trying to do hedging, recoup in pricing, and obviously, from our customers and at the retail side. But I just… we called out that our only because those of you… does create unique challenges when it goes up that quickly if it’s a short timeframe.
If you look at the performance from the standpoint of our quarter, our sales rose 16%. As John highlighted that demand… that increase was driven by the pass-through of lead cost in our pricing.
Our volumes, in terms of units were slightly down in the U.S., again driven by the lower OE built, and while Europe was up slightly. Our segment income, we talked about the fact that there was a non-reoccurring item last.
I don’t know to what extent this was factored in some of the forecast or expectations. But as John indicated, on one sense you can look at power reported information, it would be up… it would be flat, but excluding that item, we would be up 37% in the segment.
Now, if you were to take this and look at just that one single item and go back to John’s opening comments, our segment income would have been up 20%, had this item not been excluded from the prior year results. And that’s really the performance of the business year-over-year.
So, really in an outstanding performance by this segment. It continues to benefit from its cost reduction and focused on process.
Our pricing actions in hedging, so far has been able negate the impact of higher lead, but as I indicated to you, Q probably will a challenge to us only because of the lead lag that we had discussed in prior conversations. Turning to Automotive.
I think most of you are aware of what's taking place in the quarter, but just to summarize, North American production was down 2%. Light trucks were flat.
The car production was down 6%. Europe, we estimate now is up 1% in the quarter.
The Chinese market was strong, up 20% which is what it is now on a full year-to-date basis as well. In terms of our performance, our sales were down 1%.
North America was down 2%, a lot of positive in terms of new launches, around the Lambda, the Honda Pilot, the Tundra. There was also lower discontinue volume that offset that, and that’s what’s result in the down 2%.
We did have a number of new business awards in the quarter. The reference to Mitsubishi and to Ford were, in both cases electronics.
In Europe, our volumes… our sales were up 1%. Lower discontinued volume, we highlighted some of the programs that have been either discontinued or… where the volumes were soft.
And we did have a lot of new business that was awarded during the quarter. You can see across the number OEs, across the number of platforms.
In some cases exceeding in the case of Renault and BMW, in the case of BMW and Ford, it’s also instrument panels, and cockpits. Pacific RIM was down 6%.
The specific that decline was primarily due to the lower production with Nissan and also with Hyundai and Kia volumes in Korea. Our China sales were up double digits and consistent with what taking place within the industry.
Segment income was down 7%, this is to be an outstanding performance in the quarter given the surplus in the volume and just the economic pressures. We… John highlighted the fact that our North American operation had sequential improvements and achieved the 2.6% margin in quarter.
And we also talked previously about the European hitting its high 6% margin for the quarter. When you look at equity income and Bruce will talk a more about that, we had number of launches in China, which ended up being impacting the quarter.
That is good news and certainly does not reflect the overall strength of the profits that we have in China. But as we launch new programs for OE like Cherry, we expect to incur those costs periodically.
Okay. And with that I will turn it over to Bruce for the financial highlights.
Bruce R. McDonald
Okay and thanks Steve. Overall, our financial results we are pleased with the quarter.
We showed sales growth of 6% to record 8.9 billion, which really reflects the business and geographic diversification that we have and also the successful implementation of some of our growth strategies. As we indicated in the business sections, we are pleased to see the mid teens growth of building efficiencies in Power Solutions though as Steve indicated the most of the growth in Power Solutions was attributable the negative… to the impact of higher lead pass-through prices.
If you adjust for that Power Solutions sales will level with 2006 results. In terms of automotive, sales were down 1%.
Adjusting for foreign exchange were actually down 5%, really reflecting the discontinuance of certain models, the impact of some business that we returned to our customers earlier this year. For the quarter global volumes, if you look at a production on a global basis were essentially flat.
Turning to gross profit, we showed margin of improvement to 15.5% from 14.4% last year. And as we indicated last quarter, material… net material economics are not a factor when we look at year-over-year improvements, but we still got a high cost in our base.
But on a year-over-year basis, material economics is not a major problem at the gross profit line. Our commodity hedging programs are helping to insolate our short-term earnings from the negative impact of the run up in commodity costs, particularly less though there was less price increases as Steve talked about we are seeing some challenges here.
Just giving some more color to Steve’s comments in terms of the 37% increase that we seen in lead in Q3 and we have seen another 20% increase in the lead prices just since the end of June. So, we are off to another quarter where it looks like we are going to see a strong increase here.
Looking at SG&A expenses, $831 million up 33%... sorry up 13% versus last year.
Last years numbers benefited by the $33 million legal settlement that you sort of backed that out, underlying SG&A expensed were up about 8%. That really is a reflection of the investments that we are making in building efficiencies.
Power Solution SG&A levels are about flat. And if you look at SG&A auto business, it was down about 16% on a year-over-year basis with engineering costs being about level.
I would also note that within our SG&A expenses and falling into our automotive Asian results was about $8 million or $0.03 a share of costs associated with some streamlining our cost base in Japan. So that that flows through in the SG&A in the quarter, it was worth about $8 million.
Further, equity income consistent with last quarter you can see we are reporting a year-over-year decline of about $8 million. Actually if you sort of look at our overall equity income and our non-consolidated joint ventures about $1 million of that shortfall has been net differential in China as we have seen strong growth in our base operations, but mostly consumed by the startup costs with our five new joint ventures in China.
Most of the year-over-year decline, however, is attributable to higher launch costs in some of our North American automotive joint ventures, which provide product to our transplant customers, higher costs in our hybrid joint venture was soft and the negative impact associated with the rapid run up in lead prices in a couple of our equity accounted joint ventures in Power Solutions, particularly in Korea. Turning to the overall segment income and adjusting to the restructuring charge that we took last year, our underlying segment income improved 14% with margins expanding by 40 basis points to 6.4%.
Turning to slide 10. You can see net interest expense decline $3 million to $71 million in the period really reflecting lower year-over-year borrowings, but somewhat offset by higher interest expense particularly in our borrowings based in Euro.
For the quarter, our tax rate was 21% consistent with both our guidance and the underlying rate last quarter. If you look down to minority interest you will see that we didn’t have a charge in the quarter, which reflects lower year-over-year earnings at our consolidated joint venture operations.
The three main drivers in that line, first, are AutoComp at our joint venture supplying the Tundra in Texas. Volume weakness and launch cost in our consolidated joint venture in Southeast Asia and lower earnings again due to our lag lead recoveries at consolidated joint venture operation in our battery business.
If we do go down the bottom line is the earnings per share. You will see we recorded earnings per share of $1.98, $0.03 ahead of our guidance and up 16% versus last year.
Turning to the balance sheet. You will see it on a quarterly basis, our debt to total capitalization declined by about 140 basis points or 35.8%.
So, our overall borrowings were approximately leveled with the Q2 balance. As we indicated in October, we continued to forecast a debt to total capitalization declining to 30% by the end of the year.
With the capital expenditure in the quarter, we spent $140 million and we now anticipate that our full year reinvestment ratio is going to about 1.1:1, slightly below the 1.2:1 that we’ve provided in our October guidance. Most of our capacity expansion projects in Power Solutions are coming online as excepted and our lowering guidance really reflects trimming capital investments in automotive experience business.
Let me see the first comment on… also comment on working capital performance, which was a disappointment for us. It came in below our expectations.
And while we face a few headwinds, let me just comment on some of the factors. First the impact of higher lead with the rapid increase in lead prices our inventories, receivables and the value of our in the money lead hedges grows.
We also tend to have a lower than average payment terms of our lead suppliers to facilitate the net impact, that run up that lead had in terms of our cash flow in the quarter is worth about $150 million to $175 million outflow. We also had our inventory balances negatively impacted like pre-build in inventory which we expect to shift in Q4, associated with the U.S.
air conditioning distributor arrangement. Then lastly our accounts receivable balances were impacted by the timing of recoveries in our automotive business, and in some cases our financial strength works against us in settling some issues in collecting tooling balances and things like that.
Then lastly in the quarter, we had an unusually large outflow of $60 million associated with some of our restructuring initiatives, which are running higher than… which are delivering results better than our expectations. As I mentioned, we still expect to see a… we still expect to see CapEx trend lower here, despite some of these headwinds.
We are confident that we can get our debt to total capitalization back down to the 30% level that we committed to last October. Lastly, turning to our full year outlook.
I am pleased to say we are confirming our guidance, which as you recall, we increased last quarter. We anticipate sales increasing by 7% to $34.5 billion and to… and full year earnings per share increasing to 6.25% to 6.30%, a 19% to 20% improvement.
And I would note that both those numbers exclude a $0.19 one-time benefit that we experienced in the second quarter. That translates in the Q more earnings per share in the range of $2… $2.30 to $2.35.
We are also providing an update here on our… sort of tightening our bend and updating some of our segment margin on a business-by-business basis. You can see building efficiency, we are guiding to a range here on 6.7%, 6.9%, that compares very favorably to the 5.2% last year really reflects the ongoing benefits of the York acquisition.
In automotive, we expect our global margins to be in the 2.9%, 3.1% range. And lastly in Power Solutions, we are actually lowering our guidance here to 11.5% to 11.9% really reflecting the detrimental impact that lead pass through has on a reported margins, which has stripped out the impact of the higher… the higher lead prices, which inflates both costs and sales, and therefore, brings downs our margins.
Our underlying margin guidance for Power Solutions were up would be 12.5% to 13% or about a 50% basis… a 50 basis point improvement versus the guidance that we gave at the beginning of the year, really reflecting the great job that Power Solution is doing. In conclusion, we are pleased with our third… our third quarter results.
We remain committed to the full year numbers, and we are confident that 2007 will be our fifth consecutive year of double digit earnings growth. And so, with that I will turn it back over to Denise for Q&A.
Denise Zutz
Yes, operator, I think we are ready for questions.
Operator
Thank you. [Operator Instructions].
Your first question comes from Rob Hinchliffe of UBS.
Denise Zutz
Hi, Rob.
Robert Hinchliffe
Hi, Good morning. Thanks.
Hey, I guess, cash flow maybe the first one to ask you. In the last couple of calls, you said working capital maybe gets back to neutral by the end of the year.
I didn't see that. You didn't comment on that during your thoughts there.
Where do you think that ends up now?
R. Bruce McDonald
Well, there is a number of things Rob in the… in the quarter that I accept will unwind here in the fourth quarter. The hard one to….
the hard one to get a read on here though is the lead impact and that's just… we didn't… we didn’t take in to consideration the sort of… the huge run up that we’ve seen in lead prices. And as we sit here today, I mean we thought those didn't show any signs of reversing.
So, I think, our expectations as we certainly expect to see the working capital here improvement of fourth quarter. But it is going to be difficult to… for us to recover the… that sort of $150 million to $175 million that we have seen in lead.
And as I sit here today, I would expect to see the… more of an impact… more of a negative impact hit us here in the fourth quarter.
Robert Hinchliffe
Okay and then you mentioned the inventory build with the U.S. air conditioning.
You put a general dollar figure on that build.
R. Bruce McDonald
Yes, it is probably in the $25 million to $30 million range.
Robert Hinchliffe
Okay. And then on the building efficiency.
Real good growth first half, still good growth, but a little bit slower in the third quarter. Where do you see that business?
What is the kind of a growth rate you think for building efficiency going forward?
Stephen A. Roell
I think, what we’ve said, Rob, that we expect that business to be in mid teens and the backlog would certainly support that. So, I think it has unchanged.
I don't think that we… I mean, I think we always felt that we should in mid teens in terms of growth in that business. And I think again the backlog supports it.
I think that’s consistent with what we would expect going forward.
Robert Hinchliffe
And then the profit margins this quarter looked really good.
Stephen A. Roell
Yes, they are. I wouldn't expect that to repeat.
I mean I think Bruce has provided guidance for the full year for that segment. That’s probably the best we can provide to you, okay.
Robert Hinchliffe
And the full year that sort of the rate do you think going forward as well?
R. Bruce McDonald
Well, we expect to see some margin expansion in '08. But we haven't… I think that our last earnings… sorry, our last Analyst Meeting where we have really focused on building efficiencies.
We said, look we expect over the intermediate term that x-global workplace solutions we see our intermediate term margins getting to the say 10% level for building efficiency and we expect to see some margin growth in 2008.
Robert Hinchliffe
Okay. Thanks very much.
Operator
Thank you. Your question comes from Ron Tadross of Banc of America.
Ronald Tadross
Good morning, everyone.
John M. Barth
Hi, Ronald.
Stephen A. Roell
Good morning, Ron.
Ronald Tadross
I guess just hunting in on the North American automotive margins. You made the comment this is the second quarter in a row we have seen sequential improvement.
Can we kind of start thinking about this maybe being a trend over the next few years. And if so, can you give us an idea where we could get with North American automotive margins considering things think we are going to be roughly breakeven this year?
Bruce R. McDonald
Yes, I mean we will… we are roughly breakeven rate now, Ron.
Ronald Tadross
All right.
Bruce R. McDonald
On a year-to-date basis, so we expect… our expectation now is Q4 margins in North America to be around the level they were this quarter. Q4 sorry, Q4 our North America margins, being both where they were this quarter.
Ronald Tadross
That sounds good. That's good year-over-year expansion.
And then when you go forward the next few years Bruce, where do you… can we get back to like that 3% to 4% range over like the next two to three years?
Bruce R. McDonald
Yes, let me…well just clarify in Q4. So, last year in Q4 North America, we are at 2.5.
So, we are going to be a little bit ahead of that. That’s kind of our expectation right now.
If everything's played out as we think. Now we are looking for next year where we expect to see a big improvement in our margins in the North American sector.
But, I will hold off on giving more specific guidance on these… on what that is for North American. So, we see you in October.
Ronald Tadross
All right. Good.
And then just on the distress supplier revenue, the revenue that is coming from the… these guys said maybe just can't do it. Is this material like even is it $200 million or is it $500 million?
R. Bruce McDonald
It's getting in… I mean, I think last quarter we talked about is $200 million of booked business and I… and we are still gathering… that's accelerating. I am giving sort of annual run rates there.
So, probably in that $300 million change range now.
Ronald Tadross
All right.
R. Bruce McDonald
This is not big seeding stuff, which $300 million or $400 million a year. This is more on the interior side.
So, you are talking of $20 million, $30 million type annual contracts.
Ronald Tadross
Okay and then just maybe as a potential offset to that. What's going on with mix, I mean with fuel prices kind of hedging up here, maybe it's just… tell us about what you are thinking about mix in North America and Europe?
John M. Barth
I guess, we were… it’s just looking at the data and if you look even the fourth quarter, Ron, what’s interesting is that the bill schedule is actually up in the quarter we are in now, right?
Ronald Tadross
Yes.
John M. Barth
Light trucks. It's interesting that we are seeing light trucks bills fall by very aggressive incentives.
If I were going to go forward if I think there's a note that if gas prices stay above $3.50, we are going to see some mix shifts, I think and that’s fair. But we see the shifts going down in the sea realign out of the high sports utility vehicles, okay?
That's really where the shift will take place. And I think that's what I would say we are seeing bill schedules too within the light truck segment as you are aware, it’s moving down into the crossover vehicles.
Ronald Tadross
Okay. So, is there senior where your margin recovery is stalled by the mix.
I am sure there is but is it a high probability scenario or a decent probability?
Stephen A. Roell
We look pretty, Ron, well roughly in the SUV.
John M. Barth
SUV has helped us a lot, yes. We have got a pretty good margin there, pretty good presence that market across…
Denise Zutz
I think, Ron, we have always commented that contrary to what we say about where they make their money. We can make money in all kinds, all aspects of the mix.
We never suggested that… we make 90% of our money in the heavy trucks side. So, we are far more balanced.
Ronald Tadross
Okay. All right.
Thanks a lot.
Operator
Thank you. Your next question comes from Rod Lache of Deutsche Bank.
Rod Lache
Yes. Can you hear me?
John M. Barth
Yes, Hi Rod, we can.
Rod Lache
Hi. Good Morning.
A couple of things. Just to focus on the backlog a little bit in that order business.
Revenue kind of tracking inline with production. You did mention that part of that you are cycling through a couple of models that have been cancelled.
Can you just maybe give us a little color on what's happening with the underlying backlog, and when do you cycle through some of these cancellations?
Stephen A. Roell
I guess we are… have been cycling through some cancellations particularly in Europe, that's not really new to us and also in North America. I guess I would say there is a couple of programs that standout where they have… where they were the clients.
I think we are well into those. And I think most of those were reflected in our backlog data we provided to you a year ago this time, in October.
Denise Zutz
Yes, I just don’t have… we are going to be updating our backlogs here in October, of course, Rod. But thinking about '07 versus '08, we probably… my expectation is that the amount that feels associated with where we have given the business back or the auto makers have discontinued production whatever the fees maybe, the impact will be far more significant in '07 than in '08.
Rod Lache
Organic growth should pickup a little bit as you look out.
Stephen A. Roell
Right.
Rod Lache
Okay. And are you seeing any changes in the win rates in that part of the business?
Stephen A. Roell
Yes, we do. I guess I would tell you that we have been pleasantly surprised by some of the Chinese orders that we have received.
And as John highlighted, we have been successful with some of the… since Christmas, we haven't been highly representative like Fiat and BMW.
John M. Barth
And PSA.
Stephen A. Roell
And PSA. So, we have seen some successes there, but in some cases we would also expected that we are going to be successful.
So, I don't want to mislead you and tell you it's going to be a big change at this stage. We will come back and update and I would say that we were very pleased with the momentum of new orders that we received in this quarter.
This was a very strong quarter for us.
John M. Barth
To add to the… we continue to invest in innovation and new technology and products and so forth that help our customers differentiate themselves and grow their business. And so, we haven't backed away from that at all.
And so, I think that gap and our capability versus others continues to widen.
Rod Lache
Okay. Great.
Just switching gears a little bit, do you have an update on the building efficiency cost savings you have achieved so far? You have talked about the $300 million number for York synergies.
Where are we at as far as tracking to that number?
Bruce R. McDonald
We are in great shape. We are not… I would say there is nothing new coming in the bucket.
When we took our number off a $100 million, it really reflected the, some of the actions that made it to from the restructuring point of view. And as I said my comments, we had a fairly large outflow associated with some of those restructuring activities.
Our expectation was, Rod, that we would be substantially completed all of the cost synergies by the end of 2007. I would tell you right now there is a couple of facilities that we have had to defer closing out of the summer period into the fall because of unusually high demand.
We haven't been able to build enough inventory to deep close the facility, move to production equipment so rather than closing those facilities in the summer timeframe, which we had originally anticipated, we have pushed those into the fall Q1. So, that's probably… let's say $15 million to $20 million of cost savings but right now its not costs of anything because the volumes are more than offsetting the cost reductions.
John M. Barth
That's a good point. And I would tell you that we have got probably maybe three to five facilities around the world that are like that where the demand is so strong that where we had planned to move to a low cost country or where we had just planned to shut our plant down, we haven't had a chance.
We have been actually… I would tell you… our similar revenues, we have not been able to recognize simply because we didn't have the product in time. So, our lead times have been increasing.
We are trying to get our hands on it as best we can. It's a good situation to have in one sense, but Bruce's point, some of those were intended to be part of the restructuring process
Rod Lache
One last one from me. Can you just talk about acquisition appetite in general terms, how large an acquisition would you be comfortable with them, or how much leverage would you be comfortable with when you are looking out, because obviously your debt to caps is coming down and a lot of these efforts with York are pretty much on track or nearing a little bit of maturity.
John M. Barth
I think nothing really has changed. We continue to look at opportunities in all three of the businesses.
We have some gaps that we would like to fill and some product expansion. And so, I think we are comfortable with the improvements in the balance sheet.
We are forecasting, and so, I think we are in a good position to continue to invest in all three businesses.
Stephen A. Roell
The one thing I can say the latter question in terms of our appetite and our leveraging thoughts. Clearly as Bruce described our capital structure at the end of the fiscal year, we are going to be in a position to be fairly flexible and use depth for a good portion of our acquisition activity.
In terms of philosophically where we are, in terms of thinking about our ratings, we very much believe that we want to maintain a structure… a capital structure that would provide an A rating from a bond perspective for the primary purpose of leaving us flexible for other opportunities as they come available. We don't really want to leverage up not be able to take advantage of the phase that will help our business grow long-term.
That's the best way I can describe that to you.
R. Bruce McDonald
And then we have talked about before, Rod there, after the York acquisition our real focus on the de-leveraging activities that we sort of down played or sort of put on the back burner in some of these lower risk talk under type strategic acquisitions. We… obviously, there is some pent up demand from our businesses for some of those.
You should expect to start to see some of those in the next several quarters.
Rod Lache
Great. Thank you
Operator
Thank you. Next question comes from Robert Barry of Goldman Sachs.
Robert Barry
Hi guys. Good morning.
John M. Barth
Good morning, Rob.
Robert Barry
A few questions. One I just wanted to clarify on the free cash flow.
I think that at the Annual Day last year you had targeted $1 billion plus, is that still intact?
R. Bruce McDonald
Yes, that's what we are targeting, Rob.
Robert Barry
Okay. And then on the power margins and the lead.
Is this still somewhat of a timing issue or is there some elasticity of demand pressure starting to kick in as you keep passing through the lead cost with higher pricing, that's weighing on that margin?
Stephen A. Roell
Yes, let me just tell you what the dynamic is. The dynamic is timing okay and degree.
I think what I would tell you that if you have a progression of cost increases in the market, you can pretty much get a hedging program and work through pricing actions. I think the hard part now is when you see lead expanding to the degree which we just described to you, that’s hard to catch.
So, that's a timing issue for us potentially in the quarter.
Robert Barry
Okay. So, even though you are passing on these escalating or accelerating and escalating prices there is been no degradation in demand?
R. Bruce McDonald
Not meaningful.
Stephen A. Roell
I can't tell. Actually, we can point to that at all.
I would say, I mean… I am not sure that when a better replacement, a consumer makes a decision, okay, based on a battery increasing by $50 or say by $25, $40 in price. But I don’t believe so.
R. Bruce McDonald
I think one thing we are seeing, Rob, is as we have passed on all the price increases the inventory value that our customers take on it grows fairly significantly, and it does provide almost an extra incentive to maybe be a bit more careful in terms of stocking levels. So, again, that has to be fairly short-term but we… we’re passing on that sort of 300% increase that we’ve seen here.
People just get a bit more sensitive to it.
Denise Zutz
Yes. I just don’t know what that is.
I mean, first of all we've never seen the increase at consumer levels that we've been seeing here over the past couple of years. So, this is an unknown factor to us.
Historically, if you look at demand for the battery after market, it is historically extremely stable, probably the biggest factor to which you can correlate after market demand is really driving pattern. I mean that's what battery demand has most correlated with is actually numbers of miles driven.
So, it almost circles back to gas prices. That question that was brought up earlier gas prices hit the point where people would drive their cars less.
So, that's certainly an indicator we've got to keep an eye on. But again this market is pretty resistant in terms of overall economic factors because you always have to make a decision to not drive that second car or not drive that one car.
The battery dies and you want to drive the car and you pretty much have to go and buy a new battery.
Stephen A. Roell
Absolutely. I think what we… what we talked about it but remember as we go through that, that U.S.… the U.S.
air is… it’s a very specific geographic. John talked about the Southwest.
The market that they served is pretty much focused on southern California, northern California. So, we still have an appetite to grow more aggressively and expand our distribution where we have up to… where we are… this represents where we would like to be in other parts of the country.
But all that business really helps in terms of our manufacturing scale. I mean, small business, but we've always said that the reason we lag some of the margins of our competitors in that business will scale and these clearly are trying to help us close that gap.
R. Bruce McDonald
But Rob, just… if you look at the U.S. air conditioning deal sort of in a little bit more detail, they are the single largest independent distributor in the United States.
So there is not going to be another one of that size. And then if you look at well how many other distributors and sort of in that $100 million type range, you’ll get into a dozen or so.
So this was a fantastic win for us. A real boost for the business but we are not going to see big lumps like this one come in…
John M. Barth
Similar of this, that’s right.
Robert Barry
The others will be smaller.
Stephen A. Roell
Right.
Robert Barry
Okay, great. Thanks a lot guys.
Stephen A. Roell
Thank you.
Denise Zutz
Operator, is there a next question?
Operator
Your next question comes from the line of Jonathan Steinmetz of Morgan Stanley.
Jonathan Steinmetz
Thanks. Good morning, everyone.
A few questions. Have you given a number on currency translations impact on revenue and either net income or segment level income?
Stephen A. Roell
Yes. We went in… our sort of guidance for the… are you talking about versus last year?
Jonathan Steinmetz
Yes. Predominantly the Euro, but in general on a company level sort of currency neutral.
How much did the strength of the euro affect you basically?
Stephen A. Roell
I think our sales in the quarter were… we said were up 6% or 7% and if you strip out exchange it was up 3%.
Jonathan Steinmetz
Okay. And do you have an EBIT level impact as you translate?
Stephen A. Roell
Versus last year again?
Jonathan Steinmetz
Sure.
Stephen A. Roell
Yes. Sure, we have a third quarter reference, Bruce here talks about an EPS impact of about $0.04 in the quarter.
Jonathan Steinmetz
$0.04, okay. Can back it up to the EBIT line.
On the lead issue, have you seen any mix impact yet on the battery side, meaning price is arriving for the consumers and so they need a battery. But they just trade down or is there no evidence of that?
Stephen A. Roell
I have not seen that, I guess I'm just… we had conversations along with the product lines well I guess I would… I haven’t seen it. You would certainly expect it Jonathan, but we haven’t seen that.
I think primarily because of the promotions and where our after market customers are posturing the lines
Jonathan Steinmetz
Okay. And on the restructuring I think first you may have mentioned the $60 million cash out flow from I guess accelerator restructure and timing difference.
Was that a timing issue or you have actually bucketed more. I didn't see an accrual but are you bucketing more towards restructuring or was that just quarterly movement?
Stephen A. Roell
Well that was a quarterly out flow associated with some of the charges that we took last year. It was higher than normal, I would say under a normal quarter, our sort of quarterly running rates will serve in the 25 to 30 nuts, what we would expect say in Q4.
Jonathan Steinmetz
Okay. And then is this step running to the P&L that's not been called out as kind of a special items that sort of restructuring buckets so to speak that you'd expect to accelerate or is it pretty much the large charges the large output as done with.
Stephen A. Roell
We… I would say that we're not looking for any large charges. We are running through summary funding in SG&A reduction costs through a base P&L.
We have referred to when I was talking of the SG&A, we took a charge in our Europe and our automotive business in Asia of about $8 million, say $0.03 a share. That’s sort of the largest single line item but there is other $1 million and $2 million type numbers in there.
Jonathan Steinmetz
Okay. Thank you, very much.
Operator
Thank you. Your next question comes from Chris Ceraso of Credit Suisse.
Christopher Ceraso
Thank. Just a couple of follow-up items here.
First Bruce, on the tax rate do you think it can stay this low. Is it a sustainable level or where do you see it over the next two or three years?
R. Bruce McDonald
Well, right now when we brought our rate down here to 21. We… I think, we said we’d start next year being in the 22, 23.
And that with the standing buy back some of the… I'll say that, that the moving parts as I sort of look out longer term really, become what's happened with base factor tax rates globally. Right now outside North America there tends to be a trend for reductions, which holds well for us.
And I'm sure when I'm saying Germany, which is a one of our big theatres of operations; they're enacting legislation over there. Expecting this quarter to turn the rates down by 9%, so that's good for us.
The other moving sort of fund underlying tax rates globally tend to be trending lower, on the other moving part would be where we make our money. Geographic split of income and again we're growing stronger in outside North America than in inside North America, and from a tax perspective this is … tends to be with the exception of Japan, we are the highest tax rate jurisdiction in the world.
So, we sort of take all that up the planning initiative that we've got, put in place all the financing structures we have. Our expectation really here is we see rates feeding that 22%, 23% rate level for the next three to four year which from a tax perspective is really far out as we can sort of plan.
Christopher Ceraso
Okay, good. Any update on cross tail winds from the building business you talked about that at the off side?
John M. Barth
I don’t think any update. What we shared with you at that time Jonathan, just the fact that, that continues to be a key point in our growth.
And as we indicated to you probably the surprising point maybe in that, that presentation was that we are just getting on the front of that. That we'll continue to see good benefits from that as we look out the next two to three years as some of our customers make decisions there, to upgrade their facilities.
Christopher Ceraso
Okay. On the U.S.
air-conditioning distributors’ deal, can you give us a little color about how you won that? Why did they decide to go with you instead of Carrier?
What was the reasoning behind that win?
Stephen A. Roell
I am not sure I want to go in a lot of detail on that point. I think that clearly there is been some switches.
We mentioned to you that we… the same thing had happened in the northeast year earlier with web. And I think… periodically I think distributors do look for new lines and get… and look for opportunities.
And I think we offer great line… we offer great service. I think they like our management and that’s really… that’s why I would say I think that clearly, I think have them adjustable need behind the product and made a difference.
And I think people recognize that we have had a very aggressive growth down for that business.
Christopher Ceraso
Okay. And then I guess one more back to the topic of acquisitions, do you feel any sort of urgency or pressure to do a deal or to do a bigger deal to this sort of a protective measure to make sure that your leverage doesn’t get too low.
Stephen A. Roell
No, no. We don’t think that way.
We basically… our acquisition strategy… our acquisition is tied to our growth strategies. We start with that and look at what its going to do to support our business long-term; we wouldn’t response with that pressure.
Christopher Ceraso
Okay. Thanks a lot.
Denise Zutz
Yes, I think we have time for one more question, operator.
Operator
Your next question comes from Himanshu Patel of JP Morgan.
Himanshu Patel
Hi, good morning guys. The dollar amount impact for lead prices this quarter, do you have a number for that?
R. Bruce McDonald
Sort of higher to $13 million.
Himanshu Patel
And that is?
R. Bruce McDonald
Quarter-over-quarter.
Himanshu Patel
And what was--
R. Bruce McDonald
Quarter-over-quarter like this Q3 versus last Q3.
Himanshu Patel
And what was it last quarter?
R. Bruce McDonald
$75 million.
Himanshu Patel
Okay. So, that was quite big.
In the European business on the order side, you guys talked about a few new wins, should we be thinking about revenue acceleration in that business as we get into ’08 and ’09?
R. Bruce McDonald
I think, Hemanshu, if you look our backlog and specifically as it relates to Europe then, what we have got is we got a lot of… in all eight in particular… we have a lot of model change. So, we expect to see higher engineering and launch cost in ’08, ’09.
But not… most of our backlog in ’08 timeframe is not in Europe. The European growth is really ’09, ’10.
Stephen A. Roell
And as I said those wins, Bruce’s point… those wins go after in 2010 timeframe in electronics.
Himanshu Patel
All right, okay. And then--?
R. Bruce McDonald
Fairly flattish for next year. That’s kind of our expectation top line.
Then the backlog then is disproportionately healthy for Europe in ’09, ’10.
Himanshu Patel
Okay. And then on the building efficiency side, I think your European divisional margins are kind of half of what North American systems you are doing right now.
What's kind of the ability to normalize those margins? Meaning brining them up to North American levels and over what timeframe should we think that?
John M. Barth
Well, let me just tell you the factors that go into that. I think if you look at the improvement in Europe this past… this current year, a lot of this is been driven by basically cost structure improvements.
And taking over we talked about the system redesign and some of the service initiatives over the processes. That’s probably the largest single item, okay.
Now, in terms of… the other important thing, I think Himanshu, is the we talked about the order rate thing after the backlog, okay in Europe but the fact that they had a good strong quarter that’s really the next level, we have got to see some growth in that part of place. Now, having said that, we are in a different competitive world than Europe than we are in North America, okay, which is much stronger having… and there is certainly a whole array of U.K.
competitors and male that market more difficult for us. So, while I would tell you that we are moving towards that and we moved a lot of process over, it’s going to take us a lot to get there.
Because they just don’t have the same service component either that we have in North America. So, building this service business, growing in Eastern Europe, those are really to choose and keep pace are going to drive growth and margins in that business longer-term.
Himanshu Patel
I mean to speak do you think there is any structural reasons why those margins have to be permanently lower or that are touch lower or--?
John M. Barth
No, it usually be the competitive as much of the business there, okay. And structurally the service fees would be the structural fees, okay.
Himanshu Patel
All right. Okay.
Great. Thanks very much.
Denise Zutz
Okay. Thank you very much for everyone joining on the call this morning.
We appreciate your interest in the Company. As always, we will be available to take any additional calls you may have afterward by calling myself or Glen Ponczak.
So, again, thank you very much for joining us.