Air Products and Chemicals Inc (APD) 2008 Q1 法說會逐字稿

Good morning and welcome to Air Products' first quarter fiscal year 2008 earnings results conference call.

(OPERATOR INSTRUCTIONS).

Also this teleconference 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.

Nelson Squires, Director of Investor Relations.

Mr.

Squires, please go ahead.

Good morning and welcome to Air Products' quarterly earnings teleconference.

This is 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 2 PM Eastern time are also available on the website.

Two other items before we get started this morning.

First, Air Products will host its annual meeting of shareholders tomorrow, Thursday, January 24 at 2 PM Eastern standard time.

Go to AirProducts.com to access the live audio webcast.

Second, just as reminder, we have revised our business segment reporting structure.

Restated financial history was distributed this morning.

Beginning this quarter the Polymer Emulsions business is being accounted for as discontinued operations, and results for our Polyurethane Intermediates business, whose business model is very similar to our Tonnage Gases segment with long-term contracts and raw material cost pass-through provisions, are now included in the Tonnage segment.

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.

Now please turn to slide number 3 for a review of this quarter's results from continuing operations.

As you can see, we had an excellent quarter, a strong start to fiscal 2008.

Sales grew 9%.

Growth was constrained by a tough comparison in our Equipment and Energy segment.

Excluding Equipment and Energy, sales grew 15% driven by better volumes and pricing across most segments.

Currency contributed 4%.

We continue to make progress reducing SG&A as a percentage of sales.

This quarter SG&A was 12% of sales, lower than prior year and prior quarter.

Operating income of $372 million was up 17% from prior year, again, due to better volumes and pricing, and also improved cost performance and currency.

As a result, our operating margins improved by 100 basis points to 15%.

Great progress towards our goal of improving our margins by 300 basis points over the next three years.

For the quarter our net income and diluted earnings per share increased by 16% and 17%, respectively, on a continuing operations basis.

We beat the top end of our guidance by $0.06.

Our return on capital improved, with ROCE increasing to 12.3%, up 70 basis points from last year.

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 $0.03 improvement.

Higher pricing and margins together contributed $0.05.

Other costs were favorable by $0.01, as our productivity efforts continued to deliver.

Our Poland acquisition contributed $0.02.

Favorable currency contributed $0.07.

Separately, the other income line on our consolidated P&L was a bit higher this quarter than its normal runrate.

This resulted from foreign exchange gains and asset management activities.

Gains on asset sales were mostly offset by a write-down of a startup venture included in equity affiliates income.

Interest expense increased due to a higher debt balance, which was partially offset by lower interest rates.

We repurchased $2 million -- excuse me, we repurchased 2 million shares, spending $190 million this quarter.

Fewer shares outstanding contributed $0.01.

All other items net to 0.

The bottom line is we had a very strong first quarter and our fiscal year 2008 is off to a great start.

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

Please turn to slide 5, Merchant Gases.

Merchant Gases continued to grow at a solid pace during the quarter.

Sales of $897 million were up 21% versus prior year.

Acquisitions contributed 6% and currency 7%.

Underlying growth was up 8%, with pricing adding 3% and volume 5%.

Sequentially Merchant Gases sales grew 5% with both volume and price each contributing 1%, and currency 3%.

Merchant Gases operating income of $175 million was up 26% versus prior year, and segment operating margin of 19.6% was up 80 basis points due to continued pricing gains and volume growth.

Margins rose sequentially by 150 basis points.

Let me now provide a few highlights by region.

Please turn to slide 6.

Based on requests from many of you for regional data, we have decided to provide a regional sales analysis instead of specific product volume and price detail as we have in the past.

We hope you will find this change helpful.

In North America our sales increased 12% driven equally by volume and price.

Overall growth would have been higher had argon and helium not been in limited supply.

Nitrogen sales to oilfield services increased 30% year-on-year, with much of this demand coming in the vicinity of our Ashland, Kentucky and Reidsville, North Carolina plants, where we will be bringing on additional capacity later this year to meet this continuing growth.

We launched additional price and surcharge actions on 1 January of this year to address rising distribution costs.

Our new business signings were outstanding in the quarter, and are significantly ahead of target.

Our ability to bring solutions to help deal with high energy prices and address capacity needs continues to bring in new customers at solid returns.

Sales increased 31% over prior year in Europe, with volume and price each contributing 3%, currency adding 13%, and acquisitions adding 12%.

Availability of argon and helium limited volume growth.

New business signings were in line with expectations, and reflect the continued tightness in LOX/LIN capacity on the continent.

In Asia Merchant sales were up 20% over last year.

Volumes contributed 14%, currency 4%, and price and acquisitions added 1% each.

Volume growth was limited by lack of molecules in Korea and Taiwan.

The underlying LOX/LIN/LAR volume growth remained strong in areas where product was not constrained.

We have two plants coming onstream near term in Asia to help address capacity, and an additional three plants coming onstream over the next 12 months.

Please turn to slide 7, Tonnage Gases.

Sales of $791 million grew 15% compared to last year.

Volumes increased 5% versus prior year.

Natural gas and raw material prices were higher versus prior year and added 5%.

Currency added 3% and acquisitions 2%.

Sequentially volumes were down as expected due to seasonal maintenance by our customers.

Operating income of $111 million was up 16% compared to last year.

The increase over prior year was due to higher volumes, improved plant efficiencies and asset sales.

This was partially offset by higher maintenance spending and higher bidding expenses related to significant growth opportunities.

The sequential decrease of 6% was due to higher maintenance spending.

Operating margin of 14% was slightly higher than last year, and was held down by higher natural gas cost pass-through and higher maintenance costs.

This reduced margins sequentially as well.

We received letters of intent for five major Tonnage contracts during the quarter.

These were included in our previous CapEx guidance.

We will formally announce each of them over the next few quarters.

We were honored to have the President of Mexico at the dedication of our new nitrogen facility supporting PEMEX's enhanced oil recovery business.

The plant started up on time, on budget and at specifications.

We also started up an on-site this quarter in China for a steel customer.

We will bring four additional large plants onstream in fiscal '08, including our second hydrogen plant for Petro-Canada's refinery in Edmonton, Alberta.

As demonstrated by our growing number of new projects, bidding activity remains high with outstanding opportunities around the world.

Please turn to slide 8, Electronics and Performance Materials.

Segment sales of $514 million were up 6% compared to last year.

Volume gains accounted for 6%.

Lower equipment results reduced sales by 1%.

Pricing reduced sales by 1%, and currency added 2%.

Electronics sales were up 4% compared to last year, driven by higher sales in specialty materials, and offset by lower equipment sales.

Excluding equipment, sales increased 7%.

Electronics sales were up 2% sequentially due to higher Tonnage sales.

In Performance Materials volumes grew 4%.

And our new product volumes improved 15% versus prior year, and now represent more than 15% of the portfolio.

We are seeing increasing demand for our environmentally friendly products, as well as those that improve energy efficiency and productivity.

Performance Materials volumes were down 10% sequentially due to normal seasonal demand patterns.

Overall operating income of $66 million was up 33% versus prior year.

Operating margin of 12.8% was up 260 basis points versus prior year.

We are seeing the impact of the Electronics portfolio improvement, as well as the continued penetration of our formulated products in Performance Materials.

Margins were up 120 basis points sequentially, reflecting the impact of restructuring and increased sales in higher margin products.

We just announced a new plant for Signet Solar, and are seeing bidding activity for new projects increase.

We expect to see continued solid progress in improving our margins this year.

Please recognize overall revenue growth will be lower due to our SKU reduction efforts; however, we're already beginning to see these efforts pay off in margin expansion.

Please turn to slide 9, Equipment and Energy.

Sales of $100 million in this segment decreased due to a onetime sale of some off-site work for a refinery customer last year, as well as lower LNG activity.

On a sequential basis sales declined 19%, largely due to lower LNG activity.

Operating income of $9 million decreased versus prior year and versus prior quarter.

Last year's results benefited from an LNG order cancellation payment.

Our backlog of projects in this segment now totals $246 million.

As we announced yesterday, we received a LNG heat exchanger order during the quarter, and expect to receive additional LNG and large ASU orders later this fiscal year.

Please turn to slide 10, Healthcare.

Healthcare segment sales of $171 million were up 10% compared to prior year, due primarily to better performance in Europe.

Sequentially sales were up 7%, reflecting strong results in Europe and some improvement in the U.S.

business.

Operating income of $14 million was up versus prior year on higher European results.

Overall margins improved to 8% in the quarter versus 6% a year ago, and were up 250 basis points sequentially.

Now I will turn the call back over to Paul.

Now if you will turn to slide 11.

As we look forward from quarter one to quarter two, we are forecasting our second quarter earnings per share on a continuing operations basis to be in the range of $1.17 to $1.21.

This excludes any divestiture gains or pension settlement charges and represents year-on-year growth of 21 to 25%.

On the positive side, we expect to see increased earnings sequentially from the following areas.

In Merchant Gases we look to drive new applications and continue to implement price increases and fuel-based surcharges.

In Electronics, we expect higher equipment sales and further benefits from our product rationalization efforts.

In Performance Materials, quarter one as expected was a seasonally low-volume period for this business.

We therefore expect to see a seasonal rebound in volumes in quarter two.

Equity affiliate income should improve sequentially as well.

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

Somewhat offsetting these sequential improvements is our forecast for lower operating results in our Equipment and Energy segment due to higher energy development spending.

In quarter two we do expect to close our polymer sale to Wacker.

We are currently estimating a before tax gain of $65 million to $85 million.

Quarter two will also see the bulk of our pension settlement charge recorded.

For the year we are currently forecasting a charge of $25 million to $30 million, with the quarter two portion being $24 million to $26 million.

Turning to slide 12, our outlook for the full year.

Last quarter we gave you fiscal year 2008 guidance of $4.80 to $5, which included both a full year of polymers and the 2008 portion of our pension settlement charge.

This quarter we moved polymers to discontinued operations.

This lowers our guidance from continuing operations by $0.17.

And based on the confusion it created, we have also decided to exclude the pension settlement charge.

This raises guidance by $0.07.

Therefore, excluding these items, an equivalent range for the full year guidance we gave you last quarter would now be $4.70 to $4.90.

Due to our strong first quarter performance, continued growth from our new investments, and improved margins from our productivity efforts, we are raising our guidance by $0.15 on the bottom end and $0.10 on the top end to $4.85 to $5.

Based upon fiscal year 2007 EPS from continuing operations of $4.20, which excludes $0.30 of onetime net gains, we are forecasting a year-on-year increase of 15% to 19%.

Turning to slide number 13.

As we look at economic activity through the first quarter of this year, it is tracking in line with the projections we gave you in last quarter's year-end call.

There has been a lot of talk on the possibility of a U.S.

recession.

We have not seen evidence of this in our results.

As we have said before, slowing in manufacturing from the housing decline has been almost offset by increased exports due to a weaker dollar.

As we look to the future, demand for industrial gases is driven by the value they bring to our customer.

And I cannot remember a time when the demand factors have been more positive for us.

Industrial gases are used to increase energy efficiency, increase the throughput and capital efficiency of machinery and equipment, improve the end product quality, and improve environmental performance.

The prospect of sustained higher energy prices is driving significant new opportunities in both our Merchant and Tonnage businesses as customers look to increase the energy efficiency of their processes by using industrial gases.

Manufacturers today are seeing high capital costs for new equipment and also difficulties and delays in siting and permitting new investments.

Many of our customers are choosing to use industrial gases to debottleneck their existing plants, and therefore add low-cost capacity quickly.

We're also seeing much stricter environmental regulations on all manufacturers.

And these pressures are creating greater opportunities in both our Merchant and Tonnage businesses.

Finally, our global businesses are well positioned in the areas of greatest future investment, Asia, Central and Eastern Europe, the Middle East, and North America.

We believe this gives us a distinct advantage over our competitors.

This is evidenced by our global leadership in hydrogen for clean fuels, oxygen for gasification, and electronics, where our market focus brings the best applications and broadest range of products and solutions to our customers.

Recently there have been some analysts reports suggesting Air Products is more cyclical and could underperform its competitors during a downturn.

Let me assure you that the steps we have taken to transform our Company since the last economic downturn have solved this problem.

As you know, we were not pleased by our performance during the last downturn from 2001 through 2003.

The actions we have taken over the last few years to change Air Products into a more focused, less cyclical, higher growth and higher return Company were aimed at delivering sustainable results during the periods of economic uncertainty.

Please turn to slide number 14.

Let me discuss a number of the actions that we have taken.

We have moved to global business units in the past four years.

This has resulted in considerable expansion overseas, and we now have 56% of our sales outside of the United States compared to 44% in 2000.

With the sale of our emulsions assets in the next quarter we will be out of the cyclical chemicals businesses.

The downturn in our former amines and emulsions businesses were major contributors to our underperformance.

We have made major changes to our Electronics business, significantly lowering its cost of conducting business, exiting low margin productlines, introducing new, higher margin products, and winning a significant amount of new Tonnage business.

This has made Electronics a much better business with solid fundamentals, better margins and higher returns.

Also, the electronics industry has changed itself.

As you'll remember, the downturn in the electronics industry was a major contributor to our performance issues.

The industry has gone through a shakeout and consolidation has occurred.

Fundamentally the industry has shown its ability to better manage supply and demand relationships, production and inventory, without any significant cycles occurring over the past four years.

We've also increased our percentage of business under long-term Tonnage contracts from 26% in 2000 to 36% today.

The Tonnage business is shielded contractually from the ups and downs of the economy, and we have the largest percentage of any of our industrial gases competitors.

We have simplified, standardized and globalized our work processes, underpinning them with a single instance of SAP.

Across our businesses worldwide we have reduced our cost of doing business.

This has decreased our SG&A as a percent of sales from 14% in 2004 to 12% today.

Our Merchant business during the last downturn had significant excess capacity and lower margins.

We have done a lot to fundamentally improve that business and to manage capacity, price and margins better.

Additionally, we have focused a larger amount of our sales activity on applications, and it is paying off.

Our new business signings over the past quarters -- over the past quarter -- were at record levels globally.

We have been very disciplined in our use of capital, focusing it on our best opportunities.

And we have returned to shareholders over $1.5 billion through stock buyback in the past three years.

Finally, as evidenced by the achievement of our ORONA goals last year, we have significantly improved the returns across our business, and we have achieved record levels in 2007.

We, however, are not satisfied with this, and have set aggressive goals to increase our margins and returns over the next three years.

You can see by the improvements we have demonstrated in this first quarter that we are serious about delivering this 300 basis point improvement in margins over the next three years.

The bottom line is that we believe we are well positioned, both near-term and long-term, to grow earnings, increase cash generation, and improve returns, resulting in greater shareholder value.

The focus of our actions over the past few years has been to get us positioned well around the world in the key markets, with strong businesses, excellent products, and the right solutions for our customers to deliver results for our shareholders.

We have done that, and we look forward to capitalizing on this great opportunity.

Thank you.

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

(OPERATOR INSTRUCTIONS).

P.J.

Juvekar, Citigroup.

In Tonnage Gases you mentioned that margins were constrained by higher bidding expenses.

Can you elaborate on that?

Is this happening in U.S.

or Asia, and what is the competitive activity right now?

In the constraint, it was not a lot, P.J., but it did impact us.

It goes back to the bidding activity which we had.

We expense those costs as we continue to bid.

And it gets back to the drivers which I talked about, trying to drive -- as possibly looking at things to save energy, as we look for clean fuels, as we look at gasification.

We look to people to take and expand their plants and debottleneck.

Improve our metal performance.

That is happening for us around the world.

It is happening in the U.S, it is happening in Canada, it is happening in Asia, etc., Europe.

Is there a particular (multiple speakers).

I'm sorry, go ahead.

The Middle East also.

Okay.

Is there a particular product like LOX/LIN or hydrogen that is getting more competitive?

No, in your question on competition, everything is in the markets, and they are competitive.

I don't think the intensity is actually exceptionally increasing there.

And we have always competed with the large industrial gas companies around the world on these things.

I think the thing which we look at is we are seeing very strong demand for those products around the world -- oxygen, nitrogen and hydrogen, which are the primary Tonnage products.

You mentioned about SKU reductions in Electronics.

Can you tell us how much of revenue is impacted and what were the margins on those revenues, maybe like 2 or 3% margins in those businesses?

If you look at that, and we have said it is probably somewhere between $80 million to $100 million a year in revenue, which are coming off by the exits of those products for us.

And the drop was -- and those products went from, as we looked at them, from some lost money to some -- and they made money.

But as we looked at that the margins were poor.

Robert Koort, Goldman Sachs.

Paul, I don't often do a cheerleading -- good quarter.

I won't this time, but I have to say that was a pretty inspiring defense of your outlook you gave there a minute ago.

Thank you.

Maybe a little bit more granularity on the Electronics side.

When you look at the 260 basis point year-on-year margin improvement, I'm trying to assess how much of that is one-off from the HPPC divestiture and how much of it is the early stages of business optimization of what you've got.

Can you help me out there?

On the results, which you are looking at, the HPPC divestiture is completely out of all the years.

That was put in discontinued operations.

Wow.

Okay.

So it is all due to all of the things which you talked about, restructuring the business, dropping out of productlines, increasing our Tonnage revenues, the products and getting to a low-cost supply and rationalizing our businesses.

Great.

Then secondly, if I might, Nelson, you talked about adding some new letters of intent on the Tonnage side.

Can you give us some sense of what those look like on a return hurdle basis, and maybe how that has changed over the last three or four years?

Have we hit a plateau where now the competitive environment is sort of stabilized, or are you still seeing enough project activity that bid hurdles can continue to increase?

These projects are definitely going to increase our overall returns.

They have been all very good projects for us, a combination of both hydrogen -- probably a majority hydrogen and some nitrogen and oxygen.

We're very pleased with these.

They are with key customers in areas where we want to grow.

And as Paul stated, obviously the bidding activity is intense, but we are winning more than our fair share because of our offerings and the infrastructure that we have.

Jeff Zekauskas, JPMorgan.

On the cash-flow statement the gain on sale of assets is $6.2 million.

I take it that that is the number that passed through your income statement.

Yes, it is.

What was the magnitude of the charge, the asset write-down you talked about?

The write-down was -- and the write-downs overall were close to that.

But that is not included in that line?

No, it is not.

The equity affiliate line, it does not get included there.

It is like $4 billion or $5 billion, is that what you mean for the --?

No, I didn't sell the asset there.

So if I had sold those assets, it would have been.

I just took a loss on the asset because of the venture.

Secondly, your currency gains were -- or the currency benefit was $0.07.

Does that include hedging gains or is that exclusive of hedging gains?

It includes those gains.

But I will be honest with you, we do not do a lot in hedging gains, which are not exactly matched and so that is not a lot of activity for us.

Then lastly, are your targets for Equipment and Energy operating income higher for 2008 now or lower or the same, given that you had such a nice first quarter?

About the same.

Don Carson, Merrill Lynch.

A couple questions on earnings visibility.

Nelson, you talked about your new business signings in Merchant being at a high rate in calendar '07 and continuing.

As you look at that, what kind of volume growth does that give you?

And also an additional question on equity affiliate income.

Now that the PEMEX project has started up, what kind of quarterly increase should we see in equity affiliate income?

I will take the volume one and pass over to Paul for the second question.

As I have said in these calls before, one of the things that we're benefiting by has been the acceleration of signings over the last couple of years.

We're laying a very good baseline for growth in the coming quarters and coming fiscal years, so a lot of what we saw in this first quarter was the benefit of what we had signed in the previous say three or four quarters.

That all being said, it still gives us in terms of new growth somewhere in the neighborhood of 4 or 5% expectations for this year in LOX/LIN.

Obviously LAR and helium are going to be dampened because of the availability, but we still see pretty solid growth.

And the other adding comment to that is that our base business continues to move along, meaning the base business is still growing for us.

Now I will turn it over to Paul for the PEMEX.

If we look at that project, that project for the year probably adds about $0.02 to $0.03 a share for us, net of the cost of financing the deal.

Nelson, just to clarify on the Merchant signing, so you're talking 4 to 5% new growth in LIN/LOX, and then base growth should still be what, sort of in the 3, 4% range?

That is probably more of a blended number.

So I think we are seeing a high rate of conversions, which as you know, we're typically converting 2 to 3% a year.

If you take that off, adding nominal base business growth to the new growth, it's still looking like a 5% number.

Dave Begleiter, Deutsche Bank.

Paul, just in Europe are you seeing any pockets of weakness in the economy, either by region or by industry?

Certainly if you go to Europe, Western Europe is not as strong as the East.

If we look at the growth, the growth is strongest for us in our Polish assets there and in our Czech assets which we have there.

That is the area of greatest growth.

The UK, obviously, is a slow area also.

And the best areas are really in the East and Central.

Just on the pricing front, Paul, in North America what is your full year expectation now for Merchant pricing gains in North America?

If we look at pricing gains, and this is going to depend upon what happens on energy pricing obviously because of pass-throughs, but we would expect our prices to continue to go up through the year.

Whether we get to an overall of a 3 or 4% gain would probably be a good expectation for us I would say.

Lastly, on the Merchant side, given the pace of new business signings, are you gaining share outside North America?

That is always hard to tell over one particular period, but we think we are doing very well.

We are certainly -- and gaining share on the applications end as we look at certain things.

We look at certain markets like our glass and the oilfield services and stuff like that, our expansions there are doing very, very well.

Steve Schuman, New Vernon Associates.

I applaud your new JV as far as opening up -- potentially opening up the Middle East.

But what about some opportunities that are closer to home, on particular oil sands?

Obviously you have a couple of hydrogen deals up there.

When are we going to hear about more both hydrogen on the oil sands processing side and also potentially gasification for power and steam?

We continue to work in the area, and we're quite active.

We're hopeful that we will have an announcement sometime within the next year of a project in that area.

Would any of those five projects be up there at this point, that you have announced but --?

No, no, they are not.

What is the holdup?

Are the companies up there more interested in doing it themselves, either building their own plants or just buying a plant from you?

No, they are large investments, so they take -- it is in the multiple billions of dollars, and so they take a long time to get these things to come together.

But we are convinced with the position that we have and the customers who we have served up in that area, that we are uniquely positioned to win jobs in that area.

Mike Harrison, First Analysis.

You guys in one of your mid quarter sales updates, you reported that Tonnage Gases sales were up 24% through the first two months of the quarter.

And then you came out today with 15% for the full quarter.

Obviously, I think there was some impact in there from the reclassification of the PUI business.

But I was wondering if you could talk about what you saw in December in terms of Tonnage Gases sales?

Maybe what the prior year comp looked like for December?

And then as we look into the March quarter, should we expect sales growth above or below that 20% growth rate?

I think what you saw was probably the October number, as I recall, was up very strongly.

The reason why it was, and we noted this at the point in time, is currency was in there at that -- not currency, excuse me -- on gas.

Gas was in October of last year of 2006, which is the first month of the fiscal year.

It was quite low.

It was in the $4.80 range, I think.

And it was much higher, it was close to $7 for us in this year, and so that pushed sales up a lot.

The other thing which has held down the year to year growth, as you look at this in my Tonnage segment, is the movement of the polyurethane intermediates business into that segment.

And that obviously is not a business of growth for us, so that has held down -- and so that has held that down.

The other thing is that I think in '07 we had just -- we were just beginning to make a startup for a plant in the Gulf Coast at that point in time, and so we didn't get a full month of sales, so there is little volume carryover.

But if you look at this and we look forward, we certainly would not expect to see 20% sales growth on the Tonnage business going forward.

I think it is going to be in the single digit -- high single digit range for us for the rest of the year, depending obviously on gas prices.

On the Healthcare segment, obviously it is still not quite where you want to be with that business, but some nice improvement in margins there.

I was wondering if you would talk about the traction that you're getting in the North American portion of that business, and maybe whether you think the North American business may have turned a corner during this quarter.

Certainly we started to see the North American results improve, which is a very good thing for us, and we're happy about that.

The rate of progress needs to get better still.

We think we have -- and we're encouraged.

We think we have the right solutions here going forward.

And that we would expect to see continued improvement throughout the year in the Healthcare segment.

Fred Siemer, Chemical Research for Wall Street.

I have just a couple questions.

One, I was surprised to hear -- I think you said you had plenty of Merchant capacity in the United States.

That is quite a change from last year.

What is your operating rate in North America in Merchant, and how much capacity did you add as a percentage total in the last year?

This is Nelson.

We didn't say we had a lot of capacity.

The only thing we talked about in terms of capacity was that LAR and helium were still tight.

But operating rates have remained about the same as last year, because we have added capacity, we have also done a significant number of conversions in the last 12 months or so.

The capacity that we have added that has probably added about 3 or 4% to our total U.S.

production.

You were almost 86, 88% last year.

You're running that high now (multiple speakers)?

Yes.

Yes, we are.

The other question is regarding your stock, and you have pretty well completed I think your planned -- immediate plans for divesting in chemicals.

But you're still underperforming Praxair substantially.

Your stock was down 18%, theirs was down 16.

And the PE multiple discount that Air Products suffers is still 1.5 to almost 2, which implies you're leaving $400 million of valuation -- of stock valuation on the table by having this invisible chemicals business tucked into Tonnage Gases.

You once promised us that you would try to explain the noncyclicality and value of that chemical business.

Can we look forward to that this year?

We're done on the sale of that.

And we did everything which we said we would do.

The polyurethane intermediates business is the same as our Tonnage businesses.

It sells to a few customers -- long-term contracts.

They have to take the product.

They're committed to take the product.

They pay us for that.

We pass through the cost of raw material; and we index for labor and maintenance on the plant and stuff like that.

So it looks just like a contract in that business.

That is why we put it there.

I don't think that that is the reason for why we are short of Praxair, or it shouldn't be.

What is the reason?

Your gas business is as good or better than theirs.

I (multiple speakers).

We have to improve (inaudible) -- and part of the thing is trying to get our returns up.

And you have seen us talk about that.

And we have done a good job of getting that, but we still aren't at their return levels.

We need to improve that.

Part of that is couched in us going out and trying to get the margins of the business up.

We are very serious about that because we believe that we have a better portfolio as far as growth and positioning for that growth.

So we can expect nothing further in chemical divestitures then?

Right.

Peter Butler, Glen Hill Investment.

Nice to see continuing positive earnings surprises.

I have two questions.

First is simple I think.

Could you give us your projections for cash -- for some of the cash flow numbers, CapEx and DD&A for this year and in '09?

If you look on the CapEx what we have said is that it is $1.1 billion to $1.2 billion in '08.

We would also expect that to grow in '09.

There are still projects to be won obviously to get that, but we would expect that to happen.

As far as for this year, we probably expect our depreciation and amortization to be in the $850 million range or so, and probably growing in the next year as we bring more plants, so take that up by 5%, 6%.

The other question is you're making some nice improvements in your asset mix.

You should be benefiting from the weak dollar, obviously, etc.

Is there any reason for you at this point to consider increasing your ROI goals or your ORONA goals, etc.?

Our goals are to keep it growing and to continue to drive it higher for us.

So, yes, we are trying to drive it higher.

But I'm asking whether at some point here could you have a significant increase in your expectations for these goals based on some of the changes that have taken place in your mix and the dollar relationship, etc., etc.?

I would answer that in terms of trying to increase on the margin side.

If you take those 300 basis points in improvement in margin and translate that to an improvement on return on capital, which is simple, and you can see the goals are higher.

Those things are put in there.

As far as changes in currency, it really doesn't increase -- that doesn't change what happens as far as my return on capital goal, because the numerator and denominator are affected by both those things.

So it is about the same impact on both things.

It doesn't move it.

But certainly going into good projects helps us.

Mike Judd, Greenwich Consultants.

Congratulations also on a good quarter.

Just given the uncertainty in the equity markets now, I'm just wondering -- obviously your businesses are doing well, but are there any areas where you are seeing any weakness, either domestically or international?

Just anything you may want to give us a little bit of heads up on?

What we have seen, Mike, and we have talked about this before, is that we did see some drop in the housing related markets; 18 months ago it started for us.

Those have continued to be low.

But we have been able to go out and offset most of them, especially as we look on the export business.

The export markets have done very well for us, and have actually helped us because we have got a lot more exposure on export markets than we do on housing markets internally within Air Products.

If there is a slower growth globally, you guys will just basically tighten your belts a little bit, is that the takeaway also there?

Absolutely.

Kevin McCarthy, Banc of America Securities.

Paul, how would you prioritize uses of free cash flow?

And specifically given your constructive outlook and the volatility in the stock market, should we expect repurchases at a steady rate, similar to the $190 million in this quarter or do you see potential to accelerate that activity?

As far as the priorities are first to spend money on good projects and acquisitions and JV buyouts which execute our strategy.

That is obviously the first one.

The next one would be maintaining the A bond rating for us.

Then we look at increasing the dividend within the 30 to 40% range.

Then the last one is that the money goes back to the shareholders.

That is what you have seen from us for the past three years and we are going to continue that.

Yes, I would expect the ability to continue to go out and buy back shares, provided that I'm not presented with a great acquisition opportunity or something like that, which is -- but currently within this -- on the capital spending guidance, which is out there, what you can see is that it would result in a share buyback about even with what you saw in the first quarter.

That is helpful.

Then I had a few questions on the Tonnage business.

If I look at your volume growth there of 5% in the quarter, is that a reasonable baseline growth rate to think about exclusive of new plant startups?

Then on the subject of new plant startups, is your hydrogen unit in Edmonton for Petro-Canada still on track for the second calendar quarter?

The answer to that is that it starts up right at the beginning -- on that last question is that it starts up right at the beginning of our third quarter, so yes.

That is right, in the April time frame, yes, it is there.

As far as growth on the Tonnage side, to drive growth in there in that business we actually need to bring in new investments.

So we do sell some, but we are -- and we're selling a lot today as far as the system is concerned.

The underlying growth of that business depends upon being able to spend capital.

Finally, on Tonnage, what was the magnitude of PUI sales that you transferred out of the old chemicals segment into Tonnage in the quarter?

It is about $300 million a year.

Laurence Alexander, Jefferies.

I guess the first question on the pricing cycle in Merchant Gases in Europe, do you think if the conditions are tight enough that even in sort of stable environment in Europe you would be able to maintain a pricing cycle the way you have in the U.S.?

Yes.

Would it still be around 2, 3%?

Yes.

Could be.

Yes.

In terms of the Tonnage business, in terms of the growth prospects, if you look at the projects that you are confident you're signing, or that the ones that you might be announcing near-term, plus the ones that you think are likely after that, what do you see as a good reasonable volume growth rate for Tonnage over the next three years?

In the long-term I think in the low teens.

On the volume side?

Yes, 12, 13 on the volume side.

That would be over three to five years?

Yes.

Right.

Perfect.

Then in the past sometimes you have discussed doing acquisitions to double or triple the size of Performance Materials.

Given the improvement in your returns in the industrial gas side, has that dropped off as a priority?

No, but we need to get the right properties.

We continue to look and explore in that area.

Are you seeing those properties coming available or is that more a hypothetical at this point?

No, we continue to work at opportunities.

But as I said, the opportunity has to be in the right markets, have the right products and make the right return.

Perfect.

Then just to be clear on Healthcare margins it sounds as if you're still on track for your two to three year goals on North American Healthcare margins.

Yes, but it is early days, but we continue to work hard at it.

Chris Shaw, UBS.

Are there any assumptions that you can share with guidance in terms of the high end, low end?

Is there a sales number that goes with the high end or low end or any sort of industrial production estimate?

Is there anything you can share on that?

Certainly if you go back to our guidance in the beginning of the year, we said globally maybe 3, 3.5% on a global -- for the manufacturing markets globally.

So that is a number which sits there.

I think on the other end of the guidance some of the things that sits there is our ability to really deliver on some new product successes, etc., in our businesses.

Okay.

Quickly, I think it was mentioned that 2Q tax rate would be lower.

How low are we talking about and what was the reason?

Slight.

The tax rate is going to bounce a little bit all the time on us, but we try to give a year guidance.

And it depends on when we're able to book certain benefits.

Mark Gulley, Soleil Securities.

I have got three questions.

I want to talk about competition and CapEx.

As I look at your U.S.

competitor, and one of your European competitors, it looks as if they're spending more as a percent of sales.

And in the case of your European competitor, one of them double in terms of dollars, in terms of CapEx.

So do you view that as a ratcheting up of CapEx spending by your competitors?

Can you compete at a somewhat lower level of CapEx?

Can you provide some help there please, Paul?

We certainly think the CapEx which we are spending is right, right now for us and it correlates with the wins which we have had.

We think we're maintaining or expanding our competitive position.

I don't know the exact areas in which everyone is spending.

You would have to ask them to put them together.

But we have also paid a lot of attention trying to drive our cost of plants down too in this environment.

Secondly, it looks to me like you're showing two measures, two metrics for returns -- ROCE and ORONA.

Are you going to focus on one or the other in terms of how you present that to us and in terms of how your comp is determined?

They actually track together.

We have comp programs which actually stretch out a few years, so we still have some programs which track ORONA and we have -- and the ones which we introduced this year track return on capital employed, and so we are going to show both.

Finally, I wanted to wrap up with a question on coal to chemicals, certainly Pioneer, along with Eastman.

Are any of the five projects that you're going to announce in the next couple quarters associated with coal gasification, particularly perhaps in the U.S.?

No, on those five projects.

But we have been -- we are working very hard with [GG] on the IGCC plants there to get that.

And it has been announced, and we're going to -- and be with them on those.

And we should have something occurring in the near future.

Edward Yang with Oppenheimer.

My question is on industry competition.

And obviously the industry has changed a lot for the better and become more consolidated.

You mentioned that your utilization levels in North America are remaining fairly stable and at high levels.

What is your sense, Paul, in terms of how much of a cushion you have in terms of how much utilization could dip down before you might see some more price competition in the industry?

And would that level now be at a higher point than, or a lower point than it was maybe ten years ago when there were more competitors?

I would not see the utilization of the plants dropping.

It goes back to the stuff which I talked about before about the way people use the gases.

So if we go look at things, say energy prices are high, environmental performance, people are trying to go out and work on their plants.

For us our signings are at the highest levels ever in the U.S.

-- the highest levels ever.

So I would not see a drop in that occurring.

It is hard to imagine.

In the off chance that you do see a dropping, in terms of your own mindset would you tolerate lower utilization and keep pricing relatively high, or would you try to optimize the utilization more than the pricing?

A thing you have to remember is that we do have long-term contracts, and so a drop in pricing is not going to precipitate everyone coming in and getting a price decrease.

What happens is that we have these contracts for five years on the bulk of our customers, and so I would not see an easing off.

So for us it would probably result in the way in which we would go out and do that is cut back on expansions for things, cut back maybe somewhat on our conversion efforts and try to manage our capacity that way.

At this time there appears to be no further questions in the queue.

I would like to turn the conference back over to their speakers for any closing or additional remarks.

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

Thank you for joining us and have a nice day.

That does conclude our teleconference for today.

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Have a wonderful day.