Air Products & Chemicals, Inc. — Fiscal 2019 Q3 Form 10-Q
Business context and reporting period
Air Products operates regional industrial gases businesses in the Americas, EMEA, and Asia, along with global industrial-gas equipment and other equipment businesses. The filing covers the three and nine months ended 30 June 2019, compared with the corresponding 2018 periods. The financial statements are unaudited and fiscal 2019 reflects adoption of the new revenue standard under the modified retrospective method.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Sales | $2,224.0 million | $2,259.0 million | $6,635.7 million | $6,631.3 million |
| Operating income | $569.7 million | $515.8 million | $1,541.2 million | $1,431.9 million |
| Operating margin | 25.6% | 22.8% | 23.2% | 21.6% |
| Income from continuing operations attributable to Air Products | $488.0 million | $430.7 million | $1,256.8 million | $1,002.7 million |
| Diluted EPS from continuing operations | $2.20 | $1.95 | $5.68 | $4.54 |
| Adjusted EBITDA | $891.6 million | $819.5 million | $2,511.3 million | $2,293.5 million |
| Adjusted EBITDA margin | 40.1% | 36.3% | 37.8% | 34.6% |
Net income attributable to Air Products was $488.0 million, or $2.20 diluted EPS, in the quarter and $1,256.8 million, or $5.68 diluted EPS, for nine months. The 2018 comparable periods included discontinued-operations income of $43.2 million in the quarter and $42.2 million for nine months; 2019 had no discontinued-operations income.
Cash provided by operating activities was $2,003.4 million for the first nine months, compared with $1,856.2 million in 2018. Investing activities used $1,435.5 million, including $1,507.6 million of plant and equipment additions. Financing activities used $660.8 million, including $738.4 million of shareholder dividends. Capital expenditures, including acquisitions and investments in unconsolidated affiliates, were $1,630.3 million.
Cash and cash items were $2,696.8 million at 30 June 2019, compared with $2,791.3 million at 30 September 2018. Total debt was $3,819.7 million, or 24.6% of total capitalization, versus $3,812.6 million and 25.4%, respectively, at fiscal year-end. The company had no borrowings under its $2.3 billion revolving credit agreement and was in compliance with its debt covenants. Foreign cash and cash items totaled $1,091.4 million.
Material changes versus the prior comparable period
- Third-quarter sales decreased 2%, despite 6% underlying growth, primarily because of unfavorable currency effects, lower energy and natural-gas pass-through, and a modification of an Indian hydrogen contract to a tolling arrangement.
- Nine-month sales were essentially flat; favorable pricing, volumes, and energy pass-through offset currency headwinds and the Indian contract modification.
- Operating income increased 10% in the quarter and 8% for nine months. Pricing, net of power and fuel costs, was the principal benefit, while currency, higher operating costs, the facility closure, and cost-reduction charges were offsets.
- Asia was the strongest regional contributor. Q3 Asia sales increased 9% and operating income increased 25%, supported by the Lu’An project, pricing, and volume growth. EMEA sales declined 12% in the quarter and 8% for nine months, mainly because of the Indian contract modification and currency.
- Industrial Gases–Global sales declined 43% in the quarter and 46% for nine months as equipment activity on the Jazan project declined while the project approached completion.
- The effective tax rate declined to 17.9% in Q3 from 19.4% and to 21.3% for nine months from 30.6%, mainly because of prior-year Tax Act effects, a non-taxable gain, and other tax determinations.
Guidance, outlook, management commentary, risks, and unusual items
- Management expects fiscal 2019 capital expenditures of approximately $2.4 billion to $2.5 billion. Sales backlog at 30 June 2019 was $624 million, compared with $204 million at 30 September 2018.
- Remaining performance obligations were estimated at approximately $14 billion; about half was expected to be recognized over approximately five years, with the balance thereafter. Actual amounts may vary because of inflation, currency movements, contract terminations, renewals, and other events.
- Management expects to complete the Jazan project in 2019. The project’s lower equipment activity reduced current-period sales and operating income.
- Q3 included a $25.5 million pretax charge for severance and other benefits associated with eliminating or planning to eliminate approximately 300 positions. The remaining accrual was $20.6 million at 30 June 2019.
- Nine-month results included a $29.0 million charge related to the government-enforced environmental shutdown of a customer facility; management does not expect additional charges from that shutdown.
- The company recorded a $29.1 million nontaxable gain from exchanging its 50% interest in High-Tech Gases for the remaining 50% interest in WuXi, resulting in 100% ownership of WuXi. It also acquired ACP Europe SA for $106.3 million net of cash acquired.
- The quarterly dividend was increased 5% to $1.16 per share, or $4.64 annually. No shares were repurchased during the first nine months; $485.3 million remained under the repurchase authorization.
- Key risks include global economic and demand conditions, project delays or cancellations, international political and regulatory developments, tariffs and sanctions, energy and raw-material costs, foreign-exchange and interest-rate volatility, cybersecurity, environmental and climate regulation, legal proceedings, facility or pipeline damage, acquisitions and integration, and execution of backlog and productivity programs.
- A Brazilian competition-law matter involved a possible fine of approximately $47 million plus interest; the company has prevailed at an earlier appellate stage, believes an adverse final judgment is not probable, and has recorded no provision. Environmental liabilities were accrued at $71.1 million, with reasonably possible exposure estimated at $71 million to $84 million.
Most important facts for investors to verify
- Whether pricing and volume growth can offset currency pressure, the Indian tolling-contract impact, and the expected reduction in Jazan equipment activity.
- The sustainability of improved margins after excluding the cost-reduction charge, facility-closure charge, and WuXi exchange gain.
- Execution of the $2.4 billion to $2.5 billion fiscal-year capital expenditure plan and conversion of the $624 million equipment backlog.
- Cash generation relative to capital spending, dividends, acquisitions, and the company’s foreign-cash reinvestment strategy.
- Progress and final costs associated with the 300-position reduction program, environmental remediation obligations, the Brazilian litigation, and the Lu’An related-party debt and payment obligations.
- The impact of future accounting changes, particularly the fiscal 2020 lease standard, and any additional Tax Act adjustments or tax examinations.