Air Products & Chemicals, Inc. — Fiscal 2016 First Quarter Form 10-Q
Reporting period: Three months ended December 31, 2015; filed January 29, 2016. The interim financial statements are unaudited and prepared under U.S. GAAP. Air Products operates through Industrial Gases, Materials Technologies, Energy-from-Waste, and related businesses.
Financial Results and Position
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Sales | $2,355.8 million | $2,560.8 million | Down 8% |
| Operating income | $493.0 million | $430.0 million | Up 15% |
| Operating margin | 20.9% | 16.8% | Up 410 bp |
| Net income attributable to Air Products | $363.6 million | $324.6 million | Up 12% |
| Diluted EPS | $1.67 | $1.50 | Up 11% |
| Cash provided by operating activities | $573.5 million | $486.6 million | Up $86.9 million |
| Capital expenditures | $350.6 million | $446.5 million | Down $95.9 million |
| Adjusted EBITDA | $785.7 million | $723.1 million | Up 9% |
| Adjusted EBITDA margin | 33.4% | 28.2% | Up 520 bp |
Reported net margin was approximately 15.4%, compared with approximately 12.7% in the prior-year quarter. Gross margin increased to 32.2% from 28.5%. The effective tax rate increased to 26.3% from 24.0%, primarily because of income mix and separation costs without a corresponding tax benefit. Interest expense declined to $22.2 million from $29.1 million.
Cash and cash items were $279.1 million at December 31, 2015, compared with $206.4 million at September 30, 2015. Total debt was $5,817.8 million, down from $5,879.0 million, and debt represented 43.7% of total debt plus capitalization. Short-term borrowings and current maturities totaled approximately $1,947.3 million, contributing to negative working capital of approximately $793 million.
The company had a $2,690.0 million revolving credit facility, with no borrowings outstanding, and was in compliance with its debt covenants. The principal covenant limits total debt to total capitalization at no more than 70%.
Material Changes Versus the Prior Comparable Period
- Sales declined $205.0 million. Underlying sales increased 2%, but were more than offset by unfavorable currency effects of 5% and lower energy and raw-material pass-through of 5%.
- Operating performance improved substantially due to $52 million of favorable operating-cost performance, $41 million from pricing net of energy and fuel costs, and $5 million from volume. These benefits were partly offset by $23 million of currency effects, $14.3 million of project suspension costs, and $12.0 million of separation costs.
- Prior-year results included $32.4 million of restructuring charges and a $17.9 million gain on a previously held equity interest; neither item recurred in the current quarter.
- Industrial Gases—Asia sales rose 4% and operating income rose 29%, driven by 11% volume growth, including new plants in China. Industrial Gases—EMEA operating income rose 13%, while Americas operating income was approximately flat despite a 17% sales decline.
- Materials Technologies sales declined 6%, but operating income increased 22% to $127.2 million through favorable pricing, mix, and cost performance.
- Industrial Gases—Global sales increased 77% from the Saudi Aramco Jazan equipment contract, but the segment recorded a $19.3 million operating loss because no profit was recognized amid uncertainty over costs to complete the contract.
Cash Flow, Capital Allocation, and Outlook
- Operating cash flow of $573.5 million exceeded capital expenditures of $350.6 million. Financing cash outflows were $198.0 million, including $174.4 million of dividends.
- Management expected fiscal 2016 capital expenditures of approximately $1.3 billion. Backlog was $1.809 billion at December 31, 2015, compared with $1.931 billion at September 30, 2015.
- Fiscal 2016 pension contributions were expected to be approximately $100 million to $120 million, compared with $137.5 million in fiscal 2015. Management expected pension settlement losses beginning in the second quarter.
- Management stated that access to commercial paper markets remained consistent and that operating cash flow and financing activities were expected to meet liquidity needs for the foreseeable future.
- The company intended to separate Materials Technologies into Versum Materials, Inc., subject to specified conditions and final approval. The business remained reported in continuing operations until the separation occurs. Q1 separation costs were $12.0 million, with cumulative costs of $19.5 million since announcement.
- The filing does not provide a clear numerical full-year earnings or EPS guidance figure.
Risks, Contingencies, and Unusual Items
- Construction of the second Energy-from-Waste project in Tees Valley, United Kingdom, was suspended because of design and technical issues affecting the first project. Q1 suspension costs were $14.3 million, and additional costs were expected in the second quarter. The asset group had a carrying value of $938.9 million; no impairment was indicated at December 31, 2015, but future impairment remained reasonably possible if assumptions or conditions changed.
- The Saudi Aramco Jazan equipment contract had uncertain completion costs, and no profit was recognized on the contract in the quarter. Air Products owned 25% of the related joint venture, expected to invest approximately $100 million, and had a $94.3 million noncurrent liability for future equity contributions tied to the joint venture’s equity bridge loan.
- A Brazilian antitrust matter involved a potential fine of approximately $45 million plus interest. The company had prevailed in an earlier appeal, but the matter remained pending; management considered an adverse final judgment possible but not probable and recorded no provision.
- Environmental liabilities totaled $78.6 million, with estimated exposure ranging from $78 million to a reasonably possible upper exposure of $92 million. The obligations may extend for up to 30 years.
- Material risks include foreign-currency volatility, energy and raw-material costs, industrial demand and pricing pressure, oil-market weakness, customer cancellations or project delays, execution of cost reductions and the Materials Technologies separation, litigation and regulatory outcomes, environmental obligations, and potential asset impairments.
- Foreign cash and cash items were $270.3 million of total cash of $279.1 million. Repatriation of foreign funds could create U.S. tax costs, although the company intended to permanently reinvest most foreign cash outside the United States.
Most Important Facts to Verify
- Progress, final terms, timing, and costs of the planned Materials Technologies separation.
- Cost-to-complete estimates and profitability recognition for the Jazan equipment contract.
- Technical remediation, restart or abandonment decisions, further costs, and impairment testing for the Energy-from-Waste projects.
- Whether currency pressure, weak Americas industrial demand, Chinese merchant-gas overcapacity, and oil-and-gas weakness persist.
- Actual fiscal 2016 capital expenditures, pension contributions, project spending, and associated financing needs.
- Updates to the Brazilian antitrust appeal and environmental exposure estimates.
- Reconciliation and sustainability of non-GAAP operating income, Adjusted EBITDA, and EPS, particularly given the separation and project suspension adjustments.