Welcome to the Ingersoll Rand 2018 Q4 Earnings Conference Call. My name is Tiffany, and I will be your conference operator today. The call will begin in a few moments with the speaker remarks and the Q and A session. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.
Thank you. Zach Nagel, Vice President of Investor Relations, you may begin your conference.
Thanks, operator. Good morning, and thank you for joining us for Ingersoll Rand's 4th quarter and full year 2018 earnings conference call. This call is being webcast on our website at ingersolrand.com, where you'll find the accompanying presentation. We are also recording and archiving this call on our website. Please go to Slide 2.
Statements made in today's call that are not historical facts are considered forward looking statements and are made pursuant to the Safe Harbor provisions of federal securities law. Please see our SEC filings for a description of some of the factors that may cause our actual results to differ materially from anticipated results. This presentation also includes non GAAP measures, which are explained in the financial tables attached to our news release. Joining me on today's call are Mike Lamach, Chairman and CEO and Sue Carter, Senior Vice President and CFO. With that, please go to Slide 3, and I'll turn the call over to Mike.
Mike?
Thanks, Zach, and thanks to everyone for joining us on the call today. Please go to slide 3. Before discussing our 4th quarter and full year 2018 results, I'd like to begin with a brief review of the fundamental elements of our business strategy that underpin our financial performance and create value for our shareholders. First, our global business strategy is at the nexus of environmental sustainability and impact. The world is continuing to urbanize while becoming warmer and more resource reducing the energy intensity in buildings and industrial processes, reducing greenhouse gas emissions, reducing waste of food and other perishable goods, and we excel in our ability to generate productivity for our customers, all enabled by technology.
Our business portfolio creates a platform for the company to consistently grow above average global economic conditions, aided by the strong secular tailwinds I've outlined. 2nd, our business operating system is designed to excel at consistently delivering strong top line growth, incremental margins and free cash flow. And lastly, over the years, we've built an experienced management team and a high performance winning culture that makes our performance sustainable. When combined with our dynamic capital allocation strategy, we have a differentiated business model that drives strong shareholder returns over the long term. Turning to Slide 4.
Focused and consistent execution of our business strategy enabled us to deliver top tier financial performance in 2018. We delivered top quartile organic bookings and revenue growth in each quarter and closed out full year 2018 with 13% organic bookings growth and 9% organic revenue growth for the enterprise. Adjusted earnings per share growth was also top quartile, up 24% for the year and up 29% in quarter 4. Despite persistent material and other inflation and tariff related headwinds, our team successfully developed and delivered pricing and productivity actions that enabled us to effectively manage these costs and drive improved leverage and solid margin expansion throughout the year. Importantly, at the end of quarter 2, we set out to achieve significantly improved leverage of 25 percent in the second half of twenty eighteen and the team delivered against that objective, while at the same time delivering record organic bookings and record revenues.
Additionally, we achieved 10 basis points positive price cost for full year 2018 with 60 basis points of enterprise adjusted operating margin expansion, while at the same time continuing our healthy pace of incremental business investment, which is core to our ongoing differentiated operational and financial performance. Free cash flow for the year was 82% of net income, which lagged our 100 percent conversion target. The largest component of the shortfall is related to funding working capital above normal levels through the end of the year in order to meet growing customer demand for our products and services. We also funded additional CapEx for high ROI projects beyond what we expected when we entered the Q4. We've delivered an average of 110% free cash flow to net income conversion over the past 4 years and we expect to return greater than 100% in 2019.
Lastly, in 2018, we also continued to execute our balanced capital deployment strategy. After investing in the business, including $366,000,000 in capital expenditures, largely related to footprint optimization and plant consolidation, we deployed approximately $1,700,000,000 between dividends, share repurchases and mergers and acquisitions. Turning to Slide 5. Our performance against our initial guidance expectations was strong with the exception of free cash flow, which I discussed earlier. We significantly beat on both the top and bottom lines and delivered strong margin expansion while managing inflation and tariff related headwinds and making healthy investments in the business.
Turning to Slide 6. Focused execution of our business strategy is delivering differentiated results in the marketplace and for shareholders and we will maintain this focus going forward. Looking at 2019, we see the fundamental ingredients for another strong year. First, our end markets generally remain healthy and I'll address that in more detail on the next couple of slides. 2nd, we're entering 2019 with record backlog in multiple business units after achieving exceptional bookings throughout 2018.
This provides us with improved visibility into what to expect for 2019 revenues relative to where we'd have traditionally been at this stage in the year. 3rd, in 2018, we demonstrated our ability to effectively manage inflationary and tariff related headwinds through pricing and productivity. Combined with higher expected volumes, we expect this to enable us to continue to deliver solid leverage, improving margins and strong EPS growth in 2019 as we did in 2018. For 2019, we're expecting free cash flow to exceed adjusted net income. Will continue to execute a dynamic capital allocation strategy that deploys capital where it earns the best returns.
This includes organic investments, dividends, mergers and acquisitions and share repurchases. On the M and A side, we have an active pipeline of attractive we're in a strong position to execute any transactions. We also continue to see value in our own shares, which are trading well below calculated intrinsic value. Lastly, based on our performance in 2018 and our guidance for 2019, we're firmly outpacing the glide path to achieving our 2020 Investor Day revenue growth, EPS and free cash flow guidance that we laid out during our mid year 2017 Investor Day. Given the tremendous amount of inflation and tariffs the industry has endured over the last 2 years, we're moving along that glide path a bit differently than what we expected in 2017.
We're well ahead of the curve nonetheless. Turning to Slide 7. Our end markets continued to show strength throughout the Q4 and 2019 appears to be shaping up as another solid year. In commercial HVAC, the markets remain strong in virtually all geographies and we delivered strong bookings growth and revenue growth across the product portfolio. Europe has shown mixed economic signals over the past few months, but HVAC activity remains healthy there as well.
China had a solid quarter in HVAC with good growth in both equipment and services. Our direct sales strategy in China continues to progress well against our expectations and we're making good inroads in a number of verticals including infrastructure, which has been a key focus for us and continues to be one of the strongest verticals. The situation remains fluid with trade war uncertainty, but at this point in the year, we're still expecting to see modest market growth and market share expansion opportunities in China. Outside of China, the Asian markets are mixed. In total, our global outlook for the commercial HVAC market continues to be positive with low single digit to mid single digit market growth expected.
Turning to residential. Quarter 4 was another very strong quarter for us with continued share gains. Growth was primarily driven by replacement demand and we expect the majority of the market growth to come from the replacement market in 2019 as well. This plays well into our business mix, which is about 85% replacement. Economic indicators have softened modestly, but are still healthy and supportive of growth for the year.
Turning to Slide 8. Our transport business continues to be a globally diversified and resilient business with good growth opportunities across multiple areas. In 2018, we saw exceptional order growth for North American trailers and auxiliary power units and we've built a healthy backlog as a result. In 2019, our strong backlog position for these businesses gives us solid visibility into revenue growth for the year as we work to convert this backlog to revenue over time. The European transport markets are mixed with trailer a bit weaker and truck a bit stronger as Brexit uncertainty is impacting these markets.
We think additional clarity around this topic would be a positive catalyst. Overall, we're expecting low single digit to mid single digit market growth for transport refrigeration in 2019. Our Compression Technologies business had good growth globally in the Q4 with North America and Europe healthy. We continue to see trade war uncertainty impacting projects in China. Global Services growth continued to outpace equipment growth in the Q4, which is a positive and is well supported by multiple service initiatives focused on increasing attachment rates of services to equipment and increasing our share of wallet of total services provided within accounts.
All things considered, we expect to see low single digit, mid single digit growth in the compression technologies market in 2019 with China being the main area to watch closely. Small electric vehicle growth continues to be powered primarily by our consumer and utility businesses. We expect to see healthy growth in 2019. Our Industrial Products businesses including Fluid Management, Tools and Material Handling markets remain healthy and we expect to see continued solid growth in these businesses in 2019. And now I'd like to turn it over to Sue to provide more details on the quarter and discuss our 2019 guidance.
Sue?
Thank you, Mike. Please go to Slide number 9. I'll begin with a summary of a few main points to take away from today's call. As Mike discussed, we drove solid operating and financial results in the 4th quarter with adjusted earnings per share of $1.32 an increase of 29% versus the year ago period. Our earnings growth in Q4 closed out a strong year in which we delivered adjusted earnings per share growth in excess of 20% in each quarter.
Organic bookings and revenue growth was strong in both our Climate and Industrial segments. In our Industrial segment, we delivered 6% organic bookings and revenue growth. Organic bookings growth was healthy in the 4th quarter despite a difficult comparison of 12% organic growth in the Q4 of 2017. On the Climate side, organic bookings were exceptional, up 20%, including a large commercial HVAC order that will provide revenue over the next 3 to 4 years. Excluding this order, organic bookings growth was still outstanding, up 13%.
These exceptional organic growth rates accelerated despite difficult comparisons with very strong growth rates of 7% in the Q4 of 2017 and 10% in the Q4 of 2016. Organic revenue growth was also exceptional, up 9% and was broad based across all of our Climate businesses and across both equipment and services. As Mike discussed, free cash flow was 82% of adjusted net income, primarily due to funding higher working capital to support our exceptional bookings and revenue growth and funding additional CapEx for strong projects in the 4th quarter. We continue to drive high quality earnings and expect to deliver free cash flow in excess of 100% of adjusted net income in 2019. Leveraging our business operating system for operational excellence across the enterprise, we continue to manage direct material, tariff related and other inflationary headwinds in the quarter.
During Q4, we delivered our targeted 25% operating leverage and expanded adjusted operating margins 90 basis points. For the year, our 60 basis point adjusted operating margin improvement was towards the higher end initial guidance. Importantly, we also delivered on our dynamic capital allocation strategy in 2018. We deployed $480,000,000 in dividends and increased the dividend 18% during the year consistent with our commitment to maintaining a strong and growing dividend over the long term. We deployed $900,000,000 on share buybacks as the shares continued to trade below our calculated intrinsic value.
We also deployed $285,000,000 on strategic mergers and acquisitions in 2018, the majority of which was committed to spend in 2017. Looking forward, we expect to consistently deploy 100% of excess cash over time. Please go to slide number 10. As we discussed on the previous slide, the 4th quarter was highlighted by continued strong organic bookings and revenue growth in both of our segments as indicated by the positive signs on the chart. These results reflect continued strong execution of our strategy, capitalizing on healthy end markets.
The one minus sign on the chart was a revenue decline in commercial HVAC in the Middle East where orders and accompanying revenues can be lumpy. Last quarter, we highlighted that there were a couple of large orders in the Q3 of 2017. These orders shipped in the Q4 of 2017, creating a difficult comparison for us in the Q4 of 2018. European HVAC orders and revenue showed continued strength in the quarter. Please go to Slide number 11.
We delivered organic revenue growth of 8%, adjusted operating margin improvement of 90 basis points and adjusted earnings per share growth of 29%. Strong gains in volume from ongoing investments in new products, channel and system controls are delivering results in virtually every business and geography where we compete. Consistent disciplined focus on productivity and pricing actions enabled us to effectively manage inflation and tariff related headwinds and drive margin expansion across the enterprise. Please go to slide number 12. Quarter.
Our Climate segment delivered another strong quarter of operating income growth. Our Industrial segment delivered solid results with our Compression Technologies business in particular levering over 40% in the quarter. Corporate productivity initiatives drove $0.05 of earnings per share growth year over year. Below the operating income line, other expenses related to legacy legal matters negatively impacted results by approximately 0 point 0 $4 All in, we delivered 29% earnings per share growth with strong results across the enterprise. Please go to Slide number 13.
Strong execution drove 90 basis points of adjusted operating margin improvement in the quarter. Price versus material inflation was positive by 40 basis points in the quarter and positive by 10 basis points for the full year, reflecting strong pricing efficiency and a return to more normal price cost despite the extraordinary inflation we were up against in 2018. Productivity versus other inflation was notably stronger in Q4, improving margins by heavily in our business with incremental Q4 investments of approximately 60 basis points, pretty evenly weighted between operating expense reduction projects to drive further productivity, footprint optimization, plant consolidation projects for commercial HVAC and compression technologies and new product development and information technology investments. All of these investments work in concert to make Ingersoll Rand a stronger and more resilient business. Please go to slide 14.
Our Climate segment delivered another strong quarter with 9% organic revenue growth and adjusted operating margin expansion of 40 basis points. Consistent with our expectations, results were strong across the segment. Please go to Slide 15. Our Industrial business also delivered strong results with 6% organic revenue growth and 40 basis points of adjusted operating margin expansion with Compression Technologies leverage up more than 40%. Outside of Compression Technologies, the overall Industrial segment leverage was negatively impacted by discrete accrual adjustments and a legal settlement totaling approximately $5,000,000 We expect Industrial segment leverage will be strong moving into 2019 as it has been over the past several quarters.
Please go to Slide 16. In 2018, we executed a dynamic and balanced capital allocation plan, deploying capital where it earns the highest returns for our shareholders. We maintain a healthy level of business investments in high ROI projects to help customers solve their most complex challenges. These investments help drive our strong growth in both segments during 2018. Beyond that, we invested $366,000,000 in CapEx, largely on footprint optimization and cost out programs, which build a stronger, more resilient Ingersoll Rand.
We maintained a strong balance sheet that provides us with good optionality as our markets evolve. Executed against our long standing commitment to a reliable, strong and growing dividend. During 2018, we raised the dividend 18%. Additionally, we deployed approximately $900,000,000 on share repurchases as the shares continued to trade below intrinsic value. As we look forward to 2019, we remain committed to a dynamic capital allocation strategy that consistently deploys excess cash to the best return on investment opportunities.
We're enthusiastic about the future and the opportunities ahead to deploy excess capital to the best ROI investments, whether that be investment in the business, raising the dividend, repurchasing shares or making value accretive strategic acquisitions. Please go to slide 18. I'll spend a few minutes walking you through the details of our 2019 guidance. Given the market backdrop Mike outlined earlier, we expect total reported revenues to be up 4% to 5% in 2019 with the Climate segment growing slightly faster than Industrial. The difference between our reported and organic revenue contemplates about 1 percentage point of negative foreign exchange impact year over year.
For the enterprise, we delivered solid leverage and margin expansion in the back half of twenty eighteen. In 2019, we expect further margin expansion in each segment and enterprise adjusted operating margin expansion of between 30 80 basis points. Please go to slide number 19. We expect continuing adjusted earnings per share for 2019 to be in the range of $6.15 to $6.35 excluding about $0.25 of restructuring. We've modeled approximately $500,000,000 in share repurchases into our guidance, which translates into approximately 244,000,000 diluted shares for 2019.
As I outlined earlier, to a dynamic and balanced capital allocation strategy that consistently deploys excess cash over time. Net, the actual allocation of excess cash will depend on where we see the highest ROI opportunities over the coming quarters. We're targeting free cash flow to be greater than 100 percent of net income. The adjusted effective tax rate is estimated to be between 21% and 22%. And for your modeling purposes, we also offer the following guidance.
Corporate expenses are expected to be approximately $250,000,000 Capital expenditures are expected to be approximately $300,000,000 primarily driven by footprint optimization, factory consolidation and new product development initiatives. Below operating income, we estimate interest expense to be approximately $200,000,000 reflecting the debt refinancing we did in early 2018. Additionally, we estimate that pension related expenses that are classified within the other income and expense line will be approximately $40,000,000 for 20.19. We do not plan other income or expense line items outside of pension. These items are truly other and not estimable in advance.
Now I'd like to cover 2 topics of interest with you. Please go to Slide 21. It's hard to keep track of what's happening with tariffs relative to what's in and what's out of guidance, so we thought it might be useful if we laid out the assumptions that we're using. The guidance I just laid out includes the known direct and indirect impacts we expect from the Section 232 tariffs, the Section 301 tariffs, including Lists 1, 2 and 3, which is the full $200,000,000,000 and the expected China retaliatory tariffs. Relative to the Section 301 tariffs, we have included the planned step up from 10% to 25% on March 1, 2019 at the conclusion of the 90 day negotiation period.
As we've said a number of times during this call, expect to be able to effectively manage the inflationary and tariff related impacts in 2019 as we manage these types of costs in 2018. To be clear, however, if the step up from 10% 25% does not occur, you should not anticipate we'll see a windfall gain. We will implement pricing actions necessary to cover the actual inflation we see. The next topic, which is on the same slide, is on 2019 restructuring costs. We thought it would be helpful to provide a little extra content beyond what we included in the main presentation.
Estimated Of the estimated $0.25 of restructuring in 2019, more than 80% relates to our ongoing footprint optimization and plant consolidation efforts. Each optimization project is expected to reduce our fixed cost base and improve operational efficiencies, which benefits us no matter the economic we encounter going forward. And with that, I'll turn the call back to Mike.
Thanks, Sue. Please go to Slide 22. We believe the company is extremely well positioned to deliver strong shareholder returns over the next several years and our 2018 financial results bolstered our confidence. We'll be the first to recognize that 2018 was by no means a perfect year and that we have room for further improvement. However, our ability to solve complex problems and overcome escalating headwinds to drive continuous improvement in our results through 2018 is encouraging and gives us confidence our business operating system and high performing teams are prepared to successfully navigate the evolving landscape ahead.
Want to extend my full appreciation to our talented people throughout the world that are committed to delivering excellent results for our customers and shareholders. Our strategy is firmly tied to attractive end markets that are healthy and growing profitably. Our products and services portfolio is at the nexus of global energy efficiency and sustainability megatrends, which provides a tailwind for growth above average economic conditions over the long term. Unless you believe the world is getting less populated, cooler and less resource constrained, these secular megatrends will continue to create growth opportunities for Ingersoll Rand. Successful execution of this strategy enabled us to deliver exceptional bookings and profitable revenue growth in every quarter of 2018.
We have an experienced management team and a high performing team culture that incorporates operational excellence into everything we do. Our business operating system and our culture are a differentiated and sustainable competitive advantage. And lastly, our business model generates powerful cash flow and we are committed to dynamic deployment of capital. We have a strong track record of generating free cash flow and deploying excess cash to shareholders over the years. And with that, Sue and I will be happy to take your questions.
Operator?
Your first question comes from the line of Scott Davis with Melius Research. Your line is open.
Hi, good morning guys.
Good morning, Scott. Good morning.
Well, there's not much to pick on in this quarter at all, but you made a couple of comments. I just wanted to dig into a little bit, in particular, really about the push to the right in some of the commercial projects in China. Is it the opinion of your local guys that this is just more of a delay or maybe something a little bit more or something more tied to the tariff outcome or what's really the color behind some of those comments?
Yes, you have to separate the businesses a bit, Scott. So take HVAC where we saw again really strong bookings growth and continued momentum there in services as well. In those markets, I think it's less susceptible, particularly on the government commercial side involving infrastructure and institutional work that there's more of a bias toward reducing greenhouse gas emissions. And as I've said hopefully a 1000 times, if you're going to go attack the greenhouse gas emissions problem anywhere, you're going to hit HVAC whether it's stationary or transport first because it's 15% to 25% of most economies global greenhouse gas emissions. So I don't think that China lets its foot off the gas around codes, compliance, and regulations that would improve air and water quality.
That being said, you look at the industrial business, and here I think the trends are largely the same. Interestingly, we saw good growth in some of the smaller compressors, some of our contact flow rotary and certainly in our rotary compressor lineup in general, but certainly oil free would have been part of that. So that continues. What I get mostly from our suppliers and from our customers that are in China exporting outside of China particularly to the U. S.
Is they are waiting to see. However, some of them are moving more rapidly to put incremental capacity in Asia outside of China. So Vietnam is a favorite spot for that right now. So I think that you're already seeing sort of actions taken by Chinese companies at export. I think you'll continue to see that, going forward.
And by the way, that's positive, Scott, for us because it doesn't matter sort of where they set up shop, we're going to be able to support them.
Yes. That's going to be my natural follow on is that are you a net winner or a net loser? I mean, you have critical mass in China and some of those other regions, maybe you don't or do you? I guess is Yes, we
have strong footprint throughout Asia. So you really can't get to a part of Asia where we don't have a team on the ground, sufficient capacity to supply it. So it would be good so long as that capacity is unlocked somewhere, we would have opportunity. Okay. I'm going to
pass it on. Thank you, guys.
Thank you, Scott.
Your next question comes from the line of Steve Tusa with JPMorgan. Your line is open.
Hey guys, good morning.
Hey Steve. Good morning.
Can we just dig into the bridge, the margin bridge a little bit? What was exactly in investment in other? And then could you maybe just give some color on how you see kind of that price material number kind of trending? And I think you said no windfall if the tariff doesn't go through, but like you're already 40 bps ahead of the game here, definitely better than we expected in 4Q. I would think that can get better on its own ex tariffs next year.
Maybe just give a little bit of color on how you see both of those parts of the bridge probably trending into 2019 guidance?
Yes. Steve, so when you say sort of walk through the bridge, are you thinking about the 2019 bridge or the 2018 Q4 bridge?
Yes. I'm just in the context of what happened in the Q4, I guess, 2019. So maybe just explain the 60 bps, what was in there in the 4Q? And then moving beyond the 2019, how you'd see that play out?
Yes, I would start and I'll let Sue finish. The price over material inflation was something that we had hoped to get back to say 0 for the full year. We got to 10 basis points, so roughly at our expectations there. That worked out materialized as we hoped that it would. One of the questions going into 2019 then is why is there not more positive price versus cost given some of the carryover.
And what I would say there is you got to remember that the 232 tariffs were implemented in April May and the 301 were implemented in October. So the first half still sees headwinds from tariffs that didn't exist last year at the same time. We also would see commodity inflation in quarter 1 and quarter 2 still see steel as being the largest, copper as being next. And of course, the Tier 2 knock on effect containing these metals would be inflationary in the first half of twenty eighteen. But by quarter 2, you start to lap the majority of price from twenty eighteen, Materials begin to get perhaps deflationary, but tariffs remain in our model.
So you might see a wider spread in Q3 or Q4, but it's pretty early to call how all that looks. But our plan is laid out as I've just expressed in that regard. Sue, what about any of the bridge items?
Yes. So if you think about, Steve, your question on investments in the Q4 and going into 2019. So the investments in the Q4 were as we had planned them throughout 2018 and they're primarily investments in operational excellence and new product development in some of the footprint optimization that we were doing and those actually do over and we continue to invest in the business as part of our capital allocation strategy in 2019. So nothing terribly unusual or unexpected, as you think about either the Q4 of 2018 or where we're going in 2019, it's that overall strategy of really providing for projects that make us operationally better, increase productivity and allow us to manage the business.
Yes. So I'll probably add one point, which is when you think about the productivity over a long period of time, creating higher utilization and really opening up new capacities, We've taken the decision over the years to slowly as projects emerge and you can consolidate, reduce footprint, we've done that. But you've seen in 2018 2019 a more aggressive view toward that. There was a step up in 2018, not quite as high a step up in 2019. That's at this point sort of the last of what we see as the larger projects would entail for us.
And we want to be clear that we're not thinking about a recession in 2019, but we wanted to get really in front of that final large restructuring now. And just really in the event that something would happen into the future around a recession, we're just going to be that much more resilient around that. So that's another part of what the investments involved through 2018 and certainly in the Q4 of 2018.
Historically, that investment number is kind of a modest negative. Is that what we should think about for 2019, a more modest negative?
Well, the total investment number on the bridge itself is always run around 40, 50 basis points, and that's exactly what we would be modeling in 2019.
Yes. Got it. And then one last one, normal seasonality first half to second half next year, how should we think about seasonality for 1Q and the rest and next year?
Steve, I love you're adapting your question because I was expecting the one about quarter 1. And so let me answer that one actually first because I appreciate you taking a longer view on that. Quarter 1 is usually the part that I think creates the most confusion around investors. But historically, if you look at the 3 year average, we've been around 12.4%. If you go to a long term average, it's been around 11.1%.
So I think that when you think about the seasonality for us, it largely comes into the Q1. And for models that are between 11% and 12.5%, you're kind of in a safe range. If you're north of that, you're probably figuring out something that we don't know about. So that's how I would kind of give you some thoughts around quarter 1. The rest of the year sort of works itself out.
I don't think there's been that many situations where there's been confusion around the back half of the year, even quarter 2.
Well, you gave me more than I thought I was going to get. I appreciate that. Thanks guys.
Thank you.
Your next question comes from the line of Julian Mitchell with Barclays. Your line is open.
Hi, good morning. Maybe a first question around the free cash Within that step up of conversion in 2019, I think you're guiding for CapEx to drop almost 20%, but you're still guiding for operating cash flow to grow about 25%, so double the EBIT growth guide. Maybe just spell out, is that mostly coming from receivables, for example? And how quickly through the year do you think we see that improvement, given your cash flow tends to be pretty seasonal?
Yes, Julien, it should be a good story for us in 2019. We really do expect to have greater than 100% of net income and free cash flow. And so as you take apart those pieces, let's talk about CapEx for a second with the approximately $300,000,000 guide for 2019. That is lower than 2018. That was $366,000,000 and there's a couple of components to that.
We made a couple of decisions on projects in 2018. We had some carryover. We had a warehouse facility where we were doing a warehouse consolidation, absolutely a good project. We made a decision to lease versus buy. So loan Owned versus lease.
Owned versus lease. Sorry, Mike. So as you think about the CapEx, it sort of normalizes back into our more 1% to 2% of revenues range in 2019. So that's helpful. As you think about working capital, working capital isn't going to change from an overall strategy viewpoint, which is that you're always going to be looking to balance out your customer terms and your supplier terms.
So DSO and DPO always looking to balance those out. And on inventory, you're looking to make sure that you have enough product to meet the demand that we have, which has, of expect to see in the free cash flow guide in 2019 is that as we move through 2019 that the working capital as a percentage of revenue is also going to normalize back more into our 3% to 4% range of the long term guide. So we're moving back into more of the longer term metrics in the 2019 statistics and that's what gives us the additional bump in free cash flow for next year.
Great. Thank you. And then my second question, maybe a bit more color on what you're seeing in Europe overall. I think you'd mentioned that in Thermo King, you have some specific watch items, which are understandable. But anything interesting changing in train or on the industrial side in terms of customer spending appetites and so forth, and maybe split anything on Western Europe versus the Middle East?
Well, we've had a very strong, HKC year and quarter, quarter 4 in Europe. And so that continues. And again, here this is this bifurcation between economies very focused on energy efficiency, greenhouse gas emissions and making the regulatory changes to make that happen. So the growth rates there are outstanding. And then, you're looking at, sort of the industrial side of Europe, is slower than that, of course, as you're really, I think factoring in sort of a sloppier Brexit and I think the economy is a little bit in a slower mode there.
But all in all, it's certainly not bad in industrial in Europe for us and it's been great in HVAC. Middle East has just been choppier with the way orders come in there. Generally, you're talking about district cooling plants that are extremely large and whether they build them or not or modify them or not can make a difference quarter to quarter. So, I think the environment there is good for us. It's just a matter of the lumpiness in orders.
So, we're relatively optimistic on Europe and certainly the Middle East as well. In terms of transport refrigeration in Europe, it's a little bit mixed. You've got a slowdown in Western Europe. You've got continued growth in Eastern Europe. You see a little slower European trailer market and you see a little stronger European truck market.
And again, I think this is just really working through some of the general economic concerns, largely Brexit. And clarity on Brexit, frankly, sort of a good outcome there, clarity would be sort of a baseline outcome, I think is a positive for the market and for our businesses.
Understood. Thank you.
Thank you.
Your next question comes from the line of Nigel Coe with Wolfe Research. Your line is open.
Thanks. Good morning, guys. Hi, Nigel.
Good morning.
Mike, it sounds like you had that Q1 answer prepared.
I didn't want to disappoint Steve on that one, so I got it.
12.4%, that was pretty specific. So the large commercial order, I don't think I've ever seen you call out an order of that size and such long cycle. So maybe just a bit more color in terms of that and how that progresses. And what's the market like for that kind of size of order? I mean, are you seeing other opportunities that upscale out there?
Yes, we actually had one in 2016 and I wish we would have called it out in 2016 because that created a little bit of confusion in 2017 when it lapped. I think it was in the $120,000,000 range. This one's closer to $200,000,000 So I think that we're going to see more of these where it's a holistic approach toward reducing energy use in facilities, campuses, buildings, reducing the energy intensity, maybe even getting some grid flexibility, moving toward alternative power. We're seeing more of that. And so for us, we're seeing that it involves design, equipments, lots of controls, service, monitoring over time, and then some subcontracts that would go along with that.
So, they're lumpy. I've been probably talking about this for 3 or 4 quarters. So, that's one of the larger projects that we thought we would close and I think these things will get spotted in over time. This particular project will last about 40 months. And it will burn revenue in a pretty linear fashion and we like that.
We like the again the resiliency over 4 years and having a nice base of business to build on. The margins are pretty good and so it shouldn't really affect what we expect to be good leverage the business going forward.
Okay. That's really helpful. And then, I think you mentioned your shares below intrinsic value for I think 3 or 4 times during the call. You also mentioned M and A opportunities. So I'm actually wondering given that you consider your share price too cheap right now, is the needle for incremental dollars still towards buybacks?
Or do you see opportunities out there to deploy M and A more accretively than share buybacks? And any comments there would be helpful.
Yes, it's both Nigel. I mean you can expect that it would be both for us and it's really looking at the actionability, affordability, the ROICs of the M and A that's out there based on what we think we could do that for and then comparing that toward intrinsic value. Of course, the benefit on the acquisition building a compounding base of cash over time, particularly if they're good businesses strategically fit the core of the company. So that's the focus. But as you know, we're not going to let cash sit around for long and we're going to deploy it somewhere and that's what certainly happened in the Q4 where you saw us really step up the buyback in the Q4.
Balance sheet is in great shape, so plenty of capacity there and flexibility to work with the balance sheet going forward.
Okay. Thanks, Mike.
Your next question comes from the line of Joe Ritchie with Goldman Sachs. Your line is open.
Thanks. Good morning, everyone.
Good morning, Joe. Good morning.
So just to clarify a couple of points. On the cash flow, Sue, so obviously nice step up expected in 2019. You guys are expecting roughly 40% growth. Get the CapEx point, it seems like the delta is half of it seems to be coming from working capital improvement, half of it coming from earnings growth or EBIT growth, core EBIT growth. And so on the working capital side, are you assuming the turns get a turn better or how should we be thinking about that working capital piece?
Yes. I think about, Joe and I go back a little bit with the working capital as a percentage of revenue, where we would have called that at year end would have been probably 3.4%, 3.5%, somewhere right in the middle of our 3% to 4% range and it ended up at 4.3%. So you actually do get, to your point, about a full point of that coming out of there. And again, it is a process where it is not just making a decision of whether you're going to have inventory there or not. I mean, there's series of levers that happen as you see the demand forecast, as you plan what's going to happen in the factories and you plan how you're going to actually efficiently manage those factories going through time to meet that on time customer delivery.
So your point is the right one. The inventory will probably come down over time and everything else remains balanced, but it does go back into that 3% to 4% of revenue range, which is what gives you the uplift.
Yes. Of course, Joe, we deliver really outsized cash and a slowdown. So it's kind of a good problem to have as we're funding growth here and it's not a worry in terms of what we think about every day. The cash would be not a worry in terms of our ability to deliver that. We've done historically.
We'll do it in 2019 and there was good reason in 2018. The plan we always have is to increase turns. We usually plan in about a half a turn, but we always throttle that back. The trump card there is always on time shipment, on time delivery. And when you've got sort of volatile order rates particularly biasing upwards, we want to make sure you've got plenty of safety stock or increased kanban sizes to be able to handle particularly hard to get components and parts.
And so we're just going to make sure that we're making hay while the sun is shining. So Sue's point is exactly right, but we want to make sure to fulfill the growth and do it on time.
Right. So maybe even said another way, if the order book looks good as the year progresses and you may have to build inventory again next year and that's just a good problem to have?
Well, our growth rates, the forecast is probably half of what it was last year. So I think to Sue's point, you're going to see working capital come down anyway there a little bit. I think we comfortably get above 100% just based on that. But it's a 12 round fight. So you need to think about how this is going to evolve over the year.
And if we've got a good outcome on some of the stuff that's out there, whether it's the debt ceiling negotiations or Brexit or China, U. S. Tariff discussions, if there's a blue sky scenario there, we're going to adjust, as necessary to go fulfill that.
Yes. No, that makes sense. And Mike, just to follow on your question, your comment earlier around, talking about these large projects for several quarters. I recognize the lumpiness, but it'd be helpful if you can maybe talk about the pipeline, whether you see like the pipeline is being pretty robust today or you are starting to see some of these projects come through or maybe a little bit less full than maybe what you
saw over 12 months ago?
Yes. Look, I think that these projects kind of go in sort of 2 to 5 at a time that are out there on the horizon. They take often 2, 3 years to develop. We'll often put $10,000,000 or more $1,000,000 into the development of the project, you can imagine. And so, as we get closer and closer toward thinking we've got something, we can certainly do that.
This year, we knew that we had 1 or 2, turned out to be the one really large one. There's a couple smaller, but in the magnitude of $50,000,000 to 100 and $25,000,000 that are out there.
Okay, great. Thanks guys.
Thank you.
Your next question comes from the line of Andrew Kaplowitz with Citigroup. Your line is open.
Hey, good morning guys.
Hi, Andy. Good morning, Andy.
Mike, obviously, there continues to be some concern that resi HVAC for you will slow down at some point given weakened new housing. But we know you're projecting low to mid single digit growth for the resi market in 2019 based on replacement demand. Did your resi growth in Q4 match overall climate growth in the high single digits? And do you think 2019 could be another year of share gains for Ingersoll? Or should we think Ingersoll grows more in line with the market in 2019?
You're talking about resi, Andy?
Yes.
Yes. So resi, really from 2013 to the present, and I would say 2018 for sure consecutive quarters in a row, we've had share gain. We really changed the strategy in 13 product distribution, the model, investments in digital. And so for 18 straight quarters without a hiccup, we've had share gain there. It was the same in the Q4 of this year.
And the markets there remain strong. You have to realize that 85% of what we do is going to be in the replacement market, not the new construction market. So, think about the context of Ingersoll Rand, you think about residential HVAC as being less than 10% of our revenue. So you can think about, obviously, you're talking about a really small number, 1% to 2% being new construction and if that fell off even 20% would be a negligible dip for us. We're really built toward the replacement market and I think that's going to continue to be strong.
Okay. And maybe, Mike, if I can ask you about the U. S. Commercial HVAC market. Obviously, a lot of questions on the large projects, but even ex that 13% organic bookings growth in the quarter was very strong.
If you look into 2019, I think you mentioned in the prepared remarks that you better visibility here than you had. Some people still question how we're late cycle. But if you look at the strength that you've seen, is it still broad based between institutionalsupplied markets and unitary markets? Is institutional going to lead the way in 2019? And does this backlog that you have really start taking you into 2020 at this point?
Well, a couple of things, Andy. One is, certainly the Applied business remains strong, but I have to tell you the strength of the unitary commercial unitary market was really strong as well. And so this just gives us a general sense about the sort of underlying economic conditions in the U. S. Are still pretty positive.
It's got long legs to have had that kind of growth for this long, particularly the results we had in the Q4 in commercial unitary. The applied institutional work continues to move along nicely. Education and healthcare about 50% sort of of that mix and we think that education continues to be strong. We think that the healthcare continues to be strong. No outliers there that we're seeing on that front.
So, we think we've got a solid backlog built for 2019. And as I mentioned earlier on the question regarding the larger contract that we booked, I think Nigel asked, that thing is a 4 year spend. So I think this thing has got legs through 2019 for sure. Now recognize too, Andy, for people that need to just to kind of keep it in context too, when you think about our commercial HVAC business, you got to think about 50% equipment, 50% service. You get to the equipment piece of this thing, it really break downs pretty quickly between institutional and commercial.
But the large component of what we do there is still replacement buildings in the U. S. And so I think there's always an opportunity for us to have more energy efficient, more environmentally friendly ideas going into our customers. And so there's a demand creation opportunity here as well.
Appreciate it, Mike.
Thanks, Andy.
Your next question comes from the line of John Walsh with Credit Suisse. Your line is
open. Hi, good morning.
Hi, John.
Maybe just to circle back to the margin bridge into 2019 for Climate. I was just wondering if there's anything to call out in terms of mix. You obviously gave us the market growth rates for some of the sub businesses, but is there anything Ingersoll specific there? And then anything as it relates to the different growth rates between equipment and service as you think about the margin impact?
So nothing remarkable jumps out to me at all on the year. It's pretty straight stick. I think that we ought to be right in the ballpark there too of 25% leverage. That will continue to improve throughout the year. The mix of anything, I mean perhaps a little bit on the res side or the TK side because we continually expand more of the opening price point for the product line.
With TK there could be some mix with Europe being a little bit weaker and a bit more profitable than North America, a bit more maybe toward truck versus trailer in Europe. So little things on the edges, but I think it's a pretty straightforward year. The visibility around the backlog for Teekay, particularly around North American trailer units and around auxiliary power units is the most visibility we've ever had in that business. I think we feel that way about the backlog in HVAC entering the year as well too. So a relatively straightforward plan here, I think.
Got you. And then as we think about these restructuring benefits rolling through from the $94,000,000 dollars in 2018. You obviously call out the $0.25 and then having a 4 year here payback. I mean, how should we think about what's actually carrying over from earlier actions into 2019? And then even starting to think about 2020 and what kind of tailwind some of these restructuring actions could have or is it going to be later than that?
So John, the way I would think about it is the bigger pieces of the restructuring that we've been talking about in the footprint optimization arena between 2017, 2018 and what we're projecting into 2019 is sort of in the range of the 5 to 7 factories and those less than 5 year paybacks over time. So you're going to continue to build. We started that process in 2017 and so you're going to build savings as you go through each of the years going out into there will be savings obviously in 2019, but there will be increasing savings in 2020, twenty 21 from these projects. And again, it is really about optimizing the footprint, building capacity and building a better Ingersoll Rand in the catching locations that's there, but it does provide a about
extending the next round of long term planning guidance that we do, this is something that will factor into improved margins across, of course, lower fixed costs in the company going forward. And I think we can probably help recast that sometime later in the year for all investors to understand the benefit of what's happened. And so we'll make a note to do that once we are you have announced our intentions.
And I think, Mike, you made the point earlier in part of the discussions is that we're not looking at these opportunities as a way to get ahead of an economic environment. We're actually looking at these opportunities to actually operate really well regardless of the economic environment. And so the fact that you can get a great return off of that in addition to making the company stronger is terrific.
Great. Appreciate it. Thank you.
Your next question comes from the line of Josh Pokrzywinski with Morgan Stanley. Your line is open.
Hi, good morning guys.
Josh, Pock, good morning.
Yes, close enough, right? I mean, I'm used to it. Just on the industrial business, not that anyone should necessarily operate with a hard landing scenario, but thinking back to 2015 2016, I think some of the shorter cycle elements of that in tools and other industrial products caught you by surprise and some of the decrementals there were a bit abrupt. How are you thinking about inventory levels, customer tone and kind of distance from prior trough in the context of 2019? It seems like everything's fine and I'm not being overly alarmist here.
Just trying to gauge what maybe the sensitivity looks like?
Well, first, I mean, back to John's question, when you think about where all this restructuring spend has gone, the bulk of it to this point has gone into the industrial business, particularly into the compressor business. And so I think building higher margin more resilient business is certainly what they've been doing. The other piece of it is that service orders continue to outpace equipment growth certainly again in Q4 too. And that is both service penetration and its share of wallet strategies for our CTS business. We believe that from what we're seeing here, there is certainly a balanced view toward what could happen.
I mean clearly, if there is some certainty around China U. S. Tariffs, we think certainty, no matter what the outcome of that could be, is probably going to lock a little bit of growth there. So I think it's a balanced view at this point in time, but I think we've planned for a lower fixed cost base, the restructuring through higher service mix. And they've and that business has been prolific around investing back into the business.
I want to say it was a full 50 basis points going back into industrial and I think that that is always a sign of healthy business investing. In a downturn, you can take share, and we want to make sure if that happens, we're taking share in a downturn too.
Got it. That's helpful. And then just thinking about some of these larger projects in Climate, I would imagine as the cycle wears on, you see more and more large projects show up. How should we think about that in terms of operating leverage when those ship? I would imagine some of that, especially in performance contracting, is some pass through revenue, not just all your equipment.
Is there a margin hit that comes in with that or a lower incremental or is it kind of feel like normal equipment?
Yes. No, it can be, Josh, not particularly in this case, right? I don't think this one's going to be something that spikes out materially anything with leverage or incrementals. So the margins on those projects are not bad. As we've talked in the past, you've got to look at the contribution margin to the entire business.
Usually those projects have everything from an SG and A perspective loaded into the contract as well. There's very little between contribution margin and operating income that are left to look at. So I feel positive on that. Again, they're hard to forecast. We don't put them into base plans.
And when we think we've got something that's got a high probability of closing, we might start to talk about it. And certainly, when there's the magnitude of what we've booked, we'll have to spike those out. So we get everything straight from a comp perspective. So I hope that answers your question.
Sure does. Thanks Mike.
Your next question comes from the line of Andrew Obin with Bank of America Merrill Lynch. Your line is open.
Yes, good morning. Can you guys hear me?
Good morning. How are you?
Hey, I'm good. Just a question, a lot of questions have been answered. Thanks for including me. But just can you give us visibility on the institutional side because I know you guys look at state and local funding and bond issuance. How much visibility do you have for funding on the institutional side in HVAC in North America because it is a key market for you guys?
There's a lot of metrics to look at there, Andrew. I mean, certainly, you all can look at ABI, GDP growth, non resi fixed construction, all those look good. We've got
the benefit of looking at. I'm more interested in yes, you guys track bond issuance and sort of longer term metrics from local governments and state government. Those tend to be useful. Sorry.
Yes, we do as well and you guys certainly can look at that. The most important thing we can track though is we've put a lot of investment into the systems we use in the front end of the commercial process. So the ability for us to understand pipelines better really support strong institutional growth going forward. I could just tell you the number of and size of projects from the institutional perspective are very healthy. And this goes back to the question around 2019 and climate, what confidence do you have?
Or maybe even to the larger Ingersoll Rand question, what kind of confidence do you have in the guidance that you've put out? And I've got a high degree of confidence in what we've put out today on all of that. But I would say at the heart of that is because I feel very strongly about what's happening globally around HVAC compliance and certainly, gas emission visibility around institutional growth in North America and around the visibility we have into the TK business. Those are all very strong indicators that I look back over 10 years of doing this and I probably haven't had at least the visibility I've got now into the backlog.
That's a great answer. Thank you. And just to follow-up on the industrial compressors, how much of a headwind is automotive for you? And if it is a headwind, which industries are offsetting this in North America because the orders are quite good as well? Thank you.
Yes, sure. Andrew, when you go back and you look at sort of the pie charts that the business produces when we do Investor Day and it shows the end markets that we serve, You run out of colors and slivers on the pie chart. So automotive is a piece, but it's probably not more than 2% or 3% of what we do. Electronics is a piece. It's not 2% or 3% of what we do in pharma and food and beverage, so on and so forth.
So, automotive per se is not critical, but it is indicative of a broader slowdown at times. It's indicative of other spending in the economy. So we watch automotive and we see when we see automotive slowdown, it could be a leading indicator for us for sure.
But what's strong in North America? Are there any end markets that stand out as strong to you guys on the industrial side?
Industrial markets that remain strong would be food and beverage, pharma, would be anything oil free would certainly be strong for us. And then some of the weak to moderate markets are still going to be larger compressors where customers might be waiting on capacity to understand what's happening with trade.
I will now turn the conference back over to Zach Nagel for closing comments.
Excuse me,
I'd like to thank everyone for joining today's call. As always, Shane and I will be available over the coming days weeks to take any questions that you may have. So certainly reach out to us if you'd like to chat. And we look forward to seeing you all at the upcoming conferences in February and we'll be on the road in March as well. Thank you.
This concludes today's conference call. You may now disconnect.