Air Products & Chemicals, Inc. — Fiscal First Quarter 2019 Form 10-Q
Business context and reporting period
Air Products is a global industrial gases and related equipment company, reported through Industrial Gases–Americas, EMEA, Asia, Global, and Corporate and other. The filing covers the three months ended 31 December 2018, compared with the three months ended 31 December 2017. The financial statements are unaudited and presented under U.S. GAAP.
The company adopted ASC 606 revenue recognition on 1 October 2018 using the modified retrospective method. Management reported no material effect on consolidated results or opening retained earnings; prior-period information was not restated.
Key financial metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Sales | $2,224.0 million | $2,216.6 million | Flat |
| Operating income | $455.0 million | $460.7 million | Down 1% |
| Operating margin | 20.5% | 20.8% | Down 30 bp |
| Income from continuing operations attributable to Air Products | $347.5 million | $155.6 million | Up 123% |
| Diluted EPS from continuing operations | $1.57 | $0.70 | Up $0.87 |
| Cash provided by operating activities | $655.2 million | $560.0 million | Up $95.2 million |
| Adjusted EBITDA | $794.9 million | $734.9 million | Up 8% |
| Adjusted EBITDA margin | 35.7% | 33.2% | Up 250 bp |
Reported net income attributable to Air Products was $347.5 million, or $1.58 basic and $1.57 diluted EPS. The effective tax rate was 27.0%, compared with 64.2% in the prior-year quarter, primarily reflecting the different discrete effects of the U.S. Tax Cuts and Jobs Act.
Adjusted operating income was $484.0 million, with a 21.8% margin, compared with $460.7 million and 20.8% in the prior-year quarter. Adjusted income from continuing operations was $410.2 million, or $1.86 adjusted diluted EPS.
Cash flow, liquidity, debt, and capital allocation
- Operating cash flow was $655.2 million. Capital expenditures were $403.4 million, compared with $256.6 million in the prior-year period.
- Investing activities used $226.5 million, versus $480.8 million in the prior-year quarter, which included $237.1 million of acquisitions.
- Financing activities used $289.8 million, including $241.5 million of dividends and $38.0 million of net repayments of commercial paper and short-term borrowings.
- Cash and cash items totaled $2,923.3 million at 31 December 2018, compared with $2,791.3 million at 30 September 2018. Foreign cash and cash items totaled $980.1 million.
- Total debt was $3,767.9 million, or 25.2% of total capitalization, compared with $3,812.6 million and 25.4% at fiscal year-end. Debt included approximately $383.8 million of related-party debt associated with the Lu’An joint venture.
- The company had a $2.3 billion revolving credit agreement maturing 31 March 2022, with no borrowings outstanding. It was in compliance with debt covenants, including a maximum total-debt-to-total-capitalization ratio of 70%.
- Management expects fiscal 2019 capital expenditures of approximately $2.3 billion to $2.5 billion. The equipment sales backlog was $501 million at 31 December 2018, versus $204 million at 30 September 2018.
- No share repurchases were made during the quarter; $485.3 million remained under the repurchase authorization. The board declared a second-quarter dividend of $1.16 per share.
Material changes versus the prior comparable period
- Sales were essentially unchanged: underlying sales declined 2%, as a 3% volume decline was offset partly by 1% pricing growth, while energy and natural-gas pass-through increased sales 5% and currency reduced sales 2%.
- Excluding the prior-year equipment activity and other unusual comparisons, management stated that base-business volumes increased 5%, supported by regional industrial-gas growth and the full onstream of the Lu’An project.
- Operating income declined because of a $29.0 million facility-closure charge, $15 million of higher net operating costs, and $11 million of unfavorable currency impacts. These effects were partly offset by $35 million of higher volumes and $14 million of favorable pricing net of energy, fuel, and raw-material costs.
- Industrial Gases–Asia operating income rose 15% to $201.8 million, with margin increasing to 32.2%, while Industrial Gases–Global sales declined 49% to $68.2 million because of lower activity on the Jazan equipment project.
- Equity-affiliates’ income increased to $52.9 million from $13.8 million, primarily because the prior-year period included a $32.5 million Tax Act-related charge. Excluding that item, equity-affiliates’ income increased 14%.
- The company recorded a $40.6 million discrete tax expense in the quarter to finalize its Tax Act estimates. The prior-year quarter included a $206.5 million discrete tax expense from initial Tax Act estimates.
- Adoption of new income-tax accounting for intra-entity asset transfers reduced retained earnings by $17.1 million at 1 October 2018. Cash-flow classification guidance was adopted retrospectively, reclassifying $4.1 million of prior-year activity from operating to investing activities.
Guidance, outlook, management commentary, risks, and unusual items
- Management expects fiscal 2019 capital expenditures of approximately $2.3 billion to $2.5 billion and pension contributions of approximately $45 million to $65 million.
- The $29.0 million facility-closure charge resulted from a government-enforced environmental shutdown of a customer facility and primarily represented the write-off of onsite assets. The company stated that the customer’s prior annual sales and operating income were not material and that no additional charges were expected.
- The company estimates approximately $14 billion of remaining performance obligations at 31 December 2018; approximately half is expected to be recognized over the next five years and the balance thereafter, subject to contract cancellations, renewals, inflationary escalators, currency changes, and other factors.
- Material risk areas include global economic conditions, demand and pricing, project execution and delays, customer cancellations, tariffs and sanctions, environmental and climate regulation, tax-law changes, foreign exchange and interest rates, natural-gas and raw-material costs, cybersecurity, facility disruptions, legal proceedings, impairments, and joint-venture performance.
- A Brazilian competition-law matter remains pending. The potential fine was approximately $46 million plus interest, but management concluded that an adverse final judgment was possible but not probable; no provision was recorded.
- Environmental accruals totaled $74.4 million at 31 December 2018, with estimated exposure ranging from $74 million to a reasonably possible upper exposure of $88 million. The company does not expect amounts beyond disclosed exposures to materially affect any one year.
- The company’s disclosure controls and procedures were effective as of 31 December 2018, and no material change in internal control over financial reporting was reported.
Most important facts for investors to verify
- Whether adjusted earnings growth is sustained after removing Tax Act effects and the facility-closure charge.
- Progress, timing, margins, and cash requirements for the Lu’An joint venture and the Jazan equipment project.
- Execution of the $2.3 billion–$2.5 billion fiscal 2019 capital-expenditure plan and its effect on free cash flow.
- Volume trends and cost control in the Americas and EMEA, where operating margins declined despite sales growth.
- Foreign-exchange sensitivity, including the filing’s estimate that a 10% currency movement would change the net liability position of financial instruments by approximately $304 million.
- Developments in the Brazilian litigation and environmental remediation obligations, including the Pace, Piedmont, and Pasadena sites.
- Final tax consequences when the company files its U.S. federal 2018 tax return, as certain Tax Act amounts could still change.