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Airgas, Inc. (NYSE:ARG)

Q4 FY08 Earnings Call

May 6, 2008, 11:00 AM ET

Executives

Jay Worley - IR

Peter McCausland - Chairman, President, CEO

Michael Molinini - COO and EVP

Robert M. McLaughlin - Sr. VP and CFO

Analysts

David Begleiter - Deutsche Bank Securities

Michael Harrison - First Analysis

Robert Koort - Goldman Sachs

Laurence Alexander - Jefferies &Co.

Kevin Mccarthy - Banc of America

Mark Gulley - Soleil Securities/Gulley & Assoc.

Michael Sison - Key Bank

Holden Lewis - BB&T Capital Markets

Operator

Good morning and welcome to the Airgas Fourth Quarter 2008 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 at the end of the call. And for opening remarks and introductions I'll like to turn the call over to Director of Investor Relations, Jay Worley. Please go ahead sir.

Jay Worley - Investor Relations

Good morning and thank you for attending our fourth 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 last evening and is available on our website as are the slides that accompany this teleconference. To follow along please go to aigas.com, click on the Investor shortcut at the top of the screen and then go to the conference calls and webcasts page.

During the course of our presentation we'll make reference to certain non-GAAP financial measures. Please note the 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 noon Eastern Time. Now I'll turn the call over to Peter to begin our review.

Peter McCausland - Chairman, President, Chief Executive Officer

Thanks Jay, good morning and thank you all for joining us. Fiscal 2008 was a wonderful year for Airgas. It was a record year for earnings and free cash flow. It was a record year for acquisitions. We delivered on our commitments to our shareholders, our strong operating culture grew even stronger and we achieved strong internal growth in an economic environment which weakened throughout the year.

The internal growth which we experienced throughout the year and which seems to be continuing together with the strengthening of our operating culture are the things which really excite me and the other 14,000 Airgas associates. We sense that we are over the hump in terms of transitioning from an acquisition company to an operating company and that we have the people and processes necessary to drive internal growth as well as acquisitions going forward.

During the year, we generated 11.4% growth in our strategic products which were selected because most of them grow faster than the economy overall because they generate sales to non cyclical customers segments like healthcare, environmental, research, food and beverage and because they represent great cross sale opportunities to our 1 million plus core customers. We are also targeting industries which offer the best opportunities in our core products and we have had great success in energy and infrastructure construction and the export manufacturing sectors. I believe we've made significant improvements in sales and in operations and that it is showing up on the bottom line. Mike will give you some of the details on our sales performance in a few minutes.

As you can see from our guidance, we are expecting another year of growth and record profit performance barring further deterioration of the U.S. economy. We also plan on increasing our dividend those are our earning and free cash flow goals. With respect to the latter, we had a great year with free cash flow of $225 million which we used to make acquisition of businesses with similar cash flow characteristics using a cash flow financial model. Our intense focus on free cash flow over the years continues to pay off in higher earnings and tremendous financial flexibility.

We've been able to invest in our outstanding business platform, make numerous acquisitions and repurchase shares when opportunity knocks as it did last quarter when our share price drop to around $40 for a brief period of time.

Turning now to the quarter financial highlights. Earnings of $0.76 per diluted share exceeded our expected range by$0.03, representing another record quarter. Sales in the quarter increased 27% to $1.1 billion with acquisitions contributing 19% of the quarter sales growth. Total same-store sales grew 8% with price up 4% and volume up 4%. Our same store sales were 4% and gas and were 11%. Our profitable growth continues as operating margin in the quarter reached 12.1% which was a year-over-year improvement of 120 basis points.

Looking closer at quarterly results across our geographies, the Northwest [ph] and Pacific Northwest posted the strongest gains related to energy, non residential construction and metal fabrication. And when we talk about non-residential construction we are talking about infrastructure construction much of it in the energy and power sectors. The Gulf States and southwest also perform well driven by investments in energy infrastructure and petrochemical industries. Energy and infrastructure construction remained strong as do our customers in the medical, research, environmental and food and beverage segment. We did see some moderation in our Hardgoods same-store sales growth this quarter, primarily in equipment. There are some questions as to how much the quarter suffered from the impact of weather and the Easter holiday and we are encouraged with the rebound we see in April. Ferrous [ph] medals, other consumerables and safety products are still growing nicely. Rising material costs are likely to drive high goods prices higher in the coming months and we expect to keep pace with these cost increases as they occur.

Volume growth should continue to be positive but moderating compared to fiscal 2008. Highlights in the fiscal year include 25% sales growth to $4 billion dollar with same-storage sales growing 7%. Adjusted earnings per share grew 34% to $2.68. As I mentioned earlier we generated strong free cash flow of $225 million compared to a $107 million last year, paid out a 39% increase in the dividend year-over-year and re-instated our share repurchase program.

This was a truly land mark year for Airgas in acquisitions with over $500 million in acquired revenue. Slide 3 gives the full overview of this activity. The largest stand out on the chart is the acquisition of Lindy's U.S packaged gas business which added $346 million in revenue from 138 locations across 18 states and significantly enhanced our presence in the Pittsburg to Chicago corridor. We are pleased with our integration process... our progress as we met our goals to complete the majority of the integration works for the Linde Packaged Gas business by the end of fiscal 2008. There is still work to do to complete the integration, but most of the integration expense is behind us and we look forward to realizing additional synergies in the coming months.

We continue to acquire companies in our core packaged gas business after the Linde acquisition and we also maintain our focus on product lines with acquisitions in safety products, ammonia and refrigerants. The 17 transactions we completed in addition to Linde exceeded the $160 million of acquire annual revenues $30 million of which were in product line agencies adjacencies.

In the coming year we expect to be able to make more acquisitions in our core business and adjacencies and we believe we can meet or exceed our goals of $100 million to $150 million of acquired annual revenue.

Our first acquisition in fiscal 2009 was A&N Plant, a European based supplier of positioning and welding equipment for sale and rent. A&N operates in Europe, Asia and the Middle East serving a diverse customer base in offshore and on-shore oil and gas, petrochemical, power generation, environmental, industrial plant and steel fabrication industries. The company will join as part of Red-D-Arc and is an excellent addition as we expand in the far markets we will continue to evaluate international opportunities over our primary focus remains on domestic, core and product line acquisition throughout fiscal 2009.

So to sum up it's been another record breaking year at Airgas and I have never felt this good about our business as I do today. We have the right strategies, the right operating models and most importantly the right people to continue delivering exceptional results.

I'm confident that the implementation of our core strategy too which is designed to sharpen our focus on customer service will also ultimately cause each of our 1 million plus customers to feel like they are truly one in a million. We remain mind full of the economic environment and we're still optimistic. Airgas is positioned to grow during this time and to deliver value to customers and shareholders in the coming year. Mike will now give you this year's review of operation.

Michael Molinini - Chief Operating Officer and Executive Vice President

Thank you, Peter. We've just completed one of the most exciting years in our company history and are carrying significant amount of momentum into fiscal 2009. We posted strong financial performance, integrated the largest acquisition in company history and continued to execute well on our core business strategy. We are seeing success in our market strategy such as energy and infrastructure construction, biotech and life science and medical gases.

We continue to engineer solutions for our customers, meeting needs with technology and innovation, enhanced supply chain capabilities in our national footprint. Our sales and operation teams are the strongest they have ever been and will continue to gain strength together in the pursuit of outstanding customer service.

Please turn to slide 4 that begin our operational review. Our strategic product categories of bulk medical and specialty gasses, carbon dioxide and safety products make up about 40% of our revenue. They continue to outperform and drive growth as many of these product categories are focused on non cyclical customer segments like medical life sciences, environmental and food and beverage. Total strategic products posted 11% organic growth for the quarter and 11% for the year. With 11% compound annual growth rate over the last three years.

Safety products performed well with same-store sales growth of 8% for both the quarter and the year. Safety is a strong cross selling opportunity for us because so many gas and welding customers also need safety products. We are also proud of our performance as a safety supplier. In fact we recently won the gold level following performance excellence in our work for safety business. Out of Boeing's 10,000 worldwide suppliers we're one of 48 to win this award. Not only it is an excellent example of our ability to deliver appropriate solutions for our customers needs, it also reflects our drive and determination to consistently deliver outstanding customer service.

Bulk same-store gas sales were up 17% for the quarter and 15% for the year driven by enhanced production capabilities and a strong sales force, is a tremendous example of convergence and momentum as the expertise we gained with our Linde Bulk acquisition is combined with our talented and sizeable sales force to capitalize on good market opportunities. Specialty gas sales grew 15% for the quarter and 15% for the year driven by demand from key customers in Biotech, Life sciences research and Environmental monitoring. This is also an area where Airgas innovation as made significant impact on the supply chain as we have implemented production automation that improves quality, consistency. We're simultaneously reducing retime and expense.

Medical sales were strong with 10% growth for the quarter and the year. Primarily focused on respiratory therapy, the target market for our medical business will continue to grow with the population. About two thirds of our medical businesses is focused on hospitals and doctor or general practices both of which have strong future growth prospects. CO2 was up 10% for the quarter and 9% for the year. Food processing, Food and Beverage Service, Pharmaceutical and Biotech industries continue to generate good growth in CO2.

We expect to be able to deliver similar results in strategic product categories in the coming year in our three year plan calls for strategic products growth of 7% to 10% per year. On the next slide we have some key growth strategies that are driving our core business. These are marketing initiatives or product offerings wherein we have strong growth opportunities and are competitive advantages. One touch offering is our strategic accounts business which grew 13% business for the quarter and for the year. Our national infrastructure, technical expertise and broad product offering creates real value for customers with multiple locations and has enjoyed recent success with contractors who work multiple job sites.

One of our strongest performances of the year comes from our energy and infrastructure construction focus with sales up 33% for the quarter and 35% for the year. Our contractor customers are not involved in residential construction nor are they heavily involved in building office buildings or shopping malls. Over two thirds of our contract of business relates to energy and infrastructure construction which still has favorable growth outlook for the coming year.

Same store sales for our ready Red-D-Arc rental business which is heavily related to the construction business increased 28% for the quarter and 24% for the year. We expect continued growth from our Red-D-Arc business as we expand our offering domestically and expand operations internationally through the A&N plant acquisitions. Radnor private label products also continue to outperform the market posting 34% growth for the quarter. Half of that growth came from existing product lines and the other half was divided equally between growth related to product line extensions and the introduction of the Radnor brand in the recently acquired Linde stores. Radnor product penetration enhances our profitability as the Radnor line carries gross margin that are higher than that of comparable branded products.

Airgas Specialty products is another business unit with product line adjacencies that complement our distribution business and it posted over 20% same-stores sales growth this year. Largest product line is ammonia and one of our fourth quarter success stories is another great example of our ability to customize our solutions for customer needs. When the fifteen mile in anhydrous ammonia pipeline that runs from BP to Bayer in Baytown, Texas had to go... undergo emergency maintenance, our team jumped in the action to provide Bayer supply and assist with pipeline repair. In just over a month, we delivered more than 650 truck loads of ammonia to Bayer, helped Bayer continue operations and help with the purge of the pipeline. We even transported the flush products to ammonia facilities for reuse. This is the largest ammonia project that we have ever undertaken with accomplished with commendations from both BP and Bayer.

Our refrigerant business, a smaller component of Airgas specialty products also had a very strong fourth quarter. Refrigerant business has a seasonal dynamics during the latter half of our fourth quarter as customers prepare for the upcoming warm weather and our growing presence in the business enhanced our for sale this year. In addition, as production of various refrigerants is phased out over the coming years, there would be a greater need for reclamation services. Airgas is positioned well to become leader in not only distribution but reclamation of refrigerants as well and we expect to get there through strong organic growth and acquisitions.

While we focus on growth initiatives to build sales and growth profits we are on schedule for delivering our $10 million goal of run rate savings from operating efficiencies next year. The UT specialty [ph] technical labs are regularly meeting targeted savings and we are encouraged by the initial distribution and logistic projects we've undertaken. Suffices to say we are just starting to realize benefit in optimizing our distribution and as savings become more and more significant in the face of rising fuel cost. As Peter said we are keeping a weather eye on a U.S economy but believe we are in a great position to continue delivering our commitments to customers and shareholders in the coming year.

Now Bob will give our financial review of the quarter.

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

Thanks, Mike and Good morning everyone. We continue to execute well across the board and we have delivered strong results for both the fourth quarter and the full year. To review our consolidated results we will start with slide number 6 and as I go through these results please note that we have GAAP reconsolidations of the various metrics on slides 10 through 12.

Quarterly earnings per share grew 41% year-over-year to $0.76 in the fourth quarter. Sales increased 27% to $1.1 billion reflecting strong performance in our strategic product categories and with acquisitions contributing 19% of the growth. Same-store sales increased 8% with Hardgoods growing at 4% and gas and rent 11%. Same-store sales growth was driven evenly by price and volume. Gas and rents represented 59% of our sales mix comparing favorably with the prior year mix of 56.7%. The make shift is driven by the current acquisition and strong growth in Gas and rent.

Gross margin was 51.9%, an increase of a 100 basis points over last year reflecting the favorable GAAP rent mix and effective management of costs and pricing. Acquisition integration expense was $2 million for the quarter primarily related to the Lindy integration the majority of which is now behind us. Operating expense as a percent of sales was 35.3% an improvement of 20 basis points over the prior year. The impact of acquisition and integration expense added 20 basis points to this ratio. Sequentially, the ratio improved 60 basis points from our third quarter.

Operating income for the quarter was a $131 million, up 41% over last year. Operating margin improved 120 basis points from 10.9% to 12.1%. The strong underlying improvement reflects continued operating profit leverage on organic sales growth, realization of operating and acquisition synergies and effective management of costs and expenses.

There were 84.6 million weighted shares outstanding for the quarter, up 2% from last year but flat sequentially. We recently reinstated our share repurchased program and repurchased about 500,000 shares for $22 million, leaving $116 million of authorized spend available on our buyback program. Our return on capital is 13.2%, 10 basis points below the prior year. Prior to full integration and achieving our targeted synergies, the Linde acquisitions negatively impact our return on capital. The integration expense alone has reduced this return ratio by approximately 30 basis points. Subsequent the full integration and synergy attainment, these acquisitions will contribute returns consistent with the base business which generated strong improvement in return on capital this year.

Our primary working capital metrics held consistent with recent trends with DSO at 48 days and inventory turns at 4.5. For the full year, free cash flow grew to $225 million, compared to $107 million last year driven by strong growth in operating cash flows, effective working capital management and disciplined capital expenditures. Free cash flow for the fourth quarter was $63 million, the third consecutive quarter over $60 million. Adjusted debt at the end of the quarter was a little over 1.9 billion, and our adjusted debt to EBITDA ratio is now just below 3, comfortably in the middle of our target range of 2.5 to 3.5.

Please turn to slide 7 and look at our segment results. Distribution sales were up 26% to $904 million for the quarter with same store sales growth 7%. Distribution, gas and rent was up 9% and Hardgoods up 4% with price accounting for roughly two thirds of the growth and volume one third. Total distribution gas volume was negatively impacted by approximately 2% due to helium product shortages. Gas and rent represented 54.3% of our sales mix compared to 51.8% in the prior year. Gross margin was 50.3%, an increase of 90 basis points over the prior year. Similar to total company results, current year acquisitions and strong growth in gas and rent revenues grow both the gross margin improvements and the gas and rent increase in the sales mix.

Operating income in the distribution segment for the $113 million, 48% over the prior year. The related operating margin improved 200 basis points to 12.5% driven by the impact of the Linde bulk acquisition, acquisition and operating synergies and operating profit leverage on sales growth.

Sales in all other operations increased 49% with same-store sales up 17% driven by strong growth in refrigerants, ammonia as well as CO2 and dry ice. Acquisition contribution was lead by the Linde Bulk business the majority of which constitutes inner company sales to the distribution segment where the end customer revenues reside. Operating income was up 7% for the quarter and operating margin decreased 310 basis points driven primarily by the layer on [ph] of Airgas Fortune Gases, an internal supplier to the distribution segment and by the layer on fund for the National Welders portion of the Lindi package gas acquisition. In addition product dislocations of atmospheric gases CO2 and dry ice caused significant incremental distribution expense that diluted the operating margin. Most of the dislocation was related to various planned outages that are not expected to reoccur.

Please turn to slide 8, capital expenditures. Year-to-date capital spending was $267 million verses $238 million last year and decline by 100 basis points as a percent of sales from 7.6% last year to 6.6% this year. Spending has remained relatively stable across all categories. The increase in the other category includes spending associated with large plant infrastructure investment such as the kerosene, new car [ph] oil ASUs under so planned projects.

Slide 9 presents our fiscal 2009 guidance. We expect to earn between $3.24 and $3.40 per diluted share next year representing a 22% to 28% increase over the prior year. Expectations for the first quarter of fiscal '09 are $0.79 to $0.81 representing an increase of 25% to 29%. Our full year guidance assumes mid-digit single digit same-store sales growth with an operating margin of 12.4% to 12.8% and a tax rate of 39% to 39.5%. We anticipate capital expenditure in the range of 7% of sales partially driven by ASU and CO2 plant investments as well as facility investments and improvement related to the Linde packaged gas and other acquisitions. We have assumed a continuation of the current U.S economic environment in our guidance with little if any recovery in the latter part of the year.

As noted at the bottom of the slide we identified some key components driving our projected EPS growth. We have broken these components into two broad categories with both equally contributing to the growth. The first category represents projected growth of the base business included targeted operational efficiency programs. The second category reflects savings related to the acquisition synergies and reduced integration expense primarily related to the Linde acquisitions, reduced average interest rates driven by reductions in the latter half of fiscal '08 and the absence of the $0.03 national loaders charge which impacted fiscal '08. I will now turn it back to Jay to begin the Q&A portion of the call.

Jay Worley - Investor Relations

That concludes our prepared remarks. As we begin the Q&A portion of the call we ask that you limit yourself to two questions and one follow-up and then get back in the queue if you have further enquiries. Tony will now give instructions for asking questions.

Question And Answer

Operator

Thank you sir. [Operation Instructions]. Again, we do ask you please limit yourself to two questions and one follow up. [Operation's instructions]. And we would go first to David Begleiter of Deutsche Bank Securities

David Begleiter - Deutsche Bank Securities

Good morning.

Peter McCausland - Chairman, President, Chief Executive Officer

Morning

David Begleiter - Deutsche Bank Securities

Very nice quarter Peter. Hey, just on the construction business which grew 35% in '08, what's your expectation for the growth in 2009?

Peter McCausland - Chairman, President, Chief Executive Officer

We signed a lot of new business and we are expecting robust growth in our construction segment. I don't want to speculate on whether or not we do 35% again but I think it would be really good because there is a lot of projects out there, refinery expansions, airport expansions, bridge repairs, ethanol plants, power plants, natural gas pipelines and we really positioned ourselves to win a lot of these business, we've invested heavily in assets that are used on construction sites and we've invested in a national sales team and also local construction specialists, we've extended our products, service offerings and we are looking at additional acquisition that would even extend that further we've setup construction zones within our stores, there's about 35 or 40 of them now and more on the way. So hotshot delivery vehicles that a lot of our branches in the areas where there's a lot of construction business. So we've done a lot to earn this business and these customers are very demanding but given the good outlook, we expect robust growth next year.

David Begleiter - Deutsche Bank Securities

And Rob, for '09, can you just quantify the size of the acquisition synergies and the integration expense fall off for '09 versus '08?

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

Well we combined them all as you see in the slide. The acquisition synergies and the integration expense fall off are the largest components of that second component. But we don't put a specific number on that piece of it.

David Begleiter - Deutsche Bank Securities

Thank you.

Operator

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

Michael Harrison - First Analysis

Hi good morning.

Peter McCausland - Chairman, President, Chief Executive Officer

Good morning

Michael Harrison - First Analysis

Peter, you said your... you made a comment that your over the hump in terms of transitioning the company from an acquisition company to an operating company. I was just wondering can you give us a little more of a hint on how we should interpret that and maybe if that's a signal at all that you're slowing down a little bit in your M&A activities?

Peter McCausland - Chairman, President, Chief Executive Officer

Well that's not what I said, it's a signal or anything negative. We're not slowing down. We just finished a record year and we also said in the call that we're confident that we're going to meet or exceed our goal for next year, this current year's acquisitions and I can assure you the pipeline is full and I think we're pretty good at these things and we're getting better. I was just making an observation about the business. We've just gotten much more professional, our talent is a lot deeper than it's ever been. Then we've been able to put together market focused sales and marketing groups and bring in all of the capabilities to the company and bring them to their... for the benefit of customers like the construction customers but also in other area like utilities and it just seems to me that we have a lot of really good sales and operating momentum and that was the reason from my observation.

Michael Harrison - First Analysis

Alright. I appreciate the additional color there. And then there were some comments made about additional cost related to atmospheric gases as well CO2 and dry ice, having to move some of that supply around. Can you give us an update on the Deer Park CO2 facility and whether that's still on track to be completed in late '08? And then what sort of cost you might be dealing with during the summer months as a result of having to bring in CO2 supplies from Mississippi?

Peter McCausland - Chairman, President, Chief Executive Officer

The Deer Park Plant is still on track. We expect to get final permits within the next two weeks and it will be... should be on stream late '08 early '09. The... we've been operating today by moving products from Mississippi into Texas, so I'm not expecting that we're going to see anything materially different then what we've already been experiencing.

Michael Molinini - Chief Operating Officer and Executive Vice President

Except of seasonal volume --

Peter McCausland - Chairman, President, Chief Executive Officer

Yes,some additional volume, Yeah.

Michael Harrison - First Analysis

Alright. Thanks.

Peter McCausland - Chairman, President, Chief Executive Officer

Not material.

Operator

And we'll go next to Robert Koort at Goldman Sachs.

Robert Koort - Goldman Sachs

Thank you and good morning.

Peter McCausland - Chairman, President, Chief Executive Officer

Good morning.

Michael Molinini - Chief Operating Officer and Executive Vice President

Good morning.

Robert Koort - Goldman Sachs

Peter would it be wrong to assume that Red-D-Arc is delivering margins around the 20% level and how fast do you think that overall industry's growing, what are the dynamics that are leading to that impressive organic growth relative to maybe what the broader equipment industry is growing at?

Peter McCausland - Chairman, President, Chief Executive Officer

Well you're not so far off in terms of the margins and I think the driver... there's a number of things driving Red-D-Arc. Number one, it's been growing that fast or better for a long, long time. Red-D-Arc is a really, really good company that delivers not only rental equipment but technical support to the customers that are engaged and welding activities at construction sites and they have a tremendous customer service mentality or effect and they go to great lengths to do anything for their customers and their customers reward them with a lot of business. So I think a lot of Red-D-Arc's growth is a result of the fact that Red-D-Arc is a really, really good company and the two recent developments that are supporting the growth, I would say, are the pickup and infrastructure spending, there's no question about that. Number one, and number two, we've brought Red-D-Arc into an Airgas construction group informally. It will be formalized later on but their working much, much closer with our national and regional construction sales specialists who sell gases and welding and safety and what not to the job sites and the corporation has been outstanding. So I think that's being a factor, maybe Mike has something.

Michael Molinini - Chief Operating Officer and Executive Vice President

We've also done some product line extensions. Those customers that rent welders also rent other things that are related to welders, generators for power and things like that.

Peter McCausland - Chairman, President, Chief Executive Officer

Maybe one small factor in addition, Bob, would be the trend towards renting equipment versus owning it and we continue to get the benefit of that and we have customers who sign up for these logistic programs with... and basically they are renting the equipments for five years but we do the... all the maintenance, all the ISO certification, we change up the equipment as there is any problem, we upgrade the equipment if their processes change and customers find us to be hassle-free business of doing business, and it works out well, slowly.

Robert Koort - Goldman Sachs

And if I look at your guidance for '09, you've given same store sales in the mid single digit, I would think that just the pricing component alone can get you a long way there, so can you give me some sense to your price volume mix expectations?

Peter McCausland - Chairman, President, Chief Executive Officer

Well, I would just probably say 50-50 and that's a guess because I don't know exactly how sales will develop and we haven't finalized our pricing initiatives for the year and we are in a pretty good pricing environment but that's because the costs are going up so rapidly with energy prices and steel prices and diesel fuel prices and we continue to grow but if you read the newspapers, you get really scared because you know it's mostly doom and gloom. So I hesitate to say anything more of about that than that I have already speculated.

Robert Koort - Goldman Sachs

Thanks very much.

Peter McCausland - Chairman, President, Chief Executive Officer

Sure.

Operator

We will go next to Laurence Alexander with Jefferies and company.

Laurence Alexander - Jefferies &Co.

Good morning.

Peter McCausland - Chairman, President, Chief Executive Officer

Good morning.

Laurence Alexander - Jefferies &Co.

I guess, Peter, one question on the prospects of potentially doing international M&A. Can you discuss your philosophy versus doing more Red-D-Arc positions outside the U.S. versus potentially buying minority stakes in other packaged gas large regional gas businesses?

Peter McCausland - Chairman, President, Chief Executive Officer

Right, well first of all, we don't have anything against doing deals overseas and you will recall in the 1990's we did a number of them and we ended up selling them off unfortunately, they were pretty successful all things considered and so... but I guess the other point I am quick to make is that we have tremendous opportunities here to make core acquisitions when 45% or so of this $11 billion core market is held by independence and then we have acquisitions in adjacent fields like safety and refrigerants and process chemical strings like that. So our platform has gotten so strong and the integration that we have achieved over the years of our various companies and operationally we have gotten so strong that acquisition to... that add to our platform are extremely valuable and maybe it surpasses least resistance of the path with the most momentum. But that said, we continue look over to overseas, Red-D-Arc has tremendous opportunities overseas because those contractors travel all over the world to do work and so it's kind of like follow the customers. The industry is fragmented overseas, there is a real role for a company that adds a lot of technical support to the equipment that it rents, like Red-D-Arc in a highly technical area like welding and you can get add-on sales of non technical equipment or add-on rentals of non technical equipment when you do it and Red-D-Arc is pursuing that as well. It's not like just getting a bulldozer and pushing a bunch of dirt around, it's a highly technical activity and that's why Red-D-Arc's been able to carve out this very good niche.

So we'll follow them around and we continue to look at industrial gas opportunities, both 100% owned and minority interest and we have nothing against them but they've got... we're pretty disciplined about where we put our money and we're pretty conservative on our projections. So sometimes these minority interests go for huge prices and you still don't have any control, not even negative control on some cases. So,... but there are some areas that are of interest to us and we continue to pursue them and we have a team going overseas to a number of countries next month. So we'll just have to see what happens.

Laurence Alexander - Jefferies &Co.

And then just the, I guess a two part question on margins. I guess the first part is could you discuss initiatives to improve the hard goods margins either through the Radnor brand or through reducing some of the other businesses that you do in hard goods?

Peter McCausland - Chairman, President, Chief Executive Officer

I mean the Radnor brands strategy has been around for a long time and the fact that it grew 30 something percent I think is a testament for that. We continue to drive that, we have had heavy incentives to our field, people to grow the Radnor brand, we expect its going to grow heavily. We continue to add products to it to expand the line and to fill out some of the families. We continue to work with our suppliers to improve the product and get the cost down on Radnor. So that's the key part of the strategy. For years, we have had a brand strategy in Airgas on hard goods in which not every supplier was created equal and we continue to drive more and more volumes into our preferred suppliers and our Radnor brand and we continue to buy less and less from those suppliers that we would prefer not to be there and with that said, you need to keep in mind that as a service provider when a customer tells us that he wants to buy a left handed widget, in order to serve the customer at the start, we're going to get that left hand widget and we're going to supply that customer. Now once we have the customer, then the game... the process starts to change him from the left hand widget to the one where we have the better costs or the better supply chain efficiencies.

Laurence Alexander - Jefferies &Co.

And then lastly, we're seeing very tight markets in specialty gases and helium, net-to-net, is that good for you or is that been negative to margins?

Michael Molinini - Chief Operating Officer and Executive Vice President

I mean the helium; helium has been a problem on a number of fronts, the most... the biggest of which is supply availability. And its only now that were back to a what appears to be a stable supply and have some additional volume in addition to what we have before to go out and grow the business. So I think the... in the specialty gas arena to a much lesser extent than the few products within specialty gases where we have certain restrictions in some of the rare gases on the ability to get the product, but Helium by far has been the most wide spread.

Laurence Alexander - Jefferies &Co.

Thank you.

Operator

And we will go next to Amy Zhang [ph] at Goldman Sachs.

Unidentified Analyst

Sorry, I don't have any questions. I didn't dial the call.

Operator

Okay. Thank you ma'am. We will go next to Kevin Mccarthy of Banc of America Securities.

Kevin Mccarthy - Banc of America

Yes, good morning.

Peter McCausland - Chairman, President, Chief Executive Officer

Good morning.

Michael Molinini - Chief Operating Officer and Executive Vice President

Good morning.

Kevin Mccarthy - Banc of America

Peter, I know you don't get very granular on same-store sales but you've been saying mid single digit growth for a while now and I guess we came in to 7% for the year and finish strong at 8% for the quarter. So is it expectations that we should see similar growth in fiscal '09 or are you really embedding within your earnings guidance, a slight deceleration back to, the five 5% type range.

Peter McCausland - Chairman, President, Chief Executive Officer

Yeah, that's where we're doing basically. We say mixing of digits... that we're seeing... we're assuming that and we're also assuming that the economy doesn't get too much worse, the industrial economy and we're not looking for too much of a rebound either at the end of the year. So... but it's... as I said it's very hard to predict and basically its... I feel like we have a fair amount of sales momentum and I feel really good about the organization and otherwise I may not... we may not even have come to this kind of mid single digits in this environment. But the other thing that I think is causing us to be optimistic with a little bit of a hedge is that a lot of our customers are doing very well. The manufacturers who export are doing well, the manufacturers who manufacture items that are used in infrastructure projects like heat exchangers and boilers and stuff like that, they are doing very well and believe it or not, foreign manufacturers are setting up new plants in the United States and some places and we haven't seen that in a long time, so there's some optimism around U.S. manufacturing that I think is doing masked buy all the problems with Wall Street and subprime and housing, so you take that all into the mix and we come out mid single digit and have a little bit of a hedge maybe.

Kevin Mccarthy - Banc of America

Okay and on the M&A front, Peter, if I carve out the Linde packaged gas deal, it sounds to me like you are anticipating M&A activity in fiscal '09 very similar to the 160 somewhat million you did in fiscal '08, my question is should we expect a similar average acquisition multiple this year or are you seeing any meaningful changes in the private market that would cause you to have opportunities to pick up properties that are more attractive multiples.

Peter McCausland - Chairman, President, Chief Executive Officer

I haven't seen much change in the last quarter and I think for the purposes... for your purposes of trying to line out the year you should assume multiples at about the same level that we experience last year. On the other hand though when the economy does slow like we've seen for the last 9 to 12 months, sometimes multiples do come down, so, we're optimistic that... we don't know that that will happen now or not, but it might be. Practair [ph] is... can still very interested in buying from what I understand and there are a couple of other players that have expressed some interests but its really hard to say how that market will develop, all I know one thing Airgas will be there offering reasonable prices in a disciplined fashion and we will get our fair share.

Kevin Mccarthy - Banc of America

Very good, and a final question that if I make for Mike, its sounds like he helped out Bear quit a bit in the quarter on ammonia supply, what impact did that have on your sales and earnings, help them out while the BP pipeline was down?

Michael Molinini - Chief Operating Officer and Executive Vice President

It was a couple of million dollars of sales, may be two-ish, something like that.

Kevin Mccarthy - Banc of America

Okay.

Michael Molinini - Chief Operating Officer and Executive Vice President

It was nice, but it wasn't a material gain changer.

Kevin Mccarthy - Banc of America

Okay, fairly small then, great, thank you so much.

Michael Molinini - Chief Operating Officer and Executive Vice President

Yep.

Operator

And we will go next to Mark Gulley at Soleil Securities.

Mark Gulley - Soleil Securities/Gulley & Assoc.

Good morning, guys.

Michael Molinini - Chief Operating Officer and Executive Vice President

God morning,

Peter McCausland - Chairman, President, Chief Executive Officer

Good morning.

Mark Gulley - Soleil Securities/Gulley & Assoc.

A question on returning capital, I am going to refer to page 10, your report card is stellar in every respect, of course the returning capital did plateau a little bit here this year, what will be your outlook for next year? Clearly your asset base grew about as fast as your earnings base; you think you might able to get more leverage in FO9?

Peter McCausland - Chairman, President, Chief Executive Officer

Yes, definitely, it's a 12 month rolling calculation, Mark, and once we lap the heavy integration expense we going to get a boost by 30 basis points alone by that. So we would certainly expect to see some nice movements of 30 to maybe 50 bases points plus in the upcoming year.

Mark Gulley - Soleil Securities/Gulley & Assoc.

Okay, not quite as good as the 100 basis point gains you've been experiencing more recently I guess, am I right?

Peter McCausland - Chairman, President, Chief Executive Officer

That would be correct.

Mark Gulley - Soleil Securities/Gulley & Assoc.

Okay. And on the dividend, do you take a look at the dividend policy based on trailing earnings growth and if earnings were up, what 35% in F08, could we expect a 35% increase in the dividend this year, Peter?

Peter McCausland - Chairman, President, Chief Executive Officer

Well that's up to the board, we review it every year and last year was a big kind of catch up year but we going to take a look at it and we don't just look at earnings, we look at cash flow, free cash flow as well. And we will be looking at it, I can't really say whether it will be... we haven't really even thought about it.

Mark Gulley - Soleil Securities/Gulley & Assoc.

And on the third leg of growth, I focused a little bit on process compressed gases, you've talked about that today. But add a little more that could be a real third leg ammonia refrigerants and other related two trailer type products perhaps.

Michael Molinini - Chief Operating Officer and Executive Vice President

We've talked about this a number of times. Right now, we have our process chemical, we have our ammonia and we have refrigerates. And clearly the one with the biggest opportunity right now that we are spending a lot of time on is refrigerants. Lot of changes coming with the production restrictions on ozone depleting substances over the next number of years and we think it's going to be a great opportunity for us and we've only begun to scratch the surface.

Mark Gulley - Soleil Securities/Gulley & Assoc.

Thanks Mike.

Operator

And we'll go next to Mike Sison at Key Bank.

Michael Sison - Key Bank

Hey, good morning, great quarter guys.

Michael Molinini - Chief Operating Officer and Executive Vice President

Thanks.

Peter McCausland - Chairman, President, Chief Executive Officer

Thanks Mike.

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

Thanks Mike.

Michael Sison - Key Bank

Just a couple of quick questions, on the base business earnings growth and operational efficiencies components, are those two separate components within that bullet?

Michael Molinini - Chief Operating Officer and Executive Vice President

I think so.

Peter McCausland - Chairman, President, Chief Executive Officer

Yes.

Michael Sison - Key Bank

And then the... is it about half-half or something like that?

Peter McCausland - Chairman, President, Chief Executive Officer

No, it would be more related the base business growth on the organic growth.

Michael Sison - Key Bank

And that would be... so that's based on the 5% organic sales growth outlook?

Peter McCausland - Chairman, President, Chief Executive Officer

Correct, yep.

Michael Sison - Key Bank

So... okay, then in terms of... bulk gases continues to do very well, in terms of your outlook for the year, do you have sort of new product wins that support similar type growth, stronger growth, little bit less growth?

Peter McCausland - Chairman, President, Chief Executive Officer

Bulk is one of our strategic product categories and for all of those we expect at least double digit sales growth in '09.

Michael Sison - Key Bank

Okay, then in terms of pricing, is there any other pricing that you're seeing incrementals or is it mostly just to offset higher costs?

Peter McCausland - Chairman, President, Chief Executive Officer

Is our pricing incremental?

Michael Sison - Key Bank

Yes, is it just offsetting rising costs or are you getting pricing that is sort of incremental to profitability, above the cost?

Peter McCausland - Chairman, President, Chief Executive Officer

I would say that for the most part we're covering our costs but we're trying to stay ahead of the curve.

Mark Gulley - Soleil Securities/Gulley & Assoc.

Okay.

Peter McCausland - Chairman, President, Chief Executive Officer

So there can be temporary increases in profitability. We're also doing our best to increase our operating margins through mode changes and improve our gross margins through pricing. But in terms of the rat moving through the snake, most of the costs in these commodities like energy, power and things like that are pass throughs with us ahead of the game.

Michael Sison - Key Bank

Okay and when you look at your same-store sales growth going forward is it the similar split in terms of pricing or volume or is pricing really going to start to move up a little bit because of the cost side of the equation?

Peter McCausland - Chairman, President, Chief Executive Officer

Well we're saying 50-50 but that's just a place holder. There are some inflationary pressures on our business, energy prices and 70% of the costs of producing atmospheric gases is power, so you got that. You've got diesel fuel which is over $4 a gallon and you've got steel and all of our containers used to store and transport gases, cylinders, and bulk tanks, they are all steel and then electrodes. We sell a lot of consumables, welding wire and other types of electrodes then wire and flex cord and all that stuff and that's all steel related. So between crude oil, steel and diesel fuel, that's a lot of inflationary pressure on a lot of different products that we sell. So we'll just have to see how things develop, we hope it moderate somewhat, but we're prepared to stay ahead of the curve.

Michael Sison - Key Bank

Alright, thank you.

Peter McCausland - Chairman, President, Chief Executive Officer

Sure.

Operator

We'll go next to Steve Burton [ph] with Merrill Lynch

Unidentified Analyst

Hi, thank you. When I look at your earnings guidance and your operating margin guidance, even with modestly lower interest expense, it looks like your top line revenue growth would be in the 12% to 13% range, is that consistent with your view?

Peter McCausland - Chairman, President, Chief Executive Officer

Well, you'll have the later on impact of the acquisitions

Unidentified Analyst

Right.

Peter McCausland - Chairman, President, Chief Executive Officer

So, it put it in the double digit arena, yes.

Unidentified Analyst

Does that not imply sales growth from acquisitions well over that $100 million to $150 million in acquired sales range?

Peter McCausland - Chairman, President, Chief Executive Officer

Those... the $100 million to $150 million relate to new transactions that will close in fiscal '09.

Unidentified Analyst

Okay.

Peter McCausland - Chairman, President, Chief Executive Officer

The roll over impact of the acquisitions that we closed in fiscal 2008 should add over $200 million to revenues in '09.

Unidentified Analyst

Very good, thank you. And one other item, on your ammonia business, is the pass through of those significantly higher cost of purchase ammonia is that depressing margins in the all other operations segment?

Peter McCausland - Chairman, President, Chief Executive Officer

Yes, slightly, yeah.

Unidentified Analyst

Slightly because it's still a relatively small business?

Michael Molinini - Chief Operating Officer and Executive Vice President

Yes,in the big picture, it's still quite small.

Unidentified Analyst

Okay, all right, thank you

Operator

And we will take our final question of the day from Holden Lewis at BB&T.

Holden Lewis - BB&T Capital Markets

Great, thank you very much, I don't think you guys covered this, you spoke about pricing broadly but within distribution, can you talk about what the price and volume component was for gas and then separately for hard goods?

Peter McCausland - Chairman, President, Chief Executive Officer

Yeah, as I mentioned Holden, it was roughly two-thirds price and one-third volume and that's consistent with both the gas and the hard good side.

Holden Lewis - BB&T Capital Markets

And then can you also comment on the margins within both. I know your gross margins went up nicely, certainly mix with a part of that. Can you talk about the margin within gas and rent, what that did year-to-year in hard goods and what sort of trend... what impacted those trends?

Peter McCausland - Chairman, President, Chief Executive Officer

The margins were... from year-over-year were very consistent, on the base business and it was more of a shift than mix that drove it. So they were pretty stable, slightly up.

Holden Lewis - BB&T Capital Markets

In both businesses?

Peter McCausland - Chairman, President, Chief Executive Officer

Yes.

Holden Lewis - BB&T Capital Markets

Okay. And then lastly if I could, you know your forecasts for fiscal '11, obviously the 13, 13.5 type operating margins. This year conceivably you could be 12.5, 12.8 something like that which in the first year of your three year plan kind of gets you a long way down that road. Does what your seeing this year sort of make the original guidance you put out there look increasingly conservative or do we pull a lot of savings forward compared to what you expect and how should we view that?

Peter McCausland - Chairman, President, Chief Executive Officer

Well we certainly knew that we would have a fast start to those goals as a result of the significant acquisition synergies particularly from the Linde transactions as well as the integration expense fall off, so we knew we would get a quick start to those goals. Being that they are only 6 months old, we didn't feel the need to refresh them at the moment but I would say that we are off to a very good start to those goals and knock on wood, we don't know but hopefully we'll be a little quicker.

Holden Lewis - BB&T Capital Markets

That's great. Thank you, guys.

Operator

This does conclude today's question and answer session. I'd like to turn the conference back to Mr. Jay Ely for any closing or additional comments.

Jay Worley - Investor Relations

Once again we thank you all for attending our teleconference and I will be available all afternoon for follow up questions. Have a nice day.

Operator

This does quits today's conference. We do thank you for your participation. You may disconnect at this time.

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Source: Airgas, Inc. F4Q08 (Qtr. End 03/31/08) Earnings Call Transcript
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