Air Products and Chemicals Inc (APD) 2009 Q2 法說會逐字稿

Good morning, and welcome to Air Products and Chemicals second quarter 2009 earnings results conference call.

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

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

Air Products will be recording this teleconference and may publish all or a portion of the teleconference.

No other recording or redistribution of this telephone conference by any other party are permitted, without the expressed written permission of Air Products.

Your participation indicates your agreement.

Beginning today's call is Mr.

Nelson Squires, Director of Investor Relations.

Mr.

Squires, you may begin.

Thank you, Jenny.

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

This is Nelson Squires.

Today CFO, Paul Huck, and I will review our fiscal 2009 second quarter results and outlook.

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 2:00 p.m.

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.

Before we start, please note that today's comments on operating results will exclude last year's $26 million, or $0.08 per share pension settlement charge.

Details are included in the notes to the earnings release, and our Appendix slides.

Now, I will turn the call over to Paul.

Thanks, Nelson.

Good morning, and thank you for joining us today.

Now please turn to slide number 3.

As we indicated back in January, weak business conditions around the world have created a challenging business environment across our end markets.

As we expected, volumes were down significantly this quarter, as many customers ran at much lower operating rates.

On a positive note, our volume trends did improve as the quarter progressed.

Sales of $2 billion declined 11% versus prior year, excluding currency and natural gas pass-through impacts.

Underlying the business was off primarily due to lower volumes in our Electronics & Performance Materials segment, and to a lesser extent, our Tonnage Gases segment.

Volumes were lower in Merchant Gases, but this decline was mostly offset by higher pricing.

Sequentially, underlying business was down 4% on lower volumes across all segments, except Equipment & Energy.

Nelson will walk you through the details by segment momentarily.

Consolidated operating income declined by 31%, driven primarily by the lower volumes and unfavorable currency.

Our operating margin declined 140 basis points versus last year, primarily due to lower volumes, partially offset by higher prices and lower costs.

Lower costs increased operating margin by 20 basis points sequentially, even with the lower volumes.

Despite lower than forecasted volumes, cost reductions moved earnings to the high side of the range, and earnings beat expectations.

Our cost reduction actions are having an impact.

For the quarter versus prior year, our net income and diluted earnings per share, decreased by 31% and 29% respectively.

Return on capital employed fell to 11.7%.

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

There were two items of note.

In Discontinued Operations, we recognized a tax benefit related to the previously recorded healthcare impairment charge.

This tax benefit added $0.08 per share in Discontinued Operations.

And we had a pension settlement charge in the prior year that Nelson mentioned earlier.

Excluding the Discontinued Operations and the prior year pension settlement charge, our adjusted EPS from Continuing Operations decreased $0.37 versus last year.

Lower volumes accounted for $0.52 of the year-on-year decline.

Pricing and energy and raw materials together were favorable, adding $0.13.

Lower costs contributed an additional $0.12.

The unfavorable impact to operating income from currency translation and foreign exchange was $0.11.

Equity affiliate income declined $0.05, mainly due to the reversal of a fine in the prior year results, and unfavorable currency impacts.

In our Merchant segment joint ventures volume overall were about flat, with strength from LIN injection in Mexico, offset by weakness in other countries.

Lower interest expense, due mainly to lower rates and fewer shares outstanding each contributed $0.03.

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

Nelson?

Thanks, Paul.

Please turn to slide 5, Merchant Gases.

Merchant Gases posted sales of $870 million, down 14% versus prior year.

Currency reduced sales by 12%.

Underlying sales only declined 2%, with volumes down 8%, and pricing adding 6%.

Sequentially, Merchant Gases sales decreased 6%.

Volumes were down 5% versus Q1.

Pricing was up 1%, and currency reduced sales by 2%.

Volume declines versus prior year and prior quarter reflect the downturn in global manufacturing, a carry-over of shutdowns from December, and the Lunar New Year impact in Asia.

Volumes were weakest in January, with some improvement in both February and March.

System loadings for the quarter were in the low 70s.

Despite this drop in loadings, pricing was flat sequentially, and up versus prior year.

Merchant Gases operating income of $156 million was down 17% versus prior year.

Segment operating margin of 17.9% was down versus prior year and sequentially, due to lower volumes, and reduced system loading.

Margins benefited from improved cost performance.

Let me now provide a few comments by region.

Please turn to slide 6.

In North America, sales fell 10% versus prior year, driven by a very slow manufacturing climate.

Volumes were down 15% versus prior year, and price added 5%.

Volumes were especially impacted by lower argon, liquid hydrogen, and distributor sales.

New business signings were slightly ahead of Q1, but below prior year.

In Europe, sales decreased 18% versus prior year, mainly due to currency.

Underlying sales only declined 1%, with volumes down 7%, and pricing adding 6%.

Similar to North America, we saw weak demand across most end markets and regions in Europe.

Pricing remained solid in the quarter, in both our liquid bulk and packaged gas businesses.

Signings in Europe were below Q1 levels, but remained ahead of plan.

In Asia, Merchant sales were down 17% versus last year, with currency reducing sales by 10%.

Underlying sales declined 7%, with volumes down 12%, and prices up 5%.

Volumes were impacted by significantly lower demand from electronics customers, as well as the overall manufacturing slowdown in Asia.

Signings were lower than in Q1.

Please turn to slide 7, Tonnage Gases.

Sales of $625 million decreased 28% compared to last year.

Natural gas and raw material pass-through decreased sales by 15%.

Currency reduced sales by an additional 6%, and volumes were off 7%.

Hydrogen volumes were up 6% versus prior year.

Increased refinery hydrogen demand was partially offset by declines in sales to steel and chemical customers.

Sequentially, sales were down 16%, mainly due to lower natural gas and raw material pass-through, which reduced sales by 14%.

Operating income of $98 million was down 12% compared to last year, and 10% versus last quarter.

The year-on-year and sequential declines were due to lower steel and chemical customer operating rates, and a stronger dollar.

Operating margin of 15.7% increased versus last year and sequentially, due to lower natural gas and raw material pass-through.

We announced our hydrogen contract with Marathon Detroit last night, and our key projects are proceeding in-line with expectations.

Please turn to slide 8, Electronics & Performance Materials.

Segment sales of $332 million were down 41% compared to last year.

Volumes reduced sales by 38%, and currency reduced sales by 3%.

Electronic sales were down 47% compared to last year and 21% sequentially, worse than forecast.

This reflected the dramatic global downturn in semiconductor and flat panel capacity utilization, that continued to decline this quarter.

Specialty Material sales were down 50%.

Equipment sales were down 74% versus prior year, while costs in this business were significantly reduced, the collapse in Electronics Materials demand was responsible for the overall segment losses in the quarter.

In Performance Materials, volumes declined 31% versus last year, and 12% sequentially, reflecting weakened demand in our end markets.

Asia continued to be the weakest region, followed by Europe and North America.

Despite this significant drop in volumes, Performance Materials was profitable this quarter, and is forecasting steady improvement going forward.

We now expect millions of square inches of silicon processed to be down about 35% in our fiscal 2009, versus our January prediction of about 20%.

TFT-LCD production is expected to be down about 20% during this same period.

And finally, industry CapEx is now expected to be down approximately 50% versus prior year.

While we believe the worst is behind us, we now anticipate a slower recovery in our Electronics businesses than we did last quarter, based upon customers' projections.

That being said, we are encouraged by the growing number of photovoltaic opportunities that we have signed over the last few quarters.

Please turn to slide 9, Equipment & Energy.

Sales of $128 million increased 22% compared to last year, due to increased large air separation unit activity.

Operating income of $16 million increased due to improved cost performance.

We did add one LNG heat exchanger order to our backlog this quarter.

Our backlog in this segment now totals $281 million.

We are in the final stages of commissioning the first APX exchanger, in support of Qatartgas 2, and we expect to see a new order for an LNG heat exchanger this year.

Now I will turn the call back over to Paul.

Thanks, Nelson.

Now if you will please turn to slide 10.

I would like to share our outlook for the second half of fiscal 2009.

We saw significant deterioration in the economy during the first half of fiscal 2009.

And our outlook for the second half of the year is now for a slower recovery than we had previously anticipated.

We expect the global manufacturing contraction to persist through the end of our fiscal year in September.

However, we are hopeful we have reached the bottom, and that we will see modest sequential gains in both the US and Asia, excluding Japan, in our second half.

Specifically for our businesses, we are forecasting slightly higher sequential volumes in Electronics & Performance Materials, and in Merchant Gases.

We expect the steel and chemical portions of the Tonnage Gases segment will remain weak, with the refinery hydrogen volumes remaining at current levels.

On the cost side, we should see additional benefits from our cost reduction actions.

Our guidance for quarter 3 is for earnings per share of $0.93 to $1.02.

As we look at the balance of 2009, we continue to be faced with an uncertain economic environment.

Here is our current view on the global economy and our key markets for fiscal 2009.

Overall, we now expect manufacturing to decline globally by 9% to 10%, much greater than the 4% to 5% we spoke to you about last quarter.

Regionally, we are forecasting declines of 10% in the US, 11% in Europe, and about 3% in Asia excluding Japan.

Specifically by market, we expect the following.

Refinery hydrogen demand should hold up well, even with the drop in demand for transportation fuels, as the refineries that use large quantities of hydrogen have the best cash margins, and will continue to operate.

In Electronics, we do expect the market recovery will be slower than previously anticipated.

But fiscal quarter 2 should be the bottom for our volumes.

As Nelson mentioned earlier, we forecast millions of square inches processed to decline about 35% in fiscal 2009.

We expect that chemical markets will decline more than 20% in 2009 until key markets, such as autos, housing and consumer goods start to pick up.

Overall, global steel operating rates remain depressed at about 50%.

We don't expect this to improve until late in calendar 2009.

We still expect the second quarter to be our low point, with the cost reduction actions we are taking, some seasonal improvement in demand, and new project start-ups, our second half earnings should improve.

We are now forecasting our fiscal 2009 earnings from Continuing Operations, excluding charges related to cost reduction to be between $3.85 and $4.05 per share.

With regard to capital spending, we still expect that it will be about equal to fiscal 2008 spending of $1.4 billion.

While bid and inquiry activity is still active, awards for new projects have been slow, as would be expected in this uncertain economic climate.

It is still too early for us to give you a capital spending number for 2010, as it will depend upon the level of business that does get awarded over the rest of calendar 2009.

Turning to Electronics, we are disappointed by our current business performance.

We have made significant changes in the business over the past two years.

However, the recent downturn in our performance says we need to do more.

We are currently concluding a study of this entire business, with the outcome intended to return Electronics to earning above its cost of capital.

Given our more negative economic outlook, and our belief that the recovery will be slower, we are considering additional cost reduction actions in the Company, that could result in a charge in our fiscal third quarter.

I will provide more details for you next quarter after we finalize our plans.

As we look beyond the current economic turmoil, we remain convinced that there are still solid fundamentals for driving industrial gas demand growth in the future.

Remember, that our products are used to save and efficiently use energy, to improve processes and environmental performance, to efficiently debottleneck processes to quickly and cheaply add capacity, and finally to improve the quality of our customers' products.

Simply stated, industrial gases help our customers lower their costs and become more productive, while producing better products, and protecting the environment.

These continued opportunities to grow, when coupled with our solid business model based on long-term contracts, provide us with a strong set of fundamentals that will help us continue to deliver value to our shareholders.

In closing, we remain committed to the necessary actions to improve our margins and return.

The cost actions we are taking are not only to preserve our near term profit, but more importantly, they also position us with the right cost structure for achieving our 70% margin goal as volumes recover.

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

Thank you.

The question and answer session will be conducted electronically.

(Operator Instructions).

And our first question comes from Jeff Zekauskas.

Hi, good morning.

Hi, Jeff.

Good morning, Jeff.

I have got a couple of questions.

The first is that your interest expense in second quarter was $30 million, in the first it was $36.5 million.

I know your rates are down, so is $30 million a good number to use going forward?

And secondly, you talked about Equipment & Energy having good cost cutting, and on a sequential basis that also was an improvement where you went from $7 million to $16.3 million.

So basically my question is, is the $16.3 million quarterly number sustainable, and is the $30 million quarterly number sustainable?

Okay.

On the interest, Jeff, I think on the $30 million going forward, I think that is a good number.

Regarding the Equipment & Energy, I would not sustain that as the forecast.

Some of that also comes through the profit coming through the projects here, and workload continues to decline in those areas.

Okay.

And then lastly, across your businesses which are the areas where you feel that there is the most risk of price going down?

Well, certainly the most risk which we have demonstrated consistently is Electronics.

And that is the area in which I feel the most risk.

Is there a lot there or a little, or sort of how do you see pricing in Electronics over the next several quarters?

I think with the volumes coming down, there has been, as we have seen it, price pressure across Electronics & Performance Materials, Performance Materials prices have gone up so we are roughly about, have maintained ourselves about flat in that.

I would not think that price at this point in time, Jeff, for us as we look at it, is a huge down factor for us.

I think the thing which we have seen, and which has driven our earnings down, has been really two basic factors.

One has been the currency declines, the strength of the US dollar, and the second has been the contraction in volumes, and those are probably the risks for us.

Okay.

Thank you very much.

You are welcome.

And our next question comes from P.J.

Juvekar with Citi.

Yes, good morning, Paul.

Good morning, P.J.

Hi, P.J.

Yes, hi, Nelson.

Can you give us some understanding on the project pipeline?

As you mentioned, refinery steel chemical projects are getting delayed.

Can you quantify the pipeline for us, how many projects do you have?

How many are getting delayed?

Well, yes.

And we actually don't, I don't count number of projects because as we said before, you can count a $5 million project, and you can have a $200 million project, and they count the same in that.

As we had looked at this, and we looked at 2010, as far as the things which we have said, and the boost in earnings from 2010 of new projects, I think that is good for us.

I think we are going to see somewhere in the $0.30 to $0.40 a share boost in earnings, from the projects coming on-stream.

The next factor for us then comes out as to what is coming on-stream in 2011 and 2012, we do have some projects which we are currently booking, and it would not be right now as big a boost in 2011 from those projects.

Roughly stated, it is probably maybe half to two-thirds of that at this point in time, as I look at it.

But we still have time to take orders, so that is somewhat of a normal view of it.

And I am really talking mainly about our on-site projects here, P.J.

So near term you feel you are okay, but long-term some projects could slip?

Well, certainly as we have said, I mean, we are in, and you can see the capacity factors which are out there which people are running at, and so it is not a good environment now for people to expand capacity, and so a lot of the new projects go around capacity expansion.

All that said, we announced a project last night on Marathon for Detroit, for their Detroit refinery.

So we are still seeing some activity.

It is not like we have no activity.

We are still seeing activity occur around the refinery hydrogen segment, and we are also seeing activity principally in China, as we mentioned before, I think to you.

Okay.

And quickly on Merchant Gases, Paul, can you tell us what your average operating rates are in US, Europe, and Asia?

Yes, the average operating rate was in the low 70s across the regions.

If that is the case, then what do you think will happen to pricing sequentially?

Can you really hold prices at 70% operating rates?

Well for us and I can only speak for our products here, as far as the philosophy on pricing as we look at this, is that it does not pay for us to go out and cut prices to load a plant, when I am going to give a price for five years.

My operating rates are going to start to tick up.

I think we have hit the low end of things here.

We haven't seen a tremendous amount of customers go away from us.

We have seen their takes decline.

And so as we look at this, it is something which for the future you don't want to cut prices because you are going to live with the price for five years, and it doesn't make sense that you are going to take something at a low margin, to cure what could be a six to 12 month problem, let's say.

That is good thinking.

Thank you.

(Operator Instructions).

Our next question comes from David Begleiter from Deutsche Bank.

Good morning, Paul and Nelson.

Hi, Dave.

Hey, Paul.

On the Electronics study, who is conducting it?

Are you getting some help from the outside?

And could it result in the sale or divestiture of portions, or even large portions of that business?

As far as this study, and we are using the people in internally who we have to lead the study.

We are also consulting outside resources obviously on that, and taking a look given the sharp downturn in the industry, what is the outlook, what are the changes that are going to come in the industry from this sharp downturn, what sort of shakeouts do we have, what sort of changes in customer base, et cetera, so we are taking a long, hard look at that.

And Dave, as far as any sale of piece of business, or things like that, I think the thing which we have always said on the Air Products business is that there aren't any sacred cows here, and so if something is not right for us to hold it, we are not going to hold it.

How long will that study take to complete?

I would expect that we will be talking to you about the results of that study at the end of quarter 3.

And last question.

Your SG&A fell 26% in the quarter year-over-year.

Is that type of decline sustainable in the back half of the year?

The factor is that I expect my SG&A to be about the same or a little bit lower coming forward here.

Going forward, one factor on the SG&A is currency.

It has hurt earnings but it has helped SG&A also, but the cost reduction has been a big factor in there.

Thank you very much.

And our next question comes from Sergey Vasnetsov with Barclays Capital.

Good morning.

Good morning Sergey.

Paul, in the past you had a chance to buy out some of your joint venture partners in Asia, and so I realize it is the timing might be specific to a given JV, or given circumstances, again, given the continuing global recession, and in some case credit crisis, is there more likelihood now that you will be successful in some of the steps this year?

On the buyout of our JV partners, and that always depends upon the partner, and their desire to go out and sell, I can't go out and make a comment on that for them.

You would have to ask them.

We are very happy in our partnerships with them.

They are fruitful.

We believe they help us going forward.

All that said, when it comes time for the partner if they want to exit, we are there and willing to buy it.

We have the capital, and the ability to execute those transactions.

Okay.

And recently there were some news stories about the current administration being, classifying CO2 as a pollutant, and therefore maybe incrementally brings forward the time when CO2 sequestration will become a commercially feasible scalable option.

What is your view?

Has that news changed your time on the CO2 sequestration?

Sure.

As far as us trying to take a view on CO2, we think it is a business opportunity for us, and sequestering CO2, capturing it from power plants, also making other fuels, which could use industrial gases in the production of those fuels is possible for us.

Just to give you a timeline, the first thing which you need is a cap and trade system to pass, or some sort of thing to get through Congress, and so if that happens in 2009 or 2010, it is probably going to take a year or two to write the regs then around it, and then after the regs are out, then people will start taking action.

So as we have always said, we think that the market for projects on this would start somewhere maybe for us around 2012 or so.

Which would have things on-stream 2014 or 2015.

Sergey, this is Nelson.

Just to add one more comment.

Just in the past 30 days or so we announced an effort with Vattenfall in Germany, which is really the first large scale demonstration of clean coal, and we are excited about that, as not only the supplier of oxygen, but also the supplier of proprietary technology, and we also believe this is a critical step in getting things moving forward.

So I wanted to point that out as an opportunity for us.

Yes, and that is a good add, Nelson.

That is a good add there.

Thank you both.

You are welcome.

And our next question comes from Mike Harrison with First Analysis.

Hi, good morning.

Hi, Mike.

Hi, Mike.

In terms of the equity affiliate's income this quarter, quite a bit stronger than last quarter, and you mentioned something in your remarks about the reversal of a fine in the prior year.

Can you quantify what that fine was, and maybe give us a little bit of guidance for what we might expect for that equity affiliate's income number for next quarter?

The fine in the prior year revolved around the reversal of the fine, of a reserve which we took for our Italian affiliate, when we got an unfavorable, when all of the industrial gas companies in Italy got fined on the antitrust.

Those things were appealed.

The Court reversed the decision of the Italian government, and we didn't have to pay it, and so that happened in quarter 2 of '08 for us.

That was worth about $0.02 a share to us, Mike.

If we take a look at going forward and equity affiliates, and we think equity affiliates will be about flat going down here.

We are also taking costs out in those areas.

We are bringing some new projects on, and they are also seeing demand being cut as everyone is in business.

So $0.02 a share, so roughly $0.05 -- (technical difficulty)

Excuse me?

One moment, sir.

Your line is open, Mr.

Harrison.

All right.

I will move on, and maybe follow up later.

Mike, yes, and $0.02 a share, about $6 million for us.

Okay.

On the merchant side, clearly the pricing is holding up on your existing contracts, but I was wondering if you could talk about what you are seeing in terms of pricing trends for new customers, new installations, are you seeing more competitive bids that are impacting the profitability of new business, or are you still pretty happy with the margins on new business?

Nelson, why don't you comment?

Yes, Mike.

This is Nelson.

Yes, we really have not seen a significant change in bidding activity.

Obviously, there are fewer opportunities right now, but we are still seeing a fair number of opportunities tied to new uses of industrial gases, around environment, around energy, reducing reliance on carbon based fuels, et cetera.

And in those types of deals, we are able to bring applications technology to the point of sale, and that is certainly helping us with the pricing.

So there really hasn't been any significant change in behaviors in the last six to nine months.

Moving on.

We have a question from Mike Judd with Greenwich Consultants.

Yes, good morning.

You guys benefited in the quarter from lower natural gas prices in your Tonnage Gases business.

Some think that natural gas prices could go as low as $2.50.

Could you just, I realize there are volume issues and currency issues, but maybe talk about that particular aspect going forward into the remaining part of your fiscal year, what kind of impact that could have on the margins?

Yes, Mike.

If you take a look at the natural gas prices as I think as we have commented before, is that they really, they help the margin and they don't really do anything for profits for us.

So it is a sales impact because it is a pass-through in that business.

First, on your comment of $2.50, I don't think that is our forecast either going forward.

But if they did go down, we would see a slight increase in our margins but once again, we are running this business for returns, and not for margins on here.

We put a lot of capital on the ground, and if we concentrate on margins, if gas is at 10 or gas it as 3, it is how much cash we are taking out of the business versus how much capital.

Fair enough.

Thanks.

And our next question comes from Laurence Alexander with Jefferies.

Good morning.

First on the tonnage business, could you discuss whether you have seen any significant project cancellations or delays, and if that is playing into sort of the way you are looking at the 2011 timeframe?

As far as delays, yes, we have.

I think a comment which we made last quarter is we continue to see the oil sands push out in time for us.

I mean, that is not surprising, given the price of oil.

And what sort of things are happening there.

And as far as other projects, steel has been obviously slow in there, so we are seeing things push out in time.

As far as the projects which we have in-house, which we are bringing on-stream in 2009 and 2010, we believe they are solid and they are in construction.

They are in the field.

And that they are going to come on-stream.

And then if you look at the merchant business with the contracts that are coming up for renewal, roughly how much do you think pricing for those contracts is below the average of the portfolio right now?

That is, they were negotiated five years ago.

Pricing has moved since then.

How much do you have [a chance] to mark up just to catch up to the marketplace?

The prices for a lot of these contracts have been taken up over time for us, so as we have implemented price increases, we have also gone into certain customers and changed that around.

As I said before, as far as Air Products is concerned on pricing, and we look at this as we are making a dedication of a portion of our capacity for a long-term period of time, we are going to price it to get the return, which we need to do to invest in this business.

And our next question comes from Kevin McCarthy with Banc of America.

Yes, good morning.

Good morning, Kevin.

Hi, Kevin.

With regard to the tonnage business, I was wondering if you could comment on how many customers let's say in steel and chemicals, may be operating below the take or pay minimum requirements, and to the extent that may have occurred, what impact that has on your margins in the segment?

We certainly have a lot of our customers operating below the mins right now, with steel operating rates at 50%, and so that does have an impact in some instances for us.

And a thing which you have to remember is in a lot of these projects, I don't even pay the power though, and so it doesn't go through sales for me.

And so a lot of this is the capital recovery, and the operating and maintenance costs, which I still have, because I still maintain my plant ready to go.

Okay.

So if I look at your margins in the segment, and try to back out the very large effect from natural gas, it looks like tonnage margins still would have been up perhaps 50 basis points or so on an underlying basis?

We also had good costs.

Good costs as well.

We also had very good costs there.

I guess what I'm --

A comment here across the Company as I have said before, is we had good costs across in all of our segments.

Okay.

Cost performance was good.

Second, on cash flow, I appreciate you providing the full cash flow statement.

I just had a question relative to Payables and accrued liabilities, which looked like it increased roughly $215 million versus the prior quarter.

I was wondering if you could elaborate on what might be driving that?

The Payables and the accrued liabilities actually went down, and so they were actually a use of cash there by us paying that down.

The two big factors in there are our pension and tax payments which we made.

And it is a timing aspect of those things.

If I were just to look and just take this opportunity on free cash flow, and free cash flow was down roughly about $160 million, it was negative about $160 million in the first half of the year.

As we go forward and look at that, because of those timing aspects, as we think that there is about a $300 million reversal of that as we go forward here.

Capital spending is probably going to pick up as it normally does during the summer for us a little bit.

But we are going to probably be slightly free cash flow positive for the year overall.

And moving on.

We have Don Carson with UBS.

Yes, thank you.

Couple questions.

One, Nelson, on Merchant Gases, you mentioned the US that you are seeing lower liquid argon and liquid helium sales.

Is the lower liquid argon, is a that a supply constraint because your steel customers are running so low you are having trouble getting liquid argon, or does it reflect weak demand as well?

It is weak demand.

That was an issue probably through our first quarter, but demand has deteriorated enough that it is actually, there is enough supply out there.

And the other comment, Don, was lower liquid hydrogen sales.

Helium is holding up fine.

There are, just sales to the government are down substantially in liquid hydrogen in the quarter.

Again, liquid helium we are doing fine there.

And our next question comes from Mike Sison with KeyBanc.

Hey, guys.

Hey, Mike.

In terms of Electronics, there are three different areas in that business, Gases, Tonnage, Specialty Materials equipment.

Were they all let's say in the red for the quarter, or is Tonnage at least on the profitable side?

The Tonnage business is making money on that.

Okay.

The issue for us in Electronics is as we have said before, is Specialty Materials, and the related Equipment business.

The related equipment business obviously is not going to have good sales in it, given the state of capital spending.

But that is really a business which enables, on the Specialty Gases and Materials end.

Okay.

And given the sequential improvement you are looking for in the third and fourth quarter for Electronics, do we get back in the black at that point?

We would expect in the third quarter that we are still going to lose money, but that we turn to profitability in the fourth quarter.

And our next question comes from Bob Koort with Goldman Sachs.

Thanks very much.

Paul, I might have missed it, but I wouldn't have guessed if North American Merchant was off 10% and Asia off 7%, that Europe would have been down only 1%.

Could you just remind me again why that was stronger, and what the near term outlook interest would be?

This is Nelson.

That is really attributable to good results in the European home care business, and so that is really what drove the difference.

In terms of industrial demand, they were roughly similar with probably European a little worse.

Got it.

I guess I am still trying to reconcile your more somber semiconductor expectations versus some of the data out of the SIA and other industry trade groups.

I think the earliest numbers they showed actually through the first quarter, volumes were up.

Do you know why it wouldn't jive with your units down 35% for the year?

We have not seen an uptick on that, Bob, on that data, to be honest with you.

And a lot of our stuff comes from our large customers, as we have dealt with them.

And our large customers as far as the forecasts which they have, for those who are actually going out and trying to make forecasts, are pretty somber themselves.

Can you gauge if there has been a dramatic inventory reduction, so that there will be a restock on top of whatever demand growth, or do you think -- ?

Yes, Bob.

Yes, I think we can.

And there has been a drop in inventories and we have seen that.

I mean, I think everyone is being quite cautious right now.

I think this is something which at least in our view right now, happens in Q4 and not in Q3, given the forecast.

Got it.

Thank you.

And our next question comes from John Roberts with Buckingham Research.

Good morning, guys.

Hi, John.

Good morning, John.

How did the captive gas operations behave in this environment?

I assume refineries produce as much hydrogen as their oil processing is, but how about the captive oxygen units.

The emerging market steel guys and chemical guys, did they shut down and for whatever minimum they need, they take it from the merchant market, or are they protecting their own operations, and continuing to operate, and maybe hurting the merchant market a little that way?

If a person operates in their own plant, what you will typically see is that they will take from their own plant themselves, before they would buy from an industrial gas company.

So that probably higher --

on the merchant.

Operating rates on average than the independent producers like yourself?

Well, on the captive guys, I mean, and those guys are really not out there producing, and not going out and selling against us.

They are making it for their own usage.

That is right.

But they protect their own volume first?

Sure.

I mean, but that only makes sense.

Now that doesn't happen in a lot of places.

There is some obviously there is some business where we go in and top off a customer who has captive plants, but it is not a big factor in our volumes.

Thank you.

And moving on.

We have a question from Steve Schuman with Lafayette Research.

Good morning, guys.

Hi, Steve.

Good morning, Steve.

Because gases really aren't inventoried, can you talk about any uptick in demand in any of your businesses, maybe late in the quarter, where we are struggling right now, what is the underlying end demand versus an inventory restocking at the customer site?

Can you talk to that?

If we look at the operating rates, one of the things which we have seen, is we did see operating rates in a number of areas start to pick up from January and February into March.

It wasn't large.

It was not huge, as far as things are concerned, and it was expected by us.

And so have steel operating rates picked up a little bit?

Yes, they have.

On the chemical side, yes, they have.

Across Asia, to be honest with you, the economic activity was down far in January and in the beginning of February, it started to pick up a little bit in February and March.

So we have seen some things there, but those are in-line with the expectations.

What we have not seen here is anything which is solid from an economic standpoint, which would say, hey, the economies overall are starting to move back.

There is a lot of volatility out there, and the consumer is still very concerned, and until those things start to get solved, I don't think we are going to see a lot of good momentum build in the economy.

So would you say those upticks are really just a seasonal effect as opposed to potential higher end demand?

Yes.

And the other thing, and the other factor which you have to consider there is that on the inventories, I mean, people have been dragging down inventories.

Inventories are low.

They have been drug down a lot.

I don't think they have a lot more to go right now, and so people are taking up production to meet demand.

So basically while they can't inventory gas, they have destocked their end products or (multiple speakers).

Yes.

That is right.

It is the end product, right.

For us, it's the end product, which we look at and not the inventory of gas.

And then real quick, the dollar has been a bit strong here.

I guess do you guys have an outlook going forward?

We don't gamble along those lines.

No, we don't.

I mean, as far as which way, and we try to operate and set up our cash flows so that we don't have a lot of exposure.

We try to match everything as much as possible, because we think that that is a hard thing for us to do, to go out and predict the currency.

Could you remind me what your number of your contracts, your longer term contracts are independent of foreign exchange due to contractual terms?

The bulk of our contracts don't have any real exposure here, because I match my revenues and my costs up, and so I am not an exporter of a huge amount of stuff where I don't sell in dollars.

As an example, a lot of my Electronics sales even into Asia go in dollars, because of the production of some of those products here in the US.

So I try to keep myself well-matched in that area.

Thank you.

You are welcome.

(Operator Instructions).

Our next question comes from Mark Gulley with Soleil Securities.

Hey, good morning, guys.

Hey, Mark.

Got a question for you on margins.

It looks like operating margins may have troughed here at 13.3, if I am doing my math right here in the March quarter.

At the very end of your remarks, Paul, you talked about 17 being the goal.

Can you give us an idea of how long do you think it is going to take to reach that 17 goal, given where you are now?

Yes, Mark.

If I were to take a look at our operating margins, and walk you forward from there, as we look at the cost reductions, we think our cost reductions overall probably over time are going to raise the operating margins from the things in which we have put in motion right now, about 1.5 points or so.

We think the volume from our new projects probably also contributes about 0.5%, and then the remaining comes from the recovery of volume in the economy here.

And as that happens, and so is that 2010?

I don't think so.

It could be 2011 if we started to get some good momentum in the economy towards the end of 2009.

That is pretty helpful.

Can you give us an idea of what the volume, negative volume variance has hit your margins by thus far to give us an idea?

For example, how far back do I have to go to see when your margins are normal in terms of volume?

On volume impact.

And roughly the volume impact is probably about, to today about 2% or so.

Housekeeping question.

In note four you talk a little bit about the bankrupt customer.

Have you already reserved for that or is that a reserve that is still coming?

No, we have not taken any reserve on that customer.

Is there a reason why you haven't yet?

Because as we look at it, we still think there is a good chance of us being able to go out and recover that.

Thanks, Paul.

(Operator Instructions).

And moving on, we have a question from Edward Yang with Oppenheimer.

Hi, good morning.

Hi, Ed.

Hi, Ed.

In Electronics, how much further can you get margins up if revenues stay flat?

How much more cost can you take out of that business?

As far as that is concerned, we can cut some costs, but this whole thing is going to have to involve a complete look at the business.

Our goal is to still get this thing back to a 15% plus margin for us, and we are not going to get, and we can't get there with just going out and cutting costs is our view.

We have got to do other things.

And that could include pricing, it could include other actions.

So Paul, when you talk about the potential for a third quarter charge related to additional cost cutting, which businesses would that cost cutting focus on?

We are looking across the whole Company, and trying to make our plans there, and so, and we are in the process of doing that right now.

And so it is too early for me to single anything out.

But we are going to look across the Company, and say how do we -- and size the business for the opportunity going forward here.

And when you thing about your European exposure, what percentage of that is Central Europe and Poland right now, and of the 7% volume decline you had this quarter, can you segment that by Western Europe and Central Europe, please?

If we look at the European business, real roughly, central and Eastern Europe is roughly about maybe 15% of that total for us.

As far as on the volume declines, I don't do that across there, but I will tell you that volumes did decline in those countries.

We actually manage across product lines there.

But the volumes, they did decline there.

So I would not say it was extraordinarily better or worse there.

Thank you very much.

It appears there are no further questions at this time.

Mr.

Squires, I would like to turn the conference back over to you for any additional or closing remarks.

Thanks, Jenny.

Please go to our website to access a replay of this call, beginning at 2:00 p.m.

today.

Thanks for joining us, and have a nice day.

That does conclude today's conference, ladies and gentlemen.

Thank you for your participation.