Form 10-Q
Table of Contents

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 31 March 2012

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 or Other Jurisdiction of Incorporation or Organization)   (I.R.S. Employer Identification No.)
7201 Hamilton Boulevard, Allentown, Pennsylvania   18195-1501
(Address of Principal Executive Offices)   (Zip Code)

610-481-4911

(Registrant’s Telephone Number, Including Area Code)

Not Applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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    ü     No       

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes     ü  

No       

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ü     Accelerated filer          Non-accelerated filer          Smaller reporting company       
  (Do not check if a smaller reporting company)  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES          

NO   ü  

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 31 March 2012

Common Stock, $1 par value       211,431,991


Table of Contents

AIR PRODUCTS AND CHEMICALS, INC. and Subsidiaries

INDEX

 

         Page No.  
PART I.  

FINANCIAL INFORMATION

  

Item 1.

 

Financial Statements

  

Consolidated Balance Sheets – 31 March 2012 and 30 September 2011

     3   

Consolidated Income Statements – Three and Six Months Ended 31 March 2012 and 2011

     4   

Consolidated Comprehensive Income Statements – Three and Six Months Ended 31  March 2012 and 2011

     5   

Consolidated Statements of Cash Flows – Six Months Ended 31 March 2012 and 2011

     6   

Notes to Consolidated Financial Statements

     7   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     25   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     42   

Item 4.

 

Controls and Procedures

     42   
PART II.  

OTHER INFORMATION

  

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     42   

Item 6.

 

Exhibits

     43   

Signatures

     44   

Exhibit Index

     45   

 

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Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

AIR PRODUCTS AND CHEMICALS, INC. and Subsidiaries

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(Millions of dollars, except for share data)      31 March
2012
   30 September
2011

Assets

                       

Current Assets

           

Cash and cash items

       $ 319.5        $ 421.4  

Trade receivables, net

         1,381.8          1,361.6  

Inventories

         696.0          670.2  

Contracts in progress, less progress billings

         149.8          146.7  

Prepaid expenses

         105.2          77.5  

Other receivables and current assets

         373.3          269.2  

Current assets of discontinued operations

         317.3          243.2  

Total Current Assets

         3,342.9          3,189.8  

Investment in net assets of and advances to equity affiliates

         1,051.5          1,011.6  

Plant and equipment, at cost

         17,658.1          16,858.8  

Less: accumulated depreciation

         10,013.2          9,636.1  

Plant and equipment, net

         7,644.9          7,222.7  

Goodwill

         831.8          796.2  

Intangible assets, net

         276.0          260.5  

Noncurrent capital lease receivables

         1,166.5          1,042.8  

Other noncurrent assets

         367.2          478.2  

Noncurrent assets of discontinued operations

         275.0          288.9  

Total Noncurrent Assets

         11,612.9          11,100.9  

Total Assets

       $ 14,955.8        $ 14,290.7  

Liabilities and Equity

                       

Current Liabilities

           

Payables and accrued liabilities

       $ 1,587.7        $ 1,599.7  

Accrued income taxes

         39.6          65.0  

Short-term borrowings

         353.0          561.8  

Current portion of long-term debt

         506.6          72.2  

Current liabilities of discontinued operations

         52.5          43.3  

Total Current Liabilities

         2,539.4          2,342.0  

Long-term debt

         3,879.8          3,927.5  

Other noncurrent liabilities

         1,453.7          1,500.0  

Deferred income taxes

         651.5          558.2  

Noncurrent liabilities of discontinued operations

         24.0          24.3  

Total Noncurrent Liabilities

         6,009.0          6,010.0  

Total Liabilities

         8,548.4          8,352.0  

Commitments and Contingencies – See Note 12

           

Air Products Shareholders’ Equity

           

Common stock (par value $1 per share; issued 2012 and 2011 – 249,455,584 shares)

         249.4          249.4  

Capital in excess of par value

         800.2          805.6  

Retained earnings

         8,882.6          8,599.5  

Accumulated other comprehensive loss

         (1,128.1 )        (1,253.4 )

Treasury stock, at cost (2012 – 38,023,593 shares; 2011 – 39,270,328 shares)

         (2,541.4 )        (2,605.3 )

Total Air Products Shareholders’ Equity

         6,262.7          5,795.8  

Noncontrolling Interests

         144.7          142.9  

Total Equity

         6,407.4          5,938.7  

Total Liabilities and Equity

       $ 14,955.8        $ 14,290.7  

The accompanying notes are an integral part of these statements.

 

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AIR PRODUCTS AND CHEMICALS, INC. and Subsidiaries

CONSOLIDATED INCOME STATEMENTS

(Unaudited)

       Three Months Ended
31 March
     Six Months Ended
31 March
(Millions of dollars, except for share data)      2012      2011      2012      2011

Sales

       $ 2,344.3          $ 2,403.0          $ 4,665.8          $ 4,695.5  

Cost of sales

         1,715.8            1,748.2            3,438.1            3,417.8  

Selling and administrative

         237.3            242.0            468.4            468.5  

Research and development

         29.8            27.9            57.8            57.1  

Cost reduction plan

         86.8            —              86.8            —    

Net loss on Airgas transaction

         —              5.0            —              48.5  

Other income, net

         13.3            13.9            27.0            21.4  

Operating Income

         287.9            393.8            641.7            725.0  

Equity affiliates’ income

         35.5            31.7            72.6            59.5  

Interest expense

         29.4            29.4            58.8            60.4  

Income from Continuing Operations before Taxes

         294.0            396.1            655.5            724.1  

Income tax provision

         8.8            103.2            136.2            176.5  

Income from Continuing Operations

         285.2            292.9            519.3            547.6  

Income from Discontinued Operations, net of tax

         17.0            18.6            39.2            39.8  

Net Income

         302.2            311.5            558.5            587.4  

Less: Net Income Attributable to Noncontrolling Interests

         6.2            7.2            14.4            14.5  

Net Income Attributable to Air Products

       $ 296.0          $ 304.3          $ 544.1          $ 572.9  

Net Income Attributable to Air Products

                           

Income from continuing operations

       $ 279.0          $ 285.7          $ 504.9          $ 533.1  

Income from discontinued operations

         17.0            18.6            39.2            39.8  

Net Income Attributable to Air Products

       $ 296.0          $ 304.3          $ 544.1          $ 572.9  

Basic Earnings Per Common Share Attributable to Air Products

                           

Income from continuing operations

       $ 1.32          $ 1.34          $ 2.39          $ 2.49  

Income from discontinued operations

         .08            .08            .19            .19  

Net Income Attributable to Air Products

       $ 1.40          $ 1.42          $ 2.58          $ 2.68  

Diluted Earnings Per Common Share Attributable to Air Products

                           

Income from continuing operations

       $ 1.30          $ 1.31          $ 2.36          $ 2.44  

Income from discontinued operations

         .08            .08            .18            .18  

Net Income Attributable to Air Products

       $ 1.38          $ 1.39          $ 2.54          $ 2.62  

Weighted Average of Common Shares Outstanding (in millions)

         211.1            213.8            210.7            214.0  

Weighted Average of Common Shares Outstanding
Assuming Dilution
(in millions)

         215.0            218.8            214.5            219.0  

Dividends Declared Per Common Share – Cash

       $ .64          $ .58          $ 1.22          $ 1.07  

The accompanying notes are an integral part of these statements.

 

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AIR PRODUCTS AND CHEMICALS, INC. and Subsidiaries

CONSOLIDATED COMPREHENSIVE INCOME STATEMENTS

(Unaudited)

       Three Months Ended
31 March
(Millions of dollars)      2012    2011

Net Income

       $ 302.2        $ 311.5  

Other Comprehensive Income, net of tax:

           

Translation adjustments, net of tax of ($18.0) and ($34.1)

         133.9          116.4  

Net gain (loss) on derivatives, net of tax of $1.1 and $5.3

         (1.1 )        8.6  

Unrealized holding gain (loss) on available-for-sale securities, net of tax of ($.1)

         —            .6  

Reclassification adjustments:

           

Derivatives, net of tax of $.3 and ($1.2)

         2.1          (1.6 )

Available-for-sale securities, net of tax of ($9.2)

         —            (15.9 )

Pension and postretirement benefits, net of tax of $8.9 and $8.8

         16.0          17.1  

Total Other Comprehensive Income

         150.9          125.2  

Comprehensive Income

         453.1          436.7  

Comprehensive Income Attributable to Noncontrolling Interests

         9.6          7.3  

Comprehensive Income Attributable to Air Products

       $ 443.5        $ 429.4  
       Six Months Ended
31 March
(Millions of dollars)      2012    2011

Net Income

       $ 558.5        $ 587.4  

Other Comprehensive Income, net of tax:

           

Translation adjustments, net of tax of ($4.0) and ($20.1)

         95.7          164.4  

Net gain (loss) on derivatives, net of tax of ($2.3) and $1.3

         (10.4 )        2.4  

Unrealized holding gain (loss) on available-for-sale securities, net of tax of ($3.3)

         —            (4.6 )

Reclassification adjustments:

           

Derivatives, net of tax of $4.4 and $3.0

         12.0          5.4  

Available-for-sale securities, net of tax of ($9.3)

         —            (16.1 )

Pension and postretirement benefits, net of tax of $17.8 and $17.4

         32.1          33.6  

Total Other Comprehensive Income

         129.4          185.1  

Comprehensive Income

         687.9          772.5  

Comprehensive Income Attributable to Noncontrolling Interests

         18.5          22.4  

Comprehensive Income Attributable to Air Products

       $ 669.4        $ 750.1  

The accompanying notes are an integral part of these statements.

 

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Table of Contents

AIR PRODUCTS AND CHEMICALS, INC. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

       Six Months Ended
31 March
(Millions of dollars)      2012    2011

Operating Activities

           

Net Income

       $ 558.5        $ 587.4  

Less: Net income attributable to noncontrolling interests

         14.4          14.5  

Net income attributable to Air Products

         544.1          572.9  

Income from discontinued operations

         (39.2 )        (39.8 )

Income from continuing operations attributable to Air Products

         504.9          533.1  

Adjustments to reconcile income to cash provided by operating activities:

           

Depreciation and amortization

         408.3          415.3  

Deferred income taxes

         53.1          63.0  

Benefit from Spanish tax ruling

         (58.3 )        —    

Undistributed earnings of unconsolidated affiliates

         (25.0 )        (7.7 )

Gain on sale of assets and investments

         (5.1 )        (6.6 )

Share-based compensation

         27.4          21.9  

Noncurrent capital lease receivables

         (109.9 )        (98.4 )

Net loss on Airgas transaction

         —            48.5  

Payment of acquisition-related costs

         —            (153.8 )

Other adjustments

         48.1          50.5  

Working capital changes that provided (used) cash, excluding effects of acquisitions and divestitures:

           

Trade receivables

         (13.9 )        (75.1 )

Inventories

         (19.9 )        (18.8 )

Contracts in progress, less progress billings

         (1.9 )        42.6  

Other receivables

         14.2          11.3  

Payables and accrued liabilities

         5.9          (227.6 )

Other working capital

         (96.7 )        8.5  

Cash Provided by Operating Activities

         731.2          606.7  

Investing Activities

           

Additions to plant and equipment

         (734.9 )        (592.0 )

Acquisitions, less cash acquired

         (26.4 )        —    

Investment in and advances to unconsolidated affiliates

         (21.2 )        (24.2 )

Proceeds from sale of Airgas stock

         —            94.7  

Proceeds from sale of assets and investments

         12.5          51.3  

Change in restricted cash

         6.4          10.4  

Cash Used for Investing Activities

         (763.6 )        (459.8 )

Financing Activities

           

Long-term debt proceeds

         400.1          43.0  

Payments on long-term debt

         (8.6 )        (172.0 )

Net (decrease) increase in commercial paper and short-term borrowings

         (190.2 )        340.9  

Dividends paid to shareholders

         (244.1 )        (210.1 )

Purchase of treasury shares

         (53.1 )        (350.0 )

Proceeds from stock option exercises

         75.9          72.6  

Excess tax benefit from share-based compensation

         18.5          18.6  

Payment for subsidiary shares from noncontrolling interests

         (58.4 )        —    

Other financing activities

         (13.2 )        .8  

Cash Used for Financing Activities

         (73.1 )        (256.2 )

Discontinued Operations

           

Cash provided by operating activities

         20.0          20.0  

Cash used for investing activities

         (7.7 )        (20.7 )

Cash provided by financing activities

         —            .3  

Cash Provided by (Used for) Discontinued Operations

         12.3          (.4 )

Effect of Exchange Rate Changes on Cash

         3.7          5.7  

Decrease in Cash and Cash Items

         (89.5 )        (104.0 )

Cash and Cash Items – Beginning of Year

         422.5          374.3  

Cash and Cash Items – End of Period

         333.0          270.3  

Less: Cash and Cash Items – Discontinued Operations

         13.5          .3  

Cash and Cash Items – Continuing Operations

       $ 319.5        $ 270.0  

The accompanying notes are an integral part of these statements.

 

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Table of Contents

AIR PRODUCTS AND CHEMICALS, INC. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Millions of dollars unless otherwise indicated, except for share data)

 

1. BASIS OF PRESENTATION AND MAJOR ACCOUNTING POLICIES

Refer to our 2011 Form 10-K for a description of major accounting policies. There have been no material changes to these accounting policies during the first six months of 2012.

The consolidated financial statements of Air Products and Chemicals, Inc. and its subsidiaries (“we”, “our”, “us”, the “Company”, “Air Products”, or “registrant”) included herein have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In our opinion, the accompanying statements reflect 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. Adjustments included herein are of a normal, recurring nature unless otherwise disclosed in the Notes. The interim results for the periods indicated herein, however, 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. The consolidated financial statements and related Notes included herein should be read in conjunction with the financial statements and Notes thereto included in our latest Form 10-K in order to fully understand the basis of presentation. Results of operations for interim periods are not necessarily indicative of the results of operations for a full year.

 

2. NEW ACCOUNTING GUIDANCE

Accounting Guidance Implemented

Fair Value Measurements

In May 2011, the FASB issued authoritative guidance that amends previous guidance for fair value measurement and disclosure requirements. The revised guidance changes certain fair value measurement principles, clarifies the application of existing fair value measurements and expands the disclosure requirements, particularly for Level 3 fair value measurements which utilize inputs that are based on our own internal assumptions. This standard was effective for us beginning in the second quarter of fiscal year 2012. The adoption of this guidance did not have a material impact on our consolidated financial statements.

New Accounting Guidance to be Implemented

Goodwill Impairment

In September 2011, the FASB issued authoritative guidance that amends previous guidance related to the manner in which entities test goodwill for impairment. The new guidance provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If it is determined to be more likely than not that the fair value of a reporting unit is less than its carrying amount, entities must perform the quantitative analysis of the goodwill impairment test. Otherwise, the quantitative test is optional. This guidance will be effective for us for annual and interim goodwill impairment tests performed after 30 September 2012. The implementation of this guidance does not impact our consolidated financial statements.

Multiemployer Pension

In September 2011, the FASB issued authoritative guidance that amends previous guidance related to the disclosure requirements for employers participating in multiemployer pension plans. The purpose of the new disclosures is to provide financial statement users with information about an employer’s level of participation in and the financial health of significant plans. Current recognition and measurement guidance for an employer’s participation in a multiemployer plan is not affected. This guidance will be effective for our fiscal year 2012 annual disclosures. Based on our level of participation in multiemployer plans, the impact of adopting this guidance should not be material to our consolidated financial statements.

Statement of Comprehensive Income

In June 2011, the FASB issued authoritative guidance that amends previous guidance for the presentation of comprehensive income. It eliminates the current option to present other comprehensive income in the statement of changes in equity. Under this revised guidance, an entity will have the option to present the components of net income and other comprehensive income in either a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The standard is effective for us beginning in the first quarter of fiscal year 2013. We are currently evaluating the presentation alternatives for adopting the guidance, but we do not anticipate a material impact on our consolidated financial statements upon adoption.

 

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3. DISCONTINUED OPERATIONS

In January 2012, the Board of Directors authorized the sale of our Homecare business, which had previously been reported as part of the Merchant Gases operating segment.

On 8 January 2012, we reached agreements for The Linde Group to purchase our Homecare business in Belgium, Germany, France, Portugal and Spain. This business represents approximately 80% of our total Homecare business revenues. We expect to sell the remaining portion of Homecare, which is primarily in the United Kingdom, within the next year.

The transaction with Linde received regulatory approval on 18 April 2012 and is expected to close on 30 April 2012. Total sale proceeds of €590 million (approximately $785) will be received in cash at closing. This amount includes contingent proceeds of €110 million (approximately $146) related to future business activity in Spain and Portugal. The gain related to the contingent proceeds will be deferred until the contingency period ends and the final proceeds are realized per the terms of the agreement. We will also be entitled to receive up to €32 million (approximately $43) of additional cash proceeds based upon collection of accounts receivable. We anticipate an after-tax gain in the range of €105-€130 million (approximately $140-$170) on the sale of this business in the third quarter of fiscal year 2012.

The Homecare business is being accounted for as discontinued operations. The results of operations and cash flows of this business have been removed from the results of continuing operations for all periods presented. The assets and liabilities of discontinued operations have been reclassified and are segregated in the consolidated balance sheets. The operating results are summarized below:

 

       Three Months Ended
31 March
     Six Months Ended
31 March
        2012      2011      2012      2011

Sales

       $ 95.5          $ 98.3          $ 197.0          $ 197.5  

Income before taxes

         25.2            25.7            56.1            55.1  

Income tax provision

         8.2            7.1            16.9            15.3  

Income from Discontinued Operations, net of tax

       $ 17.0          $ 18.6          $ 39.2          $ 39.8  

 

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Assets and liabilities of discontinued operations consist of the following:

 

       31 March      30 September
        2012      2011

Cash and cash items

       $ 13.5          $ 1.1  

Trade receivables, net

         272.6            213.4  

Inventories

         11.1            11.2  

Other current assets

         20.1            17.5  

Total Current Assets

       $ 317.3          $ 243.2  

Plant and equipment, net

       $ 177.5          $ 189.3  

Goodwill

         96.6            96.2  

Other noncurrent assets

         .9            3.4  

Total Noncurrent Assets

       $ 275.0          $ 288.9  

Payables and accrued liabilities

       $ 41.6          $ 42.1  

Accrued income taxes

         10.9            .5  

Short-term borrowings

         —              .7  

Total Current Liabilities

       $ 52.5          $ 43.3  

Other noncurrent liabilities

       $ 12.4          $ 12.4  

Deferred income taxes

         11.6            11.9  

Total Noncurrent Liabilities

       $ 24.0          $ 24.3  

4. COST REDUCTION PLAN

During the second quarter ended 31 March 2012, we initiated a cost reduction plan. The results from continuing operations includes a charge of $86.8 ($60.6 after-tax, or $.28 per share) for this plan. This charge represents the ongoing actions we are taking to improve our cost structure, particularly in Europe. It includes removing the stranded costs resulting from our decision to exit the Homecare business, the reorganization of the Merchant business and the actions we are taking to right-size our European business cost structure in light of the challenging economic outlook.

This charge includes $80.8 for severance and other costs associated with the elimination of approximately 600 positions from our workforce. The remainder of the charge, $6.0, is related to the write-down of certain assets. For additional information regarding these assets, see Note 10, Fair Value Measurements. The planned actions are expected to be completed within the next twelve months.

The charge for the cost reduction plan is excluded from segment operating profit. The table below displays how this charge relates to the businesses at the segment level:

 

        Severance and
Other Benefits
     Asset
Impairments
     Total

Merchant Gases

       $ 71.3          $ 6.0          $ 77.3  

Tonnage Gases

         3.8            —              3.8  

Electronics and Performance Materials

         5.7            —              5.7  

Total 2012 Charge

       $ 80.8          $ 6.0          $ 86.8  

 

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The following table summarizes the carrying amount of the accrual for the cost reduction plan at 31 March 2012:

 

        Severance and
Other Benefits
   Asset
Impairments
   Total

2012 Charge

       $ 80.8        $ 6.0        $ 86.8  

Noncash expenses

         (.4 )        (6.0 )        (6.4 )

Amount reflected in pension liability

         (6.8 )                 (6.8 )

Cash expenditures

         (7.8 )                 (7.8 )

Currency translation adjustment

         .6                   .6  

Accrued balance

       $ 66.4        $        $ 66.4  

 

5. SUBSEQUENT EVENT- BUSINESS COMBINATION

On 29 February 2012, we entered into a definitive agreement with E.I. DuPont de Nemours and Co., Inc. to acquire their 50% interest in our joint venture, DuPont Air Products NanoMaterials LLC (DA NanoMaterials). DA NanoMaterials’ revenues for calendar year 2011 were approximately $90.

The acquisition closed on 2 April 2012 for approximately $150, subject to working capital adjustments, and was accounted for as a business combination. We will consolidate DA NanoMaterials results beginning in the third quarter of 2012 within our Electronics and Performance Materials business segment. Prior to the acquisition date, we accounted for our 50% interest in DA NanoMaterials as an equity-method investment. An after-tax gain in the range of $45-$55 is expected to be recognized in the third quarter as a result of revaluing our previously held equity interest before the business combination.

 

6. AIRGAS TRANSACTION

In February 2010, we commenced a tender offer to acquire all the outstanding common stock of Airgas, Inc. (Airgas), including the associated preferred stock purchase rights. Based on a decision by the Delaware Chancery Court to uphold the decision of Airgas’ Board of Directors to retain the preferred stock purchase rights, we withdrew our offer on 15 February 2011.

The three and six months ended 31 March 2011 included a net loss of $5.0 ($4.4 after-tax, or $.02 per share) and $48.5 ($31.6 after-tax, or $.14 per share), respectively, which was reflected separately on the consolidated income statements as “Net loss on Airgas transaction.” This net loss included amortization of the fees related to the term loan credit facility, the gain on the sale of Airgas stock, and other acquisition-related costs. The six months ended 31 March 2011 included cash payments for acquisition-related costs of $153.8, which was classified as an operating activity on the consolidated statements of cash flows. For additional details on this transaction, refer to Note 3, Airgas Transaction, in our 2011 Form 10-K.

 

7. INVENTORIES

The components of inventories are as follows:

 

       31 March    30 September
        2012    2011

Inventories at FIFO Cost

           

Finished goods

       $ 523.6          $ 477.3  

Work in process

         34.8          29.9  

Raw materials, supplies and other

         237.0          258.8  
         795.4          766.0  

Less: Excess of FIFO cost over LIFO cost

         (99.4 )        (95.8 )
         $ 696.0          $ 670.2  

FIFO cost approximates replacement cost. Our inventories have a high turnover, and as a result, there is little difference between the original cost of an item and its current replacement cost.

 

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8. GOODWILL

Changes to the carrying amount of consolidated goodwill by segment for the six months ended 31 March 2012 are as follows:

 

       30 September      Acquisitions and      Currency      31 March
        2011      Adjustments      Translation      2012

Merchant Gases

         $ 479.2            $ 9.2            $ 10.6            $ 499.0  

Tonnage Gases

         14.1            —              .8            14.9  

Electronics and Performance Materials

         302.9            11.0            4.0            317.9  
           $ 796.2            $ 20.2            $ 15.4            $ 831.8  

Goodwill is subject to impairment testing at least annually. In addition, goodwill is tested more frequently if a change in circumstances or the occurrence of events indicates that potential impairment exists.

 

9. FINANCIAL INSTRUMENTS

Currency Price Risk Management

Our earnings, cash flows, and financial position are exposed to foreign currency risk from foreign currency denominated transactions and net investments in foreign operations. It is our policy to minimize our cash flow volatility to changes in currency exchange rates. This is accomplished by identifying and evaluating the risk that our cash flows will change in value due to changes in exchange rates and by executing the appropriate strategies necessary to manage such exposures. Our objective is to maintain economically balanced currency risk management strategies that provide adequate downside protection.

Forward Exchange Contracts

We enter into forward exchange contracts to reduce the cash flow exposure to foreign currency fluctuations associated with highly anticipated cash flows and certain firm commitments such as the purchase of plant and equipment. The maximum remaining term of any forward exchange contract currently outstanding and designated as a cash flow hedge at 31 March 2012 is 2.4 years. Forward exchange contracts are also used to hedge the value of investments in certain foreign subsidiaries and affiliates by creating a liability in a currency in which we have a net equity position. The primary currency pair in this portfolio of forward exchange contracts is the Euro/U.S. dollar.

In addition to the forward exchange contracts that are designated as hedges, we utilize forward exchange contracts that are not designated as hedges. These contracts are used to economically hedge foreign currency-denominated monetary assets and liabilities, primarily working capital. The primary objective of these forward exchange contracts is to protect the value of foreign currency-denominated monetary assets and liabilities from the effects of volatility in foreign exchange rates that might occur prior to their receipt or settlement. This portfolio of forward exchange contracts comprises many different foreign currency pairs, with a profile that changes from time to time depending on business activity and sourcing decisions.

The table below summarizes our outstanding currency price risk management instruments:

 

       31 March 2012      30 September 2011
        US$
Notional
     Years
Average
Maturity
     US$
Notional
     Years
Average
Maturity

Forward exchange contracts:

                           

Cash flow hedges

       $ 1,456.1            .5          $ 1,512.1            .4  

Net investment hedges

         928.7            1.0            635.8            2.0  

Not designated

         298.7            .1            226.3            .1  

Total Forward Exchange Contracts

       $ 2,683.5            .6          $ 2,374.2            .8  

In addition to the above, we use foreign currency-denominated debt and qualifying intercompany loans that are related to an outstanding borrowing from a third party to hedge the foreign currency exposures of our net investment in certain foreign subsidiaries. The designated foreign currency denominated debt at 31 March 2012 included €738.4 million and 30 September 2011 included €742.1 million. The designated intercompany loans were €437.0 million at 31 March 2012 and 30 September 2011.

 

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Debt Portfolio Management

It is our policy to identify on a continuing basis the need for debt capital and evaluate the financial risks inherent in funding the Company with debt capital. Reflecting the result of this ongoing review, the debt portfolio and hedging program are managed with the objectives and intent to (1) reduce funding risk with respect to borrowings made by us to preserve our access to debt capital and provide debt capital as required for funding and liquidity purposes, and (2) manage the aggregate interest rate risk and the debt portfolio in accordance with certain debt management parameters.

Interest Rate Swap Contracts

We enter into interest rate swap contracts to change the fixed/variable interest rate mix of our debt portfolio in order to maintain the percentage of fixed- and variable-rate debt within the parameters set by management. In accordance with these parameters, the agreements are used to optimize interest rate risks and costs inherent in our debt portfolio. Our interest rate swap portfolio will generally consist of fixed to floating swaps which are designated as fair value hedges and pre-issuance interest rate swap agreements to hedge the interest rate on anticipated fixed-rate debt issuance which are designated as cash flow hedges. At 31 March 2012, outstanding interest rate swaps were denominated in U.S. dollars and Euros. The maximum remaining hedged term of any interest rate swap designated as a cash flow hedge is .8 years. The notional amount of the interest rate swap agreements are equal to or less than the designated debt instrument being hedged. When interest rate swaps are used, the indices of the swap instruments and the debt to which they are designated are the same. It is our policy not to enter into any interest rate swap contracts which lever a move in interest rates on a greater than one-to-one basis.

Cross Currency Interest Rate Swap Contracts

We enter into cross currency interest rate swap contracts when our risk management function deems necessary. These contracts may entail both the exchange of fixed- and floating-rate interest payments periodically over the life of the agreement and the exchange of one currency for another currency at inception and at a specified future date. These contracts effectively convert the currency denomination of a debt instrument into another currency in which we have a net equity position while changing the interest rate characteristics of the instrument. The contracts are used to hedge certain net investments in foreign operations. The current cross currency swap portfolio consists of a single fixed-to-fixed swap between U.S. dollars and British Pound Sterling.

The following table summarizes our outstanding interest rate swaps and cross currency interest rate swaps:

 

     31 March 2012    30 September 2011
      US$
Notional
   Pay %    Average
Receive
%
  Years
Average
Maturity
   US$
Notional
   Pay %    Average
Receive
%
   Years
Average
Maturity

Interest rate swaps (fair value hedge)

     $ 583.4          LIBOR          3.38 %       4.0        $ 583.9          LIBOR          3.38%           4.5  

Cross currency interest rate swaps
(net investment hedge)

     $ 32.2          5.54%           5.48 %       1.9        $ 32.2          5.54%           5.48%           2.5  

Interest rate swaps (cash flow hedge)

     $ 100.0          2.30%           LIBOR         .8        $ 300.0          2.33%           LIBOR          .4  

 

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The table below summarizes the fair value and balance sheet location of our outstanding derivatives:

 

          31 March
2012
  30 September
2011
       31 March
2012
  30 September
2011
          Balance Sheet    
Location
  Fair Value   Fair Value       Balance Sheet    
Location
  Fair Value   Fair Value

Derivatives Designated as Hedging Instruments:

            

Forward exchange contracts

   Other receivables   $  11.7   $22.0   Accrued liabilities   $49.8   $33.0

Interest rate swap contracts

   Other receivables       11.8       5.8   Accrued liabilities       1.4       3.8

Forward exchange contracts

   Other noncurrent
assets
      40.6       45.0   Other noncurrent
liabilities
      1.1       1.0

Interest rate swap contracts

   Other noncurrent
assets
      36.2       42.4   Other noncurrent
liabilities
      2.9       2.2

Total Derivatives Designated as
Hedging Instruments

       $100.3   $115.2       $55.2   $40.0

Derivatives Not Designated as
Hedging Instruments:

            

Forward exchange contracts

   Other receivables   $    1.3   $    3.0   Accrued liabilities   $  1.3   $  3.8

Total Derivatives

       $101.6   $118.2       $56.5   $43.8

Refer to Note 10, Fair Value Measurements, which defines fair value, describes the method for measuring fair value, and provides additional disclosures regarding fair value measurements.

 

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The table below summarizes the gain or loss related to our cash flow hedges, fair value hedges, net investment hedges, and derivatives not designated as hedging instruments.

 

       Three Months Ended 31 March
       Forward
Exchange Contracts
   Foreign Currency
Debt
   Other (A)    Total
        2012    2011    2012    2011    2012    2011     2012    2011

Cash Flow Hedges, net of tax:

                                         

Net gain (loss) recognized in OCI
(effective portion)

       $ (2.5 )      $ 8.6        $ —          $ —          $ 1.4        $ —          $ (1.1 )      $ 8.6  

Net (gain) loss reclassified from OCI to
sales/cost of sales (effective portion)

         .2          6.3          —            —            —            —            .2          6.3  

Net (gain) loss reclassified from OCI to
other income, net (effective portion)

         1.8          (8.1 )        —            —            —            —            1.8          (8.1 )

Net (gain) loss reclassified from OCI to
interest expense (effective portion)

         (.3 )        —            —            —            .3          .3          —            .3  

Net (gain) loss reclassified from OCI to
other income, net (ineffective portion)

         .1          (.1 )        —            —            —            —            .1          (.1 )

Fair Value Hedges:

                                         

Net gain (loss) recognized in interest expense(B)

       $ —          $ —          $ —          $ —          $ (4.0 )      $ (4.8 )      $ (4.0 )      $ (4.8 )

Net Investment Hedges, net of tax:

                                         

Net gain (loss) recognized in OCI

       $ (16.1 )      $ (18.3 )      $ (34.3 )      $ (71.2 )      $ (.7 )      $ (.5 )      $ (51.1 )      $ (90.0 )

Derivatives Not Designated as Hedging Instruments:

                                         

Net gain (loss) recognized in other income, net(C)

       $ .9        $ (.9 )      $ —          $ —          $ —          $ —          $ .9        $ (.9 )

 

       Six Months Ended 31 March
       Forward
Exchange Contracts
   Foreign Currency
Debt
   Other  (A)         Total
        2012    2011    2012      2011    2012    2011     2012    2011

Cash Flow Hedges, net of tax:

                                           

Net gain (loss) recognized in OCI
(effective portion)

       $ (15.3 )      $ 2.4        $ —            $ —          $ 4.9        $ —          $ (10.4 )      $ 2.4  

Net (gain) loss reclassified from OCI to sales/cost of sales (effective portion)

         .5          5.5          —              —            —            —            .5          5.5  

Net (gain) loss reclassified from OCI to
other income, net (effective portion)

         10.3          (.8 )        —              —            —            —            10.3          (.8 )

Net (gain) loss reclassified from OCI to
interest expense (effective portion)

         .4          —            —              —            .6          .6          1.0          .6  

Net (gain) loss reclassified from OCI to
other income, net (ineffective portion)

         .2          .1          —              —            —            —            .2          .1  

Fair Value Hedges:

                                           

Net gain (loss) recognized in interest expense(B)

       $ —          $ —          $ —            $ —          $ (4.9 )      $ (21.2 )      $ (4.9 )      $ (21.2 )

Net Investment Hedges, net of tax:

                                           

Net gain (loss) recognized in OCI

       $ (7.0 )      $ (14.3 )      $ 3.0          $ (54.1 )      $ (.5 )      $ (.3 )      $ (4.5 )      $ (68.7 )

Derivatives Not Designated as Hedging Instruments:

                                           

Net gain (loss) recognized in other income, net(C)

       $ (1.2 )      $ (.7 )      $ —            $ —          $ —          $ —          $ (1.2 )      $ (.7 )

 

(A) Other includes the impact on other comprehensive income (OCI) and earnings primarily related to interest rate swaps.
(B)

The impact of fair value hedges noted above was largely offset by gains and losses resulting from the impact of changes in related interest rates on recognized outstanding debt.

(C)

The impact of the non-designated hedges noted above was largely offset by gains and losses, respectively, resulting from the impact of changes in exchange rates on recognized assets and liabilities denominated in nonfunctional currencies.

 

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The amount of cash flow hedges’ unrealized gains and losses at 31 March 2012 that are expected to be reclassified to earnings in the next twelve months are not material.

The cash flows related to all derivative contracts are reported in the operating activities section of the consolidated statements of cash flows.

Credit Risk-Related Contingent Features

Certain derivative instruments are executed under agreements that require us to maintain a minimum credit rating with both Standard & Poor’s and Moody’s. If our credit rating falls below this threshold, the counterparty to the derivative instruments has the right to request full collateralization on the derivatives’ net liability position. The net liability position of derivatives with credit risk-related contingent features was $15.7 as of 31 March 2012 and $10.5 as of 30 September 2011. Because our current credit rating is above the various pre-established thresholds, no collateral has been posted on these liability positions.

Counterparty Credit Risk Management

We execute all financial derivative transactions with counterparties that are highly rated financial institutions, all of which are investment grade at this time. Some of our underlying derivative agreements give us the right to require the institution to post collateral if its credit rating falls below the pre-established thresholds with Standard & Poor’s or Moody’s. These are the same agreements referenced in Credit Risk-Related Contingent Features above. The collateral that the counterparties would be required to post was $62.1 as of 31 March 2012 and $66.1 as of 30 September 2011. No financial institution is required to post collateral at this time, as all have credit ratings at or above the threshold.

 

10. FAIR VALUE MEASUREMENTS

Fair value is defined as an exit price (i.e., the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date). The methods and assumptions used to measure the fair value of financial instruments are as follows:

Derivatives

The fair value of our interest rate swap agreements and forward exchange contracts are quantified using the income approach and are based on estimates using standard pricing models. These models take into account the value of future cash flows as of the balance sheet date, discounted to a present value using discount factors that match both the time to maturity and currency of the underlying instruments. The computation of the fair values of these instruments is generally performed by the Company. These standard pricing models utilize inputs which are derived from or corroborated by observable market data such as interest rate yield curves and currency spot and forward rates. In addition, on an ongoing basis, we randomly test a subset of our valuations against valuations received from the transaction’s counterparty to validate the accuracy of our standard pricing models. Counterparties to these derivative contracts are highly rated financial institutions.

Refer to Note 9, Financial Instruments, for a description of derivative instruments, including details on the balance sheet line classifications.

Long-term Debt

The fair value of our debt is based on estimates using standard pricing models that take into account the value of future cash flows as of the balance sheet date, discounted to a present value using discount factors that match both the time to maturity and currency of the underlying instruments. These standard valuation models utilize observable market data such as interest rate yield curves and currency spot rates. Therefore, the fair value of our debt is classified as a level 2 measurement. We generally perform the computation of the fair value of these instruments.

Other Liabilities

As of 30 September 2011, other liabilities included the obligation to purchase 25% of the remaining shares of CryoService Limited (CSL). CSL is not publicly traded and therefore, no observable market existed for the shares. The fair value of the outstanding liability was determined using an internally developed valuation model that was based on a multiple of earnings formula. On 30 November 2011, payment was remitted for this obligation and 100% of the shares are now owned. Refer to Note 15, Noncontrolling Interests, for additional information.

 

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The carrying values and fair values of financial instruments were as follows:

 

       31 March 2012      30 September 2011
        Carrying Value      Fair Value      Carrying Value      Fair Value

Assets

                           

Derivatives

                           

Forward exchange contracts

                   $ 53.6            $ 53.6                        $ 70.0            $ 70.0    

Interest rate swap contracts

         48.0              48.0              48.2              48.2    

Liabilities

                           

Derivatives

                           

Forward exchange contracts

                   $ 52.2            $ 52.2                        $ 37.8            $ 37.8    

Interest rate swap contracts

         4.3              4.3              6.0              6.0    

Long-term debt, including current portion

         4,386.4              4,673.4              3,999.7              4,284.5    

Other liabilities

         —                —                51.0              51.0    

The carrying amounts reported in the balance sheet for cash and cash items, trade receivables, payables and accrued liabilities, accrued income taxes, and short-term borrowings approximate fair value due to the short-term nature of these instruments. Accordingly, these items have been excluded from the above table.

The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels as follows:

 

Level 1     Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2     Inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the asset or liability.
Level 3     Inputs that are unobservable for the asset or liability based on our own assumptions (about the assumptions market participants would use in pricing the asset or liability).

The following table summarizes assets and liabilities measured at fair value on a recurring basis in the consolidated balance sheets:

 

       31 March 2012      30 September 2011
        Total      Level 1      Level 2      Level 3      Total      Level 1      Level 2      Level 3

Assets at Fair Value

                                                       

Derivatives

                                                       

Forward exchange contracts

       $ 53.6          $ —            $ 53.6          $ —            $ 70.0          $ —            $ 70.0          $ —    

Interest rate swap contracts

         48.0            —              48.0            —              48.2            —              48.2            —    

Total Assets at Fair Value

       $ 101.6          $ —            $ 101.6          $ —            $ 118.2          $ —            $ 118.2          $ —    

Liabilities at Fair Value

                                                       

Derivatives

                                                       

Forward exchange contracts

       $ 52.2          $ —            $ 52.2          $ —            $ 37.8          $ —            $ 37.8          $ —    

Interest rate swap contracts

         4.3            —              4.3            —              6.0            —              6.0            —    

Other liabilities

         —              —              —              —              51.0            —              —              51.0  

Total Liabilities at Fair Value

       $ 56.5          $ —            $ 56.5          $ —            $ 94.8          $ —            $ 43.8          $ 51.0  

Refer to Note 1, Major Accounting Policies, in our 2011 Form 10-K and Note 9, Financial Instruments, in this quarterly filing for additional information on our accounting and reporting of the fair value of financial instruments.

 

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Changes in the fair value of other liabilities, valued using significant unobservable inputs (Level 3), are presented below:

 

Balance at 30 September 2011

       $  51.0  

Expense included in interest expense

         .8  

Payment to settle liability

         (52.1 )

Currency translation adjustment

         .3  

Balance at 31 March 2012

       $ —    

The following is a tabular presentation of the nonrecurring fair value measurement along with the level within the fair value hierarchy in which the fair value measurement in its entirety falls:

 

       31 March 2012      Net
Loss
        Total      Level 1      Level 2      Level 3     

Long-lived assets held for sale

       $ 2.2          $ —            $ —            $ 2.2          $ 6.0  

Long-lived assets held for sale with a carrying value of $8.2 were written down to fair value of $2.2, resulting in a loss of $6.0, which was included in the cost reduction plan charge. For additional information regarding this plan, see Note 4, Cost Reduction Plan, in this quarterly filing. We quantified the fair value of assets held for sale using a market approach, based on prices for other market transactions involving comparable assets and our assessment of value considering our knowledge of the markets.

 

11. RETIREMENT BENEFITS

The components of net pension cost for the defined benefit pension plans and other postretirement benefit cost for the three and six months ended 31 March 2012 and 2011 were as follows:

 

       Pension Benefits    Other Benefits
       2012    2011    2012      2011
Three Months Ended 31 March      U.S.    International    U.S.    International              

Service cost

       $ 11.2                    $ 6.1        $ 10.9                    $ 7.3        $ 1.1          $ 1.4  

Interest cost

         31.0          15.5          30.7          16.0          1.0            .8  

Expected return on plan assets

         (44.5 )        (16.5 )        (44.9 )        (17.0 )        —              —    

Prior service cost amortization

         .6          .1          .6          .2          —              —    

Actuarial loss amortization

         19.7          3.8          16.0          8.2          .7            1.0  

Special termination benefits

         4.6          2.2          —            —            —              —    

Other

         —            .7          —            .5          —              —    

Net periodic benefit cost

       $ 22.6                    $ 11.9        $ 13.3                    $ 15.2        $ 2.8          $ 3.2  
       Pension Benefits    Other Benefits
       2012    2011    2012      2011
Six Months Ended 31 March      U.S.    International    U.S.    International              

Service cost

       $ 22.5                    $ 12.1        $ 21.8                    $ 14.5        $ 2.2          $ 2.8  

Interest cost

         62.1          31.2          61.5          31.7          2.0            1.6  

Expected return on plan assets

         (89.0 )        (33.3 )        (89.8 )        (33.6 )        —              —    

Prior service cost amortization

         1.3          .2          1.2          .4          —              —    

Actuarial loss amortization

         39.3          7.7          32.0          15.6          1.4            2.0  

Special termination benefits

         4.6          2.2          —            —            —              —    

Other

         —            1.3          —            .9          —              —    

Net periodic benefit cost

       $ 40.8                    $ 21.4        $ 26.7                    $ 29.5        $ 5.6          $ 6.4  

 

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Special termination benefits for the three and six months ended 31 March 2012 are related to the cost reduction plan initiated in the second quarter. For additional information regarding this plan, see Note 4, Cost Reduction Plan.

For the six months ended 31 March 2012 and 2011, our cash contributions to funded plans and benefit payments under unfunded plans were $23.4 and $221.4, respectively. Total contributions for fiscal 2012 are expected to be approximately $40 to $60. During fiscal 2011, total contributions were $241.

 

12. COMMITMENTS AND CONTINGENCIES

Litigation

We are involved in various legal proceedings, including competition, environmental, health, safety, product liability, and insurance matters. In September 2010, the Brazilian Administrative Council for Economic Defense (CADE) issued a decision against our Brazilian subsidiary, Air Products Brasil Ltda., and several other Brazilian industrial gas companies for alleged anticompetitive activities. CADE imposed a civil fine of R$179.2 million (approximately $98 at 31 March 2012) on Air Products Brasil Ltda. This fine was based on a recommendation by a unit of the Brazilian Ministry of Justice whose investigation began in 2003 alleging violation of competition laws with respect to the sale of industrial and medical gases. The fines are based on a percentage of our total revenue in Brazil in 2003.

We have denied the allegations made by the authorities and filed an appeal in October 2010 with the Brazilian courts. Certain of our defenses, if successful, could result in the matter being dismissed with no fine against us. We, with advice of our outside legal counsel, have assessed the status of this matter and have concluded that although an adverse final judgment after exhausting all appeals is reasonably possible, such a judgment is not probable. As a result, no provision has been made in the consolidated financial statements. We estimate the maximum possible loss to be the full amount of the fine of R$179.2 million (approximately $98 at 31 March 2012) plus interest accrued thereon until final disposition of the proceedings.

We are required to provide security for the payment of the fine (and interest) in order to suspend execution of the judgment during the appeal process, during which time interest will accrue on the fine. The security is only collectible by the court in the event we are not successful in our appeal and do not timely pay the fine. The security could be in the form of a bank guarantee or in other forms which the courts deem acceptable. The form of security to be provided by us has not been finally determined.

While we do not expect that any sums we may have to pay in connection with this or any other legal proceeding would have a materially adverse effect on our consolidated financial position or net cash flows, a future charge for regulatory fines or damage awards could have a significant impact on our net income in the period in which it is recorded.

Environmental

In the normal course of business, we are involved in legal proceedings under the Comprehensive Environmental Response, Compensation, and Liability Act (the federal Superfund law), similar state environmental laws, and the Resource Conservation and Recovery Act (RCRA) relating to the designation of certain sites for investigation or remediation. Presently, there are approximately 36 sites on which a final settlement has not been reached where we, along with others, have been designated a potentially responsible party by the Environmental Protection Agency or are otherwise engaged in investigation or remediation, including cleanup activity at certain of our current and former manufacturing sites. We continually monitor these sites for which we have environmental exposure.

Accruals for environmental loss contingencies are recorded when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated consistent with the policy set forth in Note 1, Major Accounting Policies, to the consolidated financial statements in our 2011 Form 10-K. The consolidated balance sheets at 31 March 2012 and 30 September 2011 included an accrual of $80.2 and $82.3, respectively, primarily as part of other noncurrent liabilities. The environmental liabilities will be paid over a period of up to 30 years. We estimate the exposure for environmental loss contingencies to range from $80 to a reasonably possible upper exposure of $94 as of 31 March 2012.

Actual costs to be incurred at identified sites in future periods may vary from the estimates, given inherent uncertainties in evaluating environmental exposures. Using reasonably possible alternative assumptions of the exposure level could result in an increase to the environmental accrual. Due to the inherent uncertainties related to environmental exposures, a significant increase to the reasonably possible upper exposure level could occur if a new site is designated, the scope of remediation is increased, a different remediation alternative is identified, or a significant increase in our proportionate share occurs. We do not expect that any sum we may have to pay in connection with environmental matters in excess of the amounts recorded or disclosed above would have a material adverse impact on our financial position or results of operations in any one year.

 

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PACE

At 31 March 2012, $34.6 of the environmental accrual was related to the Pace facility.

In 2006, we sold our Amines business, which included operations at Pace, Florida and recognized a liability for retained environmental obligations associated with remediation activities at Pace. We are required by the Florida Department of Environmental Protection (FDEP) and the United States Environmental Protection Agency (USEPA) to continue our remediation efforts. We estimated that it would take about 20 years to complete the groundwater remediation, and the costs through completion were estimated to range from $42 to $52. As no amount within the range was a better estimate than another, we recognized a pretax expense in fiscal 2006 of $42.0 as a component of income from discontinued operations and recorded an environmental accrual of $42.0 in continuing operations on the consolidated balance sheets. There has been no change to the estimated exposure range related to the Pace facility.

We have implemented many of the remedial corrective measures at the Pace, Florida facility required under 1995 Consent Orders issued by the FDEP and the USEPA. Contaminated soils have been bioremediated, and the treated soils have been secured in a lined on-site disposal cell. Several groundwater recovery systems have been installed to contain and remove contamination from groundwater. We completed an extensive assessment of the site to determine how well existing measures are working, what additional corrective measures may be needed, and whether newer remediation technologies that were not available in the 1990s might be suitable to more quickly and effectively remove groundwater contaminants. Based on assessment results, we completed a focused feasibility study that appears to have identified new and alternative approaches which should more effectively remove contaminants and achieve the targeted remediation goals. We continue to review the new approaches with the FDEP.

PIEDMONT

At 31 March 2012, $20.7 of the environmental accrual was related to the Piedmont site.

On 30 June 2008, we sold our Elkton, Maryland and Piedmont, South Carolina production facilities and the related North American atmospheric emulsions and global pressure sensitive adhesives businesses. In connection with the sale, we recognized a liability for retained environmental obligations associated with remediation activities at the Piedmont site. This site is under active remediation for contamination caused by an insolvent prior owner. The sale of the site triggered expense recognition. Prior to the sale, remediation costs had been capitalized since they improved the property as compared to its condition when originally acquired. We are required by the South Carolina Department of Health and Environmental Control to address both contaminated soil and groundwater. Numerous areas of soil contamination have been addressed, and contaminated groundwater is being recovered and treated. We estimated that it would take until 2015 to complete source area remediation and another 15 years thereafter to complete groundwater recovery, with costs through completion estimated to be $24. We recognized a pretax expense in 2008 of $24.0 as a component of income from discontinued operations and recorded an environmental liability of $24.0 in continuing operations on the consolidated balance sheets. There has been no change to the estimated exposure.

PAULSBORO

At 31 March 2012, $8.0 of the environmental accrual was related to the Paulsboro site.

During the first quarter of 2009, management committed to a plan to sell the production facility in Paulsboro, New Jersey and recognized a $16.0 environmental liability associated with this site. The change in the liability balance since it was established is a result of spending and changes in the estimated exposure. In December 2009, we completed the sale of this facility. We are required by the New Jersey state law to investigate and, if contaminated, remediate a site upon its sale. We estimate that it will take several years to complete the investigation/remediation efforts at this site.

Agreement to Purchase Shares in Equity Affiliate

In September 2011, we entered into an agreement to acquire 25% of the outstanding shares of Abdullah Hashim Industrial Gases & Equipment Co. Ltd. (AHG). The transaction is subject to regulatory approval and customary local closing conditions. The closing date is expected to occur in the third quarter of fiscal year 2012. AHG is a company of the privately-owned Abdullah Hashim Group, based in the Kingdom of Saudi Arabia. AHG is the largest private industrial gases company in Saudi Arabia. It is comprised of three businesses, including industrial gases, equipment and consumables and refrigerants. The transaction will be recorded as an investment in net assets of and advances to equity affiliates in the Merchant Gases segment.

 

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13. SHARE-BASED COMPENSATION

We have various share-based compensation programs, which include stock options, deferred stock units, and restricted shares. During the six months ended 31 March 2012, we granted 1,079,860 stock options at a weighted-average exercise price of $82.64 and an estimated fair value of $21.43 per option. The fair value of these options was estimated using a Black Scholes option valuation model that used the following assumptions: expected volatility of 29.0%-30.4%; expected dividend yield of 2.3%; expected life in years of 7.3-9.0; and a risk-free interest rate of 1.7%-2.1%. In addition, we granted 247,063 deferred stock units at a weighted-average grant-date fair value of $83.17 and 34,595 restricted shares at a weighted-average grant-date fair value of $82.64. Refer to Note 18, Share-Based Compensation, in our 2011 Form 10-K for information on the valuation and accounting for these programs.

Share-based compensation cost charged against income in the three and six months ended 31 March 2012 was $15.6 ($9.8 after-tax) and $27.4 ($17.5 after-tax), respectively. Of the share-based compensation cost recognized for the six months ended 31 March 2012, $23.6 was a component of selling and administrative expense, $2.6 a component of cost of sales, $.8 a component of research and development, and $.4 a component of the cost reduction plan. Share-based compensation cost charged against income in the three and six months ended 31 March 2011 was $11.7 ($7.1 after-tax) and $21.9 ($13.5 after-tax), respectively. The amount of share-based compensation cost capitalized in 2012 and 2011 was not material.

 

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14. EQUITY

The following is a summary of the changes in total equity for the three and six months ended 31 March:

 

     Three Months Ended 31 March
     2012    2011
      Air
Products
   Non-
controlling
Interests
   Total
Equity
   Air
Products
   Non-
controlling
Interests
   Total
Equity

Balance at 31 December

     $ 5,909.0        $ 148.1        $ 6,057.1        $ 5,810.0        $ 167.2        $ 5,977.2  

Net Income

       296.0          6.2          302.2          304.3          7.2          311.5  

Components of Other Comprehensive Income,
net of tax

                             

Translation adjustments

       130.4          3.5          133.9          116.3          .1          116.4  

Net gain (loss) on derivatives

       (1.0 )        (.1 )        (1.1 )        8.6          —            8.6  

Unrealized holding gain on available-for-sale
securities

       —            —            —            .6          —            .6  

Reclassification adjustments:

                             

Derivatives

       2.1          —            2.1          (1.6 )        —            (1.6 )

Available-for-sale securities

       —            —            —            (15.9 )        —            (15.9 )

Pension and postretirement benefits

       16.0          —            16.0          17.1          —            17.1  

Total Other Comprehensive Income

       147.5          3.4          150.9          125.1          .1          125.2  

Comprehensive Income

       443.5          9.6          453.1          429.4          7.3          436.7  

Dividends on common stock (per share $.64, $.58)

       (135.3 )        —            (135.3 )        (122.9 )        —            (122.9 )

Dividends to noncontrolling interests

       —            (13.0 )        (13.0 )        —            (.5 )        (.5 )

Share-based compensation expense

       15.2          —            15.2          11.7          —            11.7  

Purchase of treasury shares

       (53.1 )        —            (53.1 )        (350.0 )        —            (350.0 )

Issuance of treasury shares for stock option and award plans

       64.1          —            64.1          33.4          —            33.4  

Tax benefit of stock option and award plans

       21.2          —            21.2          14.5          —            14.5  

Other equity transactions

       (1.9 )        —            (1.9 )        (.9 )        —            (.9 )

Balance at 31 March

     $ 6,262.7        $ 144.7        $ 6,407.4        $ 5,825.2        $ 174.0        $ 5,999.2  

 

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       Six Months Ended 31 March
       2012    2011
        Air
Products
   Non-
controlling
Interests
   Total
Equity
   Air
Products
   Non-
controlling
Interests
   Total
Equity

Balance at 30 September

       $ 5,795.8        $ 142.9        $ 5,938.7        $ 5,546.9        $ 150.7        $ 5,697.6  

Net Income

         544.1          14.4          558.5          572.9          14.5          587.4  

Components of Other Comprehensive Income, net of tax

                               

Translation adjustments

         91.4          4.3          95.7          156.4          8.0          164.4  

Net gain (loss) on derivatives

         (10.2 )        (.2 )        (10.4 )        2.5          (.1 )        2.4  

Unrealized holding loss on available-for-sale securities

         —            —            —            (4.6 )        —            (4.6 )

Reclassification adjustments:

                               

Derivatives

         12.0          —            12.0          5.4          —            5.4  

Available-for-sale securities

         —            —            —            (16.1 )        —            (16.1 )

Pension and postretirement benefits

         32.1          —            32.1          33.6          —            33.6  

Total Other Comprehensive Income

         125.3          4.1          129.4          177.2          7.9          185.1  

Comprehensive Income

         669.4          18.5          687.9          750.1          22.4          772.5  

Dividends on common stock (per share $1.22, $1.07)

         (257.5 )        —            (257.5 )        (228.2 )        —            (228.2 )

Dividends to noncontrolling interests

         —            (13.0 )        (13.0 )        —            (.5 )        (.5 )

Share-based compensation expense

         27.0          —            27.0          21.9          —            21.9  

Purchase of treasury shares

         (53.1 )        —            (53.1 )        (350.0 )        —            (350.0 )

Issuance of treasury shares for stock option and
award plans

         61.8          —            61.8          65.0          —            65.0  

Tax benefits of stock option and award plans

         25.4          —            25.4          27.8          —            27.8  

Purchase of noncontrolling interests

         (4.4 )        (1.9 )        (6.3 )        (6.1 )        —            (6.1 )

Contribution from noncontrolling interests

         —            —            —            —            1.4          1.4  

Other equity transactions

         (1.7 )        (1.8 )        (3.5 )        (2.2 )        —            (2.2 )

Balance at 31 March

       $ 6,262.7        $ 144.7        $ 6,407.4        $ 5,825.2        $ 174.0        $ 5,999.2  

 

15. NONCONTROLLING INTERESTS

In June 2010, we entered into agreements to increase our ownership percentage from 72% to 97% of CryoService Limited (CSL), a cryogenic and specialty gases company in the U.K. At 30 September 2011, the liability to purchase the additional 25%, based on a multiple of earnings formula, was reported in payables and accrued liabilities on the consolidated balance sheet. On 30 November 2011, we remitted consideration of £33.2 million ($52.1) to fulfill this obligation. Refer to Note 10, Fair Value Measurements, for a rollforward of the liability balance. For additional information, refer to Note 19 in our 2011 Form 10-K.

In the first quarter of 2012, we entered into an agreement to purchase the remaining 3% of CSL, increasing our ownership percentage to 100%. On 30 November 2011, we remitted consideration of £4.0 million ($6.3) to purchase the remaining 3% of CSL.

The following table presents the effect of changes in ownership interests in subsidiaries on Air Products shareholders’ equity:

 

       Three Months Ended
31 March
     Six Months Ended
31 March
        2012      2011      2012    2011

Net Income Attributable to Air Products

       $ 296.0          $ 304.3          $ 544.1        $ 572.9  

Transfers to noncontrolling interests:

                         

Decrease in Air Products capital in excess of par value for purchase of noncontrolling interests

         —              —              (4.4 )        (6.1 )

Changes from net income attributable to Air Products and transfers to noncontrolling interests

       $ 296.0          $ 304.3          $ 539.7        $ 566.8  

 

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16. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per share (EPS):

 

       Three Months Ended
31 March
     Six Months Ended
31 March
        2012      2011      2012      2011

NUMERATOR

                           

Income from continuing operations

       $ 279.0          $ 285.7          $ 504.9          $ 533.1  

Income from discontinued operations

         17.0            18.6            39.2            39.8  

Net Income Attributable to Air Products

       $ 296.0          $ 304.3          $ 544.1          $ 572.9  

DENOMINATOR (in millions)

                           

Weighted average number of common shares outstanding

         211.1            213.8            210.7            214.0  

Effect of dilutive securities

                           

Employee stock options

         3.0            4.1            2.9            4.1  

Other award plans

         .9            .9            .9            .9  
           3.9            5.0            3.8            5.0  

Weighted average number of common shares outstanding assuming dilution

         215.0            218.8            214.5            219.0  

BASIC EPS ATTRIBUTABLE TO AIR PRODUCTS

                           

Income from continuing operations

       $ 1.32          $ 1.34          $ 2.39          $ 2.49  

Income from discontinued operations

         .08            .08            .19            .19  

Net Income Attributable to Air Products

       $ 1.40          $ 1.42          $ 2.58          $ 2.68  

DILUTED EPS ATTRIBUTABLE TO AIR PRODUCTS

                           

Income from continuing operations

       $ 1.30          $ 1.31          $ 2.36          $ 2.44  

Income from discontinued operations

         .08            .08            .18            .18  

Net Income Attributable to Air Products

       $ 1.38          $ 1.39          $ 2.54          $ 2.62  

Options on 2.2 million and 3.2 million shares were antidilutive and therefore excluded from the computation of diluted earnings per share for the three and six months ended 31 March 2012, respectively. Options on 2.1 million shares were antidilutive and therefore excluded from the computation of diluted earnings per share for the three and six months ended 31 March 2011.

 

17. INCOME TAXES

Q1 Spanish Tax Settlement

We were challenged by the Spanish tax authorities over income tax deductions taken by certain of our Spanish subsidiaries during fiscal years 2005-2011. Although we continue to believe that all positions taken were compliant with applicable laws, in November 2011 we reached a settlement with the Spanish tax authorities for €41.3 million (approximately $56) in resolution of all tax issues under examination. Of this settlement, $43.8 ($.20 per share) increased our income tax expense and had a 6.7% impact in our effective tax rate for the six months ended 31 March 2012. The cash payment for the settlement was principally paid in January 2012.

Q2 Spanish Tax Ruling

As of 30 September 2011, our unrecognized tax benefits included an amount related to certain transactions of a Spanish subsidiary for years 1991 and 1992, a period before we controlled this subsidiary. In March 2009, the Spanish appeals court (Audiencia Nacional) ruled in favor of our Spanish subsidiary. The Spanish government appealed this court decision to the Spanish Supreme Court, and as a result, we did not reverse the liability accrued for these unrecognized tax benefits. On 25 January 2012, the Spanish Supreme Court released its decision affirming the decision of the Audiencia Nacional in favor of our Spanish subsidiary. As a result, in the second quarter we recorded a reduction in income tax expense of $58.3 ($.27 per share), including interest and penalties, and a reduction in unrecognized tax benefits. This reduction in income tax expense had a 19.8% and 8.9% impact on our effective tax rate for the three and six months ended 31 March 2012, respectively.

 

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18. SUPPLEMENTAL INFORMATION

Debt Issuance

On 3 November 2011, we issued a $400.0 senior fixed-rate 3.0% note that matures 3 November 2021.

Share Repurchase Program

On 15 September 2011, the Board of Directors authorized the repurchase of up to $1,000 of our outstanding common stock. We repurchase shares pursuant to Rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934, as amended, through repurchase agreements established with several brokers. During the first six months of fiscal year 2012, we repurchased .6 million of our outstanding shares at a cost of $53.1. At 31 March 2012, $946.9 in share repurchase authorization remains.

 

19. BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION

Our segments are organized based on differences in product and/or type of customer. We have four business segments consisting of Merchant Gases, Tonnage Gases, Electronics and Performance Materials, and Equipment and Energy.

Business Segment Information

 

       Three Months Ended
31 March
   Six Months Ended
31 March
        2012    2011    2012    2011

Sales to External Customers

                     

Merchant Gases

       $ 883.6        $ 914.4        $ 1,771.3        $ 1,803.0  

Tonnage Gases

         783.5          799.2          1,593.3          1,565.2  

Electronics and Performance Materials

         567.0          575.9          1,102.2          1,101.9  

Equipment and Energy

         110.2          113.5          199.0          225.4  

Segment and Consolidated Totals

       $ 2,344.3        $ 2,403.0        $ 4,665.8        $ 4,695.5  

Operating Income

                     

Merchant Gases

       $ 152.5        $ 165.1        $ 318.8        $ 341.4  

Tonnage Gases

         125.4          120.9          236.8          236.5  

Electronics and Performance Materials

         85.5          91.6          163.6          160.6  

Equipment and Energy

         9.8          22.5          17.1          42.7  

Segment Total

       $ 373.2        $ 400.1        $ 736.3        $ 781.2  

Cost reduction plan

         (86.8 )        —            (86.8 )        —    

Net loss on Airgas transaction

         —            (5.0 )        —            (48.5 )

Other (A)

         1.5          (1.3 )        (7.8 )        (7.7 )

Consolidated Total

       $ 287.9        $ 393.8        $ 641.7        $ 725.0  

 

(A)

Includes stranded costs resulting from discontinued operations.

 

       31 March      30 September
        2012      2011

Identifiable Assets (B)

             

Merchant Gases

       $ 4,759.3              $ 4,579.6  

Tonnage Gases

         4,793.4            4,464.3  

Electronics and Performance Materials

         2,634.9            2,488.9  

Equipment and Energy

         288.4            335.6  

Segment total

       $ 12,476.0              $ 11,868.4  

Other

         836.0            878.6  

Discontinued operations

         592.3            532.1  

Consolidated Total

       $ 13,904.3              $ 13,279.1  

 

(B)

Identifiable assets are equal to total assets less investment in net assets of and advances to equity affiliates.

 

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Geographic Information

 

       Three Months Ended
31 March
     Six Months Ended
31 March
        2012      2011      2012      2011

Sales to External Customers

                           

North America

       $ 1,117.6          $ 1,194.1          $ 2,215.8          $ 2,320.0  

Europe

         626.8            645.3            1,230.0            1,277.6  

Asia

         547.4            498.3            1,120.7            979.7  

Latin America/Other

         52.5            65.3            99.3            118.2  

Consolidated Total

       $ 2,344.3          $ 2,403.0          $ 4,665.8          $ 4,695.5  

Geographic information is based on country of origin. The Europe region operates principally in Belgium, France, Germany, the Netherlands, Poland, the U.K. and Spain. The Asia region operates principally in China, Korea, and Taiwan.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Millions of dollars, except for share data)

The disclosures in this quarterly report are complementary to those made in our 2011 Form 10-K. An analysis of results for the second quarter and first six months of 2012 is provided in the Management’s Discussion and Analysis to follow.

All comparisons in the discussion are to the corresponding prior year unless otherwise stated. All amounts presented are in accordance with U.S. generally accepted accounting principles (GAAP), except as noted.

Captions such as income from continuing operations attributable to Air Products, net income attributable to Air Products, and diluted earnings per share attributable to Air Products are simply referred to as “income from continuing operations,” “net income,” and “diluted earnings per share” throughout this Management’s Discussion and Analysis, unless otherwise stated.

The discussion of second quarter and year to date results that follows includes comparisons to non-GAAP financial measures. These non-GAAP measures exclude the cost reduction plan charge, the Spanish tax settlement, and the Spanish tax ruling in 2012. For 2011, the non-GAAP measures exclude the net loss on Airgas transaction. The presentation of non-GAAP measures is intended to enhance the usefulness of financial information by providing measures that our management uses internally to evaluate our baseline performance on a comparable basis. The reconciliation of reported GAAP results to non-GAAP measures is presented on pages 37-38.

SECOND QUARTER 2012 VS. SECOND QUARTER 2011

SECOND QUARTER 2012 IN SUMMARY

 

   

Sales of $2,344.3 decreased 2%, or $58.7. Underlying sales increased 2%, primarily due to higher volumes in Tonnage Gases and higher pricing in our Merchant Gases segment. Lower natural gas prices resulted in lower energy and raw material contractual cost pass-through to customers, reducing sales by 3%.

 

   

Operating income of $287.9 decreased 27%, or $105.9, and operating margin of 12.3% decreased 410 basis points (bp). On a non-GAAP basis, operating income decreased 6%, or $24.1, and operating margin decreased 60 bp, primarily from lower volumes in our Merchant Gases segment and an unfavorable volume mix in our Equipment business.

 

   

Income from continuing operations of $279.0 decreased 2%, or $6.7, and diluted earnings per share from continuing operations of $1.30 decreased 1%, or $.01. On a non-GAAP basis, income from continuing operations decreased 3%, or $8.8, and diluted earnings per share from continuing operations decreased 2%, or $.02. A summary table of changes in diluted earnings per share is presented below.

 

   

We purchased .6 million of our outstanding shares at a cost of $53.1 under the $1,000 share repurchase program announced in the fourth quarter of 2011. At 31 March 2012, $946.9 in share repurchase authorization remains.

 

   

We increased our quarterly dividend from $.58 to $.64 per share. This represents the 30th consecutive year that we have increased our dividend payment.

 

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Table of Contents

Changes in Diluted Earnings per Share Attributable to Air Products

 

    

Three Months Ended

31 March

  

Increase

(Decrease)

      2012   2011   

Diluted Earnings per Share

             

Net Income

     $ 1.38       $ 1.39        $ (.01 )

Income from Discontinued Operations

       .08         .08          —    

Income from Continuing Operations – GAAP Basis

     $ 1.30       $ 1.31        $ (.01 )

Cost reduction plan

       .28         —            .28  

Q2 Spanish tax ruling

       (.27 )       —            (.27 )

Net loss on Airgas transaction

       —           .02          (.02 )

Income from Continuing Operations – Non-GAAP Basis

     $ 1.31       $ 1.33        $ (.02 )

Operating Income (after-tax)

             

Underlying business

             

Volume

              $ (.09 )

Price/raw materials

                .02  

Costs

                            (.01 )

Operating Income

                (.08 )

Other (after-tax)

             

Income tax rate

                .02  

Average shares outstanding

                .02  

Equity affiliates’ income

                .01  

Other

                            .01  

Other

                            .06  

Total Change in Diluted Earnings per Share from Continuing Operations – Non-GAAP Basis

                          $ (.02 )

RESULTS OF OPERATIONS

Discussion of Consolidated Results

 

       Three Months Ended
31 March
        
        2012   2011   $ Change    Change

Sales

       $ 2,344.3       $ 2,403.0       $ (58.7 )        (2)%   

Operating income – GAAP Basis

         287.9         393.8         (105.9 )        (27)%   

Operating income – Non-GAAP Basis

         374.7         398.8         (24.1 )        (6)%   

Operating margin – GAAP Basis

         12.3 %       16.4 %       —            (410bp)   

Operating margin – Non-GAAP Basis

         16.0 %       16.6 %       —            (60bp)   

Equity affiliates’ income

         35.5         31.7         3.8          12%   

 

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Table of Contents

Sales

 

        % Change from
Prior Year

Underlying business

      

Volume

         1 %

Price

         1 %

Currency

         (1 )%

Energy and raw material cost pass-through

         (3 )%

Total Consolidated Change

         (2 )%

Underlying sales increased 2% with both volumes and pricing up 1%. Volume increases in Tonnage Gases were partially offset by lower volumes in our Merchant Gases and Electronics businesses. The increase in pricing was driven by our Merchant Gases segment. Lower natural gas prices resulted in lower energy and raw material contractual cost pass-through to customers, reducing sales by 3%. Currency unfavorably impacted sales by 1%.

Operating Income

Operating income of $287.9 decreased 27%, or $105.9. On a non-GAAP basis, operating income of $374.7 decreased 6%, or $24.1. Underlying business decreased by $24, primarily due to an unfavorable volume mix of $23 and higher costs of $4, partially offset by higher recovery of raw material costs in pricing of $3. On a GAAP basis, current year operating income includes a charge of $86.8 for the cost reduction plan and prior year operating income includes a $5.0 net loss related to the Airgas transaction.

Equity Affiliates’ Income

Income from equity affiliates of $35.5 increased $3.8, primarily due to higher pricing and volumes, partially offset by unfavorable currency.

Selling and Administrative Expense (S&A)

S&A expense of $237.3 decreased $4.7, primarily due to lower incentive compensation costs, partially offset by inflation. S&A, as a percent of sales, was 10.1% in both 2012 and 2011.

Research and Development (R&D)

R&D expense of $29.8 increased $1.9. R&D, as a percent of sales, increased from 1.2% to 1.3%.

Net loss on Airgas Transaction

In the second quarter of 2011, $5.0 ($4.4 after-tax, or $.02 per share) in net loss was recognized related to the Airgas transaction. Refer to Note 6, Airgas Transaction, to the consolidated financial statements for additional details.

Cost Reduction Plan

During the second quarter ended 31 March 2012, we initiated a cost reduction plan. The results from continuing operations include a charge of $86.8 ($60.6 after-tax, or $.28 per share) for this plan. This charge represents the ongoing actions we are taking to improve our cost structure, particularly in Europe. It includes removing the stranded costs resulting from our decision to exit the Homecare business, the reorganization of the Merchant business, and the actions we are taking to right-size our European business cost structure in light of the challenging economic outlook.

This charge includes $80.8 for severance and other costs associated with the elimination of approximately 600 positions from our workforce. The remainder of the charge, $6.0, is related to the write-down of certain assets. For additional information regarding these assets, see Note 10, Fair Value Measurements, to the consolidated financial statements. The planned actions are expected to be completed within the next twelve months. The charge for the cost reduction plan is excluded from segment operating profit. The charge relates to the businesses at the segment level as follows: $77.3 in Merchant Gases, $3.8 in Tonnage Gases, and $5.7 in Electronics and Performance Materials.

In the fourth quarter of 2012, we expect that these severance actions, together with other related cost reductions, will generate savings that will offset the $6 of stranded costs generated by the Homecare divestiture. By the end of 2013, we expect the cost reduction plan to provide $60 of annual savings.

 

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Table of Contents

Other Income, Net

Items recorded to other income arise from transactions and events not directly related to our principal income earning activities.

Other income of $13.3 decreased $.6, primarily due to net gains on asset sales in the prior year, partially offset by favorable foreign exchange in the current year. Otherwise, no individual items were significant in comparison to the prior year.

Interest Expense

 

       Three Months
Ended 31 March
        2012      2011

Interest incurred

       $ 36.8          $ 35.2  

Less: capitalized interest

         7.4            5.8  

Interest expense

       $ 29.4          $ 29.4  

Interest incurred increased $1.6. The increase was driven primarily by a higher average debt balance, partially offset by a lower average interest rate on the debt portfolio. The change in capitalized interest is driven by an increase in project spending which qualified for capitalization.

Effective Tax Rate

The effective tax rate equals the income tax provision divided by income from continuing operations before taxes. On a GAAP basis, the effective tax rate was 3.0% and 26.1% in the second quarter of 2012 and 2011, respectively. The current quarter effective tax rate includes reductions in income tax expense of $58.3 related to the second quarter Spanish tax ruling and $26.2 related to the cost reduction plan. Refer to Note 17, Income Taxes, and Note 4, Cost Reduction Plan, to the consolidated financial statements for details on these transactions. On a non-GAAP basis, the effective tax rate was 24.5% and 25.9% in the second quarter of 2012 and 2011, respectively. The decrease in the effective tax rate was primarily due to the geographic mix and amount of taxable income.

Discontinued Operations

In January 2012, the Board of Directors authorized the sale of our Homecare business, which had previously been reported as part of the Merchant Gases operating segment.

On 8 January 2012, we reached agreements for The Linde Group to purchase our Homecare business in Belgium, Germany, France, Portugal, and Spain. This business represents approximately 80% of our total Homecare business revenues. We expect to sell the remaining portion of Homecare, which is primarily in the United Kingdom, within the next year.

The transaction with Linde received regulatory approval on 18 April 2012 and is expected to close on 30 April 2012. Total sale proceeds of €590 million (approximately $785) will be received in cash at closing. We anticipate an after-tax gain in the range of €105-€130 million (approximately $140-$170) on the sale of this business in the third quarter of fiscal year 2012.

The Homecare business is being accounted for as discontinued operations. The results of operations and cash flows of this business have been removed from the results of continuing operations for all periods presented. Refer to Note 3, Discontinued Operations, to the consolidated financial statements for further details.

Net Income

Net income was $296.0 compared to $304.3 and diluted earnings per share was $1.38 compared to $1.39. On a non-GAAP basis, net income was $298.3 compared to $308.7 and diluted earnings per share was $1.39 compared to $1.41. A summary table of changes in earnings per share is presented on page 26.

 

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Table of Contents

Segment Analysis

Merchant Gases

 

       Three Months
Ended 31 March
        
        2012   2011   $ Change    Change

Sales

       $ 883.6       $ 914.4       $ (30.8 )        (3)%   

Operating income

         152.5         165.1         (12.6 )        (8)%   

Operating margin

         17.3 %       18.1 %       —            (80bp )

Equity affiliates’ income

         31.2         29.1         2.1          7%   

Merchant Gases Sales

 

        % Change from
Prior Year

Underlying business

      

Volume

         (3 )%

Price

         2 %

Currency

         (2 )%

Total Merchant Gases Sales Change

         (3 )%

Underlying sales decreased 1% as the impact of lower volumes of 3% was partially offset by higher pricing of 2%. Currency unfavorably impacted sales 2%.

In the U.S./Canada, sales were flat, with price up 2% and volumes down 2%. Pricing increased due to improvement across most product lines as we took actions to recover higher costs. Volumes declined due to weakness in medical, electronics, and liquid hydrogen demand. In Europe, sales decreased 5%, with an unfavorable currency impact of 4% and volumes down 2%, partially offset by higher price of 1%. Volumes were down primarily due to weaker end market demand. Pricing was higher in both liquid/bulk and packaged gases. In Asia, sales increased 1%, with increased pricing of 1% and a favorable currency impact of 1%, partially offset by lower volumes of 1%.

Merchant Gases Operating Income and Margin

Operating income was lower primarily due to lower volumes of $16 and an unfavorable currency impact of $2, partially offset by higher recovery of raw material costs in pricing of $7. The decrease in volumes was across most businesses. Operating margin decreased 80 bp from prior year, primarily due to lower volumes.

Merchant Gases Equity Affiliates’ Income

Merchant Gases equity affiliates’ income increased primarily as a result of improved performance in our Mexican equity affiliate.

 

Tonnage Gases
       Three Months
Ended 31 March
        
        2012   2011   $ Change    Change

Sales

       $ 783.5       $ 799.2       $ (15.7 )        (2)%   

Operating income

         125.4         120.9         4.5          4%   

Operating margin

         16.0 %       15.1 %       —            90bp  

 

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Table of Contents

Tonnage Gases Sales

 

        % Change from
Prior Year

Underlying business

      

Volume

         7 %

Energy and raw material cost pass-through

         (8 )%

Currency

         (1 )%

Total Tonnage Gases Sales Change

         (2 )%

Sales decreased 2%, or $15.7. Volumes increased 7% from existing customer loadings and new projects. Lower energy and raw material contractual cost pass-through to customers decreased sales by 8% and currency unfavorably impacted sales by 1%.

Tonnage Gases Operating Income and Margin

Operating income was higher by 4% due to higher volumes of $8, partially offset by higher operating costs of $3 and an unfavorable currency impact of $1. Operating margin increased 90 bp from prior year, primarily due to lower energy and raw material contractual pass-through.

Electronics and Performance Materials

 

       Three Months
Ended 31 March
        
        2012   2011   $ Change    Change

Sales

       $ 567.0       $ 575.9       $ (8.9 )        (2 )%

Operating income

         85.5         91.6         (6.1 )        (7 )%

Operating margin

         15.1 %       15.9 %                (80bp )

Electronics and Performance Materials Sales

 

        % Change from
Prior Year

Underlying business

    

Volume

     (2)%

Price

     —  %

Currency

     —  %

Total Electronics and Performance Materials Sales Change

     (2)%

Sales decreased due to lower volumes and business mix of 2%, primarily driven by weaker electronics demand. Electronics sales decreased 4%, reflecting lower end market demand. Performance Materials sales increased 2%, due to higher volumes and price.

Electronics and Performance Materials Operating Income and Margin

Operating income decreased due to lower recovery of raw material costs in pricing of $4, lower volumes of $3, and unfavorable currency of $1, partially offset by lower operating costs of $2. Operating margin decreased 80 bp primarily due to lower volumes and higher raw material costs in Electronics.

Equipment and Energy

 

       Three Months
Ended 31 March
           
        2012      2011      $ Change    Change

Sales

       $ 110.2          $ 113.5          $ (3.3 )        (3 )%

Operating income

         9.8            22.5            (12.7 )        (56 )%

 

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Table of Contents

Equipment and Energy Sales and Operating Income

Sales of $110.2 and operating income of $9.8 decreased due to lower LNG heat exchanger activity.

The sales backlog for the Equipment business at 31 March 2012 was $312, compared to $334 at 30 September 2011.

Other

Other operating income (loss) primarily includes other expense and income that cannot be directly associated with the business segments, including foreign exchange gains and losses. Also included are LIFO inventory adjustments, as the business segments use FIFO and the LIFO pool adjustments are not allocated to the business segments. Corporate general and administrative costs and research and development costs are fully allocated to the business segments. Other also included stranded costs resulting from discontinued operations, as these costs were not reallocated to the businesses.

Other operating income was $1.5 versus a loss of $1.3 in the prior year. The increase was due to favorable foreign exchange partially offset by gains on asset sales in the prior year. Otherwise, no individual items were significant in comparison to the prior year.

FIRST SIX MONTHS 2012 VS. FIRST SIX MONTHS 2011

FIRST SIX MONTHS 2012 IN SUMMARY

 

   

Sales of $4,665.8 decreased 1%, or $29.7. Underlying sales increased 1%, primarily due to higher pricing in the Merchant Gases and Electronics and Performance Materials segments. Overall volumes were flat as higher volumes from new plants in Tonnage Gases were offset by lower volumes in our Merchant Gases, Electronics and Performance Materials, and Equipment and Energy segments.

 

   

Operating income of $641.7 decreased 11%, or $83.3, and operating margin of 13.8% decreased 160 bp. On a non-GAAP basis, operating income decreased 6%, or $45.0 and operating margin decreased 90 bp, primarily from lower Merchant Gases and Equipment volumes and unfavorable mix due to lower LNG plant sales.

 

   

Income from continuing operations of $504.9 decreased 5%, or $28.2, and diluted earnings per share from continuing operations of $2.36 decreased 3%, or $.08. On a non-GAAP basis, income from continuing operations decreased 2%, or $13.7, and diluted earnings per share from continuing operations decreased $.01. A summary table of changes in diluted earnings per share is presented below.

 

   

We purchased .6 million of our outstanding shares at a cost of $53.1 under the $1,000 share repurchase program announced in the fourth quarter of 2011. At 31 March 2012, $946.9 in share repurchase authorization remains.

 

   

We increased our quarterly dividend from $.58 to $.64 per share. This represents the 30th consecutive year that we have increased our dividend payment.

 

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Table of Contents

Changes in Diluted Earnings per Share Attributable to Air Products

 

       Six Months
Ended 31 March
    

Increase

(Decrease)

        2012    2011     

Diluted Earnings per Share

                  

Net Income

       $ 2.54        $ 2.62          $ (.08 )

Income from Discontinued Operations

         .18          .18            —    

Income from Continuing Operations – GAAP Basis

       $ 2.36        $ 2.44          $ (.08 )

Cost reduction plan

         .28          —              .28  

Q1 Spanish tax settlement

         .20          —              .20  

Q2 Spanish tax ruling

         (.27 )        —              (.27 )

Net loss on Airgas transaction

         —      &n