Air Products and Chemicals Inc (APD) 2006 Q2 法說會逐字稿

Good morning and welcome to Air Products and Chemicals' second quarter earnings release conference call. (OPERATOR INSTRUCTIONS).

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, you may begin.

Good morning and welcome to Air Products' second quarter earnings teleconference.

I am Phil Sproger, Director of Investor Relations.

Today our CFO, Paul Huck, and I will review our fiscal second 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.

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

Now I will turn the call over to Paul.

Good morning and thank you for joining us today.

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

Before I begin reviewing the quarter's results, I would like to comment on a couple of items.

First, just a reminder on Financial Accounting Standard 123R.

We adopted FAS 123R on October 1, 2005 and began expensing stock options.

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

We have not restated 2005 results.

For comparison purposes, we have included slides 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.

Recently we announced the repositioning of our Chemicals business to make Air Products a more focused, less cyclical and higher growth Company.

Let me give you a brief update on our progress.

On March 22, we announced the restructuring of our polyurethane intermediates business, the exploration of the sale of our amines and polymers businesses, and an agreement to purchase Tomah3 Products, as well as a large stock repurchase program, and a dividend increase.

On March 31, we completed both the acquisition of Tomah3 Products and the sale of our Geismar DNT facility to BASF.

The sale resulted in a pretax book gain of $70 million.

Offsetting this gain is an impairment charge of $66 million for loans to a sulfuric acid supplier to our polyurethane intermediates facility located in Pasadena, Texas.

Due to the restructuring of our polyurethane intermediates business, our sulfuric acid requirements at Pasadena have been reduced, and we now view these loans as uncollectible.

On an after-tax basis, the plant sale gain and the loan impairment charge offset one another, with a gain of $0.19 per share, offset by a loss of $0.19 per share.

There is no impact to our reported net income or earnings per share.

Further details are available in our earnings release footnotes.

We continue to explore the sale of our Amines and Polymers business, and further restructuring of our remaining polyurethane intermediates business.

We're encouraged by the interest shown by potential buyers.

Because we're in the midst of an ongoing process, we can't comment further on this today.

Now if you will turn to slide 3.

Sales grew by 16% to $2.3 billion.

Adjusting for currency, natural gas and acquisitions and divestures, we generated underlying sales growth of 13%.

This was mainly due to higher volumes of electronics, EPI, global merchant gases, and higher Equipment segment sales.

Natural gas and raw material pass-throughs increased by 5%.

This was partially offset by an unfavorable currency impact of 2%.

A more detailed sales analysis is included in the appendix.

SG&A increased $10 million or 4% on an absolute basis versus prior year.

This was primarily due to inflation and higher costs in support of our Homecare business.

We continue to make progress lowering SG&A as a percent of sales.

For this quarter SG&A was 11.9% of sales.

Sequentially SG&A increased $21 million or 8% due to salary increases which went into effect January 1, higher homecare spending in the UK in support of our new Homecare contract, and increased spending on new project development.

Operating income of $295 million was up 22% from prior year, due to improved results in all three business segments, particularly Gases and Equipment where strong volume performances drove the improvement.

The increase in Chemicals’ operating income was driven primarily by pricing actions to recover raw material cost increases.

Regarding hurricane impacts.

The other income and expense line includes $4 million in property damage expenses and $24 million in insurance recoveries.

Additionally, we experienced a business interruption impact of $5 million for a net gain of $15 million, or $0.04 a share.

This is reflected in our Gases segment.

For fiscal year 2006 our hurricane impact guidance remains unchanged.

We still expect a slight positive impact for the year in total.

Equity affiliate income was lower, mainly due to higher maintenance cost in Gases.

Our tax rate this quarter is 28%, and is impacted by the chemical plant sale and the loan impairment charge.

Excluding these two items, our effective tax rate remains 27%.

For the quarter we reported net income of $204 million, or diluted earnings per share of $0.89.

When compared with the prior year, net income increased by 21%, and diluted earnings per share was up 24%.

Most importantly, our ORONA continued to improve this quarter.

We were up 90 basis points over last year, and up 50 basis points sequentially.

Return on capital improvement remains our highest priority.

In the area of receivables we demonstrated solid improvement as our DSO was 59 days at the end of the quarter, down nine days versus prior year.

Please turn to slide 4.

Cash flow from operations was down $117 million from prior year for the first six months.

This is principally due to three areas, inventories, contracts in progress, and accounts payable and accrued liabilities.

For both inventories and contracts in progress the change was small in 2005.

Inventories are up from 30 September 2005 due to hurricane recovery and normal business activity.

This was responsible for $62 million of this change.

Overall our days on hand of inventory is slightly below our historical average.

Contracts in progress is up $22 million from 30 September 2005 due to increased activity in our Equipment segment.

Payables and accrued liabilities are down, principally due to larger pension contributions made this year which reduced our current liabilities.

These unfavorable impacts were partially offset by improvements in the principal cash flow generators, net income and depreciation, and by increases in accrued taxes shown in the other working capital line.

Please turn to slide 5.

Capital spending for the quarter was $663 million, consisting of $297 million for the repurchase of our tank lease, $230 million of property, plant and equipment, acquisitions of $127 million, and capital leases of $1 million.

Year-to-date our property, plant and equipment capital spending is $810 million, including the $297 million for the tank lease.

For the year our PP&E capital spending guidance remains unchanged at 1.2 to $1.3 billion.

Turning now to slide number 6.

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 $0.25 improvement.

Higher pricing and raw materials costs together were net a $0.05 favorable amount, driven by Chemicals pricing actions.

In Gases electronics price declines were mostly offset by North American Gases price increases.

Other costs were unfavorable as improving productivity efforts did not offset the impacts of inflation and increased costs in our Homecare business.

As mentioned earlier, hurricane impacts were a favorable $0.04 on insurance recoveries.

Unfavorable currency impacts totaled $0.02, minority interest impact was $0.02 unfavorable on better performance on our polymer emulsions JV and Taiwanese affiliate.

Fewer shares outstanding contributed a positive $0.02, and all other items net to 0.

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

Please turn to slide 7, Gases segment.

Worldwide Gases sales of $1.6 billion were up 16%, primarily due to underlying growth of 13%.

Natural gas pass-through contributed 5%.

These items were partially offset by a negative currency impact of 2%.

The underlying growth was driven by strong volume gains broadly across most Gases businesses, particularly electronics, EPI, and global merchant gases.

Pricing gains in North America and Europe merchant gases were mostly offset by decreased pricing in electronics.

Sequentially, Gas sales grew 5% with underlying growth of 8%.

The growth was primarily driven by improved volumes in electronics, EPI, and global merchant gases.

Lower natural gas pass-through impacts reduced sales by 3%.

Gases operating income of $229 million was up 15% on strong underlying volume growth in most businesses.

Segment operating margin of 13.9% was down 20 basis points compared to last year.

Year-on-year natural gas price increases offset the favorable impact of hurricane insurance recovery.

The favorable impact of increased volume was offset by lower profits in our Homecare business.

The decrease in Homecare profits was due to start up costs associated with our new Homecare contract in the United Kingdom, and flat sales and higher costs in our U.S. business.

Sequentially, operating margins dropped 80 basis points.

The impact of lower natural gas prices predominantly offset last quarter's land sale.

The hurricane related insurance gain and volume increase was more than offset by higher maintenance cost and lower bonus payments in EPI, increased European Homecare costs associated with the UK start up, and lower sales and higher costs in North American Homecare.

Let me now provide a few highlights by major businesses.

Please turn to slide 8.

In electronics, sales were up 17% year-on-year.

Excluding equipment, sales were also up 17%.

Lower pricing in several products was more than offset by strong volume gains across most products.

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

Volume gains in specialty materials more than offset pricing declines.

Sequentially, revenue was up 14%.

Excluding equipment, revenue was up 6% versus prior quarter.

Sales into semiconductors continued to show strong growth.

Activity around bidding remains high and our win rate for projects has remained around 50%.

We have recently won several new on-site deals in both the U.S. and Asia.

The fluorine derivative business continues to be very strong.

NF3 sales to LCD facilities are on plan, and NF3 sales to integrated circuit manufacturing are exceeding expectations.

WF6 demand is also showing strong growth by increased Flash memory demand.

Our NF3 capacity utilization, including the new facility, is above 80%.

We expect to see relatively strong growth both in semiconductors and LCD manufacturing for the remainder of the year.

This business continues to improve.

We're working diligently on increasing profitability by focusing on loading our plants and achieving cost reductions by simplifying the business.

Now turning to slide 9.

In our Energy and Process Industries, or EPI business, volumes increased 5% when compared to last year.

Hydrogen and CO volumes were up 8%.

This was driven by the full quarter impact of the two new plants we brought on stream in fiscal Q1.

Sequentially volumes increased 7%, as refineries which were impacted by the hurricanes were back on stream for the full quarter.

Other than one refinery in Louisiana, all refinery customers were back and running as expected.

The two new hydrogen plants located in Convent, Louisiana and Baytown, Texas, which recently were added to our Gulf Coast pipeline systems, are in full operation and are meeting performance expectations.

We currently have seven new plants under contract for our EPI customers.

Five of these are new hydrogen plants and will supply over 375 million standard cubic feet per day of hydrogen to refineries in the U.S. and Canada, another will supply over 1,500 tons per day of oxygen under long-term contract for a coal gasification project in Nanjing, China.

And the final plant will supply 3,200 tons per day of nitrogen to Pemex for use in enhanced oil recovery at their operation in Mexico.

We expect this business will continue showing solid growth during the remainder of FY '06 and beyond.

Please turn to slide 10, Global Merchant Gases.

In North America our liquid bulk volume index was up 1% year-on-year.

Excluding liquid hydrogen, volumes were up 6% year-on-year.

Overall LOX/LIN capacity utilization came in at 88%.

We continue to moderately add capacity in this business by debottlenecking our plants.

For the year we expect to increase capacity by 3 to 5% by these actions.

We also continue to convert certain large customers from liquid supply to small on-site generators.

Volumes were up 9% sequentially.

Liquid hydrogen growth was strong as our Sarnia liquid hydrogen production facility returned to full operation during February.

Average LOX/LIN pricing increased 14% year-on-year in North America.

We are in the process of converting existing surcharges to permanent price increases.

We will continue surcharging when required to recover increased electricity and fuel costs.

In Europe our liquid bulk volumes were up 7%, driven primarily by spot requirements.

Cylinder volumes were up 3% compared to last year, but remained flat on a workday adjusted basis.

LOX/LIN pricing in Europe was down slightly compared to last year as initiatives to recover higher energy costs were more than offset by mix.

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 1%.

During this fiscal year we plan to start up five on-site plants which will include liquid capacity to serve our growing customer base in Asia.

Two of these plants are located in India where we, through our joint venture, are building over 2,000 tons per day of capacity to serve the steel industry under long-term contracts.

Both these plants will have additional liquid capacity to serve our strong number one position in the local merchant market.

Finally, new business signings remained strong across most regions in our merchant business.

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

Please turn to slide 11, Chemicals Segment.

Worldwide Chemicals sales of $493 million were 1% lower compared to prior year, despite higher prices in many businesses and positive raw material pass-through impacts.

Lower volumes due to customer shutdowns in polyurethane intermediates, the shutdown of our converted products business, and the stronger dollar combined offset pricing and pass-through effects.

Sequentially, sales were up 11%, primarily due to strong seasonal volume growth in polymers and amines.

Operating income of $46 million was 8% higher than last year.

Increased pricing in Chemicals more than offset higher raw material costs.

In our Performance Products and Solutions business volumes were mixed as increases in polyurethane chemicals and surfactants were offset by lower epoxy volumes.

In intermediate chemicals amines volumes declined mainly due to customer outages and lower takes.

Polyurethane intermediates volumes were down due to the Rubicon and Lyondell shutdowns.

Next let me cover our Equipment segment on slide 12.

Sales of $180 million were up substantially, primarily due to higher air separation and LNG activity.

Operating income of $24 million increased significantly, primarily due to higher LNG activity.

Sales and operating income were both up compared to last quarter as activity increased on LNG, air separation and hydrocarbon separation units.

During this quarter we announced another LNG heat exchanger order for a project in Peru.

And this month we also received an additional order for a grass-roots LNG facility in North Africa.

The sales backlog at $596 million is up significantly.

Now I will turn the call back over to Paul.

Please turn now to slide 13 for our fiscal third quarter outlook.

Our fiscal year is off to a good start, as we delivered solid results in the first half of fiscal 2006.

We leveraged 11% topline growth into 20% earnings per share growth.

And our return on capital is 90 basis points higher than it was last year.

Looking forward, we expect solid topline growth for the remainder of the year.

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 second quarter 2006 results, we expect third quarter earnings in the range of $0.88 to $0.92 per share, year-on-year earnings growth of 11% to 16%.

While there are many factors that will impact our walk from quarter two to quarter three, let me highlight a few of the factors that will influence next quarter's results.

Factors we forecast to increase earnings sequentially include, in EPI higher volumes in our North American hydrogen franchises, coupled with three new hydrogen plants coming on stream during the third quarter.

Our Homecare business had a disappointing second quarter.

We are taking actions to improve this business and are encouraged by the early results.

In Europe we have already begun reducing the UK start up costs.

In the U.S., we have put in place sales programs to increase volume, and we already seen improved referral rates.

Factors we forecast to decrease earnings sequentially include, lower net positive impact from our hurricane insurance recoveries, lower operating results in Chemicals, partially due to the sale of the Geismar DNT business to BASF, and seasonally we anticipate lower volumes in PUI and amines due to customer outages, higher interest expense associated with the share repurchase, the new hydrogen plan investments, and the repurchase of our tank lease.

Please turn to slide 14 for our full year outlook.

Based on the progress we have made in the first half of fiscal 2006, and current business conditions, we are increasing our forecasted full year earnings guidance to a range of $3.40 to $3.50, an increase of 15% to 19% over fiscal year 2005.

A third year of strong double-digit earnings growth and improved returns.

Please note that the guidance for both the quarter and the full year exclude the impact of the future Chemical portfolio actions and any additional costs associated with maintaining our cost structure in line with our goals.

From an operating standpoint, our Gases results should improve in 2006, benefiting from the six hydrogen plants we are scheduled to bring on stream throughout this year.

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

Our electronics business improved its profitability in the second quarter, and we are expecting to sustain that improvement and continue to grow during the remainder of the year.

In Homecare, while we're disappointed in the results this quarter, we believe the fundamentals that attracted us to this business remain unchanged.

We have already implemented actions to address the issues we saw in the second quarter, and we're beginning to see improvement.

We continue to seek opportunities in Asia where we are advantaged and where we can continue to build on our strong market positions and technology capabilities.

We have five new facilities scheduled to come online in the next 12 months to serve this swiftly growing region.

As I mentioned last quarter, one of our 2006 goals is to expand our Gases margins.

We made progress in quarter one, but as expected we saw a dip in second quarter margins due to maintenance outages and lower bonuses in EPI, as well as poor performance in Healthcare and less favorable cost performance.

Actions we have already taken on price increases and in the Homecare business, plus the continued growth of volumes and contributions from increased productivity, should get Gases margins back to 15% by year end.

Shifting to Equipment.

Business activity remains strong.

Our LNG backlog is a high-level, and we continue to see a strong level of activity in this area.

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, and the sale of our Geismar facility.

While our portfolio management activity is underway in Chemicals, we are excited about the future of our Performance Materials business, and believe that we are on the way to building a unique, high return business.

Most importantly, our ORONA for 2006 should continue to expand and be between 11 to 11.5% as we continue to make progress to achieving our 12.5% target in 2007.

And finally, our full year of property, plant and equipment CapEx guidance remains unchanged.

In closing, we believe that our results and the actions we took this quarter continue to demonstrate our progress towards increasing our returns and delivering increased value to our shareholders.

We firmly believe that we are on the right path to transforming our products into a more focused, less cyclical and higher growth Company, delivering higher returns and greater shareholder value.

Thank you.

And now I will turn the call over to James to take your questions.

(OPERATOR INSTRUCTIONS).

Dave Begleiter with Deutsche Bank.

Just on productivity, were you surprised that it did not offset inflation in the quarter, and why will it offset inflation in Q3 and Q4?

Yes.

I was not happy with that and John wasn't happy with it either.

I think some of the reasons why is as we look at the action plans which we have and the actions which we're taking across our businesses, especially in our supply chain activities, we expect them to continue to pay dividends with it.

We view this quarter as a bump in the road really on that in that we still think we're on track as we look at all our key indicators.

Also, on the same track, Homecare, when did the problems really arise, and what was the impact in the quarter on overall margins, in Homecare not performing?

Let me give you a bit more color on what happened in Homecare there.

In the U.S. business, what happened is we said our sales were about flat with prior year.

They are below the first quarter.

Our costs are up versus the prior year, as we looked to build the infrastructure and to serve that volume going forward.

Costs were up versus prior quarter but not as much.

The issues which we have are around our volume, our need to drive the productivity in that business, and improving our order-to-cash performance.

We have changed management really in our sales area, in our operations area, and in our customer service area over the past six months in that area to address these issues.

So the issues are something which are somewhat new to us here.

We were making good progress in that business, but it seems that we have had some changes.

We treat this as an opportunity to improve.

We have got programs in place to address volume.

We are already seeing, as I said, increased referrals, which are good -- a leading indicator in this business for volume coming back.

We have taken our sales force in that business and taken them through training and new marketing programs to get it back.

We worked on our customer service to look at abandoned calls in that area.

So what you can see here is we're trying to hit all of the very basics where we think we fell down on.

Programs to address productivity, moving to shared services in order-to-cash.

We are looking to how we get the drivers to make more stops during the day, and reducing our bad debt in that area.

The conclusion is really that we aren't happy with the things that happened.

But as I said this is an opportunity.

We know what to do.

We're doing it.

We think that we will see improvement throughout the year into next year.

We have suspended the acquisitions in that area until we get back on track in those areas.

And we are encouraged by the initial results.

In the European business it was different.

We took this contract in the UK, and it was supposed to be a gradual turnover from the pharmacies to the outsourced Homecare providers.

We had geared up for that, and that is what we expected.

The pharmacies, who were not happy with losing the business, dropped all the business on the first day.

The doctors and everything -- the doctors weren't prepared to handle the changeover, and we had been prepared to handle a gradual changeover.

So we had to add temporary resources very quickly to handle the number of calls and stuff like that.

So we had a very busy February and March in that business, and we incurred a lot of extra cost.

We're back on track right now.

We're getting more of a gradual turnover.

And we're working to take out the temporary cost.

Once again the thing which we would view that is that we had a bump in the road for things.

Just to help you size the impact on margins for this, is that if I did not have the Homecare problems in this quarter, I would have been above a 15% margin -- slightly above a 15% margin in this quarter in Gases.

Paul, one last quick thing.

In Chemicals operating profit, how much was from businesses that will likely be retained?

If you look at that we had very good results in those businesses.

We're not going to break out those businesses at this point in time because of issues around allocations of costs in there, which will have to be relooked at from there.

But those businesses continue to improve.

They are more than 50% of our profits in Chemicals, as we have told you before on that.

Steve Schuman with Prudential.

Any comments on some of the changes that C&S is looking at on healthcare reimbursements and rent to own?

Certainly, as we look at the healthcare reimbursements, and we're active with that, and we watch that very carefully for the impact on our businesses, as far as on the meds business, I don't have a large meds business.

So a lot of the noise around that gets around meds for things.

We continue to watch it.

We certainly would and we want to make sure that the services remain at a level which encourages us to do that business, and nothing stupid gets done there.

But certainly we understand that healthcare costs are an issue overall, and that people are going to be looking to drive those down.

So one of the things which I always view on this is that we have to get the productivity in that business for us, and that that can really give us a competitive advantage long-term by being able to provide this service at a better cost than other people.

And then one more if I may.

On the Equipment side, it looks like revenues jumped -- earnings jumped quite a bit and backlog fell off quite a bit.

From the expansion did you get a lot more productivity out of this quarter?

What happened in Equipment really is the increase in Equipment sales occurred on the air separation and hydrocarbon separation side.

The air separation business has a larger component of sales.

It is a lower margin business roughly for us.

We have talked about that a number of times before for it.

So it is very hard to take a look at this business on a margin basis.

One thing I just wanted to point out in the LNG business, particularly with these last two -- or in the Equipment business, excuse me, particularly with these last two LNG orders, is that our backlog continues to improve, which means the LNG as a percentage of that backlog is actually greater than it was a year ago just due to the increase in orders in LNG.

It is a very good, high-quality backlog for us, even though the overall number may not be at a record level.

Good point Phil.

Fred Siemer with Siemer Management.

Just a three-part kind of question on Chemicals.

Your raw material position in Chemicals before the restructuring was heavily dependent on methanol and vinyl acetate.

In your new Chemical business on a pro forma basis what are your three top raw materials, and where do you source them?

And also a comment on your competitors in the surfactants business.

On our new areas our top raw materials are not going to be great -- are not going to have a great amount there.

We use a number of different materials across a number of different products here.

We're not -- in these businesses a reason for us to stay in these businesses is they didn't have the exposure on raw materials.

The other aspects of these businesses, which is very important for people to understand about this business, is they have the leverage on pricing and pricing power.

We're providing performance here, we're not providing a molecule.

And so if our raw material costs go up in this business we have historically shown our ability to raise prices and get recovery on it.

So we do not have the same impacts which we had in the emulsions business for us.

Your competition here is that Dow, BASF, people like that?

We have a number of competitors.

They are very -- there are a number of smaller competitors around the world, and these vary.

We don't have a single competitor in the businesses, nor does anyone have a business which is like our business.

It is not going to be as important, the competition; the competition is going to be very focused along a particular market or a particular product and maybe not even a productline there.

Ray Kramer with First Analysis.

A question -- getting back to the Equipment side for a moment.

Looking at the big jump in revenue this quarter it sounds like a lot of that was not driven by LNG.

Is it safe then to assume LNG activity was pretty much as normal in the quarter?

And are we going to see a step up in that from the capacity expansions you have done there?

On a year-to-year basis there was an increase in LNG.

On a sequential basis LNG is about the same.

It is slightly up because of the holiday impact which goes into the first quarter.

But the LNG activity for the past few quarters has been fairly steady, and we would anticipate it to be fairly steady.

The order intake remains very strong.

And as we have said before, as we project out into the following years, as we look out to 2007, 2008 our shop loading still remains very good in those areas.

We have deliveries scheduled out into 2009 right now, which is a long time in this business for us.

If I look at the topline number, was the second quarter sort of a blip, just on a lot of ASU activity then, and should it resume more normalized levels around 100 million?

It probably is going to go -- probably it will stay slightly higher than what it was.

We are forecasting for our ASU activity will continue at a slightly higher level.

That depends upon orders coming through also during this time period.

We have a number of bids in the ASU area.

As you know, the energy markets are very -- are out there.

So there's a lot of activity in the ASU side of the equipment area also.

Turning to EPI, you talked about seven new plants coming onstream.

Can you give us a sense of the timing of when we should see those?

I think you said three new hydrogen plants in the third quarter.

What about the remaining four plants?

Phil, why don't you give him the timing?

We brought two new plants on, Baytown and Convent, which were on in November of last year.

The new plants -- the new hydrogen plants we have coming onstream, three of them will be onstream in Q3.

And the final one, Port Arthur, will be onstream in Q4.

And that is a total then of seven hydrogen plants, including Petro-Canada which will be onstream in 2008.

Petro-Canada II.

And then sort of lastly looking at your increase in guidance, can you comment if that is more driven by more positive insight into the broad macroeconomy or if it is more internal improvements?

On the increase in guidance I think it gets down to the view which we have is that the economy has performed well and continues to perform well, and that the fundamentals of our business are very good.

We were very encouraged by the activity which we saw in electronics, merchant gases and EPI in the past quarter here.

Our equipment business remains strong.

The Performance Materials business, our Chemicals business, remains very strong for us.

So the sound fundamentals which we had in our businesses gave us the confidence to take our guidance up.

Citigroup's, P.J. Juvekar.

A question on CapEx.

You're ramping up your CapEx.

All of your competitors are doing the same thing.

I know that you have all the customers lined up and all that, but what is the long-term risk?

As you debottleneck your merchant capacity, what is the long-term risk to the return for you?

On the CapEx, and looking at what I'm doing in the merchant capacity, and let's talk about the United States, and that is where I am focusing that on.

It is not producing significant capital expenditures to do that, so I'm not adding to my asset base.

These are very -- these are changes in the way I run the plant and the processes and things like that.

So it is not costing me a whole lot of money.

I am operating -- my operating rate is 88%.

So I am at very high-level of operating rate.

I'm taking and I'm adding capacity in the areas in which I need.

I'm doing the changes in areas where the operating rates are even higher than the 88% aggregate for me.

So I'm focusing on the areas in which I can go out and sell that product.

Longer-term the fundamentals around the usage of industrial gases are still extremely good.

If you're going to increase the energy prices -- if the environmental regulations and laws continue to be tightened, that is going to drive the use of oxygen, nitrogen, argon, etc., in people's processes.

And so I think the fundamentals behind the need for this capacity are still very much there.

We are being watchful of that.

We're not going out and putting a grass-roots plant in anywhere at this point in time.

We're taking and adding on to our existing capacity in small increments where I can sell it in the near term, and it actually works to increase my return.

Fair enough.

One question on your hydrogen plant.

You have four plants coming online later this year.

That is a big number.

Can you just talk about is that meaningful contribution to your EPS?

Can you talk about what could these four plants do to your EPS?

They are a large increase to our EPS.

We have previously given some of the stuff here, as far as guidance is concerned, that one of the big areas as to why we see our earnings increasing is this additional capacity coming onstream during this time period.

And so as we look at that, we're going to increase our sales in this area probably around 35% or so.

Our typical margins have been in the low teens in that business.

I will let you make the assumptions and do the math on that as to what that could bring to me.

Just quickly finally, you didn't talk much about NF3 prices, but if you could just give us some idea of what is going on there?

Phil?

Yes.

With NF3 pricing is still under a bit of pressure.

It is still going down, but it has slowed from some of the historical trends we have seen.

Volumes are very, very high.

And the one surprise I guess we have had this quarter is they are not only high in the LCD manufacturing environment, they are also very high growth in semiconductors.

When we look forward here we look at electronics as showing great long-term growth, probably higher than it has been in the last five or so years, if you look at the industry trends.

All driven by a lot of the new digital devices that are being manufactured, and we referred to it in the script.

A lot of the new Flash memory devices are driving a lot of growth for us.

So volumes still up something like 25%?

Yes.

Well into the double digits.

Yes, very strong volumes.

Jeffrey Zekauskas with JP Morgan.

I guess just a couple of questions.

In terms of the industrial gas business, from your previous commentary about difficulties in the healthcare area, it looks like maybe there was $18 million in extra costs.

You also cited higher maintenance expenses and some other issues.

How quickly do those detriments go away?

I know that you talked about getting back to 15% margins.

How does that healthcare trend work?

In general, were there all kinds of unusual costs in industrial gases this quarter?

In that if you strip out the insurance gains, there is really not much growth in operating income.

To take a look at that, and let's first address on the maintenance cost, the maintenance cost we talked about in the first quarter call.

And we said we would have the maintenance expenses in the second quarter.

That is something which occurs on a basis of seasonality for us in this business.

We typical see that in the second quarter.

We saw it this year, and so that should go away over time, over the third and fourth quarter for us in our EPI business.

Now with regard to the Homecare costs, the Homecare costs we're going to take them out in the UK, as far as the start up costs, and they will come out gradually over the third and fourth quarter.

Then in the U.S. it is much more of an issue on volume for us -- is that we have the infrastructure.

We have built that infrastructure, and so what we want to do is to load that infrastructure.

We believe that we can drive a lot higher sales growth, take a lot more advantage of what we have there.

That will be a lot of the focus in the U.S.

We also are going to pick up on the productivity end of that, trying to get some costs out of our order-to-cash process, and trying to get our operations area to get more deliveries out of the same cost base.

Now if you take a quick look at margins for us, and we're at 13.9%, you take out the impacts of hurricanes and things like that, and you see about a 2% gap roughly.

About half of that gap is made up by the maintenance costs coming down in EPI, and bringing the new plants on in EPI.

The other half of the gap is made up by improvements in my Homecare business.

Now ongoing productivity and stuff like that and other things should continue to help us drive that even further, but that is just a quick analysis and to get at the question for you on how we're going to get to 15%.

I appreciate that.

And just lastly, your operating income in equity -- the equity operating income in industrial gas didn't grow?

Yes.

That was -- the issue which we had is we had some unusual costs in the maintenance area in one of our ventures where they had a major plant problem.

But that is taken care of, and now we will be able to go forward from here.

Bob Koort with Goldman Sachs.

Phil, and maybe it is just semantics here, I am reading too much into it, but I thought you mentioned price declines in products in the electronics space.

And normally we seem to fixate on NF3, so is this something that has been ongoing, or has it spread more recently to some other products, and would those be bulk gases or other specialty products?

No, it is primarily NF3 is the big issue that we have.

And again, volume growth way outpaced it.

But it was a comment primarily around NF3.

There are other products which are going up high single digits, low double digits.

It is not pervasive across electronics or anything like that, it is more localized to NF3.

There are some other products that are under pressure too, but NF3 is the big one.

Got you.

And then just to beat this healthcare horse a little bit more.

I looked at some of the competitor information.

Their business was up it looks like, net of pricing, around 6 or 7%.

And you guys have been in that range, so I am just wondering what caused the pothole, what changed?

Was it your behavior that changed?

Was it your competitor's behavior that somehow secured their sales?

Because it seems like you grew out of kilter with the market.

We believe the cause of this existed on the management of things, and that is why we have made the changes of things.

We have new management in there.

We're encouraged by the results which we are seeing coming out of there.

We're encouraged by the programs in which they have put in place.

We think that what happened is that a lot of the basics were not being watched.

Was it just better execution before or luck that you didn't have this problem previously?

No, and the execution was good but the business grew quickly.

And sometimes the growth in the business overcomes the management of those things.

Mark Gulley with Soleil Securities.

I wanted to go after this NF3 thing a little bit more.

Beat another dead horse.

On the conference call this morning Air Liquide indicated that NF3 prices from their standpoint were down something like 25%.

One, is that the kind of trend you're seeing?

And two, as old contracts roll over and roll into lower prices, is it a situation where this ball just keeps rolling downhill?

We're not going to comment precisely on the amount of NF3 price decline.

We're really sticking to our guns and telling you the difference in volume is way overshadowing any pricing pressure that we are seeing.

And we are seeing pricing pressure abate.

We will say that.

We don't look at it as a straight line going down, but we do believe it will continue to go down.

That has been in our modeling for some time now.

We are about on track as to where we had forecast ourselves to be.

But frankly, the volumes are higher than we had forecasted them to be now.

Even with our new expansion, our NF3 expansion online, we are well into the 80% availability of our entire NF3 production.

That volume came on only late last year, and we're already up into the 80% overall.

So really, really strong volume growth for us, pricing is going down but it is abating somewhat.

We continue to take the price of NF3 down, but we also continue to have the cost of NF3 down.

One of the things is that we – Air Products makes its own NF3 for that thing.

We think that is an advantage for us in that we have continually taken the cost of this product down.

And the volume gains in this area actually doubled the impact of prices.

So my electronics business it got a lot better this quarter for us.

And so we saw that.

I think that is important.

We have been telling people for a while that we think the advantage which Air Products has is we make a lot of our products.

We told you as we look at this business, the products which we make, we like the margins on them, we like the returns on them.

The products which we go out and repackage it is a harder problem for us, and we don't make as much money there.

In some cases we don't make any money.

So that is part of the thing as we look forward in this business to the actions which we're going to take as we move forward to reposition ourselves in this business and to increase the returns.

But it is important that you understand that on this product the returns at the prices which we're quoting today and we're giving to customers today, are still earning good returns.

Fair enough.

I understand the price and volume dynamics, but let's talk about returns.

Are returns going up or are they going down? (multiple speakers) above your cost of capital, I understand that, but are they declining or increasing?

The returns in this business -- on this product -- and they have declined in the long term from a peak.

But those peaks were, they were very, very, very high on this.

As we look at -- on the new investments in this business, as we look at the recent investment which we made, it was made at a very attractive return.

It is not at the peak return obviously, but it is still very attractive and it is something which for our shareholders and for our position in the marketplace and for the things which we can continue to do in this business, makes a lot of sense for us.

It is just in the top echelon of the investments which Air Products would make.

Don Carson with Merrill Lynch.

Just to continue on electronics, you talked last quarter that you had returned to double-digit operating margins.

With the volume uptick that you have gotten and some of your further cost cuts, what is the progression of margins there?

Where do you think margins can get back to in this business?

And given your view that this volume growth is sustainable, at what point do you start to have to think of putting new fluorine capacity in Asia?

On the margin issue, the margin -- and they continue to increase in this quarter also, which is good news.

Our returns obviously also went up, as we talked of that.

And we would like to take our electronics margins up into the mid double digits from there.

We're in the low double digits right now.

So we strive to increase them by 2 or 3% more over where they stand today.

As far as the capacity issue is concerned, we are looking at all our options at this point in time.

We're obviously encouraged by the marketplace, by the growth in the marketplace.

And so we are taking a very hard look at what our next move will be and looking at all our options.

Another player in electronic -- a supplier in the electronics industry mentioned that near term the high operating rates of the Taiwanese fabs could constrain volume growth in the next quarter or two.

Do you see that as being a constraint on your volume growth in electronics?

Certainly the operating rates are -- and they are high for that.

The other thing which is happening though is we continue to see ramps on the LCD manufacturer side for us.

Those things -- and remember that the volume which I provide to the LCD manufacturers is still -- it is a lot more as far as dollar value to us.

If I look at what is happening in the marketplace going forward, the LCDs still have some ability to ramp up.

There is a lot of activity around on the new fab side, on semiconductors also.

And so I think the growth may not be as strong as the first quarter into the second quarter, but we still forecast continued growth third quarter, fourth quarter for us going forward here.

Just as a reminder, how big is the LCD market as a percentage of your specialty gas and sales in electronics now?

If I take a look at the total electronics for us, it is about 10% -- the LCD displays for us, of our total sales.

That is a testament to the strong growth on the semiconductor side which we have seen.

We would see that moving up to 15% here in the near term as we continue to see the growth on the LCD side.

And just finally a housekeeping item.

When are you going to put the Chemicals business as a discontinued operation?

I read something about when the Board gives you the authorization to sell it -- I would have thought before you hired an investment banker to sell it that the Board had approved the exit from that business.

What the Board has approved is for us to go out and explore the opportunities which are there.

And so, as I commented before, the conversations are encouraging.

As we become firmer in our ability to execute this, and we get approval from the Board to execute it, then we will move it into discontinued operations.

And is this a fiscal Q3 event?

It could happen in Q3 or Q4 and we will see.

Laurence Alexander with Jefferies.

The first question on Europe.

You have highlighted very strong volumes on the merchant, but you also highlighted it as a mix effect.

If you take your entire European operations, including the on-site business, what were the (indiscernible) volume trends?

If we take a look on Europe there, and what our comments were, were not around the entire European business, they were on the merchant side.

We do not take a look at our business in Europe on a regional basis; we look globally.

So the EPI and electronics businesses there are shown in those areas for those things.

If you take -- and you take out the impact on the volume of the mix impact, it probably takes it to about half of that volume growth roughly.

Probably so it is like more than half.

But it also helps the price impact in there, and the price would turn to be a favorable price impact then for us.

On healthcare -- on Homecare the M&A activity in the sector appears to have dried up as people are evaluating the impact of the CMS adjustments.

Are you seeing any unusual or sort of new opportunities for M&A in that space?

Right now on the Homecare business our focus of our management team is to returning this business -- to get it to the returns for which we invested in this business for.

As far as any new opportunities, we will take looks at those new opportunities at the time at which we go out and get this problem fixed, which will be shortly for us.

Kevin McCarthy with Banc of America Securities.

Mid-April you announced some price increases in U.S. merchant gases.

You alluded to an operating rate of around 88% nationally.

Can you talk a little bit about the magnitude of the increases you expect, and which parts of the country are tightest, and where the opportunity is greatest?

And then second on the same subject, can we assume that with the debottlenecking activities you alluded to that a grass roots ASU like BOC just announced would be off the table for Air Products over the next couple of years?

Let me take those one at a time.

Regarding your last part of the question, we are comfortable where we're at, and we don't see any need to add capacity in the near term or foreseeable future right now.

Regarding the price increases that we recently announced, what we're trying to do is capture more of the surcharge into a price increase going forward.

I don't have any numbers for you.

What we're trying to do when electricity costs have been up 15% year-on-year is make sure we are over recovering -- or recovering on that, in the short-term here over recovering as we catch up to some of the lag we have had from last year.

So don't have a real number for you on that.

It is all included in our guidance going forward though.

If you were to look back on this quarter, we obviously had a good result as far as price is concerned.

About 60% of that price resulted from going out and raising the prices on our customers, the other 40% came from on the surcharge side.

On the subject of working capital, it looks like you have several moving parts with DSO down sharply, but inventories and payables up.

I know you put some money into the pension.

Can you talk a little bit about where you would expect fiscal '06 to wash out in terms of working capital?

As far as that is concerned, we would expect to continue to see the improvement on the receivables area and driving the DSO down.

A thing which you did see is you saw that the balance really on a year-on-year basis is about flat in working capital for us.

And the reason why is the growth in the business for us on receivables and not on working capital.

On the inventory side the thing which we have seen there is really our days sales which exist on the inventory side are really at a fairly -- at a low point for us.

I had some increases, but when I look overall and divide it by -- on the cost of sales, I'm better.

Last thing on the accrued liabilities and payables, a big change in that is the pension obligation for us.

And that is something which, as we look forward here, probably will not have more any more of a negative impact over the next year on this, over the rest of the year.

So the sum total is that I think that I will see improvements in working capital to my cash flow for the next six months.

That is all the time we have for questions today.

I will turn the conference over to Mr. Sproger for any additional or closing remarks.

Thank you, James.

And thank you for joining us today.

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

Goodbye.

Have a nice day.

That concludes today's conference call.

We thank you for your participation, and have a nice day.