Jul 17, 2008
Operator
I would like to remind all parties, all lines have been placed on a listen-only mode until we open up for questions and answers. Also, today's conference is being recorded.
If anyone has any objections, please disconnect at this time. I would now like to turn the call over to Denise Zutz, ma'am you may begin.
Denise Zutz
Okay. Thank you operator and welcome everyone.
Thank you very much for joining us this morning. I am here with Steve Roell, Chairman and CEO of Johnson Controls, as well as Bruce McDonald, Executive Vice President and CFO.
We do have probably about 30 minutes worth of opening commentary this morning, and then we will be happy to take your questions. Before we begin, I would like to indicate that Johnson Controls during this call, making forward-looking statements pertaining to its financial results for fiscal 2008 and beyond that are based on preliminary data and are subject to risks and uncertainties.
All statements other than statements of historical fact or statements that are or could be deemed forward-looking statements and include terms such as outlook, expectations, estimate or forecast or those statements that come in cautions that numerous important factors such as: Automotive vehicle production levels, mix and schedules; financial strength of key customers; energy prices; the ability to mitigate the impact of higher raw material costs; strength of the U.S. or other economies; currency exchange rates; cancellation of commercial contracts; changes to domestic and foreign tax rates, as well as other factors discussed in the Company's most-recent Form 10-K filing from November of 2007, could affect the Company's actual results and could cause this actual consolidated results to differ materially from those expressed in any forward-looking statements made by or on behalf of the Company.
Now I would like to introduce Steve Roell.
Steve Roell
Well thank you, Denise and good morning everyone. I am going to do a brief recap of the third quarter results and then come back and we will talk little bit more about the outlook.
First of all in terms of the third quarter, we are very pleased with the fact that we were able to achieve record sales and earnings. Our sales of $9.9 billion were up 11% over the prior year.
We continue to benefit from the diversification of our businesses all three of our businesses had higher revenue. We benefited clearly from our presence in the international markets with Europe and emerging markets performing well for us.
In North America, as we’ve talked about in our press release we’ve highlight the fact that the North American automotive and residential markets are down. Our sales were down in those respective markets, 15% and 17%.
I do not think that surprised anyone, but I think given that performance and the conditions in those two markets I think we are very, very pleased with our results. Our segment income was up 13% to $645 million.
Our profit margins therefore were up slightly. Again, the key there is that all three of our businesses reported double-digit earnings growth in the quarter, so good contribution from all three businesses.
Our net income was up 11% to a record $439 million, $0.73 a share versus $0.66 a share a year ago. As Bruce will go through, we ended the quarter with the strong balance sheet.
Our debt to cap has reduced 29%. So from the standpoint of leverage, we find ourselves in a great position in terms of being able to use our balance sheet for future investment.
I want to take this time just to thank all of our employees and the leadership teams for the results and contributions in this past quarter. I like to talk about the third quarter environment a little bit more.
The one thing that stood out is the fact that we continue to see strong demand for our Energy Efficiency and sustainability. We talked about the fact that in our Building Efficiency group, that our backlog was up 15%, our order rate stayed strong.
If we would show you a subset of some of that, we always talk about our performance contracting, our solutions business, we see that activity up 40% year-over-year. On our non-residential building market side, good growth, the thing we would highlight is that if you look at the earnings side of that, we highlighted in our press release that earnings if you would extract just the non-residential piece of our business, which is 90% of our business, earnings were up 21% in the quarter.
In terms of new orders, we continue to see good demand on new construction and existing building, a retrofit activity. Domestically, we continue to see the healthcare and the government markets to be very strong.
So we are very pleased with what we see not only in terms of the third quarter, but the fact that we’ve a backlog and strong order demand in our cooling activity going into the fourth quarter. Emerging markets across all three of our business continued to be major contributors to our results, and we are referring to Asia, in the China market.
Bruce will talk more about that in terms of the results in the quarter in India. We continue to see good demand for Eastern Europe, and the Middle East is still critical market for us in terms of our Building Efficiency group.
As I mentioned earlier, Western Europe in the quarter relatively stable in terms of all three businesses. Certainly from Power Solutions standpoint, we did see some good momentum there in terms of shipments in our battery business and the Building Efficiency in automotive businesses held up well in this quarter.
Just a general comment about the North American economy, we’ve already talked about the fact that the automotive and residential markets continue to decline. On the institutional side we still could see good demand from a vertical market standpoint.
Some of the business from an industry perspective, there are still good expectations relative to healthcare market, education and basically, what we call the institutional sector. Commodity cost escalation was really historic for the third quarter.
We will talk to you more about that in detail in terms of how it impacts our three businesses. As we then to the fourth quarter or the full year outlook, we did revise our earnings projection for the quarter down to this range of $0.72 to $0.74 from $0.78 in 2007 in our prior guidance, which was higher than that.
I would like to go through with this and just make sure that I articulate why we took down the expectations for what we had three months ago. First of all in the beginning of July we identified the fact that, while we completed the transaction with Plastech, and we identified the fact that we would be incurring restructuring costs that would impact our fourth quarter.
So that is really not new news and that was worth $0.03. In terms of the North American automotive production levels, we now estimate the production in the quarter for the industry will be somewhere in the area about the 3.071 million units and just to give an idea that is down from last year 3.526 million units, that is where it should be a million.
So that reduction is pretty dramatic. If you think about that in the context of historical norms this will be the lowest cost September end quarter since 1993.
It did take us by a surprise in the context of the severity of the reductions in the builds. We’ve highlighted a couple here but the Toyota shut down for the August - November period clearly impact this, is an example of some of the cutbacks in the SUV markets.
So, that we think is worth approximately $0.03 from what our prior guidance was. In terms of commodity cost, there we are referring primarily to cost that we identified, came to us in the May timeframe and I am referring primarily to Building Efficiency and Power Solutions.
Both of those are, we believe are commodities, which will recovered in pricing in the near-term and I want to give a slight example of that. In Building Efficiency, where we’ve the steel increase, we already have priced into our contracts, large equipment in the, lets say with a lead time, that probably extends into the fourth quarter.
So we had to reflect the fact that, we are unable to recover that. The industry practices are, you do not go back and reprice that.
That is roughly $0.06, now we did put price increases in effect in early May. So, we are confident that its contained to that period.
So, if you look at the three items I just described, Plastech, the North American automotive bill, which I think is unusually low, and also the commodities in the Building Efficiency side. All of those are really contained to the fourth quarter.
They are not things that we’ve to extrapolate into fiscal '09. With a yield then in terms of our '08 outlook, a sales growth of 11% to $38.3 billion, we had to revise that lower, given the North American production level decline and also a decline in lead price.
This will still be our 62nd consecutive record year of sales growth. Our earnings growth will be 10% to 11% with the range of $2.32 to $2.34.
That will represent our 18 consecutive record year, the second record year of earnings growth and doubled earnings growth for the sixth consecutive year. To do a little bit longer-term, as most of you know we provide our guidance for the upcoming fiscal year, in this case 2009 at our meeting in October in New York, that is currently scheduled for October 14.
At that point and time we will provide the detail and the outlook we’ve by business and in a lot of detail. However, just to put some of the things in context.
As we look at '09 and beyond, we feel we are very well positioned to win on some of the major mega-trends that we see in the world relative to Energy Efficiency, sustainability, hybrid vehicles, and the emerging markets. We feel we will end the period with a very strong backlog both in our Building Efficiency and Automotive businesses.
We’ve businesses though, we’ve described to you that we take a very annuity-like in the context of battery and are certainly our retrofit and service business in Building Efficiency. As I mentioned earlier, we will end the period with a very strong balance sheet with good cash flows.
We are investing, I will talk little bit more about in the upcoming slides. However, we are investing to continue our growth both organic and in acquisitions.
We feel that we’ve tremendous opportunity to continue to improve our cost structure and we will discuss that little bit later. So having said all that, I think we are very well positioned to outperform our markets and grow profitably in the future, and we certainly feel that in fiscal '09 that we will enjoy good earnings growth.
With that, I am going to turn to Denise, and she will walk through the businesses, each of the three businesses.
Denise Zutz
Okay, thank you, Steve. I am going to begin with Building Efficiency.
Sales in the quarter increased 13% or $3.7 billion. We had very good growth in all global regions, North America, and Asia especially, Europe was somewhat inflated by the FX translation, but double-digit increases in sales for our systems and services business for the non-residential market.
Our Global Workplace Solutions business was up 19% in sales, this is the business where we actually run facilities for a lot of global corporations around the world, facility management services, as well as consulting, and so very strong growth there. As Steve indicated, we did have weakness however though in terms of our North American HVAC shipments to the residential markets those sales were down 17% in the quarter.
Segment income increased 10% to $301 million. As we indicated in the press release we had a good margin growth on our systems and services business, North America, especially due to our process manufacturing improvement.
We did however have a decline, significant decline in our unitary products or again that residential HVAC business. The decline in sales, we had $25 million negative swing in income from that business.
As Steve indicated, also hurting the increase in earnings a little bit, in the quarter it was lag in recovering commodity costs across our market. Again, just want to go back and remind folks that if we took our unitary product business out, segment income actually would have been up 21% excluding net-residential business.
As we indicated in the press release, our margins on our systems and services business actually exceeded 10% in the quarter to 10.6%, versus just under 10% in the quarter a year ago. Steve commented on the backlog and the orders.
However, just to recap a bit, that our backlog for our non-residential business which excludes WorkPlace Solutions was up 15% at June 30th, and that reflects again double-digit growth in that backlog all over the world. Primarily viewing that growth were strong double-digit orders, North America orders were up as Steve indicated double-digit up 11% and that reflected a lot of strength in the institutional construction market and also retrofit markets, federal government buildings, particularly strong.
Again, a lot of this being fueled by gas price. Concerned over energy costs, our energy saving, Energy Efficiency where truly, we are a leader in this marketplace.
It is really paying off for us in this environment. Rest of the world at 29%, a lot of that due to very strong demand in the Mid-East market.
Going to move now with the Power Solutions business, where sales were up 36% to $1.4 billion. The increase in lead prices, and that pass-through to our customers was the major reason for that increase.
Our unit shipments were up about 2% in the quarter, and that reflected some pretty good growth actually in the North American after-market volumes, which more than offset our double-digit decline in terms of the automotive production. We did have an increase in original equipment volumes in Europe, and that reflects our increase in market share.
We also had some very strong growth in our China operations as well, reflecting the strong market there. Segment income increased 22% to a $145 million.
Again, as we’ve said, this is at least the third quarter in a row here we’ve actually had underlying margin improvement, due to the higher volume, as well as improved performances, specially in Europe and also in Asia, including some of our joint venture partners and so, a good improvement there. It looks like margins declined but they really did not.
That is really just a mathematical impact of the higher lead pass-through. Turning now to the automotive business; sales were up 3% in the quarter to $4.8 billion.
Industry, vehicle volumes where down 15% in the quarter as were our sales. If you were to look at that a little bit more deeply you can see that industry production for cars was down 7%, light truck was down 21%.
Just to give you a more of a sense of the size of that, Light truck production was down 500,000 units in the quarter versus a year ago and frankly when we compared what we were forecasting last April versus what actually came in, our forecast last April turned out to be June end 30,000 units too high. So that is just, to give you an indication of how quickly this happened here.
There are some names or some programs you can see where we had higher volume but a lot of lower volume particularly in the light truck area. Our sales in Europe were up 17%.
Frankly if you take FX out, pretty comparable with the industry, the industry was down about 2% we were about flat. Again a mixture of some volumes up in some parts of America and lower in others.
Our China revenues were up 35% to 40% now these are principally non-consolidated. About half of that growth was due to higher productions.
In China, the other half really has to do with again, our market share gains there, new joint ventures. We have a number of the new automakers, as well as new business coming on.
In terms of segment income; up 11% to a $199 million. I think to find good news and some bad news here.
Our North American operations despite our sales being down 15%, operating income was only down 10%, due to a really tremendous improvements in the cost structure and really an outstanding job, I think, on the part of our management employees there. Income from our an European operations was about level with the prior year and that is principally the reason it was not up was, due to a one-time cost associated with taking a shift out of some operations in Belgium, reflecting some changes in our customers production plan.
As we indicated, higher commodity costs was of relatively minor issue in this particularly quarter. Finally, we did have an improved operational performance coming out of China, on our joint ventures as we move from startup and launches to higher production level.
So, that has turned around for us sequentially. With that, I am going to turn the conversation over to Bruce McDonald.
Bruce McDonald
Okay, and thanks, Denise. Well as Steve already indicated, our results for the third quarter were a record, which we feel really good about given the challenging domestic environment that we face right now.
Really reflecting our business diversification and the successful implementation of our growth strategies, you can see revenues were up 11% versus the prior year. If we backout foreign exchange, our organic sales growth was about 4%.
However, that is somewhat misleading. I think if you think about our North American automotive business and the North American residential air conditioning businesses, both which Steve already said, were down 15% and 17%.
However, the remainder of our business, which is 80% of the Company, organic sales growth was just a shade over 10%. So, I feel really good about that given the environment that we are in.
If I look at it by segments, we talked about 13% sales growth at building efficiency, that is 7% if we backout foreign exchange. That really reflects the implementation of our growth strategies and the exposure that we’ve some of the high growth international markets.
In power solutions, we talked about a 36% revenue increase, but if we backout both the impact of foreign exchange and the impact of passing through higher lead costs, organic sales growth was 8%, and as Denise indicated on a 2% growth in volume. That reflects the growth in the after market side of the business and a shift to higher margin products.
In automotive experience we saw 3% sales growth and again as Denise indicated, if we backout foreign exchange we are actually down a 4% and that is obviously in a climate where production was down 15% in North America and 2% roughly in Europe. Just turning over to gross profit, you can see we had a slight decline for 15.5% to 15.1% versus last year.
The decrease is really due to a couple of factors. One is the impact of passing through to higher commodity cost, particularly lead, that is why, we just passed it through on the sale side, had a no impact on our gross profit.
So that obviously is diluted to both gross margin and our segment income. We also had poor overhead absorption in our manufacturing plants, to think about we had a number of facilities idle during the American Axle strike here in North America.
So that is obviously a head win for us. Then we had about $15 million of costs that we incurred downsizing one of our European plants, as Denise talked about in automotive taken a shift out of one of our Belgium facilities.
I am going to talk a bit more about commodity pressure later on. However, unlike our last few quarters, that really has not been an issue.
For the third quarter, the net negative impact of commodities which flows through in gross profit line, it is probably about $15 million to $20 million as a negative issue for us. Looking down at SG&A, you can see that despite the fact our sales were up 11%, SG&A expenses were only up 6%, and as percentage of sales we declined by about 40 basis points to 8.9%.
Roughly speaking in the quarter, engineering and launch costs were comparable to prior years. We are continuing to invest in our growth initiative.
Really what you are seeing here in the SG&A side of the our income statement is that the benefits of economies of scale as we grow. We do not have to add as much to the core SG&A as we otherwise would.
So we are investing in our key growth initiatives and that is something that we’ve done, though the economies firms up here, we want to take advantage of the fact that we are performing well, we got a strong balance sheet and continue to invest in our growth initiatives, so that we can outpace our competition as economy softens further. Turning to equity income, we nearly doubled it to $37 million in the quarter.
This really reflects the benefits of the investments that we’ve made in our automotive business in Asia, most notably in China, but also improved business performance in some of our Power Solutions overseas investments. As we indicated in our last quarter, we expect strong year-over-year comparisons in equity income line to really carry over into the fourth quarter and 2009.
Lastly, at segment income line, up 13%, we saw 10 basis points of margin expansion to 6.5%. Turning to slide 11 here, you can see that financing costs were down slightly from $71 million to $69 million, a reduction of a couple of million.
What we are really seeing here is the benefit of both lower interest rate and also lower borrowing levels, although these were partially offset by some costs that we incurred to repatriate some cash from South American countries and also to swap some of the fixed-rate debt into floating rate debt, that finally worth about $8 million in the quarter, a non-recurring item and financing charges of about $8 million. For the quarter, our tax rate was 21%, right in line with last year, and consistent with our guidance.
Then, reflecting the improved profitability of our consolidated joint ventures, again most notably in automotive entities with strong transplant exposure, and our European Power Solutions business, you can see minority interest was a large increase versus last year. That again is a trend that we expect to see carry over here into our fourth quarter.
So just down to bottom line $0.73, a record for us, and up 11% versus last year. I just like to spend a little bit of time here on our balance sheet and cash flow.
You can see, for the quarter, our cash flow from operations more than doubled, versus 2007 to $551 million. This enabled us to both increase our investments in the business, but also reduce our debt as a percentage to total capitalization.
We ended the quarter with a very strong balance sheet. Debt to total capitalization was 29%, as Steve indicated, down 200 basis points from last quarter, and compares very favorably to 36% where we were a year ago.
Working capital in the quarter in the quarter was a little bit of a disappointment, versus our internal expectation of being neutral here, with an outflow of $85 million. However, it was a significant improvement versus the $377 million outflow that we saw in the third quarter of last year.
We do expect, however, that in the fourth quarter, working capital will be a source of cash for us. Turning to the capital expenditure, we are above the year ago levels but we are clocking in line with our guidance, which was for reinvestment ratio for the full year of 1.1 to 1.
I would also point out that we did close on the acquisition of Plastech, or the interior assets of Plastech engineering in early July, but that is not been reflected in our balance sheet. That will be a use of cash in the fourth quarter of about $200 million here.
We expect however that, our strong free cash flow position in the fourth quarter more than offset the $200 million out flow to Plastech and to end the year was a debt to total capitalization of about 27%. Lastly, I just want to spend little bit of time talking about commodities because as we meet some of our shareholders, in a lot of the analyst community this is becoming a question that it just comes up over and over again.
They really want to spent some time talking through what the impact is, what our key exposures are, where we are seeing that globally, and the impact that it is having on our financials. Really if I could do this just I really need to talk about separately by each business because it is a different issue for all three of our businesses.
However, before I get in to the business level of detail, and we really see unprecedented increases both in terms of magnitude and also the speed and I would say the aggressive nature on watch the supply base is passing price increases on to the customers. For Johnson Controls, our key exposures from our commodity perspective are lead, steel, copper, aluminum, chemicals and resin.
However, in addition, to this we are also seeing significant price increases in things like acids that we use in power solution side of the business, transportation costs, motors, compressors and conversion costs of taking a junk batteries and converting them into lead that we can reuse. I would say while the weak dollar is magnifying the commodity issue in North America this has become an increasingly a global issue.
We’ve seen in all regions of the world, in Europe and Asia. Let me first talk a little bit about lead because we’ve talked about this in the past.
Generally speaking, we do have passthrough arrangements where we can pass the cost increases on to our customer. Lead is actually working the other way from all of our other commodities and as you can see by the chart here that I have included in our slides.
It is the one commodity that is seeing a pull back recently, though I would say that the volatility is significantly increased. If you just take the third quarter as a reference point, we saw led prices arranged from a high of nearly 3,000 a ton, to 2955 a metric ton, to a low of 1564 a metric ton, and is no longer becoming uncommon for prices to fluctuate within 20% to 30% on a weekly basis.
So we are really seeing unprecedented volatility in the lead market. Generally speaking, our hedging programs on the lead side are working well.
The indexing and commercial arrangements we’ve with supply base are working affectively and by and large insulating our financial results from rapid short-term escalations, but not completely. Now, let me swing to talk about the non-lead increases in the other three businesses.
So, let me first start with automotive. By and large in automotive, commodity inflation is not a 2008 issue, it is going to be of 2009 impact for us, mainly because of the supply contracts and hedges that we’ve in place.
The magnitude of the issue for us here and really it is particularly prevalent in steel, means that we are going to have to pass the cost increase on to our customers. We are currently in negotiations with our customers globally.
We expect to have this issue largely resolved or certainly now where we are with our customers by the end of our fiscal year. We will talk more about that obviously in our October meeting.
In terms of power solutions, as we’ve indicated before. Leads not really an issue from an earnings perspective and our lead hedging program in passthrough is working well.
The inflation here is in things like resins that we used to make the battery cases, acid as that I talked about before, transportation cost and higher energy related input cost, both tooling lead and also the electricity and natural gas related charges that we used to charge the battery. We’ve announced price increases, which we expect will be implemented here in early to mid August, which will fully recover these increases.
Although the effect for the fourth quarter is we are not going to fully recover that and I would say for Power Solution, the net impact that we are going to see in the fourth quarter will be about a $15 million, $20 million head wins, but as Steve indicated before, we expect will not be a factor for us as we go into 2009 for Power Solutions. In Building Efficiency, we started to see commodity inflation kick in here in the third quarter.
So that is the one business where its comes out as the quickest and we do expect this to carry over in to the fourth quarter and be a little bit of headwind for us as we go into the first quarter of '09. The major elements of building efficiency increases being steel, aluminum, motor and compressors, copper and fuel cost.
We’ve implemented price across all of our product lines globally and we put in place huge surcharges for our truck-based service businesses. We do expect these pricing actions to enable us to recover the increased cost but it will have a negative impact over the next couple of quarters as we work through our backlog.
As in the past, I would comment, the HVAC industry has collectively increased prices in times of rising commodity cost and we are fairly confident in our ability to offset these higher costs along with the rest of the industry. So the bottom-line from a commodity perspective is, the impact of our fourth quarter is going to be about $0.06 in aggregate and we expect that with the surprising actions that we already implemented and the negotiations that we’ve underway as automotive and have a very good feel for where we are going to be at in 2009 in at the time we make our analyst calls here in October.
So with that I am going to turn it over to Steve for a few concluding comments.
Steve Roell
Hey. Thank you Bruce.
I would just like to summarize a little bit about how we are operating and forcing things from an operating standpoint. I have mentioned in the past that even in the period where we see weakness like we are seeing in a couple of our markets, we’ve the advantage of being able to continue to invest for growth.
In our case what that means is continue to invest in our innovation, in our product, technology around information technology, to improve our processes and certainly to add to our sales forces. I feel comfortable about our ability to execute on growth strategies including on the positions that we’ve and have established in the emerging markets and may be the most important element and this really driving for our cost improvements.
This goes well beyond what we typically to refer to as our best business practices and our continuous improvement. However, we believe we still have tremendous number of opportunities to improve our cost structure and that the costs associated with those can be absorbed business very rapid pay-backs.
From the standpoint of our priorities, they remain unchanged. We still look to, from the standpoint of our sales; we look for sustainable organic sales and earnings growth.
Our long-term objective is to continue to grow at twice the rate of underlying industry growth. Further global diversification we believe is possible, reducing our dependence on individual products, market, and regions.
We believe that with our cost reduction activities that we can expand our margins and combined with our capital efficiency and working capital efficiencies we can drive for increased returns on invested capital. Our use of cash is really unchanged.
We are still focused on what we can do to identify growth platforms for future revenue expansion and finally our philosophy continues to be that we look to increase our dividends to our shareholder. With that I am going to turn it over to for Q&A.
Operator?
Operator
(Operator Instructions). Our first question comes from Himanshu Patel.
You may ask your question, and please state your company name.
Himanshu Patel
JP Morgan. Couple of questions.
When you look at the North American automotive business, it sounds like you took some cost actions in the latest quarter. Is the restructuring that is required in that business, has all the heavy lifting been done on that or are there a couple of more quarters of this that we need to go through to right size the business?
Bruce McDonald
This is Bruce, Himanshu. I would not, I would say we got to respond to the fact that it looks like it is going to be a fairly fundamental shift here and actually would be production.
Our customers are continuing to adjust their production thoughts and we are going to have to respond to that at some of our jet facilities. I would say the one area that we are still considering is our metals footprint, that is probably the one part of the business that we got to take a look at.
Steve Roell
Himanshu, the other thing, some of the recent announcement, the GM announcement took place so obviously, it did not have a great deal of impact on us. The Tundra is actually good.
The Tundra movement from Indiana down to San Antonio is actually going to be a benefit to us. So, in terms of North America, as Bruce mentioned, look the metal side, but I do not think that there is a lot of foot printing opportunities for us in North America.
Himanshu Patel
Then you mentioned recoveries on commodity costs across all units, and I noticed you referenced North American auto as well. I am wondering what is prompting that comment, are you, is that just wishful thinking are you actually seeing some behavioral changes out of the purchasing departments at the Detroit Three carmakers on this issues?
Steve Roell
Well, Himanshu, I do not want to talk about any single one. However, I would say there is some behavioral changes that are evident, we still have a lot of negotiations to go through.
I think what I have historically described is the fact the behavior outside of the Big Three has been very consistent, and I think we continue to see that as well. However, I do think that the magnitude of this as we’ve discussed with you is such that the supply based its entirety is going to have to look for some formula really from the Big Three.
Himanshu Patel
Okay. Then, just two last questions on building efficiency.
It looks like you posted 11% growth I think excluding FX. As you look forward for the next couple of quarters just based on the order rate and stuff, whether you are looking at the reported revenue growth organically or the backlog growth organically, do you see that rate of growth moderating or would you expect that to still continue for the next couple of quarters?
Steve Roell
Well I do not want to go beyond the fourth quarter, which is what our review is okay. I think that what we are going to see is the comparisons are going to get easier from the standpoint of the residential side.
As we indicated that they had a big impact on us in the quarter. I think that the comparison starts to get easier little bit in the fourth quarter, but certainly as we do go beyond that, they are easier, somewhat help from that side.
However, I think the key is this if you look at our backlog demand churn, we actually got a slide on last quarter's release there actually was a spike in Q3 a year ago. So this was our toughest comparison year-over-year, in terms of our backlog.
So I feel good that coming under this we saw two things. We saw our backlog respond with a 15% growth and we also saw the bidding activity continue strong, again as the pipeline, I refer to often times.
Himanshu Patel
Okay. Then last question, can we talk a little bit about Europe?
I mean your profits there, on the auto side are, it looks like its about quarter of your total operating income. We are seeing some of the western markets in Europe definitely seeing slowdown in new car registration.
How are you feeling about the business there? Is it too early to talk about a broader restructuring there or are you planning the business for '09 for lower industry volumes across Europe?
Steve Roell
Well, let me talk about the industry and then I will let Bruce talk about the opportunities for restructuring. I think you just saw when [Judy Powers] came out for the Western Europe estimates of being down 4% for '08, I think they are identifying about 1.5% decline for '09.
The softness right now seems to be really heavily, you have seen the numbers mentioned here in terms of Southern Europe, Italy, and Spain are particularly being very soft. We never really counted on those markets being strong for us.
Our growth is coming from the German market and primarily in the French market, but maybe more importantly from Eastern Europe. Well, it is a not high percentage.
That is where we felt we could grow. So, the deterioration that we are seeing for '08 is not surprising and we’ve been able to get through that.
If you recall also, our backlog as we go further into '09, 10, 11, a lot of our backlog is in fact in automotive and it’s skewed towards Europe and its skewed towards Eastern Europe. So, we are not surprised at what we are seeing thus far.
Himanshu Patel
That backlog kicks in '09 or if I recall.
Bruce McDonald
Probably '010.
Steve Roell
Not so early, its 10, 11 where we really see the big benefit. In terms of your comment about anything just sort about our cost structure, Bruce you want to address that.
Bruce McDonald
Yes. I would just say, maybe just before I get back, our backlog is very heavily skewed to Europe and I am very comfortable that the amount of new business that we’ve coming on, which is business that we won from our competition has under-represented customers that we’ve talked about before, were more than offset the volume softness, the general volume softness, that were seen in the marketplace.
Another fact that though that we are seeing is a little bit of softness from some of the manufacturers who had heavy export content, actually a little bit of short-term softening there, but nothing, nothing really dramatic. In terms of the footprint side of the business, clearly there continues to be opportunities as the industry is migrating from the west to the east and so yes, there is definitely something that we are going to take a look at, with respect to that.
Himanshu Patel
Great. Thank you.
Steve Roell
Thanks Himanshu.
Operator
Thank you. [Brandon Farrell].
You may ask your question.
Unidentified Analyst
Good Morning..
Steve Roell
Hi Brandon.
Unidentified Analyst
I wanted to talk about the BE business specifically the residential piece. I think, I mean you posted a 17% decline in sales, I think, when we look at some of your competitors in the residential piece of their businesses, we are seeing some low single-digit declines.
What exactly is going on with that business with respect to yourself and then your competition, is that business is structurally impaired, or is that the U.S. Air piece from last year?
Bruce McDonald
Okay, that I……
Steve Roell
I do not think we feel the business is structurally impaired at all, I think there is no change in the underlying technology. What I would tell you is, and we’ve talked about this before.
First is, our business is more heavily exposed to new construction in the marketplace. So it is 65% of the market is replacement and 35% is new construction.
We are more like 50-50. So as the economy goes through a downturn here, on new construction site, that is a negative for us and so we are just proportionally hit versus some of our competitors.
Secondly, if you look at our inventory position, we’ve a lot of destocking of inventory that we’ve in our distribution channel, and that is another thing you really need to look at. We are entering in to the summer cooling season here, or exiting the summer cooling season with inventory and our channel probably down 40% to 50% versus year ago level, so we’ve been very lean and taking product out of the pipeline and I think that means we will respond very favorably when the industry picks up.
Lastly, you asked about U.S Air conditioning acquisition that is our investment that we made at the end of '07. I would say that business is -- if that converting that channel into incremental sales have taken as to little bit longer than we had originally envisioned but we are very pleased with the progress that we are making here on a quarter-over-quarter basis, and that is something that is gaining momentum.
So I think we feel pretty good that bottom has passed in the residential air conditioning side of our business and we do expect to see lot easier year-over-year comparisons as soon as we get into the fourth quarter of ’09 and right now, our expectations is that our unitary products business will be a significantly better in '09 than it is in '08, not based on industry recovery but just in terms of cost actions that we’ve taken, the destocking that we’ve done and some of the new products that we’ve implemented a new, 33-inch furnace in our micro channel technology on the residential side.
Unidentified Analyst
Yes, Okay, so I sense that is an inventory channel issue and you have worked yourself through that because otherwise, that business is showing great margin expansion.
Steve Roell
Right.
Unidentified Analyst
Are you, can you just remind us what your margin improvement objectives are in each of your three businesses as you weigh the matter with the past year and as you think about 2009 and some of the macro issues we are seeing in each of those businesses, are you still committed to those?
Steve Roell
Yes, I mean, I can remind you on what our goals are. I mean we’ve talked a little for automotive experience that we want to get to a 5% consolidated margin from a global perspective, and that is unchanged.
In terms of building efficiency, talked about double-digit, excluding GWS and that is unchanged. Then, in terms of power solutions, we’ve talked about our margin aspirations being up about a 100 to 150 basis points.
If you backout lead because that really gets to be a lot of noise in the system, and I would say our margin aspirations for power solutions are increasing as we start to look to more levels of investment in vertical integration. I will talk more about that in our analyst meeting in October.
Unidentified Analyst
Okay.
Denise Zutz
Okay. Brandon, I think we are going to have to move on to the next person asking a question.
So thanks very much. Operator, could we move, go to the next?
Operator
Thank you. Our next question comes from Chris Ceraso.
Please ask your question and please state your company name.
Christopher Ceraso
Thanks. Good morning and Credit Suisse.
Steve Roell
Hi, Chris.
Christopher Ceraso
A couple of things. I appreciate the breakdown that you gave us on the commodities by business.
However, one thing that seemed to be missing was the automotive businesses that relates to plastics and resins. Can you comment on contract situation there, with regard to any pass-throughs or recovery, and where does that stand now that oil prices they are up further?
Steve Roell
Well Chris, I would tell you that it really becomes a much bigger issue for us with the Plastech acquisition, okay. One of the elements that was specifically negotiated, and that with our customers, was pass-through arrangements on resins, that was the key part of the discussions when we made the investment in the business with our customers.
Steve Roell
I would also tell you we, Chris that in Plastech, I do not think we alluded to in our press release for the Plastech transactions. Its been completed but we already have I think, its close to $70 million worth new awards that have been given to us in the first 15 days.
Subsequent to that, they have their protection. So we do not really have any choice in that business.
So, as Bruce mentioned that was part of our discussion and we had good cooperation and collaboration with our investment base.
Christopher Ceraso
Okay Bruce you mentioned the back log in automotive, do you have a net new business number '09, '10, '11 that you can give us for automotive on a global basis.
Bruce McDonald
We will get back to you in October, Chris.
Denise Zutz
We only update that once a year Chris. Okay, operator again we will take the next questioner.
Operator
Thank you Rich Kwas. You may ask your question and please state your company name.
Richard Kwas
Wachovia. Good morning
Steve Roell
Yes hi Rich.
Richard Kwas
Steve just a broader question acquisition, given what has transpired over the last few months with the North American auto industry, just the general economy. You are more bullish or less bullish on making acquisitions?
Steve Roell
Well let me just, there is two parts there Rich. First of all, we’ve indicated that I think from an acquisition standpoint we’ve gone through a lot of prioritization in the world of the areas where we want to go to.
First thing I would tell you is, that probably 80% of our future M&A activity will be focused BE, just simply because we think the opportunities are best there. In the automotive sector Rich, I have never really been attracted to a value propositions around the depressed values.
So we continue to look for ways to grow but they are technology based in automotive and that at BE there is whole range. That is probably the best way to describe it to you.
Okay?
Richard Kwas
Okay and then on the building efficiency, I think you said that coding activity is up 40% year-over-year. That implies most companies are not cutting budgets on energy efficiency.
Is that a fair conclusion to come to?
Steve Roell
Yes, let me go back. The 40% I referred to was coating activities specifically on the solutions performance contracted piece.
Okay. If I look at overall coating activity its up double-digit.
So, I do not want to mislead by the 40% in our total, our total business base. However, to your point I do not see and I am not hearing people cutback.
In fact I do still know where there are corporations that are taking lower flow rates for their energy conversation. I think with energy cost in general, I think is still a major focus on what they can do to reduce cost and to achieve their sustainability or targets that they have with EPA for greenhouse gas reduction.
So, I do not sense any reduction right now from the standpoint of the industrial and commercial base.
Richard Kwas
Great, thanks so much.
Operator
Thank you. Your next question comes from Brian Johnson.
You may ask your question and please state your company name.
Brian Johnson
Lehman Brothers.
Steve Roell
Hi, Brian.
Brian Johnson
Yes, given what you said about acquisition dollar going towards building efficiency rather than autos, but also recognizing Plastech was moving to liquidation. Can you give us some of your strategic thinking behind Plastech and just be into North American interior segment and how this acquisition positions you different strategically?
Steve Roell
Yes, Brian let me…
Brian Johnson
If at all.
Steve Roell
Brian why do not go back. This decision was not a strategic discussion.
We would never have in our list of areas we want to invest in and only come back on, but let me explain to you why. We did the transaction.
The primary basis was to protect our customers. We were looking for maintaining continuity of supply and that was the biggest risk we had to the industry.
Not just the ones that are partners with us, but certainly a lot of the transplants also had, had parts of their tools with Plastech. So, our primary reason for doing this transaction was to ensure continuity of supply to our customer base.
That is number one. Number two, from the standpoint of the business we felt that we can manage this business well.
We felt that we had a management team that wanted to do this business, so we felt that we can add value. As evidenced by the fact that we are getting approached for new business, I think our customers feel the same thing.
So we will do well in this business overtime. However, it is not something that we want to put on our radar, its something we wanted to necessarily invest a lot of capital in.
If you look at our total or call it acquisition capacity over the next three to five years, now it is Bruce, what is on there.
Bruce McDonald
About 2%.
Steve Roell
It is a big number, I mean; this is something in a 4 billion range, so you can picture this 200 million on that context.
Brian Johnson
There is a $0.03 head we saw this quarter, how long do you think that will continue and when does that become neutral or accretive?
Bruce McDonald
That was the first plant. Let me just clarify a little bit about the financials here.
We expect that Plastech will be about a break-even operation here in the first quarter that we own it, but we’ve got significant cost, integrating the IT systems and overhead structure into our North American infrastructure. Also addressing the fact that their footprint is underutilized, so we’ve the capacity, a lot of tools to move like several thousand, we got at too many facilities.
So we are going to have some plant closures. So it’s really the restructuring cost that make its earnings negative to us here in the first quarter.
’09, we are looking for Plastech to be about neutral. In '010, I would say, Plastech is going to be worth $0.04 to $0.05 to us.
Brian Johnson
Anyway, especially given that commodity discussions you are having about the US industry as recognizing your good citizenship in helping out Plastech?
Bruce McDonald
Well, I will just answer that briefly. We think we are getting incremental business and I know our customers appreciate us keeping their continuity supply at top of our list.
Brian Johnson
Okay, except that translates to pricing.
Bruce McDonald
Yes.
Brian Johnson
Thanks.
Denise Zutz
Okay, Brian. Yes, operator next question.
Operator
Thank you. Patrick Archambault, you may ask your question and please state you company name.
Patrick Archambault
Hi, yes, from Goldman Sachs.
Steve Roell
Hi, Patrick.
Patrick Archambault
Good Morning. Just wanted to see in the backlog you reported for building efficiency, does the Middle East chiller contract that you announced, is that included in that?
If not, what is the timing on that?
Steve Roell
No, that work took place after the quarter end. So that will be something, it'll be added to our backlog in the next report, okay.
Patrick Archambault
Okay. So the timing though would be within the next year, year and half for that contract to start rolling on in terms of revenues?
Steve Roell
Yes, yes.
Patrick Archambault
Okay, great. Also in terms of, you had talked about in the past, the integration initiatives that you in batteries that you were applying to Europe and Asia.
Wanted to see, if that was already being implemented, was that in the results we’ve seen so far, and what inning are you in terms of that process?
Steve Roell
Patrick, making sure I understand, when you are taking about integration, you are referring to our ability to go back and basically get a recycling program in place. Is that what you are referring to or you are talking about vertical integration?
Patrick Archambault
Sorry. I was talking about the moving the manufacturing process in Europe and in Asia in line with some of the advances you have made in North America to get margin expansion.
Steve Roell
Well this is referring power frame, okay.
Patrick Archambault
Correct.
Steve Roell
At this point and time, we are doing that in Europe, and we’ve not done that yet in Asia. Right now, we are looking to our green-field operations in the China market, and if we were successful in doing that, in the near future than we would actually introduce power frame in other market at that time.
So there are still ways to go. We are not fully implemented in Europe, and we’ve not started yet in Asia.
Patrick Archambault
Okay, great. Thanks.
Just one last housekeeping one. How should we think about modeling the minority interest in just given the significant change year-on-year.
Bruce McDonald
It is going to be, I would say, in the 15 to 20 ballpark for the next couple of quarters. We will obviously give full year guidance on that for '09, but it is going to be at the level its currently at, plus or minus.
Patrick Archambault
Okay, great. Thank you.
That is all I had. Thanks a lot.
Steve Roell
Thanks Patrick.
Operator
Thank you. John Murphy, you may ask your question and please state your company name.
John Murphy
Merrill Lynch. Good morning.
Bruce McDonald
Yes, hi John.
John Murphy
Three questions. First, when you talked about the coming quarter, you said that it is not an environment you can really extrapolate to North American volumes going forward.
Just trying to understand what you are thinking there. Is there something in the schedules that are changing very quickly and abruptly or did you see the market getting better going forward?
That is the first question. Second, was there a need to repatriate funds that drove up that financing cost, because you alluded too for the financing cost being higher because of repatriation of funds?
Bruce McDonald
A word about those two.
Steve Roell
John. In terms of the first question, what I was really saying is that this is a shutdown period.
So, typically what happens is that, the North American OEs are going to use this to extend and adjust our inventory or imbalances. Okay.
That happens in the third quarter in the August time frame here, okay? July-August, and then, I used Tundra as the example where the adjustment required was something extreme, which was a three month shutdown.
That is why I am saying you cannot extrapolate this into the October, November, December timeframe. The adjustment should take place as part of this downturn, okay?
That was my rationale there.
Denise Zutz
Well, and in addition to that, again, we pointed out delays in the launches of the new F-Series, as well as ramp. I am sure those will launch.
John Murphy
Those are going to launch.
Denise Zutz
That is correct, the product is going to launch in the fourth quarter, as when we had expected.
Steve Roell
Our fiscal quarter end.
John Murphy
So you do not foresee shut downs and delays happening in future quarters, in the next few quarters.
Steve Roell
We could, but I would expect this quarter to be the one where we always have the opportunity to really take advantage of it. This is their shut down period.
John Murphy
Okay.
Steve Roell
I think what they will do again. They will take one more look John at the end of the Christmas holiday.
So what might expect is that if retail were soft again you might see an extended shutdowns associated with the Christmas. Okay?
John Murphy
Yes.
Steve Roell
It’s in that timeframe okay?
Bruce McDonald
Yes I will just take the financing question there, John. Most of the cost the million it relates to swapping out for debt, from fixed to floating and that is an in the money swap.
So we will have some carry-over benefit in the future. The repatriation comment was really up-taken from, taken the opportunity that presents up in the market place, to extract some cash from some South American countries that have currency and cash control.
So it was an opportunistic thing.
John Murphy
Okay and then just lastly on slide 7 and looking at the commercial building sales and laid on the pie chart that you have there and you have servicing retrofitting at 75% of the sales, which is a good thing versus a new construction. I am just trying to understand in the service versus the retrofitting there and services clearly pretty sticky, but retrofitting when we are looking at that, how much is, of that 75% is retrofitting and when we think about that 75% slides of the pie there also, how much is government and how much is private business?
Steve Roell
Yes just trying to cover all that but just to give you a sense for in that retrofit, you have got really several on this. When I talked about that 40% growth in performance contracting that is there.
Retrofit is largely driven by expansion projects that are tied to energy conservation. That is why that is fairly secure, okay.
I just would tell you that historically that portion of that reply does not impacted during slowdowns in the economy. Okay.
The other side in terms of the government side, I would only tell you that if you were to take healthcare, education, and government, you are probably talking close to 60% of our North American volume, and that does not deal international piece. However, that would the way we describe it to you.
Denise Zutz
Yes. The additional guidance I can give you is our workplace solutions business is in that service bouquet.
So retrofit is significantly smaller than the total service dimension there. Okay?
John Murphy
Okay.
Denise Zutz
I think you can get a size of the service business, if you look at our financial footnote through the press release.
John Murphy
Got you.
Denise Zutz
Breakout products and systems versus services, there you get a clean break of our service business. So…
Steve Roell
John, if we can help you there, well then we will. We will get to you after the call.
Okay?
John Murphy
Great. Thank you.
Steve Roell
Okay.
Denise Zutz
Okay. Operator, I think we’ve time for just one more question, with one more question I hope in that question.
Operator
Okay. Our last question comes from Rod Lache.
You may ask your question and please state your company name.
Rod Lache
Deutsche Bank. Thank you.
Steve Roell
Hi, Rod.
Rod Lache
Any help on framing the amount of commodity exposure in auto that needs to be pass-through? Also on auto, just help us with just rough feeling for the eastern European versus western European exposure, I know it is tough with, were production is versus where that its sales are?
Steve Roell
I seem the later one, well I have to come back and give you a better feel for it, okay. I do not have that handy, Rod okay.
We just do not have it available here. On the commodity discussion in terms of magnitude, I am just afraid that any number we give you is not going to be relevant, because it has to be in the context of where our recoveries or our cost showing is.
I know what I would do, if I gave you a number, how I would help you with that.
Rod Lache
Okay. Then, can you confirm on FX, I assume that you mark-to-market the euro assumption in the new guidance, is that correct?
What was the bottom-line impact of FX in the quarter and if you have done the calculation the effect of that on, on that building efficiency backlog?
Bruce McDonald
Well for the FX impact on the building efficiency backlog, if you stripped out exchanges, the upper 11% versus the 15% that we reported Rod.
Rod Lache
Okay, great.
Denise Zutz
Okay. Well thank you everyone.
We appreciate your interest, and as always we will be available after the call to take any further questions. However, thank you very much for joining us today.
Steve Roell
Thank you.
Bruce McDonald
Bye bye.
Operator
Thank you. That concludes today's conference call.
You may disconnect at this time.