Air Products and Chemicals Inc (APD) 2006 Q1 法說會逐字稿

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

Just a reminder that you will be in a listen-only mode until the question and answer segment of today's call.

Also, this telephone conference presentation and the comments made on behalf of Air Products, are subject to copyright by Air Products, and all rights are reserved.

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

Mr. Sproger, please go ahead.

Thank you, Deanna.

Good morning and welcome to Air Products' earnings teleconference.

I'm Phil Sproger, Director of Investor Relations.

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

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

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

As in the past, we have included an appendix to today's slide package with additional detailed information.

Instructions for accessing the replay of this call, beginning at 2:00 PM Eastern Time, are also available on the website.

Please turn to slide two.

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 this slide and at the end of today's earnings release.

Please turn to slide three, and I'll turn the call over to Paul.

Thank you, Phil.

Good morning and thank you for joining us today.

We had a strong first quarter with continued improvement in sales, earnings and return on capital, delivering operating and financial leverage to the bottomline.

Before I begin reviewing the quarter's results, I'd like to comment briefly on Financial Accounting Standard 123-R.

As we mentioned to you on last quarter's call, we adopted FAS 123-R on October 1st 2005 and began expensing stock options.

This is our first earnings release and teleconference that reflects this accounting change.

We have not restated 2005 results.

For comparison purposes, we have included a slide in our appendix to provide pro forma 2005 results adjusted for FAS 123R.

Most of my comments that follow will reference this non-GAAP comparison.

Sales grew by 5% to $2.1 billion.

Adjusting for currency, natural gas, acquisitions and divestitures, and the hurricane impacts, we generated underlying sales growth of 5%.

This was mainly due to higher volumes in electronics and Asia-based gases and higher pricing in North American gases and chemicals.

A more detailed sales analysis is included in the appendix.

Natural gas and raw material costs pastures increased sales by 6%.

This was offset by an unfavorable currency impact of 2% and an unfavorable hurricane impact of 3%.

Operating income of $252 million was up 11% from prior year due to improved results in gases and higher equipment activity.

Chemicals performance was in line with our expectations, given the seasonality of certain businesses as well as the previously reported contract termination and customer shutdown in the polyurethane intermediates business.

At the operating impact level, the net impact from hurricanes was approximately $20 million, or $0.06 per share, for the quarter.

This is a few cents more than we expected when we provided our guidance to you, due to the longer merchant hydrogen supply disruption.

From a business segment standpoint, two-thirds of the impact is in gases with the remaining one-third in chemicals.

The $20 million impact was made up of $32 million of property damage and business interruption, offset by insurance recoveries of $12 million.

During the quarter, we received $25 million in cash, $13 million offset or receivable from the fourth quarter.

As a quick business update, hurricanes impacted three of our hydrogen pipeline systems.

Two were located in Louisiana and one is in Texas.

The Louisiana downriver system, which serves two refineries, received substantial damage from Hurricane Katrina but has returned to operation.

One of the refineries has resumed operation, and the other refinery is expected to commence operations in the third quarter.

As we indicated in our monthly updates, loading on our Texas and Louisiana upriver systems increased during the quarter as our customers resumed operations.

Both these systems returned to greater than pre-hurricane volumes during December.

As expected, our liquid hydrogen production facility in New Orleans returned to operation in December.

Unfortunately, the [Force Reserve] we have declared in liquid hydrogen remains in effect, as our feed gas supplier for our Canadian liquid hydrogen plant has not yet resumed operation following their extended maintenance outage.

For the quarter, we reported a net income of $181 million or diluted earnings per share of $0.80.

When compared with the prior year, net income increased by 13%, and diluted EPS was up 16%.

Improved results in gases and higher equipment activities drove our year-on-year improvement.

Our run also improved this quarter.

We were up 70 basis points over last year.

On the balance sheet, Accounts receivable was essentially unchanged, despite a higher level of business activity.

Most notably, we reduced DSO to 65 days at the end of the quarter, down four days versus prior year.

This quarter, our capital spending was unusually high at $327 million.

This is another impact of the hurricanes as capital spending for rebuilding was about $45 million during this quarter.

Although, will have some additional spending in later quarters, it will not continue at this high level.

Cash from operations was low this quarter, and it was due to changes in working capital.

These changes occurred principally in two areas.

First, inventories and contracts in progress were at $80 million unfavorable this quarter.

This increase in inventory was due to increased business activity and rebuilding of inventories from usually low levels at year end to the hurricanes.

The increase in contracts in progress is the result of higher equipment sale activity.

The second favorable item was a decrease in payables and accrued liabilities in $72 million.

This change was primarily result of pension contributions of 103 million in this quarter.

Turning to slide four.

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

Higher volumes in gases and equipment contributed to a $0.13 improvement.

Higher pricing and raw material costs together were a net $0.01 unfavorable.

Electronics price declines were mostly offset by chemicals and North American gas price increases.

Other costs were flat as our improving productivity efforts offset the impacts of inflation, higher pension cost and increased volume.

Hurricane impacts of a negative $0.06 were partially offset by a land sale, which generated $0.03 gain in the quarter.

This is another good example of our asset management activities.

Unfavorable currency impacts totaled $0.02.

Equity affiliates contributed $0.01 on better performance.

Fewer shares outstanding contributed a positive $0.02, and all other items net to $0.01 positive variance.

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

Thanks Paul.

Please turn to slide five, gases segment.

Worldwide gases sales of $1.6 billion were up 8%, primarily due to underlying volume growth of 7%.

Natural gas pass-through contributed 7%, but was mostly offset by negative hurricane impacts of 4% and negative currency impacts of 2%.

The underlying growth was driven by strong volume gains in electronics and Asian-based gases businesses.

Price increases in North American based gases were offset by decreased pricing in electronics.

Sequentially, gas sales were 5% higher driven primarily by higher natural gas pass-through.

Underlying growth was 3%.

Gas' operating income of $229 million was up 8%, as underlying volume growth in most businesses and the land sale was somewhat offset by lower electronics pricing, hurricane impacts and unfavorable currency.

Segment operating margin of 14.7% was flat compared to last year.

Sequentially, operating margins improved 170 basis points.

About a third of the improvement was due to the land sale.

The remaining improvement was due to higher volumes and better pricing, principally in North America and improved productivity.

Let me now provide a few highlights by major businesses.

Please turn to slide six.

In electronics, sales were up 1% year on year.

Excluding equipment, sales were up 7%.

Strong volume gains in most products, including electronics, specialty materials, tonnage, and bulk chemicals were mitigated by lower equipment sales and price erosion.

Equipment sales were lower this quarter; however, we have a strong backlog of projects and expect the equipment business to pick up in Q2 and throughout the remainder of the year.

On the profit side, our electronics margins improved this quarter.

Volume gains in specialty materials more than offset pricing declines in our productivity efforts gained momentum.

We continue to work on improving profitability by focusing on cost reductions and simplifying the business.

We're also moving more products toward bulk supply and are working on projects to reduce the number of transactions and level of support required by this business.

Sequentially, revenue was down 4% on lower equipment sales.

NF3 volumes continue to show strong growth with volume gain in excess of 25%.

Phase I of Samsung's Tangjeong LCD facility is now loaded.

This quarter, we had two more significant wins in Taiwan for an on-site nitrogen supply and bulk chemical supply.

Now turning to slide seven.

In our energy and process industries, or EPI business, volumes decreased 8% when compared to last year.

Excluding the hurricane, volume growth would have been 2%.

Sequentially, volumes increased by 3% as refineries, which were impacted by the hurricanes, have come back on stream.

With the exception of one customer, all of our pipeline and hydrogen customers are now back on-stream.

During the month of December, we were supplying hydrogen to customers at volumes which exceeded pre-hurricane levels.

We expect to return to year-on-year volume increases during our second fiscal quarter.

Late in the quarter, we brought on-stream two of the six new hydrogen plants which are scheduled to startup this year under long-term contracts.

These are the new 110 million standard cubic foot per day hydrogen plant in Convent, Louisiana, along with a new 70 million standard cubic foot per day hydrogen plant in Baytown, Texas.

In addition, we recently signed another long-term contract for supply of 105 million standard cubic feet per day of hydrogen to Petro-Canada in Edmonton, which is planned for an on-stream during the third quarter of 2008.

This is the third Canadian hydrogen plant within the last year, and importantly, marks the first time that industrial gas company has been chosen to supply over the fence hydrogen for use in upgrading [bitamin] from Canadian Oil Sands.

In addition, along with our Mexican joint venture partner, we also recently signed a long-term agreement with Pemex, Mexico's state-owned oil company, for supply of 3,200 tons per day of nitrogen to be used for enhanced oil recovery at Pemex's oil field near Tabasco, Mexico.

This plan is expected to be operational by late 2007.

Enhanced oil recovery provides continued growth opportunity for Air Products and complements our leading position in supplying hydrogen to refineries for the production of cleaner burning transportation fuels.

Our energy and process industries continues to be a strong growth story, and we expect revenue growth in fiscal 2006 to be in excess of 25%.

Now please turn to slide eight, global merchant gases.

You will note that we are presenting our merchant gases business in a different format this quarter.

We have aligned our merchant gases groups under a single reporting structure.

One of the advantages we believe we bring and one of the things that sets Air Products apart from our competitors is that we run our businesses globally.

This is based on our belief that as the markets continue to open and communications improve, speed of response will become more critical.

This structure allows us to use a common business model with common systems to drive supply chain efficiencies and bring more value to our customers, as many of them run their businesses globally also.

We've installed SAP in North America and Europe, and are beginning deployment within Asia.

This help to enable faster execution and lower costs.

This organizational shift is the next step in our evolution to run this business better, improve our productivity, better serve our customers and improved returns.

In North American liquid bulk, our volume index was down 5% year-on-year.

Excluding liquid hydrogen volumes, we're up 4%.

Excluding liquid hydrogen volumes, we're up 4%, as volumes picked up broadly across most end markets.

Volumes were down 7% sequentially as volume gains in most products were offset by lower liquid hydrogen volumes prior to the hurricanes.

Excluding liquid hydrogen, volumes were down 2% due to seasonality.

Overall capacity utilization increased to 88% from 86% last quarter.

Averaged US LOX/LIN pricing increased 4% year-on-year.

We are in the process of converting existing surcharges were contractually possible to permit price increases, and will continue surcharging for increased electricity and fuel costs on most merchant products.

In Europe, our liquid/bulk volumes were up 3% and cylinder volumes were up 1% compared to last year on increased demand.

LOX/LIN pricing in Europe was flat compared to last year.

The impact of price initiatives to recover higher energy cost was offset by increased demand from larger volume, lower price customers.

New business signings remains relatively strong and are at or above target.

Strong growth in Asia continues with liquid/bulk volumes up 24%, driven by continued solid demand, particularly in Korea, Taiwan, and China.

Sequentially, liquid volumes increased 3% as we continued to load the new plants we brought on stream.

During the next 12 months, we plan to start up five major on-site plants, which include liquid capacity to serve our growing Asian customer base.

In China and broadly across Asia, new business signings remain strong.

As a result, we expect the positive momentum in this region to continue.

Please turn to slide 10, chemical segment.

Worldwide chemical sales up $444 million were 4% lower compared to prior year, despite higher prices.

This was largely due to customer shutdowns in our polyurethane intermediates business, the divestiture of our EM&D business, shut down of a small fertilizer business and unfavorable currency during the quarter.

Sequentially, sales dropped 7% due to seasonally weaker volumes along with customer shutdowns in our polyurethane intermediates business.

Operating income of $19 million was 9% higher than last year.

Increased pricing and surcharge actions more than offset higher raw material costs.

In our performance materials business, emulsions volumes were down slightly but profitability improved versus last year due to continued focus on recovering higher raw material costs.

Performance products and solutions volumes were mixed as increases in polyurethane chemical and surfactants were offset by lower epoxy volumes.

The softness in epoxies was primarily due to inventory corrections in the Asian shipping container market.

In intermediate chemicals, the means volume dipped mainly due to customer outages and hurricane impacts.

Polyurethane intermediates volumes were down due to the Rubicon contract termination and the Lyondell shut down.

Next, let me cover our equipment segment on slide 11.

Sales of $92 million were up 5% as higher LNG activity more than offset lower ASU sales.

Operating income of $16 million increased significantly due to higher LNG activity.

Sales and operating income were down compared to last quarter as activity on several large ASU projects neared completion and overall activity was slightly lower due to the holidays.

During the first quarter, we received orders for two additional large ASU plants.

The sales backlog at $690 million is up significantly versus prior year and at a record level for us.

As mentioned previously, it now includes 11 LNG heat exchangers, and we continue to see a high level of interest in LNG heat exchangers throughout many parts of the world.

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

Thanks Phil.

Please turn now to the slide 12 for our fiscal second quarter outlook ending March 31.

Our fiscal year is off to a good start, as we delivered solid results in Quarter 1.

While our top-line growth did slow, we still produced a double-digit earnings growth and our return on capital is 70 basis points higher than last year.

Looking forward, we expect that pickup in top line growth for the remainder of the year in most of our gases businesses and in equipment.

We have substantial new investments scheduled to come on stream over the next few years with most of this volume already sold.

Based on our Quarter 1 2006 results, and taking into account that our fiscal Quarter 2 is historically seasonally stronger, we expect second quarter earnings in the range of $0.84 to $0.87 per share, year-on-year earnings growth of 17 to 21%.

While there are a lot of factors that will impact our walk from Quarter 1 to Quarter 2, let me highlight some of the largest factors that will drive the quarter-to-quarter improvement.

Factors we forecast to increase earnings sequentially include less -- business and tax related to the hurricanes, coupled with continued insurance recoveries on our property damage and business interruption claims.

Overall, we expect that net impact of hurricanes on Quarter 2 to be slightly positive.

Seasonally higher volumes in a few of our chemical businesses, including a means, emulsions, and surfactants.

In equipment, profits should increase sequentially as hours worked, and therefore, percentage completion are relative -- are higher and relative to Quarter 1, which is affected by the holidays.

And our two new hydrogen plants should be on stream for the full quarter.

Factors we forecast to decrease earnings sequentially include higher maintenance costs and lower operating bonuses and EPI.

Quarter 2 is normally at time of increased maintenance and lower bonuses, lower asset management activities as the first quarter was unusually high and electronics volumes are seasonally lower in Quarter 2.

Also in Asia the Chinese New Year holiday dampens demand as well.

Please turn to slide 13, for our full-year outlook.

Based on progress we have made in Quarter 1 and current conditions in the business, we are increasing our forecasted full year earnings per-share guidance to a range of $3.30 to $3.48, a gain of $0.12 to $0.18 -- 12% to 18% over fiscal year 2005, another year of strong earnings growth and improved returns.

Our key assumptions are on this slide, and they have not changed, since last quarter.

Our gasses operating results should experience continued good growth in 2006, benefiting from the six hydrogen plants we are scheduled to bring on-stream throughout the year.

These plants expand our capacity by over 35% and over 85% of this capacity is already sold under long-term costs pass-through contracts, which include minimum takes.

Gases results should also improve from new contracts and investments in our two other gases growth platforms, electronics and health care.

Our electronics business improved its profitability in the first quarter, and we are expecting further improvements during the remainder of the year.

In health care, we have a new major contract for serving homecare patients in the UK and expect to start serving customers towards the end of the second quarter, which should add about $20 million in revenue in fiscal 2006.

Also in health care, we should see improved volumes from the underlying growth in the market and our 2005 acquisitions.

We continue to see opportunities in Asia, where we are advantaged, and where we can continue to build on our strong positions in the market and our technological capabilities.

As I mentioned last quarter, one of our 2006 goals is to expand our gas margin.

We made progress in the first quarter, but we do expect a dip in the Quarter 2 margins based on our quarter guidance, principally due to the maintenance outages and lower bonuses in EPI and the seasonal slowdown in electronics.

Actions we've already taken on price increases, plus the continued growth of volumes and contributions from the increased productivity, should get our gas margins back to 15% or above by yearend.

Shifting to equipment, business activity remains strong.

Our LNG backlog is at a record level, and we signed two new orders in our large air separation unit business this past quarter.

Overall, we continue to forecast our chemicals profits to be below fiscal year 2005, principally due to the loss of two major contracts in our polyurethane intermediates business.

Our growth segment in chemicals, epoxies, polyurethane additives, and surfactants, are forecasted to continue to perform well in 2006.

Most importantly, our [ERONA] growth in 2006 should continue to expand and be between 11% to 11.5% as we continue to make progress to achieve our 12.5% target in 2007.

Our full-year property plant and equipment CapEx guidance remains unchanged in the $1.2 billion to $1.3 billion range.

Remember, this includes $300 million for buyout of our tank lease.

Regarding Homecare acquisitions, we did not do any in the first quarter, and it is not likely is that we will spend as much as in past years.

The reason why we are bringing -- the reason why is we are bringing new logistics and customer service IT online in this business and therefore our pace of acquisitions will slow to ensure we get the productivity and organic growth benefits.

In closing, we believe that our results demonstrate our progress and give us the confidence that we are on the right path going forward.

Our whole team is excited by the opportunities ahead in our businesses.

We remain committed to increasing shareholder value and delivering on our 2006 goals.

We believe that the positions we have in our energy, electronics, home care, performance materials and Asia growth platforms, coupled with our productivity, will deliver excellent topline growth above our competitors, and most importantly, improved our return on capital for our investors.

Thank you.

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

Thank you. [Operator Instructions] We'll first go to Bob Koort with Goldman Sachs.

Thanks very much.

I was wondering if you could go through -- you gave some information on the chemical space of what causes some depressed volumes, most of that temporary.

Is it possible to break out specifically what some of those were?

Sure, Bob.

And I'll try to provide a little bit more flavor for that for you.

First, the biggest factor occurs in the polyurethane intermediates business, which we have.

And that's where we had to terminate -- the contract termination, which was booked in the fourth quarter and then we did the shutdown of a very large customer.

And so that really drives the major factors in volume.

Sorry, Paul.

Of 6%, is that two-thirds of that or --?

It's most of that --

Okay.

-- almost all of that, when you look at that.

And we have seen our customers pick up some of that slack as the market has gotten better for them.

But it certainly hasn't picked it all up for us.

And then if you then take a look at -- on the performance materials business, the emulsions business and we have been pushing price increases through on this.

And we've talked to you about this before.

And that's where the real impact on at the volumes and performance materials are.

As we go to recover - as we move to recover the increases in materials here, we are taking prices up.

And we continue to go away from business.

And that's something which has occurred throughout the year.

It's not a phenomenon in this first quarter of the fiscal year.

This is something, which we saw as we went out and raised prices is we moved away from business.

It improved the returns of the business, it improved the probability of the business, but the challenge here now is we have plants which I can sell and so it's going out and selling into the customer base where I can make a good profit and earn good a margin for us.

Okay.

If I might follow-up around selling and chemicals, there has been a lot of speculation rumbling from Wall Street about what you might do with some of your chemical assets and partner in whole.

I was wondering if you could just address your approach to that as well as any possibility that you'd be interested in parts of BOC, if that becomes available.

Well, first on the chemical thing is I'm not going to comment on speculation, which exists in the market.

We are focused on improving these businesses and it tried to make them solid businesses and mitigate the volatility as we've done over this past year.

The company is going to continue to manage and the portfolio business we've shown that, and make the right decision for the company and the shareholder's going forward, here.

So that's our position there on chemicals and the rumors, which are out there on that.

Regarding BOC, I'm not going to comment on what's happening there, as far as that is concerned I'll leave that to the people at BOC and Lyondell.

All right.

Thanks, Paul.

Yep.

Thanks, Bob.

Thank you.

We will go next to Mark Gulley of Soleil Securities.

Good morning, guys.

I got two questions.

Hi, Mark.

First of all, with respect to refinery hydrogen, you guys really are on a roll with respect to plants starting up and plants under construction.

But can you give us any help as to what kind of returns on capital you are putting on the books in order to get more than your share of that new business?

Mark, I think we've talked about this before as far as return on capital on this hydrogen business.

It is in the low teens for us as we look forward here, on a -- kind of on a cash flow basis and that's in which and how we're going to make the decisions.

Certainly, when you bring these plants on, and they are not fully depreciated, the return on capital is going to grow a little bit over time on this, on the book accounting return on capital.

Secondly, with respect to the LOX/LIN business, it looks like you are organizing that on a line of business basis globally.

But this is a regional business with a distribution radius of couple of hundred miles.

Can you discuss how such a regional business you want to manage on a global basis?

Phil, why don't you take that and talk to him about it?

Yeah.

Mark, good question.

We are still going to keep the regional infrastructure in place.

The global overlay really is around being able to share best practices quicker.

Being able to do things the same across the globe and get cost out of the whole system.

It's not going to impact any day-to-day customer interaction or the ability to move quickly in the regional markets.

This is purely a way to simplify the business, get costs out, be able to move quicker, and bring more profitability to the bottom line.

One house-keeping item, how much of the margin or operating income in gases was due to that land sale?

It isn't a hard number to figure out.

It is about 0.6 of a point, maybe you look at that -- 9.5 million.

Thanks, Paul.

That's disclosed in our financials.

Yes.

Thank you.

We'll go next to Jeffrey Zekauskas of JP Morgan.

Hi, good morning.

Good morning, Jeff.

Just a couple of things.

On slide 4, where you have the analysis of your earnings per share, it doesn't seem to be any benefit from cost reductions.

Why is that?

And can you talk about the net cost savings this year with reference to why you've increased your guidance?

Yes, okay.

First, on the cost performance there, and what you're looking is the absolute cost.

And so, as I said in the script -- as I talked to you earlier on this, the thing which we offset with our cost is volumes are up by about 5% for us in terms of sales.

We've offset the impact of cost which go up because of those, additional plants, et cetera.

We've absorbed all them.

Inflation, we experienced inflation of somewhere of 3.5% across the world.

I've offset that impact.

And higher -- and pension costs are up for us this year.

So I've offset the impact of pension costs.

It's all included in that.

And the productivity has really gotten -- it's gotten greater than the inflationary increases, which I saw.

It's also gone into the higher pension costs and the higher costs related to the volume for that.

As I look at that, it is very good news for us.

I guess if I can just ask you a philosophical question?

Sure.

So in rough terms, operating income in the quarter was about $252 million, and last year, at least by our calculations, it was 238.

So you're up 14.

And basically your equipment is up about 10 million in operating income, and you've got a land sale, which is up -- whatever it is -- another 8.

So year-over-year, there really isn't a lot of appreciable change.

Now you're up against hurricanes, you're up against cost inflation.

So when you sort of assess your product's performance in the first quarter, did you feel that you really did well?

Were you disappointed with it?

Will the cost structure change very much in the coming quarters?

How do you see it?

Okay, Jeff.

Based on the -- if I look at the year-on-year impacts, a thing which you missed is I have $12 million of additional costs for options.

Okay.

Other than that 230 and I would take 12 out of that -- with that.

And so -- and yes, the hurricanes have been a head wind for us for that.

And that's $0.06.

And if we didn't -- and if we looked at that very hard, I would add it would have been better by that amount.

That's $120 million.

If you ask me how I feel, I feel we turned in a very good quarter.

We had some headwinds.

Certainly by that, we had some things which helped us, such as the land sale with those things.

But the land sale was a result of us trying to take a look at our assets of moving certain things around.

I have costs associated of reducing -- of closing that facility which I have.

It's not booked against that because they occur at a time, and they'll flow through income at that point in time.

But as I work forward here, I'm very encouraged by us going forward.

I think we have made very good progress in the area of productivity, and we've moved that stuff forward.

And my productivity this year is greater than what I've posted prior year, which is greater than the year before.

So I'm delivering on the commitments in which we've made.

And so the SAP system is working.

To reference back to the previous comment, which Phil that in the gases business, one of the reasons why we've consolidated that is we now have a common business model, common systems in which we can enforce that and we can derive productivity across -- going across that.

So I think we've brought the leverage to the bottom line for us, and you can see that in our improving returns.

Okay.

Thank you very much, Phil.

Thank you. (Operator Instructions).

We'll go next to Fred Siemer of Chemical Research for Wall Street.

Yes.

Good morning.

Just --

Hi, Fred.

-- hi.

Just two quick questions.

One in the polyurethane business is probably clearly not earning the cost of capital now.

My question is if Lyondell came back, would it still not earn the cost of capital and therefore as a well managed company would be a candidate for divestiture?

And the question -- Okay.

I'll do the other question later.

If Lyondell came back, I would be above my cost of capital, Fred.

You would.

Okay.

Yes.

The other one at an 88% operating rate in merchant, that's almost not sustainable.

There have been one or two standalone merchant plants built in the United States lately.

What are the prospects for your products building a merchant plant?

And the plans for us, Fred, for us is first to convert customers.

And our conversion rate is higher in this year than in last year.

Now it takes some time for us to do that conversion.

So we've got greater conversions coming out here in the future.

And second, to look at our plants and to go out and de-bottleneck certain plants in areas in which we are tight.

And the reason why we -- is that we have this opportunity is we haven't -- it hasn't been an area in which I've been spending a lot of time recently.

The past five years as the loadings across the system has been lower.

So we have a good opportunity there to meet -- to get some additional tons in areas at a ver cheap rate.

Okay.

No piggyback opportunities?

No.

Okay.

Thank you.

Thank you.

We'll go next to Laurence Alexander of Jefferies.

Good morning.

Hi, Laurence.

The first question is on electronics.

Can you discuss in more detail the pricing trends, and in -- particularly in specialty gases excluding NF3?

Phil, why don't you take that?

Sure.

Laurence, the NF3 pricing is still under some pressure.

However the good news is our volumes, which are well into the double-digits on NF3 year-over-year, are still continuing to grow.

LCDs, in particular, are up over 30% year-on-year.

Samsung is going to be starting their Phase II at some point in time.

So we do hope that the volume or the pricing pressure will abate, and we expect it to abate at some point in the future.

But in the meantime, we're continuing to pull costs out of electronics.

A good example of that is we've shut down four distribution centers in the US, so far this year.

We are continuing to look at ways of simplifying the business, pulling cost out.

And our goal is to continually improve the margin in electronics, which we've done both year-over-year and sequentially this quarter.

And continue to improve the margin and pull costs out faster than price goes down.

And secondly, if you look at the European gases business, can you discuss the trends in the on -- what in the entire business including the on-site?

What would total volumes be if you included the on-site in the volume data?

The on-site volume -- we do not go out and do that.

So as far as that if we take it out on European gases business for us, the signings in our business have gotten a lot better for us.

And so the improvements there are encouraging.

Now that's been something, which has occurred of the past six months for us.

So we haven't -- we aren't seeing the year-on-year gains yet, but we would expect our volumes to start increasing there.

Thank you.

Thank you.

We'll go next to a Ray Kramer of First Analysis.

Hey, good morning, Paul and Phil.

Good morning, Ray.

Hi, Ray.

A question here.

If I look at your full-year guidance, it seems like the hurricane impact this year is going to maybe even be a little stronger than you were looking for.

So what's -- what are maybe the one or two biggest things behind your increase there, given that your underlying assumptions, as you said, are unchanged?

Okay.

I think the driving force is our progress on the productivity front, to give you just a simple answer.

Phil has gone through some of the examples in the last answer there for things, which we have gone through.

So that's the thing, which encourages me the most.

Okay.

And then just a clarification.

When you talk about EPI bonuses having a negative effect, can you just refresh my memory of what exactly that is?

Yes.

Is that some sort of bonus paid to you by the customer for some performance metric?

Yes, they are.

And it really has to do with when the contract year falls.

And so the contract year in the second year -- I have a lot less expiring in the second quarter.

It's kind of -- they don't expire, but it's a contract year rollover there.

And I have the bulk of them in my fourth quarter or in my first quarter.

Okay.

Yes.

Thanks, Paul.

You're welcome.

Thank you.

We'll go next to Don Carson of Merrill Lynch.

Thank you.

Hi, Don.

Hi.

A question on gases ERONA.

You've talked that electronics and to a lesser extent European gases businesses is not earning the cost of capital.

Are there others and can you give us some sort of timeframe for when you'd expect Europe and electronics to return to your ERONA targets?

I think you said in the past that you're single-digit margins in ERONA in electronics for example.

And the good news, Don, in our electronics business is that the margins are double-digits in this quarter.

So we are happy about that.

So we did have good improvement in this quarter.

The timeframe is for us to have a steady improvement.

We certainly hope in that -- sometime in the 2007, 2008 period, we would get both of these over the cost of capital.

Now what they really involve is some changes in the business.

And so you have to involve customers, et cetera, and so it does take some time.

It's not something which we do overnight for us.

Would you expect Europe to get back there before electronics - is that less of a challenge?

Certainly.

The gap is not as large for us.

And the answer is probably, yes, I would.

Okay.

And then unrelated question, but in merchant, you've talked about converting surcharges to permanent price increases.

What pressures are you seeing in electricity costs?

What are your year-over-year changes in electricity costs?

Don, we've seen double-digit electricity costs in North America as well as strong double digit in Europe, particularly in the UK.

Okay.

And thus far, you have been able to stay ahead of that with surcharges?

Yes.

Yes.

Okay.

Thank you.

Thank you.

We'll go next to David Begleiter of Deutsche Bank.

Thank you.

Good morning, Paul and Phil.

Good morning, David.

Hi, David.

Hey, Paul, just on chemicals, how much of the portfolio is earning below its cost of capital?

If you look right now in what we have is that probably half or so is below its of cost of capital when I break down the product lines.

And is there a reasonable timeframe to get it above the cost of capital?

Obviously, polyurethane intermediates requires a fix to a degree.

Right.

I think if you look at that, yes.

I mean we do have a timeframe.

But the chemicals business overall, obviously, is right at its cost of capital right now or slightly above it.

But if you look at the businesses which we have, the largest one is the emulsions business for us.

And we continue to work at that.

We are making progress.

We would hope that somewhere in the 2007 timeframe to have that above.

It really involves going out -- we think the price dynamics which we've put in place are in pretty good shape.

Now, it gets in getting the volumes in the right places for us.

On the amines business, it also goes around getting some volume with the right customers.

We've also had a lot of pricing actions, in which we have taken amines, especially in the hires area to get our prices up there.

So a lot of this goes around the volume coming back in.

The productivity in this business has been excellent for us.

And Paul, just looking at '07, '08, what is the earnings power of this segment, both on a margins basis and an absolute dollar basis?

If you look at the margins, which we've said about, at these -- at the prices in which we're passing through, we probably -- I would say 10% to 11% margins would be our goal going on here.

Thanks so much.

Thank you.

Thank you.

We'll go next to John McNulty of Credit Suisse.

Good morning, Paul.

Hi, John.

A couple of quick questions.

In the last quarter you had guided-- or some of your guidance was hinging on an electronics industry with flat to slightly up or up 5% semiconductor production.

Is that still kind of what you're looking for now or are you raising kind of your outlook given the strength in the industry right now?

We're looking at about 5% now --

Okay.

-- is our outlook.

And then on a completely different topic, you had mentioned earlier in your healthcare platform, at least for the time being, acquisitions may be a little bit lighter than what you've been kind of gearing towards because you're putting systems in place for logistics, that type of thing.

When you look outside or into the rest of your businesses, would you say you have the systems in place for acquisitions there, where you can actually handle that or you're still kind of in fixing mode, which I know you have been working on over the last couple of years?

No, if you take a look at our system, the SAP system is now across the US and Europe and it's in every business, except our -- in the US, I don't have the healthcare business on it.

But if you take a look at those businesses, it's performed very well.

We're getting the productivity off of that system.

And so the IT component of this would not be a barrier.

Okay.

And then the last area, your debt to cap basically was flat with where you were last year-- or I mean last quarter.

And in that, you had said that ideally, your leverage ratio may be a little bit too light, and you'd like to use cash maybe a little bit more aggressively.

Can you give us some color, now that we're a quarter already into your fiscal year, where some of that cash may go and where you might bring some leverage on up to the balance sheet?

I can't talk about that -- about those things right now, as far as our planning is concerned.

But I think if you take a look at our actions, we're going to be a steward of the cash very well.

We're going to be conservative in the management of that.

We're going to maintain our capital discipline as we move forward here.

And so our actions of the past two years are going to continue.

We're going to give money where it makes sense to the shareholders for us.

And so that would be our plan.

I wouldn't see a change in strategy.

But as far as a specific action, I really can't comment on that right now, John.

Okay, great.

Thanks a lot.

Thank you.

We'll go next to Kevin McCarthy of Banc of America Securities.

Yes.

Good morning, Paul and Phil.

Hi, Kevin.

Good morning, Kevin.

You had numerous energy opportunities, refinery hydrogen has been well documented.

But we're also seeing the [Tar Sands] come to fruition now in Western Canada, GTL in the Mideast.

You mentioned enhanced oil recovery in Mexico and of course LNG equipment -- it's a lot for investors to keep track of.

If we look out over the long-term, let's say past the prim core, hydrogen start up in mid '06, how would you rank these various energy opportunities in terms of incremental profit opportunity to Air Products, say, over to next three to five years?

We certainly see the Tar Sands - the oil sands -- in Canada as a large opportunity for us and an area in which we could actually be involved in the investment activities.

On the gas to liquids front, right now, the way in and which we're seeing the market develop in Qatar, et cetera, is the sale of equipment market.

Certainly, as far as profit opportunities and stuff like that -- and I prefer a sale of gas with that.

LNG has been -- has grown very well throughout this past year and I would continue to see that continue to grow for us, and to maintain the profitability which I've been able to produce so far.

So we're seeing a very good year on our equipment business, and we would expect that to continue.

And the other opportunities you're going to see-- there is going to be a lot of things which are going to come down -- coal opportunities are going to be out there.

Opportunities to go out and change fuel and plants in the US.

So we see a lot of things out there.

But it falls right in the sweet spot of what Air Products does best.

Okay.

It sounds like excluding your traditional refinery hydrogen, perhaps Tar Sands is the best of the rest, so to speak?

Yes.

Certainly it's something which, as far as the -- it's very large.

It's very, very large when you look at the opportunity there.

Okay.

And then separate subject.

Paul, I think, you mentioned you injected $103 million into the pension plan.

Do you anticipate any additional contributions this year and what is the outlook over the next two to three years there?

Yes.

As far as on the pension plan, our current forecast is for about $150 to $155 million of contributions in this current year.

Going forward, I'm planning on the same amount, but that's something which changes every year with -- on the valuation, Kevin, of the pension plans.

So the -- and the number moves on us.

I understand.

Thanks very much.

-- just to caution you there.

Okay.

Thank you.

We'll go next to Robert Ottenstein of Morgan Stanley.

Hey guys.

Small thing that I just noticed.

It looks like the R&D stepped up a little bit.

Is that a timing issue or a trend?

And if it's a trend, is there something new that you're investing in?

There is not anything new from there.

In the R&D, it does tick up a little bit about $1 million on stock option expense, so you know the stock option expense gets spread throughout the PNL.

We continue to see a lot of opportunities for R&D, particularly in our performance materials electronics business for there.

So R&D spending is going to continue in those areas.

Great.

And on the SG&A side, you guys continue to do a great job keeping that down.

It's really nice to see.

What's the outlook there for the rest of the year?

Are we going to see, does that come up, as the year goes and you guys start accruing for a big management bonuses or what should we be extracting there?

On the SG&A front its certainly, it's a something we can keep as a focus.

Certainly as volumes grow, you get pressure in the transactional areas to do that.

Certainly, I think too, as I look out on the energy area, certain things which could drive SG&A up a little bit as we work on the larger projects out there in advance with those things.

So I could have some pressure there.

However, the offset to that is I think my topline growth is going to be a lot better year-on-year for the following three quarters.

So I think I can maintain my average -- percent of sales there.

Sure.

And one last question I know in electronics, pricing is down, but margins were up sequentially and year-over-year.

In terms of pricing trends, can you talk about that?

Is it stable, abating or increasing?

Phil, why --

Yes.

The only thing we can really say about that is, it is still under pressure, but our volumes are continuing to outgrow and productivity efforts are continuing to expand the margin, and that's the way we're running the business.

Okay.

Thanks a lot guys.

Thanks.

Welcome.

Thank you.

We'll go next to Jeff Cianci of UBS.

Hi guys.

Hi Jeff.

Paul, a little more on equipment.

You mentioned you've got some ASU equipment and I noticed there always seems to be seasonality in the December quarter doing less activity.

So because my question is what is the mix going forward, it's obviously almost all LNG, but you've got some gas equipment and do you still see your early projection of almost double income this year?

Yes.

As far as the guidance and stuff like that our guidance and equipment is still very strong as far as going forward there.

I think the other thing Jeff is that on the mix of equipment, certainly a good portion of this is still on the LNG area on the air separation plants.

The profits are not, the margins are not as big because the value-added component -- I buy a lot of compressors and fuel another things that reassemble the plant where in the LNG I give a process license and the exchanger and deliver that to the site.

And so the -- and the mix on how much that value added changes.

Right.

So you've got 11 in the backlog, can you talk about the proposals out there?

Is there another 11 waiting?

And -- there is a lot of activity in the LNG area and given the gas prices and where they are a lot of people are looking at these projects and so we are encouraged by this.

Will they make decisions during calendar year '06, the proposal that are out there, so the backlog could in fact be notably bigger by yearend?

I think as far as on the backlog is concerned I'm happy with the backlog, which I have now.

If I could continue that, I think I'd be in very good shape throughout -- in the next couple of years.

Okay.

And finally you've expanded Wilkes-Barre, will you expand it again?

Can you expand it again?

Yes I could expand it again.

It depends on the demand and our customer base and what their needs are, but I'm not going to go out and lose a job over this.

All right.

Great job.

Thanks.

Thank you.

Thank you.

We will go to Peter Butler of Glenhill Investments.

Good morning.

Hi Peter.

I have two things.

The first is, I might have missed it, but did you discuss any possible changes in the pricing environment in chemicals?

September quarter to December quarter, was it easier, more difficult, et cetera to get prices up versus cost?

It sounds like, without you mentioning it that maybe you had a squeeze there?

Yes.

We did have a little squeeze on the gas prices spiking Peter, which they did.

And gas prices have come back down so the squeeze is over in that.

But that certainly did not help us in this quarter.

But I think the positive news to that is that the hurt was not as large as prior years because the actions which our products has taken to pass these costs through to our customers.

So it squeezed us a little bit, but it's not squeezing as much.

The second thing is looking at your Hurricane related insurance matters.

Could you say how much you're claiming and over what timeframe do you expect to get this back or what percentage of it do you expect to get back and how are you going to treat that -- those moneys when they come in?

Are you going highlight how much you got each quarter?

Okay.

And that's a good question.

First, regarding the hurricanes and the recovery of that.

Our guidance has been and remains that we expect the hurricane impact could be about flat year-on-year to us.

And that is not going to be a hurt.

Now it was a hurt in first quarter, and so the insurance recoveries are going to continue into the second, third, and fourth quarters.

And so I'm going to get this, I should be getting the $0.06 back over the next three quarters.

It depends upon how the claims get adjusted and how quick they get adjusted as to the timing.

And right now similar -- once you model it divided by three is the best guess and for people have to go out and look at that.

I'm scratching my head over this because there's another company that just reported that -- is suggesting that the recovery will take several years, and presumably, they're going to bury the recovery in their operating earning.

Under what circumstances would it take several years to get back a claim that you made a couple of months ago, I guess?

You ought to ask them.

For us I'm going after it hard and aggressively.

Okay.

Thanks for the help.

Thanks you.

We'll go to next to Mike Sison of KeyBanc.

Sir your line is open.

Please go ahead.

And we'll go next Robert Reitzes of Bear Stearns.

I just want to ask a question a little bit differently.

One is regarding the chemical business.

I know what you said Paul, but have you guys considered some novel ways of improving shareholder value such as joint venturing with somebody taking stock and have you every looked at things like that or are you looking at things at that?

Bob, I think what you'll have to do is to trust us in that we're looking at the right alternatives to do that right thing for the company and for the shareholders in this.

Okay.

I do trust you.

And the second question is a little bit different.

Going to the equipment business, since your visibility is somewhat better there given the lead times, do you think we should see next year being -- in '07 -- should that be a better year than this year or is it too early to tell?

I'd say - I think it's too early to tell.

But I'm going to have a very good year, and I would like to be able to sustain that throughout the next few years.

Okay.

Thanks, Paul.

Thank you.

We'll go next to PJ Juvekar of Citigroup.

Yes, hi.

Hi, PJ.

Just - I have a couple of questions on the chemicals business again.

Three or four years ago, this was a core business.

The [surface science] was very important to you.

Are you committed to this business as much as you were a few years ago?

Okay, PJ.

On the area of the surface science, the connection there really is between the performance materials group -- and the growth platforms of electronics and performance materials, such as surfactants, polyurethane additives, epoxy additives.

Right.

Yes.

And we are as committed to those businesses as Air Products has been in the past.

Okay.

And then on NF3, you talked about your price volume and volumes are outpacing price declines, can you talk a little bit about how much capacity is being added by your competitors in Korea and other places?

Yes, PJ.

This is Phil.

I can't really talk about what our competitors are doing.

And as you're probably aware, we expanded our hometown -- excuse me, our -- yes, our hometown facility by 50% recently.

We don't have any plans on the books right now to expand additionally on top of that.

The volume growth is still in the strong double digits, and we'll see what happens as time goes on.

The only thing I'd remind you is we are really good and we've got a good history at expanding incrementally the NF3 plant and our LOX/LIN plant.

So we'll probably look at that before we look at anything else.

But still while answering one other previous questions, you said that you expect pricing pressures to alleviate in NF3.

I mean why do you expect that?

PJ, it's all relative.

I'm not saying we expect a significant drop in pricing pressure.

But as the price gets lower, you would expect the pricing pressure to slow down somewhat or abate over time just by virtue of it's got to.

It can't go negative.

So you're saying the growth will slow -- the decline will slow down -- the rate of decline will slow down?

I would hope so.

Yes.

But you still expect pricing pressure.

You're not saying prices would go up.

Correct.

Okay.

Thank you

Okay.

Thanks, Deanna.

Thank you for your participation.

That does conclude today's conference.

You may disconnect at this time.

Thank you, Deanna.

Thanks for joining us today.

Please go to our website to access a replay of the call beginning at 2 o'clock today.

Bye-bye.