Air Products and Chemicals, Inc.
Q4 2010 Earnings Call Transcript

Published: 22 Oct 2010

[Operator:]

Good morning, and welcome to Air Products & Chemicals Fourth Quarter Earnings Release Conference Call. [Operator Instructions] Beginning today's call is Mr. Simon Moore, Director of Investor Relations. Mr. Moore, you may begin.

[Simon Moore:]

Thank you, James. Good morning, and welcome to Air Products' Fourth Quarter Earnings Teleconference. This is Simon Moore. Today, our CFO, Paul Huck, and I, will review our fiscal 2010 results and outlook for fiscal 2011. We issued our earnings release this morning. It is available on our website along with the slides for this teleconference. Please go to www.airproducts.com and click on the scrolling red banner to access the materials. Instructions for accessing the replay of this call beginning at 2 p.m. Eastern Time are also available on the website. Please turn to Slides 2 and 3. As always, today's teleconference will contain forward-looking statements based on current expectations regarding important risk factors. Please review the information on these slides and at the end of today's earnings release explaining factors that may affect these expectations. Now I'll turn the call over to Paul for a review of our financials.

[Paul Huck:]

Thanks, Simon. Good morning, everyone, and thanks for joining us today. Please turn to Slide #4. Before we look at this quarter's results, I would like to spend a few moments looking back over these past two years. They had been quite a journey. This slide show the progress we have made at improving two key financial metrics, operating margin and return on capital, employed. If you take a look at the left side of this slide, you'll see the improvements that we made over the four-year period before the recession. We had moved our operating margin up by more than 1.5%, and we improved our after-tax return on capital to 13% by the end of 2008. In the middle of this slide, you can see the impact of the global recession on our fiscal 2009 results. During that time, we took a number of significant actions to lower our costs and position ourselves for success coming out of the recession. On the right-hand side of the slide, you can see our 2010 results, which show the improvements we have made, the impact of the actions we took and the sequential progress we are continuing to make. Our operating margin in this last quarter improved to 17.1% and to 16.5% for the full year, as we remain on track to deliver our fiscal 2011 goal of 17%. More importantly, we continued to drive our return on capital employed higher. We are already back to our prior peak despite operating rates being lower, and we have kept our return on capital well above our cost of capital across this last business cycle. Our focus on putting in place a low-cost structure makes us more competitive and positions us to grow faster with higher returns. Turning to Slide #5 for a review of fiscal year 2010. Sales of $9 billion increased 9%. Our underlying sales grew 8%, with volumes up 9%. We delivered strong volume growth as the economic environment improved. This was driven by a significant recovery in our Electronics and Performance Materials segments and new investments and contracts in our Tonnage Gasses segment. Operating income of $1.5 billion grew 25% on better performance across all business segments. Our operating margin for the year averaged 16.5%, an improvement of more than the 2%, reflecting solid productivity and strong operating leverage. This is the highest operating margin in more than a decade. Looking forward, margins should continue to expand. We still have operating leverage available, and we remain committed to driving further cost reduction. For the year, earnings per share increased 24%, and our annual return on capital employed improved to 12.4%, almost 2% higher than last year. In summary, we delivered significant improvements in 2010, some examples are

[Simon Moore:]

Thanks, Paul. Please turn to Slide 8, Merchant Gases. Merchant Gases posted sales of $948 million, up 2% versus prior year. Underlying sales improved by 5% on increased volumes with stable pricing. Currency reduced sales by 3%. Sales were up versus prior year due to continued strong Asia growth and improving volumes in both North America and Europe. Sequentially, sales were up 4%, principally from volume growth. Merchant Gases' operating income of $185 million was up 12% versus prior year and up 5% sequentially. Segment operating margin of 19.5% was up 170 basis points versus prior year and 20 basis points sequentially. Income and margins were higher than prior year, driven by higher volumes, particularly in Asia, and improved productivity, partially offset by the impact of currency and higher power costs. New business signings for the year were up over last year and exceeded our targets across all regions. We recently announced the construction commenced on a new helium production facility in Wyoming, and we also just announced yesterday a further expansion of our Shanghai-based Asia Technology Center. This expansion will enhance our ability to develop Merchant Gas and Electronics Applications closely with our customers in this key growth region. Let me now provide a few additional comments by region. Please turn to Slide 9. In North America, sales improved 5% versus prior year. Volumes were up 5%, with consistent growth across all product lines. Pricing was flat overall, with higher liquid oxygen and liquid nitrogen pricing offset by lower liquid hydrogen pricing as a result of the pass-through of lower natural gas prices. LOX/LIN plant loading increased slightly and remained in the mid-70s. In Europe, sales decreased 8% versus prior year, primarily due to currency. Underlying sales were flat, with volumes increasing by 1% and pricing down 1%. Currency decreased sales by 8%. Our LOX/LIN volumes improved, however, healthcare was flat and packaged gas volumes continued to lag. Our LOX/LIN plant loading remained in the low 80s. In Asia, sales were up 17% versus last year, underlying sales increased 14%, with volumes up 11% and pricing up 3%. Currency increased sales by 3%. Volumes continued to improve, driven by a strong growth across all products and markets. We did see some sequential moderation due to reduced liquid oxygen peaking demand for steel. Plant loadings remained in the high 80s. We delivered real price improvement responding to higher power costs by raising prices on oxygen and nitrogen across the region. Please turn to Slide 10, Tonnage Gases. Tonnage Gases sales of $752 million increased 17% compared to last year. Volumes were up 4%, and the energy and raw material pass-through increased sales by 14%. Higher volumes were primarily driven by new plants and customers. Sequentially, sales were up 4%, with volumes up 2% and energy and raw material pass-through increasing sales by 2%. Volume growth was driven by loading existing assets. Operating income of $117 million was up 11% versus prior year, primarily due to higher volumes from new plant startups and down 2% sequentially due to operating bonus timing. Operating margin of 15.6% decreased 80 basis points versus prior year due to the impact of higher natural gas cost pass-through. Sequentially, margins were lower due to volume mix. Earlier in the quarter, we announced plans to build a third air separation unit and expand our supply of oxygen, nitrogen and argon to ArcelorMittal's Gent, Belgium steel mill and increase our supply of Merchant Gases to the Northern European market. Last week, we announced plans to connect our Texas and Louisiana pipeline systems. This will create the world's largest hydrogen plant and pipeline system. The project will unite more than 20 plants with over 1 billion standard cubic feet a day of capacity and over 600 miles of pipeline. This will allow us to increase sales by better utilizing existing capacity, improve system efficiency by sourcing from our most efficient plants and better coordinating outage planning and improve customer supply reliability and flexibility. Please turn to Slide 11, Electronics and Performance Materials. Segment sales of $523 million were up 20% compared to last year. Volumes increased 21% and pricing reduced sales by 1%. Electronic sales were up 25% compared to last year and 9% sequentially, as all industry segments grew beyond previous production peaks. Electronics Specialty Materials sales increased 19% versus prior year and 4% sequentially. Tonnage sales were 9% higher versus prior year. And our Equipment business reported the best quarter in two years, reflecting the expected pickup in orders due to improving new fab CapEx. Performance Materials sales increased 15% versus last year and 1% sequentially, reflecting volume growth across all markets. Segment operating income of $84 million was up 71% versus prior year and 35% sequentially due to volume leverage and the full benefit of the restructuring actions finalized in Q3. Margins improved 480 basis points from last year and 350 basis points sequentially. Q4 margin of 16.1% exceeded our 15% operating margin goal for FY '11 with the highest quarterly margins since we began reporting this segment four years ago. New business activity continues to grow in Electronics. As you saw last week, we announced an agreement to build two ammonia on-site purification plants for Sanan OptoElectronics in Wuhu in China. This is the world's first on-site, large-scale specialty gas plant and supports the high-growth LED market. Earlier, we announced the turnkey contract to supply our SunSource Solutions gases, equipment and services to a new photovoltaic facility in Malacca, Malaysia. Please turn to Slide 12, Equipment and Energy. Sales of $128 million were up 5% versus prior year and 11% sequentially, reflecting increased LNG activity. Operating income of $20 million increased significantly versus prior year due to higher LNG activity and favorable project performance. Our backlog versus prior year is higher due to the previously announced LNG orders but reduced sequentially. Now I'll turn the call back over to Paul.

[Paul Huck:]

Thanks, Simon. Now if you'll please turn to Slide 13, I'd like to share our thoughts and our outlook. For our fiscal 2011, we are projecting that gradual economic recovery continues. We expect that manufacturing will continue as the leading sector in the recovery. Fiscal year 2010 growth was somewhat stronger than expected, led by Asia. We anticipate that growth will moderate in fiscal year 2011, as inventory restocking ends and global stimulus programs expire. We expect that regional differences will continue, with stronger growth in Asia and more gradual recoveries in the U.S. and Europe. Based on our global footprint, we are planning for worldwide manufacturing growth of 3% to 4% for our fiscal 2011. Our current forecast is that the U.S. will see positive growth of 3% to 4% in manufacturing. Europe should be up about 1% to 2%, and we expect Asia will continue to be the strongest region, growing 6% to 7%, led by China. Volume growth will be the key factor driving earnings improvement in 2011 for us. New plant on-streams in 2010 and 2011 and loading our existing assets should each add $0.30 to $0.40 to EPS. Offsetting these volume gains, pension expense will be about a $0.10 headwind due to the drop in interest rates from September 2009 to September 2010 and lower asset returns. Based upon current rates, currency should not have a significant impact on earnings next year. Based on these factors and our economic outlook, we are forecasting our fiscal 2011 earnings from continuing operations to be between $5.50 and $5.70 per share, which represents a year-on-year earnings growth of 10% to 14%. Now turning to our outlook by business segment. In Merchant Gases, capacity utilization continues to improve globally. We continued to expand our merchant capacity in Asia. Last year, we delivered on our 1% operating margin improvement goal. For 2011, we are targeting to exceed our goal of 20%. In our Tonnage Gases segment, we will see the benefit from the full year loading of our fiscal year 2010 start-ups, along with a number of investments due to come on-stream of this year. The major projects that will drive the improvement from fiscal year 2010 fiscal year 2011 are

[Operator:]

[Operator Instructions] And we'll take our first question from Jeff Zekauskas with JPMorgan.

[Jeffrey Zekauskas:]

A couple of questions. The first is, there really wasn't much change in your Tonnage revenues from the second quarter to the fourth quarter. And I guess Baton Rouge is a little bit late. But it also turns out you had a number of other plants at Corpus Christi, Baytown, Port Arthur. Why didn't those have more of a pronounced effect on Tonnage Gas revenues?

[Paul Huck:]

The big impact is gas there, Jeff. Gas is down about $1, when you look at it. So the volumes are up. But if we look at that, the gas from quarter two to quarter four is down $1. We've pass the natural gas through, as you know.

[Jeffrey Zekauskas:]

Right, but the sequential volumes don't really change all that much.

[Paul Huck:]

Our volumes are up. Our volumes were up in there. I mean, but the big impact on sales, if you're looking at the revenue delta, which I think is what you're trying to look at it here, is that gas gets passed through in the revenue line to our customers.

[Jeffrey Zekauskas:]

Right. I guess, I would have expected the volumes to be up more. But we'll let that go. In terms of, just lastly, on the pension side, what's the magnitude of the pension contribution for next year?

[Paul Huck:]

We think the pension contribution is probably going to be about $250 million or so. And the bulk of it, we're going to do in quarter one.

[Jeffrey Zekauskas:]

And then lastly, what's the cost of the new hydrogen pipeline to link Louisiana and Texas? And how does that get done?

[Paul Huck:]

We have not disclosed the cost of the pipeline for people. And people could do an estimate, if they care to because of the length of it. But we do not like to disclose the cost of our projects on that. And it will get spent over the next two years or so as far as timing is concerned.

[Operator:]

Our next question will come from John McNulty with Credit Suisse.

[John McNulty:]

And on the Electronics business, clearly the margins, you had a solid pick-up that you've actually exceeded what you were really targeting. And even sequentially, I mean, it looks like you saw incremental margins of like 80%. How should we think about the margin going forward, looking into 2011? Was there anything that may have been a little bit unusual in the fourth quarter or a 16% kind of the right base to start looking out to 2011 with?

[Paul Huck:]

John, if you look at the fourth quarter, it certainly is the strongest quarter from a volume standpoint in the business. We normally see a seasonal slowdown towards the end of quarter one of our fiscal year and then into quarter two caused by the holiday season, first around Christmas and then the holidays in Asia in the second quarter. So we normally see it depends whether you actually do see a real volume decline, and we probably will see some volumes decline in this, and then pick up again in the third quarter and the fourth quarter.

[John McNulty:]

Another question in the Merchant business. We've gone basically a year, it looks like without any real, other the raw material, any real price increases on the U.S. and European businesses. What kind of volumes do we need to see come back in the Merchant business before we start to see real price increases in those platforms?

[Paul Huck:]

And actually I consider that to be a good thing in that we haven't seen the price erosion here because of the operating rates. I think need you need to see the operating rates and get above the 85% or so place before you're going to see a growth in price.

[Simon Moore:]

And John, this is Simon. Maybe I could just add, too. In North America versus last year, LOX/LIN pricing was actually up. It was offset by a lower liquid hydrogen with the pass-through of the lower natural gas prices.

[John McNulty:]

And then the last the last question on the pipeline that you're building in the Gulf that we were talking about, how do you think about getting returns on that? Because it doesn't sound like it's necessarily a big revenue-generating opportunity for you, or at least that certainly wasn't how it was highlighted. So how should we think about the revenues? And how should we think about the returns when you get maybe paid back for that pipeline?

[Paul Huck:]

Yes, and it has a good return on it. The return is generated in two areas, John. First off, if you think about the sales, increased sales, and we will be able to sell more the product just because we have in the connection with the systems. So we now have the best supply system, bar none, in the Gulf Coast. We're certainly the broadest here. So our reach to customers is, by far, the best. And our ability to deliver to those customers is, by far, the best. So we would expect to see an increase in sales on that. The second aspect is that we are also going to be able to source the product a lot better. We're going able to pick and get to the lowest-cost source for us to go out and generate the hydrogen and optimize the plants across the systems. So we think that it's a combination of cost and revenue but those both those give us a very nice return on the project, if you just look at the amount of investment required there.

[Operator:]

Now we'll hear from Michael Sison with KeyBanc.

[Michael Sison:]

In total, Paul, when you take a look at volume growth for '11, and I apologize if I missed this, you add up all the loadings for Merchant and Electronics and Tonnage, but what do you expect for volume growth for full company?

[Paul Huck:]

And we expect an impact, as I said before, Mike. First on the new plants, which we brought on-stream into '10 and '11, probably, which impact about $0.30 to $0.40 a share. And then the other thing is that we will also load the existing asset base which we have, which will probably generate another $0.30 to $0.40 a share also for us.

[Michael Sison:]

Yes, so I mean volume growth for Air Products in '11 versus...

[Paul Huck:]

Air Products in total?

[Michael Sison:]

Yes, in total.

[Paul Huck:]

On a volume growth basis, we don't run indices on this, Mike, so I'll give you an estimate. I think it's probably 8% to 9%.

[Michael Sison:]

Right. And then in terms of your silicon growth outlook for the full year, the 5% to 10%, is the fiscal first quarter going to be much higher than that than sort of a little bit lower for the rest of the year?

[Paul Huck:]

It jumps around a lot on the individual quarters. I don't know about that, Mike. If I had to guess right now, I would think of that, that growth is pretty steady across the year. And the reason why is that Electronics ran hard in Q1 of our 2010. And we think of that we're more likely to see now that of production has gone up, that is not going to run and more likely to take a drop in production rates over the December-through-February time frame. But we're still seeing -- we have more fabs on-stream, the fabs are running harder than what they are running a year ago. So we still are looking for a good set of volumes in our Electronics business in quarter one.

[Michael Sison:]

In terms of Electronics and Performance Materials with profitability of 16%, was the Electronics side in the fourth quarter basically running full out?

[Paul Huck:]

No, we still have room to grow in Electronics.

[Operator:]

Next, we'll hear from P.J. Juvekar with Citi.

[P.J. Juvekar:]

Several questions on Electronics here, but just one more. How much of your growth is from traditional silicon these days versus LCD and Photovoltaic business? And then secondly, can you compare margins in the IC business versus LCD and Photovoltaic?

[Paul Huck:]

Simon, since you just came from the business, please take that question, okay?

[Simon Moore:]

Yes, sure. So I think, just to kind of frame out our Electronics business, about three quarters or so of it is in the IC business; LCD, about 15%; and then the last 10% is made out of PV, LED. So the growth rates on the PV LED are quite high as they are coming off a relatively small base. But in terms of absolute growth, it's still the IC that drives the business primarily. Your second question, in terms of margins, I would say we don't see a substantial difference between pricing across the different industry segments. The customers that are in those are largely sophisticated, and so we have fairly similar pricing across the different segments.

[P.J. Juvekar:]

And margins, you think margins are similar as well?

[Simon Moore:]

Yes, so with pricing being similar, I was really commenting that margins are fairly similar across those segments.

[P.J. Juvekar:]

Some of your Electronics customers had indicated slower growth coming out of the summer, and you think there was maybe some inventory correction that took place in Electronics. And do you think that's behind us?

[Simon Moore:]

So we saw fairly steady consistent growth in our volumes through this time period and through the last quarter. And that's where our customers are telling us they're going to continue to operate. They're operating rates are in the 90s, expected to stay there. And a couple of things that have come out recently, of course, everybody knows this, we've been talking about hand-helds driving particularly the memory market. I'm sure everybody saw that for Apple, although their Mac sales on units were up 27% year-over-year, they still sold more iPads that last quarter than they sold Macs. So again, the concept that the hand-held devices are not necessarily replacing PC sales, but they are complementary in bringing in additional demand. As another example, TSMC, the Taiwan foundry, announced the month-to-month sales increase in September. So just a little flavor to help you see what we're seeing there.

[P.J. Juvekar:]

And just, Paul, lastly, can you give us a geographic breakdown of your capital spending?

[Paul Huck:]

Sure. If you take a look at the CapEx which we have, I think we have a slide in there.

[P.J. Juvekar:]

I'm sorry, you do have a slide here.

[Operator:]

Don Carson with Susquehanna has our next question.

[Donald Carson:]

Paul, question on the Merchant business. I know you've put out some domestic price increases on September 16, but you also made the comment that you don't see pricing power returning until you kind of get to the mid-80s operating levels. And you're still at the high 70s. So are these price actions -- are you expecting to get them, or would you categorize them as more trying to recover some higher costs, like power, for example? And then finally, what's the incremental operating leverage as you improve loading in the Merchant business?

[Paul Huck:]

Okay. First, on the leverage comment, it's about 35%, Don, on sales. But as far as pricing power is concerned and if you look at -- and the increase, its early, obviously, because we're still in the first month. But so far, things are going well. And as people know, it isn't across every customer who gets the same price increase. So we think we're going to be successful in the goals which we have for that. The other thing, which you know, is that new business which we're signing is coming in below the average price today. And we've said that before we, and that's normal for the way in which we're operating at this point, with the operating rates that we have. And we will take those prices up over time on the price increases. And they will be the targets of us going out and increasing in the future.

[Donald Carson:]

So basically, you need these price increases on existing business just to offset the price declines on the new business you're signing for your pricing to be flat overall?

[Paul Huck:]

Yes, as far as prices are flat overall, the thing that we look at, Don, is that we actually look at the conversion margin of our business. And so what our goal is to get a positive increase in conversion margin in this year, which is the price less the variable cost to produce and deliver, and get that number contributing in a positive way to our fiscal '11 results. So that's our goal for this year. And we think the actions which we're taking are going to be effective there.

[Donald Carson:]

And you're talking about 3% to 4% outlook for U.S. manufacturing growth, so would you expect a similar volume growth in your U.S. Merchant business and maybe get back up to sort of the 80% operating rate level by second half of fiscal '11?

[Paul Huck:]

Yes, I think it actually should be a little bit higher than 3% to 4%. I think 5% to 6%, Don.

[Operator:]

We'll move on to Paul Mann with Morgan Stanley.

[Paul Mann:]

Just a couple of questions. You mentioned you have three new hydrogen customers in your Edmonton pipeline. What sort of utilization of that Edmonton pipeline is coming in place. What sort of utilization rate will you get to once you get your hydrogen customers onboard? And my second question, just thinking about the electronics market. You mentioned that it was like maybe the account's about 10% of your revenues in Electronics. And clearly, LED lighting has been a big focus of Japan. Energy efficiency is clearly a part of China's next five-year plan. Do you see any interest from your Chinese Electronics customers regarding LED lighting? How do you think of the opportunity for LED lighting in China?

[Paul Huck:]

I'll let Simon answer the Electronics question under the Edmonton pipeline. And we're close to sold-out on that pipeline right now.

[Simon Moore:]

So Paul, good question on Electronics, maybe just clarify what I said before, right? So together, PV LED make up less than 10% of our sales, so just to clarify that in the Electronics side and. We are absolutely excited about the growth in the LED market. As you saw, we announced the industry's first large on-site spec gas plant for Sanan for LED in China. So we think the dynamics of the world being more interested in energy efficiency will drive LED demand overall. And China, clearly, has identified LED as an industry they would like to promote in-house. So we think that's a good opportunity. To be fair, though, it's a modest size part of our portfolio right now. And while it will have strong growth rates, the overall business is still very dependent on IC.

[Operator:]

The next question comes from Mike Harrison with First Analysis.

[Michael Harrison:]

I wanted to ask you a little bit about Merchant pricing in Asia. It looks like pricing in Asia is accelerating a little bit. You mentioned LOX/LIN prices had become higher in order to recover higher power costs. But I was wondering, are you still getting more traction in the pricing front there? Or had the gains kind of leveled off at this point? And are there any other drivers of the improved pricing besides the LOX/LIN pricing?

[Paul Huck:]

Simon?

[Simon Moore:]

Sure. So yes, I mean, we were very pleased, quite frankly, to show positive pricing moves in Asia. As you know, as you look back a little bit of history, that hasn't been the case. It was the case last quarter. So we're pleased by that. At the same time, we continue to invest for the growth in Asia. And we bring on new projects in Asia. We have a fair number of projects coming on. So bottom line is we're pleased by the pricing that we're able to secure in the marketplace in Asia.

[Michael Harrison:]

And in terms of the new Merchant business signings coming at lower pricing, is that something that's consistent across all regions? Or would you see maybe better pricing in a higher-demand region like Asia and lower pricing in, say, Europe and North America?

[Simon Moore:]

That's right. You're right.

[Michael Harrison:]

And in terms of new business signings, particularly in North America Merchant pricing, is the pricing improving? Or is it pretty steady over the last couple of quarters?

[Paul Huck:]

And the prices have been steady over the past few quarters, Mike.

[Michael Harrison:]

Wanted to ask a little bit about the Tonnage business and the outlook for Q1 outage plans. Are your customers seeming to be a more or less at normal rate of downtime or...

[Paul Huck:]

Yes.

[Michael Harrison:]

And do you have any significant opportunities, significantly larger-than-normal opportunities to upgrade facilities or do maintenance on your facilities?

[Paul Huck:]

No.

[Simon Moore:]

But having said that, of course, we will time our outages with our customers outages to take advantage of that opportunity, obviously.

[Michael Harrison:]

Last question I wanted to ask you was on Electronics and Performance Materials. It looks like the Performance Materials side of that business saw kind of a deceleration in the rate of growth. I was wondering if that's a seasonal September quarter issue, or if you feel like some of those markets have hit a point where they've hit maybe that normalized rate of more gradual growth rather than inventory-driven growth?

[Paul Huck:]

Yes, and the business starts to slow down in the September time frame because the construction in the north tends to go out. And so the inventory builds -- and people tend to start to take the inventory down of their products here on the construction markets, which they serve.

[Operator:]

We'll move on to Laurence Alexander with Jefferies.

[Laurence Alexander:]

I don't want to count chickens before they're hatched, but if the Airgas deal goes through, do you have any sort of internal sense for how long that would take to get back to the relatively high return on capital that you're posting right now? Will it be like three years, four years?

[Paul Huck:]

Yes, and we think that it takes three years for us to get through the trough and the return on capital, Laurence.

[Laurence Alexander:]

And secondly, on helium, would you mind characterizing the current supply demand situation and what you're seeing in terms of pricing in the helium market?

[Paul Huck:]

In the market, as far as helium is concerned, and the supply and demand goes up and down because of some plants which have had production issues in the Middle East, principally. But it's pretty much in balance right now. And pricing is okay. Electronics drives a lot of demand of helium.

[Laurence Alexander:]

And so pricing is fairly stable?

[Paul Huck:]

Yes.

[Operator:]

Our next question comes from Kevin McCarthy with Bank of America Merrill Lynch.

[Kevin McCarthy:]

Paul, as you show on Slide 4, you've achieved your 17% operating margin goal at least on a short-term quarterly basis. I think when you unveiled that goal, natural gas prices were significantly higher than they are today. And so my question is if we kind of strip out some of the volatility in percentage margin related to energy, how much additional upside in the margin level do you think is still available over the next year?

[Paul Huck:]

Well, we certainly are going to look for -- and to drive the margin higher. If you look at natural gas, when we put it out, we said that a gas price of $6 was in the assumption. At this time, gas is $4.35, $4.50 or so in quarter four. So that had a slight help on the margin. But it has a bigger impact on the On-site business, on that business. It doesn't have as big impact on the company obviously, for us. So it's still a good margin for us.

[Kevin McCarthy:]

So am I correct in understanding that you would expect to sustain the current level into fiscal '11?

[Paul Huck:]

And for us, I think if you do look at Q1, I think, and the margin is going to decline a little bit for us because the factors on the cutdown in production in Electronics and Performance Materials, so as the volumes pull back there and also the on-site spending on the turns in the Tonnage Gas business, so we have that as a little drag on margins. We are going from quarter four to quarter one. We have that every year. We see that every year.

[Simon Moore:]

And Kevin, our goal, certainly, is to hit 17% for the full year for next year. And then when we're optimistic we'll be successful doing that, we'll look to reset some longer-term targets at that time.

[Operator:]

Next, we'll hear from Mark Gulley with Soleil Securities.

[Mark Gulley:]

As part of your CapEx plans, Paul, you were referring a little bit to, I guess, sometimes what you call de-captivations buying; selling Equipment plants and turning them to sell gas. One, are you active in that area in China? And two, are you seeing some competition for the new start-up that seems to be rolling at the China market, Yindee [ph]? Had they had an impact on your ability to accomplish that goal?

[Paul Huck:]

Yes, we do it in China. We have not seen Yindee [ph] buying any plants today, although I'm sure that they are trying to do those things and look at those opportunity because a thing which we do, Mark, is we look for us to go out and buy a plant from someone. What we want is the ability to invest again at that site. And what I don't want is just go in and finance that plant for that person. I'd like to be able to go in and expand the site for us and give us opportunity to invest more.

[Mark Gulley:]

Following up on Laurence's question, you talked about a three-year recovery in your return on capital employed. Can you share us what you think the decrement will be the day of closing, if you will, and assuming you do buy your gas?

[Paul Huck:]

Yes, I think it drops us down by about 3% or so. And then we come back from there.

[Mark Gulley:]

And then finally, can you update us on the balance sheet, again, following through on the Airgas thing. Are you going to be able to maintain investment grade financing internal capital as you talked about today in Airgas without an equity raise? Or can you update us on balance sheet strategy going forward?

[Paul Huck:]

Yes, and we can do this at the top price which we are willing to pay for this and do it with all debt. So the strategy has not changed any there. We're not going to need to raise equity and we'd remain in the investment grade, and that's a BBB.

[Operator:]

Next, we'll hear from Bob Koort with Goldman Sachs.

[Robert Koort:]

A little more clarity on Merchant Gas and pass-through of natural gas to energy costs there, can you just give me a sense if hydrogen unit price was $100, what would a $1 change in gas do to that price?

[Simon Moore:]

So you're talking about on the liquid hydrogen side?

[Robert Koort:]

Yes.

[Simon Moore:]

So I mean, think we generally talk about the energy cost being in the range of 1/3 of the cost there, so it could be in that sort of range. Again, remember, on the Merchant business, it's not quite as quick as it is on the Tonnage business, the pass-through. There is some lag there, that's why you see some different things on a time basis.

[Robert Koort:]

And then, Paul, could you talk a little bit about if you've seeing any evolution in behavior since the financial crisis to present? And then looking forward, in terms of competitive activity around bids and implicit returns in those of bids? Has it changed much over the period?

[Paul Huck:]

No, it has not changed, Bob. I think everyone is looking still for a good return on that. The only people who've said, "Well, I'm going to take advantage of the fact that rates are low, et cetera, and finance a plant real cheap on those things," --on the competition, we always have that competition. But we have not seen anyone really out there doing anything, which we think destroys the opportunities for us investing.

[Operator:]

John Roberts with Buckingham Research has our next question.

[John Roberts:]

I wanted to ask about your 1% to 2% growth outlook for Europe for 2011. The volume in the quarter just reported was only up 1%, and I think that was a deceleration from 4% last quarter?

[Paul Huck:]

Yes.

[John Roberts:]

That comp was actually easier, so it decelerated I think even more because, again, you're decelerating on a one-year basis in a two-year, the comps are easier if you go back a couple of years. So is the turnaround here? Is it the lagging Packaged Gas business coming up that will cause things to pick up a little bit because the trend is actually the other way right now.

[Paul Huck:]

And yes, John, the Packaged Gas business does lag. The volumes in that business were down for us as we looked at this year-over-year. And that's a business which depends upon people really starting to invest again, and we aren't predicting that to happen until late 2011.

[John Roberts:]

So it's the Packaged Gas lag turnaround here that's going to start the turn?

[Paul Huck:]

Yes.

[Operator:]

Our next question comes from Edward Yang with Oppenheimer.

[Edward Yang:]

First, on Equipment. Why are margins there so volatile? Is there any way to kind of model that out in a predictable way? Usually, it's sort of a plug in my model. But I look at '10 results versus '09, your revenues are down, but the operating income is up substantially. So what are the drivers there?

[Paul Huck:]

Yes, Ed. And that's caused by the mix of the business in the LNG and the Air Separation units. The Air Separation units, which we sell, have a lot of equipment which we buy in and we don't put up a markup on. But it's run through our sales. LNG, we make the exchanges, we do the process design, it's 100% value added. And the margin in the LNG business are a lot higher than on the Air Separation business. So if you'll just look at 2009 to 2010, the 2009, the mix of the business was a lot more on the Air Separation plant side than on the LNG side and it reversed in 2010, a lot more on the LNG side. And we would expect in 2011 for the bulk of our profits to come from the LNG side also.

[Edward Yang:]

And on a refining hydrogen, what were volumes in the quarter including new projects and also on a same-store sales basis and your expectations for 2011?

[Paul Huck:]

Yes, in the quarter, if we look against prior year and the volumes on the refinery side were up a little bit for us and about flat same-store sales.

[Edward Yang:]

And your expectation for next year?

[Paul Huck:]

For them to continue to grow. I don't have an exact number on the volume side.

[Operator:]

That's all the time we have for questions today. I'll turn the conference for Mr. Moore for any additional or closing remarks.

[Simon Moore:]

Thanks, James. Please go to our website to access a replay of this call beginning at 2 p.m. today. Thank you for joining us, and have a nice day.

[Operator:]

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