Praxair 10-K 2010
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the fiscal year ended December 31, 2009
For the transition period from to
Commission file number 1-11037
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ Accelerated filer ¨ Non- accelerated filer ¨ Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ
The aggregate market value of the voting and non-voting common stock held by non-affiliates as of June 30, 2009, was approximately $22 billion (based on the closing sale price of the stock on that date as reported on the New York Stock Exchange).
At January 31, 2010, 306,321,560 shares of common stock of Praxair, Inc. were outstanding.
Documents incorporated by reference:
Portions of the Proxy Statement of Praxair, Inc., for its 2010 Annual Meeting of Shareholders, are incorporated in Part III of this report.
ANNUAL REPORT ON FORM 10-K
For the fiscal year ended December 31, 2009
TABLE OF CONTENTS
Praxair, Inc. and Subsidiaries
Praxair, Inc. (Praxair or the company) was founded in 1907 and became an independent publicly traded company in 1992. Praxair was the first company in the United States to produce oxygen from air using a cryogenic process and continues to be a major technological innovator in the industrial gases industry.
Praxair is the largest industrial gas supplier in North and South America, is rapidly growing in Asia, and has strong, well-established businesses in Europe. Praxairs primary products for its industrial gases business are atmospheric gases (oxygen, nitrogen, argon, rare gases) and process gases (carbon dioxide, helium, hydrogen, electronic gases, specialty gases, acetylene). The company also designs, engineers, and builds equipment that produces industrial gases for internal use and external sale. The companys surface technologies segment, operated through Praxair Surface Technologies, Inc., supplies wear-resistant and high-temperature corrosion-resistant metallic and ceramic coatings and powders. Sales for Praxair were $8,956 million, $10,796 million, and $9,402 million for 2009, 2008, and 2007, respectively. Refer to Note 18 to the consolidated financial statements for additional information related to Praxairs reportable segments.
Praxair serves approximately 25 industries as diverse as healthcare and petroleum refining; computer-chip manufacturing and beverage carbonation; fiber-optics and steel making; and aerospace, chemicals and water treatment. In 2009, 94% of sales were generated in four geographic segments (North America, Europe, South America and Asia) primarily from the sale of industrial gases with the balance generated from the surface technologies segment. Praxair provides a competitive advantage to its customers by continuously developing new products and applications, which allow them to improve their productivity, energy efficiency and environmental performance.
Industrial Gases Products and Manufacturing Processes
Atmospheric gases are the highest volume products produced by Praxair. Using air as its raw material, Praxair produces oxygen, nitrogen and argon through several air separation processes of which cryogenic air separation is the most prevalent. As a pioneer in the industrial gases industry, Praxair is a leader in developing a wide range of proprietary and patented applications and supply systems technology, including small non-cryogenic nitrogen plants. Praxair also led the development and commercialization of non-cryogenic air separation technologies for the production of industrial gases. These technologies open important new markets and optimize production capacity for the company by lowering the cost of supplying industrial gases. These technologies include proprietary vacuum pressure swing adsorption (VPSA) and membrane separation to produce gaseous oxygen and nitrogen, respectively. Praxair also manufactures precious metal and ceramic sputtering targets used primarily in the production of semiconductors.
Process gases, including carbon dioxide, hydrogen, carbon monoxide, helium and acetylene are produced by methods other than air separation. Most carbon dioxide is purchased from by-product sources, including chemical plants, refineries and industrial processes and is recovered from carbon dioxide wells. Carbon dioxide is processed in Praxairs plants to produce commercial carbon dioxide. Hydrogen and carbon monoxide are produced by either steam methane reforming of natural gas or by purifying by-product sources obtained from the chemical and petrochemical industries. Most of the helium sold by Praxair is sourced from certain helium-rich natural gas streams in the United States, with additional supplies being acquired from outside the United States. Acetylene is typically produced from calcium carbide and water or purchased as a chemical by-product.
Industrial Gases Distribution
There are three basic distribution methods for industrial gases: (i) on-site or tonnage; (ii) merchant liquid; and (iii) packaged or cylinder gases. These distribution methods are often integrated, with products from all three supply modes coming from the same plant. The method of supply is generally determined by the lowest cost means of meeting the customers needs, depending upon factors such as volume requirements, purity, pattern of usage, and the form in which the product is used (as a gas or as a cryogenic liquid).
On-site. Customers that require the largest volumes of product (typically oxygen, nitrogen and hydrogen) and that have a relatively constant demand pattern are supplied by cryogenic and process gas on-site plants. Praxair constructs plants on or adjacent to these customers sites and supplies the product directly to customers by pipeline. On-site product supply contracts generally are total requirement contracts with terms typically ranging from 10-20 years and containing minimum purchase requirements and price escalation provisions. Many of the cryogenic on-site plants also produce liquid products for the merchant market. Therefore, plants are typically not dedicated to a single customer. Advanced air separation processes allow on-site delivery to customers with smaller volume requirements. Customers using these systems usually enter into requirement contracts with terms typically ranging from 5-15 years.
Merchant. The merchant business is generally associated with distributable liquid oxygen, nitrogen, argon, carbon dioxide, hydrogen and helium. The deliveries generally are made from Praxairs plants by tanker trucks to storage containers owned or leased and maintained by Praxair or the customer at the customers site. Due to distribution cost, merchant oxygen and nitrogen generally have a relatively small distribution radius from the plants at which they are produced. Merchant argon, hydrogen and helium can be shipped much longer distances. The agreements used in the merchant business are usually three-to five-year requirement contracts.
Packaged Gases. Customers requiring small volumes are supplied products in metal containers called cylinders, under medium to high pressure. Packaged gases include atmospheric gases, carbon dioxide, hydrogen, helium and acetylene. Praxair also produces and distributes in cylinders a wide range of specialty gases and mixtures. Cylinders may be delivered to the customers site or picked up by the customer at a packaging facility or retail store. Packaged gases are generally sold by purchase orders.
A substantial amount of the cylinder gases sold in the United States is distributed by independent distributors that buy merchant gases in liquid form and repackage the products in their facilities. These businesses also distribute welding equipment purchased from independent manufacturers. Over time, Praxair has acquired several independent industrial gases and welding products distributors at various locations in the United States and continues to sell merchant gases to other independent distributors. Between its own distribution business, joint ventures and sales to independent distributors, Praxair is represented in 48 states, the District of Columbia and Puerto Rico.
Praxairs surface technologies segment supplies wear-resistant and high-temperature corrosion-resistant metallic and ceramic coatings and powders to the aircraft, printing, textile, plastics, primary metals, petrochemical and other industries. It also manufactures a complete line of electric arc, plasma and high-velocity oxygen fuel spray equipment as well as arc and flame wire equipment used for the application of wear resistant coatings. The coatings extend wear life and are applied at Praxairs facilities using a variety of thermal spray coatings processes. The coated parts are finished to the customers precise specifications before shipment.
Inventories Praxair carries inventories of merchant and cylinder gases, hardgoods and coatings materials to supply products to its customers on a reasonable delivery schedule. On-site plants and pipeline complexes have limited inventory. Inventory obsolescence and backlogs are not material to Praxairs business.
Customers Praxair is not dependent upon a single customer or a few customers.
International Praxair is a global enterprise with approximately 59% of its 2009 sales outside of the United States. It conducts industrial gases business through subsidiary and affiliated companies in Argentina, Belgium, Bolivia, Brazil, Canada, Chile, China, Colombia, Costa Rica, France, Germany, India, Italy, Japan, South Korea, Malaysia, Mexico, the Netherlands, Paraguay, Peru, Portugal, Russia, Spain, Taiwan, Thailand, United Arab Emirates, Uruguay and Venezuela. Societa Italiana Acetilene & Derivati S.p.A. (S.I.A.D.), an Italian company accounted for as an equity company, also has established positions in Austria, Bulgaria, Croatia, the Czech Republic, Hungary, Romania, Russia and Slovenia. Yara Praxair, which is also accounted for as an equity company, has established positions in Denmark, Norway and Sweden. Praxairs surface technologies segment has operations in Brazil, China, France, Germany, India, Italy, Japan, Singapore, South Korea, Spain, Switzerland, Taiwan and the United Kingdom.
Praxairs international business is subject to risks customarily encountered in foreign operations, including fluctuations in foreign currency exchange rates, import and export controls, and other economic, political and regulatory policies of local governments. Also, see Item 1A. Risk Factors and Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Seasonality Praxairs business is generally not subject to seasonal fluctuations to any significant extent.
Research and Development Praxairs research and development is directed toward developing new and improved methods for the production and distribution of industrial gases and the development of new markets and applications for these gases. This results in the development of new advanced air separation and hydrogen process technologies and the frequent introduction of new industrial gas applications. Research and development for industrial gases is principally conducted at Tonawanda, New York; Burr Ridge, Illinois; Rio de Janeiro, Brazil; Shanghai, China; and Bangalore, India.
Praxair conducts research and development for its surface technologies to improve the quality and durability of coatings and the use of specialty powders for new applications and industries. Surface technologies research is conducted at Indianapolis, Indiana.
Patents and Trademarks Praxair owns or licenses a large number of United States and foreign patents that relate to a wide variety of products and processes. Praxairs patents expire at various times over the next 20 years. While these patents and licenses are considered important, Praxair does not consider its business as a whole to be materially dependent upon any one particular patent or patent license. Praxair also owns a large number of trademarks.
Raw Materials and Energy Costs Energy is the single largest cost item in the production and distribution of industrial gases. Most of Praxairs energy requirements are in the form of electricity, natural gas and diesel fuel for distribution.
The supply of energy has not been a significant issue in the geographic areas where the company conducts business. However, the outcome of regional energy situations or new energy situations is unpredictable and may pose unforeseen future risks.
For carbon dioxide, carbon monoxide, helium, hydrogen, specialty gases and surface technologies, raw materials are largely purchased from outside sources. Praxair has contracts or commitments for, or readily available sources of, most of these raw materials; however, their long-term availability and prices are subject to market conditions.
Competition Praxair operates within a highly competitive environment. Some of its competitors are larger in size and capital base than Praxair. Competition is based on price, product quality, delivery, reliability, technology and service to customers.
Major competitors in the industrial gases industry both in the United States and worldwide include Air Products and Chemicals, Inc., Airgas Inc., LAir Liquide S.A., and Linde AG. Principal competitors for the surface
technologies lines are Chromalloy Gas Turbine Corporation, a subsidiary of Sequa Corporation, Bodycote, PLC, and Sulzer Metco Management AG. Other competitors in surface coating technologies vary by geographic region.
Employees and Labor Relations As of December 31, 2009, Praxair had 26,164 employees worldwide. Of this number, 10,315 are employed in the United States. Praxair has collective bargaining agreements with unions at numerous locations throughout the world, which expire at various dates. Praxair considers relations with its employees to be good.
Environment Information required by this item is incorporated herein by reference to the section captioned Managements Discussion and Analysis Environmental Matters in Item 7 of this 10-K.
Available Information The company makes its periodic and current reports available, free of charge, on or through its website, www.praxair.com, as soon as practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (SEC). Investors may also access from the company website other investor information such as press releases and presentations. Information on the companys website is not incorporated by reference herein.
In addition, the public may read and copy any materials filed with the SEC at the SECs Public Reference Room located at 100 F Street NE, Washington, D.C. 20549. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website, www.sec.gov, that contains reports, proxy information statements and other information regarding issuers that file electronically.
Due to the size and geographic reach of the companys operations, a wide range of factors, many of which are outside of the companys control, could materially affect the companys future operations and financial performance. Management believes the following risks may significantly impact the company:
Significant external factors include:
General Economic Conditions Weakening economic conditions in markets in which the company does business may adversely impact the companys financial results and/or cash flows.
Praxair serves approximately 25 diverse industries across more than 30 countries, which generally leads to financial stability through various business cycles, however, demand for Praxairs products could be adversely affected by a broad decline in general economic or business conditions in the industries served by its customers. In addition, many of the companys customers are in businesses that are cyclical in nature, such as the chemicals, metals and refining industries. Downturns in these industries may adversely impact the company during these cycles.
Recent turmoil in the financial markets has adversely affected global economic activity. A sustained decline in economic activity could adversely affect demand for the companys products and impair the ability of our customers to satisfy their obligations to the company, resulting in additional uncollected receivables and/or unanticipated contract terminations or project delays. Additionally, such conditions could impact the utilization of the companys manufacturing capacity which may require the company to recognize impairment losses on tangible assets such as property, plant and equipment as well as intangible assets such as intellectual property or goodwill.
Cost and Availability of Raw Materials and Energy Increases in the cost of energy and raw materials and/or disruption in the supply of these materials could result in lost sales or reduced profitability.
Energy is the single largest cost item in the production and distribution of industrial gases. Most of Praxairs energy requirements are in the form of electricity, natural gas and diesel fuel for distribution. Praxair attempts to minimize the financial impact of variability in these costs through the management of customer contracts, which typically have escalation and pass-through clauses for the companys larger contracts. Such attempts may not successfully mitigate cost variability which could negatively impact its financial condition or results of operations. The supply of energy has not been a significant issue in the geographic areas where it conducts business. However, regional energy conditions are unpredictable and may pose future risk.
For carbon dioxide, carbon monoxide, helium, hydrogen, specialty gases and surface technologies, raw materials are largely purchased from outside sources. Praxair has contracts or commitments for, or readily available sources of, most of these raw materials; however, their long-term availability and prices are subject to market conditions. A disruption in supply of such raw materials could impact the companys ability to meet contractual supply commitments.
International Events and Circumstances The companys international operations are subject to the risks of doing business abroad and international events and circumstances may adversely impact its business, financial condition or results of operations.
Praxair has substantial international operations which are subject to risks including devaluations in currency exchange rates, transportation delays and interruptions, political and economic instability and disruptions, restrictions on the transfer of funds, the imposition of duties and tariffs, import and export controls, changes in governmental policies, labor unrest, possible nationalization and/or expropriation of assets, domestic and international tax laws and compliance with governmental regulations. These events could have an adverse effect on the international operations in the future by reducing the demand for its products, decreasing the prices at which it can sell its products, reducing the U.S. dollar value of revenue from international operations or otherwise having an adverse effect on its business.
Global Financial Markets Conditions Macroeconomic factors, including the recent turmoil in the U.S. and global credit and equity markets, may impact the companys ability to obtain financing or increase the cost of obtaining financing which may adversely impact the companys financial results and/or cash flows.
Volatility and disruption in the U.S. and global credit and equity markets, from time to time, could make it more difficult for Praxair to obtain financing for its operations and/or could increase the cost of obtaining financing. In addition, the companys borrowing costs can be affected by short and long-term debt ratings assigned by independent rating agencies which are based, in significant part, on the companys performance as measured by certain criteria such as interest coverage and leverage ratios. A decrease in these debt ratings could increase the cost of borrowing or make it more difficult to obtain financing. While the impact of continued volatility in the global credit markets cannot be predicted with certainty, the company believes that it has sufficient operating flexibility, cash reserves, and funding sources to maintain adequate amounts of liquidity to meet its business needs around the world.
Competitor Actions The inability to effectively compete could adversely impact results of operations.
Praxair operates within a highly competitive environment worldwide. Competition is based on price, product quality, delivery, reliability, technology and service to customers. Competitors behavior related to these areas could potentially have significant impacts on the companys financial results.
Governmental Regulations The company is subject to a variety of United States and foreign government regulations. Changes in these regulations could have an adverse impact on the business, financial position and results of operations.
The company is subject to regulations in the following areas, among others:
Changes in these or other regulatory areas may impact the companys profitability, may require the company to spend additional resources to comply with the regulations, or may restrict the companys ability to compete effectively in the marketplace. Noncompliance with such laws and regulations could result in penalties or sanctions that could have an adverse impact on the companys financial results.
Catastrophic Events Catastrophic events could disrupt the operations of the company and/or its customers and suppliers and may have a significant adverse impact on the results of operations.
The occurrence of catastrophic events or natural disasters such as hurricanes, health epidemics, acts of war or terrorism, could disrupt or delay the companys ability to produce and distribute its products to customers and could potentially expose the company to third-party liability claims. In addition, such events could impact the companys customers and suppliers resulting in temporary or long-term outages and/or the limitation of supply of energy and other raw materials used in normal business operations. These situations are outside the companys control and may have a significant adverse impact on the companys financial results.
Significant internal factors include:
Retaining Qualified Personnel The inability to attract and retain qualified personnel may adversely impact the companys business.
If Praxair fails to attract, hire and retain qualified personnel, the company may not be able to develop, market or sell its products or successfully manage its business. Praxair is dependent upon its highly skilled, experienced and efficient workforce to be successful. Much of Praxairs competitive advantage is based on the expertise and experience of its key personnel regarding its marketing, technology, manufacturing and distribution infrastructure, systems and products. The inability to attract and hire qualified individuals or the loss of key employees in very skilled areas could have a negative effect on the companys financial results.
Technological Advances If the company fails to keep pace with technological advances in the industry or if new technology initiatives do not become commercially accepted, customers may not continue to buy the companys products and results of operations could be adversely affected.
Praxairs research and development is directed toward developing new and improved methods for the production and distribution of industrial gases and the development of new markets and applications for the use of these gases. This results in the frequent introduction of new industrial gas applications and the development of new advanced air separation process technologies. The company also conducts research and development for its surface technologies to improve the quality and durability of coatings and the use of specialty powders for new applications and industries. The results of these research and development activities help Praxair to create a competitive advantage and provide a platform for the company to grow its business at greater percentages than the rate of industrial production growth in the geographies where it operates. If Praxairs research and development activities did not keep pace with competitors or if it did not create new applications that benefit customers, then the companys future results of operations could be adversely affected.
Litigation and Governmental Investigations The outcomes of litigation and governmental investigations may affect the companys financial results.
Praxair is subject to various lawsuits and governmental investigations arising out of the normal course of business that may result in adverse outcomes. These actions are based upon alleged environmental, tax, antitrust and personal injury claims, among others. Adverse outcomes in some or all of the claims pending may result in significant monetary damages or injunctive relief that could adversely affect its ability to conduct business. While management currently believes that resolving all of these matters, individually or in the aggregate, will not have a material adverse impact on the companys financial position or liquidity, the litigation and other claims Praxair faces are subject to inherent uncertainties and managements view of these matters may change in the future. There exists the possibility of a material adverse impact on the companys results of operations for the period in which the effect of an unfavorable final outcome becomes probable and reasonably estimable.
Environmental Laws and Regulations The costs of complying with environmental laws and regulations may adversely impact the companys financial position and results of operations.
Praxair is subject to various environmental and occupational health and safety laws and regulations, including those governing the discharge of pollutants into the air or water, the storage, handling and disposal of chemicals, hazardous substances and wastes, and the remediation of contamination. Violations of these laws could result in substantial penalties, third party claims for property damage or personal injury, or sanctions. The company may also be subject to liability for the investigation and remediation of environmental contamination at properties that it owns or operates and at other properties where Praxair or its predecessors have operated or arranged for the disposal of hazardous wastes. Although management does not believe that any such liabilities will have a material adverse impact on its financial position and results of operations, management cannot provide assurance that such costs will not increase in the future or will not become material. See the section captioned Managements Discussion and Analysis Environmental Matters in Item 7 of this 10-K.
Tax Liabilities Potential tax liabilities could adversely impact the companys financial position and results of operations.
Praxair is subject to income and other taxes in both the United States and numerous foreign jurisdictions. The determination of the companys worldwide provision for income taxes and other tax liabilities requires judgment and is based on diverse legislative and regulatory structures that exist in the various jurisdictions where the company operates. Although management believes its estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in its financial statements and may materially affect the companys financial results for the period when such determination is made. See Notes 5 and 17 to the consolidated financial statements.
Operational Risks Operational risks may adversely impact the companys business or results of operations.
Praxairs operating results are dependent on the continued operation of its production facilities and its ability to meet customer contract requirements and other needs. Insufficient or excess capacity threatens the companys ability to generate competitive profit margins and may expose the company to liabilities related to contract commitments. Operating results are also dependent on the companys ability to complete new construction projects on time, on budget and in accordance with performance requirements. Failure to do so may expose the business to loss of revenue, potential litigation and loss of business reputation.
Also inherent in the management of the companys production facilities and delivery systems, including storage, vehicle transportation and pipelines, are operational risks that require continuous training, oversight and control. Material operating failures at production, storage facilities or pipelines, including fire, toxic release and explosions, or the occurrence of vehicle transportation accidents could result in loss of life, damage to the environment, loss of production and/or extensive property damage, all of which may negatively impact the companys financial results.
Acquisitions The inability to effectively integrate acquisitions could adversely impact the companys financial position and results of operations.
Praxair has evaluated, and expects to continue to evaluate, a wide array of potential strategic acquisitions. Many of these acquisitions, if consummated, could be material to its financial condition and results of operations. In addition, the process of integrating an acquired company, business or group of assets may create unforeseen operating difficulties and expenditures. Although historically the company has been successful with its acquisition strategy and execution, the areas where the company may face risks include:
Foreign acquisitions involve unique risks in addition to those mentioned above, including those related to integration of operations across different cultures and languages, currency risks and the particular economic, political and regulatory risks associated with specific countries. Also, the anticipated benefit of the companys
acquisitions may not materialize. Future acquisitions or dispositions could result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities or amortization expenses, or impairments of goodwill, any of which could adversely impact the companys financial results.
Praxair has received no written SEC staff comments regarding any of its Exchange Act reports which remain unresolved.
Praxairs worldwide headquarters are located in leased office space in Danbury, Connecticut. Other principal administrative offices are owned in Tonawanda, New York, and leased in Rio de Janeiro, Brazil; Shanghai, China and Madrid, Spain.
Praxair designs, engineers, manufactures and operates facilities that produce and distribute industrial gases. These industrial gas production facilities and certain components are designed and/or manufactured at its facilities in Tonawanda, New York; Burr Ridge, Illinois; Rio de Janeiro, Brazil; Monterrey, Mexico; Shanghai, China; and Bangalore, India. Praxairs Italian equity affiliate, S.I.A.D., also has such capacity.
Due to the nature of Praxairs industrial gas products, it is generally uneconomical to transport them distances greater than a few hundred miles from the production facility. As a result, Praxair operates a significant number of production facilities spread throughout several geographic regions.
The following is a description of production facilities for Praxair by segment. No significant portion of these assets was leased at December 31, 2009. Generally, these facilities are fully utilized and are sufficient to meet our manufacturing needs.
The North America segment operates production facilities in the U.S., Canada and Mexico, approximately 250 of which are cryogenic air separation plants, hydrogen plants and carbon dioxide plants. There are five major pipeline complexes in North America located in Northern Indiana, Houston, along the Gulf Coast of Texas, Detroit and Louisiana. Also located throughout North America are packaged gas facilities, specialty gas plants, helium plants and other smaller plant facilities.
The Europe segment has production facilities primarily in Italy, Spain, Germany, the Benelux region and France which include more than 50 cryogenic air separation plants. There are three major pipeline complexes in Europe located in Northern Spain and the Rhine and Saar regions of Germany. These pipeline complexes are primarily supported by cryogenic air separation plants. Also located throughout Europe are specialty gas plants, packaged gas facilities and other smaller plant facilities.
The South America segment operates more than 40 cryogenic air separation plants, primarily located in Brazil. Many of these plants support a major pipeline complex in Southern Brazil. Also located throughout South America are carbon dioxide plants, packaged gas facilities and other smaller plant facilities.
The Asia segment has production facilities located primarily in China, Korea and India which include more than 25 cryogenic air separation plants. Also located throughout Asia are noncryogenic air separation, carbon dioxide, hydrogen, packaged gas and other production facilities.
The surface technologies segment provides coating services and manufactures coating equipment at approximately 40 sites. The majority of these sites are located in the United States and Europe, with smaller operations in Asia and Brazil.
Information required by this item is incorporated herein by reference to the section captioned Notes to Consolidated Financial Statements 17 Commitments and Contingencies in Item 8 of this 10-K.
Praxair did not submit any matters to a shareholder vote during the fourth quarter of 2009.
The principal market for the companys common stock is the New York Stock Exchange (NYSE). At December 31, 2009 there were 17,407 shareholders of record.
NYSE quarterly stock price and dividend information
Praxairs annual dividend on its common stock for 2009 was $1.60 per share. On January 26, 2010, Praxairs Board of Directors declared a dividend of $0.45 per share for the first quarter of 2010, or $1.80 per share annualized, which may be changed as Praxairs earnings and business prospects warrant. The declaration of dividends is a business decision made by the Board of Directors based on Praxairs earnings and financial condition and other factors the Board of Directors considers relevant.
Purchases of Equity Securities Certain information regarding purchases made by or on behalf of the company or any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934, as amended) of its common stock during the three months ended December 31, 2009 is provided below:
Peer Performance Table The graph below compares the most recent five-year cumulative returns of Praxairs common stock with those of the Standard & Poors 500 Index (SPX) and the S5 Materials Index (S5MATR) which covers 28 companies, including Praxair. The figures assume an initial investment of $100 on December 31, 2004 and that all dividends have been reinvested.
FIVE-YEAR FINANCIAL SUMMARY
(Dollar amounts in millions, except per share data)
The following discussion of the companys financial condition and results of operations should be read together with its consolidated financial statements and notes to the consolidated financial statements included in Item 8 of this 10-K.
Praxair is the largest industrial gases supplier in North and South America, is rapidly growing in Asia, and has strong, well-established businesses in Europe. The companys primary products are oxygen, hydrogen, nitrogen, argon, carbon dioxide, helium, electronic gases and a wide range of specialty gases. Praxair Surface Technologies supplies high-performance coatings that protect metal parts from wear, corrosion and high heat. Praxairs industrial gas operations are managed on a geographical basis and in 2009, 94% of sales were generated in four geographic segments (North America, Europe, South America, and Asia). The surface technologies segment generated the remaining 6% of sales.
Praxair serves approximately 25 industries as diverse as healthcare and petroleum refining; computer-chip manufacturing and beverage carbonation; fiber-optics and steel making; and aerospace, chemicals and water treatment. The diversity of end markets creates financial stability for Praxair in varied business cycles.
Praxair focuses its operational and growth strategies on the following 11 core geographies where the company has its strongest market positions and where distribution and production operations allow the company to deliver the highest level of service to its customers at the lowest cost.
Praxair manufactures and distributes its products through a network of hundreds of production plants, pipeline complexes, distribution centers and delivery vehicles. Major pipeline complexes are located in the United States, Brazil, Spain and Germany. These networks are a competitive advantage, providing the foundation of reliable product supply to the companys customer base. The majority of Praxairs business is conducted through long-term contracts which provide stability in cash flow and the ability to pass through changes in energy and feedstock costs to customers. The company has significant growth opportunities in diverse markets including: hydrogen for refining; oxygen for gasification and oxy-fuel applications; and nitrogen and carbon dioxide for oil and gas production.
EXECUTIVE SUMMARY FINANCIAL RESULTS & OUTLOOK
Praxair delivered strong financial results in 2009 given the difficult economic and operating environment. Sales were down 17% with diluted earnings per share down 5% on an adjusted basis versus 2008. Praxair generated record operating cash flow and refinanced a significant amount of debt at attractive interest rates during 2009. The cost reduction actions made in the fourth quarter of 2008 have been successful at partially mitigating the impacts of significantly lower volumes and negative foreign currency translation effects. Several major projects started up in South America and China and the project backlog heading into 2010 remains robust.
Adjusted Amounts and Comparisons
The discussion of consolidated results and outlook in this Managements Discussion and Analysis (MD&A) includes adjusted amounts and comparisons with adjusted amounts which exclude the impact of the Brazil tax amnesty program and other charges in 2009, a cost reduction program and other charges in 2008, and the first quarter 2010 impact from the Venezuela currency devaluation (referred to as special items). Adjusted amounts are non-GAAP measures that supplement an understanding of the companys financial information by presenting information that investors, financial analysts and management use to help evaluate the companys performance and ongoing business trends on a comparable basis. See the Consolidated Results section of this MD&A for a summary of these adjusted amounts. A reconciliation of reported amounts to adjusted amounts can be found in the Non-GAAP Financial Measures section of this MD&A.
2009 Year in review
Praxairs outlook is cautiously optimistic for 2010 as the company expects growth in the emerging markets and slower growth in the U.S. and Europe.
The above guidance should be read in conjunction with the section entitled Forward-Looking Statements.
Praxair provides quarterly updates on operating results, material trends that may affect financial performance, and financial earnings guidance via earnings releases and investor teleconferences. These materials are available on the companys website, www.praxair.com, but are not incorporated herein.
CONSOLIDATED RESULTS AND OTHER INFORMATION
The following table provides selected data for 2009, 2008, and 2007:
Special Items in 2009 and 2008
Brazil Tax Amnesty Program and Other Charges 2009
In the third quarter 2009, Praxair recorded a pre-tax charge of $306 million (net after-tax benefit of $7 million or $0.02 per diluted share), related to a Federal tax amnesty program in Brazil (referred to as Refis Program) and other charges.
The Refis Program required a cash outlay of $34 million in the 2009 fourth quarter and is expected to require up to an additional $60 million in 2010.
Cost Reduction Program and Other Charges 2008
In 2008, Praxair recorded pre-tax charges totaling $194 million ($125 million after-tax and noncontrolling interests or $0.40 per diluted share), including $118 million related to severance and other exit costs in response to the economic downturn.
See Note 2 to the consolidated financial statements for a more detailed description of these special items.
Results of Operations
As previously described, references to adjusted amounts refer to reported amounts adjusted to exclude the impact of special items and are non-GAAP measures. A reconciliation of reported amounts to adjusted amounts can be found in the Non-GAAP Financial Measures section of this MD&A. Additionally, certain prior years amounts have been reclassified to conform to the current year presentation. Such reclassifications relate primarily to the sales variance tables and adjusted amounts.
2009 Compared With 2008
Sales in 2009 decreased $1,840 million, or 17% versus 2008. Excluding the impacts of currency and cost pass-through, sales declined 8% reflecting significantly lower volumes in most geographies due to lower demand consistent with the global economic slowdown partially offset by higher overall pricing. The unfavorable impact of currency, primarily in South America, Europe, Mexico and Canada, decreased sales by 5%. Lower cost pass-through decreased sales by 4%, with a negligible impact on operating profit.
Gross margin in 2009 decreased $377 million, or 9%, versus 2008. The increase in the gross margin percentage to 43.8% in 2009 versus 39.8% in 2008 was due to higher pricing, cost reductions and the impact from lower cost pass-through.
Selling, general and administrative (SG&A) expenses in 2009 were $1,088 million, or 12.1% of sales, versus $1,312 million, or 12.2% of sales, for 2008. The decrease in SG&A expenses was due to cost savings resulting from the cost reduction program initiated in 2008, ongoing productivity programs and currency impacts.
Depreciation and amortization expense in 2009 decreased $4 million versus 2008. The slight decrease was due to currency effects partially offset by the increased depreciation associated with project start-ups.
Other income (expenses) net in 2009 was a $35-million expense versus a $35-million benefit in 2008. The change in 2009 versus 2008 was due to a decrease in partnership income and currency related items. See Note 7 to the consolidated financial statements for a summary of the major components of Other income (expenses) net.
Adjusted operating profit of $1,881 million in 2009 was $196 million, or 9%, lower than adjusted operating profit of $2,077 million in 2008. As a percentage of sales, adjusted operating profit improved to 21.0% in 2009 versus 19.2% in 2008. This improvement is a result of significant cost reductions, higher pricing and the impact of lower cost pass-through on sales.
Interest expense net in 2009 decreased $65 million, or 33% versus 2008 due to lower interest rates on commercial paper and bank borrowings during 2009.
The adjusted effective tax rate for 2009 was 27.6%, versus 28.2% in 2008, which was essentially unchanged.
At December 31, 2009, noncontrolling interests consisted primarily of noncontrolling shareholders investments in Asia (primarily in China and India), Europe (primarily in Italy), and North America (primarily within the U.S. packaged gas business). The $2 million decrease in noncontrolling interests in 2009 was due to $6 million of lower income partially offset by a $4 million impact related to the cost reduction program and other charges in 2008.
Praxairs significant equity investments are in Italy, Norway, the United States and China. The companys share of net income from equity investments decreased $12 million in 2009 primarily related to lower earnings from all equity investments.
Adjusted net income Praxair, Inc. of $1,247 million in 2009 was $89 million, or 7%, lower than adjusted net income Praxair, Inc. of $1,336 million in 2008. The decrease was due to lower operating profit and income from equity investments partially offset by lower interest expense.
Adjusted diluted earnings per share (EPS) of $3.99 in 2009 decreased $0.21 per diluted share, or 5%, from adjusted diluted EPS of $4.20 in 2008. The underlying decrease in adjusted EPS is in line with the decrease in net income Praxair, Inc. partially offset by the impact of the companys net repurchases of common stock during 2009.
The number of employees at December 31, 2009 was 26,164, reflecting a decrease of 772 employees from December 31, 2008 primarily related to the 2008 cost reduction program partially offset by the additional employees related to the Sermatech acquisition.
2008 compared with 2007
Sales in 2008 increased $1,394 million, or 15%, versus 2007. Sales grew in all geographies driven by new business, plant start-ups and continued strong pricing trends. Volume growth of 3% reflects strong sales to the manufacturing, energy and metals end-markets, mitigated by shut-downs in the third quarter due to Hurricanes Ike and Gustav and significantly lower volumes in November and December due to production cut-backs and
shut-downs related to the global economic crisis. Higher pricing contributed 4% to sales growth due primarily to continued pricing actions. The favorable impact of currency, primarily in Brazil, Europe and Canada, increased sales by 3%. The net effect of acquisitions and divestitures contributed 2% to sales. Higher cost pass-through to customers increased sales 3%, with a minimal impact on operating profit.
Gross margin in 2008 increased $456 million, or 12%, versus 2007. The decrease in the gross margin percentage to 39.8% was due primarily to higher cost pass-through to customers.
Selling, general and administrative (SG&A) expenses in 2008 were $1,312 million, or 12.2% of sales, versus $1,190 million, or 12.7% of sales, for 2007. The decrease in SG&A as a percentage of sales was due to realized benefits from productivity initiatives and the increase in sales due to higher cost pass-through to customers.
Depreciation and amortization expense in 2008 increased $76 million, or 10%, versus 2007. The increase was principally due to new plant start-ups.
Other income (expenses) net in 2008 was a $35-million benefit versus a $3-million benefit in 2007. 2008 included currency related net gains of $23 million, which primarily consisted of net income hedge gains (see Note 12 to the consolidated financial statements). See Note 7 to the consolidated financial statements for a summary of the major components of Other income (expenses) net.
Adjusted operating profit of $2,077 million increased $291 million, or 16%, versus 2007. The increase was principally due to higher pricing, new business and the continued impact of productivity initiatives.
Interest expense net in 2008 increased $25 million, or 14%, versus 2007 due to higher debt levels during 2008 partially offset by capitalized interest relating to higher capital expenditures and lower interest rates in the fourth quarter.
The adjusted effective income tax rate for 2008 was 28.2% versus an effective income tax rate of 26.0% in 2007. This increase in 2008 was primarily due to earnings growth.
At December 31, 2008, noncontrolling interests consisted principally of noncontrolling shareholders investments in Asia (primarily in China and India), Europe (primarily in Italy), and North America (primarily within the U.S. packaged gas business). The $2 million increase in noncontrolling interests in 2008 was due to $6 million of higher income partially offset by a $4 million impact related to the cost reduction program and other charges in the 2008 fourth quarter.
Praxairs significant equity investments are in Italy, Norway, the United States and China. The companys share of net income from equity investments increased $10 million in 2008 primarily related to the acquisition of a 50% interest in an industrial gas business in Norway in November of 2007 (see Note 3 to the consolidated financial statements) and higher earnings in its investments in Italy and China.
Adjusted net income Praxair, Inc. increased $159 million, or 14%. Operating profit growth was the primary driver of the net income growth partially offset by higher interest expense due to higher debt levels in 2008 and the increase in the effective tax rate.
Adjusted EPS increased 16% in 2008 versus 2007. The growth is in line with the growth in net income Praxair, Inc. and the lower number of diluted shares outstanding due to the impact of the companys net repurchases of common stock in connection with two publicly announced stock repurchase programs (see Liquidity, Capital Resources and Other Financial Data section of MD&A). See Note 6 to the consolidated financial statements for a calculation of diluted EPS.
The number of employees at December 31, 2008 was 26,936, a decrease of 1,056 employees from December 31, 2007, primarily due to the cost reduction program in the fourth quarter of 2008, partially offset by acquisitions made during the year.
Related Party Transactions
The companys related parties are primarily unconsolidated equity affiliates. The company did not engage in any material transactions involving related parties that included terms or other aspects that differ from those which would be negotiated with independent parties.
Praxairs principal operations relate to the production and distribution of atmospheric and other industrial gases, which historically have not had a significant impact on the environment. However, worldwide costs relating to environmental protection may continue to grow due to increasingly stringent laws and regulations, and Praxairs ongoing commitment to rigorous internal standards.
Praxair operates in jurisdictions that have, or are developing, laws and/or regulations to reduce or mitigate the perceived adverse effects of greenhouse gas (GHG) emissions and faces a highly uncertain regulatory environment in this area. For example, the U.S. Environmental Protection Agency (EPA) has proposed rules controlling GHG emissions and it is possible the U.S. Congress may renew its deliberations on GHG-related legislation. If the rules are promulgated, the EPA would be able to regulate GHG emissions from on-road vehicles and certain large manufacturing facilities, many of which are Praxair suppliers or customers. Among other impacts, such regulations could raise the costs of energy, which is a significant cost for Praxair. However, Praxairs customer contracts routinely provide rights to recover increased electricity, natural gas, and other costs that are incurred by the company.
Praxair anticipates continued growth in its hydrogen business, as hydrogen is essential to refineries which use it to remove sulfur from transportation fuels in order to meet ambient air quality standards. Hydrogen production plants have been identified under California law as a source of carbon dioxide emissions and these plants may also become subject to federal climate change legislation if enacted. Praxair believes it will be able to mitigate potential costs through the terms of its hydrogen supply contracts; however, legislation that limits GHG emissions may impact growth in this area by increasing operating costs or decreasing demand.
To manage these potential business risks from potential GHG emission regulation, Praxair actively monitors current developments, evaluates the direct and indirect business risks, and takes appropriate actions. Among others, actions include: increasing relevant resources and training; consulting with vendors, insurance providers and industry experts; incorporating GHG provisions in commercial agreements; and conducting regular reviews of the business risks with management. Although there are considerable uncertainties, Praxair believes that the business risk from potential regulations can be effectively managed through its commercial contracts. Also, Praxair continuously seeks opportunities to reduce its own energy and GHG footprint.
Governmental regulation of GHG emissions and the growth of renewable energy alternatives may provide Praxair with business opportunities. Praxair continues to develop new applications technologies that can lower emissions, including GHG emissions, in Praxairs processes and help customers lower energy consumption. Stricter regulation of water quality in emerging economies such as China provide a growing market for a number of gases, e.g., oxygen for wastewater treatment. Renewable fuel standards in the European Union and U.S. create a market for second-generation biofuels which are users of industrial gases such as oxygen, carbon dioxide, and hydrogen.
Costs Relating to the Protection of the Environment
Environmental protection costs in 2009 included approximately $25 million in capital expenditures and $24 million of expenses. Environmental protection expenditures were approximately $1 million lower in 2009 versus 2008 primarily due to decreases in capital spending and decreased compliance costs. Praxair anticipates that future annual environmental protection expenditures will be similar to 2009, subject to any significant changes in existing laws and regulations. Based on historical results and current estimates, management does not believe that environmental expenditures will have a material adverse effect on the consolidated financial position, the consolidated results of operations or cash flows in any given year.
See Note 17 to the consolidated financial statements for information concerning legal proceedings.
The net periodic benefit cost for the U.S. and International pension plans was $43 million in 2009, $54 million in 2008 and $50 million in 2007. Consolidated pension expense included settlement charges of $4 million and $17 million in 2009 and 2008, respectively.
The funded status (pension benefit obligation (PBO) less the fair value of plan assets) for the U.S. plans improved $92 million to a deficit of $427 million at December 31, 2009 from a deficit of $519 million in 2008. This improvement in 2009 from 2008 was primarily due to cash contributions of $113 million and strong pension asset investment performance in 2009, partially offset by the increased PBO due to the use of a lower discount rate. The funded status deficit for the international plans increased by $42 million at December 31, 2009 versus 2008 primarily due to the increase in the PBO from lower discount rates.
Pension contributions were $128 million in 2009, $20 million in 2008 and $22 million in 2007. Estimates of 2010 contributions are in the range $50 million to $75 million. The increase in pension contributions in 2009 was primarily due to the decline in the value of pension assets in 2008 as a result of the turmoil in the global securities markets.
Praxair assumes an expected return on plan assets for 2010 in the U.S of 8.25%. In 2010, consolidated pension expense is expected to be approximately $60 million versus $43 million in 2009. The increase is due primarily to an increase in the amortization of net actuarial gains/losses. The amortization is recognized based the amount of net actuarial gains/losses above certain thresholds and over the period of either the average remaining service lives or average remaining life expectancies of the employees or retirees.
The net periodic benefit cost for postretirement benefits other than pensions (OPEB) was $20 million, $19 million and $20 million in 2009, 2008 and 2007, respectively. The funded status deficit increased $34 million during 2009 due primarily to the lower discount rates used in 2009 versus 2008.
Net periodic benefit costs for the OPEB plans in 2010 are expected to be similar to 2009 amounts.
See the Critical Accounting Policies section and Note 16 to the consolidated financial statements for a more detailed discussion of the companys retirement benefits, including a description of the various retirement plans and the assumptions used in the calculation of net periodic benefit cost and funded status.
Praxair purchases insurance to limit a variety of risks, including those related to property, business interruption, third-party liability and workers compensation. Currently, the company self-retains the first $5 million per occurrence for workers compensation, general and vehicle liability and retains $2.5 million to $5 million per occurrence at its various properties worldwide. To mitigate its aggregate loss potential above varying retentions, the company purchases insurance coverage from highly rated insurance companies at what it believes are reasonable coverage levels.
At December 31, 2009 and 2008, the company had recorded a total of $36 million and $39 million, respectively, representing an estimate of the retained liability for the ultimate cost of claims incurred and unpaid as of the balance sheet dates. The estimated liability is established using statistical analyses and is based upon historical experience, actuarial assumptions and professional judgment. These estimates are subject to the effects of trends in loss severity and frequency and are subject to a significant degree of inherent variability. If actual claims differ from the companys estimates, they will be adjusted at that time and financial results could be impacted.
Praxair recognizes estimated insurance proceeds relating to damages at the time of loss only to the extent of incurred losses. Any insurance recoveries for business interruption and for property damages in excess of the net book value of the property are recognized only when realized.
The following summary of sales and operating profit by segment provides a basis for the discussion that follows (for additional information concerning Praxairs segments, see Note 18 to the consolidated financial statements). Praxair evaluates the performance of its reportable segments based on operating profit, excluding special items. Accordingly, segment operating profit and the following discussion of segment results, including comparisons with prior periods, exclude the impact of the Brazil tax amnesty program and other charges in 2009 and the cost reduction program and other charges in 2008.
The North America segment includes Praxairs industrial gases operations in the U.S., Canada and Mexico.
Sales for 2009 decreased $1,313 million, or 22%, versus 2008. Excluding the impacts of currency and cost pass-through, sales declined 12% due to lower volumes partially offset by higher pricing. Higher sales to the energy markets were offset by lower sales to the chemicals, metals, electronics and manufacturing end-markets. Currency depreciation in Canada and Mexico, reduced sales by $201 million, or 3%. Lower cost pass-through decreased sales by $443 million, or 7%, with a minimal impact on operating profit.
Operating profit for 2009 decreased $34 million, or 3% versus 2008. Excluding the negative impact of currency, operating profit was higher than the prior year despite significantly lower volumes due to cost savings from the cost reduction program and ongoing productivity initiatives.
Sales to the steel and chemical markets in 2010 are expected to continue to improve. The recovery in general manufacturing is expected to be slower due to weakness in the non-residential construction, metal fabrication and machinery markets.
Sales for 2008 increased $754 million, or 15%, versus 2007. Volume growth of 1% reflects higher sales to the energy and manufacturing markets which were mitigated by lower volumes in the third quarter due to Hurricanes Ike and Gustav and lower volumes in November and December, primarily in the metals, chemicals and electronics end-markets, due to production cut-backs and shut-downs related to the global economic crisis. Higher pricing contributed 4% to sales growth, due to continued strong pricing trends. Currency appreciation in Canada contributed 1% to sales. Acquisitions of U.S. and Canadian packaged gas distributors contributed 4% to sales. Higher cost pass-through increased sales by 5% for the year with minimal impact on operating profit.
Operating profit for 2008 increased $131 million, or 14%, versus 2007. Strong pricing trends and cost savings from productivity and cost reduction programs were the primary drivers of operating profit growth.
In 2008, Praxair acquired Kirk Welding Supply, Inc., an independent packaged gas distributor with sales of $28 million in 2007 and operations in Kansas and Missouri as well as several smaller independent packaged gas distributors in the U.S. and Canada.
Praxairs European industrial gases business is primarily in Italy, Spain, Germany and the Benelux region.
Sales for 2009 decreased $219 million, or 15% versus 2008. Unfavorable currency reduced sales by 6%. Excluding the impacts of currency and cost pass-through, sales declined 9% due primarily to sharply lower volumes in the metals, chemicals and electronics end-markets. Cost pass-through to customers increased sales by $9 million, or less than 1%, with a minimal impact on operating profit.
Operating profit for 2009 decreased $97 million, or 27% versus 2008. Operating profit included net income hedge losses of $2 million in 2009 and a gain of $10 million in 2008 (see Note 12 to the consolidated financial statements). Excluding the impact of net income hedges in both years, operating profit decreased $85 million, or 24%. The underlying decrease in operating profit was due to lower volumes and negative currency partially offset by cost reductions.
The economic recovery has been led by Germany. Spain and Italy have been weaker, but have been beginning to show signs of improvement moving into 2010.
Sales for 2008 increased $157 million, or 12%, versus 2007. Favorable currency contributed 9% to sales growth. Volume growth of 1% was due to new business and new applications and higher sales to the chemicals, healthcare and food and beverage markets. Volume growth during the year was partially offset by lower volumes in the fourth quarter driven by cutbacks by steel and chemical customers in Germany and lower sales to the metals and general manufacturing end-markets in Spain. On April 1, 2008, Praxair completed the sale of its majority interest in Maxima Air Separation Center Ltd. with operations in Israel. The divestiture of the industrial gas business in Israel decreased sales by 2% for the year.
Operating profit for 2008 increased $50 million, or 16%, versus 2007. Operating profit for 2008 included a $10 million gain related to net income hedges (see Note 12 to the consolidated financial statements). Excluding the impact of net income hedge gains, operating profit increased $40 million, or 13%. Operating profit growth was driven by increased sales volumes, the continued impact of cost-reduction programs and currency appreciation.
Praxairs South American industrial gases operations are conducted by its subsidiary, White Martins Gases Industriais Ltda. (White Martins), the largest industrial gases company in Brazil. White Martins also manages Praxairs operations in Argentina, Bolivia, Chile, Colombia, Paraguay, Peru, Uruguay and Venezuela.
Sales for 2009 decreased $244 million, or 13% versus 2008. Excluding the impact of currency and cost pass-through, sales decreased 5%. The decrease was primarily due to lower volumes to metals and manufacturing customers, partially offset by higher sales to the food and beverage, healthcare end-markets and higher pricing. Cost pass-through to customers increased sales by $17 million, or 1%, with a minimal impact on operating profit.
Operating profit in 2009 decreased $39 million, or 10% versus 2008. Operating profit included currency related net losses of $13 million and gains of $8 million in 2009 and 2008, respectively, which primarily pertained to net income hedges (see Note 12 to the consolidated financial statements). Excluding the impact of currency and net income hedges, underlying operating profit grew as cost savings from productivity initiatives, cost reduction programs and higher pricing more than offset lower volumes.
Strong sales growth is expected in 2010 as volumes continue to increase and as Brazils economy continues to recover.
Sales for 2008 increased $285 million, or 18%, versus 2007. Excluding the impact of currency and cost pass-through, sales increased 11% for the year primarily due to higher sales in the manufacturing, healthcare and food and beverage markets and realized price increases. Volume growth was mitigated by lower on-site volumes to commodity producers and lower sales to export industries in the fourth quarter, particularly in metals and chemicals.
Operating profit in 2008 increased $78 million, or 25%, versus 2007. Operating profit for 2008 included currency related net gains of $8 million which primarily consisted of net income hedge gains (see Note 12 to the consolidated financial statements). Excluding the impact of the currency related net gains in 2008, operating profit increased 23%. 2008 operating profit also included amounts related to various contingencies in Brazil reflecting developments which, on a net basis, were not significant. Underlying operating profit growth was due to strong organic growth in the first three quarters across all major end-markets. Currency appreciation also contributed to operating profit growth in 2008.
The Asia segment includes Praxairs industrial gases operations in China, India, Korea and Thailand, with smaller operations in Japan, Malaysia and Taiwan.
Sales for 2009 decreased $6 million, or 1% versus 2008. An equipment sale contributed 3% to sales during 2009. Unfavorable currency decreased sales by 6%. Excluding the impacts of currency, cost pass-through and the equipment sale, sales were flat with 2008. The full year 2009 results reflect strong growth in sales volumes in the fourth quarter due to large plant start-ups and higher sales to all major end-markets. Cost pass-through to customers increased sales by $16 million, or 2%, with a minimal impact on operating profit.
Operating profit for 2009 decreased $11 million, or 7% versus the respective 2008 periods, primarily as the result of currency depreciation.
Strong growth in Asia is expected to continue over the next 3 to 5 years supported by a strong project backlog and plant start-ups.
Sales for 2008 increased $145 million, or 19%, versus 2007. Volume growth of 11% was due to higher on-site and merchant sales in most major end-markets due to new business and new plant start-ups. Price increases contributed 4% to sales. Higher pricing for rare and specialty gases due to strong demand and tight supply for certain products contributed to these increases.
Operating profit for 2008 increased $28 million, or 23%, versus 2007. Increased sales volumes and productivity initiatives were the primary drivers of operating profit growth.
Surface technologies provides high-performance coatings and thermal-spray powders in the U.S. and Europe, with smaller operations in Asia and Brazil. On July 1, 2009, Praxair acquired Sermatech International Holdings Corp. (Sermatech), a global supplier of protective coatings and advanced processes used on industrial and aviation gas turbines with operations in the U.S., Canada, United Kingdom, Germany and South Korea.
Sales for 2009 decreased $58 million, or 10% versus 2008. The acquisition of Sermatech contributed $44 million in 2009, or 8% of sales. Excluding the impact of negative currency translation and acquisitions, underlying sales decreased 14%. In 2009, growth from higher coatings for jet engines was more than offset by lower coatings for industrial gas turbines and the general manufacturing end markets in the U.S. and Europe.
Operating profit for 2009 decreased $15 million, or 16%, for versus 2008 periods. The decrease was principally driven by lower volumes and the negative impact of currency partially offset by productivity and cost reduction initiatives.
Volumes for jet engine coatings and industrial gas turbines are expected to increase in 2010.
Sales for 2008 increased $53 million, or 10%, versus 2007. Underlying growth was due to strong coatings volumes for industrial gas turbines and oilfield drilling parts and realized price increases, partially offset by lower coatings volumes to the aviation markets due to delays in the production of plane engines. Currency appreciation, primarily in Europe, contributed 5% to sales growth.
Operating profit for 2008 increased $4 million, or 4%, versus 2007. Increased sales volumes and productivity initiatives were the primary drivers of operating profit growth.
The results of Praxairs non-U.S. operations are translated to the companys reporting currency, the U.S. dollar, from the functional currencies used in the countries in which the company operates. For most foreign operations, Praxair uses the local currency as its functional currency. There is inherent variability and unpredictability in the relationship of these functional currencies to the U.S. dollar and such currency movements may materially impact Praxairs results of operations in any given period.
To help understand the reported results, the following is a summary of the significant currencies underlying Praxairs consolidated results and the exchange rates used to translate the financial statements (rates of exchange expressed in units of local currency per U.S. dollar):
LIQUIDITY, CAPITAL RESOURCES AND OTHER FINANCIAL DATA
The company generated strong operating cash flow of $2,168 million in 2009. Operating cash flow funded $1,352 million of capital expenditures in the year primarily related to new global projects. Operating cash flow also funded $131 million of acquisitions, primarily the purchase of Sermatech, which is included in the surface technologies segment. The remaining amount of cash flow from operations was primarily returned to shareholders in the form of repurchases of common stock of $141 million, net of issuances, and dividends of $491 million.
Cash Flows From Operations
2009 compared with 2008
Cash flow from operations increased $130 million to $2,168 million from $2,038 million in 2008. The increase was primarily due to higher net income Praxair, Inc., adjusted for the non-cash portion of the Brazil tax amnesty program and other charges, and lower tax payments in 2009 partially offset by increased pension contributions and working capital changes.
2008 compared with 2007
Cash flow from operations increased $80 million to $2,038 million in 2008 from $1,958 million in 2007. The increase was principally a result of the reduction in working capital, higher net income Praxair, Inc. and higher depreciation and amortization partially offset by tax payments in 2008 included in Other-net.
2009 compared with 2008
Net cash used for investing activities of $1,452 million in 2009 decreased $235 million versus 2008 primarily due to decreased capital expenditures partially offset by the impact of lower divestitures and asset sales.
Capital expenditures in 2009 were $1,352 million, a decrease of $259 million from 2008. Capital expenditures during 2009 related largely to new production plants under contract for customers in North and South America, China and India.
Acquisition expenditures in 2009 were $131 million, which were about flat with 2008. 2009 included the acquisition of Sermatech, a global supplier of protective coatings and advanced processes with operations in the U.S., Canada, United Kingdom, Germany and South Korea, and several small acquisitions, primarily related to North American packaged gas distributors. 2008 included the acquisition of Kirk Welding Supply Inc., an independent packaged gas distributor in the United States, and several small acquisitions in North America, Europe and South America (see Note 3 to the consolidated financial statements).
Divestitures and asset sales in 2009 totaled $31 million, a decrease of $23 million from 2008.
On a worldwide basis, capital expenditures for 2010 are expected to be about $1,400 million. The majority of capital expenditures in 2010 will be for new production plants under long-term contracts with customers. By region, approximately half of forecasted capital expenditures will be for projects in North America, the largest of which are energy-related projects. The second largest region for investment is Asia, primarily in China and India.
2008 compared with 2007
Net cash used for investing activities of $1,687 million in 2008 decreased $126 million versus 2007. The decrease was primarily due to lower acquisitions spending partially offset by higher capital expenditures.
Capital expenditures in 2008 were $1,611 million, an increase of $235 million from 2007. This increase reflects new investment in customer on-site supply systems supported by long-term customer contracts primarily in North America, South America and Asia.
Acquisition expenditures in 2008 were $130 million, a decrease of $346 million from 2007. 2008 included the acquisition of Kirk Welding Supply Inc., an independent packaged gas distributor in the United States, and several small acquisitions in North America, Europe and South America. 2007 included several larger acquisitions including an industrial gas business in Mexico, an independent packaged gas distributor in the United States and the acquisition of a 50% interest in an industrial gas business in Norway (see Note 3 to the consolidated financial statements).
Divestitures and asset sales in 2008 totaled $54 million, an increase of $15 million from 2007. 2008 includes the proceeds from the divestiture of the industrial gas business in Israel.
Praxairs financing strategy is to secure long-term committed funding at attractive interest rates by issuing U.S. public notes and debentures and commercial paper backed by long-term bank credit agreements. Praxairs international operations are funded through a combination of local borrowing and inter-company funding to minimize the total cost of funds and to manage and centralize currency exchange exposures. As deemed necessary, Praxair manages its exposure to interest-rate changes through the use of financial derivatives (see Note 12 to the consolidated financial statements and Item 7A. Quantitative and Qualitative Disclosures About Market Risk).
The credit environment in the United States has not had, and is not expected to have, a significant adverse impact on the companys liquidity. While the impact of continued volatility in the global credit markets cannot be predicted with certainty, the company believes that it has sufficient operating flexibility, cash reserves, and funding sources to maintain adequate amounts of liquidity to meet its business needs around the world. At December 31, 2009, the companys credit ratings as reported by Standard & Poors and Moodys were A-1 and P-1 for short-term debt, respectively, and A and A-2 for long-term debt, respectively. Additionally, the company plans to maintain its undistributed earnings of foreign subsidiaries to support foreign growth opportunities and reduce local debt.
During 2009, Praxair issued $1,700 million of fixed rate and $500 million of floating rate debt. These issuances were completed as a result of the favorable interest rate conditions in the United States. The proceeds from all issuances were used to repay short-term debt and for general corporate purposes. On January 4, 2010, Praxair entered into an interest-rate swap agreement related to the $400 million 1.75% Notes due 2012. Also, on January 14, 2010, Praxair issued an additional $500 million of 2.125% Notes due 2013 and concurrently entered into an interest-rate swap agreement. Both interest-rate swap agreements effectively convert fixed-rate interest to floating-rate interest.
Note 11 to the consolidated financial statements includes information with respect to the companys debt refinancing in 2009, current debt position and available credit facilities; and Note 12 includes information relating to derivative financial instruments. Such credit facilities are with major financial institutions and are non-cancellable until maturity. Therefore, the company believes the risk of the financial institutions being unable to make required loans under the credit facilities, if requested, to be low. Praxairs major bank credit and long-term debt agreements contain standard financial covenants which the company is in compliance with at December 31, 2009 and expects to remain in compliance with for the foreseeable future.
Cash used for financing activities was $711 million in 2009 compared to $333 million in 2008. This increase was primarily due to lower net debt issuances in 2009 partially offset by lower stock repurchases net of issuances. Cash dividends of $491 million increased $23 million from the year ago period to $1.60 per share ($1.50 per share in 2008 and $1.20 per share in 2007).
On July 23, 2008, the companys board of directors approved a share repurchase program authorizing the company to repurchase $1 billion of common stock from time to time on the open market or through negotiated transactions, subject to market and business conditions. Stock repurchases under this program are expected to be completed over the next year and will be financed by available cash and debt. As of December 31, 2009, $858 million of stock repurchases had been completed under the program, leaving an additional $142 million remaining authorized for purchase.
At December 31, 2009, Praxairs total debt outstanding was $5,055 million, $30 million higher than $5,025 million at December 31, 2008. The proceeds from debt issuances during 2009 were used primarily to repay short-term debt obligations and for general corporate purposes. The December 31, 2009 debt balance includes $4,708 million in public securities and $347 million representing primarily worldwide bank borrowings. Praxairs global effective borrowing rate was approximately 4% for 2009.
Other Financial Data
Praxairs debt-to-capital ratio decreased to 47.2% at December 31, 2009 versus 53.8% at December 31, 2008. The decrease is due to an increase in Praxair, Inc. shareholders equity as a result of currency movement reflected in other accumulated comprehensive income (loss) and retained earnings after dividend payments.
After-tax return on capital decreased to 13.8% at December 31, 2009 versus 2008 due primarily to the decline in operating profit as total capital remained flat.
See the Non-GAAP Financial Measures section for definitions and reconciliation of these non-GAAP measures to reported amounts.
The following table sets forth Praxairs material contract obligations and other commercial commitments as of December 31, 2009:
Long-term debt and capitalized lease maturities of $ 4,828 million are more fully described in Note 11 to the consolidated financial statements and are included on the companys balance sheet as long-term liabilities and current portion of long-term debt. $500 million of floating-rate debt has been reflected in 2013 maturities due to the companys intent and ability to refinance this debt on a long-term basis.
Contractual interest on long-term debt of $1,036 million represents interest the company is contracted to pay on outstanding long-term debt, current portion of long-term debt and capital lease obligations, calculated on a basis consistent with planned debt maturities, excluding the interest impact of interest rate swaps. At December 31, 2009, Praxair had fixed-rate debt of $3,793 million and floating-rate debt of $1,262 million. The rate assumed for floating-rate debt was the rate in effect at December 31, 2009.
Obligations under operating leases of $357 million represent non-cancelable contractual obligations primarily for manufacturing and distribution equipment and office space. See Note 4 to the consolidated financial statements for further details.
Retirement obligations of $384 million include estimates of pension plan contributions and expected future benefit payments for unfunded pension and postretirement benefits other than pensions (OPEB). Pension plan contributions are forecast through 2010 only. For purposes of the table, $75 million of contributions have been included for 2010 based on the range of $50 million to $75 million. Expected future unfunded pension and OPEB benefit payments are forecast through 2019. Contribution and unfunded benefit payment estimates are based upon current valuation assumptions. Estimates of pension contributions after 2011 and unfunded benefit payments after 2019 are not included in the table because the timing of their resolution cannot be estimated. Retirement obligations are more fully described in Note 16 to the consolidated financial statements.
Unconditional purchase obligations of $3,464 million represent contractual commitments under various long and short-term take-or-pay arrangements with suppliers. These obligations are primarily minimum-purchase commitments for helium, electricity, natural gas and feedstock used to produce atmospheric and process gases. During 2009, payments under these contracts totaled $1,020 million, including $581 million for electricity and $195 million for natural gas. A significant portion of these obligations is passed on to customers through similar take-or-pay contractual arrangements. Purchase obligations that are not passed along to customers do not represent a significant risk to Praxair.
Construction commitments of $967 million represent outstanding commitments to customers or suppliers to complete authorized construction projects as of December 31, 2009. A significant portion of Praxairs capital spending is related to the construction of new production facilities to satisfy customer commitments which may take a year or more to complete. Significant commitments include two large hydrogen plants to supply hydrogen and steam to BPs refinery complex in Whiting, Indiana and a large hydrogen plant in India to supply India Oil Corporation.
Liabilities for uncertain tax positions totaling $326 million, including interest and penalties, are not included in the table because the timing of their resolution cannot be estimated. See Note 5 to the consolidated financial statements for disclosures surrounding uncertain income tax positions.
OFF-BALANCE SHEET ARRANGEMENTS
As discussed in Note 17 to the consolidated financial statements, at December 31, 2009, Praxair had entered into various guarantees and other arrangements, and had undrawn outstanding letters of credit from financial institutions. These arrangements were entered into in connection with normal business operations and they are not reasonably likely to have a material impact on Praxairs consolidated financial condition, results of operations, or liquidity.
CRITICAL ACCOUNTING POLICIES
The policies discussed below are considered by management to be critical to understanding Praxairs financial statements and accompanying notes prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). Their application places significant importance on managements judgment as a result of the need to make estimates of matters that are inherently uncertain. Praxairs financial position, results of operations and cash flows could be materially affected if actual results differ from estimates made. These policies are determined by management and have been reviewed by Praxairs Audit Committee.
Depreciable Lives of Property, Plant and Equipment
Praxairs net property, plant and equipment at December 31, 2009 was $8,990 million, representing 63% of the companys consolidated total assets. Depreciation expense for the year ended December 31, 2009 was $828 million, or 11% of total operating costs. Management judgment is required in the determination of the estimated depreciable lives that are used to calculate the annual depreciation expense and accumulated depreciation.
Property, plant and equipment are recorded at cost and depreciated over the assets estimated useful lives on a straight-line basis for financial reporting purposes. The estimated useful life represents the projected period of time that the asset will be productively employed by the company and is determined by management based on many factors, including historical experience with similar assets, technological life cycles, geographic locations and contractual supply relationships with on-site customers. Circumstances and events relating to these assets, such as on-site contract modifications, are monitored to ensure that changes in asset lives or impairments (see Asset Impairments) are identified and prospective depreciation expense or impairment expense is adjusted accordingly. Praxairs largest asset values relate to cryogenic air-separation production plants with depreciable lives of principally 15 years.
Based upon the assets as of December 31, 2009, if depreciable lives of machinery and equipment, on average, were increased or decreased by one year, annual depreciation expense would be decreased by approximately $37 million or increased by approximately $41 million, respectively.
Pension benefits represent financial obligations that will be ultimately settled in the future with employees who meet eligibility requirements. Because of the uncertainties involved in estimating the timing and amount of future payments, significant estimates are required to calculate pension expense and liabilities related to the companys plans. The company utilizes the services of several independent actuaries, whose models are used to facilitate these calculations.
Several key assumptions are used in actuarial models to calculate pension expense and liability amounts recorded in the financial statements. Management believes the three most significant variables in the models are the expected long-term rate of return on plan assets, the discount rate, and the expected rate of compensation increase. The actuarial models also use assumptions for various other factors, including employee turnover, retirement age, and mortality. Praxair management believes the assumptions used in the actuarial calculations are reasonable, reflect the companys experience and expectations for the future and are within accepted practices in each of the respective geographic locations in which it operates. Actual results in any given year will often differ from actuarial assumptions because of economic and other factors.
The weighted-average expected long-term rates of return on pension plan assets were 8.25% for U.S. plans and 9.10% for international plans for the year ended December 31, 2009 (8.25% and 8.50%, respectively, at December 31, 2008). These rates are determined annually by management based on a weighted average of current and historical market trends, historical and expected portfolio performance and the current and expected portfolio mix of investments. A 0.50% change in these expected long-term rates of return, with all other variables held constant, would change Praxairs pension expense by approximately $8 million.
The company has consistently used a market-related value of assets rather than the fair value at the measurement date to determine annual pension expense. The market-related value recognizes investment gains or losses over a five-year period. As a result, changes in the fair value of assets from year to year are not immediately reflected in the companys annual pension expense. Instead, annual pension expense in future periods will be impacted as deferred investment gains or losses are recognized in the market-related value of assets over the five-year period. The consolidated market-related value of assets was $1,667 million, or $244 million higher than the fair value of assets of $1,423 million at December 31, 2009. These net deferred investment losses of $244 million will be recognized in the calculation of the market-related value of assets ratably over the next four years and will impact future pension expense. Future actual investment gains or losses will impact the market-related value of assets and, therefore, will impact future annual pension expense in a similar manner.
The weighted-average discount rates for pension plan liabilities were 5.90% for U.S. plans and 7.70% for international plans at December 31, 2009 (6.50% and 8.20%, respectively, at December 31, 2008). These rates are used to calculate the present value of plan liabilities and are determined annually by management. The discount rate for the U.S. plan is established utilizing a bond matching model provided by the companys independent actuaries. The portfolio of bonds includes only corporate bonds graded AA by Moodys or Standard & Poors and matches the U.S. plans projected cash flows to the spot rates and calculates the single equivalent discount rate which produces the same present value. The discount rates for the remaining international plans are based on market yields for high-quality fixed income investments representing the approximate duration of the pension liabilities on the measurement date. A 0.50% change in discount rates, with all other variables held constant, would change Praxairs pension expense by approximately $8 million and would impact the projected benefit obligation (PBO) by approximately $118 million.
The weighted-average expected rate of compensation increase was 3.50% for U.S. plans and 3.90% for international plans at December 31, 2009 (3.25% and 4.00%, respectively, at December 31, 2008). The estimated annual compensation increase is determined by management every year and is based on historical trends and market indices. A 0.50% change in the expected rate of compensation increase, with all other variables held constant, would change Praxairs pension expense by approximately $8 million and would impact the PBO by approximately $28 million.
At December 31, 2009, the company had goodwill of $2,070 million, which represents the aggregate of the excess purchase price for acquired businesses over the fair value of the net assets acquired.
The company performs a goodwill impairment test annually in the second quarter or more frequently if events or circumstances indicate that an impairment loss may have been incurred, and no impairments were indicated. The company has continuously re-evaluated the likelihood of goodwill impairments in its reporting units subsequent to the second quarter test, and does not believe there is indication of impairment for any of its reporting units. At December 31, 2009, Praxairs enterprise value was approximately $30 billion (outstanding shares multiplied by the year-end stock price plus debt, and without any control premium) while its total capital was $11 billion.
The impairment test requires that the company estimate and compare the fair value of its reporting units to their carrying value, including goodwill. Reporting units are determined based on one level below the operating segment level. Fair value is determined through the use of projected future cash flows, multiples of earnings and sales and other factors.
Such analysis requires the use of certain future market assumptions and discount factors, which are subjective in nature. Estimated values can be affected by many factors beyond the companys control such as business and economic trends, government regulation, and technological changes. Management believes that the assumptions used to determine fair value are appropriate and reasonable. Although current calculations indicate that no reporting units are at risk of goodwill impairment, changes in circumstances or conditions affecting these assumptions could have a significant impact on the fair value determination, which could then result in a material impairment charge to the companys results of operations.
See Note 9 to the consolidated financial statements for disclosures concerning the carrying value of goodwill by reportable segment.
Property, Plant and Equipment
Property, plant and equipment is tested for impairment whenever events or changes in circumstances indicate that the carrying amount of an individual asset or asset group may not be recoverable. To assess recoverability, the company compares the estimated undiscounted future cash flows expected to be generated from the asset or asset group to the carrying amount of the asset or asset group. If the undiscounted future cash flows are less than the carrying amount of the asset or asset group, an impairment charge reducing the carrying amount to fair value is required. Fair value is determined based on the most appropriate valuation technique, including discounted cash flows. This analysis requires management to make various subjective estimates and assumptions, including the amount of projected future cash flows related to the asset or asset group, the useful life over which cash flows will occur and the assets residual value, if any.
At December 31, 2009, Praxair had deferred tax assets of $814 million (net of valuation allowances of $37 million), and deferred tax liabilities of $1,182 million. At December 31, 2009, uncertain tax positions totaled $372 million (see Notes 1 and 5 to the consolidated financial statements). Income tax expense was $169 million for the year ended December 31, 2009.
In the preparation of consolidated financial statements, Praxair estimates income taxes based on diverse legislative and regulatory structures that exist in various jurisdictions where the company conducts business. Deferred income tax assets and liabilities represent tax benefits or obligations that arise from temporary differences due to differing treatment of certain items for accounting and income tax purposes. Praxair evaluates deferred tax assets each period to ensure that estimated future taxable income will be sufficient in character (e.g. capital gain versus ordinary income treatment), amount and timing to result in their recovery. A valuation allowance is established when management determines that it is more likely than not that a deferred tax asset will not be realized to reduce the assets to their realizable value. Considerable judgments are required in establishing deferred tax valuation allowances and in assessing exposures related to tax matters. As events and circumstances change, related reserves and valuation allowances are adjusted to income at that time. Praxairs tax returns are subject to audit and local taxing authorities could challenge the companys tax positions. The companys practice is to review tax filing positions by jurisdiction and to record provisions for uncertain income tax positions, including interest and penalties when applicable. Praxair believes it records and/or discloses such potential tax liabilities as appropriate and has reasonably estimated its income tax liabilities and recoverable tax assets. If new information becomes available, adjustments are charged against income at that time. Management does not anticipate that such adjustments would have a material adverse effect on the companys consolidated financial position or liquidity; however, it is possible that the final outcomes could have a material impact on the companys reported results of operations.
The company accrues liabilities for non-income tax contingencies when management believes that a loss is probable and the amounts can be reasonably estimated, while contingent gains are recognized only when realized. If new information becomes available or losses are sustained in excess of recorded amounts, adjustments are charged against income at that time. Management does not anticipate that in the aggregate such losses would have a material adverse effect on the companys consolidated financial position or liquidity; however, it is possible that the final outcomes could have a material impact on the companys reported results of operations.
Praxair is subject to various claims, legal proceedings and government investigations that arise from time to time in the ordinary course of business. These actions are based upon alleged environmental, tax, antitrust and personal injury claims, among others (see Note 17 to the consolidated financial statements). Such contingencies are significant and the accounting requires considerable management judgments in analyzing each matter to assess the likely outcome and the need for establishing appropriate liabilities and providing adequate disclosures. Praxair believes it records and/or discloses such potential contingencies as appropriate and has reasonably estimated its liabilities.
NEW ACCOUNTING STANDARDS
See Note 1 to the consolidated financial statements for information concerning new accounting standards and the impact of the implementation of these standards on the companys financial statements.
Fair Value Measurements
Praxair does not expect changes in the aggregate fair value of its financial assets and liabilities to have a material impact on the consolidated financial statements. See Note 13 to the consolidated financial statements.
NON-GAAP FINANCIAL MEASURES
The company presents the following non-GAAP financial measures in the discussion of financial condition, results of operations and liquidity throughout the MD&A. These measures are intended to supplement investors understanding of the companys financial information by providing information which investors, financial
analysts and management use to help evaluate the companys financing leverage, return on net assets employed and operating performance. Special items which the company does not believe to be indicative of on-going business trends are excluded from these calculations so that investors can better evaluate and analyze historical and future business trends on a consistent basis. Definitions of these non-GAAP measures may not be comparable to similar definitions used by other companies and are not a substitute for similar GAAP measures.
The following are the non-GAAP measures presented in the MD&A:
After-tax Return on Capital (ROC)
After-tax return on capital is a measure used by investors, financial analysts and management to evaluate the return on net assets employed in the business. ROC measures the after-tax operating profit that the company was able to generate with the investments made by all parties in the business (debt, noncontrolling interests and Praxair, Inc. shareholders equity).
Return on Praxair, Inc. Shareholders Equity (ROE)
Return on Praxair, Inc. shareholders equity is a measure used by investors, financial analysts and management to evaluate operating performance from a Praxair shareholder perspective. ROE measures the net income attributable to Praxair, Inc. that the company was able to generate with the money shareholders have invested.
The debt-to-capital ratio is a measure used by investors, financial analysts and management to provide a measure of financial leverage and insights into how the company is financing its operations.
Amounts are adjusted for the impact of the 2009 Brazil tax amnesty program and other charges, the 2008 cost reduction program and other charges, 2005 pro forma stock option expense, 2005 repatriation and other income tax charges, and the 2010 first quarter impact of the Venezuela currency devaluation. The company does not believe these items are indicative of on-going business trends and, accordingly, their impacts are excluded from the reported amounts so that investors can better evaluate and analyze historical and future business trends on a consistent basis. There were no special items in 2007 and 2006.
This document contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on managements reasonable expectations and assumptions as of the date the statements are made but involve risks and uncertainties. These risks and uncertainties include, without limitation: the performance of stock markets generally; developments in worldwide and national economies and other international events and circumstances; changes in foreign currencies and in interest rates; the cost and availability of electric power, natural gas and other raw materials; the ability to achieve price increases to offset cost increases; catastrophic events including natural disasters, epidemics and acts of war and terrorism; the ability to attract, hire, and retain qualified personnel; the impact of changes in financial accounting standards; the impact of tax, environmental, home healthcare and other legislation and government regulation in jurisdictions in which the company operates; the cost and outcomes of investigations, litigation and regulatory proceedings; continued timely development and market acceptance of new products and applications; the impact of competitive products and pricing; future financial and operating performance of major customers and industries served; and the effectiveness and speed of integrating new acquisitions into the business. These risks and uncertainties may cause actual future results or circumstances to differ materially from the projections or estimates contained in the forward-looking statements. The company assumes no obligation to update or provide revisions to any forward-looking statement in response to changing circumstances. The above listed risks and uncertainties are further described in Item 1a (Risk Factors) in the companys latest Annual Report on Form 10-K filed with the SEC which should be reviewed carefully. Please consider the companys forward-looking statements in light of those risks.
Praxair is exposed to market risks relating to fluctuations in interest rates and currency exchange rates. The objective of financial risk management at Praxair is to minimize the negative impact of interest rate and foreign exchange rate fluctuations on the companys earnings, cash flows and equity.
To manage these risks, Praxair uses various derivative financial instruments, including interest-rate swaps, currency swaps, forward contracts, currency options and commodity contracts. Praxair only uses commonly traded and non-leveraged instruments. These contracts are entered into primarily with major banking institutions thereby minimizing the risk of credit loss. Also, see Notes 1 and 12 to the consolidated financial statements for a more complete description of Praxairs accounting policies and use of such instruments.
The following discussion presents the sensitivity of the market value, earnings and cash flows of Praxairs financial instruments to hypothetical changes in interest and exchange rates assuming these changes occurred at December 31, 2009. The range of changes chosen for these discussions reflects Praxairs view of changes which are reasonably possible over a one-year period. Market values represent the present values of projected future cash flows based on interest rate and exchange rate assumptions.
Interest Rate and Debt Sensitivity Analysis
At December 31, 2009, Praxair had debt totaling $5,055 million ($5,025 million at December 31, 2008). At December 31, 2009, there was one interest-rate swap agreement outstanding that converts fixed-rate interest to variable-rate interest on the $400 million 3.25% notes that mature in 2015. No interest rate swap agreements were outstanding at December 31, 2008. When considered necessary, interest-rate swaps are entered into as hedges of underlying financial instruments to effectively change the characteristics of the interest rate without actually changing the underlying financial instrument. For fixed-rate instruments, interest-rate changes affect the fair market value but do not impact earnings or cash flows. Conversely, for floating-rate instruments, interest-rate changes generally do not affect the fair market value but impact future earnings and cash flows, assuming other factors are held constant.
At December 31, 2009, Praxair had fixed-rate debt of $3,793 million and floating-rate debt of $1,262 million, representing 75% and 25%, respectively, of total debt. At December 31, 2008, Praxair had fixed-rate debt of $2,677 million and floating-rate debt of $2,348 million, representing 53% and 47%, respectively, of total debt. Due to favorable interest rate conditions in the United States during 2009, Praxair issued long term fixed-rate debt and reduced its short term floating-rate debt (primarily commercial paper), which increased the percentage of fixed-rate debt in 2009 versus 2008. Holding other variables constant (such as foreign exchange rates, swaps and debt levels), a one-percentage-point decrease in interest rates would increase the unrealized fair market value of the fixed-rate debt by approximately $209 million ($128 million in 2008). This increase is due to the higher level of fixed rate debt in 2009. At December 31, 2009 and 2008, the after-tax earnings and cash flows impact for the subsequent year resulting from a one-percentage-point increase in interest rates would be approximately $9 million and $16 million, respectively, holding other variables constant.
Exchange Rate Sensitivity Analysis
Praxairs exchange-rate exposures result primarily from its investments and ongoing operations in South America (primarily Brazil, Argentina, Colombia and Venezuela), Europe (primarily Italy, Spain and Germany), Canada, Mexico, Asia (primarily China, India, Korea, Malaysia, Taiwan and Thailand) and other business transactions such as the procurement of equipment from foreign sources. Among other techniques, Praxair utilizes foreign exchange forward contracts and options to hedge these exposures. At December 31, 2009, Praxair had $1,289 million notional amount ($636 million at December 31, 2008) of foreign exchange contracts of which $1,161 million ($616 million in 2008) were to hedge recorded balance-sheet exposures and $128 million ($20 million in 2008) were to hedge anticipated future net income. See Note 12 to the consolidated financial statements.
On January 8, 2010, Venezuela announced a 50% devaluation of the Venezuelan bolivar (from an exchange-rate of 2.15 between the bolivar and the U.S. dollar to an exchange-rate of 4.3). This will result in an estimated charge to earnings of $ 0.08 per diluted share in the first quarter of 2010 due primarily to the remeasurement of the local Venezuelan balance sheet to reflect the new official 4.3 exchange rate.
Holding other variables constant, if there were a 10% adverse change in foreign-currency exchange rates for the portfolio, the fair market value of foreign-currency contracts outstanding at December 31, 2009 and 2008 would decrease by approximately $9 million and $1 million, respectively, which would be largely offset by an offsetting gain or loss on the foreign-currency fluctuation of the underlying exposure being hedged.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
MANAGEMENTS STATEMENT OF RESPONSIBILITY FOR FINANCIAL STATEMENTS
Praxairs consolidated financial statements are prepared by management, which is responsible for their fairness, integrity and objectivity. The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America applied on a consistent basis, except for accounting changes as disclosed, and include amounts that are estimates and judgments. All historical financial information in this annual report is consistent with the accompanying financial statements.
Praxair maintains accounting systems, including internal accounting controls, monitored by a staff of internal auditors, that are designed to provide reasonable assurance of the reliability of financial records and the protection of assets. The concept of reasonable assurance is based on recognition that the cost of a system should not exceed the related benefits. The effectiveness of those systems depends primarily upon the careful selection of financial and other managers, clear delegation of authority and assignment of accountability, inculcation of high business ethics and conflict-of-interest standards, policies and procedures for coordinating the management of corporate resources, and the leadership and commitment of top management. In compliance with Section 404 of the Sarbanes-Oxley Act of 2002, Praxair assessed its internal control over financial reporting and issued a report (see below).
PricewaterhouseCoopers LLP, an independent registered public accounting firm, has completed an integrated audit of Praxairs 2009, 2008 and 2007 consolidated financial statements and of its internal control over financial reporting as of December 31, 2009 in accordance with the standards of the Public Company Accounting Oversight Board (United States) as stated in their report.
The Audit Committee of the Board of Directors, which consists solely of non-employee directors, is responsible for overseeing the functioning of the accounting system and related controls and the preparation of annual financial statements. The Audit Committee periodically meets with management, internal auditors and the independent accountants to review and evaluate their accounting, auditing and financial reporting activities and responsibilities, including managements assessment of internal control over financial reporting. The independent registered public accounting firm and internal auditors have full and free access to the Audit Committee and meet with the committee, with and without management present.
MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Praxairs management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including the companys principal executive officer and principal financial officer, the company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (often referred to as COSO). Based on this evaluation, management concluded that the companys internal control over financial reporting was effective as of December 31, 2009.
Praxairs evaluation of internal control over financial reporting as of December 31, 2009 did not include the internal control over financial reporting related to Sermatech International Holdings Corp. because it was acquired by Praxair in a business purchase combination consummated on July 1, 2009. Total assets and sales for this acquisition represent 1% and 0.5%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2009 (See Note 3).
PricewaterhouseCoopers LLP, an independent registered public accounting firm, has issued their opinion on the companys internal control over financial reporting as of December 31, 2009 as stated in their report.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To The Board of Directors and Shareholders of Praxair, Inc:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, equity and cash flows present fairly, in all material respects, the financial position of Praxair, Inc. and its subsidiaries at December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009 based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The companys management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, and on the companys internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As discussed in Note 1 to the consolidated financial statements, the company changed the manner in which it accounts for uncertain tax positions in 2007 and the manner in which it accounts for noncontrolling interests in 2009.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As described in Managements Report on Internal Control Over Financial Reporting, management has excluded Sermatech International Holdings Corp. from its assessment of internal control over financial reporting as of December 31, 2009 because it was acquired by the Company in a purchase business combination during 2009. We have also excluded Sermatech International Holdings Corp. from our audit of internal control over financial reporting. Sermatech International Holdings Corp. is a wholly-owned subsidiary whose total assets and total sales represent 1% and 0.5%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2009.
/s/ PricewaterhouseCoopers LLP
February 24, 2010
PRAXAIR, INC. AND SUBSIDIARIES
(Dollar amounts in millions, except per share data)
The accompanying Notes on pages 54 to 92 are an integral part of these financial statements.
PRAXAIR, INC. AND SUBSIDIARIES
(Dollar amounts in millions)
The accompanying Notes on pages 54 to 92 are an integral part of these financial statements.
PRAXAIR, INC. AND SUBSIDIARIES
(Millions of dollars)
The accompanying Notes on pages 54 to 92 are an integral part of these financial statements.
PRAXAIR, INC. AND SUBSIDIARIES
(Dollar amounts in millions, except per share data, shares in thousands)