Air Products and Chemicals Inc (APD) 2007 Q1 法說會逐字稿

Good morning and welcome to Air Products & Chemicals first-quarter 2007 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.

Air Products will be recording this teleconference and may publish all or a portion of the teleconference. No other recording or redistribution of this telephone conference by any other party are permitted without the express written permission of Air Products. Your participation indicates your agreement.

Beginning today's call is Mr. Nelson Squires, Director of Investor Relations. Mr. Squires, you may begin.

Thank you, Cynthia. Good morning and welcome to Air Products' quarterly earnings teleconference. I am Nelson Squires. Today, our CFO, Paul Huck, and I will review our first-quarter results.

We issued our earnings 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.

Instructions for accessing the replay of this call, beginning at 2PM Eastern Time, are also available on the website. As in the past, we've included an appendix to today's slide package with additional detailed information. In the appendix, you will find reconciliations for any non-GAAP information.

As a reminder, Air Products will host its annual meeting of shareholders tomorrow, Thursday, January 25, at 2PM Eastern Standard Time. Go to www.airproducts.com to access the live audio webcast.

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.

Thank you, Nelson. Good morning and thank you for joining us today. Please turn to slide number 3 for a review of this quarter's operating results.

As you can see, we had an excellent quarter. Sales grew 21%, driven by increased volumes, equipment sales and improved pricing across most of our segments. The consolidated sales analysis is included in the appendix.

We continue to make excellent progress reducing SG&A as a percentage of sales. This quarter, SG&A was 11.7% of sales, lower than prior year by 70 basis points. We continue to get benefits from our SAP investment, helping us accelerate productivity, and we are taking out the [Australian] costs following our amines divestiture.

Record operating income of $332 million was up 31% from prior year, again due to strong volumes and higher equipment activity, better pricing, and also improved cost performance.

For the quarter, our net income was $230 million and our diluted earnings per share was $1.03. When compared with the prior year, net income increased by 27% and diluted EPS was up 29%. And most importantly, we continued to improve our return on capital again this quarter, with ORONA increasing to 11.8%, up 170 basis points from last year. We're another step closer to achieving our 2007 goal of 12.5% ORONA.

Not surprisingly, following our very strong October and November sales updates, our results this quarter came in better than expectations. Relative to our guidance for the quarter, about a third of the upside was driven by stronger than expected performance in our European merchant gas business. This resulted from higher volumes and pricing, coupled with good cost performance in both our liquid bulk and packaged gas businesses.

Another third of this quarter's upside came from our equipment and energy segment. This gain resulted from better than expected project cost performance and a contract termination. And the final third came from better than expected volumes and costs broadly across all of the other businesses.

Now, please turn to slide number 4. Now let me talk about the factors that affected the quarter's performance in terms of earnings per share. Higher volumes contributed a $0.28 improvement. Higher pricing and margins together contributed $0.05. Other costs were unfavorable by $0.15 due to increased costs to serve the higher volumes, the impact of our productivity efforts offset inflation, and we did see productivity get to the bottom line as our operating margins expanded by 110 basis points to 13.7%.

The absence of last year's hurricane impacts resulted in a favorable $0.06, partially offset by our prior-year land sale gain of $0.03.

Favorable currency effects were offset by higher interest expense. Interest expense increased due to a higher debt balance, lower capitalized interest and higher interest rates. Our debt balance increased due to our share repurchase program and the large voluntary pension plan contributions we made this quarter.

We repurchased 1.8 million shares, spending approximately $126 million in quarter one. We expect to repurchase approximately $500 million this fiscal year, the same amount as we have repurchased in the two previous years.

We also made a $240 million cash contribution to our pension plans this quarter. As we have said before, it is our intent to make tax-efficient pension contributions, and this year we have that opportunity. Please note that this contribution also reduces our operating cash flow this quarter. If the pension contributions had been spread evenly across 2007, our operating cash flow would have been $170 million higher in this quarter. Our projected cash pension contributions for fiscal year 2007 remain unchanged at approximately $280 million.

Finally, fewer shares outstanding contributed $0.02 and all other items net to zero.

The bottom line is we had another strong quarter, and our fiscal year 2007 is off to a great start. Now I will turn the call over to Nelson to review our business segment results. Nelson?

Thanks, Paul. Please turn to slide 5, Merchant Gases. Merchant Gases sales of $740 million were up 19% versus prior year. Strong volume growth contributed 10%, pricing contributed 4% and currency added another 5%. Sequentially, Merchant Gases sales grew 2% due to improved pricing and currency.

Merchant Gases' operating income of $139 million was up 32% versus prior year, and segment operating margin of 18.8% was up 190 basis points compared to last year due to volume and pricing gains. Let me now provide a few highlights by region.

Please turn to slide 6. In North America, our liquid bulk volume index was up 11% year on year, primarily due to increased hydrogen and argon volumes, which have recovered from last year's hurricane-affected levels. Our liquid bulk volume index was down 3% sequentially, primarily due to seasonality.

Average LOX/LIN pricing increased 9% year on year in North America. This was the result of price increases put in place early in calendar 2006. Additionally, during Q1, we implemented price increases for oxygen, nitrogen, argon and hydrogen. These price increases were put in place to recover increased power and distribution costs.

New business signings continued at a solid pace and were ahead of target for the quarter.

The European liquid bulk volume index was up 4% year on year, continuing the strong growth we have seen the last four quarters across the region. New business signings were on target for the quarter.

Our European LOX/LIN pricing was up 5% as price increases to offset higher power costs have taken effect. Price increases were implemented during Q1 across Europe to continue to recover increased costs.

Cylinder volumes in Europe were strong, up 3% versus prior year and 3% sequentially, reflecting the continued success of our new offerings in this business.

Our Asia liquid bulk volume index was up 21% over last year, driven by solid demand for all liquid products across the region. We continue to see strong growth as we profitably load our new liquid plants in Asia. Pricing was flat versus prior year.

Please turn to slide 7, Tonnage Gases. Sales of $605 million grew 13% compared to last year, driven by the impact of the fiscal year 2006 plant startups and improved plant loadings versus the hurricane-affected levels of a year ago. Natural gas prices were down significantly from prior year and reduced sales by 20%, partially offsetting the 31% volume growth. Sales were down 1% sequentially due to seasonally lower volumes.

Operating income of $89 million was up 20% compared to last year and down 15% compared to last quarter. The increase over prior year was primarily due to the impact of the six new hydrogen facilities brought onstream, as well as increased baseloading and prior-year hurricane impact. The sequential decrease is due to seasonality, the absence of hurricane recoveries and lower operating bonuses.

Operating margin of 14.7% increased 80 basis points over last year, benefiting from loading and lower natural gas costs. Sequentially, margins were down due to seasonally higher maintenance costs, lower bonuses and the absence of hurricane recoveries. Looking ahead, bidding activity remains high and we expect to announce several new orders this year.

Please turn to slide 8, Electronics and Performance Materials. Segment sales of $510 million were up 22% compared to last year. Volume gains accounted for 19%, lower pricing reduced sales by 2% and currency added 1%. Electronics sales were up 21% compared to last year, driven primarily by higher volumes across all product lines. Electronic sales excluding equipment increased 7%.

In Performance Materials, sales grew 26% compared to last year. Approximately half of this increase was volume driven, with the other half coming from the Tomah acquisition.

Overall operating income of $51 million was up 32% and operating margin of 10% was up 80 basis points versus last year -- prior year -- driven primarily by volume gains. Operating margins decreased by 170 basis points from the previous quarter, due primarily to seasonally lower Performance Materials volumes.

Turning to slide 9, Equipment and Energy, sales of $196 million in this segment increased 109% compared to last year. About half of this gain is due to a one-time sale of some off-site work for a refinery customer on a cost-reimbursable basis. Therefore, it did not have much profit impact. The rest of the sales gain is due to increased sales activity across all product lines.

Operating income of $27 million was up 85% over prior year and 37% over prior quarter. This increase was driven by LNG heat exchanger activity. In this quarter, our LNG profits peaked as we saw favorable cost performance and we had an exchanger order canceled as the customer decided not to proceed with the project.

We currently have eight LNG heat exchangers under construction. Our backlog of projects now totals $403 million. Interest in LNG heat exchangers and large air separation units remains strong.

Please turn to slide 10, Global Healthcare. Global Healthcare segment sales of $156 million were up 15% compared to prior year, due to the impact of the UK contract awarded last year, along with recovery in the U.S. business. Sequentially, sales were up 4%, driven mainly by improvement in the U.S. business.

Operating income of $9 million was down 48% versus prior year, split evenly between higher costs and the absence of a prior-year land sale gain in Europe. Excluding last year's land sale gain, operating income was down 23%. Higher volumes in Europe were mostly offset by lower U.S. volumes.

Our efforts to turn around the U.S. business have resulted in revenue and income improvement this quarter. This will continue to be an area of high focus as an improved Healthcare segment represents a significant upside for the Company.

Please turn to slide 11, Chemicals. The Chemicals segment, which includes polymer and polyurethane intermediates, had sales of $227 million, up 5% compared to last year, primarily on higher volumes. Operating income of $19 million was up versus prior year, principally due to higher volumes. This quarter's results also include an environmental charge.

We should point out that due to the restructuring of Chemicals, starting this year, certain indirect costs previously allocated to these businesses are now being absorbed by the other business segments.

Recapping our recent comments regarding our Chemicals restructuring efforts, we continue to have discussions with prospective buyers of our polymers business and our partner Wacker Chemie about structuring our exit from this business.

Regarding our polyurethane intermediates business, we are also in discussions with our customers to restructure and maximize our returns from this business. You should know that we remain committed to completing these actions and making certain we receive the appropriate value for these properties. Despite the complexity of these transactions, we continue to be optimistic that we will be able to conclude them in 2007.

Because of the ongoing nature of these discussions, we hope you understand that we will not be able to provide any more information today on this matter.

Now I will turn the call back over to Paul.

Thanks, Nelson. Now, if you will turn to slide 12, while our quarter one 2007 results had some favorable impacts in the Equipment and Energy segment, they were offset by the higher environmental costs in Chemicals and smaller unfavorable items in our other businesses. So overall for the quarter, we believe our underlying run rate is about $1.03.

As we look forward from quarter one to quarter two, we're forecasting our second-quarter earnings per share to be in the range of $0.98 to $1.03. This represents year-on-year growth of 14% to 20% on a continuing operations basis.

The factors we forecast to decrease earnings sequentially include -- we do our annual reviews of our employees' performance in our first quarter and their merit increases take effect in the second quarter. This raises our costs, with a total impact on a sequential basis in the second quarter.

In our Tonnage Gases segment, we will be seeing turnarounds at four major facilities related to customer outages. This increases maintenance costs and also results in lower volumes.

Also, late in the first quarter, we did see foundry and fab operating rates start to dip as Electronics' inventory started to grow and we come into a seasonal slowdown post the holiday season. We are forecasting lower fab utilization rates, which we expect to be only temporary, in the second and third quarters of our fiscal year.

On the positive side, we also expect to see increased earnings sequentially from the following areas -- Q1 is a seasonally low-volume period for our Performance Materials business. We therefore expect to see a seasonal rebound in volumes in this business.

As we saw improvement in our Healthcare business in the first quarter, we expect continued improvement in the second quarter and throughout the year.

Finally, we expect our productivity efforts will continue to expand our margins.

Overall, while our guidance is about even with last quarter's performance, it represents a significant double-digit growth relative to our performance last year, further demonstrating that our strategies continue to work and produce shareholder value.

Turning to slide 13, based on our strong operating performance in quarter one, we are increasing our fiscal year 2007 earnings per share guidance to $3.98 to $4.10, which represents earnings growth of 14% to 17% on a continuing operations basis. This is up from the 10% to 14% increase we gave you last quarter. The reason for this increase is our strong performance in bringing on new business and our continued success in driving productivity.

Our assumptions and economic forecasts remain largely unchanged from last quarter. However, as we said earlier, there have been some less bullish forecasts from several of our Electronics customers with regard to growth in the first half of calendar year 2007. Like everyone else, we will see how this plays out in the market.

And lastly, our property, plant and equipment capital spending forecast remains unchanged at $1 billion.

Wrapping up with our ORONA graph on slide number 14, you can see our steady progress to our goal continues. While one quarter does not make a year, we would be remiss not to point out to you that our ORONA for the quarter is at our 12.5% target.

In closing, 2007 is off to a great start and should turn out to be another year of solid progress in executing our strategies, improving our businesses, delivering our results and making Air Products a great investment for our shareholders.

We are all excited about the opportunities that lie ahead of us. For example, the recently announced planned acquisition of BOC's Poland business from Linde is a great opportunity to add a number one position in a strong growth market. This adds to our portfolio of bright growth prospects.

Our new project activity remains high as we continue to win good, profitable opportunities across our businesses. Our productivity efforts are producing expanded margins and improved return on capital. These efforts enable us to grow faster as we load more business onto an efficient chassis. Our results demonstrate the resolve of the entire Air Products team as we transform Air Products into a more focused, less cyclical, higher-growth and higher-returns company that delivers greater shareholder value.

Thank you, and now I will turn the call over to Cynthia to take your questions.

(OPERATOR INSTRUCTIONS). Laurence Alexander, Jefferies.

I guess first on Merchant, as your price initiatives roll through your customer base, how do you see pricing trends evolving over the next couple of years in North America and in Europe?

On the look forward, I think we think very strong pricing trends will continue in this business, from our outlook. Despite some additions in capacity, they are localized, they are occurring in markets where the products are required, and so as we look forward on this, we believe that the climate is very good for us.

But should we see some moderation from current levels due to the pull-back in energy prices?

If you're trying to see are there going to be price increases, one of the things which drives price increases is obviously cost. So it depends a lot on energy costs and what power costs, what diesel fuel costs and those things.

Don Carson, Merrill Lynch.

Paul, just had a question on the Tonnage side of the business, when you had big capacity growth in calendar 2006. When do you start lapping some of these new plants, and what do you think of as sort of the sustainable revenue and volume growth in the Tonnage business, driven by HYCO?

Don, we lapped a couple of plants in this quarter, not entirely, but we brought two plants onstream late in the first quarter in fiscal year 2006. Now, obviously, we had the hurricane impact which occurred, and that makes the comps hard on that one. But then we brought two plants onstream in the third quarter. And then very late in the fourth quarter, we brought a plant onstream. Excuse me, we brought three plants onstream in the third quarter, and then very late in the fourth quarter, we've had a plant come onstream. So that's how the lapping effect happens.

As you know, growth in volume in this business is very much tied to capital investments. We have the Petro-Canada plant coming onstream in 2008, middle of 2008. And that will give a boost from the hydrogen standpoint.

As we look going forward, as far as growth in hydrogen, we do believe that there is sustainable double-digit growth in hydrogen for us for a number of years going forward, due to what is happening in the refiners, which we have talked about, to what's happening in bringing the new feedstocks into the refinery, which are heavier and more sour as refineries convert for those things.

So we think our goal -- not our goal, but our marketing information, would tell us that the market overall for hydrogen is going to about double in the next 10 years from what it was in the past 10 years.

Just a quick follow-up on Merchant -- Nelson, you mentioned that the fiscal first quarter was normal seasonal decline. Are you seeing any impact from the weaker manufacturing environment or any impact of a slowdown in metal fabrication related to the auto industry? And then are your prices outstripping these rising power costs that you're talking about?

The first one, the business mix that we have is so broad based that we're not really seeing any impact from any specific industry. One of the things that we look at is what our measure of new business is. And we're still seeing a good churn of new business coming onstream that customers that made commitments to us six months ago for onstream dates, those are still happening. And so we really are seeing continued growth and no issues, if you will, from that regard in the volumes in the North America business.

Moving on to pricing, absolutely, we are basically ahead of the curve right now and have been probably for about a year in keeping ahead of rising costs. And we expect that to continue.

Fred [Siemer, Siemer] Management.

These very, very excellent results from the gas business flow from your superior portfolio in gases, but my question is, I wonder if Wall Street would pay more for those earnings if there was more visibility to the performance chemicals operation? And I wondered if you plan any meeting with analysts to go through the Performance Materials business or even a teleconference with question-and-answer on the Performance business?

Fred, that's a good question. We do plan to get some additional information out about what we consider to be a very good position in Performance Materials, and we'll be educating the analysts and our investors over the next year on that area.

Mark Gulley, Soleil Securities.

Two questions relating to energy prices and your demand. First of all, some people are concerned that, quote/unquote, on the margin lower oil and gas prices may mean lower demand in some of your energy-driven areas. Do you share that concern or do you think there is a threshold at a much lower oil price where only when you get there are you going to see lower demand?

On our existing products, I don't think it has a lot -- on our existing sales, excuse me, I don't think it has a big impact for those things. It's more on what impact energy prices have overall on the economy in some of our other businesses, is where we see the impact of energy prices. But if you're looking at our hydrogen business, we are not going to see a big impact from there.

I think it does have an impact if prices were to come way, way, way down as far as on the alternative energy solutions. But I don't think anyone is forecasting that energy is going to go down to those levels.

When you talk to Scott and to Jeff, what do they think that threshold is?

If you're looking at the threshold, it varies by individual product, really, when you go at it, for us. Certainly, LNG, we have talked about that before. And LNG is about a $4 price in the U.S., $3.50 to $4 -- it makes it a very viable source of energy into the U.S., as an example there.

That was my last question -- does LNG termination, heat exchanger termination, does that bother you? Do you see more coming? Are people getting nervous about lower prices, or what is going on there?

No. A good point on the LNG termination here -- what happened was we had a customer who is out there and they canceled their project due to the rising costs and complications and the local government and participants on there, and the sponsors just canceled the project. It was not an extremely large project for us. And so we are sad, obviously, to see it go, but we still see the same dynamics as far as the market demand in LNG going forward.

David Begleiter, Deutsche Bank.

SG&A, while impressive from a percent of sales, was up about I think 13% quarter, year over year. Could you comment on that, if you could?

Sure. What happens is we obviously have a lot of business which has been added for those things. So we have those things occurring. So that is one portion of that.

The other thing which we have in SG&A is we continue to be more aggressive around some of our opportunities in the energy area. So that is occurring also.

The bottom line, though, is that we continue to spread our margins using SG&A as a tool here. As we continue to load our SAP system and we bring a lot more business onstream, we continue to see this as a very good driver long term for us to continue to drive SG&A down as a percent of sales, which, in the end, spreads our margins for those things. But SG&A is going to somewhat increase over time when you have strong sales growth and strong volume growth, which we are seeing.

And Paul, just on Electronics, the last downturn, you did see a lot of volatility in your earnings. Obviously NF3 was an issue. What level of cyclicality do you foresee in your current Electronics portfolio if we are entering a downturn in the semi or electronics industry?

Don't take my comments as we're seeing a downturn here. I think we are seeing kind of leveling for the industry here. We had a very unusual thing which happened the last time when you look at that. It has to be an aberration as you go forward.

So that is not our forecast by any means, Dave. But some of the things as we look at this and which we think make this business different is first, we've had a lot of things on the productivity side. And so we have expanded our margins. We are lower cost in this business by far. And we are ahead of the curve; we are continuing to take costs out, as you well know, and to drive better margins in this business. So we've got a good productivity effort going forward in Electronics.

The other thing is that we are a broader business right now because we aren't just in the chipmaking. We're also in the flatscreens, the LCDs. And that business is growing very strongly. And that is a different market driven by a different set of dynamics and different demands, and so that will also help to buffer us.

And the same, last issue, NF3 pricing and volume in the quarter? Volumes are going to exceed the price decline?

Yes.

Robert Koort, Goldman Sachs.

When I look at SG&A to sales, I come to a relatively sanguine conclusion that if you took the natural gas deflation in your revenue stream out it might have looked even 60 or 70 basis points better year on year. How much more can you push SG&A and extract cost synergy?

Bob, I broke below 12, so now my goal is to break below 11 on this thing. As we have said here, we are trying to drive this cost down. We continue to see opportunities here. So it's a very simple measure for us. We continue to focus on it with our people and to drive that to expand our margins.

Do you think that is something new in the industrial gas industry? Because over time, we've never seen an awful lot of operating leverage in the business model for this industry. So what is going on that is different now, or is it just Air Products-specific opportunities, do you think?

As far as that is concerned, Air Products as a whole, the whole Company, is committed, the whole management team. We are all committed to delivering improved productivity. I will speak for ourselves here. And we are committed as a management team towards driving our margins up, getting our returns higher.

One of the things which we -- the investment in the SAP system which we made was a very important investment for us. It took a decent amount of time, but it is paying itself back right now. There were a lot of people who had a lot of questions about why would Air Products do that, and this is why, because we saw what the payoffs were, and we made the investment, and we guided through it. And now we are at the portion at which we can take the rewards of it.

And this is not just a one-year or two-year type of thing. We think this is something which is sustainable and which we can continue to lever as a tool going out into the future. Plus our investment in our continuous improvement tools also is another important thing which we have done.

Switching gears, where does return on capital in Healthcare stand? And can you give me the over/under on the time in the future when you will be proud of your U.S. homecare business?

Well, as far as the return on capital, the Healthcare business, obviously, is not in good shape at this point in time, given the problems which we have had. However, it is improving, which is very important. We would anticipate to have our margins over 10% by the end of the year or in the fourth quarter. We are a little bit ahead of plan as far as that is concerned.

And as far as in the U.S. business, we are proud of the people who are working in that business. They're working very hard to improve this business. And we are starting to see the fruits of their labor. So I would expect that we will make this thing better and make it a good business for our investors in the near future here.

And last quick question -- with the gazillions of ethanol plants going up, is this creating any opportunity for you to get more involved in the CO2 business, or is there any desire on your part to be more active there?

As far as on the ethanol plants and CO2, we haven't really done anything yet on that.

P.J. Juvekar, Citigroup.

You had a nice benefit from the six new hydrogen plants and all the other plants in Asia that you explained. How many big projects are starting up in 2007?

As far as 2007, we saw the number of facilities, which are smaller facilities, which are coming online. We don't have anything as large as the hydrogen plants really coming online in 2007. But certainly, we have a lot of investment going in our Electronics business which is still forthcoming. And we continue to have a lot of success, especially in Asia, in some of the base businesses as they continue to invest in a broad portfolio -- glass, steel, etc.

So do you expect your organic growth to be a tad lower in '07 because of lack of these new projects?

Remember, the organic growth, you get a big push from any single large one, or if you have a number of small ones, that comes out. If I look at the rest of the year, as we look at that, I think the thing which we see is we see probably sales growth with a declining gas price, gas a little bit lower, of somewhere 8%, 9%, the high single digits for the next three quarters.

If we were then to look and take out the impact of gas, because we would say gas probably takes us down somewhere 2% to 3% over that time period, maybe it is in the 10% to 12% on a constant gas prices basis. So I think we have still good strong growth coming here.

And then one quick question on Europe. You saw some nice improvement there. Is that due to improvement in the economy, would you say, or is that better focus on your part on your business?

I think it is both. It's a result of a lot of things which our people have done over there. And we are very proud of what they have been able to deliver with all their hard work. And also, we've put a focus on signings, as we did in the U.S., about a year, year and a half ago, and we are starting to see the benefits of the good business coming in there. So those are the things which we see.

And then lastly, one housekeeping question -- what was the impact of the land sale in the quarter?

The land sale occurred in fiscal year 2006 -- $10 million, roughly. It is in the other income line item, but it was a 2006, not a 2007 issue for us.

John McNulty, Credit Suisse.

With regard to Healthcare, you have started to see a decent turnaround there. I know you have changed the management team and started working on the systems. What is left to improve the Healthcare side of your business now?

There's a lot left. We've got a very good team in place down there, John, and they're just starting to have an impact with these things. They're certainly growing the volumes. One of the things which attracted us to the business originally was the good organic growth rates in this business, roughly about 7% or so, plus an ability to capture share as we go through here. So we see this as a very good business for us if we can get back on track.

The other thing is driving the costs down in this business. We have said this a number of times -- we believe that a business like this can take a lot of benefits from what Air Products does very well of running systems and processes very well and driving costs down. And so we see that as a great opportunity for us to expand margins in that business.

On the Electronics front, it's my understanding that the semiconductor inventories have really kind of built up a lot going into the fourth quarter. So I am wondering if incrementally if you are seeing a hit at all in terms of the inventory build or you're really just worried about the seasonality going into this next quarter, and the inventory hit may have already happened, even though you put up some pretty good numbers in that division?

We will see how it plays out, as we said here. And the signals are there in that we could see some slowing. And we have warned somewhat on this and not had it occur, and we have warned and had it occur a little bit. We do not think that this is a big item, though, for us.

And then the last question, on the LNG contract termination, this may be a dumb question, but can you help me understand why that helps you or helped your profitability?

Because of the termination I recognized as a percent complete on sales. Now, I don't get the full profits here. But as far as -- I got a little bit a profit from the termination because everything ends. It just ends. I don't bring anything -- I don't carry anything forward, because the customer is no longer buying it. He is obligated to pay me X amount and my costs were Y and I made a little bit of additional profit from what I already put through the P&L.

Mike Sison, KeyBanc Capital Markets.

Great quarter. Question on North America Merchant -- can you give me an idea where your operating rates are? Are there any areas in the country that you are sort of overly tight? And what are your planes to expand capacity, if need be, going into calendar '07?

We continue to see about the same level of operating rates, right around the 89%, 90% range, as has been the case for probably the last three years. We are tighter east of the Mississippi versus west of the Mississippi. But that is a little bit of variation depending on the market. But overall, we are still in a position to satisfy the demand that we see coming from the base business, as well as the impact of the new signings.

That being said, we have a number of incremental projects that are under review right now. And we do expect to continue to invest in the business to keep up with the growth rate. So all in all, again, we are able to meet demand and are debottlenecking and our productivity efforts continue at these plants to make us more efficient.

And your demand outlook for North America Merchant is sort of low single digits?

That is correct.

And Paul, just a question on Electronics and Performance Materials profitability -- is one part of the business, meaning Electronics, Chemicals or Performance Materials, much higher than the average? Are they much lower? Are they about even -- close to that 10%?

The margin for these businesses, right now they're about the same as far as this quarter is concerned. And one of the things in which we have here is we obviously have a goal to raise the margins in this business. And so that is important. We've said that our goal is to get these to a 15% margin.

When you think about the volume growth in the quarter, for both were pretty good; the operating leverage could be better, I guess. What is holding back the better leverage?

As far as the businesses are concerned, one of the things which holds the margin down here is on the Performance Materials business, it is a business which sees a degree on the seasonality impact of it, Mike. And so we're always going to see a drop in margins because of the volume seasonality in that business. And that is going to hold it back.

So in the quarter, though, your Electronics leverage on the volume was --

-- was good.

-- satisfactory?

My Electronics business performed well during this quarter. So I don't see the same amount of effect on seasonality that I saw in Performance Materials. My comment really to you about the margins was kind of overall on this business.

But when you look at this, the Electronics business performed -- it had a good quarter. As we look at Performance Materials, the margins get a little squeezed in the first quarter for us. And that is what held down our margins.

And I just want a point of clarification -- when you -- the silicon for square growth, I guess the guidance that you gave out last quarter was plus 5%. Is that still intact?

Yes, it is.

And does that includes calendar first-quarter -- I mean, is that a fiscal year outlook --

Yes, it is.

-- or a calendar '07 outlook?

No -- it is based on the Air Products fiscal year.

Kevin McCarthy, Banc of America.

A question on the Merchant business in Europe. You mentioned that variance there accounted for about one-third of the positive earnings surprise. I was wondering if you could elaborate a little bit on where exactly the upside came from? Was it the price realization of plus 5 coming in a bit better than expected?

Also, if you could comment on the future volume trends there. It seems to me that broadly across the chemicals sector right now we are seeing accelerating volume patterns in Europe. Do you think the plus 4 can come up to mid- to high single digits as the year progresses on the volume side?

Kevin, what we said in the comments which we gave is that it was really a bunch of things and which worked very well. The volumes were higher and to a great extent I think that is the work of our people on the signings, of getting that and so we had good volume growth. But certainly the economies have cooperated there too.

The second thing is pricing, and that is recovery of our raw materials -- the power and the diesel fuel costs, which we used to get the stuff out there.

And then the last item is the cost of taking the costs out. So our productivity efforts continue to work, once again driven by SAP, driven by our continuous improvement efforts.

And also, in the packaged gas business, and we've made a point to point that out, too, we saw very good volume growth in that business, as we have made a lot of changes in the offerings to give a differentiated product out there to our customers. We are seeing us taking out and [avoiding] business in that business -- we are doing very well.

Shifting gears to the Tonnage side, I think you commented the bidding activity remains high there. How many new hydrogen projects do you expect to be awarded on an industry-wide basis in calendar year 2007?

And that is always -- it is a hard one to give you any particular number. But we do see that there are going to be some awards coming up here in the near future.

And then on ORONA, I think you have a slide, number 14 in here, that gives us a projection. Does that kind of collide path upward through the fourth quarter include the impact of the pending acquisition in Poland?

Yes, it does.

Last housekeeping item, if I may -- did I hear you correctly that you had an environmental charge in the Chemicals segment?

Yes, we did.

How much was that charge, please?

We are not going to disclose the exact amount on that thing. It did hold down earnings a little bit in the Chemicals segment. But it was for an existing plant and a groundwater cleanup action which we have ongoing there.

Sergey Vasnetsov, Lehman Brothers.

A couple of quick questions on your overall corporate line. Your projected interest expense this year -- is 170 a reasonable number, or is it a little bit high?

As far as the interest expense for us going forward, the interest expense in the first quarter, we don't see any real change going into the second quarter for them. Rates are holding about even for us.

Don't you have additional borrowing for your Poland acquisition coming up?

We do. That is the second quarter. So we will have obviously then the additional cost of Poland coming in. But we'll also be generating cash on those things. But we do have that.

Would it be reasonable for us to put any decline in interest expense for the fourth quarter due to chemical divestitures or we should really think about this next year?

When you think about on the Chemicals divestitures, and this always gets down to the exact timing of that, but obviously, we do anticipate, as we said, trying to get these things done. And so when they come down -- and they will have an impact on interest expense. Now, we are also buying back shares at the same point in time. We have given you the numbers which you can go out and run a cash flow and model that for us.

Will do. And so on your tax rates, your expectations for the full year 2007 still is 26.5%?

Well, the way our tax rate actually treats and the way we take it is we take the minority interest out of our -- we take that away from PBT and we get 27%, because our minority interest actually is before tax there.

Peter Butler, Glenhill Investment.

Just a thought -- when you talk about share repurchases, you shouldn't use the word "spend." You should talk about it as an investment.

Thank you, Peter.

Among the people skeptical about what you are doing in SAP, probably foremost was Mr. Jones. I'm wondering, as you started to turn the corner here, what will actually be the bottom-line impact? If you go back a couple of years, how much was this costing you, and where are you going, and the benefit in the next couple of years?

John was a big supporter, realized that we would not have done this without John saying yes. So John was our ultimate decision-maker on that. So I would not classify him as someone who had question mark on it, Peter -- is a big supporter of that.

As far as we look at that, and we think the investment is paying off very well for us -- a very handsome return on investment here as we are getting that, and you can see the impact on our SG&A as a percent of sales.

And we would also start to see as we continue to go forward making a better decision and running the business better, which you will see in a lot of places on the P&L. You'll see it in sales, as I get more sales, because I'm able to price better, as I'm able to distinguish the volume that I should get with things. So we think that we made an investment here for the long term which not only reduces costs, but also can drive growth.

I didn't mean to imply that Mr. Jones wasn't the guy that said go or no go on SAP; I'm just suggesting that in the early going that this thing was looking like it was going to be a lot more costly and time consuming and a drain on management, etc. But you did get it out and you turned the corner. So I'm asking what is the impact on the bottom line? The last couple of years, how much of a loss was it causing and how much of a benefit are you going to see?

Well, that is what we are saying. So we think a portion of our margin expansion is responsible for that. It is very hard to get that exactly with those things. So there's a lot of work which goes into it. We have packed our continuous improvement tools around this whole thing.

And so when we look at this, it has been part of a total effort by the whole Company to get our margins up higher, to get our returns up higher. So it is one of those things which is driving it. It is hard to isolate any one thing -- a lot of hard work, as you have said, by a lot of people to make this thing a good thing for the Company.

Jeffrey Zekauskas, JPMorgan.

A couple of small issues. What was the operating income benefit to the contract termination in the Equipment business?

This is below the level in which we would disclose something, Jeff, so it's not a huge impact on things. Certainly the improvement in the cost forecasts, etc., which we had are larger and were a larger impact on our Equipment segment.

Is it less than $3 million?

Jeff, I'm not going to comment exactly on what it was as far as that thing -- it wasn't a huge impact on it. And really, when you look at this, one of the things which I tried to do is say, when I look at the businesses which we have going forward and where do we stand and we look at the one-time items, because one of the things which we want to understand and communicate to you is where is the run rate of this business overall, and when we look at that and we added everything up, we came up with $1.03, the pluses and minuses, the gain which we had from the contract termination, the extra costs associated with the environmental charge and some other very small items across our businesses.

Secondly, your Merchant Gases business did splendidly. But your equity affiliates income in Merchant Gases was flat or flat to down. Why is that?

As we look at that, we had some -- in our Italian affiliate we had some lower profits come across here. We are looking into that and taking actions to make sure that we get a recovery in there.

In your Chemicals business, I think your revenues were up $10 million and your profits were up $10 million. How did you do that?

Well, one of the things which we had is we've put a lot of work into our Chemicals business as far as making improvements, taking costs out. One of the things, though, and Nelson pointed out here, is that we have changed the allocation methodologies. So we aren't putting the corporate costs. So that is responsible for a small portion of that.

But the other thing is just good performance on these businesses. The businesses here are pretty good, solid businesses, as we have said before, for us. So we think that they aren't a bad thing for people to get involved in. They just don't define our future for where we want to invest and put our money in the future.

Your corporate and other was negative $1.7 million. That seems low. Is there some kind of nonrecurring benefit in there?

The goal which we're trying to get is to drive that to a zero. And we want to get all of it -- it is the over/under account, if you would think about, for our allocations, for things like foreign exchange, etc. So we're trying to keep that as small as possible.

I guess lastly, if you look at the stock prices of Apria and Lincare, they have done nothing but shoot up. Is there something fundamental going on in the regulatory environment for health care that is positive, in your opinion, Paul? Or is it still too murky to tell?

On the regulatory environment, and especially on the costs which the government pays, obviously, those things always get -- they get a lot of press with things. I believe that the general consensus is that what happened in the last election is probably a positive sign on the reimbursement front.

Jeffrey Cianci, UBS.

Just a couple of quick things. First, on the margin for gases, it would strike me in Tonnage that you might see margins down a bit if you are ramping up all those hydrogen plants. Or was it just that the loading of the non-hydrogen got so much better that it offset that effect?

Well, as we look at this -- and the thing which we told you is that the bulk of the investments, 85% of the product which was coming on on these new facilities, was sold already for us. So we do not think that these -- well, we know that these facilities are not going to be a drag on our returns and on our margins here as we bring them up.

And then the Equipment and Energy LNG, trying to understand -- can you indeed make more than the eight under construction? Could you expand your capacity there?

Yes, we can, as far as LNG orders. And we could take more LNG orders. But we actually have had 12 LNG orders going at once, and not all were being built in the shop there, but the capacity is not a constraint for us in this business.

But yet you weren't running at full capacity, yet you had a favorable project cost performance, as you put it. Do you get a price up front and then you can lower the cost as you go and it costs you less to make these things?

Certainly as we go through these things, we strive to take costs out everywhere in everything that we do. That is exactly right.

And the last quick thing, Paul, as I look at the guidance range of this year, you are not accounting for any chemical events, I think, as you pointed out. Without naming prices and things for polymers, is it safe to say that that could dilute your earnings somewhat and that the range could be restated downward on the polymers sale? Because we're really trying to look for an '08 number to grow from, and it's safe to say this will be divested, right?

Yes. I think when you look at the divestitures, Jeff, and we look at this constantly, and given our current expectations, we would say right now that the actions which we are going to take with both the proceeds and taking costs out would make the polymers and the actions in the polyurethane area to be a zero impact on accretion dilution.

We will obviously boost the operating income for theirs, but we are working to take costs out, which is a big aspect of that, and then we will use the proceeds as far as on the share buyback. And those two things, as we run the numbers, sum out to be a zero at that time at which we are done.

Now, aligning those things exactly in time is sometimes exactly tough. But from start to finish of this thing, we are going to be there. And we are pretty much at start and finish on amines, and we have had a zero impact on EPS from amines. We obviously lost some operating profit from that business. But we went and we took the proceeds, those proceeds went into our pension plan, tax-efficient contributions because of the gains which we had on that business, and that has helped lower our pension expense. And so I've got an offset there, and I'm zero, basically.

Mike Judd, Greenwich Consultants.

Ray Kramer, First Analysis.

Just a few quick questions left. First, in terms of your change in guidance for the rest of the fiscal year, I think I've got a sense of it, but can you sort of quantify or give a broad brush -- how much of the improvement is a result of internal Air Products improvements versus market improvements?

We believe the bulk of it is from the internal Air Products improvements, because we're not changing anything about the -- on our economic forecast.

And then looking to SG&A, you had talked casually I guess about maybe having an 11% target for SG&A. Is that something you think you can hit by the end of fiscal '07?

That's going to depend upon the move forward here and it's going to be a slow and steady progress as we look at this. And we started this journey, let's say, and we were above 13%. And so the original goal was to get below 13%. And then what's the next goal? Well, let's go down to get to try to get under 12%. Let's try to get under 11%. And just a constant, a constant desire on our part, a hungriness to really drive cost out of the equation.

Looking out five years, say, how low do you think it can go?

It does depends on the business mix for those things. The higher transaction of the businesses are going to have higher on SG&A for us. And so as we expand our Healthcare business, which is the most transaction-intensive business we have, in there is a lot of SG&A.

Now, on the other side of that, there's also more things to work on on that for us. And so it really gets down to the trade-off there. But just trying to drive our -- the whole -- the end of this whole game, Ray, is to drive our operating margins up and to get our returns up overall and to work on the leverage there.

And then just lastly on the Chemicals side, to try to give us a little sense of what that can do, do you think you can hit low-double-digit operating margins sometime in fiscal '07 there?

On the Chemicals side, and we have hit those before with things, and it really depends upon our view of what happens. But yes, we could hit that.

At this time, there are no further questions. Mr. Squires, I will turn the conference back over to you.

Thanks, Cynthia. Please go to our website to access a replay of this call beginning at 2PM today. Thank you for joining us and have a nice day.

Ladies and gentlemen, this will conclude today's presentation. We do thank you for your participation, and you may disconnect at this time.