TWST: We would like to begin with a brief historical sketch of the company and a picture of the things you are doing at the present time.
Mr. McCausland: Let me start up by saying, we are doing what we've been doing for about 26 years, acquiring and running a very good industrial, medical, and specialty packaged gas business, which also sells related hardgoods items like welding and safety equipment. So I think it's fair to say that we've had a consistent strategy from the very beginning that's included both growth in same-store sales through product line extensions, growth in our core business, adjacency acquisitions, cross-selling, and things of that nature, and also a consistent strategy that included acquisitions from the very beginning, with more than 400 acquisitions in our history now. We are still operating in that fragmented industry with a lot more momentum than we've ever had before. In terms of having made the transition from a roll-up or a collection of acquisitions to a very strong operating company which has a strong operating culture, we have in place many efficiency programs that we are benefiting from and we have tremendous sales momentum in many of our products, including our core business and also with our national accounts business, which we call strategic accounts, which is a real benefit to customers with multiple locations. We've just finished several record years of acquisitions and we've acquired about a $150 million in sales so far this year and we have a few more in the pipeline, and we expect to continue acquiring companies. We think that if we do get a downturn in the industrial economy here, it might be a good opportunity to pick up some acquisitions at reasonable prices.
TWST: You said that the economic downturn has given you an opportunity for attractive acquisition and good prices. Would you tell us about your relation to the general economy?
Mr. McCausland: First of all let me clarify, I said the economic downturn has potential opportunities. I'm not sure what opportunities will emerge, and our industry actually is doing pretty well right now. So with the caveat that we are a daily sales company and don't have the greatest visibility into our future sales, we are doing very well right now and we are getting ready for something worse, but right now we are enjoying the fact that we are a company that's doing fairly well in a difficult environment.
In past downturns, we have been able to acquire significant businesses right in our core through acquisition as a result of the downturn. I don't know if it will happen again next time. If the downturn does hit our business, there is a reasonable chance that will happen. Now, in terms of what the downturn means to us, I would say that, first you have to remember our worst year ever in same-store sales was down only 1.9% and we've never had a down year in our gas and rent sales. Gas and rent generate most of the profits of our business.
Let me start by putting everything in perspective. That downturn, where we did have the slight decline in sales, we basically had flat EBITDA during that period — that was 1998 through 2002 — and it was a prolonged industrial downturn, you'll recall. But we've got many levers to pull when business turns down. We have highly leveraged compensation systems that automatically turn down because bonuses, gainsharing and commissions and things like that retract, and we manage our overtime, temporary help, and travel and entertainment aggressively during a downturn. Our working capital and our cap ex also pull back. So we actually have nice increases in free cash flow during a downturn, which gives us plenty of firepower to make acquisitions opportunistically when they present themselves. So we feel like the way we are structured and the nature of our business is such that we are ready for anything.
In terms of what will happen this time, we are pretty optimistic. I'll compare it to the last downturn, the — 1998-2002 — and I'll point out a couple of differences here. First of all, pricing is better going into this downturn and the simple reason is because capacity utilization in the industrial gas business is very high. It's up in the high 80%. It was in the low 70% range going into the last downturn. Pricing was very weak because the industry had over built and it took years to work out of that over building. We dealt with it nicely and kept our EBITDA flat, but other companies in our industry had severe declines in EBITDA.
The second big difference, I think, between this one and the last one was the high dollar. We had a very high dollar and a lot of manufacturing moved offshore right through that period. It seemed like every one of our regions would report closures of significant top 50 customers every single month.
The third reason is that our customer base has always been diversified, but it's even more recession resistant than ever because of our strategic products program. Our strategic products include five categories: bulk gas, medical gas, specialty gas, CO2 and dry ice, and safety products. About 10 years ago, we identified these products as being strategic, and decided that we would hire specialists in every one of these products in every one of our regions and then we would push these products because they had the potential to grow much faster than our core business for a number of different reasons. First of all, they grow faster than the economy for various reasons like bulk gases on the strength of applications, specialty gas on the strength of environmental regulations, and medical gas on the strength of demographics. Another reason that we selected these is because many non-cyclical and counter-cyclical customers use these products. CO2 and dry ice principally to the food industry, medical gases to healthcare, bulk gases, a lot of process gases, but many non-cyclical applications and, of course, medical. Another reason we selected these is because most of them represented very good cross-sell opportunities. We've collected more than 400 companies over the years and the vast majority of them were welding supply companies. They sold welding equipment plus industrial gases that were used mostly in metal fabrication. So bulk gases, medical gases, specialty gases, safety, CO2 and dry ice were basically new products to cross-sell to their existing customer base. Now, these strategic products for us grew 11% in the last quarter. In fact, they've been growing at 11% compounded for over three years in Airgas. So we have that momentum going in. We also have the momentum of a couple of adjacencies like refrigerants and ammonia business, which are in many cases environmentally driven and less economically sensitive.
Finally, going into this downturn, we have a fair amount of infrastructure construction in the energy, power, water, transport business. This country has under-invested in infrastructure for a long time and when this slowdown started almost a year ago, it's had somewhat of an impact on some of the planned projects, but high energy prices and the need for infrastructure are going to keep this driving, these are five- to seven-year trends. So we are optimistic because that's going to cushion some of the downturn. In terms of what we are actually seeing right now, we've seen a slowness in general industrial for almost a year offset by strong sales of strategic products and strong sales to infrastructure construction. In strategic products, those sales are being driven by things like health care and environmental regulation and life sciences and other kinds of research. So, as of yesterday, the kind of slowness in the industrial thing is creeping along and our sales look okay. We haven't seen any deterioration in our DSO and we are prepared for the worst and hoping for the best.
TWST: What are the main items on your strategic agenda as you look out over the next two to three years?
Mr. McCausland: If I had to categorize it broadly, I'd say more of the same. We've got many operating goals involving sales and marketing programs. We are really focusing hard on our strategic accounts business because when business turns down, the customers with multiple locations are looking for ways to reduce costs and vendor consolidation and supply chain management by Airgas at multiple facilities for customers is one way to do that. We continue the strategy of getting operating efficiencies from our platform and extending our platform with products and services by acquisitions in our core business and in the product line areas. So it's getting better in what we do and it's continuing the acquisition program and you are not going to see anything radical from us because we have further opportunity in our sweet spot. I would say that the one difference is, we recently launched something called a core Strategy-II program and it's a program that looks at every single way in which we touch our customers. The goal of that program is outstanding customer service and it is a very extensive program. It involves everybody in our organization. I think we've already done a lot of things in this industry to set us apart from the competition and I think this is going to put even greater distance between us.
TWST: What are the possible challenges or problems? What might you worry about?
Mr. McCausland: I view myself as a CEO and I say CEO stands for Chief Environmental Officer, so I think protecting the Airgas environment or culture is a primary concern to me. As we get to be a bigger and bigger company, we need to focus on keeping our organization flat so that we can be very responsive to customers at the local level because that's where you win. We have lots of products and services and we have the best national accounts offering in the business that adds the most value and we have engineering solutions that we can bring to bear for customers. We have all those things, but unless we maintain our culture so that they can be delivered to the customer in an efficient and a helpful way for our customers, then we lose everything. So I focus a lot of my time on preserving our culture and one aspect of our culture is that we need the best people in the industry in Airgas, the best people we can find and then we need the right people on the right seats on the bus. So I am constantly preaching that we need to upgrade our people through better recruiting, better training and better development programs. Our industry is not a big cyclical industry. We are not as sexy as some, we don't make 40% EBITDA, and we are not flat screen TVs and things that have astronomical sales numbers in any given year, but we don't turn down as much either. So it creates a nice environment where you can grow your business in a steady and secure way and you can develop your people and so I'm not too worried about what's going to happen with the economy because I know it's just going to make us better and it's going to cause us to reinforce our values and our culture, which means we are going to come out on the other side stronger.