Air Products & Chemicals Inc (APD) — Q2 2015 Earnings Call Transcript

Thank you, Orlando. Good morning, everyone and welcome to Air Products' second quarter 2015 earnings results teleconference. This is Simon Moore, Director of Investor Relations. I'm pleased to be joined today by Seifi Ghasemi, our Chairman, President and CEO; Scott Crocco, our CFO; and our senior business leaders. After our comments, we will be pleased to take your questions. Please limit yourself to one question and a follow-up. Our earnings release and the slides for this call are available on our website at airproducts.com. Please refer to the forward-looking statement disclosure on page 2 of the slides and at the end of today's earnings release. Now, I am pleased to turn the call over to Seifi.

Thank you, Simon and good morning to everyone. Thank you for taking time from your busy schedule to be on our call today. We do appreciate your interest in our company. First, let me introduce our team who are on the call today. In addition to Simon, I have Mr. Scott Crocco, our Senior Vice President and Chief Financial Officer; Mr. Corning Painter, Air Products' Executive Vice President responsible for Industrial Gases; and Mr. Guillermo Novo, Air Products' Executive Vice President in charge of Materials Technologies. All of us will be participating in the call and in answering your questions. I'm very pleased to report that Air Products delivered strong results in the second quarter of our fiscal year 2015. Despite significant currency headwinds and weaker economic growth in most of the geographies that we operate in, we delivered good improvement in our safety performance, our EBITDA margins are up 440 basis points versus last year and our earnings per share improved by 17%. This is a significant improvement versus last year and is a clear demonstration of the effectiveness of the strategic actions we have taken in the last 10 months. Our new organization is in place, it is functioning well and delivering results. So before I go any further, I want to thank all of the talented, dedicated and committed employees of Air Products for doing such a great job. What we are presenting to you today is the result of our 20,000 employees coming to work every day committed to serve our customers and improve every aspect of our performance. Our people are the force behind our progress. I certainly consider it an honor and a privilege to be part of this winning team. Now please turn to slide number three, our safety performance. Year-to-date, we improved our lost time injury rate by 28% and our recordable injury rate by 30%. As Scott said during the investor conference, excellence in safety requires focus, discipline, process orientation and execution. These same characteristics are required for excellence in business performance too. The improvement in our safety results which is our number one priority, is encouraging, but we need to move forward to achieve our goal of zero incidents and zero accidents. Now please turn to slide number 4. I would like to continue to remind everybody that our goal is and will continue to be a constant and persistent effort to become the safest and most profitable industrial gas company in the world, providing excellent service to our customers. Now please turn to slide number 5. You have heard us many times that our goal is to create value for our shareholders. To do that, we are focused on two key elements. One, responsible allocation of capital. Air Products generates a significant amount of cash. We, the management of the company, fully understand that the proper and responsible allocation of that capital is a clear element of value creation. The second key point is that it is not enough to have a strategy. You have to be able to execute it. Strategy without execution is worthless. So we are fully committed to actually execute our five-point strategic plan. Before I comment on our strategic plan, please go to slide number 6 which, in simple words, explains our overall management philosophy. We have shown this slide to you before, but it is important to emphasize the key points that cash is king, EPS doesn't determine the long-term value of the company, it is the share price and the importance of capital allocation in addition to reorganization. Now please go to slide number 7. This in summary is our strategic plan. We have made several presentations explaining the details and our executives have spent a full day at our Investor Conference on March 31 describing how we are implementing this plan. I have this slide as a reference for you. All of the presentations that we have made at our Investor Day are posted on our website for your reference and I highly encourage you to take a look at them if you have not already done so. Now please turn to slide number 8. On Monday, April 20, we announced that Air Products has had the honor and privilege of being awarded a contract to build, own and operate with our partners, ACWA, the world's largest industrial gas complex, to supply about 75,000 tons per day of industrial gases to Saudi Aramco's refinery in Jazan, Saudi Arabia. This is by far the largest contract we have ever won in our company's 75-year history. We did have a conference call to explain this project and the details of that conference call are again on our website. We've included the highlights here for your reference and we will be happy to answer any questions about it later on. The key point that I would like to make is that the award of this project demonstrates that Air Products has the technology, people and the self-confidence to compete for the world's largest industrial gas projects. It also demonstrates that in addition to our focus on improving our day-to-day performance, we are committed to participate and win the right growth opportunities in the energy sector, environmental sector and the emerging markets. Now please turn to slide number 9, a summary of our quarterly results. Scott will go into the details of these numbers, but I would like to draw your attention to the significant improvement in our margins, 440 basis points, a key goal for us to become the most profitable industrial gas company in the world. In addition, despite the significant headwinds from currency of $0.09 per share, we improved our EPS by 17% versus last year and had positive free cash flow. In particular, the Materials Technologies team, operating more and more as an independent business under Guillermo's leadership, delivered great results driven by the strong market position and focused cost and productivity efforts. We continue to be optimistic about the future of Materials Technologies. Now please turn to slide number 10 where you can see our steady progress toward improving our EBITDA margin. We do appreciate that we still have a long ways to go to meet our stated goal of being the most profitable industrial gas company in the world, but the key fact is that we have started on our journey and we are making progress. Air Products is moving forward with the full force and support of our people. I am very proud of our entire team and optimistic and excited about our future. Now I would like to turn the call over to Mr. Scott Crocco, our Senior Vice President and Chief Financial Officer, to go through the details and then I will come back after comments from Corning, Guillermo and Simon to make some closing remarks and then we will answer your questions.

Thank you very much, Seifi. Now please turn to slide 11 for a more detailed review of our Q2 results. Sales of $2.4 billion decreased 6% as strong underlying growth of 5% was offset by an unfavorable currency impact of 5% and a lower energy pass-through impact of 6%. Volumes increased 4% primarily from strength in two areas. In Gases Asia, volume growth was driven primarily by new plants in China. And Materials Technologies again saw solid growth across all businesses. Pricing was 1% higher driven by price increases in Gases Americas, Gases Europe and Materials Technologies. We delivered operating leverage again this quarter as EBITDA improved 10% and operating income improved by 15% despite the lower sales. Versus prior year, EBITDA margin improved 440 basis points to 29.4% while our operating margin improved 340 basis points to 18.3%. This is the highest quarterly operating margin in over 25 years. Sequentially, our margins improved primarily due to Materials Technologies and higher sales in our equipment businesses. Versus prior year, net income increased 19% and earnings per share grew by 17% and we continue to improve our return on capital employed which increased by 80 basis points versus prior year to 10.5%. Please turn to slide 12. My presentation at our Investor Conference last month focused almost entirely on cash flow. We do not want to borrow money to pay dividends. This is consistent with the way we are focusing on running the business. As you can see, in our second quarter of 2015, distributable cash flow was up 14% and free cash flow was up $63 million as we generated higher EBITDA and spent less on maintenance capital. We are focused on optimizing maintenance capital, spending the right amount at the right time and properly supporting the base business. These improvements were more than offset by an increase in cash taxes and dividends. From a timing perspective, it is not unusual for items to move around quarter to quarter, particularly maintenance capital and cash taxes. For the remainder of fiscal 2015, we expect to continue delivering higher EBITDA due to our cost-reduction efforts and our capital expenditures should decline in the second half of the year due to project timing. We continue to work towards being free cash flow positive for fiscal year 2015. Turning to slide 13, you can see an overview of this quarter's performance in terms of earnings per share. Before I comment on our Q2 operating performance, I would like to spend a moment reviewing two non-GAAP items, both resulting from our organizational restructuring actions. First, our restructuring charges totaling $55 million pretax or $0.18 per share. Second, we recorded a pension settlement charge of $13 million pretax or $0.04 per share. As I have mentioned on prior calls, we expect to see restructuring costs and pension settlement costs during FY 2015 as we continue to simplify the organization and reduce costs. Excluding these items, our Q2 continuing operations EPS of $1.55 increased $0.23 or 17% versus last year. Higher volumes increased EPS by $0.22. Pricing, energy and raw material taken together contributed $0.10. Net cost performance was $0.02 unfavorable as the benefits of our cost-reduction actions were offset by higher incentive compensation costs of about $0.15 and an unfavorable impact from other income and expense of $0.04. We have higher incentive compensation costs this year due to better expected performance versus lower incentive compensation costs last year due to worse performance. Furthermore, in Q2, we adjusted our incentive compensation for the first half of the year, so this impact this quarter reflects both Q1 and Q2. Our incentive compensation program is very well-aligned with the performance of each business unit and it encourages action and it rewards for delivering results. Unfavorable currency translation was $0.09 as almost all currencies weakened against the dollar. As a reminder, our currency exposure is primarily translational as the vast majority of our products are made and sold in the same currency. Equity affiliate income was a penny higher. Interest expense was $0.03 lower due to higher capitalized interest and lower rates. Our tax rate of 24% remained unchanged versus prior year. And finally, higher shares outstanding reduced earnings per share by $0.02. Now to begin the review of our business segment results, I'll turn the call over to Corning.

Thank you, Scott. As we shared at our Investor Conference last month, our global industrial gas team is working on our 5 Point Plan to improve business operations. We discussed what focusing on the core means for Industrial Gases, which includes building density and integrated positions locally. We highlighted how the new organization helps facilitate better and quicker decision-making close to our operations. You heard examples worldwide of behavior and decision-making changes driven by our new culture centered on Safety, Simplicity, Speed, and Self-confidence. There were numerous instances of local empowered teams altering how we operate plants, manage assets, deliver products, and source key materials and services, ultimately leading to improved business outcomes. You also heard how aligning rewards at the local level, allowing people to see the impact of their actions on their pay, motivates our workforce and strengthens teamwork. As Scott mentioned, we have provided for higher bonus payouts this year compared to last, which aligns employer rewards with shareholder value. The impact of these changes is reflected in our safety and business results. I want to express my gratitude to our team members who continue to be dedicated and deliver results. Now, addressing a common inquiry, the price of oil stayed in the $45 to $55 per barrel range during the quarter, about half of what it was a year ago. To recap, we have minimal direct exposure to Oil Exploration & Production, approximately $30 million to $40 million annually in sales. However, we have started witnessing minor effects, including a reduction in liquid nitrogen volumes to the oilfield services market and some influences on our offshore business. We have seen a few customers postponing project decisions, although the reasons can be hard to pinpoint. Importantly, we have not noticed any decline in the underlying hydrogen demand in the Americas, as our refinery clients continue to operate at high levels. Lastly, we announced last week that Marie Ffolkes will join Air Products next month as President of Industrial Gases America, and we are thrilled to welcome her to this role. Please refer to slide 14 for a review of our Gases Americas results. We achieved strong performance this quarter, with modest underlying sales growth and significant cost improvements resulting in substantial margin growth compared to a weak second quarter last year. Sales totaled $890 million, down 14% from last year due to a 13% decline from the pass-through of lower energy prices. The price of natural gas in the Houston Ship Channel fell nearly 40% to about $3 per million BTU. Currency fluctuations, particularly with the Chilean peso, Brazilian real, and Canadian dollar, contributed to a 3% reduction in our sales. Underlying sales grew by 2% driven by higher volumes and prices. Volumes increased by 1% with liquid oxygen, nitrogen, and argon volumes up in North America, although demand wasn't as high as anticipated in March. As mentioned, hydrogen volumes remained robust and increased compared to last year due to fewer maintenance outages by customers. Helium volumes decreased across the region. Sequentially, volumes declined due to seasonality in Latin America and lower hydrogen volumes in North America from customer outages. We consider this as normal variation in our pipeline hydrogen volumes and do not perceive any overall demand decline. Our refinery customers continue to function at high levels. Pricing increased by 1% from last year, reflecting our successful pricing strategies, although this was partially neutralized by contract formula reductions for some liquid customers as power and diesel prices have decreased. Additionally, we are experiencing lower power and diesel costs. It's important to remember that last year we faced significantly higher power costs due to rate spikes during the severe cold weather in North America. Pricing in Latin America remained strong amid the inflationary environment. We encountered profit challenges from currency, reduced energy pass-through, and higher incentive compensation. Nevertheless, our team was able to overcome these challenges, achieving 7% growth in both EBITDA and operating income due to the benefits of our restructuring efforts, lower maintenance costs, volume leverage, and favorable pricing. The operating margin reached 20.4%, an increase of 400 basis points, with about a third attributed to lower energy pass-through, another third from volume and price increases, and the remaining from reduced costs. The EBITDA margin rose to 33.7%, benefiting from a 640 basis point increase. Sequentially, profits declined due to currency effects, lower volumes, decreased natural gas prices, and higher incentive compensation, although partially offset by our restructuring actions. While we remain focused on reducing costs, we are pleased to announce that we received a new project from Big River Steel to support their hot rolled steel facility in Mississippi County, Arkansas. This aligns with our strategy, as our new integrated gases facility will enhance density in the local market.

Thank you, Corning. Please turn to slide 17. The Materials Technologies team achieved another strong quarter with double-digit underlying sales growth, improved product mix, and a focus on productivity and costs that raised margins to their highest level in two and a half years. As I mentioned at the Investor Conference, we have a robust portfolio of businesses in leading market positions. Our team is enthusiastic about our emphasis on Materials Technologies, delivering both safety and business results. Segment sales reached $533 million, reflecting a 7% increase compared to the prior year. Underlying sales rose by 11%, supported by 9% volume growth and a 2% positive effect from pricing and mix. Electronic sales increased by 16% due to favorable volume and pricing, with strong contributions from all businesses. Process Materials volumes rose due to sustained high demand in the memory sector. As noted last quarter, due to tighter supply-demand conditions, we are actively negotiating several multiyear supply agreements with our customers, which is a significant step for our Process Materials division and should enhance the stability of our volumes and earnings moving forward. Meanwhile, we achieved positive pricing this quarter. Advanced Materials continues to experience volume growth as customers operate their newest and most advanced production lines at high capacity. Delivery Systems performed well, although we anticipate a decline in performance later this year. Sequential volumes decreased due to diminished activity during the Lunar New Year, yet pricing and mix remained positive. Performance materials encountered more currency impacts, with underlying sales increasing by 4%. Volumes grew in the mid-single digits thanks to healthy demand across all three businesses. Price and mix were slightly negative, but improved margins were driven by lower raw material costs and enhanced productivity. As mentioned at the Investor Conference, innovation is vital for our success in Materials Technologies. We are seeing strong results from the Advanced Materials portfolio in electronics and our non-emissive catalysts in the polyurethane sector. These innovations are driving business results, and we are also satisfied with the achievements of our innovation initiatives across the rest of our portfolio. EBITDA reached $148 million, a 27% increase, and EBITDA margins improved to 27.8%, marking a 440 basis point rise from last year. Both EBITDA and operating margins have reached their highest levels in two and a half years. These impressive results were achieved despite challenges from currency fluctuations and higher incentive compensation compared to last year. We capitalized on volume growth, maintained positive pricing, improved cost margins, and benefited from productivity, while also beginning to see results from our cost restructuring initiatives, thanks to the excellent work of our team. We are now concentrating on our key priorities: safety, quality, top-line growth, margin enhancement, and advancing our strategic initiatives to further boost our business performance. Now I'll turn the call back over to Simon.

Thanks, Guillermo. I'll just comment quickly on our corporate segment that consists of our LNG and helium container businesses, as well as corporate costs which are not business-specific. Sales were up this quarter as higher LNG project activity more than offset lower helium container sales. We have seen no change to the LNG projects we are executing in our backlog. We have seen some signs of a slowdown in customer decision-making on new projects. The improved profitability was driven by the higher LNG activity. Corporate costs were flat with a reduction from our cost-saving actions offset by higher incentive compensation. Now I will turn the call back over to Seifi.

Thank you again, Simon. Now please turn to slide number 18 for a discussion of our outlook. At this time, based on what we know today, our guidance for the next quarter is $1.55 to $1.60 per share. At midpoint, this will be an increase of 8% over previous year. As for all of fiscal year 2015, we are maintaining our guidance of $6.35 to $6.55 per share. At midpoint, this represents a 12% increase over 2014 results despite the fact that we expect almost $0.40 per share negative headwind from currency translation. As I said last quarter, we are not going to use currency headwinds as an excuse to lower our guidance this year. We take very seriously what we have promised investors at the beginning of the year and consider it to be our job to take actions to deliver the numbers we promised rather than reducing our guidance each quarter because of currency fluctuations or economic conditions. We also understand that our guidance implies a strong fourth quarter. But again, we expect that the accelerating benefits of our restructuring will give us the ability to deliver on this forecast. As for capital expenditure in 2015, we now expect for it to be around $1.7 billion which is at the lower end of our previous guidance. This is due to the impact of currency and also our increased focus on all capital expenditures. We continue to enjoy a robust backlog with a high level of secure on-site pipeline projects. The backlog of $3.2 billion remains unchanged from last quarter and you can see a list of our major projects in the appendix slides. Please note that we have not included the significant project that we just won, the Jazan project, in this backlog. In closing, I would like to say that we are totally focused on actions that we can control to deliver on the commitments that we are making here. We are executing on our improvement actions and our team is working together to achieve our goals. Once again, I would like to take a minute and thank all of the Air Products people for the outstanding job that they are doing. At the end of the day, our performance is the result of their hard work. I'm incredibly proud of the 20,000 talented, committed and motivated employees at Air Products and I certainly consider it an honor and a privilege, as I said before, to be part of this winning team. We are working hard to move Air Products forward and create value for our shareholders. Now with that, we are more than happy to answer your questions.

Actually this is Matt Andrejkovics calling in for Vincent. Thanks for taking the call. The decline in the CapEx forecast, can you just elaborate on some of the delays that you are seeing?

There are no delays in our CapEx forecast. The CapEx forecast is because of two reasons. Number one, we are focused on doing the right projects and the second thing is that some of the projects that we are doing are coming in under the estimate that we had before. And obviously the effect of currency. There is no delay on any projects.

And then can you just comment a little bit on the volume increases in Materials Technologies and also is it possible to parse out the difference in margin improvements that you're seeing from productivity as opposed to operating leverage?

I would like to turn that over to Guillermo to answer for you.

In terms of volume growth, all segments have experienced good growth. In Electronics, the consumer side is performing exceptionally well. There is high demand for memory, and our position with key players benefiting from growth in mobility, such as the cell phone markets and other rapidly growing sectors, has been very favorable for us. Additionally, we have been approving many new technologies for the next generation nodes, which has aided our ramp rates. Looking at Performance Materials, the growth has been broad-based. This is not our peak season; the peak is anticipated in the next two quarters due to weather and seasonality, but we have seen strong volumes globally, including in Europe and in specific segments where we differentiate ourselves. While we haven't disclosed the specific factors driving margins, all areas are contributing; there is no single major contributor. As I mentioned during the conference call in New York, we have taken targeted actions over the past year to drive improvement, establishing a solid foundation. Currently, we are experiencing good volumes, high plant loadings, and are implementing numerous productivity initiatives in our plants to enhance capacities and yields across our networks. The new products we are launching are positively affecting our mix, and all these elements are contributing to our results.

A couple of questions. Seifi, when you took over, you started announcing local currency price increases, but with lower energy and distribution costs, I would imagine that getting pricing is difficult, so can you just talk about the pricing dynamics that you are seeing in the marketplace?

I will give you a general answer and I would like to turn it over to Corning to elaborate. But, overall, we are still getting price increases in some of the markets that we operate in because of supply/demand and I would like to have Corning elaborate on that.

So first, just to be clear, anything that is let's say related to our onsite business or our HyCo business, where there's energy in that, you see that all in pass-through. So when we report our pricing, you are really looking at our liquid products that we deliver to a customer and you are seeing that the average price has gone up and down a little bit, so what is the trade-off of mix, it means customers with higher prices or lower prices. So that's what you see in it. And if you think of what we referred to in North America, you are seeing there the net impact we've been able to achieve in a pure price where we simply move the price up, offset by places where, in those liquid contracts, there's a formula that takes the price down or a surcharge comes down in cases where power costs come down or diesel costs come down and that is fair. And in terms of let's say net contribution margin to us, that really holds us neutral because those costs are coming down for us at the same time.

And my second question is on your maintenance CapEx which was down by 50% which seems like a big cut, was there something in the old CapEx number that shouldn't have been there and if you continue to produce this kind of free cash flow, when does stock buyback come in the picture? Thank you.

Regarding maintenance costs, they fluctuate each quarter depending on scheduled maintenance and other related factors. Generally, I want to note that the company includes expenses for trucks, new vehicles, customer stations, and similar items in these maintenance costs. We aim to ensure that all our plants function reliably, but I acknowledge that we haven't been as disciplined as we should be regarding maintenance expenses, and we are concentrating on this issue. I anticipate that these costs will vary from quarter to quarter. For the company, we project annual maintenance capital expenditures to be between $250 million and $300 million. As for free cash flow, our first priority is to ensure we have the cash available. Once we do, the best way to add value for our shareholders is to invest in organic growth and new projects that offer a higher return than our cost of capital. Fortunately, we see many opportunities to achieve this, particularly with large projects and our HyCo initiatives, and we've already highlighted some examples. Beyond that, we also have the option to increase the company’s dividend before considering stock buybacks.

This is Ryan Berney on for Bob. Just had a question on the energy pass-through, is the level of sensitivity that we saw this quarter versus natural gas and power costs coming down in the Gases Americas segment? Is that pretty indicative of kind of what it would be in the future if those prices were to come back up?

Yes, there's nothing particularly unique on the way we did the calculation and if things reverse, you just expect a reversal of what you saw in the P&L here.

Did you see any margin improvement this quarter due to the fixed cost structure, and if so, how much compared to the declining sales?

Are you referring to our HyCo business or are you referring on our business in general?

So a lot of moving pieces if you look at the Gases Americas as a whole, so there is currency because we've got South America, we've got Canada, we've got the natural gas, we have the incentive, we have seasonality in Chile and all of that. And if you wash all of that out and you think about norming for volumes, I think we are in a similar range to where we have been.

Can you explain the change in the interest expense from the first to the second quarter? Did your cash interest change or is it a different accounting treatment? Why did you go down so much with your net cash balances or net debt balances not changing very much?

Very good. Can I have your other questions and then we can answer them. Interest expense is one. The next one?

The second one is your cash flow from operations in the first half is down $60 million, notwithstanding the earnings growth. Is that because you are putting a lot more in your pension? I don't know what you contributed in your pension in the first half of last year, the first half of this year, but why isn't the operating cash flow stronger all things being equal?

Okay. Anything else?

In terms of interest, the main factor affecting its change is currency. Regarding free cash flow, I want to emphasize that we are focused on the all-in simple free cash flow metric. We've considered various elements, but the straightforward nature of our free cash flow metric is crucial, especially in relation to EBITDA, interest expense, cash taxes, and maintenance costs. There are other aspects of cash flow from operations that my team and I are monitoring closely, including severance payments due to right-sizing the organization. These severance payments do not appear in our simple free cash flow metric, but we are handling them. We are also managing working capital, which has seen cash usage, and we are trying to improve on that front. Furthermore, there are timing considerations related to payments from equity affiliates, earnings, and dividends received. The key takeaway is that for this quarter, our simple free cash flow metric has turned positive. While there are additional factors to manage, the responsible individuals are on top of this, and although it has used cash, we are committed to enhancing our working capital. We will need to address severance payments, but we aim to make improvements across the board.

But, obviously, Jeff, as you realize, those are kind of one-time items that doesn't indicate our kind of operating rate on a steady-state basis, that's why we separate them.

What was the pension change in the first half year-over-year in the funding?

Overall contributions include expenses that are non-cash, amounting to a net favorable impact of around $30 million. Additionally, severance payments incurred in the second quarter are significant. These payments affect the cash flow but are not reflected in the standard free cash flow metric.

The severance payment is obviously significant, Jeff, considering what we have discussed.

Seifi, I think you got a 440 basis points EBITDA margin improvement over the last year. You have cut the gap with Praxair in half from 7% to 3.6%. How much of this is your $600 million cost-cutting program and within that cost-cutting program, have you made any progress yet on the operational efficiencies or is it still all SG&A and functional support costs? And then a related question would be, on your volume growth, as you load up plants in the U.S., what kind of incremental margin should we expect?

Okay. First of all, Don, as you say, we are 17% EPS up versus last year despite the currency, the margin improvement of 440 basis points. All of that is related to the cost actions that we have taken. And most of that is on the first $300 million of so-called overhead cost reduction that we've been talking to you about. We have made progress on the other $300 million, but that is still not significant enough to show in our bottom line. It will, starting at the end of this year and into 2016. So then with respect to volume growth, I would like to have Corning comment on that.

So I think volume growth right now in this current economic environment we are in, looking around the world is not something we want to be counting on going forward. I think if you think about the restructuring we are doing, if we were in very high let's say economic growth, you could maybe be concerned on how you are going to keep up with it. I think if you think about the economic environment we are in really globally today, the cost actions we are taking are perfectly timed for the environment we are in.

Yes, but in terms of specifically the question you had about what kind of a margin, with the volume growth, we will expect more than 50% leverage dropping more than 50% to the bottom line.

Corning, did your volumes grow in the U.S. and what are operating rates in your U.S. merchant system?

So operating growth that we reported for the U.S. was 1% and I would say operating rates are in the high 70%s.

More of a bigger-picture question here. With your backlog of primarily focused on on-site and yet clearly one of your big strategic goals is to increase density, are you going to need to spend some more CapEx to improve the density side of the portfolio or how can you increase density while still keeping your CapEx relatively disciplined?

Well, I think, first of all, you saw one example that Corning mentioned. Big River Steel is a very good example, that it would help us build density in one part. But the other thing is that please keep in mind that most of our backlog, the capital for that backlog has been mainly spent. So as we go forward, we don't need to spend $1.7 billion to support that backlog; that is already done. Therefore, we would have plenty of cash in order to still maintain a reasonable CapEx level of expenditure, but we have plenty of cash to support our activities to increase density in different parts of the world on smaller projects which is what we are going to do. I'd like to have Corning add to that, please.

I think there's a path as well with your current assets to improve your density which is simply customers who are further away. We can think about what our cost to serve them is and what the right price should be and we can think about what that is for our opportunities who are closer to us. These are things that don't change overnight, but with month after month of diligence this is something we can improve.

And then just a different question, there is some degree of change in the gasoline pool going from tier 2 to tier 3 in terms of sulfur. How much of an opportunity would you see that in for your hydrogen business?

It is very difficult to quantify that right now, but obviously that would be a positive. For us to quantify that at this stage would be a challenge, but until we know more about the details, but it certainly is in the right direction.

With regard to atmospheric gases in the Americas, I think in your prepared remarks you'd commented that volumes were not what you expected in March and was wondering if you could elaborate on what you saw in terms of the monthly cadence and what you are seeing so far in April there?

I would just like to make a general comment and I'll turn it over to Corning to elaborate on that. But fundamentally we did see a softening of the economic activity in March. I think everybody is seeing that and that seems to be continuing in April. But, Corning, you want to elaborate on that?

Just to quantify it a little bit. So let's say underlying oxygen, nitrogen, argon liquid volumes we would say were up in the low to mid-single digits for the quarter as a whole and just to say the volumes in March and a little bit the March volumes in April, they are not quite as strong as one would have hoped.

I am happy to clarify that. The incentive system for 95% of our employees is based on constant currency. In constant currency terms, we expect our estimate for the year to be $7. We are accruing based on constant currency as part of the incentive for our employees. Since they are performing ahead of the plan in constant currency, we are obligated by accounting rules to accrue for that, as they will receive more than 100% in terms of bonuses. In the second quarter, we had to account for accruals for both quarters because we didn't do so in the first quarter. This explains the significant amount of $0.15, which actually equates to $45 million. Our performance in constant currency is significantly ahead of the plan. As I mentioned, 99% of our employees are incentivized based on earnings per share because that's the appropriate method, but for plant managers, their evaluation must be based on constant currency, as it's the most equitable way to assess their performance. I hope this clarifies the situation.

Just to follow up on that last point then, we should expect that the incentive compensation, all else being equal, should come down by $20 million to $25 million next quarter?

Well, it depends on how our people are performing versus their plan, but obviously in the third quarter we wouldn't have a $45 million charge, sure. It would be a lot less than that.

And the second point is you said that your hydrogen was up year-to-year on fewer shutdowns and two things. I'm wondering, first, could you address the comment on margin? Second, with the hydrogen, is there a catch-up that you can see at some point in the future when turnarounds accelerate?

First of all, I would like to confirm what Corning said for the month of March. Regarding hydrogen, we are actually witnessing an increase in demand due to lower oil prices, which is leading to more driving and refineries operating at higher capacities than ever before. We do not anticipate a slowdown in hydrogen; in fact, we expect it to remain quite strong.

Two questions here. I think Linde reported a pretty big drop in new orders for the equipment side of its business. You obviously scored a big order in the quarter in Saudi Arabia, but you mentioned some caution by customers for lower oil prices, so maybe you could elaborate a little bit more on what your bidding backlog looks like now? And then, secondly, I think this is the first quarter we have seen the pension settlement loss. Will that get to be a relatively large number or will that be just a small number occasionally?

Very good. I'll answer the first question and the second question I will have Scott answer that. On the equipment side, as you know, we do not have a very big equipment business like some of our competitors. Obviously, the award of the Jazan project is a significant boost for our equipment business, but the rest of our equipment business is not that significant; therefore, we have not seen a significant drop and I don't expect anything material there, but the Jazan project is going to be obviously a significant boost for our equipment business.

I will address the second part of the question regarding pension and settlement. We anticipate seeing a bit more in the future, though it won't be substantial; possibly around $10 million each quarter. The main point is that we are committed to adjusting the organization for the future. We will highlight this, report it as non-GAAP, and continue to focus on the core business performance. I would estimate that it will be in that range for the next few quarters.

Seifi, it's Ram Sivalingam sitting in for David. A quick question for your business heads. Corning, good margin trajectory in Q2. The outlier was industrial gases; EMEA, you said margins should lift as we get through the back part of the year. Can you give sort of any insight as to how the cadence of that is going to flow through? And then for Guillermo, stellar margins, obviously, but as you think about the run rate going forward, how are you thinking about that?

Okay, so let's start off then with Europe. We have taken a large number of the actions we need to take in Europe. There's always a little bit more of a delay in Europe between the action and when it shows up in the P&L, but we would expect to see a step up in both quarters for it.

From Materials Technologies, I think we are doing well and we see opportunities for further improvement across our different businesses. We have a broad portfolio, so it is six businesses, each one is with their own dynamics. So we are very optimistic that we can continue to drive improvement moving all levers.

Guillermo, you are referring to sequentially from Q2 into Q3, Q4?

Yes, if you look at the sequence, the next two quarters typically show stronger performance for us in terms of volume. These quarters usually contribute significantly to our year's results.

You mentioned that the outlook for Q4 implies a significant increase, with an annualized run rate around 720. Over the past seven to eight years, Air Products has consistently posted annual results that are $0.10 to $0.20 higher than the previous Q4 run rate. Does this indicate that your baseline for projecting 2016 is actually over 740 or 750? Also, should we be considering any offsets for next year in relation to this?

It would be difficult for me at this stage to speculate about 2016. I'm sure you understand with all of the moving parts that there are in the world it would be difficult to do that, but the way you are doing the math, if nothing else changes that is one way of coming to some kind of numbers, but I cannot really comment on that. Okay. I would just like to say thanks again for your questions. Thank you for being on the call, and we look forward to talking to you in the near future. Thank you very much.