Air Products & Chemicals, Inc. quarterly report, Q2 FY2013

Air Products & Chemicals, Inc. — Form 10-Q Summary

Business context and reporting period

Filed 25 April 2013 for the quarter and six months ended 31 March 2013. Air Products operates through Merchant Gases, Tonnage Gases, Electronics and Performance Materials, and Equipment and Energy. The interim financial statements are unaudited and should be read with the 2012 Form 10-K.

The Homecare business is presented as discontinued operations following the sale of approximately 80% of the business to The Linde Group. The remaining business, primarily in the United Kingdom and Ireland, was being marketed for sale, with management expecting completion by the end of fiscal 2013.

Financial performance and key metrics

Metric	Three months ended 31 March		Six months ended 31 March
	2013	2012	2013	2012
Sales	$2,484.2m	$2,344.3m	$5,046.6m	$4,665.8m
Operating income	$389.7m	$287.9m	$762.1m	$641.7m
Operating margin	15.7%	12.3%	15.1%	13.8%
Income from continuing operations attributable to Air Products	$289.3m	$279.0m	$566.2m	$504.9m
Diluted EPS from continuing operations	$1.37	$1.30	$2.67	$2.36
Net income attributable to Air Products	$290.4m	$296.0m	$568.7m	$544.1m

GAAP results benefited from the absence of the $86.8m second-quarter 2012 restructuring charge. On management’s non-GAAP comparable basis, second-quarter operating income increased 4% and diluted EPS from continuing operations increased 5%; six-month operating income increased 5% and diluted EPS increased 4%. The non-GAAP comparisons exclude specified restructuring and Spanish tax items.

Equity affiliates’ income was $39.8m in the quarter and $81.2m year to date, up 12% in each comparison, primarily due to improved performance at a Mexican equity affiliate. Interest expense increased to $35.2m in the quarter and $71.0m year to date, reflecting higher average debt balances partly offset by lower average interest rates.

Cash flow, liquidity, debt, and capital allocation

Six-month cash provided by operating activities was $598.2m, compared with $731.2m in 2012. The decline primarily reflected $238.9m of pension contributions versus $23.4m in the prior year and unfavorable working-capital changes.
Cash used for investing activities was $702.2m, including $707.3m of plant and equipment additions. Management’s non-GAAP capital expenditures, including capital-lease spending and purchases of noncontrolling interests, were $834.1m.
Cash provided by financing activities was $42.7m. Net borrowings provided $716.4m, while share repurchases used $461.6m and dividends used $268.9m.
Cash and cash items were $401.6m at 31 March 2013, including $388.4m held outside the United States. Management stated that operating cash flow and financing access were expected to meet liquidity needs for the foreseeable future.
Total debt increased to $5,981.2m from $5,291.9m at 30 September 2012. Debt represented 47.9% of total debt plus equity, versus 44.4% at fiscal year-end. Short-term borrowings were $1,239.8m and long-term debt, including the current portion, was $4,741.4m.
The company issued a $400.0m senior note bearing 2.75% interest and maturing in February 2023. A €300m, or approximately $385m, Eurobond maturing in November 2013 was classified as long-term debt because refinancing capacity was available.
The company had a $2,170.0m committed multicurrency credit facility maturing in June 2015, with no borrowings outstanding under that facility at 31 March 2013. Management reported compliance with applicable debt covenants.
Air Products repurchased 5.7 million shares for $461.6m during the first six months, leaving $485.3m of authorization. The quarterly dividend increased 11% to $0.71 per share, representing the 31st consecutive annual increase.

Material changes versus the prior comparable period

Reported second-quarter sales increased 6% and six-month sales increased 8%, but underlying second-quarter sales declined 2% because volumes fell 2% and pricing was flat. Acquisitions, principally Indura and DA NanoMaterials, contributed 6% in the quarter and 7% year to date.
Merchant Gases second-quarter sales increased 14% and operating income increased 10%, largely due to the Indura acquisition and cost reductions, although the operating margin declined 50 basis points to 16.8% because of acquisition mix and lower volumes.
Tonnage Gases second-quarter sales rose 3%, while operating income fell 2% and margin declined 80 basis points. Six-month operating income increased 10% and margin improved 40 basis points.
Electronics and Performance Materials second-quarter sales declined 3%, operating income declined 9%, and margin declined 100 basis points due primarily to lower volumes. Six-month operating income declined 15% and margin declined 220 basis points, including an unfavorable inventory revaluation effect.
Equipment and Energy sales increased 12% in the quarter and 15% year to date, driven by LNG project activity. The equipment backlog declined to $326m at 31 March 2013 from $450m at 30 September 2012.
Income from discontinued operations fell to $1.1m in the quarter and $2.5m year to date, versus $17.0m and $39.2m, respectively, in 2012, reflecting the Homecare divestiture.
The effective tax rate was 24.3% in both the second quarter and first six months of 2013, compared with 3.0% and 20.8% in the corresponding 2012 periods. Prior-year results included a $58.3m benefit from a Spanish tax ruling, a $43.8m Spanish tax settlement expense, and restructuring-related tax effects.

Outlook, commentary, risks, contingencies, and unusual items

Management described the financial position as strong and expected operating cash flow and financing activities to satisfy foreseeable liquidity requirements. No formal earnings guidance is provided in the filing text.
The 2012 restructuring and cost-reduction program was substantially complete at 31 March 2013. Remaining accrued severance and other benefits were expected to be paid primarily in the third quarter of fiscal 2013; the remaining restructuring accrual was $149.1m.
The company is dismantling the Pasadena, Texas polyurethane intermediates facility, with completion expected in fiscal 2014. A separate long-term take-or-pay silane contract termination negotiation remained unresolved; the filing states that any settlement was not expected to be material to financial position, although timing and amount were uncertain.
Air Products was appealing an approximately $89m Brazilian competition-law fine, plus accrued interest. Management assessed an adverse final judgment as reasonably possible but not probable and recorded no provision.
Environmental accruals totaled $86.8m, with estimated exposure ranging from $86m to a reasonably possible upper exposure of $100m. The obligations include approximately 34 sites and may be paid over as long as 30 years.
Indura shareholders held a put option covering up to 30.5% of Indura beginning 1 July 2015. Redeemable noncontrolling interest was $398.7m at 31 March 2013. Air Products also had an obligation to purchase an additional 2% of Indura no later than 3 November 2013, for which an $11m liability was recorded.
Key risks identified by management include global economic weakness, demand and customer concentration, project cancellations, pricing and raw-material recovery, supply interruptions, foreign-exchange and interest-rate changes, acquisitions and divestitures, litigation, environmental obligations, regulatory changes, tax-rate volatility, and the execution of productivity programs.
Foreign-currency forward contracts had aggregate notional value of $2,556.1m at 31 March 2013. Derivative agreements could require collateralization if credit ratings fall below specified thresholds; no collateral was posted at the reporting date.

Important facts for investors to verify

Reconcile reported growth with underlying volume and pricing trends, particularly the contribution from Indura, DA NanoMaterials, energy pass-through, and discontinued Homecare operations.
Assess whether the lower non-GAAP operating margin and weaker Electronics and Performance Materials performance represent continuing pressure or temporary effects.
Monitor leverage, the elevated short-term borrowing balance, refinancing of the November 2013 Eurobond, and compliance with debt covenants.
Evaluate cash conversion after unusually high pension contributions, capital spending, dividends, and share repurchases.
Track the timing and proceeds of the remaining Homecare divestiture and the potential Indura minority-interest put option.
Review developments in the Brazilian fine appeal, environmental remediation estimates, and the unresolved silane contract settlement.
Confirm subsequent filings for changes in guidance, backlog, acquisition integration, restructuring payments, and foreign-currency or interest-rate exposures.