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Ingersoll-Rand plc (NYSE:IR)

February 21, 2013 12:30 pm ET

Executives

Michael W. Lamach - Chairman, Chief Executive Officer and President

Joseph Fimbianti

Analysts

Scott R. Davis - Barclays Capital, Research Division

Scott R. Davis - Barclays Capital, Research Division

Okay, Thanks. Thanks for your patience. It took me a couple of minutes to find my way back to this room. I should have never left the room, I forgot that I'm on like, I think, all day. I'm going to have some sort of sunburn from these lights by the end of the afternoon.

Anyways, we are thrilled to be moving on to the afternoon session of our conference. It's been an interesting, I think, couple of days so far. Just to summarize some of our takes, I think, yesterday was a day where, I think, for the most part, the responses, the questions, the answers were pretty much right down the middle and what we expected, there was not a lot of debate around a lot of the names and stocks. It was a focus from -- at the company level on growth more so than we've seen in the past years.

And when I mean growth, I don't mean necessarily adding more capital and such to China and emerging markets, what I mean really is core organic growth initiatives at the company level, more explicitly tied towards research and development spend, of which I think, literally, every company we've had so far has announced some sort of material increase in their R&D spend rate. It just tells you how in a slower global growth world, folks are hyper-focused on not only driving to a higher growth rate, but investors focused on figuring out which companies can actually do it.

We've also had, I think, a pretty interesting response from the audience response system with the questions, in general, just eyeballing it versus last year that investors seemed to be very comfortable with the higher multiples they've come and they're trading at now versus a year ago. A year ago, it was funny because we had an awful lot of companies who were trading substantially higher than what investors said that they were willing to pay for the securities. And now this year, even though the stocks have gone up, investors are actually responding that they're comfortable paying the current multiples if not even higher multiples than their current trading value, right. I think that's a very interesting -- maybe Fed policy is finally making its way through to the shareholder base or maybe a nice S&P rally has gotten people in a better mood. But for one reason or another, I think, we're at a position now where people are more excited or interested in names at even these higher valuations.

So with that, Ingersoll Rand, I think follows a trend of several companies we've had today, companies where there is still a lot of debate around buying the stock or not owning a stock here. Ingersoll is one of the companies last year that was fairly out of favor in our audience response system. A lot of investors were skeptical of the company's kind of progress with the turnaround and such. And over the last year, the stock performance has been quite exceptional. I think, 2012, Ingersoll ended up being, if not the best performing stock in my group, it was pretty darn close. There is a little bit of a trend there, names that are out of favor at this conference tended, last year, to be some of the better performers.

So fast forward now to where we are at with Ingersoll Rand, I think, there's still a lot of debate around the HVAC recovery and what we're going to see. And most importantly, for Ingersoll is the commercial side of it. I think there's still -- there's an interest level among investors that we talked to in owning commercial exposures, but there's a lot of debate about the timing and magnitude of a recovery there. I think there's a fair amount of debate around Ingersoll Rand's ability to outgrow its core markets. There's, generally, a belief out there that Ingersoll Rand has not outgrown its core markets over the last, call it, 5 or 7 years or whatever time frame you want to use. There's some debate about that. And then there's clearly been some activist involvement and some debate around capital structure and what Ingersoll will look like in 3 years.

To the credit of the folks who are here, capital structure today and the share buyback plan has been, seemingly, been very, very well-timed and fairly aggressive. So I would give you guys credit for being one of the few companies that we cover that has actually timed their share purchases pretty effectively and really bought back sizable amounts of stock at reasonably depressed levels. That's not, a common response or common thing that we generally see.

So look, I don't think Michael Lamach needs much an introduction to you guys, but he is President, Chairman and CEO of the company. And with that, Mike, I know you have maybe some initial comments, going to give us a State of the Union or tell us what's new at Ingersoll, and then we can move into questions.

Michael W. Lamach

Great. Thanks, Scott. What I'll do is maybe 3 to 5 minutes, just to level set everybody. I know that there would be people that know us quite well and maybe those that don't. So if you follow along with what Joe passed out in terms of the handout, you can do that. If not, I'll talk at a fairly general level so you won't need to follow too closely.

If you know the company, you know we've got a great portfolio of brands. Ingersoll Rand, Trane, Thermo King, Schlage, Club Car. And typically, 1 -- or #1 or #2 in most markets that we play. I started as COO in 2009 and President and CEO, 2010, and to tell you that my vision of the company and what we needed to do has been to really move from more of a holding company to an integrated company. And working, not only in the sourcing and technology and manufacturing areas, but also looking at the systems and what we can do to better leverage the company, has been fundamental to what I've been trying to do.

At the same time, looking back at 2008, at the portfolio and looking at how long in the tooth it had become, we knew that we had to do a great deal in the area of innovation to really refresh and revitalize the portfolio. And we've been very active and consistent around that the last 5 years.

Last point would be with regard to the strategy is, we've been doing this in a way that's really shareholder focused, and I'll talk more about that in terms of what we've done and certainly what we plan to do going forward will be covered as well.

So if you go to Slide 4. Innovation is an area that we highlighted, it's been critical to growth for us. This was, again, a very aged portfolio. We've essentially doubled the amount of revenue that comes from products that are new to rolling 36 months, the number. We followed a roadmap that we established in '08 to be able to do that, we've been able to execute against that. And that generally means that we've been able to refresh the portfolio, where we've launched new products, generally, get a little higher pricing, a little better margins on the product. And fundamentally, grow share in some of the key areas that we had targeted. Now with the right growth rate for innovation that's going forward, well, we think that this year because a lot of the heavy lifting has been done throughout the portfolio.

Second has been in the area of thinking about how we improve the talent, the investment selection, the prioritization of how we go into markets, how we look at new products in the portfolio. We had good success here in product development cycle time, speed to market, margin improvement, market share growth. I will tell you one interesting indicator, it's just in the area of intellectual property disclosures, we have been tracking that for a while now. And we were up almost threefold the number of disclosures passed this past year compared to the prior year, and our patent filing is up about 75%. And that's a good leading indicator for us as to whether what we're doing is differentiated in the marketplace and the way that we can drive increased growth in margin.

Slide 5 gets into the operational excellence program of the company. This has been a real personal passion for me. I continue to spend a lot of my time personally out in our plants and in our supply chain. And it's been, for me, a journey to build the capability in the company to improve our operational execution across the company. I think about it really, simply in 4 main levers. What we're doing with strategic sourcing, the upgrade of talent, the centralization of talent, the buy for the whole company.

Then there's 2 elements of lean. One is around the lean implementation in our factories, we refer to that as the value streams. The third is the second area of lean, which is around lean in our functional organization. This is information technology, human resources, finance, legal, et cetera, engineering. And the fourth area has been around pricing, in pricing excellence and putting people, tools, systems in place to be able to really maximize not just price list management but how we actually can drive price in excess of material cost on an ongoing basis.

We've got about now 24%, 25% of our company in some state of a lean transformation. We think we'll be at about 40% at the end of this year and about 60% at the end of next year. That's going exceedingly well. We're driving that very deep into the company and it's something that we know we can sustain when we do that. That's sort of why the progress across the company has been carefully measured out, metered out. We talk about the separation of performance on the slide, and that will refer to things like cycle time, margin improvement, on-time delivery and quality, dramatically improved from the average of the portfolio. So we know we're doing good work there and we've got plenty of runway left on that one.

Functional costs are little harder to get at for us. We've set a target to reduce that by a couple of points over the next few years. It's heavily predicated on a systems implementation that we're doing. About 1 of the 2 points, or maybe even more than 1 point of the 2 points, we'd like to get, really, comes from rationalization of ERP and technology systems in the company. The other half has really got to do with all the excess cost that get put into the company to manage some of the manual processes that we have to do to make decisions around the company. So this is a big area for us that will continue through 2016, with the first phase going live here at the end of this quarter.

Very proud that we've been able to achieve operating leverage for the last 3 years of 38%, 31% and 73%, respectively. And that is really a testament to the execution and improvement across the company, and we have been typically a top quartile operating leverage or incremental margin company over that period of time. This year, think at the midpoint, we should do about again a 40% operating leverage there. So in terms of the self help or the execution improvement in the company, clearly, over 3 years we've been able to make some nice improvements there.

And then finally, on price. This was the longer-term build for us. We had to put the right people, the right tools, the right processes in place. At first, we looked at it on a transactional basis, it was the low hanging fruit. We've mainly now moved to more, I would say, value pricing and using these tools to drive more sophisticated analytics around pricing. So elasticity would be an example of us being able to look at our pricing at a more detailed, very specific way. And teaching these tools to the organization has been good for us in that we've been able to drive a nice gap to material cost.

Capital allocation on Slide 5, I'll talk about that quickly. We had a 31% increase, again, in the dividend in December. I'm very pleased that when you compare back 2008, and I do that because that was a pre-Trane acquisition, we are now about 17% above that point, so we've been able to take the dividend up from that past peak by 17%. And as Scott pointed out, we are able to buy back 55 million shares in '11 and '12 for about $2 billion. Going forward we've announced the new $2 billion share repurchase that will commence this year and complete by the first quarter of 2014.

The big news on Slide 7 was the announcement we made in December to spin off our security business in a separate publicly traded company. That remains on track and we're executing well against the timeline there, and we anticipate that being complete by the end of the year.

And then probably on Slide 9, just to maybe reinforce a few of the points I've made. We made a lot of progress in the company over the last few years. I do think, from what I look at, growing earnings, improving ROIC, are fundamental in creation -- creating cash and returning it to shareholders, we've been able to do that, I think, in a very consistent way. We've reduced cost, we've done a great job on the fixed cost footprint. We're using lean to look at the transformation cost of the company and reducing those conversion costs as well. We've done all that by incrementally still putting $100 million a year into the innovation or the product portfolio of the company. So we're on track with the revitalization campaign we put in place.

So for 2013, I look for a continuation of more progress in the way that you would see the execution capability, the company progressing. Look for us to do about 24% or 25% of our revenues from products that we've introduced over the past 3 years. We'll execute security spend, we'll keep that on track.

And with that, I'll open it up to questions.

Question-and-Answer Session

Scott R. Davis - Barclays Capital, Research Division

Thanks, Mike, for the overview. I think I want to make sure we get to the audience response questions, too, before we get too far along. But I think the first thing that I'd like to dig into is commercial HVAC. And I remember years ago when I covered Trane, and I was starting to do the work on American Standard, Fred Poses said to me, "Look, if you get commercial HVAC right, you'll get our stock right. Don't worry about all the other stuff." And sometimes I think about that with Ingersoll Rand that we're all fixate on residential, we fixate on lots of different things, but getting commercial HVAC right is a pretty important component of the recovery story. And I think we've had something in the neighborhood of a 70-month construction recession or something, in that neighborhood. When you think about how you guys think the shape of the recovery may look, and on a global basis, maybe even we can go by geography or major geographies, what signs do you see out there that we can get the kind of recovery that we've seen historically that can impact you guys directly? And the reason why I kind of ask the question that way is that, I don't think building multifamily homes is going to have a huge impact on Ingersoll Rand. But when we get down the road, where we're building bigger facilities and a much -- I mean, even casinos and bigger rollouts, then you guys tend to do really well on the big stuff. So tell us how you guys think about it internally and then we'll open any question?

Michael W. Lamach

Yes. I think first of all, let me talk about where we look at to -- look at a forecast, rather than sort of predict the exact timing of recovery. There are about 4 things that we try to triangulate there or look at. The first is, clearly, what you all can see, which would be data like the AVI would be a good example. Here, we know that when we lag the security business by 10, 12 months or lag the commercial HVAC business by 6 to 9 months, we can get pretty close on forming an opinion about sort of the general direction of a recovery. But the second -- and probably now you're getting into sort of more accuracy here as you get into the Dodge put in place numbers or the global equivalent where they exist of that sort of information, and we look at the put in place numbers, we take it down to a vertical market view because we have different shares and different verticals, and we would actually take it one step lower than that and look at the usage factor of what sort of density in a square-foot basis, of what we do goes into a building of that type. And that's a pretty good indicator that we can look at and time with the put in place information. The third thing is, I would say an increasing capability to look at the pipeline blowing up from our field very early in the process. So around the time that you would see an architectural inquiry is the time where we would be typically working with an end user or an engineer doing, maybe, capital budgeting or scenario planning or some sort of activity. But with the knowledge of that particular customer, we would have a pretty good opinion and estimation as to what the probability of that project going forward might be. So that rolls into a forecast that our team rolls up. And then the fourth thing we do, and this is really a third-party view, is we engage a couple of third parties that have access to our data to be able to, in a more proprietary way, do a more detailed modeling, so just take an independent third-party look at all of that. We put all those things together in the forecast, the ranges that we give. Now that being said, we've got pretty good visibility to the next 6 to 9 months. And the only thing about our 2013 forecast that would be somewhat sort of open for change would be the fourth quarter. We'd have to see a lot more sustainment in the metrics that we're seeing to call the inflection off the bottom in 2013. And most of the data that we look at, but this data now tends to be long-term data, more third-party data, shows some inflection up in 2014 in most of our major markets. And so, Scott, long story short, we're looking at 1% to 4% for the company percent growth. If you look at 1% to 3% in commercial HVAC and 2% to 4% in security, that's how we're seeing the world today yet.

Scott R. Davis - Barclays Capital, Research Division

So relatively benign?

Michael W. Lamach

Yes. Muted I would say, yes.

Scott R. Davis - Barclays Capital, Research Division

I think what we're struggling with the most, and we don't have the answers either, is that we have a comparable forecast to the Dodge forecast up 5% commercial in 2013 and up 7% in 2014. And it's very rare that you see a cycle up 5% and then up 7%. And it's only up 4% and up 15%. And I mean, it's -- and I think for some reason or another, this is a much more difficult cycle than in the past on the construction side.

Michael W. Lamach

Right. To that point back in 2009 and '10, when we were thinking about a 3-year plan and giving a framework, we thought that today we will be in a $17 billion revenue environment, and we think about that incremental $3 billion coming in at the incrementals that we've had which have averaged 40% to 50% and then divide that by a 300 million share count, I mean, that's a big, big sort of earnings power there and...

Scott R. Davis - Barclays Capital, Research Division

Almost double your earnings.

Michael W. Lamach

Yes. We wouldn't have been too far off the number that we gave a long time ago around what the targets were. And I think those targets, when the markets recover, still work. And I think that we've been able to see what we're doing in a relatively flat environments through the good operating leverage happening in the model itself. That gives us some reason to be very optimistic around our ability to take advantage of volume when it comes into the portfolio.

Scott R. Davis - Barclays Capital, Research Division

My last question on commercial, and then I wanted to start in the ARS question is that, there was a view, and a commonly perceived view, and this goes back probably 4 or 5 years, that the commercial HVAC business had been underinvested in and maybe an asset base that was higher cost in competitors and such. But we could never really find any data that support that being true or not. What is your view now of either where your cost position is? I mean, obviously, you've done a fair amount of heavy lifting but so have some of your competitors as well. So what do you think your cost position versus your competitors' is at this juncture?

Michael W. Lamach

Well, let me first on the revitalization of the portfolio. It's really interesting. When I was a President and COO and I had the Trane business, I remember standing up in 2009 saying we have now developed in the past 18 months more product than Trane developed in the prior 10 years. I was at the AHR show a couple of weeks back, and we had 1,400 customers join us for a dinner that evening. And the President of Trane stood up and said, in the last 18 months, we've developed more product than we have in the last 10 years. He was right, okay. So the momentum around what we're doing to revitalize is really important. If you take the centrifugal chiller product line, a billion-dollar product line for the Trane business, it's the 1964 design that we put in place. And certainly, electronics have improved and with VA/VE, the product to a greater extent. But we have not really done any fundamental redesign work on the product. And so that's an example of the kinds of things that we're trying to do now is, really, take back that technology leadership that Trane really had in the '80s and '90s. And where we have launched that product, we see share gains. And I like the share gains that come from the third-party reported data where it's not just sort of our view of the world, but it's a view of all of the sort of industry participants. And we like what we're seeing around the revitalization taking the form of higher share. So AHR, this last couple of weeks ago, was a great event. We had 8 major product launches there, and that's now the culmination of, really, 3 years or 4 years of work that begins to roll off now. So that's incredibly exciting, I think, going forward for us.

Scott R. Davis - Barclays Capital, Research Division

Okay. That's helpful. Let's take the first ARS question please, Doug. I think we have enough people back from lunch now to have a quorum here. Do you currently own this stock? I think you're all familiar with how to vote by now. Yes, overweight. Yes, equal weight. Yes, underweight or 4 do not own the stock. So why don't we turn on the system and get voting.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Third is no, it's surprising. There was more in -- Rockwell was 80% now, I think, so you're in good company. That means there's still a lot of people on the sideline with some opportunity. You can front run it with your buyback.

Michael W. Lamach

All right.

Scott R. Davis - Barclays Capital, Research Division

Okay. Let's go to the next question. What is it your general bias towards the stock, and remember we're trying to differentiate the stock in the company, we're just talking stock here. What's your general bias towards the stock right now? Do you have a positive view? A negative view? Or a neutral view? Please vote.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Really split. Positive, neutral, not a lot of negatives, but positive and neutral pretty split. We've seen a lot of that for the last 2 days, that's not a surprise. That's been pretty common. Okay, let's go to the next one. In your opinion, true cycle earnings growth and it's EPS -- EPS, not operating earnings, EPS growth for Ingersoll Rand will be 1, above peers; 2, in line with peers; 3, below peers? Please vote.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Okay. 43% above peers. That's a pretty good number. 70 -- about 73%, 74% of the people think you're in line or above peers. That's probably -- if we looked at last year, I bet you this is much, much more positive of a feedback. Okay, we'll do the next 3 questions later. I have a question that's somewhat consistent with this and maybe a little challenging to answer. But you've had a lot of time with shareholders in the last -- I mean, you've had fairly intensive conversations with shareholders both new and old over the last 6 months. What have you learned from that process as far as shareholders' patience or lack thereof? And what things that Ingersoll Rand used to even get more aggressive on? And let's exclude this share buyback and stuff that you've already announced, but are there common themes that you're getting feedback on of issues that people would like you to be more aggressive on, particularly in the operating basis?

Michael W. Lamach

Yes. I mean, nothing new really there in terms of you find that the internal plans that we have over a 3-year period are exactly sort of what an activist investor, an investor would want to see over the next 3 years. So there really, I would say, was no misalignment around expectations 3 years out. So as you think about an investor giving you a 3-year view of where you should be, and that's comparing it to a 3-year view of what we're telling our board independently, you put the 2 together, they were right on top of each other. So not a lot on the operating side. We have high aspirations for the company, and we realize that it's more important for us to build some of the core capabilities into the company over the long haul and to sustain it, than it is certainly to do anything that would be shortsighted in the company. So as an example to that, we took a multiyear view toward restructuring the manufacturing footprint of the company, and it really increased utilization of our plants by a multiple of where it was, okay. That's a phased approach to do that. To be able to do that with very little disruption to our business. For the ERP system conversion, which is a multiyear activity, it needs to be done in a way that we can really take the breadth of the company, implement the ERP solution in a way that we don't bring the company to its knees at any given quarter. And so we'd all love to move fast around some of these things, but the best way to botch an ERP implement is to try to flame it in, in 18 months, in a $14 billion company. So that's an example of we all want to move faster, but we need to move within our own capability.

Scott R. Davis - Barclays Capital, Research Division

Okay. That's a fair issue. Let's move on to industrial technologies, a business that does have fairly high margins and has generally been catching up to a pretty good competitor, but it's a fairly consolidated industry. I mean, what's your outlook on not just the cycle but the competitive dynamics within that segment?

Michael W. Lamach

Well, when we look at that business, there's a couple of real drivers for us. One, they were early in all product revitalization. They had started before the Trane acquisition and completed a year or 2 ago the bulk of the portfolio with still the tail to go on some of the product. But for the most part, they've had the benefit now of both tailwind, restructure the footprint and new product. And so the trajectory around margin improvement about 8 full points around share gain and important businesses like the oilfree business has been very good for us. We have solved a lot of the capacity constraints, actually, that we had in some of the core technology that we are manufacturing for those products. We solved for a lot of those problems, and we set a target for that business by 2013 to be in the 17% to 19% operating margin range, and it's interesting when you pull Club Car out. And Club Car, by the way, doesn't really take that much effect off it. We're above 17% through 2012 in that core industrial business. So we're already in that target range, and we see sort of the taillights on a competitor at this point in time that we think we're gaining ground on. And the best way for us to look at this is that every quarter we are really passionate around the incremental margins that we're seeing. And at the end of day, if we can sustain another 8, 10 quarters with that sort of margin improvement, we're going to be at the top end of our range and we'll be a lot closer to those taillights.

Scott R. Davis - Barclays Capital, Research Division

Okay. Let's open up to the Q&A to the audience. Gentleman right here.

Unknown Analyst

Just a question, Mike, if you went through the back part of the year and early this year and we went through all the fiscal cliff issues and so on, just curious how your order rate reacted, if at all. First, in the back part of the year where there was a lot of concern and then if it did come down, has there been a recovery in the front part of this year? Just a feel for what your customers are like.

Michael W. Lamach

Yes. That's a great question, because I saw it as a -- sort of a customer of other companies and how we reacted to it, and I saw it certainly as a provider of goods and services. And in both cases, it really took the legs out of the last couple of quarters. We pulled our horns in wherever we could. I think we took sort of any notion of incremental investment beyond sort of what was a baseline requirement in a core program, really, didn't get started for us. So in terms of our own capacity and our own investments, we took a more conservative approach. And we saw the same thing with our customers, across the board. Asia, particularly China, it's a little bit different. A little bit different there in that there was a bit of a vacuum in the economy and the change of leadership in China. We had expected to see a fourth quarter rebound in bookings in China once that cleared, and we did see that in the fourth quarter. However, I would also tell you although we're bullish on China, we're really thinking about China more as a maturing or a mature economy, we should see nice growth rates, but probably not the GDPs, the 8% or 9% in the past. But we're really moderating our view about what that outlook is, as an example. Europe, boy, Europe works in its own way. We've really seen in Europe about what we expected. We're not expecting a great deal in Europe for 2013. We don't expect to fight foreign exchange headwind though, we think we'll be fairly neutral there, so that should have a bit more of a positive in terms of organic growth rates across the company.

Scott R. Davis - Barclays Capital, Research Division

Okay, next question.

Unknown Analyst

On pricing, and it's obviously a very powerful lever. What things are you doing differently than you were in the past? And also how far are you in your pricing initiatives? Are you pretty much -- was it like a onetime catch-up and you're done or is it something that into 2013, 2014 you see driving the business?

Michael W. Lamach

Yes. Again, think about this as building a capability which required people, that some cases could be developed inside the company and some cases were brought into the company, enough of them to matter. Tools which could include both model software and tools to be able to do a different price analytics and methodology. And then a process by which we're never too far away from how we're doing with pricing and there's a cadence around reporting that out in the company and accountability around that in the company. And it took us about a year to 18 months to really get all of that working, as you can imagine pulling that together in a way that we began to see the effect truly hitting price and the spread to material cost. We look at that spread as being the spread we want to maintain a positive bias on. We want to always price better than material cost inflation, particularly over a 12-month period. Sometimes quarter-to-quarter you could have an anomaly, but for the most part over a year. When we started that, the low hanging fruit was on the transactional side, and it was really managing basic recoveries of price and execution of sort of the transactional element, and it has now evolved into that plus more value pricing and how we do discount management. How we think about value pricing new products based on elasticity analysis and other factors, conjoint analysis, that we were doing, the launch of a product, which has helped us really fine-tune that value pricing going forward. I think that the transaction side is sort of in the fabric of the company at this point in time, and we intend to maintain good discipline around that. And I think the value side of that is still fairly early as we really have the opportunity to apply that to the newer product portfolio in particular. So I feel pretty good about what we've accomplished there. I don't think we'll see the 1-point spread that we had last year. This year, I think maybe more realistically, 30, 40 basis points would be a good number for us. But the notion of keeping that positive is what I really want you to take away.

Scott R. Davis - Barclays Capital, Research Division

Good question. Okay, let's go to the audience response system. Allen, get through the next couple of questions here. In your opinion, what should Ingersoll Rand do with excess cash? This is an interesting question for you guys since already been somewhat answered. But let's vote on this to see if the audience agrees with what's been going on.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Wow, okay. I guess the audience does agree. All right, so let's move on to the next question, which I think might be -- the next couple might be more relevant. In your opinion, at what multiple of 2013 earnings as PE should Ingersoll Rand trade? That's 2013. So please vote.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Fairly concentrated, comparable to what we saw last year, but I think it's a step up from last year. I don't think there was a lot in that 16% to 18% range last year. So that's higher than it was a year ago. And then let's go to the last question. What do you see the most significant investment issue for Ingersoll Rand? Core growth? Margin performance? Capital deployment? Or execution/strategy? I think this is a pretty relevant question, so let's vote on this one.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Pretty split up. Okay. So if I was to interpret this, people feel like you've already succeeded on capital deployment, which I think you arguably have. The question is, can you get margins up? Can you execute on margins? There might be some overlap there, right?

Michael W. Lamach

If we do everything right. Okay, regarding growth and execution right.

Scott R. Davis - Barclays Capital, Research Division

Well, it's funny. Capital deployment was the area people had some of the most complaints historically, right? So you've addressed that issue and it's no longer an issue, right? So it's now back to performance. So let's go to Q&A, the gentleman in the front row here. You can press the microphone button on that, handheld if you want.

Unknown Analyst

I got it. So I have 2 questions. One, just from a persons who is not as familiar with the stock, do you guys have any tailwinds from either lower cost due to raw materials, et cetera, or corporate restructuring other than, I know what you're doing in terms of what you're doing, and that's #1. #2, we all know Europe stinks. I think that message is -- we didn't need this conference to tell us. The question is how much do you see, let's say, if we came back 2 years from now, I can't believe I'm even asking that question because 2 years is [indiscernible] a lifetime, how much of your business do you think will be in Europe? How would you geographically describe your businesses, let's say, in 2 years?

Michael W. Lamach

Okay. Great. In terms of headwinds, there's a little bit we need to do on the pension front, so maybe $30 million to $50 million there, not horrible in that regard. A little bit of material inflation, although somewhat muted, so I don't see that as a major headwind. But we will see the effect of salary, health care, all these associated costs, fuel, et cetera, for doing what we do. Those costs could be maybe 3.3%, 3.5% sort of growth in that particular cost element. And likely we'll take price against material inflation. We take net productivity against all other inflation as being the other spread which we try to create. So we think that on price we could get 30, 40 basis points of price spread. When you look at the productivity versus other inflation side, maybe we can get 70, 80 basis points, so positive spread there. And then if you pull away about 50 basis points for investment, we kind of get to that 50 basis point improvement that we're looking for this year. And then on your geographical sort of discussion, I think as a percentage, you probably see as a ratio basis a smaller Western Europe as a percent. When we report, we report though Europe, East and West, we have the Middle East and we typically have India in there as well. Okay, so you -- as we look at it, you might get a little different number there, because we do expect for the Middle East, Eastern Europe and India to grow at multiples of Western Europe. Asia is interesting. More than half our business is outside China and we don't know what's going to happen inside China. China moderating, so 5% -- 4% to 6% type market growth. The rest of Asia may do a little bit better. Therefore, I think you'll see a sort of a pro rata increase in Asia. And I think that the area that you might see the most significant growth for us could be Latin America, frankly, where we've got a relatively small presence today down there, but I feel fairly bullish about what we're going to see in all of Latin America going forward.

[Question Inaudible]

Scott R. Davis - Barclays Capital, Research Division

Can you repeat the question?

Michael W. Lamach

When you're talking about EMEA, how much is non Western Europe, and I'm going to ask my friend Joe here to help me with that.

Joseph Fimbianti

[indiscernible]

Michael W. Lamach

2/3 Western Europe, 1/3 West.

Scott R. Davis - Barclays Capital, Research Division

Okay. Another question?

Unknown Analyst

I'm going to ask a question that I probably asked you too many times, but maybe the answer changes over time. Commercial HVAC seems like -- and it's a fairly consolidated industry, you have competitive advantages there, it's always been thought of as being a pretty good business for you overall. But one of the thing the missing pieces has been versus other big capital equipment industry is there hasn't been much of a razor, razor blade post the install really being able to capture the big service revenues of these units that can stay in service for really, really long time. How do you increase that? Is there a way that you can kind of drive that aftermarket higher?

Michael W. Lamach

Yes. Interesting question. Because when we talk about productivity, I said there are 4 levers. When I think about growth, I think about 3. Innovation we talked about, that's going to continue the drumbeat there. Emerging markets, China not being so much an emerging market anymore continues to be a focus. But the third one, right, is the services business. And we think that as an example, this year, we'll probably see 2 points growth more than we would see in equipment business in our overall service business, right. The mix will continue to change and mix up toward service. It's a great story for us on a contribution basis. We've got higher overheads there, but much higher gross margins there, so it's a very good business for us. And fundamentally here, it's really not so much the parts business. It's really around the services component, and it could be everything from unscheduled service to really linking equipment to scheduled service, which is a big opportunity for us. We're taking on more and more competitive equipment every year. That continues to grow for us as well. And it's such a fragmented market as mom-and-pops and small service providers that when you typically can take service and you can put some sort of a guarantee around it, financial is good, right, where you can put some sort of a return of service or some sort of a sort of a risk association with your performance, that typically really narrows the playing field, okay, in terms of who can do that. Now the more confidence you have particularly in your own stuff, around reliability, the more data you have around that customer and that reliability of that equipment, the more sophisticated you can be in terms of the risk you take on from a margin perspective. So that is a growing and evolving business for us to provide more planned service. And then there's the retrofit element of this, and I'm never sure if that really service or if it's equipment because it's both, right. But the turnkey retrofit business, the ability to go in directly to an end user and sell a product or a solution which really return on total cost of ownership. It's a 10-, 15-, 20-year asset, the whole service model and what you package with that is another big advantage, I think, that we can bring relative to the competition. All that being told, it's a major push to move the service mix up in the company and eventually get back to say half the company, right, so your razor, razor blade would be about 50% razor blades.

Unknown Analyst

How many years to get there?

Michael W. Lamach

I don't know. It really depends on the equipment business, right? I mean, it's kind of funny because it's a little bit counterintuitive. We love to see a great equipment market. We worked really hard to benefit on that, so it's hard to know what that mix would be. If we had a 15% equipment market, right, how are we going to change that mix. Over the long haul, really growing the service base.

Scott R. Davis - Barclays Capital, Research Division

Let's wrap up there. Thank you for your time, Mike. Thanks, everybody, for your interest, and see you soon.

Michael W. Lamach

Thank you.

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Source: Ingersoll-Rand Plc Presents at Barclays Industrial Select Conference, Feb-21-2013 12:30 PM
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