Air Products & Chemicals, Inc. — Fiscal 2016 Third-Quarter Form 10-Q
Business context and reporting period
Form 10-Q for the quarter and nine months ended 30 June 2016. Results primarily cover Industrial Gases, Materials Technologies, and Corporate and other. The Energy-from-Waste business was classified as discontinued operations following the decision to exit its two U.K. projects.
Financial performance and position
| Metric | Three months ended 30 June 2016 | Change vs. 2015 | Nine months ended 30 June 2016 | Change vs. 2015 |
|---|---|---|---|---|
| Sales | $2,434.4 million | Down 1% | $7,061.4 million | Down 5% |
| Operating income | $535.1 million | Up 26% | $1,559.0 million | Up 26% |
| Operating margin | 22.0% | Up 480 bp | 22.1% | Up 550 bp |
| Income from continuing operations attributable to Air Products | $355.7 million | Up 11% | $1,113.3 million | Up 19% |
| Diluted EPS from continuing operations | $1.63 | Up $0.15 | $5.11 | Up $0.79 |
| Adjusted EBITDA | $832.8 million | Up 10% | $2,418.3 million | Up 10% |
| Adjusted EBITDA margin | 34.2% | Up 340 bp | 34.2% | Up 470 bp |
GAAP net income attributable to Air Products was $346.8 million, or $1.59 diluted EPS, in the quarter and $237.1 million, or $1.09 diluted EPS, for the nine months. The nine-month result includes an $846.6 million after-tax loss from discontinued operations related to the Energy-from-Waste exit.
Gross margin for the quarter was 32.7%, up 210 basis points. Selling and administrative expense declined to $212.0 million, or 8.7% of sales, from 9.8% of sales in the prior-year quarter. The effective tax rate was 33.1% for the quarter and 28.3% year to date, including a $45.7 million tax expense associated with planned repatriation of South Korean earnings.
Cash provided by operating activities was $1,834.3 million for the first nine months, compared with $1,674.5 million in 2015. Capital expenditures were $797.3 million, and cash used for investing activities was $722.4 million. Cash used for financing activities was $650.8 million, including $534.9 million of dividends. Cash and cash items increased to $514.8 million from $206.4 million at 30 September 2015.
Total debt was $5,683.7 million at 30 June 2016, down from $5,879.0 million at 30 September 2015. Current borrowings and debt due within 12 months totaled $1,758.1 million, contributing to negative working capital of $280.1 million. The company had no borrowings under its $2,690.0 million revolving credit facility and was in compliance with its debt covenants. Debt represented 44.2% of total debt plus capitalization.
Material changes versus the prior comparable period
- Sales declined despite higher volumes because of lower energy-related contractual pass-through and unfavorable currency effects. Third-quarter underlying volume increased 4%; year-to-date underlying sales growth was 2%.
- Operating performance improved substantially, driven by operational improvements, lower incentive compensation, lower pension expense, cost reduction actions, and lower energy costs.
- Approximately 500 positions were eliminated through cost-reduction actions during the first nine months, compared with significantly higher restructuring charges in the prior year.
- Industrial Gases–Asia sales increased 7% in the quarter and operating income increased 17%; Industrial Gases–Americas and EMEA sales declined, but operating income increased 14% and 18%, respectively.
- Industrial Gases–Global sales increased 112% in the quarter and 73% year to date, largely from the Jazan, Saudi Arabia, equipment project. Approximately $100 million of third-quarter sales and $200 million year-to-date were recognized, with no profit recognized because of project risks.
- Materials Technologies sales declined 4% in the quarter and 6% year to date, while operating income increased 3% and 9%, respectively.
- The company entered into an agreement to sell Performance Materials to Evonik for $3.8 billion in cash plus assumed liabilities and continued preparations to spin off Electronic Materials as Versum Materials.
Outlook, commentary, risks, and unusual items
- Management expected approximately $1.2 billion of fiscal 2016 capital expenditures, fiscal 2016 pension contributions of approximately $80 million to $100 million, and additional Energy-from-Waste exit costs of $50 million to $100 million.
- The Energy-from-Waste disposal included a $913.5 million pretax asset write-down and related costs. Management stated that the estimated net realizable value had not materially changed as of 30 June 2016.
- The company expects additional pension settlement losses in the fourth quarter and additional costs from cost-saving initiatives.
- Sales backlog was $1.524 billion at 30 June 2016, down from $1.931 billion at 30 September 2015. Management cited continued weakness in energy markets and expected delays in new LNG project orders.
- Key risks include foreign currency and interest-rate volatility, energy and raw-material prices, customer demand and project delays, pricing pressure in Asian merchant markets, regulatory approval and execution of the Evonik sale and Versum spin-off, litigation, environmental remediation, and potential changes in tax or environmental law.
- The Brazilian competition matter carried a disclosed maximum possible loss of approximately $56 million plus interest, although management considered an adverse final judgment possible but not probable and recorded no provision. Environmental accruals totaled $82.7 million, with reasonably possible exposure estimated at $82 million to $96 million.
- On 21 July 2016, the board declared a fourth-quarter dividend of $0.86 per share, payable 14 November 2016.
Important facts for investors to verify
- Whether the $3.8 billion Performance Materials transaction receives regulatory approval and closes on expected terms.
- The timing, structure, tax consequences, and execution risk of the planned Versum Materials spin-off.
- Actual cash requirements and final costs associated with the Energy-from-Waste exit, including the indicated $50 million to $100 million of future exit costs.
- Profitability and cash collection of the Jazan equipment project, for which substantial sales were recorded without recognized profit because of project risks.
- Refinancing or repayment plans for the $1,758.1 million of short-term debt and debt maturing within 12 months, including the $350 million senior note due in the fourth quarter.
- Whether operational improvements and cost reductions offset lower volumes, currency pressure, energy pass-through declines, and weakness in LNG markets.
- Potential outcomes of the Brazilian competition case and changes in environmental remediation exposure.