Air Products and Chemicals Inc (APD) 2005 Q1 法說會逐字稿

Good morning and welcome to the Air Products and Chemicals first quarter earnings release conference call.

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Beginning today's call is Mr. Phil Sproger, Director of Investor Relations.

Mr. Sproger, you may begin.

Thank you, Angela, and I apologize for starting a bit late.

We were just waiting for some people to sign on.

Welcome everyone, to the Air Products and Chemicals earnings teleconference.

I am Phil Sproger, Director of Investor Relations.

Today our CFO, Paul Huck, and I will review our first quarter results.

We issued our press release this morning, and it is available on our website along with the slides for this teleconference.

Please go to airproducts.com and click on the scrolling red banner to access the materials.

Like last year, we have included an appendix on the slide material with additional detailed information.

Instructions for accessing the replay of this call beginning at 2:00 P.M. eastern time are also available on the website.

Please turn to slide 2.

As always today's teleconference will contain forward-looking statements based on current expectations regarding important risk factors.

Please review the Safe Harbor language on the slide at the end of the earnings release.

Now, please turn to slide 3 and I'll turn the call over to Paul.

Thank you, Phil and thank you for joining us today.

Let me first review the quarter's highlights.

Sales grew by 18 percent, almost $2 billion this quarter, driven by our growth performance.

Over two-thirds of our revenue growth this quarter is from these businesses: refinery hydrogen, electronics, healthcare, performance materials, and Asia.

Our leadership positions in these businesses continue to set us apart.

I am pleased to report that ARONA, our return on capital measure, again improved to 9.7 percent on a four-quarter basis.

This is 100 basis points higher than it was a year ago and we are confident that our positions in our growth markets, our focus on productivity, our efforts to continue loading our existing asset base, and maintaining capital discipline, are the keys to achieving our 13 percent ARONA goal in fiscal 2007.

Our earnings per share this quarter are $0.72, an increase of 24 percent versus prior year and exceeded our guidance range.

This is the fourth consecutive quarter we have posted 20 percent plus earnings per share increases.

This shows that our strategies are working; however, we are not done.

We continue to make solid progress in loading our production facilities.

Meanwhile, our productivity initiatives are on schedule to drive significant improvement.

Operating results in our gases businesses were strong, with total sales up 20 percent.

Operating income also improved to record levels.

Volume growth in chemicals was a solid 6 percent year-on-year, however challenges in this segment continued this quarter.

Rising feed stock cost once again outpaced our price increases and plant operating costs were higher due to planned turnarounds.

This results in our operating income being down.

Phil will provide more details later.

In equipment, profits grew and I'm happy to report that we received two LNG heat exchange orders for our new Apex technology in fiscal Q1.

This Monday we announced the first order and hope to announce the details of the second one soon.

This proprietary technology can increase the capacity of a single LNG train by 50 percent.

We are a leader in this business and we continue to innovate to sustain our competitive advantage.

Our operating and free cash flows remain strong and this is reflected in our cash balance.

We remain disciplined in our capital spending, investing where we can further build our leadership positions.

Overall, we are pleased with our progress in a number of areas, but we still have a lot of work to do.

One of the areas we must improve is chemicals.

We took actions this quarter that laid the foundation for a rebound in the business in the second quarter.

We finally received the methanol source from Trinidad.

After a long regulatory process we finally sold our EM&D business, and we have gotten more aggressive on pricing to cover our increased raw material costs.

Additionally, in all of our businesses we are continuing to load our assets and drive productivity efforts by reaping the benefits of our SAP investment.

Now turn to the quarter results on slide 4.

Today Air Products reported net income of $167 billion, or diluted earnings per share of $0.72 for the quarter ended December 31.

Net income increased by 27 percent and diluted EPS was up 24 percent when compared with the prior year.

Once again, solid proof that performance gains are reaching the bottom line as we execute our strategies.

Strong volume gains drove the results again this quarter.

Now let me talk about the factors that affected the quarter's performance in terms of earnings per share.

Higher volumes broadly across gases, chemicals and equipment, contributed $0.18 Pricing in raw material costs together were a negative $0.04.

Electronic prices and chemicals/raw materials were unfavorable and were slightly offset by higher gas pricing in the U.S. and Europe.

Other costs were higher by $0.05.

This increase accessed of higher compensation costs.

Productivity gains offset the impact of inflation.

Equity performed with broadly contributed $0.02 to our overall results.

Currency added $0.03 to the quarter as the dollar was weaker year-on-year against most of the major currencies.

All other factors are small.

The total is a $0.14 increase over the first quarter of fiscal 2004.

Now please turn to our financials on slide 5.

As I said earlier, record sales of $2 billion were up 18 percent from prior year.

Adjusting for currency, natural gas and acquisitions and divestitures, we generated strong underlying sales growth up 11 percent.

This is due to higher volumes across our gross businesses.

A detailed sales analysis is included in the appendix.

Sequentially, our revenues were up 1 percent on higher natural gas and raw materials pass throughs and favorable currency effects.

These were offset by seasonally-lower volumes.

SG&A costs increased by approximately $20 million due to acquisitions, currency, and costs to achieve our future productivity.

For the quarter, we turned the quarter on SG&A as productivity gains offset inflation.

This is important because when we were implementing SAP over the past two years we were not doing this.

Once again, another sign of progress.

On a percentage of sales basis, SG&A was 12.7 percent, 1 percent lower than it was last year.

Operating income of $238 million was up 20 percent from prior year, principally driven by volume gains.

Versus prior year, our net income and EPS grew 27 percent and 24 percent respectively.

And, most importantly, we continue to improve our return on capital.

ARONA stands at 9.7 percent versus 8.7 percent last year.

On the balance sheet, receivables were up 20 percent versus prior year, due to acquisitions, currency, and a higher level of business activity.

Our DSO was 69 days at the end of the quarter, up one day from prior year.

Receivables will remain an area of focus for improvement in fiscal year 2005, as we continue to make our processes more efficient and drive down DSO.

Now I'll turn the call over to Phil to review our business segment results.

Thanks, Paul.

Please turn to slide 6, Gases Segment.

World wide gases sales of $1.4 billion were up 20 percent compared to prior year, with volume accounting for about 60 percent of this growth.

This was primarily driven by higher volumes in electronics and energy and process industries.

Sequentially, gases sales are up 3 percent due to natural gas pass through and currency.

Gases operating income of $220 million was up 21 percent from the prior year on higher volumes.

Segment operating margin of 15.2 percent was up slightly from last year.

This quarter's margin was unfavorably impacted by the contractual pass through of higher natural gas and productivity implementation costs.

If we adjust for these two items, gases operating margin is 1 percent higher, or 16.2 percent.

This shows that the actions we are taking are producing operating leverage and improved returns on capital in gases.

Now a few highlights by major businesses.

Please turn to slide 7.

In electronics, we continue to see strong business activity broadly, with sales up 20 percent year-on-year.

Excluding equipment, sales were up 12 percent.

Sequentially, revenue declined on particularly strong equipment sales in Q4 of 2004.

Specialty material sales were essentially flat versus prior quarter.

Overall, at the operating income level, volume growth more than offset average pricing decline.

Given our leading market position we continue to see strong year-on-year volume growth.

Volumes for several major specialty products were up 20 percent or more.

For the quarter, fabulization [ph] rates declined sequentially.

There's been a lot of news lately about LCD-- about the LCD market, and our sales into this market are continuing to grow in line with our expectations.

Now turning to slide 8.

In EPI we saw strong double -digit volume gains year-on-year in HyCO products.

Hydrogen growth continues to be led by the ongoing trend for refineries to meet lower sulfur specifications, and we again benefited from spot activity in both hydrogen and CO.

Our results reflect solid operating performance across our hydrogen franchises.

In November, we announced the ExxonMobil/ Baytown Hydrogen Expansion Project Award.

Seventy million standard cubic feet per day in which we will add-- which we will add to the Gulf Coast pipeline franchises.

Also, we hosted a conference in Houston in December-- on December 1st to highlight our strengths in refinery hydrogen.

Presentation slides are available on the website.

Bidding activity remains high as refineries finalize projects to meet future fuel specifications.

Please turn to slide 9, our home care business.

Strong growth continued in the first quarter with global home care revenues up 33 percent.

In our U.S. home care business, we completed two more bolts-on acquisitions in the quarter; one in New York and the other in Chicago, for a total of $42 million.

Both of these will fold nicely into existing operations in these areas.

We would expect to spend 75 to $100 million on acquisitions during fiscal 2005.

On U.S.

Medicare reform, certain reimbursement reductions did occur as anticipated at the beginning of the calendar year.

However, reductions in respiratory therapy pricing are still being reviewed, and we do not expect a large impact on our business.

in our European home care business, We saw revenues grow by 8 percent.

Please turn to slide 10.

In our North American liquid bulk business, the volume index is up 3 percent year-on-year.

We see increased year-on-year volume momentum in line with the improving economy.

Sequentially, volumes were seasonally lower.

Average U.S.

LOX/LIN pricing increased 1 percent year-on-year.

Note that we've implemented a national price increase over most products effective November 1st.

We continue to see higher energy costs in the first quarter and, in addition to the price increases, we are aggressively implementing surcharges in this business.

For the past couple of quarters, we have reported increases in our business signings.

The improved year-over-year volume performance of 3 percent while steadily increasing prices is evidence we are achieving our goals.

Going forward our new business signings indicate we are on track for higher volumes and profitability for this business.

Please turn now to slide 11, European merchant gases.

In our European Liquid Bulk business the volume index decreased 1 percent year-on -year.

The underlying base business was sequentially flat in line with the manufacturing economy.

New customer additions did not offset lost business which was unusually high due to three lost customers.

One shut down, one switched to an alternative technology, and one converted to an onsite.

Sequentially, volumes were seasonally lower.

European LOX/LIN pricing improved 2 percent versus last year.

Package gases volumes were down 1 percent, reflecting a flat manufacturing environment and fewer workdays in this year.

Adjusting for the workdays, volumes were 1 percent higher.

Package gas pricing was up 1 percent for the quarter.

Slide 12 shows our Asian Liquid Bulk business.

LOX/LIN volumes was up 1 percent driven mainly by solid demand growth across the region, particularly in Korea and Taiwan.

We've experienced some slowing in China, principally related to government actions to control steel production in northern China.

Sequentially, liquid volumes increased 5 percent as we continue to load our existing capacity.

We are currently capacity constrained in some areas.

We have three new liquid plants coming on stream in China in 2005: an expansion of our existing liquefier in southern China, a new steel piggy back in northern China, and an additional piggy back in an electronics joint venture with Air Lockheed in the eastern China area.

This facility will supply ann LCD flat-panel display plant in China.

We expect to see a strong year-on-year growth in Asia for the remainder of 2005 and beyond.

Now let's move on to review our chemical segment results on slide 13.

World wide chemical sales were up 12 percent compared to prior year with half of this growth coming from higher volumes.

Sequentially, sales decreased 5 percent primarily due to seasonally lower volumes and the divestiture of our Mexican polymers business.

You can reference slide 21 for more detail.

In our performance materials business, volumes increased 7 percent on gains in epoxy and polyurethane additives, and surfactants.

Worldwide emulsions increased 2 percent, as we are aggressively raising prices on on all products in this business, and dealing with raw materials shortages.

In our intermediates business volumes increased 3 percent due to higher North American methalymines and polyurethane intermediates.

Volumes in higher amines were lower due to raw materials shortages in our efforts to raise price.

Operating income of $20 million was lower versus prior year due to escalating raw material cost and higher manufacturing cost due to scheduled outages.

It was also lower versus prior quarter due to lower seasonal volumes.

Most of the increased raw material costs were in our emulsions and amines business.

Our epoxy, polyurethane chemical and surfactants businesses have seen less dramatic increases and we have recovered most of the cost increases during the quarter.

As a result, segment operating margin came in at 4.3 percent, down from both prior year and prior quarter.

Raw material costs were approximately $37 million higher than last year.

Through a combination of higher prices and contract terms we recovered roughly $23 million.

This includes a portion of the favorable impact of the Trinidad Methanol which we began in December.

Sequentially, raw material costs including the off-setting favorable impact of Trinidad Methanol were up approximately $16 million.

Higher price and contract terms recovered all of this increase.

Raw materials which were significantly higher included: vinyl acetate monomer driven by higher natural gas, and ethylene isopropyl alcohol, ammonia,.and acrylates.

We also experienced supply shortages in isopropyl alcohol and acrylates.

To address the higher material costs we will implement price increases across most of our products.

For example, we raised have prices on van-based emulsions by $0.04 a pound on December 15 and another $0.03 cent on February 1, 2005.

We are also taking actions to get our larger customers on raw material pass through contracts.

In emulsions we currently have 30 percent of our volume on these type of contracts.

These actions must continue as we need to recover margins to improve these businesses.

We also finally completed our long-awaited divesture of our EM&D business in December.

The regulatory process here tried our patience and stalled our process but we now have it behind us.

Paul will comment further on our near-term improvement plans for this business when he goes through our outlook.

Next, let me cover our equipment segment on slide 14.

Sales of $88 million and operating income of $6 million increased on higher LNG activity.

We received two Apex LNG heat exchanger orders in the first quarter.

As Paul said earlier, this patented technology increases throughput capacity by 50 percent.

The sales backlog of $400 million is up significantly versus prior year and prior quarter, and the quality of the backlog continues to improve.

Now I'll turn the call back over to Paul.

Thanks, Phil.

If you'll please turn to slide 15.

We delivered solid results in quarter one fiscal year 2005.

Our strategies are working and our priorities and goals remain unchanged.

As I said before, we achieved 20 percent plus earnings growth for the fourth consecutive quarter and we have spread our return on capital by 100 basis points over last year.

We are confident in our ability to deliver throughout fiscal year 2005 and importantly our return on capital should continue to improve.

We still have a lot of work ahead of us.

John Jones and his leadership team are committed to achieving our 13 percent ARONA goal by loading assets, by driving a step change in productivity, by maintaining capital discipline and by pursuing the excellent opportunities we have in our growth businesses.

Turning to our outlook for next quarter.

Based on our quarter one 2005 results, we expect second quarter earnings in the range of $0.73 to $0.78 per share, or about 18 to 26 percent growth year-on-year.

While many factors impact our walk from quarter one to quarter two, let me give you the three largest factors that will drive the quarter-to-quarter improvement.

In chemicals, seasonally stronger volumes, our pricing actions and the full quarter impact of Trinidad Methanol, should generate significant profit and margin improvement.

Volumes will increase on higher demand for our amine products, which are driven by the agricultural season and we should see a seasonal rebound in our emulsions and surfactants businesses.

You can see the seasonal cycle or pattern repeated over several years on appendix slide #21.

Seasonal volume gains should contribute $0.02 to $0.04 per share.

Also, we expect to deliver a positive impact from the chemicals price increases, which we have implemented and will continue to implement.

Plus, we will see the full-quarter impact of Trinidad and the EM&D business divestiture.

The total impact of these items should add another $0.02 to $0.04 per share.

Somewhat offsetting the sequential gains in chemicals will be higher costs associated with scheduled maintenance strategies in two larger refinery customers, and lower operating bonuses in EPI of $0.02 to $0.03 a share.

I would like-- I would now like to update you on our outlook for the full year.

Please turn to slide 16.

We are forecasting fiscal year 2005 earnings per share in the range of $2.95 to $3.15 per share, a year-on-year growth rate of between 12 and 19 percent.

Note that our guidance is inclusive of productivity implementation costs of $0.10 to $0.15 a share.

We are still targeting productivity savings for the year of $0.15 to $0.20 per share.

Our original guidance had U.S. manufacturing growth of 15 percent.

Our current forecast is coming in about the middle of that range.

Our guidance for semiconductor growth was zero to 5 percent volume growth.

Current estimates for the industry are taking us to the low end of this range.

Flat panel sales continue to grow and we expect to achieve our 30 percent growth rate.

Semiconductor capital spending is expected to slow during 2005.

Pricing pressure continues on some specialty gases but overall pricing in those-- in these products is in line with our fiscal year 2005 expectations.

Gases had a solid first quarter, and we expect gases to deliver strong year-on-year improvements for the full year.

While we didn't count on chemicals to have a good first quarter, as you can see, we anticipate significant improvement throughout the rest of the year.

We have seen increased success with our new Apex LNG heat exchanger technology and expect fiscal year 2005 equipment segment profits of 25 to $30 million.

And finally we expect full-year property plant and equipment expenditures to be in the 900 to $950 million range, slightly higher than our initial forecast for 2005.

This is due to increased HyCo franchise opportunities.

In closing, we are off to a good start in fiscal year 2005.

We remain focused on delivering our commitments to our shareholders.

Thank you.

And now, I'll turn the call over to Angela to take your questions.

[ Operator Instructions ] We'll take our first question from Robert Koort with Goldman Sachs.

Thank you very much.

Hi Bob.

Hi, Bob.

Good morning.

Good morning.

Question around the chemical side.

I think Phil, you said in the fourth quarter the sequential increases in raw materials were covered by price hikes.

So am I to assume, then, that the profit degradation is all a fixed cost issue?

And then, secondly, what's the outlook for that price cost spread as we go through '05?

Clearly your suppliers are continuing to raise prices, and you've got some price hikes of your own in store.

So, will we expect continued static movement or will you be able to actually make up some ground?

Okay, Bob.

To just take you through that again.

Yes, you did hear Phil right.

The price off set --- the price offset the raw material increases which we saw from quarter four to quarter one as going forward here.

We also had the increased turnarounds and a drop in volumes in chemicals from quarter four to quarter one.

So, the major-- the major reason for the drop in operating income is not increased in fixed cost, it is the fact that the volumes were lower because of the seasonable factors which Phil talked about.

Ok?

Going into the second quarter, as I said in the outlook, what we had is the seasonable recovery in the-- in volumes.

We have gotten more aggressive on price.

You go back and take a look at our pricing announcements, they come out every month, practically now, for us.

So, we are getting ahead on price.

I think its a good sign in that we were flat quarter-to-quarter on price.

We plan to get ahead on that and start recovering that, and start spreading the margins this quarter.

That's the other $0.02 to $0.04.

The methanol contract comes in.

EM&D is shut down with things too.

So it's a combination of both volume and spreading the margins.

And Paul, do you expect you'll offset the share creep we're starting to see with the performance-- compensation performance increasing?

Excuse me, Bob?

I didn't understand compensation performance?

You're getting a share count creep.

Yes, we are.

Are you going to be able to offset that?

Is there a plan to offset that dilution or not really?

As far as-- as far as, if you are getting down to what the uses of cash are, we are going to take-- we obviously have a large cash balance which is building up here.

We have some debt coming due.

We have other things which we are looking at with regard to whether, you know, as to what you do with dividends and share repurchase, et cetera.

So we'll be looking over that this next quarter, Bob.

Thank you very much.

Thank you.

Next we'll go to PJ Juvekar with with Smith Barney.

Hi, Paul.

Hi, PJ.

Good morning.

In electronics, can you break down your price in volume between bulk gases and specialty gases and chemicals?

One thing, PJ, in in electronics is our bulk gases actually flow through our -- the U.S. gases business on that.

So, the LOX the LIN the LAR, which is sold into that,is sold into there.

As far as price in volume, we have the tonnage which sits in there.

The bulk chemicals, the high-purity chemicals we bought in Ashland, which would sit in that sort of segment as far as the price in volume are concerned.

Year-on-year we had good growth across the board in our electronics-- in our electronics business.

Quarter-to-quarter, as Phil said, sales declined but principally on high-- on higher equipment.

I'm sorry but can you just-- on your electronics, specialty gases, can you break down volume versus price?

The volume versus price, is the comments which we talked about here is that the volume has actually, it is larger than the impact of average prices declines which we have.

So, we are gaining and the basic question are we improving the margins?

Yes.

We are improving the margins in that business in this specialty materials.

Let me ask you, what kind of price declines are you seeing in those chemicals?

Well, as you know, as we talked about, we're not going to disclose the specific amount of price increases and those are simply because of competitive reasons as we go out here.

I don't want, if prices go down then everyone looks for a price decrease and everyone is trying to guess our product prices and that isn't for public consumption for us, really, as far as I'm concerned.

I don't want to hurt our business by doing that.

But certainly, as we've said, electronics prices did come down this quarter.

We did see volumes go up and the volume increases are off setting the, more than off setting the price declines and they're spreading margins for us.

Okay.

Okay?

Quick question.

Chemicals.

You know, you look at three broad categories, emulsions, additives. and intermediates.

You show the European business Are there businesses in the U.S. you could potentially divest?

Thank you.

With regard to chemicals, we're not going to speculate on any-- on any potential divestitures activities there.

We are focused on improving these businesses.

Certainly, the business which is the major portion of our focus, as we've talked before, is our emulsions performance polymers business.

That's the one if you go back look at our price increases, we've been putting the most out on price increases.

It's the one which we saw some of the material shortage i acrylates.

We've seen the pressure of gas and ethylene on VAN [ph] this quarter so that's one we've been most active and the one which we have the largest hill to climb right now.

On the methylamines business, we think we are, as we look at the results, we got one-- we got one-- one month on Trinidad under our belt but that business looks a lot better with that in as the raw material.

Thank you.

Ok?

Thank you.

Next, we'll go to Sergey Vasnetsov with Lehman Brothers.

Good morning.

Good morning, Sergey.

Good morning.

I want to ask you for a couple of qualifications.

One is on 515, around the lower effective tax rate.

Can you mention what practice would allow you to get to the lower tax rate in '05?

And second, when you say lower, does that mean sequentially from 28 percent this quarter, over 27 percent in '04?

No, Sergey.

What it means is that the 28 percent is probably going to be the tax rate.

We had previously given you guidance of 29 percent.

As we worked through you know the final things of working through our tax planning, the main thing is something which we constantly look at.

It's an estimate which we have to make going through the year, and we think it's going to be 28 percent for the year now.

Ok.

And secondly what's the impact of options dilutions for you and see if its included in your forecast?

What you can see on the impact of options dilutions you can see that in the difference between the basic earnings per share and diluted earnings per share on the earnings release.

And that's the thing we don't have anything else, don't have any convertible debt which would be impacting that.

So that's the impact of the option dilution there.

If you are looking at, I don't know if your question was as to what the impact of expensing options would be--

Exactly, yes.

Ok.

If you're looking at the impact of expensing options, for last year it was $0.13 a share, which is what we disclosed for the year.

For next year we aren't exactly done with this.

I've been through almost all the calculations now.

It looks about $0.12 a share for the full year which is about $0.03 a quarter for us.

And just to clarify.

These-- these numbers are included in your outlook for the year?

They are not included in my outlook for the year.

They're not?

They are not included in my outlook for the year.

No

Just out of curiosity, what's the reason why you wouldn't include them?

Given by now it's become a rule, it's really not an option to expense if you like.

Any reason to take them out of there the pressure of the usual expense?

Well, the one thing is we don't have everything finally done.

We got probably a few more days to finalize that thing up.

It gets down to a lot of assumptions.

They have put a new method of calculating whether you adopt the new method or old method, which is something we need to look at.

There isn't a rush to get something out here.

Plus it's one of these items which, doesn't become -- it drives out, it takes things and doesn't make them as comparable, Sergey.

As far as my look on this is that we'll do this, we'll take a good studied look on this.

We got to allocate these back to the businesses, got to get them back to the business segments.

The rule came out on 16 December.

We're not going to rush and go out and do that.

It takes a while to get this run through in the accounting.

Ok.

Understood.

Thank you.

Next we'll go to David Begleiter with Deutsche Banc.

Thank you.

Good morning, Paul and Phil.

Paul, just on Europe, I know Phil mentioned some three customers who were lost.

Any additional losing of some business within the continent there given some of the weak numbers you've seen?

David, this is Phil.

Let me answer that question.

The European economy has been relatively flat.

Those were three examples of customers that went away or were converted to onsites.

We don't have any other large customers that we're looking at.

Our loss rate, or leakage rate if you will, is nothing that we're concerned about other than those couple aberrations that we had during last quarter.

Okay and just on North American LIN/LOX as conditions seem to improve.

Do you think you will get any additional price increases on LIN/LOX other than the 1 percent you posted in Q1?

Yeah.

We just announced the price increase November 1st, and as you're probably aware, it takes a little bit of time to work its way through the system, but that is a high priority for the business as we go forward and we would expect to have margins expand as a result of that and some of the productivity efforts we have going through our North American gases business.

And Paul, last thing.

Now that you have methanol flowing through, what's the longer-term margin potential in chemicals going out 18 to 24 months?

Yeah if you take us out going out 18 to 24 months, raw material prices, which we're at today which has obviously inflated sales, I think our goals are here is to get these margins out into the 10 percent plus range, as we go.

So return to a double-digit margin.

But if you go back many years back to the '97/'98 time frame, the peak of our chemicals business, our margins were in the 17-18 percent range.

We are not going to get there but that is mainly on the raw materials aspect because sales have been inflated by raw materials.

If we got to the 10 to 11 percent range, Dave, it would be a good return on capital business for us.

Thank you very much.

Next we'll go to Peter Butler. with Glen Hill Investment Research.

Good morning, guys.

Good morning, Peter.

Obviously the level of LNG and hydrogeneticist activity are heating up.

Could you help us dream to where these businesses, what they might be earning in say three years?

We don't put out, you know, guidance out three years, Peter.

But certainly you are right: The level of activity has heat-- has gotten more for us especially in the LNG, most recently, as you see by the order flow coming through.

I think the-- the Apex technology is really hitting the market well generating a lot of interest with things.

And just the general need for more LNG in the world to move gases-- to move the strain of gas around our goods.

Our view on this is both for LNG and hydrogen is that these are good sustainable businesses long-term at which profits will grow.

Now we're not going to go out and throw tons of capacity money at building more stuff to build LNG heat exchangers, obviously.

But--but--but we've done very well in our order intake here and we continue to look at that.

As far as hydrogen, that's a primary growth vehicle and you can see that by the raising of the guidance on capital spending.

So we think that's going to continue to grow in the double digits and profits, they will grow in the double digits, also, and the returns will get better.

On the negative side of things.

This Internet 3 business of yours is looking, has all the characteristics of a cash trap coming along.

Are you-- How concerned are you about that?

As far as, as Internet 3 as we look at the pricing of those things, we constantly go out and manage that with volume tradeoff.

We don't offer prices to customers which we are not prepared to go out and live with long-term.

So our pricing is, we are not going to be crazy about volume on pricing for us.

We have the best cost position, we believe, in the world on this.

We certainly have the largest scale of anybody on this thing.

So we-- so we provide opport-- we provide things to customers which they're not going to get from other suppliers.

And we intend to leverage that and use that and to be successful in that in that business and not have it turn into a cash trap or you know, a cash business, as you would call it.

Well, the history is when you have a rapidly growing business and it attracts a lot of competition, and at the end of the day you get stuck with a lot of disproportionate amount of your assets are in products in a business that where the prices might start coming down faster than you think.

Well, yeah, it does attract other competition but this is not a simple product to make.

A lot of people who have tried to get into this business not gotten into it successfully.

There are some people who are good.

We have competition in Japan who have done very well with the business.

But as far as we're concerned, is we have the best cost position in the world.

We can serve a lot more of the larger customers in this business and we consider that to be an advantage going forward here.

So we think our strategy is sound on it.

It's not going to return to the prices, and we aren't counting on it returning to the prices to which it was years ago, with things.

But, you know, we intend to make-- intend to make these investments good investments for our shareholders and solid growth vehicles--

Okay.

Thanks for the help.

Yep.

Next we go to Jeffrey Zekauskas with JP Morgan.

Hi.

Good morning.

Good morning, Jeff.

A couple of things.

When I look at your working capital, I mean, it seems like you're making some progress but can you improve it, I don't know, $500 million?

Your cash, your receivables are still high.

Your inventories are still high.

I mean, can you make material changes in this?

Ok.

I'll comment on all three.

I'll go through them in pieces here, Jeff.

If I took a look at the cash, certainly the cash situation which we are in, is not something which we intend to stay in for a long period of time.

So we are going to have to come up with you know we are going to have a use for that cash.

So, we have debt coming due within this, within the next couple of quarters.

We can pay down debt.

We can do a share repurchase.

We can increase the dividends.

There are lots of decisions we have to make over the next quarter or so, and stand by for more information for that.

So that could come down.

With regard for inventories.

There is a possibility of some reduction in our inventory levels but realize when you compare our inventories to our sales, it is-- it is not a very large number.

We generally carry about a month or so of inventories as a company.

When you look at that.

The chance for any large-- large reduction there is not great.

Also showing in my inventory number is the spare parts for the business, et cetera.

So, I need to keep those things on to keep my operations.

But-- but -- but we have continued to drive those down and there is some small opportunity there.

The largest opportunity which we consistently said is in Accounts Receivable and I think there is a substantial opportunity in there as we streamline our process, drive down our DSO, drive down our terms.

That is something which we have out -- which we have targets out with the individual business, and is the major focus on reduction in working capital for us right now.

Yes, I think there is a chance for substantially and as high as $500 million, I think that's a high number but it's certainly not $100 million.

It could be-- we could have substantial reductions in our Accounts Receivable balance.

Last question is you were talking about lifting your ARONA from, you know, call it 10 percent to 13 percent.

What's your expectation of asset growth?

The expectation for asset growth is actually in line with the capital spending which we have in there.

And the problem with asset growth is a lot of -- we had a decent amount of asset growth from the end of this year, interest from the end of '04 right into this quarter.

Half of that asset growth is currency related.

You're going to have some portion of asset growth that is currency, so I don't want to give you any real projections there on asset growth.

I'll give you a qualitative answer there, Jeff.

The thing we are looking is we'll have capital spending which as you can see is over depreciation as we look out here.

So that is a different change from where we were last year.

The other offsetting factor is to drive down the working capital, I talked about.

So the other uses for the cash, the reductions in receivables are the two primary areas.

We would look to offset the bulk of the increase-- the bulk of the increase as I could go forward, in our assets.

It probably will not offset all of it but the new assets will bring, because they are for growth opportunities, also will bring profits with them.

So they will contribute-- the new asset growth will not be a drag.

Asset growth is not going to be a major item for us or an obstacle for us going forward here 13 percent.

So the idea is you want to hold your asset growth to, I don't know, call it under 5 percent annually, something like that?

Yes.

Absolutely.

If you were to say, take out currency, take out the extra currency, certainly, yes.

That would be something which I would have as a goal.

Okay.

Thank you.

Thank you, Jeff.

Next we'll go to Don McNulty with CSFB.

A couple--

Hi Don.

couple quick questions.

Can you give us an update on the cost-cutting plan?

I know you were looking for $0.15 to $0.20 in '05.

Can you kind of give us a little walk through on what you may have found at this point and how far along on that you think you are?

Yeah.

As far as the gains there which we have in productivity, as I said, we went out and offset our inflation so we did achieve the targets in which we had here for the first quarter.

Now the impact of our productivity improvements actually get and they are larger going out here, so we would expect to have those impacts actually exceed inflation as we get out into the second half of the year, going forward.

We also have you know the other thing which hides some of this from hitting the margin this year is the impact of the cost to do this, you know, as we bring that in.

So that coming into the P&L offsets some portion of it, it doesn't offset all of the productivity improvement which we're seeing.

But as far as the $0.15 to $0.20 we're on track.

Ok.

Great.

And then just to circle back on something you touched on earlier.

Right now your debt to cap is about 32 percent or so.

You've got a lot of cash on your books.

You're seeing working capital improvement potential out there, and you should be throwing off a lot of free cash throughout the rest of this year.

How should we be thinking about your debt to leverage ratio targets might be and what, can we expect another large dividend increase like last year?

It seems like you could do that and buy back a lot of stock at the same time?

As I said, and those are exactly the things which we're going to take a look at over the next quarter here.

We have been looking at obviously but the decisions come up for us as we look at what that strategy is going to be.

You hit on the things in which we're going to look at.

Take the debt to capital ratio down.

We could have a share repurchase, we could have a large dividend, et cetera.

All those are things we considered, and as I said, stay tuned, within the next couple of quarters we'll have some news for you on that.

Just a follow-up on that.

In your mind for a company like Air Products, what is the right kind of normalized or average debt ratio you would be expecting in terms of debt to cap?

What is under leverage versus you know, properly leveraged versus overleveraged?

Well, for us historically we have said 40 percent, is something we're comfortable with, which gives us the bond rating.

It isn't the only factor in our bond rating, though.

There's probably other factors which are probably a lot more important on the rating agency part, which we need to take them through.

Okay.

Just one last thing tied into that.

With the exception of some small acquisitions in the health care arena, is there any risk in our perspective or from our perspective we can see Air Products making a rather large acquisition at this point?

We don't comment on acquisition activity things.

So, I mean it--it-- it's not something which I comment on.

Okay.

Thanks a lot.

Thanks, Don.

Next we'll go to Mike Stefan with Key McDonald.

Good morning, guys.

Hi Mike.

You talked about getting pass through contracts and emulsions, you said roughly 30 percent of your clients are on that.

What is the goal there?

And sort of give me a better idea or describe the contracts generally how long they are, that type of stuff?

The contracts, what the contracts do, is you lock people up for a period of time and your able to pass your costs through.

And these are not our typical long-term like in the gas onsite business so they are for periods of time, you know.

Probably on average we tend to be in the three-year range or so on most of these things as we go out there.

And--and--and what they are is a facility to share that and, and let the customers share in the ups and downs of the market really with things.

As far as a goal is concerned, you're only going to do this on large customers, essentially.

The smaller customers are not something which you're going to do this on.

So, you know, a 50 percent, if we can get this above 50 percent it would be very good progress for us.

Your smaller customers though, in terms of getting pricing through that, it really is an issue.

Get those prices through to them.

Well, yeah on the smaller customers, you have other things you do and consider and look at.

In the gases business we handle that well in the surcharge arena.

Taking out price protection for customers is another thing.

You know, that's a historical thing for the chemical industry.

We look to take that out.

Drop that away.

Ok.

And a couple quick questions on NF3 capacity utilization.

Can you give us an idea where you're at?

Phil, you want to take--

Yeah.

On NF3 capacity utilization, we are in the mid-80s.

Mid-80s and that includes all the expansions?

Yes.

The expansion at hometown is on schedule and should be completed mid-summer.

Okay.

Then in terms of profitability, how did electronics do?

Are you seeing some improvement there?

We don't comment on that segment other than to say the general pricing thing which Paul went through before, that we are trying to expand the margins and volume growth is outpacing any pricing pressure.

And we have seen a number of our specialty materials that have volume wise increased in the 20 percent plus area.

Are you happy where the electronics margins are at right now or think there's room for improvement.

I would like to see them improved, Mike.

And everyone would.

We think there is room to do that.

And final question did you-- in terms of increased guidance, is there a new goal for ARONA by year end?

You were talking mid-tens?

Right.

Our goal, which we said, was 10.5 to 11 and remains there.

Great.

Thanks, guys.

Welcome.

Our next question Don Carson from Merrill Lynch.

Thank you.

Question on the--

Good morning, Don.

Good morning.

Almost good afternoon.

Merchant gases question.

Phil, you talked about the new rate of signings.

I mean, your merchant growth has lagged.

You know, the manufacturing index, you've been around 3 percent.

The new signings you talked about, will that accelerate the rate of growth and you also mentioned some surcharges you put in place.

Can you quantify those?

And then finally, Paul, just one question for you on chemicals.

Back in December you talked about getting to a 10 percent run rate on operating margins by fiscal fourth quarter, and 12 percent kind of an intermediate goal.

I notice you seem to talk about 10 percent as an intermediate goal now.

So, have you revised downward your expectations for the chemicals business?

Don, let me handle your first two questions first.

First thing about signings, yes, we do expect the level of new contract activity that we see in North American gases to improve our volumes over time, and we expect a kickup in that.

Around surcharges, we have seen some price increases, energy costs.

We got the surcharges in line, so we would expect this business to continue improving as it has been in the pas,t because remember years ago this business was not above its cost of capital.

It is now, continues to improve.

We're continuing to manage it on a profitability level, balancing volume with price.

And it should be continuing to improve especially with the new price increase we put in November 1st.

So just to follow-up on that, when can we see the pick up on this 3 percent growth rate.

When can we look for that, next year?

Yeah, Don, I would think it would start next quarter and continue improving from there.

And, Don, as we turn to chemicals there in your question there.

As far as the expectation for the year, I think I have to take the expectation maybe down a little bit lower than the 10 percent margin for the year, because the first quarter was not as good as we were counting on, as you know, you can see.

But we think the fundamentals for return to profitability and a return to the teens margin, you know, something in the 10 to 12 percent range, are there.

And that we would certainly hope to have our follow-on quarter margins, probably not the second quarter, but some in the third and fourth, be in the double digits for us, but not finishing for the year in double digits.

But still getting to that run rate by--

But still getting to that run rate, yeah.

And the first quarter is always going to be a little bit soft because of the ag/chem, and the emulsions and surfactants.

So there's not anything about the base, the base is now permanently lower and can't get back to double digits.

No.

As we go forward I know the results aren't good, but as far as we go we feel pretty good about how we're going forward here.

Thank you.

Welcome.

Our next question comes from Michael Judd with Greenwich Consulting.

Hello, Michael.

Not there.

Maybe not.

And, we'll move on to Robert Ottenstein with Morgan Stanley.

Hey, guys.

Hi Robert.

It looks to me that Cap Ex is getting tweaked up again in terms of the forecast?

Can you talk about that, is that all hydrogen related?

And in that context can you give us a sense what your views are on the Air Lockheed's latest activities in that area?

Let me answer that one.

The kickup in Cap Ex is related to the opportunities we still see in the pipeline for the hydrogen business relating to the 2006 clean fuel standards, which a lot of refineries still have to meet.

So, you know, stay tuned.

There still are opportunities out there that should be coming down the pipe here.

And, your second question was regarding Air Lockheed?

Right.

I assume you're talking about the deal that they won in the Houston area?

Right.

Yeah, that--that was not a surprise to us.

They won a deal, I think it was the McGonagle [ph] Phillips in Sweeney, and frankly it's a pretty good bellwether for us for capital discipline, and also speaks to the ability when you have a franchise, it's a little more difficult to penetrate it.

We, frankly, didn't add the most volume to that account.

We would have had to add a lot of infrastructure to get to that particular customer.

We did take a look at it but didn't have the most value, and therefore, were not able to secure that business at a price that was reasonable for us.

And just to follow up on that, Air Lockheed does have a presence down in Houston.

They do have a couple of pipelines, small enclaves down there but it's nothing we see as a big new threat.

They've been down there for a while and a few small enclaves and now and then we compete with them.

What about their announcement of the Bayport plant?

That's when the expansion for this facility is occurring.

They are going to build a plant in Bayport.

You should talk to them about that, actually.

You don't see things getting too crowded?

No.

There's a lot of opportunity there.

Ok.

Great.

And then just a modeling thing.

For the corporate expense line, what should we be modeling for that for the rest of the year?

It's something which has the overs and unders in there.

It has some unallocated f foreign exchange gains and losses there.

It's hard to give you guidance.

It's a small number, Robert.

And the number for this year is about even.

You know, about, you know, somewhere between 35 to $40 million of expenses which we typically have had in there.

So about 10 a quarter?

Nine to ten a quarter.

Nine to ten a quarter.

And can you just give us the sales amounts on the acquisitions that you closed?

In the healthcare?

The sales amounts were about probably four-four-four $40 million on an annual basis.

So it's about $40 million of sales and you spent about $40 million for them.

Slight--Slightly over the $40 million, 42.

Okay.

Close enough.

One last question.

In terms of acquisitions, what are your priorities now?

You talked a few years ago on the electronics side as a big priority.

You made Ashland, is that still a focus?

I'm just trying to get a sense where your head is in terms of acquisitions.

As far as acquisitions are concerned, you know, they are done to support the growth strategies, as we would look here and to support our businesses.

So, if a good acquisition comes along which is going to make solid investment, add shareholder value we'll do it but we are not out shopping for acquisitions just for the sake of growth, they've got to fit in with our growth strategies and the things we are doing.

Is electronics still a priority?

Absolutely.

Electronics is a priority here.

And, Robert, on the sales on healthcare, I gave you a bad number there.

It's probably around 30 or $35 million.

Thirty to thirty-five.

As far as the sales in those healthcare, I gave you.

Forty was the cost there.

Thanks a lot.

Yeah.

And just as a reminder that is star 1 if you have any questions or comments.

Next we'll go to Jeff Cianci for a follow-up question with UBS.

Hey, guys.

Hey, Jeff.

Just a clarification for what you said on the Cap Ex.

Is the whole Delta '05 versus '04 hydrogen?

It seems like a big jump.

It is not all-- it is not entirely hydrogen.

There is some pickup in Asia and there is a little pickup in electronics as we look at it.

The bulk of it, Jeff.

So you think 900 is if you take the big picture?

I'm sorry?

I missed you.

I think the big picture.

Nine hundred is roughly a third of that hydrogen?

Or less than 300?

No, the spending is probably more than that.

More than a third of the total?

Right.

Interesting.

Ok.

And, finally, on equipment.

I want to understand the nature of that backlog.

You got these APX, bigger units.

I presume-- How quickly you can move them through the shop?

How does that track?

Can you do eight at a time?

Are they higher profits than the old ones?

Yes, basically takes two years to take and move these things through the shop.

So depends upon the scheduling, on the winding [ph] stations, it depends upon our productivity.

It takes about two years.

We will work with our customers to make sure we keep the market fed on these things.

Are they higher margins, Paul, or same as the old margins?

No, margins are good on these things and we obviously have given efficiencies to these people so we expect to be paid for our patented technology here.

Right.

How many can you put in there at one time?

We're not going to comment on our capacity to do that.

Are you bumping capacity now?

Or have you got plenty of growth potential there?

As far as now and the loading is good.

The loading is very good right now, Jeff.

All right.

Thanks, Paul.

And there are no further questions at this time.

I'll turn the call back over to you for any closing or additional remarks.

Thank you very much.

Just wanted to thank everyone for taking the time to join us today and wish everyone a great day.

Thank you.

Bye-bye.

And that does conclude today's conference.

Thank you for your participation and have a wonderful day.