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

Praxair, Inc. (NYSE:PX)

Q2 FY08 Earnings Call

July 23, 2008, 11:00 AM ET

Executives

James S. Sawyer - EVP and CFO

Elizabeth Hirsch - Director of IR

Analysts

David Begleiter - Deutsche Bank

Prashant Juvekar - Citigroup

Michael Harrison - First Analysis Corp.

Mark Gulley - Soleil - Gulley & Associates

Sergey Vasnetsov - Lehman Brothers

Donald Carson - Merrill Lynch

Laurence Alexander - Jefferies & Co.

Kevin Mccarthy - Banc of America Securities

Chris Shaw - UBS

Jeffrey Zekauskas - JP Morgan

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2008 Praxair Incorporated Earnings Conference Call. My name is Chanel and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. [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, Mr. Jim Sawyer, Executive Vice President and Chief Financial Officer. Please proceed.

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

Hi. Thank you Chanel, and good morning to you all on the webcast. Thanks for attending the quarterly earnings call and I would like to mention that Pat Clark, our Vice President and Controller and Liz Hirsch, Director of Investor Relations are with me this morning. Liz will deliver our prepared remarks and walk you through the slides, and afterwards Liz and I will be available to take your questions.

Liz?

Elizabeth Hirsch - Director of Investor Relations

Thanks Jim and good morning. Today's presentation materials are available on our website at www.praxair.com in the Investors section. Please read the forward-looking statement disclosure on page 2 and note that it applies to all statements made during this teleconference.

Please turn to page 3 for a summary of our second quarter results. Praxair had another very strong quarter with double-digit sales growth in all our geographic regions. We achieved these results despite a challenging U.S. economy and some signs of macro-economic weakness in Europe. In both these regions, we achieved solid organic growth from new business and new applications.

Growth in Asia and South America has continued to accelerate. New project proposal activity is robust. Domestic and foreign investment in China, India, Brazil and other South American countries for infrastructure expansion and commodity production is growing and we are very well positioned in these locations. Our base business in these emerging markets continues to benefit from strong economic activity and a positive pricing environment.

Overall sales grew 23% to $2.88 billion. Currency appreciation contributed 7% to sales growth. Underlying organic growth was a strong 12% from higher volumes and higher pricing in all our geographies.

Acquisitions contributed 2% to sales growth in the quarter. This was primarily the quarter-over-quarter impact of North American packaged gas distributor that we acquired in 2007 and 2008. Globally sales growth was highest in energy, manufacturing and metals market, continuing the business trends we have been seeing in recent quarters.

High oil and gas prices continue to stimulate oxy-fuel combustion conversions and oil and gas well fracturing. Industrial manufacturing has continued to be strong in the emerging markets and for us has remained reasonably strong in the U.S. Our business is not directly exposed to the obvious weakness in U.S. consumer demand and we have a relatively small exposure to the auto industry. We estimate that about 4% of our sales are to that industry both direct and indirect, through suppliers and steel and stainless production. Our sales are largely going into non-residential construction, infrastructure spending and commodity.

Operating profit was a record $543 million, 24% above the second quarter of 2007. The higher mix of hydrogen sales dilutes this operating leverage a bit as hydrogen sales have a lower operating margin percentage than oxygen or nitrogen due to the high cost of the natural gas feedstock which is passed through the customers in our hydrogen prices. Ex hydrogen, our operating profit margin would be over 19%, demonstrating a success we are having in largely offsetting escalating power and fuel cost with higher prices and cost savings from productivity programs.

Net income increased 20% quarter-over-quarter to $349 million. The slower growth in net income versus operating profit results from higher interest expense due to higher debt levels to support our common stock repurchases. And also due to the higher effective tax rate of 28% versus 26% in 2007.

Our earnings per share of this quarter were $1.08 versus $0.89 in the prior year quarter. EPS grew 21% from the strong growth in net income and fewer shares outstanding versus the prior year. Earnings per share would have grown 25% with an equivalent tax rate in both years, which indicates the operating leverage we continue to achieve from growth and good control of fixed expenses.

We generated cash flow from operations of $389 million in the quarter. Capital expenditures were $380 million, primarily funding the growing number of onsite plans in our backlog. We invested $30 million in this quarter to acquire several North American packaged gas distributors. We closed the sale of our industrial gas business in Israel and this represented the bulk of the divestiture proceeds.

We announced this morning a new $1 billion share repurchase program. You'll recall that we announced a $1 billion program in July 2007 and at that time said that we expected to complete the repurchases over a two-year timeframe. Due to our strong cash flow generation, we are substantially ahead of that schedule and have repurchased 931 million to-date under that program. This new program is in addition to what is remaining under the first authorization and demonstrates our ongoing commitment to using our free cash flow for shareholder value creation.

Our first priority for cash flow is to fund our profitable growth projects, but we forecast that because of our high return on capital, we will continue to generate cash well above what we need for capital investments.

Our debt to capital ratio at quarter end was 43.4%, lower than last quarter due to strong net income growth. Our return on capital and return on equity ratios both increased to 15.4% and 25.7% respectively.

Please refer to pages 4 and 5, for our results in North America. Sales in North America rose to $1.57 billion, 22% above the prior year quarter. Higher natural gas prices passed through to customers in hydrogen prices contributed 4% of this sales growth. Sales from acquired packaged gas companies added another 4%.

Underlying growth from higher volumes and price was 12% versus the prior year. Sales growth was broadly diversified, coming from new business and solid demand from existing customers in energy and refining, metals, chemicals and general manufacturing markets.

Those certain sectors of the U.S. economy like housing, auto and financial are struggling we do not have any significant exposure to these markets. And as such, we have not seen significant slowdown in our base business.

The year-over-year volume growth in merchant and packaged gases is more moderate than what we were experiencing a year ago. But new business activity is robust and pricing trends are very strong for all products and in all markets. Given steady demand, generally tight supply conditions, minimal expected incremental production capacity coming online, and inflation in power and fuel cost.

In North America sales growth to the manufacturing sector, excluding acquisitions, was a solid 9%. This may sound surprising, but sectors that we serve including agriculture, metals, commodities and energy are growing well, due to the weak U.S. dollar and strong global demand.

Mexico's economy is growing rapidly and our sales there were up 21% in the quarter, boosted by higher sales to energy due to increasing demand from refiners and oil and natural gas well service companies.

On-site sales grew 25%, excluding the effect of higher natural gas prices. Higher on-site hydrogen volumes to refiners which were 28% above the prior year, contributed to this growth. Strong demand for hydrogen from our refining customers is driven by low sulfur, diesel production. Refiners are currently running at minimal gasoline production, due to rising inventories and low margins due to softening consumer demand. Therefore they have switched their production to diesel fuel and other metal distillates which have better margins for them.

These products are very hydrogen intensive and we have seen no impact on our hydrogen demand from lower gasoline demand.

On-site oxygen and nitrogen volumes were 12% above the prior year on solid demand from steel and chemical customers.

Merchant sales were up 13% from good volume growth and higher pricing. Sales to oil well service companies were strong in U.S., Canada and Mexico. We expect sales to this sector to continue to grow.

Rapidly escalating natural gases prices have supported increasing investment in natural gas exploration, new technology and drilling in tighter geological stratus such as coal, shale and sandstone.

Nitrogen or carbon dioxide is required when the formations are under pressurized and require an energized fluid to stimulate flow from the well. Carbon dioxide and nitrogen sales were also up to food and beverage from new applications and seasonal demand as is typical in warmer weather.

Packaged gases sales in North America grew 15% from the prior year, including the benefit of several acquisition we made in the U.S. and in Canada. In PDI, which is our U.S. and Canadian business, same-store sales growth was 5% driven by higher gases sale. Demand for rare gases and specialty gases is increasing and supplies are tight.

Some key markets where we are seeing strong growth, are refining, universities and research lab, electronics and biopharma. Pricing trends are positive and up substantially for these specialized gases. We are successfully implementing the most recent price increases that we announced in April to recover higher power and distribution cost.

Sales of hard goods weakened in the U.S. and Canada which we believe reflects the slowdown in the auto, transportation and construction industry. Energy, metals, mining and agriculture are sectors where we continue to see some strength.

Operating profit in North America grew 19% to $275 million from volume growth and higher pricing and the operating margin was 17.5%. The growth is slightly lower than the sales growth because of the sharply higher prices of natural gas, power and fuel. We recover these costs by passing the increases through the customers contractually in our product prices but the impact depresses the operating margin percentage.

Please turn to page 6 for our results in Europe. Sales in Europe of $406 million grew 21% versus 2007 with currency appreciation contributing 16%. Underlying growth was 7%. We are seeing moderate growth in Spain and Italy despite slowing industrial production and a weak housing market. Sales in Spain were up 8% ex currency.

Industrial production in Germany is stronger due to growing exports and our business is growing. Underlying sales in the quarter grew 13%. We announced last week that we are building a large new plant on our pipeline which will supply under contract the increasing requirements of our chemical, steel and refining customers in that region as well as the number of new customers. In addition, the plant will supply liquid to the growing merchant markets.

New business from applications technology transfer is driving good growth in merchant and packaged gases. Operating profit grew 25% to $99 million. We are working hard to increase prices to stay ahead of rapidly escalating power costs which are up more than 20% versus last year. We completed the sale of our industrial gas business in Israel this quarter. The business had sales of $27 million in 2007. The impact of the sale on operating profit is immaterial.

Page 7 highlights our results in South America. Sales in South America continue to reflect the strength and stability of Brazil's economy as well as growth in the rapidly developing economies of Peru, Chile, Colombia and Argentina. Industrial production in Brazil far exceeds the U.S. and the Euro zone driven by exports and high prices of commodities and growing consumer demand. Sales of $514 million were 31% above the prior year.

Year-over-year growth was 15% excluding currency appreciation from higher on-site merchant and package gas sales. Our backlog of projects in the region is increasing as our on-site customers in steel and non-ferrous metals, petrochemical, paper and other general manufacturing are expanding and adding capacity.

The supply systems which we are currently building will come on-stream through the end of 2010. Merchant and packaged gases sale are also growing to food and beverage and health care. Sales of LNG through our joint venture with Petrobras continued to ramp up. Operating profit grew 34% to $102 million. Price increases and productivity savings outpaced cost increases and the operating margin improved to 19.8%.

Please look at page 8 for our results in Asia. Our Asia results were very strong this quarter. Sales of $232 million were 30% above the prior year from strong volume growth and higher prices. On-site and liquid sales grew in China, India and Korea. Our sales to electronics grew 37%. Growth in flat panel and solar manufacturing is fueling demand for on-site nitrogen supply, silane, helium and rare gases. Demand for these products globally is outstripping supply leading to strong pricing gains which you can see in our results.

This quarter we announced a new 2000 ton per day plant which in late 2009 will supply multiple on-site and liquid gases to Samsung for one of its thin film transistor liquid crystal display facility. Chemicals, metals and manufacturing are also rapidly growing markets for our products. A newer market for us in China is pharmaceuticals. We recently announced a new contract for our proprietary nitrogen cooling system and technology which will be used for precision cooling of production freeze dryers and chemical reactors. We have not seen any slowdown in the region in our base business and project proposal activities accelerating. Many of these projects are expansions with the existing customers. We started up two new plans this quarter which will ramp up in the second half of this year.

Operating profit grew 33% to $40 million. We have an operating margin over 17% even though we are growing our engineering infrastructure to support the large number of projects we are building and biding in the region as well as globally.

Please turn to page 9 for Surface Technologies results. Surface Technologies sales grew 17% to a $153 million and 9% excluding currency effects. Our sales growth came from two sectors.

First; we quote a higher volumes of jet engine parts for the major airline engine manufacturers. We are seeing a little trickle through effect of delays in the new large Boeing and Airbus planes, but orders are not being canceled, so we see this as perhaps just a more moderate ramp in our expected growth this year.

Secondly, coatings demand for industrial gas turbines and oil well components is growing, a function of high global energy prices. We just started up a new manufacturing plant in India to supply thermal spray coatings for gate valve components made in India, used in oil and gas production.

PST's operating profit grew 17% to $27 million. The operating margin of 17.6% improved from last quarter due to higher volume.

Now please look at page 10 which shows our global end-market trends for this quarter. On this chart, we are showing you year-over-year sales growth in our major markets, with and without currency effects. And you can see that underlying growth is very strong across the board.

Sales to the energy markets continue to be very strong and were up 33% in the quarter, excluding higher natural gas pass-through in the hydrogen business.

While refining margins are being squeezed from high crude prices and softening gasoline demand, this has not impacted our hydrogen sale. The spread between heavy and light crude still favors processing heavy crude, which is very hydrogen intensive. Most of our Gulf Coast customers are making larger amounts of ultra-low sulfur diesel, which has been one of the few profitable products for refiners.

Growing demand from Europe... for diesel fuel passenger cars is supporting diesel margins. High global crude and natural gas prices also support increased drilling activity, and we expect there will be increasing opportunities to supply gases for well fracing in many of the new shale locations in North America that are being developed.

Our LNG business in Brazil continues to grow, and we are exploring similar opportunities in other country. Electronics continues to grow nicely. Sales were up 15% this quarter driven by sales in Asia for flat-panel and semiconductor production. The photovoltaic market is an emerging opportunity. It is forecasted to grow rapidly and we estimate that the total solar gigawatts will grow by 30% to 40% per year through 2015.

Gas products which are required in the manufacturing of polysilicon and the modules include nitrogen, argon, hydrogen, helium, specialty gases like silane and doping gases. In addition, targets are required for physical vapor deposition, and we are uniquely positioned to be able to supply both.

We expect that the total market for gases and deposition materials will grow from about a $100 million this year to over $2 billion in 2015. We currently supply a number of customers in the U.S., Europe and Asia and most recently announced a new contract with the Pevafersa Group in Spain.

Sales to the chemical sector are up 24%. As all of you know North American producers are benefiting from a weak dollar and the spread between natural gas and oil. While domestic demand has fallen, exports are picking up the slack, and so our volumes have been generally strong. I mentioned earlier the growth we are seeing in Germany, in addition, we are continuing to build out our key petrochemical on place in China to meet the requirement of our customers there.

Sales to metals were up 19% and 10% at currency, most of the new growth is from projects in Brazil, China and India. U.S. volumes are strong as steel producers here our cost competitive globally with the weak dollar and the U.S. demand has dropped to differences made up in the export market. High global prices for other metals like zinc and copper are supporting new investment by the mining sector and we have signed numerous contract to supply the mining industry expansions in Chile and Peru.

Manufacturing was strong with sales up 29%. Excluding currency and acquisitions, underlying sales were up 11%. We saw strong growth in all regions and highest in the emerging markets where infrastructure spending is still very strong.

The U.S. is beginning to weaken in certain markets but not all. Global healthcare sales grew 8% coming from Spain, Brazil and our U.S. hospital business. Growth from these businesses is somewhat offset by U.S. home care which is still under pressure from reimbursement rate cuts and from rationalization we are doing in the non-GAAP or DME portion of the business.

Sales to aerospace were up 13% due to higher jet engine coatings in our Surface Technologies business and sales to NASA. The food and beverage market up 11% is giving a good growth in North and South America. Our sales to the food segment are very strong from new applications and growing demand. However, underlying growth was muted by lower carbon dioxide sales in Thailand where shrimp exports have declined due to the strengthening currency.

Please turn to page 11 for our financial outlook and earnings guidance. For the balance of 2008, we have a positive outlook for our business in spite of a global economy which is presenting some challenges. We expect to achieve strong growth in sales, earnings and cash generation in the second half of the year fueled by double-digit growth in South America and Asia.

For North America, we expect growth to moderate in most end markets but that will be offset by additional growth from several new plant start ups and increasing sales to the energy sector. We are appropriately cautious on economic growth, particularly in Europe, but expect that our business will grow faster than the economy with new contracts and new plants coming on-stream.

For the third quarter, our earnings guidance is a range of $1.06 to $1.10 per share on a fully diluted basis. This represents earnings growth of 13% to 17% from the third quarter of 2007.

For the full year, we now expect higher year-over-year sales growth in the range of 16% to 20%. This increase from our prior guidance is based on the underlying business trends we are seeing and the additional currency appreciation which we have realized in the first two quarters. The expected growth percentage is below our 23% growth rate in the first half of this year, primarily because currency appreciation contributed 7% in the first half and we don't expect it to continue at that rate.

We are raising the upper end of our 2008 earnings guidance by a nickel and the bottom end by $0.10 to a range of $4.20 to $4.30 per diluted share excluding the $0.03 impact of the pension settlement charge which we took in the first quarter. This represents earnings growth of 16% to 19% above 2007 in spite of the higher tax rate this year.

At the bottom we have better visibility now on the full year results. At the top we are very confident in our ability to achieve higher earnings due to the growth we are seeing and our tight focus on pricing and productivity to offset fairly significant cost inflation.

We are keeping our 2008 CapEx forecast at about $1.5 billion. Due to our rapidly increasing backlog of projects, this could be several $100 million higher in the coming year. Overall, our outlook continues to be positive, particularly considering the negative macro-economic data which is coming out. We would likely see some slow down in our base business in the U.S. and Europe but that will be offset by growth in South America, China and India plus our large backlog of new projects coming on-stream.

Now we will take some questions. And I would like to ask you to please limit your questions to one and a follow-up and then you can get back in the queue so everyone who is on the line will have a chance.

Question And Answer

Operator

[Operator Instructions]. And your first question comes from the line of David Begleiter. Please proceed

David Begleiter - Deutsche Bank

Thank you, good morning.

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

Hi David.

David Begleiter - Deutsche Bank

Hi can you just give us the update on the backlog, how much of that it... how much start-up and the ending number?

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

Right, first of all, I apologize, I have cold this morning. So my voice is a little bit off. But we started-up six projects during the quarter. We signed 7 new ones. And just to give you a little bit of an idea of the diversification in those projects, among the new ones that we signed, two were in the U.S., one in Mexico, one in Europe, two in South America and one in Asia. And also to show the diversification of the new sign-ups from end-market point of view, we had one in energy, one electronics, one in chemicals, one in glass, one in pulp and paper, and two in metals.

So you can see that, we're still signing new projects on a broad basis. Globally both by end-market sector. And the size of the new projects continues to grow relative to the sizes of the projects that we are starting up.

David Begleiter - Deutsche Bank

Very good. And just on... in the quarter, did pricing and productivity offset costs in the quarter?

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

Yes.

David Begleiter - Deutsche Bank

And that's true for the first quarter as well?

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

Yes.

David Begleiter - Deutsche Bank

Thank you.

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

Yes. I mean basically, we're getting pricing to offset energy cost, first of all. Plus we are getting another 3% or 4% of price, which I would call real price. And then on top of that our productivity programs are primarily offsetting the inflation in labor and non-energy items.

David Begleiter - Deutsche Bank

Thank you very much.

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

Yes.

Operator

And your next question comes from the line of P.J. Juvekar of Citi. Please proceed.

Prashant Juvekar - Citigroup

Good morning.

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

Hi P.J.

Prashant Juvekar - Citigroup

I had a question on your healthcare business.

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

Yes.

Prashant Juvekar - Citigroup

Your competitor is selling its healthcare business, I think you've done a much better job in this area, in this difficult time of reimbursement cuts. So the question is, what kind of synergies do you see between your healthcare and your packaged gas business?

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

Okay. Well we have a fair amount of synergy between healthcare and packaged gas, in the sense that the packaged gas business is somewhat a backbone from a production, distribution, selling point of view. But I think, actually both the packaged gases and healthcare businesses, the key competency is how you... what kind of people you have and how you manage those people and so forth. It is not like the on-site business where you're relying on a machine to generate your sales and earnings. You're relying on your people to generate your earnings in sales.

And I think that's what we have been focusing on in healthcare business because it is even more people dependant than packaged gas business. And adding... we've got a good set of technicians out there visiting with customers taking care of them for the most products you can say for all but I think for the most parts are motivated and committed to what they do and same thing on the productivity side with the price cuts coming down from Medicare we do have to generate productivity and so far we've been able to generated our productivity pretty much to offset the price cuts coming down for the Medicare.

Prashant Juvekar - Citigroup

And the second question I have Jim, is over the years your tax rate has crept up by 5 to 600 basis points.

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

Right.

Prashant Juvekar - Citigroup

Can you shed some light on that, why it's creeping up and where do you see it going? Thank you.

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

I think it should stay about 28% rate. The main reason that had been growing up is really that we... in one sense you can call that this has a amount of tax deductions in the course of the company is succeeding that but I expect the rate will remain about 28%, our U.S. rate is full statutory rate and the businesses in Europe, Asia, Canada, Mexico and South America are really worthy, tax rates are lower.

Operator

And your next question comes from the line of Douglas Judy [ph] of KeyBanc. Please proceed

Unidentified Analyst

Good morning just a question on your PDI business have you seen any sort of margin squeezed due to a higher energy and distribution cost during the quarter or have you been able to cover that with pricing?

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

Obviously the cost has been an issue because of higher diesel cost and transportation costs. I think we've... on the gases side we've been able to offset that, pretty well the price increases so far. On the hard good side, the margins at hard good are just slower than the margins in gases and what we are seeing right now, is that while our same-store sales growth is about 5%, our gases growth is above 5% and hard goods that was actually shrinking.

Unidentified Analyst

Okay, and just one final question, with the share repurchase the new authorization, any update on timing do you expect to be active in the market during the second half of the year or its just kind of depend?

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

Well, we said we did take up to 24 months to do that, we said that year ago with the last program and we nearly finished it in 12 months, but we will buyback stock more as a function of the stock price than doing it on a sort of continuous basis month-by-month.

Unidentified Analyst

All right, thank you.

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

Yes.

Operator

And your next question comes from the line of Mike Harrison. Please proceed.

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

Hi, Mike.

Michael Harrison - First Analysis Corp.

Hi, Good morning. You said last quarter that your PDI gas rent same-store sales were up 9% and hard goods was more like 1% to 2%, did I understand correctly that hard good sales were negative?

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

Yes, just slightly negative, but you clearly see the trend of what's going on and I've just referenced the commerce departments, industrial production report that came out we could go and in the U.S. second quarter industrial production was about 4 percentage point lower than the first quarter industrial production. So that's the industrial production going down at a 4% annualized rate and that would probably will continue going forward. So we can see a one-to-one correlation between our hard good sales in industrial production rate there. But the gas sales stay well above industrial production.

Michael Harrison - First Analysis Corp.

And so holiday gas rent same-store sales growth this quarter relate to the 9% number you saw last quarter?

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

Little bit slower.

Michael Harrison - First Analysis Corp.

Okay. And then, I was also hoping I could get a little bit more detail on your comment about robust business development activity in North America. Should we expect to see new projects hit the backlog in the second half, is that how we should interpret that comment?

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

Yes, I mean the two of the ones that we signed that came in the U.S. in the first quarter were U.S. projects and we expect couple of more coming on during the course of the year.

Michael Harrison - First Analysis Corp.

All right, thanks very much.

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

Yes.

Operator

And your next question comes from the line of Mark Gulley of Soleil Securities. Please proceed.

Mark Gulley - Soleil - Gulley & Associates

Hi, good morning guys I had a question regarding CapEx to sales and, Liz, addressed this at the very end of our comment here I think I want the slides. You talked about a several $100 million increase in CapEx in '09 when your competitors had announced a big ramp as well. Can you kind of hone out little bit more precisely and what that CapEx could be for next year, Jim?

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

Yes, our guidance this year, as we said was $1.5 billion. We might be slightly above that based on what's coming into the backlog could be a $100 million, may be $200 million and higher than that next year and the year after. So I don't see a huge pick up. We were just talking about more increase coming in that we are doing FEL cost quotation on and the projects are bigger. And really the two reasons why the projects are bigger, one is that customers requirements are larger, other one is the that the cost of building projects is going up. But that's not really a problem because what that means is that facility fee that we are charging our customers is going up proportionally to numbers of possibility of the projects is going up.

Mark Gulley - Soleil - Gulley & Associates

So my follow up question I noted with interest the big price increase you posted in Asia I know for a time that has been a problem but now seems to be the double digit category is that kind of a one-off thing on mix or are those kind of price increases is sustainable in Asia?

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

It is primarily a one of thing and its primarily a rare gases. The rare gases that we make which come from atmosphere point at some of the very large atmosphere plants are totally sold out and I talked about xenon, krypton, and argon's tight and helium is tight. So most of our price increase came from those products but the positive side we did get some positive increase in LIN/LOX in China and in India.

Mark Gulley - Soleil - Gulley & Associates

Thank you.

Operator

And your next question comes from the line of Sergey Vasnetsov of Lehman Brothers. Please proceed.

Sergey Vasnetsov - Lehman Brothers

Good morning.

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

Hi Sergey.

Sergey Vasnetsov - Lehman Brothers

Hi, I want to ask you about the chemical business. The 18% growth excluding ForEx it's pretty strong. Can you help us split between the pricing reporting growth in new customers and what would you expect it to be going forward?

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

Okay, yes, we are surprisingly high year-over-year sales chemicals but... and that's really the three specific areas. All three of which where we have 5.15 [ph]. The Gulf Coast we had higher sales with certain of our customers producing higher volume. Secondly, in Chaoxing [ph] the chemical industrial part in China that we got pipeline system in is building quite rapidly with new capacity coming on-stream.

And then lastly, in... surprisingly in Germany on the River Valley pipeline system our main customers there are the chemical industry and that's growing high... quite rapidly as well and consequently we're really sold out on product and we're building a new plant there which is going to allow us to take more customers there to serve the customers we've got at higher levels which are available to us and also a significant amount of cost reduction because as you might know we bought that system from Aero Lockheed and the operating efficiency of the plant. So we've got there very low and we're replacing it with very highly efficient compression system.

Sergey Vasnetsov - Lehman Brothers

Okay, and secondly, do you see some acceleration in the interest and actual business activity related to the energy conservation projects; some of them you discussed in Rio [ph] given us the oil price to 100 plus became reality seems like for a while now. Do you see several change there?

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

It sounds like you're asking fuel combustion primarily and other energy savings.

Sergey Vasnetsov - Lehman Brothers

Yes.

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

Project, yes, I mean that's going very, very well. We've got very strong applications development team which is out there working with customers and helping customers, essentially customize a burner system and an oxygen supply to do the oxy-fuel combustion which will save them 15% to 20% in total energy consumption.

Sergey Vasnetsov - Lehman Brothers

Okay, thank you.

Operator

And your next question comes from the line of Don Carson of Merrill Lynch. Please proceed.

Donald Carson - Merrill Lynch

Yes, thank you. Just want to go to North America and get a little more granularity on price volume specifically in merchant you talked about sales up 13% just wondering what the split is on price volume there and also on your refinery hydrogen was up 28% what was that how much that was organic how much of that was new projects year-over-year?

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

Right. Well let me talk about the refinery hydrogen first. And some people have commented that hydrogen volume Chicago one to one correlation with gasoline volume. That's really not true. The hydrogen volume is really a function of site specific to specific customers; what equipment those customers are running and what slate of input are they taking or taking more heavy solid crude coming in they need more hydrogen. And they're producing more clean diesel and that requires more hydrogen. And then lastly, our cavern system is significantly helping us because as we have customers who take outages for maintenance and so forth we just supply them right out of the cavern and that's turned out to be a good business for us.

Otherwise on the on site atmospheric gases that volume is up strongly to chemicals, steel and pretty much across the board. And then in merchant business pretty much across the board growth in merchant sales as well.

Donald Carson - Merrill Lynch

But Jim, can you be more specific about volume for example on your 28% refinery hydrogen. How... I assume that's not all organic you get some new plants up versus last year. I was just wondering what you see as organic growth in that business?

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

It's... I really can't say it is... the organic growth is starting up new plants and serving new customers and new contracts.

Donald Carson - Merrill Lynch

Right.

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

And the volumes fluctuate from month to month and day to day. So if you try to draw a chart and draw a trend line through it, I wouldn't know... how about the slope of that trend line should be.

Donald Carson - Merrill Lynch

Okay. And then again on merchant of that 13%, what was the sort of price volume split?

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

It was, a little bit more price and volume. But pretty evenly split.

Donald Carson - Merrill Lynch

Okay. What is growing up faster, I know diesel fuel costs were up significantly. But what's been the general inflation on the power side? And how much will lag if any due have in your surcharge is on recovering those higher diesel and power costs?

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

Well, let's divide it up first. Power cost globally are up about 20%, year-over-year. And they will be up even more in the third quarter, year-over-year. U.S. some is about the same number in terms of the mill rate. And... but we capture that through the normal contract language in the on-site contracts. And then transportation costs are on diesel fuel is up. But it's not a hugely significant part of our cost structure. And we have been along the terms of contracts doing surcharges which are specifically based on the cost of diesel fuel.

Donald Carson - Merrill Lynch

Okay. Thank you.

Operator

And your next question comes from the line of Laurence Alexander of Jefferies. Please proceed.

Laurence Alexander - Jefferies & Co.

Hi Jim. I guess first one on pricing. What's your confidence that you can sustain so the 5... 3% real pricing? So are there... in a slowing environment. I mean how far do you think you can push that?

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

Well I guess what I've just said right now is, we're pretty much sold out all over the world. And that applies in North America, it applies in Europe, it applies in South America. Our main constraint to volume growth right now is the capacity... molecule capacity.

And we are actually operating above what you might call it optimal operating rate, because we're having to ship product longer distances from the plants, to do that capacity into the customers that new link [ph] product. So with our environment I think it still is a very positive pricing environment.

Laurence Alexander - Jefferies & Co.

And if you look at the backlogs in the industry, I mean there is more capacity coming on-stream for... you've got nitrogen and oxygen. But do you see sort of the supply demand balance easing for the rare gases or helium? Or is that a structural shift?

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

I am sorry, I couldn't clearly hear the end of the question. Could you--

Elizabeth Hirsch - Director of Investor Relations

I think Laurence your question is, do we see any significant change in the supply demand equation for some of the rare gasses with new capacity plants.

Laurence Alexander - Jefferies & Co.

Or is this a structural shift in the industry?

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

Well, helium is different. Helium is not taken out of Europe, helium is a depleting natural resource. And there is just only so much helium in the ground, and most of it is controlled in the three locations around the world. And the demand for helium is just going up for scientific applications for MRI machines and a lot of industrial applications to the point where the price is up, and there will be fewer helium balloons around.

The rare gases, we have to take out of the very large oxygen plants. And we are actually in that moment, doubling our capacity for rare gases right now. And the demand for those gases is really growing fast, they are used in lasers or used in lot more in semiconductors, and so forth.

Laurence Alexander - Jefferies & Co.

Thank you.

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

Yes.

Operator

And your next question comes from the line of Kevin Mccarthy of Banc of America Securities. Please proceed.

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

Kevin.

Kevin Mccarthy - Banc of America Securities

Yes, good morning, Jim if I look at your pipeline of projects, what is the average internal rate of return for that pipeline? And how is that number changed if at all over the past year or so?

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

We do these projects on a discounted cash flow, over 15 years with no residual value. And that's the way we talk about, internal rates of return on projects. And first of all, the smallest projects which would be projects where we've got a new customer on an adjacent pipeline or something like that. The smallest projects can have very, very high returns. Sometimes 30%, 40% may be one year pay back that type of thing. The very largest projects on the other hand and particularly the hydrogen projects which are heavily competed for, you'd be looking at a 12% to 14% IRR on them but when you take the average together its about 18%.

Kevin Mccarthy - Banc of America Securities

Okay and that 18 has been relatively stable, has it?

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

Yes.

Kevin Mccarthy - Banc of America Securities

Okay then shifting gears to PDI. You referred anecdotally that a lot of small business owners are cognizant to the risk that the capital gains tax regime could change with the new political administration. I see you've made some bolt-ons there. What should we look for in terms of future bolt-on activity. Do you see sellers of small regional businesses as more receptive to acquisitions today?

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

Not yet, I understand the theory and maybe that will happen in the second half of the year, if the people expect the capital gains tax rate to go up next year, and then you want to sell earlier but we haven't seen any change in the attitude of business owners from that perspective.

Kevin Mccarthy - Banc of America Securities

Yes thank you Jim.

Operator

And your next question comes from the line of Chris Shaw of UBS. Please proceed.

Chris Shaw - UBS

Yes, hi good morning, I just read the pricing data you gave for say South America and China, does that include natural gas pass-throughs or not? There is a 8% for South America 12% for Asia.

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

There's got to... we don't... we're not selling that much hydrogen outside of North America. So its not a relevant number.

Chris Shaw - UBS

So do you think there are pricing gains of those levels are sustainable then. And then you continue to get those like for next year or --?

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

I said both... remains to be seen but our supply system is tied around the world and you know we're going to keep working to recover costs and we've kind of moved to a model which people would say obviously you should do that but it's not always as easy in practice but we've moved to a model of really trying to price to the customers next best alternative which was bulk competitive pricing and away from the model of what you call cost plus pricing. And I think that's part of where we're getting a lot more success in the pricing environment.

Chris Shaw - UBS

Okay and then I am sure as you have talked about this before but on the... when you sign new contracts around by projects what do the... the costumers have any outs [ph] once if they decide for some reason business conditions.

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

It depends, but there are often clauses in the contracts where they have before the start of the plan, they have an outlook, they have to pay as back for the plan, they have to reimburse us for what we have spent. And then after the start of the plan they usually have to reimburse us for the remaining net percent value of the contract. So they can get out but it's fairly painful.

Chris Shaw - UBS

Okay, sounds pretty good, thanks.

Operator

And your next question comes from the line of Jeff Zekauskas of JPMorgan, please proceed.

Jeffrey Zekauskas - JP Morgan

Hi, good morning. Normally your operating cash flow grows, about as fast as your earnings but your operating cash flow is down for the quarter and it was flat from the first half. Sort of why is that and what do you expect the operating cash flow change to be by the end of the year?

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

Okay. If you look at the cash flow statement, the big difference is in the line called other which is consumed about $100 million of cash flow. That is timing of tax payments. And we've made a number of tax payments in the second quarter particularly because our environment cost is only about 2.5% right now and so when you pay taxes earlier you will have to pay late payment penalties and so forth. But that's a one time thing in the second quarter.

Jeffrey Zekauskas - JP Morgan

Right. But that's still only a $100 million.

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

Well let me also explain it to you this way. You normally would not have cash flow growth faster to net income growth you have net income growth and then you have CapEx, you have depreciation growth. You have net income growth Depreciation is growing at about half the rate of net income, okay. And then because you are grown your consuming in working capital along the way. So verbally you're not going to have cash flow growth as strong as net income growth.

And then... but we... we have done an excellent job in managing working capital. Our working capital percentage sales is down, our DSOs is down and so forth.

Jeffrey Zekauskas - JP Morgan

Okay. I mean your depreciations in fact up 15% year-over-year. But what I can do is I can follow up. Just lastly, Jim, so you brought back $32 million in stock in the quarter which was the smallest amount that you bought for the last couple of years. Why is that?

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

It's because we pretty much consumed our... and we had $1 billion authorized in a year ago and then August-September of 2007 was a rocky time for the stock market outright our stock price was low so we bought back a lot of stock. Then same thing happened in first quarter so that by the end of this first quarter we had actually spent most of what was authorized our resources and therefore didn't spend as much in the second quarter.

Jeffrey Zekauskas - JP Morgan

What's remaining on the yield authorization?

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

About $60 million

Unidentified Analyst

Thank you very much

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

Yes

Operator

And your final question comes from the line of Mark Gulley from Soleil Securities. Please proceed.

Mark Gulley - Soleil - Gulley & Associates

Yes I wanted to ask a question regarding the technology business same kind of products were used in both silicon that handle space in forward retaliates. Can you kind of generally size those markets for us Jim, and could be as big as flat panel display is as flat panel display is now, and were are you talking 2015?

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

Oh, you're talking about solar?

Mark Gulley - Soleil - Gulley & Associates

Yes solar I guess it's synonymous with --

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

Solar I think could be great business for us. We we've already got about 50 customers under contract we make solar panels. And that is growing very rapidly those are for the most merchant and specialty gas contracts so not large on site contracts. But we are we have a technology for physical vapor deposition for their position and what's required is to make progress big enough to be to coat a large solar panel and that's where we're working on right now.

Mark Gulley - Soleil - Gulley & Associates

Okay thanks for your help.

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

Yes.

Operator

There are no further questions. I will now like to turn the call back over to Mr. Jim Sawyer.

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

Yes, I'd just like to thank you all for being on the call. We are still very positive in our outlook in spite of the negative macro economic scenario. And I think our authorization of another $1 billon stock purchase program is evidence that we have confidence going forward in both earnings growth and cash strong. So thanks very much for attending the call.

Operator

This concludes the presentation. Thank you for your participation. You may now disconnect. Have an excellent week.

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, Inc. Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts