Business Context and Reporting Period
Air Products and Chemicals, Inc. filed its Form 10-K for the fiscal year ended September 30, 2016. The company supplies atmospheric and process gases, gas-production equipment, LNG technology, helium systems, electronic materials, and performance materials in more than 50 countries. Its principal reporting segments were Industrial Gases–Americas, EMEA, Asia, Global, Materials Technologies, and Corporate and other.
The filing includes fourth-quarter results but primarily reports the full fiscal year. Energy-from-Waste was classified as a discontinued operation after the company committed to exit the business. Air Products completed the spin-off of Electronic Materials into Versum Materials on October 1, 2016, immediately after year-end, and had agreed to sell Performance Materials to Evonik for $3.8 billion, subject to closing conditions.
Financial Highlights
| Metric | Fiscal 2016 | Fiscal 2015 | Change |
|---|---|---|---|
| Sales | $9,524.4 million | $9,894.9 million | Down 4% |
| Operating income | $2,106.0 million | $1,708.3 million | Up 23% |
| GAAP operating margin | 22.1% | 17.3% | Up 480 basis points |
| Income from continuing operations attributable to Air Products | $1,515.3 million | $1,284.7 million | Up 18% |
| Diluted EPS from continuing operations | $6.94 | $5.91 | Up 17% |
| Net income attributable to Air Products | $631.1 million | $1,277.9 million | Down primarily due to discontinued operations |
| Adjusted EBITDA | $3,273.0 million | $2,984.1 million | Up 10% |
| Adjusted EBITDA margin | 34.4% | 30.2% | Up 420 basis points |
| Cash from operating activities | $2,707.4 million | $2,446.4 million | Up $261.0 million |
| Capital expenditures, GAAP | $1,055.8 million | $1,304.4 million | Down $248.6 million |
Fiscal fourth-quarter sales were $2,463.0 million and operating income was $547.0 million. Fourth-quarter diluted EPS from continuing operations was $1.84.
Net income was reduced by an $884.2 million after-tax loss from discontinued operations, primarily related to the Energy-from-Waste exit. The disposal included a $913.5 million impairment of plant assets and a $32.2 million liability for disposition and other costs.
Liquidity, Debt, and Capital Structure
- Cash and cash items were $1,501.3 million at September 30, 2016, compared with $206.4 million a year earlier.
- Working capital was positive $1,034.0 million, compared with negative $851.0 million in 2015.
- Total debt was $6,225.2 million, including $997.2 million of Versum debt that was on the consolidated balance sheet immediately before the spin-off. Debt represented 46.3% of total capitalization, versus 44.3% in 2015.
- Debt maturities included $371.3 million in fiscal 2017 and $419.4 million in fiscal 2018. The company had no borrowings under its $2.69 billion revolving credit facility at year-end and was in compliance with its debt covenants.
- Operating cash flow funded capital spending, dividends, and other needs. Dividends paid were $721.2 million, and dividends declared increased to $3.39 per share from $3.20.
- The company expected to use proceeds distributed by Versum to reduce debt, primarily commercial paper, in the first quarter of fiscal 2017.
Material Changes Versus the Prior Comparable Period
- Sales declined because 2% underlying growth was more than offset by unfavorable currency effects of 3% and lower energy and raw-material cost pass-through of 3%.
- Profitability improved substantially because of cost-reduction actions, lower operating and maintenance costs, lower pension expense, and favorable pricing net of energy and raw-material costs.
- Cost-reduction actions resulted in approximately 700 position eliminations and a $33.9 million charge in 2016, compared with a $207.7 million restructuring charge and approximately 2,000 position eliminations in 2015.
- Industrial Gases–Asia sales increased 5% and operating income increased 18%, supported by new plants and higher volumes. Industrial Gases–Americas and EMEA sales declined 9% each, although operating income increased because of cost improvements.
- Industrial Gases–Global sales increased 74%, primarily because of approximately $300 million of revenue recognized on the Jazan, Saudi Arabia equipment project. The project contributed approximately $20 million of favorable operating-income impact from changes in estimates, primarily in the fourth quarter.
- Materials Technologies sales declined 3%, while operating income increased 11% and operating margin rose to 26.3%.
- Equipment backlog declined to approximately $1.1 billion from $1.5 billion. Management expected 60% to 70% of the 2016 backlog to be recognized as fiscal 2017 revenue, subject to project execution schedules.
Outlook, Risks, Contingencies, and Unusual Items
Management’s fiscal 2017 priorities were bringing new industrial gas plants online, progressing the Jazan equipment project, and continuing cost reductions. Management expected continued weakness in new LNG equipment orders because of low oil and natural-gas prices. Fiscal 2017 earnings were expected to decline because of the Electronic Materials separation and potentially decline further if the Performance Materials sale became a discontinued operation.
- Energy-from-Waste exit costs of approximately $50 million to $100 million were expected in future periods.
- Additional legal and advisory costs related to the Versum spin-off and Performance Materials sale were expected in fiscal 2017.
- The company had approximately $13.2 billion of contractual obligations, including $5.3 billion of debt maturities, $5.3 billion of unconditional purchase obligations, and $1.2 billion of pension obligations. Approximately $4.0 billion of purchase obligations related to helium, including take-or-pay arrangements.
- Environmental liabilities were accrued at $81.4 million, with estimated exposure ranging from $81 million to a reasonably possible upper exposure of $95 million across approximately 33 sites.
- A Brazilian antitrust fine of approximately $55 million remained pending on appeal. Management considered an adverse final judgment possible but not probable and recorded no provision.
- The company provided bank guarantees of up to $311 million in support of the Jazan project; exposures were expected to decline as the project progressed.
- Pension obligations were materially underfunded: the net unfunded liability increased to approximately $1.2 billion, primarily because of lower discount rates. Fiscal 2017 pension expense and contributions were expected to increase.
- Principal risks included global economic weakness, customer and industry cyclicality, foreign-currency movements, energy and raw-material costs, interest rates, international operations, environmental and regulatory requirements, project execution, litigation, cybersecurity, competition, and the potential taxability of the Versum spin-off.
Most Important Facts for Investors to Verify
- Verify the post-spin-off treatment of Electronic Materials and the timing and final terms of the Performance Materials sale.
- Assess whether fiscal 2016 margin gains from cost reductions, pricing, and lower costs are sustainable after separation-related effects and portfolio changes.
- Reconcile reported debt and liquidity for Air Products after removing the $997.2 million of Versum debt included at September 30, 2016.
- Monitor execution, profitability, backlog conversion, guarantees, and estimate changes on the Jazan project.
- Evaluate the cash impact of Energy-from-Waste exit costs, pension funding, environmental obligations, purchase commitments, and potential litigation outcomes.
- Distinguish GAAP continuing-operations results from adjusted measures and from consolidated net income, which was significantly affected by the Energy-from-Waste discontinued-operation loss.