Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Kelcey E. Hoyt - Director of Investor Relations

James S. Sawyer - Chief Financial Officer and Executive Vice President

Analysts

Steven Schwartz - First Analysis Securities Corporation, Research Division

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

P.J. Juvekar - Citigroup Inc, Research Division

Abhiram Rajendran - Crédit Suisse AG, Research Division

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

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

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

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Unknown Analyst

James Sheehan - Deutsche Bank AG, Research Division

Brian Maguire - Goldman Sachs Group Inc., Research Division

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Duffy Fischer - Barclays Capital, Research Division

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

Vincent Andrews - Morgan Stanley, Research Division

Praxair (PX) Q1 2012 Earnings Call April 25, 2012 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2012 Praxair Earnings Conference Call. My name is Jeff, 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 conference over to your host for today, Ms. Kelcey Hoyt, Director of Investor Relations. Please proceed, ma'am.

Kelcey E. Hoyt

Thanks, Jeff. 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 praxair.com in the Investors section. Please read the forward-looking statement disclosure on Page 2 of the slides and note that it applies to all statements made during this teleconference.

In addition, please note that sequential comparisons include an adjustment in the fourth quarter of 2011 and the reconciliation to the U.S. GAAP reported numbers are in the appendix to this presentation and the press release. Jim and I will now review Praxair's first quarter results and outlook. We'll then be available to answer questions.

James S. Sawyer

Thank you, Kelcey, and good morning, everyone. Praxair turned in another solid quarter, with EPS growth of 7% year-on-year despite currency headwinds and weakening economic conditions in several markets. Our North American segment, Canada, the United States and Mexico, turned in a stellar performance with operating profit growth of 16%, fueled by improving manufacturing conditions and strong operating leverage as volumes rebounded. In Europe, we experienced lower volumes and negative operating leverage particularly due to the financial crisis affecting Spain and Italy. In South America, operating profit was negatively impacted as currency devaluation, a recession in Brazil and production distribution dislocations in our operations all occurred at the same time. In Asia, a strong performance in industrial gases with much of our production capacity sold-out was partially offset by falling volumes and prices of product sold to the electronics and solar markets.

Fully diluted earnings per share were $1.38. Earnings included about $10 million of other income attributable to the net effect of gains on asset sales and the recognition of income from a legal settlement, partially offset by some restructuring and severance costs. Excluding the onetime items, the underlying run rate of EPS is closer to $1.36.

For the second quarter, we're expecting a continuation of the same business trends and are issuing earnings guidance of $1.40 to $1.45. For the full year, our earnings guidance is $5.75 to $5.90, increasing the bottom end of the range by $0.05. We do expect a stronger second half of 2012 as the Brazil economy gets back on track to a 4% annualized GDP growth rate and as the electronics sector picks up in the fall.

Our long-term growth plans remains strong and we're maintaining our capital spending forecast of $2.1 billion to $2.4 billion against a backlog of $2.7 billion of projects under construction with committed customer contracts. As these projects start up over the next 2 to 3 years, the contribution to sales and earnings growth should accelerate. At the same time, we are in negotiation on a record amount of new contracts, mostly in the emerging markets which should extend our growth horizons significantly. The production of cleaner energy is the largest growth driver in our portfolio. Within the next 18 months, we'll start up 3 world-scale steam methane reformers, which will increase our hydrogen production capacity by 35%. Additionally, our backlog of projects in China where we're currently sold out, should increase our sales there by more than 40%. And now, I'll let Kelcey explain in more detail our first quarter results.

Kelcey E. Hoyt

Thanks, Jim. Now please turn to Slide 3 for our consolidated first quarter results. Praxair's first quarter results reflect solid growth and continuing operating leverage, with sales growth of 5%, operating profit growth of 6% and EPS growth of 7%. Consolidated sales in the first quarter were $2.8 billion, up 5% versus the prior-year quarter. Foreign currency translation negatively impacted sales 2%, as foreign currencies weakened against the U.S. dollar from the prior-year quarter. The most significant impact to sales came from the Brazilian real, Mexican peso and euro. Underlying sales grew 8% excluding currency and the impact of cost pass-through from lower natural gas prices passed through to hydrogen customers. Higher volumes contributed 4% growth and price contributed 2%. Underlying sales grew in all geographic segments with the exception of Europe. Growth was strongest in North America, driven by strong sales to metals, energy and manufacturing markets. Sales growth continued in South America and Asia from new projects and higher volumes from applications for industrial gases. In Europe, sales were higher than the prior year due to the consolidation of our industrial gas business in Scandinavia. Excluding this acquisition and negative currency effects, sales in Europe were below prior year due to the weak economic environment, particularly in southern Europe.

Sequentially, sales grew 2% from underlying growth in all geographic segments except Asia, where volumes were lower. Primarily from seasonal impacts of the Lunar New Year and further weakness in specialty gases for electronics markets. Operating profit grew to $627 million in the quarter, 6% above the prior year and the operating margin was a strong 22.1%. Higher volumes, combined with price and productivity savings, were the primary contributors to the growth.

Net income of $419 million grew 5% from the prior year and less than operating profit due primarily to higher interest expense from increased long-term debt issued during 2011 to lock in lower interest rates. During the first quarter, we issued $600 million of 10-year notes at a rate of 2.45% to refinance other long-term debt maturities. Our debt-to-capital ratio for the quarter was 51.3%, and debt-to-EBITDA was 1.9x.

Earnings per share of $1.38, up 7% from the prior-year, grew faster than net income due to share repurchases. During the quarter, we completed the $1.5 billion program authorized during July of 2010. $1.4 billion remains available under the new $1.5 billion program authorized during January of this year, which we expect to complete in 2013.

After-tax return on capital for the quarter decreased slightly to 14.2% due to the large amount of project capital under construction and therefore, on our balance sheet, not yet completed. Return on equity increased to 29.4%.

Please turn to Page 4 for our results in North America. Sales in North America were $1.4 billion, 6% above the prior-year quarter. Underlying sales grew 10% from higher volumes and pricing. The negative effects of currency translation and cost pass-through, primarily, historically low natural gas prices, which are contractually passed on to customers, reduced sales by 4%. Underlying sales growth versus the prior-year quarter came from all 3 distribution methods, on-site, merchant and packaged, and in all countries, the United States, Canada and Mexico. Sequentially, sales grew from 1% higher volumes in on-site and packaged gas primarily in the steel and manufacturing markets. On-site sales volumes versus the prior-year quarter were quite strong and driven primarily by the energy and metals markets in all 3 countries, with the strongest growth in the United States.

Our Gulf Coast refinery volumes were significantly stronger year-over-year due to fewer of our hydrogen customers taking turnarounds in the first quarter of 2012 versus the prior year, as well as the refineries taking increased volumes of hydrogen. We also had strong spot sales out of our Gulf Coast hydrogen storage cavern to meet customer needs. The cavern stores over 2 billion cubic feet of high purity hydrogen and is uniquely integrated into our 310-mile Gulf Coast area hydrogen pipeline, which serves more than 50 refineries and chemical plants from Texas City, Texas, to Lake Charles, Louisiana. On-site volumes rose to metal customers in part due to strong oxygen sales on our pipelines in the northern United States. During the quarter, several customers increased utilization at existing assets in their steel mills. In addition, on-site sales grew from continued usage and new installations of our applications technology in the area of blast furnace, oxygen enrichment, Stove Oxygen Enrichment and oxy-fuel steel reheating at steel customers in the area. This includes Praxair's dilute oxygen system combustion technology that provides operators with a flexible, low-cost way to convert burners from air fuel to oxy-fuel systems and can increase productivity, decrease fuel consumption, lower operating cost and reduce emissions. Even though low natural gas price -- even with low natural gas prices, our customers continue to use oxy-fuel technology for fuel substitution, which provides increased throughput and cost savings and energy efficiency benefits.

Merchant sales volumes grew modestly versus the prior-year quarter. Sequentially, merchant volumes were steady. Canada experienced some slowing in liquid nitrogen sales late in the first quarter, as the warmer weather accelerated the timing of the spring thaw, which prohibits heavy trucks from getting to the frac-ing locations. Packaged gas sales remained strong, in line with manufacturing strength. In PDI, our U.S. and Canadian business same-store sales, which excludes currency and acquisitions, were 12% above last year. Gases were up 9% and hard goods were up 19%.

Hard goods' strength continues to spin [ph] around welding equipment, including robotics and automation solutions that help improve customer productivity. The packaged gas business is heavily weighted towards metal fabrication and sales are strong for automobile-related welding, including auto parts, the oil and gas industry, heavy equipment building and repair that requires welding. North American operating profit was $361 million, 16% above the prior-year quarter. The operating margin was 25.8%. The strong operating margin reflects the strength and efficiency of our production and distribution systems, which result in improved operating leverage.

Merchant pricing trends for all products remains positive. As these contracts are typically of a 3- to 5-year duration, our ability to increase the price is impacted by the timing of contract renewals. We expect to continue to realize low single-digit percentage impact from pricing actions in North America this year. The region has several projects in the backlog that are expected to start up within the next 12 months, including the 2 hydrogen projects under construction for Valero at St. Charles and Port Arthur, as well as others serving the manufacturing, energy and metals market. Proposal activity for new on-site plants remains strong, with activity in energy, chemicals, manufacturing and metals.

Last week, we announced a new long-term contract to supply oxygen, argon and nitrogen to Deacero, a leading Mexican steel company. We will build, own and operate a new state-of-the-art and energy-efficient cryogenic air separation unit in northern Mexico with a capacity of 500 tons per day, which is expected to start up in 2014. The plant will also expand Praxair's capacity in the region. Now, please turn to Page 5 for our results in Europe.

Sales in Europe increased 9% for the first quarter versus 2011. The sales increase was due to the acquisition of an increased ownership interest in Yara Praxair in October of last year, which now requires consolidation. This was partially offset by a 3% negative impact from currency as the euro devalued versus the U.S. dollar. Excluding these items, underlying sales decreased from lower overall volume, partially offset by higher pricing. Volumes in Spain and Italy were below prior year, primarily attributable to packaged gases where customer demand was weaker due to lower industrial economic activity. Higher volumes in Germany versus prior year partially offset this impact. Pricing was slightly higher across the region due to initiatives taken to offset cost increases. Price improvements in Spain, Italy and Germany were partially offset by a continued pricing weakness in electronics and medical oxygen. We remain focused on obtaining and improving price in the regions in which we operate. Packaged gas organic sales declined 6% year-over-year and grew 3% sequentially. The sequential growth is driven by Italy, Germany and Scandinavia, partially offset by further volume weakness in Spain.

Operating profit of $68 million was comparable to the prior year. Excluding the favorable impact of the Yara Praxair acquisition and the negative currency impact, underlying operating profit decreased 5% versus the prior-year quarter. Lower volumes decreased operating profit by 8%, partially offset by higher productivity and cost savings, resulting from our fourth quarter restructure. During the second half of 2012, we plan to start up 3 of our 4 plants currently under construction in Russia. In addition, last month, we announced the acquisition of an industrial gas business located in the South Volga region. Two of the 3 on-site plants scheduled to start up later this year are also located in this region and will allow us to accelerate the establishment of a fully-integrated industrial gas model to leverage on-site merchant and packaged gas, and build production distribution density in the area. The on-site plants will serve the chemical and glass industries.

Page 6 shows our results in South America. South American segment sales were $562 million, up 1% from the prior-year quarter. Underlying sales grew 5% from higher volumes and higher pricing. This growth was offset by negative currency translation impacts, primarily, the weakening of the Brazilian real against the U.S. dollar, which reduced sales by 5%. Higher volumes increased sales by 2%, and were driven by new on-site production facilities serving metals and energy markets. Volumes to merchant and packaged gas customers were below prior year, largely attributable to the lower industrial production rates in Brazil. Higher pricing increased sales by 3% and helped partially offset cost increases.

By end market, year-over-year sales increased to metals, health care and food and beverage customers and were relatively flat to manufacturing customers. Sequentially, on-site and packaged gas sales grew but were partially offset by modest declines in merchant. Operating profit in South America was $115 million, a decrease of 14% versus the quarter a year ago. Currency reduced operating profit by 6%. Excluding the currency effects, operating profit was 8% below the prior-year quarter. Higher pricing increased operating profit, but only partially offset higher costs related to power, distribution and product dislocation. In addition, a lower mix of higher-margin merchant liquid volumes contributed to the lower profit. South America has a number of projects scheduled to start up and again, generating revenue under long-term contracts over the next 12 months in Brazil, Peru and Uruguay, serving the chemicals, metals and manufacturing markets. The proposal activity for new large growth projects remains strong in the energy, chemicals, steel and manufacturing markets across South America.

Please turn to Slide 7 for our results in Asia. Sales of $334 million grew 5% versus the prior-year quarter due primarily to volume growth. Volume growth of 5% came primarily from new plant startups in China and India from metals and chemicals customers, which resulted in higher on-site and merchant volume. Overall volume growth was negatively impacted by 5% lower sales to electronics customers in Asia, due to lower demand from semiconductor, flat-panel display and solar customers. Lower pricing, primarily to the electronics end market, reduced sales by 1% from the prior-year quarter. We expect this challenging price environment to continue as long as electronics volumes remain weak. Asia's operating profit grew 8% from the prior-year quarter, primarily as a result of higher volumes. In most markets, growth is constrained, as our plants are operating at full capacity. Looking forward, we have 11 projects expected to start up over the next 12 months, including our second gasification project in China. This one for the Wuwei coking project, our fifth expansion for Meishan Steel and high purity nitrogen for a large electronics customer in Korea. New project activity for the region remains robust, and we expect several new project announcements in the next few months, as customer contracts are signed.

Our results for Surface Technologies are shown on Page 8. PST sales this quarter were $169 million, up 8% year-over-year. During the quarter, we continued to see stronger growth in coatings to the oil and gas market, globally driven by deepwater and shale gas drilling, as well as strong demand for jet engine coatings particularly in North America. Operating profit in the first quarter was $26 million, driven primarily by higher volume and price, partially offset by increases in cost. With that, I'd like to turn this call over to Q&A. [Operator Instructions]

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Mike Harrison with First Analysis.

Steven Schwartz - First Analysis Securities Corporation, Research Division

It's actually Steve Schwartz sitting in for Mike today.

On South America, can you give us some more color on the product dislocations in the higher power cost?

James S. Sawyer

Yes. Yes, this was one of the quarters where South America didn't do as well as we had expected. And basically, I kind of describe it as one of those perfect storm situations with 3 negative factors happening all at the same time. The first one being that the currency is off about 5% year-on-year and about $1.80 real exchange rate. I don't see that getting better during the rest of the year and I'll talk about that in a second. The second one being basically a manufacturing slowdown in Brazil, with industrial production off about 3% and vehicle builds off about 10% year-on-year. I do expect that the economy will significantly rebound in the second half, as the government is doing pretty much everything it can to improve the economy.

They are trying to keep the real from getting too strong and that's why I don't think it will be much better for us in the rest of the year. They're also lowering interest rates, putting tariffs on imported goods and so forth. So we do expect the economy to pick up in the second half. Now the comment on the production side, we had some plant outages during the quarter, which really didn't affect our sales all that much but required us to pull a lot of liquid, which we lost money on and we also had less power efficiency in our power costs, all happening at the same time. And those should straighten out in the second quarter.

Steven Schwartz - First Analysis Securities Corporation, Research Division

Okay. Can you give us an idea of the magnitude of those costs? How much?

James S. Sawyer

Roughly $6 million in the quarter.

Steven Schwartz - First Analysis Securities Corporation, Research Division

$6 million. Okay, Jim. And you're saying that this is all isolated to the first quarter?

James S. Sawyer

Pretty much.

Operator

Our next question comes from the line of Edward Yang with Oppenheimer.

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

Jim, the comment on the negative pricing in Asia to the electronics and solar markets, assume that wasn't in atmospheric gases, that was all in specialty gases and materials?

James S. Sawyer

Right. It's sort of a combination of a number of products, but it's specialty gases and some of them is the materials that we sell into the semiconductor market. On top of that, we had argon pricing in China significantly lower year-on-year as a result of the solar production being reduced to about 50% of capacity utilization and solar production is a pretty big consumer of argon. And so Argon prices were also lower this year than last year.

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

Okay. And India, the merchant up 17%, that was very strong and you mentioned application tech. Could you provide some color around that?

James S. Sawyer

Yes, India is doing very well. We're getting good, solid growth, not only from on-site projects as we build and start up new on-site projects but also, from merchant sales which are partly just coming from overall growth in the economy and growth in demand. But I also think we're doing a great job with technology transfer and applications development in the metal fab and welding markets, in the food and beverage markets, also growth in the pharmaceutical markets. So I think that we're doing a good job in India and we've got a good growth outlook there. Again, similar to China, our merchant capacity is pretty much being fully utilized right now. And so, we're waiting for some of these projects to start up to grow the merchant volumes more.

Operator

Our next question comes from the line of P.J. Juvekar with Citigroup.

P.J. Juvekar - Citigroup Inc, Research Division

Jim, electronics was down 5%, the volumes were down I think 5%. Can you slice that further? Is solar dragging the business down and what are you seeing in electronics, the semiconductors business, and what are your expectations there in the second half?

James S. Sawyer

Right. Well, there are basically 3 end markets. And one way of looking at it, the semiconductor market, which is the largest market, followed by the LED and liquid crystal displays and then the solar market, which is really actually the smaller of the markets right now. The solar market is not doing well and is dragging down sales and particularly, silane and argon, okay? So that's hurting and I think that -- I don't know when that will get better but I think there's a big overinvestment in solar production capacity right now. Semiconductor and LED probably will pick up in the second half. It tends to be a bit of a seasonal business where some of the semiconductor and displays are -- grow faster in the second half and part of that's related to the holiday season and Christmas and so forth in North America.

P.J. Juvekar - Citigroup Inc, Research Division

And secondly, in the U.S. merchant business, you showed some modest growth while your competitor struggled. So I'm wondering if you believe you gained share in U.S. merchant.

James S. Sawyer

I can't really comment on that, the competitive side of it. But basically, what we're seeing in North America and I speak really for Mexico, Canada and the U.S. is packaged sales, I'll come back to that. But package and merchant volumes are recovering nicely in line with a rebound in manufacturing activity, metal fabrication, in the equipment and so forth. On top of that, you do see some fluctuation in the merchant volume that is related to the frac-ing side of the business. And the frac-ing side of the business, it was actually fairly strong in the last couple of quarters, probably be a little bit weaker in the second quarter because of the -- what they call the breakup of the frozen ice in Canada. But we're continuing to see strong growth in manufacturing and I think that we're in for a couple a year, a very strong volume [ph] in North America in overall manufacturing, pretty much fueled by the low natural gas prices, which makes the United States a very low cost production location for steel and a lot of other items.

Operator

Our next question comes from the line of John McNulty with Crédit Suisse.

Abhiram Rajendran - Crédit Suisse AG, Research Division

This is Abhi Rajendran calling in for John.

With pricing continuing to lag in Europe, it feels like the one strong discipline in the industry may be cracking a bit. Do you have concerns about this? And if not, I guess why is Europe a different animal relative to the rest of the world?

James S. Sawyer

Well, it is a fair -- there's a number of differences. But basically, Europe is in a pretty tough recession right now and some of our products get sold into what I would call the capital investment cycle, which means that where customers are building things, they’re not only building more cars but they're building plants to build more cars, for example. And so, with this financial crisis going on in Europe right now, particularly metal fabrication and machinery and construction and maintenance spending are significantly curtailed, both in -- particularly in Spain and Italy but also, in France and other parts of Europe as well. And so, the lack of clarity on the financial side has really kind of paralyzed the capital spending in Europe. So that's really the biggest issue in Europe. I think a second issue is it's harder to control inflation in Europe and I'm not saying that inflation is out of control, but you have mandated wage increases and so forth for your employees. And also, power cost increases going on. So we're not getting enough price increases in Europe to offset our cost increases. And so, to get back at that, we just need to redouble our efforts on productivity.

Abhiram Rajendran - Crédit Suisse AG, Research Division

Okay. Got it. And just a quick follow up on Asia. So the backdrop, especially with post Chinese New Year's pick up being a little bit slow period, a little bit difficult in the quarter, could you talk a little bit about your kind of, more positive outlook for the back half of the year in this geography and which country and sectors you're particularly positive on rebounding?

James S. Sawyer

Okay. Well, China always has the Lunar -- I mean, in other parts of Asia, always have the Lunar and Chinese New Year holiday and everybody stops working for a week or 2, and plants take turnarounds and shutdowns and so forth. So that's not a new phenomenon. It just makes our first quarter results in Asia typically soft relative to the rest of the year. As historically in Europe, the third quarter with summer vacation would make the third quarter soft relative to the rest of the year. So I don't see anything that is a trend of a slowdown in Asia other than in the electronics sector, which I just spoke about. We're continuing to see strong year-on-year growth in demand in Korea and India, in China, in Thailand, in Taiwan, which are the countries that we operate in. And as I said before, we're bringing on some significant new projects this year which will not only improve our sales growth and volume growth to the on-site customers, which are the baseload for those projects, but will also give us a little bit more liquid oxygen, liquid nitrogen and argon to sell in the merchant markets, where we’re basically capacity constrained right now.

Operator

Our next question comes from the line of Don Carson with Susquehanna Financial.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Jim, I want to go back to the strength that you're seeing in North America on a relative basis. Do you think it's -- that you have a better geographic footprint in North America in terms of your exposure to steel and autos and sort of that strength in the Midwest corridor? Or do you think it's better applications technology? What kind of drives your strong relative performance in North America?

James S. Sawyer

I don't know without being about a comparative basis, I can't really speak. But I can tell you that we've -- our -- we're seeing a nice resurgence in end markets on steel. We're basically near full capacity. Our steel customers in both the Chicago region and the Great Lakes region are now extremely competitive on a global basis and some of the international companies that own operations both in Brazil and the United States, for example, are producing more in the United States and less in Brazil or Europe and the United States, the same thing. For steel, natural gas is probably the fourth or fifth highest cost item in producing steel after iron ore and pet coke, I mean, coking coal and so forth. So that's -- the lower natural gas price is helping steel. We're also seeing people like General Motors and Caterpillar and others decide to build more factories, buy more rail cars, that kind of thing. And so, it's just giving us some -- a lot of good sales growth. And at the same time, we've got some pricing leverage in North America and very little inflation in our cost structure.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

And I know argon and helium have been tight, but I assume if you're running flat out on steel, that you got very good availability on argon, but can you comment on the helium outlook?

James S. Sawyer

Yes, argon is pretty well in balance. Helium is a different beast. Helium is not made as a byproduct from air separation. Helium is basically created in the earth from the decay of radioactive materials and like oil and gas, it gets trapped under cap rocks as it rises. And they're really only about 6 places in the world where you can get helium. And the United States being a strong one, but also, in the Middle East and Russia. We have really invested a lot of capital in backward integrating in our sources of helium over the last, in my lifetime with the company, 25 years. So we have a very strong sourcing in helium. I think we're the only sourcer of helium and the only company in the helium business that has not put customers on allocation. And so, we are actually increasing price in helium because the demand -- supply-demand imbalance there.

Operator

Our next question comes from the line of Mike Sison with KeyBanc.

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

In terms of PDI continues to post pretty impressive results there, still in the double digits, do you see that sustainable for the next several quarters in terms of demand?

James S. Sawyer

I think so. I think that what you have to -- part of what you have to do is look back and we are now in this quarter, finally back above what I would call pre-recession levels in terms of base business in packaged gas. So we still got room to grow there. I think the customer base, the metals fab, and equipment and so forth [ph] that I spoke about earlier is going to continue to grow in North America. So I do see a good, solid outlook for packaged gases in North America.

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

Okay. And then when I think about North America volumes in total, 7%, pretty impressive there, can you break that out between maybe new projects? Did you have a lot of new projects coming in? And just trying to get a feel for what base demand looks like here in North America.

James S. Sawyer

Right. Probably about 3/4 of that is not related to new projects, and about 1/4 is related to new projects. We haven't started up a lot of projects in the last 12 months. And if I kind of reflect on that a little bit, we have about $2.7 billion as we discussed, of backlog of new projects. To just kind of spread out when are those starting up over time, roughly $400 million starts up in the first half of 2012, $600 million in the second half of 2012 and closer to $800 million in the first half of 2013. So we will start to see some much more significant contribution from startups moving into 2013.

Operator

Our next question comes from the line of Laurence Alexander with Jefferies.

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

I just want to slice the electronics business from a different angle. How much of that is nitrogen or on projects that are on take-or-pay contracts?

James S. Sawyer

Right. Our total electronics business I would say, probably 60% or 70% is on-site gases. And they are -- if we just look at that in isolation, it's not down year-on-year, okay? And the biggest concentration -- location for that and concentration is with Samsung in Korea. And generally, what they do when there's a downturn is where they've outsourced production to third-party fabs and there's a downturn, they bring that production back into Korea again. So what I would say that relative good performance for our electronics business is largely a function of the fact that most of it is on-site nitrogen.

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

But those contracts are now above the take-or-pay, so if there's a cyclical recovery, you still get the upside left?

James S. Sawyer

There's nobody who's on a take-or-pay situation where they're paying but not taking products.

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

And then you mentioned in a few regions and end markets, you're being capacity-constrained. If you just look at the portfolio globally, how much capacity would you need just to get to a point where you didn't feel that you were capacity-constrained and putting customers potentially at risk or in tight situations?

James S. Sawyer

Well, perhaps I should correct myself a little bit. I would say -- I don't want to leave the impression that if we had more capacity in the quarter that just ended, that we would've sold more. That's not the impression -- that's not the situation. But we've got good growth and we're close to full capacity. And so we can always kind of make more capacity by moving products around from one location into another location. Because sometimes, you're -- in one particular area, you may be totally sold out but then if you got a production distribution system, you can haul product in from other locations where you're not sold out. But that tends to increase the distribution cost. But generally speaking, if I commented around the world, we're running in the kind of low- to mid-80s in merchant capacity utilization and probably mid-80s in North America and a little bit higher than that in China and India but down in the low-70s in Europe.

Operator

Our next question comes from the line of Jeff Zekauskas with JPMorgan.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Your other income was unusually large this quarter at $14 million versus a cost of $1 million in the year ago period. What caused that $15 million swing?

James S. Sawyer

Okay. We always have nonrecurring, I guess you could call things happening. But basically, we had some other income coming from a power contract that we won in a litigation award on in South America. We also had a piece of land sale in Korea, and a gain on some of our electronic component business that we sold. And we also at the same time, increased our severance cost and incurred some restructuring costs. So we're not going to be running $14 million of other income every quarter. So as I mentioned, roughly about $10 million of that was kind of from those items and we'll typically see other income of closer to $5 million in a quarter, most quarters.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Okay. And then for my follow-up. Some industrial gas companies not only have large capital expenditures but they also have large capital leases, whereas for a large capital lease payments, when I look at Praxair, I don't seem to see that structure. Do you have that structure, and is that a choice of the industrial gas company or does it have something to do with the industrial gas customer? Can you clarify a little bit of that?

James S. Sawyer

That's a result of a quirky accounting rule that really doesn't make much logical sense. But basically, there's an accounting rule which says that if 100% of a project output is going to a single customer in a single location, that's really a capital lease from the customer's point of view. And so, we would need to book that as a capital lease receivable rather than as capital expenditures. We don't have much of that because we have a more integrated business. And if we were -- if you're just doing standalone projects with a single customer in a single location, it's likely that some of those, the customer will have to account for as a capital lease and therefore, you'll have to account for it that way. But the vast majority of our projects, as you know are places where we have a pipeline system where we can supply to other customers from the same plant or where we've got liquid take-out and so forth. So we just don't have very much of that.

Operator

Our next question comes from the line of Mark Goley [ph], with Goley [ph] and Associates.

Unknown Analyst

First question is on hydrogen, if I can. In your early remarks, I think Jim, you talked about 3 hydrogen plants and then Kelcey talked about 2 for Valero. Can you talk about who the third one is? Could it possibly be Chevron El Segundo or is it somebody else?

James S. Sawyer

There's another one that's coming on stream in the next 12 months in India, from an Indian oil company. The other project that you mentioned in the Chevron, in Richmond is still in a delayed situation and will not be coming on stream at least in 2012 or 2013.

Unknown Analyst

Okay. And secondly, for my follow-up, one of the negatives associated with lower natural gas costs for one of your competitors was the fact that bonus payments and inefficiency segments are worth less if the natural gas price is lower. Do you have the same kind of a bonus arrangement and are you getting hit just a little bit on the backside by lower natural gas costs regarding that particular item?

James S. Sawyer

Yes, it's really in our -- I don't think it's really a bonus payment issue. The issue is when you sign a contract to sell either oxygen and you have an escalation formula where you pass through the price of electricity, the percentage of revenue which escalates to your electricity should be about equal to what you spend on electricity, okay? And the same thing with natural gas pass-through in hydrogen sales. But you can do contracts which are over escalated or under escalated, and then you're really not neutral to the price of natural gas anymore. And part of that has to do with the additional products that we sell in the hydrogen business, where pretty much, the underlying escalation will be related specifically to the hydrogen sales. But we're also selling steam in the form of -- well, energy in the form of steam to the customer and those sales are based on the value and the price of natural gas. And to the extent to which you got steam sales going on, that can be real operating profit, which goes up or down with natural gas.

Operator

Our next question comes from the line of David Begleiter with Deutsche Bank.

James Sheehan - Deutsche Bank AG, Research Division

This is Jim Sheehan sitting in for Dave.

Some of your peers in Europe commented on electronics markets starting to stabilize or maybe troughing and starting to get better sequentially. Are you seeing any evidence of that?

James S. Sawyer

I think they probably will. I haven't seen our results for April yet. But that's probably a good commentary.

James Sheehan - Deutsche Bank AG, Research Division

Okay. And just on the project backlog and your expectation of it about $0.60 in earnings per share uplift in 2013, could you just discuss with the bid activity level as it is, what is the upside to that EPS level that you've discussed?

James S. Sawyer

There's probably no upside to that number in 2013 because basically, I would say, a project that we would sign today, we wouldn't be starting up until 2014. So our -- the cake that we baked for 2013 is pretty much already baked.

Operator

Our next question comes from the line of Bob Koort with Goldman Sachs.

Brian Maguire - Goldman Sachs Group Inc., Research Division

It's Brian Maguire on for Bob today.

Just kind of a follow-up to that last one, just talking about the European volumes, packaged gas down 6% and the overall volume's down a couple of percent. Any kind of change in regional trends within Europe where you're seeing any improvement below the surface that might be a leading indicator for things getting better?

James S. Sawyer

Well, I don't know if I would call it a leading indicator but it's clearly the places that don't have government finance issues are doing pretty well and that would be primarily our business in Scandinavia, which is really pretty much un-impacted by that followed by Germany, which has got as a lesser impact and then Spain, Portugal and Italy where basically, people just aren't making spending decisions right now. And hopefully, that'll correct itself pretty soon.

Brian Maguire - Goldman Sachs Group Inc., Research Division

Okay. And just a follow up in the areas targeted by the increased severance spending. Any particular geography or end market targeted?

James S. Sawyer

Well, primarily, the places where we're not doing as well, where we had soft quarters and that would be South America and Europe.

Operator

Our next question comes from the line of Kevin McCarthy with Bank of America Merrill Lynch.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Jim, I guess 2 questions on Europe. I think you gave us some moderate restructuring activity there and how is that going and what is the associated cost savings that you would expect in the back half of the year? And then the second question I have was on the Russia, with regard to your 3 plant startups. How much could that contribute in 2013? And perhaps, you could comment more broadly on how you see the Russian market shaping up over the next 3 years or so.

James S. Sawyer

Right. Severance costs or benefits from severance, we'll start to see benefit in the second half in Europe. It's not going to be a huge number especially where we've got inflationary cost greater than we can get price increases. But kind of the $5 million year run rate being kind of a number. Russia, we actually are absorbing that benefit since we're spending $5 million to $10 million a year in business development cost right now without any revenue today to show for it. But we will be starting up our first on-site plant next quarter or in the third quarter. And what we're basically doing is building an integrated on-site and merchant gas business in the Volgograd region which is sort of the center for chemical production, as well as some steel production. And then also up in near the Ural Mountains, with the large projects that we're doing with EVRAZ up there. So we should start to I guess, as we start up the first plant, that will probably cover our business development costs and then, as we start up the larger plants in the Urals, they'll start contributing pretty significant amounts of operating profit in the second half of 2013.

Operator

Our next question comes from the line of Duffy Fischer with Barclays Capital.

Duffy Fischer - Barclays Capital, Research Division

Just to go back to the U.S. which I thought had a wonderful quarter, the 7% volume and 3% price that you got, does that feel like about the right run rate if kind of U.S. underlying business stays at the same

level it was at in Q1?

James S. Sawyer

Yes. That's pretty good. I mean, if you look at it, industrial production is growing faster than they did and if you look inside of industrial production at markets like machinery and so forth, are still showing 8% kind of increases. So our numbers pretty much line up with that [indiscernible].

Duffy Fischer - Barclays Capital, Research Division

Okay. And then if you're getting price and we're already kind of touching 26% margins or close to that in the first quarter, can this segment get up 27% or so if this recovery lasts for another, call it 4 to 6 quarters?

James S. Sawyer

I don't know. It's a pretty good margin. The guys are doing a terrific job. We and a lot of other companies really have restructured our people cost in the United States and in Mexico and Canada. So we're operating a very high level of sales and productivity. And that's helped a lot, not only for us but some of our customers. I don't see a lot of upside in the operating margin percentage in North America. But I'm very happy with what the guys are doing.

Operator

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

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

My question is on the negative impact of natural gas in currencies in the second quarter and beyond. As I'm looking at the revenues, the combined negative impact this quarter was about 3%. Is it possible that could be as much as twice the impact next quarter? And similarly, on the gross margin line, just given the natural gas pass-through, rough calculations, I'm coming up with maybe 50 basis points of gross margin improvement because of the collapse in natural gas prices and there too, couldn't that be as much as twice as big an impact as we look to the second quarter and third quarter?

James S. Sawyer

I don't see the natural gas impact being much different in the rest of the year than it is in the first quarter. In other words, we’ve had roughly $2 natural gas through the quarter and that's probably what we'll continue on. That's a -- been about a 50 basis points impact on the margin, I don't see that changing going forward. Now the other half of your question I think was about currencies and one -- we're expecting currencies to stay about where they are right now. Of course, they could end up being different than that but I'm not smart enough to forecast that. But the year-over-year comparables to last year's second and third quarters are going to see more like a 5%, 4% to 5% year-over-year comparison. And that's because the dollar was much weaker in the second and third quarters of last year than it is right now.

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

Right. Okay, And then just quickly, you've always been really good at growing your SG&A plus D&A at a slower rate than sales or I guess more appropriately, your gross profit dollar growth. Is there any reason that this year should be any different? As I'm looking at your guidance range in the EPS, it's sort of shaking out of that SG&A growth would be in the excess of sales growth or GP growth and I'm just wondering if there's anything unusual going on to have caused that.

James S. Sawyer

No. Generally, we would expect to see SG&A growth much lower than sales and gross margin growth. The one factor I would add to that which is the increase in our pension costs which is kind of a step change from the fourth quarter to the first quarter where we have on an annualized basis, about $30 million increase in pension and benefit costs this year.

Operator

Our final question comes from the line of Vincent Andrews with Morgan Stanley.

Vincent Andrews - Morgan Stanley, Research Division

Maybe just as a last question. Jim, you talked about the low natural gas prices in the U.S. being a stimulant for all sorts of activity. Are any of your customers coming to you and asking you to hedge that gas for them? Obviously, you have no reason to do it for yourself, this is the pass-through but are your customers looking for hedges?

James S. Sawyer

No. Our -- basically our customers are primarily the refining industry, okay? And the refining industry is quite well able to hedge its own exposure to energy prices, if you will. So basically, our -- what we want to do is, I’ll describe it this way. The energy sector is a big end market for us and a big sector for growth. But we don't want our margins to be impacted plus or minus by changes in energy prices. We don't want to be in the energy business in that way. So we really just try to lock-in our operating profit dollars. But what I would say is that the low natural gas price relative to the price of oil significantly reduces the cost for refineries to use hydrogen in their refinery as a proportion of their total refining cost. And that's tending to drive up the consumption of hydrogen, which is a good thing for us.

Operator

Ladies and gentlemen, that will conclude the Q&A portion of our call. I'd now like to turn the presentation back over to Ms. Kelcey Hoyt for closing remarks.

Kelcey E. Hoyt

Okay. Thank you again for participating in our first quarter earnings call. Our next quarter earnings call, the second quarter, will be held on July 25. Thank you.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now all disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Praxair Management Discusses Q1 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts