Air Products and Chemicals, Inc. (APD) Q3 2013 Earnings Report, Transcript and Summary

Simon R. Moore - Director of Investor Relations John E. McGlade - Chairman, Chief Executive Officer, President and Chairman of Executive Committee M. Scott Crocco - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Robert A. Koort - Goldman Sachs Group Inc., Research Division David L. Begleiter - Deutsche Bank AG, Research Division Donald Carson - Susquehanna Financial Group, LLLP, Research Division P. J. Juvekar - Citigroup Inc, Research Division Kevin W. McCarthy - BofA Merrill Lynch, Research Division Laurence Alexander - Jefferies LLC, Research Division Michael J. Harrison - First Analysis Securities Corporation, Research Division James Sheehan - SunTrust Robinson Humphrey, Inc., Research Division Mark R. Gulley - BGC Partners, Inc., Research Division Vincent Andrews - Morgan Stanley, Research Division Ernie Ortiz Duffy Fischer - Barclays Capital, Research Division Basili Alukos - Morningstar Inc., Research Division Edward H. Yang - Oppenheimer & Co. Inc., Research Division

Good morning, and welcome to Air Products and Chemicals' Third Quarter Earnings Release 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.

[Audio Gap] welcome to Air Products' third 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, and good morning. Before we take you through the details of the quarter, I would like to make a few comments. While we did see signs of improvement, the quarter generally continued the pattern of weak economic growth and a soft electronics market. Despite this, our earnings did come in above the midpoint of our range. Our underlying volumes were flat versus prior year, excluding the impact of our decision to exit the Polyurethane Intermediates business. As we said last quarter, we expect this slow growth environment to continue for some time. Most importantly, we continue to stay focused on actions within our control. Last year's European restructuring is complete and delivering the full $60 million per year run rate benefit we expected. The integration of our Indura acquisition is proceeding as planned. And while early, the initial results of our EPCO acquisition announced last quarter are encouraging. Through the quarter, we remain focused on execution and continue to drive improvement through cost discipline and productivity. Further, we are confident our $3 billion project backlog, which is over 80% on-site/pipeline business with long-term take-or-pay contract terms, will drive earnings growth into the future. In our Merchant and Electronics and Performance Materials businesses, we are taking proactive steps to continue to improve the performance of the business today, and we see significant opportunity when the economy improves to load our existing assets at high incremental margins. As I mentioned on last quarter's call, we are actively assessing additional actions we can take that would result in improved margins and returns, and increase value to our shareholders. That process is ongoing, and we are making good progress. As a result of these new actions, we expect to take a charge of approximately $100 million to $150 million pretax, or $0.30 to $0.50 per share in our fiscal Q4, with savings beginning in the first quarter of fiscal year '14. Once fully implemented, we expect the savings to be of the same order of magnitude as the $60 million per year benefit we achieved through the actions announced in 2012. Our plan is focused on improving our cost position in those regions and businesses that are facing the greatest challenges from slower market growth. We will have more specifics to share with you about this on or before next quarter's earnings call. I want to be clear that these cost actions do not mean our assessment is completed. We are continuing to actively review additional opportunities available to us to further improve our operations and increase shareholder value, and we'll keep you updated on our progress. Finally, our cash priorities remain unchanged: invest in our businesses at returns that create increasing shareholder value; increase our dividend each year, which we've now done for 31 consecutive years; strive to maintain an A bond rating; and repurchase shares. Now let me turn the call over to Scott to review our results.

Thanks, John. Please turn to Slide 3. As we look back at this past quarter, manufacturing growth was weaker than expected when we developed our prior guidance. As a result, while we did see a pickup in our volumes versus the previous quarter, the improvement was modest relative to the seasonal uptick we typically see in this quarter. Let me provide you a few comments around what we are seeing. In North America, we continue to experience modest growth as the economy decelerates due to the impacts of higher taxes from the fiscal cliff and sequestration spending cuts. In Europe, the economy is worse than we expected and continues to contract versus last year despite some weak sequential growth during the quarter. In Asia, China continues to grow below trend line as the new government policy is focused on reforms in addition to growth. And the slower growth in China and the developed markets is impacting other emerging economies in Asia and South America. The electronics industry has remained soft with new fab construction delays, and the outlook for silicon processing remains below last year. Non-residential construction did not pick up during the quarter as we had expected, and this has impacted our Performance Materials volumes. As I mentioned last quarter, the LOX/LIN pricing environment in Merchant has become more difficult due to softer volumes, particularly in Europe and Asia, thereby impacting our ability to completely recover variable cost increases. While pricing was stable in North America, we were not able to fully recover power cost increases. Despite these challenges, and as John mentioned, we did deliver EPS above the midpoint of the guidance we provided in April. Let me now take you through our overall results. For the quarter, sales of $2.5 billion were 9% higher versus prior year, with acquisitions contributing 6% and energy and raw material pass-through adding 5%. 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 Merchant Gases and Equipment businesses were offset by lower volumes in our Electronics business. Sequentially, overall sales increased 3%, primarily due to seasonally stronger volumes in our Merchant and Performance Materials businesses. Simon will provide additional segment and geographic detail shortly. Operating income of $383 million decreased 3% versus prior year and 2% sequentially. Our operating margin of 15% was down 200 basis points versus prior year due to higher pension costs, higher energy pass-through and the underrecovery of increased variable costs, primarily in the Merchant business. Each of these had about a 50-basis-point impact on margin. And consistent with past quarters, the Indura acquisition has about a 20-basis-point dilutive impact. Sequentially, our margin declined 70 basis point, primarily due to pension settlements and higher merchant costs. Net income and diluted earnings per share were down 5% and 4%, respectively, versus last year. Our return on capital employed of 10.5% was lower due to an increase in our capital in part due to the Indura acquisition. 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 $1.36 decreased by $0.05 or 4% versus last year. Volumes increased EPS by $0.10, including $0.06 from Indura. Pricing, energy and raw materials taken together decreased EPS by $0.05, due primarily to higher power costs in our Merchant business. Net cost performance was $0.06 unfavorable, including a $0.05 unfavorable pension impact. Our productivity about offset inflation and higher planned maintenance. Excluded from the volume and cost lines is the net $0.04 unfavorable impact from our decision to exit the PUI business. We saw no impact from currency translation and foreign-exchange year-on-year. Equity affiliate income contributed $0.01, and noncontrolling interest was $0.01 greater due to the addition of Indura. Interest expense was $0.03 higher due to increased debt. Our tax rate was 24%, slightly lower than last year and contributed $0.01. And lastly, lower shares outstanding as a result of our $460 million share repurchase in Q1 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 just over $1 billion were up 18% over last year, driven by stronger volumes and the Indura acquisition. Underlying sales were up 2% on 2% higher volumes and flat pricing. Liquid oxygen, nitrogen and argon volumes were up in all regions, partially offset by lower helium volumes due to supply challenges and packaged gases demand weakness in Europe. Sales were up 3% sequentially on 4% stronger volumes, flat pricing and a negative 1% impact from currency. Volumes were notably stronger in Asia, rebounding from the Lunar New Year slowdown in the prior quarter. Helium volume was below our expectations and was down versus prior year, driven by limited availability from our helium feedstock suppliers, particularly in the U.S. We expect helium to remain relatively tight over the next few years until some of the longer-term sources we are developing come on stream. We do expect a slight improvement in Q4 and more into FY '14 as we get product from our Wyoming facility and additional Middle Eastern supply helps the industry. We are also actively developing additional new sources and expect to make a specific announcement soon. Merchant Gases' operating income of $165 million was flat versus prior year and down 2% sequentially. Segment operating margin of 16% was down 280 basis points compared to last year and down 80 basis points sequentially. Versus last year, operating income was up on profit from the Indura acquisition and the higher volumes but was offset by higher pension costs and higher power costs that were not fully recovered with price increases. Sequentially, operating income was down on higher power, maintenance and other operating costs. Overall, the Indura business continues to operate well. We have delivered on the expected synergies with good cost performance, saw improved margins this quarter and are seeing growth opportunities in a variety of end markets. We announced the new plant and the expansion of a second plant earlier this quarter. 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 50 basis points. Margins were also negatively impacted by increased pension costs and higher power costs that were not recovered in the marketplace as pricing was flat overall. Let's review the Merchant business by region. Please turn to Slide 6. In U.S./Canada, sales were up 6% on 2% higher volumes and 4% higher pricing. Liquid oxygen and liquid nitrogen volumes were up 5% on strength in the oilfield services, metals processing and petrochemical markets. The strong LOX/LIN volume performance reflects the benefit of our recent robust contract signings coming onstream. Liquid argon volumes were also up, but helium volumes were down due to supply limitations. We had our best quarter so far this year for new contract signings, and lost business was below last year. LOX/LIN capacity utilization is in the low to mid-70s. Although, overall pricing was positive, this was primarily due to helium and the contractual recovery of higher natural gas prices in liquid hydrogen. LOX/LIN prices were down slightly, and given the increase in power costs, this had a negative effect on margin. We announced earlier this quarter the acquisition of EPCO, the largest independent liquid CO2 company in the U.S. Liquid CO2 is a great complement to the rest of our liquid bulk offerings and improves Air Products' supply to those customers who use multiple products in key markets such as food freezing, oilfield services, pharmaceutical and metal fabrication. The integration is going well. In Europe, sales were down 2% versus last year on 2% lower volumes and 1% lower pricing, partially offset by a 1% increase from currency. LOX/LIN volumes were slightly positive, helped by wholesale volumes, but underlying end-market demand remains weak, particularly in metals, glass and cement and food. Helium volumes were down on supply limitations, while cylinder volumes were down throughout Europe, particularly in Central and Southern Europe and U.K./Ireland. Overall pricing was down 1%, with positive helium pricing partially offsetting negative LOX/LIN pricing. The LOX/LIN price decline was driven by both lower price and the mix effect from the increased wholesale volumes. New contract signings were comparable to last year but down relative to the last few quarters, and LOX/LIN plant routings remain in the mid-70s. We have fully completed the cost savings program announced last year and are seeing the savings in the P&L. In Asia, sales were down 1% versus last year on flat volumes, 2% lower prices and a positive 1% currency impact. LOX/LIN volumes were up across the region and up mid-single digits in China, both x conversions. Liquid argon volumes showed improvement after a few quarters of weakness, and helium was down on supply limitations. Cylinder volume growth was moderated by customer profitability actions and conversions, and we continue to see good growth in our Microbulk product line. Pricing was down in the liquid oxygen, nitrogen and argon business, particularly in China. Power costs were up, negatively impacting margins. Plant loadings remain in the mid-70s. Capacity additions will continue to impact loadings despite volume growth as we bring on projects under construction. And new contract signings were stronger than last quarter, which have been the best in years. Please turn to Slide 7, Tonnage Gases. Tonnage Gases' sales of $846 million were up 10% versus last year on higher energy pass-through, partially offset by lower PUI volumes. Base volumes are relatively flat as U.S. Gulf Coast customer maintenance outages and 2 steel customer outages offset fewer customer outages in Europe. The exit of our PUI business by January 2014 is proceeding as we expected. For the quarter, PUI sales were down about $50 million versus prior year, and operating income was down over $10 million. Our expectations for the full year haven't changed. We expect PUI sales to be down about $160 million and operating income to be down about $25 million. For the segment, sequential sales were up 5% on slightly higher volumes x PUI and higher energy pass-through. Operating income of $120 million was down 11% versus prior year. X PUI, operating income of $118 million was down 2% on higher planned outage maintenance costs. Operating income was down 3% sequentially. X PUI, operating income was flat as lower bonus payment timing was offset by lower overhead costs. Operating margin of 14.2% was down 330 basis points versus prior year and down 100 basis points sequentially on the lower operating income and higher energy cost pass-through. As we said last quarter, we continue to see strong project development activity in the global hydrogen business. Customers are making decisions, and we expect to have project announcements in the near future. Please turn to Slide 8, Electronics and Performance Materials. Segment sales of $566 million were down 6% versus last year, with volumes down 5% and pricing down 1%. Sequentially, sales were up 3% on 4% higher volumes, partially offset by a negative 1% currency impact. Versus prior year, electronic sales were down 11% with significantly lower equipment sales and weaker processed materials, somewhat offset by new on-site projects. The lower equipment sales are due to the slowdown in new fab CapEx, but we do expect equipment sales to rebound next quarter. Processed materials was impacted by lower fab utilization, PV market weakness and competitive activity affecting both volume and price. Sales were up 1% sequentially, a modest increase, below our expectations based on historical seasonal patterns, with improved materials volume somewhat offset by the negative currency impact. Performance Materials' sales were down 1% versus last year as higher volumes were offset by lower prices. Autos and the U.S. housing market continue to be positive, while non-residential construction was weaker than we expected and marine coatings continue to be weak. Sequentially, PMD sales were up 5% on improvement across Asia, Europe and North America. However, this growth was below our expectations. Operating income of $87 million was down 4% versus prior year on the lower electronics volumes and the combination of lower prices and product mix in PMD. Operating margin was up 30 basis points to 15.3% on mix, primarily in the electronics equipment business. Sequentially, operating income was up 12%, and operating margin was up 120 basis points, primarily due to the higher electronics materials and PMD volumes. Now please turn to Slide 9, Equipment and Energy. Sales of $104 million were up 9% versus prior year, primarily on higher LNG project activity and down 16% sequentially on lower LNG and ASU activity. Operating income of $16 million was up 63% over prior year on the higher LNG project activity and lower development spending. Operating income was down 22% versus prior quarter on the lower project activity. The backlog of $327 million is down 25% from last year and unchanged versus last quarter as new orders were modest. During the quarter, we were pleased to announce our first major LNG order in the U.S. for Dominion's Cove Point, Maryland LNG export terminal, designed to produce over 5 million tons per year of LNG when operational in 2017. LNG development activity remains strong, and we expect to have additional announcements soon. 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 weaker-than-expected conditions we saw in Q3, we remain cautious on our expectations for near-term economic growth. In the U.S., 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 and diminished global demand are likely to continue to impact the pace of the recovery. In Europe, FY '13 will show negative year-over-year growth in manufacturing, below our expectations. We are hopeful that we are approaching the bottom and anticipate sequential growth going forward. In Asia, we expect a gradual acceleration in manufacturing growth to continue, particularly in China. However, the recent government focus in China on reform is expected to temper growth going forward. And in South America, we expect the year to be at the low end of our original expectations. Our backlog remains robust, about $3 billion including a few projects that have not yet been announced. We still see a number of opportunities in oxygen for coal gasification in China and in hydrogen projects around the world. CapEx is expected to be about $2 billion this year, consistent with our most recent guidance. For Q4, our EPS guidance is $1.44 to $1.50, based on the following factors: on the positive side, we expect to see improved sequential volumes in Merchant; higher volumes and lower maintenance and tonnage following a number of customer outages this past quarter; less of an impact from the PUI business; and Equipment and Energy results should show some sequential improvement as well. A partial offset is expected from a higher share count. This results in our full year EPS guidance range being $5.47 to $5.53, within the range we shared with you last quarter despite the slower economy. Now let me turn it back to John to wrap up.

Thanks, Scott. We delivered earnings results within our commitments for the quarter despite the more modest economic activity. This earnings performance is a result of us taking decisive actions to manage what is within our control, with a particular focus on reducing costs, driving productivity and disciplined project execution. As I said earlier, we are actively assessing additional actions we can take that would result in improved margins and returns and increase value to our shareholders. The process is ongoing. We are making good progress and as a result, expect to take a charge in our fiscal Q4. Our plan is focused on improving our cost position in those regions and businesses that are facing the greatest challenges from slower market growth. We will have more specifics to share with you about this on or before next quarter's earnings call. And we continue to actively review additional opportunities available to us to further improve our operations and increase shareholder value. I believe our focus on increasing shareholder value remains unwavering. We are executing well on our strong backlog of projects that will drive earnings and cash flow growth as they come online. We have significant leverage in our existing assets that leaves us well positioned for a recovery, and we remain focused on productivity, improving our core businesses and delivering on our cash priorities. Thank you. And now we are happy to turn your questions -- turn to your questions. Jessica?

[Operator Instructions] We'll go first to Robert Koort with Goldman Sachs.

A couple of questions. One, power costs continue to be an issue you guys talk about. And I'm just curious, is there anything that's changed about the time it takes you to get through power increases? And what regions did you see the greatest inflation in power?

Yes, Bob, good question. So certainly, there, you are acknowledging that there is a lag delay in recovering the power costs, and I think we really saw the power cost impact. We saw it primarily in North America, certainly with the increase in natural gas costs and that significantly impacting power costs, where gas is on the margin for power producers. We also saw increased power costs in Asia. And I guess it's important to note that we did see these power costs increase. At the same time, while we wouldn't have been expecting to recover all of that in price this quarter, we are also seeing some pressure on the liquid oxygen, liquid nitrogen pricing as well.

And then would there be a similar benefit from the natural gas in your Tonnage business? I know when the business was struggling, that was certainly a factor in margin compression. So have you not seen any symmetric benefit as gas has gone back up here to the $3.70 range?

No, Bob. We've seen it -- and consistent with the rough rules of thumb we shared, both in terms of the impact on sales and operating income, we have seen that in the Tonnage business.

We'll go next to David Begleiter with Deutsche Bank.

Just to get on the LOX/LIN pricing pressure, anything changed, fundamentals in the market in terms of increasing competitive intensity that's coming forth right now?

So I think if we're talking about -- I made a comment on the LOX/LIN pricing. Perhaps -- John, you want to comment on kind of the broader competitive dynamic, particularly on the big projects?

Certainly, on the larger projects that -- we still see very, very good bidding activity. We've been quite successful. We mentioned the fact that we've had about a $3 billion project backlog when you consider projects that are in execution and a few that we'll announce shortly. In my mind, in this business, it's always been about where you have your skills, your competitive differentiation. And to be clear, and I think I've said this many times, there's no strategic project when you're making a $100 million bet or more on a long-term take-or-pay contract. You really have to earn the return expectations that are accretive to the strategy of the business and the corporation or you don't take it.

And just lastly, on China, given the slowing growth in that region, have you seen any slowing of bidding activity in that region on new projects?

Yes, David, a couple of points. Really, China is really a tale about 2 stories right now in the context of the slowing Merchant business, although, as Simon noted, it's starting to improve a little, is really a function of decisions made in China to slow down the sort of manufacturing-driven economy in favor of urbanization, in favor of consumer opportunities, et cetera. The projects that we're pursuing -- and the answer specifically to your question is we have not seen a slowdown once the new government had gotten in place. For a couple of quarters there, as the government transition was happening, projects weren't getting approved at the national or the provincial level until they understood where the new government is. But frankly, the policies of the new government, whether they'd be around the energy policy of self-sufficiency, around energy and feedstocks or environmental policies, has really put a pretty strong focus on opportunity. And so we see the bidding continuing at levels now that it was, say, before the government changed. And one of the hidden opportunities in this new government's focus, frankly, is their real drive to stronger environmental standards, particularly around transportation fuels in and around the large urban cities, we believe is going to start generating a hydrogen opportunity that's kind of a new opportunity in China. We're executing a couple of hydrogen plants as we speak there, but we see more of that opportunity coming.

We'll go next to Don Carson with Susquehanna Financial.

Yes, 2 questions, John, on these additional actions you're taking to enhance the margin. Is this just going to be cost-driven? Are there any further portfolio moves like your exit from PUI? And then secondly, can you just give us the progression of the backlog? What projects are starting up in the next 3 to 6 months? And I know in the past you'd talked about a $0.20, $0.25 EPS benefit from new projects this year. Is that still the number? And what would you expect that number to be in fiscal '14?

Yes, Don. Let me take the first part and I'll look to Scott on the second part, if you don't mind. Look, what we're looking at is really overhead and asset, but not business, adjustments to really reflect sort of our current and future view of where the economic growth of the world is going. I think in the last call, I was pretty clear that we like our portfolio as it is. I think good companies continually do assessments of their portfolios, asking the questions around, "Are you the high-value owner or not?" And as I sit here today, I'll go back to my comments last quarter and my comments a moment ago that I like the quality of the portfolio we have, but that we will continue to focus to improve the underlying margins and returns of those assets.

In terms of your second question, Don, this is Scott, the $0.25 we would expect to see for FY '13 is still our number. Recognize that there's been some adjustments in terms of the timing. We have not seen any project cancellations. Obviously, with large projects, delays are not uncommon. But for the year, we would expect to see earnings per share year-on-year growth of $0.25 from new projects coming onstream. And while we haven't yet developed our guidance for next year, as we work through the backlog, we would expect a commensurate amount next year as well as we bring onstream those projects in backlog.

We'll go next to P.J. Juvekar with Citi.

John, you guys have been aggressive in bidding for coal-to-gas projects in China. These are much bigger ASUs so presumably, risk is much higher as well. So how do you make sure you have the right customers? And can you cite the risk for us on these projects?

Sure. That's a great question, P.J. And maybe if I go back to when I was in the Tonnage business here in the early 90s and we began looking at hydrogen for refineries, you got a similar set of questions. And the way we looked at that in terms of our own view of risk was really to do pretty robust assessments of the economics of that particular refinery in that case, or this particular gasification project in China. And what I'm really trying to say is will that project, one, with the economics that meet the needs of the energy costs or the feedstock costs that they're producing as opposed to who the ownership of that project is. And the reason we started doing that, if you will, back in the hydrogen days, is you were having a lot of refineries bought by unknown entities. They weren't multinational oil companies operating them anymore. So it's really critical to get an assessment of that project's economics in the context of the marketplace that they operate in. We do the same on these projects in China. And frankly, we've passed on quite a number of them, where we didn't even place bids if we didn't feel either the end product they were going into. So the end products ranged from methanol to synthetic natural gas to chemical building blocks, and we've passed on frankly a lot of the projects that we're in, in areas that we felt, long-term, the economics weren't sustainable. Many of the projects -- most of the projects that we're involved in now and most of the new projects are really in the coal to liquids and the synthetic natural gas, and the economics, the scale, we believe, are competitive with alternative energy sources or feedstock sources in China. But rest assured, it's a question that I ask the team long before we've submitted a bid as to whether or not we should deploy our resources on a particular project. We do earn, as we've talked many times before, higher risk-adjusted returns because of the nature of cost of debt and equity and country risk factors and all of the things that you would expect when you're not operating in other geographies. As you know, we adjust that by the geographies we operate in, and we do ensure that we get a high-quality take-or-pay on-site contract to underpin these projects.

And just on the project backlog, I think you mentioned your $3 billion backlog. Do you believe that the backlog has peaked? And where do you see CapEx going? Or do you see CapEx declining over the next 2 or 3 years?

So, P.J., this is Scott. So as you mentioned, we've got a $3 billion backlog currently and recognize that's going to move around, especially with these projects being fairly large. We would expect for the foreseeable future going forward that the backlog would remain roughly at $3 billion. And in terms of capital spending, this year we said $2 billion, and we think that, that's probably going to be about the range where we come in next year as well, about $2 billion CapEx.

We'll go next to Kevin McCarthy with Bank of America Merrill Lynch.

A question for you on returns. John, on Slide 16, you were kind enough to give us the time series of returns on capital employed in your appendix, and I guess if I exclude items, it looks like we're at a multi-year low here. But based on your instantaneous calculation, fairly flat over the last 3 quarters. So my question would be, when you take into account the restructuring efforts you have and the new projects that will be flowing through your financials, what is your outlook for returns from here? Do you think we're near bottom?

So one of the things that obviously has depressed the returns is, if you think back over the last maybe 18 months to 2 years, our CapEx has picked up both because of the organic opportunities that we have in the marketplace, so hydrogen, large ASUs, as well as the Indura acquisition. And you've got to grow into that quite frankly. And the way we calculate that return, which is a rolling 5-quarter or 4-quarter average, you begin to feel the impact of that gradually over sort of the next year to 1.5 years going forward. As Scott mentioned a moment ago, with CapEx and bidding activity sort of in the range, minus the acquisitions that we have, we should grow into that, if you will. And then the combination of the actions we're taking to drive the performance in the business, the addition of the new project backlog to the P&L now as they come on stream, and some continued gradual economic recovery, one, I would expect returns to improve; and two, they need to return -- improve. And let me turn it over to Scott, and I'm sure he can provide a little bit more color on that.

Right. So just to build on what John said, Kevin, so I would see the year coming in on a low 10. As John mentioned, we're working through the projects that are in backlog. And as we've talked about in the past, we've got a lot of existing leverage to load the facilities we have. So I would see kind of a bottoming out, either where we are now or maybe in '14. And then as those projects come on from the backlog, immediately start contributing both to earnings and cash flow, as well as loading the existing capacity we have in our system that will then start driving up both returns on capital, cash flow, as well as earnings.

We'll go next to Laurence Alexander with Jefferies.

Another way of looking at the backlog is, as you think about the cadence of projects over the next few years, is the average life cycle extending? I mean, that is, is it taking longer to bring projects onstream once they get into the backlog? And if so, do you have a rough sense for by how much?

So -- I mean, let me weigh in a minute, Laurence, and certainly, Simon or Scott can add some additional commentary to what I'm about to say. The reality of it is we get into -- whether it's a refinery project, a gasification project, although the projects in China tend to be quicker perhaps sometimes than the refinery expansions, these are long-cycle projects, 4 years, 3 or 4 years in the making. We get brought into the process maybe a year into the customer's project, and I would argue that projects are 2.5 years on average, some a little less, some a little more depending on where they're located and the customer, frankly, that's building the project. So I can't -- within months, I can't really see a definitive difference in the cycle if I'm comparing it to large hydrogen additions to refineries as we've seen a lot of historically.

We'll go next to Mike Harrison with First Analysis.

I had a couple of questions around the LOX/LIN strength that you saw in the U.S. and Canada. Are we really just seeing some of the new accounts that have come onstream over the last several quarters? Or are there other things that you could point to that are driving the strength? Kind of how sustainable do you think those volumes could be?

Well, good question, Mike, and I appreciate your acknowledging that the team has done a great job with growing those volumes. And I think what you're really seeing is we've been sharing with you some insight into our contract signings over the last year or so, and we're really seeing a benefit of that step-up and that new business coming on stream. As we've said in the past, though, the overall volumes are also dependent on kind of what's happening with our base business, and I think we've seen some good performance in our base business as well. As I mentioned today, contract signings continue to be strong, so we're optimistic that we'll continue to see good volume growth in our U.S./Canada LOX/LIN business.

All right. And now that we've gotten some improvements there, I think the expectation is that we would see some pretty big incremental margin. It doesn't look like that's showing up. Obviously, you've got a lot of moving pieces within Merchant. So if we looked at the U.S. and Canada margin on its own, would that margin have improved sequentially? Or there are enough moving pieces and power costs that, that's still creating some pressure?

Yes, Mike, this is Scott. So between the -- principally, from the power perspective, that would have been the pressure on the margins, recognizing also the Merchant business will pick up its share of the pension impact as well.

And then question on the Mexico business. Have you seen any weakness there related to some of the budget issues that have been going on at PEMEX?

No, we haven't seen that. Our business in Mexico continues to be very robust, performs well.

And, Mike, quite frankly, in the past, we've added that in. To give you some insight in there, if we did add in those Mexico LOX/LIN volumes, it'd be up a little bit more than even the U.S./Canada.

Got you. And then last one I had is on equipment and energy. You noted the earnings are progressing about in line with the initial guidance, which was for a $0.05 EPS tailwind this year. If I do the math, it looks like you're a little bit ahead of that piece, and it would suggest that Q4 would be down sequentially, but the guidance slide calls for that to be up sequentially. So is it fair to say you're now looking for more than $0.05 of EPS tailwind? And what are your thoughts, maybe kind of early thoughts, on what next year looks like in terms of LNG activity and the Equipment and Energy business?

Mike, this is Scott. We know that in this business, it's a little bit lumpy. And so just directionally, maybe it's a little bit higher than $0.05 year-on-year, but not huge. And I think as we mentioned before, we continue to see opportunities out there on a global basis, and we continue to not only work down the backlog but look for additional orders and look to have announcements in the not-too-distant future.

We'll go next to James Sheehan with SunTrust Robinson Humphrey.

Guys, could you just comment a little bit about Merchant pricing trends in Asia?

Yes, Jim, this is Simon. It's a good question. And again, I think one of the things that we need to make sure we're keeping an eye on is not just price on its own, but also kind of the price/cost trade-off. And so specifically in Asia, we have seen some price pressure in our LOX/LIN/LAR, liquid oxygen, liquid nitrogen and liquid argon business. So we've seen some negative pricing in Asia in those businesses, and that's come at the same time that we're seeing some power cost increases. So we're seeing -- as we commented, that's one of the key issues that's creating a little bit of a margin squeeze for us in that business. Now if I could just -- the helium scenario is different than what I've just described. Helium pricing has been strong and positive in all the regions.

We'll go next to Mark Gulley with BGC Partners.

Well, I was going back to the strong backlog of $3 billion. Can you give us an indication and, of course, the whole gasification opportunity in China, about how much of that backlog is in China? And would that number change materially when you get to include some of the hydrogen projects that you've just alluded to?

So, Mark, this is Scott. I would say about half or so of the backlog is in China. And again, we've got a lot of different opportunities on a global basis, so I would see that number staying about that -- in that range going forward.

And then secondly, as a follow-up, you talked about the additional restructuring actions, so we're going to hear more a month or so. Looking at the low operating rates, particularly for LOX/LIN in U.S. and Europe, is it safe to assume that you've got to have some asset write-downs, plant closings there to tighten up capacity, maybe get some pricing flexibility? And could that be a big part of the margin improvement you expect to see in Merchant?

Mark, this is Scott. So we're looking at each -- as we've said before, we're looking at each of our businesses and identifying opportunities to make sure that we are rightsized given the economic environment and the level of business activity. And so there's -- every area of the company is under evaluation.

And a housekeeping question on PUI being a negative factor. Do we finally lap that in the second quarter of fiscal '14?

Well -- so it's going to go away at the end of this calendar year, and so we'll see -- in '14, we'll see a year-on-year impact, 1 quarter seen in '14 versus a full year that we saw here in '13. That will take us a while before we lap it.

We'll go next to Vincent Andrews with Morgan Stanley.

I had to hop off for a minute, so I apologize if this has been covered, but I wanted to just dive in a little bit into working capital and also pension. The working capital increase so far year-to-date, I believe that's not including Indura. But correct me if I'm wrong about that. Can you just help me understand what's driving it and how that might play out over the balance or, I guess, the one remaining quarter, and then what you might be able to do to improve it going into next year?

So this is Scott. So working capital does in fact include Indura. We track closely all our accounts and look at past dues, day sales outstanding and so forth. And so there's not -- recognizing there's a mix across the different geographies, we are diligently managing that, and we don't see any issues in terms of working capital.

Okay. So x Indura, it looks fine. And then on the pension, given the idea that rates may be increasing in the near future and you made a big pension contribution, I see here, how should we be thinking about that relative to your liability going into next year?

Let's separate it into 2 pieces. First, the cash and ERISA requirement versus the book accounting. From an ERISA perspective, we feel good about the level of contributions that have been made and don't foresee any large additional contributions in the near term. If I shift then to a book perspective, as you point out, rates -- who knows where they're going to go? But to the extent that they do go up and then reduce the liability on a present value basis, there might be some tailwinds going forward from a book accounting perspective and pensions in the future.

We'll go next to John McNulty with Credit Suisse.

This is actually Ernie Ortiz filling in for John. Just on the helium project, with the startup of the project, you've been benefiting with some good pricing recently. Can you just talk about the supply/demand impacts from the new project? How should we think about pricing going forward? And just on overall industry, kind of how it affects it?

Yes. So, Ernie, let me just make a few comments broadly about helium. And so first of all, setting a context that we think over a multi-year time frame, helium remains tight, why is that? We've got increased demand, customers are utilizing more helium in medical applications, in the electronics industry and in welding applications. And at the same time, today, 30% of the world's helium comes from the U.S. government, and that opportunity to supply is declining over time. So there are new sources that are needed to come on to replace some of the decline in existing sources, and we have increasing demand. So that's the kind of long-term time frame. If we step back from that a little bit, we have our project in Wyoming that we expect to get product from later this year. You've also seen, for the industry, some new projects come onstream here just recently. So those projects will help. But quite frankly, again, it's in a framework where the demand is increasing and some of the existing supply is coming down. I would also just note that you might have heard me mention that we have another project, separate from this Wyoming project, that we would expect to have an announcement on fairly soon.

Okay. That's helpful. And then just lastly, on Electronics, can you talk about like where industry operating rates are and kind of your outlook for '14 for Electronics?

Sure. I think Electronics -- so first of all, maybe reset for FY '13, our fiscal year, we expect Electronics square inches of silicon demand to be down somewhere in the 0 to a few percent, and that's different than what we had expected of mid-single digit growth when we set out for the year. So clearly, the industry has not grown the way we and others expected for the year. I think -- as we look to 2014, I think the industry forecasts we see are generally up in that mid-single digits range, but we're going to have to take a very hard look at that as we get closer to the end of the year here. I think if there's one good thing in the industry, while it hasn't been a strong growth period, you've seen a relative amount of stability, where inventory levels have maintained relatively stable levels for our customers along this time.

We'll go next to Duffy Fischer with Barclays.

A question on Indura. If you look apples-to-apples, what would margins look like this quarter versus a year ago?

For Indura? Just to clarify.

Yes, for Indura. Yes.

They'd be up modestly as we go through the integration and deliver on the synergies that we've expected there as part of the implementation.

Okay. Fair enough. And then just last one, quick on Tees Valley. On-time, on-budget there? How is that progressing?

Yes, it's progressing quite well. I was over there a month or 2 ago, and the project is on budget, on schedule. The team's really, really charged up about the opportunity and already looking at ways to further improve the existing project authorization through some of the opportunities they've been able to identify.

And then just on the Tees Valley and that concept, from a timing standpoint, will we get that plant up and running and proven out before we announce new projects? Or is there a chance that we get new projects before we've actually proven out that system?

Well, first, what I'd suggest is every unit op in that facility is a unit op that we operate or have operated across our assets over the years. It's just really the combination of those unit ops. So from a technology point of view and an operating point of view, while we've done very rigorous assessments across -- with internal and external experts, I'm very comfortable with our ability to do this. And I'm very comfortable in our ability to do it with the reliability and capabilities that we've committed to our customer base. So we're going to make decisions on the opportunities for these projects based on the market availability of them, and then frankly, being a first mover into the market, given the profitability of these projects and the opportunity of that to deliver value to our shareholders.

We'll go next to Basili Alukos with Morningstar.

I commend the work you guys are doing on kind of re-looking at the portfolio and all the cost structure, but I kind of want to go back to that issue. If I go back to 2010 when you had your Analyst Day, you talked about -- originally, there, you had 17% margins. We're looking to get to 20%. There are a lot of puts and takes that have happened from then until now. Obviously, Europe is probably worse than what you expected. I think you talked about Indura maybe being a little bit of -- pulling down margin, at least in the near term. So maybe, at best, we can say the company is at a push for margins relative to that time frame. So kind of in that context, I'm just wondering how you're thinking and taking into account the commentary that you like the portfolio. It looks like margins really haven't kept up, so I'm just wondering, in that context, how are you further thinking about kind of the portfolio?

Well, certainly -- let me start with -- where our margins are today aren't acceptable to me. I understand that we need to improve them. And what I was really trying to say, both in the actions we've said we're evaluating, that will help us in that context. As it relates specifically to the portfolio, my commentary there is I like our business positions. I don't necessarily -- around the globe, I don't necessarily like the economic scenarios today in all of those positions, but the combination of the actions we're taking and an expectation, as Scott mentioned in his talk, that Europe is bottoming, Simon's comments on Electronics a little bit ago, where we're probably getting towards the bottom of the cycle there as well, really, I believe, will be accretive to margins as we begin to see some economic uptick over the next number of quarters. The other point I'd make relative to the discussion that you referenced back to in the '10, '11 time frame was one of the things that -- on the positives that has developed is the on-site opportunities driven either by the energy or policy or environmental regulations in China and more broadly, around the globe, that gives us a higher mix of Tonnage. In the short term, that higher mix of Tonnage has some depression on margins as you work through the capital in construction. So you have a depression on margins. Frankly -- typically, on the Tonnage businesses, you have lower absolute margins because of the nature of the energy pass-through, but frankly, also lower absolute risk because of the contract.

Great. So I guess if I think about it in hypotheticals, speaking, if the economy and the rest of the regions were some type of normal growth and margins were still depressed, then it would be more likely in that scenario to see further pruning and divestitures of the portfolio? And that's more trying to get cost structure in line until the economy, at least in Europe, turned around?

Yes. I mean, to be clear -- and I meant what I said. I do like the portfolio that we have today. There are assets and overhead opportunities broadly across the globe, and we'll work on those.

We'll go next to Edward Yang with Oppenheimer. Edward H. Yang - Oppenheimer & Co. Inc., Research Division: Most of my questions have been answered, but on Electronics, revenues were a little bit lighter than expected, but your margins improved. Was wondering what was driving the margin improvement. Was that mix or cost-cutting?

Well -- so it's really -- I mean, it's a combination of both. Right? We obviously aren't in a robust growth environment from Electronics, and it's still a good job by the team to share margin improvements. Specifically year-on-year, we did have a mix effect in the electronics equipment business that helped that as well. Edward H. Yang - Oppenheimer & Co. Inc., Research Division: Okay. Got it. And one thing that struck out at me with your slide on Merchant Gases and just the different pricing trends across the different geographies, the operating rates, the LOX/LIN capacity utilization rates are actually lower in the US and Canada, but you had positive pricing. And in Europe and Asia, you're in the mid-70%s and you have negative pricing. So what accounts for the deltas there in terms of pricing? Is it just the quality of competitors? Or is there anyone out there that's being particularly disruptive on pricing -- or had been in the past, as being less disciplined?

Yes. So I think you make a good observation. And I will say, for the last few quarters, we have seen pricing dynamics that aren't necessarily exactly correlated with overall regional loading rates, right? And so this isn't a commodity business, right? It's a very local business. So specifically, your question on what's happening in pricing, we've got some price pressures across all of the regions, particularly, again, I'm speaking of the LOX/LIN/LAR business. So we are seeing some price pressure in Europe, where prices are coming down. In the U.S./Canada and LOX/LIN, while prices are stable, we've got input costs going up. And in Asia, quite frankly, we've got higher power costs and higher -- and LOX/LIN prices coming down. So I don't know that we would necessarily select one competitor as creating this competitive pressure, but I think you are seeing some price pressure across LOX/LIN, again contrasting that with helium, where pricing continues to be strong.

This does conclude today's question-and-answer session. At this time, I will turn the conference back over for any closing or additional remarks.

Thanks, Jessica. Let me just wrap up by saying our focus on increasing shareholder value remains unwavering. Our emphasis on cost reduction, productivity improvement and disciplined project execution remain key priorities. Our future prospects are strong given our record project backlog and the significant leverage we have in our existing assets. You'll have an opportunity to see a replay of this call at 2 p.m. today. And thank you for joining us, and have a great day.

This does conclude today's conference. Thank you for your participation.