Business Context and Reporting Period
Air Products and Chemicals, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended 30 June 2017, covering fiscal year 2017. The company is focused on Industrial Gases, with reporting segments in the Americas, EMEA, Asia, Global, and Corporate and other.
Results exclude the former Materials Technologies businesses and Energy-from-Waste operations from continuing operations. Electronic Materials was spun off as Versum Materials on 1 October 2016, and Performance Materials was sold to Evonik on 3 January 2017 for $3.8 billion in cash. Comparisons have been reclassified accordingly.
Financial Performance and Key Metrics
| Metric | Three Months Ended 30 June | Nine Months Ended 30 June |
|---|---|---|
| Sales | $2,121.9 million, up 11% | $5,984.5 million, up 8% |
| Operating income | $252.6 million, down 36% | $971.9 million, down 15% |
| Operating margin | 11.9%, down 870 basis points | 16.2%, down 430 basis points |
| Income from continuing operations attributable to Air Products | $104.2 million | $660.2 million |
| Diluted EPS from continuing operations | $0.47 | $3.00 |
| Adjusted operating income | $462.9 million, up 11% | $1,276.8 million, up 7% |
| Adjusted EBITDA | $722.4 million, up 7% | $2,026.4 million, up 4% |
| Adjusted operating margin | 21.8%, unchanged | 21.3%, down 20 basis points |
Sales growth was driven primarily by higher volumes and energy and natural-gas cost pass-through. Third-quarter volume increased 8%, while pricing was flat, currency reduced sales by 2%, and energy pass-through increased sales by 5%. Nine-month volume increased 6%, currency reduced sales by 2%, and energy pass-through increased sales by 4%.
Reported earnings were reduced by significant unusual items. Third-quarter results included a $162.1 million noncash goodwill and intangible-asset impairment charge and a $79.5 million noncash impairment of an equity affiliate investment. Cost reduction and asset actions were $42.7 million for the quarter and $103.0 million for the nine months. The nine-month period also included $30.2 million of business separation costs and $9.6 million of pension settlement losses.
Net income attributable to Air Products was $101.9 million, or $0.46 diluted EPS, in the quarter, compared with $346.8 million, or $1.59, in the prior-year quarter. For the nine months, net income attributable to Air Products was $2,531.7 million, or $11.52 diluted EPS, compared with $237.1 million, or $1.09, primarily because the 2017 period included the after-tax gain from the Performance Materials sale. The gain from discontinued operations was $1,871.5 million for the nine months of 2017.
Cash Flow, Debt, and Liquidity
- Cash provided by operating activities was $1,613.4 million for the first nine months, compared with $1,522.2 million in the prior-year period.
- Capital expenditures were $806.8 million; management expected approximately $1.0 billion of fiscal 2017 capital expenditures.
- Cash used in investing activities was $1,810.8 million, reflecting capital spending and purchases of short-term investments.
- Cash used in financing activities was $1,854.4 million, including $483.5 million of long-term debt repayments, a $799.2 million net reduction in commercial paper and short-term borrowings, and $580.9 million of shareholder dividends.
- Cash and cash items were $2,332.6 million at 30 June 2017, including $1,016.1 million of short-term investments. Foreign cash and cash items totaled $962.9 million, most of which management intended to permanently reinvest outside the United States.
- Total debt declined to $3,926.0 million from $5,210.9 million at 30 September 2016. Debt represented 29.2% of total debt plus equity, compared with 41.9% at fiscal year-end.
- A new five-year $2.5 billion revolving credit agreement was executed on 31 March 2017. No borrowings were outstanding under the facility at quarter-end, and the company reported compliance with its debt covenants.
- The quarterly dividend increased from $0.86 to $0.95 per share. The board declared another $0.95 dividend on 20 July 2017, payable 13 November 2017.
Material Changes Versus the Prior Comparable Period
- Underlying Industrial Gases performance improved, but reported margins declined because of impairments, restructuring and asset actions, higher energy pass-through costs, unfavorable currency, and weaker pricing net of power costs in some regions.
- Industrial Gases–Asia was the strongest regional contributor, with third-quarter sales up 20% and operating income up 26%. Industrial Gases–Global benefited from the Saudi Aramco Jazan equipment project.
- Industrial Gases–EMEA sales increased 5% in the quarter, but operating income declined 10% because of unfavorable pricing net of power costs and currency. The nine-month operating income decline was 6%.
- Corporate and other performance weakened because of lower LNG project activity. Management expected delays in new LNG project orders because of continued LNG market oversupply.
- Latin America weakness led to a $145.3 million goodwill impairment and a $16.8 million trade-name and trademark impairment. Management stated that a further 125-basis-point reduction in revenue growth or 225-basis-point reduction in EBITDA margin, with other assumptions unchanged, could impair remaining Latin America goodwill.
- The 25%-owned Abdullah Hashim Industrial Gases & Equipment investment was impaired by $79.5 million because of challenging Saudi Arabian economic conditions, lower oil and gas prices, increased competition, and unrealized growth opportunities. Its carrying value was $68.5 million at quarter-end.
Outlook, Risks, Contingencies, and Unusual Items
Management expected additional pension settlement losses in the fourth quarter of fiscal 2017 and projected total fiscal-year pension contributions of approximately $65 million to $85 million. The company reported a sales backlog of $618 million at 30 June 2017, down from $1,057 million at 30 September 2016.
Key risks include regional economic weakness, especially in Latin America and Saudi Arabia; currency and interest-rate volatility; energy and natural-gas prices; delays, cancellations, or cost changes on equipment projects; LNG market oversupply; execution of the Jazan project; further asset impairments; divestiture-related stranded costs and tax effects; environmental remediation; litigation and regulatory matters; and changes in tax, environmental, sanctions, or other laws.
The company disclosed approximately 32 environmental sites subject to investigation or remediation. Environmental accruals totaled $84.8 million, with estimated exposure ranging from $84 million to a reasonably possible upper exposure of $98 million. A Brazilian competition-law fine of approximately $54 million remained subject to appeal; no provision was recorded because an adverse final judgment was not considered probable. The Energy-from-Waste discontinued operation retained a $5.7 million accrual at 30 June 2017, and additional exit costs may arise.
Management stated that operating cash flow, cash balances, commercial paper access, and available credit were expected to meet liquidity needs for the foreseeable future. The filing provides no formal full-year revenue or earnings guidance.
Important Facts for Investors to Verify
- Separate recurring Industrial Gases performance from the $162.1 million asset impairment, $79.5 million equity-investment impairment, restructuring charges, pension losses, and other adjustments.
- Assess the sustainability of volume growth, particularly the contribution from the Jazan equipment project and short-term equipment activity in Asia.
- Monitor Latin America revenue growth, EBITDA margins, and remaining goodwill for potential additional impairment.
- Evaluate LNG project delays, the reduced backlog, and the effect of transition-service income as divestiture arrangements expire.
- Reconcile reported net income and EPS with continuing-operations results because the Performance Materials sale substantially distorts nine-month comparisons.
- Review debt maturities, interest-rate sensitivity, foreign-currency exposure, and the availability of the $2.5 billion revolving credit facility.
- Track environmental remediation costs, the Brazilian competition matter, Energy-from-Waste exit obligations, and potential future pension settlement losses.
- Consider the limitations of management’s non-GAAP measures, which exclude charges that may recur or differ from adjustments used by other companies.