Business Context and Reporting Period
Air Products and Chemicals, Inc. filed this unaudited Form 10-Q on 24 July 2014 for the fiscal quarter and nine months ended 30 June 2014. The company operates through Merchant Gases, Tonnage Gases, Electronics and Performance Materials, and Equipment and Energy.
Results benefited from volume growth in Merchant Gases and Electronics and Performance Materials, while Tonnage Gases remained pressured by maintenance costs and the completed exit from the polyurethane intermediates business.
Key Financial Metrics
| Metric | Three Months Ended 30 June 2014 | Prior Year | Nine Months Ended 30 June 2014 | Prior Year |
|---|---|---|---|---|
| Sales | $2,634.6 million | $2,547.3 million | $7,762.0 million | $7,593.9 million |
| Operating income | $413.8 million | $383.1 million | $1,184.1 million | $1,145.2 million |
| Operating margin | 15.7% | 15.0% | 15.3% | 15.1% |
| Income from continuing operations attributable to Air Products | $314.0 million | $287.8 million | $884.6 million | $854.0 million |
| Diluted EPS from continuing operations | $1.46 | $1.36 | $4.12 | $4.03 |
| Interest expense | $31.3 million | $35.4 million | $96.1 million | $106.4 million |
| Effective tax rate | 24.0% | 24.0% | 24.1% | 24.2% |
Third-quarter net income attributable to Air Products was $314.0 million, or $1.46 diluted EPS. Nine-month net income attributable to Air Products was $887.7 million, or $4.13 diluted EPS, including $3.1 million of discontinued-operations income.
Operating cash flow for the first nine months was $1,584.0 million, compared with $1,051.2 million in the prior-year period. Capital expenditures were $1,264.9 million, producing cash used in investing activities of $1,230.1 million. Cash used in financing activities was $482.7 million, primarily reflecting dividends and net debt repayments. Ending cash was $337.6 million, down from $450.4 million at 30 September 2013.
At 30 June 2014, total debt was $6,136.0 million, down from $6,273.6 million at fiscal year-end. Debt represented 42.8% of total debt and capitalization, compared with 45.3% at 30 September 2013. Long-term debt, including the current portion, had a carrying value of $5,020.8 million and a fair value of $5,258.0 million.
The company amended its revolving credit facility to increase capacity from $2,500.0 million to $2,595.0 million. No borrowings were outstanding under the facility at quarter-end, and the company was in compliance with its debt covenants. Management reported continued access to commercial paper markets and expects operating cash flow and financing activities to meet liquidity needs for the foreseeable future.
Material Changes Versus Prior Comparable Period
- Third-quarter sales increased 3%, driven by 2% volume growth and 1% higher pricing. Nine-month sales increased 2%, including a 1% benefit from energy and raw-material cost pass-through.
- Third-quarter operating income increased 8% and operating margin expanded 70 basis points. Nine-month operating income increased 3% and margin expanded 20 basis points.
- Third-quarter continuing-operations income increased 9%, while diluted EPS increased 7%. Nine-month continuing-operations income increased 4% and diluted EPS increased by $0.09.
- Electronics and Performance Materials was the strongest segment: third-quarter sales increased 9%, operating income increased 23%, and margin increased to 17.3%; nine-month operating income increased 32% and margin increased to 16.6%.
- Merchant Gases third-quarter operating income increased 5%, but nine-month operating income declined 4% because of higher power and fuel costs, lower raw-material cost recovery, adverse currency effects, and a prior-year equity-affiliate gain.
- Tonnage Gases third-quarter sales declined 1% and operating income declined 2%; nine-month sales declined 3% and operating income declined 9%, primarily because of maintenance costs, lower volumes, and the PUI exit.
- Equipment and Energy backlog increased to $584 million at 30 June 2014 from $402 million at 30 September 2013, primarily from new LNG orders.
- Operating cash flow increased substantially, partly because prior-year cash contributions to pension plans were unusually high. Fiscal 2014 pension contributions are expected to be approximately $80 million to $100 million, compared with $300.8 million in fiscal 2013.
- The quarterly dividend increased 8% from $0.71 to $0.77 per share, representing the 32nd consecutive year of dividend increases. No shares were repurchased during the first nine months of fiscal 2014.
Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide a specific quantitative earnings or sales forecast. Management stated that it continues to evaluate the company’s strategy and portfolio, and that future actions could materially affect operating profit.
- Management expects pension settlements in the fourth quarter of fiscal 2014.
- The company settled a $144 million contingent liability related to the prior Homecare sale on 17 July 2014, after the reporting date. The remaining Homecare business was sold in the first quarter of fiscal 2014, with a $2.4 million gain.
- An operations guarantee related to assigned Homecare contracts has a maximum potential payment of approximately $34 million, with exposure extinguishing by 2020.
- A Brazilian competition-law fine of approximately $81 million was dismissed on appeal, but the Brazilian competition authority appealed. No provision was recorded because an adverse final judgment was not considered probable.
- Environmental liabilities were accrued at $84.9 million, with estimated exposure ranging from $84 million to a reasonably possible upper exposure of $98 million. Remediation obligations may extend for up to 30 years.
- The company retained a $31.2 million accrued balance under its 2013 restructuring plan at 30 June 2014. The plan primarily addressed weakness in photovoltaic and LED markets, weaker conditions in Europe and Asia, and organizational changes.
- Key forward-looking risks include global economic conditions, customer project delays or cancellations, competitive pricing, raw-material and natural-gas costs, foreign currency and interest-rate movements, litigation and regulatory matters, environmental obligations, acquisitions and divestitures, tax-rate changes, and asset impairments.
- A 100-basis-point increase in interest rates would decrease the net liability position of financial instruments by approximately $190 million; a 10% strengthening of an entity’s functional currency would decrease that position by approximately $352 million.
Most Important Facts for Investors to Verify
- Whether Electronics and Performance Materials’ volume growth and restructuring benefits are sustainable after the recovery in electronics and performance-materials demand.
- Whether Tonnage Gases maintenance costs, PUI-related volume losses, and Merchant Gases power, fuel, and currency pressures continue into future periods.
- The company’s ability to refinance $400 million of commercial paper and the $411 million Eurobond maturing in March 2015.
- The timing and cash impact of expected fourth-quarter pension settlements and the remaining restructuring payments.
- The ultimate outcome and potential interest cost of the Brazilian competition matter and the range of environmental remediation obligations.
- Whether the $584 million Equipment and Energy backlog converts into revenue and cash flow as expected.
- The effect of the 17 July 2014 Homecare liability settlement and the remaining operations guarantee.
- Future capital spending, dividend commitments, share repurchases, and the company’s ability to maintain liquidity while funding international investment plans.