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Airgas (NYSE:ARG)

Q2 2013 Earnings Call

October 23, 2012 10:00 am ET

Executives

J. Barrett Strzelec - Director of Investor Relations

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

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

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

Analysts

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

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

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

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

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

Christopher Perrella

Charles A. Dan - Morgan Stanley, Research Division

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Holden Lewis - BB&T Capital Markets, Research Division

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

Operator

Good morning, and welcome to the Airgas Second Quarter 2013 Earnings Conference Call. Today's call is being recorded at the request of Airgas. [Operator Instructions] For opening remarks and introductions, I will now turn the call over to the Director of Investor Relations, Barry Strzelec. Please go ahead, sir.

J. Barrett Strzelec

Thanks, Melanie. Good morning, and thank you for attending our second quarter earnings teleconference. Joining me today are Peter McCausland, Executive Chairman; Mike Molinini, President and CEO; and Bob McLaughlin, Senior Vice President and CFO. Our earnings press release was made public this morning and is available on our website, as are the teleconference slides. To follow along, please go to airgas.com and click the Investor shortcut at the top of the screen and go to the Earnings Call and Events page.

During the course of our presentation, we will make reference to certain non-GAAP financial measures. And unless specified otherwise, metrics referred to in today's discussion will be adjusted for the unusual items identified in our earnings materials. Reconciliations to the most comparable GAAP measures can be found in our earnings release, 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, and we ask that you please note our Safe Harbor language.

We'll take questions after concluding our prepared remarks as time permits. We plan to end the teleconference by 11 a.m. Eastern Time.

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

Peter Mccausland

Thanks, Barry. Good morning, and thank you for joining us. Please turn to Slide 2. I'm going to begin today by giving you an overall view of our quarterly results, the current business landscape and our outlook for the rest of this fiscal year.

Our second quarter adjusted earnings of $1.05 per share and same-store sales growth of 3% were solid and what we were -- and were moderating macroeconomic conditions across our customer base and in light of the year-over-year impacts of the incremental SAP cost, one less selling day and helium supply constraints, which in the aggregate reduced our earnings growth by $0.07 or 700 basis points.

Same-store sales in our core distribution business grew 2% this quarter, with hardgoods growth of 1%, decelerating to a greater extent than we had expected, and gas and rent slowing the 3% growth. The sluggish conditions were broad-based, reflecting an overall slower pace of daily activity in the industrial economy. July was weak throughout the month. August started off well but finished weak, coming in below our expectations overall. And September improved over August but remained sluggish and was overall weaker than we had expected.

The relative strength of the U.S. metal fabrication and energy sectors, which had been bright spots for the economy earlier this year, appeared to have softened of late, tampering our growth even in those areas. But we continue to win new business in these sectors on the strength of our Strategic Accounts program, technical support of customers, breadth of our product and service offering and outstanding customer service. From our vantage point, smaller customers in particular seemed to be impacted most profoundly by slowing industrial activity levels. The overall slowing has continued during October, and it's very difficult to predict when activity levels will pick up to support the growth rates we had expected when we entered the fiscal year.

Accordingly, we're revising our guidance range down from a range of $4.65 to $4.75 to a range of $4.45 to $4.60 to reflect the slower base business growth environment than we previously assumed. Though we're appropriately cautious about the near-term business environment, we're very optimistic about the long-term prospects for U.S. manufacturing and energy industries, the related infrastructure built to support those industries that will drive improvement in our nonresidential construction customer base and our ability to leverage our unique value proposition, which will only be enhanced by our conversion to SAP and unrivaled platform to drive growth in these and other key customer segments.

This morning, we announced the $600 million share repurchase authorization by our board, which reflects the confidence we have in the future of Airgas. Our balance sheet is solid, and our strong cash flow continues to be a hallmark of our business model.

Year-to-date, our adjusted cash flow from operations increased 8% year-over-year to $277 million. And free cash flow increased 15% year-over-year to $121 million. The strength of our balance sheet and cash flow generation afford us the opportunity to repurchase shares and realize attractive earnings accretion while continuing to fund our growth strategies, including our acquisition program. Since the beginning of this fiscal year, we've acquired 8 businesses with aggregate annual revenues of around $19 million. The pipeline remains solid, and I'm optimistic we'll see greater activity in the next 6 to 9 months.

Now I'll hand it off to Mike to review some of our key initiatives.

Michael L. Molinini

Thank you, Peter. I'd like to start by providing a brief update on the helium supply chain constraints that we highlighted on our last earnings call. While we did start to see some relief in certain areas of the country during the quarter, supply is still very tight and is expected to remain tight well into the next calendar year. At this time, the year-over-year negative impacts of lower sales due to helium supply constraints for the remainder of this fiscal year remain as we projected last quarter, which Bob will revisit as part of the guidance discussion.

Please turn to Slide 3. As Peter said, current business conditions indeed present some near-term challenges, but we will continue to invest in our long-term growth strategies, including the further development of our sales and marketing strategies focused on key customer segments, our Strategic Accounts program, infrastructure enhancement and leveraging our SAP platform. Our sales and marketing strategy focused on tailoring our value proposition to the unique needs of each major customer segment continues to gain momentum, and it's a driving force behind the Airgas organic growth story going forward.

Our Strategic Account program, which leverages this segment-driven approach, presents us with tremendous cross-sell opportunities, both in terms of product lines, services and locations, and represents more than 20% of total sales. In the second quarter, our Strategic Accounts business was up 3% over the prior year as we -- as continued new account signings and cross-selling to existing customers was tempered by broad-based slowing in general activity across most of our customer segments. Our large metal fabrication customers continued to post the strongest growth on a relative basis, though showing modest deceleration from first quarter growth rates. The retail segment again posted double-digit sales decline due to the substantial reduction in helium supply this year compared to last year. Excluding retail, Strategic Accounts, in aggregate, were up 4% over the prior year.

Strategic Products continued to be an important part of our value proposition to customers and from a product standpoint have strong growth profiles due to their use in favorable customer segments, application development, increasing environmental regulation, strong cross-sell opportunities or a combination of these factors. In the second quarter, growth in sales of Strategic Products also decelerated to 3% over the prior year, with each product category posting sales growth in the 2% to 3% range, driven by broad-based economic softening.

Deceleration in Strategic Products growth rates was most pronounced in our safety product sales, driven by general slowing in activity levels in our core industrial customer base.

Our Radnor private label sales were up 1% over the prior year, consistent with total hardgoods same-store sales growth. The long-term growth opportunity for the Radnor brand remains strong. In addition to building brand loyalty within our customer base, gross margins on Radnor products are 1.5x or greater than those of comparable OEM products.

In September, we announced plans to build a new 400 ton-per-day air separation unit in the Chicago area in order to meet increasing demand for merchant gases in the region, which we fully expect to be the long-term trend in the Midwest. The ASU will produce oxygen, nitrogen and argon and is expected to begin production in the fall of 2014. With our strong base load of packaged and merchant gas customers in the region and the potential to idle a smaller, less efficient plant in Wisconsin in favor of this new plant that is also closer to our customer base, we expect capacity utilization on this new plant to be strong at the time of start-up.

Moving on to SAP. The implementation is on schedule, with 10 out of 12 regional distribution companies now running successfully on the new platform. We expect the 11th region to be converted this quarter, with the last region converted by March. The rollout of our expanded telesales channel, Airgas Total Access, continues to gain momentum across the Airgas regions that have converted to SAP. We now have more than 70 full-time Total Access telesales representatives trained and deployed and calling on customers in the target size and span range selling gases and welding-related hardgoods in addition to our traditional telesales offering of safety products. About half of our regional companies have begun to leverage the data mining and functionality of SAP to take a more strategic approach to product pricing and discount management. The early results of our efforts in both of these areas reinforces our confidence that we'll realize the economic benefits as planned and that this investment will further enhance the value of our full-service offering to customers, which will be clear as Bob walks through the guidance. The 3 areas of opportunity for value enhancement that we have announced do not represent the full benefit of our investment in SAP. And we expect to explore additional areas of opportunity after the implementation is completed.

Thank you. And now Bob will now give our financial review of the quarter and provide an updated guidance for the year.

Robert M. McLaughlin

Thank you, Mike, and good morning, everyone. Please turn to Slide 4 for a review of our consolidated results for the second quarter. Sales increased 4% year-over-year to $1.2 billion, reflecting acquisition growth of 1% and same-store sales growth of 3%, comprised of a 4% increase in gas and rent and a 1% increase in hardgoods. Total price was up 4%, and volumes were down 1%. Same-store sales and volumes for both gas and rent and hardgoods were reduced by approximately 1% due to one less selling day in the current quarter versus the prior year, with helium supply constraints also reducing gas volumes by an additional 1%.

Gas and rent represented approximately 63% of our sales mix in the quarter, up slightly from the prior year and up 100 basis points from the first quarter. Gross margin for the quarter was 55.1%, an increase of 160 basis points from the prior year, driven by the sales mix shift towards higher-margin gas and rent, as well as margin expansions on underlying gases and hardgoods.

Adjusted operating income for the quarter was $148 million, up 2% from last year, including nearly $3 million of incremental SAP implementation cost and depreciation expense. Not included in adjusted operating income were pretax charges of approximately $2.4 million related to the previously announced Business Support Center restructuring.

Adjusted operating margin of 12% for the quarter included 90 basis points of impact from SAP implementation cost and depreciation expense. The prior year adjusted operating margin of 12.2% included 70 basis points of SAP-related cost. Excluding $0.02 of the BSC restructuring and other special charges, adjusted earnings per diluted share were $1.05, an increase of 2% from $1.03 in the prior year. The adjusted EPS of $1.05 included $0.09 of SAP implementation cost and depreciation expense, which were $0.02 higher than the prior year. One less selling day in the current year compared to the prior year reducing EPS by approximately $0.03.

And as expected, lower helium sales volumes driven by the inability of suppliers to meet their helium supply commitments to us during the quarter reduced year-over-year earnings by $0.02 per diluted share. There were approximately 78.9 million weighted average diluted shares outstanding for the quarter, up 2% year-over-year and flat sequentially. Return on capital, which is a trailing 4 quarters calculation, was 12.5%, an improvement of 20 basis points over last year.

We generated strong free cash flow of $121 million year-to-date through the second quarter, an increase of 15% over the prior year, driven by adjusted cash from operations of $277 million, which increased 8% over the prior year.

Total debt decreased by $122 million year-over-year to approximately $2.1 billion at September 30. Our fixed load debt ratio at the end of September was approximately 53% fixed, and our debt-to-EBITDA ratio declined to 2.4, comfortably within our target range of 2 to 3.

As Peter noted, this morning we announced that the board has authorized the repurchase of up to $600 million of our common stock. A repurchase program now is appropriate since our leverage has been declining, cash flow has been strong, we have confidence in our future, and we have yet to realize the full benefits from our implementation of SAP. We are well positioned to continue to effectively manage our balance sheet leverage while capitalizing on an improving acquisition environment, investing in growth CapEx and executing the share repurchase program.

Now turn to Slide 5, and we'll look at our segment results. SAP implementation costs, which are included in our consolidated adjusted earnings operating results, have not been allocated to our business segments, nor has special items that have been excluded from the consolidated adjusted operating results.

Distribution sales in this quarter were up 3% versus the prior year to nearly $1.1 billion. Same-store sales for distribution were up 2%, with pricing up 4% and volume down 2%. Gas and rent same-store sales were up 3%, and hardgoods were up 1%, with volume down 2% in both categories. Distribution, same-store sales and volumes for both gas and hardgoods were reduced by approximately 1% due to one less selling day in the current quarter versus the prior year, with helium supply constraints also reducing gas volumes by an additional 1%.

As Peter and Mike noted, the deceleration in the sales growth rate has been broad-based, reflecting an overall slower pace of activity in the industrial economy. Gas and rent represented 58.4% of distribution sales in the second quarter, up from 58.1% in the prior year and up from 57.4% in the first quarter. Distribution gross margin was 55.8%, an increase of 180 basis points from the prior year, driven by the sales mix shift towards gas and rent and margin improvements in both gases and hardgoods. Sequentially, distribution gross margin increased 80 basis points from the first quarter, primarily driven by the sales mix shift towards gas and rent. Operating income in the distribution segment increased 2% year-over-year to $134 million, while operating margin declined slightly, 10 basis points, to 12.4%. Operating margin was pressured by moderating sales growth and the year-over-year decline in helium sales due to supply constraints, which also negatively impacted the year-over-year increase in operating income.

All Other Operations reflects our CO2, dry ice, refrigerants, ammonia, nitrous and nitrous oxide business units. Sales for All Other Operations were up 7% from the prior year, with same-store sales also up 7%, largely driven by an increase in R-22 prices in our refrigerant business and by both volume and price in our ammonia and CO2 businesses. Refrigerant sales had continued to benefit from increased demand ahead of a potential EPA ruling, which would accelerate the phaseout of new production of R-22, the most commonly used refrigerants in HVAC systems. Airgas is well positioned in the refrigerants market to reclaim, recycle and distribute R-22 nationwide to satisfy ongoing market demand in a tighter supply environment. Sequentially, sales in All Other Operations increased by 1%, as increases in our CO2, dry ice and ammonia businesses were partially offset by seasonality in the refrigerants business. Gross margin for All Other Operations was 47.1%, an increase of 130 basis points from the prior year, primarily driven by margin expansion in our refrigerants and CO2 businesses. Sequentially, the 260-basis-point decline in gross margin from the first quarter was primarily driven by margin compression in our ammonia business due to rising feedstock cost. Operating income in All Other Operations was $22 million, an increase of $3 million over the prior year, and operating margin of 14.2%, which was up 100 basis points year-over-year driven primarily by the margin expansion in our refrigerants and CO2 businesses.

Please turn to Slide 6, capital expenditures. Year-to-date, CapEx represented 6.5% of sales, down from 7.1% of sales in the prior year. Construction and process spend was driven by the final stage of construction of our new ASU in Clarksville, Tennessee, the construction of our new hardgood distribution center in Bristol, PA, the buildout of our Business Support Centers and projects to expand or consolidate plants and branches across the country as we continue to focus on improving the efficiency of our operations.

Rental welder spend increased by $21 million on the improvement of our Red-D-Arc rental welder business, which continues to be a strong business for us. Excluding major projects, CapEx as a percentage of sales was approximately 4%.

Now I'd like to discuss our guidance for the third quarter and full fiscal year. Please note that our fiscal 2013 guidance excludes restructuring and other special charges, which were $0.05 in the first quarter, $0.02 in the second quarter and are expected to be approximately $0.02 in the -- for the third quarter and $0.10 for the full fiscal year, as well as the $0.07 gain on the sale of businesses in the first quarter. Special gains and charges in fiscal 2012 were a net total charge of $0.11. Please also note that our guidance does not include the potential impact from share repurchases under the new authorization announced this morning.

Slide 7 presents a walk through the primary elements of our third quarter guidance using second quarter adjusted EPS of $1.05 and fiscal 2012 third quarter adjusted EPS of $0.97, respectively, as the starting points. In the sequential walk in the left-hand column, we expect headwinds of $0.04 from the impact of one less selling day in the holidays; an additional $0.05 headwinds from normal seasonal declines in our CO2, dry ice and refrigerants businesses, partially offset by Red-D-Arc; SAP benefits, net of expenses, are expected to contribute $0.07 to $0.08, which represents the difference between $0.09 of net expense in the second quarter and an expected $0.01 to $0.02 of expense, net of expected benefits, in the third quarter. On a sequential basis, our base business growth is expected to contribute additional earnings of $0.02 to $0.07.

The right hand of the column on this slide shows the year-over-year walk. Helium supply constraints are estimated to reduce year-over-year earnings by $0.03. We are expecting year-over-year SAP benefits, net of implementation cost, to contribute $0.08 to $0.09, which represents the difference between the $0.10 of net expense in the third quarter of fiscal 2012 and the expected $0.01 to $0.02 of expense, net of benefits, in the third quarter of this year. And on a year-over-year basis, our base business growth is expected to contribute an incremental $0.03 to $0.08, representing 3% to 8% of growth.

In aggregate, when factoring in the headwinds and the contributions from incremental SAP and base business growth, we are estimating adjusted EPS for our third quarter to be in the range of $1.05 to $1.11, representing year-over-year growth of 8% to 14%. Third quarter guidance assumes same-store sales growth in the low single digits.

Slide 8 presents a year-over-year walk through the primary elements of our implied fourth quarter and revised full year guidance using 2012 fourth quarter adjusted EPS of $1.11 and fiscal 2012 adjusted EPS of $4.11, respectively, as the starting points. For the fourth quarter, we expect the headwind of $0.03 for the impact of one less selling day in the fourth quarter of fiscal '13 compared to the prior year. Helium supply constraints are estimated to reduce year-over-year earnings growth by $0.01. A higher expected tax rate is expected to be a headwind of approximately $0.02. We're expecting year-over-year SAP benefits, net of implementation cost, to contribute $0.14 to $0.17, which represents the difference between $0.09 of net expense in the fourth quarter of last year and $0.05 to $0.08 of net benefit in the fourth quarter of this year. And on a year-over-year basis, our base business growth is expected to contribute an incremental $0.03 to $0.09, representing 3% to 8% growth.

In aggregate, when factoring in the headwinds and contributions from incremental SAP and base business growth, we're estimating adjusted EPS for our fourth quarter to be in the range of $1.22 to $1.31, representing year-over-year growth of 10% to 18%. Implied fourth quarter guidance assumes same-store sales growth in the low single digits.

The right hand of the slide shows a year-over-year walk through our full year revised guidance. The impact of 2 less selling days is expected to be a headwind of $0.06. Helium supply constraints are estimated to reduce year-over-year earnings by $0.10, which is consistent with the expectations we provided on our first quarter earnings call. And a slightly higher tax rate relative to fiscal 2012 is expected to be a headwind of approximately $0.02. SAP implementation costs, net of the ramp-up of benefits, are expected to provide year-over-year improvement in earnings of $0.18 to $0.22, which represents the difference between $0.34 of net expense in fiscal 2012 and an expected net expense of $0.12 to $0.16 in fiscal 2013, which is consistent with the expectation we provided in our original guidance in May. Base business growth is expected to contribute $0.34 to $0.45 or 8% to 11% over prior year's adjusted EPS.

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

J. Barrett Strzelec

Thanks, Bob. That concludes our prepared remarks. [Operator Instructions] Melanie will now give instructions for asking questions.

Question-and-Answer Session

Operator

[Operator Instructions] We will go first to Ryan Merkel with William Blair.

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

The first question I've got is on the October price increase. Is that sticking as you expected?

Robert M. McLaughlin

Yes.

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

Okay. And so we should expect to see 4% price here for the next couple of quarters?

Robert M. McLaughlin

Well, Ryan, we will -- we'll lap a price increase in December. And we didn't go -- depending upon the timing in the sequence of SAP, we didn't go for 100% of normal price increase in October. Some of the companies were out of sequence relative to that. But we do expect a healthy contribution of price in the back half of the year, no question.

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

Okay. And then my second question, on October trends. Are we seeing the growth rate kind of stabilize, or was the growth rate in October lower than it was in September?

Robert M. McLaughlin

It's about the same, I think. In the last few days, it seemed a little weaker. Really, too early to tell the first 7 or 8 billing days seemed about the same, and but it's squirrely. We're looking at it pretty closely.

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

And could you just maybe lastly comment on what you're hearing from customers and why you're kind of confident in that low single-digit growth rate for the rest of the year?

Peter Mccausland

Well, it's kind of funny because in some segments, you have some customers going gangbusters and others laying off people. So it's not across the board within a segment. But the general tone is that there's been another notch down. We started with the -- in the spring with a slowdown. And what we have, we think we've confirmed over the last couple of months, that it's taken another notch down. Now, it hasn't fallen off the cliff, but it's definitely another notch down, and that's why we've lowered our guidance.

Operator

We will go next to Mike Harrison with First Analysis.

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

In terms of the weakness that you're seeing in hardgoods, can you kind of parse out what you're seeing in terms of bigger automation equipment that had been strong over the last few quarters versus what you're seeing in maybe machines, and what you're seeing in consumables?

Michael L. Molinini

Yes. The biggest weakness we're seeing is in machines, not the larger -- the activity level on the larger capital equipment, automation, cutting machines and things like that, the activity is still strong. The activity level on the -- that kind of relates to our comments about the smaller -- the medium and smaller customer seems to be more affected with the pullback because the equipment that we sell to that segment has dramatically slowed.

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

All right. And then, Mike, in terms of the Red-D-Arc business, it looked like you guys were adding quite a bit of capacity. But at the same time, I think about a sluggish environment as being a tougher environment for Red-D-Arc. So can you just help me understand what's going on in Red-D-Arc and kind of how you're seeing trends in that business?

Michael L. Molinini

Much of Red-D-Arc's growth has been either international or it's been in the natural gas exploration and development area with both equipment and, particularly, with the power generation equipment. In the classical nonresidential construction arena, where Red-D-Arc had historically played, it's still primarily plant turnarounds.

Operator

We'll go next to Mike Sison with KeyBanc.

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

Peter, can you talk a little bit about acquisitions? Does the stock buyback sort of signal that people are sort of keeping -- are going to wait a while before they are willing to sell?

Peter Mccausland

I don't know about acquisitions. I expect it to have higher activity than we have had. We do have a number of -- I think, 7 companies under letter of intent. And we have a full pipeline, and so we're trying to get it going. But as I said on the last 3 calls, these companies that are selling are still a long way from getting back to even. I mean, Airgas' gas volumes, they are 10% below our peak volumes back in 2009 still. And this recession has impacted smaller customers, which are the mainstay of a lot of these acquisitions. So even though we're going over a fiscal cliff and the Bush tax cuts are going to -- the cap gains, that's going from 15 to 20, and we have Obamatax and all that stuff, it's not enough to drive people. Now there has been an increase in activity, and I'm hopeful that -- I think we have a good shot at making our $150 million in sales acquired by the end of March, which was our -- which is our plugged goal every year. But I really can't explain it except to say that we're -- people are waiting to get back to even, and they aren't looking forward to taking the next proceeds and putting them to the stock market either, I think. So I don't know, I'm speculating now, but I'm confident we'll get our share and that we'll do well in that area. 50% of the market, $13 billion market, is still held by independents. And we still -- and we have acquisition opportunities in our adjacencies, but we're going to be price-disciplined because we don't have to buy anything. And I think we'll get our share.

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

Great. And a quick one for you, Mike. In terms of your outlook for the second half of '13, SAP is a big contributor there, $0.21 to $0.25 if you add up the third and fourth first quarter walks. Is it pretty high confidence in getting that number through? It seems like it's pretty much within your control. And then any changes to what could be the positive effects for '14 at this point?

Michael L. Molinini

We -- I mean, we are working feverishly on completing the SAP implementation. We can see the end of the tunnel in sight, and we have 2 more businesses to convert. The costs will begin to roll off pretty quickly. We are -- we have a lot of people that have been working tirelessly on some of the -- realizing the benefits, whether it would be in the -- in some of the strategic pricing areas, then as well as the Total Access program. So we think we can get there. We're making really good progress, but I mean, it's arduous.

Operator

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

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

First off, on helium availability into October, some of our contacts are saying they're seeing it getting better, and some expect it to get much better by year-end. And I think based on your Slide 8 sequential decline, it implies that you see things maybe getting a little bit worse. Maybe I'm not reading that right. And so how do you see that? And then second, with price increases to compensate for some of these supply constraints, if the supply comes back, how do you see those lines intersecting as we go forward? Would the prices just naturally come down and you meet in the middle, or how does that play out?

Michael L. Molinini

?Okay. So now we're talking -- this whole discussion is about helium?

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

Yes, sir.

Michael L. Molinini

All right. We did get some relief in -- beginning in this quarter. We were advised we were going to get some relief. But as of this date, neither of our supplier -- our main suppliers, has been able to meet the increased amount that they were going to increase to. It has gotten somewhat better. In talking with those companies, both of whom several months ago had indicated that by the beginning of the calendar year things might be running normally, things have changed for them. And at this point, we don't see any increase above the level that they have raised us to now for the foreseeable future. And when I say the foreseeable future, I'm kind of leaning toward mid-calendar 2013. And that whether it's related to plants in Wyoming that are not even going to start, to continued additional problems in Algeria, to whatever, there are new issues on the horizon that are going to prevent them from getting back to full production. Now with that said, prices on helium have definitely significantly increased over the past year. In the long-term, the longer-term view, meaning 2014 and beyond, the shortfalls, the U.S. production of helium in the -- going forward, will always be a very tenuous supply chain. We have an aging infrastructure, a declining reserve. It will have to be made up by other sources. Those other sources are not located in the U.S. for the most part, so there will be helium -- to make up the shortfall, helium will be imported into this country from other parts of the world. It will be expensive helium. So the likelihood that we're going to see major declines in helium prices, in my opinion, is very low.

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

Okay. And earlier, Bob had mentioned something of these -- the commitment. Is it just that, it's a verbal commitment, there's no financial penalty tied to that at all or anything?

Michael L. Molinini

I'm not sure I understand that.

Robert M. McLaughlin

The verbal commitment to -- what are you referring to?

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

Helium commitments, if they say, We're committed to move your allocation up to 85%, and they don't, there's no financial impact that they have to pay you or anything?

Robert M. McLaughlin

No.

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

Okay. And then final question, on -- with the holidays, it looks like you've factored that into your guidance. Are you counting the 2 Mondays before the holidays as selling days, or are you fading those and using them sort of as half days?

Robert M. McLaughlin

We generally look at those as half days.

Operator

We will go next to Laurence Alexander with Jefferies.

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

First question, just in terms of end markets, you described broadly sort of a notch down rather than a drop. But are there any areas or particular niches where you are seeing more severe deceleration?

Peter Mccausland

Well, like energy, in some parts like Eagle Ford and Bakken, business is very strong. But in Haynesville, business has dropped precipitously. So we're kind of seeing a lot of variation within the -- each customer segment. But I would -- that aside, generally, it's been pretty broad-based. And even in health care and other noncyclical segments, they've been a little softer here, and that's why we're cautious.

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

Can you give an update on the urea distribution and refrigerants businesses, both where they are now and how you're looking at them over the next 1 to 2 years?

Michael L. Molinini

Well, the urea business you're referring to is the DEF business. We are in the DEF business, we are -- it's -- I doubt if we've broken even yet. We do -- we are selling several millions of dollars a year in that business. We primarily -- it's primarily a regional business for us. And it's shaking out. It is primarily going to be a bulk opportunity. I doubt in the next several years that it will be material to earnings. The refrigerants business, on the other hand, is very dynamic, and there is a lot of things happening in the refrigerants business. ^^ The supply-demand curves are getting very much -- are getting very closer to each other. The EPA is studying a potential acceleration in the phaseout of Refrigerant 22, which has firmed and increased prices, which, depending on what they say, could create even more significant shortage and opportunities for expanding margins. So the reclamation business, the pounds and quantities of product that we are buying back to reclaim continue to increase. So all of the dynamics of what we said we thought were going to happen with the refrigerants business are happening. The point -- problem is, we can't be absolutely precise on when these things occur because a lot of it has to do with government regulations and the phaseout and the timing.

Operator

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

Christopher Perrella

This is Chris Perrella on for Kevin. Would you say, with the step with the notch down in activity, is there an opportunity or are you picking up market share in the U.S., specifically, I guess, more in the merchant area?

Michael L. Molinini

Well, as we said before, merchant is, the bulk of the business, is new -- it's not new to Airgas, but it's new in the sense that we became a significant player after we acquired Linde Bulk Business, and then went on to build 3 or 4 air separation plants. And we have over 1 million customers, and many of those customers buy bulk. And from time to time, they generate new bulk applications. And because we're in those customers every day with our 1,500 outside salespeople and our technical support people and outlook supply chain people, we often get a first look at these new applications or renewals. And I've noticed that our bulk business has been growing a little faster than some other companies in the U.S., but I don't think we're -- I don't think it's -- we're taking a huge amount of share, but we're just slowly growing the business and cross-selling our entire product line. And we've been fortunate to be able to get good loads on our plants. And now we have announced a new plant.

Peter Mccausland

Yes, I mean, we just opened a plant in Tennessee. And clearly, that's an area we've had -- we have some -- we have capacity. And so, I mean, there are pockets of the country where we have a new competitive advantage and we're trying to explore -- exploit that. So...

Christopher Perrella

Okay. And implicit -- in shifting over to the guidance. Is the $150 million in acquisition target implicit in that guidance, or is that upside to the $4.45 to $4.60 number for fiscal 2013? And then also what type -- what industrial productivity or industrial production is implicit in that guidance as well?

Peter Mccausland

Well, the acquisitions aren't in there, but in terms of upside, depending on the price and what business, maybe we can have $0.01 or $0.02. Mostly for the first few months, they tend not to be too accretive. So I wouldn't call it a big upside if it is one. And Bob, we notched down our same-store sales to what?

Robert M. McLaughlin

We've taken it down, roughly, 3% from what was implicit in our guidance that we issued at the end of Q1.

Peter Mccausland

And what kind of underlying is that?

Robert M. McLaughlin

We're assuming kind of more stable relative to what it's been over the last few months.

Operator

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

Charles A. Dan - Morgan Stanley, Research Division

This is Charlie Dan on for Vincent. Just looking at your SG&A expense in the distribution segment, it seems like it's been growing faster than sales the last couple quarters. Can you give us a sense for when or if that should come down, and if we should still expect SG&A as a percent of sales to come down over time?

Michael L. Molinini

Well, I think it will definitely come down over time as a percent of sales. Clearly, the drop-back in our sales hurts that ratio significantly. We've had some incremental expense relative to SAP that's not fully captured, I think, on the SAP line relative to just doing daily work daily. We're very judicious in terms we don't want that to be a crush to our people. And so there's been some other costs relative to, particularly, the first half of this year, we had lower-than-normal healthcare costs in the first half of fiscal '12. That will be an easier comp in the back half of this fiscal year. And there are some other items like that. So I think you will be definitely seeing a meaningful improvement relative to our expense-to-sales ratios going forward.

Charles A. Dan - Morgan Stanley, Research Division

And just a follow-up on that point. I mean, we've seen several other companies announce new, more aggressive restructuring programs. Is that something you guys are considering?

Michael L. Molinini

No, I think at this time, we still are seeing growth, it's just moderating growth. And we always keep a careful eye relative to being right-sized to service the volumes that we have. But at this point, we're still optimistic that there'll be a positive break at some point. And we're not in a workforce-reduction mode at the moment.

Peter Mccausland

That said, we're cautious. And we -- at our management meeting the other day, we all decided that we're going to watch our expenses very closely and keep an eagle eye out on CapEx. And we'll never -- we've never turned down a growth capital expenditure, but plan upgrades and things like that don't always have to happen immediately. And so we've begun to give those greater scrutiny, and we're cautious. And there's a lot of uncertainty out there, and it has to do with the election and the fiscal cliff and China and things way beyond our control, so we're trying to stay lose.

Operator

We will go next to Donald Carson with Susquehanna Financial.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Peter, just a question on this flip in same-store sales growth. I mean, have you ever seen this kind of a deterioration in hardgoods sales before that didn't kind of indicate a recession, or do you just think this is this confluence of near-term uncertainty that you just outlined?

Peter Mccausland

I think the latter, but I'm not an economist. And I don't -- I mean, there's so much stimulus out there, and the government is trying to inflate the economy, and it's happening all over the place. If I had to guess, it's just a slowdown. We're pretty bullish on the long-term prospects for U.S. industry. And we're a low-cost energy producer now, which means we'll be a low-cost petchem producer, we'll be a low-cost fertilizer producer. We'll have to build a lot of infrastructure to support that kind of production of the energy and the other products. And so we like the fact that we're mostly a U.S. company now, and we're pretty bullish long-term on the U.S. But like most American citizens, we would hope that the people in Washington can get their acts together, and we can all move on to better days.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

And just based on what you're seeing in October, you expect no change in that sort of mix of same-store sales growth, that it be more skewed to gas and rent near-term?

Peter Mccausland

I think we'll see that because we have this pricing action that took place partly in September, but it wasn't a full-blown price increase because many of our companies were out of sequence because of SAP conversions and things like that. So we should get the -- even though we're going to lap another price increase in December, we should get the benefit in the second half of pricing, and that will fall more heavily on the gas side of our business and the hardgoods, although it will impact both of them. And so I think it's hard to know when the hardgoods will pick up again, but we think the gas is -- I guess we're more certain about the gas because we know we're getting a price there and it's pretty steady.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Okay. And then a follow-up on merchant. What is your current merchant operating rate, if you take out the Tennessee plant, which obviously you get to load, where are you running on your national merchant system?

Peter Mccausland

Low 80s.

Michael L. Molinini

Yes, I'd say low 80s.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

And one of your competitors had talked about significant competition, not just from any one producer but across the board. Are you seeing more aggressive moves by some of your competitors to try and increase their loading as well?

Peter Mccausland

Well, we're seeing it in the microbulk business from Air Products. They've gone around and put in place this program where they're going to sell microbulk, which is really a packaged gas, but they're selling it from their bulk plants around the country and cutting prices pretty aggressively to get share. We haven't lost much business, but it's certainly -- it's made that business a little less attractive than it once was. It's pretty capital-intensive. A microbulk unit cost a lot of money. So I've seen that, but I think, overall, I haven't seen a major change in the competitive landscape in bulk. Have you, Mike?

Michael L. Molinini

No.

Operator

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

Holden Lewis - BB&T Capital Markets, Research Division

Great. I feel like I need to ask. Last time that you did the share buyback, obviously, you did it relatively quickly, similar size kind of financially, kind of in the same place. Can you give some sense -- I mean, is this something again which you feel is going to get done, get done in short order, or is this one going to differ in some way from the last one?

Peter Mccausland

I really can't say, we're -- we like to be opportunistic and buy on dips and -- but we also feel like if you announce a buyback, you ought to go ahead and get it completed. And so we'll be looking at the market and our stock price and hope -- I would say it's more likely that we'll get this completed in the next 6 months than not, but I can't guarantee that. We're just going to have to take a look and see what's happening.

Holden Lewis - BB&T Capital Markets, Research Division

Okay. And then you also commented, I think, when you go through your slides, that the gross profit increase in your -- or the gross margin increase in distribution, normally mix plays a huge role in that, you cited mix again, but you also talked about seeing gross margin improvements, I think you said in both the gas and rent business and the hardgood business specifically. Can you just talk about those improvements, what drove the sustainability or the lack of? How should we view those?

Michael L. Molinini

Well, to some extent, there was some mix even within those categories that drove some of the improvement. But we also, depending upon the timing of the SAP systems, we've had a little bit of price increase that has gone on. Hardgoods, we're always having -- that's not an event, that's an ongoing pricing change, depending upon our cost increases. And we've been able to get more than the cost increase on the hardgoods side over the last couple quarters, when those opportunities presented themselves. So there is an element relative to some pricing that's happened off cycle. We've also had some productivity improvements relative to our internal manufacturing operations, which have drove some margin improvement as well.

Operator

We'll go next to Edward Yang with Oppenheimer.

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

Most of my questions have been answered. But on CapEx, I guess you're expecting to spend 6.5% of revenue, and that's down from 7.5% of revenue last year. You've noted that outside of major projects in the second quarter, the spending was 4% of revenue. So could you provide us with a peak in terms of what your expectation will be for next year?

Robert M. McLaughlin

We'll probably do that relative to the analyst meeting coming up in December, but we typically don't give out guidance for the next year until the end of the current fiscal year.

Operator

We'll go next to Mark Gulley [ph] with CGC [ph] Partners.

Unknown Analyst

A couple questions. First of all, with respect to merchant business, do you see more opportunities out there where you can combine high regional operating rates so we have a good presence with the opportunity to shut down perhaps an old and efficient plant? Do you see more situations like Chicago presenting themselves?

Michael L. Molinini

No. That's probably -- that is a very old plant, and it's really the only one at this point that we would consider because of its age and location that we should replace it. The other opportunities we're looking at are more of the traditional ones, similar to the ones we've done in the last couple years, where we -- it's in an area where the market is going to need products, and there's a base load opportunity that we can hook up with to help pre-load the plant.

Unknown Analyst

Okay. As my follow-up, now that SAP looks like it's going to be pretty much installed, and as you look, Mike, to reap the benefits of it, how much price lift can we expect going forward, perhaps the difference between your announced price increase and the actual effective price increase may be shrinking because SAP allows you a much, much better pricing enforcement in the field?

Michael L. Molinini

Well, I mean, we're -- at this point, we're learning how to do all this. And this is a work in process. And if you recall, what we have said is that between the first 3 initiatives, the first 3 areas of focus that we were going to work on, that by the -- we'd be at the run rate -- by a year from the end of this December, we'd be at the run rate of $75 million to $125 million of benefits, of which $40 million to $60 million of lift was related to the strategic pricing area that you're talking about. And at this point, we're in Round 1 of -- maybe not 1, Round 1a of learning how to do this, and to find out exactly what we can get. Now at this point, we will firmly stand behind our $40 million to $60 million of strategic pricing benefits at the run rate of that by December 31, 2013. And by that time, we'll have a really good -- we should have some really good visibility on where we think that can eventually be.

Unknown Analyst

And then turning to the helium opportunity. If I look at your EPS walk, particularly for this fiscal year, if helium flips the other way, could better availability of helium for fiscal '14 be a $0.10-per-share lift?

Michael L. Molinini

Well, it all depends on where it's coming from and what the cost will be and what the market -- how the market reacts to where -- whatever the supply chain yields, where it comes from and the costs that it comes with and their willingness to pay appropriate prices.

Peter Mccausland

And when it comes.

Michael L. Molinini

And when it comes.

Peter Mccausland

And getting the customers back.

Michael L. Molinini

Yes, and getting the customers back that we've lost. Now from -- just as an aside, the likelihood that a majority of the helium customers will likely stay with helium and stay using the applications that they use the helium for with higher prices which might be imported from other parts of the world, in our opinion, is good. So I don't think you're going to see a massive move from helium to something else, or abandoning the products that helium is used in. But there's a lot of water to go under the bridge here between now and the time we get reliable supply chains at a consistent cost back for helium.

Operator

And we will go next to Holden Lewis with BB&T.

Holden Lewis - BB&T Capital Markets, Research Division

One follow-up here, specifically on the hardgoods. Peter, you reported, I guess, sort of a 1% increase. ITW today indicated that they saw sort of North America up about 4.5%, and they do a lot of machines, and you said that was sort of the weakest area. So I guess I'm kind of curious about how do you feel about your inventory, particularly -- generally, but also specifically within the hardgoods space? Do those differences in growth rates suggest that maybe you got a little bit surprised on the hardgoods, built up some inventory, and that required some adjustments going forward?

Peter Mccausland

No. What I said was the small machines, small-sized machines, that the smaller and mid-sized customers typically buy, were the areas of biggest weakness. I also said that the larger automation systems, there's still a lot of activity in those. Now those are very, very large dollars, not necessarily an arena that ITW place in all that much, but that still remains strong. Our inventory -- we don't inventory many machines. Our machines are a more of a just-in-time. You buy one, I get a replenishment one. So in any of the big orders, they're shipped directly from the manufacturers.

Holden Lewis - BB&T Capital Markets, Research Division

Okay. So you feel like your inventories, despite the fact that things have weakened, you feel your inventories are kind of where you want them to be now?

Peter Mccausland

We -- our stores pretty much run a floor stock inventory, and that's all we inventory for the most part. The rest is all -- that is replenished quickly from the manufacturers. And also, large orders are shipped directly from the manufacturers. So I'm not really waking up in the middle of the night worrying about machine inventories.

Holden Lewis - BB&T Capital Markets, Research Division

Okay. But is that true across your businesses, as well, not just machines but consumables as well as non-hardgoods?

Peter Mccausland

I'm not sure about that. I know safety products were the area that was impacted the most, okay? I know that part. The piece I don't know is the split between filler metals and all the other welding accessories.

Operator

That concludes today's question-and-answer session. At this time, I would like to turn the conference back to Barry Strzelec for any additional or closing remarks.

J. Barrett Strzelec

Again, we thank you for joining us today. I will be available for follow-up questions this afternoon. Have a good day.

Operator

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

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