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ARG > SEC Filings for ARG > Form 10-Q on 10-Feb-2014All Recent SEC Filings

Show all filings for AIRGAS INC

Form 10-Q for AIRGAS INC


10-Feb-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

OVERVIEW
Airgas, Inc. and its subsidiaries ("Airgas" or the "Company") had net sales for the quarter ended December 31, 2013 ("current quarter") of $1.24 billion compared to $1.21 billion for the quarter ended December 31, 2012 ("prior year quarter"), an increase of 3%. Organic sales increased 1% compared to the prior year quarter, with gas and rent up 1% and hardgoods also up 1%. Current and prior year acquisitions contributed sales growth of 2% in the current quarter. The Company's organic sales growth reflected the impact of sluggish business conditions and persistent economic uncertainty, which continued to challenge sales volumes to a greater degree than expected.
The consolidated gross profit margin (excluding depreciation) in the current quarter was 56.7%, an increase of 60 basis points from the prior year quarter, reflecting margin expansion on price increases and a sales mix shift away from lower-margin refrigerants, partially offset by supplier price and internal production cost increases and significant margin pressure in the Company's refrigerants business.
The Company's operating income margin increased to 12.5%, a 30 basis-point increase from the prior year quarter. The Company's operating income margin increase was primarily driven by the combination of a reduction in SAP implementation costs compared to the prior year quarter and the achievement of SAP-related benefits as planned during the current quarter. Steps taken to alleviate the impact of rising costs in the current quarter also contributed to the expansion of operating income margin. These benefits were partially offset by a significant decline in operating income margin in the Company's refrigerants business and overall margin pressure from low organic sales growth. The prior year quarter's operating income margin benefited from a 10 basis-point adjustment related to lower than previously estimated restructuring charges. Net earnings per diluted share increased to $1.10 in the current quarter versus $1.05 in the prior year quarter. The current quarter's earnings per diluted share included SAP-related benefits, net of implementation costs and depreciation expense, of $0.14 per diluted share compared to $0.03 per diluted share of net expense in the prior year quarter. Additionally, following the U.S. Environmental Protection Agency's ("EPA") announcement in March 2013 (see comments below), the Company's Refrigerant-22 ("R-22") prices and volumes continued to be pressured during the current quarter. Net earnings per diluted share in the current quarter also included an $0.08 per diluted share charge related to a loss on the early extinguishment of debt, while the prior year quarter included a net $0.01 per diluted share benefit related to lower than previously estimated restructuring charges. Net special items in each quarter consisted of the following:

                                                           Three Months Ended
                                                              December 31,
Effect on Diluted EPS                                       2013          2012
Loss on the extinguishment of debt                      $    (0.08 )     $    -
Restructuring and other special (charges) benefits, net          -         0.01
Special items, net                                      $    (0.08 )     $ 0.01

Financing
On October 1, 2013, the Company's $300 million of 2.85% senior notes (the "2013 Notes") matured.
At March 31, 2013, the Company had $215 million outstanding of 7.125% senior subordinated notes originally due to mature on October 1, 2018 (the "2018 Senior Subordinated Notes"). The 2018 Senior Subordinated Notes had a redemption provision which permitted the Company, at its option, to call the 2018 Senior Subordinated Notes at scheduled dates and prices beginning on October 1, 2013. On October 2, 2013, the 2018 Senior Subordinated Notes were redeemed in full at a price of 103.563%. A loss on the early extinguishment of the 2018 Senior Subordinated Notes of $9.1 million was recognized during the three months ended December 31, 2013 related to the redemption premium and the write-off of unamortized debt issuance costs.
Acquisitions
During the nine months ended December 31, 2013, the Company purchased nine businesses with aggregate historical annual sales of approximately $70 million. The largest of these businesses was The Encompass Gas Group, Inc. ("Encompass"), headquartered in Rockford, Illinois. With eleven locations in Illinois, Wisconsin, and Iowa, Encompass was one of the largest privately-owned suppliers of industrial, medical, and specialty gases and related hardgoods in the United States, generating approximately $55 million in annual sales in calendar 2012.


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Production Challenges and Supply Constraints On March 27, 2013, the EPA issued a ruling allowing for an increase in the production and import of R-22 in calendar years 2013 and 2014, rather than reaffirming the further reductions that much of the industry, including the Company, had been expecting based on a previously issued No Action Assurances letter from the EPA. R-22 has historically been one of the most commonly-used refrigerant gases in air conditioning systems in the U.S., and many of those systems are expected to remain operational for years to come. As production and imports of R-22 are phased out by the EPA in accordance with United States regulations adopted in response to the Montreal Protocol on Substances that Deplete the Ozone Layer (the "Montreal Protocol"), the gap between demand and supply is expected to be filled increasingly by reclaimed and recycled R-22. The Company believes that as a leading reclaimer, recycler and distributor of R-22, its refrigerants business is well-positioned to benefit from an expected increase in demand for reclaimed and recycled R-22, as well as from expected increases in market pricing of R-22 as the phase-out progresses. The regulations adopted in response to the Montreal Protocol currently require a step down in R-22 production and imports beginning in calendar year 2015, which should favorably impact the prevailing supply and demand imbalance of R-22. As such, the Company believes the impact on its earnings from the EPA's ruling to be temporary in nature.
During the current quarter, the EPA's ruling continued to pressure both volumes and pricing of R-22. The Company expects this ruling to negatively impact its year-over-year sales volumes and pricing through at least fiscal 2014, as a greater-than-expected amount of virgin R-22 will be available in the marketplace. For the full fiscal year 2014, the Company estimates a year-over-year negative impact of $0.17 per diluted share.
The global industrial gas industry continues to work through supply constraints related to helium. Disruption in crude helium production overseas has been the primary cause of the worldwide helium shortage, aggravated by outages and temporary shutdowns at the Federal Helium Reserve and shutdowns at a major private helium source. The Company procures helium from its primary suppliers under long-term supply agreements. As a result of the helium shortage, however, over the past 30 months the Company's suppliers have instituted helium volume allocations, which have limited the Company's ability to supply helium to its own customers. These supply constraints have also forced the Company to shed non-contract helium customers at times and to allocate its limited helium supply to contract and critical need customers. To help mitigate the financial impact to Airgas, the Company has and will continue to explore alternative sources of helium and has instituted product allocations and price increases related to its helium customers at appropriate times.
During the current quarter, the Company's helium suppliers continued to fall short of their volume commitments under the long-term supply agreements. With the recent start-up of a new helium production facility in the Middle East, the global marketplace is expected to see some increase in product availability; however, this added supply is not expected to meet full industry demand. As such, the Company continues to expect some level of supply chain disruption during the remainder of fiscal 2014 and anticipates that the time frame for regaining lost customers and recovering lost sales may be longer. Enterprise Information System
As of March 2013, the Company had successfully converted its Safety telesales, hardgoods infrastructure, and regional distribution businesses to the SAP platform, representing over 90% of the Company's Distribution business segment. Each of its four Business Support Centers ("BSCs"), into which the regional company accounting and administrative functions were consolidated upon converting to SAP, is firmly in place. As with the implementation of any new enterprise information system, the Company has experienced distractions and disruptions as its associates learn the new system and processes, but they have not had a material impact to date on the Company's financial results or internal controls. The Company will continue to monitor these items carefully going forward.
The Company began to realize meaningful SAP-related economic benefits from more effective management of pricing and discount practices, as well as from the expansion of its telesales platform, in the second half of fiscal 2013. These benefits continued to ramp-up in fiscal 2014. The current quarter included $0.14 per diluted share of SAP-related benefits, net of implementation costs and depreciation expense, compared to $0.03 per diluted share of net expense in the prior year quarter.
The Company previously quantified the economic benefits expected to be achieved through its implementation of SAP in three key areas: accelerated sales growth through expansion of the telesales platform, more effective management of pricing and discount practices, and administrative and operating efficiencies. At December 31, 2013, the Company had achieved its long-standing target of reaching an annual run-rate of $75 million in SAP-enabled operating income benefits by the end of calendar year 2013. The Company expects to continue to leverage SAP's capabilities and the benefits of having a unified platform across its distribution operations to improve the way the Company manages its business for many years to come.

Fourth Quarter Outlook


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The Company expects earnings per diluted share for the fourth fiscal quarter ending March 31, 2014 to be in the range of $1.18 to $1.23, an increase of 4% to 9% over earnings per diluted share of $1.13 in the fourth fiscal quarter ended March 31, 2013. The Company expects its organic sales growth rate for the quarter ending March 31, 2014 to be in the low single digits.


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RESULTS OF OPERATIONS: THREE MONTHS ENDED DECEMBER 31, 2013 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2012

STATEMENT OF EARNINGS COMMENTARY
Net Sales
Net sales increased 3% to $1.24 billion for the current quarter compared to the prior year quarter, driven by organic sales growth of 1% and sales growth from current and prior year acquisitions of 2% in the current quarter. Gas and rent organic sales increased 1% in the current quarter, with hardgoods organic sales also up 1%. Organic sales growth in the current quarter was driven by pricing increases of 2%, offset by volume declines of 1%.
Strategic products account for approximately 40% of net sales and include safety products, bulk, medical and specialty gases, as well as carbon dioxide ("CO2") and dry ice. The Company has identified these products as strategic because it believes they have good long-term growth profiles relative to the Company's core industrial gas and welding products due to favorable end customer markets, application development, increasing environmental regulation, strong cross-selling opportunities or a combination thereof. During the current quarter, sales of strategic products grew 3% on an organic basis over the prior year quarter, with safety products and bulk and specialty gases outperforming the category overall.
The Company's strategic accounts program, which represents approximately 25% of net sales, is designed to deliver superior product and service offerings to larger, multi-location customers, and presents the Company with strong cross-selling opportunities. Sales to strategic accounts grew 2% in the current quarter, with new account signings, expansion of locations served and product lines sold to existing accounts, and positive pricing more than offsetting the lower levels of activity in several areas, including mining and related equipment manufacturing, defense contractors and some pressure in the medical homecare market.
In the table below, the intercompany eliminations represent sales from the All Other Operations business segment to the Distribution business segment.

                               Three Months Ended
Net Sales                         December 31,
(In thousands)                2013            2012         Increase/(Decrease)
Distribution              $ 1,125,522     $ 1,076,102     $            49,420       5  %
All Other Operations          124,663         139,670                 (15,007 )   (11 )%
Intercompany eliminations      (7,339 )        (8,064 )                   725
                          $ 1,242,846     $ 1,207,708     $            35,138       3  %

The Distribution business segment's principal products include industrial, medical and specialty gases, and process chemicals; cylinder and equipment rental; and hardgoods. Industrial, medical and specialty gases are distributed in cylinders and bulk containers. Rental fees are generally charged on cylinders, dewars (cryogenic liquid cylinders), bulk and micro-bulk tanks, tube trailers and certain welding equipment. Hardgoods generally consist of welding consumables and equipment, safety products, construction supplies, and maintenance, repair and operating supplies.
Distribution business segment sales increased 5% over the prior year quarter, with an increase in organic sales of 2%. Incremental sales from current and prior year acquisitions contributed sales growth of 3% in the current quarter. Higher pricing contributed 3% to organic sales growth in the Distribution business segment, more than offsetting the negative 1% impact from volume declines. Gas and rent organic sales in the Distribution business segment increased 3%, with pricing up 4% and volumes down 1%. Hardgoods organic sales within the Distribution business segment increased 1%, reflecting pricing increases of 1% and flat volumes.
Sales of strategic gas products sold through the Distribution business segment increased 4% in the current quarter from the prior year quarter on an organic basis. Among strategic gas products, bulk gas sales were up 4% as the impact of higher pricing, volumes and new business was partially offset by moderation in industrial activity. Sales of medical gases were up 1%, with the slight increase reflecting weakness in the homecare segment. Sales of specialty gases were up 5%, with increases in both prices and volumes.
Sales of both Safety products and the Company's RadnorŪ private-label brand product line contributed to the organic sales growth in hardgoods for the Distribution business segment. Safety product sales increased 4% in the current quarter, and the Company's RadnorŪ private-label line was up 3% for the current quarter. Both compared favorably to the 1% increase in total hardgoods organic sales for the Distribution business segment for the same period.


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The All Other Operations business segment consists of six business units. The primary products manufactured and/or distributed are CO2, dry ice, nitrous oxide, ammonia and refrigerant gases.
The All Other Operations business segment sales decreased 11% in total and on an organic basis compared to the prior year quarter. Both the total and organic sales decreases were driven by lower pricing and volumes in the Company's refrigerants and ammonia businesses and volume declines in the Company's CO2 business during the current quarter. The decline in CO2 volumes as compared to the prior year quarter was driven by hurricane-related sales and outage-related surcharges in the prior year quarter.
Gross Profits (Excluding Depreciation)
Gross profits (excluding depreciation) do not reflect deductions related to depreciation expense and distribution costs. The Company reflects distribution costs as an element of the line item "Selling, distribution and administrative expenses" and recognizes depreciation on all of its property, plant and equipment in the line item "Depreciation" in its Consolidated Statements of Earnings. Other companies may report certain or all of these costs as elements of their cost of products sold and, as such, the Company's gross profits (excluding depreciation) discussed below may not be comparable to those of other companies.
The Company reclassified $3.1 million out of selling, distribution and administrative expenses into cost of products sold (excluding depreciation) for the prior year quarter to correct an error in the prior year classification. Consolidated operating income and net earnings for the prior year quarter were not impacted by the correction, and the amount is not material to either of the impacted line items in the Company's Consolidated Statement of Earnings for the prior year quarter. The following commentary for the prior year quarter has been updated to reflect the reclassification.
Consolidated gross profits (excluding depreciation) increased 4% compared to the prior year quarter, reflecting the overall growth in sales and margin expansion on price increases and a mix shift away from lower-margin refrigerants, partially offset by supplier price and internal production cost increases and significant margin pressure in the Company's refrigerants business. The consolidated gross profit margin (excluding depreciation) in the current quarter increased 60 basis points to 56.7% compared to 56.1% in the prior year quarter. The increase in consolidated gross profit margin (excluding depreciation) reflects the items described above. Gas and rent represented 63.6% of the Company's sales mix in the current quarter, down from 64.0% in the prior year quarter.

                             Three Months Ended
Gross Profits (ex. Depr.)       December 31,
(In thousands)               2013          2012       Increase/(Decrease)
Distribution              $  641,439    $ 611,072    $            30,367      5  %
All Other Operations          63,737       66,071                 (2,334 )   (4 )%
                          $  705,176    $ 677,143    $            28,033      4  %

The Distribution business segment's gross profits (excluding depreciation) increased 5% compared to the prior year quarter. The Distribution business segment's gross profit margin (excluding depreciation) was 57.0% versus 56.8% in the prior year quarter, an increase of 20 basis points. The increase in the Distribution business segment's gross profit margin (excluding depreciation) reflects margin expansion on price increases, partially offset by supplier price and internal production cost increases and a mix shift within gases to lower margin fuel gases. As a percentage of the Distribution business segment's sales, gas and rent increased 20 basis points to 59.9% in the current quarter, up from 59.7% in the prior year quarter.
The All Other Operations business segment's gross profits (excluding depreciation) decreased 4% compared to the prior year quarter. The All Other Operations business segment's gross profit margin (excluding depreciation) increased 380 basis points to 51.1% in the current quarter from 47.3% in the prior year quarter. The increase in the All Other Operations business segment's gross profit margin (excluding depreciation) was primarily driven by the impact of higher margins in the Company's ammonia business due to lower feedstock costs and a mix shift away from lower-margin refrigerants, offset in part by continued margin compression in the Company's refrigerants business, largely resulting from the EPA's unexpected ruling in late March 2013. Operating Expenses
Selling, Distribution and Administrative ("SD&A") Expenses SD&A expenses consist of labor and overhead associated with the purchasing, marketing and distribution of the Company's products, as well as costs associated with a variety of administrative functions such as legal, treasury, accounting, tax and facility-related expenses. Although corporate operating expenses are generally allocated to each business segment based on sales dollars, the Company reports expenses (excluding depreciation) related to the implementation of its SAP system


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as part of SD&A expenses in the "Other" line item in the SD&A expenses and operating income tables below. Additionally, the Company's restructuring and other special charges are not allocated to the Company's business segments. These costs are captured in a separate line item on the Company's Consolidated Statements of Earnings and are reflected in the "Other" line item in the operating income tables below.
Consolidated SD&A expenses increased $14 million, or 3%, in the current quarter as compared to the prior year quarter. Contributing to the increase in SD&A expenses were approximately $8 million of incremental operating costs associated with acquired businesses, representing approximately 2% of the total increase in SD&A. Also contributing to the increase in SD&A expenses were staffing, training, and other setup costs associated with the expansion of the Airgas Total Access telesales program, costs associated with the analysis and execution of the Company's strategic pricing initiative and enhancement of its e-Business platform, as well as rising health care costs. These expenses substantially offset the favorable impact of the reduction in SAP implementation costs compared to the prior year quarter. As a percentage of net sales, SD&A expenses remained consistent at 38.0% in both the current and prior year quarters.

Three Months Ended

SD&A Expenses              December 31,
(In thousands)          2013          2012       Increase/(Decrease)
Distribution         $  427,440    $ 405,591    $            21,849      5  %
All Other Operations     43,409       44,866                 (1,457 )   (3 )%
Other                     1,838        8,718                 (6,880 )
                     $  472,687    $ 459,175    $            13,512      3  %

SD&A expenses in the Distribution business segment increased 5%, while SD&A expenses in the All Other Operations business segment decreased 3%, compared to the prior year quarter. For the Distribution business segment, more than one third of the increase in SD&A costs was driven by incremental operating costs of $8 million associated with acquired businesses. As a percentage of Distribution business segment net sales, SD&A expenses in the Distribution business segment increased 30 basis points to 38.0% compared to 37.7% in the prior year quarter, primarily driven by moderating sales growth relative to the increase in expenses. As a percentage of All Other Operations business segment net sales, SD&A expenses in the All Other Operations business segment increased 270 basis points to 34.8% compared to 32.1% in the prior year quarter, primarily driven by significant sales declines relative to the fixed cost base in the Company's refrigerants, CO2 and ammonia businesses. SD&A Expenses - Other
Enterprise Information System
While the Company has successfully converted its Safety telesales and hardgoods infrastructure businesses, as well as all of its regional distribution businesses, to the SAP platform, the Company continues to incur some post-conversion support and training expenses related to the implementation of the new system. SAP-related costs were $1.8 million for the current quarter as compared to $8.7 million in the prior year quarter, and were recorded as SD&A expenses and not allocated to the Company's business segments. Restructuring and Other Special Charges (Benefits), Net The following table presents the components of restructuring and other special charges (benefits), net for the prior year quarter:

                                                               Three Months Ended
(In thousands)                                                 December 31, 2012
Restructuring costs (benefits), net                           $           (3,332 )
Other related costs                                                        1,603
Total restructuring and other special charges (benefits), net $           (1,729 )

Restructuring and Other Related Costs
In May 2011, the Company announced the alignment of its then twelve regional distribution companies into four new divisions, and the consolidation of its regional company accounting and certain administrative functions into four newly created BSCs. Additionally, the Company initiated a related change in its legal entity structure on January 1, 2012 whereby each Airgas regional distribution company would merge, once converted to SAP, into a single limited liability company ("LLC") of which Airgas, Inc. is the sole member. Prior to conversion to SAP, each of the Company's twelve regional distribution companies


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operated its own accounting and administrative functions. Enabled by the Company's conversion to a single information platform across all of its regional distribution businesses as part of the SAP implementation, the restructuring allows Airgas to more effectively utilize its resources across its regional distribution businesses and form an operating structure to leverage the full benefits of its new SAP platform.
As of March 31, 2013, the divisional alignment was complete and all material costs related to the restructuring had been accrued.
During the prior year quarter, the Company recorded $3.3 million in net restructuring benefits. The Company re-evaluated its remaining severance liability related to the divisional realignment during the prior year quarter and, as a result of this analysis, reduced its severance liability by $3.7 million. The change in estimate was driven by fewer than expected individuals meeting the requirements to receive severance benefits. This reduction was due to both the retention of employees through relocation or acceptance of new positions, as well as former associates who chose not to remain with the Company through their designated separation dates. Offsetting the benefit from the reduction to the severance liability were additional restructuring costs of $0.4 million for the three months ended December 31, 2012, primarily related to relocation and other costs. The Company also incurred $1.6 million of other costs in the prior year quarter related to the divisional alignment and LLC formation. These costs primarily related to transition staffing for the BSCs, legal costs and other expenses associated with the Company's organizational and legal entity changes.
Depreciation and Amortization . . .

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