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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended 30 June 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
Commission file number 1-4534
AIR PRODUCTS AND CHEMICALS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 23-1274455
(State of Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
7201 Hamilton Boulevard, Allentown, Pennsylvania 18195-1501
(Address of Principal Executive Offices) (Zip Code)
610-481-4911
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at 7 August 2003
- --------------------------- ----------------------------
Common Stock, $1 par value 227,263,870
AIR PRODUCTS AND CHEMICALS, INC. AND SUBSIDIARIES
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
30 June 2003 and 30 September 2002 ...................................................................... 3
Consolidated Income Statements -
Three Months and Nine Months Ended 30 June 2003 and 2002 ................................................ 4
Consolidated Comprehensive Income Statements -
Three Months and Nine Months Ended 30 June 2003 and 2002 ................................................ 5
Consolidated Statements of Cash Flows -
Nine Months Ended 30 June 2003 and 2002 ................................................................. 6
Summary by Business Segments -
Three Months and Nine Months Ended 30 June 2003 and 2002 ................................................ 7
Summary by Geographic Regions -
Three Months and Nine Months Ended 30 June 2003 and 2002 ................................................ 8
Notes to Consolidated Financial Statements ................................................................. 9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................. 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk ............................................ 28
Item 4. Controls and Procedures ............................................................................... 28
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ...................................................................... 29
Signatures .................................................................................................... 30
Exhibit Index.................................................................................................. 31
BASIS OF PRESENTATION:
The consolidated financial statements of Air Products and Chemicals, Inc. and
its subsidiaries (the "company" or "registrant") included herein have been
prepared by the company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. In the opinion of the company, the
accompanying statements reflect all adjustments necessary to present fairly the
financial position, results of operations and cash flows for those periods
indicated, and contain adequate disclosure to make the information presented not
misleading. Such adjustments are of a normal, recurring nature unless otherwise
disclosed in the notes to consolidated financial statements. However, the
interim results for the periods indicated herein do not reflect certain
adjustments, such as the valuation of inventories on the LIFO cost basis, which
can only be finally determined on an annual basis. It is suggested that these
consolidated condensed financial statements be read in conjunction with the
financial statements and notes thereto included in the company's latest annual
report on Form 10-K.
Results of operations for interim periods are not necessarily indicative of the
results of operations for a full year. Reference the 2003 Outlook included on
page 23 of Item 2 in Management's Discussion and Analysis of Financial Condition
and Results of Operations. Risk factors that could impact results are discussed
under Forward-Looking Statements on page 27.
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AIR PRODUCTS AND CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Millions of dollars, except per share)
30 June 2003
(Unaudited) 30 September 2002
------------ -----------------
ASSETS
CURRENT ASSETS
Cash and cash items $ 141.3 $ 253.7
Trade receivables, less allowances for doubtful accounts 1,133.5 980.9
Inventories 437.9 392.6
Contracts in progress, less progress billings 67.9 68.1
Other current assets 237.8 214.0
------------------------------
TOTAL CURRENT ASSETS 2,018.4 1,909.3
------------------------------
INVESTMENTS IN NET ASSETS OF AND ADVANCES TO
EQUITY AFFILIATES 550.7 484.2
PLANT AND EQUIPMENT, at cost 11,369.9 10,879.8
Less accumulated depreciation 5,926.5 5,502.0
------------------------------
PLANT AND EQUIPMENT, net 5,443.4 5,377.8
------------------------------
GOODWILL 610.2 431.1
OTHER NONCURRENT ASSETS 326.2 292.6
------------------------------
TOTAL ASSETS $ 8,948.9 $ 8,495.0
==============================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Payables and accrued liabilities $ 913.9 $ 839.3
Accrued income taxes 35.9 72.9
Short-term borrowings and current portion of long-term debt 217.6 344.0
------------------------------
TOTAL CURRENT LIABILITIES 1,167.4 1,256.2
------------------------------
LONG-TERM DEBT 2,150.7 2,041.0
DEFERRED INCOME & OTHER NONCURRENT LIABILITIES 914.2 827.4
DEFERRED INCOME TAXES 766.5 725.6
------------------------------
TOTAL LIABILITIES 4,998.8 4,850.2
------------------------------
MINORITY INTEREST IN SUBSIDIARY COMPANIES 178.9 184.4
------------------------------
SHAREHOLDERS' EQUITY
Common stock (par value $1 per share, issued 2003 and 2002-
249,455,584 shares) 249.4 249.4
Capital in excess of par value 468.6 437.1
Retained earnings 4,440.7 4,312.8
Accumulated other comprehensive income (loss) (444.9) (566.9)
Treasury stock, at cost (2003 - 22,191,714 shares; 2002 - 22,236,196
shares) (766.2) (767.8)
Shares in trust (2003 - 7,322,458 shares; 2002 - 8,684,265 shares) (176.4) (204.2)
------------------------------
TOTAL SHAREHOLDERS' EQUITY 3,771.2 3,460.4
------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 8,948.9 $ 8,495.0
==============================
The accompanying notes are an integral part of these statements.
3
AIR PRODUCTS AND CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
(UNAUDITED)
(Millions of dollars, except per share)
Three Months Ended Nine Months Ended
30 June 30 June
2003 2002 2003 2002
---------------------------------------------
SALES $ 1,629.9 $ 1,374.0 $ 4,655.0 $ 4,003.2
COSTS AND EXPENSES
Cost of sales 1,225.4 976.7 3,434.7 2,856.1
Selling and administrative 243.4 172.9 638.1 531.3
Research and development 32.1 31.9 93.2 90.4
Other (income) expense, net 89.0 (22.6) 73.5 (28.7)
---------------------------------------------
OPERATING INCOME 40.0 215.1 415.5 554.1
Income from equity affiliates, net of
related expenses 20.0 17.7 58.3 56.4
Gain on sale of U.S. packaged gas
business -- -- -- 55.7
Interest expense 32.5 27.5 92.8 93.6
---------------------------------------------
INCOME BEFORE TAXES AND
MINORITY INTEREST 27.5 205.3 381.0 572.6
Income taxes (2.9) 60.6 100.9 179.0
Minority interest (a) 3.8 3.4 11.2 12.5
---------------------------------------------
INCOME BEFORE CUMULATIVE
EFFECT OF ACCOUNTING
CHANGE 26.6 141.3 268.9 381.1
Cumulative effect of accounting change -- -- (2.9) --
---------------------------------------------
NET INCOME $ 26.6 $ 141.3 $ 266.0 $ 381.1
=============================================
BASIC EARNINGS PER
COMMON SHARE
Income before cumulative effect of
accounting change $ .12 $ .65 $ 1.23 $ 1.76
Cumulative effect of accounting change -- -- (.02) --
---------------------------------------------
Net Income $ .12 $ .65 $ 1.21 $ 1.76
---------------------------------------------
DILUTED EARNINGS PER COMMON
SHARE
Income before cumulative effect of
accounting change $ .12 $ .63 $ 1.21 $ 1.71
Cumulative effect of accounting change -- -- (.02) --
---------------------------------------------
Net Income $ .12 $ .63 $ 1.19 $ 1.71
---------------------------------------------
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES (in millions) 219.7 218.0 219.3 216.8
---------------------------------------------
WEIGHTED AVERAGE NUMBER OF
COMMON AND COMMON EQUIVALENT SHARES (in millions) 223.3 224.7 222.9 222.7
---------------------------------------------
DIVIDENDS DECLARED PER
COMMON SHARE - Cash $ .23 $ .21 $ .65 $ .61
---------------------------------------------
(a) Minority interest primarily includes before-tax amounts.
The accompanying notes are an integral part of these statements.
4
AIR PRODUCTS AND CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED COMPREHENSIVE INCOME STATEMENTS
(UNAUDITED)
(Millions of dollars)
Three Months Ended Nine Months Ended
30 June 30 June
2003 2002 2003 2002
---------------------------------------------
NET INCOME $ 26.6 $ 141.3 $ 266.0 $ 381.1
---------------------------------------------
OTHER COMPREHENSIVE INCOME
(LOSS), net of tax
Unrealized (losses) gains on investments:
Unrealized holding (losses) gains
arising during the period 1.4 3.3 2.3 .8
Less reclassification adjustment for
gains included in net income -- (2.9) -- (4.6)
---------------------------------------------
Net unrealized holding (losses) gains on
investments 1.4 .4 2.3 (3.8)
Net (loss) gain on derivatives (.6) (.2) (4.9) .2
Translation adjustments 79.2 105.9 124.6 64.1
---------------------------------------------
TOTAL OTHER COMPREHENSIVE
INCOME (LOSS), net of tax 80.0 106.1 122.0 60.5
---------------------------------------------
COMPREHENSIVE INCOME $ 106.6 $ 247.4 $ 388.0 $ 441.6
---------------------------------------------
The accompanying notes are an integral part of these statements.
5
AIR PRODUCTS AND CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Millions of dollars)
Nine Months Ended
30 June
2003 2002
--------------------------
OPERATING ACTIVITIES
Net Income $ 266.0 $ 381.1
Adjustments to reconcile income to cash provided by operating activities:
Depreciation 477.1 423.9
Impairment of long-lived assets 91.7 3.7
Deferred income taxes 60.8 30.8
Undistributed earnings of unconsolidated affiliates .7 (33.2)
Gain on sale of assets and investments (9.2) (66.6)
Other (15.3) 8.4
--------------------------
Subtotal 871.8 748.1
Working capital changes that provided (used) cash, excluding effects of
acquisitions and divestitures:
Trade receivables (64.9) (16.8)
Inventories and contracts in progress (26.9) 15.9
Payables and accrued liabilities 11.4 (58.9)
Other (60.9) 36.4
--------------------------
CASH PROVIDED BY OPERATING ACTIVITIES 730.5 724.7
--------------------------
INVESTING ACTIVITIES
Additions to plant and equipment (a) (440.0) (459.8)
Investment in and advances to unconsolidated affiliates (6.1) (35.2)
Acquisitions, less cash acquired (b) (234.2) (10.3)
Proceeds from sale of assets and investments 99.5 283.7
Other (.1) 6.3
--------------------------
CASH USED FOR INVESTING ACTIVITIES (580.9) (215.3)
--------------------------
FINANCING ACTIVITIES
Long-term debt proceeds 135.4 43.6
Payments on long-term debt (212.8) (174.1)
Net decrease in commercial paper and other short-term borrowings (100.8) (229.6)
Dividends paid to shareholders (138.0) (129.8)
Issuance of stock for options and award plans 42.8 96.4
--------------------------
CASH USED FOR FINANCING ACTIVITIES (273.4) (393.5)
--------------------------
Effect of Exchange Rate Changes on Cash 11.4 3.7
--------------------------
(Decrease) Increase in Cash and Cash Items (112.4) 119.6
Cash and Cash Items - Beginning of Year 253.7 66.2
--------------------------
Cash and Cash Items - End of Period $ 141.3 $ 185.8
--------------------------
(a) Excludes capital lease additions of $6.8 and $2.7 in 2003 and 2002,
respectively.
(b) Excludes $1.4 of capital lease obligations and $4.0 of long-term debt
assumed in acquisitions in 2003.
The accompanying notes are an integral part of these statements.
6
AIR PRODUCTS AND CHEMICALS, INC. AND SUBSIDIARIES
SUMMARY BY BUSINESS SEGMENTS
(UNAUDITED)
Business segment information is shown below:
(Millions of dollars)
Three Months Ended Nine Months Ended
30 June 30 June
2003 2002 2003 2002
---------------------------------------------------------------------
Revenues from external customers
Gases $ 1,138.1 $ 915.7 $ 3,293.4 $ 2,706.6
Chemicals 421.2 385.4 1,173.5 1,092.5
Equipment 70.6 72.9 188.1 204.1
---------------------------------------------------------------------
Segment Totals 1,629.9 1,374.0 4,655.0 4,003.2
---------------------------------------------------------------------
Consolidated Totals $ 1,629.9 $ 1,374.0 $ 4,655.0 $ 4,003.2
---------------------------------------------------------------------
Operating income
Gases $ 79.2(a) $ 166.7 $ 402.6(a) $ 441.2(d)
Chemicals (29.2)(b) 47.9 37.6(b) 130.4(e)
Equipment (0.6)(c) 5.7 6.5(c) 11.7
---------------------------------------------------------------------
Segment Totals 49.4 220.3 446.7 583.3
---------------------------------------------------------------------
Corporate research and development and
other income (expense) (9.4) (5.2) (31.2) (29.2)
---------------------------------------------------------------------
Consolidated Totals $ 40.0 $ 215.1 $ 415.5 $ 554.1
---------------------------------------------------------------------
Equity affiliates' income
Gases $ 16.5 $ 14.4 $ 43.1 $ 46.5
Chemicals 3.6 3.4 6.9 8.5
Equipment (0.1) (0.1) -- 1.4
---------------------------------------------------------------------
Segment Totals 20.0 17.7 50.0 56.4
---------------------------------------------------------------------
Other -- -- 8.3 --
---------------------------------------------------------------------
Consolidated Totals $ 20.0 $ 17.7 $ 58.3 $ 56.4
---------------------------------------------------------------------
(Millions of dollars)
30 June
2003 2002
--------------------------
Identifiable assets (f)
Gases $ 6,614.5 $ 5,771.1
Chemicals 1,441.7 1,399.3
Equipment 168.4 202.4
--------------------------
Segment Totals 8,224.6 7,372.8
--------------------------
Corporate assets 173.6 295.2
--------------------------
Consolidated Totals $ 8,398.2 $ 7,668.0
--------------------------
(a) Included a global cost reduction plan expense of $92.2.
(b) Included a global cost reduction plan expense of $58.1.
(c) Included a global cost reduction plan expense of $2.4.
(d) Included a global cost reduction plan expense of $26.2.
(e) Included a global cost reduction plan expense of $4.6.
(f) Identifiable assets are equal to total assets less investments in
equity affiliates.
7
AIR PRODUCTS AND CHEMICALS, INC. AND SUBSIDIARIES
SUMMARY BY GEOGRAPHIC REGIONS
(UNAUDITED)
(Millions of dollars)
Three Months Ended Nine Months Ended
30 June 30 June
2003 2002 2003 2002
----------------------------------------------------
Revenues from external customers
United States $ 939.4 $ 845.8 $ 2,700.8 $ 2,503.6
Canada 19.2 28.5 76.5 80.6
----------------------------------------------------
Total North America 958.6 874.3 2,777.3 2,584.2
----------------------------------------------------
United Kingdom 133.3 122.4 362.4 341.3
Spain 97.7 89.2 271.0 250.9
Other Europe 242.0 173.8 683.1 506.2
----------------------------------------------------
Total Europe 473.0 385.4 1,316.5 1,098.4
----------------------------------------------------
Asia 165.8 88.1 471.8 240.1
Latin America 32.3 26.1 89.0 80.3
All Other .2 .1 .4 .2
----------------------------------------------------
Total $ 1,629.9 $ 1,374.0 $ 4,655.0 $ 4,003.2
----------------------------------------------------
Note: Geographic information is based on country of origin. The Other Europe
segment operates principally in Belgium, France, Germany, and the
Netherlands. The Asia segment operates principally in China, Japan,
Korea, and Taiwan.
8
AIR PRODUCTS AND CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Millions of dollars, except per share)
NEW ACCOUNTING STANDARDS
STANDARDS ADOPTED
The company adopted Statement of Financial Accounting Standards (SFAS) No. 143,
"Accounting for Asset Retirement Obligations," on 1 October 2002. The Statement
requires that the fair value of a liability for an asset retirement obligation
be recognized in the period in which it is incurred. The liability is measured
at discounted fair value and is adjusted to its present value in subsequent
periods as accretion expense is recorded. The corresponding asset retirement
costs are capitalized as part of the carrying amount of the related long-lived
asset and depreciated over the asset's useful life. The company's asset
retirement obligations are primarily associated with Gases on-site long-term
supply contracts under which the company has built a facility on land leased
from the customer and is obligated to remove the facility at the end of the
contract term. At 1 October 2002, the company recognized transition amounts for
existing asset retirement obligation liabilities, associated capitalizable costs
and accumulated depreciation. An after-tax transition charge of $2.9 was
recorded as the cumulative effect of an accounting change. The ongoing expense
on an annual basis resulting from the initial adoption of SFAS No. 143 is
approximately $1.
In November 2002, the Financial Accounting Standards Board (FASB) published
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others." The
Interpretation expands on the disclosure requirements to be made in interim and
annual financial statements. The company has included the required interim
disclosures under Guarantees and Warranties below. The Interpretation also
requires that a liability measured at fair value be recognized for guarantees
even if the probability of payment on the guarantee is remote. The recognition
provisions apply on a prospective basis for guarantees issued or modified after
31 December 2002. The company has not issued or modified any guarantees
subsequent to 31 December 2002.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require more prominent and frequent disclosures
in financial statements. Also, SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. The company has included the interim
disclosures prescribed by SFAS No. 148 under Stock-Based Compensation below. The
company does not intend to change its accounting method for stock-based
compensation until a new uniform accounting standard is issued.
RECENTLY ISSUED STANDARDS
In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on
Issue No. 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables." This Issue addresses the appropriate accounting by vendors for
arrangements that will result in the delivery of multiple products, services
and/or rights to assets that could occur over a period of time. The Issue is
effective for revenue arrangements entered into in fiscal periods beginning
after 15 June 2003. The application of EITF Issue No. 00-21 is not expected to
have a material effect on the company's financial statements.
9
In January 2003, the FASB published Interpretation No. 46, "Consolidation of
Variable Interest Entities." This Interpretation clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. The Interpretation establishes standards under which
a Variable Interest Entity should be consolidated by the primary beneficiary.
The company does not have an interest in any Variable Interest Entities.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." In May 2003, the FASB issued
SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity." The application of these Statements is not
expected to have a material effect on the company's financial statements.
In May 2003, the FASB ratified the EITF consensus on Issue No. 01-08,
"Determining Whether an Arrangement Contains a Lease." The EITF consensus
applies prospectively to new or modified arrangements beginning after 30 June
2003. The issue addressed is how to determine whether an arrangement contains a
lease that is within the scope of SFAS No. 13. Under the EITF consensus, certain
contracts within the company's Gases segment associated with on-site tonnage
facilities servicing one customer may potentially be considered leases. In cases
where operating-lease treatment is necessary, there would be no change to the
company's financial reporting. In cases where capital-lease treatment is
necessary, the timing of revenue and expense recognition would be impacted.
Revenue would be recognized immediately for the sale of equipment component of a
contract (as compared to the current method of revenue recognition over the life
of the arrangement). A portion of revenues formerly reported as sales would be
reflected as interest income resulting from the lease receivable. Based on the
company's estimate of new or modified contracts for the remainder of this fiscal
year, the company does not expect a material effect on its financial statements
during 2003. The impact of the EITF consensus on the company's financial
statements beyond 2003 is dependent upon the contracts executed and potential
changes in business practices and contractual arrangements.
STOCK-BASED COMPENSATION
At 30 June 2003, the company had various stock-based compensation plans as
described in Note 14 to the consolidated financial statements in the company's
2002 annual report on Form 10-K. The company accounts for its stock option plans
under the recognition and measurement principles of APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations. No
compensation expense has been recognized in net income for stock options, as
options granted had an exercise price equal to or greater than the market value
of the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share if the company had
applied the fair value recognition provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," to its stock option plans.
10
Three Months Ended Nine Months Ended
30 June 30 June
2003 2002 2003 2002
------- -------- --------- --------
Net income, as reported $ 26.6 $ 141.3 $ 266.0 $ 381.1
Deduct total stock option employee (9.5) (10.2) (28.4) (30.6)
compensation expense determined under fair
value based method, net of related tax effects
------- -------- --------- --------
Pro forma net income $ 17.1 $ 131.1 $ 237.6 $ 350.5
------- -------- --------- --------
Basic Earnings per Share
As reported $ .12 $ .65 $ 1.21 $ 1.76
Pro forma $ .08 $ .60 $ 1.08 $ 1.62
------- -------- --------- --------
Diluted Earnings per Share
As reported $ .12 $ .63 $ 1.19 $ 1.71
Pro forma $ .08 $ .58 $ 1.07 $ 1.57
------- -------- --------- --------
GUARANTEES AND WARRANTIES
As disclosed in Note 18 to the consolidated financial statements in the
company's 2002 annual report on Form 10-K, the company is a party to certain
guarantee agreements, including equity support agreements, debt guarantees of
equity affiliates and a residual value guarantee. These guarantees are
contingent commitments that are related to activities of the company's primary
businesses. The company does not expect that any sum it may have to pay in
connection with these guarantees will have a materially adverse effect on its
consolidated financial position or results of operations. A summary of the
guarantees and warranties that the company had as of 30 June 2003 is listed
below:
An equity support agreement was entered into related to the financing of a
cogeneration project. At 30 June 2003, the remaining term of this guarantee is
18 months with maximum potential payments of $15. A partner in this project has
agreed to share equally in any required equity contribution.
The company has entered into an equity support agreement related to the
financing of an air separation facility being constructed in Trinidad for a
venture in which the company, through equity affiliates, owns 50%. The maximum
potential payments, under a joint and several guarantee with the partner, are
$72 upon commencement of operations. The maximum exposure under the equity
support agreement declines over time as an underlying loan balance is amortized.
Additionally, the company and its partner provided guarantees of certain
obligations related to the normal operations of this facility. The maximum
potential payments, under the joint and several operations guarantees, are $32.
The total combined maximum potential payments, under the joint and several
equity support agreement and the operations guarantees, are $104. The term of
these guarantees is related to the underlying twenty-year customer gas supply
contract from the facility.
The company has guaranteed repayment of some borrowings of certain foreign
equity affiliates. At 30 June 2003, these guarantees have terms primarily in the
range of one to seven years, with maximum potential payments of $30.
11
In September 2001, the company entered into an operating lease of U.S. cryogenic
vessel equipment, which included a residual value guarantee not to exceed $256.
The guarantee extends to September 2006.
The company has not accrued any amounts related to these guarantees. To date, no
equity contributions or payments have been required since the inception of these
guarantees. The fair value of the above guarantees totals approximately $10.
The company, in the normal course of business operations, has issued product
warranties within its Equipment segment. Also, contracts and purchase orders
often contain standard terms and conditions which typically include a warranty
and indemnification to the buyer that the goods and services purchased do not
infringe on third party intellectual property rights. The impact of these
warranties is not material.
2003 GLOBAL COST REDUCTION PLAN
The results for the three and nine months ended 30 June 2003 included an expense
of $152.7 ($96.6 after-tax, or $.43 per share) for a global cost reduction plan
(2003 Plan). This expense included $56.8 for severance and pension related
benefits recorded in cost of sales, selling and administrative, and research and
development and $95.9 for asset disposals and facility closures in the Gases and
Chemicals segments recorded in other expense.
During the third quarter of 2003, the company completed a capacity utilization
analysis in several businesses in the Gases segment. To reduce capacity and
costs several facilities ceased operation as of 30 June 2003. An expense of
$37.6 was recognized for the closure of these facilities, net of expected
recovery from disposal. A decision was made to terminate several incomplete
capacity expansion projects. An expense of $13.0 was recognized for the cost of
terminating these projects, net of expected recovery from disposal and
redeployment. An expense of $3.6 was also recognized for the planned sale of two
real estate properties and the termination of several leases for small
facilities. These expenses are principally in the North American merchant and
tonnage businesses with a modest amount in our Electronics business.
The rationalization of excess capacity in certain products has resulted in a
decision to exit certain Chemical Intermediates operations. Late in the quarter
ended 30 June 2003, the company decided to pursue the sale of its European
methylamines and derivatives business. The company expects to complete the sale
by 30 June 2004. Expected proceeds from sale were determined and a loss was
recognized for the difference between the carrying value of the assets and the
expected net proceeds from the sales. Additional expenses for the closure of the
methanol and ammonia plants in Pensacola, Florida, which make products for
internal consumption, were also recognized. The total expense for these actions
was $41.7.
In addition to the capacity reduction initiatives, the company continues to
implement cost reduction and productivity related efforts. The divestitures, the
capacity reductions and the cost control initiatives will result in the
elimination of 461 positions from the company. The company will complete the
2003 Plan by 30 June 2004. Approximately 30% of the position reductions relate
to capacity rationalization and divestitures. An additional 40% relates to
ongoing productivity efforts and balancing engineering resources with project
activity and the remaining 30% relates to a reduction in the number of
management positions.
12
The 2003 global cost reduction plan expenses were recorded to the following
income statement line items and operating segments:
Selling and Research and
Segment Cost of Sales Administrative Development Other Expense Total
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Gases $ 10.3 $ 26.9 $ .8 $ 54.2 $ 92.2
- -------------------------------------------------------------------------------------------------------------------
Chemicals 9.5 5.8 1.1 41.7 58.1
- -------------------------------------------------------------------------------------------------------------------
Equipment .8 1.4 .2 -- 2.4
- -------------------------------------------------------------------------------------------------------------------
Total $ 20.6 $ 34.1 $ 2.1 $ 95.9 $ 152.7
- -------------------------------------------------------------------------------------------------------------------
Results for the remainder of 2003 and beyond will benefit from the 2003 global
cost reduction plan. Cost savings of $3 are expected in the fourth quarter of
2003. Cost savings of $38 are expected in 2004. Beyond 2004, the company expects
the 2003 global cost reduction plan to provide annualized incremental cost
savings of $59, of which the majority is related to reduced personnel costs.
The following tables summarize changes to the carrying amount of the accrual for
the 2003 global cost reduction plan for the three and nine months ended 30 June
2003 by cost categories and segments:
Pension and Asset
Cost Categories Severance Medical Impairment Other (1) Total
- ---------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------
Provision-2003 Plan $ 42.3 $ 14.5 $ 90.1 $ 5.8 $ 152.7
- ---------------------------------------------------------------------------------------------------------------
Noncash expenses -- (14.5) (90.1) -- (104.6)
- ---------------------------------------------------------------------------------------------------------------
Cash expenditures (1.2) -- -- (.5) (1.7)
- ---------------------------------------------------------------------------------------------------------------
Balance at 30 June 2003 $ 41.1 $ -- $ -- $ 5.3 $ 46.4
- ---------------------------------------------------------------------------------------------------------------
Segments Gases Chemicals Equipment Total
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
Provision-2003 Plan $ 92.2 $ 58.1 $ 2.4 $ 152.7
- ----------------------------------------------------------------------------------------
Noncash expenses (64.6) (39.7) (.3) (104.6)
- ----------------------------------------------------------------------------------------
Cash expenditures (1.5) (.2) -- (1.7)
- ----------------------------------------------------------------------------------------
Balance at 30 June 2003 $ 26.1 $ 18.2 $ 2.1 $ 46.4
- ----------------------------------------------------------------------------------------
(1) Expenses related to facility closures are included in the other category.
2002 GLOBAL COST REDUCTION PLAN
The results for the nine months ended 30 June 2002 included an expense of $30.8
($18.9 after-tax, or $.09 per share) for a global cost reduction plan (2002
Plan) including U.S. packaged gas divestiture related reductions. The plan
included 333 position eliminations, resulting in an expense of $27.1 for
severance and pension related benefits. An expense of $3.7 was recognized for
asset impairments related to the planned sale or closure of two small chemicals
facilities. The restructuring expenses included in cost of sales, selling and
administrative, research and development, and other expense were $13.4, $14.1,
$.4, and $2.9, respectively. This cost reduction plan was completed as expected
in March 2003.
13
ACQUISITIONS
On 30 June 2003, the company announced it had signed a definitive agreement to
acquire the Electronic Chemicals business of Ashland Specialty Chemical Company,
a division of Ashland Inc., in a cash transaction valued at approximately $300.
Honeywell International Inc. has filed a lawsuit in the Delaware
Chancery Court in New Castle County, Delaware seeking to block the acquisition
alleging the acquisition would cause a breach of an agreement between a
Honeywell joint venture and the company. Ashland's Electronic Chemicals business
is a leading global electronic service provider and supplier of ultrapure
specialty chemicals used by the electronics industry to make semiconductor
devices.
Acquisitions for the nine months ended 30 June 2003, totaling $234.2, included
American Homecare Supply, LLC (AHS), additional small homecare businesses, and
Sanwa Chemical Industry Co., Ltd. The principal acquisition of the company was
AHS in October 2002, for $166. AHS is a homecare market leader throughout the
northeastern United States.
In July 2002, the company purchased an additional 22% of the outstanding shares
of San Fu Chemical Company, Ltd. (San Fu), increasing the company's ownership
interest from 48% to 70%. As of 30 June 2002, the company accounted for its
investment in San Fu using the equity method. With this acquisition, the company
obtained control and began to consolidate this investment.
The acquisitions in 2003 and the San Fu acquisition in 2002 contributed $290 and
$47 to sales and operating income, respectively, for the nine months ended 30
June 2003.
DIVESTITURES
On 28 February 2002, the company completed the sale of the majority of its U.S.
packaged gas business, excluding the electronic gases and magnetic resonance
imaging related helium operations, to Airgas, Inc. (Airgas). The company also
sold its packaged gas operations in the Carolinas and in Southern Virginia to
National Welders Supply Company, Inc., a joint venture between Airgas and the
Turner family of Charlotte, N.C. For the five months ended 28 February 2002, the
assets sold generated revenues of approximately $100 with a modest contribution
to operating income. The proceeds from these transactions were $254.5. The
results for the nine months ended 30 June 2002 included a gain of $55.7 ($25.7
after-tax, or $.12 per share).
On 1 April 2003, the company completed the sale of the majority of its Canadian
packaged gas business to the BOC Group for approximately $40.
EQUITY AFFILIATES' INCOME
Income from equity affiliates for the nine months ended 30 June 2003 included
$14 for adjustments related to divestitures recorded in prior periods. $8 is
included in Other equity affiliates and $6 is included in Gases equity
affiliates.
14
GOODWILL
Changes to the carrying amount of consolidated goodwill by segment for the nine
months ended 30 June 2003, are as follows:
Gases Chemicals Equipment Total
--------- --------- --------- ---------
Balance as of 30 September 2002 $ 332.1 $ 89.6 $ 9.4 $ 431.1
Acquisitions and adjustments 146.5 -- -- 146.5
Disposals (9.7) -- -- (9.7)
Currency translation and other 38.5 3.7 .1 42.3
--------- -------- -------- ---------
Balance as of 30 June 2003 $ 507.4 $ 93.3 $ 9.5 $ 610.2
--------- -------- -------- ---------
The increase in goodwill was principally due to the acquisition of AHS. The
disposal of goodwill relates to the divestiture of the Canadian packaged gas
business.
15
EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share (EPS):
Three Months Ended Nine Months Ended
30 June 30 June
2003 2002 2003 2002
-------------------------------------------------
NUMERATOR
Used in basic and diluted EPS
Income before cumulative effect of
accounting change $ 26.6 $ 141.3 $ 268.9 $ 381.1
Cumulative effect of accounting change -- -- (2.9) --
------ ------- -------- -------
Net income $ 26.6 $ 141.3 $ 266.0 $ 381.1
------ ------- -------- -------
DENOMINATOR (in millions)
Weighted average number of common shares used
in basic EPS 219.7 218.0 219.3 216.8
Effect of dilutive securities
Employee stock options 3.2 5.9 3.2 5.2
Other award plans .4 .8 .4 .7
------ ------- -------- -------
3.6 6.7 3.6 5.9
------ ------- -------- -------
Weighted average number of common shares and
dilutive potential common shares used in
diluted EPS 223.3 224.7 222.9 222.7
------ ------- -------- -------
BASIC EPS
Income before cumulative effect of accounting
change $ .12 $ .65 $ 1.23 $ 1.76
Cumulative effect of accounting change -- -- (.02) --
------ ------- -------- -------
Net income $ .12 $ .65 $ 1.21 $ 1.76
------ ------- -------- -------
DILUTED EPS
Income before cumulative effect of accounting
change $ .12 $ .63 $ 1.21 $ 1.71
Cumulative effect of accounting change -- -- (.02) --
------ ------- -------- -------
Net income $ .12 $ .63 $ 1.19 $ 1.71
------ ------- -------- -------
Options on 4.7 million and 8.4 million shares of common stock were not included
in computing diluted earnings per share for the third quarter and second quarter
of 2003, respectively, because their effects were antidilutive.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIRD QUARTER FISCAL 2003 VS. THIRD QUARTER FISCAL 2002
All comparisons are to the corresponding period in the prior year unless
otherwise stated.
(MILLIONS OF DOLLARS, EXCEPT PER SHARE)
RESULTS OF OPERATIONS
CONSOLIDATED
Sales of $1,629.9 increased 19%, or $255.9. The effects of acquisitions and
divestitures, favorable currency effects, and higher natural gas cost
pass-through accounted for 16% of the increase. Higher gases and chemicals
volumes primarily drove the remaining underlying revenue increase of 3%.
Operating income of $40.0 included an expense of $152.7 for the 2003 global cost
reduction plan. Refer to the 2003 Global Cost Reduction Plan discussion in the
Notes to the consolidated financial statements on page 12. Operating income in
the prior year was $215.1. The 2003 results were unfavorably impacted by higher
raw materials and energy costs, higher operating costs in Gases, lower
electronics specialty material pricing, and higher pension and SAP
implementation expenses. Favorable factors were higher gases volumes, the
contribution of acquisitions and currency effects.
Income from equity affiliates of $20.0 increased 13%, or $2.3. This increase was
primarily due to improved results within the Gases segment for its Italian and
Asian affiliates and favorable currency effects, partially offset by the
consolidation of San Fu Gas Company, Ltd. (San Fu).
Net income was $26.6, or $.12 diluted earnings per share, which included an
expense for the 2003 global cost reduction plan of $96.6, or $.43 diluted
earnings per share. Net income in the prior year was $141.3, or $.63 diluted
earnings per share.
GASES
Sales of $1,138.1 increased 24%, or $222.4. The effects of acquisitions,
favorable currency effects, and higher natural gas cost pass-through accounted
for 22% of the increase. Higher gases volumes, principally in the Chemicals
Process Industries (CPI) Division and in Asian merchant gases, drove the
remaining underlying revenue increase of 2%. Higher worldwide liquid bulk
pricing was more than offset by lower electronics specialty material pricing.
Excluding the impact of the acquisition of San Fu, electronics sales declined
approximately 1%.
On-site and pipeline volumes in CPI were up 5%. Liquid bulk volumes declined 8%
in North America and 5% in Europe. Liquid bulk volumes were strong in Asia, up
7%.
On average, prices for liquid oxygen and liquid nitrogen (LOX/LIN) in North
America increased 2%. Although underlying prices for LOX/LIN increased 3%, a
negative 1% year-on-year surcharge variance resulted in the average price
increase of 2%. LOX/LIN pricing in Europe was up 6%.
17
Operating income of $79.2 declined $87.5. The results included an expense of
$92.2 for the 2003 global cost reduction plan. Results were favorably impacted
by the contribution of acquisitions and favorable currency effects, partially
offset by higher operating costs and higher pension and SAP implementation
expenses. Higher worldwide liquid bulk pricing was more than offset by lower
electronics specialty material pricing.
Gases equity affiliates' income of $16.5 increased 15%, or $2.1. The increase
was due primarily to improved results for the Italian and Asian affiliates and
favorable currency effects, partially offset by the San Fu consolidation effect.
CHEMICALS
Sales of $421.2 increased 9%, or $35.8. The effects of currency and natural gas
cost pass-through accounted for 5% of the increase. The overall volume index
increased 1%. In Chemical Intermediates, volumes increased 13%, led by strong
polyurethane intermediates volumes, given the improved fundamentals in the
polyurethane foam end market. In Performance Materials, volumes were down 5%,
primarily in emulsions.
Operating loss of $(29.2) included an expense of $58.1 for the 2003 global cost
reduction plan. In comparison to operating income of $47.9 in the prior year,
results were unfavorably impacted by higher raw material and energy costs and
weaker emulsions volumes. These factors more than offset the favorable impact
from improved volumes in polyurethane intermediates and higher amines along with
favorable currency effects.
Chemicals equity affiliates' income of $3.6 increased 6%, or $.2 primarily from
favorable currency effects. Chemicals equity affiliates' income consists
primarily of a global polymer joint venture.
EQUIPMENT
Sales of $70.6 decreased 3%, or $2.3. Operating loss of $(0.6) decreased $6.3.
The results included an expense of $2.4 for the 2003 global cost reduction
plan. Operating income was down due to lower helium container sales and
weaker non-liquefied natural gas (LNG) project activity.
The sales backlog for the Equipment segment at 30 June 2003 was $296.5 compared
to $145.7 at 30 June 2002 and $114.2 at 30 September 2002. The sales backlog
includes an air separation order received in the second quarter for a
gas-to-liquids project in Qatar. The sales backlog increased in the third
quarter from the addition of an air separation order for the Saudi Basic
Industries Corporation's Yanbu petrochemical complex. Three LNG heat exchangers
are included in the sales backlog.
ALL OTHER
All other principally comprises corporate research and development expense and
unallocated corporate expenses and income. Operating loss of $9.4 increased
$4.2, primarily due to the recognition of foreign exchange gains in the prior
year.
18
ANALYSIS OF OTHER ITEMS
OTHER (INCOME) EXPENSE, NET
Other expense of $89.0 increased $111.6 from other income of $22.6 in the prior
year. The portion of the 2003 global cost reduction plan recorded to other
expense totaled $95.9. Results in 2002 included favorable impacts from the sale
of investments, insurance settlements and foreign exchange gains.
SELLING AND ADMINISTRATIVE EXPENSE (S&A)
S&A expense of $243.4 increased 41%, or $70.5. The portion of the 2003 global
cost reduction plan recorded to S&A totaled $34.1. The effects of acquisitions,
divestitures and currency accounted for a 17% increase. In addition, S&A
increased due to SAP implementation expense, higher pension expense, and
increased spending on growth initiatives.
INTEREST EXPENSE
Interest expense of $32.5 increased 18%, or $5.0. This increase resulted from
the impact of a weaker U.S. dollar on the translation of foreign currency
interest and lower capitalized interest, partially offset by lower average
interest rates.
INCOME TAXES
The effective tax rates exclude minority interest. In the third quarter of 2003,
the effective tax rate was (12.2%) compared to 30.0% in the prior year.
The company's income tax expense is equal to taxes computed at statutory rates,
based on book taxable income, reduced by tax credits and adjustments. For the
three months ended 30 June 2003, the tax credits and adjustments exceeded the
tax computed at statutory rates resulting in a net tax benefit. Book taxable
income was at a relatively low level due to the 2003 global cost reduction plan
expense.
19
NINE MONTHS FISCAL 2003 VS. NINE MONTHS FISCAL 2002
All comparisons are to the corresponding period in the prior year unless
otherwise stated.
(MILLIONS OF DOLLARS, EXCEPT PER SHARE)
RESULTS OF OPERATIONS
CONSOLIDATED
Sales of $4,655.0 increased 16%, or $651.8. The effects of higher natural gas
cost pass-through, favorable currency effects, and acquisitions, net of
divestitures, accounted for 13% of the increase. The remaining underlying
revenue increase of 3% was driven by higher worldwide gases volumes.
Operating income of $415.5 included an expense of $152.7 for the 2003 global
cost reduction plan. Prior year operating income of $554.1 included an expense
of $30.8 for the 2002 global cost reduction plan. Favorable operating income
variances resulted from higher gases volumes, the contribution of acquisitions,
currency effects, and lower incentive compensation costs. More than offsetting
these favorable impacts were higher raw materials and energy costs, higher
pension and SAP implementation expenses, higher maintenance and operating costs,
and lower electronics specialty material pricing.
Income from equity affiliates of $58.3 increased $1.9 from the prior year.
Favorable adjustments were recorded in the first quarter of 2003 related to
prior period divestitures, partially offset by the impact of consolidating San
Fu and a one-time tax benefit related to an asset revaluation of an Italian
affiliate recorded in the prior year.
Net income was $266.0, or $1.19 diluted earnings per share, compared to net
income of $381.1, or $1.71 diluted earnings per share. Income before the
cumulative effect of an accounting change related to the company's adoption of
Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for
Asset Retirement Obligations," was $268.9, or $1.23 diluted earnings per share
in 2003. Current year results included an expense for the 2003 global cost
reduction plan ($96.6, or $.43 per share). Prior year results included a gain on
the sale of the U.S. packaged gas business ($25.7, or $.12 per share) and an
expense for a global cost reduction plan ($18.9, or $.09 per share).
GASES
Sales of $3,293.4 increased 22%, or $586.8. The effects of acquisitions, higher
natural gas cost pass-through, and favorable currency effects accounted for 17%
of the increase. Higher worldwide gases volumes drove the remaining underlying
revenue increase of 5%. Excluding the impact of the acquisition of San Fu,
electronics sales increased about 8%.
On-site and pipeline volumes in the Chemicals Process Industries (CPI) Division
were up 6%. Liquid bulk volumes in North America declined 4% while liquid bulk
volumes increased 2% in Europe. Liquid bulk volumes were strong in Asia, up 16%.
On average, prices for LOX/LIN in North America were down 1%. A negative 3%
year-on-year surcharge variance more than offset the underlying price increases.
LOX/LIN pricing in Europe increased by 2%.
20
Operating income of $402.6 decreased 9%, or $38.6. Operating income included an
expense of $92.2 for the 2003 global cost reduction plan as compared to the
prior year, which included an expense of $26.2 for the 2002 global cost
reduction plan. Operating income was favorably impacted by increased gases
volumes, currency effects, acquisitions net of divestitures, and lower incentive
compensation costs. Partially offsetting these gains were higher raw materials
and energy, higher operating costs, higher pension and SAP implementation
expenses, and lower electronics specialty material pricing.
Gases equity affiliates' income of $43.1 decreased by 7%, or $3.4. The decrease
was due primarily to the consolidation of San Fu and the one-time tax benefit
related to an asset revaluation of an Italian affiliate recorded in the prior
year, offset to some extent by favorable adjustments to customary post-sale
liabilities associated with two divested cogeneration plant investments and the
impact of currency effects.
CHEMICALS
Sales of $1,173.5 increased 7%, or $81.0. The effects of currency and natural
gas cost pass-through accounted for 5% of the increase. The overall volume index
increased 1%. In Chemical Intermediates, volumes increased 6%, led by
polyurethane intermediates. In Performance Materials, volumes were down 1%,
especially in emulsions.
Operating income of $37.6 included an expense of $58.1 for the 2003 global cost
reduction plan. Prior year operating income of $130.4 included a $4.6 expense
for the 2002 global cost reduction plan. The decline in operating income was
driven by the global cost reduction plan expenses, higher raw material and
energy costs and weaker volumes in emulsions. This decline was partially offset
by favorable currency effects and improved volumes in polyurethane
intermediates.
Chemicals equity affiliates' income was $6.9 compared to $8.5 in the prior year.
Chemicals equity affiliates' income consists primarily of a global polymer joint
venture.
A long-term supplier of sulfuric acid, which is used in the production of
dinitrotoluene (DNT), emerged from Chapter 11 bankruptcy protection on 9 June
2003. To facilitate the supplier's ability to emerge from bankruptcy and to
continue supplying product to the company, the company agreed to participate in
the supplier's financing. The company does not expect a material loss related to
this supplier or from the supplier's inability to continue operations.
EQUIPMENT
Sales of $188.1 decreased 8%, or $16.0. Operating income of $6.5 decreased $5.2.
The results included an expense of $2.4 for the 2003 global cost reduction plan.
Operating income was down due to lower helium container sales and weaker non-LNG
project activity.
ALL OTHER
All other principally comprises corporate research and development expense and
unallocated corporate expenses and income. Operating loss of $31.2 increased
$2.0 primarily due to variances in foreign exchange gains and losses.
EQUITY AFFILIATES' INCOME - OTHER
Equity affiliates' income of $8.3 represents a favorable adjustment to a
customary post-sale liability associated with a divested business not associated
with any of the company's current segments.
21
ANALYSIS OF OTHER ITEMS
OTHER (INCOME) EXPENSE, NET
Other expense of $73.5 increased $102.2 from other income of $28.7 in the prior
year. The portion of the 2003 global cost reduction plan recorded to other
expense totaled $95.9 as compared to a 2002 global cost reduction plan expense
of $2.9. Results in 2002 included favorable impacts from the sale of
investments, insurance settlements and foreign exchange gains.
SELLING AND ADMINISTRATIVE EXPENSE (S&A)
S&A expense of $638.1 increased 20%, or $106.8. The portion of the 2003 global
cost reduction plan recorded to S&A totaled $34.1 as compared to a 2002 global
cost reduction plan expense of $14.1 in the prior year. The effects of
acquisitions, divestitures and currency, accounted for a 12% increase. In
addition, S&A increased due to SAP implementation expense, higher pension
expense, and increased spending on growth initiatives.
INTEREST EXPENSE
Interest expense of $92.8 decreased 1%, or $.8. This decrease resulted from
lower average interest rates and a lower average debt balance excluding currency
effects, partially offset by the impact of a weaker U.S. dollar on the
translation of foreign currency interest and lower capitalized interest.
INCOME TAXES
The effective tax rates exclude minority interest. For the first nine months of
2003, the effective tax rate was 27.3% compared to 32.0% in the prior year. The
effective tax rate was lower in 2003 due to higher expense associated with the
global cost reduction plans in Quarter 3 with similar levels of offsetting
credits and adjustments to Quarters 1 and 2. Nondeductible costs included in the
sale of the U.S. packaged gas business in 2002. Book taxable income was at a
relatively low level in 2003 due to the global cost reduction plan expense.
22
2003 OUTLOOK
Economic growth was slower than expected in the first nine months of 2003. While
most forecasts expect a recovery in U.S. manufacturing activity levels, the
timing and strength of a recovery remains very hard to predict. We remain
cautious expecting continued modest growth in U.S. manufacturing. Weak economic
activity continues in Europe.
Electronics markets have improved. The current outlook for electronics assumes
about a 5% sequential improvement in silicon processed by the semiconductor
industry.
Energy and raw material costs this year were higher than originally anticipated
and have impacted our Chemicals segment and to a lesser extent, Gases. Within
the Chemicals segment, the cost volatility of energy and raw materials impacts
the U.S. methylamines business which uses natural gas and the emulsions business
which uses vinyl acetate monomer (VAM). Despite recent declines, we expect
natural gas pricing will stay at levels above last year. While VAM prices have
increased several cents per pound so far this year, we expect the price to
stabilize going forward. A modest sequential improvement in Chemicals margins is
expected.
We expect to see continued weakness in the Equipment segment.
In the fourth quarter of 2003, we expect results similar to the third quarter
for the corporate and other segment, equity affiliates' income and interest
expense.
The company continues its portfolio management actions and continues to look for
ways to lower its cost structure and improve its competitive position. In the
third quarter, management announced a global cost reduction plan, which resulted
in an after-tax expense of $96.6, or $.43 per share. These actions will reduce
the company's overall cost structure and improve margins and returns in the
future. For the fourth quarter of 2003, cost savings of $3 are expected.
23
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW
The company's cash flows from operating, investing, and financing activities,
as reflected in the Consolidated Statements of Cash Flows, are summarized in
the following table:
Nine Months Ended
30 June
2003 2002
--------- ---------
Cash provided by (used for):
Operating activities $ 730.5 $ 724.7
Investing activities ( 580.9) (215.3)
Financing activities ( 273.4) (393.5)
Effect of exchange rate changes on cash 11.4 3.7
--------- ---------
(Decrease) increase in cash and cash items $ (112.4) $ 119.6
--------- ---------
OPERATING ACTIVITIES
Net cash provided by operating activities increased $5.8, or 1%. Before working
capital changes, the contribution of net income adjusted for non-cash items to
cash provided by operating activities was up $123.7. Net income decreased by
$115.1. Non-cash adjustments favorably contributing to the change in cash
provided by operating activities included depreciation expense, impairment of
long-lived assets, deferred income taxes, and the gain on the sale of assets and
investments. The increase in depreciation expense of $53.2 was due principally
to currency effects and acquisitions. The expenses for the impairment of
long-lived assets increased $88.0 principally due to the 2003 global cost
reduction plan. The $30.0 increase in deferred income taxes resulted from higher
temporary differences associated primarily with pension plan funding. The gain
on the sale of assets and investments was higher in 2002 by $57.4 principally
due to the sale of the U.S. packaged gas business in 2002. Additionally, cash
provided by operating activities in 2003 benefited from higher dividend payments
from equity affiliates. These favorable impacts were virtually offset by an
increased usage of cash for working capital in 2003. The increase in accounts
receivable was primarily due to the impact of natural gas cost pass-through.
Inventories increased as a result of higher energy and raw material costs.
Payables and accrued liabilities increased primarily due to expenses for the
2003 global cost reduction plan. The Other working capital use of cash increased
due to lower accrued income taxes during 2003 due to higher temporary
differences.
INVESTING ACTIVITIES
Cash used for investing activities increased $365.6 due primarily to
acquisitions in 2003 and lower proceeds from sale of assets and investments. For
the nine months ended 30 June 2003, acquisitions totaling $234.2 included
American Homecare Supply, LLC. (AHS), additional small homecare businesses, and
Sanwa Chemical Industry Co., Ltd. The principal acquisition of the company was
AHS in October 2002, for $166. Proceeds from the sale of assets and investments
declined $184.2 from the prior year. The company sold its Canadian packaged gas
business in April 2003 for proceeds of $41.2. In 2002, the company sold the
majority of its U.S. packaged gas business for proceeds of $254.5.
24
Capital expenditures are detailed in the following table:
Nine Months Ended
30 June
2003 2002
--------- --------
Additions to plant and equipment $ 440.0 $ 459.8
Investments in and advances to 6.1 35.2
unconsolidated affiliates
Acquisitions 234.2 10.3
Long-term debt assumed in acquisitions 4.0 --
Capital leases 8.2 2.7
--------- --------
$ 692.5 $ 508.0
--------- --------
Capital expenditures for new plant and equipment are expected to be
approximately $600 in 2003. In addition, the company intends to continue to
pursue acquisition opportunities and investments in affiliated entities. It is
anticipated these expenditures will be funded with cash from operations,
proceeds from asset sales, and proceeds from debt issuance.
FINANCING ACTIVITIES
Cash used for financing activities declined $120.1, primarily due to lower
short-term debt repayments.
Total debt at 30 June 2003 and 30 September 2002, expressed as a percentage of
the sum of total debt, shareholders' equity, and minority interest, was 37% and
40%, respectively. Total debt decreased from $2,385.0 at 30 September 2002 to
$2,368.3 at 30 June 2003.
The company's total revolving credit commitments amounted to $600.0 at 30 June
2003. No borrowings were outstanding under these commitments. Additional
commitments totaling $67.4 are maintained by the company's foreign subsidiaries,
of which $11.5 was utilized at 30 June 2003.
The estimated fair value of the company's long-term debt, including current
portion, as of 30 June 2003 is $2,527.6 compared to a book value of $2,344.2.
PENSION FUNDING
For the nine months ended 30 June 2003 and 2002, the company contributed $50.8
and $38.1, respectively, to the pension plans. Cash contributions are estimated
to be approximately $60 in 2003.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The company is obligated to make future payments under various contracts such as
debt agreements, lease agreements and unconditional purchase obligations, and
has certain contingent commitments such as debt and residual value guarantees.
There have been no material changes to Contractual Obligations and Commercial
Commitments as reflected in the Management's Discussion & Analysis in the
company's 2002 annual report on Form 10-K. Refer to Notes 11 and 12 to the
consolidated financial statements in the company's 2002 annual report on Form
10-K for additional information on long-term debt and leases and Note 18 for
information on commitments and contingencies.
25
Information on the company's obligations under its various retirement plans,
including amounts recognized in the balance sheet, is reported in Note 17
(Pension and Other Postretirement Benefits) to the consolidated financial
statements in the company's 2002 annual report on Form 10-K.
OFF-BALANCE SHEET ARRANGEMENTS
The company's off-balance sheet arrangements include certain guarantee
agreements and the sale and leaseback of U.S. cryogenic vessel equipment with a
third party. The company's guarantee agreements are discussed in the Notes to
the consolidated financial statements under Guarantees and Warranties.
Information on the sale and leaseback of U.S. cryogenic vessel equipment is
contained in Note 12 to the consolidated financial statements in the company's
2002 annual report on Form 10-K. The company has not entered into any agreements
under which the company has an obligation arising out of a variable interest
entity. The company's off-balance sheet arrangements are not reasonably likely
to have a material impact on financial condition, changes in financial
condition, results of operations, or liquidity.
RELATED PARTY TRANSACTIONS
The company's principal related parties are equity affiliates operating in
industrial gas and chemicals businesses. During 2002 and the nine months ended
30 June 2003, the company did not engage in any material transactions involving
related parties that included terms or other aspects that differ from those
which would be negotiated with clearly independent parties.
MARKET RISKS AND SENSITIVITY ANALYSIS
The company's earnings, cash flows, and financial position are exposed to market
risks relating to fluctuations in interest rates and foreign currency exchange
rates. It is the policy of the company to minimize its cash flow exposure to
adverse changes in currency and exchange rates and to reduce the financial risks
inherent in funding the company with debt capital.
The company addresses these financial exposures through a controlled program of
risk management that includes the use of derivative financial instruments.
Counter parties to all derivative contracts are major financial institutions,
thereby minimizing the risk of credit loss. All instruments are entered into for
other than trading purposes.
The net financial instrument position of the company increased from $2,363.0 at
30 September 2002 to $2,571.5 at 30 June 2003 primarily due to the impact of a
weaker U.S. dollar on the translation of foreign currency debt and the market
value of foreign exchange forward contracts and the impact of lower global
interest rates on the market value of fixed rate debt.
Information on the company's utilization of financial instruments and an
analysis of the sensitivity of these instruments to selected changes in market
rates and prices is included in the company's 2002 annual report on Form 10-K.
There was no material change to market risk sensitivity since 30 September 2002.
26
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of the company's financial condition and
results of operations is based on the consolidated financial statements and
accompanying notes that have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The significant accounting policies of the company are described in Note 1 to
the consolidated financial statements and the critical accounting policies and
estimates are described in the Management's Discussion and Analysis included in
the 2002 annual report on Form 10-K. Information concerning the company's
implementation and impact of new accounting standards issued by the Financial
Accounting Standards Board (FASB) is included in the notes to the consolidated
financial statements. There have been no other changes in accounting policy in
the current period that had a material impact on the company's financial
condition, change in financial condition, liquidity or results of operations.
NEW ACCOUNTING STANDARDS
In November 2002, the FASB published Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," and the Emerging Issues Task Force
(EITF) reached a consensus on Issue No. 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables." In December 2002, the FASB issued
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure." In January 2003, the FASB published Interpretation No. 46,
"Consolidation of Variable Interest Entities." In April 2003, the FASB issued
SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." In May 2003, the FASB issued SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity." In May 2003, the FASB ratified the EITF consensus on Issue No. 01-08,
"Determining Whether an Arrangement Contains a Lease." See the notes to the
consolidated financial statements for information concerning the company's
implementation and impact of these new standards.
FORWARD-LOOKING STATEMENTS
The forward-looking statements contained in this document are based on current
expectations regarding important risk factors. Actual results may differ
materially from those expressed. Factors that might cause forward-looking
statements to differ materially from actual results include those specifically
referenced as future events of outcomes that the company anticipates, as well
as, among other things, overall economic and business conditions different than
those currently anticipated and demand for the company's goods and services
during that time; competitive factors in the industries in which it competes;
interruption in ordinary sources of supply; the ability to recover increased
energy and raw material costs from customers; spikes in the pricing of natural
gas; changes in government regulations; consequences of acts of war or terrorism
impacting the United States and other markets; the success of implementing cost
reduction programs; the timing, impact, and other uncertainties of future
acquisitions or divestitures; significant fluctuations in interest rates and
foreign currencies; the impact of tax and other legislation and regulations in
jurisdictions in which the company and its affiliates operate; and the timing
and rate at which tax credits can be utilized.
27
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to the Market Risks and Sensitivity Analysis on page 26 of Item 2 on
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision of the Chief Executive Officer and Chief Financial
Officer, the company's management conducted an evaluation of the effectiveness
of the design and operation of the company's disclosure controls and procedures.
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the design and operation of its disclosure controls and
procedures have been effective. There have been no significant changes in
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of such evaluation.
28
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits required by Item 601 of Regulation S-K
12. Computation of Ratios of Earnings to Fixed Charges.
31.1. Certification by the Principal Executive Officer pursuant to
Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange
Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2. Certification by the Principal Financial Officer pursuant to
Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange
Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32. Certification by the Principal Executive Officer and Principal
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
(b) Reports on Form 8-K
During the quarter ended 30 June 2003, the registrant filed Current
Reports on Form 8-K dated 8 April 2003, in which Item 5 was reported,
and 24 April 2003, in which Item 9 was reported.
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
Air Products and Chemicals, Inc.
-------------------------------
(Registrant)
Date: 13 August 2003 By: /s/ John R. Owings
------------------------------------------
John R. Owings
Vice President and Chief Financial Officer
30
EXHIBIT INDEX
12. Computation of Ratios of Earnings to Fixed Charges.
31.1. Certification by the Principal Executive Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2. Certification by the Principal Financial Officer pursuant to Rule
13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32. Certification by the Principal Executive Officer and Principal
Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
31