Radnor, PA - Airgas, Inc. reported sales and earnings results for its second quarter ended September 30, 2013, which reflected the realization of SAP-related benefits as planned, despite sluggish business conditions and continued economic uncertainty. Results for the quarter also reflected the favorable impact of one additional selling day compared to the prior year and the benefit from a change in a state income tax law.
"Our earnings results for the quarter were solidly at the midpoint of our guidance range; however, sales volumes were challenged to a greater degree than expected. Customer activity levels softened during the back half of September, which is normally a time when activity picks up meaningfully," said Airgas President and Chief Executive Officer Michael L. Molinini. "The degree to which the federal government shutdown may have affected our customers is difficult to gauge, but it can only have had a negative impact on business confidence and spending, particularly for our smaller customers. Although we are frustrated by the current economic environment and near-term uncertainty, we will continue to focus on the growth drivers that we can control and are ready to capitalize when sustained growth in the industrial economy resumes."
Second quarter earnings per diluted share were $1.27, up 23% over prior year, and adjusted earnings per diluted share* were $1.25, up 19% over prior year. Results included SAP-related benefits, net of implementation costs and depreciation expense, of $0.11 per diluted share in the current year quarter compared to $0.09 of expense in the prior year quarter.
Second quarter sales were $1.28 billion, an increase of 4% over the prior year. Organic sales in the quarter were up 2% over the prior year, with gas and rent up 4% and hardgoods down 2%. Both total and organic sales growth in the quarter included approximately 1% from the benefit of one additional selling day compared to the prior year. Acquisitions contributed sales growth of 2% in the quarter.
"Selling, distribution, and administrative expenses increased by about 4% over the prior year, with operating costs associated with acquired businesses and rising health insurance costs together representing more than 2% of the increase," said Molinini. "The favorable impact of the reduction in SAP implementation costs compared to prior year was substantially offset by expenses associated with the expansion of our telesales business through Airgas Total Access, our strategic pricing initiative, and other strategic growth initiatives."
Operating margin was 13.2%, up 140 basis points over prior year operating margin of 11.8% and up 120 basis points compared to prior year adjusted operating margin* of 12.0%, which excluded prior year restructuring and other special charges.
"There were a number of factors that contributed to the increase in our operating margin this quarter, including the combination of a reduction in SAP implementation costs compared to the prior year and the achievement of SAP-related benefits as planned during the quarter. The impact of one additional selling day compared to the prior year, the sales mix shift toward gas and rent, and steps taken to help alleviate the impact of rising costs in the quarter also contributed to the expansion of our operating margin," Molinini added. "Refrigerants again challenged margins this quarter as R-22 prices continued to be pressured following the EPA's unexpected ruling in late March to allow for an increase in the production of R-22 this year."
Year-to-date free cash flow* was $238 million, up 96% over the prior year, and adjusted cash from operations* was $397 million, up 43% over the prior year. The increase in cash flows was primarily driven by the lower required investment in working capital in the current year compared to the prior year.
Return on capital* was 12.4% for the twelve months ended September 30, 2013, a decrease of 10 basis points from the prior year and an increase of 30 basis points from the twelve months ended June 30, 2013.
Since the beginning of its fiscal year, the Company has acquired five businesses with aggregate annual sales of approximately $12 million. Additionally, on October 7, 2013, the Company announced that it had reached a definitive agreement to acquire the assets and operations of The Encompass Gas Group, Inc., headquartered in Rockford, IL. With eleven locations and more than 130 employees in Illinois, Wisconsin, and Iowa, Encompass is one of the largest privately-owned suppliers of industrial, medical, and specialty gases and related hardgoods in the U.S., generating approximately $55 million in annual sales in 2012. The transaction is expected to close on November 1, 2013, subject to regulatory approval and satisfaction of other customary closing conditions.
"As the generally lower levels of activity have continued into October and near-term uncertainty persists, we are taking a cautious view of the remainder of the year. Our revised fiscal 2014 earnings guidance assumes volumes will follow a normal seasonal pattern during the back half of the year relative to current levels, with softness around the holidays and strengthening in February and March. We will also continue to focus on effective management of expenses, cognizant of the balance between the needs for short-term cost containment and investing to position Airgas for long-term growth," said Airgas Executive Chairman Peter McCausland. "While we're not seeing sustained broad-based economic improvement yet, we are starting to see encouraging signs for growth in non-residential construction next year, as order flow has begun for a couple of upcoming projects and a number of the rumored large projects have moved into the planning and permitting phases. We also remain optimistic about the long-term prospects for the U.S. manufacturing and energy industries, as structural drivers like the abundant supply of low-cost energy, increasing shipping costs from overseas, and the protection of intellectual property should favor the U.S. for years to come. Airgas is well-positioned to leverage our unique value proposition and unrivaled platform as a leader in our industry to capitalize on the opportunities that lie ahead of us. The growth investments we continue to make, including in our Airgas Total Access telesales and our e-Business programs, will only serve to enhance our position when the economy improves."
For the third quarter of fiscal year 2014, the Company expects earnings per diluted share, including an $0.08 loss on the early extinguishment of debt, in the range of $1.07 to $1.12, reflecting an increase of 2% to 7% over prior year earnings per diluted share of $1.05. The Company expects adjusted earnings per diluted share* for the third quarter of $1.15 to $1.20, an increase of 11% to 15% over prior year adjusted earnings per diluted share* of $1.04. Guidance for both earnings per diluted share and adjusted earnings per diluted share assumes a year-over-year organic sales growth rate in the low single digits, and includes an estimated year-over-year increase of approximately $0.17 related to the SAP initiative, reflecting an estimated $0.14 of net benefit in the fiscal 2014 third quarter compared to $0.03 of net expense in the fiscal 2013 third quarter. Guidance also reflects year-over-year negative impacts to earnings per diluted share related to variable compensation reset following a below-budget year and a challenging and unpredictable refrigerants market, and year-over-year benefits to earnings per diluted share related to the Company's fiscal 2013 share repurchase program.
For the full fiscal year 2014, the Company expects earnings per diluted share, including an $0.08 loss on the early extinguishment of debt and a $0.02 benefit from a change in a state income tax law, in the range of $4.79 to $4.94, reflecting an increase of 10% to 14% over the prior year. The Company expects adjusted earnings per diluted share* of $4.85 to $5.00, an increase of 11% to 15% over the prior year. Both earnings per diluted share and adjusted earnings per diluted share* were $4.35 in the prior year. Fiscal 2014 guidance for both earnings per diluted share and adjusted earnings per diluted share assumes a year-over-year organic sales growth rate in the low single digits, and includes an estimated year-over-year increase of approximately $0.65 related to the SAP initiative, reflecting an estimated $0.47 of net benefit in fiscal 2014 compared to $0.18 of net expense in fiscal 2013. Guidance also reflects year-over-year negative impacts to earnings per diluted share related to variable compensation reset following a below-budget year and a challenging and unpredictable refrigerants market, and year-over-year benefits to earnings per diluted share related to the Company's fiscal 2013 share repurchase program, one additional selling day in fiscal 2014, and the incremental contribution from acquisitions closed to-date.
The Company's previous fiscal 2014 guidance range for both earnings per diluted share and adjusted earnings per diluted share* was $5.00 to $5.15, an increase of 15% to 18% over the prior year. The guidance revision primarily reflects a reduction in the Company's year-over-year organic sales growth rate assumptions.