Air Products and Chemicals Inc (APD) 2011 Q2 法說會逐字稿

Good morning and welcome to Air Products and Chemicals second quarter earnings release conference call.

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

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

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

No other reporting or distribution 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.

Simon Moore, Director of Investor Relations.

Mr.

Moore, you may begin.

Thank you, Elizabeth.

Good morning, and welcome to Air Products' second quarter 2011 earnings teleconference.

This is Simon Moore.

Today, our CFO, Paul Huck and I will review our Q2 results and outlook for the remainder of 2011.

We issued our earnings release this morning.

It is available on our website, along with the slides for this teleconference.

Please go to www.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 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 information on these slides and at the end of today's earnings release, explaining factors that may affect these expectations.

Now I'll turn the call over to Paul for a review of our financials.

Thanks, Simon.

Good morning, everyone, and thanks for joining us today.

Please turn to Slide number 3.

With half of our fiscal year behind us, we are well on our way towards delivering on our 2011 financial goals.

For the quarter, sales of $2.5 billion were up 11% versus prior year on growth in our electronics and performance materials, tonnage, and merchant segments.

Underlying sales increased 12% on 11% higher volumes and 1% higher pricing.

Sequentially, sales were 5% higher.

Underlying sales were up 3%, with volumes contributing 2%, and pricing adding 1%.

The sequential improvement was driven primarily by our electronics and performance materials segment and our merchant gases segment.

Operating income of $425 million increased 17% from prior year, primarily on higher volumes.

Our operating margins improved to 17%, up 80 basis points versus prior year.

We remain on track to deliver on our 17% goal for fiscal 2011.

For the quarter, net income increased 16% and diluted earnings per share increased by 15%, each versus prior year.

Return on capital employed for the quarter improved to 13.3%, up 110 basis points.

Turning to Slide 4 for a review of the factors that affected the quarter's performance in terms of earnings per share.

Our adjusted earnings per share increased by 15%, or $0.18 per share.

Higher volumes in the electronics and performance materials, tonnage and merchant segments increased earnings per share by $0.27 year-on-year.

The impact of pricing, combined with energy and raw material costs subtracted $0.02.

Costs were $0.04 unfavorable, as our productivity gains were more than offset by higher operating, maintenance, and distribution costs, particularly in our merchant segment.

Currency translation and foreign exchange netted to a $0.01 unfavorable impact and a higher tax rate and higher shares outstanding cost us a penny each.

In March, we announced an 18% dividend increase, marking 29 consecutive years of increases.

We are all proud of this record.

Also, in this past quarter, we repurchased $350 million of our stock, about 3.8 million shares.

We have $300 million remaining on our repurchase authorization.

In summary, this was another quarter of solid gains in sales, earnings, margins, and returns.

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

Simon?

Thanks, Paul.

Please turn to Slide 5, merchant gases.

Merchant gases sales of just over $1 billion were up 10% versus prior year.

Underlying sales improved by 9% on 8% higher volumes and positive pricing.

Currency increased sales by 1%.

Year-on-year sales improvement was driven by volume growth across the segment with the greatest improvement in Asia.

Sequentially, sales were up 3%, with underlying sales up 2%, even with the lunar new year holiday.

Merchant gases operating income of $185 million was up 4% versus prior year, and down 8% sequentially.

Segment operating margin of 18.3% was down 100 basis points versus prior year, and down 200 basis points sequentially.

Versus last year, volume leverage was more than offset by higher operating, maintenance, and distribution costs, and lower pricing in European healthcare.

We had a number of plant operating challenges that increased maintenance costs and resulted in higher distribution costs as we reallocated our supply chain to meet customers' needs.

Versus prior quarter, the same cost impacts, combined with smaller sequential volume increase, drove the margin decline.

We believe these challenges are largely behind us and expect operating margins to improve through the rest of the year.

Let me now provide a few additional comments by region.

Please turn to Slide 6.

In North America, sales improved 5% versus prior year.

Volumes were up 3% on growth across all product lines.

Pricing was positive, with a 2% broad based increase led by helium.

LOX/LIN pricing was up 2%.

LOX/LIN plant loading remained in the mid-70s.

During the quarter, we announced plans to construct a new liquid nitrogen production facility in Mooreland, Oklahoma, to further strengthen our leadership position in supplying the region's oil field services markets.

We also announced an increase in merchant oxygen and argon production at Middletown, Ohio.

This facility and expansion are fully integrated with an increase of our onsite oxygen supply.

These 2 opportunities were driven by specific opportunities to create value.

As always, we will carefully consider loadings as we manage capacity going forward.

In Europe, sales increased 3% versus last year.

Volumes were up 4%, with strong liquid bulk growth, particularly liquid oxygen and nitrogen up 9%.

Package gas volumes were up slightly and healthcare volumes were flat.

Pricing was down 1%, with positive package gas pricing offset by unfavorable healthcare and liquid bulk pricing.

Our LOX/LIN plant loading remained in the low 80s.

In Asia, sales were up 30% versus last year, with underlying sales up 25%.

Volumes were up 18% with strength across all products led by the electronics market.

Pricing was also strong, up 7%, the highest increase in over 4 years.

We were able to continue to take advantage of the higher spot argon pricing in China that we mentioned last quarter.

LOX/LIN pricing stayed strong across Asia, up 3%.

Plant loadings were in the mid-80s with a slight dip due to the lunar new year.

We will continue to bring capacity on stream over the next few quarters.

Please turn to Slide 7, tonnage gases.

Tonnage gases sales of $799 million increased 6% versus last year, with volumes up 10%, and energy and raw material pass-through decreasing sales by 5%.

The volume increase was primarily driven by refinery hydrogen customers.

Sequentially, sales were up 4% on flat volumes and higher energy and raw material pass-through.

New plant volume growth was offset by scheduled outages.

These maintenance outages are scheduled to coincide with our customer outages to eliminate any impact on their operations.

Operating income of $121 million rose 13% from the prior year on higher new plant volumes and increased operating efficiencies, particularly in our Gulf Coast system.

Operating margin of 15.1% increased 90 basis points versus prior year due to improved operating efficiency and lower natural gas cost pass-through.

Moving to new business, we announced an increase of our pipeline hydrogen supply to Marathon Petroleum in Garyville, Louisiana.

We are pleased with this latest expansion of our relationship, as we have been supplying this refinery for almost 20 years.

Marathon will continue to benefit from the reliability and flexibility of the Air Products Gulf Coast Hydrogen Pipeline System.

This is the world's largest hydrogen pipeline.

As I mentioned in the merchant discussion, we also announced the expansion of our facility in Middletown, Ohio, including a new air separation unit and a new hydrogen production plant.

We've been supplying pipeline and merchant customers from this facility since the 1960s.

Please turn to Slide 8, electronics and performance materials.

Segment sales of $576 million were up 28% compared to last year on 23% higher volumes and 3% positive pricing.

Sequentially, sales were up 9% on 6% higher volumes and 2% higher prices.

Electronic sales were up 33% compared to last year, and up 6% sequentially, as the industry continued to demonstrate strong growth.

The sequential sales increases particularly notable, given the typical slowdown for lunar new year.

Electronics specialty material sales increased 16% versus prior year and 4% sequentially.

Ongoing tonnage sales were up 18% versus prior year, and 3% sequentially, and our equipment business was up significantly versus prior year and sequentially.

Electronics specialty materials pricing was essentially flat versus last year and last quarter.

Performance materials sales increased 22% versus last year, with volumes up 16% and pricing up 5%.

Our pricing actions successfully recovered increased raw material costs.

Sequentially, sales rose 14% with a stronger than typical rebound from normal Q1 seasonality.

Segment operating income of $92 million is the highest ever for this segment, up 61% versus prior year, primarily due to volume leverage and the positive effect of the electronics restructuring actions taken last year.

Income was up 33% sequentially due to volume leverage and the inventory revaluation in Q1.

The segment operating margin of 15.9% improved 330 basis points from last year, due to higher volumes and improved productivity.

Sequentially, margins were up 280 basis points on higher volumes and the Q1 inventory revaluation.

In terms of the Japan tragedy, our first thoughts go to the victims and their recovery effort.

We did not see any significant impact on our business during Q2.

In terms of new business, last month we announced a new nitrogen plant and pipeline at our Hwasung, Korea site to supply Samsung electronics fabs in the Hwasung, Giheung area.

And yesterday, we announced an expansion of our Carlsbad, California electronic materials development and production facility supporting product development, process demonstration, new product scale-up, and performance testing to create the next generation materials our electronics customers need.

Now, please turn to Slide 9, equipment, and energy.

Sales of $114 million were down 5% versus prior year and up 1% sequentially, reflecting lower ASU activity.

Operating income of $23 million increased 24% versus prior year and 11% sequentially due to higher L&G activity.

Our backlog is lower both versus prior year and sequentially.

We expect it to improve by the end of the year.

We did announce a new L&G technology and equipment order from JGC Corporation for the 2 million ton-per-year Donggi-Senoro L&G project in Indonesia.

Air product's leading L&G technology has been supporting projects in Indonesia since the late 1970s.

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

Thanks, Simon.

Now, if you'll turn to Slide 10, I'd like to share my thoughts on our outlook.

Our guidance for quarter 3 is for earnings per share of $1.42 to $1.47, which is year-over-year growth of 11% to 15% and is based on the following factors -- on the positive side, we expect to see increased earnings sequentially from the following areas.

We expect the manufacturing, economy globally, to continue its gradual recovery.

This along with some seasonal boost should result in higher sequential volumes in merchant gases and electronics and performance materials segments.

We also expect better cost performance in our merchant segment, as the operating and related distribution impacts should not repeat this quarter.

And our fiscal quarter 3, tax rate will be lower as we anticipate closing some open tax audits.

Our tax rate next quarter should be 24% to 25%.

For the year, we expect the rate to come in towards the lower end of our original guidance range of 25% to 26%.

Partially offsetting these sequential improvements, in tonnage, results will be down sequentially.

We expect that our operating bonuses will be lower, as these bonuses are tied to contract year-end and quarter 2 is our peak bonus quarter.

Also, quarter 3 will be the highest quarter for maintenance spending this year.

As Simon told you, we coincide our maintenance outage timing with our customer plant shutdowns.

For quarter 4, we expect significantly higher operating income in tonnage.

And in equipment and energy, we expect lower results as our air separation unit backlog is currently low.

As a result, we expect operating income in the second half of the year will be about half of what we recorded in the first half.

As Simon mentioned, we expect to add orders to our backlog by fiscal year end.

To date, we have not experienced any significant business impact from the Japan tragedy.

Japan represents only about 2% of our revenue.

While our electronics customers are continuing to operate at high utilization rates, there is still some uncertainty on the potential global supply chain impact.

On balance, we do not expect any material impact on our business and have reflected this in our guidance.

For fiscal year 2011, the underlying assumptions from the beginning of the year remain unchanged.

Our capital expenditures guidance also remains unchanged at $1.5 billion to $1.7 billion, up from last year's $1.3 billion.

With half of our fiscal year completed, we're raising our earnings per share guidance, increasing our full year guidance range to $5.65 to $5.75, 13% to 15% growth over last year.

Now, let me wrap up.

With the first half of our fiscal year behind us, we are off to a great start in 2011 with sales and earnings continuing to grow.

We also continue to improve our operating margin and our return on capital.

As I mentioned, we are all proud of the fact that we increased our dividend by 18%, marking 29 consecutive years of increases.

We are confident that we can continue to drive strong growth and higher returns over our planning horizon.

Before the recession, we generated annual top line growth of 14% from 2004 through 2008 with underlying growth of 9%.

As we have emerged from the recession, we have seen this underlying growth rate increase and have consistently beaten our competitors.

We expect that our revenue growth will continue this strong pace because of the following factors.

First, with the world experiencing higher energy costs and more environmental pressures, we are seeing industrial gases being used in more and more processes, applications, and industries, as companies look to increase energy efficiency and improve environmental performance.

Second, as manufacturing grows in the emerging markets to serve the needs of their large populations, we are seeing industrial gas usage grow significantly in those countries.

Finally, Air Products' leading position in the electronics, hydrogen, and energy markets, coupled with our leading position in a number of the Asian countries, makes us the industrial gas company that has the best opportunity to take advantage of these macro trends.

We have also demonstrated our commitment to improve returns by increasing our return on capital employed by about 300 basis points over the past 6 years.

We believe we have a number of opportunities to further expand our returns.

Some examples are -- as we look to the future, we still have operating leverage in our existing facilities.

We are also pursuing a number of programs to improve the way we price our products, simplify the way we do business with our customers and suppliers, improve the efficiency and output of our plants, and lower the capital costs of our investments.

We are excited by these opportunities and believe that they will make us the best investment in our industry going forward.

To find out more about what we are doing and what our long-term goals are, please join us at our investor conference on June 9 for a day of presentations, questions and answers, and interactive discussions regarding Air Products' strategy, opportunities and outlook.

You will have a chance to discuss our businesses and interface with a broad cross-section of our management team.

If you're interested in attending, please contact our Investor Relations team.

Thank you.

And now I'll turn the call over to Elizabeth to take your questions.

(Operator Instructions) And our first question this morning will come from Kevin McCarthy with Bank of America Merrill Lynch.

Yes, good morning, thank you.

Paul, the margin trend in electronics, up 280 basis points sequentially, certainly more than we would have anticipated, can you elaborate on the drivers there?

And now that it's eclipsed your 15% goal, should we be thinking of this new level as sustainable?

It doesn't sound like you anticipate meaningful impacts from Japan.

Yes, well, Kevin, a couple of questions which you have there.

First, regarding the electronics and the electronics margins.

We certainly intend to continue to drive margins in that business.

The thing which has driven them are two things.

First, we've had very strong volume growth that -- not only from our existing products, but some of our -- but some of the new products which have been introduced.

And those new products come in at a very nice margin for us.

So that has helped and the leverage on our facility certainly has helped.

Second, as everyone knows, we have put that group through a lot of changes over the past few years, and those changes have paid off in increased margins and better operations for that facility -- for their facilities and the way they operate.

So, yes, we do think that we have a sustainable model in there and that we will continue to experience good growth.

With regard to Japan, from an electronics standpoint, we don't, to date, we have not seen any real impacts.

We've watched our volumes very closely through April.

Our volumes look good with things.

We've talked to our customers.

Our customers continue to operate.

There's obviously people who are concerned about supply chain.

Apple recently commented that they did not see any issues with it.

That's good news from our standpoint, because they're a downstream, people who produce units.

And so we hope that as we go forward that -- and that it won't be a problem for us.

Okay and then a second question, if I may, Paul, on merchant margins.

You had 100 basis points erosion year-over-year, 200 there sequentially.

I guess I heard a number of issues on lunar new year distribution costs, EU healthcare.

Can you help us understand how much of that pressure you would view as transitory versus potentially more durable through the balance of the fiscal year?

Yes, it's -- and with regard to margin, we are certainly not happy with the results which have come through on the merchant area.

If you look at it, we did get the volume leverage so we have had good volume growth in the business here.

We lost the volume leverage, principally because of a couple of items.

Number one, we had some operating problems at facilities which caused us extra distribution costs to move product around, higher costs to operate and maintain those facilities and fix those problems.

Now, some of those costs will go away in the next quarter.

But there will be more costs which need to go away in the longer term to get that.

The second factor is that we have not delivered the -- in this quarter, we have not delivered the productivity gains which we had planned upon.

And that's something which we need to fix and get moving forward.

We constantly have inflation in this business, as anyone in any business has.

We aim to more than offset our inflation with -- on the productivity end.

We did not do that this quarter, obviously, and we fell back a little bit.

And so we are attempting to come out of that.

Will margins jump back up to the quarter one levels in quarter three?

We're going to try to get them back up, but that's a large task for us.

I will tell you that right now.

But we do expect to start to see continued improvement as we look to the future here and see margins improve on a sequential basis in quarter three and in quarter four.

Okay.

Thank you, Paul.

We'll take our next question from John McNulty with Credit Suisse.

Good morning.

Just two quick questions.

On the electronics front, it looks like the volumes came in noticeably higher than what, I guess, you would guided for the full year at the beginning of the year.

So I'm wondering how we should be thinking about the growth going forward, based on what you're hearing from your customers?

Yes, I mean -- and we expect the electronics volumes to continue to grow.

Now, whether we will see as strong a seasonal impact in quarter three and quarter four as we have in other years, I think remains to be seen.

But we are certainly expecting to see volumes grow sequentially as we go into the last half of the year.

Simon, I don't know if you have any other comments on what you've seen?

Thanks, Paul.

I think just another thing to point out too, really, from an MSI standpoint, we would still be consistently aligned with our original guidance and I think that lines out well with third party measures.

I think some of the things that we talk about that continue to allow us to grow at a higher level than MSI is our strength with the leading producers in that industry, our strength in leading regions, and then beginning to see some benefit from some of the smaller, faster growing areas in LED and PV.

So MSI guidance, kind of consistent with where we said, but we see the opportunity to grow faster than MSI.

Okay, great.

And then just with regard to your L&G equipment business, it sounds like the backlog you're expecting it to start firming up later on this year.

In terms of discussions that you've had with some of your potential customers, how are you thinking about the opportunities now in the US with companies and regions looking to monetize this strand of natural gas?

So regarding the L&G equipment backlog, the L&G equipment backlog is, for us, is strong.

As far as the equipment backlog, our shortfall to what our plans were exist in the air separation plant orders.

So the L&G equipment business is -- looks very good.

As far as going and trying to export and with L&G out of the US, there are people who are taking looks at that.

These projects though do take a long time to develop and are subject to a lot of ups and downs with things.

We will go out and support those projects and look at those things.

I think, this is just a personal one for me, is I think it's going to be tough to get one and to get a permit within the United States to export L&G.

But we'll see what happens.

Okay, great.

Thanks for the color.

Yes, thanks.

Our next question will come from PJ Juvekar with Citi.

Yes, Paul, quick question on your -- this negative operating leverage in margin.

I understand you had some maintenance issues and all that.

If you exclude those issues, for 10% top line growth, what kind of operating income growth should you see?

Yes, well, if you take a look at how much operating income growth from a sales growth, if we see our sales this quarter, so if you just take our sales this quarter, we are about $90 million from this -- from the past year.

And so if I then take a look at that and say, well, how much was due to pass-through of higher costs and raw material costs, and that adds about $11 million.

Currency took us up about $12 million on those things.

And so the growth in volume for us was about $70 million when you look at that just on a rough number.

We would expect operating income to grow somewhere around $20 million or so, based upon that, PJ, for that.

So it's somewhere around 0.3 times the sales, whatever the sales growth would be.

But that gives you some numbers which you can work on from there.

And we didn't see this this quarter, to be honest with you, we didn't see it and we're not very happy with that.

Okay, that's fair enough.

And can you discuss your overall project pipeline, not just L&G, but overall backlog of onsite projects?

Sure, yes.

And how is that progressing?

Is it accelerating, is it sort of flat in terms of its growth?

Yes, and so I'll turn from the equipment backlog, which we actually track.

We track these two things on a separate basis.

Equipment backlog is one aspect of things, and the capital project backlog is another aspect of things.

So if you take a look at our capital backlog for us, our capital backlog is about $2 billion at the end of this quarter.

At the end of last quarter, I think I told you on the call, it was $1.8 billion, so we are up over 10%.

So we have seen some award activity occur in this quarter, which is good news for us, because we were expecting that stuff to occur.

It is principally on site projects, so when I look at that backlog, three quarters of it is in the -- is on the tonnage side, 15% in the merchant area, and 10% in electronics for us as we go forward here.

It's spread across the world, so we have projects in North America, in Asia and Europe also for us.

I think maybe the other point then, too, would be, as always, you heard Paul reaffirm our perspective on CapEx guidance for FY '11, which would be up 15% to 30% over last year.

Okay.

If I may just ask one more quick question.

You were announcing some new merchant plans, Oklahoma, Ohio.

I think last quarter you announced a couple of plants in India.

Are you seeing your competitors and you getting more into merchant business or maybe is merchant plants?

Well, as far as the announcements within the United States, as Simon said to you, they were opportunities which presented us.

One was around an onsite supply, so people are going to do that.

And the other one was for a particular market in the opportunity for injection to LIN for fracking, for the oil field services area.

So as far as the US is concerned, we aren't seeing a whole lot of activity with people announcing plants there.

I think we are seeing activity with people announcing plants in Asia, but that goes with the manufacturing growth.

Okay.

This is not a big merchant capital cycle coming up--?

No, it is not, no.

Okay.

It think it's supply and demand.

If you take a look -- but most of our capacity, most of our capacity, PJ, comes as we look to the future here, capacity additions are going to be in Asia.

They're going to be around the emerging markets and particularly China.

India will have some, but China will have more.

China's going to be the biggest market for industrial gases out here in the future someday with the amount of the manufacturing that is done there.

And so as that manufacturing needs grow, they drive a need for more and more gases from the merchant side and so those -- so that growth is normal.

Our operating rates, mid-80%s to high 80%s across the board in those countries.

So we are in very good shape there from a loading capacity standpoint and we need new capacity as we project out in the future just to take the normal market growth.

You've got manufacturing still growing at double-digit rate in China.

It's over 10% this year.

Okay.

Thank you.

Thanks.

Our next question will come from Jeff Zekauskas with JPMorgan.

Hi, good morning.

Good morning, Jeff.

Your operating income year-over-year was up 24% from $340 million to $420 million, but your equity affiliates income was down from $32 million to, I don't know, $31 million and change.

Why such a difference in the performance?

Well, one of the things which we did, as you know, we have an equity affiliate which we dropped out in this last quarter, so that's a slight drop with things for us.

Our equity affiliates are performing well with things.

And as we look at it around the world, we think we are in good shape there.

I think we did see, if you will, growth in those ventures in sort of a base business aspect of it.

The reported results, there was a number of things that Paul mentioned in terms of changes of ownership, some legal costs, inventory valuations.

So the key I think is that those ventures continue to perform and grow as we expect them to.

All right, and then lastly, your depreciation charges, both for the quarter and for the first six months are flat at about $435 million.

But your CapEx last year was $1 billion, which is above depreciation, and this year you're doing whatever it is, $1.5 billion.

Why are the depreciation and amortization charges growing faster?

I think -- and one of the things which you're seeing is, as we look at this, you are seeing more and more onsite investment.

If you look at our total PP&E in the ground, more and more onsite investment, which is 15 to 20-year depreciation.

And we're seeing roll off merchant investment, which tends to be more in the 10 to 15 type of cycle.

So as you see that shift within the Company as we've gone to be more and more of an onsite tonnage company.

You're seeing that the replacement of the depreciation is you're seeing assets which become fully depreciate at the 10 to 15-year life, and some things are going to the 15 to 20-year life.

Okay, thank you very much.

Our next question will come from Laurence Alexander with Jefferies.

Good morning.

This is Rob Walker on for Laurence.

Hi, Rob.

Hi.

I guess first question, in terms of the upside to your prior 2011 guidance, I'm just curious if you could break out what you are now expecting for the benefit for -- from new project startups and operating leverage and merchant, if there's any change to those prior numbers?

Well, on the new project startups, most of that is in the tonnage area and we don't break it out by segment, Rob, but we still think we're going to see about $0.35 a share year-on-year from that.

The -- probably the increase in the guidance comes from the loading being better and volumes being better on the existing assets, particularly electronics and performance materials.

Great, thank you.

And then a follow-up on the electronics strength, using the rough math you laid out for merchant incremental margins, looks like incremental margins in that segment were 44% year-on-year.

How much of that would you attribute to structural improvements and what would a normalized margin be in that segment?

You were talking about electronics, or you said--?

Yes, electronics, just kind of taking the volume growth year-on-year, about $100 million, and then profits up about $44 million.

Just kind of how much of that is structural improvement and then what would normalized incremental be in that segment?

Okay.

If you take a look at the -- on the margins on an incremental basis, they are probably around 40% in electronics.

On the performance materials end of the business, they aren't as high.

It's not as capital intense so they tent to be closer to a 30% range for us.

And then what you're also seeing year-on-year is the improvement on the cost reductions which we've done.

And the efforts for those people to save cost and increase their margins, which they've done a very good job on them.

Okay, great.

Then just finally, on merchant, as we see rates increase and as you're seeing improved loading, is there potential, or how do you assess the potential to start seeing sort of 2% to 3% growth in pricing in that segment?

Thank you.

And with regard to pricing in the merchant area, I think if you look at the US for us and where the loading is, we are not at the point where I think you're going to see real price increase.

However, we are determined to get recovery of our costs.

So we are implementing surcharges in the merchant area within the US.

In Europe, as I've said before, prices do need to go up.

It's a competitive market, obviously, but the margins which we have there are not satisfactory, and one of the solutions to that, it's not the only solution has to be that we have to get some of our customers to pay more, we got to get costs out in that area.

And in -- as you look at Asia, I think you've seen prices go up and we would expect that to continue.

Now, since some of the increases which you saw this year for the first half get around the shortage of liquid argon, which have occurred.

But underlying, we have seen good strong growth of about 2% or so in LOX/LIN, which is the base product in those areas.

And that's -- and I think that is something which should sustain here going forward.

Great, thank you very much.

Thanks, Rob.

And Don Carson with Susquehanna Financial has the next question.

Yes, Paul, couple questions.

One, you've met your margin goal and, obviously, you would have exceeded it had it not been for the setbacks in merchant and return on capital, as you say, has improved 300 basis points.

Given your revenue growth that you talked about as being better than your peers going forward, what do you think's some reasonable new targets are for return on capital and for operating margins?

And then just smaller question on electronics for Simon, I understand that your largest NF-3 competitor in Japan has had power availability issues, is telling customers they won't be up and running fully until October.

Is this leading to any spot pricing opportunities in specialty electronic materials?

Okay, Don, and first, regarding the goals, we will have comments about the goals on June 9.

I think they will get everyone excited.

We have -- we think we have a great opportunity, as I mentioned here at the end, both in growth and increasing return on capital for us.

But you have to stand by and come see us on June 9.

Simon?

All right, thanks.

Good question on NF-3.

So, obviously there's a lot of facilities in Japan and this is a broader comment than just NF-3 that are affected, not only by any potential damage, but also by rolling power outages.

So we don't know exactly what our competitors are doing, but NF-3 is a type of process where you'd have a very difficult time to run the plant if you were still experiencing rolling power outages.

So we have seen increased requests for product from our customers.

I would say that NF-3 pricing, specifically, was slightly positive versus last year and also slightly positive sequentially.

Some of the things we've talked about over the last few quarters about mitigating the downward pressure, we are starting to see some positive effects there.

Now, keep in mind, NF-3 is roughly around 10% of our electronics sales and so while that is a flat to slightly up, we also have some of the newer products that we are pleased our customers are adopting and we have shown them some price volume curves.

So on balance, as we've said before, for the electronics segment, we probably see stable pricing going forward.

The other point to make about NF-3, is we typically have this under contracts.

Now, they're not as long as the contracts in the other aspects of our business, so about a year.

So we're certainly honoring our contracts and we're looking to manage the price and availability with our customer relationships as best as we can.

And, Simon, where are you on NF-3 utilizations?

Is Korea running flat out and you scale back hometown?

Or just wondering what kind of interim volume opportunities you might have.

Yes, we are running pretty high rates right now on NF-3.

As we continue to line out the Korea plant, as it's a new plant, we continue to look for and find ways to squeeze some more capacity out.

But we're running at a pretty high operating rate right now on the two plants.

Okay, and then one additional question.

European healthcare looked attractive for a while, but it seems, obviously, with fiscal precious there that reimbursements are getting tougher.

I'm just wondering whether strategically your view as to whether you should be in home care in Europe has changed given some of those ongoing pressures.

Is it going to start looking more like the US used to look?

That, Don, in regarding the European healthcare, it's been a good, successful business for us.

There has been price pressures.

That is nothing new.

There's been pricing pressures which we've been dealing with for a long time.

We match out with reductions on costs for us, and we look at businesses and we look to make the right decisions.

There aren't any sacred cows for us as far as the business, but we basically don't comment or try to speculate on these businesses.

It's been a successful business for us.

Okay, thank you.

We'll now hear from Dave Begleiter with Deutsche Bank.

Thank you.

Paul, you mentioned tonnage would be down in Q3 sequentially due to lower bonuses.

Could you quantify the impact of the bonuses in Q2 and just how much down do you expect Q3 to be?

As far as how much the bonuses -- we don't actually comment exactly on the -- and give amounts of what the -- of the bonuses.

Year-to-year, the impact of bonuses is not huge, Dave.

And so what this is, is it's really something which is, which gets to be a cycle for us, and we have the peak period, as I said in the second quarter.

If we look at going forward on the tonnage segment, with the additional maintenance activity, which we're going to see, and also due to the decline in bonuses, in aggregate, we're probably down pretty close to what our Q1 results were in that segment for us.

And Paul, just on the backlog, the $2 billion backlog, should that be up by year-end and should that be even higher in 2012?

Yes.

And that is our goal.

We think that there are lots of opportunities for us.

This always gets around the issue of trying to time the projects.

So trying to predict the backlog is always very difficult for us, and we'll have more to say on the CapEx guidance as we get closer to 2012.

But our hope is that our 2012 CapEx actually grows from 2011.

That certainly -- the things which as we look to the future, is something which we see those opportunities for us.

Paul, lastly on North American merchant pricing, what does it take to get higher real pricing?

Is it just higher operating rates or something else?

No.

For us, I think is that the operating rates in the business really have to go up here right now.

Thank you very much.

Thanks.

We'll now hear from Mike Harrison with First Analysis.

Hi, good morning.

Good morning, Mike.

Was wondering if you could go through in a little bit more detail exactly what the costs were that you encountered, what the operational issues were that you encountered in your merchant business.

And also address whether diesel, higher diesel prices, were an impact in the quarter and kind of remind us how your surcharges work on the diesel front.

Sure.

Okay.

If you take a look at the costs, one of the things which we looked at and the amount of the -- of what the shortfall for us was to get to kind of the margin where our leverage would've shot the flow-through, we were short about $15 million in profit in an estimate which we did here.

About half of that is unrecovered inflation, where we didn't get the productivity savings which we were planning on getting for us.

The remainder -- the other -- the remainder of that then sits in two other areas.

The first is the cost of additional power and the variable cost to move product around from an operations standpoint.

In other words, you got a plant out in a particular place, so you got to move product a longer distance to serve the customer.

We have the capacity in most products to be able to do that.

So we didn't lose a lot in volume.

We lost some in volume, but we didn't lose a lot.

And then the additional fixed costs to fix the plants, maintain the plants, and stuff like that, and that was the other half of those things.

Those are split about even when you look at that.

With regard to pricing overall, in this segment, we about recovered the variable cost increases, which we saw year-on-year for those things.

So pricing -- we can pick on certain areas and certain regions, but on net, overall, it looked good.

There is opportunity for us to increase margins with the pricing, as I've covered before, particularly in places like Europe and in some of the recovery areas of some of the costs.

With regard to the surcharges on diesel costs and things like that, diesel was not a huge issue for us in this quarter, as I said, but our surcharges typically go on the way they are [triggered], they lag by a month or so for us before we can get that out to the customer and it varies contract by contract.

All right, thanks.

And then in the discussion of electronics margin, it seemed to me that you omitted mentioning that pricing went positive there for the first time in a couple of years.

Was wondering if that was a component of the margin improvement as well?

Is demand strong enough that we're going to continue to see positive pricing into the second half of FY '11?

And is it primarily market-driven, or are some of the restructuring and internal changes that you guys have made also an important factor in getting pricing positive in products?

As far as the pricing, I'm going to put that to Simon, because he ran the business in which you're talking about the pricing for things.

If you look at this, if you look at this overall from a margin standpoint, pricing has typically been a big drag for us on margin.

It isn't a drag anymore on margin for us.

But the big factors for us, which you've seen this, have been the two factors which we talked about, are volume and the efforts which we've done to really get real, sustainable productivity gains across this segment.

But Simon, why don't you take the answer on pricing there.

Good point.

And then again, just a couple of things.

We said on the performance materials side, we were successful with the price increases we took out recovering additional costs on the performance materials side, so good work by the team there.

On the electronics side, we said that the specialty materials, and obviously, as Paul said, historically that's the area that has the most variability and has had the most downward pressure.

That was flat versus last year and basically flat versus last quarter in specialty materials.

So that's a big change from the historical direction that this business has been taking.

I gave you some -- a little bit more color specifically on NF-3, but again, we have a suite of products in this area and I think we'd say stable pricing going forward as we continue to drive productivity allows us the opportunity to expand margins.

All right, and then last question for you, Paul, is what was the diluted share count as of the end of the quarter?

And have you done any additional share repurchases since you announced the $350 million in mid-March?

And we have not done any additional repurchases of shares since then.

Let me just get you the diluted share count.

I got to look at that.

So we're on the same page here, Mike, we're talking about the average for the quarter.

Right?

Because that's the number that actually gets used.

Right?

So, at the end of Q2, that was 218.8 million.

That was down a little bit from the end of Q1.

The share purchases we did were primarily in the second half of the quarter.

So you see maybe about a third of that effect in this quarter and you'll see the full effect of that in the next quarter.

I guess that's what I'm trying to get to, is kind of what's a good number to use for next quarter for the diluted share count?

So let me -- as Paul said, we bought back about 3.8 million shares.

We do have, as you know, the option exercises do continue to expand those number of shares as well.

So, again, I think we'd see about two-thirds more than we saw in this last quarter.

If you look at that, I think, Mike, a good number to use would be maybe about 217 million to -- 217.7 million to 217.8 million -- right around there when you just take the number.

So down, Mike, 1 million shares or so.

And we'll now move to our next question.

That will come from Mike Sison with KeyBanc.

Hi, guys.

Hi, Mike.

In terms of oil moving up here to these levels, has that helped the base for finding hydrogen business?

And any thoughts on -- is project in the oil sands or other areas potentially could pickup for you?

Yes, and with the increase in oil prices, I think if the increase in oil price is sustained, I think it helps the oil sands.

So I think that's -- so those things -- I think it makes it more attractive, makes the economics work better for us.

And with regard to the refinery/hydrogen business, we do not see the that respond to oil prices on the spot basis.

Okay.

And then--?

Just as we -- sorry, Mike, just maybe--?

Yes, go ahead.

Well, in terms of 2012, I know it's a little bit early.

But can you help us understand the momentum that you see in terms of, let's say, new tonnage projects coming on stream, you still have operating rates at levels that can continue to improve and, maybe the potential for electronics to continue to improve?

Yes.

I think you outlined a lot of the things which we do.

And so we'll talk more about this at the investor conference as we talk about our goals going forward.

But I think we are very excited about continued strong improvement in 2012.

We got -- we still have loading which we can do.

We've got projects which are coming on stream, which we'll get the -- projects from this year will get the full effect.

We'll have projects coming on stream in 2012 also for us, and we think that sustains out into the future.

Okay, great.

And one last quick question.

In terms of North America and Europe volumes, do you see them accelerating into the second half of the year, or sort of staying in these low single-digit levels?

I think as far as the gains in volumes in Europe, I think those -- I think we are pleased with those.

I think the gains in the US, I think we would expect to start seeing them accelerating.

Great.

Thank you.

Thanks, Mike.

Mark Gulley with Soleil Securities has the next question.

Been a lot of talk about US merchant today.

And with the low operating rates in the low 70s, would one of the opportunities to improve margin and productivity be to shut down some of your oldest, least efficient plants to raise margins there?

Yes, Mark, I think one of the things which you can be assured of is that we look at run our plants to give the best margin to us in the near term.

We can certainly do that and do that all the time.

I think as we go forward and look at this, we think there's still growth which occurs here and so that's something which we can take advantage of here and we think we have the opportunity to load.

Well, as a follow-up, if your operating rates are, let's say the low 70s and let's say you want to aim for, I'll just pick a number, the 85 to 90 area, it would take years to get there, given your volume growth rates.

So am I missing something in terms of the opportunity for capacity declines?

It depends on what you see those opportunities in the US being.

We still see fairly decent growth within the US from a manufacturing standpoint.

So we're predicting the growth rates in the manufacturing end to be 5% or so going forward in the future.

And if we get a multiple of that, it's -- we ought to be there.

We ought to be up higher in operating rates.

Okay, and then in your concluding remarks, you talked about some of the growth opportunities and you talked about the fact that you have enjoyed some very good volume growth historically.

Without giving away your investor day, can you kind of highlight for '12 the opportunities for volume growth that you're most excited about?

You're right, Mark.

I'm not going to give the investor day, because I want everyone to come for this because I think we've got a good story for people and it's worth coming to.

But if you look at those opportunities for us, and these are even longer term, as we look at the emerging markets, we certainly see greater opportunities and we're very happy with our positions, both from a merchant and onsite business in these emerging markets and the product offerings which we have and the applications which we have to serve those markets.

I think you'll be excited by those things going forward here.

And then obviously, also, the improvement in returns for us which we've been working very hard at and we continue to focus on.

Okay, thanks.

We'll now take our next--.

Go ahead.

We'll take our next question from Robert Koort with Goldman Sachs.

Thanks.

Paul, I think you mentioned that you believe your portfolio, the Asian exposure, electronics, et cetera, gives you a more attractive opportunity for investors.

Have you considered over the long-term sizing that?

How much faster do you think you can grow than the gases market?

Sure, and if you come to the investor day we'll have some things and we will talk to you about that very opportunity.

Can you tempt me more specifically now?

As far as that is concerned, sure.

We think that overall is that we can grow faster than our investors by 1% or 2%.

Sustained.

Which is a lot when you look at that.

I would encourage you to have some data behind that, because I think generally investors don't share that perception, so I think that would be pretty interesting.

I agree with that.

Okay, thanks.

And ladies and gentlemen, that is all the time we have for questions today.

I'd now like to turn the call back over to Mr.

Moore for any closing comments.

Okay, thanks, Elizabeth.

Thank you, everybody, for joining us.

Please go to our website to access a replay of this call beginning at 2.00 PM.

today and have a nice day.

Ladies and gentlemen, that does conclude today's conference call.

We thank you for your participation.