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Executives

Peter McCausland - Chairman & Chief Executive Officer

Mike Molinini - Executive Vice President & Chief Operating Officer

Bob McLaughlin - Senior Vice President & Chief Financial Officer

Jay Worley - Vice President, Communications and Investor Relations

Analysts

Robert Koort - Goldman Sachs

Mike Sison - Keybanc

Mark Gulley - Soleil Securities

Edward Yang - Oppenheimer

Tom Hayes - Piper Jaffray

David Begleiter - Deutsche Bank

Kevin McCarthy - Bank of America

Mike Harrison - First Analysis

David Manthey - Robert W Baird

Amanda Sigouin - Jefferies

John Roberts - Buckingham Research

Airgas Inc. (ARG) F3Q10 Earnings Call January 29, 2010 9:00 AM ET

Operator

Good morning and welcome to the Airgas third quarter 2010 earnings conference call. Today’s call is being recorded at the request of Airgas. All participants will be in a listen-only mode until the question-and-answer session of the call.

Now for opening remarks and introductions, I’ll turn the call over to the Vice President of Communications and Investor Relations, Jay Worley; please go ahead

Jay Worley

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

Our earnings press release was made public this morning and is available on our website as are the teleconference slides. To follow along, please go to www.airgas.com, click on the investor shortcut at the top 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. Please note that reconciliations to the most comparable GAAP measures can be found in our earnings release, in the slide presentation, and on our website.

This teleconference will 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 and we plan to end the teleconference by 10 O’clock Eastern Time.

Now, I’ll turn the call over to Peter to begin our review.

Peter McCausland

Thanks, Jay and good morning and thanks for joining us. Slide two highlights some of the key points are covered today and the reason why we believe that we’re stronger than ever as a company on the right track and poised to capitalize as the economy recovers. Earnings were slightly below guidance for our third quarter of fiscal 2010 and that’s clearly not how we like to do things.

Nonetheless, our performance with strong, the key factors than the earnings miss were weaker than expected sales during the holiday season and the cancellation are postponement of plan turnaround negatively impacting are vary profitable rental welder business. On the bright side this quarter mark the first sequential increase in our daily sales rate since our second quarter of fiscal 2009 and we generated record year-to-date free cash flow of $289 million.

In spite of the challenges in our Red-D-Arc rental welder business that I just mentioned our distribution segment posted healthy results including 2% sequential increase if daily sales and a sequential expansion in operating margin. Our guidance this year has been predicated on moderate space of sequential economic recovery and we continue to hold that expectation.

It may take more time to unfold than we hoped, but a recovery does seem to be underway across most of our geography and customer segments. As we conveyed to you at our analyst meeting in December we’re very confident in our ability to drive above market results on the strength of the growth accelerators we outlined.

Service to multi-location customers, cross sale opportunities, our customer service culture, technology implementation, increasing regulation, favorable demographics and demand for supply chain management and other services including our e-Commerce offerings.

Our strategic accounts customer base continues to grow, adding mass to our book of business and our strategic products continue to outperform and effectively diversify offering and provided stability. As the premiere U.S. packaged gas distributor we’re in a strong position to capitalize on an improving economy.

To recap the third quarter, net earnings for the third quarter were $46.9 million or $0.56 per diluted share. Excluding a $0.05 dead extinguishment charge and $0.04 multi-employer pension plan withdrawal charge, adjusted earnings per diluted share were $0.65. This compares to a very strong $0.76 per diluted share last year.

Earnings were $0.02 below the bottom of our guided range primarily due to the unseasonably low sales in our rental welder business, which accounted for $0.02 and slower than expected daily sales activity in December which accounted for another $0.02.

Total sales in the quarter declined 13% to $942 million, driven by a total same store sales decline of 14% with price down 3% and volume down 11%. The price declines were most pronounced in our ammonia and welding filler metals products as declining costs accounted for the price movement.

Overall our gross margin expanded. Gas and rent same store sales declined 11% and hardgoods 19%, acquisitions contributed sales growth of 1%. On a sequential basis total sales declined by 2% from the second quarter reflecting the impact of fewer selling days and the seasonality of certain businesses in the all other operation segment.

Total daily sales increased 1% from the second quarter. In the distribution segment we were encouraged by the 2% sequential increase in daily sales. Looking across our geographies our Pacific Northwest region posted the smallest year-over-year decline followed by Airgas national welders which covers the Carolinas and Southern Virginia.

The deepest declines took place in our mid-South and Southwest regions where oil field service activity continues to be slow and in our North Central region where construction activity is tapered off. We continue to benefit from a product mix shift towards gas and rent sales, which represents 65% of total sales in the quarter.

Year-over-year comps remain tough for most of our customer segments and will ease next quarter. We were pleased to see a sequential increase in sales to our industrial manufacturing customers. Utilities and petrochemical along with our always steady medical business posted the strongest sequential growth on a daily sales basis.

Activity with our contractor customers that serve new construction and repair and maintenance projects decreased sequentially, challenging our package gas, hardgoods and rental welder business. A lack of funding seems to have brought major products to a halt and plant turnaround are being postponed.

Overall hardgoods sales continue to be under the most volume pressure led by steep declines in equipment which is the only product line we sell that is a capital purchase for our customers.

We expect equipment to drop deepest in a downturn followed by filler metals used in manufacturing. Fortunately these tend to be the lower margin sales compared to the rest of hardgoods. Additionally, sales mix from hardgoods to gas and rent drives gross margin expansion as gas and rent carry higher gross margins than hardgoods.

Our gas gross margin also benefited from lower cost partially offset by lower prices. Total company margin expanded 220 basis points from last year. This gross margin expansion worked in conjunction with our cost reduction efforts to minimize operating margin erosion. Adjusted for multi-employer pension plan withdrawal charges, our operating margin only dropped 110 basis points to 11.1% from 1.2% last year and 50 basis points from 11.6% in the second quarter.

Cash flow continues to be one of the strengths of our business model. Year-to-date free cash flow increased to a record $289 million, a 69% increase over the prior year and representing about 10% of our sales. Adjusted cash flow from operation grew 8% from $436 million last year to $470 million this year and capital spending dropped by 32% to $192 million. Roughly two thirds of our free cash flow has been used for debt reduction, about $190 million so far.

We were pleased to increase our dividend again as our strong cash flow allows us to reward shareholders, while still pursuing our growth strategies. This was our fifth dividend to increase in the past three years and it will result in a 36% increase in dividends per share paid in fiscal 2010 over 2009.

Acquisition activity has been slow as potential sellers assess their business in the wake of the downturn. However, our pipeline has been recovering recently as the anticipation of improving business conditions has stirred some interest. Year-to-date, we have acquired five businesses with an aggregate of $47 million in annual revenues.

In our largest transaction this year, we acquired Tri-Tech, a very well run, highly profitable independent distributor with 16 locations throughout Georgia, Florida and South Carolina, generating $31 million in annual revenue.

We also improved our presence and density in Oklahoma and West Texas with our purchase of Fitch industrial & Welding Supply, a Lawton, Oklahoma based distributor with around $10 million in annual revenues. Most recently, we added a small distributor in Houston called champ sales, representing about $3 million in revenue.

Our acquisition activity has historically accelerated during the rover phase of a business cycle and we hope recent developments in the pipeline are signs of sustainable improvement. Our strategy is unchanged, we have the capacity to purchase and integrate quality businesses and we remain diligent in sourcing transactions. We will continue to evaluate international opportunities as they arise, but our primary focus remains on domestic core product service offering acquisitions.

Looking forward, in the fourth quarter our package gas business should post another sequential improvement. Will be slightly offset by seasonality in the all other operation segment and continue pressure in our rental welder business. January sales have us off to a good start, showing slight sequential improvement from last quarter, actually gas sales are up 5% to 6% and we expect the month of January to end with hardgoods sales down around 1%.

We intend to stay focused on our fundamental strategies, enhance our sales organization and performance, and continue to train our associates as we position ourselves to emerge even stronger when recovery does take shape. We have converted many new customers to Airgas over the last 18 months and we expect that to have a positive impact as the economy continues its recover.

Although, we hate to miss our guided earnings range, and believe me it’s especially hard on me, I’m a large shareholder in the company, and I take this very, very seriously, but we’re a daily sales company and it’s very, very hard to know what our sales are from quarter-to-quarter and especially in this quarter which ends with the holiday season.

However, I really don’t think $0.02 below the ends of our range is meaningful in the larger scheme of things, particularly, after delivering results near the high end of our range in the past two quarters. What is meaningful is that, we’re on track to deliver strong performance as a U.S. economy recovers. We think our stock is undervalued and I would say that history confirms that and we hope that our loyal shareholders will take this opportunity to increase their holdings.

Mike will now give us a review of market strategy and operation.

Mike Molinini

Thank you, Peter, and good morning everyone. As Peter mentioned, the business climate remains challenging, but we turned a corner by posting our first sequential increase in daily sales in a year. Encouragingly, volumes in our core business drove the improvement and distribution segment daily sales were up in spite of a tough quarter for Red-D-Arc. Before I start the broader discussion, I’d like to touch on Red-D-Arc in a bit more detail.

Rental welder business primarily, serves two contractor segments: first, new construction and second the repair and maintenance operations of multiple customer segments. The new construction segment has been slowing all year as jobs are completed and new startups are limited.

However, the fall is prime outage season and we anticipated that the fall outage season would see a normal seasonal up tick in turn around maintenance activity, and this is where we fell far short of expectations. The end result accounted for at least $0.02 of our earnings mess.

While plant shutdowns did take place the volume of turnaround work during the shutdowns was very low. It seems that plant utilization rates in the past few quarters have allowed customers to minimize the repair and maintenance work during this outage cycle or indefinitely postpone major plant turnarounds.

Often, customers made these decisions last minute and in several large cases after our rental welder equipment had already been delivered to the job site. It is difficult to determine at this time, whether customers will continue to delay scheduled turnarounds or simply skip the cycle altogether.

Now let’s discuss our core package gas business. We have seen some increased price competition recently. We do need and deserve a broad price increase and as much as our last increase was 17 months ago. We will initiate a pricing action at the appropriate time to achieve the optimal result and in the meantime, we’ll continue to address pricing tactically in lowly markets where it makes the most sense.

We’re focused on achieving real gains through new business signings, while cross selling to our existing customer base and building market position. As Peter mentioned, we have many ways to accelerate our sales growth beyond market rates and we believe we’re doing so even in this economy.

Our sales and marketing strategy focused on segment alignment is taking shape. Success this far has been most pronounced in the strategic accounts program where it originated and was already underway in the medical and construction segments. For the third quarter, strategic accounts business was down 8% from the prior year as the benefit of new account signings across all customer segments continued to be outpaced by the year-over-year declines in our existing metal fabrication, construction and petrochemical customer base.

For customers with multiple location, our strategic account focus offer superior service and supply chain savings through our national infrastructure, breadth and depth of products and services and technical expertise. Customers facing tougher times tend to renew their interest in supply chain savings and we have been busy responding to customer inquiries.

Momentum is beginning to build in our more recently aligned sales and marketing segment including retail, energy, metal fabrication, food and beverage, chemicals and pharmaceuticals and laboratories. When the economy recovers this part of our business is positioned for strong growth.

Turning to slide three, our strategic products which combined to make up about 40% of our revenue declined 4% for the quarter comparing favorably to the overall same-stored sale decline of 14%. Sequentially, daily sales per total strategic production improved by 2% from the second quarter. Our strategic products as a group continue to have good long term growth profiles as many of our growth accelerators impact their performance.

Safety products, sales declined 5% year-over-year in the quarter, comparing favorably to the overall hardgood same-store sales decline of 19%, and partially reflecting the impact of last year’s Boeing strike on our third quarter last year.

On a sequential basis daily sales of safety products were up 3%. Although, low operating rates and rising unemployment are headwinds safety products still present a strong cross sell opportunity for us as the value in vendor consolidation is greater for our customers in today’s economy.

Both gas sales were down 5% for the quarter compared to prior year. On a daily sales basis however, bulk sales increased by almost 5% sequentially as sales of bulk nitrogen for food freezing applications continued to show strength and bulk sales to industrial manufacturing customers began to recover in segments such as steel, auto and alternative energy.

Bulk sales continue to represent significant opportunity for us due to combination of our extensive sales presence, full range of supply modes and ability to engineer solutions for customer needs. Medical sales grew 2% year-over-year and 3% sequentially in daily sales. While slowing in elective and non-critical procedures has reduced overall medical demand we continue to expand our medical business through new customer signings.

Our proprietary walkabouts orders, all capabilities, and new medical gas piping and certification business combined with our core medical package gas offering have allowed us to cross sell and expand business with existing customers and have proven to be successful in helping us win new key customers including some of the top hospitals in the country.

Specialty gas sales declined 7% year-over-year driven largely by slowing in chemical processing industries. Sequentially, however, specialty gas sales improved by almost 4% on a daily sales basis driven by broad based increase in demand for core specialty gasses including further strengthening of our market position in EPA protocol gasses.

As we highlight during our December 15, analyst meeting, we remain extremely optimistic about our growth prospects given our expanding account base in the biotech, life sciences, research and environmental monitoring fields, our ability to drive the industry forward through the pursuit of new technologies and automation and increasing regulation globally. In addition our investment in proprietary automated production and automated analytical it will now fully deployed at all major specialty gas cylinder production plants provides quality and capacity we will need to service future growth.

Finishing out our strategic products CO2 and dry ice were down 5% from last year as increases in sales for food and industrial freezing applications was more than offset by lower surcharges compared to prior year. Sequentially, CO2 and dry ice were down on a daily sales basis due to seasonality in those businesses.

Radnor private label were down 18% for the quarter, slightly less than the overall drop in hardgoods volume. Long term growth opportunity for Radnor private label products remains strong. In addition to building brand loyalty within our customer base Radnor products enhance profitability because they carry gross margins higher than comparable OEM products by one and a half times or more.

In contrast with the rest of our gas business, ammonia, which is the main product of Airgas specialty products, posted a sales decline in excess of 30% for the quarter. Volumes actually increased 4% in the quarter, but were more than offset by pricing driven by the impact of falling costs compared to very high levels in the ammonia industry last year. In spite of lower volumes, our gross margin percent on ammonia improved over last year as costs declined greater than selling prices.

Similarly refrigerants are down year-over-year as economic conditions and mild weather have fostered indefinite delays in the maintenance of HVAC systems and elective refrigerant conversion products that typically take place around this time of the year. The buying patterns of our refrigerant customers have changed significantly during the downturn. Looking forward it is difficult to determine at this time whether the preseason buy that typically takes place in March will material lies.

Our operating efficiency programs, which focus on cylinder maintenance and testing, distribution of fill plant logistics, and freight and fuel management, are progressing according to schedule. We’ve achieved $10 million in annual run rate savings this fiscal year, composed largely of UT cylinder test benefits, distribution logistics initiatives and common carrier freight reductions.

At our December analyst meeting, we set a goal to attain $40 million of new operating efficiency savings over the next four years driven largely by logistics plan cylinder studies and cylinder testing, cost containment and operating efficiencies have become significant element of the Airgas operating culture we are confident in our ability to deliver on our goals. To date we have fully implemented $57 million of annual expense reduction since the downturn began last year representing more than 7% of our annual run rate EBITDA at the time.

In light of the results and outlook for rental welder business we are evaluating the cost structure of that business. Excluding the rental welder business we are feeling that our cost structure is a appropriate for the current demand levels. We are able to make additional reductions if conditions deteriorate further, but we intend to balance short term profit protection with long term strategy for creating shareholder value.

Now Bob will give our financial review of the quarter.

Bob McLaughlin

Thanks Mike and good morning everyone. I’d like to start today by reviewing our segment results. Please turn to slide four. As I go through these results please note that we have GAAP reconciliations for various metrics on slides nine through 13. Peter and Mike have talked about the drivers of the earnings shortfall and contrasted them with the relatively positive fundamentals of our core business.

The segment results paint that picture pretty clearly, so we will start there. Distribution sales in the quarter were down 12% versus prior year to $852 million with same store sales down 14%. On sequential basis distribution sales decreased 1% from the second quarter.

However, since there were fewer selling days in the third quarter our distribution sales actually improved by 2% sequentially on a daily sales basis. Distribution gas and rent same store sales were down 10% year-over-year with volumes down 8% and pricing down 2%.

This is also the category that suffered the most direct impact of the Red-D-Arc shortfall in rental revenues, which were down more than 20% from last year. Distribution hardgoods same store sales down 19% with volumes down 17% and pricing down 2%. Declines in cost and prices for filler metals were the most pronounced impact on hardgoods pricing with most other product lines slightly down or stable.

Both hardgoods and gas and rent sales improved sequentially on a daily sales basis. Distribution gross margin was 56.2%, an increase of a180 basis points over the prior year, reflecting a favorable sales mix shift to gas and rent. Sequentially distribution gross margin improved 10 basis points with the mix of gas and rent sales consistent at approximately 61%.

Excluding multi-employer pension plan withdrawal charges, adjusted operating income in the distribution segment was $94 million, down 20% from the prior year and flat sequentially. The related operating margin was 11.1%, a decline of 110 basis points year-over-year and an increase of 10 basis points sequentially.

Our distribution operating margins held up relatively well in light of the significant year-over-year sales decline due to aggressive reduction of operating expenses. We implemented $57 million of companywide annual expense reduction since December, 2008, of which a significant portion benefited the distribution segment. The favorable mix shift to gas and rent also helped our operating margins.

All other operations reflect CO2, dry ice, refrigerants, ammonia and nitrous oxide business units. Sales for all our operation were down 18% from the prior year both in total and on the same store basis. The decline was driven largely by lower pricing on ammonia products related to corresponding drop in raw materials and lower wholesale refrigerant volumes reflecting sluggish contractor demand.

Sequentially the sales decline was driven by normal seasonality in the dry ice and carbonic businesses as well as the challenging business conditions in refrigerants that Mike mentioned earlier. Operating income for all other operations was down 21% from the prior year.

Operating margin decreased 50 basis points driven primarily by margin compression in the refrigerants business as a result of the volume declines. Sequentially the 450 basis point declines in operating margin is primarily attributable to the normal seasonal decline of CO2, dry ice and refrigerant sales. The all other operation segments was the driver of the entire sequential decline in our consolidated operating margin.

Now turn to slide five, and we’ll look at our consolidated results. Sales declined 13% year-over-year to $942 million, reflecting acquisition growth of 1% and a total same-store sales decline of 14%, comprised of 11% decline in gas and rent and a 19% decline in hardgoods. Volume was down 11% and price was down 3%.

As mentioned in the segment discussion, declines in costs and prices for ammonia are the most pronounced impact in the gas and rent sales. In the same dynamic, impacted filler metals in hardgood sales. Sequentially, sales declined 2% driven primarily by fewer selling days and the seasonality discussed in the all other operation segment.

However, on a daily sales basis, sales rose sequentially by 1%. Gas and rent represented almost 65% of our sales mix, comparing favorably with the prior year mix of just over 62%. The sales mix shift is driven by the relative strength of gas and rent same-store sales compared to hardgoods. The favorable gas rent mix is also reflected in our 55.8% gross margin for the quarter, an increase of 220 basis points over the prior year.

As mentioned in the distribution segment discussion, gross margin was up 10 basis points sequentially, reflecting stable relationships between costs and pricing across most products. Excluding pretax multi-employer pension plan charges, operating income for the quarter was $105 million, down 20% from last year.

While operating margins were negatively impacted by the significant year-over-year decline in sales, the $57 million in annual expense reductions that we implemented between December 2008 and September 2009, in addition to our ongoing operating efficiency initiatives significantly mitigated the impact on our operating margins.

Our adjusted operating margin, which excludes pretax multi-employer pension plan charges, held up relatively well for the quarter at 11.1%, a decline of 110 basis points year-over-year and 50 basis points sequentially. The sequential decline is entirely attributable to the normal seasonal decline in our all other operation segment.

We continue our efforts to withdraw from multi-employer pension plans and we’re successful to a significant degree this quarter. We entered the year with 12 collective bargaining agreements that contain multi-employer pension plans, and thus far have exited six. The remaining six agreements which cover approximately 80 employees come up for renewal between now and the end of fiscal 2012.

Adjusted earnings per diluted share of $0.65 in the second quarter, presents a decline of 14% year-over-year and a decline of 4% sequentially. We were short of our guidance due to a $0.02 impact of the challenging conditions in our rental welder business and a $0.02 impact from a weaker than expected sales finished in the quarter.

Including a $0.05 loss on the early extinguishment of debt related to the previously announced redemption of $150 million six and a quarter notes and a $0.04 charge for multi-employer pension plan withdrawals, GAAP earnings were $0.56 per diluted share. There were approximately $84 million weighted diluted shares outstanding for the quarter, up about 1% year-over-year, and fundamentally flat on a sequential basis.

Return on capital was 10.1%, a 340 basis point decline from the prior year, primarily driven by the slowing economy and related decline in operating income. With respect to accounts receivable, our collection rates for the quarter have remained relatively consistent both year-over-year and sequentially, and our quarterly DSO of 48 days was consistent with the second quarter results.

Inventory churns held consistent with recent trends and inventory reductions have contributed more than $45 million to our cash flow this year. Year-to-date free cash flow was $289 million, compared to $171 million last year driven by strong adjusted cash from operations of $470 million, up from $436 million last year; and by a 32% reduction in capital expenditures to $192 million this year.

We increased our dividend for the fourth quarter by 22% to $0.22 per share, representing a 36% increase in dividends per share paid in fiscal 2010 over 2009. Adjusted debt at December 31 was $1.9 billion and $523 million was available under our revolving credit facility.

Adjusted debt has been reduced by approximately $300 million since December, 2008 and a little more than $190 million year-to-date to fiscal 2010. Our fixed float ratio at the end of December was 53% fixed and our adjusted debt-to- EBITDA ratio was 2.7 in the middle of recently revised target range of 2 to 3.

Slide six is one that we introduced at our analyst meeting in December and it serves to demonstrate some of the defensive and resilient financial aspects of our performance as well as where we seem to be in the economic cycle. A review of the EBITDA line reveals a remarkably gentle slope when compared to the magnitude of the same store sales decline we experienced in the past four quarters.

The work we have done to diversify our customer base and product mix, the relatively stable nature of our rental revenue stream, and the quick effective expense reductions we implemented in the downturn serve to hold EBITDA relatively flat in this challenging sales environment. The result is an expanded EBITDA margin compared to the peak quarters of just over a year ago.

Secondly the sequential change in daily sales show that after a period of sharp decreases we just posted our first sequential increase in the year. The timing of the sequential decline suggests that the package gas business lagged the downturn slightly and is exhibiting these characteristics coming out of it as well.

Please turn to slide seven, capital expenditures. He capital spending was $192 million fiscal year-to-date versus $282 million last year. Spending on cylinders, bulk tanks and rental welders declined as sales have slowed and overall capital spending was down 32% compared to the prior year. Excluding the impact of major capital projects year-to-date capital spending is about 4% of sales. We are still on pace to realize our target of reducing capital expenditures by more than a $100 million in this fiscal year.

Slide eight presents a walk through the primary elements of our fourth quarter guidance using the third quarter adjusted EPS of $0.65 at the starting point. The $0.04 headwind we have is related to two dynamics. One is the normal seasonal slowing of our dry ice and carbonic businesses as colder weather elevates the demand for some of these products.

The second is our expectation of further pressure on rental welder business associated with sluggish construction activity which we do not expect to turn up in the near term. At our back the absence of the holiday season should help us with a couple extra pennies and the big additions come from modest sequential increase in the core business supported by improving economy, an additional selling day and incremental operating efficiencies.

We expect negative same store sales in the low single digits representing a slow steady pace of rover. We expect earnings per share to be in the range of $0.67 to $0.71 in the fourth quarter, roughly flat to slightly up from last year. The high end of the range assumes an improving economic environment particularly related to industrial manufacturing.

Please note that the fourth quarter guidance does not incorporate the impact of any future multi-employer pension plan withdrawal charges as we continue our efforts to withdraw from such plans although we do not anticipate material charges in our fourth quarter. We also reiterate that prevailing economic conditions offer limited visibility into future sales and earnings, which should be taken into consideration when valuating our guidance.

I’ll now turn it back to Jay to begin the Q-and-A portion of the call.

Jay Worley

That concludes our prepared remarks. As we begin the Q-and-A portion of our call we ask that you limit yourself to two questions and one follow up. The operator will give instruction for asking questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robert Koort - Goldman Sachs.

Robert Koort - Goldman Sachs

I was wondering, Peter if you could maybe give assessment of what you expect the path of your same store sales recover to be along with the U.S. economy, I guess specifically non-tech IP, and then if you put it in the context of historical and is there something different based on what you’ve done around the cost structure and portfolio that would make recovery profile different now than maybe it was out of the early 2000 recession?

Peter McCausland

First of all, I think we have outperformed non-tech IP for the most part over the last eight years. There were quarters where we dipped a little bit below it, but for the most part we have outperformed because of our strategic products and our strategic accounts program. So I think that we will run ahead of it as it improves.

I think, in terms of what might be different in this recovery, I do feel that our cost reduction and our efficiency programs have a lot of momentum. They have really become a part of our culture. We’re launching new programs, we’ve got good technology that we’re deploying and so that’s going to be different and should help our fall through with sales increase.

I would also say that we’ve added a lot of customers to our rolls in the last 18 months and I really think that’s going to give us somewhat of an extra kick as the economy recovers. So I think there’s a few things different this time, which will benefit us more than in the past, but I also expect that we’re going to run ahead of non-tech industrial production.

Robert Koort - Goldman Sachs

Any chance you could give us some sense of what you think if we were back to a normal sort of 3% growth rate given the current asset base where normalized margins might fall?

Peter McCausland

I think it’s really, it’s hard to say. We do have, we do have the benefit of a more efficient organization, there’s no question about it. So follow through might be better coming out of this recession than the last one as a result of that. There’s no question about it. Our gas and hard goods mix has improved as well, which is going to help that. So, I think that once we get a year into this recovery, I would expect that our EBITDA margins would get back to where they were and hopefully see our peak margins that we experienced in the last rover.

Bob McLaughlin

I would add to that Peter, we did put out kind of fiscal 13% to 14% financial goals at our December analyst meeting and we talked about operating margins in the 13% to 14% and return on capital in the 14.5% to 15.5% range. For all the reasons that Peter articulated it is definitely within our sight assuming economic conditions to get to those levels. A significant upside from where we are at today.

Peter McCausland

Bob, just to supplement that, we’ve increased our gross profit nicely in this recession, now albeit, part of its mix, but part of it is declining cost to produce gasses and buy gasses, partially offset by some lower prices, but it’s been quite a while since we’ve had an across the board price increase. I would hope that we’re planning on price increases as the recovery gets a little firmer hold here and the energy markets have all risen from their, off their lows and that should give us some favorable backing for our price increases.

Operator

Your next question comes from Mike Sison - Keybanc.

Mike Sison - Keybanc

In terms of the same store sales outlook for the fourth quarter, any particular areas that you need to see to see that improvement year-over-year relative to steeper declines in the previous three quarters?

Peter McCausland

You mean areas that the economy?

Mike Sison - Keybanc

Well, in your markets. I mean your same-store sales were going to go to low single digits, any particular areas that you’re sort of banking on to see the improvement.

Peter McCausland

The core metal fab business, we’re hoping is going to come back. We can’t imagine it’s going lower and it started to improve slightly the last quarter and petrochemicals and chemicals also showed improvement. So they’re important to us and so continued improvement is going to be important to our same-store sales progress. As I mentioned, our gas sales were up over December levels; in January 5% to 6%, which is pretty nice, and that’s without any price increase.

We expect hardgoods to come in at about 1% below December at this rate, but combined it’s going to be a solid same-store sales performance for January, and we just hope it carries on into February and through March. This tends to be our strongest quarter, so we’re cautiously optimistic that it will develop positively.

Mike Sison - Keybanc

If the economic environment continues to improve, would you expect sort of your same-store sales to turn positive as you head into 2011?

Peter McCausland

Yes. In fact, this quarter coming up, the third quarter last year, was a pretty good quarter for us and then our fourth quarter last year, we got hit pretty hard and so we could have positive comps on same-store sales. We will have I would think this year, right Jay. First quarter of next year, yes.

Operator

Your next question comes from Mark Gulley - Soleil Securities.

Mark Gulley - Soleil Securities

A couple things, one, Peter, should we take a look at the big dividend increase and congratulations on that, as any sign whatsoever that you’re pulling back on your need or your desire to pursue acquisitions?

Peter McCausland

Absolutely not, our dividend has lagged our peers in industrial distribution and in industrial gasses, so we wanted to bring it back up. It’s also lagged the growth in earnings cash flow from operations and free cash flow. We have plenty of availability to execute on all of our growth programs including acquisitions and also reward our shareholders, so not at all.

Mark Gulley - Soleil Securities

Robert, I think you commented on this before, but what would be the normalized ratio of Cap Ex to sales? Clearly, it looks like a cyclical low this year, but what’s the normalized level?

Bob McLaughlin

Well, our maintenance as we talked about cutting down to pure maintenance is somewhere in the 3% arena. So then depending upon the level of growth that we’re having within the business, it’s probably in a 3% to 5%, 5% bandwidth if we’re having some normal growth.

Mark Gulley - Soleil Securities

Finally, Peter, you made some nice adjacent acquisitions over the years, but not all of them have worked out, Rutland Tools comes to mind. If you look at the portfolio now, are there any areas that perhaps haven’t fit, haven’t worked as well as you would hope?

Peter McCausland

No. Rutland Tool was a major screw up for sure and not just product line, but optionally, we couldn’t do the best in integration there, but no, some of them are newer like oil land and integrating that with our sales efforts, especially, in the worst recession since the great depression has been a challenge, but we like the business. It really fits well with our product and service offering on the maintenance products that we sell, maintenance welding and maintenance gasses as well as Red-D-Arc.

Red-D-Arc is a fabulous company and a very, very profitable company. They’ve been knocked back by this recession and the big decline in construction and most recently the postponement of plant turnaround. So I would say no, looking across at some of the other new ones like ammonia, it’s been a big winner, profits are up this quarter, even though prices are down, because we’re selling very price sensitive commodity.

Refrigerants, another good acquisition hasn’t developed as quickly as we thought, but fits very well with our regional companies. We have a great program where regional companies are selling refrigerants and Airgas Refrigerants Inc is doing all the fulfillment and our customers like to buy these products from us. So I would say no, but, as always it takes a long time to really get these things right, but I think we’re really doing well with the ones we have.

Operator

Your next question comes from Edward Yang - Oppenheimer.

Edward Yang – Oppenheimer

Hi Peter, Mike mentioned the erratic customer behavior in rental welders with some of the last minute cancellations. Are there any steps you could take to minimize that volatility or is that just the nature of the business or the competitive environment clouds taking any steps.

Peter McCausland

It’s the nature of the business. They call you up and they want it yesterday in that business when decisions are made for refineries or petrochemical plants that take maintenance outages either partial or whole, we had expected Red-D-Arc to bottom a few months ago and then they came in with a pretty weak quarter.

So as Mike said we’re looking hard at the cost structure there. Once before in the last recession we took some cost reduction measures at Red-D-Arc, but it’s a very profitable, very well run business, so we think there’s some things we can do, but we’re not going to change the behavior of the customers, they love us because we’re ready when they, when they call. So Mike, do you have anything to add to that.

Mike Molinini

The core business of Red-D-Arc is for large projects or turnaround they’re generally known in advance. It’s not like somebody, walks up and wants to rental welder for a week, it’s usually, months-and-months and it’s usually quite a few. So these are well planned in advance and up until this quarter we have never experienced the situation where we have, collected and assembled and prepared several hundred rental machines and actually delivered them to the job site only be called to say come back and get them because we’re not going to do it. I mean we have never experienced that before. So, again we’re trying to get our arms around how, is this the new normal for that or what.

Edward Yang – Oppenheimer

The dollar seems to be strengthening again it’s up more than 6% versus the Euro since the fourth quarter and has that factored into your outlook, I know you don’t have much direct FX exposure, but what percentage of your customers are export reliant and would a stronger dollar also affect your appetite for international acquisitions.

Peter McCausland

Well, we continue to look at international acquisitions and we’re in fact actually looking at a couple, three hard right now, but the dollar goes up and down, it really, it’s been in sort of a range bound now for quite sometime I think. I think more importantly a really, really strong dollar can hurts U.S. manufacturers and so I don’t particularly favor it.

I think the dollar has moved up because people are talking about, they’re worried about Greece and other places and sort of the safe haven thing, but long term with our deficits and whatnot I don’t see a huge increase in the dollar, but, I’m not an Commerce. I don’t think U.S. manufacturing can go any lower as a percentage GDP and we’re encouraged because we’re seeing the construction of a lot of new plants in the United States.

There are four or five automobile manufacturing plants, Intel’s building two new fabs, several other semiconductor firms are taking over plants that were shutdown and renovating them, there’s stainless steel plants, uranium processing plants going in and solar plants. So I’m pretty positive on U.S. manufacturing going forward here and I think the dollars will probably, that this is just a blip up, I don’t see it getting too much stronger, possibly could go down.

Operator

Your next question comes from Tom Hayes - Piper Jaffray.

Tom Hayes - Piper Jaffray

Regarding the pickup it sounds like you’re seeing in January business, does it appear the purchasing imaginers are ordering refill stock, main catching up for delayed December non-purchases or we finally seeing stocking orders recover from the large destocking we over the past couple of quarters?

Peter McCausland

We don’t have any stocking of gasses, so this is directly related to business activity and most of the hardgoods, they don’t carry big inventories, that’s our job. We keep them in our stores and in our distribution centers for our customers. So no, we think it’s directly related to increased activity.

Operator

Your next question comes from David Begleiter - Deutsche Bank.

David Begleiter - Deutsche Bank

Peter, you mentioned some selling price pressure and package gasses, can you give us a little more color on where that is occurring and by whom, any further details?

Peter McCausland

Every time there’s a big recession you have some price pressure, we had it the last time. I think the important thing here to know is that our gross profit is up a couple hundred basis points in package gasses and of course gross profit is a function of selling prices mix and then also cost of sales. Cost of sales is down both purchase products and manufacturing products on the gas side. We have added a lot of new customers and when you add new customers in this business it tends to be lower prices.

A lot of customers have closed their doors and long time customers during this recession and they tend to be at higher prices that are the way the business works. We haven’t had a general price increase for 17 months. So what we’re seeing is the sort of end of recession, beginning of recovery, normal price competition. We’re not concerned about it and our gross margins have actually improved.

David Begleiter - Deutsche Bank

Peter, on the cost issue, are you seeing any increases in your purchase gas prices yet, or in the future?

Peter McCausland

They’ve actually been going down, because we buy 70% of our molecules and we have, you know, electricity indexes in the pricing clauses and they have been going down. Now, electricity and gas, gas cost, natural gas and oil prices have gone up over the last couple of months. We lag, so we could have some increases a few months out, but we welcome higher energy prices because that justifies us getting price increases and so we’re not opposed to that.

David Begleiter - Deutsche Bank

On share buy backs given where the stock price is today, what are your thoughts?

Peter McCausland

We will be talking about that at our next Board meeting as we do every Board meeting and at this price it’s going to get a very, very hard look.

Operator

Your next question comes from Kevin McCarthy - Bank of America.

Kevin McCarthy - Bank of America

Peter, just a follow-up on the 5% to 6% increase that you referenced for the month of January, I was wondering if you could comment on how that compares to, what you would normally experience as a seasonal trend?

Peter McCausland

It’s 5% to 6% on gasses and we’re expecting hardgoods to end down 1% sequentially, so it would be like a 3% somewhere around there increase is what we’re projecting and there is a seasonal pickup in January, there’s no question about it, but we’re also seeing increased activity in the customer base, so how much of it is seasonal and how much of it is actually increased activity I can’t really say, but they’re both factors in the improvement.

Kevin McCarthy - Bank of America

Then within the welding hardgoods business, when you look at some of the larger ticket items therein, that you would consider leading indicators, what are you seeing in terms of level of inquiries or orders in recent weeks and months, how does the trend look there?

Peter McCausland

Overall flow, we had a pickup in December because, welding machines are capital item and a lot of people have them in their budgets and they’re on a calendar fiscal year. So we saw that little blip up, but overall slow. I’d say the one encouraging thing is that there are still even in this environment some interesting automation projects underway that we’re involved in with our customers and, those kinds of things are leading, but I wouldn’t say it’s robust at this point.

Kevin McCarthy - Bank of America

Final question if I may for Bob, as we approach the fiscal year end here in March, are there any year end true ups or variances that you would foresee in terms of tax rate, stock base comp or preps, other issues so we should be keeping in mind from a modeling perspective, recognizing you still have a few months to go?

Bob McLaughlin

Nothing that’s needle moving or significant.

Operator

Your next question comes from Mike Harrison – First Analysis

Mike Harrison – First Analysis

Peter, in the welder rental business do you charge customers a fees when they cancel a rental reservation like it sounds like they did this quarter?

Peter McCausland

Not a good customer.

Mike Harrison – First Analysis

Also wondering if there are any new competitors in the welder rental business that might have had an impact on the quarter?

Peter McCausland

No. I’d say that we’re by far and away the best company in the business, no one can compete with our fleet or our service or our technical support and we’re, when that business comes back we will do very well.

Mike Harrison – First Analysis

Alright the last number I had in terms of Red-D-Arc sales was an FY ‘07 number at $94 million that still about the ballpark of where annual sales is I’m trying to get a sense of the magnitude of the drop off you might have seen this quarter?

Peter McCausland

It’s around 120 million, in that ballpark.

Mike Harrison – First Analysis

Then the last question I had is the pricing component of the 10% decline in distribution gas rent, what was it?

Mike Molinini

Well, I think it was somewhat, broad and as Peter mentioned part of it was driven by our lower cost. So as our cost went down be it related to electricity or, in some cases fuel surcharges, our costs came down, some of our pricing came down in some selective areas, but as Peter also mentioned we preserved and actually slightly increased the underlying margin on our gasses.

Mike Harrison – First Analysis

What was pricing a 1% negative of that 10% total decline in gas?

Mike Molinini

It was probably around 1.5%, 2% overall on selling prices. Now, part of that is mix, this recession’s impacted that the smaller customers more, they pay higher, but that’s probably 1.5, 2, is our best guess.

Operator

Your next question comes from David Manthey – Robert W Baird

David Manthey – Robert W Baird

Could you for the third quarter just so we have specific numbers here, I’m not sure if you gave us this, could you tell us what Red-D-Arc rental average daily revenues were year-over-year and quarter-over-quarter, then the same for welding machines?

Mike Molinini

Dave, how about I’ll try and get back to you on that one. I mean, $120 million revenue base is probably your best starting point, but we don’t have what you’re asking at our fingertips.

David Manthey - Robert W Baird

Then in terms of the debt structure today, could you just talk about your thoughts over the next 18 months or so and if you give us a number, I’m not sure if this is in the release, but the dollar amount that was on the revolver this quarter?

Peter McCausland

We have about half, we have $500 million available under our $1 billion revolver that’s not part of a term note. We have an AR securitization agreement that comes up in March that we’re actively discussing renewal now on and/or as you’re aware our revolving credit facility matures in July of 2011.

We’re looking and preparing for that as well, but as you also know we are enjoying significantly low rates, 50 basis points over LIBOR on our current agreement and we just recently a few months back issued $400 million in 4.5% bonds. We’re obviously actively looking at the bond market now given the attractiveness.

Operator

Your next question comes from Amanda Sigouin - Jefferies.

Amanda Sigouin - Jefferies

This is Amanda Sigouin on for Laurence. First question, if the refrigerant business sees the normal March preseason buy how much of a benefit would this be to Q4 EPS?

Bob McLaughlin

It would be a nice upside surprise that we’re not building into our guidance and any somewhere around an incremental boost beyond what we have, maybe a penny.

Amanda Sigouin - Jefferies

What should incremental margin in the all other business be for the next few quarters?

Bob McLaughlin

We have a seasonal low, coming up in all other Ops.

Peter McCausland

You’re talking about the operating margin?

Amanda Sigouin - Jefferies

Yes, incremental operating margin.

Peter McCausland

We have additional seasonality as we go from our third quarter to our fourth quarter as we talked about and historically we have gone down from an operating income margin standpoint from the third to the fourth quarter in that segment. I think last year I don’t have the numbers in front of me, but it was probably 200 basis points.

Amanda Sigouin - Jefferies

Last one, will a merchant price increase wait on improving he wanted markets or do you think that can go through, go ahead in a more stable market?

Peter McCausland

Merchant price increases are generally driven by power costs and with higher energy prices coming up off the bottom and some deregulation, there’s been some merchant price increases and I think capacity is still relatively high given how bad the economy is, capacity utilization. So I think that they could stand alone on the basis of higher energy prices.

Operator

Your final question comes from John Roberts - Buckingham Research.

John Roberts - Buckingham Research

Does your guidance for the current March quarter include positive same store gas and rent comps or negative same store gas and rent comps?

Bob McLaughlin

Flat.

John Roberts - Buckingham Research

Should we still think of hardgoods as a leading indicator for gas and rent, I’m asking you that because we’re using one year comps and it’s been such a volatile series on hardgoods that year-over-year comps, I don’t know if they become somewhat meaningless relative to a leading lag indicator for gas and rent?

Peter McCausland

I still think they’re meaningful.

Mike Molinini

I think, used to be that it wasn’t necessarily hardgoods. It was the equipment portion of hardgoods, where capital spending kind of led the way out. Now, two things have changed. First are the percentage of our business that’s tied to manufacturing continues to decline. So the capital equipment component of what we do is really not linked, is not as strong TAS used to be.

After four or five years of robust economy prior to this there was a tremendous amount of new investment in equipment that was put in and this recession came on so fast that I think a lot of that equipment was just shutdown. It wasn’t really in need of replacement, it was relatively new, and they just shut it off. So my belief is we’re not necessarily going to see a huge leading indicator rebound on capital equipment this time around.

John Roberts - Buckingham Research

Lastly, Praxair’s call earlier when they were asked about stimulus activity by the federal government said, the states were in such bad shape that anything you might see at the federal level, we might not make it see to through end activity. Either it will be offset by a decline in state activity I guess, or absorbed by the state. Would you sort of agree with that, or do you think there’s still something yet to come?

Peter McCausland

Well, I don’t know. We’ve seen some positive impacts like in Cryo/Bio Equipment, because NIH has given lot of money to major research institutes. We’ve seen some bridge work, but the overall decline in construction has sort of, dwarfed that. If they increase the nuclear plant loan guarantee program, we’ll see a lot of positive sales developments; and things like that. The stimulus that’s been enacted so far I would tend to share present view in terms of it having very little beneficial effect on the economy or Airgas.

Operator

Alright, thank you and that does conclude today’s question-and-answer session. For any further or concluding remarks, I’d like to turn the conference back over to our presenter Jay Worley.

Jay Worley

Thank you very much for attending today and I will be available all afternoon for follow-up questions. Have a nice day.

Operator

Thank you everyone for your participation in today’s conference call. That does conclude today’s event.

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Source: Airgas Inc. F3Q10 (Qtr End 12/31/09) Earnings Call Transcript
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