Welcome to Johnson Controls 4th Quarter 2017 Earnings Call. Your lines have been placed on listen only until the question and answer
session.
I will now turn the call over to Antonella Franzen, Vice President of Investor Relations. Please go ahead.
Good morning, and thank you for joining our conference call to discuss Johnson Controls' 4th quarter and full year fiscal 2017 results. The press release and all related tables issued earlier this morning as well as the conference call slide presentation can be found on the Investor Relations portion of our website at johnsoncontrols.com. With me today are Johnson Controls' Chairman and Chief Executive Officer, George Oliver and our Executive Vice President and Chief Financial Officer, Brian Stief. Before we begin, I would like to remind you that during the course of today's call, we will be providing certain forward looking information. We ask that you review today's press release and read through the forward looking cautionary informational statements that we've included there.
In addition, we will use certain non GAAP measures in our discussions and we ask that you read through the sections of our press release that address the use of these items. In discussing our results during the call, references to adjusted EBITA and adjusted EBIT margins exclude transaction and integration costs as well as other special items. These metrics are non GAAP measures and are reconciled in the schedules attached to our press release. All comparisons to the prior year are on a combined basis, which excludes the results of Adient and includes the results of Tyco, net of conforming accounting adjustments and recurring purchase accounting. GAAP earnings per share from continuing operations attributable to Johnson Controls ordinary shareholders was $0.93 for the quarter and included a net benefit of $0.06 related to special items.
These special items primarily related to mark to market pension and post retirement gains and discrete tax items, partially offset by restructuring, impairment and integration costs. Adjusting for these special items, non GAAP adjusted diluted earnings per share from continuing operations was $0.87 per share compared to $0.76 in the prior year quarter. Now let me turn the call over to George.
Thanks, Antonella, and good morning, everyone. Thank you for joining us on today's call. Let me begin with a look back at our 1st year as a combined company. And the message that I hope you walk away with is, although our financial results came in at the low end of where we would have expected in fiscal 2017, we made significant progress on the integration of a historic merger with Johnson Controls. I'm extremely proud of the work our teams around the globe have done and what we have accomplished throughout the year.
We completed a major reorganization of our operating structure across the globe, most recently in North America. We made significant strides in aligning our cost structures, generating $300,000,000 in incremental cost synergies and productivity savings, driving 90 basis points of margin expansion for the year. Despite the substantial amount of integration taking place, we also maintained rigor around optimizing our portfolio and capital structure. We completed the spin off of Adient and divested ADT South Africa and Scotts Safety, as well as several other small non core assets. We redeployed the proceeds from those divestitures into paying down a substantial portion of the merger related TESARL debt.
Additionally, we pursued opportunistic share repurchase in an effort to offset the coming dilution related to the Scotts Safety transaction and we finished the year with approximately $650,000,000 of share buybacks. That said, as we have identified on the right side of slide 5, there are areas in our performance where we need to improve as we move forward. Accelerating organic growth in orders in buildings, expanding gross margins in buildings, improving free cash flow conversion and consistently delivering on our commitments. If we turn to Slide 6, I'll tie those areas of improvement to the changes we have already implemented to enable us to put shareholder value creation at the forefront of everything we do. First, as you may have seen in a press release this morning, we announced a change in our General Counsel with the departure of Judy Rheinsdorf.
I have worked with Judy for well over a decade. She was instrumental in my time as CEO of Tyco and has been a crucial voice throughout her transitional role for the past year here at Johnson Controls. I'd like to sincerely thank Judy for her many years of service and wish her all the best. I'd also like to take this opportunity to welcome John D'Onofrio to the team, who is joining us from Mars Incorporated. With this and a few other recent appointments, our senior leadership team is coming together and will be held accountable for driving execution.
Beginning in fiscal 2018, we plan to change our compensation incentives to be more closely linked to our performance and aligned with shareholder expectations. Specifically, we plan to tie compensation incentives to the key performance areas that we are focused on organic revenue growth, EBIT growth and free cash flow conversion. When it comes to accelerating organic sales and orders growth in the field businesses, tracking sales capacity and sales productivity metrics are essential. Growing the field businesses requires a strong and expanding sales force by business and by region with continued productivity. It sounds simple, but demands intense focus and consistent monitoring by our business leaders, including myself.
With the combination and reorganization of the buildings businesses, we have remixed the sales force and reinvested in areas of growth. For the full year, we were short of the increased capacity required to accelerate growth. However, in the Q4, we enhanced the process and achieved net adds of 50 sales people. As we move forward in our new structure, we are targeting 400 net sales adds in fiscal 2018, which will be core to accelerating orders in organic revenue growth. This investment is in response to strong positive feedback from our customers with respect to how our technologies and solutions are helping our customers enhance their businesses.
This will put a bit of pressure into the first half of the year as the new sales people ramp up, but the increase in capacity will ultimately drive improvements in execution and higher growth. As we move through the course of fiscal 2018, we will keep you posted on our progress. Additionally, not all revenue growth is created equal and similar to how I operated at Tyco, we will be focused on profitable growth. This starts with going after the right projects, remaining disciplined on pricing to ensure that we are being paid for the value that we provide to our customers and rigorous project management down to driving change orders. With the installed base we create, it is critical that we continue to accelerate our service growth, which enhances our margin profile.
As we look at the underlying fundamentals of our backlog, there is some gross margin pressure we expect to see as the backlog turns in our North America field business. To put this in context, the size of backlog in our North America field business is $5,200,000,000 And I would say we are entering the year with roughly 75 basis points of gross margin pressure. We have put in place a more strict approval process for large installation projects and are realigning the incentive compensation structure for the entire sales organization. We plan to weight sales incentives more towards gross margins and sales growth so that we can ensure our teams are targeting more profitable growth. With more discipline on price, sales productivity, project management and service acceleration, we expect to drive both improved margins and increased profitability.
When it comes to improving free cash flow conversion, we had an intense focus in the Q4 to ensure we met the expectations set. I, together with Brian, established a weekly meeting to drive the importance of this metric and closely monitored our free cash flow generation. Additionally, we are in the process of establishing a cash management office, reallocating internal talent to solve some of our working capital challenges and focus solely on achieving the targets we have set out. While we saw improvement in our free cash flow generation in the Q4, we know we have a lot more work to do to increase our cash flow conversion. As we move forward, we will also be more selective in our CapEx spending, focused on higher return projects and reducing our reinvestment ratio.
In terms of capital allocation, you can expect us to remain disciplined when it comes to returning cash to shareholders with a near term focus remaining on opportunistic share repurchases, and over time a more balanced approach between accretive M and A and buybacks. We have leading market positions and are strongly positioned to win across our core businesses. That said, we will continue to look at the portfolio both within power and buildings, ensuring we are allocating resources in areas where we can generate the highest returns in divesting businesses that are non core. With all of these key business fundamentals I have discussed, we have established discipline and accountability from which we set grounded expectations. We know our performance needs to improve and as a management team we are entirely focused on executing on the actions I have outlined.
I am humbled and honored to be leading this organization and I want to reiterate that this team is intensely focused on driving execution and creating shareholder value. My personal mission as CEO of Johnson Controls is to lead with clarity, simplicity and confidence and my intent is that those same values permeate beyond the executive management team throughout the entire organization. I remain confident that with the organizational changes over the past year, we are well positioned to lead the evolution of building solutions and battery technologies. Turning now to Slide 7. Let me recap the results for the quarter and Brian will provide more detail in a few minutes.
Overall, another quarter of solid earnings growth with strong EBIT margin expansion driven by continued progress on synergy and productivity actions. Sales of $8,100,000,000 increased 4% on a reported basis in the quarter. Excluding the impact from divestitures, FX and lead pass through, sales increased 2% organically, led by strong performance in our Power Solutions business as well as our Global Products business within buildings. Adjusted EBIT of $1,100,000,000 grew 10% driven by cost synergy and productivity realization. EBIT margins were up 80 basis points year over year on a reported basis or up 110 basis points excluding the impact of FX in lead.
Turning to our EPS bridge on slide 8. You can see synergy and productivity savings adding $0.09 to the prior year in line with our expectations. Volume and mix added $0.01 as strong volume in Power Solutions was partially offset by increased logistics and distribution costs, hurricane disruptions and price cost pressure. The lower effective tax rate year over year also added $0.02 and strategic investments were an incremental $0.01 Overall, this resulted in a 14% increase in adjusted EPS year over year. Just a quick mention on synergies and productivity on Slide 9.
As we have been detailing for you throughout the year, synergy and productivity savings came in at the high end of our original $50,000,000 to $300,000,000 range or $0.27 in 2017. As we look to fiscal 2018, we are planning for an incremental $250,000,000 in savings. With that, I will turn it over to Brian to discuss the performance within the segments.
Thanks, George, and good morning. Let's start with our new segment structure within Building Technologies and Solutions on Slide 10. As you can see, Buildings has 2 main components, Building Solutions and Global Products. Building Solutions, which has annual revenue of about $15,000,000,000 is our field business and direct channel. We operate in a regional structure and report 3 segments North America, AMEA and Asia Pacific.
Global Products has $8,000,000,000 of annual revenue and will be reported as our 4th segment within buildings. This is our indirect channel with its sales through distribution and storefronts. I will speak to the new segments as I go through the results for buildings. Now let's get into the details of the quarter on Slide 11. Total building sales in the quarter of 6 year over year on a reported basis.
However, excluding the impacts from FX and divestitures, sales grew 1% organically. The impact of the hurricanes, the earthquake in Mexico and some final sales related purchase accounting adjustments impacted sales growth by approximately 60 basis points in the quarter. So let's start by unpacking the 1% organic decline in Building Solutions, which again represents our project and service based field business. In North America, our largest region, sales declined low single digits. Our fire and security field business, which comprises about half of the revenue in North America, is relatively flat year over year.
HVAC and controls installation and service activity, which typically accounts for about 35% to 40% of sales in North America, grew low single digits. However, this growth was more than offset by a decline in large projects within our solutions business, which declined low double digits in the quarter. And I just point out that about half of that decline was driven by weaker sales to the U. S. Federal Government.
Turning to EMEA, we saw low single digit growth in the quarter. Growth in Europe was led by solid project activity in fire and Security. In the Middle East, sales inflected to positive growth in the quarter driven by HVAC. Latin America also grew low single digits with balanced growth across fire and security, HVAC and controls. In Asia Pacific, organic growth was flat in the quarter as strong growth insulation spend year over year, particularly in China.
Turning to Global Products. Sales increased 3% organically year over year with growth across building management, HVAC and refrigeration equipment
and specialty
products. Building management, which is about 15% of global products revenue includes controls, security and fire detection, and we saw nice growth across all three of these product lines. HVAC and Refrigeration Products, which comprises about 65% of Global Products revenue, includes unitary and applied HVAC equipment and products, our Hitachi joint venture products, as well as industrial refrigeration and marine equipment. Within these businesses, resi and light commercial HVAC grew low single digits or a low single digit decline in resi HVAC was more than offset by low teens growth in light commercial, where we saw significant growth in our national accounts business. I would point out that the resi HVAC decline was impacted by a tough prior year comparison with fiscal 'sixteen Q4 growth north of 20% as well as lower cooling degree days.
For the full year, our resi HVAC business grew high single digits organically benefiting from new product launches in the spring of 2016. Our Applied business grew in the mid single digits range in the quarter with strong performance from North America and larger projects in the Middle East. Finally, we continue to see solid growth in our Hitachi joint venture as well as a pickup in our industrial refrigeration businesses led by the improving natural gas and food and beverage markets. The remaining 20% of revenue in global products is specialty products, which includes fire suppression and Scotts Safety. This platform saw low single digit growth in the quarter.
And as you know, Scotts Safety was sold to 3 ms in early October. So let's turn to EBITDA. Buildings grew 5% year over year in both a reported and adjusted basis to $904,000,000 with margins expanding 80 basis points year over year to 15.1%. This growth was led by cost synergies and productivity savings, partially offset by price cost pressure as well as continued investments we're making in new products and our channels. Over the course of 2017, we launched 14 new chiller products globally and expanded our factory direct for the full year, Buildings EBITDA margin expanded 50 basis points.
So let's turn to Slide 12. Orders grew 2% organically year over year led by the 5% growth in our products business. Field orders were flat as high single digit growth in Asia Pacific was offset by a low single digit decline in North America and EMEA. Backlog of $8,500,000,000 at year end grew 4% year over year on an organic basis. So let's move to Power Solutions.
Sales of $2,100,000,000 increased 18% year over year on a reported basis, but this includes a significant tailwind from lead pass through. Excluding lead and FX, sales grew 9% organically, led by strong shipments to the aftermarket channels across all regions. Global battery shipments increased 5% year over year with aftermarket unit growth of 8%, partially offset by a 5% decline in OE shipments, which is consistent with the lower auto production in our 2 biggest markets, the U. S. And Europe.
China rebounded nicely versus last quarter with total shipment growth of nearly 40% with strength across both OE and aftermarket. Global shipments of start stop units increased 30%, led by strong growth in China and the Americas. EMEA start stop units increased 7% due primarily to strong aftermarket growth, which is more than offset by a low single digit decline in OE. Segment EBITDA of $431,000,000 increased 4% on a reported basis or 5% excluding the impact of FX and lead. Power's margins declined 2 60 basis points year over year to 20.2% on a reported basis, but this includes 170 basis point headwind from lead.
Excluding the impact of FX and lead, Power's margins declined 80 basis points. In the quarter, leverage and higher volumes, favorable mix and productivity savings were more than offset by ongoing product investments, start up and launch costs and increased logistics and distribution costs, including the disruptions related to the hurricane. For the full year, Power's margin declined by 60 basis points to 19.5 percent on a reported basis, but this includes 150 basis point headwind for lead. Excluding the impact of lead and FX, Power's margins expanded a strong 100 basis points for the year. Moving to Slide 14, corporate expense was down 25% year over year to $107,000,000 benefiting from continued synergy and productivity savings as well as a lower compensation expense versus the prior year.
For the full year, corporate expense was $465,000,000 on an adjusted basis, better than the $480,000,000 to 500,000,000 dollars guidance range we provided last December. I am pleased with the progress in reducing our overall corporate expense and we expect to see continued improvement in fiscal 2018. Now let's turn to free cash flow on Slide 15. In the quarter, we generated $1,000,000,000 in reported cash flow. Excluding $100,000,000 of transaction and integration costs in the quarter, adjusted free cash flow was 1,100,000,000 dollars This outperformance versus the $900,000,000 Q4 target we provided in July resulted primarily from the strong Q4 volume growth in Power Solutions, which allowed us to work through a portion of the inventory build from the end of the third quarter and we also saw a reduction in receivables across our businesses.
As George mentioned, we are in the process of establishing internal cash management office. This team will be dedicated to improving our overall cash management and forecasting process and will report directly to me. This team will be comprised of individuals from corporate, treasury, our shared service center groups and the business units. This area is one of our top priorities for fiscal 2018 and we remain committed to delivering adjusted free cash flow conversion of 80 plus percent, which excludes net one time cash outflows of $800,000,000 to $900,000,000 related primarily to integration, restructuring and income tax payments. Let me stop there just for a second and give you the components of the one time items.
We have got restructuring and integration costs of roughly $500,000,000 which is probably $100,000,000 higher as a result of us accelerating or pulling forward some of these actions to Q4 of 2018 versus fiscal 2019. Secondly, we've got about $100,000,000 of executive severance and the Butek unfavorable arbitration award that occurred in the 4th quarter. We've got the $50,000,000 worth of Scotts Safety tax payments. And then we've got about $350,000,000 which is broken into 2 buckets in the tax area. 1 would be $200,000,000 outflow related to a Mexican tax law change regarding the no longer accept consolidated filings in Mexico.
There is a deconsolidation that's required that will cause $200,000,000 of cash outflows in the Q1 of fiscal 2018. And there were some specific tax planning in the U. S, which was $150,000,000 outflow. So in aggregate, that's about $1,000,000,000 and as you may recall, originally we thought $300,000,000 was going to be the tax refund in the Q1 of fiscal 2018. That number is now $200,000,000 but the $600,000,000 that we expected in 2019 has now increased to $700,000,000 So essentially where we are now is we've got about $1,000,000,000 worth of cash outflows and $200,000,000 related to the tax refund in the Q1, which gets you that $800,000,000 number.
And again, I just point out that as we move into 2019, we now expect $700,000,000 of tax refunds related to the Adient tax that was paid in the Q1 of 2017. Similar to recent years, we expect our adjusted free cash flow to be much more weighted to the second half of the year with an outflow in Q1 and our largest inflow in Q4. Moving to Slide 16, we ended the year with a net debt to cap of 39.3 percent versus 41.2% at June 30. During the quarter, we again took advantage of the low interest rate foreign debt environment and issued $310,000,000 of yen denominated 5 year notes and $175,000,000 denominated 1 year note. During the quarter, we used the strong cash flow generation as well as the debt issuances to repay $1,000,000,000 in commercial paper and $150,000,000 bond maturity.
Additionally, we repaid $165,000,000 in TESARL debt with Tyco related cash flows. As everyone knows, the safety sale to 3 ms closed in early October and we repaid $1,900,000,000 of TESARL debt with the net proceeds from this transaction. These payments, along with the proceeds of the ADT South Africa sale in the Q2 of this year reduced our original $4,000,000,000 in TESARO debt to a current balance of 1,800,000,000 dollars During the quarter, we repurchased $225,000,000 in stock or about 5,500,000 shares. For the year, we repurchased just under 16,000,000 shares for $650,000,000 I'd also mention that we completed another $150,000,000 of buybacks during the month of October. As we move through fiscal 2018, we will at a minimum buy back stock to offset the impact of option dilution.
On slide 17, we provided details in the appendix related to the Q4 special items, all of which have been excluded from our adjusted results. And as I mentioned earlier, the Building segment change was effective in the 4th quarter and the revised fiscal 2017 quarters are provided in the appendix as well. And just finally, the House U. S. Tax reform proposal was released last week and the Senate proposal is expected shortly.
Interest deductibility and repatriation taxes on foreign earnings will be headwinds for us, but we are in the early stages of reviewing the overall pluses and minuses in the John's controls as well as other available tax planning opportunities. So with that, let me turn the call back over to George to review our fiscal 2018 guidance.
Thanks, Brian. I mentioned earlier, we have made significant progress over the past year related to the merger integration, but we still have plenty of work to do. Fiscal 2018 will be a year of change. We will intensely focused on driving execution. Turning to Slide 18, we expect total sales to be in the range of $30,100,000,000 to $30,700,000,000 Based on current exchange rates, this includes a $265,000,000 tailwind related to changes in foreign currency, as well as a $70,000,000 tailwind related to lead prices.
Additionally, the impact of recent divestitures are expected to be a $700,000,000 headwind to sales. We expect overall organic sales growth to be in the low single digits. Going through our expectations for buildings and power, let me start with buildings. Based on current backlog, we expect organic growth in the low single digits as we begin to ramp our sales capacity in fiscal 2018. From an adjusted EBITDA margin perspective, we expect the benefit from synergies and volume growth to be partly offset by gross margin pressure within our North American field business backlog, which I spoke to earlier, as well as continued incremental investments in our products and channels.
Overall, we expect adjusted EBIT margin expansion in buildings of approximately 10 basis points to 30 basis points, including a 40 basis point headwind related to the divestiture of Scottsafety. Underlying margins are expected to increase 50 to 70 basis points. In Power Solutions, we expect organic sales growth in the low to mid single digits, driven by volume growth in the aftermarket. We expect volume mix and productivity benefits to be offset by higher lead prices and incremental investments, including launch costs. We expect adjusted EBITDA margins to be relatively flat on a year over year basis.
As Brian mentioned earlier, we expect to see continued reductions in corporate expense and are targeting an incremental 5% to 9% reduction, which would bring our adjusted corporate expense down to a range of $425,000,000 to $440,000,000 Overall, we expect adjusted EBIT margins to increase 30 to 50 basis points to 12.2% to 12.4%, which includes a 30 basis point headwind related to the divestiture of Scottsafety. Underlying adjusted EBIT margins are expected to increase 60 basis points to 80 basis points. As we move to the below the line items, we expect to see a tailwind to interest expense related to the pay down of the T SORL debt from the Scottsafety proceeds. This decrease is expected to be mostly offset by an increase in variable interest rates. In total, we expect net financing charges to be in the range of $460,000,000 to $475,000,000 Additionally, we have seen very nice growth from our joint ventures, particularly Hitachi over the last few years and expect to see our non controlling interest increase to $200,000,000 to $210,000,000 Based on these items, we expect adjusted EPS to be in the range of $2.75 to $2.85 which represents a 6% to 10% increase in earnings per share versus fiscal year 2017.
As Brian mentioned, we expect adjusted free cash flow conversion of 80 plus percent, which includes CapEx of up to $1,300,000,000 Consistent with prior years, we expect our earnings per share to be stronger in the second half of the year due to the normal seasonality of our businesses. We expect our quarterly EPS cadence to be similar to last year with a slightly lower percentage of earnings in the Q1, given the ramp up of our sales force in lower margin backlog in buildings and the lead price movements in power. With that, let me turn it over to our operator to open the line for questions.
Thank you. We will now begin the question and answer session. Our first question comes from Jeff Sprague of Vertical Research. Please go ahead.
Thank you. Good morning, everyone.
Good morning, Jeff. Good morning, Jeff. Good morning, Jeff.
Hey, George, just first on the George, just first on the portfolio and maybe putting power aside, which is a whole other discussion. You've only been in the CEO seat for 2.5 months or so, but obviously you've been evaluating the portfolio as COO all along. I wouldn't expect you to name names on what might be a candidate to be divested, but can you give us a general assessment of your view? Is there 5%, 10%, 15% of the portfolio that's kind of a question mark in your mind? Just some way to kind of frame how you're thinking about that.
And if you do have some additional thoughts on power, would love to hear them too.
Sure. So what I would say, Jeff, starting out is, certainly over the last couple of months, the opportunity to really take a fresh look at the portfolio. I have been working very closely with the business leaders and really understanding the core businesses, adjacencies and complementary type businesses. We've got incredible platforms in both Power Solutions and in buildings, but as we look at the portfolio, there are opportunities for potential divestitures where we could take those proceeds and double down on some of our core businesses. And as I have always demonstrated in the past, as we do this, we certainly will continue to focus on how do we create the most long term shareholder value in the remix of the portfolio.
So what I would say, starting out here, just with the type of businesses that you have seen us looking at here, in that kind of high single digits, mid to high single digits potentially as some opportunities here that we see that are kind of outside of our core that would raise capital and be able to position us to be able to double down from an investment standpoint in our more core HVAC and building system businesses within our buildings portfolio.
Mid to high single digits within buildings, not relative to total?
That is correct.
Yes. And I was wondering also just shifting gears on tax and cash flow and the like, really kind of a couple of questions related anyhow for Brian. How do we get comfortable that there is it's Mexico next year and it's not something else the year after, so to speak? And I wonder if you could just elaborate a little bit more on the magnitude of pressures you see on U. S.
Tax reform relative to your initial analysis?
Yes. So let me start with U. S. Tax reform. And I think the two areas that I commented on providing the most headwind are probably the limitations on interest deductibility as well as the repatriation taxes on foreign earnings.
And we are in the early stages, Jeff, of taking a look at the implications of the proposal and we'll see what comes out from the Senate as well. But those two items certainly do put pressure on our effective rate in the mid teens where it is today. But I would also say that until we really sit back and study all the provisions of it, we really aren't in a position today to comment on what the ultimate effect will be because I'm sure there'll be tax planning opportunities that we'll have in front of us as well. So I think this is one we're going to probably just have to keep front and center with you and everyone on the call and the more information we get and as ultimately the regulations come out, we'll address it at that time. As far as your comment on Mexico, the calculations that were completed on the specifics around deconsolidation of Mexican returns.
I mean the tax law changed just to give you a little bit of color here was that in Mexico no longer can you file a consolidated return and get group track tax relief, but you've got to file individual returns. And that payment is required to be made for us in our Q1 of fiscal 2018 and we didn't finish the calculations on what that net payment was going to be after unpacking all these individual returns until just recently. And so the one thing I would point out there is that the payment that we're going to make of $200,000,000 the way these regulations are working in Mexico, we will recoup that payment over a period of time of up to 7 years. So, it's something we'll get back over time, but it was a one time payment that's large enough that we called out in our commentary here.
Great. Thank you.
Thank you. Our next question comes from Steve Tusaof, JPMorgan. Please go ahead.
Hey, guys. Good morning.
Good morning, Steve. Good morning, Steve.
So just wanted to kind of dig into these first half margin dynamics. You said you're adding some new salespeople, the backlog margins are down. So can you just give us some color on kind of how that at a higher level, just perhaps on an operating margin level, how that will play through here in the first half to make sure people are kind of level set on the expectation as these costs and this lower margin revenue rolls through?
Sure. So, let me start with North America. As I said, we have about $5,200,000,000 in backlog there. And as that flows through, there's probably about 75 basis points of headwind. And that combined with the investments we are making in the sales and we are making good progress there, that certainly is going to create some pressure in the first half as we are ramping up the orders and that begins to convert to revenues.
So that's one big part of it. And then the other is, when we look at our reinvestment, we are last year, we had about $0.06 of reinvestment, mainly into our products and that's beginning to really start to show a performance as we look at our products organic growth and that will continue here through 2018 and we are estimating somewhere around $0.06 or $0.08 of reinvestment into our products. Those are the 2 large pieces as we think about 2018 guidance. Brian, maybe you want to comment? I would just comment on that.
On buildings, that's correct, George. And then when you look at Power Solutions, given the spike up that we have seen in lead
over the last few months here, there's probably a bit of headwind as we look at just Q1 impact. But as we've kind of commented on before, when it spikes like that, we can have an individual quarter impact with based upon the arrangements we've got with our customers to pass on those lead increases over the course of a year that tends to normalize and we wouldn't expect that to be a big number for the year. But there could be a little bit of an impact in Q1 from the spike in lead prices as well, Steve.
Got it. So when I look at this kind of EPS growth trajectory for the year $6 to $0.10 off of the $0.48 in 1Q sorry, dollars 0.53 in 1Q 'seventeen. I mean, will you be growing earnings here in the Q1?
Yes. I mean, I think the way to think about this is we've historically been around 20% in the Q1 and then it's probably been maybe slightly less of that in the second quarter. And so I think for the first quarter, you can probably dial it in maybe a little less than where we've been before, but that's kind of the general guidance we give.
Okay. And then one last question for you. The whole comp discussion around what you're getting paid for, I guess it's EBIT, organic growth and conversion. Is there any so if like tax rates go up and net income is impacted by that and your free cash is impacted by that, that doesn't impact your the kind of incentive package you guys have. Is that correct?
On the AIPP side, that's correct. On the long term side, it could have some impact. But on the short term bonus here, it would be a third on EBIT growth, a third on organic revenue growth and a third on free cash flow conversion. And then there could be some modifiers that might also address things like EBIT margin improvement to ensure that we aren't just chasing revenue dollars, we're chasing profitable growth.
And that's adjusted conversion?
Correct. Correct.
Okay.
Thanks a lot guys.
You bet.
Thanks, Steve.
Thank you. Our next question comes from Deane Dray of RBC Capital Markets. Go ahead please.
Hi, good morning everyone. This is David Lu on for
Hi, David. Hi, David. Hey. So on
the cash flow for 2018, could you parse out sort of what the increase with the ramp up from 2017 2018 will be? Is it more on the working capital side? I know you gave some color around CapEx, but how should we think about the different buckets that leads to this sequential increase in cash flow?
Yes. So CapEx is going to be still in the range of about $1,300,000,000 up to 1,300,000,000. Dollars The way to think about that is if you look at where we are this year and adjust for the items that we talked about in the Q3. What happened in the Q4 here, we were able to flush through about $100,000,000 or so of the inventory build that we saw at the end of the Q3 in Power Solutions. And we also saw about $100,000,000 reduction in receivables.
So if you recall, at the end of the third quarter, we talked in terms of a couple of $100,000,000 in inventory we thought we could take out and $100,000,000 worth of receivables. So $200,000,000 to $300,000,000 we were able to take out in the Q4 here. So, there's really $100,000,000 more that we expect in the inventory side. And then I would tell you that would get you up to that 80% plus range. And beyond that, it would be the additional effort that our cash management office team is going to put in place to continue to drive trade working capital improvements and look at payment terms and billing terms to our customers.
So right now, we're looking at around 80% plus. Great.
Thank you very much. And then for my follow-up, can you provide an update on the non residential sector either in the U. S. Or globally? How has it trended?
How do you expect it trend in 2018? Is it accelerating or decelerating? Just any color around that would be great. Thank you.
Yes. So when we look at our non residential, we've got pretty good presence across all the regions. If you break it out into regions, North America is going to, as we said, we see lots of opportunity there and we are expanding our sales force here to be able to capitalize on that. If you look at the metrics, there has been pluses or minuses here recently, but we are starting to we still see a very strong pipeline for growth and that's what we are ultimately positioned to do to accelerate orders through the course of the year and then begin to turn that as we go through the year. Regionally, when you look at EMEA, our businesses in EMEA, we are actually performing pretty well.
We have seen some nice progress in Continental Europe, offsetting some little bit of pressure we have had in the U. K. And as we plan for 2018, it's still going to continue to grow low single digits. Latin America has been pretty strong for us and with the investments and the expansions we've been making there, that's been a little bit better than the EMEA region. If you look at in Asia Pac, when we look at our business there and the investments we are making, we have seen nice progress here in 2017 with the new products that we are bringing into that market and the footprint expansion.
And so I would say that we are continuing to look at kind of mid single digits opportunity there with the market continuing to play out as we expected and then with the investments we are making. So overall, a fairly solid position as far as a market standpoint and then with the investments we are making, we are going to be positioned to capitalize on that on a go forward basis.
Great. Very helpful. Thank you very much everyone.
Thanks.
Thank you. Our next question comes from Andrew Kaplowitz of Citi. Go ahead please.
Good morning guys. This is Seth Gersby on for Andy. How are you guys doing? Good. How are you?
Good morning. Good. So Building Solutions was down 1 organic growth for buildings overall?
Sure. When you look at our business here, let's look at Q4 in buildings. We are seeing some nice progress in our products businesses pretty much across the board and that's an output of some of the fire and security markets coming back and those businesses performing well in the Q4. And then with the investments we have been making HVAC and controls and the regionalization of some of those products, we're beginning to see the pickup. And that also would include the work we've been doing with Hitachi.
So we see that with those investments continuing in 2018. When you look at the field businesses, that's where the pressure has been. We were down about 1% and that was driven by our Performance Solutions business in North America, as well as we did see some timing of some of our projects in Asia. We saw a little bit of slowdown there. But we have got a very robust pipeline of opportunities and we are seeing the orders coming through there.
So, don't believe that that's a longer term concern. So when you look at what we are doing from a sales capacity standpoint, where we fell short in 2017, we've now over the last few months picked up our activity and being able to add sales people not only driving projects, but also service. And so as we now project what that's going to mean, we will see accelerating orders through the course of the year and start to see better conversion of the backlog that we have in place. Backlog was up 4% year on year, so that does give us confidence that we will begin to see the acceleration of revenue through the course of 2018 and while we are driving increased secured orders, that also gives us confidence that as we plan for 2018, we will be in a much better position to continue that acceleration of growth.
Got it. That's helpful. Thanks. And then in terms of synergies, can you talk about any progress you're seeing on the revenue synergies with any cross selling opportunities that continue to progress?
Sure. I mean, what's happening is, within our business, we have very strong relationships with the customers served historically, whether it be HVAC controls or whether it be fire and security. And we've seen nice progress here in the 1st year with pipelines, pipelines developing and then the conversion of those pipelines across the board. And what I would tell you is most of these projects are in, it's anywhere from less than $1,000,000 to $5,000,000 or $10,000,000 These are customers that have expansion that are executing on expansions that we are bringing in our combined capabilities to truly differentiate how we can serve their needs within the new space. And we are starting to see some really nice traction.
And so, on a go forward basis, when we originally laid out the longer term plan, we did say that the 1st year was going to be about securing orders and that the second and third, we start to see the conversion of revenue. So that's what's going to happen. We will start to see a pickup of the now that we are beginning to see orders, we are going to start to see the acceleration of the turn of those orders into revenue here in 2018.
Great.
I
would just add to that that we've got there is a lot of momentum that we've got in the back half of this year. So we aren't seeing benefit in 'seventeen from the revenue pull through, but given the 3rd and 4th quarter activity, we'll get some benefits on the top line in 2018.
Awesome. Thanks a lot guys.
Your next question comes from Rich Kwas of Wells Fargo. Go ahead please.
Hi, good morning.
Good morning.
Good morning, Rich.
On CapEx, so up to 1,300,000,000 dollars what does that imply for the power CapEx? I thought there were some build some expansion of facilities in China. So what's the latest on that?
Yes. So we've got for Power Solutions next year, we've got $500,000,000 in the plan and that would include the construction of the facility that will be part of our Bohai Piston joint venture. The other facility that we have talked about in China will be starting late in 2018, maybe even into 2019. So the second facility in China will probably not have a big impact on the cash flows in fiscal 2018.
So Brian, I know as we think about 2019, is this still kind of the peak ish year for CapEx as you look out the next couple of years or is there a little a ramp in 2019?
No, I would say this is the peak. I mean, I could see depending upon levels of the buildings investments, I would say that we're probably looking at the 1 point 3 being a peak. I mean, it would have to be something very opportunistic for us to not have a peak at the 1.3. Even at that level, we end up with a reinvestment ratio that's 1.4%, 1.5%, something like that. So we're working to get that down into the more 1.1%, 1.2% range.
Okay, good. And then just on the synergy, so $300,000,000 for 'seventeen, that was better than expected. The guide includes 250
Is that
I mean, is that a conservative number or is it a reasonable number? And how should we interpret that considering you had upside last year? And I know there's moving parts with regards to projects and whatnot. But how do you feel that in terms of potentially delivering some upside to that later in the
year? No, I would say, we guided $250,000,000 to $3,000,000 last year. We ended up at the high end. I would tell you the $250,000,000 is a number that's pretty much what we have got road map for fiscal 'eighteen. I mean, as we go through the year, could there be some upside?
Maybe. But right now, we've got the teams focused on the $250,000,000 which is exactly what we got in our trackers and we're working toward delivering that. So I think that's where we are, Rich.
Okay. And then quick last one, what's the lead price assumption for the year?
Our next question comes from Gautam Khanna of Cowen and Company.
Yes, thanks. Good morning and congratulations, George, on the new job.
Thanks, Robin.
So two questions. First one, if you could expand upon why pricing in the backlog is softer in North America. Is it a function of chasing worse projects or is it just the demand conditions warrant that? And if you could just expand that comment to pricing in the applied market abroad as well? And as a follow-up, Brian, will adjusted free cash will actual free cash flow all in in 2019 exceed adjusted free cash flow?
And if so, by how much given the $700,000,000 Adient tax recovery? Any color there on both of those questions? Thank you.
Sure. Gautam, I'll take the margin pressure. As I said in my prepared remarks, the incentive systems that were in place were incentivizing purely sales in the past. And what we've done, we have changed that now on a go forward basis that it's sales and margins. So we weren't consistently applying that concept across the board.
And so over the last, it's really been over the last 18 months, there certainly was a deterioration of book margins and as a result that backlog then plays out over the course of 18 months and you've got pressure in gross margins. That all being said, we've got the discipline in place, the accountability that's going to ultimately drive improvement and then with all of the other cost actions that we are taking, we will get benefit also in addition to the pricing to be able to improve that gross margin through the course of the year. And so and then the other element is service growth. As I talked about making sure that we are getting the right mix of service growth, which as you know is higher profit growth within those field businesses. We had it was very low single digit growth in 2017, I believe and we are working across the board to accelerate that service growth, which is going to be a very attractive part of the business on a go forward basis.
So it's really those 2 elements that contribute to the overall margin rate and I have confidence with the actions that we have taken that we will be positioned to execute well on that.
And Gautam, just on pricing
outside the U. S. As well? Just on pricing outside the U. S.
As well?
Yes. So we've been we have had a little bit of price cost as it relates to some of the HVAC equipment and you've seen that with some of our competitors. We've been very disciplined around price and continuing to put a lot of intensity in driving out cost. And so what I'd say is the price cost in the 4th it was in the Q4 was about $20,000,000 or 30 basis points within our Building segment. We're going to see a little bit more of that in the Q1, but based on all of the reviews and the details I have seen that with the price actions that have been taken with the other cost actions that we will start to see that improve in the Q2 and beyond within 2018.
Okay. Thanks. And Brian, you were saying?
Yes. So on cash flow for 2019, I mean, it's a early to talk about 2019, but I guess I'll give you my thoughts as we sit here today. I mean that $600,000,000 refund from the Adient tax payment is now $700,000,000 that we are going to get in 2019. I think we have talked in the past, we hope to get that in fiscal 2019, whether it's fiscal 2019 or calendar 'nineteen really depends upon how quickly we can get it through a joint committee because given the size of the refund, it's got to go to Joint Committee. But obviously, we're targeting to get it in, in fiscal 2019.
So that 700,000,000 dollars when we look at the other one time items that could be out there, it'd be restructuring and integration and I would expect those to be well below that $700,000,000 number as we move into fiscal 'nineteen. There's probably a bit of a wildcard, right, relative to tax reform and what that might mean. I mean, I guess, we just need to sort through that. But I guess the short response is, I would expect adjusted free cash flow or reported cash flow to exceed adjusted free cash flow in fiscal 2019.
Operator, we have time for one more question.
Your last question comes from Joss Pokrzywinski of Wolfe Research. Go ahead please.
Hi, good morning everyone.
Good morning. Good
morning. Just to continue on some of the comments that you guys made on the margin pressure, gross margin pressure in the backlog. George, I think at Tyco, you went through a similar phenomenon when you took over there trying to bring up backlog margins and enhance some bidding discipline. I think there was a period of time where that selectivity showed up in growth. Is that something that you guys are anticipating in the current outlook?
Is that something that over the next couple of quarters could be kind of a slow or uneven handoff as you just work that through the system?
Not at all. We are doing both. I mean, what I think what's different is that during that period of time, maybe the markets weren't as strong and when we did the selectivity, it resulted in a net decline, obviously, with margins significantly improving. What I would tell you in the current environment is, the market is pretty strong. We are adding salespeople, talking to our customers.
We are getting a lot of good feedback that there's a lot more we can do for our customers and making sure that now we have got the capacity to go after that and staying focused on projects that ultimately create the most amount of value and then certainly from a price standpoint, we get the proper return for the projects that we actually deliver. And so, I think it is different than what we went through in Tyco. Some of the same principles apply. It's more focus and discipline in making sure that the incentive systems are aligned to ultimately what we are trying to achieve, both in growth as well as margins.
Got you. That's helpful. And then just a follow-up on the cash flow. It seems like the mix of growth that you guys are projecting for 'eighteen between more growth in Asia and more growth in Power or Asia on the battery or on the building side. Those would be I guess your lower cash generating businesses since Asia has Hitachi if that's a big component of the growth and obviously Power is a working capital consumer.
Is that something that factors into maybe a suboptimal mix of cash flow growth this year and that that could normalize something better than 80%. I'm just trying to calibrate, it seems like the mix of growth is not your best case scenario for free cash generation?
Yes. I don't think that's going to impact it in a big way. I mean, I guess the way to think about this right now is we're looking at the buildings business globally, targets about 85% free cash flow and Power Solutions is around 70% today with the growth investments we're making. I think as we work through some of the growth investments that we've talked about on this call at Power, I think moving toward the 90% target we've got in 2020, that's still where we're headed. But I don't think the mix that you're referring, the geographic mix you're referring to is going to be is going to impact that in any significant way.
Got you. Thanks, Brian.
Yes. Operator, I'd just like to turn the call over to George Oliver for some closing comments.
Thanks, Antti Oliver. And again, thanks everyone for joining our call this morning. As I mentioned earlier, I am even more excited about the future opportunity as we look at 2018 and beyond and certainly look forward to engaging with many of you here over the next coming weeks. So, operator, that concludes our call today.
This concludes today's conference. Thank you for your participation. You may now disconnect.