APD

Business Context and Reporting Period

Company: Air Products & Chemicals, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2005
Business Overview: The company operates in three primary segments: Gases, Chemicals, and Equipment. The Gases segment is the largest contributor to revenue and operating income. The reporting period reflects the first quarter of fiscal year 2006.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Sales increased 5% year-over-year, driven by a 6% increase from natural gas/raw material cost pass-throughs, 4% from volume growth (primarily in Gases), and 1% from pricing in Chemicals. This was partially offset by a 3% decrease due to Hurricanes Katrina and Rita and a 2% decrease from unfavorable currency effects.
• Operating Income: Increased 6% to $252.2 million. Key drivers included volume growth in Gases ($43M benefit), pricing in Chemicals ($15M benefit), and a $10M gain from a land sale in Europe. These were offset by a $20M negative impact from hurricanes, $12M in share-based compensation expense (due to SFAS 123R adoption), and $11M from lower electronic specialty material pricing.
• Segment Performance:
  • Gases: Sales up 8%; Operating income up 4%. Volume growth in Electronics and Asia offset hurricane impacts.
  • Chemicals: Sales down 4%; Operating income down 4%. Declines were due to volume losses from customer shutdowns/terminations and hurricane impacts, partially mitigated by price increases.
  • Equipment: Sales up 5%; Operating income up 170% (from $6.0M to $16.2M), driven by LNG heat exchanger sales.
• Cash Flow: Operating cash flow decreased 23% to $271.9 million, primarily due to working capital changes, including $80.0 million used for inventory rebuilding and $73.6 million used for payables (driven by $102.9 million in pension contributions).

Guidance, Outlook, and Risks

• 2006 Outlook: Management expects a strong year-on-year improvement for the full year.
  • Gases: Margins expected to improve in the second half. EPI volumes expected to return to growth in Q2. EPI revenues forecast to grow >25% in 2006.
  • Chemicals: Annual profits expected to be lower than 2005 due to the loss of two major contracts in the Polyurethane Intermediate (PUI) business.
  • Equipment: Backlog at a record high of $690 million.
• Capital Expenditures: Expected to range between $1,200 million and $1,300 million for 2006.
• Accounting Changes: Adoption of SFAS No. 123R (Share-Based Payment) effective Oct 1, 2005, is expected to reduce diluted EPS for the full year by approximately $0.13.
• Risks and Contingencies:
  • Hurricanes: Continued impact from Katrina and Rita on Gulf Coast facilities, though recovery is underway.
  • Supplier Risk: A long-term sulfuric acid supplier emerged from Chapter 11; the company has provided $94.4 million in loans. Failure of this supplier could materially impact the Chemicals segment.
  • Market Risks: Sensitivity to foreign currency exchange rates and interest rate fluctuations.

Investor Verification Checklist

• Hurricane Recovery: Verify the timeline for full operational restoration of Gulf Coast facilities and the finality of insurance recoveries ($25M received to date).
• Chemicals Segment Strategy: Monitor management's analysis of options for the PUI business and the financial health of the sulfuric acid supplier.
• Share-Based Compensation Impact: Confirm the full-year EPS impact of SFAS 123R adoption against the estimated $0.13 reduction.
• Working Capital Trends: Assess if the $80M inventory increase is a one-time rebuild or a structural change in inventory management.
• Debt Levels: Review the increase in total debt to $2.6 billion and the utilization of the $700 million revolving credit facility.