Air Products and Chemicals Inc (APD) 2008 Q3 法說會逐字稿

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

(OPERATOR INSTRUCTIONS).

This teleconference 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 published all or a portion of the teleconference.

No other recording or redistribution of this teleconference by any other party are permitted without expressed written permission of Air Products.

Your participation indicates your agreement.

Beginning today's conference 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 third 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.

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 just turn to slide number 3.

Before we look at this quarter's results, I would like to spend a few minutes updating you on several portfolio management items.

First, as we mentioned last quarter, we were marketing our remaining emulsions properties and closed on the sale of those facilities to Ashland on June 30.

Second, we have completed the review of our strategic alternatives for our U.S.

Healthcare business.

As part of our review process we performed an asset impairment test, and have recorded a $315 million impairment charge this quarter.

We also reviewed our options for the business with our Board last week.

We have approval to sell the business, and have already started the process.

We have reached an agreement in principle to sell our business in New York and New Jersey, which represents about 10% of our U.S.

Healthcare business sales.

We expect to close on this transaction in the fourth quarter.

Regarding the remaining U.S.

business, we have solicited and received a number of indications of interest in the business.

We are currently in discussions with those potential buyers.

As a result of our Board approval, we will begin reporting the U.S.

Healthcare business in discontinued operations starting in quarter four.

We will also move the leadership of our European Healthcare business into our Merchant business, reporting it as part of that segment.

Prior to our earnings announcement for the quarter we will provide you with restated segment information.

This transaction will have a favorable impact on a number of key metrics we are working to improve.

The sale of the business should improve earnings per share from continuing operations by $0.11 in 2008.

It will also improve our return on capital employed by 30 basis points and operating margin by 70 basis points.

Excluding the U.S.

Healthcare results and our pension settlement, our year-to-date operating margin would be 14.9%.

Now let me turn to slide 4 and review the factors that affected the quarter's performance in terms of earnings per share.

Our GAAP or as reported EPS decreased 75%.

Excluding discontinued operations and the disclosed items shown at the top of this slide, adjusted EPS from continuing operations grew by $0.20, or 18%.

Higher volumes added $0.06.

Pricing and margins together, including energy and raw materials, were unfavorable, netting to $0.02.

Favorable currency and foreign exchange added $0.06.

Higher equity affiliate income contributed $0.06, as we continue to see good growth and operating performance in a number of countries.

About half of this is attributable to US GAAP adjustments made by several affiliates in Asia.

Fewer shares outstanding contributed $0.03.

All other items net contributed $0.01.

Now turning to slide number 5 for a review of this quarter's consolidated financial results from continuing operations, excluding the U.S.

Healthcare charge.

As you can see, we had another good quarter.

We have continued to make progress on our 2008 financial targets.

For the quarter sales grew 16% versus prior year.

Underlying growth, excluding Equipment and Energy was 5%, driven by better volumes in our Merchant and Electronics and Performance Materials segments, and higher pricing in Merchant Gases.

Higher natural gas and raw material pass-through contributed 7%.

Currency contributed 5%.

We continue to make progress reducing SG&A expense as a percentage of sales, and we are now at 11.4%.

Operating income of $382 million was up 9% from prior year, again, due to better volumes and pricing and also favorable currency.

Our operating margin declined 100 basis points versus last year, entirely due to the higher natural gas and raw material cost pass-through.

Lower Equipment and Energy results further reduced our margins; however, this was offset by underlying performance improvement in our Merchant, Tonnage and Electronics and Performance Materials segments.

With the improvements we are forecasting for quarter four, we are on track to achieve our operating goal of 15% for the year, excluding U.S.

Healthcare.

For the quarter our net income and our diluted earnings per share increased by 16% and 18%, respectively.

Our return on capital improved, with return on capital employed increasing to 12.5%, up 50 basis points from last year.

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

Please turn to slide 6, Merchant Gases.

Merchant Gases grew at a solid pace during the quarter.

Sales of $973 million were up 19% versus prior year.

Currency contributed 8% and volume contributed 5%.

Pricing added 4% and acquisitions 2%.

Merchant Gases' operating income of $177 million was up 20% versus prior year, and segment operating margin of 18.2% was up 20 basis points, mainly due to pricing and volume gains.

Margins were down sequentially by 30 basis points due to significantly higher energy and fuel costs in May and June.

Let me now provide a few highlights by region.

Please turn to slide 7.

In North America our sales increased 11%, driven by continued strong pricing gains and solid volume growth.

We are seeing the expected volume growth in oxygen and nitrogen versus last year, realizing the impact of new business signings from previous quarters.

Liquid nitrogen for oilfield services was also very strong in the quarter.

We are bringing on previously announced capacity at three of our facilities, and are pleased with the loading and returns on these new expansions.

Pricing continued its strong trend; however, we were not able to keep up with rising energy costs in the quarter.

In this quarter alone we saw an unprecedented 30% increase in the cost of diesel fuel.

Diesel is now up over 50% versus prior year.

We implemented another fuel surcharge on July 1, our third this year, to recover the most recent cost increases, what has been incurred since our previous surcharge implementation on May 1, 2008.

We expect this action to help drive improvement in our overall segment margins in the fourth quarter.

New business signings continued their strong pace in the quarter.

And this fiscal year will be our best ever in terms of both quantity and quality of signings.

In Europe sales increased 23% over prior year, with price added 3%, volumes 1%, currency 15%, and acquisitions 4%.

Business continued to be generally soft in the UK and Spain.

Client utilization remains high on the Continent.

Signings were strong in the quarter, especially in the UK where we have product available.

We're also beginning to see the impact of increased volumes as a result of new signings in previous quarters.

Pricing was solid.

And we are in the process of launching several actions across Europe to address rising energy costs.

In Asia Merchant sales were up 21% over last year.

Volumes contributed 15%, currency 4% and price 2%.

Similar to our other regions, on July 1 we implemented price increases in China, Taiwan, Korea, Malaysia and Indonesia to recover energy costs.

Please turn to slide 8, Tonnage Gases.

Sales of $976 million increased 26% compared to last year.

Volumes were flat versus prior year as new plant onstream were offset by lower spot sales.

Natural gas and raw material prices were higher versus prior year and added 23%, while currency added 3%.

Sequentially volumes were down 3% due to lower refinery runrates.

Operating income of $126 million was up 4% compared to last year, and 13% versus prior quarter due to improved operating efficiencies.

Operating margin of 12.9% was 260 basis points lower than last year, held down by significantly higher natural gas cost pass-through.

This impacted margins sequentially as well, though the impact was offset by performance bonuses and improved operating efficiency.

We announced two significant contract signings in the quarter with U.S Steel at Nanticoke, Ontario, Canada and Total at Port Arthur, Texas.

New business activity continues at a solid pace, and we expect to announce additional signed agreements in the near future.

Please turn to slide 9, Electronics and Performance Materials.

Segment sales of $580 million were up 9% compared to last year.

Volumes were up 6%, pricing 1% and currency contributed 2%.

Electronic sales were up 5% compared to last year, driven by higher sales in specialty materials and tonnage, and offset by lower equipment sales and a SKU reduction effort.

Excluding equipment and the SKU reduction effort, sales increased 20%.

Electronic sales were down 1% sequentially due to lower equipment sales.

Ex equipment, sales increased 4%.

In performance materials overall volumes grew 5% versus prior year and 7% sequentially.

Continued weakness in North America was more than offset by strong sales to Asian customers.

Overall operating income of $70 million was up 13% versus prior year.

Operating margin of 12.1% was up 40 basis points versus prior year.

We expect to see continued margin improvement in the current quarter as the cost to support the SKU reduction efforts will be largely behind us, and the full benefits of the restructuring effort will begin to take hold.

While capital spending in the semiconductor industry has slowed as expected in 2008, we were successful in winning two fab awards in Asia during the quarter.

Bid activity has also began to pick up.

Activity level in the photovoltaic area continues to be very high as well.

Please turn to slide 10, Equipment and Energy.

Sales of $107 million in this segment decreased due to lower LNG activity.

Operating income of $4 million decreased versus prior year and prior quarter.

Our backlog of projects now totals $228 million.

We signed agreements for two large air separation units in the quarter, which have been added to the backlog.

Please turn to slide 11, Healthcare.

Healthcare segment sales of $172 million were up 9% compared to prior year, due primarily to currency.

Sequentially sales were up 1%, reflecting continued solid results in Europe.

Excluding the impairment charge, operating income of $13 million was up 54% versus prior year on higher European results and currency.

Operating margins were at 7.6%, improving 220 basis points versus prior year.

Our margins improved 210 basis points sequentially due to strong performance in Europe.

Now I will turn the call back over to Paul.

Now if you will turn to slide 12.

Now let's take a look at our guidance.

As I mentioned earlier, we will be moving the U.S.

Healthcare business to discontinued operations in quarter four.

On a continuing operations basis this will add $0.07 to 2007 and $0.11 to our 2008 guidance.

Therefore, the equivalent range to our 2008 $4.95 to $5.05 guidance would now be $5.06 to $5.16.

Based upon the third quarter improvement and a strong outlook for quarter four we are raising this range $0.10 on the bottom and $0.05 on the top to $5.16 to $5.21.

And now expect to deliver 21% to 22% growth in 2008 versus last year.

Year-to-date ex U.S.

Healthcare and the pension settlement charge, we have earnings per share from continuing operations of $3.79.

This gives us fourth quarter guidance of $1.37 to $1.42.

Turning to slide number 13.

As we look forward from quarter 3 to quarter four we see the following.

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

In Merchant Gases we continue to implement price increases and fuel-based surcharges to recover escalating energy costs.

In Tonnage Gases we expect higher operating performance bonuses and lower maintenance spending in quarter four.

In Electronics and Performance Materials we anticipate higher electronics specialty materials volumes and lower costs, partially due to our productline rationalization efforts.

Finally, we expect to book a quarter four effective tax rate of approximately 24% as a result of continuing benefits from our tax planning strategies.

Slightly offsetting these sequential improvements is our forecast for lower equity affiliates income due to onetime favorable adjustments in this quarter.

On the economic front globally, the outlook has turned more pessimistic over the past three months.

The credit crisis continues to spread, consumer confidence has dropped, and inflation concerns are rising with higher energy and commodity prices.

Fortunately, growth in manufacturing exports continues in the US.

And am generally pleased with our volume growth and the new business signings broadly.

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

Turning to slide 14.

We are currently developing our plans for the next three years, and we are excited by the opportunities we see going forward.

As Nelson said in his business commentary, we continue to see strong bid activity in Tonnage Gases, as well hydrogen for refining and oxygen for gasification continue to grow.

To get an accurate look at our capital spending, you do have to make one adjustment.

A few years ago there was an accounting change that moved the one-on-one on-site to capital lease treatment.

Previously this was shown in property, plant and equipment capital spending.

You can see this as a use of cash under our operating cash flows in the line item, non-current capital lease receivables.

Therefore, you need to add this to our property, plant and equipment capital line.

When you do, you see our capital spending is about $1.4 billion for 2008.

About 40% of this is for long-term on-site and pipeline contracts.

In fiscal 2007 the equivalent spending was $1.1 billion, and 40% was for on-site contracts.

Looking forward to fiscal 2009 we expect that capital spending under the same method will rise to $1.7 billion to $2 billion level.

And approximately 50% of this will be in the on-site area.

As a rule of thumb you can translate the amount of sales produced by each dollar of capital in the on-site and Merchant areas by 70%.

What this says is that the same demand factors we have discussed with you in the past year are delivering significant growth opportunities as we expected.

These factors are higher energy prices and demand, higher capital costs and stricter environmental regs.

This results in more of our business moving to long-term, take-or-pay contracts, reducing our cyclicality and providing greater consistency in our cash flows.

Turning to slide 15.

While we're not done with our 2009 forecast, I can share with you what we are seeing.

For our Merchant, Tonnage and Electronics and Performance Materials segments we expect to see underlying sales growth from volume and price of about 6% to 7%.

This excludes any changes due to currency or energy and raw material pass-through.

This is slightly below our longer-term forecast due to the current manufacturing environment we are seeing around the world.

In 2009 we would expect our Equipment and Energy segment to be about even with 2008 as the impact of new orders offset the projects completed this year.

Our top priority continues to be to improve our returns by making progress towards our 17% margin goal for 2010.

Our efforts are focused on achieving productivity through the full year benefit of the productline rationalization effort in electronics and the elimination of the restructuring costs we have carried in this area.

Continued transactional cost reductions by using shared services and SAP globally.

Continued benefits from making the right decisions on how to source products, run our plants and price our products, driven by the business information we get from SAP.

And in a higher energy price world, many improvements that we have identified in the past now look even more promising.

We're taking action and turning them into cost savings.

We will have more specific guidance at the year-end call in October.

Right now 2009 is shaping up to be another solid year of earnings growth driven by both volume and productivity gains.

Growth in 2010 and 20011 also look strong.

As we have said before, we have very good visibility into our business because of the long-term contract nature of much of the business.

For those years we are seeing even stronger growth as the impact of increasing capital spending comes onstream and starts generating revenues and profits.

Finally, you can see the changes we have made over the past few years are delivering consistent, strong growth in revenue, income and returns.

We remain committed as a team to continue taking advantage of the excellent market opportunities we have to continue this growth and deliver increased shareholder value.

Thank you.

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

(OPERATOR INSTRUCTIONS).

Dave Begleiter, Deutsche Bank.

On the CapEx outlook, what are the return on capital metrics of the backlog right now?

If you look at the return on capital, it is above -- and the returns which we have experienced in our existing business, we are probably seeing our returns going up over time.

It is hard to give an average, because it is a mix of risk there, and we look at the projects individually.

But I can assure you that we are exceeding our return on capital from a cash flow standpoint by a very good margin.

Any reason why the CapEx would be down in 2010, given the strength of the backlog?

No, no.

To be specific about that I think, as we look at 2009, we look at CapEx growing.

And given the bidding activity which we have today, and the projects which we are working on, we would expect our CapEx to grow into 2010 and 2011, primarily driven by on-site contracts, hydrogen and gasification.

On the on-site projects, the ones you aggressively bid for, what is your win rate?

It is hard to actually get at a win rate because these are large deals, but I think we feel very good about our win rate on here.

I don't really keep track of a batting average per se in that area for us.

A lot of the jobs, which we're getting now, and we really aren't bidding.

A lot of them sit on our pipeline systems or sit with existing customers who we have built a relationship with.

So it is a deal for us, in which they aren't going out and getting some bids on.

Jeff Zekauskas, JP Morgan.

A couple of things.

The equity income went from I think $35.5 million last year to $46.5 million, so it was up 30%.

Your operating profits I think were up 8.

So what is the difference?

What is going on in equity income that is so strong?

The first thing in which we said with you is about half of that gain is due to some adjustments for converting to GAAP in our Asian affiliates, US GAAP as they made adjustments over the period of time.

We have consolidated that now and taken a look at those things.

If you then look at the other things, and you have to look at the underlying economies in which these are.

Our Mexican affiliate is getting very strong growth in volumes, principally due to a lot of the things on oil recovery.

We continue to grow in India.

We continue to grow in Italy.

So it is just -- it is the underlying growth in those areas.

I take it that is about $0.03 a share, that benefit?

The benefit from the equity affiliates in total?

Yes.

Yes.

Secondly, can you just remind me like what your output in standard cubic feet is in hydrogen?

And when you look at the new business you are bringing on for '09, how much does that grow -- and for 2010, when you're just talking about new capacity you're bringing on?

When you look at the new capacity, which we are bringing on in '09 in hydrogen, in '09 it is not substantial for us, as we look at that right now.

We have -- most of the new capacity, which we have won in hydrogen, comes onstream in 2010, 2011 for us.

If you look at the annual sales of the on-site business is about at the runrate today and the current hydrogen prices it is about $4 billion.

About 75% or so of that, 80% of that is hydrogen for us.

P.J.

Juvekar, Citigroup.

You guys did a big U-turn in Healthcare.

If you're trying to make earnings less cyclical and increase return on capital, then by the same logic why wouldn't you sell your equipment business?

If you look at -- if you take a look at the equipment business, it is something which we have, which actually supports the on-site business.

We have been through this probably a lot of times with people, is that it leads to orders in the future for us.

So a lot of the work which we have done in the equipment business to sell large air separation plants has actually led us to have the right solutions in the gasification end of projects.

Which we're doing very well at.

We've got a number projects in China, which we are working on in our backlog right now.

So that does support it.

The other thing is the LNG business it helps us in our presence in the Middle East, as does the oxygen plant cell business, which we have there.

A lot of this really is a support business in the on-site area, and has performed very well for us.

So it is part of that business.

It doesn't really put a lot of cyclicality into it.

It doesn't take a lot of capital for it.

It is not something which I would like to sell to somebody and put somebody else in the business of this.

I understand the ASU business, but the LNG business is cyclical.

(multiple speakers).

The LNG business is.

Absolutely.

It does go up and down.

It doesn't require a lot of investment for us.

We actually think that Air Products is the high-value owner for this business.

We think the skills which we have built up, and we don't think we can get the same value out of it from somebody else.

I am not saying you should sell it, I just wanted to understand your logic.

I understand.

Okay.

That is fine.

The second question I have is on operating margins and our operating margin goals.

Are you focusing on the right things?

Because with this natural gas raw material pass-through these operating margins are becoming quite volatile, and it is very difficult to track them against the goals.

You are right if you take a look at the on-site business in the Tonnage Gas business, as you saw this quarter, and the margins were taken down by that.

However, if you look at the electronics business, the performance materials business, the Merchant Gases business, all those are businesses in which we have established targets for margin.

We have an overall target, but I think more importantly we have targets for each of those areas.

And that is to get the Electronics and Performance Materials business above 15, to get the Merchant Gases business about 17.

If the pass-throughs -- and prevent some improvement on the Tonnage side, as long as I'm looking and getting a good return, I'm going to be happy with that business.

So I think we're focused right.

I know we're focused right on this here -- on the right metrics for how we're measuring it going after this business.

I have a follow-up question.

Just a quick question on gasification.

I've just got to correct.

I made a mistake.

I said on the Merchant Gas business we've got to get that about 20%.

I think I said 17%.

That was an error on my part.

In your answer to Jeff Zekauskas' questions about this equity income, you said there was a conversion of some of this equity income to US GAAP.

Does that mean it was not recorded under US GAAP before?

(multiple speakers).

It was reported under GAAP before, but what happens here is that the conversions were down done in the country.

And we took the work back here and we looked and made adjustments as to how they did the conversions.

And the conversions were wrong.

Was there a catch-up benefit in the quarter -- this quarter (multiple speakers)?

Yes, there was.

That was about half of the increase.

Mike Harrison, First Analysis.

It is my understanding that one of your competitors recently raised pricing in Europe.

I was wondering if you could talk about the impact that you have seen as a result of that on the pricing environment in Europe?

Yes.

And the pricing environment in Europe is getting better, as we have talked about that.

We are out there trying to get our prices up in that area.

You can see in this quarter on, I think it is slide 7, that our prices were up 3% quarter three '08 over '07.

And then I was wondering if you could give us an update on the Eastman gasification project.

Is construction there still planned to begin in early '09 or have there been any changes there?

On the project I think you are best to talk to Eastman.

And they are the person who is actually controlling it, and we're -- both the customer of the project and the supplier.

We're excited to be in it.

We see it as a great opportunity for us.

But I don't want to comment on my customer's project for you.

Then in the Merchant business you were talking about the two fuel surcharges you put in place.

Can you walk through how those work?

And as you see diesel prices rising, what assumptions had you been making about fuel costs?

And has the surcharge been something that is static or is it something that changes with changes in fuel costs?

This is Nelson.

I will comment on that.

It is indexed to basically published information on diesel fuel cost index.

Both the government and Air Products do forecasts going forward.

Clearly the run-up that we saw in the last quarter, we talked about the 30% jump.

We talked about it in May and June, and you could really see it happened over about a four to six week period.

Clearly it got out in front of us from that standpoint.

We were pretty comfortable with what we had out there in May versus forecast.

What we have done with the July action is increased the amount required to not only catch up, but also get ahead of whatever forecast is out there.

Then this surcharge will basically if diesel prices fall down.

And we typically use a three quarter rolling average.

Why we like this mechanism is that our contracts allow us the surcharge.

And so this is something that we can implement very rapidly and get that in place pretty quickly so it can have a fairly quick impact on the P&L.

Laurence Alexander, Jefferies.

First of all, on the Tonnage, what was the incremental margin on the spot sales?

How much of a delta should we think about in Q4 versus Q3?

The margin on the spot sales, if you look at that, really depends upon what the price it was for gas there.

But I think you can look at spot sales margins incrementally, and not being costed on the overhead activities, of somewhere in the 20% range or so.

Do you had a rough sense for -- you have gotten done a good job on taxes this year -- do you have a rough sense for whether the tax rate is sustainable next year or should we expect it to creep higher?

Right now I would expect it to be up 1% or 2% over the 25%, which I'm going to book overall in this year.

But that is something which we are currently taking a look at.

It depends a lot of decisions on how we manage our cash and fund things.

But we obviously try to keep this as low as possible and pay as few taxes as we are required to.

Then net accretion on Healthcare is $0.11 for this year.

That is about $0.09 in the first three quarters?

It is about $0.08 in the first three quarters.

Just lastly, this has been an unusual quarter in having pricing lagging, energy costs.

Is there anything -- is there a mix issue embedded in that or are there particular end markets where you have had an issue, or is it across the board?

No.

What happened was that the diesel cost went up a lot more than what we anticipated.

And we have taken the action to get the price increases out there.

But that was simply the fact that we didn't see -- and there wasn't anyone who saw the amount of increase in the diesel cost which occurred in May and June.

Don Carson, Merrill Lynch.

A question on the Tonnage business.

You talked about a volume slowdown due to lower refinery utilization rates.

A question there is that specific to some of your customers?

I would have thought that those who are switching over to greater distillate production would have required even more hydrogen.

Then I know you have three projects that you have signed but haven't announced.

And you've got some potential in the oil sands.

Again, what would be the volume impact from these project as they start up in 2010/2011?

What percentage of your existing business would they be?

If you take a look on the customers, yes, up it was specific to a few of our customers in the Tonnage area for hydrogen.

And it was around how the refining was running, whether the refinery was up or down.

We don't think there is anything long-term.

Overall we think the dynamics here are for the refiners to require a lot more hydrogen in the future to make more transportation fuels and to also process heavier and more sour crudes.

If you take a look at the projects in which we have -- and the three projects and the work which we are doing in the oil sands, I think what we're looking at is sales growth.

It is going to be lumpy, obviously, with the project, but if you looked over a period time something in the 15% to 20% range for us is what we're predicting.

Nelson, a follow-up on Merchant.

You talked about some capacity additions in the US.

You are still seeing volume growth.

What are your operating rate trends there?

And if you could also tell us what operating rates are doing in Europe?

US operating rates are holding pretty steady.

We're consuming this product that we are bringing onstream.

If anything, we probably saw a slight tick up quarter to quarter in utilization, even with capacity coming onstream.

As we have said before, we were careful in where we placed this product.

These expansions and the demand has come in as expected.

So that continues to work pretty well for us.

In Europe, clearly, the UK is light from a loading prospective.

As we made the comment in the commentary, we are happy to see some of our signing rates picking up.

And the new customers that have come onstream, specifically in the UK, have helped us load those plants.

Volumes or capacity is pretty tight.

It remains tight on the Continent.

We're not seeing any slippage in utilization rates.

And our Eastern Europe plants are still very tight.

As you know, we're adding some capacity in Poland to address that.

So it still remains pretty tight across the system, which should continue to support our pricing efforts.

By tight, you meant in the US you are still sort of in the mid to upper 80s?

Yes, upper 80s.

Mark Gulley, Soleil Securities.

I want to talk a little bit about the CapEx to sales.

If I do the math it would appears if for next year your CapEx to sales on an adjusted basis is going to be in that 15% area, well above the 10% where you have been running -- and the industry had been running for a while.

And a lot closer to the bad old 20% then I would care to remember.

Is that 15% CapEx a sales number that is going to be something sustained for a while, and are you concerned about a capacity surge here?

I do believe that that -- and the number is going to sustain going out in the future.

I'm not concerned about the capacity coming onstream because this CapEx is sold as we're bringing it onstream.

It is in the Tonnage Gas area, principally for hydrogen and refining, and oxygen for gasification, are the two areas in which we look at.

It is not like the old days, in which a lot of plant and equipment was going in the liquid plant area.

Fair enough.

The industry has been very successful in getting price increases and surcharges for some time now.

Are you starting see any kind of pushback at all and customers saying enough is enough that we really can't absorb these higher costs?

Nelson responding to that.

We have not seem the pushback.

What we have talked about in previous calls is that our customers have been more successful in the last two or three years or four years of passing these increases on to their customers.

And that trend certainly is continuing.

Again, with our third surcharge of the year our customers understand why we're doing it.

They are seeing those prices themselves.

So we continue to be successful in getting those out there.

A final question is, one of your competitors has announced another share repurchase program as they look at their balance sheet.

I know you haven't talked a lot about F'09 yet, but Paul can you share with us whether or not surplus free cash flow could be used to buy even more stock for Air Products?

The answer is yes.

And I had been through -- and the way in which we are going to use our cash, and we still have about $840 million of authority from our Board on that, and we would use it in that way.

Kevin McCarthy, Banc of America Securities.

If I look at the equipment and energy business, it looks like your backlog improved sequentially there.

You have some new ASU equipment orders.

Profit was down quite a bit in the quarter.

If you look at that $4 million operating income number, how does that compare to what you would envision as a cyclic trough level in that business?

I am trying to gauge how close we might be to the cyclical bottom there.

I think we are close to the bottom there.

You would expect that business to remain in the black through the bottom?

Yes.

To follow-up on Tonnage a little bit, you referenced lower spot sales.

Could you advise what percentage of sales in that business are spot?

And whether or not you are seeing customers that are off-line completely because of operating problems, or is it a situation where you are saying folks throttle back due to poor spreads?

With regards to the percentage of sales and what you have, if you take a look at the pipeline systems which we operate, somewhere between 10% and 15% of the systems are available for spot in general.

So that would be the way in which I would look at that.

As far as on the customers coming [out], there were some turns which customers had, and there are also decisions on the customers' part to operate and cut back.

So we saw both of those things.

And then finally, can you give us an updated timeline on your ASU starts at Reidsville and Ashland?

I was expecting Reidsville to come up fairly soon here.

Reidsville is onstream.

Ashland will be up very soon, like within the next 30 days.

Mike Sison, KeyBanc.

When you take a look at that 15% goal that you had thought for the total Company for operating margins, are you on track there for Merchant Gases and Electronics and Performance Materials this year?

Yes, we are.

As far as the progress, yes.

Then when you think about your electronics business, I thought I heard you say that it was growing 20% excluding equipment.

Yes.

Is that runrate sustainable?

Can you give us a little bit of an idea where the wins or where the growth is coming from there?

Certainly.

This is Nelson.

Materials growth is very strong.

So that number was ex equipment and ex the SKU reduction effort -- the 20%.

Continuing to see good volume growth in products like NF3 and the other key products that we're selling.

Our ACT productline continues to perform pretty well.

That is all in the fact of silicon that is growing probably a little light than last year, probably in the 5%, 6% versus a full year 7%.

So we are getting a multiple on the silicon growth, as we expected.

Our prospects as we see things, flat-panel has also been a bit better than expected this year.

We expect that to basically continue.

Silicon growth appears to be solid.

So that looks like it will continue.

The other part of this is we are bringing the new NF3 capacity on as we speak in Korea.

And we expect that to be largely loaded fairly quickly.

Behind that is, again, some new low-k products, which are picking up momentum in sales.

We think we're going to continue in a solid growth pattern there.

Then when you take a look at the European Healthcare business, can you just remind us why you think that business is a good business to keep?

When you put it into Merchant will it depress margins, help margins, margins about the same?

It is going to help the margins in the merchant area as it goes in.

You can see the math from the stuff which we have put out there.

But overall, the structure of the market is not the same as in the US.

The bulk of the business which we have in Europe is bid.

And you get it, and you get the business, and you are able to serve it.

That is not the same thing as what occurs here in the market here.

One last quick question.

You seemed a low bit more pessimistic in the overall global economy.

Can you just give us a little bit of -- at least a little more pessimistic than what you thought in April and May.

Can you just give us an idea of maybe regionally or if there any certain end markets there that are causing you to be a little bit more watchful in terms of the economy?

It is not so much driven on the end markets, it is more driven by the factories in that we continue to see the banks having trouble.

So we continue to see that happen.

We see a drop in consumer confidence which is going to -- it has to reflect itself back.

We actually think consumer confidence is too low for how the economy is actually working.

And probably the bad news which comes over on the news on TV every night, it weighs upon people and they hear it too much.

But there are a lot of good things in the economy too.

If you look at the underlying -- the strength, especially in the US of exports has really buoyed the manufacturing economy here.

It is a balanced look on those things.

Overall we think the manufacturing sector is actually performing the best of anybody in our area.

And we're feeling pretty good.

Chris Shaw, UBS.

To beat this spot sales for us to death, from what you described, is the reduction in spot sales a reflection of refinery usage rates as well, utilization rates?

Yes.

Then most everything has been covered.

But what was the accretion from the -- or the impact of investing in U.S.

Healthcare for the quarter?

$0.03 it will be when you look at it.

Marybeth Connolly, Goldman Sachs.

It is Bob Koort.

Just a quick question on Healthcare, and I'm sure you'll be glad to stop talking about it soon.

But why the magnitude of the write-off?

And then why sell it piecemeal instead of trying to package it?

I thought, at least the strategy when you guys owned it, was getting critical mass to provide some synergy.

As far as the size of the charge, it is based upon an impairment analysis of trying to take a look at the cash flows of the business.

And that is what it comes out to be.

Our view of the business and based upon the things which we are seeing today and what is has happened in the marketplace, it is a lot worse than it was a year ago.

That is why the size of the charge.

As far as trying to go out and sell the thing in pieces, we're not.

We're actually trying to -- we're going to market with the thing as a whole.

The New York and New Jersey properties came as an opportunity for us.

That business actually it was in a very bad place for us as far as from a cash standpoint.

We had an opportunity from a local guy who wanted that business and we chose to sell it.

Sergey Vasnetsov, Lehman Brothers.

Can you help us understand how much of a factor was the escalation of the construction costs?

And by this I mean total construction costs, labor, materials, etc.

If you have the numbers handy maybe from 2005 to 2008, or maybe you had even any old numbers.

The impact of construction costs on capital spending?

Correct.

If we take a look at that and go from 2000 -- and let's say 2003, 2004 before the commodity prices started to run up, it depends upon the area of the country.

But we could see capital cost being up anywhere from 25% to 50%.

When you sign your new contracts nowadays do you try to achieve a certain profit per tonnage of output, or you are taking into account higher current construction costs and that becomes your base factor?

We price based upon -- and the cost of the capital layer.

So what we're doing is recovering on the cost of capital there.

And so it is not based upon the output, it is based upon the cost which we're going to have to invest in there.

Lastly, on this topic, when we think about you move from $1.4 billion in '08 to let's say $1.8 billion in '09, how much of this increase is due to the high construction costs?

From '08 to '09 it is not a lot probably.

So it is mostly volume change then?

10, maybe 5, 10.

So it is mostly volume driven, yes.

Yes, a lot of that -- a lot of the inflation on the construction costs has already occurred for those things.

The other thing, and we're taking a different look as far -- on the risk of these projects.

We're trying to pass a lot more of that risk on to our customers here.

John McNulty, Credit Suisse.

Just two quick questions.

In the Merchant CapEx that you're going to be spending can you give us a rough idea of regionally where that CapEx is going to be spent for the Merchant capacity coming on in '09?

The bulk of that is being spent in Asia.

It has to do with capacity for Electronics and Performance Materials, which a lot of that is in Asia.

Then that a lot of our expansion on the liquid products is Asia also -- and the bulk of that.

That's helpful.

In the materials -- or the performance materials business with volumes up 5%, can you give us some help in understanding where that is actually coming from?

I thought this business was mostly inks and coatings related, which certainly wouldn't be an up 5% type number.

The bulk of this is Asia.

And it is driven by a lot of -- and good demand in the epoxy, which goes around the infrastructure improvements being made in Asia.

Hassan Ahmed, HSBC.

Clearly a fair bit of chemical and general process industry activity in the Middle East.

Could you guys just give me your view of the lay of the land out there, essentially in terms of future gases growth?

And maybe also elaborate on essentially Air Products' strategy to win incremental business in the region?

The Middle East is a market, which Air Products has worked in for a while.

We actually have two plants which will be coming on later in the year, which are sell of gas JVs in that area.

As far as -- and the market for gases in that area has principally been sales equipment.

We're trying to convert that to a sell of gas market for oxygen, nitrogen and hydrogen.

We're working very hard at that.

We think we're going be a success in that area, and we're excited by that opportunity.

So you think the prudent strategy is that sell of equipment leads to sell of gases there?

And there will be a move towards let's say outsourcing on the part of the Middle Eastern companies?

Yes.

Outsourcing in terms of gases?

Yes.

Edward Yang, Oppenheimer.

Just on NF3, what was the growth in volumes and pricing this quarter and also in the prior quarter?

If we look at that on the NF3, I have to check here.

Hold on for a second.

I will pull a number here as far as NF3.

I don't have the individual product volumes brought in front of me.

But if we look at that the pricing and volume basically were an offset over the whole spec materials area.

We're up versus about 17% in volume in that area in the quarter over the prior year right now.

I just got the number.

The second quarter it was faster or slower?

It is about flat with Q2.

On Merchant in Europe, again, the improvement in volumes there was that driven by England, Spain or Germany?

It was driven by probably the UK because that is the area in which we have the capacity sale.

In the other countries I'm sold out.

Thank you.

At this time I would like to turn it back over to you for any additional or closing 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.

Thank you, that does conclude today's conference.

Thank you for your participation.

And have a great day.