Air Products and Chemicals, Inc. — Fiscal 2015 Third-Quarter Form 10-Q
Business context and reporting period
Air Products and Chemicals is a global industrial gases and materials technologies company. The filing covers the three and nine months ended June 30, 2015, compared primarily with the corresponding 2014 periods. Reporting segments include Industrial Gases—Americas, EMEA, Asia and Global, Materials Technologies, Energy-from-Waste, and Corporate and other. The company adopted a new segment structure effective October 1, 2014, with prior periods restated.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | First 9 months 2015 | First 9 months 2014 |
|---|---|---|---|---|
| Sales | $2,470.2 million | $2,634.6 million | $7,445.5 million | $7,762.0 million |
| Operating income | $422.5 million | $413.8 million | $1,226.9 million | $1,184.1 million |
| Operating margin | 17.1% | 15.7% | 16.5% | 15.3% |
| Net income attributable to Air Products | $318.8 million | $314.0 million | $933.4 million | $887.7 million |
| Diluted EPS | $1.47 | $1.46 | $4.30 | $4.13 |
| Adjusted EBITDA | $757.7 million | $695.9 million | $2,189.5 million | $1,998.1 million |
| Adjusted EBITDA margin | 30.7% | 26.4% | 29.4% | 25.7% |
Q3 underlying sales increased 4%, comprising volume growth of 3% and pricing growth of 1%, but reported sales declined 6% because of a 6% unfavorable currency effect and a 4% reduction in energy and raw-material cost pass-through. Nine-month underlying sales also increased 4%, offset by 5% currency headwinds and 3% lower pass-through.
Cash provided by operating activities for the first nine months was $1,657.9 million, versus $1,584.0 million in 2014. Cash used for investing was $1,239.0 million, including $1,214.7 million of plant and equipment additions. Cash used for financing was $528.7 million, including $503.4 million of shareholder dividends. Cash and cash items declined to $215.3 million from $336.6 million at September 30, 2014.
Total debt was $5,863.2 million at June 30, 2015, down from $6,118.5 million at September 30, 2014. Debt represented 42.3% of total debt and capitalization, compared with 43.9% at the prior fiscal year-end. The company had no borrowings under its $2,405.0 million revolving credit facility and was in compliance with its debt covenants. The facility matures April 30, 2018 and includes a maximum total-debt-to-total-capitalization covenant of 70%.
The quarterly dividend increased 5% to $0.81 per share, representing the 33rd consecutive year of dividend increases. Fiscal 2015 pension contributions are expected to be approximately $130 million to $150 million; $119.2 million had been contributed through June 30.
Material changes versus the prior comparable period
- Reported profitability improved despite lower sales: Q3 operating income rose 2%, net income rose 2%, and diluted EPS rose 1%; nine-month operating income rose 4%, net income rose 6%, and diluted EPS rose 4%.
- Reported margins benefited from higher volumes, pricing, lower energy and operating costs, and cost-reduction actions. Q3 GAAP operating margin expanded 140 basis points; nine-month margin expanded 120 basis points.
- On a non-GAAP basis, Q3 operating income increased 17% and adjusted EBITDA increased 9%; nine-month operating income increased 16% and adjusted EBITDA increased 10%.
- Industrial Gases—Asia and Materials Technologies were the strongest contributors. Q3 Asia sales rose 14% and operating income rose 20%; Materials Technologies sales rose 3% and operating income rose 36%.
- Industrial Gases—EMEA sales declined 15% in Q3, principally because of currency, while operating income increased 2%. Industrial Gases—Global reported an operating loss of $24.1 million, versus a $14.4 million loss in the prior-year quarter.
- The company recorded $58.2 million of Q3 and $146.0 million of year-to-date restructuring and cost-reduction charges, including actions associated with approximately 1,500 eliminated positions. The Q3 charge included $35.7 million for asset and contract actions related to product-line exits.
- The company recorded a $14.2 million year-to-date pension settlement loss and a $17.9 million gain on the remeasurement of a previously held equity interest following the acquisition of a North American joint-venture interest.
- Sales backlog increased to $2,101 million at June 30, 2015, from $520 million at September 30, 2014, primarily due to a Saudi Arabia industrial-gas facility contract.
Outlook, risks, contingencies, and unusual items
Management stated that cash flows from operations and financing activities were expected to meet liquidity needs for the foreseeable future and that the company continued to have access to commercial paper markets. The filing does not provide a clear quantitative full-year earnings guidance figure. Management expects additional pension settlement losses and curtailment charges in the fourth quarter and additional restructuring charges as specific actions are approved.
In the third quarter, Air Products entered a 25%-owned Saudi Arabian joint venture to supply oxygen and nitrogen to Saudi Aramco’s Jazan refinery and power project. The company expects to invest approximately $100 million, guaranteed repayment of its 25% share of an equity bridge loan with maximum exposure of approximately $100 million, and expects to provide bank guarantees of up to $326 million under the associated equipment contract.
The Energy-from-Waste projects in the United Kingdom remained under construction and experienced technical challenges and on-stream delays. Future actions and assessments could affect the investment’s disposition.
Key risks include foreign-exchange volatility, global and regional economic conditions, customer demand and project cancellations, energy and raw-material prices, the ability to recover costs through pricing, competition, litigation and regulatory investigations, environmental obligations, political risks, impairment risk, and execution of restructuring and productivity initiatives.
Environmental accruals totaled $82.5 million at June 30, 2015, with estimated exposure ranging from $82 million to a reasonably possible upper exposure of $95 million. A Brazilian competition matter remains pending on appeal; the maximum potential fine was approximately $58 million plus interest, although management concluded an adverse final judgment was not probable and recorded no provision.
After quarter-end, in July 2015, the company completed its purchase of the remaining 30.5% interest in Indura S.A. for $278 million, funded with commercial paper. This eliminated the redeemable noncontrolling interest balance.
Important facts for investors to verify
- Reconcile GAAP results with management’s non-GAAP measures and assess the recurring nature of the $146.0 million year-to-date restructuring charges.
- Evaluate the sustainability of margin expansion after separating cost reductions, energy pass-through effects, currency movements, and unusual items.
- Monitor foreign-exchange exposure, particularly in EMEA and Latin America, and the potential effect of further currency changes on sales and earnings.
- Review the Saudi Arabia joint venture, $100 million loan guarantee exposure, $326 million bank guarantees, expected investment, and backlog conversion timing.
- Assess liquidity after the post-quarter-end $278 million Indura acquisition and related commercial-paper funding.
- Track Energy-from-Waste construction delays, future investment decisions, and potential impairment exposure.
- Review pension funding requirements and anticipated fourth-quarter settlement and curtailment charges.
- Consider environmental liabilities, the Brazilian competition proceeding, and other litigation or regulatory contingencies disclosed in the filing.