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Situation Under Control

Despite fiscal and economic uncertainty in the U.S. and Europe, multinational Johnson Controls sees better growth ahead. An interview with R. Bruce McDonald, EVP &spamp; CFO, Johnson Controls.

7Feb

After two fat years following the recession, Johnson Controls fell on lean times in fiscal 2012. Thanks in part to the impact of foreign exchange, growth tailed off sharply, to 2.7% from 19% and 20.4% in 2011 and 2010, respectively. Still, the Fortune 100 multinational, with businesses in auto parts, building efficiency, and power solutions, recorded revenues of $42 billion, while gross margins remained steady at 14.8%. The company also paid quarterly dividends, something it has done each year since 1887, two years after it was founded as Johnson Electric Service Co.

Two impediments to Johnson’s growth have been fiscal uncertainty in the United States (read: the fiscal cliff) and the economic slump in Europe. “I think [companies] have been clamping down for the last 12 months waiting to find out what happens here,” says CFO R. Bruce McDonald. “They’re unsure about consumer demand.” Meanwhile, the European slowdown has taken a toll on two of Johnson’s main markets, automotive and construction.

McDonald, 52, joined Milwaukee-based Johnson Controls in 2001, as corporate controller, and became CFO four years later. We caught up with him on the company’s Investor Day in December, when Johnson released a better-than-expected outlook for fiscal 2013: revenue growth of 3% to 4%. (Two weeks after the interview, Congress backed off from the fiscal cliff by passing new legislation.) Here’s what McDonald had to say about the company’s prospects, as well as his priorities as CFO, developing a finance team, and the value of diversity.

So what did you tell your investors at Investor Day?

We went through a deep dive on our overall strategies and our financial outlook for the next year. We have a September 30 year-end, so we’ve typically done this every October. But this year, given the uncertainty around the fiscal cliff and the very uncertain environment in Europe, we decided to push it back.

What are your thoughts about the fiscal cliff?

I think the fact that we’re in this position is a real travesty in terms of government setting a business-friendly environment. But we’re guardedly optimistic that we will get through it without a major interruption in the economy. We’re hopeful that once we get through these negotiations, we’ll come up with something that gives business some clarity around what type of economic environment we’re going to be competing in here for the next couple of years. It will be a welcome change.

What’s your view of the automotive industry in 2013?

From a global perspective, the automotive market is a mixed bag. China continues to perform very well, as it has now become the world’s largest market. For 2013 we expect passenger car sales [in China] to be up 8% to 10%. In North America, the market has increased dramatically from the depths of the recession. We expect North American production to be up 3% to 5%. The European market is difficult. We are forecasting production to be down 7% to 10% next year. At these levels, European production will be at a 20-year low. Many analysts expect European volumes to recover in the second half of calendar 2013, but we are skeptical.

While Johnson Controls is quite profitable, its margins are low. Can you describe the pressure that puts on the company to be as efficient as possible?

If you look across our business, we have some businesses with very high returns and others where the returns are relatively low. You really need to look at margins in the context of the capital deployed in the business. As an example, our Global Workplace Solutions business provides a full range of facility management services. This business has very low margins, approximately 1% to 2%, but it has a very low asset base, as we largely get paid by our customers faster than we pay our supply base. Because of this our lowest-return business actually delivers the highest return on capital employed.

Having said this, we operate in highly competitive businesses with intense pricing pressure. In automotive, our customers expect a year-over-year price reduction. To deliver we need to be constantly improving our productivity, generating savings from our suppliers and being as efficient as possible. For several years we’ve looked to take high-labor-content factory work to lower-cost regions and countries. In today’s environment, this is not enough. Increasingly we’re moving back-office and white-collar functions like HR, finance, IT, and engineering to low-cost countries.

As CFO, what are your priorities?

One of the main focuses is working with our businesses to help identify possible areas of growth. [Relating to the] balance sheet, most of us large corporates have fundamentally changed the way we approach liquidity. We want to have a lot more of it, a lot more comfort from a lot more secure sources. Pension funding is also a high priority.

How is your funded status?

Right now our total liabilities for pension and retiree medical are just a shade over $6 billion and our fundings are about $5 billion, so we’re about $1.1 billion underfunded. That puts it at around 80% [funded].

What about talent development? How do you develop your finance team?

We take a proactive approach. We’re a multi-industry company, and 60% of our business is outside the United States. So if you want to succeed here and advance your career, you can’t stay in one business; you need to get overseas experience. We’ve been very clear about that. I sit down with my top financial team on an annual basis and spend a couple of days going through, say, who needs to move in the next 12 months and where’s the best fit for them. As a result, we have a lot of expats. Looking at my direct reports, over half have worked overseas, and probably three-quarters of them have worked in more than one of our businesses.

How important is having a diverse workforce to Johnson Controls?

It’s important. We want our workforce to mirror our customer groups. One thing we feel good about within finance is that we are making a big difference in terms of [recruiting] diverse talent. Our internal audit function leads the way, because we use audit to bring in finance people from outside the company, to give them a few years’ experience. In our audit group we aim for a 75%-plus female and diverse population. That pays some big benefits for us.

What kind of benefits?

For example, we want diversity of thought. If everybody were the same age and had the same background, then when we looked at a problem or an opportunity, we’d all look at it through the same lens. That’s where you get the benefit of having diversity.

As CFO, what is your greatest current concern about the business environment you’re in? What’s keeping you up at night?

The single biggest concern for me as CFO is the difficulty of forecasting future business performance. We operate globally and in a very dynamic environment. It is a big enough challenge focusing on the things within our control. It’s very frustrating when we face considerable uncertainty around fiscal and monetary policy. Here we are, less than two weeks away from 2013, and we still don’t know what our 2013 tax rate will be.

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