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Praxair (NYSE:PX)

Q1 2011 Earnings Call

April 27, 2011 11:00 am ET

Executives

James Sawyer - Chief Financial Officer and Executive Vice President

Kelcey Hoyt - Director of Investor Relations

Analysts

Mark Gulley - Soleil Securities Group, Inc.

Brian Maguire - Goldman Sachs Group Inc.

Michael Sison - KeyBanc Capital Markets Inc.

Abhiram Rajendran - Crédit Suisse AG

Donald Carson - Susquehanna Financial Group, LLLP

Jeffrey Zekauskas - JP Morgan Chase & Co

James Sheehan - Deutsche Bank

Edward Yang - Oppenheimer & Co. Inc.

David Manthey - Robert W. Baird & Co. Incorporated

Laurence Alexander - Jefferies & Company, Inc.

Kevin McCarthy

P.J. Juvekar - Citigroup Inc

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2011 Praxair Inc. Earnings Conference Call. My name is Michelle, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Kelcey Hoyt, Director of Investor Relations. Please proceed, ma'am.

Kelcey Hoyt

Thanks, Michelle. Good morning, and thank you for attending our first quarter earnings call and webcast. I'm joined this morning by Jim Sawyer, Executive Vice President and Chief Financial Officer; and Liz Hirsch, our Vice President and Controller. 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 2 and note that it applies to all statements made during this teleconference.

In addition, please note that the comparisons are to prior-year results, which include an adjustment in 2010, and these reconciliations to the U.S. GAAP reported numbers are in the Appendices to this presentation and the press release. Jim and I will now briefly review our first quarter results and future outlook, and then we'll be available to answer questions.

James Sawyer

Thanks, Kelcey, and good morning, everyone. Praxair began the year with another record quarter as the manufacturing economy in the U.S. begin to recover, augmenting our long-term growth initiatives in emerging markets, energy and environment. Consequently, we delivered earnings-per-share growth of 18%, which is the high end of our long-term earnings growth forecast range of 12% to 18%. Overall, sales growth was 11%, driven primarily by volume growth in both our base business and new project startups. We're beginning to see some opportunities to improve pricing particularly in Asia and South America, where inflation has crept up to the 5% range. We're also able to increase overall price in the U.S. Most importantly, we continue to deliver earnings leverage, with operating profit growing faster than sales and EPS growing faster than operating profit. This is due to our unrelenting focus on productivity, which drives margin, and cash flow, which drives earnings.

New project signings in the quarter accelerated to about $500 million, bringing our on-site backlog to 40 projects, representing about $2.5 billion in capital investment. As we continue to sign more projects and complete the ones in our backlog, on budget and on schedule, we'll continue to drive double-digit earnings growth.

Kelcey Hoyt

Thanks, Jim. Now please refer to Slide 3 in our presentation for a summary of our first quarter results. Sales this quarter were $2.7 billion, up 11% versus the prior-year quarter. Higher volumes contributed 8% growth and price contributed 1%. Volume growth was strongest in Asia, followed by South America, North America and Europe. Pricing opportunities are improving with capacity utilization increases and are reflected in Asia, South America and North America. Sequentially, sales grew 3% also due to higher volumes, price and currency. Overall volume growth of 1% reflects seasonal effects of the Lunar New Year, Carnival in Brazil and customer turnarounds in North America, which are typical during the first quarter.

Operating profit was $591 million in the quarter, up 17% from the prior year and the operating margin rose to 21.9%. The increase was driven primarily by higher sales volumes, price and ongoing productivity initiatives. Net income was $398 million, 17% above the prior-year quarter and earnings per share grew 18% to $1.29. Earnings per share grew faster than net income due to share repurchases under our $1.5 billion share repurchase program authorized in the middle of last year. $835 million remains available under this program, which we expect to complete by the middle of next year. EBITDA of $844 million grew 14% from the prior year.

During the first quarter, we extended the maturity of our debt profile by issuing $500 million of 10-year notes at a rate of 4.05%. Our debt-to-capital ratio for the quarter was 47.2% and debt to EBITDA was a strong 1.7%. After-tax return on capital for the quarter was 14.4% and return on equity was 26.6%.

Now, we'll review our results in North America, which are summarized on Page 4. Sales in North America were $1.3 billion, 8% above the prior-year quarter due primarily to 6% volume growth. Merchant liquid and packaged gas volumes both showed growth versus the prior year. Underlying sales, including price, increased 7%, primarily driven by the manufacturing, chemicals, metals and energy end markets. We completed the divestiture of U.S. Homecare in early March which decreased sales by 1% versus the prior-year quarter.

Sequential sales increased 2%, primarily reflecting the continued steady recovery we are seeing in merchant and packaged gases. On-site volumes were impacted by the timing of hydrogen customer turnarounds. Merchant sales grew 10% from the prior-year quarter and grew 3% sequentially. We continue to see strong demand from the energy sector, some of which is seasonal. Natural gas frac-ing in Canada remains strong due to frac-ing for natural gas liquids. However, these volumes will decline during the second quarter as they do each year with the spring thaw, which makes it too difficult for the trucks to access the sites. Oil well service volumes also increased in Mexico, with the higher price of oil driving increased activity from Pemex.

Merchant pricing trends for all products are positive with some momentum from recent price actions. As these contracts are typically of a 3- to 5-year duration, our ability to increase the prices impacted by the timing of the renewals of the contracts. We expect to realize low single-digit percentage impact from pricing actions in North America this year.

North American packaged gas sales were 9% above the prior year and 2% above last quarter, reflecting the continued strengthening of the manufacturing environment. In PDI, our U.S. and Canadian business, same-store sales were 11% above last year. Gases and hard goods were both higher, with hard goods continuing to grow faster than gases, as expected during an economic recovery cycle. However, overall sales are still below peak from 2008, providing additional upside as the recovery continues.

In addition, the pipeline of opportunities for potential small acquisitions of distributors is picking up again. Volumes in Mexico grew from the prior year due to stronger demand from energy and manufacturing customers. Operating profit in North America was $322 million. This reflects strong operating leverage versus the prior-year quarter as a result of higher volumes, price and benefits from ongoing productivity initiatives.

Our North American backlog is growing from energy and manufacturing projects. This includes the Tennessee pipeline complex expansion that we announced last month to supply Nucor Corporation, Valero Energy Corporation and the growing requirements of merchant customers in this region. In addition, proposals for smaller plant opportunities are increasing.

Please look at Page 5 for our results in Europe. Sales in Europe were $343 million and excluding foreign currency, up 4% from the prior year, driven by 3% volume growth. In our Europe segment, due to current local economic conditions, sales results continue to vary by country and by distribution method. In Spain, on-site and merchant volumes grew year-over-year and sequentially primarily in the metals, food and beverage, and chemicals markets.

Packaged gas remains slower to recover as construction and met fab remained weak. Construction was overbuilt prior to the recession and credit remains constrained. Italy is growing modestly with improved trends in medical oxygen pricing. German volume trends, as compared to the last year, are positive across all 3 distribution methods. Growth was strongest in manufacturing, metals and the chemical end markets. Operating profit was $65 million compared to $67 million a year ago, primarily due to negative currency effects.

Page 6 shows our results in South America. South American segment sales were $558 million, up 22% from the prior-year quarter. Excluding currency and cost pass-through, underlying sales grew 14% versus the prior-year quarter from 10% higher volumes and 4% higher price. Merchant and packaged gas volumes grew 7% year-over-year and 2% sequentially due to the local manufacturing rebound. On-site volumes grew year-over-year and sequentially due to strong auto demand within the metals end market during the quarter.

The cost inflation that began to arise during the fourth quarter of last year is continuing, and power and distribution cost recovery remains a significant focus for our Brazilian team. Operating profit in South America was $133 million, an increase of 22% versus the quarter a year ago. Underlying operating profit grew primarily due to higher volumes and higher pricing. Our project opportunities in South America remain strong. During the quarter, we signed and added several projects to the backlog in the metals, chemicals and manufacturing end markets. These projects are located in Brazil, Peru, Colombia and Argentina.

Slide 7 shows our results in Asia. Asia had a very strong quarter year-over-year. Sales of $310 million were 20% above 2010, largely due to 14% volume growth. On-site and merchant volumes in China, India and Korea grew from stronger demand for metals, electronics, chemical customers and new plant startups. Merchant volumes grew over 20% year-over-year. We are growing the business by bringing our applications technology into China, India and Korea for opportunities such as oxy-fuel, that utilizes 100% oxygen fuel as opposed to air fuel at various lead, copper and aluminum melters to save energy and reduce emissions.

Merchant pricing trends remain positive, especially in certain geographic areas with tight argon supply. Asia's operating profit increased to $46 million or 35% from the prior-year quarter. Operating profit increased faster than sales due to the effect of higher volumes, price and ongoing productivity initiatives. New project opportunities in Asia continue to be robust. Last night, we announced a 5,000-ton per day atmospheric gases project to supply oxygen, nitrogen and argon at a major chemical industrial park in Chongqing, the largest and fastest-growing city in Inland China. This project is being structured as a Praxair-controlled joint venture with the park's developer.

The park will house about 5 billion in chemical facilities, including a new state-of-the-art MDI facility being constructed by BASF, who'll be the primary customer. In addition, we signed long-term supply agreements for a significant electronics customer in Korea, and Praxair India won a contract to supply oxygen and nitrogen to Usha Martin Limited.

Our results for Surface Technology are shown on Page 8. PST sales this quarter were $157 million, up 15% year-over-year. Coatings for jet engines were strong, particularly EBPVD. The industrial gas turbine and industrial coatings markets are starting to strengthen. The fourth quarter operating profit and margin improved due to our higher volumes.

Now, I'll turn the call back to Jim, who'll discuss our global end market trends and our updated earnings guidance for 2011.

James Sawyer

Thanks, Kelcey. Please turn to Page 9, which shows our global end-market trends. This page shows year-over-year sales growth for our major end markets, excluding currency, acquisitions, divestitures and natural gas pass-through, so represents real organic growth from price and volume. We've included the sequential growth numbers next to the year-over-year quarter so you can get a sense for the comparisons.

Growth in the energy market primarily reflects higher oil well services in Mexico and Canada, and hydrogen sales to refineries. The sequential decline is a result of a number of refinery turnarounds, which is typical on the Gulf Coast during the first quarter. Longer term, hydrogen demand from refineries continues to be strong because refiners need hydrogen for desulfurization of crude to make low-sulfur diesel and other middle distillates.

We expect future growth to come primarily from new refinery investment in overseas markets for upgrading and new capacity. Potential number and the size of these projects is large, so we continue to see hydrogen as a significant growth driver for us. Sales in this market also include sales for enhanced oil recovery and gas well fracturing.

Electronics sector continues to be very strong. We signed a significant new on-site contract during the quarter and now have 3 new world scale high-purity nitrogen plants under construction in Korea, which will continue to boost growth over the next several years. Chemicals sector in the U.S. is benefiting from low natural gas prices and rising demand. It has also grown significantly year-on-year as it represents the largest share of our capital spending in China. Global steel production in the first quarter improved sequentially, in line with seasonal demand in North America as the fourth quarter is typically slower due to holiday shutdowns.

China exported more steel as the price of steel rose in North and South America, and South America grew due to increased auto demand even with the higher steel prices. Our outlook is for modest growth to continue in 2011.

Sales to manufacturing were 14% above last year and 7% higher than the fourth quarter. It was driven by the uptick in U.S. manufacturing and particularly in sectors like machinery. Aerospace is beginning to recover, particularly for our PST business and as deliveries finally materialize on the Boeing 787 using GE GEnx engines, we expect our electron beam vapor deposition business to pick up.

Now please look at page 10 for earnings guidance. Our earnings guidance for the second quarter is for EPS of $1.33 to $1.38. We're forecasting improvement from the typical first quarter of seasonal slowdowns in South America and Asia, as well as modest sequential volume growth overall. We're raising 2011 full-year earnings per share guidance to a range of $5.35 to $5.45, which is 13% to 15% growth from our 2010 adjusted earnings of $4.74. We continue to expect sales to be in the area of $11 billion, roughly 10% above 2010.

Our expectations for capital spending are in the range of $1.6 billion to $1.8 billion due to the projects signed in the first quarter. About 20% of this spend is maintenance capital for our base business. We spent another 5% for cost reduction projects such as improving the energy efficiency of our plants by upgrading compression equipment's turbo machinery. We'll typically look for a 3-year payback on these projects. The remaining 75% of our capital spend or approximately $1.2 billion to $1.4 billion is for new production plants under long-term contracts with customers, which will deliver sales and earnings growth for this foreseeable future.

Our capital spending guidance is driven by a strong project backlog of 40 large projects with a capital value of over $2.5 billion. Projects are all under construction, with scheduled startup dates from next quarter through late 2014. Our outlook is positive for nearly all of our market sectors, product lines and geographies. The U.S. is finally emerging from the recession as capital investment and business spending have picked up substantially.

In Europe, volumes are picking up slightly or are being lost to falling prices as a result of intense competition between the 2 major industrial gas companies there. China, Korea, India and Brazil continue to grow at a breakneck pace. As inflation creeps up in their economies, we'll be working diligently to raise our prices to cover our costs.

And finally, I'd like to announce that we'll be hosting an Investor Field Trip in the Chicago area on June 22. The primary focus will be on hydrogen and pipeline enclaves, and we will visit the 2 world-scale sulfur formed [ph] hydrogen units recently commissioned at the BP Whiting Refinery. Additional details will be made available over the next couple of weeks.

And now, we'll be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Kevin McCarthy from Bank of America.

Kevin McCarthy

Jim, if I look at your project activity, it fluctuated last year within a pretty narrow range, +/- $100 million a quarter. In 1Q, you had a larger jump in dollar value as well as the number of projects. Can you comment on your outlook for the balance of the year there and maybe give us some color on number of projects in and out and the mix?

James Sawyer

All right, Kevin. Basically, in any given quarter, our booked capital spending will be somewhat lumpy depending on which projects are at which stage of their construction. But we expect through the course of the year, CapEx or the guidance that we gave about $1.6 billion to $1.8 billion, which will be a significant increase over last year and probably a record level for us. What's been happening is there is a tremendous number of projects that we are in the process of doing FEL-1 and FEL-2 cost estimates for and working on proposals. And that's over $5 billion worth of work. Now not all of that is going to happen. We're not going to win it all, and all those customers aren't going to build those projects, but it's a similar comparison to what I might call our opportunity set in the next 12 months. We added about $500 million of projects in the first quarter and started up about $200 million or $300 million, so that brought the backlog at $2.5 billion. And we'll probably add a significant amount more the second quarter and the third quarter as well, as some of these contracts get signed with customers. The locations are all over the world, about 2/3 in emerging markets with about 15% each in Korea, India, China and South America and about 25% in the U.S. and another 10% to 15% in Europe. And then in terms of end markets, it's about 30% energy, 10% electronics, 13% chemicals and about 16% [ph] metals and about 30% in manufacturing and kind of all other categories. So that gave you a pretty good breakdown of where the backlog is.

Kevin McCarthy

Okay, it's helpful. And the second question, if I may, Jim, on South America. It looks like your price mix contribution there accelerated to 4% from 2% last quarter. What is driving that and how does it compare to the higher inflation and cost that you referenced?

James Sawyer

All right. Well, there's accelerating inflation in South America and that applies to labor, particularly, and materials but also applies to electricity pricing. When we do the pass-through of electricity pricing, that doesn't show up as a price, that shows up as our pass-through category. But we are able to increase price to offset the inflation that's going on. And I think we'll continue to be able to do that going forward.

Operator

And our next question comes from the line of David Begleiter from Deutsche Bank.

James Sheehan - Deutsche Bank

This is James Sheehan filling in for David. One of your competitors reported some plant operating problems in Q1. Were you able to pick up some additional business in North America in merchant this quarter?

James Sawyer

No. I mean, I'm really not -- I realized -- I know that they did report that, but I am not aware of where those operational problems could have been, and certainly, it wasn't an opportunity for us to pick up any business.

James Sheehan - Deutsche Bank

Okay. And on the end market strength that you saw in metals, manufacturing and chemicals and so forth, could you -- are those run rates -- can we expect the strength of those to continue for the rest of the year? What's your outlook on some of those?

James Sawyer

Well, the growth is a combination of what I'll call base business growth with just higher volumes to existing customers as well as startups of new plants. I think the base business growth is probably going to be a little slower during the rest of the year if you're looking at quarter-on-quarter comps with the prior year because of -- and last year, we had a pretty significant run-up as well. But we'll still see positive comps, I think, in all the markets, particularly since we're bringing new projects on stream. I'd say basically right now that we've -- at least in those 3 markets, electronics, chemicals and metals, volumes have come back to pre-recession levels in North America anyway, not necessarily in Europe. And they've exceeded pre-recession levels in Asia, and about the same as pre-recession levels in Brazil. The manufacturing, which is more heavy manufacturing, metal fabrication, machinery and so forth, was the last sector to come out of the recession, and it's still not really up yet. For example, our packaged gas business, volumes are still 10% below pre-recession levels.

James Sheehan - Deutsche Bank

Okay. And then just on Surface Technologies. Your margins were very strong in Q1. Do you think that's sustainable for the full year?

James Sawyer

Yes, I do. I think there are 2 things going on in that business. About 1/3 of its sales go to the industrial markets and about 1/2 of that is in Europe. And capital spending in Europe is very slow right now, but it is speeding up, and so I think we'll get a good lift not only in sales but higher margins with the production increases. And we've got a lot of opportunity for more volume with very strong operating leverage in both industrial gas turbines, which were off last year significantly and are going to come back, as well as the jet engines.

Operator

And our next question comes from the line of P.J. Juvekar of Citi Financial.

P.J. Juvekar - Citigroup Inc

Jim, your Asian margins declined about 140 basis points. Is it a raw material cost inflation issue or what's going on there in terms of pricing in Asia given all the capacity -- all the capacity that's being added?

James Sawyer

Yes, Europe is not exactly running on all cylinders for us right now.

P.J. Juvekar - Citigroup Inc

I meant Asia.

Kelcey Hoyt

Asia.

James Sawyer

Oh, Asia. I'm sorry. I thought -- sorry, about Europe. No, I think Asia margin percentage is typically low in the first quarter because we have this Chinese or Lunar New Year, which significantly reduces the day count of the first quarter and reduces your volume in the first quarter. You can see volumes off 2% sequentially. That's just a normal seasonal thing. And what happens is when the volume goes down like that on a quarterly basis because of day count, your operating margin percentage goes down because you've got operating leverage in that operating margin. And so when you get back up, this will be in the remaining quarters, the operating margin will go back to the high-teens.

P.J. Juvekar - Citigroup Inc

Okay. And then secondly, how much of your volume growth, your 8% volume growth in first quarter, how much of that is coming from new project startups? And do you have a similar number for 2011?

Kelcey Hoyt

The volume growth.

James Sawyer

Which part of it?

Kelcey Hoyt

The totals combined.

James Sawyer

Oh. I thought we were still talking about Asia. Sorry. I would say about 1/2 of that is coming from project startups and 1/2 is coming from the base business.

Operator

And our next question comes from the line of Laurence Alexander of Jefferies.

Laurence Alexander - Jefferies & Company, Inc.

Two questions this morning. First, on Latin America, can you discuss the market opportunity for hydrogen projects and what market share you think Praxair will capture going forward? And second question is, what is the current pricing trends in U.S. argon?

James Sawyer

I'm sorry. To answer your first question, the major oil companies in South America that -- primarily we're talking about Petrobras, are building several new grass-roots refinery projects, which will all be very, very hydrogen-intensive. And we're working very closely with them and expect to most likely be the supplier of that hydrogen. But they also have the opportunity to build it and own it themselves. So that kind of remains to be seen. And I didn't get your second question.

Laurence Alexander - Jefferies & Company, Inc.

Just what are the current pricing trends in U.S. argon?

James Sawyer

Okay. Pricing trends in the U.S. are good, especially coming out of the recession. We're getting a couple of percentage point overall pricing in merchant and argon is part of that. And we expect that to tighten up a lot further because a lot of the argon goes into construction or welding and heavy manufacturing which, in my mind, has been the slowest part of recovery, and it's now really stepping up. So I'm expecting that argon, which is really the only product in our portfolio that has somewhat volatile pricing, to go up significantly going forward.

Operator

And our next question comes from the line of John McNulty of Credit Suisse.

Abhiram Rajendran - Crédit Suisse AG

This is Abi Rajendran calling in for John McNulty. You started talking about this a little a while ago, but the Europe margins seemed to be a bit weak year-over-year and sequentially. Could you elaborate a bit on why and when we might see it pick back up?

James Sawyer

Yes. It remains to be seen. I think that what has to happen in Europe is they've got to get out of the worry about the euro and the worry about Spain and Italy, because there's very little credit available in Spain and Italy, and people are just not spending money on capital investment. And that's what's hurting our business and our margin there. Our packaged gas business is down about 30% from pre-recession levels, and so if we could get a little bit more capital spending going on in Europe, I think our business would improve significantly, both in terms of growth and higher margins.

Abhiram Rajendran - Crédit Suisse AG

Got it. And a quick follow-up. Besides the power outages that you saw in Japan in the quarter, do you expect to see any further impact from the events in Japan to either Surface Tech or to any of your electronics customers in the region?

James Sawyer

We really don't. It may be like coincidence, but we really don't have much business in Japan. It's always been a fairly low margin region of the world, and therefore we haven't really set up much business there. And as you know, we really focus on a kind of high-density strategy. So we're really not expecting any significant impact overall from the earthquake and the power outages and so forth.

Operator

And our next question comes from the line of Mike Sison of KeyBanc.

Michael Sison - KeyBanc Capital Markets Inc.

Jim, in terms of the projects you're bringing in that's building up your backlog, are the returns on those staying about the same? Are they accelerating maybe, given things are a little bit better in the economy these days?

James Sawyer

I would say the returns are about the same. The average in the backlog is about 16% and that's pretty much what we're signing on average for new projects. Some of them above that, some of them below it. But no real change in the average IRR of the projects.

Michael Sison - KeyBanc Capital Markets Inc.

Okay. And then in terms of your hydrogen business, you talked about pretty nice future backlog there for the next several years. What kind of growth will that business see potentially, let's say, over the next 3 to 5 years?

James Sawyer

I'm guessing probably about 20%. It really depends on which of the new projects that would sign, and we're in negotiation on quite a few as we speak today. But I'm guessing 3 years out, about 20% per year growth.

Michael Sison - KeyBanc Capital Markets Inc.

Okay. Great. And last question on PDI. Same-store sales was pretty impressive in the quarter. Is that a run rate that you should continue to see for the next couple quarters?

James Sawyer

I'm expecting it to accelerate in the next couple of quarters, particularly on the gas side. What we've seen in packaged gases as the economy's finally bouncing back is that the cyclicality and then right now, the improvement in the hard goods side of the business, which is the lower margin and not that attractive side of the business for us. But hard good sales are up more than gas sales, and so I expect both the margin in that business and the same-store sales to be going up.

Operator

And our next question comes from the line of Mark Gulley of Soleil Securities.

Mark Gulley - Soleil Securities Group, Inc.

Had a couple of questions. A follow-up on PDI, I think you said sales are up 11% and same-store was 9%. Does that imply therefore a 2% lift from acquisitions?

James Sawyer

No, we don't have much change in acquisitions in PDI.

Mark Gulley - Soleil Securities Group, Inc.

But the currency perhaps? A strong loonie help here?

James Sawyer

No. It's hard goods driving that. Gas sales are more like 8%, but the hard goods are up 20%.

Mark Gulley - Soleil Securities Group, Inc.

Okay. And looking regionally, it looks like Asia is about to overcome Europe in terms of sales but not in terms of profits. Is there potential for margins in Asia to pick up over time? Or is that just given the nature of the business, nature of the motive [ph] supply mix just going to be a lower margin area for you?

James Sawyer

Margin in Asia will definitely pick up over time and what you have to understand is that most of our plants in Asia were commissioned in the last 5 years, let's say. We've been there for 15 or 20 years but most of the CapEx been in the last couple of years. So at this point, we don't have anything that's fully depreciated in Asia. And we have a lot of startups going on. So startups going on is in the short term compressing the margin. So there's nothing different structurally in the business in Asia versus anywhere else in the world. And the only thing that is a little bit different is the higher proportion of electronics. But most of our electronics is large on-site. And we've got roughly $300 million, $400 million in the backlog just specifically for Samsung on large on-site. So when those come on stream, we'll get even higher margins.

Mark Gulley - Soleil Securities Group, Inc.

And then lastly, if I may, the real has been very strong. It's helped you in terms of the currency effect. Are you concerned about the company, the countries' attempts to control that? Will that have an influence on your sales growth going forward?

James Sawyer

Yes. I know a lot of people talk about that, and it's certainly something that the commodity exporters in Brazil are concerned about. But so far, it hasn't had any impact that we can detect. Consumer spending is very, very strong in Brazil right now. An interesting thing that's happening is that I think I just read that China has overtaken the U.S. as Brazil's major trading partner. And in that kind of means that you have inflation going on in China, that Brazil will always be competitive with China even with stronger exchange rate. So I'm not concerned about that. I think that the economy is continuing to grow rapidly. There's a lot of work to do on the infrastructure and the refinery side, the oil side, the World Cup coming there and Olympics going there. They've got their hands full in Brazil right now.

Operator

And our next question comes from the line of Bob Koort of Goldman Sachs.

Brian Maguire - Goldman Sachs Group Inc.

It's Brian Maguire on for Bob. Just a question on North American margins, showed good year-over-year improvements there. Just wondering if you could kind of quantify how much of that was just lower natural gas prices and lower pass-throughs, and how much of an impact that the mix shift to hard goods, which have a lower margin, had to dampen them and if the year-over-year gain for this quarter is sustainable. And what's your kind of outlook there for the rest of the year?

James Sawyer

Well, I think the year-over-year gain in margin is totally driven by getting operating leverage on the volume growth. And generally, what we're seeing is volume growth in our base business, we're getting about 30% operating margin leverage on that. So that's the driver there, and I don't see that going down anytime soon.

Brian Maguire - Goldman Sachs Group Inc.

Okay, great. And then on the recently announced deal in Chongqing, I was wondering if you could kind of size that deal. I know it's a couple of years out, but could you size it in terms of CapEx or sales contribution that you'd expect?

James Sawyer

Yes, I'm not going to go into the cost of the plant but basically, it's 5,000 tons per day of oxygen. We're using 2 of our standard 2,500-tons-per-day plants. It should start up in 2.5 years. And it's basically a new chemical park that's being built by the developer, very much like the Xiaochang [ph] Park near Shanghai. And we really have the inside track on being the gas supplier in the park and the first major customer is going to be BASF for their MDI. So that's just another example of the kind of growth that we're seeing in China. And the fact that it's inland in the fastest growing city area means that there's still a lot of upside there.

Brian Maguire - Goldman Sachs Group Inc.

Was that one of the big deals that you referenced last quarter that was taking a little bit longer to get signed and done? Or are there a couple of other big deals still in your pipeline that you were expecting to close in the quarter that fell through to the second quarter?

James Sawyer

That is one that we've been -- it's probably been -- had pushed out by almost a year from the first time we started working on that until we got to the signing. So that is exactly what happened there. And that tends to happen in a lot of these newer grassroots projects.

Operator

Your next question comes from the line of Jeff Zekauskas of JPMorgan

Jeffrey Zekauskas - JP Morgan Chase & Co

Jim, you said in your opening comments that over the next year or so, you'll spend $835 million on share repurchase. So that would knock your share count down by about 8 million but I imagine there is some share issuances that should offset that. So is it fair to say that if you execute the program, maybe your average shares would drop by about 5 million shares over the next year? Is that correct?

James Sawyer

Probably somewhere in that range. That's about right.

Jeffrey Zekauskas - JP Morgan Chase & Co

And your tax rate was 28% this quarter. As you see your growth profile changing geographically over the next year or 2, does that change the tax rate and give it an upward bias or a downward bias? Or does it keep it where it is?

James Sawyer

I think it'll stay more or less where it is. The areas where we're spending more capital and growing faster, like Korea and Brazil and China, do have lower tax rates than our average. And so that would tend to push it down. But given the fiscal situations in most countries around the world, I'm not optimistic of the overall rate going down to that. So I expect the 28% to hold for a long time.

Jeffrey Zekauskas - JP Morgan Chase & Co

And then lastly, there seems to be more positive price momentum in the industrial gas business generally, but all of the industrial gas companies are quite profitable and becoming more profitable. So in your opinion, when you go out and you try to get price, what's the primary rationale for achieving it?

James Sawyer

The primary rationale is inflation. And so we start to see inflation, it's much easier to get price increases. And the average customer spends less than 1% of his cost of goods sold buying gases. So nobody likes a price increase, but it doesn't really hurt them very much. And they understand that we have inflation and power costs and so forth.

Operator

And our next question comes from the line of Don Carson of Susquehanna.

Donald Carson - Susquehanna Financial Group, LLLP

Jim, a couple of questions on North America. I'm just wondering on the margin benefit, how much you're getting from -- if you'd remind us what healthcare going out the door did for your margins as well, because presumably that's sustainable going forward.

James Sawyer

Right. Well, healthcare, we didn't actually close until in March so...

Donald Carson - Susquehanna Financial Group, LLLP

Okay. So that will be more of a Q2 benefit then.

James Sawyer

It'll reduce our quarterly sales by something like $40 million a quarter, with very little impact on operating profit.

Donald Carson - Susquehanna Financial Group, LLLP

Okay. So a nice margin improvement there on a recorded basis.

James Sawyer

Yes.

Donald Carson - Susquehanna Financial Group, LLLP

On your merchant pricing, you're at 82%, but I know you've often talked about when you get to 85%, that's where you can get pricing above and beyond cost inflation. But is that more common in your rates or industry rates, because certainly your largest competitor is quite a bit below you on operating rates. I'm wondering what the outlook for real price improvement in North American merchant is.

James Sawyer

I think over the next couple of years, we'll get back to the 2% to 3% to 4% kind of annual price increases. Really, during the recession, we kind of fell off that track because the long-term contracts or 3- to 5-year contracts, they don't come up for renewal, except over kind of a 3- to 5-year period. So I think we'll be able to get back on track with that.

Donald Carson - Susquehanna Financial Group, LLLP

Okay. And then finally on PDI, what are margins there in that business compared to merchant right now? And you mentioned 30% incremental margins. Was that a comment on just merchant or did that include PDI as well?

James Sawyer

Well, that was a comment on North America combined, pretty much applies to both merchant and PDI. And I think that where there's still a lot of excess capacity in the economy is in the packaged gas business, mainly because it just really hasn't picked up yet. But we're really starting to see people spending money on machinery and nonresidential construction and so forth. So we're expecting that margin to go up, and right now it's about 15%

Donald Carson - Susquehanna Financial Group, LLLP

And what's the dynamic there between -- because obviously, as hard goods recovers, you have lower margins there, but is the operating leverage on gases enough to offset that and eventually take margins up overall?

James Sawyer

I'm assuming that going forward, the growth rate, same-store sales growth in gases will catch up with the same-store sales growth in hard goods, so actually it'd be a positive to margins.

Operator

And our next question comes from the line of Edward Yang of Oppenheimer.

Edward Yang - Oppenheimer & Co. Inc.

Jim, you mentioned inflation a couple of times and what percentage of your contracts have inflation protection?

James Sawyer

I would say virtually 100% of them. I can't say for sure all of them, because I haven't read all of them, but virtually 100% of them have some level of inflation indexation. And the newer contracts in the emerging markets tend to have a lot more inflation protection. But basically, they've got -- the model is to escalate the price to your power cost at whatever percentage your power cost is of sales and escalate your other costs at an inflation index and then kind of as a currency hedge, either we get the rest of it currency escalated or inflation escalated. So inflation should be quite positive for us in those countries.

Edward Yang - Oppenheimer & Co. Inc.

Okay, great. And interest expense ticked up a bit sequentially. What's your target for the full year?

James Sawyer

I'd say it's going to stay about where it is right now. It's higher because we moved to more fixed rate this quarter. And so I think it'll stay more or less where it is right now.

Edward Yang - Oppenheimer & Co. Inc.

Okay. And is there any update on your early activities in Russia and the Middle East?

Kelcey Hoyt

Update on Russia and the Middle East.

James Sawyer

Russia and the Middle East. Not much of one. We've got a couple of projects under construction in Russia, working on proposals for a number of new ones. And then in the Middle East, we're working on a number of proposals in the Emirates, United Arab Emirates, as well as in Saudi Arabia. And we haven't -- obviously, we're troubled by the civil unrest there, but think it's very unlikely that either the Emirates or Kuwait or Saudi Arabia or Qatar really will be affected.

Operator

Our next question comes from the line of David Manthey of Robert W. Baird.

David Manthey - Robert W. Baird & Co. Incorporated

Jim, the realization of pricing in the U.S. packaged gas business, I believe you said was 2%. Does that imply that the March 15 price increases are sticking? And what do you expect once we get a full quarter impact in the second quarter? Would it be just the full impact relative to that 2% or a little bit less?

James Sawyer

We're still yet to see much price improvement in packaged gases. We put through some increases in certain areas. I think we'll start to get it, going forward. Maybe we'll get 2% overall for the year. It's probably not a bad average number.

David Manthey - Robert W. Baird & Co. Incorporated

Okay. And then last quarter you mentioned that you're trying to close the gap in South America on energy costs. Are you still chasing those up or have you closed the gap now?

James Sawyer

We closed 88% of it. So we're almost there.

David Manthey - Robert W. Baird & Co. Incorporated

Okay. And then finally, in terms of the U.S. home healthcare divestiture, were the gross margins in that business similar to your overall gross margin, or higher or lower, just so we can understand the GP and SG&A impact.

James Sawyer

The gross margin was very similar, around 50%, to the rest of our business. But the SG&A was higher and so consequently, the operating margin was closer to 0 rather than around 20%.

David Manthey - Robert W. Baird & Co. Incorporated

Right. So maybe $20 million impact on SG&A?

James Sawyer

Yes, something like that.

Operator

Ladies and gentlemen, this does conclude the question-and-answer portion of today's conference call. I'd like to turn the presentation back over to Mr. Jim Sawyer for closing remarks.

James Sawyer

Thank you all for joining the call and wish you well and have a good quarter. Take care.

Operator

Ladies and gentlemen, thank you for your participation in today's conference call. This does conclude your presentation, and you may now disconnect. Have a great day.

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