Air Products & Chemicals, Inc. — Fiscal 2018 Second-Quarter Form 10-Q
Reporting period: Quarter and six months ended 31 March 2018; filed 26 April 2018. Results are primarily presented on a continuing-operations basis. The former Performance Materials Division and Energy-from-Waste segment are reported as discontinued operations.
Business Context
Air Products operates primarily through Industrial Gases segments in the Americas, EMEA, Asia, and Global operations, with additional Corporate and other activities. Fiscal 2018 growth was driven by higher volumes, new project onstreams, acquisitions, improved pricing in Asia, and favorable foreign-currency translation. The company completed five acquisitions during the first half, including air separation units serving customers in China.
Key Financial Metrics
| Metric | Q2 2018 | Q2 2017 | Change |
|---|---|---|---|
| Sales | $2,155.7 million | $1,980.1 million | Up 9% |
| Operating income | $455.4 million | $395.6 million | Up 15% |
| Operating margin | 21.1% | 20.0% | Up 110 basis points |
| Income from continuing operations attributable to Air Products | $416.4 million | $304.4 million | Up 37% |
| Diluted EPS from continuing operations | $1.89 | $1.39 | Up $0.50 |
| Adjusted EBITDA | $739.1 million | $651.9 million | Up 13% |
| Adjusted EBITDA margin | 34.3% | 32.9% | Up 140 basis points |
| Metric | Six months 2018 | Six months 2017 | Change |
|---|---|---|---|
| Sales | $4,372.3 million | $3,862.6 million | Up 13% |
| Operating income | $916.1 million | $723.9 million | Up 27% |
| Operating margin | 21.0% | 18.7% | Up 230 basis points |
| Income from continuing operations attributable to Air Products | $572.0 million | $556.0 million | Up 3% |
| Diluted EPS from continuing operations | $2.59 | $2.53 | Up $0.06 |
| Adjusted EBITDA | $1,474.0 million | $1,306.8 million | Up 13% |
Quarterly sales growth reflected 4% higher volume, 1% higher pricing, a 1% reduction from energy and natural-gas pass-through, and 5% favorable currency effects. The six-month increase reflected 8% volume growth, 1% pricing growth, and 4% favorable currency effects.
Cash provided by operating activities was $1,110.1 million for the first six months, compared with $861.2 million in the prior-year period. Capital expenditures were $572.5 million, and cash paid for acquisitions was $271.4 million. Cash used in investing and financing activities was $544.9 million and $815.6 million, respectively.
Cash and cash items totaled $3,066.9 million at 31 March 2018, compared with $3,273.6 million at 30 September 2017. Total debt was $3,566.5 million, down from $3,962.8 million, and represented 25.0% of total capitalization versus 28.0% at fiscal year-end. No borrowings were outstanding under the $2.5 billion revolving credit agreement, and the company reported compliance with its debt covenants.
Dividends declared increased to $1.10 per share from $0.95. Six-month dividends paid were $415.5 million. The company retained $485.3 million of share-repurchase authorization and made no share repurchases during the period.
Material Changes Versus the Prior Comparable Period
- Regional Industrial Gases performance improved, particularly in EMEA and Asia. Q2 sales increased 36% in EMEA and 28% in Asia; operating income increased 32% in both regions.
- Americas Q2 operating income was essentially flat, while the six-month operating income declined 2% because of higher planned maintenance and other costs.
- Industrial Gases–Global Q2 sales declined 53% and operating income declined 47%, primarily because of lower equipment-sale activity related to the Saudi Aramco Jazan project.
- No business separation or cost-reduction and asset-action charges were recorded in fiscal 2018, compared with $32.5 million of business separation costs and $60.3 million of cost-reduction and asset-action charges in the first six months of fiscal 2017.
- Reported six-month earnings benefited from the absence of prior-year discontinued-operation gains, but were reduced by provisional Tax Act effects. The prior-year period included a large after-tax gain from the sale of the Performance Materials Division.
- The Tax Act produced a six-month net expense of $239.0 million, including a $420.5 million deemed-repatriation and related tax expense, partly offset by a $214.0 million deferred-tax remeasurement benefit. The reported six-month effective tax rate increased to 37.2% from 23.3%.
Guidance, Outlook, Risks, and Unusual Items
Management expected fiscal 2018 capital expenditures of approximately $1.8 billion to $2.0 billion, including the Lu’An joint venture investment. The company stated that cash, operating cash flow, and commercial-paper-market access were expected to meet liquidity needs for the foreseeable future. The filing does not provide a clear consolidated revenue or EPS forecast.
On 26 April 2018, after the balance-sheet date, Air Products completed formation of a 60%-owned, consolidated joint venture with Lu’An Clean Energy in China. Air Products paid approximately $270 million and expected a further payment of approximately $230 million in the fourth quarter of 2018. The joint venture is expected to have approximately $1.3 billion of plant and equipment, subject to valuation.
Material exposures include approximately $6.5 billion of unconditional helium purchase obligations, primarily after fiscal 2022; environmental accruals of $81.0 million with estimated exposure of $80 million to $95 million; and a disputed Brazilian competition-law fine with a maximum possible loss of approximately $54 million plus interest. The filing states that an adverse outcome in the Brazilian matter was possible but not probable.
Other risks include foreign-exchange and interest-rate volatility, project execution and percentage-of-completion estimates, customer cancellations or contract terminations, energy and natural-gas prices, acquisitions, environmental and regulatory matters, and changes in tax law. A 10% currency movement would change the net liability position of financial instruments by approximately $330 million at 31 March 2018.
The Tax Act accounting remained provisional, with a one-year measurement period for finalization. The company also expects to adopt new revenue-recognition guidance in fiscal 2019 and is evaluating the future effects of lease, credit-loss, and other accounting standards.
Investor Verification Priorities
- Verify the final accounting for the Tax Act, including the $263.4 million noncurrent deemed-repatriation-tax liability and subsequent tax-audit settlements.
- Assess the cash requirements, valuation, consolidation effects, and operating contribution of the Lu’An joint venture and its expected fourth-quarter payment.
- Monitor execution, margins, and backlog conversion for major equipment projects, including the Jazan project; backlog was $317 million at 31 March 2018 versus $481 million at 30 September 2017.
- Evaluate whether higher volume growth and favorable currency effects offset rising operating, maintenance, incentive-compensation, and project-development costs.
- Review helium purchase commitments, environmental remediation estimates, Brazilian litigation, and other contingent liabilities.
- Distinguish GAAP results from management’s adjusted measures, particularly the effects of tax items, discontinued operations, and prior-year separation and restructuring charges.