Illinois Tool Works Inc (ITW) 2011 Q2 法說會逐字稿

Welcome to the ITW second-quarter 2011 earnings release call.

All lines will be on listen-only mode until the question-and-answer session.

(Operator Instructions).

Today's conference is being recorded.

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

I would like to introduce your host, John Brooklier, Vice President of Investor Relations.

Please begin.

Thank you.

Good morning, everyone.

Welcome to all who have joined us for ITW's second-quarter 2011 conference call.

As usual, joining me this morning is our CEO, David Speer, and our CFO, Ron Kropp, to discuss our second-quarter financial results.

David Speer will now make some introductory remarks.

David?

Thank you, John.

Our second-quarter revenues finished slightly lower than our original forecast as we experienced some modest slowing in industrial markets.

We had good activity on the acquisition front and we also repurchased shares during the quarter.

Here are the highlights.

Our total revenues grew 17.5% in the quarter with contributions from organic revenues, acquired revenues, and currency translation.

However, our total revenue growth was 100 basis points lower than what we originally forecasted in April.

Organic revenues increased 6.3% versus the year ago period, but underperformed our original forecast of 7.5%.

A combination of modest slowing in industrial production metrics in both Europe and the US, along with the Japanese crisis, translated into a bit slower growth in the second quarter.

However, it is important to note that we firmly believe our overall end markets will continue to be in a long-term recovery mode.

Acquisitions net of divestitures added 4.8% and currency translation contributed 6.3% to total revenue growth.

While operating margins of 15.4% decreased 50 basis points, base operating margins increased 30 basis points.

Acquisitions and restructuring negatively impacted operating margins during the quarter by 90 basis points.

I remind everyone our net income per share was $0.99 before considering the $0.03 per share impact of discontinued operations that we highlighted in our June release.

During the quarter, we also repurchased stock of $550 million or approximately(Sic-see press release) 9.7 million shares.

Finally, we acquired seven companies in the second quarter, bringing our first-half 2011 acquired revenues total to an annualized revenue of $485 million.

When you add the three additional companies we acquired thus far in July, including our acquisition of Despatch Industries that we announced yesterday, our current total of acquired revenues exceeds more than $700 million year-to-date.

Remember, we set an acquired revenue range for the year originally of $800 million to $1 billion earlier in our guidance.

We believe the acquisition environment continues to be promising and we look forward to more results in the second half.

Now let me turn it back over to John.

Thank you, David.

Here is the agenda for today's call.

Ron will join us shortly to discuss Q2 financial highlights.

I will then cover Q2 operating highlights for our eight reporting segments, Ron will then return to detail 2011 third-quarter and full-year forecast.

Finally we will open the call to your questions.

As always we ask your corporation per our one question, one follow-up question policy.

We are targeting a completion time of one hour for today's call.

Moving along, let's cover the traditional housekeeping items.

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 income per share from continuing operations, diluted net income per share, restructuring expenses, acquisition activity, tax rate, end market conditions, and the Company's related 2011 earnings forecast.

Finally the telephone replay for this conference call is 402-220-9704.

No pass code is necessary.

The replay is available through midnight of August 9, 2011.

Now, let's move along and have Ron Kropp discuss our second-quarter of 2011 results.

Ron?

Thanks, John.

Good morning, everyone.

Before I run through the financial results for the second quarter, I'd like to remind you that, as we announced in late June, we have reclassified certain businesses as discontinued operations.

All 2010 and 2011 data presented, including forecasts, reflect this reclassification.

As part of this, I would also like to remind you that we had revised our forecast range in our June release from $0.99 to $1.05 to $0.95 to $1.01.

Now here are the highlights for the second quarter.

Revenues increased 18%, primarily due to higher base revenues, acquisitions, and translation.

Operating income was $711 million, which was higher than last year by $85 million.

Operating margins of 15.4% were lower than last year by 50 basis points.

Diluted income per share for continuing operations was $0.96 which was higher than last year by $0.17.

This EPS of $0.96 compares with our forecast range of $0.95 to $1.01.

Finally, free operating cash flow was $225 million.

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

Our 17.5% revenue increase was from primarily due to three factors.

First, base revenues were up 6.3% with North American base revenues increasing 7.4% and international base revenues up 5.1%.

Next, currency translation increased revenues by 6.3%.

Lastly, acquisitions under divestitures added 4.8% to revenue growth.

Operating margins for the second quarter of 15.4% were lower than last year by 50 basis points.

The base business margins were higher by 30 basis points primarily due to the favorable impact of the higher sales volume, partially offset by the negative impact of non-volume items.

Non-volume items reduced margins by 100 -- base margins by 120 basis points.

Included in the non-volume impact for the second quarter were the unfavorable impact of price costs which reduced margins by 80 basis points, and a one-time gain related to a licensing settlement last year which had an unfavorable margin impact of 30 basis points this year.

In addition, margins were lower by 30 basis points due to higher restructuring expenses and the dilutive impact of acquisitions reduced margins by 60 basis points.

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

In a non-operating area, other income and expense was favorable by $13 million due to higher interest income and higher investment income.

The second-quarter effective tax rate of 29.0% was lower than last year's rate of 31.7%.

Excluding the one-time benefit in the first quarter related to the Australian tax case, the forecasted tax rate for the rest -- for the full year 2011 is between 28.5% and 29.5%.

Turning to the balance sheet, total invested capital increased $622 million [from] the first quarter, primarily due to higher working capital and currency translation.

Accounts receivable DSO was 61.4 days versus 61.1 at the end of the first quarter.

Inventory month on hand of 1.9 was consistent with last quarter.

For the second quarter, capital expenditures were $88 million and depreciation was $84 million.

Return on invested capital for the second quarter was 15.6% versus 16.3% in the second quarter last year.

On the financing side, our debt level increased approximately $725 million from the first quarter due to higher commercial paper borrowings and currency translation.

Our debt to capital ratio increased to 28% from 24% last quarter.

Our cash position increased $146 million in the second quarter as our free operating cash flow of $225 million and additional borrowings of $695 million were utilized for share repurchases of $550 million, acquisitions of $205 million and dividends of $170 million.

During the second quarter, we acquired seven companies which have annual revenues of $156 million.

As a result, for the first half of 2011, we have acquired 13 companies representing annualized revenues of $485 million.

For the full year, we are forecasting acquired revenues between $800 million and $1 billion.

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

Thank you, Ron.

Starting with our Transportation segment, our 2011 Q2 organic revenues grew 7.4% compared to the year-earlier period.

Segment operating margins of 14.9% were 90 basis points lower than the year ago period, mainly due to a large acquisition we closed in the second quarter in the auto aftermarket space.

The organic revenue growth in Q2 was mostly attributable to our automotive OEM businesses.

While our worldwide automotive OEM business produced organic growth of 7.5% versus the year ago period, there was clearly a production impact from the Japan disaster.

Case in point, North America auto build increased only 1% in Q2 due to production decreases from the new domestic OEMs.

But while North American production lagged, our basic revenue growth of 6.6% in Q2 underscored our ongoing product platform penetration gains.

In Europe, we had similar penetration success.

While Q2 European auto production grew 4%, our base revenues increased 8.2% for the same time period.

All in all, we had solid automotive results in the quarter even with the production and component problems coming from Japan.

For the full year 2011, we believe North American auto build will be in a range of 12.9 million to 13.1 million units and European auto builds will be in the range of 19.8 million to 20 million units.

These auto build projections represent year-over-year increases of 9% and 6%, respectively.

Finally, in our auto aftermarket businesses, we had modest Q2 organic growth of 1.3%, mainly due to elevated gas prices and the resulting lower miles driven by consumers.

Moving to the Industrial Packaging segment, Q2 organic revenue growth of 9.6% versus the year ago period continued to reflect reasonable industrial production fundamentals around the world with North America leading the way.

Segment operating margins of 10.9% were 20 basis points higher than Q2 2010 and in the most recent Q2, our total North American Industrial Packaging units increased organic revenues 11.2% while total international Industrial Packaging organic revenues grew 7.6%.

Breaking down the underlying numbers from those numbers, North America strap and related equipments organic revenues grew 8.8% with North America increasing 12.9% and international growing 6.2%.

For both geographies, the equipment portion of the strapping business produced double-digit growth in the quarter.

Another area of strength for us was the protective packaging units which produced organic revenue growth of 11.3% in the second quarter.

Moving to Power Systems and Electronics, this segment had another quarter of strong organic growth.

Segment organic revenues grew 11.9% versus a year ago period due to the strong contributions from both the welding and segments of the Electronics businesses.

Segment operating margins of 20.6% were 50 basis points higher than Q2 2010.

Notably, our worldwide welding organic revenues grew 18.2% in Q2 due to strong demand from heavy equipment OEMs and industrial manufacturers.

Specifically, in North America, our welding organic revenues grew a robust 19.9%, and nearly as impressive our international organic revenues increased 14.1% with Europe and Asia-Pacific both contributing to topline growth.

In Electronics, this category grew 4.1% in Q2 and the growth was mainly attributable to our PC Board Specialty Equipment businesses and increased organic revenue double digit in Q2.

Organic growth as in the past was directly tied to consistent demand for consumer electronic products such as PDAs, smartphones, and iPads.

Moving to the Food Equipment segment, we saw some retrenchment in international demand, and as a result, organic revenues grew approximately 2% in Q2 versus the year ago period.

As a result, segment operating margins of 13.6% were 20 basis points lower than Q2 2010.

The Q2 story was simple.

Equipment sales fell internationally, but were relatively strong in North America.

Internationally, organic revenues declined 0.4% in Q2 with equipment base revenues decreasing 2.8%.

Our [French cooking] business was impacted by a lower government spending levels than originally anticipated and elsewhere in Europe, we also exited some revenues associated with lower growth, lower margin customers.

The better news was that international service base revenues grew 2.1% in the quarter.

Moving to North America, organic revenues grew 4.2% with equipment base revenues increasing 6.2%.

From an end market standpoint, chain restaurants and health care continued to show growth in the second quarter and on the service side of the business, organic revenues grew 3% in North America.

Moving to the Construction Products segment, organic revenues declined 2.2% in Q2 versus a year ago period, as demand moderated in Europe and our Asian Pacific businesses dealt with pricing issues.

In addition, North America markets remain very weak as characterized by low housing start numbers and what I would describe as trough commercial construction activities.

Segment operating margins of 12.4% were 210 basis points lower than the prior year quarter.

Geographically, on the international side, organic revenues grew 2.1% in the quarter with European organic revenues increasing 6.1%.

By comparison, European organic revenues grew 18.4% in Q1.

In Asia-Pacific, pricing pressure from Asia customers and Australia contributed to base revenues declining 2.8% in the quarter.

In North America, total construction base revenues declined 10.7% in Q2 with residential construction and renovation construction base revenues decreasing 8.1% and 3.1%, respectively.

Commercial construction reported a base revenue decrease of 24% in Q2, but when you exclude a one-time revenue gain in Q2 2010, commercial construction base revenues only declined 5.3%.

Moving to the next segment, Polymers and Fluids, organic revenues grew 1.5% in Q2 versus the year ago period and segment operating margins of 16.8% were 330 basis points lower than Q2 2010.

Similar to last quarter, the margin decline was due to timing related to cost recovery around raw materials, especially in some of our international businesses.

The modest growth in base revenues in the quarter reflected moderated demand for polymer products in both North America and international niche end markets.

Worldwide polymer organic revenues were flat in Q2.

And while a much smaller revenue category, the story on the fluid side of the business was much more positive.

Worldwide fluids organic revenues grew 5.6% in Q2, with North America accounting for the majority of the growth.

Moving to the Decorative Services segment, organic revenues increased a surprisingly strong 6.5% in Q2 versus the year-earlier period.

But segment operating margins of 12.5% were 170 basis points lower than the year ago period, mainly due to higher raw material costs.

As noted, the segment's organic revenue story was a positive surprise and reflected Wilsonart's nearly 5% growth in North American base revenues.

This growth was due to ongrowing product innovation by Wilsonart and good penetration in what I earlier described as trough and commercial construction environment.

Internationally, the news was equally good with organic revenues growing 8.3% in Q2 and the components of that organic revenue growth include Asia-Pacific increasing 6%, China growing 22%, and Europe increasing 7% in the quarter.

Finally, in our final segment, All Other organic revenue grew 8.1% in Q2 versus the year ago period.

Segment operating margins of 18.4% were 80 basis points higher than year-earlier period.

Organic growth was directly tied to two major business groups, Test & Measurement and Consumer Packaging.

For Test & Measurement, organic revenues increased a very strong 17% as the increased capital spending drove equipment orders to double-digit growth levels in virtually all geographies.

For example, our businesses in China produced organic revenue growth of 23% in Q2 in the Test & Measurement category.

For consumer packaging organic revenues grew 5% -- 5.7%, excuse me, due to strength in the decorating and consumer packaging businesses.

Finally, our base revenues or industrial appliance businesses decreased 0.5% in Q2 as demand from appliance OEMs weakened in the quarter.

This concludes my segment-related remarks.

I will now turn the call over to Ron who will cover our 2011 forecast and related assumptions.

Ron?

For the third quarter of 2011, we are forecasting diluted income per share from continuing operations to be within a range of $0.95 to $1.03.

The low end of this range assumes a 15% increase in total revenues versus 2010, and the high end of the range assumes an 18% increase.

The midpoint of the EPS range would be 24% higher than last year.

For the full year 2011, our forecasted EPS range for continuing operations is now $4.05 to $4.21, based on a total revenue increase of 16% to 18%.

The midpoint of $4.13 would be 43% higher than 2010.

This full-year range compares to our previous forecast range of $4.08 to $4.26.

Other assumptions included in this forecast are exchange rates holding at current levels, acquired revenues between $800 million and $1 billion, restructuring costs of $40 million to $50 million for the year, and a tax rate ranged between 28.5% and 29.5% for both the third quarter and full year, excluding the impact of the first-quarter favorable Australian tax case.

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

Thank you, Ron.

We will now open the call to your questions.

Once again we are asking people to honor our one question, one follow-up question request.

We are ready to take our first question.

(Operator Instructions).

John Inch with Merrill Lynch.

Thank you.

Good morning, everyone.

Couple of sort of M&A-related questions, but first the higher investment income, Ron, could we get a little more color?

Was that from realizing a gain from, say, selling an asset or assets, or what was the Delta there?

The biggest piece, I mean, part of it was higher interest income.

We have a lot of cash on the balance sheet invested overseas, but we also have in our investment portfolio a venture capital investment that we mark to market so we had some mark to market gains in the quarter.

And how much was that?

It was a couple of million dollars above what we expected.

Okay.

When I ask you about Despatch, the reason I'm asking this is, you have seen because I think of some subsidy curtailment in Europe and perhaps elsewhere, the outlook for the solar industry has actually in a short-term basis, come under a little bit of pressure.

What is it about their mix that maybe makes them somewhat immune to that and maybe you could just sort of talk through sort of a thought process about getting into that space?

Well solar, John, is only one element of their business.

It represents maybe 20% of their overall business.

So they have a broad array of end markets, solar clearly being one of them, the carbon fiber business being another and general industrial process environment process controls, a lot of which is related to electronics, production of electronic wafers, semi-conductors and so forth.

So pretty broad array of end markets, generally with some very strong long-term growth profiles.

No, that's helpful.

One last one.

You know, David and John, there's just perpetual speculation that you are a potential bidder for Charter.

I understand there is mixed differences in terms of they are a little bit more commoditied, if you will, on the welding side.

I mean, is there some obvious reason though that -- I mean, I realize it's a big company, $3 billion of revenue, is there obvious reason why it would or potentially not fit strategically with what you are looking at, perhaps say historical desire to sort of stick to bolt-ons?

Or I don't know maybe is there anything you could say to that?

Well as you know we don't comment on speculation around acquisitions.

So I won't comment specifically about Charter.

I will say that we continue to be interested in growing in the welding space and we look at many different opportunities, certainly primarily in Europe and in Asia.

So as we continue to look at those opportunities, I think you'll see our focus in that space will remain strong, but certainly no comment specifically about any target company.

Especially a public company.

I know.

I understand, but your strategy to stick to smaller deals really hasn't -- has your thought process changed as the environment's changed for M&A, David?

Well, I think if you're talking about M&A in general, you see that we've done a couple of larger deals already this year, SOPUS and the recent (multiple speakers) Despatch deal.

I think obviously we are looking hard in spaces that we think have long-term growth characteristics and for assets that we think have the right mix of allowing us to leverage growth from those categories.

Size is one element, obviously, and the ability to do some larger sized deals in those spaces is certainly attractive to us.

But that said, we are comfortable doing the smaller deals you know in those spaces if they make sense as well.

But we have done two larger deals, as you noted, this year and I think we continue to focus on what we think is the sweet spot of assets in sort of $100 million to $500 million size.

Right.

Thank you very much.

Ann Duignan with JPMorgan.

Good morning.

It is actually Ingrid, I am just standing in for Ann.

If we could circle back to kind of the acquisition environment you noted.

It seems like that it is improving and that you're likely to come into the higher end of your range given where you stand to date.

Could you talk a little bit more about the environment?

Well, I think, clearly the environment as we have seen it, we've been talking about this throughout the year has been improving.

I think in terms of our own pipeline, certainly the activity levels overall in the M&A market are in fact up, but there are plenty of bidders out there for assets, so it is still a reasonably competitive market.

I can tell you that our activity levels in terms of pre-pipeline are significant and continue to be, and we are pleased with what we've been able to transact thus far.

But as we know, the acquisition business is cyclical, it is opportunistic.

So while I am encouraged with what we've been able to accomplish so far, and I think the environment remains a favorable one, we haven't chosen to make any adjustment in our range just yet.

We will continue to look at that as our pipeline activities build.

That's helpful.

Thanks.

And then I guess following the recent reclassification of some of your businesses, can you just discuss a little bit more about what your plans for selling businesses in the future are?

Well, we've disclosed obviously what we have in the pipeline at the moment in discontinued operations as we restated at the end of June.

But I think that contains one large asset, which really drove the decision to put that in discontinued operations of our finishing systems businesses.

There's certainly nothing in the near term of that size, but we continue to look at our portfolio and we will continue to look at a divestiture as an appropriate alternative for some of those assets.

You know, we have averaged over the last several years eight to 10 divestitures a year.

This certainly -- the finishing business would be the largest asset, single asset in that range.

So but we will continue to look at divestitures as we analyze our portfolio and you can expect to continue to see some level of activity.

We always report on those, as you might imagine when they become material and when they are generally after-the-fact.

Okay.

Thank you.

I'll get back in queue.

Jamie Cook with Credit Suisse.

Good morning.

It is actually Peter Chang in for Jamie.

My first question was on the implied incremental margins for the back half of the year.

It looks like they are expected to increase meaningfully from the first half, but more specifically I wanted to get into why it seems like Q3 implied incremental are significantly lower than in 4Q.

Is that because of price recovery in the fourth quarter or is there going to be greater restructuring charges taken in the third quarter?

Could you elaborate on that please?

Yes, sure.

The incrementals in the third quarter we are still working through price costs.

They will get better, but it'll still be negative 40 to 50 basis points year on year for price cost versus the third quarter of 2010.

Although it is positive 20 basis points versus the second quarter of 2011.

Also contributing to the better incrementals in the fourth quarter is, we had a very low margin fourth-quarter last year, especially the month of December for our international businesses.

So our overall margin on a restated basis last year in the fourth quarter was 12.3%.

So we are getting some incremental bump in the fourth quarter based on a weaker comparable.

Got you.

Great.

Thank you.

And my follow-up is on the Transportation segment.

You know, compared to our model, revs were a little bit lighter than our forecast.

Was that -- I know you had talked about the impact from Japan.

Can you quantify that or was there may be a greater focus on integrating SOPUS versus a focus on sales?

As we went into the quarter, we had anticipated revenue to decline associated with Japan on OEM of about $25 million to $30 million and it turned out to be approximately around $30 million.

So it was on the high end then?

It was on the higher end of what we had thought coming into the quarter.

Okay, great.

That's all for me.

Thanks for taking my questions.

Deane Dray with Citi Investment Research.

Thank you.

Good morning.

David, I was hoping you would comment on the operating environment in June with a little more color.

Certainly it caught you by surprise, now no sense of a disaster just under 6% at base, but still it was a change at the margin.

So if you just kind of from your perspective both geographic, customer activity, code activity, pushback on pricing, just -- and take us through what was -- where was the surprise and where do we go from here?

Yes, well, I think obviously the June numbers overall base growth of 5.7%.

That was clearly weaker than what we had in our original forecast.

March numbers that fell off in the three-month rolling numbers were 11-plus percent.

So significantly different June.

The profile in April and May, April was a little over 4% and May was just about 9%.

So a pretty mixed bag if you look at it by month, but clearly the trend in June was slower than what we had anticipated and that really I think in the end is the story of why we were 100 basis points lower than our original base revenue forecast.

If I look at it geographically, North America was 7.4% so a little bit lighter than our base forecast originally which was a little bit north of 8%.

Europe was at 4.6%.

That was clearly the weakest link.

The overall Asia-Pacific region was just under 6%, China at 18%.

So I think clearly the big drivers were weaker industrial numbers in both Europe and in North America and primarily in June.

How about just on the construction side?

You called out the pricing on the Asia-Pacific.

Was that just one business, Australia-related?

And then take us through commercial, residential, renovation color at the margin.

Yes, well, the continued construction markets here are the [80] of the story, if you will.

That is the majority of the issue in construction.

Housing starts at well below what our original forecast was and frankly below what we thought was going to happen in Q2.

You know, the numbers now are in the [570] range where housing starts.

We started the year at a range of about [670] which was actually lower than most of the estimates that were out there from NAHB and others.

So the housing market has continued to be extremely weak and that obviously underperformed what we thought was only a modest expectation in Q2.

The commercial numbers as John pointed out down 9% for the quarter, that is the start data or the contracts awarded data.

Still weak, but we think getting close to the trough.

So that end market was obviously weak as well in North America.

The European numbers came in, as John pointed out, plus 6%, so pretty much in line with what our expectations were.

In Australia we have some price-related issues, but also some business that we shifted away from and some lower margin categories that drew the negative comparable there in terms of base revenue growth.

But I would say, again, the majority of the story is what happened in construction in North America.

And was the deck surfaces uptick more product line-specific or was there a read through in terms of commercial activity?

Yes, there is -- it was based on two things.

One is product innovation, you decides they have introduced in their high-definition category which has driven significant market penetration in several commercial categories, including the case goods area and office furniture.

Great.

Thank you.

Robert McCarthy with Robert W.

Baird.

Good morning, everybody.

The mismatch between price costs in the quarter is particularly severe in both Construction and Decorative Services, we've been talking about that.

But also Industrial Packaging and Polymers and Fluids.

Could you talk about the latter two?

Why such a severe effect, particularly in Industrial Packaging and how you see those trending through the balance of the year?

Yes.

Industrial Packaging, the overall non-volume impact on margins is 230 basis points.

Of that, 110 was price cost.

Now that is better than the negative 200 than it was last quarter.

This segment has the most sensitivity to raw material price increases, but also has the best ability to get price.

For example, when the price of steel goes up, they are buying from the steelmakers and selling back steel strap to them.

So it is much more transparent than most of our other businesses.

So it does go up and down quite a bit.

So it has gotten better.

We have continued to get price.

We are recovering margin dollars, but given the extent of the price and the cost dollars, it still has a negative impact on margins.

(multiple speakers)

Go ahead.

By extension, Ron, you're saying that you expected to moderate.

Do we -- does it turn positive by the end of the year?

Yes.

By the fourth quarter if the price stays where it is at and costs stay where they are at, it will be positive.

Okay.

So there are price increases that have been put in place that we haven't seen the full impact of.

We also saw some modest drop in some of the strapping volumes which meant we didn't get leverage on some of the growth in revenue there that we were expecting.

Again on the Polymers and Fluids side, the price cost impact was negative 180 basis points, which is similar to what it was last quarter.

Here the primary raw material is chemicals and we have a basket of chemicals that we kind of track the market prices; and those chemical prices were up about 25% for this quarter versus last year.

So while steel and plastic prices have stabilized a bit, and in some cases gone down, we have not yet seen that in the chemical business and we do have price increases in place.

We are continuing to do them in place and they will have less of an impact if everything stays the same in the third quarter.

It will still be negative, but it will have less an impact -- less of an impact.

Is this the only segment where you expect to still be running negative by the time you get to the fourth quarter?

The third quarter, we are looking at still negative year on year 40 to 50 basis points.

So in the third quarter there will be other segments that have a negative impact.

For the most part, as we start to anniversary some of these cost increases and price increases stick, we should be generally positive slightly in the fourth quarter.

I think the only other one where it might be modestly negative would be Decorative Services where we have got significant increases in phenol and resins that are again oil drive products that we haven't seen yet bottom out in terms of cost.

If I might, I would like to also ask about specifically, John, when you were going through the Industrial Packaging fundamentals, you mentioned specifically that international equipment sales in the strapping-related businesses were up double digit, but actually (multiple speakers) --.

And North America, too.

So the implication then would be that strapping volume growth was nominal or even negative, yet you are taking price increases.

So can you talk a little bit about what you saw in the quarter and whether we have some kind of a leading indicator or something here?

Well, we did see strapping volumes moderate, I would say nominal is probably a good word to use for what we saw in the quarter.

It is a mixed bag again between steel and plastic and in general is probably related to what we have seen happen in some of their core end markets moderating activity.

So I'm not sure that, based on what we saw in the quarter, that I would be drawing any huge conclusions about early indicators as it relates to strap volume.

Year to date, they performed much better the quarter, particularly the latter part of the quarter, June and probably the latter half of May were weaker in volume in some of the metals categories in particular and then the construction materials categories as well.

Other than that, they were pretty much in line with what we would have expected.

But you wouldn't point to China as the source of the significantly slower volume trend?

No.

We don't have enough penetration in China with strapping for that to be a consideration.

Certainly the equipment side, one of the reasons the strength in the equipment side to focus on that is clearly the underspend that took place from a capital standpoint over the last several years and now we are starting to see that break loose with some larger system orders that I think loom well in the future for strapping volumes that will go with it.

But certainly, the recovery in the equipment businesses, it was expected perhaps a little bit stronger in the quarter that what we had thought, but largely in line with what we would have expected at this point in the recovery.

Okay.

Thank you.

Ajay Kejriwal with FBR.

Thank you.

Good morning.

Just some capital allocation, so on acquisitions you are trending well, you are more than halfway done on your full-year goal.

So, and buybacks you did about [$550 million] but there is a substantial amount of authorization left and it looks like the balance sheet is still very underlevered, a lot of cash on the balance sheet.

So maybe any color on how we should be thinking about buybacks from here?

Clearly, second quarter -- decent run rate, but part of that is to offset the dilution from the desktop.

But any color there would be helpful.

So, a couple of comments.

First of all, although we do have cash on the balance sheet essentially all of that is overseas.

So it is not readily available for dividends and share repurchase, etc.

We do use it for acquisitions, however, to the extent we have international acquisitions.

Our debt to cap is currently at 28%.

Our target range in a normal acquisition period is 20% to 30%, absent any significant large acquisitions.

We obviously go above 30%, but so we are at the higher end of the range, but that's with a strong acquisition year, stronger than last year, and some amount of buybacks already in the first half of the year.

The way to think of share repurchases now is it's a bit different than it was a couple of years ago when we were underneath our range.

We were in the teens and we had to do a significant amount of buybacks even to get into our target range.

The way to think about it now is, we will have a normal level of share repurchases to the extent we have a normal level of acquisition activity.

We much prefer to use our capital for acquisitions.

So if we continue to see acquisition activity go up and we end up above our range, you know you will see less share repurchases.

If acquisition activity is lighter, you'll see more share repurchases.

Good color there.

And then just on your full-year guidance at the top and taking it down by I think $0.05, so I imagine part of that is the quarter, but maybe talk about the acquisition impact.

Historically, acquisitions have been dilutive in the first year, so it's impossible to quantify what is the impact from acquisitions?

Well, first of all the range decreased by $0.04.

$0.02 for Q2 and $0.02 for the balance of the year, not $0.05.

In terms of acquisitions, as you accurately note, they are dilutive in the first year.

We get done with amortizations and step-ups.

I think Ron has got some flavor and he can add to that, but clearly given the activity levels we had in the first half of the year, we have not seen a significant amount of earnings impact yet, which is normal and what our expectation would be is, I think Ron pointed out one of the reasons for the margins for the quarter being lower is, in fact, the acquisition activity in the lower margins associated with those after amortization and step-ups.

So Ron, if you want to add some flavor to that --.

Yes.

So typically we are buying companies that have margins in the 10% range before amortization.

Once you factor in amortization, especially the first year, which was a higher average amortization rate, it is more like 4% to 5% incremental margins.

So if you think about acquired revenues and you don't acquire them all at the beginning of the year and it is only a partial year and you take 4% to 5% of that, that is about what the acquisition impact would be.

And that will have a dilutive margin impact on the total Company in the 40 to 50 basis point range.

Thanks for the clarification.

My comment on the guidance was just on the top end, but yes it is $0.04 at the midpoint.

Thank you.

Walt Liptak with Barrington.

Good morning.

I wanted to ask about the Transportation segment and just the operating leverage and if you could run through and talk about whatever impact the profits may be?

Japan had a bigger impact on the operating profits or price costs -- and where we stand through the rest of the year?

Do you have any on the --?

So, on the margin side, margins were down 90 basis points.

A non-volume piece of that was 110 and of that price costs was negative 90 basis points.

Slightly better than last quarter when it was negative 100 basis points.

So that's a segment where it takes us a little longer to recover price.

We have price plans in place, price increase plans in place now, but as Ron pointed out, we would expect that gap to close somewhat in Q3 and be neutral or potentially positive for Q4.

Walt, I would add one other thing to your question on volumes.

If you look at the second half of the year, particularly in North America, the production decrease we saw in Q2 should largely be made up in the second half.

Okay, great.

Thanks very much.

Joel Tiss with Buckingham Research Group.

I just wondered if your drop in guidance a little bit for the full year means that the slowdown in June is continuing into July?

I don't have enough on July numbers to give you that reflection, but largely what we have projected in organic growth for the balance of the year is between 6.5% to 7%.

So lower than what we would have originally forecast by probably 100 basis points.

So, it is, I think what I would suggest is that looks more like what we saw in Q2, not what we saw in June.

June was under 6%.

But, yes, moderating demand in some of these markets that have been under recovery now for, in some cases, eight to 10 quarters.

Okay.

And I wonder if you can sort of tie together the shape of the economic recovery and how you are seeing it unfold to more the medium-term margin potential?

So you know what I mean, like it is a tough environment, and price costs is a little bit negative, it has been kind of an issue for a little while.

You know, is this going to be the -- or is this feeling like the kind of recovery where operating margins a couple of years down the road get back to historic peak levels or don't because of more acquisition activity or just sluggishness?

You know what I'm trying to say?

Just any sort of color you can give me around (multiple speakers) think about that?

I think from a standpoint, I think yes, absolutely.

I think margin recovery or margin rates a couple of years down the road quarterly back to historic peak kind of levels.

I fully expect that.

I think the major factor if you are looking out a couple of years is more about the dilutive impact of acquisitions than anything else.

What we are seeing right now is clearly one of those spots in the middle of an economic recovery, where you have got costs going up relatively fast, certainly faster than anybody had anticipated for this part of the recovery.

And that has led to some short-term disruptions between price and cost.

But nothing fundamentally I think, that alters the margin outlook long term.

And the customers are pushing back on price increases harder than before?

Well, of course they are, but that is all part of the process.

Nobody is asking for price increases, but the reality is that these have not been modest increases that we are talking about and there have been multiple increases.

With that said, I think as Ron pointed out earlier, we have seen in some cost categories some moderation in cost increases, certainly on the steel sides and certainly more recently, as Ron pointed out, on the plastic side.

So it's the normal sort of environment that you have to fight through with probably more volatility in raw material input costs than what we would had expected heading into the year.

All right.

Thank you very much.

(Operator Instructions).

Henry Kirn with UBS.

Good morning, everyone.

Wondering if you could talk a little bit about where the base business expectations for the second half of the year might have become a little more robust than they would've been a few months ago?

I'm sorry, those that are more?

Yes.

Where might things have actually gotten a little bit better?

Well, certainly, the Test & Measurement area has shown particular strength and some of that, obviously, is projected in what we see going forward in the second half of the year, and as John pointed out in his earlier comments, the Welding segment, those are probably two of the more notable areas where we have seen strength beyond what our original estimates were.

And with reasonable momentum, we would expect to continue through the second half of the year.

So those are probably the 2 most notable ones that I would highlight.

John also pointed out the comparables in Transportation.

The auto build in the second half of the year is going to be much better than it was in the first half as the expectation, particularly in the US, is a lot of the volume that lost in the second quarter due to the Japanese crisis and parts is going to be made up in the second half of the year and that certainly would bode well for us.

As you saw, our penetration gains in the first -- or in the second quarter in both Europe and the US were nearly 5 points of penetration gains, so you put a little bit more volume than that and we are going to see a lot stronger performance in that category as well.

And then in the M&A market, could you talk about where -- whether seller expectations are higher or lower now than they were earlier in the year?

And the likelihood that acquisitions could be higher in the second half and into 2012 than you currently bake in?

You are talking about the second half of 2011, I think, right?

Right.

Second half of 2011 and into 2012.

Yes.

Certainly, we have done, as John pointed out, a little over $700 million in acquired revenues through this stage in July.

I would say that the pipeline and the buyer and seller expectations, I wouldn't note any particular change in that.

I think the expectations are about similar to what they would have been a quarter ago.

I think the opportunity for us to have a stronger -- strong second half is there.

And, as you know, we will revise our range as we see the pipeline activity grow and it may well be that certainly the run rate we are at right now which suggests that we could see a stronger than the current forecast in acquisitions, that may well be the case.

But we need a little bit more data before we will adjust our range.

But I would describe the market activity as very similar to what we have seen over the last couple of quarters.

So definitely improved from what we saw this time last year, no question.

That's helpful.

Thank you very much.

Holden Lewis.

BB&T.

Good morning.

Back on that acquisition question, in terms of the numbers of acquisitions, it seems like the number that you have been closing each quarter has kind of stabilized in this mid- to high single digit number.

Based on how you are seeing the pipeline, I mean, would you expect that the numbers of deals that you can do would continue to go up or is there a limit to the number, just in terms of resources?

And if that is the case, are you just seeing that the average revenue that you are looking at is going up?

How do you grow from the current rates or expand the buy-in from the current rates?

Obviously the metrics that we look at our based on the individual assets that we are looking at.

So we don't have a number of deals, if you will, that we are trying to close.

It is more a question of looking at the underlying assets and how they fit with our strategies for growth.

So the numbers can vary obviously from quarter to quarter.

Obviously, larger sized assets have a bigger impact in terms of the overall revenue numbers and certainly the activity levels, but we continue to do smaller acquisitions that we think are well suited to bolting on to existing platforms.

So I am not sure I can give you any flavor.

There is not a metric that says we are going to do a lot more smaller deals.

I can tell you that we have spent a fair amount of time consciously looking at larger deals in spaces that we think have got good long-term growth characteristics and I think you are starting to see some of that pay off with some of the larger transactions that we have closed thus far this year.

But those are not at the exclusion of looking at smaller deals that make sense.

Particularly in market spaces that we have highlighted that we think have good long-term growth characteristics.

Yes, I'm just wondering in the past, I think in 2006 through 2008, you were kind of in that $1.6 billion, $1.7 billion in acquired revenues.

I mean, are you -- I'm just trying to get a sense of as you look out beyond [2011] at in the pipeline do you think that whatever the number is this year that you achieve, can you build on top of that?

Or is there something different about the environment where the 2011 levels look stable and we are not going to go back to the high ones towards the high 1's toward 2 type of level of M&A activity?

I fully expect that as the M&A environment continues to improve, as the markets continue to improve, we are going to see higher acquisition levels.

As you accurately noted, we closed deals during that 2006 to 2008 time frame.

Each of those years was north of $1 billion.

I think we did $4.2 billion for those three years, so the average was like $1.4 billion.

I fully expect that we will see those opportunities.

I think the difference this time is that we have definitely seen the ability to close several larger deals this year and last year, and I think we are purposely focused on deals of that size.

So it may be that we get to those numbers with fewer deals, but I think the opportunities from an acquisition standpoint in terms of overall impact are still in that 5% to 7% annualized revenue range that we have been talking about that we have done historically and that I think we are comfortable it will be a good look at the future as well.

If you look at it from a capacity standpoint and look at it historically in that 2006 to 2008 time frame, we were doing 45 to 50 deals per year.

So I don't think we are constrained by the number of deals.

I think to David's point, it is really a question of the combination of bigger and smaller deals.

Okay and then just lastly if you can comment, the implied sort of margin on your acquired revenues this quarter was especially low and lower than we have seen in quite some time, I think.

You are sort of building up the pipeline.

I mean, at what point would you expect to -- would you expect that these numbers remain low or is it some point they get better question or is there something about the acquisitions in this quarter that was notable?

I -- you know the -- it really comes down to how much amortization burn you have for the deal.

So it is fairly deals specific.

You go through a process of identifying step ups and intangibles and each deal is different.

So it is on the lower end this time from what it would normally be.

I think it was about 3%, 3.5% or mental margin.

More -- typically it is more like 4% to 5%.

And for these deals, as they anniversary their first year in the next year, these deals will become part of base and some of this amortization goes down.

So you'll see a bump-up for these deals, but you won't necessarily see it in the reported numbers because we will have new acquisitions -- new acquisitions that have new amortizations.

So typically our general margin profile is we are buying things that are in the 9% to 10% range and we want to get those to the overall Company margins within a three- to five-year time frame and I think that is still true.

[Weakening] --

For Q2 there's no question that the higher margin profile, particularly of the acquisition we did in late Q1 of SOPUS, had a dramatic impact on the amortization for Q2 which is, as Ron points out, is that anniversaries and we get into a more normal operating environment, that is a high margin business with good returns and so we see a different profile as we look at these numbers a year from now.

But it doesn't look like more competitive bidding or easing up on some of the expectations of acquired deals?

No.

No.

Thank you.

We will take one more question.

Mark Koznarek.

Cleveland Research.

Good morning.

I snuck in under the wire.

Nobody beat up on Food Equipment yet, I don't think, and so I was just wondering what kind of visibility do you have with regard to shipments in the second half?

And if you could also address the really lackluster service revenue growth.

It is really surprising to see kind of flattish service activity with you guys having such a well-regarded service organization.

I'm wondering what is going on with the market or is there a competitive dynamic unfolding there?

Well, first of all, the historic growth rates in the service business, which is a high margin business, is in that 2% to 3% range.

So that is pretty normal, pretty typical.

Perhaps you would have expected that to be a little higher on -- in the basis of where we are on the recovery, but not significantly.

I think the big challenge for us in the Q2 numbers Food Equipment were as John pointed out earlier, the international numbers particularly in Europe on the Equipment side were negative due to us exiting a couple of categories of lower performance businesses that we consciously got out of and as he pointed out, some pullback in institutional spending.

Particularly that supported by government spending in our French market businesses.

So I think I would characterize that as what I would view as not a normalized expectation going forward.

We don't have a lot of visibility.

There is not big backlogs in these businesses.

However, for the institutional categories there is a fair amount of planning and project activity before the order arrives.

That activity clearly has increased, which bodes well for continued improvement in equipment revenues in those categories.

But not a great deal of visibility long term in terms of backlog.

Okay, but that international comment if you are exiting -- I guess you are exiting customers, not divesting (multiple speakers).

But if you are pulling back from customers, that is going to be sort of a weak -- some pressure on the growth until we anniversary that a year from now, right?

Correct.

Okay.

But that is built into our expectations here forward.

So we expect that and we factored that into our overall guidance.

Okay and then just one final clarification on the repurchases.

We -- forgive me if I should know this, but I don't -- has finishing closed yet?

And number one, has finished -- has the finishing deal closed?

No, it has not closed yet.

As you might have noted, there was an announcement made I think a week and a half ago by [Greco] that the FDC has done a second request.

So they are looking for more data in their analysis of the transaction before they provide HSR approval (multiple speakers).

No it is not closed yet and based on the timeline that we are on, it probably would not close until probably late this quarter at best.

Okay and those proceeds are still slated towards repurchase.

Is that right?

Yes.

Correct.

Very good.

Thank you.

Thank, everybody, for joining us on today's call.

We will look forward to talking to everybody I can and I'll be talking to a number of people later this morning and this afternoon.

Thank you very much.

Have a good day.

Thank you for your participation.

Today's call has concluded.

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