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Executives

Paul E. Huck - Chief Financial Officer and Senior Vice President

Simon R. Moore - Former Director of Investor Relations

Analysts

P.J. Juvekar - Citigroup Inc, Research Division

Robert Koort - Goldman Sachs Group Inc., Research Division

Laurence Alexander - Jefferies & Company, Inc., Research Division

James Sheehan - Deutsche Bank AG, Research Division

Mark R. Gulley - Ticonderoga Securities LLC, Research Division

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

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Duffy Fischer - Barclays Capital, Research Division

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

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

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

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

John P. McNulty - Crédit Suisse AG, Research Division

Air Products & Chemicals (APD) Q1 2012 Earnings Call January 24, 2012 10:00 AM ET

Operator

Good morning, and welcome to the Air Products and Chemicals First Quarter 2012 Earnings Release Conference Call. [Operator Instructions] Also, this telephone conference presentation and the comments made on behalf of Air Products are subject to copyright by Air Products, and all rights are reserved. Air Products will be recording this teleconference and may publish all or a portion of the teleconference. No other recording or redistribution of this telephone conference by any other party are permitted without the express written permission of Air Products. Your participation indicates your agreement.

Beginning today's call is Mr. Simon Moore, Director of Investor Relations. Mr. Moore, you may begin.

Simon R. Moore

Thank you, Mark. Good morning, and welcome to Air Products First Quarter Earnings Teleconference. This is Simon Moore. Today, our CFO, Paul Huck, and I will review our Q1 results and outlook for the remainder of 2012. We issued our earnings release this morning. It is available on our website along with the slides for this teleconference. Please go to airproducts.com to access the materials. Instructions for accessing the replay of this call beginning at 2:00 p.m. Eastern Time are also available on our website.

Please turn to Slide 2. As always, today's teleconference will contain forward-looking statements based on current expectations and assumptions. Please review the information on these slides and at the end of today's earnings release, explaining factors that may affect these expectations.

Now I'll turn the call over to Paul for a review of our financials.

Paul E. Huck

Thanks, Simon. Good day, everyone, and thanks for joining us. Please turn to Slide #3 for a review of our first fiscal quarter of 2012.

For the quarter, sales of $2.4 billion were 1% higher versus prior year. Underlying sales increased 1% year-on-year on higher prices in our Merchant Gases and performance materials businesses. While overall volumes were flat, volumes were higher from new plants in Tonnage Gases but were offset by lower equipment sales and lower volumes in our performance materials and Merchant Gases businesses.

Sequentially, sales declined 7% with volumes down 4% due to seasonality in our Electronics and Performance Materials and Merchant Gases segments. Merchant volumes declined more than we expected as we experienced weakness in Asia, including China. Simon will provide the geographic details later.

Sequentially, lower energy prices reduced sales growth by 1% and currency reduced sales growth by 2%. At the current rates, currency would be a headwind for the remainder of 2012. Operating income of $385 million decreased 5% from prior year due primarily to lower volumes in our equipment and Merchant Gases segments. Higher pricing did not fully recover raw material increases, but productivity offset this impact. Our operating margin declined to 15.9%, down 100 basis points versus prior year and was 60 basis points due to volume and the rest due to under recovery of raw material increases. For the quarter, net income decreased 1% while diluted earnings per share increased by 1% due to share repurchases. Our return on capital employed on an instantaneous or run-rate basis dropped to 12.2%. On an annual basis, return on capital employed is 13%.

Turning to Slide 4 for a review of the factors that affected the quarter's performance in terms of earnings per share. As we announced back in October, we settled the dispute in Spain where the authorities disallowed certain deductions taken by the company's Spanish subsidiaries in fiscal years 2005 to 2011. This $44 million or $0.20 per share charge is excluded from our quarter 1 EPS analysis. Our adjusted continuing operations earnings per share increased by $0.01. Lower volumes decreased earnings per share by $0.05 year-on-year. Pricing, energy and raw materials, taken together, reduced EPS by $0.02. And costs were $0.02 favorable as our productivity gains more than offset cost inflation. Currency translation and foreign exchange taken together had a $0.02 unfavorable impact. Equity affiliate income was $0.03 higher as the prior year had a charge for a plant sale within one of our Asian affiliates. Excluding the Spanish tax settlement and as we guided to last quarter, our effective tax rate of 23.5% contributed about $0.02. For fiscal year 2012, we still expect the rate to be in the range of 25% to 26%. And finally, fewer shares outstanding contributed $0.03.

Now I'll turn the call over to Simon to review our business segment results. Simon?

Simon R. Moore

Thanks, Paul. Please turn to Slide 5, Merchant Gases.

Merchant Gases' overall sales of $989 million and underlying sales were both unchanged from prior year with positive pricing offset by lower volumes. Sequentially, sales declined 5% due to a 3% unfavorable currency impact and lower volumes partially due to seasonality. Pricing was positive. Merchant Gases' operating income of $192 million was down 4% versus prior year and flat sequentially. Segment operating margin of 19.4% was down 90 basis points compared to last year but up 100 basis points sequentially. Versus last year, operating income declined on lower volumes particularly in our European liquid/bulk and packaged gas businesses. Our cost performance improved significantly this quarter but did not overcome the volume decline. The startup of our new LaPorte ASU this quarter helped alleviate the liquid argon sourcing challenges we had previously experienced. Versus prior quarter, the improved operating and distribution cost performance offset lower volumes and unfavorable currency as operating income was flat. And the 100 basis point improvement in operating margin versus prior quarter resulted from the improved operating and cost performance, more than overcoming the impact of lower volumes.

Let me now provide a few additional comments by region. Please turn to Slide 6.

In U.S./Canada, sales improved 2% versus prior year. Volumes were down 1% on weakness in food, medical, electronics and distributors. Helium sourcing challenges continued. We expect our new U.S. helium facility to be onstream late in our second quarter as we are awaiting feedstock from our supplier. Pricing was 3% positive with improvement across the product lines as we took actions to recover higher costs. LOX/LIN capacity utilization is in the low 70s. Contract signings were below recent high levels but our prospect pipeline remains robust, and we expect strong signings next quarter and through the rest of the year.

In Europe, sales decreased 2% versus last year. Volumes were down 2%, partially due to business we've shed to improve profitability in the region, as well as weakness in the packaged gas market. Pricing was positive in liquid/bulk and packaged gases but partially offset by continued negative price pressure in Homecare, the business we announced we are divesting. LOX/LIN plant loadings are in the low 80s, and new contract signings were strong this quarter.

In Asia, sales were up 2% versus last year, with underlying sales flat, which is a change from the strong growth trend we had been experiencing. Overall, volumes were up 1%. LOX/LIN volumes were up 2%, excluding conversions as we experienced weaker steel and PV markets notably in China. Packaged gas volumes increased on continued growth of our micro bulk product line, and helium volumes were lower as product availability limited sales. Pricing was down 1% on lower liquid argon pricing due to prior year price premiums in the China spot market. Plant loadings are around 80%. New contract signings were roughly equal to the last few quarters. We expect signings will improve through the year, driven in part by China taking action to stimulate their economy.

This quarter, we continued to win business in key emerging markets. In December, we announced that INOX Air Products, our joint venture in India, will build 2 new air separation units for the growing merchant market in West and South India. One of the units will also supply nitrogen to Posco Maharashtra Steel for their Phase 2 expansion. We will also supply hydrogen to Posco from 2 steam methane reformers. We also signed a contract to provide our integrated oxy-fuel solution to Techpack in Korea. We will install a VSA non-cryogenic oxygen production unit. It will control skid and our clean fire burners to reduce emissions and improve energy efficiency and productivity for their glass production.

Please turn to Slide 7, Tonnage Gases. Tonnage Gases sales of $810 million increased 6% versus last year, with volumes up 6% driven by new plants. Sequentially, sales were down 8%. Volumes were down 2%, and we saw a 4% decline from lower energy pass-through. Operating income of $111 million declined 4% versus prior year as higher maintenance costs more than offset the contribution from new plants. As expected, operating income declined sequentially due to higher maintenance spending, favorable gases contract modifications in the prior quarter and an unfavorable polyurethane intermediates contract modification this quarter. Operating margin of 13.8% decreased 130 basis points versus prior year and 340 basis points sequentially on the lower operating income.

During our Investor Conference last year, we shared our view of the significant opportunity in the China market and specifically, large on-site oxygen for coal gasification. We are pleased to have announced another project in this important market segment. Last month, we announced the largest single on-site ASU order ever awarded to supply Shaanxi Future Energy Chemical Company in Yulin, Shaanxi Province, China. This multiple train project will produce 12,000 tons per day of oxygen and large quantities of nitrogen and compressed dry air for Shaanxi's coal to chemical plant.

Please turn to Slide 8, Electronics and Performance Materials. Segment sales of $535 million were up 2% compared to last year on 1% higher volumes and 1% higher pricing. Sequentially, sales were down 9% on lower seasonal semiconductor volumes and soft demand across the LED, display and solar markets. Electronics sales were up 4% compared to last year and down 7% sequentially on seasonality and slower market growth as we expected. Electronic materials sales were down slightly versus last year, while tonnage and equipment were higher. Electronics materials pricing was stable. Performance materials sales decreased 1% versus last year, with 4% higher prices and a 1% positive currency effect, mostly offsetting a 6% volume decline. Sequentially, sales were down 11% primarily on volume declines. The softness reflects seasonal slowdowns in key markets, including housing and construction.

Operating income of $78 million was up 13% versus prior year, and the segment operating margin improved 150 basis points to 14.6% on improved cost performance. Sequentially, operating income was down 15%, and the operating margin declined 100 basis points primarily due to lower volumes.

In new projects, we announced the onstream of the world's first on-site electronics gas plant to supply high-purity ammonia for Sanan OptoElectronics' LED production in Anhui Province, China. To support Sanan's expansion plans, we will be building a second high-purity ammonia plant at their site. Bringing in the stability and scale of the on-site business model to electronics gases is a success for both Air Products and Sanan.

Now please turn to Slide 9, Equipment and Energy. Sales of $89 million were down 21% versus prior year on lower ASU and LNG sales. Sequentially, sales declined 7% on lower LNG sales. Operating income of $7 million was down 64% versus prior year and down 37% sequentially due primarily to lower project activity. Profitability has bottomed in this segment, and while it should remain at approximately this level for the next few quarters, we expect some improvement in our fourth quarter based on anticipated orders. Backlog is up 48% over last year primarily on new ASU orders. Bidding activity remains strong, and we hope to announce several LNG orders shortly.

Now I'll turn the call back over to Paul.

Paul E. Huck

Thanks, Simon. Please turn to Slide 10. Before we discuss our outlook, let me make some comments on the sale of our Continental European Homecare business. Earlier this month, we announced that we reached agreement with Linde [ph] to acquire our Homecare business in Spain, Germany, France, Belgium and Portugal subject to regulatory agreement and employee consultation. Both of these processes are underway and on a timeline to close the transaction by the end of March. The deal has conditions to modify the price based upon future business results and receivables collections. Therefore, it is too early for us to give you a reasonable estimate of the gain which we will book.

We have also decided to exit our remaining Homecare businesses. In the second quarter, we will begin accounting for the Homecare business in total as a discontinued operation. As we finalize our restatement, we will provide history for people to update their models.

Also, in quarter 2, we will begin taking cost-reduction actions and plan to record a charge for cost reduction in our second quarter results. The charge will cover reductions needed to remove stranded cost resulting from our exit from the Homecare business. This will involve cost reductions in our corporate, regional and Merchant Gases area as we take actions to remove the cost, which Linde and other potential purchasers will not assume. The charge will also cover cost reduction necessary to appropriately size our European business cost structure in light of the European economic recession.

I know everyone has questions as to the size of the reduction, the cost and the benefits. We will detail that information later once we have everything finalized. For 2012, we expect that the sale of our Homecare business will be modestly dilutive to our earnings per share for continuing operations. We will take actions to remove the stranded costs, buyback shares and pay down debt with the proceeds that should make the transaction neutral to fiscal 2013's earnings per share for continuing operations.

Now let me give you a brief summary of our economic outlook. As we told you last quarter, we expect that the first half of our fiscal year would be slower in the U.S. and Asia, and that Europe would be in a recession. We also expected that the second half of our fiscal year would be much stronger as economic activity picks up in the U.S. and Asia. So far, we have seen that scenario play out, with continued slow growth in the United States and Asia seeing a slowdown, particularly in China as policymakers took actions to control inflation. Europe continued to decline. We expect that these conditions will continue through our second quarter.

Looking to the second half of our fiscal year, we believe that we should start to see improvements in both the U.S. and Asia. For the U.S., as the election draws closer, the debates have changed to how we can create jobs faster. This should improve both consumer and business confidence, thereby strengthening the recovery. For Asia, we have seen some easing of inflation in China. Going forward, during the second half of the year, we expect policymakers to shift their focus from fighting inflation to increasing growth. Asia will also benefit as the U.S. economy strengthens. For Europe, we expect the second quarter to be the trough. However, recessionary conditions will remain throughout the rest of the year.

In terms of Air Products, our capital expenditure guidance remains robust and unchanged at $1.9 billion to $2.2 billion, up from last year's $1.6 billion. And with one quarter completed, we are keeping our earnings guidance unchanged as well. Our earnings per share full year guidance range remains at $5.90 to $6.30.

Now let's turn to our second quarter outlook. Please turn to Slide 11. Our guidance for quarter 2 is for earnings per share of $1.37 to $1.43 based on the following factors: On the positive side, in Electronics and Performance Materials, we expect higher volumes as the first quarter is typically seasonally lower. In Tonnage Gases, profits are expected to improve on higher operating bonuses and lower maintenance costs and also, less of an impact from our polyurethane intermediates contracting renegotiation. Higher volumes from new plant onstreams, including our new hydrogen plant in Rotterdam and our new ASU in LaPorte, Texas, will also contribute. Merchant volumes should improve in the U.S./Canada as we see the impact of our fiscal 2011 new business signings partially offsetting this sequential improvement. Our effective tax rate for fiscal quarter 2 should come in between 25% to 26%. This will be a $0.03 to $0.05 headwind. We expect the Lunar New Year to negatively impact Asia volumes, and we expect currency to be a $0.02 to $0.03 headwind next quarter.

Just to clarify, at this time, the guidance for both the next quarter and the full year include the Homecare business.

Now let me wrap up. Quarter 1 started off our fiscal year as we expected. Our project backlog is strong and now totals just over $2.5 billion, a similar level to last quarter with the addition of new air separation unit projects in China, offsetting the onstream of our hydrogen plant in Rotterdam and our air separation unit in LaPorte, Texas. You can see a list of our major projects on backup Slide #13. Our recent orders, combined with the strong bidding activity, gives us a solid outlook for future growth. As we move forward, our priority remains to deliver the growth, margin improvement and higher returns that will make us the best investment choice in the industry for our shareholders. 2012 will certainly offer its challenges. However, we believe we are well positioned to make the progress we need to make to deliver our 2015 goals. Thank you.

And now I'll turn the call over to Mark to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question today from Jeff Zekauskas with JPMorgan.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Can you talk about Asian demand generally in that you talked about a flatness in your Asian merchant growth? And in the old days, when China would slow down or Asia would slow down, maybe volume growth used to be mid-single digits and now it seems much slower than that. How do you read it? Or how do you read the differences in your Asian end markets?

Paul E. Huck

Well, if you take a look, Jeff, I think what you have to remember -- I think for us is that we do have an electronics business in Asia, which last year grew from quarter 4 to quarter 1. And so -- and that also included the impact which occurs in the merchant area. This year, electronics did what it normally does from quarter 4 to quarter 1, is it contracted. So that's probably one of the big factors. It's that we were seeing the growth of electronics and we didn't see the same level of seasonality which we normally see for things. On top of that, we have also seen our volumes in China slow. And I mentioned that in my remarks principally because the interest rates have been raised a lot in China to kind of control inflation. We have seen inflation start to ease. So we don't think it's a long-term condition for them to tighten up the money supply. And that should ease sometime late quarter 2, or time is our guess. So probably not right post the Chinese New Year, with timing some time right now, we're forecasting in the March timeframe. Those are the 2 big factors for us as we look at that.

Simon R. Moore

Jeff, also just a reminder too that obviously, we continue to enjoy success in our tonnage volumes. Your question was appropriately more about the merchant with new business and new project onstream there. So we do see some strong activity on our tonnage business in Asia and China as we expected.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

And then lastly, if -- your depreciation charges were down year-over-year in the quarter. And I think the Praxair numbers, maybe they run sort of up high single digits. Is there something different in your business versus their business which is leading to a more level or down depreciation number for you?

Paul E. Huck

So -- and we have taken a look at that as to why that happens, Jeff, a couple of factors, which we'll go in. First, the currency aspect of things. So as the currency -- as the dollar tends to strengthen, which it did this quarter, it's going to drive the depreciation from our overseas facilities down a little bit with that. So there's -- that does not have an equalization of it. Plus the other thing which we have seen over time is that we have seen some facilities roll off their depreciation. So we have seen that occur. Those facilities are still operating. Obviously, it helped our margins with -- rolling forward. Plus a good portion of our capital spending right now, you can see this in the capital lease element of things. That does not get recorded through the depreciation accounts anymore. And so that's the other factor. Depending upon the -- but the way in which we treat the one-on-one on-sites does not lead to depreciation. So a lot of the large gasification plants are not going to have depreciation associated with them. It's going to have a capital receivable, which gets booked as an asset instead of PP&E and then that flows through.

Operator

Next, we'll hear from P.J. Juvekar with Citi.

P.J. Juvekar - Citigroup Inc, Research Division

Paul, your performance materials business continues to underperform the electronics portfolio. Is this really a core business for you given all kinds of opportunities that you have in your industrial gases business?

Paul E. Huck

Well, what you're talking about on the performance materials, P.J., they had a sequential downturn in volumes and a year-on-year downturn on volumes. The profitability and returns in that business are still very good for us. And so as we look at this, we think it is still an excellent business. It is not a business which introduces a lot of ups and downs and cyclicality to Air Products for things. As we look at this, we don't have large swings really in that much in our volumes overall in the business. We continue to see opportunities to get our products formulated in and to make them a steady cash flow for us. So we're happy with the business. We think it's performed very well. And so for right now, the answer is yes.

P.J. Juvekar - Citigroup Inc, Research Division

Okay. And then if you look at the commentary from semiconductor companies in January, it does materially improve and they're seeing some at the bottom. So when should you begin to see that improvement in your numbers? And what are your expectations for square inches of silicon this year?

Paul E. Huck

So as far as that's concerned, and I'll let Simon chime in here too, what we would expect is really to have a much stronger second half than the first half period. So it's probably a few months' lag on that. Simon, you are close to the business?

Simon R. Moore

Yes. Thanks, P.J. And I mean, we would still say for the year, we expect square inches of silicon to grow in that 0% to 5% range, probably right in the middle of that, which is what we've talked about last quarter. And as you pointed out, I think generally speaking, Intel talked about a stronger second half. TSMC actually talked about having a better first calendar quarter than seasonality would expect. And just one statement that we talked about a few times is our strength with Samsung, Intel and TSMC. They're expected to be almost half of the industry CapEx in 2012. So we continue to benefit from our strong position with them.

P.J. Juvekar - Citigroup Inc, Research Division

And just lastly, housekeeping. You had that slide on the project backlog. None of those projects were in Europe. So I was wondering what percent of your project backlog is in Europe.

Paul E. Huck

Yes, it is a small amount, I know, of our capital spending, P.J. I think our capital spending is somewhere about 10% to 15% of our CapEx for growth. Next year is in Europe, I guess 12% or something like that. So it might be 15%, but it's not a huge amount for that right now.

Simon R. Moore

And obviously, we brought on the big hydrogen plant in Rotterdam. We do have the one large oxygen plants in Europe that will come onstream in 2013.

Paul E. Huck

But that shouldn't surprise anyone. And given the European economy right now, when you look at things, they're not adding a lot of industrial capacity.

Operator

And our next question will come from Don Carson, Susquehanna Financial.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

For Paul, I won't be able to ask you anymore when you're going to sell off European healthcare, but I will ask you what you're going to do with polyurethanes. It seems to be a drag on the tonnage business and has very inconsistent results. Is that business making money? And tell us more about this negative contract modification you had. And then one follow-on for merchant. Your U.S. operating rate seems stuck in the low 70s. Is there a need for some capacity rationalization to get that operating rate up?

Paul E. Huck

Okay. First, with regard to polyurethane intermediates, as you know, we said this before, it's not a business in which we're investing in. We don't see the opportunity to extend in the model which we have. So we have some contracts which we are working through at this point in time. The business -- as far as today is concerned, the returns on the business are still very good. Our contracts are still very good, we think. So as far as the drag, yes, it might be a drag on growth. But a drag of the profits, no for us. And we continue to look at our options going forward for that business, but it's not a business which obviously we're going to be investing in. We can extend the model to Asia. And most of the PUI -- and most of the TDI production is moving to Asia, as you know. If you then turn to and take a look at what's happening in the U.S. in merchant, the capacity rates have been low. We would expect that we would start to see improvements in volumes in this quarter based upon -- in the signings which we have seen. Do we think we need to take capacity out? The answer is no. We believe that there are opportunities to sell that capacity. For us, we don't see any place in which we can't imagine us being able to sell that based upon the applications which we have. It was a question of us on the sales force during the Airgas transaction of not pushing as hard, not replacing people and not trying to grow the sales force. We have taken those actions. We've seen an improvement in signings. We would expect signings to improve in the second quarter of 2012 also.

Simon R. Moore

And Don, I think you also may be asked about the PUI customer, maybe just to kind of go back to that. We talked about that last quarter, and we have one specific customer that we described at last quarter we were concerned about their financial viability. The good news is they're still operating. We did end up renegotiating their contract and sequentially, that was about a $0.03 to $0.04 hit in the tonnage segment. That will not be -- the delta for the year will not be 4x that. So there is significant change for this Q1. And the impact for the rest of the year, Q2 through Q4, is probably a little bit less than it was in Q1. Okay?

Paul E. Huck

Probably -- and to clarify that, there's probably about $0.03 of bad news year-on-year still to come from what was our run rate. However, the run rate on a sequential basis is going to improve in that business.

Operator

Next, we'll hear from Duffy Fischer with Barclays Capital.

Duffy Fischer - Barclays Capital, Research Division

In October, you changed out and installed John in merchant, global merchant, as GM. Can you kind of talk about what we should expect to see differently with him running that business and what you were trying to change by putting a new person in that spot?

Paul E. Huck

Well, I think -- and one of the things, I'd say -- I think we've already talked about it. So we're going to take some actions in Europe to reduce our cost structure in that business. So the focus of the things in which we are trying to improve have been clear from -- for about a year now on that. We're trying to get the volumes up in the United States, and we think we're on the right track to do that. We're trying to get the prices improved in Europe, and we've seen some improvement there. We're trying to get our cost structure improved in Europe, and you'll see some actions coming in the second quarter for that. We're trying to improve the operating performance of the plants, and we've made progress there. You can see that in the cost, in the margins this quarter. And the last thing is improving on the supply of helium. So what we expect is for everyone to execute better.

Operator

Next, we'll hear from John McNulty with Crédit Suisse.

John P. McNulty - Crédit Suisse AG, Research Division

Just a couple of quick questions. You indicated that China slowed down a little bit at least in your merchant business based on kind of the overall slowing that the government was putting in place and that you thought that might be short-lived. What are you seeing on the tonnage side in terms of request for proposals and new projects? Have things slowed down there? Or is that the kind of "steady as she goes"?

Paul E. Huck

The answer is yes. We have seen a slowdown in China. It has not affected really on the on-site projects or the equipment projects, which we're chasing there. We still see a good backlog and a lot of bid activity.

John P. McNulty - Crédit Suisse AG, Research Division

Okay, great. And then just one follow-up question. A lot of the growth or at least a reasonable amount of the growth in the U.S. over the last decade was largely to -- tied to energy efficiency, where natural gas prices were high, oil prices were high and your customers were looking to be more efficient using things like oxygen. With natural gas kind of in the 250 to, say, 275 range, how should we think about the potential hit to your business there, if there is any, kind of looking forward?

Paul E. Huck

So -- as far as people, it certainly is going to have a damper on people trying to increase the efficiency of natural gas because their benefits are going to be lower. Oil is still relatively high as far as you look at that. And other products are still relatively high, which provide energy, electricity prices, albeit a lot, but they're still at high prices for things, especially due to things like environmental rigs or things. So I think there's is going to be some hit to the opportunities for things going forward. But the other thing is that it's going to open up chances for us to do other things with things, and we're exploiting those opportunities there too.

Simon R. Moore

Well, I think we also believe that low energy prices are very good for the economy, which helps provide general economic growth as well.

Operator

Next is David Begleiter with Deutsche Bank.

James Sheehan - Deutsche Bank AG, Research Division

This is James Sheehan sitting in for David. Just with respect to pricing in Europe, you started to see some improvement there on the liquid/bulk side and packaged gases. I'm just wondering about your outlook for pricing going forward given the economic headwinds there. And do you -- can you comment a little bit about what you're continuing to see in terms of competitive pricing pressure?

Paul E. Huck

Okay. As far as the pricing in Europe, we expect that -- and that the prices will continue to improve. There is still cost pressures for us with the need to recover our increased power cost, increased cost of diesel in Europe. So we still see that as a driver for us. As far as the competitive pressure, the business has always been competitive. I think we commented on last quarter is that we see our -- we also see our competitors showing a need for price increases also as everyone isn't happy with their margins and their returns in Europe. So we have seen our competitors raise prices also.

James Sheehan - Deutsche Bank AG, Research Division

Okay. And then back on performance materials. We're starting to see some initial signs of maybe a perking up of the construction market. What is your outlook on construction? And do you see any material change going forward in 2012?

Paul E. Huck

The outlook for us in construction, I think, is still -- and we're still -- I'm going to say we're not going to be bullish on that yet as far as that is concerned. Our performance materials business though has performed very well and is prepared to respond to that. I would expect the volumes to grow from quarter 1 to quarter 2 and to continue to grow in quarter 3 to quarter 4.

Operator

Kevin McCarthy with Bank of America Merrill Lynch has a question.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

With regard to the European Homecare sale to Linde, what is the amount of cash proceeds that you would expect relative to the sale price of EUR 590 million? And what is your expected split of deployment between share repurchases and debt reduction that might be included in your annual earnings guidance, please?

Paul E. Huck

Thanks, Kevin. And so with regard to that, we're going to have to pay taxes on this. Given where we see that today, we think that probably about half of the -- no, excuse me -- if you look at the proceeds, probably about 20% or so is going to wind up going to cash tax payments for us to make, and that will not -- and it isn't the same as booked, obviously, there, because you'll have depreciation in there. And then we will probably come pretty close to half of that being used for share buyback, half of that being used to reduce debt overall.

Simon R. Moore

And just Kevin, I would -- just as a reminder also that we may not see that full level of proceeds as Paul mentioned.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Okay. And then just to follow up, you've got remaining assets in Brazil, Argentina, United Kingdom. If I understand you correctly, you're moving all of that into discontinued operations in the fiscal second quarter. Maybe if you comment on what prospect of divestiture looks like there and remind us how large those businesses are in the aggregate.

Paul E. Huck

Yes, and so if you look at the business overall for us, about 80% of the business fits on the continent in what we're selling today. The bulk of the rest of it sits in the U.K. And then the business in Ireland, the business in Brazil and Argentina are all small.

Operator

Our next question will come from Bob Koort with Goldman Sachs.

Robert Koort - Goldman Sachs Group Inc., Research Division

Paul, I know most of your contracts in tonnage and hydrogen allow for pass-through of gas or electricity. Is there -- are there any opportunities there to harvest certainly the release in gas and maybe some help in electricity? And why wouldn't we have seen more pronounced effect on the margin percentage?

Paul E. Huck

So Bob, what you're saying is that on the drop in gas prices, you're expecting to see a bigger increase in margin percentage on the on-site business on the tonnage. So you have seen -- remember that gas prices have been down for a while now. And so we haven't seen a tremendous difference. If I look at my average gas price from quarter 1 of last year to quarter 1 of this year, gas price is probably down maybe about 7% or 8%. It's not down a huge amount for us. So it's been down for a while. And so I think -- and that play has already come through the margin walk for us.

Robert Koort - Goldman Sachs Group Inc., Research Division

Can I ask you about the growth path you've laid out, Paul? At -- in one of the positive attributes of the gas industry, it's more stability and steadiness yet. It looks like the guidance implies something around a 20% or 22% lift in second half versus first half of the fiscal year. Is -- do you think there's a great degree of risk there? Is there a historic precedent that gets you comfortable you can see that kind of elevation in the second half? Or how would you characterize the path this year compared to maybe other periods?

Paul E. Huck

Okay. And so I think what we see happening from an economic standpoint is somewhat the reverse of what we saw at 2011. If you go back to the comments which we made on the economy and what we saw in underlying sales growth in 2011, we saw underlying sales growth come out in the first half of the year, 11% to 12%. In the second half of the year, we saw the underlying sales growth dip to -- I think it was 7% in quarter 3, 4% in quarter 4. So we saw a slowdown and most of that, as we look at it, came from the economic picture because we saw economy started to slow around the world. We saw the U.S. growth rates drop, manufacturing wise. We saw Asia started to come off. We certainly saw electronics started to come off in our fourth quarter, I think. So we saw a number of things. And we saw the European economies and start to go into a recession through the last half of 2011. So what we're -- as we look at this, we think 2012, from a growth standpoint, in the first half of the year, because of the carryover from 2011, it doesn't start with a lot of momentum behind it. And the economic picture in the first half of our fiscal year, we think, is slow. However, as I said in my remarks that the policy in the United States, we ought to be start talking as the election starts to become clear and more things turn towards how jobs are going to be created, that should lift consumer confidence, should lift the confidence of businesses to invest. And so we see people start trying to increase production. In Asia, we think that they -- and they've taken steps to fight inflation. We think those steps probably have had the right impact in China, but we also think that China is going to turn to a more stimulative process -- policy. In Europe, quarter 2 is likely to trough. So sequentially, things ought to start be getting better. We'll still be in a recessionary period and down on the comps year-on-year, but sequentially, we'll start -- we should start to see growth after quarter 2. And so as far as the economy is concerned, we think it's down in the second half. So if you want to say risk, yes, there is risk in our economic scenario. If you take a look at our products, typically, our product seasonally has a better second half than first half. So in this year, the impact of the second-half pickup, which we normally see, is also going to be added on to a better economy. So that's why the growth is much stronger for here. We also see a number of plants coming onstream in the second half. You see that in the backup slide. And we expect a pickup in LNG orders, which we think starts to show in the fourth quarter profits in the -- on the equipment business trying to get better. So those are some of the reasons. There is risk on it. Yes, we have made a call on the future of the economy, but we do think that as our future looks, things are likely to get better.

Robert Koort - Goldman Sachs Group Inc., Research Division

And so Paul, just to conclude there, you would still expect global manufacturing up 2%, 3% or 4%, something like that?

Paul E. Huck

Yes, if you take a look at the economy, then we said we saw global manufacturing up 2% to 5%, we think it's probably coming out close to the middle portion of that range right now for us. The U.S. probably goes -- if the U.S. starts to get better as the fiscal is trying to indicate, it might go to the higher end for the U.S. Europe probably stays to the lower end of our previous forecast.

Operator

Our next question will come from David Manthey with Robert W. Baird.

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

Just 2 quick questions. First, in terms of the equipment business, could you talk about how volume sensitive that business is? And if you got backlog up 40-some percent this quarter, why does profitability not improve until the fourth quarter? And then second question, if you could specifically isolate the impact of higher maintenance cost on the tonnage segment EBIT margin this quarter, that would be great.

Paul E. Huck

And the last one was what? I missed that.

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

I'm trying to understand exactly what the impact of just the increased maintenance costs were on the tonnage segment EBIT.

Paul E. Huck

Okay. Yes. I'll handle that. I know it's probably $0.02 to $0.03 a share on the EBIT aspect of things, all right? If you take a look at the equipment business end, the issue here for us is -- on the backlog, is the backlog includes LNG orders. It includes the air separation orders. As we consistently said on the LNG side that the profitably for that business is a lot better because we aren't selling a lot of purchase equipment along with the stuff we manufacture unlike we do in the air separation side. So the LNG backlog is actually down for us. And that's why as we look to the future, we are expecting the LNG backlog to pick back up. And when that happens, the profitability in the equipment business will improve.

Operator

Next, we'll hear from Mike Harrison with First Analysis.

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

I was curious about your comment that you're seeing lower volumes in your U.S. and Canada merchant business, lower volumes to distributors. Given that those distributor customers are typically serving the manufacturing market, which according to all the work we've done suggests things should be pretty strong in the U.S. How do you account for the weakness that you're seeing right now?

Paul E. Huck

And so for us, what we see is that construction markets are still depressed as far as that. And distributor markets tells a lot about construction markets. So we haven't seen a lot of the big pickups in capital spending for us either which -- in the U.S.

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

And then I wanted to ask also about the tonnage business. Historically, that business had been more stable in terms of the quarter-to-quarter operating income in terms of dollars. And here over the last 3 quarters, we've seen a $40 million swing-up last quarter and back down this quarter. Is this a new pattern of volatility that we're going to see kind of contract modifications, swinging one way or the other or maintenance costs being concentrated in one quarter and not in another? Or do you think this pattern we've seen in the last 3 quarters is a little bit more unusual? I'm just kind of trying to get a little bit better sense of any kind of how to model it going forward?

Paul E. Huck

Okay, Mike. And that's, for us, we have taken a look at that. So I'm going to break it into 2 pieces. The contract mods, there is never a pattern to them. We had an unusual mods, which occurred in the last quarter, in quarter 4, which brought a lot of profit for us. That is not going to happen typically in the business. So I would not say that -- that was a one-time event for things. The other thing which we had in this year is we have the mods to -- on the polyurethane customer, which helped him survive a difficult time. For those things that caused us some profit, it's going to cost us a little bit ongoing, but that also was a one-time item. Now if you turn to does the business have a seasonal pattern? The answer to that is yes on the side of hydrogen, unfortunately, and not so much on the oxygen side. But remember, about 2/3 of the business is hydrogen for us. And so what we see is the bonuses for us peak in quarter -- in our Q4 and the maintenance spending is always the lowest typically in our Q4. And so that's always going to introduce more profit into Q4 for us typically than in the other quarters. So -- but last quarter, we had the impact of the mods, which obviously helped us. They didn't reoccur. The maintenance increased from quarter 4 to quarter 1. So that's why you see the large peak, and then we also -- the large drop. And also, the mods to the polyurethane customer. So quarter 1 was an unusually low quarter, but quarter 4 was an usually high quarter last month. So -- and you're just seeing that. I don't think you're ever going to see swings like that without unusual one-time items happening like, Mike.

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

And is maintenance spend typically highest in your fiscal fourth quarter then?

Paul E. Huck

No, it's not. It's typically -- if you look at that, it depends upon when the turns are scheduled. It could be anywhere in quarter 1, quarter 2 or Q3, depending upon how much is due at that particular plant at that particular time for us.

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

Okay, all right. And then the last question I had was related to the helium capacity that you're bringing on. Has that been delayed? Or can you maybe update us on the timing of that new capacity in Wyoming?

Paul E. Huck

Okay. And the capacity right now is -- and we are waiting for the crude supply to come from our customers. It's being installed, a gas processing facility. We currently expect that to come onstream at the end of quarter 2.

Operator

And our next question will come from Laurence Alexander with Jefferies.

Laurence Alexander - Jefferies & Company, Inc., Research Division

I guess 2 questions. First, is there any sort of anything unusual on the real estate sale side that will skew free cash flow generation this year?

Paul E. Huck

No.

Laurence Alexander - Jefferies & Company, Inc., Research Division

And secondly, are you seeing any shift in competitor behavior in China that will help sort of make the comparisons easier on the next recovery?

Paul E. Huck

I don't think we're -- as far as China is concerned, the market and the dynamics remain the same. It's a competitive market, and we think we are positioned well and have a good set of products chased in the on-site orders.

Laurence Alexander - Jefferies & Company, Inc., Research Division

And lastly, can you give an update on what you're seeing on your cement market, customers in North America?

Paul E. Huck

Cement customers. I'm going to pass that to Simon, who will probably handle that in an update with you, okay?

Simon R. Moore

Yes. We'll follow up on that, Laurence. Thanks.

Operator

Next, we'll hear from Mike Sison with KeyBanc.

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

In terms of the operating margin improvement sequentially, first quarter versus the fourth quarter, of merchant, can you give us a little bit more color on the operating performance? Did you cut costs? Were you just running the plants better? And is that 100 basis point improvement somewhat sustainable as we head into the rest of the year?

Paul E. Huck

The answer is yes. It is sustainable. And it didn't come from volume, obviously, as you see that sequentially. And it's by principally -- and the plants going out and running well, we also had, towards the end of the quarter, the argon sourcing improved for us, with the LaPorte being onstream in the U.S. And so that -- and that helped also, of course.

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

Okay. Then just on tentative basis when you think about electronics here, your fiscal first quarter was good. You've seen a lot of other companies see further destocking or such in the December quarter. Do you feel better as we head into the fiscal second and third that electronics could even pick up sequentially?

Paul E. Huck

Yes, I think it would. Yes, and we believe electronics is going to pick up sequentially, quarter 1 to quarter 2, and even more so in quarter 3 and quarter 4, Mike.

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

Great. And last question in tonnage, you've got 6% volume growth in the first quarter. Does that number accelerate with the projects coming onstream? Or does that just sort of support that level as the year unfolds?

Paul E. Huck

It should actually get better as the year unfolds for us as far as for this year.

Operator

And our final question will come from Mark Gulley with Ticonderoga Securities.

Mark R. Gulley - Ticonderoga Securities LLC, Research Division

Getting in under the wire, a few questions on tonnage, actually. One is with respect to -- I want to go back to back -- I'm sorry, financial side, the debt pay down. You said the split between share repurchases and debt pay down will be about 50-50. With interest rates so low, Paul, why would you want to pay down any debt whatsoever?

Paul E. Huck

And the thing which we are going to manage, Mark, is we're going to manage to a debt rating for us. And so as we look at our capital spending and everything like that and our cash flows, we have a Eurobond which is coming due in the beginning of April. And we're going to use the bit of proceeds to pay down the Eurobond for us. And then if capital spending needs go up, we will borrow more, but we're managing toward -- right now to be a debt -- to be A rating.

Mark R. Gulley - Ticonderoga Securities LLC, Research Division

Okay. And then my on-site question was this. Given the very low natural gas cost in the U.S., does that affect the economics of refinery of hydrogen enough that stimulates demand? Or is that just a small part of the cost that it's -- it does not really move the needle all that much? I'm talking about customers' economics now.

Paul E. Huck

Yes. And so it is certainly going to help crack spreads for them. It certainly will help if they're going to export products out of the U.S. into other countries for those things. So it does help them in that way, Mark. As far as driving the price of gas down for us overall, it's not going to have a big impact of that, which -- to take gas from $3.50 to $3, it’s not going to do that.

Simon R. Moore

Okay. Thanks, everyone. Please go to our website to access a replay of this call beginning at 2:00 p.m. today. Thank you.

for joining us, and have a great day.

Operator

And that does conclude today's conference call. Thank you for your participation.

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