Jan 22, 2010
Operator
Welcome and thank you for standing by. At this time, all participants will be in a listen-only mode until the question-and-answer portion of this call.
(Operator Instructions) Now, I’ll turn the call over to your host, Mr. Glen Ponczak, Executive Director of Investor Relations.
Sir, you may begin.
Glen Ponczak
Thank you, Marcella and good morning everybody. Thank you for joining us.
Before we begin here, let me remind you of our forward-looking statements. Johnson Controls will make forward-looking statements in this presentation pertaining to its financial results for fiscal 2010 and beyond that are based on preliminary data and are subject to risks and uncertainties.
All statements other than statements of historical fact are statements that are or could be deemed forward-looking statements and include terms such as outlook, expectations, estimates or forecasts. For those statements, the company cautions that numerous important factors, such as automotive vehicle production levels, mixes, and schedules, financial distress of key customers, energy prices, the strength of the U.S.
or other economies, currency exchange rates, cancellation of, or changes to commercial contracts, changes in the levels of timing of investments in commercial buildings, the ability to execute on restructuring actions according to anticipated time lines and costs, as well as other factors, discussed in the company’s Form 8-K filed March 9, 2009, could affect the company’s actual results, could cause its actual consolidated results to differ materially, from those expressed in any forward-looking statement made by, or on behalf of the company. Today, we’re joined by Steve Roell, the Chairman and Chief Executive Officer of Johnson Controls, who will provide an overview of the quarter.
After that, he’ll be followed by Bruce McDonald, Executive Vice President and Chief Financial Officer, who will give a detailed review of our business results, as well as more on our financial performance. That will be followed with questions and answers.
With that, I’ll turn it over to Steve.
Steve Roell
Thank you, Glen. Good morning and thank you for joining us.
We’re very pleased with the first quarter results. We had good contributions from all of our businesses, each one performing either on plan or exceeding the expectations we had when we talked to you back in October.
I want to talk just briefly about the importance of the diversification of our business. In the past, we’ve highlighted this and while it might not have been so obvious a year ago when we were seeing the global economic crisis, I think that you can begin to get a sense for how important diversification is from the standpoint of our three businesses.
The geographies that we operate and the customer base that we have. We look at first quarter segment earning income and also net income driven by double digit revenue growth.
We’re very pleased with the fact that our earnings were driven by top line growth, a combination of market improvements and finally, share gains in all three of our businesses. We are converting well in the higher automotive volumes.
I know that was part of our discussions as we came through fiscal 2009, was the fact that as the markets did improve, we felt that we would see contribution margins of somewhere in the high teens to 20% in the automotive segment and we’ve seen that. We saw it month-by-month in this quarter and we’re very pleased and I think it bodes well for the outlook.
Finally, as we indicated coming into the year, we expected to benefit from the restructuring actions of the past year and we expected to see roughly a $0.35 to $0.40 benefit. I think it was $0.40 throughout the fiscal year.
I guess, I would tell you that we saw probably between $0.10 and $0.15 of that benefit flow through in the first quarter. So if you dissect our earnings, I guess the way this page is, I think sort of depicts and illustrates where those benefits came from in the order, primarily from top line growth; second, from that conversion of the automotive volumes; and thirdly, from the restructuring benefits.
If I didn’t look at just some of the absolute numbers for the quarter, sales of $8.4 billion were up 15%, adjusted for foreign exchange, it’s roughly up 9%, segment income of $406 million versus a loss of $48 million. Net income of $288 million, yielded diluted earnings per share of $0.43 versus a loss of $0.13 and I think that’s the right comparison.
Out of the $0.43, we took the onetime favorable tax item out of that number and I think we’ve cleaned up the prior year. So the $0.43 to $0.13 loss is the right year-over-year improvement.
I think it that may have surprised a lot of you was the strength of the cash flow in the quarter. Bruce is going to go into that in more detail, but the fact that we generated $651 million of free cash flow and paid down our debt by $552 million, I think speaks to two things.
First of all, the quality of earnings we had in the quarter and also our ability to manage and effectively lower our working capital. I think if you look at the quarter, I guess the thing I would point out is that we had good performance.
I would also tell you, though that we still saw very challenging environments in all of our markets. Let me just talk about that as I go to the next page.
In automotive production in both North America and Europe were stronger than what we had earlier expected. If you were to have seen our plans for the first quarter, we actually expected North American volumes to be just down slightly I think 1% from what they were a year ago and as it worked out, they were up 3%.
Now Europe was also stronger than what we expected, primarily due, again, to the fact that the government incentives throughout a number of those countries continued through the quarter and drove demand. Our conference call and many of you follow the auto industry know that dealer inventories were severely depleted at the end of September, even at the end of December, we’re still seeing just 53 days on hand that compares to 93 days a year ago and probably more normalized level between 60 and 70 days is what we would estimate.
So we did benefit from the replenishment of that depleted inventory at the end of September. We continue to see very strong growth in China, and we’ll talk more about that in the outlook, but clearly I’ve seen some of the numbers regarding just how strong that was as the year played out and Bruce and I were just in China and as it works out, they continue to be very positive about the outlook for 2010.
In the power solutions, higher overall demand for the automotive batteries, we saw aftermarket demand pick up. Partially we can attribute the weather.
Partially I think it’s just a function of stocking, balance sheets are better, so I think the after market customers I have laid in more inventory weather did help that. Stronger global demand as the automotive production increased throughout the world really, both Western Europe and the U.S., we clearly benefited we saw strong unit growth in our OE sector.
We continued to, even though this is a comment about Johnson Controls, we saw market share shifts and we benefited from a couple new customers who we launched in the past 12 months and made the year-over-year comparison better. Building efficiency, as we’ve talked about, this business will continue to be challenged as a late cycle, non-residential market continues to be under pressure, but we do see signs and we’ll talk about that, that maybe we’re bottoming out and starting to see some improvement in both the domestic and some of the global markets.
We talked about the next three points are really about vertical markets and let me first make a comment about ARRA. Activity and from our standpoint, bidding, continues to be extremely weak and behind our expectations, particularly in the educational sector.
Now, having said that, the two segments that really performed well in terms of growth year-over-year in orders was the educational market and what we’re beginning to see is that projects that might have been earmarked with ARRA are shifting back to more traditional funding. The Muni bond market is improved and maybe because of some of the reporting requirements regarding ARRA, educational sectors have decided to use more traditional financing.
That’s our sense right now. We did see strong government building market demand in both our orders and our pipeline, in both local and federal.
The one area that I would acknowledge was weak was healthcare and it’s been weak for about the last nine months. We are seeing that weaker than what we expected at the beginning of the year.
We have mixed international markets in the quarter we have currently lower demand in Western Europe and I guess we would anticipate that would continue. We continue to see opportunities in the Middle East, in Latin America and specifically in Brazil, and in China.
Finally, we did continue to see some improvement in the residential HVAC market in the quarter and it was attributed to our results. In terms of the 2010 outlook, we did give new guidance this morning.
We essentially are very cautiously optimistic about automotive production in the second half of 2010 and the reason we are, we still are looking for signals regarding the strength of consumer demand, specifically around the larger higher priced consumer items and so we’re a little bit not pessimistic, but just cautious as we go into the second half. As I mentioned, we do see strong growth in China continuing at a rate at probably in the 15% range.
So, as part of that, we did update our automotive production assumptions previously we guided to 9.9. In North America, we now see North America at 10.3 it again just remind you, that’s our fiscal year that ends in September.
We are seeing improved profitability outlook in the power solutions business, primarily due to increased volumes. We did see our inventories depleted severely at the end of December.
We were down to five days of plays, so that’s probably about 20% about what we normally would want to be. So demand really did hit us hard and we were able to satisfy that demand and satisfy our customers, that debt demand did help in our first quarter outlook.
We would expect it to continue throughout the year. Finally, building efficiency to performance again very much inline with the previous expectations, we’re not changing and revising that.
Our year-over-year sales growth is expected later in the year partially as the domestic markets recover. We don’t expect any improvement in Europe, but we are expecting to see improvement in Asia, Latin America, as the year plays out.
We have a stable pipeline of energy projects, solution projects, we do see momentum in the emerging markets, as I mentioned, and so I think as we would categorize building efficiency for you, I think we would say that we feel we’re seeing signs that it is starting to improve. In terms of the absolute guidance, Bruce is going to go into this more detail regarding all of the assumptions, but as you’ve seen in the press release we increased our guidance for our fiscal year to a range of $1.70 to $1.75 per share.
Just there’s been some clarification this morning that again does not include the $0.09 positive tax item that was in the first quarter that we excluded from our $0.43. So for those of you that asked, wondering about that clarifies that one.
So with that, I’m going to turn it over to Bruce and he’ll go through the business segments. Bruce.
Bruce McDonald
Okay, thanks, Steve. Well, I’ll start on slide 10, automotive.
A pretty terrific quarter here for automotive business and I think the quarter’s results really demonstrate the strong momentum that we have in our automotive businesses globally. You can see on a constant currency basis, sales were up 24% and we saw sales gains that were significantly better than the market.
So if you look at that on a regional basis, North American sales were up 14% versus an estimated production increase of 3%. In Europe, excluding currency, we’re up 35% versus an estimated increase in production of about 18% to 20%.
In China you can see including our consolidate operations our sales were up 112% in the quarter from $745 million. Our estimate is the China production was somewhere up in the 80% to 85% range.
So good share gain in all three of those major markets. In terms of looking at our segment income for the quarter, we’re at $121 million versus a large loss last year and we’re seeing good profit conversion on incremental volumes, really reflecting the benefits of better capacity utilization and the benefits of the restructuring initiative.
Most of the restructuring initiative gains that Steve referred to you really flow in through automotive operations here in the quarter. The top line growth in China is really been reflected in significantly higher equity earnings.
You see that on the space of our income statement not close to segment income for the automotive sector here. If you do look at our geographic results here, in terms of return on sales, you can see North America our margin in the quarter were 5.4% and 6.1% in Asia, and you see in Europe, we’re at 0.5%.
That probably warrants a little bit more discussion, the European results in particular. In Europe, we’re really being negatively impacted by a few things.
First of all, that’s where the bulk of our launch activity is concentrated this year and we’ve got some launches that we’re having some difficulties with. We’re also dealing with a couple of and we’re starting to see parts and components shortages in the supply chain.
If you sort of aggregate all those things together, those factors probably cost us $40 million to $50 million in the quarter and we expect those to sort of drop off over the next two to three quarters. So that’s a head wind that we have to deal with here, but it’s going to get better here as we go forward.
Flipping over to building efficiency, our sales were at $3 billion, or down 8% on a constant currency basis, and as Steve indicated earlier, and we are seeing signs that our markets are beginning to stabilize. So if we look at the global workplace solutions business and our North American residential business, neither of which flows through our backlog, I would remind you.
In our energy solutions business, we saw double digit growth in those areas. In the performance contracting business, revenues increased by more than 10%, and we continue to see a real strong pipeline of coating activity.
Europe and Latin America are the two areas that remain soft and were both down double digit in the quarter. In terms of the income side, our segment income declined by 21% to $104 million that reflects the impact of lower volumes.
A couple other things in there, we are interesting in implementing a new IT system in our North American systems business. That’s really to enable our service work force.
Those costs are going to flow through in Q1 and Q2. In the quarter, we cost of that implementation about $15 million.
So, that’s kind of depressing that’s downward pressure on our margins here. We are also continue investment some of our growth initiatives most notably that would be an emerging market infrastructure and our energy businesses.
If you look at the turnaround in our North American residential business, that’s been quite impressive for us. In the quarter, and the first quarter is typically the seasonally weakest, we actually broke even in our residential business in the quarter.
Looking forward, we’re pretty confident that building efficiency’s going to report year-over-year improvements in profitability and you’ll start to see that here in the second quarter we’re expecting to take year-over-year improvement. In terms of our backlog 4.3 billion which was the same as last quarter, down 10% on a constant currency basis, we experienced double digit growth in performance contracting backlog in the quarter.
If you look at our orders, which were down slightly in the first quarter, we saw strong results again in performance contracting and if you look at North America, our orders were down only 2% in the quarter. We do continue to see softness, though, in Europe and the Middle East.
Though in the case of the Middle East, we expect to see improvements later this year. The other comments I would make is we did see good order momentum throughout the quarter and if you actually looked at our December orders, they were 6% higher on year-over-year basis.
So that’s what’s really given us the confidence that we’re going to see a turnaround here in building efficiency in the second quarter and sort of driving our improved margin guidance that we’ll talk about later. If flip over to power solutions, slide 12, another exceptionally strong quarter for our power solutions business, sales were up about 12%.
If you look at the volume growth, 9% in the aftermarket, 19% in OE, of the 12%, I would say approximately 4% to 5% of that unit volume growth is attributable to new customer wins. The remainder is due to sort of the uplift in the industry.
Segment income was very strong at $181 million. Here we’re just seeing continued strong operational performance, improving product mix, and then I would also call your attention to the fact that in the year ago quarter, we had a $50 million non-recurring charge as we revalued some of our led in inventory.
From knowledge flip over to the financial highlights section and as I talk about our financials, I’m going to talk about the, our numbers, excluding some of the onetime items that we’ve talked about earlier here. This lets me really talk the operational and financial trends in each of the businesses.
So if we just look at the sales side here up 15% at $8.4 billion, as Steve indicated before, if we back out exchange on the underlying growth was 9%. The increase was really driven by higher volumes associated with the improving industry and share gains in both automotive and battery and battery and building efficiency we are seeing, as I indicated before, we are seeing a sign of that market is bombed out and for the quarter, our revenues were down 8% on a constant currency basis.
In terms of gross profit, you can see what 14.7% an improvement of 390 basis points versus the year ago levels. This really reflects both the improvements we’ve made as associated with our restructuring initiatives, but also better capacity utilization in our manufacturing operation.
SG&A expense was $883 million. We’re up 3% versus last year again, if you adjust for currency, our underlying results were actually down 2%.
Here we’re maintaining a fairly firm grip on our cost base, but we are investing in some key growth areas and I guess I would also remind folks that last year we had no incentive compensation accruals this year, we are accruing for that. So that also is making the increase look a little bit larger than normal here.
Equity income, you can see more than tripled to 53 million and as I mentioned here, the primary driver here that Chinese automotive joint ventures, although we did see improved results in a lot of our joint ventures in other parts of the world within the automotive space. On page 15 here, maybe just talk about financing charges in the quarter, about $35 million.
So that’s a reduction of $21 million versus last year. Approximately $10 million of that decline is due to some non-recurring foreign currency gains that we had in the quarter.
The remainder of the reduction is due to the fact that we had significantly lower borrowing levels and also we saw a real big decline in short term interest rates. Due to a deteriorating geographic mix of our income, offset by some tax planning initiatives, we’re lowering our effective tax rate for the year from 20% down to 18%.
In the as reported column, we also have a $62 million or $0.09 onetime benefit adjusting from deferred tax valuation allowances. As we go through the remainder of the year, we probably have another $100 million to $150 million of potential onetime positive tax items and has been our past practice, we’ll strip those out so you can see underlying rate and exclude those from our operating results.
Income from attributable to non-controlling interest, which is formerly known minority interest, you can see that we have a big increase in that charge of $16 million versus zero last year. That’s really, again due to the improved level of profitability in the minority share of our automotive joint ventures primarily in North America and then diluted earnings per share of $0.43, you can see the big turnaround versus last year, really demonstrates the magnitude of the improvement in our business operations.
Move over to balance sheet now. Quite frankly, our balance sheet has never been in better shape and our liquidity position continues to improve.
If you look at our net debt position, we’re at about $2.7 billion. We reduced that, as Steve indicated before, by $550 million in the quarter.
If you look at our liquidity cushion, which we define as the amount of surplus borrowing capacity that we have over our peak intra monthly need. It’s about $3.2 billion at the end of the first quarter.
Our cash flow in the quarter was terrific, with net cash flow from operating investing activities or free cash flow of $623 million versus a significant use last year. The real driver in earnings and working capital management, if you look at the elements of our working capital performance, what you’ll find is it’s a reduction in our DSO and improvement in inventory churns.
On the payables side, we actually had deterioration. It came from the right places and it’s sustainable.
Our net debt, as a percentage of our capitalization was 22%, four point decline in the quarter, and 13 point reduction versus a year ago. In terms of capital expenditures, about $177 million in the quarter, a reduction versus last year.
We continue to see our businesses being less capital intensive, as we’re able to up our manufacturing capacity utilization here without incurring any capital expenditure. As I’ll comment on later, however, we are increasing our CapEx outlook for the year to a range of $700 million to $725 million, as we’ve decided to pull forward some investments we planned for 2011 in our power solutions business.
Just giving you a little bit more color in terms of our revised financial outlook, as Steve indicated earlier, we’re up in our guidance here from $1.70 to $1.75 per share. Let me maybe just comment on a few of the specific line items here.
Let’s start with revenue. We’re increasing our guidance to $33 billion that’s $2 billion uplift from October.
This increase is really attributable to higher North American vehicle production and stronger volumes and higher lead levels in power solution. In building efficiency, we’re increasing our sales outlook from plus 3% to plus 5%, reflecting the fact that we’ve got pretty good visibility on our order quoting activity and we’re seeing strong growth in those businesses that don’t flow through our backlog or order channels.
In terms of EPS, $1.70 to $1.75, the primary driver here is increased revenue. The fact that we’ve reduced our tax base from 20% to 18% adds about $0.04 to our full year numbers.
In terms of segment margins, we’re expanding our year-over-year improvement to 290 basis points. I’ve given here the revised guidance for each segment.
These are unchanged and we’ve taken out auto and power solutions significantly. So auto, a range of 2% to 2.2%, is up from 1.3 to 1.6.
In the case of power solutions, we’re at 11.8 to 12 up from a 11 to 11.2. In terms of financing charges, we’re dropping those fairly significantly to reflect the improved cash flow performance.
The foreign exchange gains in the first quarter, and lower short term interest rates, which we expect to see continue through the balance of our fiscal year here. Here at already talked about the increase in capital expenditures and build in power solutions.
Then lastly, our net debt, we continue to expect that we will end the year with net debt total capitalization of below 20% and our free cash flow outlook for the year now is about 1.2 billion. That gives us a lot of flexibility to accelerate both our organic investments in our businesses, but also start to look at some M&A opportunities in the marketplace right now.
With that, operator, maybe we’ll open it up for questions.
Operator
(Operator Instructions) Your first question comes from John Murphy.
John Murphy
Steve I apologize. I don’t mean to put words in your mouth, but it sounds there was a quote that came across from you I think in an interview that said you viewed your outlook as intentionally conservative and I was just wondering if you might be able to give us a little bit more detail about where you might think it’s conservative, or maybe I’m completely off.
The headline that came across and sometimes those are misquoted, but I just wanted to see if we could give you any detail on that.
Steve Roell
John, I was on CNBC this morning, but I don’t think I talked about the outlook at all, so it must have been Bruce.
Bruce McDonald
I think as we indicated in our comments here this morning, we are, I would say, being a little bit cautious in terms of second half of our fiscal year, particularly as it relates to North American order flow where we’ve been encouraged by the increase in the sharp here, our customers are building inventories this quarter in anticipation of that continuing and we’re just a little bit uncertain. I think if you look at our production assumptions, John that we’ve got for the full year we’re probably 400,000 or 500,000 units below CSM.
So CSM is the right in our numbers conservative and I want to look at.
Steve Roell
John, this is Steve now. I think two other things.
I guess looking at lot more is the quarter place all, but I think by the time we get into that April timeframe, but then we’ll know what the second half looks like. It’s just a function where the consumer is going to be.
We’re probably hedging our best, too, in terms what kind of pullback there could be in Western Europe. That would be the other thing we don’t know.
As these incentives come off, whether governments will come back in and extend. We haven’t improved that, but I think we’re just concerned about how those markets could respond or react in the second half.
John Murphy
Maybe just staying on autos, looks like if we were to exclude or adjust for the stress of buyer payments or costs of $450 million, your trade incremental margins were about 39%. That’s really high for the seating business and interiors.
Is that something that could continue as we see this big production ramp up, or what number should we be thinking about there? It sounds pretty high.
Bruce McDonald
Yes, I think it’s very high on a year-over-year basis, John, because of the benefits of the restructuring action. I think what we talked about is, if you stripped out restructuring, which we talked about adding $0.10 to $0.15 on the quarter, primarily in automotive, then our underlying contribution margin on incremental volumes in the 15% to 20% range.
That’s the number that’s sustainable.
John Murphy
Then on building efficiencies, just on the backlog there real quick, what’s sort of the duration or what’s the timing of this increasing quoting activity that you’re seeing? Is this stuff that could roll on really in the next six months, or are we looking at stuff that’s 18 months out I would just trying to get a gauge of when this increase could come through?
Steve Roell
I guess the activity we’re seeing right now would impact it best the late second half of our fiscal year. It has to go from the pipeline to it unsecured to executed work.
So, John, I guess I would tell you it’s maybe fourth quarter and probably gives us more confidence relative to what we have going into 2011.
Operator
Your next question comes from Chris Ceraso - Credit Suisse.
Chris Ceraso
So if this stuff isn’t going to come on maybe till the fourth quarter, why boost the revenue outlook plus five from plus three? It’s been there something from somewhere else?
Bruce McDonald
Two things: One, if you look at the parts of our business that don’t flow through the order quoting channel, which would be our service business, the North American residential business and global workplace solutions, in the latter two of those, we’re seeing double-digit growth. So that’s driving growth.
If you look at orders specifically, we expect to see year-over-year order growth in the second quarter.
Steve Roell
Yes, I guess presumably I will tell is that often times I refer to the pipeline when referring to the North American market. I guess I would tell you, what we see right now, Chris, is some big work out of the Middle East coming at us and so that’s probably where the top line I would expect to see growth as well.
We’ll get some of that in the fourth quarter.
Chris Ceraso
Second question, how do we reconcile the margin that you did in the first quarter, particularly in North America, and even in Europe if we adjust for some of these items, the guidance in the low 2% range, you did 5% in North America, 6% in Asia. Is there anything where you were over earning in Q1, or why so weak for the full year versus a good first quarter?
Steve Roell
Well, I think, Chris, couple things. First of all, our anticipation is that we’re going to start to see a little bit of softness in the volumes in Europe.
So, we talked about some operational things that are going to get better for us, but we are concerned, I think like everybody else, about what’s sort of going to be the hangover effective of the incentive programs. China performed exceptionally well for us in the quarter, but the sort of comparables get to be a little bit more difficult and the rate of growth there may not be sustainable as we go through the year.
As we indicated before, our outlook assumes we sort of trended down here a little bit in Q3 and Q4 in North America.
Chris Ceraso
Just a quick one, the $100 million to $150 million tax, is that cash?
Steve Roell
It’s probably half cash items and half non-cash items.
Operator
Your next question comes from Rich Kwas - Wachovia Capital Markets.
Rich Kwas
I guess, Bruce, or Steve, on the service revenue within building efficiency that was down double digits in the prior quarters. What was the number this quarter?
I think you just mentioned that you see things picking up a little bit there. Could you give us a little more color there?
Bruce McDonald
For Q1, our service North America revenue was down 5%.
Steve Roell
Let me tell you what we see there, just to give you a sense. Surprisingly, we saw an increase, a nice double digit increase in new orders and new activity around what we call our scheduled service.
So people are running into contracts, where we didn’t see the improvement was what we would call small project work, or people who are calling for service work we call labor and material is basically as you would think about at home, you pick up home, you pick up, you don’t have a contract which you call up contractor to do service work. That’s still soft.
People are still deferring part of that and that’s the high margin business for us. So another contributing factor, Rich, to why building efficiencies loss was greater than as earnings, Bruce talked about all those investments we made in IT and in the sales force, but also was the mix.
We got a good growth in GWS, which has lower margin than the high margin labor material. So that also was a factor in terms of why, but we’re not seeing an improvement yet.
We’re hoping maybe the weather will give us some kicker in January and some of the extreme states, but, we’re still seeing people defer that maintenance. Not canceling maintenance contracts, which is what we saw two years ago, but rather still postponing maintenance.
Rich Kwas
Steve, how do you feel about the e-Business in Europe right now with the restructuring? I know the end markets are soft, but you still have some restructuring benefits that have to come through later this year.
What’s the progress there? What are you seeing?
Steve Roell
Yes, I think they’re slower, probably the slowest of our business in terms of being able to generate the benefit we expected. I think automotive is converting much higher and faster on their restructuring.
So we’ll get some benefit, Rich, to your point in the second half, but the key to Europe is going to be volume. There’s nothing we can do in terms of that restructuring.
It’s going to compensate for the volume side. So we’ve got forecasts in our European management’s forecasting they are going to see growth in the first quarter.
That will be a good bellwether for us.
Rich Kwas
Last question on power solutions with lead price, I think they’ve moved above where you bench marked for the year. I think $2100 was the number you put out there back in October?
Bruce McDonald
That’s right.
Rich Kwas
What’s your expectation now? Have you revised it and what are your thoughts with the recent activity in the lead price?
Bruce McDonald
Yes, I mean it’s trending up, as you said, Rich, and we’ve seen that get as high as a little bit north of 2500. In our outlook right here, we’re sort of thinking it’s going to be a couple hundred dollars a ton higher than we talked about.
So we’re using 2300 in the fall, I think we have 2100.
Rich Kwas
How much of a negative impact did that have? I know you raised the overall segment margin, but how much of the negative impact did that have on the margin forecast?
Bruce McDonald
Not very much at all.
Operator
Your next question comes from Brett Hoselton - Keybanc Capital Markets.
Brett Hoselton
I want to ask about the automotive segment income, and I apologize, I may have missed a little bit of this, but the European production changes that you guys saw, what was the change on a year-over-year basis percentage wise?
Bruce McDonald
It’s tough to get specific data, Brett, but if you look at new vehicle registration in the quarter, they were up 18%. So our sense is production and there’s not a lot of inventory typically in the channels there.
So we would say production was somewhere in the 15% to 20% range.
Brett Hoselton
Then as you think about that $40 million to $50 million in distress that you took in the quarter, what would be the comparable number in the fourth quarter? Is it lower, higher, about the same?
Bruce McDonald
Let me just clarify. It’s distressed supplier.
I’ll say expedited freight because of parts shortages, and some launches that we’re struggling with $40 million to $50 million in this quarter. I don’t have the number in front of me, but I’m going to say orders of magnitude, it’s doubled.
Brett Hoselton
Then as you think about that sequential improvement from the fourth quarter to the first quarter in segment income, you went from $77 million to $121 million. Can you possibly bucket that between the improvements you saw on Europe, improvements you saw in China and North America in terms of was Europe a third of that, China a third of that, North America, third of that?
I mean can you kind of give us a break down of what that $44 million sequential improvement?
Bruce McDonald
I don’t have that with me, Brett, but we can follow that up with Glen.
Operator
Your next question comes from Colin Langan - UBS.
Colin Langan
There’s actually been some recent speculation about, how China’s divesture businesses are selling them off. Can you provide any commentary on that?
I know in the past, you’ve said all three divisions were core to your business. Has that changed any way today?
Glen Ponczak
I think what he’s asking, there’s been talk about some change in our portfolio decision, whether all three of our businesses are core or not. We’re changing our thinking in any way.
Steve Roell
Colin, no, we’re not changing. All three are core.
We talked about the value diversification in our business and it’s paid off for us. We like the growth characteristics of all three.
So no, there’s no intention to change. We’re investing all three.
Colin Langan
Second question, can you give any color to the margin sensitivity on the auto side from higher production estimates, I mean if is closer to CSM? How sensitive are your margin forecasts?
Steve Roell
Again, as we’ve talked Colin, in the past, we would expect as a general rule of thumb, we’ll get somewhere in the high teens, 20% range on incremental volume, in terms of contribution margin.
Bruce McDonald
We’ll move along if you need to follow up, give me a shout later on.
Operator
Your next question comes from Ravi Shanker - Morgan Stanley.
Ravi Shanker
It just on the Europe auto headwinds again I mean how long do you thing those are going to persists and do you think these are industry wide issue are they more specific to you guys.
Bruce McDonald
Well, I think the bulk of them are launch-related that are specific to us, but the financial distress in Europe and parts shortages I think others may see that. I would say the bulk of the charges are JCI specific and in terms of duration here, we expect to see these wind down over the next two to three quarters.
Ravi Shanker
You had mentioned that some of the higher CapEx is going to BNS far solution. Can you elaborate on exactly what you are investing that money in and what about the DOE current I mean how does that come into play here?
Bruce McDonald
Two areas are our focus. One is expanding our capacity in China, in power solutions and the second one is accelerating some investment in our lead smelting operations here.
That’s the two areas. In terms of the government grant that really flows through our joint venture that we have with soft which isn’t consolidated.
So, you don’t really see that on the face of our statements.
Operator
Your next question comes from Ryan Brinkman - JP Morgan
Ryan Brinkman
This is Ryan Brinkman for Himanshu. I was hoping you could better help us understand what might have been some of the drivers behind the double digit increase in North American HVAC in the fourth quarter, residential HVAC, in the first fiscal quarter.
Bruce McDonald
This quarter’s typically a heating month, so you tend to sell more furnaces than air conditioners, just given the weather patterns in the US. I think first of all, we continue to invest in our new product pipeline in that business.
We have an industry leading range of high efficiency furnaces. That demand was very robust for us, there was some government incentives to encourage people to buy higher efficiency units, and our investments paid off and we drove the volume growth.
We’re up 24% in our residential business in the quarter, from the top line perspective.
Ryan Brinkman
You think you’ve definitely outperformed the industry then?
Bruce McDonald
Yes.
Operator
Your next question comes from Itay Michaeli - Citigroup
Itay Michaeli
You mentioned M&A opportunities specifically in what areas you are looking, and this is to drill into previous rational bit more and the divesture side what are your thoughts on the interior business specifically within the auto industry segment?
Steve Roell
On the M&A side, I guess I would tell you that right now we’re in the midst of our strategy planning updates and as part of that, were because of the condition of our balance sheet, we’ve thus off our look in terms of where we can find new growth platforms, typically as we’ve described in the past, we’re not consolidators. We don’t buy value looking for growth, so primarily looking for technology or geographic reach and we would make M&A investments in all businesses near term.
Probably longer term, over a period of time, you would see it more heavily skewed towards building efficiency, but near term, we’re looking at opportunities across our business lines. From the standpoint of divestures, we are, as I indicated earlier, we’re not looking to divest in any business.
We still feel that we can do well in the interiors business. We have a specific focus on that with our customers and we think we’ll benefit from that overtime and it will improve.
Itay Michaeli
Just a quick book keeping question, did you explicitly breakout auto experience as well as power solution revenue guidance and free cash flow tax include dividends?
Steve Roell
No, we don’t provide that breakout. We just give consolidated there.
Itay Michaeli
On free cash flow it’s include dividends?
Steve Roell
Pay dividends.
Operator
Your next question comes from Rod Lache - Deutsche Bank Securities.
Rod Lache
In the auto experience, the 2.9% margin that you did sounds like it was more than a point of drag from distressed suppliers. I just wanted to clarify, this guidance of 2.2% for the year, is the difference between where you are now and the full year mostly just the production falloff that you’re anticipating?
Are you anticipating any kind of raw material costs acceleration? Can you clarify what your new production assumptions are for North America and Europe?
Bruce McDonald
We aren’t changing our production outlook, Rod, for Europe, but I would tell you the reduction in the margins is really a reflection of the volume. We were forecasting a softer second half.
As Steve indicated, we would anticipate a 15% to 20% conversion rate on incremental volumes and I think if the industry and its numbers are consistent with CSM, then I think most of our forecasted margin deterioration will go away.
Glen Ponczak
Our forecast for North American production is $10.3 million units.
Rod Lache
Raw materials are not a concern at that point in that division?
Steve Roell
I guess, we’re seeing upward trend. Again, if we’ve talked in the past about the fact that we have index posturing with our customers, we have no reason to believe that that will continue.
Rod Lache
Just on the power solutions business, how much of that growth do you figure came from restocking and looks like you had a 40% incremental margin there too, which was pretty strong ex-lead. Is that something you see as sustainable in that business?
Steve Roell
Let me comment. Bruce, come in.
My sense is just based on the inventory we own in the weather conditions. Order patterns stayed heavy into January.
So I think there wasn’t a lot of restocking it. I think we saw that maybe earlier in the quarter, the weather patterns that hit in December.
That inventory I think was blown up pretty well. We were concerned right about the fact whether or not we could supply our customers.
We had so much demand. So I’m convinced we haven’t gone through any restocking to any extent, but I guess I would tell you that as we do talk to our customers, I think they are going to be reverting back to the more normal stocking levels they’ve had in the past.
Bruce McDonald
I think Rod, the margin story is I mean it’s a very highly capital intensive business and when we’re running at levels of capacity utilization that we were here in the first quarter, it falls through the bottom line very nicely.
Steve Roell
Just to comment, typically in our business, if your work force ends up working over the holiday, that’s when you know that you’ve got demand continues to be sustained during the winter months and we had that situation. We were going full bore at all our plants in the U.S.
Operator
Your next question comes from Pat Archambault - Goldman Sachs.
Pat Archambault
One question, one clarification, can you tell us a little bit about the cadence of margins for the auto business? It used to be they were sort of back end loaded, just because of the timing of recoveries, customer recoveries.
Does that still the case or has some of this new indexing that you’ve done taken away some of that?
Bruce McDonald
I would say if you went back in time, you’re quite right. We used to be a lot of customer and commercial settlements flowed through in the fourth quarter.
I think that’s much more evenly spread now. It’s not as lumpy as it once was.
Pat Archambault
I guess that’s not, that’s a phenomenon that probably goes back two years, Bruce?
Bruce McDonald
Yes.
Steve Roell
I think Bruce’s answer was absolutely perfect. I think we’re seeing it smooth.
Indexing really was commercial settlements around engineering and cost of recovery.
Pat Archambault
Other one, I know you guys have covered it, but I just wanted to make sure I understood it. You’re talking about going from sort of a year-on-year decline in building efficiency from a volume perspective to an increase next quarter.
Your backlog is down though and I know there’s a bunch of different moving parts. Can you just walk through that one more time?
Bruce McDonald
First of all, there’s businesses that don’t flow through the backlog. So workplace solutions, our residential business and our service businesses, all of those, when we talk about backlog and pipeline, are excluded.
So those businesses, Jim, you asked the residential business, are growing strong double digit. If you look at the time it takes from an order to start to revenue, and what you see within our first quarter.
Our December orders are actually up 6% versus last December, the month of. So we’ve got good orders momentum and we’re now starting to see year-over-year growth in orders.
Once the order gets booked, it starts to turn into revenue as we execute that job, as Steve said, so based on all of that, our expectation is here that you’ll start to see that revenue growth happen here in the second quarter.
Pat Archambault
I guess is an order that would take longer than just one quarter to translate into revenue? Isn’t it first order then backlog then revenue?
Bruce McDonald
Once we were awarded the order, it goes into the backlog. Let’s say it’s $1 million order, then we will start to revenue that within a month or two.
Not the whole million, as we recognize working on a percentage of completion basis, so once we get the order, we do 5% of the work, we’ll book 5% of the revenue and the costs and away we go.
Operator
Your final question comes from Ted Wheeler - Buckingham Research.
Ted Wheeler
When you talked about the costs in Europe from both your own execution on startup and the supplier issues, I guess I’m thinking back to a few years ago where you were running margins at 5% and they were the best in the company. Is there any reason that someday when you get these straightened out margins in Europe can get back to good levels like they were before?
Is there something structural in Europe that’s going to change that?
Bruce McDonald
I would say there’s no reason, why it won’t get back to where they were. I mean I guess I would just make a couple comments in Europe.
Our expectation was that when we restructured our European business to lower the breakeven rate, we’ve got an awful lot of our backlog, like 80% plus is skewed toward Europe. We were able to take out manufacturing costs.
We have a lot of engineering and infrastructure costs to support the launch in top line growth that we expect to see absent the industry turning around. Also restructuring in Europe takes longer and is significantly more expensive.
There was no abnormal bubble, I would say in Europe. So we were a bit more cautious in terms of how much costs we took out of that business because we do expect to see it comeback.
Ted, our European margins previously were nearly 6% and there’s not a fundamental reason that as the business grows and the market recovers, we expect that business, like our other regions to get in that 6% target.
Steve Roell
In addition, to the restructuring that we’re taking on in Europe, the other thing I guess I would point out, Bruce, is that new backlog in business we did win. The margins are some of the best that we’ve had, okay.
We’ve indicated that we’re going to launch that at much higher margins. So I feel confident, as Bruce indicated, that Europe will be a major contributor to as we as go forward.
Ted Wheeler
One other question, again, on Europe, you talked about I think European building efficiency revenues being up in the second quarter, and I’m just wondering, will that be across the product lines? Will that include equipment, or would it be more service-oriented and why don’t you give color on pieces of the business?
Steve Roell
First of all, we don’t have a strong service base like we do in the U.S. and Europe, so it will be contract work, but we also expect to see the equipment up as well.
It won’t be a big increase, Ted, but directionally, it’s up.
Ted Wheeler
Well, it’s significant I guess, I think, later cycle market, Europe seems to be lagging U.S. in some ways, so that’s…
Glen Ponczak
We’ll limit questions there and turn it over to Steve for some concluding comments.
Steve Roell
Okay, thanks, Glen. We’ll just a couple wrap-up comments.
First of all, in terms of the quarter itself, I think what did they demonstrate is the ability to convert on the higher volumes, and we expect to continue to see that, as the year progresses. As we’ve indicated, we’re benefiting from those vast cost improvement initiatives, those restructuring costs we took last year.
We’re cautiously optimistic about our production in North America. I think we spend a great deal of time talking about that.
In terms of efficiency, some positives are emerging, but we recognize it’s a late cycle business. 2010 will continue to be difficult.
We’ll just have to watch it, but we’re getting more confidence as time goes on. We continue to invest in the growth strategies and that’s important from our standpoint to make sure that we take advantage of the energy opportunities and so that’s where a lot of our investment is going and then balance sheet continues to strengthen and that’s really important.
I think what you should take away from the quarter is good top line growth in margin improvement, coupled with strong cash flow. We’re off to a good start in 2010.
So thanks for your interest and your support of Johnson Controls. I know Glen will be available today as the day plays out, but again, thank you very much.
Operator
This concludes today’s conference call. Thank you for your participation.
You may disconnect your lines at this time.