Air Products and Chemicals Inc (APD) 2013 Q2 法說會逐字稿

Good morning and welcome to the 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.

(Operator Instructions).

Also, this telephone conference presentation and any 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 teleconference 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, Alicia.

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

This is Simon Moore.

I'm pleased to be joined today by John McGlade, our CEO; and Scott Crocco, our CFO.

After our remarks, we'll be pleased to take your questions.

We issued our earnings release this morning.

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

Please go to airproducts.com to access the materials.

Instructions for accessing the replay of this call, beginning at 2 p.m.

Eastern Time, are also available on our website.

Please turn to slide 2. As always, today's teleconference will contain forward-looking statements based on current expectations and assumptions.

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 John.

Thanks, Simon.

Before we take you through the details, let me make several overview remarks.

While there were some bright spots, the second quarter was certainly a challenge, given the softening of the global economy.

Our earnings did come within guidance, but slower-than-expected economic growth and a weak electronics market resulted in lower volumes than we had anticipated.

We expect this slow growth environment to continue for some time, and are no longer anticipating as strong a second half economic improvement as we had originally planned for.

Most importantly, we continue to stay focused on actions within our control.

We completed the European restructuring provision that we announced last year on schedule and with the full benefits achieved.

We remain focused on execution and continue to drive improvement through cost discipline and productivity.

As a result, we saw good cost performance again this quarter, helping to offset the weaker volume.

Over the long term, we are well positioned to grow via our $3 billion project backlog, which is over 80% on-site pipeline business, with long term take-or-pay contract terms.

And we've continued to be successful signing new business.

In February, we announced another oxygen order for coal gasification in China for Lu'an Mining; and just last week, another LNG order from Petronas in Malaysia.

In our Merchant and Electronics and Performance Materials businesses, we have a tremendous opportunity to load our existing assets when the economy does improve.

And our cash priorities remain unchanged -- invest in core projects at good returns; increase the dividend each year, which we've done now for 31 consecutive years, having announced an 11% increase in March; strive to maintain an A bond rating; and repurchase shares, which you saw us do in Q1 for $460 million.

In addition, let me assure you we will continue to take decisive actions to improve our operations and deliver value to shareholders, regardless of economic conditions.

Now let me turn the call over to Scott to review our results.

Thanks, John.

Turning to slide 3 -- as we look back at this past quarter, the economy came in at the low end of what we anticipated when I provided you with our guidance in January.

March volumes were a disappointment relative to the normal historical uptick we typically see for this month.

Moving around the globe -- in North America, we experienced modest growth.

Europe sunk deeper into recession, with Southern Europe remaining particularly weak, while the Northern Continent and Central Europe worsened.

And in Asia, there was a slower-than-expected ramp-up after the Lunar New Year holiday.

As I'm sure you've heard from other sources, the electronics industry has remained soft.

We have seen new fab construction delays and the outlook for silicon processing has been reduced significantly.

MSI forecasts are now flat to down for our fiscal 2013 versus previous forecasts of 4% to 6% growth.

For Air Products, both electronics materials and equipment sales were below our expectations.

The pricing environment has held up to date, but is increasingly more difficult due to softer volumes.

However, we continued to deliver good cost performance.

As a result, we delivered EPS within the range provided in January.

With that backdrop, let me take you through our overall results.

For the quarter, sales of $2.5 billion were 6% higher versus prior year, with the Indura and DA Nano acquisitions contributing 6%.

On an underlying basis, sales were down 2% due to our previously announced decision to exit the polyurethane intermediates, or PUI, business.

Excluding PUI, higher volumes in our Tonnage Gases segment and higher Equipment segment sales were offset by lower volumes in our Electronics and Performance Materials and Merchant segments.

Sequentially, overall sales declined 3% primarily due to lower volumes in our Tonnage segment, as a result of planned customer maintenance outages.

Simon will provide additional segment and geographic details later.

Operating income of $390 million increased 4% versus prior year, and increased 5% sequentially.

Our operating margin of 15.7% was down 30 basis points versus prior year, primarily on acquisitions and higher pension expense, partially offset by better cost performance.

Sequentially, our margin improved 120 basis points, primarily due to last quarter's inventory revaluation and cost improvement.

Net income and diluted earnings per share were up 3% and 5%, respectively, versus last year.

Our return on capital employed, at 10.9%, was lower due to our higher capital spending, acquisitions, and lower asset loadings.

Turning to slide 4, you can see an overview of the factors that affected the quarter's performance in terms of earnings per share.

Our continuing operations EPS of $1.37 increased $0.06 or 5% versus last year.

Volumes increased EPS by $0.07, including $0.06 from acquisitions.

Pricing, energy, and raw materials taken together decreased EPS by $0.04, due to higher energy and distribution costs, primarily in our Merchant business.

Net cost performance was $0.07 favorable, despite a $0.03 unfavorable pension impact.

Base business costs were positive, primarily due to the impact of our European cost reduction and improved operating efficiencies.

Also, our other income and expense P&L line item typically averages about $10 million to $12 million of income per quarter.

This quarter's results were a bit higher than average, as they include a gain of about $0.02 from an asset sale.

Excluded from the volume and cost line is the net $0.02 unfavorable impact from our decision to exit the PUI business.

Currency translation and foreign exchange, taken together, were $0.02 unfavorable as we experienced a small FX loss this year compared with a small FX gain last year.

Equity affiliate income contributed $0.01 on continued strong results from our Mexican affiliate.

Noncontrolling interest was $0.01 lower due to the addition of Indura.

Interest expense was $0.02 higher due to acquisitions and last quarter's share repurchases.

The tax rate was unchanged versus last year.

We now expect our tax rate for the year to come in between 24% and 25%, slightly lower than previous guidance.

And, finally, lower shares outstanding contributed $0.02.

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

Thanks, Scott.

Please turn to slide 5, Merchant Gases.

Merchant Gases sales of $1 billion were up 14% versus prior year, driven by the Indura acquisition.

Underlying sales were down 1%, on 2% lower volumes, and 1% positive price.

Volume weakness was most apparent in lower demand in Europe and in helium, due to supply limitations globally.

Sales were down 1% sequentially.

Underlying sales were down 1% on flat pricing, and 1% lower volumes due to helium and the Lunar New Year in Asia.

Helium production was lower in the US and Algeria, driven by operational challenges with our helium feedstock suppliers.

We expect these issues to improve in our third quarter.

Going forward, we expect supply from our Wyoming facility by the end of our fiscal year, and further Qatar supply to the industry into early next year.

We are also actively developing additional new sources, and expect to be able to make a specific announcement soon.

However, we expect supply to remain tight over the next few years until this longer-term capacity can be brought onstream.

Merchant Gases' operating income of $168 million was up 10% versus prior year, and down 2% sequentially.

Segment operating margin of 16.8% was down 50 basis points compared to last year, and essentially flat sequentially.

Versus last year, operating income was up on profits from the Indura acquisition and improved productivity, including the benefits from our Europe cost reduction programs.

As Scott mentioned, we also saw a $0.02 benefit in Merchant from an asset sale.

This was partially offset by lower volumes and higher energy and distribution costs that were not fully recovered with price increases.

Overall, we continue to be pleased with the performance of the Indura business.

We have delivered on the expected synergies with good cost performance, and are seeing growth opportunities in small on-sites for a variety of end markets.

As we expected and said in the past, given Indura's business mix, their margins are in the low-double-digits.

As a result, for the quarter, Indura negatively impacted segment margins by about 80 basis points.

Excluding the Indura impact, segment margins were up 30 basis points versus prior year, primarily on improved productivity.

Versus prior quarter, we did see the impact of lower seasonal volumes in Asia, with a slower post-Lunar New Year recovery.

Let's look at the Merchant business by region.

Please turn to slide 6. In US/Canada, sales were down 1%, on 2% lower volumes, and 1% higher price.

As I mentioned, helium supply remained a challenge this quarter, accounting for the negative volume variance.

Liquid oxygen/liquid nitrogen volumes were up on strength in metals processing and primary materials.

Liquid argon volumes were down on lower demand.

Contract signings were solid, and lost business was minimal.

LOX/LIN capacity utilization remained in the low 70s.

Pricing continues to be favorable, led by helium; but, overall, did not fully recover recent power and distribution cost increases.

We continue to work hard on pricing, and you probably saw that we announced a price increase just last week.

In Europe, sales were down 5% versus last year on lower volumes across most markets, particularly food, metals, and construction.

Regionally, for LOX/LIN, while the UK/Ireland and Southern Europe continued to decline, we did see an even more significant drop-off in the Northern Continent and Central Europe, particularly Poland.

And for packaged gases, we saw declines across Europe, but particularly in Central and Southern Europe.

Overall pricing was flat, with some pressure on liquid products, offset by positive helium pricing.

LOX/LIN plant loadings were in the mid-70s.

New contract signings were up significantly versus last year, as the team leveraged the integration of our liquid bulk and packaged gas sales teams in Europe.

In Asia, sales were up 4% versus last year.

Underlying sales were up 2% on flat volumes, and 2% higher price.

Currency had a positive 2% effect.

LOX/LIN volumes were up across the region and up mid-single digits in China.

Liquid argon volumes continue to be weak across the region, on lower PV and fabrication demand.

Cylinder volume growth was moderated by customer profitability actions, and we continue to see good growth in our microbulk product line.

Pricing was up 2%, primarily on helium strength, as we are seeing some price pressure in the liquid oxygen and nitrogen business, particularly in China.

Plant loadings remain in the mid-70s.

Additional capacity will continue to impact loadings over the next few quarters despite the volume growth.

And new contract signings for the quarter were the best in years.

Please turn to slide 7, Tonnage Gases.

Tonnage Gases sales of $809 million were up 3% versus last year, on new plant volumes and higher energy passthrough, partially offset by lower PUI volumes.

As expected, base volumes were relatively flat, as planned customer maintenance outages in Europe were mostly offset by stronger US Gulf Coast volumes.

We are proceeding with the exit of our polyurethane intermediates business.

For the quarter, PUI sales were down about $50 million versus prior year, and operating income was down about $5 million.

For the full year, we expect PUI sales to be down about $160 million, and operating income to be down about $25 million -- more than expected, due to higher shutdown costs and lower volumes.

For this segment, sequentially, sales were down 10%, on 8% lower volumes, ex-PUI.

As expected, planned customer maintenance outages and lower spot volumes impacted sales.

Operating income of $123 million was down 2% versus prior year.

Ex-PUI, operating income of $117 million was up 3%, on stronger new plant volumes and improved plant efficiencies.

Operating income was down 11% sequentially on lower volumes and higher maintenance costs, due to the expected outages.

Operating margin of 15.2% was down 80 basis points versus prior year, primarily due to bonus timing and the higher energy cost passthrough.

Margin declined 20 basis points sequentially on the lower volumes.

We are pleased to have announced a new long-term agreement with Shanxi Lu'an Mining, a large provincial state-owned coal mining company.

We will supply over 10,000 tons per day of oxygen, as well as nitrogen, air, and steam to their coal gasification project in Shanxi province, China.

Lu'an will use the oxygen to gasify coal and produce diesel fuel.

Including the Lu'an project, we are now executing seven projects to supply oxygen for coal gasification in China, totaling over 38,000 tons per day, all under long-term contracts with take-or-pay terms.

Great success by the team, and we continue to see strong bidding activity in this growing market.

We also have seen strong project development activity in the global hydrogen business.

Customers are making decisions, and we expect to have more to say on this in the near future.

Please turn to slide 8, Electronics and Performance Materials.

Segment sales of $549 million were down 3% versus last year, with lower base electronics volumes, partially offset by the DA Nano acquisition.

Sequentially, sales were flat.

Versus prior year, Electronics sales were down 3%, with the DA Nano acquisitions partially offsetting lower equipment sales in an overall weaker materials market.

The lower equipment sales are not surprising, given the slowdown in new fab CapEx, but we do expect this to rebound by the end of the year.

Tonnage continues to show growth, with new products coming onstream.

In the more advanced materials, we continue to see customer adoption of our solutions, creating growth opportunities even in a weak market.

However, for the more mature processed materials, we are seeing volumes impacted by lower fab utilization, and competitive activity impacting both volumes and prices, driven by the much lower outlook for the rest of 2013.

Sales were down 5% sequentially, primarily on lower equipment sales.

Performance Materials sales were down 3% versus last year, on both volume and price impacts.

While the auto market remains consistent, we have seen weakness globally in construction, industrial coatings, and particularly marine coatings.

Prices were down slightly more than costs.

Sequentially, PMD sales were up 7% on seasonal improvement, particularly in Europe and North America.

Operating income of $78 million was down 9% versus prior year.

And operating margin was down 100 basis points, to 14.1%.

Operating income and margin were impacted by lower volumes and price pressure.

Sequentially, operating income was up 26%.

And operating margin was up 290 basis points, primarily due to the inventory revaluation last quarter.

Now please turn to slide 9, Equipment and Energy.

Sales of $124 million were up 12% versus prior year, and up 17% sequentially, primarily on higher LNG project activity.

Operating income of $21 million was more than double prior-year and prior-quarter, on the higher LNG project activity and lower development spending.

This is consistent with the guidance we provided for significant improvement in the business for 2013.

The backlog of $326 million is up 5% over last year, and down 16% versus last quarter, as new orders in Q2 are modest but bidding activity remains strong.

As an example of the strong LNG activity, we just announced a new order with Petronas in Malaysia last week to support the expansion of their Bintulu LNG complex.

This is the second order we announced with Petronas over the last year, following the floating LNG project announced last July.

We would expect additional LNG announcements through the rest of the year.

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

Thanks, Simon.

Now please turn to slide 10, and let me provide you a brief summary of our outlook.

Given the weakness we saw coming out of fiscal Q2, we are tempering our expectations for economic growth in the second half of our fiscal year.

Manufacturing output has slowed globally, and we now expect a more muted recovery off this lower base.

As a result, we think it is appropriate to reduce our full-year EPS guidance to $5.45 to $5.60.

In the US, slower growth in manufacturing output is expected to come in at the low end of our range.

Uncertainty in the economy remains, and unresolved fiscal challenges may impact recovery.

In Europe, the recession worsened during Q2, due to widespread austerity programs and high unemployment.

We now expect Europe, and particularly the countries where we have higher exposure, to show negative year-over-year growth in manufacturing for FY13.

In Asia, we expect a gradual acceleration in manufacturing growth to continue, benefiting from more stimulus spending on infrastructure projects, particularly in China and Korea.

And in South America, Chilean manufacturing was strong in January, but slowed through the rest of the quarter.

We expect the year to be consistent with our original expectations.

Our backlog is back up to $3 billion, primarily from the addition of the Lu'an coal project.

We still see a number of outstanding opportunities in the oxygen for coal gasification market in China, and in hydrogen projects around the world, but continue to see decisions being delayed on electronics projects.

Based on this strong backlog of projects, with signed long-term contracts with take-or-pay terms, CapEx is expected to be about $2 billion this year, consistent with our most recent guidance.

And as I mentioned, we now expect our tax rate for the year to come in between 24% and 25%.

For Q3, our EPS guidance is $1.33 to $1.38, based on the following factors -- on the positive side, we expect to see improved sequential volumes in our Merchant and Performance Materials businesses on slightly improved economic activity and seasonality, as well as improved volumes in our Tonnage Gases segment due to less planned customer outages.

Partially offsetting this sequential improvement, we expect a lower level of activity in our Equipment and Energy segment, similar to the level that we saw in fiscal Q1, with an uptick in Q4; a greater impact from the PUI business exit; and we expect further headwinds from higher pension settlement costs, and lower gains from asset sales.

Now let me turn it over to John.

Thanks, Scott.

As I reflect on the first half of fiscal year 2013, Air Products delivered earnings growth in a very challenging economic environment, where our base volume growth was well below what we had anticipated.

This earnings growth is a result of the actions we have taken to tackle things within our control, with a particular focus on reducing costs, driving productivity, and disciplined project execution.

We also repurchased $460 million in shares in the first half of the year, and raised our dividend 11%.

You have seen us take a number of steps to optimize our portfolio over the last year, including selling our European home care business; exiting the PUI business; and restructuring our PV market position.

And in light of the continuing slow growth environment, we are actively assessing whether there are additional actions we can take that would result in increased value to our shareholders.

In closing, I believe Air Products remains well positioned to deliver increased shareholder value.

We have a strong backlog of projects; we have significant leverage on our existing assets that leave us well positioned for a recovery; and we remain sharply focused on productivity, improving our core businesses and delivering on our cash priorities.

Thank you.

And now we are happy to take your questions.

Alicia?

(Operator Instructions).

Laurence Alexander, Jeffries.

Good morning.

Two quick questions -- first, given the current outlook, can you give a little bit more of a sense on the restructuring in Europe, and how much more you might need to do to see significant margin improvement there, if demand doesn't recover?

And, secondly, with a slower demand environment this year, does that change the way you think about how much of a backlog-related tailwind you should have next fiscal year?

Because some of the projects that come onstream this year would be ramping up with a bit of a lag.

Thank you, yes.

Laurence, this is John.

On your first question, as we noted, we did complete the restructuring in Europe on-schedule and on-budget, delivering the benefits that we forecasted.

Certainly and my comments in the script are we're going to continue to look across our portfolio as to what the current business environment looks like, and we'll make judgments around any additional actions we need to take as we go through our planning cycle this summer, and as we link that planning cycle with the business environment we see going forward.

From the standpoint of the backlog impact for next year -- and then I'll let Scott add some commentary here as well -- I think we've talked a number of times around the fact that while the general economic environment in a lot of the markets that we operate in, particularly impacting, say, our Merchants and Electronics businesses, the bidding activity in the energy and the environmental areas -- whether it be large air separation for gasification, hydrogen, LNG -- continues to remain strong.

And the majority of those projects are currently in execution, and meeting what we would have anticipated to be schedules associated with large, complex projects like that.

And just to build -- and this is Scott -- I just want to reinforce that over 80% of our projects in backlog are tied to long-term take-or-pay contracts.

And so we're not exposed to the general economic uncertainties that we are when we put in Merchant capacity.

Then just a very quick clarification on the helium -- the BLM is talking about shifting to market-based pricing supplies.

Would that be neutral for you, or negative?

Laurence, this is Simon.

It's a good question.

There's obviously a lot of dynamics going on in helium supply.

There is different bills in front of different sections of the government to extend the helium program.

What we believe is the BLM will want to continue to provide helium that will help enable industry as best as it can.

And we're going to be a key player in that helium business going forward.

At this point, it's unclear exactly how that's going to shake out, but we think helium will continue to be a good part of Air Products going forward.

Thank you.

Robert Koort, Goldman Sachs.

Good morning.

This is actually Neal Sangani on for Bob.

Just looking to understand how much the firmness in the general outlook for natural gas prices over the quarter would have been a tailwind in the guidance, prior to the back-half macro headwind.

This is Scott.

There really hasn't been any change in our outlook for natural gas in terms of our results or guidance.

Okay.

And then in the past, you've been a bit more aggressive with the purchases around the current share price levels.

Is the lower outlook going to change the strategy, or should we expect a similar pace?

There's no change to our strategy and our cash priorities, just to re-emphasize.

We're going to focus primarily and foremost on core projects with good returns; focus on raising the dividend and striving to maintain an A rating; and then buy back shares.

I will remind folks, too, that we did do a share repurchase last quarter of about $460 million.

And if I look back over the last seven years or so, we did about $3 billion of share repurchases.

That said, at this point in time, we're always looking at it.

I wouldn't see anything on the order of what we did in the first quarter going forward, in terms of share repurchase.

Okay, thank you.

Jeff Zekauskas, JPMorgan.

Hi, good morning.

I think you reduced your guidance for the year by $0.27.

And if you look at the midpoints -- so that's about $57 million after-tax; $76 million pre-tax.

And so your margins are roughly 15%.

So what that would imply is something like a $500 million reduction to your sales expectations, which seems like an awful lot.

Is that really what you're trying to do with your guidance?

And of the $76 million in pre-tax income that should disappear versus your previous expectation, where should it disappear from by segment?

The two areas -- Jeff, this is Scott -- the two areas that we're seeing the biggest decline is in electronics.

As we talked about previously, we had expectations of MSI growth being in the 4% to 6% range -- now, flat to down, year-on-year.

And then, additionally, as we also mentioned, in Europe, while things haven't been robust there all year, we expected a turn for the second half of the year.

And instead, we continue to see a decline here in the second quarter.

And so with particular weakness now emerging in Central and Northern Europe; so the two areas that we are going to see the biggest decline are in the electronics area for the materials, and the Europe Merchant business.

Okay.

That's clear enough.

It's funny, when you look at TSMC volumes or UMC volumes, they look reasonably good on a monthly basis.

But it really doesn't come across in your Electronics results.

Can you describe, a little bit more precisely, why -- it looks like there are winners and losers in the Electronics area -- and how that may affect your overall volumes.

Yes, great question, Jeff.

And I think it's a reminder that the electronics market is certainly dynamic.

And while we can talk in general about what's happening to the overall industry -- and, again, as Scott has said, it looks clear that the forecast for industry growth this year are much below expectations were at the beginning of the year -- you're absolutely right.

In addition, within there, certain companies have strengths and weaknesses.

The foundries continue to benefit from the idea that folks want to outsource production of chips.

At the same time, you see some other companies perhaps that are more tied into PCs that are showing a little bit less growth.

But I think, again, as we said before, we touch all the key players in this segment; we're the leading supplier to Samsung, Intel, and TSMC, which we believe over the long term will continue to be the right companies to be with.

They're making the capital investments to drive growth going forward.

And so, really, the industry -- again, flat to down for the year; and that's one of the big reasons why our expectations are below what they were.

Okay.

Thank you very much.

Vincent Andrews, Morgan Stanley.

Thanks and good morning, everyone.

Maybe we could triangulate some of the comments, in terms of staying within that A rating and considering other strategic actions, which sounds like it might include further divestitures.

And then your comments on not being as aggressive, most likely, with share repurchases, relative to what we saw last quarter.

And then just the negative free cash flow year to date.

If the economic environment continues as it is, and earnings are going to be flat, I think for about the third year in a row, where does all this settle out from a balance sheet perspective?

And how aggressive do you think you can be?

Let's try to take this from the top and go down.

We've taken a lot of actions over the last number of years.

Both from a portfolio point of view and from a restructuring point of view -- which I, quite frankly, feel we've got the right portfolio for success going forward.

Certainly the economic environment hasn't helped us.

And we made the comment that we have a fairly large amount of leverage on our existing assets in Merchant and Electronics that we believe will provide benefits as we see slowly recovering economic growth, as we look out beyond 2013; our fiscal year 2013.

And so from that perspective, I'm pretty comfortable that we are in the right place.

What I was commenting on is -- we'll look and we'll calibrate what that economic environment is as we go through our planning process for 2014, and make adjustments -- more to our cost base than to, let's say, our portfolio of businesses, which I did comment I was comfortable with.

The other point I'd like to make is, right now is where the opportunities are in the gasification and in the hydrogen area.

And that's an area, as I mentioned earlier, where we do see growth.

And that will be good, solid growth under our Tonnage business model for the future.

And so we're going to continue to pursue those opportunities.

This is Scott.

Just to build in on those comments.

As we've said in the past, our focus is on executing the projects that are in the backlog -- again, over 80% of which have take-or-pay terms.

And while we have a terrific opportunity to load the existing assets in our Merchant business and in our Electronics business, given the economic environment, we're not waiting for the economy to come back in order to load them.

Rather, we're taking the actions in the areas that we can control to improve the margins as quickly as possible, and improve our cash flow going forward.

Okay.

And could I just ask a quick follow-up on -- I don't think you covered this in the prepared remarks -- the inventory revaluation in Electronics and Performance Materials, can you just go through what that was?

So, yes, just to refresh, folks -- back in the end of last year, we -- typically during the course of the year, we have inventory held at standard.

Then we get to the end of the year and we move it to actual.

In the beginning of this fiscal year, we moved it back to standard.

Typically when you make that move, between year-end and the new year, there is not that big of a movement in terms of the inventory carrying value.

However, we've taken actions to reduce our costs, both from a supplier perspective as well as bringing in some manufacturing capability in-house.

And so while there was an inventory adjustment down in the first quarter, we're going to get that back over the course of the year as we see higher margins.

And so that was a -- just to remind you, about a $10 million impact that we saw in the first quarter, which did not repeat here in the second quarter.

Okay?

Okay.

Thanks very much.

Kevin McCarthy, Bank of America Merrill Lynch.

Yes, good morning.

A couple of questions on oxygen for gasification of coal in China.

If I think about the seven large projects that you've won there, would you comment on how the aggregate returns would compare to the Company average return on capital employed of 10.9% on slide 3?

Is it lower, similar, or higher?

How should we think about that as those begin to flow through?

Kevin, yes, this is John; and then I can let Scott add color to this as well.

Bottom line -- you know well that we do risk adjusted returns that look at the project risk, the country risk, the cost of debt, inflation, et cetera.

And when you add all of those together, China is going to have an absolute higher hurdle rate, if you will, than the corporate average.

And such that while I'm not going to disclose the average returns, we feel good about the overall returns of these projects when they achieve their potential to be accretive to the returns to the Company.

Recognize that a project like this, when you make an investment day one, it takes time for it to grow into its return on capital, if you will, because you're putting all the capital out three years before you begin to produce any cash flow from the project.

That's right.

So just to build on that -- so there is the WIP spending before it starts contributing back to earnings.

And then just to remind folks, and when you bring it on, it would be completely un-depreciated.

And so as you go through time, as depreciation comes down, you'll see an improvement in the ROCE.

Understood.

So, if I look at it on an IRR basis, it sounds like the returns will be higher due to the adder for country risk.

Is that fair?

That's a fair statement.

Okay.

And then just as a follow-up, do you think the pace of coal gasification related oxygen activity in China will be similar the next couple of years, or any faster or slower than what we've seen for the last two years?

So, I think what you've seen in the latter part of this past year is a slowdown, frankly, in approval of some of the projects, as China was going through its governmental changes at different levels of leadership.

And so they slowed things down.

Our view is that the pace of this market will continue at or above -- if you look over the last several years -- the trend line rate that you saw there.

It's an absolute key to both their goals around energy independence and, frankly, environmental benefits, by really driving these projects to really typically one of three output products.

So, right to diesel fuel, so a clean diesel fuel; or to a synthetic natural gas, again, a more cleaner-burning fuel that would be put in pipelines and pushed to the Eastern seaboard; or directly into olefins as a chemical feedstock or building block.

And our assessment of the market is that there are multiple opportunities of the scale and quantity of projects that you've seen, if you looked over a trend line of the last several years.

Okay.

And then a final question, John, if I may.

You've taken action in European healthcare and PUI.

Are there any businesses remaining in your portfolio that you would consider non-core?

I made a comment earlier and I'll go back to that.

I actually like where the portfolio is today.

I'd like to see more improvement in terms of the underlying profitability of the businesses.

And I believe that will be there, as we see some economic recovery in them, because we have gotten a lot of the cost structure right.

And we've taken a lot of actions on productivity.

But the composition of the portfolio, and what I believe either their current or future contributions, the value to be -- are solid.

Very good.

Thank you.

PJ Juvekar, Citi.

Yes, hi, good morning.

I had a question on Indura.

The hard goods business at Indura was a big piece of the portfolio.

How is that business holding up?

I know that Indura was not big in Brazil.

But Brazil sort of drives the Latin American growth.

And with slowdown in Brazil and rest of Latin America, what's the risk to Indura's portfolio?

So, PJ, obviously South America or Latin America in general has slowed down some.

It's still growing more robustly than most of the other geographies that we are operating in.

Indura is meeting our expectations across the broad business.

The area that's probably weaker as we sit here today in Chile, in particular, is the mining segment.

And that's obviously a piece of what Indura supplies in; more on the equipment side of things than the gases side of things.

The good news on Indura is, first, it is holding up in terms of what our expectations were on cost, and our being able to deliver the synergies.

And then, second, what we bring to the table with Indura is a broader portfolio of offerings that's allowing us to enter into new market segments, if you will, from a Merchant point of view, and into the small on-site and Tonnage businesses that Indura hadn't been focused on historically.

From a Brazil point of view, you are correct -- Indura really doesn't operate in Brazil.

I think you know that we have a business in Brazil that Air Products has had for many years, and obviously that business has followed the way the Brazilian economy has performed.

And, frankly, there, what we're doing is, we've taken a lot of actions around improving our productivity, driving down our variable cost of production there.

And we'll continue to look at what the opportunities are to leverage the significant investment that we now have in a fairly strong number-two position in South America; and, frankly, in some countries, the number-one position.

So how do we get the benefits, if you will, of the Indura position within the geographies they play in, with some of the offerings that they have that might make sense in Brazil.

Just to build on John's comments, we are very pleased with how the integration is going.

At the beginning of this fiscal year, we give you guidance that year-on-year we would expect to see a $0.10 increase in our earnings per share, based off of Indura, and the smooth integration and delivering of the synergies, and we're on track to deliver that.

Great.

And your overall CapEx spending is still about 2 times G&A.

And with the slowdown in growth around the world, maybe outside of the US, are you seeing any delays in projects, given lower stimulus spending you talked about in China?

Yes, I think -- so, I think we really have to think about it in two buckets, PJ.

Certainly from the standpoint of -- and I don't know that we're that unique relative to our competitors -- certainly from the standpoint of investment in merchant capacity, yes, there is a slowdown in the investment in merchant capacity.

And also, obviously, in, as you've seen, in some of the electronics sectors, where people have announced -- not a cancellation of fabs, but perhaps a several-quarter delay until either they see a stronger market coming back.

More importantly, though, I think, if I go back to the large oxygen for gasification and the hydrogen area, they are being driven by different macrodynamics than the underlying economy.

They're being driven either by, in China, a combination of energy independence and environmental regulations around how they get to cleaner fuels, or how they get to substitute fuels.

And then China plus the global environment, the demand for cleaner transportation fuels continuing to drive hydrogen.

And, as Scott mentioned, 80% of our backlog is in those two product lines, fundamentally to support the Tonnage business segment and have Tonnage type of terms and conditions.

And I want to clarify something that Scott said.

Scott, did you say that you saw weakness in Southern Europe now spreading to Central and Northern Europe?

Yes.

We've seen in both Central and Northern Europe, while there's always been a decline, we saw an acceleration of the decline in those two regions here in the second quarter.

Duffy Fischer, Barclays.

Yes, good morning.

Question -- and I apologize, you'll have to follow some math here.

But in 2008 you guys did roughly $5 of EPS.

This year on your guidance you'll do, midpoint, $5.50 or so; so roughly a $0.50 increase.

But if you look from 2008 to 2012, you spent about $8.5 billion in capital, or about $39 a share.

And the way I break that down, $15 was for maintenance, $24 a share was for growth.

So, if you just use simple math and say, okay, we want a 10% pre-tax return on that capital, that $24 a share, that should be about $2.40 a share.

Tax effected, that's about $1.80.

So, that capital should have grown earnings by about $1.80 a share, where we have only grown $0.50.

So, can you help me triangulate that missing $1.20 or $1.30?

How much of it is my assumptions on returns are wrong?

How much of it is maybe the base business that was there in 2008 is significantly smaller now?

But it just feels like we're not getting the bang for the buck when we are spending the capital that we should.

So, two big elements, Duffy -- and appreciate you providing the math; I'll have to look at it after the call.

But the two fundamental issues here are, as you mentioned, the investment that we've made in the base business around the Merchant terms and conditions, not loading that capacity.

We did not see the downturn coming that has come upon us.

And so, as we've mentioned before, we're taking actions to control our costs for when the economy comes back.

The other element, of course, is from a -- as we've talked about -- from the backlog, the fact that we've got $3 billion in that backlog, and it is currently not contributing to sales or earnings.

That's why we need to focus on executing those projects and then bringing them onstream.

Fair enough.

And then I guess the follow-on question would be, even though they are on-site, if we don't start to see the earnings increases from capital, how long is the rope before we actually start to significantly ratchet back to capital spending?

Well, as I said earlier, if they are on an on-site basis, we do expect that.

Recognize we kicked up our capital from a 10 level and 11 level to a much more significant level in 2012 and in 2013.

And these projects have about a three year WIP, frankly, from the time that you put them in the capital stack, or the backlog, until they are brought onstream.

We are constantly asking ourselves the questions around our priorities for cash, and looking at whether or not these continue to be consistent with -- they're attractive projects that support the long-term growth.

I think we've demonstrated throughout the last five or six years, as Scott mentioned earlier, we make those judgments -- real-time is a poor choice of words -- but we make those judgments as conditions change, and move between investing in the business, buying $3 billion of shares back, and increasing the dividend each of the last 31 years.

From my perspective, the growth opportunities -- provided they fit the strategy and they meet our return criteria -- are ultimately going to contribute the value that our shareholders are expecting from us.

Great.

Thank you, guys.

Don Carson, Susquehanna Financial.

John, a question on US Merchant -- your loadings continue languish here in the low 70s.

I know that, post the end of the Airgas bid, you had put in place a major initiative in minibulk and expanded your salesforce.

And I know you talked about increasing signings.

So I'm just wondering where the payoff from this effort is.

Or -- and I guess, as a follow-up to that, do you need to rationalize some of your US Merchant system?

And just wondering if you feel you are disadvantaged by not having a cylinder gas outlet for some of that liquid.

Let me start from the back, and go forward.

Obviously, the calculus of getting back into a packaged gas business was the whole thought process around an integrated gas model, therefore more touches to the market through the sales teams, as well as more touches to a broader set of vertical sectors or market sectors.

And that's old history.

But if I go more to what we have done, I do feel good about the fact that we've added salesforces; we've added commercial technology resources; we've been extremely selective on where we would add capacity.

And the new signings in the business have increased year-on-year for the last several years, as we've added those resources.

So we're getting a payoff there.

What isn't as readily obvious is that the underlying base business -- and I don't think this is unique to Air Products -- has not been as strong as we would have hoped in the recent number of quarters.

And so what you have is, you're getting the benefit of the signings; they're coming in.

The losses in the business are at typical levels, so they haven't moved up significantly at all.

But the underlying economy -- when we came into this planning year, we thought we would see a 2% to a 4%, with the hope that we were going towards 4% in the US business.

And we are, quite frankly, from an economic -- as a general macroeconomic -- closer to 2%, 2.5%, as we sit here today.

A lot of words to say, yes, I'm comfortable that the resources adds are delivering the merit that they were justified on.

I'm not comfortable with the broader underlying business performance in certain sectors.

So, think of oilfield services.

Simon may want to add some more color on some of the sectors that are more --

Yes.

Great, John.

And the only thing I was going to add, Don, is -- of course, when we show you the negative 2% volume for US/Canada, that's across the spectrum of products.

And as we mentioned on the comments, that's really driven by the helium supply challenges.

In fact, if you take a look at our LOX/LIN business in US/Canada, it's up modestly versus prior year.

It's also up sequentially.

So, as John said, we're starting to see the benefit of some of these new contract signings the team is bringing in.

And, John, a portfolio follow-up.

You haven't talked much about Performance Materials, but that's not really a core gases business.

I know it's been attractive financially in the past.

But wouldn't you think that there is a higher value owner of that business out there, and that you could use the funds to pay down debt, or do something else for shareholders?

Well, Don, as I mentioned earlier in the call, I feel comfortable about the portfolio we have today.

That statement is inclusive of Performance Materials.

Frankly, it adds value to the shareholders.

And I really believe that we are delivering and are operating as a high-value owner of that business today.

Thank you.

David Begleiter, Deutsche Bank.

Thank you.

Good morning.

John, Air Products' peers used to talk about industrial gases growing at a multiple of GDP, maybe 1.3, 1.5 times.

Has that multiplier -- or IP -- has that multiplier compressed over the past few years?

I think -- that is sort of an all-in average, if you will, that's going to really be a function of the maturity level of the economies that you are growing in.

And so if you were to look at areas like Latin America, and you were to look at Asia during a trendline time versus some of the blips we've seen in the economic cycle, I think that multiple still holds pretty well.

Certainly, in the more mature economies of the world, it's at the low end of that.

And then if you go into a scenario where you're in Europe, where you have an economic decline, obviously there's very limited growth there; and, therefore, you're not going to get that.

So that's what -- you've got to aggregate the different economies of the world to come to that.

As well as the drivers.

So, as John mentioned before, that's a high-level statistic over a long period of time.

There are fundamental drivers that aren't directly correlated with GDP or manufacturing output.

For example, oxygen for coal gasification; driving energy independence in China; hydrogen for cleaner fuels.

Those sorts of drivers are things that are not directly cause and effect to manufacturing output or GDP.

That's helpful.

Thank you.

And, Scott, just on the backlog, what was the actual backlog at quarter-end?

And given the number of projects coming onstream, should that be lower by year-end?

So, $3 billion was where we were at the end of this quarter, and it's lumpy.

So as projects come in and come out, it might be -- I don't see a substantial change by year-end.

Maybe down a little bit, as we process through some of the projects in there.

But also, of course, depends on the wins, and we feel good about some opportunities that we're pursuing as well.

Thank you.

Mike Harrison, First Analysis.

Hi.

Good morning.

You mentioned some LOX/LIN pricing pressure in both Europe and Asia.

I was wondering if you could maybe give a little bit more color around what's driving that.

Could it worsen?

And maybe just talk in general terms about LOX/LIN supply and demand dynamics, and the competitive environment that you're seeing across Asia, Europe, and North America.

Yes, good question, Mike.

And I think it's important to frame this.

So, what we are not saying is we've seen a step-change or anything like that in competitive price pressure.

But I think, as you look at the different regions, particularly if you look at a region like Asia, there's clearly some extra capacity in the ground for the industry right now.

So, I think what we're just trying to help you appreciate is, we are seeing a slight increase in competitive pressure.

I would say you tend to see that more on new business.

So it's not so much that we are seeing competitive pressure on existing business, but new business growth is eagerly looked for by most of the companies.

So that's probably the case in Asia.

Again, in Europe, we're not signaling any step-change here, but a little bit more pressure on the LOX/LIN.

As we said, we have -- the team is doing a great job on new contract signings.

And traditionally, those do come at a slightly lower price than the base business.

In North America, we talked about we are getting positive price.

You saw the price increase announcement we that we put out last week.

We believe that that makes sense, and we can continue to earn more price increases, recognizing that we have seen power and distribution cost increases as well.

And can you talk in a little bit more detail about some of the higher costs you're seeing that is driving you to push a little bit harder on the Merchant pricing?

Are those just US costs?

And as you look out a couple of quarters, are you still going to be playing catch-up on costs?

Or do you think you should be covered if you get the traction that you are looking for?

Well, it's a good question.

And I think you appreciate that while we put that increase out and certainly that triggers a discussion with our customers, really our pricing decisions are made on a customer-by-customer basis.

So we take a good, hard look at the economics and the profitability of a customer, and make a decision about what we want to do from a price standpoint.

Again, I would say primarily in the US, which is what the price increase announcement was referring to.

Again, as I said, it was really power and distribution costs that we'll be hoping to catch up on.

And sticking with the North American Merchant market, can you talk a little bit about how volumes were trending during the quarter?

It sounds like, if we exclude what's going on with helium, and just look at LOX/LIN that, net-net, it was flat to maybe slightly up during the quarter, year-on-year.

Presumably January was pretty strong, and February weakened.

What have you been seeing over the last two months or so?

Well, that's a good question.

And, again, as we said, overall for the quarter we were up slightly.

I don't think we saw anything significantly different as we went through the three months of the quarter.

So it was fairly consistent, relative to last year.

All right.

And last question is just on the Tonnage business and the hydrogen spot sales that were pretty strong last quarter.

You didn't expect those to be sustainable into this quarter.

Can you talk a little bit about what spot activity looked like?

And, in particular, how the Gulf Coast pipeline was operating during Q2?

So, I think from a strategic point of view, that investment has demonstrated its worth in the first couple of quarters that it's been operating, whether it be from the standpoint of the spot volumes, the efficiencies, or the productivity or cost gains that we can get.

The biggest issue probably in Q2 was a number of significant turnarounds of our customers' facilities, combined with a couple of unexpected outages at two important customers that gave, frankly, the whole opportunity to sell more hydrogen -- less of an opportunity; I didn't quite phrase that right.

But you had less of an opportunity because you had some of the biggest sources -- or users -- some of the biggest customers down, either because of scheduled turnarounds or unscheduled turnarounds.

But if I were to step back and say, from a strategic point of view, has that created a differentiated competitive position for us?

Absolutely.

And does it give us the opportunity to continue to drive productivity efficiency and spot sales?

Also, absolutely.

I agree.

I think we have time for one more question.

All right.

Thanks.

Mike Sison, KeyBanc.

Good morning, guys.

Two quick ones.

In terms of your outlook for Tonnage new projects coming in this year, I think it was $0.25 to $0.30.

Is that the same?

And just curious how much of that came in the first half; and I would imagine the remaining is pretty visible to you.

Yes, so -- Mike, this is Scott.

So we do see it still in that range.

Probably with some of the projects that had been deferred by a quarter or so, maybe trending towards the low end of that range, but still in that range.

And I would say, while we have seen some of it, it's going to be more towards the back half of the year as opposed to the first half.

Great.

And then your outlook for Merchant for the second half of the year -- you noted that it would be better in the third versus the second on a sequential basis.

But will you be able to generate some volume growth?

Is that the assumption for the second half?

Or is it still going to be kind of tough to do that in this environment?

So we are assuming that -- recall that in the first half of a year, there's more holidays.

You've got Christmas in Q1; you've got Lunar New Year in the second quarter.

So as we move into the second half of the year, in general, we have a stronger Q3 and Q4, let's call that seasonality.

And then on top of it, we're also anticipating a sequentially improving economic environment, both of which will drive volume increases, as well as the impacts from our new signings coming onstream.

Great.

Thank you.

This is John, just following up with a very quick wrap-up.

I wanted to just make the point again that we do have a strong backlog of projects with numerous opportunities for growth in those projects.

We have significant leverage on our existing assets.

That leaves us well positioned for a recovery.

And we remained sharply focused on productivity, improving our core businesses, and delivering on our cash priorities.

You'll have the opportunity to go to our website for a replay of this call, beginning at 2 p.m.

today.

And I'd like to just thank you on behalf of the management team for joining us and having a great day.

Thank you.

That does conclude today's conference.

We thank you for your participation.