Air Products & Chemicals, Inc. — Fiscal Q1 2018 Form 10-Q
Reporting period: Three months ended December 31, 2017; comparative period ended December 31, 2016. The filing was submitted January 26, 2018. Results are presented primarily on a continuing-operations basis. Former Performance Materials and Energy-from-Waste activities are reported as discontinued operations.
Business Context and Financial Overview
Air Products operates primarily through Industrial Gases segments in the Americas, EMEA, Asia, and Global markets. Fiscal Q1 benefited from higher volumes, new project onstreams, favorable pricing in Asia, currency benefits, and an equipment sale related to a terminated contract in Asia. The quarter also included the provisional impact of the U.S. Tax Cuts and Jobs Act enacted on December 22, 2017.
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Sales | $2,216.6 million | $1,882.5 million | Up 18% |
| Operating income | $460.7 million | $328.3 million | Up 40% |
| Operating margin | 20.8% | 17.4% | Up 340 basis points |
| Income from continuing operations attributable to Air Products | $155.6 million | $251.6 million | Down 38% |
| Diluted EPS from continuing operations | $0.70 | $1.15 | Down $0.45 |
| Net income attributable to Air Products | $154.6 million | $299.8 million | Down 48% |
| Adjusted EBITDA | $734.9 million | $654.9 million | Up 12% |
| Adjusted EBITDA margin | 33.2% | 34.8% | Down 160 basis points |
Cash Flow, Liquidity, Debt, and Capital Allocation
- Cash provided by operating activities was $564.1 million, compared with $574.3 million in the prior-year quarter.
- Cash used in investing activities was $484.9 million, including $256.6 million of capital expenditures and $237.1 million for three acquisitions.
- Cash used in financing activities was $641.1 million, including $408.6 million of long-term debt repayment and $207.5 million of dividends.
- Cash and cash items totaled $2,722.6 million at December 31, 2017, down from $3,273.6 million at September 30, 2017. Foreign cash and cash items totaled $1,396.9 million.
- Total debt was $3,513.3 million, or 25.4% of total capitalization, versus 28.0% at September 30, 2017. The reduction primarily reflected repayment of a $400.0 million senior note that matured in October 2017.
- The company had no borrowings under its $2.5 billion revolving credit agreement and was in compliance with its debt covenants. The agreement includes a maximum total-debt-to-total-capitalization covenant of 70%.
- Fiscal 2018 capital expenditures are expected to be approximately $1.2 billion to $1.4 billion, excluding possible acquisitions and the announced Air Products Lu’An joint venture.
- The quarterly dividend declared was $0.95 per share; the board subsequently declared a second-quarter dividend of $1.10 per share.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven by 13% volume growth, 2% pricing, and 3% favorable currency effects. Asia sales increased 47%, EMEA sales increased 29%, and Americas sales increased 5%; Global sales declined 10%.
- Reported operating income benefited from the absence of $32.5 million of business separation costs and $50.0 million of cost reduction and asset-action charges recorded in Q1 2017. On an adjusted basis, operating income increased 12% to $460.7 million, but adjusted operating margin declined 100 basis points to 20.8%.
- Operating costs increased, principally from higher planned maintenance costs. Margins were also pressured by lower-margin new hydrogen volumes in India, the Asia equipment sale, and higher costs.
- Income from continuing operations declined primarily because of the tax effects of the U.S. Tax Cuts and Jobs Act. The reported effective tax rate was 64.2%, compared with 23.3% in the prior-year quarter.
- The Act produced a provisional net expense of $239.0 million, including $453.0 million for deemed repatriation and related future repatriation costs, partially offset by a $214.0 million benefit from remeasuring U.S. deferred tax liabilities.
- Non-GAAP income from continuing operations was $394.6 million, or $1.79 diluted EPS, compared with $322.0 million, or $1.47 diluted EPS, in Q1 2017.
- Equity affiliates’ reported income fell to $13.8 million from $38.0 million, primarily because of a $32.5 million tax reform adjustment. Excluding that item, equity affiliates’ income increased 22% to $46.3 million.
- The company completed three acquisitions for $237.1 million, including air separation units serving onsite and merchant customers in China. The acquisitions added $53.7 million of goodwill and $53.4 million of intangible assets.
- Sales backlog declined to $405 million from $481 million at September 30, 2017.
Guidance, Outlook, Risks, and Unusual Items
- Management expects fiscal 2018 capital expenditures of approximately $1.2 billion to $1.4 billion.
- Management estimated a fiscal 2018 effective tax rate of approximately 20.0% to 21.0% after one-time adjustments and did not anticipate a significant change in the fiscal 2019 full-year rate versus that estimate. Tax reform accounting remained provisional.
- Management expected all transition services for Versum Materials to end in the second quarter of fiscal 2018 and stated that it would continue reducing stranded costs after those services end.
- Corporate and other operating loss increased to $46.0 million from $29.1 million, primarily because of lower LNG activity. Management expected delays in new LNG project orders due to continued market oversupply.
- Management stated that cash balances, operating cash flow, and access to commercial paper were expected to meet liquidity needs for the foreseeable future.
- Key risks include global economic and demand conditions, foreign-exchange and interest-rate volatility, customer project delays or cancellations, execution of equipment projects, acquisitions and divestitures, environmental and regulatory matters, litigation, tax-law changes, energy-price volatility, and the ability to achieve productivity improvements.
- Environmental liabilities were accrued at $81.4 million, with estimated exposure ranging from $81 million to a reasonably possible upper exposure of $95 million. The company identified approximately 32 sites involving investigation or remediation.
- A Brazilian antitrust matter carried a maximum possible loss of approximately $54 million plus interest, but management concluded that an adverse final judgment was possible but not probable and recorded no provision.
- The deemed repatriation tax obligation included approximately $296.6 million recorded in noncurrent liabilities, payable over eight years beginning in fiscal 2019.
Investor Verification Checklist
- Verify the final accounting for the U.S. Tax Cuts and Jobs Act, including the deemed repatriation liability and deferred-tax remeasurement.
- Assess whether Asia’s equipment-sale benefit and new project onstreams are recurring or nonrecurring and whether the associated margin pressure persists.
- Compare future operating-cost trends, particularly planned maintenance, with the company’s adjusted margin targets.
- Monitor cash conversion, capital expenditures, acquisitions, debt repayment, and compliance with the revolving-credit covenant.
- Review the decline in equipment backlog and the outlook for LNG orders and project execution.
- Evaluate environmental, Brazilian antitrust, project-contract, foreign-exchange, and derivative-related exposures.
- Reconcile reported GAAP results with management’s non-GAAP measures and confirm the effects of discontinued operations and prior-year separation charges.