Air Products & Chemicals, Inc. — Fiscal 2013 First-Quarter Form 10-Q
Reporting period: Three months ended 31 December 2012; filed 25 January 2013. Comparative period was the three months ended 31 December 2011. The interim financial statements are unaudited and should be read with the fiscal 2012 Form 10-K.
Business Context and Reporting Period
Air Products operates through Merchant Gases, Tonnage Gases, Electronics and Performance Materials, and Equipment and Energy. Fiscal first-quarter sales benefited from the Indura S.A. and DuPont Air Products NanoMaterials LLC acquisitions. The Homecare business is reported as discontinued operations following the sale of most of the business to Linde; the remaining U.K. and Ireland operations were being marketed for sale.
Key Financial Metrics
| Metric | Q1 FY2013 | Q1 FY2012 | Change |
|---|---|---|---|
| Sales | $2,562.4 million | $2,321.5 million | +10% |
| Operating income | $372.4 million | $353.8 million | +5% |
| Operating margin | 14.5% | 15.2% | (70) basis points |
| Income from continuing operations attributable to Air Products | $276.9 million | $225.9 million | +23% |
| Diluted EPS from continuing operations | $1.30 | $1.06 | +$0.24 |
| Net income attributable to Air Products | $278.3 million | $248.1 million | +12% |
| Diluted EPS including discontinued operations | $1.31 | $1.16 | +$0.15 |
| Cash provided by operating activities | $278.4 million | $424.3 million | Down $145.9 million |
| Capital additions to plant and equipment | $357.0 million | $342.3 million | Up $14.7 million |
Profitability and drivers: Underlying sales increased 4%, consisting primarily of 4% volume growth; pricing, currency, and energy/raw-material pass-through were broadly neutral. Acquisitions contributed approximately 6% to consolidated sales. Operating income benefited from higher volumes, including acquisitions, and favorable currency, but was reduced by higher costs, lower raw-material cost recovery, and a $12 million unfavorable inventory revaluation in Electronics and Performance Materials.
The effective tax rate was 24.4%, compared with 35.2% in the prior-year quarter. The prior-year rate included a $43.8 million Spanish tax settlement charge. Excluding that item, management reported non-GAAP continuing-operations net income of $276.9 million versus $269.7 million, up 3%, and non-GAAP diluted EPS of $1.30 versus $1.26, also up 3%.
Segment Performance
| Segment | Sales | Sales change | Operating income | Margin change |
|---|---|---|---|---|
| Merchant Gases | $1,009.1 million | +14% | $171.0 million | 16.9%, down 180 bps |
| Tonnage Gases | $898.4 million | +11% | $138.1 million | 15.4%, up 160 bps |
| Electronics and Performance Materials | $549.0 million | +3% | $61.3 million | 11.2%, down 340 bps |
| Equipment and Energy | $105.9 million | +19% | $8.4 million | Not clearly provided |
Merchant Gases sales growth was driven primarily by the Indura acquisition, while underlying volumes declined. Tonnage Gases benefited from higher spot volumes, new projects, and lower maintenance costs. Electronics and Performance Materials earnings declined principally because of the inventory revaluation and higher costs. Equipment backlog was $389 million at 31 December 2012, down from $450 million at 30 September 2012.
Cash Flow, Liquidity, Debt, and Capital Allocation
- Cash and cash items from continuing operations were $545.6 million at 31 December 2012, compared with $454.4 million at 30 September 2012. Foreign cash represented $529.4 million, and management stated that most foreign cash was intended to remain reinvested outside the United States.
- Operating cash flow was reduced by a $230.0 million pension contribution, compared with $8.1 million in the prior-year quarter. Fiscal 2013 pension contributions were expected to total approximately $275 million.
- Investing cash outflow was $355.8 million, primarily reflecting $357.0 million of capital expenditures. Management’s non-GAAP capital expenditures, including capital lease expenditures, were $428.4 million.
- Financing cash inflow was $157.1 million. Net borrowings contributed $721.4 million, primarily from a $709.1 million increase in commercial paper and short-term borrowings; this funded share repurchases, dividends, capital spending, and other uses.
- Total debt increased to $6,035.7 million from $5,291.9 million at 30 September 2012. Debt represented 48.3% of total debt plus equity, compared with 44.4% at fiscal year-end.
- Cash dividends paid were $136.0 million; dividends declared were $0.64 per common share, compared with $0.58 in the prior-year quarter.
- The company repurchased 5.7 million shares for $461.6 million during the quarter. Approximately $485.3 million remained under the $1.0 billion authorization at 31 December 2012.
- Air Products reported continued access to commercial paper markets, no borrowings under its $2.17 billion committed credit facility, compliance with debt covenants, and a maximum leverage covenant of 60%.
Material Changes Versus the Prior Comparable Period
- Sales increased $240.9 million, or 10%, with 4% underlying growth and 6% acquisition-related growth.
- Operating income increased $18.6 million, but the operating margin declined 70 basis points because of higher costs, pension expense, acquisition effects, and inventory revaluation.
- Reported continuing-operations EPS increased 23%, but the comparable non-GAAP increase was 3% because the prior-year period benefited from excluding the one-time Spanish tax settlement.
- Operating cash flow declined substantially because of the $230.0 million pension contribution and other working-capital effects.
- Debt increased by approximately $743.8 million from 30 September 2012, while treasury-stock purchases totaled $461.6 million.
- Discontinued-operations income declined to $1.4 million from $22.2 million, and discontinued-operations sales declined to $13.8 million from $101.5 million.
- Other comprehensive income was $104.5 million, compared with a $21.5 million loss in the prior-year quarter, primarily reflecting favorable currency translation and derivative-related changes.
Guidance, Outlook, Risks, and Unusual Items
- Management expected the fiscal 2012 restructuring and cost-reduction actions to be substantially complete by the end of the second quarter of fiscal 2013 and to generate approximately $60 million of annual savings by fiscal year-end.
- Management expected to complete the sale of the remaining Homecare business, primarily in the United Kingdom and Ireland, by the end of fiscal 2013.
- The PUI facility in Pasadena, Texas was scheduled for dismantling, with completion expected in fiscal 2014. Related environmental and dismantling costs will be expensed as incurred.
- The company recorded a $327.4 million fiscal 2012 restructuring and cost-reduction charge, including $186.0 million related primarily to weakness in the photovoltaic market and $54.6 million related to PUI actions. These charges were not recorded in the current quarter but remain relevant to future cash expenditures and contingencies.
- Indura’s largest minority shareholder may require Air Products to purchase up to a 30.5% interest during a two-year period beginning 1 July 2015. Redeemable noncontrolling interest was $390.7 million at 31 December 2012.
- A Brazilian competition-law matter involved a potential fine of approximately $87 million plus interest. Management considered an adverse final judgment reasonably possible but not probable; no provision was recorded.
- Environmental liabilities were accrued at $86.6 million, with estimated exposure ranging from $86 million to a reasonably possible upper exposure of $100 million. Approximately 34 sites remained subject to investigation or remediation.
- Principal forward-looking risks include global economic conditions, demand and customer cancellations, pricing and raw-material recovery, supply interruptions, litigation and regulatory outcomes, environmental obligations, acquisitions and divestitures, pension requirements, foreign exchange and interest-rate volatility, and access to capital markets.
- The 2013 accounting guidance for goodwill and indefinite-lived intangible-asset impairment testing did not affect the consolidated financial statements. Management reported effective disclosure controls as of 31 December 2012.
Investor Verification Priorities
- Reconcile reported EPS growth with the prior-year Spanish tax settlement and discontinued-operations effects; assess performance using both GAAP and comparable non-GAAP measures.
- Monitor debt growth, commercial-paper reliance, refinancing plans for 2013 maturities, and compliance with the 60% leverage covenant.
- Evaluate whether operating cash flow can recover after the unusually large pension contribution while funding capital expenditures and share repurchases.
- Assess the sustainability of Tonnage Gases volume gains and the weaker European Merchant Gases and Electronics trends.
- Track the remaining Homecare sale, Indura minority-interest put rights, restructuring savings, and PUI dismantling obligations.
- Review exposure to the Brazilian competition matter and environmental sites, including the disclosed range of possible environmental costs.