Illinois Tool Works Inc (ITW) 2010 Q2 法說會逐字稿

Welcome and thank you for standing by.

At this time all participants in a listen-only mode.

(Operator Instructions) Today's call is being recorded.

If you have any objections, you may disconnect at this time.

I would now like to turn the meeting over to Mr John Brooklier, Vice President of Investor Relations.

Sir, you may begin.

Thank you, Barb.

Good afternoon, everyone.

Welcome to ITW's second quarter 2010 conference call.

With me today on today's call is CEO, David Speer and CFO, Ron Kropp.

Thanks for joining us to discuss what turned out to be a very, very strong operating quarter in total revenues, base revenues, operating margins and acquisition activity.

I'll now turn the call over to David who will talk more about these key Q2 categories.

David?

Thank you, John.

I certainly agree, we had a very robust quarter on a number of fronts.

Our second quarter operating revenues grew 20%, versus the year-ago period, and exceeded our forecasted expectations.

Our base revenues increased 15% for the quarter, with North American base revenues increasing 16%, and International base revenues growing 14%.

Clearly, a number of our end markets continued to improve during the quarter.

It's also important to note that despite all the headlines and chatter, our International business results have shown no discernible signs of slowing during the second quarter.

We will continue to closely monitor International results as the third quarter progresses, but so far things have proven to be quite strong.

Operating margins were a strong 16% for the second quarter.

That's 610 basis points higher than our Q2 of 2009, and certainly underscores our unique decentralized approach to restructuring.

Remember, we leave restructuring decisions to our local general managers.

Those women and men who are closest to the end markets and customers and restructuring is never a one size fits all approach at ITW.

Acquisition activity notably picked up in the second quarter.

We completed seven transactions in the second quarter for annualized revenues of about $253 million.

That's considerably higher than Q1 when we completed only four deals for $26 million of annualized revenues.

As important, our pipeline currently is approximately $600 million of prospective deals.

Additionally, we're optimistic that a number of acquisition conversations that we're having that are not part of the pipeline with many different sources including private equity and privately owned companies will ultimately show up in our official deal pipeline as the year continues to progress.

Finally, a brief comment about our full year 2010 forecast.

We believe our base revenues will grow in a range of 7% to 10% in the second half of the year, versus the year-ago period.

Our view is these numbers would represent a solid operating environment for our worldwide businesses.

John, back to you.

Thanks, David.

Here is the agenda for today's call.

Ron will join us shortly to talk about the Q2 financial highlights.

I will then cover Q2 highlights for the eight reporting segments.

We'll then go into our Q3 and full year earnings forecast, which I'm sure many of you are interested in.

And finally, we'll take your questions.

We continue to ask for your cooperation as we always do for our one question, one follow-up question policy.

We plan on finishing this call within an hour.

First, let's cover our mandatory housekeeping items.

Please note that this conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Including without limitation statements regarding operating performance, revenue growth, diluted net income per share from continuing ops, acquisition activity, restructuring expenses, and related benefits, tax rates, end market condition and the Company's 2010 related forecasts.

Finally, the telephone playback for this conference call is 203-369-1871, the replay is available through midnight of August 3.

No pass code is necessary.

Now, here's Ron Kropp who will comment on our 2010 second quarter financial highlights.

Ron?

Thanks, John.

Good afternoon, everyone.

Here are the highlights for the second quarter.

Revenues increased 20%, primarily due to higher base revenues and improved from the first quarter revenue increase of 15%.

Operating income was $653 million, which was higher than last year by $318 million.

Margins of 16% were higher by 610 basis points.

Diluted income per share was $0.83, which was higher than last year by $0.47.

Included in EPS for this quarter was a higher than expected tax rate of 31.6%, which reduced EPS by $0.03 versus our forecast.

Finally, free operating cash flow was $276 million.

Now let's go to the components of our operating results.

Our 21.1 revenue increase was primarily due to three factors.

First, base revenues were up 15.1%, which was favorable by 7.6 percentage points versus the first quarter base increase of 7.5%.

We have seen solid revenue gains worldwide led by the Transportation, Industrial Packaging, Power Systems, and Polymers and Fluids segments.

North American based revenues increased 15.8%, and International based revenues increased 14.2% in the second quarter.

We showed a continued improvement from the first quarter increases of 7.1% and 8.0% respectively.

Next, currency translation increased revenues by 2.3%, which was unfavorable by 310 basis points versus the first quarter currency benefit.

Lastly, acquisitions added 3% to revenue growth which was 100 basis points higher than the first quarter acquisition impact.

Operating margins for the second quarter were 16%, and were higher than last year by 610 basis points and higher than first quarter margins by 260 basis points.

Base business margins were higher by 470 basis points due to both the favorable impact of the higher sales volume, and the positive impact of non-volume items.

Non-volume items increased base margins by 60 basis points, which was lower than the first quarter non-volume effect by 490 basis points.

Included in the non-volume impact for the second quarter were lower costs as a result of past restructuring programs, which improved margins by 120 basis points.

Partially offset by the unfavorable impact of price costs, which reduced margins by 40 basis points.

In addition, margins were higher by 160 basis points, due to higher restructuring expenses last year.

And acquisitions reduced margins by 20 basis points.

When I turn it back over to John, he'll provide more details on the operating results as he discusses the individual segments.

In the non-operating area, other non-operating income and expense was favorable by $26 million, mainly due to higher income from investments.

Second quarter effective tax rate of 31.6% was lower than last year as a result of unfavorable discrete tax adjustments in the prior year.

The tax rate is forecasted to be in a range of 30.25% to 30.75% for the third quarter, and 31.25% to 31.75% for the full year.

Turning to the balance sheet, total invested capital increased $40 million from the first quarter, primarily due to higher inventory and accounts receivable levels as a result of the higher revenues.

Unfavorable currency translation reduced invested capital by $330 million.

Accounts receivable DSO was 57 days versus 61.2 at the end of the first quarter.

Inventory month on hand was 1.7 at the end of the quarter versus 1.8 last quarter.

For the second quarter, CapEx was $63 million, depreciation was $84 million.

ROIC for the second quarter increased to 17.0% versus 8.6% last year.

On the financing side, our debt level decreased approximately $100 million from the fourth quarter, and debt to capital remained stable at 26%.

Cash on the balance sheet decreased to $1.3 billion, from $1.4 billion at the end of the first quarter.

Our cash position decreased $152 million in the second quarter and our free operating cash flow of $276 million utilized for acquisitions of $190 million and dividends of $156 million.

Regarding acquisitions, we acquired seven companies in the second quarter which have annual revenues of $253 million.

Given that we have seen some pick up in acquisition activity, our current acquisition forecast for full year 2010 acquired revenues is now $500 million to $700 million, which is an increase from the prior range of $300 million to $500 million.

I'll now turn it back over to John who will provide more details on our second quarter results.

Thank you, Ron.

Let me quickly review our second quarter segment highlights starting with our Transportation segment.

Q2 2010 total segment revenues increased 34.1% versus the year-ago period.

Base revenues grew a very healthy 29.3% in the quarter compared to the year earlier period.

As important, operating margins of 16.2% were 1190 basis points higher than year-ago period and 250 basis points higher than Q1 2010.

The sizable increase in segment based revenue growth was again largely attributable to strong auto production increases in both North America and Europe, as well as improved auto aftermarket demand.

In North America, Q2 auto builds of 3.1 million units were significantly higher than the 1.8 million auto builds in the 2009 second quarter.

Both Detroit three and new domestic auto OEMs contributed to the increase in builds in the second quarter.

In Europe, same kind of story.

Auto builds totaled 5.0 million units in Q2 versus 4 million units in the year-ago period.

We continue to believe that auto builds will remain relatively strong for full year 2010.

North American auto production today is forecasted to hit 11.5 million units, while European auto production is forecasted to total 16.9 million units for full year 2010.

We'll keep you posted as we go through the year on these numbers.

In our auto aftermarket category businesses Q2 based revenues increased 4.2% versus the year-ago quarter largely due to an uptick in miles driven and related consumer spending in this category.

That's the best base revenue performance for this category in more than a year.

Moving to the next slide, Industrial Packaging's total segment Q2 revenues grew 23.5% versus the year-ago period.

Q2 base revenues totaled a strong 17.7% compared to the year earlier period.

Operating margins of 10.6% were 710 basis points higher than the year-ago period and 80 basis points higher than the first quarter of 2010.

On the next slide you'll see that Industrial Packaging base revenues continue to improve in the second quarter of 2010.

That was driven largely by improving industrial production metrics and end market demand including key industries such as automotive, parts of the construction and appliance sectors.

All of these helped contribute to base revenue growth.

Most notably, our total North American Industrial Packaging base revenues grew 22.5% versus the year-ago period.

And within that category, our plastic and steel strapping and equipment sales increased nearly 29% on a year-over-year basis.

That clearly underlies better industrial production activity and as we've said before, the Industrial Packaging segment is a good barometer for ongoing industrial production rates.

The consumables portion of this business was the largest contributor to the growth in the quarter with equipment growing at much, much smaller rates.

Internationally, total Industrial Packaging based revenues grew 11.9% in Q2, with strapping consumables and equipment growing approximately 15% versus the year-ago period.

Moving to our next segment, Food Equipment's total revenues grew a very modest 0.7% in the second quarter as a trend of our customers delaying equipment purchases continued.

You heard this story from us before and it continues on into the second quarter.

As a result, base revenues were slightly negative in Q2 versus the year-ago period.

The better news was that operating margins of 13.4% in Q2 were 50 basis points higher than the year-ago period, and 160 basis points higher than the first quarter of 2010.

As noted, Food Equipment segment's Q2 base revenues declined 0.2%, and that reflected a story of slow equipment sales.

Case in point, total North American Food Equipment based revenues decreased 3.7% versus the year-ago period.

The equipment part of the business declined 7.8% in Q2 compared to a year-ago.

Again, the better news was that North American service portion of the business met our service and support of our products grew 2.8% in Q2 versus the year-ago.

Internationally, our base revenue results were better.

Total International Food Equipment base revenues increased 3.3% in Q2, thanks to growth in both our service and equipment categories.

The Power Systems and Electronics total segment revenues in Q2 grew a very healthy 24.6% versus the year-ago period.

Base revenue growth increased substantially with an increase of 22.6% year-over-year.

As important, operating margins of 21.8% were 630 basis points higher than the year-ago period and 100 basis points higher than Q1 2010.

This segment's Q2 substantial growth in base revenues was directly tied to strong performance from our welding businesses, as well as our PC fabrication units.

Our worldwide welding business produced base revenue growth of 13.5% in Q2, with North American welding base revenues growing at a rate of slightly over 20% versus the year-ago period.

The industrial based welding equipment and consumables was the fastest growing area for the business in Q2 with base revenues increasing 29% year-over-year.

Internationally, Asian and European welding base revenues were both flat compared to 2009 second quarter.

Asian welding base revenue performance was hindered by a slowdown in shipbuilding in that region.

Moving to the PC board fabrication side of the business, they continue to perform at very, very strong levels in the quarter.

These units, which I'll remind you, provide solder and OEM manufacturing equipment to worldwide consumer electronic customers produced Q2 base revenue growth of nearly 90% year-over-year.

Increased consumer demand for a variety of products such as cell phones, portable computers and PDAs has significantly aided business growth.

Moving to Construction Products.

Total segment revenues grew 24% in Q2, versus a year-ago and base revenues grew at a healthy 12.9% in Q2, year-over-year.

Notably, Q2 operating margins of 14.7% were 880 basis points higher than year-ago quarter and 780 basis points higher than 2010 first quarter.

The segment's Q2 base revenue improvement was due to contributions from both our North American and International business units.

Total North American construction based revenues were up 17.2% in Q2.

And the components of that would be North American residential based revenues growing 14.2% in the quarter, and that's due to slightly better year-over-year housing starts and the modest inventory restocking in channels.

In North American renovation base revenues increased 11.5% versus the prior year period.

While North American commercial construction based revenues increased 30.5% in the quarter, that growth was aided by a one time revenue gain due to a licensing agreement related to a patent settlement.

Absent the one time gain, commercial construction based revenues grew a much more modest 5.3%.

And that tracks more coincidentally with the kind of commercial construction numbers we're seeing domestically today.

Internationally, total construction based revenues grew 6.6% year-over-year with European based revenues increasing 11.6% and Asian based -- Asia Pacific based revenues growing 6.3%.

Moving to Polymers and Fluids, total segment revenues grew 22.8% in Q2 versus year-ago period and base revenues grew substantially at 15.6% in the quarter, versus the prior year.

Operating margins of 16.4% were 560 basis points higher than Q2 2009.

And nearly 400 basis points higher than Q1 of this year.

The segment's strong Q2 base revenue growth reflected growth from both our International and North American businesses, thanks to expanding industrial production and MRO usage in the quarter.

While base revenues for worldwide polymers grew 16.1% in Q2 year-over-year, our International polymers base revenues increased 17.5% in the quarter.

North American polymers base revenues grew 11.6% in Q2 compared to the year ago.

For worldwide fluids base revenues increased 10.8% in Q2 versus the year-ago period.

Moving to Decorative Surfaces, total segment revenues grew 2.6% in Q2 versus the year-ago period and base revenues increased a modest 1.5% on a year-over-year basis.

Operating margins of 12.1% were 110 basis points lower than Q2 2009, but 260 basis points higher than the first quarter of this year.

As I said, Decorative Surfaces base revenues improved modestly in the quarter versus Q1 as marginally better commercial construction and residential activity took place in Q2.

Base revenues for the segment in Q2 was about 1.5%, largely driven by North American laminate growth of 4.1% in the quarter.

This Q2 growth in North American laminate in part demonstrates strength and resiliency of the Wilson R brand name, even under difficult commercial construction environments.

Internationally, base revenues declined 0.5% in Q1, I should say in Q2, mainly as a result of weaker commercial construction activity overseas.

Finally, our All Other total segment revenues grew nearly 22% in Q2 versus the year-ago.

Base revenues increased a substantial 14.2% in the quarter.

And our strong operating margins of 19.0% were 560 basis points higher than Q2 2009, and 220 basis points higher than Q1 2010.

Couple notes here.

In the components, major components that make up the All Other segment, we saw significant growth in our test and measurement business.

Base revenues grew 10.4% in Q2.

I should note, this was the first positive growth comparison we've had in this business since the 2008 fourth quarter, and perhaps suggests that a CapEx recovery is possible for 2011.

Consumer packaging base revenues grew 7.6% in Q2 versus the prior year period thanks in large part to the ongoing recovery in the graphics and decorating businesses.

And finally our industrial appliance based businesses produced base revenues of 21.6% in Q2 versus the year-ago period due to a Q2 pickup in appliance sale incentive and improved industrial activity.

So, I'll turn it over to Ron who will cover the 2010 third quarter and full year forecast.

Ron?

For the third quarter of 2010, we are forecasting diluted income per share from continuing operations to be within a range of $0.72 to $0.84.

The low end of this range assumes a 9% increase in total revenues versus 2009, and the high end assumes a 13% increase.

The midpoint of this EPS range of $0.78 would be 30% higher than the third quarter of 2009.

For the full year, our forecasted EPS range is now $2.82 to $3.08.

Based on a total revenue increase of 11% to 13%.

The midpoint of the EPS range of $2.95 would be 53% higher than 2009.

This EPS forecast reflects an increase in the low end of the range from our prior forecast range of $2.72 to $3.08.

Other assumptions included in this forecast are exchange rates holding at current levels, acquired revenues between $500 million and $700 million, restructuring costs between $50 million and $70 million for the year and tax rate range between 30.25% and 30.75% for the third quarter and 31.25% to 31.75% for the full year.

I will now turn it back over to John for the Q&A.

Thank you, Ron.

We'll open your call to questions.

Remember one question, one follow-up.

(Operator Instructions) It will be one moment.

And our first question comes from Walt Liptak.

Your line is open.

Hi, good afternoon, everybody.

Walt, how are you?

Good.

I wanted to ask about the Power Systems and Electronics.

I guess there's two questions in there.

One, the welding business and the demand pick up, is it -- if you can connect it to any one industry or group of industries or is it an inventory refresh.

And then second, on the Electronics portion of it, the growth rate's been close to 100% now for a couple of quarters.

Is it -- I guess the normal growth rate for this business over the next couple of years?

Walt, first of all, on the welding question, the North American welding increase, as John pointed out in his comments, in the quarter were nearly 21%.

Very strong rebound.

Obviously on the equipment component of our business, as well as the consumables, pretty broad spread in terms of end markets here in North America.

Clearly, the rebound that's occurred in the automotive space, in the heavy equipment space, in the general industrial space all provided lift in those revenues for the quarter.

So while we saw the beginning of what we thought would be some uptick in welding, clearly at the end of the first quarter we really saw a decided upward change during Q2.

I would say some modest portion of that was undoubtedly related to some restocking.

Hard to estimate it exactly.

But most of these markets now are operating at a level where I wouldn't expect to see any more significant impact of restocking unless we take a significant further leg up in demand.

The PC board fabrication business that's tied to largely consumer Electronics, you're right, we've had a couple of quarters of very strong impressive gains.

I would point out that we had two quarters in the beginning of last year of pretty unimpressive declines.

So this has been a very volatile market.

It's tied largely to handheld devices, cell phones, PDAs and also computers and you're seeing it across the board obviously upward momentum in those categories.

Importantly, embedded in this business is a significant component of equipment sales and certainly the equipment revenues are up significantly as a result of the rebound in those industries.

On a sustainable basis, these are markets that are typically operating in the 6% to 8% growth range.

So clearly the first two quarters are well outside of that.

I would certainly expect these growth rates to begin to dampen as we approach the second half of the year, but nonetheless the consumer electronics rebound has been strong thus far.

As a follow-up in the welding segment, what does pricing look like?

Did you raise prices during the quarter on either the consumables or the machines?

Yes, we had some modest price increases in the quarter largely based on fluctuation in metals prices, primarily steel.

We've seen some of those steel prices, or costs I should say abate somewhat, but relatively modest impact on price cost in the segment in the quarter.

Okay.

Great.

All right.

Thank you.

And our next question comes from Nigel Coe.

Yes, good afternoon, this is actually Nicole asking questions on Nigel's behalf.

Hi, Nicole.

First of all, if you could talk a bit about M&A.

It's great to hear that the bidding environment's getting better.

Which segments are the focus of this and could you give some more detail on the bidding environment that you're seeing?

Well, in terms of the focus of what's occurred thus far, we've closed 11 transactions.

The biggest of which have been in the construction segment and the Polymers and Fluids organization, that segment as well.

In terms of ongoing activity, it's pretty well spread out.

I'd say the majority of the activity in the pipeline is probably concentrated around the Test and Measurement space, Polymers and Fluids, to a lesser extent in the Consumer Packaging spaces as well.

I expect that we'll continue to see things improve as the year unfolds.

That's certainly been the pattern we've seen over the first two quarters.

So we've seen an improvement in the first quarter of the pipeline that materialized into more deals closed in the second quarter.

The pipeline at the moment is about $600 million in size.

So it's more than double what the pipeline was at the beginning of the year.

In terms of valuations, I'd say valuations are, I would say somewhat more favorable than they were at the beginning of the year, although still somewhat challenging as some businesses that are target acquisitions still have market segment declines that are occurring and so the forward view on earnings is somewhat clouded, but nonetheless I think the middle ground between buyers and sellers is being achieved more frequently.

So I think that's largely what's improved the environment.

Okay.

Great.

That's really helpful.

Just as a follow-up, if you could give some detail around how the quarter trended month by month.

It appears based on the total growth that you saw for the quarter versus your monthly growth in May that organic growth peaked in May.

Is that true?

What did you see in June?

For each of the three months, here are the growth rates.

April was 16, May 15.5, June, 13.8.

Got it.

Thank you so much.

And next is David Raso.

Good afternoon.

I was curious, the guidance, looks like you have margins sequentially going down from 16% to about 15.2%, 15.3%, then down to about 14.6% or so for the fourth quarter.

And there's obviously some history behind that as well seasonally, but I'm just trying to get a breakdown of price versus cost that you're looking for, third and fourth quarter, and also the restructuring benefit year-over-year and obviously within that I'm including goodwill impairments that you now do in the third quarter.

And lastly, currency.

So again, those three factors.

I'm just trying to think the second or third, third or fourth, how are you thinking about those year-over-year metrics?

So starting with the second quarter, the 16%, historically that's been our highest margin quarter, highest revenue quarter.

Last year we didn't quite have that trend, given the economy.

But we're closer to it this year.

So we would expect that second quarter would be the highest margin quarter.

The big puts and takes to go from the 16% this quarter to the 15.2%, 15.3%, in the third, the biggest factor is obviously the revenue decline at a 40% decramental.

That's 30 to 40 basis points.

We also had a -- John mentioned a patent settlement during this quarter, in the second quarter.

That won't repeat in the third.

So that's about 20 basis points.

Price cost is about 10.

Restructuring expense will be higher.

We had very little restructuring expense in the send quarter.

It will be higher in the third, in the fourth, so it's--.

How much more, if you don't mind, the restructuring?

The restructuring expense in the second quarter is $3 million.

And we're looking for the rest of the year to be about $30 million, so $15 million -- say, $15 million each quarter.

We've spent about $31 million on restructuring year-to-date.

That's about a negative 20 basis points quarter to quarter for that.

We do have impairment testing that we do in the third quarter now, so that's about 20 basis points.

We have a little bit in the forecast for that.

So that gets you to about the 15.2%, few other nits and nats, but that's the majority of it.

There's no real impact of currency on margins.

The primary change in the revenue profile, David, as you would imagine is Q3 for us Internationally includes all the vacation months in Europe.

So Q3 for us is June, July and August.

And that's traditionally a weaker demand profile.

So it has less of an impact on margins, but clearly has an impact on the top line.

And then third to fourth essentially currency, maybe a little more of a drag and price versus cost begins to flatten out a little bit, what if you went from 40 bips to now you're thinking about 10 bips in the third quarter.

But you were talking sequential just now.

Sequential.

So what's been happening with price cost, if you remember last year in the third quarter that's when the raw material costs were at the bottom.

So we had a pretty significant pick up last year and that's what we're comparing to third quarter this year.

So we're looking for something like north of 150 basis points negative for price cost in the third quarter.

At the same time, the restructuring benefit--.

That's year to year, David.

Year to year.

The restructuring benefit year to year will flatten out a bit.

So probably something like 40 to 60 basis points in the third quarter and then even less in the fourth quarter.

David, I think our math would suggest that the margin rate in the fourth quarter is just under 15, like 14.9.

Okay.

So that would get you roughly 15 for the year.

Correct.

Obviously you've run at 16 to 17 for a lot of years.

Last questionthen, about the restructuring activity you put into place and so forth, if I gave you flat revenues in 2011, how do you view your margins, essentially what you can control 2010 to 2011?

Are you talking about flat base, or are you talking about flat overall?

Flat base, currency essentially flat, obviously the acquisitions are potentially under your control to some degree.

We see continued margin lift in our base businesses based on the restructuring.

Clearly, as Ron pointed out, we will continue to spend restructuring this year and we'll realize only a modest portion of the benefits from that additional restructuring this year.

The big variable typically in that kind of an environment is going to be more around the dilutive impact of what we would acquire.

Base businesses we would expect margins to continue to accelerate even with a modest or flat top line.

Okay.

I appreciate it.

Thank you very much.

And the next question comes from Joel Tiss.

Hi, guys, how's it going?

Hi, Joel.

Can you talk a little bit about the -- two things.

One, any large acquisitions in the pipeline?

What do you define as large, Joel?

Your seven-year itch has come and gone, so wondering if there's anything a little bit bigger that's starting to get more reasonably priced?

There are a couple of deals in the pipeline that are north of $100 million.

But I would characterize the pipeline as populated by more typically the sort of $40 million to $50 million types of transactions.

That's what's really rebuilt.

We did close one transaction in the second quarter that was about $135 million, $140 million US in size.

That was a construction business in Europe.

So we're beginning to see some of those $100 million plus deals begin to come back.

There's probably more of those in the conversation phase that are not in the pipeline than what I've seen in quite some time, but in the pipeline there's two that are $100 million or more.

And then can you talk a little bit about the construction business, that was kind of a surprising jump that we saw in the revenues and the margins there and just about the sustainability of that going forward, how much pipeline fill and how much is really from end market demand getting better?

Yes.

Well, I think, remember, John pointed out that we had a one time gain during the quarter.

If you factor that out of the commercial construction business, we still had a 5% gain in North America in the face of a market decline.

From a start perspective that's in the mid-20s still.

So we typically -- we've done very well in terms of share of market penetration, but it's still a depressed market on the commercial side.

Certainly, probably the most disappointing side of construction has remained the residential side where the housing starts have yet to really gain traction.

You may recall, our forecast for the year at 675 was initially seen as very conservative, perhaps underdone, while others were talking about numbers that were north of 800.

675, the rate at the end of June is now more in the high 500s, I think 570, 580.

So we're still south of that, south of our forecast.

So I think the residential side is still challenging.

We've done better than the market on the residential side.

The International revenues have been very good in Europe on the commercial construction side.

And have been reasonably good also in the Asia Pacific region.

But North America I would characterize as we're outperforming the market, but the market remains weak in both the commercial and residential sectors.

Okay.

And then the reason for such a wide range on third quarter?

Such a wide range on third quarter.

In terms of?

In terms of your earnings guidance.

Well, I think it's not as wide a range as what we had in Q2 when we started Q2.

I think we've narrowed the range.

But if you look at the revenue expectation range, it's also broad.

So it's really driven by the range of revenues in the forecast or the guidance.

Typical range is $0.12 for a quarter.

All right.

Thank you very much.

And next it's Henry Kirn.

Hi.

Hi, Henry.

Is it possible to give a little more granularity by geography for what you're seeing, especially interested in what you're seeing in European economic activity right now.

Sure.

If you look at the numbers from Q2, our European revenues -- first of all, overall the International revenues were up 12.7%.

Europe was up 11% in Q2.

So a very strong improvement from what we saw in Q1.

Q1 we were slightly under 3% base business growth in Europe and 11% base business growth in Q2.

So we've seen very good demand across a number of end markets.

John highlighted earlier the auto build improvements in Europe which are important.

But I would also highlight the Industrial Packaging build or improvement in our European businesses.

So as an example, the consumable volumes in Europe for the second quarter were up nearly 31%, so that's a pretty strong uptick in our strapping and film businesses.

So very good demand profile there as well.

If you want some other geographic flavor, the Asia Pacific region was up 17%, driven by China which was up 22% for the quarter.

And again, the North American businesses as highlighted in the original comments up nearly 16%.

So it's pretty broad based in terms of geographic improvements.

That's helpful.

Could you chat on your CapEx and working capital expectations for the third quarter and then for the rest of the year in general?

I think as Ron pointed out, our CapEx was relatively modest during the quarter.

I think for the year, we're under $150 million in spend against a budget of about $450 million, so we've clearly underspent what we've budgeted.

I expect that we'll see some uptick in capital expenditures in the next two quarters as things begin to stabilize and more of that spend has actually been in the emerging markets as you would imagine, where we continue to see growth, but I don't think we'll come anywhere close to spending our budget this year as we don't have any significant need to add capacity in any of our developed markets, North America and Europe, with some modest exceptions.

So I expect that depreciation will continue to be somewhat higher than our capital spend for the balance of the year.

So I'd use $70 million to $75 million each quarter for CapEx the rest of the year and the depreciation side we're using 325 to 340 for the full year.

So similar run rate to the second quarter.

And on the working -- I asked on the working capital side as well, anything different there or business as usual?

So obviously working capital has ticked up a bit over the last couple quarters as revenues have substantially increased, but they are at reasonable levels if you look at the DSO and the month on hand.

So as the sequential revenue is not dropping dramatically through the rest of the year, we'll see some down tick in working capital, but not anything significant.

Thank you very much.

And next is Ajay Kejriwal.

Thank you.

Good afternoon.

How are you?

Just wanted to follow up on an earlier question where you expect margins to improve next year, even if base revenues were to remain flat and that's a function of the cost structure and the cost cutting you have done.

So maybe if you could help us with putting some numbers, would that benefit be 50 basis points.

And then in a scenario where it's not flat but, say, up mid single digit, how should we think about incremental margins?

Well, I would suggest the following.

I'm not trying to provide guidance first of all for 2011.

So I'll give you some directional flavor to that.

I think we were talking about flat revenues, the benefit of an increased margin would be driven largely by the restructuring benefits that were not realized during 2010.

I would characterize that as perhaps 20 to 25 basis points.

Not a significant number overall, but directionally we would expect to still see improvement.

I think if you want to talk about what kind of incrementals we would expect to see on growth, this year we were experiencing incrementals in the 40% to 50% range.

I would expect next year we would be returning to a more traditional range which would be somewhere between 30% to 40%.

Our traditional range over long periods of time is 30% to 35%.

Perhaps we could be as high as 40% depending on which markets, but I would expect incrementals to be based on that.

So you can develop your own view of what that might mean based on what growth assumptions you use.

That's helpful.

Looking at your second half base guidance, 7% to 10%, that's better than at least what we were modeling for.

What are you assuming in terms of the big swing in markets that get to the high end versus the low end of that range?

Well, I think what you'll see is that's a modest change from our original forecast.

So while it may sound more aggressive than what you had assumed, it's really only modestly up from what we had originally forecast.

It's largely based on Q3.

It would be based largely on what's happening in automotive, appliance, Industrial Packaging markets, and the rebound more recently in the welding and electronics segments.

Got it.

Thank you.

And next is Ann Duignan.

Hi, good afternoon.

Hi, Ann.

Hi, guys.

Can we talk about Industrial Packaging Europe first?

David, could you give us some sense of how much of that business is really tied or leveraged to German industrial production and, thus, benefiting from exports as opposed to strength in the domestic economies in Europe?

Well, I certainly don't have the detail by country for that European volume that was up 31%, but certainly amongst our largest concentration of business would be Germany, followed by France.

UK and Italy, those would be the top four countries.

Germany certainly would be the largest.

There's no question that we've benefited somewhat from the rebound in exports in Germany in those numbers.

Okay.

That's helpful.

And then on the construction side, I've got a couple of clean-up questions.

One, can you give us a sense of why you think you outperformed in that market?

Two, can you give us a bit more color on what that patent income was all about?

And then three, I'm kind of sitting here scratching my head wondering why you would be acquiring assets in the construction sector.

Maybe you could help us understand what it is you're acquiring and why?

I think that's a three-part follow-up.

My first one was very short.

Okay.

All right.

Well, I would say that as it relates to why we're doing better than the market in construction, I think it relates to a number of things.

First of all, we positioned ourselves well in spite of the downturn to be able to respond to short incremental demand which has positioned us well particularly here in North America where the demand or supply lines for a number of alternatives or competitors may be quite a bit longer than ours.

I would also suggest that a number of the new products that we've introduced and worked on in spite of the downturn have begun to launch and receive favorable impact in the marketplaces as well.

So I think those are probably largely the two largest reasons why we've been able to outperform the market.

That's most notable here in North America.

Why would we acquire in construction?

Because fundamentally it's a strong market for us long-term and we think we were able to acquire an asset in Europe that will help leverage growth into a number of segments on both the commercial and the renovation side that will allow us, not only better access to some of those markets, but the opportunity to drive some of our traditional higher value add products through those new channels.

And the patent income?

Sorry.

The patent income.

I knew there was a third piece.

Yes, I'm not at liberty to disclose the details of the underlying settlement because that was confidential.

Okay.

But it was in your commercial?

Correct, it was in our commercial construction segment, correct.

Thanks, guys.

I'll get back in line.

And next is Eli Lustgarten.

Good afternoon.

Nice quarter.

Hi, Eli.

Patent income, sounds like it was around a $10 million settlement or a couple pennies a share, is that a fair estimate of what it was?

That's what we're all trying to get to.

It was $9 million.

Okay.

So couple pennies a share.

Can you give us some idea of how your economic outlook or how your sectors, some detail, has changed?

You were at $675,000 in housing.

We got some lousy housing numbers.

We're staying there.

The automotive production number I think you gave us is the same, 11.5 is what it was before.

Can you give us some idea of what's changed as you look out next year, some flavor economically of how you're viewing the market both here and abroad?

I would say that the positives that have impacted our outlook are largely around automotive, around the appliance market, and the general industrial markets and more recently welding.

So those have all trended upward.

The auto build has in fact gone up during Q2.

Our original estimate for the year was in the 10 to 10.5 range.

We revised that upward, I think to 10.8.

After Q1 it's now at 11.5.

The auto build in Europe has also gone up, it's now about 17.5 million from an original forecast of just over 16 million.

You said 16.9 million during the presentation.

I think during the Q1 call we said 16.9 right.

During today you said 16.9.

So 17.5 is the new number?

17.5 is the latest estimate out of Europe from CSM for the auto build.

So I would say those are the four that have changed the most.

On the more disappointing side, the commercial construction numbers are even somewhat weaker than we projected, but residential is at about 570, I think it is at the moment.

The latest data all in on starts is about 100,000 starts below our 675.

There would have to be a fair improvement in the second half of the year for us to get close to our 675 number.

Is there any way of measuring how much of the volume in this year, in the first half has been for supply chain rebalancing?

I'm not sure if it's restocking or almost rebalancing that won't repeat itself.

Particularly in construction, just sounds like there's a lot of that going on that's going to be difficult to sustain.

Well, there hasn't been a lot of rebuilding of supply chain in construction because the demand profile has actually been fairly weak.

I don't think we can put much on construction about supply chain.

I think auto, there's not much build in that.

It's basically the supply chain was rebuilt at the beginning of the year.

So I'd say some of the later recovery businesses, no doubt some of the welding demand had some restocking in it because this was the first quarter it really turned strongly positive, but I would say that the bulk of the markets, we're not seeing any significant supply chain or inventory rebuilds going on.

Most of that is behind us and until we see another, I think significant leg up in the market, I don't think we're likely to see a huge impact out of that.

All right.

Thank you.

And next is John Inch.

Thank you.

Hi.

Hi.

Start with your cash flow.

Was there a drag to operating cash from the tax issue?

And was there working capital drag?

And if so, I think you mentioned higher inventories, right, to support the higher revenues, how much was it?

The operating cash certainly year-over-year and sequentially kind of didn't match our forecast assumptions.

Yes, the reason that the free cash flow is below our normal 100% plus conversion rate is tied to all the operating working capital.

There's no impact from the tax charge.

That was a non-cash adjustment.

So it's basically the build-up of inventories and receivables, part of which is seasonal.

This is the typical time where we would have the highest level of receivables, but also really since we cut back on working capital so dramatically last year, some of that's coming back and probably would stay.

But I think the key metric is, to look at is our DSO for receivables which is at 57 days, and our month on hand for inventories which is at 1.7.

And second quarter's also typically our weakest cash flow quarter because, as Ron points out, it's the strongest revenue quarter, we see working capital generally increase then.

Are you expecting in the second half, are you expecting working capital to be a source of cash or are you still going to expect to build some?

Probably a small source, not a significant source.

So we're probably back to close to converting 100% of our net income or maybe a little bit more even in both the third and the fourth quarter.

Are you guys expecting any of your businesses to sequentially soften in the second half as part of your guidance?

I guess you could look at that geographically or you could look at it from an end market perspective.

You've talked about what's disappointed.

I'm just trying to get a little bit more color in terms of how you're thinking about the trajectory into the second half.

No, I think if you -- the only significant variable, John, is really the third quarter European vacation schedule always has an impact on our numbers, but I think if you look at the all-in numbers, we're talking about a top line in Q3 that's probably $150 million or so less than the actual Q2 result.

So that's a very modest reduction.

Normally we would see a reduction in Q3 in the top line of somewhere around 5% to 6%.

So I don't see any significant change in sort of the sequential outlooks of what we've seen in any of our major end markets.

I think the modest increase we put into our Q3 top line forecast was really based on stronger end market demand in a number of the North American businesses, and slightly better demand than what we had in our original profile for Europe.

But to get to the low end of your second half range, it strikes me you must be assuming a fairly negative macro scenario.

Is that a fair statement?

I think the low end of our range would certainly be a step down from what we have seen in terms of performance in Q2.

It would have to be a significant -- it would have to be a weakening in North America beyond what we have currently seen and likewise in Europe and frankly, given the continued volatility in the markets, that's why we have as broad a range as we do.

As you know, normally we wouldn't have a range this broad on the revenue side, but I think given where we are, that still seems prudent to have a broader range than normal.

I'm sorry, David, what do you mean volatility of the markets.

Do you mean end market demand or do you mean stock market?

No, I'm talking about end market, not stock market.

Just do be clear.

End market demand.

Obviously, we expect the profile to continue to strengthen, but we could strengthen a lower rate and that would push us closer to the lower end of our range.

Not what we would expect to see, but I think given the volatility we've seen across markets over the last two years, it's probably still prudent to have a broader revenue range than what we would typically have.

Understood.

Thank you.

You're welcome.

And next it's Meredith Taylor.

Hi, good afternoon.

I'd like to revisit the acquisition pipeline.

First, if you could give us a sense of where you've seen the most movement on the part of sellers.

Has this been predominantly family businesses?

Private equity owned companies?

And then maybe if you could address where you've seen the movement as well from a geographic perspective, specifically have you seen the changes in FX rates changing the attractiveness of some of the acquisition targets?

Yes, I think the source of deals has been pretty broadly based.

The large deal I talked about that we closed in Q1 in Europe, in the construction segment was owned by a private equity owner.

So we've seen, if you will, a sort of meeting in the middle between buyers and sellers, not only in the private equity space, but also in the privately owned business space.

I think the overall market dynamic of buyers and sellers being able to find a middle ground coming out of the significant decline in 2009 is what has largely, in my view, driven the improvement.

I think the prepipeline discussions that I referenced in my comments earlier, these are discussions that are taking place that are not yet deals that are recognized in our pipeline.

I think they are also pretty broadly spread.

I would say some slight uptick in interest out of private equity from a selling standpoint that we would expect to continue.

So there's a lot of assets, private equities accumulated, particularly in spaces we've been interested in over the last four or five years and it's no question that they're looking for the right time to sell and I think that we're starting to see early indications that that activity is picking up.

Any difference in the size of these private equity owned properties?

Do these tend to be larger than the family owned businesses for example?

Yes, they do.

They definitely tend to be larger.

I would say just as an example, Meredith, if I look at the last 10 deals we've done over $100 million in size, nine of them have come from private equity owners.

So it's very typical that the private equity deals tend to be larger and certainly that's been the case in our experience.

Then just as a follow-up, you've talked about these deals that are in the conversation phase that haven't actually entered the acquisition pipeline.

Could you characterize what's keeping them from entering the acquisition pipeline.

Is it just a matter of buyer and seller getting to know each other better.

Is it a matter of the bid ask spreads still really needing to narrow and if that's the case, to what extent?

Or is it just a case of as you had talked about previously, some of the end markets are still in the process of bottoming and really figuring out where they bottom and what the profitability looks like at those levels?

It's sort of all of the above.

Typically the preacquisition discussions that take place, the feelers that go out particularly from private equity, they come in a variety of ways.

Sometimes they come directly.

Sometimes they come indirectly through advisors or investment bankers.

You don't know exactly in those situations when and if they're going to put the deal on the block.

There are other situations where they are running a process, but the process isn't far enough along for us to say that we're definitely in the hunt which was -- be what would be required to put it in our pipeline.

I do think that there is still some feeling out going on in the market around valuations, and multiples, and financing and all of that impacts when people formally decide to run a process.

So you do get a little bit of everything going on in this kind of an early stage recovery in the M&A environment.

Okay.

Thanks so much.

And the last question comes from Andy Casey.

Wells Fargo.

Good afternoon.

Wells Fargo Wachovia.

No, just Wells Fargo.

Sorry, Andy.

Follow up on an earlier question on the revenue trajectory through the second half.

If I, and maybe I'm not doing the math correctly, but if I take the revenue forecast, it looks like you're expecting Q4 to be in total about up 2% to 5% year to year.

And then if I go back and strip out acquisition, assuming you continue to make them in Q3, which you indicated probably is a good bet, Q4 base it looks like the Q4 base plus FX is about flat plus or minus.

First, is that about right?

Well, base for Q4 is about 6.

And the total is about 4.

Okay.

So Ron can talk to the components if you want more granularity.

When we talk about base in the second half being in a range of 7% to 10%, it's really based on looking at Q3 somewhere in the 11% range for base and Q4 in the 6% range.

Obviously we have some headwinds on currency in the second half.

The currency in the fourth is at current rates is almost down 6% and it will get 3% to 4% from acquisitions positive.

Okay.

And so the -- as you indicated, David and Ron, the organic growth for the second half, the 7% to 10% is weighted to Q3 and then you see a moderation in Q4.

Correct.

Based on tougher comps.

Yes.

Okay.

Got it.

Thank you very much.

Okay.

Thank you very much.

This will conclude our second quarter conference call.

We look forward to talking to everybody again.

Thank you.

Thank you for participating today.

Please disconnect your lines at this time.