Air Products and Chemicals, Inc. — Fiscal 2011 Third-Quarter Form 10-Q
Reporting period: Quarterly and nine-month periods ended June 30, 2011, compared with the corresponding 2010 periods. The filing was signed July 27, 2011. Air Products operates through Merchant Gases, Tonnage Gases, Electronics and Performance Materials, and Equipment and Energy.
Financial Highlights
| Metric | Q3 2011 | Q3 2010 | Change | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|---|
| Sales | $2,577.8 million | $2,252.3 million | 14% | $7,470.8 million | $6,674.8 million |
| Operating income | $416.8 million | $336.4 million | 24% | $1,196.9 million | $1,022.0 million |
| Operating margin | 16.2% | 14.9% | +130 bp | 16.0% | 15.3% |
| Income from continuing operations attributable to Air Products | $317.6 million | $253.2 million | 25% | $890.5 million | $757.0 million |
| Diluted EPS from continuing operations | $1.46 | $1.17 | 25% | $4.08 | $3.49 |
| Net income attributable to Air Products | $326.5 million | $253.2 million | 29% | $899.4 million | $757.0 million |
| Diluted EPS | $1.50 | $1.17 | 28% | $4.12 | $3.49 |
Underlying performance: Excluding Airgas transaction costs, Q3 operating income increased 11% and operating margin declined 40 basis points to 16.2%. Nine-month non-GAAP operating income increased 15% to $1,245.4 million, with margin improving 50 basis points to 16.7%. Nine-month non-GAAP diluted EPS was $4.26 versus $3.67.
Drivers: Q3 underlying sales increased 7%, led by 6% volume growth and 1% pricing; currency contributed 5% and energy and raw-material pass-through contributed 2%. Management cited higher volumes in Tonnage Gases and Electronics and Performance Materials, while higher operating, maintenance, distribution, and raw-material costs pressured margins.
Cash Flow, Balance Sheet, Debt and Liquidity
- Operating cash flow for the nine months was $1,128.7 million, up from $1,033.2 million. Capital expenditures for plant and equipment were $965.3 million, compared with $757.2 million.
- Cash used in investing activities was $851.2 million; cash used in financing activities was $232.4 million. Cash and cash items increased to $430.1 million from $374.3 million at September 30, 2010.
- Total debt increased to $4,497.7 million from $4,128.3 million. The debt-to-total-debt-and-equity ratio declined to 41.3% from 42.0%.
- At June 30, 2011, short-term borrowings were $430.4 million, current long-term debt was $13.0 million, and long-term debt was $4,054.3 million. Total equity was $6,397.0 million.
- The $2.17 billion multicurrency revolving facility was extended to June 30, 2015, and its financial covenant was changed from maximum total debt-to-EBITDA of 3.0 to long-term debt-to-equity of no more than 60%. No borrowings were outstanding under the facility. Management stated that the company remained in compliance with its debt covenants and had continued access to commercial paper markets.
- The company repurchased 3.8 million shares for $350.0 million during the first nine months. Remaining authorization was $299.2 million. The quarterly dividend increased from $0.49 to $0.58 per share.
Material Changes Versus the Prior Comparable Period
- Sales and earnings improved substantially, primarily because of volume growth, favorable currency, and stronger Electronics and Performance Materials results.
- Electronics and Performance Materials Q3 sales increased 21% and operating income increased 75%; nine-month sales increased 23% and operating income increased 61%.
- Tonnage Gases Q3 sales increased 20%, but operating income declined 4% and margin fell 330 basis points because of higher maintenance and natural-gas costs. Nine-month operating income increased 7%, while margin declined 60 basis points.
- Merchant Gases Q3 operating margin declined 160 basis points to 17.7%; nine-month margin declined 90 basis points to 18.7%, reflecting higher operating, maintenance, and distribution costs.
- Equipment and Energy Q3 sales declined 31% and operating income declined 59%; the nine-month sales decline was 11%, although nine-month operating income increased 9%. Equipment backlog was $246 million at June 30, 2011, versus $274 million at September 30, 2010.
- Air Products withdrew its $70-per-share tender offer for Airgas on February 15, 2011, after the Delaware Chancery Court upheld Airgas’s preferred-stock-rights position. The related $6.7 billion term-loan facility was terminated. The company recorded a $48.5 million pretax net loss related to the transaction in the first nine months, compared with $61.3 million in the prior-year period.
- A tax audit settlement generated an $8.9 million benefit in discontinued operations, or $0.04 per diluted share.
Outlook, Commentary, Risks and Unusual Items
Management stated that cash flow from operations, financing activities, and continued access to commercial paper were expected to meet liquidity needs for the foreseeable future. The filing does not provide specific revenue, earnings, or margin guidance.
- Key operating risks include a stalled global recovery, weaker customer demand, project cancellations or delays, competitive pricing, supply interruptions, energy and raw-material cost inflation, and the ability to pass those costs through to customers.
- Foreign-currency and interest-rate movements materially affect reported results; the company uses forward contracts and interest-rate swaps to manage exposures.
- Air Products faces a Brazilian antitrust fine of R$179.2 million, approximately $115 million at June 30, 2011, plus interest. The company appealed, considered an adverse final judgment reasonably possible but not probable, and recorded no provision.
- Environmental accruals totaled $83.2 million. Estimated environmental exposure ranged from $83 million to a reasonably possible upper exposure of $97 million, with payments potentially extending up to 30 years.
- Unrecognized tax benefits totaled $162.9 million, of which $127.3 million would affect the effective tax rate if recognized. Spanish tax authorities were challenging deductions, but the filing did not provide a quantifiable exposure range.
- Fiscal 2011 expected pension contributions were approximately $247 million; $229.5 million had been contributed or paid through June 30, 2011.
- The company adopted new guidance for variable-interest entities and multiple-deliverable revenue arrangements without a material impact. Future comprehensive-income and fair-value guidance was not expected to have a material adoption impact.
- Management concluded that disclosure controls and procedures were effective as of June 30, 2011, with no material change in internal control over financial reporting during the quarter.
Investor Verification Checklist
- Reconcile reported GAAP earnings with management’s non-GAAP measures, particularly the $48.5 million Airgas transaction loss.
- Assess whether higher volumes and pricing can offset higher maintenance, distribution, energy, and raw-material costs, especially in Merchant Gases and Tonnage Gases.
- Monitor debt growth, commercial-paper reliance, covenant compliance, and the terms of the amended $2.17 billion revolving facility.
- Evaluate capital spending of $965.3 million against operating cash flow of $1,128.7 million and future project returns.
- Follow the Brazilian antitrust appeal, environmental remediation obligations, and Spanish tax challenge for potential cash or earnings impacts.
- Track Equipment and Energy backlog, customer project activity, currency movements, and demand trends in Electronics and Performance Materials.
- Confirm the sustainability of the increased $0.58 quarterly dividend and ongoing share repurchases in light of debt and capital expenditure requirements.