Air Products and Chemicals Inc (APD) 2008 Q2 法說會逐字稿

Good morning welcome to Air Products and Chemicals' second quarter 2008 earnings results conference call.

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

(OPERATOR INSTRUCTIONS).

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

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.

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

This is Nelson Squires.

Today, our CFO, Paul Huck, and I will review our second 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 the call beginning at 2:00 PM Eastern time are also available on the website.

Before we begin, I would like to call your attention to two items included in this quarter's results -- sale of our Polymer Emulsions business and the pension settlement charge.

These items have been excluded from our discussion this morning.

A reconciliation of these items is contained in the appendix to the slides and the earnings release.

Please turn to slide two.

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

Please review the Safe Harbor language on this slide and at the end of today's earnings release.

Now I'll turn the call over to Paul.

Thank you, Nelson.

Good morning and thank you for joining us today.

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

As you can see, we had another good quarter and as we reached the midpoint of our fiscal year, we continue to make solid progress on a number of our fiscal year 2008 financial targets.

For the quarter, sales grew 13% versus prior year.

Growth was limited by softness in several of our equipment product offerings, mainly due to customer concerns around higher capital costs and less new investment in general.

Excluding equipment, sales grew 15%, driven primarily by better volumes in our Electronics and Performance Materials and Tonnage segments and higher pricing in Merchant Gases.

Currency contributed 4%.

Higher natural gas pass-through and acquisitions each contributed 2%, for an underlying equivalent growth rate of 7%.

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

This quarter, SG&A was 12% of sales, an improvement from prior year.

Operating income of $365 million was up 18% from prior year, again due to better volumes in pricing and also favorable currency.

As a result, our operating margins improved 60 basis points to 14%.

Margins were down 100 basis points sequentially, related to a number of factors in each segment.

Higher natural gas costs and bidding expenses impacted Tonnage, SAP implementation in central and eastern Europe impacted Merchant, equipment sales more than doubled quarter-on-quarter in Electronics, and finally Healthcare margins declined due to ongoing issues in the US business.

With the volume and pricing gains we're forecasting for the second half of the year, we're on track to achieve our operating margin goal of 15% for the year.

For the quarter, our net income and diluted earnings per share increased by 24% and 27%, respectively.

Our return on capital improved with return on capital employed increasing to 12.4%, up 70 basis points from last year.

Now please turn to slide number four.

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

Our GAAP or as-reported EPS, increased 40%.

This reflects $0.28 from discontinued operations, which includes a gain on the sale of our Polymer Emulsions business.

And, we also had a pension settlement charge of $0.08 per share.

Excluding the discontinued operations and the pension settlement charge, EPS from continuing operations grew to 27%.

Higher volumes added $0.08.

Higher pricing and margins together contributed $0.01.

Our pull-in acquisition improved earnings $0.02.

Favorable currency added $0.07.

Higher equity affiliate income contributed $0.05 as we continued to see good growth in operating performance in a number of countries.

$0.02 of this is attributable to the reimbursement of an antitrust fund in our Italian affiliate.

We repurchased 4 million shares, spending $365 million this quarter.

Fewer shares outstanding contributed $0.02.

A slightly lower tax rate was pretty much offset by higher interest expense.

All other items net contributed $0.01.

The bottom line is that we had a very solid second quarter, and our fiscal year 2008 is off to a good start.

We continue to deliver leverage to the bottom line.

At midyear, sales growth is 11%, and our EPS growth is 22%.

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

Nelson?

Please turn to slide five, Merchant Gases.

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

Sales of $902 million were up 15% versus prior year.

Currency contributed 7% and acquisitions contributed 5%.

Pricing added 4%, and volume was down 1%.

Lower equipment sales reduced volumes by 4% in the quarter.

Merchant Gases operating income of $167 million was up 18% versus prior year, and segment operating margin of 18.5% was up 50 basis points, mainly due to pricing gains.

Margins were down sequentially by 110 basis points due to higher costs to support growth, including our SAP implementation in central and eastern Europe.

Let me now provide a few highlights by region.

Please turn to slide six.

In North America, our sales increased 8%, driven by strong pricing gains.

Overall growth was limited by the availability of argon and helium and less spot liquid hydrogen sales versus a year ago.

We will implement an additional fuel surcharge in North America on the first of May to recover the cost increases incurred since our previous surcharge implementation on 1 January.

New business signings were strong in the quarter and are significantly ahead of target for both the quarter and year-to-date.

We expect to see the impact of these signings in the second half of the year.

Sales increased 27% over prior year in Europe with price adding 3%, currency 14%, acquisitions 12% and volumes down 2%.

Business was generally soft in the UK and Spain during the quarter.

Volumes were impacted by fewer spot sales versus a year ago, availability of helium across the region and general tightness of supply of LOX/LIN on the continent.

In Asia Merchant sales were up 22% over last year.

Volumes contributed 15%, currency 4% and price 3%.

We saw less impact on volume from lunar new year than in previous years.

Please turn to slide seven, Tonnage Gases.

Sales of $867 million increased 25% compared to last year.

Volumes increased 12% versus prior year, reflecting growth from new plants in Asia and Europe and improved plant loading.

Natural gas and raw material prices were higher versus prior year and added 8%.

Currency added 3%, and acquisitions 2%.

Sequentially, volumes were up 4%.

Operating income of $111 million was up 20% compared to last year.

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

Operating income was flat sequentially.

Operating margin of 12.8% was 50 basis points lower than last year, held down by higher natural gas cost pass-through and higher project bidding expenses.

This reduced margins sequentially as well.

We brought our second hydrogen plant onstream on schedule for Petro-Canada's refinery in Edmonton, Alberta, in April.

Bidding continues at a high level across the segment.

We're making solid progress on the Tonnage projects discussed during the last call and expect to announce signed agreements during the current quarter.

Please turn to slide eight, Electronics and Performance Materials.

Segment sales of $562 million were up 6% compared to last year.

Volumes were up 5%, accounting for the majority of the gain.

Electronics sales were up 2% compared to last year, driven by higher sales in Specialty Materials and Tonnage, offset by lower Equipment sales and the SKU reduction effort.

Excluding Equipment and the SKU reduction effort, sales increased 10%.

Electronics sales were up 7% sequentially due to higher equipment sales.

In Performance Materials, overall volumes grew 3% versus prior year and 7% sequentially.

Continued weakness in sales to the North America housing market was more than offset by strong sales to the commercial construction markets in Europe and the Middle East.

Overall operating income of $68 million was up 20% versus prior year.

Operating margin of 12% was up 130 basis points versus prior year, due to the impact of the Electronics restructuring and higher volumes in Performance Materials.

Margins were down 80 basis points sequentially, mainly due to higher equipment sales.

We expect to see continued progress in improving our margins over the second half of this year.

Please turn to slide nine, Equipment and Energy.

Sales of $105 million in this segment decreased due to lower LNG activity.

On a sequential basis sales increased 4%.

Operating income of $10 million decreased versus prior year and increased slightly versus prior quarter.

Our backlog of projects now totals $203 million.

We did receive letters of intent for a few large air separation units in the quarter, which will be added to the backlog next quarter.

We're also seeing the bidding activity pick up for LNG.

We expect to receive additional LNG orders later this year.

Please turn to slide 10, Healthcare.

Healthcare segment sales of $170 million were up 8% compared to prior year, due primarily to currency.

Sequentially, sales were down 1%, reflecting solid results in Europe and softness in the US business.

Operating income of $9 million was up 34% versus prior year on higher European results and currency.

Overall margins were at 5.5%, improving 100 basis points versus prior year.

Our margins declined 250 basis points sequentially, due to continuing issues in the US business.

Paul will have more to say on the US Healthcare business in his closing remarks.

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

Thanks, Nelson.

Now, if you'll turn to slide 11, as we look forward from quarter two to quarter three, we are forecasting our third-quarter earnings per share on a continuing operations basis to be in the range of $1.25 to $1.30.

This excludes any further divestiture impacts and represents year-on-year growth of 12% to 16%.

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

In Electronics, we expect higher Specialty Materials volumes on increased foundry operating rates and further benefits from our product rationalization efforts.

In Performance Materials, we expect to see a continued seasonal rebound in volumes into quarter three.

In Merchant Gases, we expect higher volumes as we continue to drive and applications.

We also continue to implement price increases and fuel-based surcharges to recover escalating costs.

In Tonnage Gases, we have new plans onstream, and we anticipate lower maintenance spending in quarter three.

Finally, we expect to continue to see favorable currency impacts next quarter.

Slightly offsetting these sequential improvements is our forecast for lower operating results in our Equipment and Energy segment, due to the higher energy development spending and maintenance outages.

On the economic front, we continue to see about 2% industrial production growth for US manufacturing this fiscal year.

The continued declines in US housing and the weakness in autos is being offset by growth in manufacturing exports.

In Europe, growth continues on the northern continent while both the UK and Spanish economies are essentially flat.

Year on year, we still expect to see growth in Europe at around 2%.

Asia growth is also on track with our forecast at around 6% to 7%.

Overall, that puts our forecast for world manufacturing at around 3%.

This compares to last year's growth of about 4%.

While there is continued economic uncertainty and speculation, we still see strength and growth in our markets, both near-term and long-term.

Given our strong first-half performance, our growing backlog of new investments and improved margins from our pricing and productivity efforts, we're raising our guidance by $0.10 on the bottom and $0.05 on the top to $4.95 to $5.05.

Based upon fiscal 2007 EPS from continuing operations of $4.20, which excludes $0.30 of one-time net gains, we are forecasting a year-on-year increase of 18% to 20%.

As Nelson mentioned in his business commentary, longer-term we are seeing strong bid activity across our businesses, which gives us confidence for continued growth in 2009 and beyond.

Our property, plant and equipment capital spending guidance for fiscal 2008 remains unchanged at $1.1 billion to $1.2 billion.

Before we take your questions, let me up you on a few items.

First, we closed the Polymer Emulsions sale on January 31, and we're on schedule towards completing the sale of the two remaining plants.

We have received bids and are currently in negotiations.

Second, as you have likely read in our earnings release today, we're behind on our plan to improve our US Healthcare business.

While we continue to execute on our improvement plan, we're also evaluating all of our strategic alternatives for our US business.

We expect to complete this process during the third fiscal quarter and will update you then.

Finally, in spite of slower economic growth, we increased earnings guidance again this quarter.

Demand factors such as higher energy prices, high capital cost and stricter environmental rates are creating greater opportunities for many of our product offerings.

Our global businesses are well positioned to continue capturing our share of these opportunities, and our people are focused on continuing to deliver double-digit sales and earnings growth, improved margins and higher returns in the future.

Thank you, and now I'll turn the call over to Jimmy to take your questions.

(OPERATOR INSTRUCTIONS) P.J.

Juvekar, Citigroup.

Margins were down in Tonnage, and you talked about higher project bidding expenses.

What has changed?

Is it just number of projects, or are you constrained by personnel?

No.

As we've mentioned before, P.J., there are a number of projects which people are starting to move forward on, and so that has increased.

It's going to increase our order intake, but it has also increased our expenses right now because, as you go through the bidding expenses, you put them into the P&L.

So we're working on a record number of projects right now.

Our personnel are tight, but we still feel good about our ability to win these projects and execute them.

So it's really the number of projects that you're working on?

It's the number of projects, yes.

It's an all-time high as far as the amount of capital and the numbers there.

That's the good news.

And once you're finished with divesting remaining chemical businesses, are you done with your portfolio?

Are you happy with it, or do you see more divestitures or acquisitions?

Where do you see your portfolio?

As far the portfolio is concerned, I think managing our portfolio is really something which is going to be an active thing for us at all times.

As we have said, there aren't any sacred cows; [in other words], our businesses have to perform through here.

That's going to be the demand which we make upon them, and it's something which our investors, I think, should expect of the management team here.

You mentioned that Europe was down 2% and sort of weak UK spend.

Is there a bigger read through for European economy in these comments are?

Well, I actually said, as far as we look at the European economy, we think it's going to be up 2% in the view of things, as we said that.

Certainly, the UK has been weak for a long period of time.

If you look at economic growth as far as on the manufacturing side, it goes up and goes down a little bit.

But for the past five or six years, I think if I showed you the graph, you'd say flat.

That's what, essentially, we're looking at right now.

As far as Spain is concerned, Spain has suffered some of the same problems from a housing bubble -- and that the US has suffered.

Plus, we're also seeing some of the impacts of the euro over there because some of the manufacturing is coming here for things.

David Begleiter, Deutsche Bank.

Paul, margins were down sequentially in Merchant Gas.

You mentioned some higher costs to support growth.

Can you detail those costs, and will it continue going forward?

Yes.

As far as in Merchant, and the thing which we mentioned was that our SAP costs, because we're bringing Poland and Europe and the Eastern Europe countries live on SAP, we had some extra costs, which always occur in the months going up to that go-live.

So we do expect the margins to come back and to rebound in Merchant.

For the year, we're still looking to make our gain to a 19% margin or so.

Paul, just on Electronics, you mentioned 10% growth ex the SKU reduction and equipment.

What's driving that growth?

Is it LCDs?

And what's the potential for margin in this segment going forward?

Well, firstly I said the potential for margin.

As we mentioned, our goal is to get the Electronics and Performance Materials margins to 15% or above, and so we're making good steady progress towards that.

Now, if you take a look at what's driving the growth, it is all of the product lines as we look at this.

It's the chips, and it's also LCD and solar is starting to make some inroads, albeit it is very small.

But we're seeing a lot of bid activity on the solar end right now.

The market for solar, Dave, would be very similar to the market for -- on LCDs as far as products are concerned.

Jeff Zekauskas, JP Morgan.

You mentioned that there was a $0.02 [a] share refund, I think, a fine in one of your equity income ventures.

So is that $4 million or $6 million?

I don't know how to treat the tax effects of that in equity income.

For that [money], it's $6 million.

It's 6?

It's $6 million.

(multiple speakers) -- something like 36.

So your equity income is really advancing very nicely, or at least this quarter it is.

Order of magnitude, I guess it's up about 18%, though in the first quarter it was down.

But maybe it was penalized by fines?

No -- and the fine actually occurred in -- I think it was Q3 '06 for us, and we disclosed that at the time.

The things which have helped us as far as the equity affiliate income, and it does bounce around, as a lot of things, because it is contained within ventures, is that our large affiliates are our Italian affiliate and our Mexican affiliate, Thailand.

We also brought our plant for serving Pemex online in the -- towards the end of the first quarter of this year, and so we got the full effect in this quarter.

So that was a nice gain for us.

India is also in there; that's another one that is growing very nicely for us.

So we have a lot of good countries covered from growth.

It's something which I feel is not -- people don't have and don't understand as well and don't appreciate as well.

It's a good source of earnings and cash for us.

In the Electronics area, you have obviously made wonderful progress in your margins year over year.

But when you look at your Electronics business sequentially, your revenues are up about $50 million, and operating profits are flat.

Why is that?

When Nelson went through the Electronics area, one of the things he mentioned is that the Equipment sales were up.

Equipment sales do not carry the same amount of profit with them.

Equipment sales are bumpy in this business and they are not smooth, so we had very low equipment sales in the first quarter.

We had twice as much equipment sales in the second quarter, so that did produce some of the shift there.

I think the other thing which happens, Jeff, is that we have seen a pattern as far as the Electronics business of seeing that the second quarter is slow.

That gets down to -- a lot of Electronics goes into the consumer, and so there are a lot of things which go around Christmas.

So you see, as the pickup period is in the late spring, as they start manufacturing, and so you see a pickup back in our Q3, a strong Q4, a strong Q1 and then a little bit of a slowdown on a sequential basis in our Q2.

That is something which we've observed for the past few years.

We wouldn't probably expect that to change.

But the business still has very good, strong growth fundamentals around it and it continues to grow strongly.

A good indicator for us as we follow very closely from the industry standpoint are the foundry operating rates (multiple speakers) [UMC] (multiple speakers).

Lastly, you're exploring strategic options for your Healthcare business.

Why are you doing that?

And is the idea to divest it on favorable terms or to grow it through joint venture?

What is your bias?

Well, as far as Healthcare business, and what we're talking about is not the business in Europe.

The business in Europe is operating extremely well; it's the US.

The US, as we have talked to people before -- it is not the same as the business in Europe, a different market for Healthcare.

Healthcare is delivered in a different way, and prices are set in a different way in the US.

The first quarter we were actually a little bit behind plan, although we had made some progress and were encouraged by that.

But we fell even further behind in this quarter.

Our plan was based upon making volume gains and taking it and doing simplification efforts on our products and saving some money.

We are on track on the saving money case.

We are not on track as far as the volume is concerned.

So our concern around this business goes to the volume.

So we decided that it has been a drag on this Company as far as earnings are concerned, and we're not happy with that.

So we're going to look at other alternatives, which we have.

So it includes everything, which you would think of, Jeff, of a company trying to take a good, hard, long look at a business and doing the right thing for the investors.

Sergey Vasnetsov, Lehman Brothers.

I wanted to ask you a couple questions from corporate lines.

Your interest came down this quarter [hence] a [tax] (inaudible) also quite a bit lower than what we expected.

Is it in your run rates, or it's just onetime blip on the downside?

As far as the tax rate is concerned, the answer to that is yes.

And those things are going to move -- and the tax rate is going to go up and down.

Our tax rate guidance for the year is probably still good, which we had probably -- will probably -- and closer to the low end of the 27 to 28 for us as we look into the future.

But it does depend upon planning actions which we take, and so we book them at the time at which those actions are certain and we view we're going to be able to take them.

So it does produce -- it's not going to be steady at all times, is my message.

As far as the interest expense is concerned, we continue to pay a lot of attention to managing cash properly.

But, as you can see, we're also paying a lot of attention to making sure we go out and buy back shares.

Our capital spending -- it does produce -- we do take and capitalize a portion of that interest as well.

But if you look at that, you can model those things in your model pretty good.

As far as the share buyback, should we expect it to continue at the run rate you said is recently at around [52] million a year -- a quarter?

Yes.

Actually, if you look at what we did, the share buyback for us in this quarter was higher than that.

First quarter was like $189 million.

This quarter it was $355 million -- $365 million.

And so total, we're at $554 million to date.

We did take advantage of the drop in the market, when it occurred.

We had a program out there which enabled us to do that, a 10b51 program.

We have now completed the $1.5 billion of share buyback over the -- from the mid '06 buyback.

We're about $100 million into the $1 billion which we announced in September, so that gives you the update on the stats there, Sergey.

The other thing is, as far as the share buyback going forward, it depends upon the capital and the cash which we generate.

I would expect that over the next two quarters, that we would be back in the market buying shares, yes.

Don Carson, Merrill Lynch.

Paul, a question to follow up on Electronics.

What is your latest view on square inches of silicon processing?

You've talked about foundry operating rates, I know.

And then, as you get into the current quarter now with the Korean and F3 plant about to go commercial, is that one of the reasons why you are more optimistic on the specialty materials front?

Yes.

Certainly, Don, on our expansion and F3, it gives us more product to sell and it helps us with our sales growth there.

But as far as on the square inches, we're looking about 6% right now.

So no real change there?

I think you've been talking about that for some time.

It's down a little, I think we said seven, you know.

But it's about the same, roughly.

On the Tonnage business, is your mix changing there?

Because I know you that started up a few new [doc scan] plants in Europe and in Asia, which I think would improve margins of that business.

So has there been any change in the mix between atmospheric and hydrogen, which would have a margin impact?

There have not been any large changes in the mix when you look at -- it is a large business.

About two-thirds of our sales, 70% our sales or so, are hydrogen still.

In terms of the quarter, I know that a lot of refineries were running at reduced operating rates, due to lower crack spreads.

Did that have a material impact on your business, especially when you combine it with your higher maintenance expense, or did you just take that opportunity to take more maintenance and get that behind you?

We actually took -- and we took the opportunity.

Mike Harrison, First Analysis.

As you look at the growth potential in a geography like the Middle East, looked at refineries as (technical difficulty) chemical plants, my understanding is that there, it's mostly design and engineering business, rather than Tonnage or Merchant type business.

Can you talk about how you're positioned in the Middle East relative to your competitors, and maybe what your expectations are for capturing some of that design and engineering business?

Yes, Mike.

Historically, it has been for us, and to sell equipment into there.

And we have done that; we have had a number of plants in which we've sold both on the LNG side and the air separation side.

However, in the first quarter, we (technical difficulty) two plants which went on a sale of gas on-site basis.

So (inaudible) a conversion of that.

One was in Oman, the other was in the UAE.

So we have had success there in doing some of the conversions.

But that's a challenge in the business.

Going forward here, it's something in which we're spending a lot of people's time on, trying to make that happen, because we view that there's a value proposition to be offered to the customer here and a lot of growth for us for the things which we do best.

With regard to the helium joint venture with Matheson Trigas, given the current tightness that you are seeing in the helium market, I'm curious how that new plant is progressing and whether you have any plans to accelerate, possibly, when that plant is coming onstream?

And the plant is progressing well, and the schedule which we put it on was about as an aggressive as one could get on that one, originally.

I also was hoping maybe you could give us an update on the Equipment and Energy segment, maybe where you expect earnings to come out by the end of the year.

If you look at the Equipment and Energy segment, we actually said about $0.15 to $0.20 a share down year on year was going to be the impact.

I think that is still a good forecast for us.

We are expecting orders to come in, in this year, still.

We have gotten some -- on the air separation side, as Nelson talked about.

We have some air separation orders which have come in, and so we'll be announcing them shortly and we'll also be starting to execute them and put them in our backlog and starting to book sales on them.

So that's good news.

And then we also would expect some LNG orders in the last half of this year, probably more in the fourth quarter than in the third, though.

Last question I had on the Electronics segment, you reported 11% growth in January, and then your next sales update had 8% growth.

Now, for the full quarter, you came in at 6%.

I was just wondering if you could explain maybe quite the growth there appears to be slowing during the quarter.

Is that just a function of the additional equipment sales, or -- how should I think about that?

Yes, well, and yes.

And the Equipment is lumpy, as we talked about.

But the other thing which people have to remember is we had the SKU reductions in Electronics, and those are occurring here.

However, as you can see, they are actually improving margins in that business year on year also.

And the sales -- and the growth rate is held down, but the growth in profit is a lot more, and therefore the margins continue to get a lot better in that business.

Laurence Alexander, Jefferies.

First, on specialty gas pricing, and I think this pertains mostly to Electronics but also to the Merchant business, can you discuss pricing trends, in particular, like the gasses, where you're seeing more scarcity; and not just argon, but also xenon, neon and so on?

We're clearly getting price in the products that are tight -- silane, xenon, argon, helium.

We're seeing very good price movement in those products.

In general, pricing pressure is probably -- it's still there.

It's probably less than it was a year ago.

We're managing our supplies of NF3 reasonably well, bringing capacity on very carefully.

So I think, from a trend standpoint, we're happy with where price is overall.

So if you were to aggregate that bucket, including the gasses in the Merchant side, if there are any, as well as in the Electronics, how large a bucket would that be as a percentage of sales?

Help me on the question again.

If you have a more favorable supply-demand dynamic on the more niche specialty gases -- so the helium, xenon, neon, silane -- put them all as a bucket.

How large is that?

I would say that that roughly is probably 15% to 20%.

In Performance Materials, can you help us quantify the percentage of the Performance Materials business that goes into commercial construction?

On the commercial construction side in the US, it's about a third -- about a third of the segment is performance materials, and about a third of that is the US, and roughly about a third.

So it's a little over 10% of that segment in total.

With the equipment business -- just a follow-up on the question about the sale of the equipment in the Middle East -- are you seeing improvements in your margins on the sale of ASUs as you move --

Yes.

-- towards larger projects?

And, can you quantify that over time?

Yes, and we are seeing that.

And that has been, I think, as we've seen demand pick up for this thing, supply and demand is going to help.

As the dynamics of that get better, our markups are getting a lot better in that business also for us.

It is not to the stage of the LNG markups, but then we don't have the same amount on the value-added component.

So even if LNG were not to recover, you would still see, over time, a margin improvement in the segment?

Yes, we would.

Mike Judd, Greenwich.

Thanks for your comments about the equity affiliate income, about how it could be kind of lumpy.

I was wondering if, looking at the June quarter, do you think that it will be up or down from the March quarter?

And again, I think you talked a little bit about some of the European equity affiliate income.

Does that imply that maybe the September quarter it would be lower than June?

Or just anything you can help us, because it is lumpy.

Maybe another way of doing it is just to take an average of the December and March quarters.

But any help would be appreciated.

I think as we look forward on that, we think that -- and that it will probably be close to flat on the equity affiliate income going from the second to the third quarter.

And then it should be, probably, seasonally weaker in the September quarter?

It could be a little weaker, and because of the slowdown in the summer in Europe, which has a big -- Italy is a big portion of that.

Peter Butler, Glen Hill.

There's currently a pretty large gap to in the value of oil versus gas, but it looks like that could close pretty quickly.

I'm wondering how many potential LNG projects are you talking about, and what has been the impact on these negotiations on your new technology?

Dave, there are currently more than 12 projects which we are currently in stages of development on, as far as LNG is concerned.

And that's an improvement from -- in the prior year.

If you look at the Journal, there was actually an article on gas last week, I believe it was Friday, which painted a very good picture for LNG in the future, and when you look at that.

So there's a lot of gas around the world.

As far as the Air Products, the [apex] technology, that actually gives us an advantage.

It goes into a large field, though, so you've got to have the right field for it.

But there are a lot of fields out there which qualify for us.

So longer-term, we believe LNG is going to be a very good business for us.

On the Healthcare, not to beat the dead horse, but I would bet that Mr.

McGlade knew that this thing was a goner before he even took over as CEO.

I'm wondering, how long does it take to study the alternatives?

And if you said goodbye, what is the immediate impact on your earnings and your ROC?

As far as this business is concerned, the alternatives are a lot here.

We've got to study them, we've got to do the right thing for the investor.

That's why we're going to take a quarter to take a look at that.

We had plan, and we made some progress against that plan in the first quarter, and the progress has slowed in the second quarter.

We're not going to wait around, so I think -- and John has made the decision to move forward and to look at all the things which we can do, to do that.

The business loses money at the operating profit line first, now.

So it is a drag on earnings, and if we were to cure that, it does improve our return on capital.

It does improve our margins.

It will improve our earnings.

Is there any lesson to be learned in turning lose your Lehigh engineers, trying to turn around the Healthcare business?

In any sort of situation, you can always learn, Peter.

Kevin McCarthy, Banc of America Securities.

In the past, you've expressed some interest in consolidating some of the I guess nearly $2 billion in unconsolidated sales that you have at your various joint ventures around the world, on a 100% basis, anyway.

Now that you're reviewing Healthcare, if you look out a year or two and considered portfolio management on the buy side, how would you characterize the opportunities these days to go ahead and consummate some of those fold-in type deals, based on your discussions with folks in Mexico, Italy and elsewhere?

That is something which is out there for us.

However, it is not something which we decide.

Our partner gets to make that call on the timing.

So, as it happened in Taiwan, in Korea, the partner will give us some warning, but not a lot.

That's fine with us because we maintain the capital to do these things and the balance sheet to do these things.

But for right now, we continue to believe our partners add value.

They are good for the business, and we are happy to be in the position we're in.

Question on the Merchant business.

I understand you're implementing a new fuel surcharge for May 1.

Am I correct in understanding that that's a nominal adder, if you will?

And if that's the case, have you ever looked at moving to an index based on diesel, maybe, so that it flows through in a rolling fashion?

That's actually what we do have, Kevin.

Essentially, what we do is look at the three-quarter rolling average of diesel and set the surcharge accordingly.

Now, what we're doing now is essentially adding a new line on that because it has rolled up to a new, higher level -- roughly $0.70, $0.75 higher in the quarter.

But that's basically what we continue to do.

And then our customers can look at this.

If diesel does go down, they can see at what threshold their surcharge would come off.

Just to clarify, what would that new line be?

And has this had an impact on your margins for the last quarter or so?

It really has hasn't.

What we were trying to do it all these activities is anticipate where we think diesel is going.

So what we had in place in January pretty much did cover us in North America for the quarter, and this is basically speculating where we see diesel going.

The numbers that we look at are different than, say, what the price is at the pump.

We're purchasing it at a different price.

The intent on here is to actually keep ourselves whole on these things, and that's how we go out and talk to our customers about it.

Understood.

And then finally on the new air separation units, are Reidsville and Ashland still on track for mid-calendar '08 and late '08, respectively?

Yes, they are.

Chris Shaw, UBS.

In Tonnage, would margins have been flat or up without the increase in natural gas costs?

In Tonnage, no.

As far as for the year is concerned, they would have been down a little bit because of the expenses on bidding.

Then, you mentioned what the impact on volumes in Merchant was in North America from the lack of availability of helium and argon.

If those were to have been available, do you know what volumes would have looked like?

Nelson?

We would have seen growth there.

Those are, in the scheme of things, just portions.

The LOX/LIN drives the business there in terms of volumes.

But it would have been worth a couple of percent, probably.

And then, I think in the comments around Electronics, I think there was a mention that without equipment, it would have been up about 10% this quarter.

Then, you also said you thought it might accelerate into Q3 because of the foundry activity.

Do you expect grow faster than 10%, than, in third quarter?

Certainly, what we expect to see is growth from a sequential basis.

Year on year, we also saw a pickup in last year in that thing.

So, as far as the growth from prior year, the 10% growth is probably a good number for us.

Mark Gulley, Soleil Securities.

I'm trying to measure the degree of competitive intensity in tonnage bidding.

One of your global competitors has upped the ante in terms of going after tonnage projects.

But given the number of projects that are out there, are you noticing any sharper degree of competition for those projects amongst the three players that go after them on a sale of gas basis?

No.

It has always been intense, Mark.

Okay.

Secondly, with respect to the plants that you're going to be announcing here pretty soon, can you give us any idea of the split, hydrogen versus atmospheric ox/GAN, or maybe US versus international, just help us, prepare us for what's coming at us?

The bulk of them are hydrogen projects, and the bulk are in the US or Canada.

On the Merchant side, I know we've talked about this already with Equipment, a lot of things going on.

But can you attribute -- at least against my model, you were kind of down.

Can you attribute any of this weakness to the economy, or do you think really it's not the economy at all, given your markets?

We're still tracking in line with that IP number, industrial production number, around 2%.

The base business has grown year on year, as I said earlier, driven by LOX/LIN.

A couple things pulled us down in the quarter -- the availability of helium and argon.

Also, though, in terms of a comparison, we had very strong hydrogen spot sales last year, in the first quarter.

We did a six-week long job to support an SMR that was down, and that did help our volumes this year and that wasn't there this quarter.

I should say, it helped last year, and it wasn't there this quarter.

But in general, one of the things we keep watching is what's going on in the base business.

The base business is expanding, not at the same rate it was last year, but it is expanding, and the signings continue to be strong.

So we're happy with where we are right now.

Michael Sison, KeyBanc.

In Electronics, with the product rationalization efforts closing, I think, as I recall, by year end, to get to the 15%, what is left, just to grow into the business (multiple speakers) the margin?

No.

We continue to take actions on price, and we continue to take actions on cost reduction and saving cost.

So there are a lot of things.

We would expect to see the impact of the new materials which we've talked about also helping to grow margins in that business because they're going to come in and they're going to add a slug of growth on the business, and they're going to come in at a good margin, too.

Back to merchant real quick, you commented that a pretty good order backlog, I suppose.

Should we see the volumes in North America and Europe sort of accelerate to a degree into the second half of the year?

Yes, that's our expectation.

And, to what degree?

Does it get back to that high single-digits, mid single-digits?

Mid single is probably fair.

Then, in terms of pricing in North America, it has been pretty strong.

Are you getting any incremental margin on that, or is that just strictly to offset the higher costs?

And the answer is that on the margins, and they continue to improve, the pricing to a large extent is geared on recovering cost.

But the other thing which we continue to work on is driving our costs out of the business, our fixed costs, our SG&A cost.

And those help improve the margin.

In solar, I know it's a small business.

What's the market growing, and is this more of a Tonnage or a Merchant opportunity?

Why don't you handle that, Nelson.

What we like about the growth in solar is with the newer technology, the thin film technology, there's a much higher industrial gases intensity versus polycrystalline silicon, and what that means is really a mix of products.

It's going to be very good for industrial gases, but also specialty gases -- silane, NF3 and others -- that we actually do have a good position on products such as phosphorus oxychloride, for example, that we've been making for 15 years and requires a lot of -- it presents a lot of handling challenges.

We've been supplying it to the industry for a long time.

That appears to be one of the chemistries that will be used in greater volume.

So it's going to be very good for us across the board.

(OPERATOR INSTRUCTIONS) Bob Koort, Goldman Sachs.

I have a question, maybe it's more a theoretical one, but as we're seeing natural gas prices go north of $10, and I guess if there's convergence to oil, you could even dream up a $15 gas number.

What's the net effect?

I would think some of your customers are getting compromised by this.

On the other hand, there's probably some folks that could use guess that haven't yet.

How do you see that playing out, Paul?

The net impact of prices on the Energy side for us is positive, for us.

And so as we've said, industrial gases are used to help improve the efficiency of processes on the Energy side.

They're also used to take and substitute fuels in.

So, as you go on the environmental side and you want to go to a dirtier fuel, industrial gases have a lot of things to help use the alternate fuel.

So on the higher Energy price side, we actually see that as a positive for us.

Are there any customers that become problematic from a credit standpoint, just because at high gas or energy prices they're not making any money?

Or is that not an issue?

I don't think it's -- and it would be impossible to say none.

By I actually think that, as prices on the Energy sides rise, people are able to get those passed through the economy because people see that all over.

So it is an easier thing for people to go out and claim -- they need an increase in price on.

So what we see is that our customers are holding up well in this time period.

At this time, it appears we have no further questions.

I'll hand the conference back to management for any closing comments.

Please go to our website to access a replay of this call beginning at 2:00 PM today.

Thank you for joining us and have a nice day.

That will conclude our conference.

Again, thank you all for your participation today.

We do hope you enjoy the rest of your day.