Air Products and Chemicals Inc (APD) 2014 Q2 法說會逐字稿

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

(Operator Instructions).

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

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

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

Your participation indicates your agreement.

Beginning today's call is Mr. Simon Moore, Director of Investor Relations.

Mr. Moore, you may begin.

Thank you, Derek.

Good morning, everyone, and welcome to Air Products' second-quarter 2014 results teleconference.

This is Simon Moore, Director of Investor Relations.

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

John will make a few opening remarks.

Scott will review our results and update our outlook.

And I will provide perspective on each of our operating segments.

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

Please limit yourself to one question and a follow-up.

We issued our earnings release this morning.

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

Please go to airproducts.com to access the materials.

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 this slide, and at the end of today's earnings release, explaining factors that may affect these expectations.

Now, I will turn the call over to John.

Thank you, Simon, and let me also wish everyone a good morning.

We appreciate you joining us on the call today.

Please turn to slide number 3. The bottom line is, we continued to deliver on our commitments during the second quarter.

Earnings are within our guidance range, despite a $0.03 to $0.04 negative impact from adverse weather in the United States and Canada; which, to be clear, we expect to recover the effects of in Q3 and Q4.

We are executing on the projects in our backlog.

We brought onstream two major projects in our pipeline networks.

One is the new hydrogen plant in Louisiana, supporting the world's largest hydrogen system in the United States Gulf Coast.

And the second is a new nitrogen plant in the Tainan Science Park in Taiwan, supporting some of the world's leading semiconductor manufacturers.

We are driving asset loadings with strong volume growth in Merchant and Electronics & Performance Materials.

We continue to deliver on our cost reduction programs.

We were on track and seeing the savings from the program we announced last year, and we raised the dividend by 8.5%, making this the 32nd year of consecutive increases.

However, we can do more.

We need to continue to improve our productivity and the results from higher asset loadings, and we are aggressively managing price and costs.

Air Products' management team remains committed to driving increasing shareholder value.

The investments we have made over the past several years, the strength and position of our portfolio, and our ability to execute, going forward, will drive a very positive future for Air Products.

I also realize many of you are interested in an update on the progress of the search for a new CEO.

As I shared with you previously, the Board is working with an executive search firm to find the right high-quality candidate who has the skills and expertise to take our Company forward.

While I am purposefully not involved in that process, I know that there has been significant, productive activity.

And I remain confident that we will find the right leader for Air Products within the expected timeframe we previously shared.

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

Thanks, John.

Turning to slide 4, let me now take you through our fiscal Q2 results.

For the quarter, sales of $2.6 billion were 4% above prior year, on higher energy pass-through and stronger volumes, primarily in our Merchant Gases and Electronics & Performance Materials segments.

Underlying sales were up 2%, excluding the polyurethane intermediates, or PUI, business.

As we have mentioned previously, a significant number of our Tonnage Gases customers had scheduled outages this quarter, impacting our volumes.

Sequentially, overall sales increased 1% on higher energy pass-through.

Underlying volumes were 1% lower, primarily due to the impact from Lunar New Year, which more than offset the seasonal upturn in our performance materials business.

Operating income of $385 million decreased 1% versus prior year, and strong results in our Electronics & Performance Materials and Equipment & Energy segments were more than offset by lower Merchant and Tonnage Gases results.

Tonnage was impacted by the customer outages I just mentioned, and Merchant was affected by the unusually harsh US/Canada weather, which impacted power costs and our operations.

As John said, we expect to recover the weather-related costs over the next two quarters.

Our operating margin of 14.9% declined 80 basis points versus prior year, as the positive contribution from higher volumes was offset by the higher costs and the dilutive effect of higher energy costs pass-through.

Net income and diluted earnings per share were 2% and 4% lower, respectively, versus last year.

Our return on capital employed declined 120 basis points to 9.7%, as a result of higher capital employed, lower earnings, and the Indura acquisition.

This remains well above our 8% cost of capital.

I want to remind you that the new projects we are developing, executing, and operating will be accretive to ROCE over the next few years.

Turning to slide 5, you can see an overview of the factors that affected this quarter's performance in terms of earnings per share.

Our continuing operations EPS of $1.32 decreased by $0.05 versus last year.

Volumes increased EPS by $0.12, driven by the strong performance in our Electronics & Performance Materials and Equipment & Energy segments.

Volumes were also higher in Merchant Gases.

Pricing, energy, and raw materials, taken together, decreased EPS by $0.07, due primarily to higher variable cost in Merchant and Electronics & Performance Materials, including the impact of weather on power costs.

Net cost performance was $0.04 unfavorable, as higher costs, primarily due to the planned tonnage maintenance outages and inflation, offset the benefit of our 2012 and 2013 cost reduction programs.

The impact of the PUI business exit was about $0.03.

Equity affiliate income was down about $0.03, due mainly to weaker emerging market currencies and some one-time items.

In general, the underlying business performance remained solid, and we expect equity affiliate income to rebound next quarter.

Lower interest expense contributed $0.01.

A slightly lower tax rate and non-controlling interest together contributed $0.01.

For FY14, we expect our effective tax rate to be approximately 24%, unchanged from last year.

And, finally, higher shares outstanding reduced earnings per share by $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 6. Overall, the Merchant Gases segment had a challenging quarter that included the negative effect of the adverse winter weather in US/Canada.

However, we see this as a timing issue, and expect to fully recover those lost profits in Q3 and Q4.

We have a robust set of actions in place that we are confident will drive improvement in this business.

Merchant Gases sales of over $1 billion were up 4% versus last year, on 4% higher volumes.

All regions showed positive liquid oxygen, nitrogen, and argon volumes, but this was partially offset by lower helium volumes globally, due to supply challenges and continued packaged gas demand weakness in Europe.

Sales and volumes were down 1% sequentially, due to economic weakness in South America and the Lunar New Year slowdown in Asia.

With regard to helium, we continued to see challenges from reduced feedstock availability, particularly driven by low LNG production levels in Algeria, and the continuing decline in crude deliveries from the US government.

Our new helium plant in Wyoming has produced some product, during a short period, of acceptable feed gas supply.

We expect to ramp production and begin exporting product this quarter, as our supplier lines out their gas processing plant.

We are just beginning to see an increase in crude from one of our existing US suppliers, as a result of working with them to expand their natural gas pipeline collection system.

And our Colorado facility is on schedule for FY15.

We expect this additional supply to roughly offset the declines from the US government over the next year or so.

Merchant Gases operating income of $143 million was down 15% versus prior year and sequentially.

Segment operating margin of 13.8% was down 300 basis points compared to last year, and down 230 basis points sequentially.

There were a number of factors that negatively impacted profits despite volumes being up.

To be clear, additional volume that improves loading on our existing facilities has, in general, been consistent with the 30% to 40% incremental operating margins we have shared with you in the past.

While we are pleased with our EPCO CO2 acquisition -- and this is a profitable business -- in the first year, no new investment would show incremental margins versus the prior year.

Going forward, loading of existing EPCO assets will provide similar incremental margins as the rest of our liquid bulk business.

In China, the pricing dynamic, new capacity, the economy, and the wholesale market, limit incremental profit growth.

We took actions to recover the US/Canada weather-related costs in Q2, and expect to fully recover the net $0.03 to $0.04 impact by the end of the year.

In addition to this weather impact, we continue to see price versus variable cost challenges, and we did see fixed cost inflation.

And, finally, last year, we shared that we had a $0.02 positive impact from an asset sale.

Now let me share a few examples of specific actions we are taking to drive improvement in the business.

The team is driving China liquid and Europe packaged gas volume improvements, in part through enhanced sales incentive programs.

We are focused on delivering productivity benefits including product swaps; power management; distribution optimization and efficiently upgrading and replacing older plants; and, of course, recovering the US/Canada weather impact through pricing.

We are confident these programs will improve profitability going forward.

Now let's take a look at the Merchant business by region.

Please turn to slide 7. In US/Canada, sales were up 11%, on 6% higher volumes and 5% higher pricing.

Despite the difficult weather conditions, liquid oxygen/liquid nitrogen volumes were up 4% on oilfield services, food, and metals market strength.

We saw positive volume contribution from the EPCO acquisition, but helium volumes were down due to supply limitations.

Capacity utilization remains in the upper 70s.

Both helium and LOX/LIN pricing were positive, and we will continue to work hard to recover the Q2 weather impact.

In Europe, sales were up 2% versus last year due to currency, as both volumes and prices were down 1%.

LOX/LIN and LAR volumes were positive, but were offset by lower helium and cylinder volumes.

LOX/LIN volume growth was strong in Central, Northern, and Southern Europe, with the food, metals, and medical market showing strength.

Construction remains weak, and cylinder volumes were down across the continent.

Overall pricing was down slightly, as positive helium pricing did not fully offset negative liquid products and cylinder pricing.

And LOX/LIN plant loadings remain in the high 70s.

In Asia, sales were up 6% versus last year, on 6% higher volumes.

LOX/LIN volumes were again up double-digits across the whole region and in China, while helium was down on supply limitations.

Plant loadings remain in the mid-70s, with capacity additions roughly matching the volume increase.

Pricing was down in the LOX/LIN and LAR business, particularly in China, driven in part by the wholesale market.

Lower prices and higher variable costs impacted margins.

Helium pricing was up.

Let me provide a little more insight into the China market, where the liquid oxygen, nitrogen, and argon business has a slightly different dynamic.

First, as manufacturing growth and resultant merchants' demand growth over the last few years has been below expectations, there is capacity available across the industry.

We expect China's strong underlying manufacturing growth to absorb this capacity, but it will likely take a few years.

In 2014, the market is still absorbing new capacity additions from project decisions made a few years ago, but we have not approved any new merchants' capacity in China in the last 18 months.

Second, China has a wholesale market structure that doesn't exist to the same degree in other regions.

Although the outsourcing, or on-site model, is increasingly popular, traditionally large volume customers would buy and operate their own plans.

In the case of steel mills, many also have their own liquid capacity.

When the steel mill is running hard, they use all their own capacity and sometimes buy additional product from the market.

When steel demand is weaker, and the mills are not running as hard, they often export product into the wholesale market.

Where we have capacity to sell, we are using the wholesale market as an outlet for product, even at lower prices, as the wholesale market doesn't lock in the lower prices for a long period of time.

As a result of the combination of available capacity and a larger wholesale market, we are likely to continue to see volume and price dynamics in China.

We continue to see incremental margins in the context of additional load on existing facilities in the range of 30% to 40%.

However, new capacity additions aren't incremental; and, combined with the price pressure, will prevent us from seeing those incremental margins in China in the near-term.

We're taking actions in a number of areas to manage this situation.

In terms of demand creation, while our volumes are impacted by manufacturing activity, we also have the ability to use our applications expertise to help our customers improve their operations, while creating new demand for industrial gases.

In February, we announced we had signed more than 20 contracts with recycled copper manufacturers in China, providing oxygen, our patented burner, and fully integrated control equipment.

Compared to the previous air/fuel solution, using oxygen improves productivity and material qualities, while reducing emissions and fuel consumption.

We are also optimizing capacity in regions where it makes sense.

While we are reviewing each plant in our system, we would not expect this to result in a significant impact.

Turning to Latin America, as a reminder, the segment results include our wholly-owned business in Brazil and our majority-owned business, Indura.

While our market-leading equity affiliate joint venture in Mexico is not in the segment results, our Mexico business continues to show volume growth, driven primarily by nitrogen for enhanced oil recovery.

As reported in the segment, underlying sales were up 5%, on 3% higher volumes and 2% higher prices.

There was a negative 14% impact from currency, primarily from the Chilean peso.

Indura volumes and Brazil LOX/LIN volumes were up slightly, as the region experienced slower economic growth than expected.

LOX/LIN plant capacity utilization remains in the mid-70s, and pricing was up, but still under recovered inflation.

Please turn to slide 8. As expected, Tonnage Gases saw both the maintenance expense and negative volume impact from the higher level of planned outages, as we do required maintenance work on our plants during our customers' outages.

Base demand, including hydrogen on the US Gulf Coast system, remains strong.

Tonnage gases sales of $840 million were up 4% versus last year.

Gases volumes were down 3%, as strong demand on the US Gulf Coast hydrogen system continued, but was more than offset by maintenance outages and lower Latin American volumes, due to our prior-year contract termination.

Lower PUI volumes impacted sales by 5%, while higher energy pass-through added 11%.

We fully exited the PUI business at the end of Q1, but still see the effect in prior-year comparisons: about $40 million of sales, and about $0.03 of profits.

For the full year, we still expect PUI sales down about $140 million, and about a $0.10 EPS headwind.

Excluding the effect of the PUI business exit, operating income was down 3% versus prior year, primarily due to the impact of the planned maintenance outages, partially offset by the positive impact from higher natural gas prices.

We saw about $0.05 for maintenance costs, and expect to continue to see an elevated level of maintenance activity in Q3, associated with non-refinery customers on the US Gulf Coast and a few outages outside the US.

Air Products continues to profitably grow the world's largest hydrogen plant and pipeline network in the US Gulf Coast.

We recently brought onstream our new world-scale hydrogen plant in St.

Charles, Louisiana, in part to support Valero's St.

Charles refinery.

And just last week, we announced a long-term agreement to utilize the hydrogen-rich off gas from Enterprise in Mont Belvieu, Texas, to provide additional capacity for our pipeline customers.

A recent Gulf Coast refinery contract expansion, with increased hydrogen supply of potentially up to 50 million standard cubic feet a day, is an example of continued demand growth from our customers.

Both of these facilities will be fully integrated with our hydrogen plant and pipeline network.

Please turn to slide 9. The Electronics & Performance Materials segment delivered a very strong performance this quarter, with both businesses showing volume growth and robust leverage to the bottom line from our cost improvement actions.

Segment sales of $592 million were up 8% versus last year, driven by 9% higher volumes and 1% lower price.

Versus prior year, electronics sales were up 6%, primarily driven by higher delivery systems equipment sales.

Sales growth in advanced materials was offset by the impact of product exit through improvement actions in process materials.

The strength of our delivery systems business reflects our leadership positions with key customers.

However, given the lack of new fab projects currently being developed, we expect activity to normalize to more historical levels later this year.

Sequentially, electronics sales were down 3%, on the expected Asia seasonality.

Performance materials sales were up 10% versus last year, as we saw double-digit growth from stronger demand, and share gains across most product lines and growth in all major regions.

Autos, protective and specialty coatings, and oilfield continue to be strong.

Sequentially, sales were up 9%, in line with stronger demand and expected seasonal improvements.

Operating income of $107 million was up 38%, and operating margin was up 400 basis points to 18.1%, as leverage from the higher volumes was expanded with strong cost performance.

We remain on track, and are delivering on our business restructuring and cost reduction programs.

Pricing was relatively stable across both businesses, reflecting a strengthening in the electronics materials market.

Complementing our previously announced bulk gas supply to Samsung in Xi'an, China, we announced the contract award for bulk specialty gas and chemical delivery systems equipment at the same location, to support Samsung Electronics' largest-ever overseas investment.

We also brought onstream the first phase of our expansion in the Tainan Science Park in Taiwan, home to a number of world-scale semiconductor manufacturing facilities.

We have been successfully supporting key customers in this science park for over 15 years.

Now please turn to slide 10.

The Equipment & Energy segment had another strong quarter, as our LNG leadership position continues to drive profit growth.

Sales of $110 million were down 11% versus prior year, while operating income of $23 million was up 11%.

More higher-margin LNG projects and less lower-margin ASU activity drove the profit increase.

The backlog of $338 million is relatively stable.

In general, we continue to see a high level of project development activity, with a number of awards signed, but not yet announced.

Now, I will turn the call back over to Scott.

Thanks, Simon.

Now please turn to slide 11, and let me provide you a brief summary of our outlook.

Economic activity in the second quarter of 2014 was in line with our expectations in most regions.

Given current economic conditions, we continue to expect modest economic growth in the second half of fiscal 2014.

Globally, for the regions we operate in, we are maintaining a manufacturing growth forecast of 2% to 4% for our fiscal year.

In the US, some policy uncertainty has been reduced, but harsh winter weather conditions restricted manufacturing growth in January and February.

We expect the slowdown to be temporary.

Although still weak, conditions in Europe have been improving.

Austerity programs, restricted credit, and high unemployment remained the largest obstacles to the European recovery.

We expect stronger manufacturing growth for Asia in FY14, despite a slight deceleration in China.

Improving manufacturing conditions in Japan, Singapore, South Korea, and Taiwan are driving stronger growth in Asia.

And in South America, manufacturing activity continues to be below expectations.

The easing of demand for global commodities, particularly from China, has adversely impacted countries, including Chile.

We expect the electronics market will grow in 2014, but likely at a slower rate than anticipated.

We continue to expect FY14 capital spending to be approximately $2 billion, and our backlog at the end of the quarter remains at about $3.5 billion.

You can see an updated list of our major projects in the appendix, slide 14.

Based on our current outlook for the year, our FY14 EPS guidance range is now $5.70 to $5.85 per share for the year.

Our guidance for Q3 is for earnings per share of $1.42 to $1.47, based on the following positive factors: the absence of the Q2 weather impact, and the recovery of a portion of that in the Merchant business; volume improvements across the businesses, including new plant onstreams; higher equity affiliate results; and further progress on our cost reduction initiatives.

Now let me turn the call back over to John to wrap up.

Thank you, Scott.

Please turn to slide number 12.

In conclusion, I want to assure you that our management team and I remain focused on the strategic priorities we set out at the beginning of this year: executing on our project backlog, driving productivity and cost reductions, winning profitable business in the marketplace, and delivering profitable growth from our existing assets.

We are confident these actions will generate long-term shareholder value.

Thank you, and now we are ready to take your questions.

(Operator Instructions).

PJ Juvekar, Citibank.

A couple of questions.

First of all, can you quantify the weather impact?

And then if it's increased costs, et cetera, because of weather, how do you plan to recover that in the second half?

PJ, this is Scott.

So, again in the second quarter here, we saw higher costs, particularly in the Northeast and the Midwest, driven by power, on the order of $0.03 to $0.04 per share.

And we've recovered some of that during the quarter.

But going forward, we would expect to have about a $0.02 recovery in the third quarter, and again a $0.02 recovery in the fourth quarter.

So overall for the year, a $0.03 to $0.04 headwind in the second quarter, and tailwinds of $0.02 in both Q3 and Q4.

Okay, thank you.

And secondly, can you update us on the [sixth] coal-to-chemicals project that you are working on in China?

The timing and the returns that you expect, especially in light of your cautious comment on the margin market in China.

This is John, PJ.

Those projects are tracking with what we originally expected from a return point of view and from a schedule point of view, within the context of recognizing that these are very large projects.

None of these -- well, few of these projects have liquid of any major amount on them.

Sometimes there's a little bit of co-produced liquid, but these were not justified or built on the basis of the margin business.

These were straight up, on-site projects that had to earn a return on the on-site return, and pricing to the customer, and the risk profile of those projects.

Thank you.

(Operator Instructions).

Robert Koort, Goldman Sachs.

I wonder if you could talk a little bit on the electronics side in your margin.

It's starting to look pretty attractive again.

Where are you in terms of the realization of some of the cost cuts you've done there?

And then also could you maybe give some help on the equipment sale?

I know those tend to be lumpy.

How much was that accretive to the margin during the quarter?

Right.

So, Bob, this is Scott.

As you pointed out, we've got a variety of actions underway in the electronics, both from a profitable volume growth, as well as restructuring asset and other costs.

And those actions are progressing very well.

As you also pointed out, there was a bunch of -- a fair amount of delivery systems that we had in this quarter.

And while we would expect to continue to see them going forward, not at the rate that we saw in the second quarter.

The electronics team has done a nice job repositioning that portfolio, taking the actions that they had committed to, and improving the margins.

Recognizing I would not expect to see going forward the same level of margins in the second half of the year that we saw in this quarter.

But that said, continue to see good execution on their part, and really turned that business around.

And I know when you guys addressed some of the capacity reductions for ammonia and NF3, you mentioned lackluster photovoltaic demand trends.

But it seems like maybe things are starting to get better there.

So is there any risk that you maybe cut capacity just as things get better?

Or do you have sufficient ex-US capacity to meet that demand growth?

Just a reminder, we've gotten out of the silane, and so it was small to begin with; and so, there's not really any impact there from that market.

Thanks.

David Begleiter, Deutsche Bank.

Just on tonnage, it looked like it should be a better second half of the year and a much better 2015, given these new projects coming onstream and a few headwinds in [the first there].

How should we think about that earnings progression in Q2 -- second half versus first half this year, and then 2015 versus 2014?

So, I'll take the top level here, and then Scott can give you a little bit more details.

But I think you hit it spot-on -- we've been saying for a while that the project backlog, as we execute that and bring that in to the portfolio, is going to drive earnings into 2015 in 2016.

And as you well know, something like 85% of that $3.5 billion backlog is in the tonnage sector.

As we look to the second half of this year, two real key things are happening here, is you're going to forgo some of the -- you're going to get beyond the maintenance outages that hit us in Q1, Q2; they will be in Q3, but largely back to a fairly low level in Q4.

And then we'll begin to see the benefits of some of the new plant startups in Q3, and then accelerating in Q4.

Right.

And, John, just on the CEO search, what's taking the Board so long?

It's been now seven months since your announcement late September.

It shouldn't be this long.

What's preventing the Board from making a decision?

It probably can't be helpful to your organization, not knowing who the next leader will be.

So why is it taking so long to name a new CEO here?

Well, we could probably debate what long is.

But that aside, this Board takes -- and the search committee -- takes this very, very seriously.

And they are really focused on making sure that they get the right candidate in this role.

I know that they completely understand their fiduciary responsibilities and the commitments we've made from a timing point of view, and they are tracking to that.

Thank you very much.

David, this is Scott.

Let me take you back to the first question about the second half of the year, and I'd like to broaden it beyond tonnage.

We look at the first two quarters, and what we've delivered, and compare that to our outlook for the full year, and recognize there's a considerable step-up in the second half versus the first half.

If we step back and take a look at what are the drivers of those things are, I'd put about two-thirds of those drivers being specific things, beyond just general base business improvement.

Let me give you some examples, and let me give you some numbers.

So when we looked at the second half versus the first half for the full year for the full Company, weather in the second half versus the first half -- because we don't have any more inclement weather projected in the second half, and we do have the recovery of those costs that we saw in the second quarter -- about $0.07 to $0.08 improvement, second half versus the first half, driven by weather.

We're going to continue to execute on the cost reduction actions.

Second half versus the first half would be on the order of about $0.05.

Maintenance, like we've talked about, is going to decline in the second half, particularly in the fourth quarter; there will be a reduction.

Second-half maintenance expense versus first-half, maybe $0.04 or $0.05.

And then a considerable step-up from new plants as we bring the projects onstream, somewhere on the order of, call it, $0.12 to $0.14.

And that leaves about one-third of the step-up in the second half of the year, driven by base business improvement and general increases.

So I just wanted to take you through that, and give you some numbers and specifics around the drivers of our outlook.

Very helpful, thank you.

Thank you, Scott.

Vincent Andrews, Morgan Stanley.

I just wanted to follow up on the cost recovery in the second half of the year, you said it's related to -- largely related to power.

What is the mechanism by which you actually get that back from your customers, such that you couldn't get it back in the -- sort of in real-time?

It kind of feels like spilled milk to me, at this point.

Right, so there's various mechanisms.

Whether that's in the form of formulas, as it works its way through various indices or surcharges, or just straight price increases; making sure that we're taking the appropriate actions, given the current situation with the customer, and the supply situation in that region.

Okay.

And then just on a follow-up, as well, to the succession or management issue -- there's a fair amount, as I'm sure you're aware, of speculation about what could change in the Company when new leadership comes in.

So I'm going to assume that's also the case within the Company.

And what, if anything, have you been able to do to keep everybody focused and executing on your plan?

Or is it at all a concern for you?

Well, I think it's not a concern; and, in fact, I'm a firm believer, when you look at certain external events, whatever they are, you really sit down with your leadership team and say, look, our job is X. And in this case, our job is running this company and delivering on the commitments that we've made to our shareholders at the beginning of this year.

And I believe that we're doing that.

And to the extent that people aren't on board with that, then there's another dialogue with them.

But from my perspective, making sure that there's no lack of clarity and/or accountability around what we need to do -- we're not going to influence -- they're not going to influence who the new CEO is.

That's the Board and the search committee's responsibility to do that.

It's one of the prerogatives of the Board; one of their key issues is on succession.

And so it can be an interesting dialogue, but not one that is worth spending a lot of time on.

And I'd be (technical difficulty).

Okay.

Thank you very much.

Kevin McCarthy, Bank of America Merrill Lynch.

Yes, good morning.

I wanted to probe a little bit deeper on your Merchant Gas segment margins, which declined about 300 basis points.

I heard quite a few different issues there.

I think I scribbled down five different ones.

Trying to get a sense of how much of the decline might be attributable to transitory issues, such as the weather that you discussed, versus more durable issues.

It sounded, for example, like the China pressure might extend for a while.

Is there a way to disentangle the margin delta in that sort of simple fashion?

Yes, Kevin, I'm going to let Scott give you the details.

But I want to just be really clear to you and our other shareholders: I and the management team and the Board are not happy with the performance of this segment.

And I've been working very closely with Corning Painter, who took over this segment in the early part of Q1, and with his leadership team.

I think he has a really good set of actions that vary, as you acknowledge, by the different geographies and business environments that we're operating in.

But I don't want there to be any confusion that this level of margin performance in this business is not acceptable, and that we're absolutely committed to getting the margins in this business back on track to where they ought to be, and where they have been in the past.

Scott can give you a little bit more granularity around the specifics to your question, but I wanted to really reinforce that point.

Thanks, John.

So, Kevin, let's talk about operating margin versus prior-year for the Merchants segment: down 300 basis points.

Of that, call it, 100 basis points is the weather impact.

And again as we talked about, that was costs seen in the second quarter that we are committed to recover over the course of Q3 and Q4.

Then we also mentioned that there was a prior-year sale; let's call that impact -- that's a one-time item that doesn't repeat -- let's call that impact about 50 basis points.

Also, then, the dynamic that was talked about in Simon's comments around in China, around the wholesale market, the pricing environment, and the fact that we're bringing on new capacity.

Let's call that another 50 basis points.

And then the balance is what John was talking about: costs in excess of productivity actions of about 100 basis points, that we need to make sure that we're taking the actions to drive improvement going forward.

I hate to jump back on this question, but just to reinforce the point: we're answering the specifics because of the question.

They aren't acceptable, in my views.

And we've got to be, and are focused on, not having this dialogue on this business going forward, because we're delivering on what this business is capable of.

Well, I appreciate the color.

It's very helpful.

If I can switch gears to the tonnage segment, you had outages, as you mentioned, in the quarter.

It sounds like there will be some, as well, in 3Q.

What is the sequential volume differential that you expect looking ahead to 3Q?

How much of a pickup might there be as we move forward?

This is Scott, Kevin.

So, Q3 versus Q2, about flat.

A similar sort of level of maintenance, with the fourth quarter seeing a reduction of maintenance expense; and, of course, the corresponding impact on volumes, as well.

Okay.

Thank you very much.

Just to clarify, Scott.

That was a comment about the outages impact on volume.

Not a more general comment about volumes.

Yes, thank you.

Perfect.

Thank you.

Don Carson, Susquehanna Financial.

Yes, a couple of questions.

First on Merchant, a lot of people have been talking about an economic improvement in Europe.

You've got a large Merchant presence in Europe.

I'm surprised that that wouldn't have offset some of that weather-related issues in North America.

So perhaps you could comment on that.

And then, secondly, are you still looking for $0.20 to $0.25 of EPS from new project startups this year?

And more importantly, how do you see that unfolding in 2015?

First -- Don, this is Scott.

So, first on the Merchant Europe.

We did see good volume growth in the liquid oxygen/liquid nitrogen.

The area that we saw the weakness was in packaged gases, and offset that, right?

Then your other question around $0.20 to $0.25 for the year -- yes, that is still our outlook.

And in terms of FY15, we haven't quantified what that's going to be.

But it will be higher than the $0.20 to $0.25, as we bring onstream these projects that are in backlog.

And again I will reiterate, that overwhelmingly these are take-or-pay contracts that don't have volume risk.

And, Scott, you talked about the drag on return on capital from the buildout of new projects.

And I know -- what about the drag on earnings?

I know depreciation alone is up about $100 million over the last couple of years; that's about $0.35 a share, on a full-year basis.

What other drags do you see on earnings as you -- in advance of starting up these new projects?

So I guess if I just take a step back and think about the levers that we have in order to drive earnings going forward.

So as we've brought on capacity in the past -- so we've talked about this -- we have existing capacity that can be leveraged.

This is the $1 billion or so of existing sales capacity that's already installed, and when brought onstream has a 30% to 40% incremental margin, given that we're already incurring the depreciation.

Then there's the projects that are in backlog that we've already talked about, and getting those executed on time and on budget also drive earnings growth.

And then execution and focus on productivity to more than offset the impact from inflation to, again, drive improvement to the bottom line and earnings.

Okay, thank you.

Jeff Zekauskas, JPMorgan.

Can you remind me when exactly Tees Valley comes on in 2015?

And what's the size of the PCEC in Weinan, China, oxygen facility that comes on in the fourth quarter?

We've talked about commissioning in Tees Valley 1 to start at the end of fiscal 2014.

But, frankly, that's just the beginning of the commissioning, so it will be coming online early in fiscal 2015.

And in terms of PCEC, I don't think we have quantified the size of it.

We are expecting that to be onstream here by the end of the year.

Okay.

And then if I could just make a suggestion.

Your maintenance costs seem to be large and volatile, quarter by quarter.

Perhaps you could disclose what they are, in that I don't think it would harm you from a competitive standpoint, and it might make the modeling of the divisions a little bit easier.

Thanks very much.

Thanks for your feedback, Jeff.

James Sheehan, SunTrust.

I just wanted to follow up on the CEO succession issue.

I understand these things do take some time, but maybe you could give us a little color on the process, and why does it take so long?

I am sensing some frustration among investors I talk to about the pace of the process.

Do you expect this to last weeks or months?

Or is going to last all the way through the current CEO tenure, as has been disclosed?

So, I said in my opening remarks, Jim, that the Board takes this very seriously.

And they are committed to the obligations and their fiduciary responsibilities that we disclosed earlier this fiscal year.

From a process point of view, what we've said that the past, the process is not that complicated in the context of the process, which is you've got to hire an executive search firm; you've got to come up with a list of viable candidates; you have to vet that list of viable candidates; and then you have to interview that list of viable candidates.

And that interview process is with the search committee, and then ultimately our full Board.

And that does take some time.

But having said that, we understand what our responsibilities are.

The Board understands what their responsibilities and commitments are, and they're executing to them.

Thank you, John.

Just another question on performance materials growth.

It has been very strong recently.

It seems to be broad-based.

Do you think that growth is sustainable here, and what gives you confidence that it will continue?

Well, I would just say, our focus in that business for a long time has really been to grow at 2 times the underlying growth in whatever market it's in, through new products that meet the technical, environmental, and performance needs of our customers.

And that team, in my opinion, has done a very, very good job leveraging their knowledge of the markets they are pursuing, the technologies and product offerings they have to play, and the customer base that's going to help them drive new products into the marketplace, and then broadly penetrate adjacent markets as well.

Thank you very much.

Mike Harrison, First Analysis.

If we could look at the margin performance in the Merchant business by geography, relative to that overall 300 basis point decline year-on-year, where have we seen margins weaken the most, and what regions have maybe been a little bit more stable?

This is Scott, Mike.

So, obviously the weather impact is the North America comment, right?

The Europe margin has been under stress; again, as I mentioned, due to the weakness in packaged gases.

But I also just want to reiterate that we're taking steps in that business to rightsize the organization, and make sure that we're focused on the end markets where we see long-term, profitable growth.

And then South America, particularly with Indura -- as I mentioned in my prepared remarks, that's been an area where the economy, frankly, has been below what our expectations have been.

But again, our acquisition in Indura was based off of an integrated gases, marrying the great business that they had from a packaged gases with our liquid bulk and on-site capabilities.

And so we're happy with that investment, and see growth opportunities going forward, even if we are at a current economic situation that is below our expectation.

And then in Asia, would we have seen margin weaker than that negative 300 basis points, or not quite as bad?

So, again, a little bit of a dip, for the reasons that Simon described during the comments, as well, around some of the pricing pressures, as well as the wholesale dynamics in that market.

Right, okay.

And then looking at the 6% volume growth number in the US and Canada, can you quantify how much of that was from EPCO?

I think it has been about 5% in the past couple of quarters.

And maybe comment more broadly, now that you've owned that business for a few quarters, how is that business trending?

Are you pleased with the acquisition?

And what has it done for your merchant capabilities, broadly speaking?

Right.

So, you're right, it has been in the 5% range or so, similar to what we've said in the past.

We're happy with the investment, and it's going well.

We're obviously going through the integration and going after the synergies associated with that acquisition, at the same time recognizing it's a nice complement to our offerings in CO2, particularly in the foods arena.

And we've already seen the impact and the synergistic opportunities, from an end market, of having that offering as well.

And then last question I have is just on tonnage.

And you've noted customer outages in the business creating pressure a few times, and it doesn't sound like the pressure stops here in the third quarter.

Over that time, we've seen volumes flat to declining despite new projects, despite the Gulf Coast pipeline coming onstream, and these trends and volumes have been detrimental to your returns as well.

Can you just maybe delve into a little more detail on what explains the volume performance?

And why are we seeing such volume pressure at a time when refineries and other customers on the Gulf Coast -- it would seem like they should be running about flat out right now.

Yes, so again, I'll just reiterate, Mike, that this is a high outage season, and that's why we're seeing the impact on the volumes; coupled, again, with the termination that we had in prior years, so be careful of the comparison point, but that's the main driver of the volumes.

But to emphasize, again, as we said is what's really important is the demand from our refining customers on the US Gulf Coast is strong.

We talked about a couple of new capacity additions that we're bringing on there, as well as some new business opportunities.

So we remain optimistic, and feel good about our position down there.

But I guess is, if we're talking about outages and having a seasonality around outages and maintenance costs, this quarter was bad; last quarter was maybe not quite so bad, but it was a factor last quarter; and you're pointing to Q3 as also being quarter-to-quarter flattish, or similar amount of outages.

So, again, getting to maybe Jeff Zekauskas's point, maybe we need a little bit more detail on exactly what the drag is each quarter, so that we can understand what the underlying performance looks like.

Yes, and I think Scott said we'll consider that comment when Jeff brought it up, and I appreciate you re-emphasizing it.

I think one of the things you've got to understand about this business -- and maybe we've got to do a better job explaining it -- is that you don't take an outage on every hydrogen plant every year.

And it just so happened that a greater number than typical, given the size of our hydrogen fleet, has occurred this year, in these quarters.

And so, point noted, about us being able to perhaps show some more light to that.

And we'll go back and think about how we do that.

All right, appreciate that.

Thanks, gentlemen.

John McNulty, Credit Suisse.

Just a quick question regarding the sequencing of earnings.

And you were pretty clear on the one half versus second half.

But if I look at your third-quarter guidance, the midpoint is kind of $1.44, $1.45.

That basically implies the fourth quarter has got to be somewhere in the $1.65, $1.66 kind of range.

That's a much larger jump than you've pretty much ever had, going from a 3Q to 4Q.

So what's driving that?

Is it the lumpiness of the projects?

Or how should we think about what's different this time around, versus past second-half sequencing?

So, John, thanks for the question.

The same fundamental drivers that I described in the second half versus the first half are true for the Q2 to Q3 walk; and, for the most part, the Q3 into Q4 walk.

So, again, just to reiterate -- about two-thirds of the increase is driven by specific items, as opposed to just broad-based general business improvement.

So, again, let's talk about the third quarter versus the second.

With the inclement weather impact that we saw here in the second quarter, $0.03 to $0.04, not repeating, and getting a couple cents recovery on price; that's going to be, call it, a $0.06 step-up.

Cost reduction efforts will continue, again at a stepped-up level, for a couple of cents.

Maintenance, as I mentioned before, roughly flat in the third quarter versus the second quarter.

And then we're going to start seeing even a bigger impact from new plants coming onstream.

And, again, the rest is going to be from just base business improvement.

And then again I'll point out that the other element is in the fourth quarter we will see a decline in maintenance, relative to what we've seen in both the second and third quarter, and we'll see a bigger impact of the new onstreams.

Okay, great.

Thanks for the granularity.

Mike Sison, KeyBanc.

John, given what you and Corning are working on, there was a time when you thought Merchant margins could be closer to 20%.

Do you still think that's an area of potential for the business, longer-term?

Absolutely.

This business needs to be a high-teens business on a global basis when it is at steady-state.

And I made that very clear to Corning, and I made that very clear to his leadership team.

We need to do that.

Now, I believe while -- and I want to be clear.

We gave you some granularity on what happened this quarter.

And I don't want anyone to walk away thinking those are excuses that if they happen, they happen.

But that's not how we can run this business.

And Corning and his team completely understand that, and are focused on returning it to the level of profitability that it's capable of.

Okay, great.

And then just in terms of China, can you give us your thoughts on where capacity utilization is?

Either for the industry or for yourself, just to give as a gauge of -- you talked it might take a couple of years to fill that up.

Yes, Mike, this is Simon.

So, as we shared with you, in Asia our overall LOX/LIN capacity utilization is in the mid-70s.

And I would say, on balance, it's not hugely dissimilar in China.

The slightly different dynamic you've got to appreciate is we are absolutely seeing good LOX/LIN volume growth in China again.

We are also, though, bringing on capacity additions.

And I'll just reiterate what I said earlier: these are capacity additions that we made decisions on a few years ago.

We have not made any decisions to add new capacity in the liquid business in China in the last 18 months.

So that's clear for us, and I think you're seeing it in the industry in a similar mode.

Okay, got it.

Thank you.

David Manthey, Robert W. Baird.

Just quickly back on the Merchant piece, where you were talking about weather, it's not so much the weather impact as it is -- I'm understanding this is a power increase -- that the cold weather led to higher natural gas prices, which led to higher electric power prices, which are your input in the Merchant business.

Is that right?

Yes, that's right.

This is Scott, David.

So, while there is some dislocation, the biggest driver of the weather impact that we saw in the second quarter was from power, including -- especially in the Northeast in the Midwest, where, on the increment, power is going to be -- the feedstock for power is going to be natural gas, and there was a big run-up in natural gas.

And so that's been -- that was the biggest driver.

So higher variable costs, or power costs, that we are committed to recouping here in the second half of the year.

Okay.

It sounds like you may have started taking action.

But given the fact that you're saying over the next two quarters, that won't hit a full run rate until sometime mid- this quarter, and then have a full impact the following quarter, correct?

Right.

So we saw a little bit higher costs in the second quarter.

We saw some of those costs that were recouped.

And that number that we gave you, $0.03 to $0.04, is net.

And now, as we to go forward, we're going to recover that.

A couple of cents here in the next quarter; and then we'd expect, again, $0.02 in the fourth quarter, then a flat Q3 to Q4.

And so, overall, it will be a scratch for the year; $0.03 to $0.04 of bad news seen here in the second quarter; $0.02 favorable in both Q3 and Q4.

Perfect, okay.

And then just last question.

Lower equity affiliates income, I believe you said that you expected that to rebound next quarter.

I'm just trying to understand, what is the dynamic that's going to make that improve next quarter, relative to this quarter?

Right.

So this quarter, there was some one-time in a non-ramp run rate items that were in there that won't repeat.

And so, and as I mentioned in my prepared remarks, the underlying performance in general in the equity affiliates is solid.

And so it's the absence of those non-run rate items that we are confident is going to see an increase in equity affiliate in third quarter.

Got it, okay.

Thank you.

Just to wrap up.

Thanks, Derek, and thank you all for tuning in today.

I just wanted to leave you with the thoughts that our focus on increasing shareholder value remains.

Our future prospects are strong, given our record project backlog and the significant leverage we have on our existing assets.

We're committed to delivering on the strategic goals that we set out for ourself earlier this year, and shared with you.

And I'd like you to -- thank you for joining us today, and have a safe and great day.

That does conclude today's conference.

Thank you for your participation.