Johnson Controls International plc (JCI) Q4 2012 Earnings Report, Transcript and Summary

Welcome, and thank you for standing by. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I will turn the meeting over to Mr. Glen Ponczak.

Good morning, everyone, and thank you for joining us. Before we start, I want to remind you that Johnson Controls will make statements in this presentation that are forward-looking and therefore are subject to risks and uncertainties. All statements in this document, other than statements of historical fact, are statements that are or could be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In this document, statements regarding further financial position, sales, costs, earnings, cash flows, other measures of results of operations, capital expenditures or debt levels and plans, objectives, outlooks and targets are forward-looking statements. Johnson Controls cautions that these statements are subject to numerous important risks, uncertainties, assumptions and other factors, some of which are beyond the company's control that could cause Johnson Controls' actual results to differ materially from those expressed or implied by such forward-looking statements. These factors include the strength of U.S. or other economies, automotive production levels, mix and schedules, energy and commodity prices, availability of raw materials and component products, currency exchange rates and cancellation of, or changes to commercial contracts, as well as other factors discussed in Item 1A of Part 1 of Johnson Controls' most recent Annual Report on Form 10-K for the year ended September 30, 2011 and Johnson Controls' subsequent quarterly reports on Form 10-Q. Shareholders, potential investors and others should consider these factors in evaluating the forward-looking statements and should not place undue reliance on such statements. Steve Roell, our Chairman and Chief Executive Officer, is with us this morning, and we'll start with an overview of the quarter and of the full 2012 fiscal year. Then followed by Bruce McDonald, our Executive Vice President and Chief Financial Officer, who will go through a more detailed business review and -- of the business results. That will be followed with questions and answers, and we will end the call at the top of the hour. And with that, I'll turn it over to Steve.

Okay. Thank you, Glen, and good morning. First of all, for those of you that are on the East Coast, that are joining us on the call or listening to this on a replay, we hope that you and your families are safe and that life gets back to normal as soon as possible. We considered postponing this call, but based on our other conflicts and the fact that we thought we could get a lot of information out to you this morning, we opted to continue and go through the call with earnings. Well let's start about -- with fiscal 2012. It proved to be a very challenging year. And while we achieved record sales and earnings, we were not able to reach the levels of performance that we had set for ourselves, nor that we had communicated to our shareholders coming into the year. In the last 2 weeks, I'm sure you've had an opportunity to listen to a variety of earnings reports and most of those are focused on the deteriorating business climate and the uncertainties that lie ahead. I want to spend just a few minutes to recap 2012 and in doing so, provide some context for our performance or our outlook for fiscal 2013. My comments are not intended to be an excuse for our performance. We have a history of overcoming market challenges, and we're disappointed we were not able to do so this year. Let's start with the global automotive production industry, what took place. We benefited from the stronger-than-expected North American auto build and the continued strength of the Asian markets. By contrast, as I'm sure you're all well aware, the European auto build continued to weaken and particularly hit us hard in the second half of the fiscal year. In terms…

Okay, thanks, Steve, and good morning, everyone. Before I get into the sort of detailed business results, I just want to provide a little bit more color on some of the nonoperational items, which we booked in the quarter, which would -- which netted to a charge of $0.78. So there was really 3 items. One was the $245 million restructuring charge. The second was a noncash, mark-to-market pension and retiree medical charge, both of those items that we've sort of previously highlighted in the Street in a filing last week. Then we had a nontax charge of $35 million related to the restructuring of our Power Solutions facility in Shanghai. As -- I'll provide a little bit more commentary on some of those items later on when I get to the financial section here, but as I talk through the business results, I'm going to exclude the impact of these items and items of a similar nature that impacted our 2011 comparable quarter here. So just turning to Slide 8 for Building Efficiency. From a financial perspective, Building Efficiency delivered a very solid quarter here, especially when you consider the state of the markets. If you look at the sales, they were down about 7% to $3.8 billion. If we back out the impact of foreign exchange, it's about a 4% reduction. And we feel good about that, given the headwinds that we saw in pretty much all of our markets. On a geographic basis, we saw good revenue growth in Asia where our businesses were up 7%. GWS was up 2%, though when you look at the rest of our businesses, they were down more than the -- these 2 segments were out delivering a net reduction overall. If you look at the North American market in particular,…

Corey, we're ready to take questions.

[Operator Instructions] Brian Johnson of Barclays, you may ask your question.

I -- two questions around the 2013 outlook. One is a little bit of housekeeping. The $0.08 to -- 2 things around the housekeeping. $0.08 to $0.10 EPS impact, is that spread through the year, or is that first half loaded?

It's primarily first half, Brian.

Okay. And does this guidance -- where does it bake in some of the pension accounting that you've been talking about?

It's within there.

Okay. And so is there a year-over-year pension impact?

Yes, it would be -- well, if you look at the impact, the positive impact from the pensions, about $0.08 in 2012. It'll be less than that going into 2013, because we've -- in it -- we've got lower discount rates, and we have -- we're bringing down our planned return on assets as well. So it is a benefit of -- it's -- I'm not going to get into what specific number, as I don't have that with me, but it's less than $0.08.

But not significant. I guess the real question then is, it sounds like you're being a little, I -- we think appropriately conservative on European production, fiscal first half. But really, what is the pace of the operational improvements, at what point can we separate the macro impact from what we were hoping to see in terms of some reengineering improvements? And just how is that likely to proceed during the year? Because if I look at the first half, it seems like you're saying softer B revenues, certainly North America looks better. So is it, I guess, A, is it the true that most of the weakness is coming from Europe in first half; and B, kind of how does that pace improve through the year?

Yes, I mean, maybe to help you out there, I think if you look at our profitability challenges in what we report as Europe, I would really be -- it would be really be 3 things, okay? First of all would be, we've talked about South America. That's probably the smallest issue. That's a business where this year, we probably lost $40 million to $50 million, and I'd say, we expect to see that halved next year, okay? And that wouldn't be a first half, second half thing, I mean that's certain to -- we're on an improving trend line there. Second would be our Interiors business in Europe. And I guess I would tell you that whilst we do expect some improvement there, just the length of the time that it takes to address from our footprint, and when we'll see a bit of an improvement in our European automotive operations next year, but that's really going to be more of a 2014 step up. And then in terms of our Metals business, I mean this would be the one, and if you looked at Metals overall, we -- we've got, roughly, a 4% negative ROS in that business, and our goal is that by the end of the year, I want to exit the year with that business at a run rate of like a 2% to 3% ROS, close. So that's kind of what the improvement program that we have in place there drives to.

Brian, little bit more color to that last one, in terms of the sequencing of that, why it'll take place in the second half. Last call in, back in July, I talked about a couple of the work streams that we're focused on. One of them is operationally-based, one is purchasing-based. And so what we're doing is we're moving our Metals purchasing to the east, #1. And secondly, in our -- in terms of our operations where we're actually going and using some of the new processes that we inherited from Hammerstein on how we, as an example, how we merged the track, the 2 pieces. So we're changing processes, as Bruce mentioned, we're moving our -- moving footprints to Mexico, moving to Hungary, doing things in the U.K. So that's why those are going to build up momentum as we go through the year.

And in terms of what you're assuming about customer pricing, put in context, Lear indicated its European seating businesses was about 3.5%, and obviously they don't have interiors and maybe not as much metals. But they didn't seem to report the same kind of pricing pressure that you had. Is that because the pricing is more on interiors? Or is it because the way you sequence customer recoveries between calendar third and fourth quarter?

Yes, that's interesting. I -- there's a couple of things, I guess. First of all, I would tell you, I think the customer recovery requests are getting stronger, getting higher, we'll start with that, okay? I think that claims processing is being extended, the way it has been, let's say, over the last 2 years. So you got 2 factors. You got 1 where, there's a request for more price down and that's difficult in some markets where markets are sluggish. The claims are taking -- that's part of our issue in the fourth quarter. We should have actually had better results with some of our claims processing and recovery from the -- the customers actually got delayed. We also did some things in our Q4, Brian, where we actually, with 1 global OE, we negotiated a settlement for not only '12 but all of '13 at the same time. That's the kind of environment that we find ourselves in. I think that there's tremendous pressure on the number of OEs in terms of profitability, and I guess it's not a -- I wouldn't distinguish between Seating and Interiors, and I wouldn't distinguish between Europe and North America. Most of these are being resolved on a global basis.

Chris Ceraso of Credit Suisse, you may ask your question. Christopher J. Ceraso - Crédit Suisse AG, Research Division: Have you thought about maybe exiting the Interior business? I know Lear did that years ago, and now your separating out the results between Seating and Interior. It just seems like that market is too crowded, there's a lot of material risk, and it's just tough to make money in that business. And most customers, correct me if I'm wrong, are less interested in sourcing the complete interior. So what's your latest thought on staying in that business?

We aren't separating it out because we want to dispose of it. I think it's clearly, we want to bring a new focus on it. We recognize its capital investment intensity is much different. And so we want to focus on the returns. We think there are ways to be profitable in this business. There are players in interiors who are. And we -- Chris, I guess to your comment, I would concur with you that complete Interiors is not something right now that the customers are looking at. But it's an important market for us, in terms of our technology, it's important for us in terms of how we partner around the world with some of our customers. So we are committed to it, and we believe that we can achieve reasonable returns or we find ways to exit.

Yes, Chris, maybe just to help you out, if you actually look at our -- the returns in the interior business, we -- it's a very profitable business for us, both in China and North America. Our real issue's in Europe, specifically. And I think it is fair to say that there are some product areas within our current portfolio that we're looking at, with a view to possibly getting out of if we can't improve the pricing. But our challenge in Interior's really European-centric, not global. Christopher J. Ceraso - Crédit Suisse AG, Research Division: Okay. And then, within the rough guidance for '13, have you factored in the expected losses from your acquisition of A123, and how much do you expect that business to lose in 2013?

No, we've not. And it's a little premature to be talking about A123. There's still a lot of things that have to take place and occur in that business, so no, there's no fact- -- we've not factored anything relative to that transaction in 2013, yes. Christopher J. Ceraso - Crédit Suisse AG, Research Division: Okay. And then just a big picture, like 1/2 or 1/3 or whatever, however you want to frame it, can you just give us an idea of how much of the better second half '13 performance do you think is macro, i.e. recovery in orders and building or autos, versus how much is company-specific self-help restructuring?

Let me frame it a different way, if I could, Chris, okay? If I look at some of the internal things we can do, let's think about the restructuring savings that we identified for you, that's internal. The improvement in our Metals operations, that's internal. The avoidance to some of the cost we incurred last year, relative to the China disruption, that's internal. On top of that, we really don't have any headwinds to speak of in launch cost in 2013, in engineering recovery. Commodities, while they're going to be higher, is not a big issue. So if I look at it, we can point to a lot of things that are within our control that we can -- that I would say are positive. On the negative side, it's a macro environment. And that's really where our uncertainty regarding the European build, being concerned about maybe the North American, certain of the North American and global construction markets. So I would say macro issues are what's causing us to be concerned. Our internal -- the things we can control internally, we feel very good about.

I would add to that, I think, it's -- we're not, I think, going over what you're asking about, getting to the bottom of here, Chris, is we are not forecasting that in the second half of the year, the economy is going to improve, and that's going to pick up. I think, for us, it really isn't going to be a factor in Automotive, and it potentially could be a benefit for us in Building Efficiency. But we'll see that, the signs of that coming through our pipeline and order activity. And right now, we don't see any reason to believe it's going to get better in the second half.

Joseph Spak of RBC Capital Markets, you may ask your question.

Sorry if you -- I did sort of lose connection for a little bit, but just on the pace of margin of improvement in Europe. I mean, is it possible that we can get to a breakeven point by the end of 2013, in Europe?

Well, yes, I would say so. I think -- we'll -- I think when we have our Analyst Meeting in December, I'm going to kind of hold off on that one. I think we'll -- we would -- I mean, clearly, we -- we're going to provide a lot more detail around the cadence of our operational improvement and what we're doing to really address our Metals challenges. And when Bill Jackson is presenting interiors, I mean, clearly, the turnaround in Europe will be front and center there. So I don't expect -- I mean, if you sort of look at our overall European business today, like I said, it's at a 0.5% loss for the full year, and we don't -- we aren't forecasting that we're going to exit next year in a loss-making position.

Okay. And then can you just remind us, you're moving to seating interiors and electronics. Are -- is that fairly evenly split among the geographies? Or is -- it sounds like maybe Europe's a little bit overexposed to interiors and electronics?

I actually don't know the answer to that off the top of my head. I think what we will do, though, is we won't wait until January to provide some -- we're going to free and kind of give out to the Street some information, like saying, Here's this year's numbers, and here's the sort of restated numbers on a comparable segment basis. We'll get that out earlier to help people do their modeling.

Okay. And then finally, with just the restructuring in Europe and Auto. I mean, it sounds like it -- most of the restructuring you guys have announced thus far is probably in interiors. Is there more that can be done on the seating side, or do you need to sort of wait to see how automaker capacity shakes out there?

Well, I've -- it isn't all in Interiors. I guess what I -- what would probably be accurate to say is, if you looked at facilities that were closing, there's not really a lot of them in right at this point in time. It's more a question of new volumes are going down, so we have to take our headcount levels down.

Matt Stover of Guggenheim, you may ask your question.

Couple of questions. First, you may have gone over this in the commentaries, so I apologize if you -- if we're going over trod land, but if we look at the change in the weakness in the backlogs in the Building Efficiency business in North America, do you think that this would change meaningfully after some sort of resolution with regards to election, the fiscal cliff, or does this portend sort of weakness throughout '13 and into '14? And I have a follow-up question.

Well, it's interesting, we look at the backlog, just to go back to what Chris talked about. The increase we see in the backlog, is in Asia. But if I look at, Matt, if I look at the institutional market, okay, and I'll try to address your fiscal cliff comment, if I look at where demand is held up or it hasn't, orders in the quarter, orders for the year, in pipeline, the softness that we've seen in the institutional markets, patterns that in both the educational, the K-12 and higher ed and health care. Where our data is vastly different than the market, is we continue to see reasonable growth in state and local government, and good growth in federal. So we have not seen a fall-out yet on the federal side of the marketplace. That's the best way I can describe it to you. I think that, that's been our history here for a couple of years, where the government side of the businesses has held up very well, and provide a good growth opportunity.

I mean, how about in the overall market? Or do you get a sense of folks are withholding in terms of next year, just kind of concerned about that one?

I don't think it's the fiscal cliff, I think it's other things, okay? I think there's just a great deal of uncertainty, and there's not a lot of demand. I mean, there's not a lot of growth in the underlying economy. There's a lot of cash on the balance sheets. There's a lot of need for them to look at ways to reduce their cost, and energy efficiency's a good one. So I think that -- it's mixed. Let me give you a few more tidbits here. If -- when we talk about the pipeline, some of the areas that we have seen picked up recently is some of the solutions activity, bidding activity. And that's the one that Bruce described, where we saw the orders off so far in the fourth quarter, but activity's trying to pick up again. We just talked to our Asian management yesterday in China, and they're actually seeing some, I wouldn't say a strong demand, but they feel there's good demand out there in China yet. The area that we probably get the best sense for the economy is what we call our project work within our Service business. Our truck base is okay, Matt. We still grew truck base. But the service work that we get associated with that, that salesforce, is what -- where we probably get a sense where people are holding back. They're not doing small projects. Those are [indiscernible] of the projects.

Okay. And then the other question is on the automotive side, the commercial recovery. Can you give us a sense of what the value of that impact was for the fourth quarter? And is that a question of the recovery gets pushed out in the first quarter or is just the recovery gone?

Our recovery's not gone, but it get pushed out, whether it's the first quarter, but then -- it's not what we're going to see, a sudden recovery in the first fiscal quarter. I said that those are things are just getting pushed out in general. And so things we would've recovered in the fourth quarter, probably push in the first, first gets pushed to the second. So I think it's just a function that the -- and this is consistent with -- when you listen to other calls from the auto suppliers. There just has been a tendency to see commercial claims push. And just a function of the economy, I think. And they're...

No, I understand that. And that's just sort of typically what happens, but I'm trying to describe that with the outlook for the first and second quarter given the deltas in production rates. Because holding the volume constant, if you're delaying recoveries that would've occurred in fiscal Q4 for you folks into the first quarter of next year, and then comparing and contrasting that to significantly down versus last year. I'm just trying to balance it.

I guess Matt, keep in mind, I would say our first quarter, which is calendar Q4, is not and never has been a very good in terms of commercial claims, because our -- mostly our customers are year-end. So most of the time, we don't do very well. So there's little to no chance that some things that maybe we thought we were going to recover in this quarter, that we'll get them in Q -- in our first quarter.

It looks like that.

Rich Kwas of Wells Fargo, you may ask your question.

Building Efficiency, Steve. So last year, you took some restructuring activity, and I guess you cut some SG&A out earlier in the calendar year. You got some benefit from that. How are you thinking about margins for Building Efficiency? And I understand you're going to be doing a lot more detail in December, but how should we think about the benefits you've accrued so far from some of the actions you took earlier in the year?

Well, 2 things. First of all, some of the actions we took in the first half of the year will still have benefits and provide year-over-year -- just by themselves, year-over-year benefit in the Q1 and Q2 of our fiscal year. I think our focus right now, with Dave and the team, is primarily trying to protect our continued margin expansion by looking at contingency efforts in case volumes do soften further. So that's really where our focus is right now. But there -- definitely we expect margin expansion to continue to be in fiscal 2013.

Okay. And that's even kind of considering that's a tougher quarter environment right now?

That's correct.

Okay. And then on the restructuring, the $120 million in savings, Bruce, what's the risk you don't get that? I assume that's not a run rate, that's an actual number for the full year, but what's the risk that the, that to your payback gets extended a bit, given everything going on in Europe right now?

Well, keep in mind, Rich, I said that's net, right? So I -- actually, we have about $0.08 to $0.10 of nonqualifying, we think costs that we can accrue, like moving tools and inventory banks, and those types of costs that are headwind for us, it's in the first half of the year in particular. So if you take the gross, the gross savings, it's a much stronger pace of payback. I guess, I would -- if I was looking at the items that we have there, we got a pretty good track record of delivering on the savings. There's nothing -- I would tell you that the riskier things in the past have tended to be where we're closing some plant and moving it into a brand new location, and there's very little, if any, of that in there. So I think it is, it's just standard, sort of headcount-related reductions to move volumes. It's the Power Solutions facility in China that's been idle for some time, and we're paying the workers. So that cost goes away. I think it's very low risk.

We've got great oversight. We've got people who report to Bruce who are dedicated to tracking this. And it's -- from that standpoint, I think the surety of it and our ability to view it, what's transpiring, and if there are any issues, we know them early. I think it's pretty good, Rich.

Okay. And then one last one. What was the dollar number in terms of the cost headwind for the quarters this quarter?

Rich, I don't have that figure off the top of my head, but I guess, I could -- would tell you it's sort of in that -- as we go into this current quarter, it's probably in the $15 million to $20 million range. So it's trending down, it was like, I think we said $40 million in Q3. So it's somewhere in between there.

Colin Langan of UBS, you may ask your question.

Could you just remind us of the timing difference between, it seems like Building Efficiency's sales are down, but the backlog is up and the orders are down. So with the backlog and orders are kind of a -- what kind of time frame lead are they indicative of?

Yes, I think, if you look at our backlog, it typically would flow through, and it sort of would depend. In the equipment side, it's shorter, 9 to, say, 9 months on average. On the controls side, it's -- it could be 15 or 18 months, would sort of be typical. I think one of the reasons, Colin, you can't sort of put the 3 of them together is there is some of our business that doesn't go through the backlog. And that would be like our truck-based Service business. It would be the Residential business, so those...

GWS.

GWS. So those aren't flowing through the -- that sort of standard model that you're referring to.

Okay. So but from the backlog, where you should normally see 9 months out, some benefit is normal?

Yes. But I think the best -- I mean, if you want to look at, sort of forward visibility, I'd say the best thing to focus on is the orders, because if we, if our order intake, like we said in the quarter, is down 10%, it's just -- and -- or turns negative, it's just a matter of time until our backlog's going to turn negative. And backing it up, we really talk about our pipeline, our quoting activity, and that -- that will be the first thing that we see start to pick up, we're hoping, as Steve indicated, we are seeing some signs of recovery there. But the time it's taking to, quote, "to win," is being extended right now. And I would say that, that is, just -- that it's a factor of there being a lot of uncertainty in the marketplace. People are being cautious before we decided to go ahead with some of our programs.

Okay. And any color on -- you have Europe, you're expecting Europe to be down double digits. Is that more first half weighted? I mean, is that reflected in your view for the first half earnings being a lot worse? Or is that pretty much even throughout the year, a 10% decline?

It's pretty much even, Colin. I mean, you may have seen there's a recent IHS, I think the last IHS numbers for Europe were better than that. But if you take our -- we're talking about our fiscal year. If you adjust for our fiscal year, we're right on top of IHS, so we expect to be down here in Q1 and down for the full year. And that's kind of been a change for us, up until about, really, this quarter. We've outperformed the market there, because the -- particularly because of our German customers have been strong, and were tend to be underrepresented at, in Fiat and French customers.

Ravi Shanker of Morgan Stanley, your line is open.

If I can ask a follow-up on the guidance. Steve, you'd said that -- you delayed your Analyst Day because you said you wanted more clarity on macro and the fiscal cliff and elections and those kind of things. So and you've given us some preliminary guidance now. Have you gotten more visibility into 2013? Or is this kind of a level of guidance that you're pretty comfortable achieving, kind of, unless the macro gets significantly worse or something?

Yes, I think it has. I think, if you go back in time, you go back to July, we made this decision, we thought that there was, that the market was really starting to weaken, or that some of leading indicators that we had, and yet it wasn't being reflected that any forecast or projections or EPS changes, okay? I think if you look at this quarter, now we recently have some reality that set in, regarding just how difficult the environment is, not just in the U.S., but also the fact it's slowing and then also Europe. So I think that we do have more clarity. I think that we've seen order rates now for another 90 days. We've seen the opportunity to watch what's happening in the building markets, a better feel, certainly for what we think in Europe. So it did give us a lot more clarity. We still have analysts who haven't adjusted their forecasts since July. We're 90 days, 90 days-plus, and 40% of our analysts haven't really adjusted their numbers yet. So I think that we just wanted, really, for the analysts and the Street to get a better sense for the economic environment, the climate that we're really operating in. So I do think we have a much better discussion than we'll have now, given the economic realities that we see in the marketplace.

Got it. And also, can you help with a little more color on the segmentation change in Auto. I don't know why you're going away from the geographic split towards the business-wise split. And is that kind of how you're thinking about internally, also, that you're looking more individual businesses? And does that risk taking away some of the focus away from Europe, which clearly is the area you need to pay the most attention to right now?

Yes, I'd say, I wouldn't read a lot into that, this change, Ravi. I mean, under the SEC guidance, we're required to represent segment data that reflects how we manage the company. And when we make a change to the way we manage the company, we have to go back and relook at our segments with our auditors. And so this is a change that we need to make. In no way will this impact our focus on Europe, and it's also -- we're also not going to go radio silent in terms of how our business is doing in a geographic basis either.

Yes, please realize that. I think going back to my comments, Ravi, the primary focus is the fact that these are much different businesses in the context of their capital intensity, the business models, the footprints, everything else. And for that reason, we just had to bring a better focus to that -- to the capital and returns on this business. And that's why we're doing it, and that's what we explained to all the customers. They understand. So we'll find a way to make sure that -- we're not trying, in any way -- to be transparent with our European results of that, that'll clearly be there, it'll be there in 2 ways. We'll talking about it within Seating, as is pertains to our Metals operation; and we'll be talking to it about Interiors, specifically, okay?

Okay, thanks, everybody, for participating. Dave and I will be available to take phone calls for the balance of the day. And stay safe out there, for all, everyone on -- in the East Coast. Take care.

This concludes today's conference. Thank you for your participation and you may disconnect at this time.