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Praxair Inc. (NYSE:PX)

Q4 2008 Earnings Call

January 28, 2009 11:00 am ET

Executives

Jim Sawyer - EVP and CFO

Liz Hirsch - Director of IR

Analysts

Kevin McCarthy - Banc of America-Merrill Lynch

Sergey Vasnetsov - Barclays Capital

John McNulty - Credit Suisse

Bob Koort - Goldman Sachs

Laurence Alexander - Jefferies

Steve Sherman - Lafayette Research

Chris Shaw - UBS

Chris Willis - Impala Asset Management

Mike Harrison - First Analysis

Mike Sison - KeyBanc

P.J. Juvekar - Citi

Operator

Good day, ladies and gentlemen and welcome to the fourth quarter 2008 Praxair Incorporated Earnings Call. My name is Jerri, and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of the conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Jim Sawyer, Executive Vice President and Chief Financial Officer. You may proceed sir.

Jim Sawyer

Good morning and thank you for attending our fourth quarter earnings call and webcast. Matt White, Vice President and Controller, and Liz Hirsch, Director of Investor Relations are with me this morning. Liz will review our full year and fourth quarter results. Afterwards, I will discuss the business environment, our current outlook and the earnings guidance for 2009. We will then be able to answer questions. Liz?

Liz Hirsch

Thank you Jim and good morning everyone. Today's presentation materials are available on our website at www.praxair.com in the Investor Section. Please read the forward-looking statement disclosure on page two, and note that it applies to all statements made during this teleconference.

Please turn to page three for a summary of our full-year results. Please note that our discussion of earnings for both the full year and the fourth quarter, including year-over-year comparisons excludes the charges taken in the fourth quarter for restructuring and other actions, and the pension settlement charge taken in the first quarter. These charges are detailed and reconciled to GAAP reported numbers in the appendices to this presentation and the press release.

Our 2008 full-year results were very strong, with sales up 15%, earnings per share up 16%, and record operating cash flow of over $2 billion. These results reflect strong sales growth in the first three quarters and a sequential decline in the fourth quarter due to sharply lower volume in November and December, and negative impact from currency translation.

2008 sales reached $10.8 billion dollars. Sales growth came primarily from volume growth and higher pricing. In addition, several core business acquisitions we made during the year contributed 2% to sales growth. Currency added 3% for the year, significantly below the 6% we had in the first three quarters, because of the significant weakening of foreign currencies in the fourth quarter.

We grew operating profit 16% to $2.1 billion. Strong pricing gains, productivity programs, and cost reduction contributed to the overall improvement in operating margin to 19.2% for the year.

Full-year net income was $1.3 billion, 14% above net income in 2007. Earnings per share of $4.20 grew 16% versus prior year on a lower share count due primarily to our stock repurchases during the year. Our return on capital for the year was 15.3%, inline with 2007. We started off a record number of new projects in 2008, which increased our capital base, but the high project returns generated contributed to the strong earnings growth.

We generated over $2 billion of operating cash flow, which was a record. This was primarily a result of the growth in net income, higher depreciation due to new plants that started up during the year, and improvements in working capital. Capital expenditures were $1.6 billion, supporting a large number of growth projects that we are building under contract for customers. We spent $76 million on acquisitions, net of divestitures. Our acquisitions were primarily North American package gas distributors. We continue to be very selective about acquisitions, and highly disciplined in terms of risk and returns.

In 2008, we purchased $892 million of stock, net of issuances. $622 million of this amount was completed under the $1 billion authorization we announced in July, as we opportunistically took advantage of lower share prices. We also paid $468 million in dividends.

We announced this morning that we are increasing our quarterly dividends from $0.375 to $0.40 in the first quarter of 2009. Additionally, we plan to continue our stock buyback program in 2009 using the remaining $378 million of the $1 billion authorization approved by the Board of Directors last July. This is a strong indication of the confidence we have in our ability to continue to grow our cash flow, while funding our backlog of large growth opportunities despite the currently weak environment.

Please turn to page four for our fourth quarter results. Our results in the fourth quarter reflect two significant changes in the business trends we had been seeing through the first three quarters. First, it is the currency headwind resulting from the sharp and rapid appreciation of the dollar in response to risk aversion and the global credit crisis.

Secondly, as economic conditions worsened and led to the steep drop in commodity prices globally, many customers significantly reduced production rates beginning in November. Fourth quarter sales of $2.4 billion were 5% below 2007. Excluding currency, sales rose 2% as higher pricing and a small contribution from acquisitions offset a 4% overall decline in volumes. The largest volume decline occurred in three markets, electronics, chemicals and metals. These industries are going through significant inventory destocking due to declining demand and falling prices for their products.

The volume declines we saw in these markets were partially offset by higher sales to energy, food and beverage, and healthcare. Business trends in general manufacturing markets have continued the slow sequential volume decline we had been seeing all year inline with the slowdown in industrial production.

Operating profit of $491 million was slightly above prior year, but lower than the third quarter due primarily to the volume and currency effects I mentioned. A portion of the negative currency impact was offset by $17 million of net currency hedge gains. As we said last quarter, we have been hedging net income in foreign currencies one quarter forward on a rolling basis. This net gain is the mark-to-market impact of those hedges, and largely offsets at the net income line, the impact from weaker currencies.

Operating margin increased to 20.4% as we increased operating profit despite the decline in sales. In addition to the hedge gains, which helped offset some of the negative currency impact, we were able to quickly realize some benefits of our cost reduction program which we announced last month. The amount of the charge and our reports numbers was $177 million on a pre-tax basis.

This amount included $118 million related to severance and non-core business restructures in order to achieve about $100 million of run rate cost savings to offset the impact on our operating profit of the global economic downturn. Because, we moved quickly back in October, we expect to realize 80% of this amount in 2009. This is one of the main reasons that we expect to be able to maintain our margins in 2009 versus 2008, despite the decline in our volumes.

Fourth quarter net income was $314 million, slightly below prior year, due to the higher effective tax rate. Our effective tax rate this quarter, excluding the restructuring charge, was 28.5% versus 26.5% last year, which is inline with our guidance for the year. Earnings per share, excluding the charge were $1.1, as compared to $0.98 in the prior year.

Cash flow from operations in the quarter was a record $640 million from net income, depreciation, and a networking capital benefit coming primarily from lower levels of receivables due to strong collections and lower sales. Cash flow primarily funded CapEx of $482 million, and five small package gas acquisitions. Debt increased a bit, primarily to fund $177 million of net share repurchases in the quarter.

Now, I will review our results for North America which are summarized on pages five and six. Sales in North America were $1.36 billion, 2% above the prior year quarter, ex-currency. Strong pricing gains of 6% and a 2% contribution from acquired package gas distributors offset 6% lower volume.

The largest volume declines were in electronics, chemical, and steel, the industries which have significantly cut their production levels to work down excess inventories. Also, because of weakening demand, many large customers closed plants down ahead of the Holidays, and these closures have extended into January.

Sales to general manufacturing markets were about 5% below prior year, continuing the slow sequential weakening we saw throughout the year. A bright spot is energy. Our sales to this market were 23% above prior year, due to strong demand for hydrogen by refiners, and strong demand for nitrogen for enhanced oil recovery.

Overall on-site sales were about flat with the prior year. On-site hydrogen volumes were up 11%, which offset a 12% decline in atmospheric volume. Merchant liquid sales were up 1%, with 6% pricing gains offsetting about a 5% volume decline. We signed new business during the quarter for food, energy and environmental applications. For example, last week, we announced a new hydrogen supply contract with Dynamic Fuel. We will be supplying this company hydrogen which they will use to produce synthetic fuels for non-food grade animal fats. These fuels are expected to provide performance and environmental advantages over petroleum based fuel.

Packaged gases sales in North America were 2% above the prior year ex-currency. Higher pricing and acquisitions offset lower volumes. In PDI, our US and Canadian business, same-store sales declined 1% versus prior year. Gases same-store sales were up 5%, and hard goods down 10%. Pricing was strong and offset negative volume in gases and hard goods.

Lower gases volumes reflect declining industrial production and lower hard good sales reflect reduced capital spending on machines and equipment by customers, because of lack of credit and the uncertain economic outlook. Our early read for first quarter is very cautious, as January sales have been weak coming out of the holidays.

Our business in Mexico had another very strong quarter with underlying sales up 22%. Manufacturing is slowing their sequentially, as the economy is tied very closely to the US. We expect our energy business to remain strong as oil production is the government's main source of revenue.

North America operating profit grew 5% from prior year to $267 million, and the operating margin increased to 19.7%. Higher pricing and cost reductions more than offset the impact of lower volume. Our outlook for the first quarter is for volumes to remain at a low level due to weak demand, extended holiday shutdowns by our customers, and several planned plant maintenance turnarounds by refiners.

New proposal activity for large customers outside the energy sector has slowed. As I mentioned, we continue to sign new liquid contracts for non-cyclical markets, and for productivity and environmental applications.

Please look at page seven for our results in Europe. Sales in Europe of $322 million were 3% below prior year ex-currency. In Spain, volume declines were driven by metals and general manufacturing. In Germany, pipeline volumes declined to chemicals and steel. Packaged gas sales were above prior year as we believe many businesses are doing repair and maintenance work during production downtime. While base business volumes are down broadly across the continent, we have gained new merchant business for wastewater, environmental, and productivity applications.

Operating profit of $83 million includes a $4 million hedge gain which offset some of the currency impact. But, we're maintaining margin through pricing productivity and accelerated cost reduction actions.

Page eight reviews South America. South America segment sales were $382 million. Currency depreciation reduced sales by 18% year-over-year, and underlying growth was 4%. Brazil saw a contraction in industrial production in the fourth quarter. Rising commodity prices throughout the first three quarters of the year had fueled significant growth and investment in the country's export industries.

In the fourth quarter, many large customers cut production as much as 30%, as world prices for their products fell. Our overall volumes declined modestly, driven by the large customers. Merchant and packaged volumes were steady with strong pricing gains. Sales to food and healthcare markets remained strong. Our sales of LNG and CNG grew 25% versus last year, as our joint venture company with Petrobras continues to sign more contracts with customers.

Operating profit of $87 million included $9 million of net currency hedge gains. But, excluding this, our margin percentage was higher than prior year, and pricing and cost reduction offset the impact of lower volume. Sequentially, for the first quarter, we expect volumes to remain low as this is the summer season in Brazil. Longer term, we expect that growth will come from a return to a more normalized run rate by our customers, and new plant start-ups from our backlog of committed projects.

Page nine highlights our results in Asia. Sales in Asia of $209 million grew 8% ex-currency versus 2007. We had higher on-site and merchant liquid volumes in most end-markets from new business and new plant start-ups, offset this quarter by a significant decline in electronics where volumes were down 14% year-over-year.

Industrial production in the fourth quarter slowed, and we expect it will be in the zero to 5% range in China and India in 2009. So we expect that our base business will grow more or less in line with that range, supplemented by new project start-ups.

Our current backlog is strong and we expect it to hold with a few projects delayed by the customer for several months. New proposal activity for large projects has taken a pause in the short term, like it has elsewhere around the world, but we continue to be optimistic about the long-term prospects for our business in the developing economies of China and India.

Key growth areas for us include gasification projects in China. China will continue to stimulate its economy to provide jobs, upgrade its infrastructure, and become more self reliant in basic industries like chemicals and plastics and energy. And these projects require significant amounts of industrial gases.

Asia's operating profit and operating margin were comparable to last year at $34 million and 16.3% respectively. Our outlook for 2009 is for normalized sales growth ex-currency in the range of 10% to 15%. We expect the normal sequential decline in the first quarter because of the Chinese New Year holiday.

Please turn to page 10 for a discussion of Surface Technologies results. PST's results this quarter were $135 million, about even with last year, but up 4% ex-currency. Growth was muted by lower volumes of jet engine EB-PVD coatings due to two factors.

First, the delay in delivery dates for the new Boeing and Airbus plane programs has pushed out the production schedule for the next generation, fuel efficient engines. As a result, GE and the other OEMs have not yet ramped up the number of parts they will send to us that need to be coated. Secondly, the Boeing labor strike delayed the normal production of the current CFM56 engines, and this also pushed out our pipeline of parts to coat, but we expect this business to pick up in the coming year.

Offsetting the slowing aviation business is growth in sales to the energy sector. Coatings for industrial gas turbines are strong, with key end users in China and the Middle East. Coatings for oil field service components are also growing. So, oil prices are down. We do not expect to see a fall-off in this business, even if drilling declines because we are securing a greater penetration of the parts which are coated in this industry. Operating profit of $20 million declined due to the mix effect of lower aerospace coatings, which have the highest margin. The margin percentage will improve as these volumes pick up.

Now, I will turn this call over to Jim, who will discuss our end-market trends, and our outlook and earnings guidance.

Jim Sawyer

Thanks, Liz. Please turn to page 11 which shows our global end-market trends. This page shows you year-over-year sales growth for our major end-markets, excluding currency, acquisitions, and natural gas pass-through. So, it represents real organic growth from price and volume.

We've included the third quarter numbers next to this quarter, so you can get a sense for the comparisons. What you can see is that while sales to all of our major end-markets were up in the third quarter, in the fourth quarter, the business environment changed significantly, such that energy, food and healthcare are up, but the others are all down.

Growth in the energy market primarily reflects higher hydrogen sales to refineries. Hydrogen demand from refineries has continued to be strong despite the drop in oil prices, because refiners need hydrogen for desulfurization of crude to make low-sulfur diesel and other metal distillates.

Our global hydrogen sales in 2000 eight were over $1.1 billion, up from $840 million in 2007. This growth came from new business and higher demands from existing customers. With two very large plants scheduled to startup in North America in 2010, sales in this end-market will also include gas sales for enhanced oil recovery and gas-well fracturing.

We expect EOR to continue to be a good growth market and these projects are under long-term contracts. The fracking market has continued to be strong, but we expect to see it slowdown in the near term, due to low gas prices and cutbacks in capital spending by some of the drillers.

Electronics slowed down considerably in the fourth quarter. Fabs and foundries cut production volumes significantly in the US, Europe and Asia due to declining demand for PC's and flat-panel TVs, emanating ultimately from the consumer. Semiconductor chip production was down about 10% in the fourth quarter and is expected to contract significantly more in 2009. So, our near-term outlook for this market is not positive. We expect to continue to see growth and win business in the solar market, but this is a small part of our overall business today.

The chemical sector as we previously discussed, customers reduced production significantly in November and December. We saw this in our US volumes first, while our volumes in Europe supplied off our German pipeline system held up pretty well until later in the quarter. In Asia, sales were up year-over-year due to new project starts.

Sales in the metals sector declined 9% in the quarter. US producers cut back production significantly throughout the quarter. Following the cut backs by the US producers, we've also seen a slowdown in the rest of the world, but not to the same extent. This sector is ripping through inventory destocking, and though we have not seen a meaningful pickup in volumes yet, we do expect it to return to a more normalized level of demand in 2009.

You can see that sales to manufacturing reflect a slowdown in global and industrial production, which we expect will be in the range of negative 2% to 5% in 2009. This sector may get a boost from infrastructure spending but, that is not something we're going to be counting on. Healthcare sales are up 6%. It's not a cyclical end-market, and our businesses in Brazil and Spain are growing nicely, as is our US hospital business. Decline in aerospace is due to lower PST volumes which Liz previously discussed.

Finally, food and beverage continues to be very resilient and showed steady growth around the world from new accounts and new technologies. Sales were up 8% this quarter.

Now, please turn to page 12 for some detail on our capital spending plans. Expect our capital spending in 2009 to be in the range of $1.4 to $1.5 billion, about 10% below of our spending in 2008. 20% of this amount or about $300 million is for maintenance CapEx in our base business.

We'll spend another $70 million to $75 million for cost reduction projects, which is an ongoing part of our business. For example, we'll be replacing compression equipment or turbomachinery at existing plants to improve energy efficiency. We typically look for a three year payback on these investments. Most of our capital spend however is for new production plants or expansion of the existing plants, which are supported by 15 to 20 year customer contracts with 'take or pay' provisions, and fixed price with cost pass-through provisions.

We currently have a strong backlog of 42 large on-site projects, which are in some stage of construction and which are scheduled to come on stream in 2009 to 2011. Projects are in very diverse end-markets. You can see from the pie-chart on this page where the capital dollars we expect to spend this year will be invested by region.

A large percentage is in North America which may seem surprising, because energy is our largest growth market and these new hydrogen projects are very large. Our largest projects are two hydrogen plants we're building in Indiana and California. After that, it would be two large oxygen plants we're building in China to supply a coal gas fires being built by chemical customers.

We also have a large number of projects in South America and Asia supplying metals, manufacturing, paper, electronics, and chemical customers. Though the pace of new project [approvals] has paused because of the uncertain environment we're in. We expect 90% of the projects in our backlog to be completed and come on stream on schedule.

While several customers have requested delays in the scheduled startup dates, we have strong contracts with these customers, and in most cases, a significant investment has already been made in the customer project we're supplying. And in addition, when the new project starts up, it will be a low cost, competitive facility which the customer will run.

Please look at page 13 for our productivity initiatives. In 2008, we achieved $320 million in cost savings from productivity initiatives throughout the company. As you can see, this amount increases every year as we grow. Our target has been to achieve productivity savings each year of about 4% of our fixed costs. This is critical to offset cost inflation in the business. Without it, margins would deteriorate. We've been able to increase margins by getting price increases in addition to productivity.

In 2009, we stepped up our cost reduction program because of the impact on our business of the global recession. We're accelerating our productivity initiatives and the severance and cost reductions actions we announced in December will give us an additional $80 million in savings in 2009. And, we will reduce additional discretionary costs as necessary in order to reduce costs enough to offset the lower volumes we expect.

Therefore, we expect to be able to hold our margins flat in 2009, notwithstanding lower volumes and lower capacity utilization. And, this is what really differentiates us from companies who sell products with commodity pricing. In economic down cycles, they feel the effect of lower volume and lower prices, and consequently their margins get squeezed. In our business, price is pretty well locked in. So, although we will see lower sales, our margins will not be impacted much.

Now, please turn to page 14 for our earnings guidance. As we move into 2009, we expect the first quarter to be down sequentially from the fourth quarter of last year. This is due primarily to the fact that October was actually a strong month, and it wasn't until November and December that the major currency devaluations occurred and the production curtailments began. So, we expect the first quarter to follow the trends of November and December.

At some point in time, probably in the second quarter, the destocking of inventory in the metals, chemicals, and semiconductor industries will slowdown and production will pick up, even if only to support anemic customer demand. So, we do expect some pickup in volumes later in the year as a result of customer inventories falling to the point where production must increase.

For the full year of 2009, we expect sales to be in the range of $9.5 to $10 billion or roughly 10% below 2008 sales. There are a number of 'puts and takes' contributing to the lower sales guidance. First, currency and lower natural gas prices will reduce sales by about 10% combined.

Second, we're expecting our base business volumes to been 5% lower. Offsetting this will be 3% or 4% growth from new projects starting up, and additionally, applications technology with new merchant contract signings should add another couple of percent as well. Early forecast for earnings per share is a range of $3.80 to $4.20 which on a low-end would be 10% below 2008, and on the high-end, would be flat with 2008.

The range is a function of the extent and recovery of the economy and the movement of currency rates. The low end we are giving you pretty much assumes that we don't see any improvement in the base business from the very low level we expect to see in the first quarter. We expect our effective tax rate to remain at about 28%.

We don't have any reason to believe that the overall economy will improve any time soon. This is why earlier in the fourth quarter we began to reduce our fixed costs with a major restructuring. We have downsized our fixed costs to match the lower level of demand, and we will continue to accelerate our productivity projects to reduce costs further. We are also expecting a reduction in variable costs as we negotiate with suppliers for price decreases in this deflationary environment.

On the revenue side, we expect our pricing to hold with the inception of pass-through of lower natural gas prices and potentially lower electricity prices. Consequently, we're confident in our ability to hold operating margins in the 20% area. This is what differentiates our business from commodity businesses, where both volumes and margins suffer in the downturn.

For the first quarter, we expect earnings per share in the range of $0.90 to $0.95 cents. This guidance assumes a negative currency impact of about 8% versus the first quarter of 2008, based on current exchange rates.

The step-down in EPS versus the fourth quarter is because we expect that our November and December volumes will continue through the first quarter, where as the fourth quarter included the benefit of a strong October.

Please look at 15. Based on the confidence we have in our ability to generate strong cash flow, we've increased our quarterly dividend from $0.375 per quarter to $0.40 per quarter as we mentioned earlier. This is the 16th annual increase for Praxair, and this chart shows that we've increased the annual dividend at a compound annual growth rate of 19% over that time period.

In addition to increasing the dividend, we will continue to return cash to shareholders by repurchasing stock in 2009 under our remaining $378 million of authorization.

In 2009, we expect to generate well over $2 billion of operating cash flow and spend $1.4 billion to $1.5 billion to fund the construction of a large number of projects in our backlog. Therefore, we will generate approximately $600 million of free cash flow, while at the same time, funding a record backlog of projects.

And looking forward, we still expect to sign a significant number of new on-site projects in 2009 and beyond, which will extend our organic growth into the next decade.

And now, we would be happy to take your questions.

Question-and-Answer Session

Operator

And your first question comes from the line of Kevin McCarthy with Bank of America-Merrill Lynch. You may proceed.

Kevin McCarthy - Banc of America-Merrill Lynch

Yes, good morning. Jim, with regard to the project pipeline, would you comment on how many projects were entered and exited in the quarter, and also, what happens in the event that the timelines are attenuated as your customers attempt to take advantage of lower E&C costs in the future or just adopt a more conservative posture financially. Can you elaborate on how that would impact your financials please?

James Sawyer

Yeah, let me just mention first on the backlog, it did decline during the course of the quarter for a couple of reasons. We started up a handful of plants. We only added one new contract signing during the quarter, which is really a function of the fact that, with all of the uncertainty, very few people were willing to make commitments.

And we did actually bring three projects out of the backlog as a result of customers looking or informing us that they plan to delay the projects, we actually took it out of the backlog even though the customer said that they are just going to delay the project. And for example, Valero announced this morning they are going to delay the new catalytic cracker at the Memphis refinery.

That's one of the projects that we had in the backlog that we have taken out until we get further commitment from Valero that they’re going to go ahead with that. Now, that was a project they had just been signed and so, no work had obviously been done on it. But, they still do have a 'take-or-pay' contract obligation to us.

So, there are a couple of ones that were maybe signed late in the quarter where the customer for his own reasons might not build his own facility, but there is no opportunity for a customer to kind of come back say, well, now we think costs are lower and we want to renegotiate the contract. That's just not a possibility, because they are airtight contracts.

And looking forward, we still got a lot of very interesting projects that are in the proposal stage, and which I think we will sign over the next couple of quarters. There are about 15 that look very close. And so, even though we had a slowdown in new signings in the fourth quarter, I think the pace of that will pick up as the year goes on.

Kevin McCarthy - Banc of America-Merrill Lynch

Okay. Great. And then if I may follow up on slide 11, the sales to the energy sector actually managed to accelerate in Q4 on an underlying basis, notwithstanding the decline in commodity prices. Can you talk a little bit about why that was the case, and what your expectations for growth would be in that industry in 2009?

James Sawyer

Yes, the main acceleration in the fourth quarter was due to higher hydrogen demand. And with a number of oil companies who operate refineries and also make chemicals, shutting down some of the chemical manufacturing. They also lost a source of in-house hydrogen, and consequently had to buy more hydrogen from us. And so that was one of the drivers of higher growth there.

Moving forward, you know, we will see huge growth in 2010 and 2011 when big SMR projects for Chevron and BP come on stream. Otherwise, my guess is that we will see the oil well services decline.

We've got a couple of EOR contracts we are pretty close to signing, and I think those will continue to make sense. We are also very close with Pemex and Petrobras who are continuing to invest in improving their annual yield of energy and will be doing more EOR work. So, despite of lower oil prices, I expect this sector to keep growing.

Kevin McCarthy - Banc of America-Merrill Lynch

Okay. Thanks very much, Jim.

Operator

And your next question comes from the line of Sergey Vasnetsov with Barclays Capital. You may proceed.

Sergey Vasnetsov - Barclays Capital

Good morning. Jim, if you take a look at page 17, given as you just addressed energy expectations for 2009, can you help us to see your expectations for the rest of the segments on a full year basis for '09?

James Sawyer

What was your question again?

Sergey Vasnetsov - Barclays Capital

How this table might look like for your expectations for 2009?

James Sawyer

Just generally, what we will expect to see in end-markets?

Sergey Vasnetsov - Barclays Capital

Yes, exactly.

James Sawyer

I guess I'm just going to kind of talk sequentially rather than year-over-year. All these charts are year-over-year, but I think it's easier to talk sequentially. Energy will hold up and probably grow slightly and somewhat sequentially.

Electronics will probably continue to go down in the first quarter. Now, one of the issues with electronics is that we don't have any exposure to the construction or the capital cycle of semiconductor manufacturing. We are only selling consumables into the fabs. And so, we actually think that the rate of capital cycle in the semiconductor will be down about 60% year-over-year.

Chemical is weak right now and it will stay fairly weak, the same thing with metals and manufacturing. I think healthcare will continue to grow. Aerospace will definitely pick up and food and beverage will keep growing.

Sergey Vasnetsov - Barclays Capital

Okay. Now, my initial question was on full-year, but some appreciative comments on the first quarter. Can you go through once again for the full year 2009?

James Sawyer

I think I kind of gave you that sense there.

Sergey Vasnetsov - Barclays Capital

Okay.

James Sawyer

I gave you that there is a direction they are going in. And to try to predict a number that it will be percentage-wise up year-over-year versus 2008, we need a better crystal ball than I have.

Sergey Vasnetsov - Barclays Capital

Okay. On the share buybacks, you have some authorization left. What are your thoughts on the pace of this buyback? These are stretched through the entire year? Do you see the price starting to come up and keep up the pace that you've had recently?

James Sawyer

We will continue to buyback stock through the year. It is essentially using the excess cash flow we're generating, and also taking advantage of where the stock happens to be today, which we think is a pretty good bargain. But, we have, a huge amount of operating cash flow coming through right now, and with lower capital spending, we’ll have more free cash flow to buyback stock.

Sergey Vasnetsov - Barclays Capital

Okay. Thank you.

Operator

And your next question comes from the line of John McNulty with Credit Suisse. You may proceed.

John McNulty - Credit Suisse

Yeah. Good morning. With regard to your margins, it looks like clearly even when you take out the FX benefits that you had, the margins are noticeably higher in almost all of the divisions than they've been almost ever in the fourth quarter, and I think you've certainly implied that you expect to hold the strength of the margins. Is there any reason to think that the margins would start to drift back down when the business picks back up? Or is this something where you really should hold the margins and the leverage is really going to fall directly to the bottomline going forward?

James Sawyer

No. I'm optimistic that we’ll be able to hold the margins pretty much across the world. It is really a function of lower costs more than anything else. It is where we're getting a benefit of our productivity programs, and actually, if you look at variable margin, if you take our cost of goods sold and you take depreciation out of that, you will see our variable margins are holding up very well, north of 50%, and it is mainly a question of becoming more efficient in production and distribution through the productivity programs.

John McNulty - Credit Suisse

Okay. And then just with regard to pricing, you clearly saw continued strength in pricing, including in North America despite the really weak volumes. What can we expect looking throughout 2009? Do you hold the price? Do you expect to give a little bit back or do you actually continue to get at least a little bit more moderate pricing still going forward?

James Sawyer

I think for the most part we will hold the price. There are still some accounts that will come up for renewal this year which are below market where we can increase the price, but generally, I would say we will hold price.

John McNulty - Credit Suisse

Okay. Great. Thanks a lot.

Operator

And your next question comes from the line of Bob Koort of Goldman Sachs. You may proceed.

Bob Koort - Goldman Sachs

Sorry about that. You mentioned the operating cash flow and the CapEx expectations, and obviously you got your dividend there. It would seem that doesn't leave much room left for share repurchase which I think you intimated might happen in '09, so would you be comfortable taking on more debt to buyback stock?

James Sawyer

Yeah, I think we've been taking on debt to buyback stock. We will continue to take on some debt to buyback stock. We're at a very strong EBITDA of 1.7 times debt. And we're funding A1/P1 commercial paper at less than 0.5%. So we're a very strong balance sheet, very strong cash flow and we can support some more debt for stock buyback.

Bob Koort - Goldman Sachs

And then if I might follow-up, you gave some trends on the packaged gas business and mentioned that it's gotten a little bit weaker here in January. Would you expect as the environment is sufficiently sluggish that you could actually go to negative gas comps there or do you think as we've seen historically, those will still remain positive from a pricing component?

Jim Sawyer

I don't know. I think we probably will go to negative volume growth in gases. I don't think people realize how bad the environment is out there in manufacturing and construction. So I think we will go to negative, some, not huge, but some negative volume growth in gases.

And you know, a lot of people are talking about, well how will this infrastructure program that the government will fund. Well, they're going to take $800 billion, the first part is going to go to bailout the banks and the second part is going to go to give taxpayers checks and then the third part is supposed to go to infrastructure. But I think by the time it goes around being allocated to infrastructure, the states are going to be in huge budget deficits and they're going to need that money just to hold their budget deficits. So, it would be nice if we see a pickup from this so called infrastructure spending, but it's not going to happen soon.

Bob Koort - Goldman Sachs

Got it. Thank you.

Jim Sawyer

Yes.

Operator

And your next question comes from the line of Laurence Alexander with Jefferies. You may proceed.

Laurence Alexander - Jefferies

Good morning. Two questions on pricing. First, could you discuss your confidence on pricing trends by region, particularly in the merchant business? And secondly, are you seeing any push-backs by customers on some of the contract terms in the onsite contracts and not so much on the pricing structure, but on some of the other terms in the contracts?

James Sawyer

Well, first of all, on merchant pricing, I think it will hold everywhere in the world. I don't see any reason why one part of the world will be different than any part. We use the same contract model with five-year contracts everywhere in the world. And we have a very small amount of merchant sales that are actually on spot pricing, that's something we avoid like the plague.

In terms of customers with onsite contracts, complaining about their contracts, well, they signed the contracts with their eyes open. They know what’s in the contract. The contracts are commitments and they are what they are. So, we don't go back and say that we’ll lower the contract price, and take dollars away from our shareholders and give them to your shareholders.

Laurence Alexander - Jefferies

But, just to follow-up on that, you're not seeing any deterioration in the quality of the contracts that you're signing for new customers on the onsite side? I mean they're not pushing back and you're able to maintain the quality of the terms?

James Sawyer

Actually, it’s just the reverse. Over the last five years, we have really stuck to our guns in tightening up contract terms and putting protection in those contracts that, 10 years ago we wouldn't have had. So, in fact, the ones that we've signed recently are probably the best contracts we've been signing in history.

Laurence Alexander - Jefferies

And then lastly, just on a bookkeeping question, the lower share count, was that entirely share buybacks or was some of that changing in of the accounting treatment of some of the incentive comp?

James Sawyer

It was mostly share buyback, but if you understand the way common stock equivalents are calculated, they're basically calculated based on the spread and the stock price above the strike price of the options and so as the stock price comes down, the common stock equivalent calculation gets smaller. But you can actually see that when you look at the numbers and the real number of shares and the common stock equivalent shares.

Laurence Alexander - Jefferies

Thank you.

James Sawyer

Yes.

Operator

And your next question comes from the line of Steve Sherman with Lafayette Research. You may proceed.

Steve Sherman - Lafayette Research

Good morning. On the hydrogen, how much of the increase in hydrogen was due to BP Texas city versus other organic growth or new projects?

James Sawyer

I think all, almost all, if not all of our customers on the Gulf Coast took more hydrogen in the fourth quarter than they did in the third quarter. And we've got small new projects coming on stream that quarter, last quarter, but the next big slug is going to be the big 200 cubic feet per hour contracts we have at Chevron and BP.

Steve Sherman - Lafayette Research

So for the fourth quarter, I guess BP, year-over-year, was sort of a mix with everybody else or was that the largest piece?

James Sawyer

BP was up; actually, BP was about the same year-over-year.

Steve Sherman - Lafayette Research

Okay.

James Sawyer

But several of our other customers were up.

Steve Sherman - Lafayette Research

Great. And then for 2009 EPS guidance, could you triage how much is sort of cost reductions, how much is margin expansion, volume, plus or minus or just new projects ? Do you have sort of a rough feel on the high end of your guidance, the 420 number?

James Sawyer

Well, I tried to sketch it out, the sales line. We have a 10% lower guidance on sales, and we also have about a 10% hit from currency, okay? So that ex-currency, we're kind of flat there. And then, we've got probably about minus 5% from base business volumes going down. And another 3% to 4% from projects starting up and then another 2% to 3% growth from new merchant contract signings and applications technology and so forth.

So, if we're lucky, we'll be able to offset most of the currency and some of the organic volume decline. And that pretty much runs its way down to earnings per share where our guidance for earnings per share is being from flat last year to down 10% last year. I realize it's a wider guidance that we've given before, but we have a 10% headwind right off the top from currency and earnings per share.

So ex-currency, you could look at that as guidance that goes from zero to plus 10%, and that's going to be coming largely from productivity more than anything else, plus the 5% or so growth from new projects coming on stream.

Steve Sherman - Lafayette Research

And hardgood sales are being down significantly more than gases, is that just because there are other companies that supply those products where there’s only a few gas companies out there?

James Sawyer

No, no, they're the same customers. But hardgoods has basically two kinds of things in it. It has consumables in it like welding wire, and so forth, that get consumed right along with the gases. But it also has equipment, which I would describe as capital equipment for welders, like welding machines and laser cutters, and so forth. And what happened in the fourth quarter, and it has been creeping in throughout the year, but there are very, very few sales of capital equipment in hardgoods, because, anybody who is in business is going is delaying any capital equipment purchase until they see the volumes there.

The capital equipment part is the first to come up with the beginning of the cycle and the first to go down.

Steve Sherman - Lafayette Research

Right. But, the welding wire and the consumables in that, those are manufactured by someone else; you guys resell that as a convenience, correct?

James Sawyer

Yes. That’s all manufactured by someone else.

Steve Sherman - Lafayette Research

All right. Thank you.

Operator

And your next question comes from the line of Chris Shaw with UBS. You may proceed.

Chris Shaw - UBS

Yeah. Hi, good morning everyone. I think Jim from your comments, I think you expected aerospace to pick back up. Can we interpret that as we'd expect Surface Technologies volumes to be up in 2009?

James Sawyer

Yeah, definitely. 2008 was horrible for PFT volumes. We actually did less engine coatings than we did in 2007. And even the new, so called genex engines, there is a Rolls-Royce engine, and GE engine that are going to go on the Boeing 787 and the Airbus 850, and these genex engines are more energy efficient and require more coatings.

Well, in fact, we didn't coat any genex engines in the fourth quarter. But they need to build those engines about six months ahead of plane deliveries, and that's when we will see the work.

Chris Shaw - UBS

Okay. And then, I saw news that Valero was, I guess, taking downtime at I think at its Texas City refinery, and I think that’s one of yours. It’s 30 to 40 days, and I think that is normal. Is that an impact for a quarter or is that not even like a penny in EPS?

James Sawyer

That is kind of a normal thing in the first quarter, where refineries do turnarounds. And that's one of the reasons why the first quarter is usually not a great quarter for us when you look annually. So that is not unusual.

Chris Shaw - UBS

And we're not seeing any more turnarounds than normal?

James Sawyer

Not on the refinery side per se.

James Sawyer

Okay.

Chris Shaw - UBS

Then, just a comment on the slides about a near-term pause in the pace of proposal activity, how should we read that? I'm assuming there is going to be some level of proposals again that come back, but is it going to be at the same levels that we saw in the past few years or do you think that it is going to be permanently impaired? Do you have any thoughts on that?

James Sawyer

I don't think it will be at the same level we saw in the past few years. I think that the rise in commodity prices, the rise in energy prices was behind the planning for new projects, okay? So, for example, even though we're building two oxygen units for coal gasification projects in China, I don't think there are going to be any coal gasification projects in the US. And you know, we have been doing a lot of proposal work on coal gasification projects in the US. So, that kind of stuff I don't see coming back, at least not for a while.

Chris Shaw - UBS

Okay. Thanks. That's helpful.

James Sawyer

But we will still see strong activity in most other industries.

Chris Shaw - UBS

Thanks.

Operator

And your next question comes from the line of Chris Willis with Impala Asset Management. You may proceed.

Chris Willis - Impala Asset Management

Good morning. I just had a quick question about SG&A. It had a nice downtick in the quarter. Can you sort of walk through the detail there? And then also on your other income, I know there were some forex gains in there? Any other sorts of 'cats and dogs' kicking around in the 32 million in the P&L?

James Sawyer

SG&A being down is a function of several things. First of all, along with the currency headwinds, that impacts sales and it also impacts SG&A, so the translation of SG&A in our foreign businesses was down quite a bit. Otherwise, there is the effect from our cost reduction program, the folks that we severed in the fourth quarter with the restructuring really got notice on November 15. So we got a month and a half of savings there.

So those are the pretty much the two impacts on SG&A. Then other things in other income, we have a partnership called Wellnite that does a lot of oil and gas work. That had a very strong quarter. And we had a few other smaller 'cats and dogs' in the other income line, probably some small real estate sales and stuff like that.

Chris Willis - Impala Asset Management

Great. Thank you. I Appreciate it.

Operator

And your next question comes from the line of Mike Harrison with First Analysis. You may proceed.

Mike Harrison - First Analysis

Hi, good morning.

James Sawyer

Hello, Mike.

Mike Harrison - First Analysis

You commented that, packaged gas sales in Europe were stronger as a result of repair and maintenance during customer shutdowns. I was wondering to what extent have you seen that trend occurring in the United States?

James Sawyer

Definitely saw that in the United States too. When the chemical plant, the steel plants shutdown, they do maintenance work, and that does give you a temporary uptick in packaged gas sales.

Mike Harrison - First Analysis

And then, in terms of PDI, when you guys gave your preannouncement, you were talking about gases volume being down 5% and hardgoods down 20% for the quarter. It looks like, adding in some pricing and you still came in quite a bit better than those expectations. Can you talk about what had changed in December and yet do you maybe have a slightly more optimistic outlook for the first quarter given where you came in this quarter?

James Sawyer

Well, actually, the best information I can give you is the information you gave me, which was, there was a lot of surprise packaged gas sales associated with mills and chemical plants that had downturn. And, so there actually was a fair amount of maintenance spending by big companies during the quarter.

Mike Harrison - First Analysis

All right. And then a last question is on South America. Obviously Brazil is the cornerstone of that market for you. But, can you talk about what is going on outside of Brazil to show the 15% organic growth rate you saw this quarter, and whether that kind of growth is sustainable outside Brazil?

James Sawyer

Yeah. No, that’s sustainable I think. We've got a lot of projects coming on stream. We've got one coming on stream in Chile, and some new business in Columbia, and some new business in Argentina. So I think we're still going to see good strong growth in the non Brazil countries in South America. And Brazil itself will be strong too.

Mike Harrison - First Analysis

Thanks very much, Jim.

Operator

And your next question comes from the line of Mike Sison with KeyBanc. You may proceed.

Mike Sison - KeyBanc

Hey, good afternoon. Jim, when you take a look at the global on-site business, maybe excluding the hydrogen, what level of volume declines are you seeing and are the bulk of your customers now take-or-pay minimum?

Jim Sawyer

Well, I think on an overall basis, our onsite volumes were relatively flat year-over-year in the fourth quarter. But in spite of that, our atmospheric gases were down about 10%. And our hydrogen was up about 10%. Now, of the atmospheric gases being down, there are a handful of customers who are taking product below their take-or-pay level, but for the most part, the reduction is in volumes that were still above the take-or-pay level for customers.

Mike Sison - KeyBanc

Okay. So if more of your customers go to the take-or-pay level, then is there a little bit of downside in volumes heading into the first and second quarter?

Jim Sawyer

Yeah, that is hard to say. I would expect our volumes probably on the onsite business to be about the same in the first quarter as they were in the fourth quarter. And hopefully pick up in the second quarter if the de-stocking starts coming to an end.

Mike Sison - KeyBanc

All right. And last question, when you think about the 42 onsite project backlogs that you have alluded to, if, due to the external environment, really nothing comes into the pie again in this year, but that does support 3% to 4% growth annually through 2011 and is it pretty linear?

Jim Sawyer

It is pretty linear, yes. And yes, even if we sign a new project today, that wouldn't start up until 2011? So everything between 2009 and 2010 and in the first half of 2011, the dies are all cast for those projects and there will be the 3% to 4% growth from the projects without any new ones coming in. And I think what you would then see, if we didn't get any new projects, is that our CAPEX would start to really go down in 2010 and 2011 and we would have a huge amount of free cash flow.

Mike Sison - KeyBanc

Great. Thank you.

Jim Sawyer

Yes.

Operator

And your next question comes from the line of P.J. Juvekar with Citi. You may proceed.

P.J. Juvekar - Citi

Yes, hi. Jim, you had some FX gains in the quarter that offset your top line weakness and you said that these are mark-to-market benefits. How long are these hedges and would they continue in '09?

Jim Sawyer

Well, the gains are gone. What we basically do is at the beginning of the quarter, we lock in the exchange rates and that kind of locks in our earnings for that quarter, so that even if the translation rate goes down and our sales and our operating profits goes down, we offset that by a gain on the hedge gain. But we only go one quarter forward. So starting off in 2009, we don't expect to see any more hedge gains.

P.J. Juvekar - Citi

But this quarter also, you would put on new hedges or no?

Jim Sawyer

Yes, we're hedged. But we're hedged at rates that are pretty close to the current rates.

P.J. Juvekar - Citi

Okay.

Jim Sawyer

So, it's not possible. I wish you could go back and say well, I really want to go back and re-hedge this at the rate that was available a year ago, but you can't do that.

P.J. Juvekar - Citi

Right. Then there is the question on Asia. Your volumes were flat in Asia which was much weaker than what the GDP numbers would suggest. So, I guess a lot of your end products, like electronics that are exported out.

Jim Sawyer

Yes. Well, there are a couple of things there. First of all, we had good, strong double-digit growth in every end-market sector with the exception of electronics. Okay and then electronics was down I think 18% to 20% something like that. So, the growth we had in the other end markets was offset by the decline in electronics.

P.J. Juvekar - Citi

Okay. And, then I think you said you expect 90% of your backlog to get completed on time and that's the first time we have heard that number, 90%. I guess three months ago, what was your expectation? And is that number slipping?

Jim Sawyer

Well. I put that number out because in fact we took three projects out of the backlog because of delays, okay. So, actually, the 42 projects are back to 100%. Will there be more projects to come out from delays? I don't think many, only ones that nobody has broken ground on anything yet. And even so, we have recourse under our contracts for those customers.

P.J. Juvekar - Citi

Thank you.

Jim Sawyer

So, I still believe that 90% of the backlog will get built and will come on stream, on schedule and to the extent that they're not, we're taking them out of the backlog.

P.J. Juvekar - Citi

Thank you.

Jim Sawyer

Yeah.

Operator

This concludes the question-and-answer portion of your conference. I would now like to turn the call over to Mr. Jim Sawyer for closing remarks. Sir, you may proceed.

Jim Sawyer

Well, thank you all for joining us today. And, for those of you in the Northeast in the snowstorm, travel safely when you go home. And, I look forward to seeing you all or talking with you all later in the year. Goodbye.

Operator

Thank you for your participation in today's conference. This concludes your presentation. Good day.

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