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Airgas (NYSE:ARG)

Q2 2014 Earnings Call

October 23, 2013 10:00 am ET

Executives

J. Barrett Strzelec - Director of Investor Relations and Corporate Communications

Peter McCausland - Executive Chairman, Founder, Chairman of Management Committee and Member of Executive Committee

Michael L. Molinini - Chief Executive Officer, President, Director, Member of Executive Committee and Member of Management Committee

Robert M. McLaughlin - Chief Financial Officer and Senior Vice President

Analysts

Robert A. Koort - Goldman Sachs Group Inc., Research Division

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Ryan Merkel - William Blair & Company L.L.C., Research Division

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Laurence Alexander - Jefferies LLC, Research Division

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Vincent Andrews - Morgan Stanley, Research Division

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

Thomas L. Hayes - Thompson Research Group, LLC

Walter S. Liptak - Global Hunter Securities, LLC, Research Division

Edward H. Yang - Oppenheimer & Co. Inc., Research Division

Holden Lewis - BB&T Capital Markets, Research Division

Mark R. Gulley - BGC Partners, Inc., Research Division

Operator

Good morning, and welcome to the Airgas Second Quarter 2014 Earnings Conference Call. Today's call is being recorded at the request of Airgas. [Operator Instructions] For opening remarks and introductions, I would now like to turn the call over to the Director of Investor Relations and Corporate Communications, Barry Strzelec. Please go ahead, sir.

J. Barrett Strzelec

Thanks, Jennifer. Good morning, and thank you for attending our second quarter earnings teleconference. Joining me today are Executive Chairman, Peter McCausland; President and CEO, Mike Molinini; and Senior Vice President and CFO, Bob McLaughlin.

Our earnings release was made public this morning and is available on our website, as are the teleconference slides. To follow along, please go to airgas.com, click on the Investor Relations shortcut at the bottom of the screen and go to the Earnings Calls and Events page.

During the course of our presentation, we will make reference to certain non-GAAP financial measures, and unless otherwise noted, metrics referred to in today's discussion will be adjusted for the unusual items identified in our earnings materials. Reconciliations to the most comparable GAAP measures can be found in our earnings release and in the slide presentation.

This teleconference will also contain forward-looking statements based on current expectations regarding important risk factors, which are identified in the earnings release and in our slide presentation. Actual results may differ materially from these statements, so we ask that you please note our Safe Harbor language.

We'll take questions after concluding our prepared remarks as time permits. We plan to end the teleconference by 11:00 a.m. Eastern Time. Now if you can please turn to Slide 2, I'll turn the call over to Peter to begin our review.

Peter McCausland

Thanks, Barry. Good morning, and thanks to everyone for joining us. I'm pleased with our performance this quarter in what continues to be a challenging environment. Our adjusted earnings per share for the quarter were up 19% year-over-year to $1.25, which is at the midpoint of our guidance range. We delivered on our SAP-related benefits for the quarter, managed expenses well and posted strong operating margin expansion. Cash flow continues to be strong, with year-to-date free cash flow up 96% to $238 million and adjusted cash flow from operations up 43% to $397 million.

Sales volumes were challenged to a greater degree than we expected, particularly as customer activity levels softened during the back half of September, which is normally a time when activity picks up meaningfully. And that softness has continued into October. We have more than 1 million customers, many of which are small businesses. The degree to which the federal government shutdown may have affected our customers is difficult to gauge, but it can only have had a negative impact on business confidence and spending, particularly for our smaller customers. Growth is hard to come by in this economy. There's a lack of confidence, which is having a negative impact on business spending and on hiring.

With that in mind, and as near-term uncertainty persists, we are taking a more cautious view of the remainder of the fiscal year. Accordingly, we've revised our fiscal 2014 guidance, primarily due to lower organic sales growth assumptions, to a range of $4.85 to $5, which represents 11% to 15% growth during a tough economic period.

Our new guidance assumes volumes will follow a normal seasonal pattern during the back half of the year relative to current levels, with softness around the holidays and strengthening in February and March. Though we're not seeing broad-based economic improvement yet, we are starting to see encouraging signs for growth in nonresidential construction next year, as order flow has begun for a couple of large projects and a number of rumored large projects have moved into the permitting phase.

We also continue to be optimistic about the long-term prospects for U.S. manufacturing and energy industries, as structural drivers like the abundant supply of low-cost energy, increasing shipping cost from overseas and the protection of intellectual property, should favor the U.S. economy for years to come.

The acquisition pipeline is improving. Since the beginning of our fiscal year, we've acquired 5 businesses with aggregate annual sales of approximately $12 million. Earlier this month, we announced a definitive agreement to acquire the assets and operations of The Encompass Gas Group, headquartered in Rockford, Illinois. This company is outstanding and has been on our top 15 list for years. With 11 locations and more than 130 employees in Illinois, Wisconsin and Iowa, Encompass is one of the largest privately owned suppliers of industrial medical and specialty gases and related hardgoods in the U.S., generating approximately $55 million in annual sales in 2012. The sales mix is heavily weighted toward gas and rental. We expect this acquisition to close on November 1, and we're excited about the prospect of Encompass' loyal associates and customers joining the Airgas family.

Please don't think that our outlook, our cautious outlook, dims my excitement about the future. Airgas has never been better positioned to leverage our unique value proposition and unrivaled platform as a leader in our industry to capitalize on the opportunities that lie ahead of us. Some economic indicators, particularly the ISM, suggest that the economy is picking up since this summer. Historically, we've lagged any sustained improvement in the ISM by a couple of quarters. So if history is a good guideline, we're hopeful it's just another sign that our optimism about our future is well founded. In the meantime, we need to be cautious, and I think we are doing a very nice job executing on the things within our control, and I'm looking forward to the day when the economy is supportive of volume growth, because I think Airgas is really going to shine.

Now I'll hand it over to Mike to discuss the business in greater detail.

Michael L. Molinini

Thank you, Peter. Please turn to Slide 3. Our sales and marketing strategy, which is focused on tailoring our value proposition to the unique needs of each customer segment, continues to gain momentum and is a driving force behind the Airgas organic growth story going forward. Our Strategic Accounts program, which leverages this segment-driven approach, presents us with tremendous cross-sell opportunities in terms of product, product line services and location and represents 25% of sales.

In the second quarter, our Strategic Accounts sales were up 5% from the prior year, with new account signings, expansion of locations served and product lines sold to existing accounts and positive pricing driving much of the improvement. Strategic Products continued to be an important part of our value proposition to customers, and from a product standpoint, have strong growth profiles due to their use in favorable customer segments, application development, increasing environmental regulation, strong cross-sell opportunities or a combination of these factors. In the second quarter, sales of Strategic Products increased 5% over the prior year, with the specialty gas category showing the most improvement on increased prices and volumes.

Sequentially, CO2 and dry ice sales increased 9% on normal seasonality of the business. Our Radnor private label hardgoods sales were up 4% year-over-year, reflecting outperformance relative to total hardgoods organic sales.

Before I move to SAP, I'll provide you with a brief update on refrigerants. As you know by now, the EPA's unexpected ruling in late March to allow for an increase in the production of refrigerant 22 this year has caused some real challenges for us this year. Refrigerant 22 prices continue to be pressured despite some stabilization in volumes. Our previous expectation was that the year-over-year headwind related to this issue would be in the $0.12 to $0.15 range. Our current forecasts indicate that year-over-year headwind is likely closer to the full $0.15, which is what we have incorporated into the revised fiscal 2014 guidance that Bob will review shortly. But we've said all along that this is a challenging environment and an unpredictable situation, and I expect it will continue to be challenging and unpredictable for the next few quarters, and we'll continue to keep you informed as it develops.

Moving on to SAP. As you recall, all of our regional distribution businesses are successfully running on SAP. We remain focused on improving the productivity and proficiency of our branch associates' use of the SAP system, and we continue to see improvement each month resulting from our additional training and process improvement efforts.

The rollout of our expanded telesales channel, Airgas Total Access, is progressing well and in line with our expectations. We now have a full complement of Total Access telesales representatives trained and deployed across all of our distribution regions, calling on customers in the target size and spend range, selling gas, welding and related hardgoods in addition to our traditional telesales offering of safety products.

All of our regions are now leveraging the capabilities of SAP to take a more strategic approach to product pricing and discount management, and efforts in that area continue to bear fruit. We continue to expect to achieve the minimum of $75 million in annual run rate operating income benefits related to the SAP initiative by the end of this calendar year, consistent with our long-standing target. And our revised EPS guidance assumes a contribution from SAP benefits net of expenses of $0.47 in fiscal 2014, consistent with our previous expectations.

Although we are frustrated with the weak economic environment and the uncertainty caused by the lack of government leadership, we will continue to focus on the growth drivers that we can control, and we are ready to capitalize when sustained growth in the industrial economy resumes. The heavy lifting associated with our SAP implementation is behind us, and we have exited the cloud of distraction.

We're focused on gas' growth and fine-tuning our organizational structure. All of our associates are now focused on what they do best, servicing our more than 1 million customers. And overall, I continue to strongly believe we have a good reason to be optimistic about our future.

Thank you, and now Bob will give our financial review of the quarter and walk through our guidance for the remainder of the year.

Robert M. McLaughlin

Thank you, Mike, and good morning, everyone. Please turn to Slide 4 for a review of our consolidated results for the second quarter. Total sales were up 4% year-over-year to $1.28 billion. Organic sales in the quarter were up 2% over the prior year, with gas and rent up 4% and hardgoods down 2%. Both total and organic sales growth in the quarter included approximately 1% from the benefit of an additional selling day compared to the prior year. Acquisitions contributed sales growth of 2% in the quarter.

In aggregate, volumes were down 1% and pricing was up 3% year-over-year. Gas and rent represented approximately 64% of our sales mix in the quarter, up 100 basis points over the prior year and 90 basis points over the first quarter.

Gross margins in the quarter were 56.1%, an increase of 140 basis points from the prior year, reflecting the sales mix shift towards gas and rent, as well as margin expansion on price increases, partially offset by supplier price and internal production cost increases and significant margin pressure in our refrigerants business.

Selling, distribution and administrative expenses increased by about 4% over the prior year, with operating cost associated with acquired business and rising health care cost together representing more than 2% of that increase.

The favorable impact from the reduction in SAP implementation cost compared to the prior year was substantially offset by expenses associated with the expansion of our telesales business through Airgas Total Access, our strategic pricing initiative and other strategic growth initiatives.

Operating income for the quarter was $169 million, up 14% over last year's adjusted operating income, which excluded restructuring and other special charges. Operating margin was 13.2%, up 120 basis points over the prior year's adjusted operating margin of 12%. There are a number of factors that contributed to the increase in our operating margin this quarter. The most significant component was the combination of a reduction in SAP implementation cost compared to the prior year and the achievement of SAP-related benefits, as planned, during the quarter.

Also contributing to our margin expansion was the impact of 1 additional selling day compared to the prior year, the sales mix shift towards gas and rent and steps taken to help alleviate the impact of rising costs in the quarter. All of these were partially offset by margin pressure from low organic sales growth and a significant reduction in refrigerant margins this quarter, as R-22 prices continue to be pressured following the EPA's unexpected ruling in late March to allow for an increase in the production of R-22 this year.

Adjusted earnings per diluted share increased 19% to $1.25, which excludes the $0.02 benefit related to a change in state income tax law. We delivered significant SAP benefits consistent with our guidance, and the current quarter included SAP-related benefits net of implementation costs and depreciation expense of $0.11 per diluted share in the current year quarter, compared to $0.09 of expense in the prior year quarter.

There were approximately 74.8 million weighted average diluted shares outstanding for the quarter, down 5% year-over-year, driven by the share repurchase program that was completed in fiscal 2013.

Return on capital, which is a trailing 4-quarter calculation, was 12.4%, down 10 basis points year-over-year and up 30 basis points sequentially from the first quarter. Year-to-date free cash flow was $238 million, up 96% over the prior year, and adjusted cash from operations was $397 million, up 43% over the prior year.

The increase in cash flows was primarily driven by the lowered required investment in working capital in the current quarter compared to the prior year quarter.

Total debt increased by approximately $400 million year-over-year to $2.5 billion at September 30, driven primarily by the fiscal 2013 share repurchase program and acquisitions, partially offset by strong operating cash flow during the past 12 months. Since March, total debt has been reduced by more than $115 million.

Our fixed flow debt ratio at the end of September was approximately 79% fixed and our debt-to-EBITDA ratio was 2.7, within our targeted range of 2 to 3.

Now turning to Slide 5, we'll look at our segment results. SAP implementation costs, which are included in our consolidated adjusted operating results, have not been allocated to our business segments. Distribution sales in the quarter were up 5% versus prior year to $1.1 billion. Organic sales for the distribution segments were up 2%, with pricing up 4% and volume down 2%. Distribution, gas and rent organic sales were up 5%, with pricing up 6% and volume down 1%, with pricing reflecting the impact of the current quarter, as well as the prior year's third quarter pricing actions.

Distribution hardgoods organic sales were down 1%, with pricing up 2% and volumes down 3%. Gas and rent represented 59.8% of distribution sales in the second quarter, up from 58.4% in the prior year and 58.9% in the first quarter. Distribution gross margins were 56.9%, an increase of 150 basis points over the prior year, reflecting the sales mix shift towards gas and rent, margin expansion on price increases, partially offset by supplier price increase and internal production cost.

Operating expenses in the distribution segment increased by about 6.5% over the prior year, with operating costs associated with acquired business -- businesses and rising health cost and expenses and expenses associated with the expansion of our telesales platform, our strategic pricing initiative and other strategic growth initiatives, together accounted for more than half of that increase.

The benefit of lower SAP implementation costs do not flow through the distribution segment, but are reflected in our consolidated results. Operating income in the distribution segment increased 13% year-over-year to $152 million, and operating margin increased 90 basis points to 13.3%. The year-over-year increase in operating margin reflects the achievement of SAP-related benefits, as planned during the quarter, the impact of 1 additional selling day compared to the prior year, the sales mix shift towards gas and rent, steps taken to -- and steps taken to alleviate the impact of rising costs in the quarter and partially offset by margin pressure from low organic sales growth rates.

All Other Operations reflects our CO2, dry ice, refrigerants, ammonia and nitrous oxide business units. Sales for All Other Operations were down 4% from the prior year, as sales increases in our dry ice business was more than offset by a decline in sales in our refrigerants, CO2 and ammonia businesses. Sequentially, sales in All Other Operations segment increased 2%, as the normal seasonality in our CO2, dry ice and ammonia businesses more than offset the decline in refrigerant sales from our first quarter. Gross margin in All Other Operations was 47.3%, an increase of 20 basis points from the prior year, primarily driven by the impact of higher margins in our ammonia business due to lower feedstock cost, offset by continued margin compression in our refrigerants business.

Sequentially, gross margins expanded 90 basis points, primarily due to higher margins in our ammonia business and favorable sales mix shift to higher-margin CO2 and dry ice, partially offset by lower margins in refrigerants.

Operating income for All Other Operations was $19 million, a decrease of $3 million compared to the prior year, and operating margin of 12.6% was down 160 basis points year-over-year, both driven primarily by margin pressure in refrigerants, partially offset by margin improvement in our ammonia business.

Please turn to Slide 6, capital expenditures. Year-to-date, CapEx represented 6.6% of sales, relatively consistent with the prior year. Excluding major projects, CapEx as a percent of sales was approximately 4%.

Now I'd like to discuss our guidance for the remainder of the fiscal year. Slide 7 presents a walk through the primary elements of our third quarter, implied fourth quarter and revised full year guidance. The first column shows a sequential walk for the third quarter using second quarter adjusted EPS of $1.25 as the starting point. SAP benefits, net of cost, are expected to contribute $0.03. The impact of 2 less selling days and the holidays are expected to be a headwind of $0.07 to $0.08. Seasonality in our All Other business units, excluding refrigerants, is expected to be a headwind of $0.05. And the base business is expected to contribute between $0 and $0.04 to EPS, reflecting sequential growth in EPS of between 0% and 3%. In aggregate, we are estimating EPS for our third quarter to be down 4% to 8% on a sequential basis.

The second column on this slide shows the year-over-year walk for the third quarter using fiscal 2013 third quarter adjusted EPS of $1.04 as the starting point. SAP benefits, net of costs, are expected to contribute $0.17, which represents the difference between $0.03 of net expense in the third quarter of fiscal 2013 and an expected $0.14 of benefits, net of costs, in the third quarter of fiscal 2014.

The reduction in share count, net of projected share creep, and related interest cost to fund the 2013 share repurchases is expected to contribute $0.04. Variable compensation reset is expected to be a headwind of $0.03, and refrigerants are expected to reduce EPS by $0.01 in light of the EPA ruling and challenging market conditions. And the base business is expected to decline by $0.06 at the low end to $0.01 on the high end. In aggregate, we're assuming EPS for our third quarter to increase by 11% to 15% year-over-year to a range of $1.15 to $1.20, reflecting organic sales growth in the low single digits and the items noted above.

In the third column -- the third column shows a year-over-year walk for our implied fourth quarter guidance using fiscal 2013 fourth quarter adjusted EPS of $1.14 as the starting point. SAP benefits, net of costs, are expected to contribute $0.12, which represent the difference between $0.04 of benefits net of cost in the fourth quarter of fiscal 2013 and an expected $0.16 of benefits in the fourth quarter of fiscal 2014.

The reduction in share count is expected to contribute $0.03, and previously closed acquisitions are expected to contribute a net $0.02. Variable compensation is expected to be a headwind of $0.01 to $0.02, and refrigerants are expected to reduce EPS by $0.03 in light of the EPA ruling and challenging market conditions. And the base business is expected to improve by $0.04 in the low end and $0.15 at the high end as our year-over-year comps ease significantly in the fourth quarter and we anticipate a normal seasonal uptick, which did not materialize in the prior year.

In aggregate, we are estimating EPS for our fourth quarter to be in the range of $1.31 to $1.41, representing year-over-year growth of 15% to 24% and reflecting organic sales growth in the low to mid single digits and the items noted above.

The right-hand column on this slide shows the year-over-year walk for our revised fiscal 2014 EPS guidance range. We're expecting EPS benefits net of cost to contribute $0.65 to year-over-year earnings growth, which represents the difference between $0.18 of net expense in fiscal 2013 and the expected $0.47 of net benefits in fiscal 2014. The reduction in share count is expected to contribute $0.16. We expect tailwinds of $0.03 from the impact of 1 additional selling day in fiscal 2014 and $0.02 from acquisitions net of divestitures closed to date.

Variable compensation reset is now expected to be a headwind of $0.05 at the low end of our guidance range and $0.07 at the high end. We are currently projecting refrigerants to be a $0.15 headwind year-over-year. And on a year-over-year basis, our base business is expected to decline by $0.16 in the low end and improve by $0.01 on the high end. In aggregate, we now expect EPS for fiscal 2014 to be in a range of $4.85 to $5, which represents year-over-year growth of 11% to 15% and assumes a normal seasonal volume pattern in the back half of the year relative to current levels, with softness around the holidays and strengthening in February and March, organic sales growth in the low single digits, as well as the items noted above.

Our previous fiscal 2014 guidance range for both earnings -- for earnings per diluted share and adjusted earnings per diluted share was $5 to $5.15, an increase of 15% to 18% over the prior year. The guidance revision primarily reflects a reduction in our year-over-year organic sales growth rate assumptions, including volumes roughly 1.5% below our previous assumptions on average for the back half of the year.

And now I'll turn it back to Barry to begin our question-and-answer session.

J. Barrett Strzelec

Thanks, Bob. [Operator Instructions] The operator will now give instructions for asking questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go to Robert Koort of Goldman Sachs.

Robert A. Koort - Goldman Sachs Group Inc., Research Division

I was wondering, you guys mentioned the refrigerants business, and it seems like maybe the helium debacle has been cleared up. Can you talk a little bit about what you anticipate on year-on-year benefits there and what the new legislation means going forward for your helium sales?

Peter McCausland

Well, I'll let Mike talk about the impact and the current supply situation. I'll just comment on the legislation. It's going to rulemaking, so we really don't know what's going to come out of it. We're watching it very closely, and we hope it results in an increased supply of helium for Airgas, because we've been hurt very badly by the helium shortage over the last 18 months. Mike?

Michael L. Molinini

We've had problems for so long on supply of helium, that I'm not sure I can remember when they even started. But we have 2 main suppliers of helium, both -- we've been on allocation for both. One of our largest supplier had anticipated some additional issues in the September, October period. Those have turned out to be not as serious, which would've resulted in further reductions. That has passed and they're back to the levels they were at before. Our other supplier is having great difficulties and continues to be unable to come even close to the allocation levels that they have committed to us. So it's still hand-to-mouth, month-to-month. We're expecting some improvement from one of our suppliers in the next quarter or 2, but we're not sure at all on one of our other suppliers, when they're going to be able to firm up the supply.

Robert A. Koort - Goldman Sachs Group Inc., Research Division

Okay. And Peter, maybe something a little longer term in nature. You mentioned some hopes for some of these projects to start moving forward. Can you help us dimensionalize how big some of those could be? I mean, obviously, there's a long list of giant petrochemical and gas-based plants that are going to be built over the next 5 or 6 years. On the other hand, looking currently in the rearview mirror, there's been a bunch of pipeline and natural gas liquids, the railcars to move some of these condensates from all the shale. And I guess we haven't necessarily seen that translate into a big uplift. So can you talk about how important all this could be for you or maybe look at a prior period of investment spending by some of those customers? I know your business is incredibly diverse, so can this really move the needle appreciably?

Peter McCausland

Well, let me first address what you said about the energy not giving us a boost that one would expect. We have had a boost from the natural gas and oil drilling, fracking and the equipment that's used in that business and also to transport the oil and gas. But we've also had big declines in our business serving the coal industry, too. So there's been an offset. A lot of the energy infrastructure that this country needs is just getting started to be put in place. So we expect benefits there. The wave of petrochemical, utility, chemical investment is in the hundreds of billions of dollars, according to a BofA study that we looked at recently, starting in the back half of '14. We have good relationships with many of the large E&C companies, and all of them tell us that the U.S. is their place to shine over the next 5 years and that we can expect a lot of business. A couple of big projects have already started, Cheniere, the LNG export facility in Houston, in the ship channel, and they're starting to weld, and we've got gas and welding orders, and that's good. The Dow Freeport thing is moving forward. There's a Sasol cracker in Louisiana that's moving forward. And so the gas contracts are being negotiated, and that's what's making these things move forward, and we're very optimistic, not just for the fieldwork, because we supply a lot of gas and welding equipment and safety to the site, and also Red-D-Arc does very well and their principal business is construction. But many of the components that go into these projects, like vaporizers and compressors and boilers and things like that, are fabricated by our met fab customers offsite and then brought to the site during construction. So we're very optimistic. How important is it? Well, we have 2 primary drivers of our business: non-tech industrial production and nonresidential construction. And the latter has been very, very weak, especially in the last 12 months, when what was going on tailed off and there was a big lag in new projects. So I've been saying this for so long, probably people are getting tired of hearing it. But I remember during the 1970s when I got into this industry, when they were building the nuclear plants and the Alaska pipeline business was fantastic. The packaged gas and welding business grew very, very rapidly. Distributors started up overnight and got to be $25 million or $30 million in 2 years. There were shortages of welding wire and welding equipment and argon. And so whether we're going to have that kind of boom or not, but I don't know, I think it's easy -- because it's been delayed so long, it's easy to underestimate the impact of energy independence on the U.S. economy long term. And so we're ready to go. We're waiting.

Operator

We'll go next to Don Carson with Susquehanna Financial.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

A question on your pricing. Bob, you mentioned that your gases and rent in distribution, that pricing was up 6%. So I'm just wondering, I know you had a 6% to 12% price initiative on July 1. Does this speak to the success of that price initiative? And can you talk about how SAP has perhaps been a benefit in getting more uniform price increases?

Robert M. McLaughlin

Yes. So I guess the first point I would emphasize is that 6% included the benefit of the prior year's price increase in October as well. And of course, the pricing doesn't go to all products at one time. And we would characterize it as very successful, particularly in these economic times. And as we've said on many of our calls, the SAP approach -- the SAP system, but more importantly, our approach to pricing, our strategic approach to pricing, has been very different and very beneficial. Mike, you wanted to add?

Michael L. Molinini

Yes. We don't want to underestimate the value of having all of your customers and all of their prices on all of their products in a single database that affords you the opportunity to compare prices among like customers of like sizes for like products in like geographies. And that's really new for us -- to be able to have the ability to study and make decisions regarding pricing in that way. And that's been a significant change and it will be a very material driver going forward.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

And just to follow up, so how much of that price increase came from the July 1 initiative? And what should we expect that initiative to give you in terms of pricing momentum as we go through the balance of the fiscal year?

Michael L. Molinini

Probably half, maybe a little more.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

So you'd expect pricing -- year-over-year gains to fall, as we go forward then? I mean fall from the 6%?

Robert M. McLaughlin

Yes, after we lap the -- yes, the lapping.

Operator

We'll go next to Ryan Merkel with William Blair.

Ryan Merkel - William Blair & Company L.L.C., Research Division

I just want to follow up on that last question. So the guidance for low-single-digit organic growth, is that kind of assuming 1%, 2% price and 1%, 2% volume?

Robert M. McLaughlin

I would say price probably more in the 3% range.

Ryan Merkel - William Blair & Company L.L.C., Research Division

Okay, then, flattish volumes? Or up 1%?

Robert M. McLaughlin

For the low end would be slightly down in volumes and the high end would be up 1.5% to 2% in volumes over the last 6 months, year-over-year.

Ryan Merkel - William Blair & Company L.L.C., Research Division

Okay. And can you just speak to October? Is it tracking at this level currently?

Robert M. McLaughlin

Yes, relative to the third quarter guidance. And it started out weaker, we typically, as we mentioned, September, we usually see a meaningful uptick in September that carries into October. And to date, we haven't seen that historical pattern.

Ryan Merkel - William Blair & Company L.L.C., Research Division

Okay. And then for my follow-up, the slowdown in the second half of September, was that broad-based across all the end markets? Or did certain customers stand out?

Peter McCausland

We've taken a look at it, and it was very broad-based, probably more smaller customers than large overall. But in the large customer segment, there are industries that are -- like mining equipment, that are way, way down. And then there is -- there are other metal fab customers that are way up, like railcars for hauling Bakken crude or things like that. So the industrial customers were kind of all over the place, but I would say that it's more small customers.

Operator

We'll go next to Kevin McCarthy with Bank of America Merrill Lynch.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Peter, it sounds like you started to see some slightly more encouraging signs on nonresidential construction. Do you have enough visibility or confidence yet at this point to think about when your hardgoods business could inflect and turn positive?

Peter McCausland

Well, we've been waiting a long time, as I said. And I'm not going to make any predictions. This business is a good business and it always comes back. And when it comes back, it tends to come back very strong, with hardgoods leading and then gas following. And if this construction boom that your bank has written about really does get the traction that everyone expects, I think it's going to have -- it could be a dramatic impact on our hardgoods business for several years. So it's just -- we're just sitting around waiting for it, like everyone else is right now.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Okay. And then a follow-up, if I may, on SAP. There's a fair amount of discussion on the price. And it looks like realizations are tracking fairly well. Are you experiencing any elasticity effects? In other words, as you integrate all the data into one system and execute on truing up whatever laggards there might have been through strategic pricing efforts, are you retaining the amount of business that you want to retain through that effort?

Peter McCausland

Well, if you raise prices and you're effective and you don't occasionally lose a couple of customers, then you haven't been very effective on your price increase. But we've looked at this a lot of different ways, and these are -- our sales reflect volume declines and big customers and lack of activity in small customers and not loss of business as a result of price. We're very confident about that. And this price increase that we went through in terms of business loss has been -- hasn't been materially different than any other price increase that we've had in prior years. So it's a competitive market out there, but in this environment, with cost increasing, competitors need to raise prices, too. So I would say that the overall pricing environment is pretty good despite the fact that the growth has been flat to very slightly up. So I don't know, Mike, do you want to add something to that?

Michael L. Molinini

Yes. Our strategic pricing initiative is not about run off all the low-price customers. Our strategic pricing initiative is taking a longer-term, intelligent view on how do we get the prices up. So that's one of the reasons that we call it strategic, because it is in the way you do -- it's in the way you manage your pricing. And at this moment, not every customer is where we would hope they're going to be over the next few years. So you can only go as fast as you can go.

Operator

We'll go to Laurence Alexander with Jefferies.

Laurence Alexander - Jefferies LLC, Research Division

Two quick questions. Can you discuss a little bit more the sequential trends that you're seeing outside the railcar and mining markets? Any geographies or niches where you've seen a pickup in demand or a sharp deceleration? And secondly, as you think about the comp reset flow-through, how does that set you up for comparisons in 2000 -- in fiscal 2015?

Peter McCausland

You take the second one.

Robert M. McLaughlin

The question was on how does the variable comp reset set us up for next year?

Laurence Alexander - Jefferies LLC, Research Division

Right. For the year-over-year comparisons. I mean, is it going to -- I mean, are we going to see a similar kind of adjustment next year or how does that work?

Robert M. McLaughlin

I would expect that we would see -- while we always start the year out expecting we're going to meet our goals, and this year does not reflect the full payout, although slightly at a higher level than the prior year, thus the reset, so it'll continue to be a headwind. But I don't have the math done yet, but it'll be a slight headwind, probably similar to what this year's is, maybe a little less.

Peter McCausland

And what was the other question? It was about the customer? Yes. I would say that some of the big metal fab segments have been particularly weak, that they were strong in the last couple of years, mining equipment, Caterpillar, companies like that, that were gangbusters during the commodities boom. And I mean, they're suffering for the same reason that the whole Australian economy is suffering, because of China principally. But other metals, we've had positives in the metal fab segment. One thing I would say is that it seems like the health care or the research -- the universities and startup research companies are getting healthier again and getting funding, which is really good, because since the, 2009, they were really hurting. And although there's pressures on the health care institutions like hospitals, the new system is spawning the startup of a lot of smaller surgery centers and things like that. So health care, it seems to be getting more robust for us as well, and food, too. So I think the noncyclical parts of our business seem to be recovering from the worst recession since the Great Depression, and it's been very slow since 2009, but it's starting to get a little healthier.

Operator

We'll go next to Mike Harrison with First Analysis.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Peter or Mike, was wondering if you could give us a little more detail on what specific steps are being taken to control expenses right now. And is there another shoe to drop potentially if we don't see the hoped-for pickup as we get into February, March?

Michael L. Molinini

Well, most of our focus so far has been on what we would call controllable expenses, which is, overtime, travel, entertainment and temporary labor. And those have all showed significant improvements over the last couple of quarters, since we really started to rein those in. We're limiting new hires, obviously. But beyond that, we have not taken any additional reductions in force actions. And at this point, we are trying to avoid that, if at all possible.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Then I was also hoping that you might be able to comment a little bit on beyond the telesales and some of the other SAP benefits that you were explicit about. Can you maybe talk a little bit more about some of the SAP benefits operationally that you might be seeing?

Michael L. Molinini

The only other SAP benefit that we spoke about publicly has been a headcount reduction related to administrative efficiencies, of consolidating back offices from 12 to 4. And although we expect we're going to get that, we have not gotten that yet, and that's primarily an issue that's related to the productivity and proficiency of our branch, of our SAP users to transact and record transactions accurately. To the extent that we continue to improve -- as we continue to improve that, which means they're making less mistakes that will require fewer people to fix, we expect that we're going to achieve that. But that's going to be the last of the 3. Now beyond that, there's a whole host of other things we're looking at and that we're working on, but we have not commented about them publicly yet.

Operator

We'll go next to Mike Sison with KeyBanc.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

In terms of the base business, demand being sluggish, is there -- I mean, are you seeing any secular changes, maybe in the hardgoods side? Did customers over-order in the last few years and it just might take more time for them to use that equipment? Or are customers using less packaged gases in terms of this slowdown?

Peter McCausland

No. We've just seen a very lumpy economy and an economy where there's not a lot of confidence and there's not a lot of business spending, and our customers, particularly our smaller customers, are very reluctant to hire. And we've never -- we haven't seen any fundamental change in the dynamics of our business. And in terms of secular trends, nonres construction is secular to us because it comes in waves that are very long, and we haven't had that in this country for a long time. So that's been negatively impacting us, as we've mentioned. We actually geared up our construction group and bought a lot of -- and added a lot of capabilities, both equipment and service offerings to our construction sector a couple of years ago, in anticipation of this coming sooner. It looks like it's starting, and we're optimistic about that, but that would be a secular trend that would have a positive impact on our business.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Right, great. And then just a quick one on bulk. It looked like it accelerated nicely in the second quarter versus where it was in terms of growth in the first quarter. Any particular -- is that more pricing, share gains, any sort of color on the improvement there?

Michael L. Molinini

Probably a little bit of both. We've got a good bulk program. And with 1 million customers and we have an ongoing built-in pipeline of customers that either buy bulk from a competitor or are growing into bulk. We've also spent -- are spending more time in the microbulk area, which is the transition area between packaged gases and bulk. And again, it fills out the modes of all the gases. But our plants are still operating. Our ASUs are in the low 80s, so there's no material uptick or decline either way. It's been pretty steady.

Operator

We'll go next to Vincent Andrews with Morgan Stanley.

Vincent Andrews - Morgan Stanley, Research Division

If we just look a little bit on sort of your sequential assumptions from your third quarter to your fourth quarter on the base business, where you're expecting some nice improvement, what do you need to see incrementally to give you comfort with that range for the fourth quarter? Like how much of it is within your control versus how much of it is -- outside of pricing, what needs to happen that hasn't been happening in the last couple of quarters?

Robert M. McLaughlin

Well, we typically have a normal seasonal uptick as we enter into the spring, February and March timeframe. And that's been a fairly consistent pattern over our long history, which we did not have last year. So we are expecting kind of the normal uptick, albeit from lower levels. So we do expect both the year-over-year and a sequential improvement in our fourth quarter.

Michael L. Molinini

And that typically, if you look at what drives that, that typically is related to construction. Construction is the driver that usually pops in early spring for us.

Vincent Andrews - Morgan Stanley, Research Division

And the easy comp last year was somewhat a function of weather, correct? Was there a weather issue last year?

Michael L. Molinini

No. I mean, it was not obvious to us what the driver was. The year before was warm winter and a lot of speculation on that. But last year, the quarter in total was weak.

Peter McCausland

And kind of for us, started to weaken last February, and it's been coming down ever since and sort of bottomed out. We saw a little improvement in the first few months of this quarter that we're now reporting on. And we were optimistic as a result of those 2 months and even in the beginning of September. And then around mid-September, things dropped off precipitously, and it was unusual. But that was what happened.

Vincent Andrews - Morgan Stanley, Research Division

Okay, and then just as a follow-up, Peter, you mentioned the acquisition pipeline was improving, and obviously, you just did a bigger deal that you had your eyes on for a while. Is there anything in particular you think is causing the pipeline to improve here or people's willingness to engage in discussions?

Peter McCausland

Well, demographics are always a factor. Capital gains, tax rates are a factor. Most people think taxes are headed north in the years ahead. I do think that the fact that we've had 5 tough years from 2009 on, the worst recession since the Great Depression, and it's a tough business environment, I think that's causing some people to consider it. I think that the increased regulation and increase in litigation and higher insurance costs are certainly a factor. And I also think that the fact that Airgas and Praxair and the Japanese company Taiyo Nippon Sanso are all interested in buying these companies is bringing some people out of the woodwork, and pricing has moved up on these companies and it's cycled up and down over the years. Fortunately, Airgas has been the only company that's been steady in this business for the last 30 years and has stayed in it, and I don't know what's going to happen in the future. But the consolidation trend, long term, continues apace. And in most of the world, the packaged gas, the industrial gas companies are vertically integrated and the packaged gas industry has many fewer players, and the U.S. market is kind of an anomaly. We have 900 independents, many of which are pretty strong companies and good competitors. And so customers have choices, and that's why our market is more competitive. But over time, we believe that over time, the industry will continue to consolidate. And right now, I guess half or a little less than half is held by these 900 independents and it was a lot higher than that 15 years ago. So that's the direction it's headed.

Operator

We'll go next to David Manthey with Robert W. Baird.

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

First of all, on the welder rental fleet, CapEx last year more than doubled, and in the second quarter here it accelerated and was greater than average. I just wonder if you can discuss Red-D-Arc rental revenue growth rates and utilization this quarter or if you're getting any price there. Just any sort of leading indicators or the leading indicators here.

Michael L. Molinini

Red-D-Arc had a relative -- I'm not sure exactly what the growth was, but had a relatively weak quarter by Red-D-Arc standards. We did not have a very strong outage season in the fall. However, Red-D-Arc, one of the drivers of our optimism on some of these construction projects is Red-D-Arc is projecting a good spring outage season. So we also -- we have DnD. DnD was the generator, portable power rental company that we acquired late last year that rents power to natural gas wells for lift pumps and things. We invest, a lot of our Red-D-Arc investment has been to expand the fleet. They had been renting a lot of generators from third parties, so we've been expanding the fleet and replacing those, as well as some new growth opportunities that we have with DnD. So Red-D-Arc is still a growth story for us, and we are very bullish on their outlook and continue to invest in more and additional types of equipment in their fleet.

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then just lastly, given the drop you've seen in R-22, have you made any changes in your aggressiveness to source and stockpile lower-cost inventory ahead of what will be inevitable supply tightness in the future? I just don't know, is there capacity to scale this business in that way?

Michael L. Molinini

There is, and we have not chosen to do that at this stage. We maintain inventories, months' worth of inventories that's consistent with what we have maintained in the past.

Operator

We'll go next to Tom Hayes with Thompson Research Group.

Thomas L. Hayes - Thompson Research Group, LLC

I was just wondering maybe you could discuss what you're seeing as the main catalyst and your thoughts on the sustainability of the better-than-expected growth you're seeing in the spec gas business so far?

Michael L. Molinini

I would say it was our segmented approach to these markets and getting more of our sales force specialized in certain segments and concentrating on some of the larger research universities and things, is beginning to bear fruit. So I would say most of it is -- obviously, there's probably some price in there, but the organic part is more on share gain by a more focused approach to universities and research centers.

Peter McCausland

I would agree, I would say that 75% of the improvement is the result of what Mike pointed out. I'd say the rest is an increase or an improvement in the overall research analytical markets as well.

Operator

We'll go next to Walt Liptak with Global Hunter Securities.

Walter S. Liptak - Global Hunter Securities, LLC, Research Division

Thanks for all the color on the slowdown. I guess my one question is, it sounds like you're thinking that it was related to the government shutdown and that slowed some smaller customers, and 6% of your sales is government-related. Wouldn't you think that now that the shutdown's over and things are getting back to normal that you would see that sort of coming back? Or is that why you're more cautious, because you didn't see things picking up in October?

Peter McCausland

Well, we haven't seen them pick up yet. We're still at the sales levels that we had at the back half of September. They're not getting any worse, but we could have a rebound. In terms of government sales, we don't sell 6% of our sales to government.

Michael L. Molinini

The Government and Other is the category, and the actual sales to the government is -- yes, it's smaller.

Peter McCausland

And where we get hurt is defense contractors and people like that who shut down or slowed down as a result of the shutdown. So we're indirectly impacted by the government shutdown. But what we see is just a general uncertainty out there, and it's pretty much across-the-board, and it's -- companies don't -- the small companies don't want to hire. I think a lot of that has to do with the uncertain outlook for health insurance and getting up to over 50 employees. But businesses are holding off on spending until they see some kind of real growth. And this has been a 4- or 5-year recovery without the kind of snapback in growth that everyone expected. And so everyone's holding off right now and making for a pretty cautious environment.

Walter S. Liptak - Global Hunter Securities, LLC, Research Division

Okay. Okay, I get it. And then I wanted to ask about the acquisition. Can you provide any numbers, the revenue that it's going to contribute or how much you paid for, or EBITDA?

Peter McCausland

We don't really give out the sales prices. Sometimes we can't because of confidentiality, but it's $55 million in annual revenue. And as I recall, it's almost 2/3 gas and rent or 60%, somewhere around there. It's a very nice business and fills in a thin spot in our platform, has some terrific employees, really very professional. And if we'd get 10 more of them in the next 2 years, I'll be a happy camper.

Walter S. Liptak - Global Hunter Securities, LLC, Research Division

Okay. In the next quarter, is there going to be any purchase accounting that is meaningful? Or is it small enough where it just kind of gets to a...

Peter McCausland

Too small to move the needle.

Walter S. Liptak - Global Hunter Securities, LLC, Research Division

Okay. And then I think in one of the disclosures, you had accretion from deals. Is there some accretion that comes in 2014?

Peter McCausland

Usually, in our projections, we don't put any accretion in for like a year, right?

Robert M. McLaughlin

Yes, what's in the walks is from the acquisitions that have already closed. And we don't have this new one fully baked in yet, but it will not be meaningful for this year.

Operator

We'll go next to Edward Yang with Oppenheimer.

Edward H. Yang - Oppenheimer & Co. Inc., Research Division

Just a quick one. The guidance that you referenced during the Q&A, price up 3%, volume, minus 1%, plus 1%. Is it your expectation that hardgoods would be a positive organic growth contribution and gas -- or remain negative and gas positive?

Robert M. McLaughlin

Yes. And it's a consistent pattern, both gaining some ground, but yes, a relative contribution.

Edward H. Yang - Oppenheimer & Co. Inc., Research Division

But hardgoods remaining somewhat lagging...

Robert M. McLaughlin

Somewhat behind gas.

Operator

We'll go next to Holden Lewis with BB&T.

Holden Lewis - BB&T Capital Markets, Research Division

Sort of thinking about the nonres opportunity a different way, I think right now your nonres is in the neighborhood of sort of low teens. Can you talk about, just from a mix perspective, if you got sort of a real sort of surge in the activity, if you're midteens now and that business is mostly maintenance, very little project, if maintenance holds up and project picks up, I mean, can you see the nonres going from kind of low teens up to north of 20% of the total mix? And if so, what's the relative margin or profitability of that type of business for you?

Peter McCausland

Well, I remember during a boom in the late '70s to early, well, probably mid '80s, I guess it was, the first time we put the chart together, we had nonres at 19%, but there was some pretty good stuff going on back then. I don't think -- I think high teens, if it really gets rolling here, is a possibility. But there is the follow-on effect of an increase in nonresidential construction, which is very substantial, and that this with our metal fab customers who are fabricating components for these projects off-site. And I don't know exactly what that impact would be and how much would be attributable to the projects. It's hard to gauge, really. And then once these projects get built, they're really good sources of continuing business. They have -- these petrochemical plants have multiple use points for our products and services and are very, very large customers in our universe. So it's going to have a positive impact if we get this big wave. But we're a big company now, so maybe high teens is reasonable.

Holden Lewis - BB&T Capital Markets, Research Division

And do you think that you can get that big wave given, I guess, perhaps labor constraints? Can you get to a late '70s, '80s kind of environment given what I hear are labor restraints in that activity? And then I also asked sort of about the relative level of profitability for that type of business.

Peter McCausland

Right. The business is profitable. There's no question about it, and the companies that get the business are the ones that are ready to serve it. And that means having the equipment and the service offering, as well as the product offering and when the customer wants it, where the customer wants it. And we have a very strong national accounts program with the E&C companies and a single point of contact. They can call us anywhere, tell us where they are, and we can serve them. So we've geared up very nicely. It is profitable business, and we're ready to serve it. What was the other part of the question?

Michael L. Molinini

When you're talking about the labor restriction, you mean for the contractors?

Peter McCausland

Or welders?

Michael L. Molinini

To find welders?

Holden Lewis - BB&T Capital Markets, Research Division

Right.

Michael L. Molinini

I mean, that's an issue that's out there. It's been out there, and we know of some in our projects where they're going to bring in welders from outside the country. So we have not heard yet by anybody that said we have to delay our plans because we can't find welders. But that's obviously -- it could be an issue at some point.

Operator

And we'll go to Mark Gulley with BGC Financial.

Mark R. Gulley - BGC Partners, Inc., Research Division

A couple of questions around volume growth. The first one is, we've talked a lot about margin improvement and SAP. Aside from the telesales effort, Mike, can you think of areas where SAP will benefit volume growth going forward? After all, it looks like it's going to be sluggish for a little while yet to go.

Michael L. Molinini

I mean, with the data that we have, I mean, there's all kinds of things you could think about. But at this point, I don't have anything that comes to mind that's going to be a key driver.

Peter McCausland

I would say Total Access, I mean, it's not...

Michael L. Molinini

Excluding that one. Besides that one. That one for sure. I mean, we're doing a lot of things with eBusiness. Customers will have a lot of access to a lot of information, things they've been wanting to get from us for a long time. And again, all of that is enabled by having one database where you've got every -- all the information in one place. But we have never sat around -- I mean, there's a lot of things we could sit around and talk about and brainstorm about, but going from that to quantifying exactly what the implication is, that's a little more difficult.

Mark R. Gulley - BGC Partners, Inc., Research Division

Okay. Then lastly, if I may, I know it's only mid-fiscal year, and SAP has been a nice addition to earnings this year, but what about next year, fiscal '15? How should we begin to think about the incremental year-over-year impact of SAP next year?

Robert M. McLaughlin

Well, I think, Mark, based upon what we put out in the fourth quarter walk, a net $0.16 benefit, that gets us to roughly $80 million run rate contribution. And if you annualize that, that's roughly $0.64, compared to the $0.47. So out of the gate, that's kind of the minimum add that we'd have, jumping from $0.47 to $0.64. So we'll have a nice tailwind as it relates to SAP.

Michael L. Molinini

And that's not obviously the end of the SAP story. And we'll be in a mode of assessing what else do we want to concentrate on. I mean, there's a whole litany of things that now that we have it installed, are options and things that we can pursue. So right now, we're working really hard to find some organic growth.

Operator

I will now turn the call back over to Mr. Barry Strzelec for closing remarks.

J. Barrett Strzelec

Great. Thanks, everyone, for joining us today, and thanks for your patience as I know we ran a little over the hour. Joe and I will be available all day for follow-up questions. Thanks.

Operator

That does conclude today's conference. Thank you for your participation.

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