Good day, ladies and gentlemen, welcome to the second quarter 2018 Praxair Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during this conference, please press star three to reach an operator. As a reminder, this conference call is being recorded today, July 26, 2018. I would now like to introduce your host for today's conference, Juan Pelaez, Director of Investor Relations. You may begin.
Thanks, Ezra. Good morning, thank you for attending our second quarter earnings call and webcast. I am joined this morning by Matt White, Senior Vice President and Chief Financial Officer, and Kelcey Hoyt, Vice President and Controller. Today's presentation materials are available on our website at praxair.com in the investors section. Please read the forward-looking statement disclosure on page two of the slides and note that it applies to all statements made during this teleconference. In addition, please note that year-over-year and sequential comparisons exclude transaction costs related to the potential merger with Linde. The reconciliations to the U.S. GAAP reported numbers are in the appendix to this presentation and the press release. Matt and I will now review Praxair's second quarter results, including the current business environment. We will then be available to answer questions. Let me now turn the call over to Matt.
Thanks, Juan, good morning, everyone. The strong momentum continued into the second quarter as sales and EBITDA exceeded $3 billion and $1 billion, respectively. Organic sales growth of 7% is consistent with recent trends, and we successfully increased operating and EBITDA margins for the fifth consecutive quarter, as incremental volume growth and pricing actions more than offset the effects of cost inflation. The culmination of these efforts led to a record EPS of $1.72. Furthermore, this was accomplished without significant use of capital, as net debt decreased $318 million this quarter, supporting a 13.6% return on capital, which is 150 basis points better than last year. The organization achieved this performance and captured incremental value through multiple initiatives, including price and cost management, prudent investments in the project backlog, and a focused and disciplined capital allocation process owned by all employees.
We continue to position ourselves for future growth by winning three new on-site projects, increasing the project backlog to $1.7 billion of capital spend, all underpinned by high-quality customer contracts. Overall, the economic landscape for industrial gases has remained quite positive, and we anticipate a continuation of these trends, especially in North America and Asia, which are two of the best-performing regions. The North American segment, at 52% of sales, has steadily improved several quarters in a row as U.S. industrial production rates have grown 3%-4%. Approximately a year ago, we anticipated a recovery in the U.S. packaged gas market, which we have experienced with recent growth rates ranging from high single to double digits for both cylinder gases and hard goods. In fact, the manufacturing and industrial recovery in North America has supported increased gas consumption across all supply modes.
Chemicals, aerospace, and manufacturing have been the fastest-growing end markets due to a combination of large project startups and higher levels of demand. The metals end market has been steadily increasing as customer run rates improve, and the resilient end markets of food, beverage, and healthcare continue to grow in line with demographic trends. The North American energy market was softer versus prior year, as we experienced a few customer outages, which have since returned to normal run rates. Pricing improvement of 2% is offsetting cost inflation, enabling operating margin to exceed 27%. Finally, we added another project to the backlog and are confident in our ability to win new on-site business opportunities, especially in the U.S. Gulf Coast. In summary, North America remains a strong market, and we anticipate these trends to continue.
Asia is the fastest-growing segment, with sales and operating profit growth of 19% and 34%, respectively. Similar to North America, higher levels of industrial activity, coupled with cost inflation, have enabled price attainment and volume growth across every end market and supply mode. Metals, manufacturing, and electronic end market improvements drove sales growth, but we also experienced a substantial increase in the energy market with the startup of our CNOOC project. The pricing improvement of 3% was mostly driven by China merchant pricing actions, as years of pent-up inflation is being passed through. Korea and India also have seen price improvements in line with inflation trends. Project backlog opportunities remain healthy as we sign two new projects supporting the chemical and electronic end markets. The Europe segment at 15% of sales continues to demonstrate positive growth on a very stable base business.
The 2% volume growth is consistent with prior quarter, as most end markets have been steadily improving, led by metals and manufacturing. More importantly, the pricing improvement of 3% is a clear demonstration of the team efforts to recover cost and power inflation. Margins expanded 30 basis points from prior year, but this includes a 90 basis point headwind from higher cost passthrough. Therefore, underlying margins improved 120 basis points from pricing actions in excess of inflation. In the second quarter, we had supply disruptions from our crude CO2 suppliers, primarily due to unanticipated shutdowns of ammonia plants, which negatively affected margins from higher dislocation costs. The majority of our sources are back up and running, so we do not expect the same level of supply disruption for Q3.
As anticipated, the South American segment continues to lag the rest of the world due to sluggish economic conditions in Brazil. While volume levels grew 4% due to higher steel mill operating rates, the manufacturing end market was quite weak from a nationwide Brazilian trucker strike that contributed to a negative 7% year-over-year industrial production rate for the month of May. Fiscal and political concerns have created significant devaluations of the Argentine peso and Brazilian real, resulting in a 10% year-over-year currency headwind for the quarter. While conditions are expected to remain challenging for the foreseeable future, our team continues to run a quality business with 27% EBITDA margins and high cash generation. The PST business posted good results with year-over-year sales and operating profit growth of 14% and 24% respectively.
You may recall last quarter, the ramp-up costs incurred to increase coater capacity in support of the aviation end market. Now we are selling from that new capacity while also seeing positive recovery in the energy and industrial end markets. We anticipate further growth as more capacity comes online to serve the large backlog of engine parts required for jet orders. In summary, I'd say we are firing on four out of five cylinders. A strong performance across most segments more than offsets a weak South America. It's clear that all Praxair employees have maintained focus to deliver value and grow a high-quality business. We've also made substantial progress toward the merger, which you can find on slide five. The current focus of both organizations can be boiled down to two major areas. First, to obtain regulatory approvals, including potential divestiture agreements.
Second, to accelerate merger planning efforts. As you've seen from recent announcements, there have been a few key accomplishments on the regulatory front. At this stage, there are six remaining regulatory approvals required under the BCA, as we recently received clearance in Mexico. Milestones are being completed as we work toward closing the transaction prior to the October 24th long-stop date. In addition, Praxair and Linde each announced executed agreements to sell their respective European and Americas assets in support of ongoing regulatory negotiations. While the completion of these agreements does not assure approval from the relevant regulators, we continue to work constructively through the process. In parallel with antitrust efforts, we are conducting integration planning activities in order to prepare for the merger close date. Since we are still competitors, we're unable to begin integration, but we can develop detailed plans for day one readiness.
Examples include plans for organization structure and talent selection, operating rhythm, IT systems, accounting filings, and several other initiatives. As you can imagine with a merger of this size, there is a substantial amount of work and complexity. We continue to have positive interactions between both companies as we move forward. Similar to prior quarters, we are not in a position to provide any details on the process. I appreciate your efforts to refrain from asking merger-related questions. I'd now like to hand it back to Juan to review the second quarter results.
Thanks, Matt. Please turn to slide six in our presentation for our consolidated results. Sales of $3.1 billion were 8% higher than prior year and 2% higher than the first quarter. Year-over-year, volume was the largest contributor with growth of 5%, of which 40% came from project startups and the balance from organic growth. Furthermore, the growth was broad-based with every end market contributing, although metals, manufacturing, chemicals, and electronics led the way. Additionally, at 4% of our total sales, aerospace was another significant contributor to the overall growth, up 16% year-over-year. For the past six quarters, this end market has been growing at healthy rates, primarily led by sales to space technology companies in the U.S. that demand large amounts of atmospheric and processed gases for manufacturing and launches, as well as coating to aviation engines, mainly through our PST business.
Price contributed to a 2% increase in sales for the quarter, driven primarily by strong price actions in Asia, Europe, and North America in both merchant and package. Sequentially, volume growth of 3% was broad-based across all end markets, but led by food and beverage, primarily North America and Europe, due to seasonality. In Europe alone, food and beverage grew 17% sequentially, given our strong network in the region. Currency translation was flat year-over-year, but negative 2% sequentially, as major currencies weakened versus the U.S. dollar. The strengthening of the U.S. economy, coupled with global trade concerns and political uncertainty, have contributed to this trend, and we anticipate it will continue through the back half of the year. Operating profit of $713 million was $92 million, or 15% better than last year, and $41 million, or 6% better than the first quarter.
Operating margins expanded 140 basis points year-over-year, and 90 basis points sequentially, led by overall strong fundamentals in the base business. Operating cash flow was $790 million, and capital expenditures were $351 million, of which 65% was invested in North America, mainly in the U.S. Free cash flow was $439 million, which was used to pay dividends and reduce net debt below $8 billion, the lowest level since 2012, prior to the NuCO2 acquisition. Project backlog for the quarter rose to $1.7 billion, up $200 million from prior period, after starting up two large ASUs to serve Sinopec in China and winning three on-site projects, two in Asia and one in North America. Of the total backlog, close to half will supply chemicals, 40% will serve electronics, and the balance the aerospace and manufacturing end markets.
Additionally, we have over 30 small on-site project wins totaling $80 million in investment that we expect to start up in 2019, but are not part of our project backlog, since each investment is under $5 million. Similar to the project backlog, these investments have fixed monthly payments and are underpinned by a long-term contract. As a result of our disciplined capital management and cash focus, the after-tax return on capital closed the quarter at 13.6%. This is the fifth consecutive quarter where we have expanded return on capital, and we expect it to continue improving throughout 2018. With that, let me now turn the call back to Matt, who will discuss our third quarter outlook.
Please turn to slide seven for an outlook on the third quarter. At this point, we are anticipating similar business trends across all segments, adjusted for normal seasonality. For Q3, we expect more stable operating conditions for both crude CO2 suppliers and U.S. Gulf Coast refiners. Although helium will remain tight due to certain source outages. Tax rates should remain in the 23%-25% range. The most significant difference for Q3 relates to foreign currency rates. You may recall that we had a 3% FX tailwind in the first quarter, and no year-over-year FX effect for this second quarter. In fact, for the second quarter, we originally anticipated a 2% tailwind in the earnings guidance, which quickly evaporated to 0%.
Based on recent forward rates, the second half of 2018 could experience translational currency headwinds of 2%-4% as the U.S. dollar continues to strengthen from higher interest rates and a stronger economy. Earnings guidance is not provided for Q3 due to the anticipated merger close date with Linde, which is consistent with the full-year approach taken this January. Since it is possible this could be the last Praxair earnings call, I'd like to personally thank all 26,000-plus employees for their tireless effort and support. For over 25 years, the Praxair name has been synonymous with operational excellence, prudent capital management, and industry-leading performance. Although the name Praxair may go away, the people will continue to thrive as we join with Linde to create a new, more valuable company. I'd now like to turn the call over to Q&A.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. As a reminder, to prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from the line of Vincent Andrews from Morgan Stanley. Your line is open.
Thank you. Good morning, everyone.
Morning.
Just a question. If we look through North America, if you look at the pricing in merchant versus packaged gas, could you just give us a sense of the trends there?
As you saw on our total North American slide, pricing for the entire segment is up a few % here. Of the 2%, you may recall that onsite, really, we don't show much in price. That represents all of the merchant and package price improvements over the entire revenue balance. What I would say from that perspective is your low single- to mid-single-digit pricing we're seeing both in packaged as well as merchant. As you can imagine, we are seeing inflation across North America. In some cases, it's power. In other areas, in distribution costs. We need to continue to do this, as you can imagine, to recover that inflation. Some of it contractual in our merchant package contracts. Some are actually pricing actions that we have to go out and get.
Okay. Just as a follow-up, I might have missed this, did you talk about what the volume was in Asia if you stripped out the project startups?
We had said consolidated of the 5%, a little less than half is related to projects and the balance organic for the total consolidated. I'd say Asia is probably a little more projects, closer to half for the entire segment.
Okay. Thank you very much.
Thank you. Our next question comes from the line of Duffy Fischer from Barclays. Your line is open.
Yes, good morning.
Good morning.
Question on Latin America. The run rate, does it still feel like it's falling, or have we kind of stabilized at a lower level, if we kind of annualize what we've seen over the last quarter, that gets us a decent look for the next year or so?
That's the question we're all trying to figure out. I would say, as you know, our South American business, a little more than three-quarters would be Brazil, but I'll start with the non-Brazil section. I think there we continue to do fairly well. It's more just of a currency issue. Places like Argentina, Colombia, we do have more resilient markets in some of those countries that, from a growth rate perspective, continue to be pretty good, but it's getting drowned out with some of the currency effects. In Brazil, clearly the trucker strike, we lost about an entire week in the month of May and really did not get much of that back. It's hard to take this particular quarter, given that sort of anomaly that happened.
When I look underlying what we're seeing in Brazil, clearly we continue to see improvements in the onsite metals as you're seeing more metals being produced. Now, part of that is for export. With the real softening, it's making those products more competitive globally. I'm hoping that some of that could be for use for internal to start some thawing. It really, until the election, it's going to be hard to see. As you may recall, in North America, when we hit some industrial recessionary conditions going back four years ago, metals was the first one to rebound and recover, and then over time, merchant and then package. In Brazil right now, we just haven't seen merchant and package really turning the corner. Next quarter, hopefully, will be a better comp, just given the lack of any anomalies.
Frankly, until the October elections, it's going to be tough. I think we're going to really have to see what happens in 2019. I think Mexico is kind of a good example. When AMLO was elected, there were obviously some views and concerns, when he came out and announced kind of his cabinet, his views, I think it calmed some of the markets and calmed some of the views, we'll have to see if that happens in Brazil. Time will tell.
Okay. Then a relatively small business for you, your Russian business, the headlines have obviously been getting worse throughout the year. Do you see that in your business, does that feel like it's still the same structural strategic bet that you've always made, be patient long term and it's still a decent place to be?
Well, we always need to be patient long term in this industry, as you know, Duffy, given the nature and the structure of it. Clearly, economic cycles will go up and down. I would say with Russia, to your point, it is quite small for us in the grand scheme. It's mostly onsite, and those onsite contracts we feel very good about. From that perspective, we absolutely expect they'll be withheld or upheld, I should say. A lot of them are based on English law and things like that. From that perspective, we feel good. The merchant and package has been tough for a while. I would say more than just the last six months. We had a period of stagflation there for a bit of time. From that perspective, which is very small for us, by the way, the package and merchant.
Russia has not been easy for a while, but the onsites have been very good and anything related to, I think, exports of natural resources continues to be good. We'll have to see. It is one of our geographies and at this point, we haven't made a lot of incremental investments though, and we'll just have to see what opportunities present themselves in the future.
Great. Thanks, Phyllis.
You're welcome.
Thank you. Our next question comes from the line of Michael Sison from KeyBanc. Your line is open.
Hey, guys, nice quarter. It looks like the backlog continues to improve. You're at $1.7. Can you maybe remind us where that backlog peaked historically and given the industrial backdrop has been pretty positive here, do you see that backlog continue to improve over the next couple of years?
Mike, I think for us, our backlog peaked probably in the mid twos. One thing you'd want to take into consideration on that, we had a large steam methane reformer project that was in there for quite some time, probably seven, eight years when you go back in time on that. We did resolve that. That actually became a sale of equipment when all the dust settles. If you pull that one out, I'd say low twos is probably the more normalized where we peaked on that. The nice thing I like about this current cycle, to your point, it is a good cycle, and what we're seeing, and I'd say the quality of our contracts and customers, is a nice rhythm of startups and replacements. From my perspective, the best thing about a backlog is a backlog that's constantly churning.
A growing backlog can be good, but we need to make sure we're starting them up. Right now, we're having large startups. As you know, we had a very large startup in the first quarter, but we're replacing it with new projects. As long as we can keep replenishing, and actually taking something that's a use of cash and turning it into a source of cash, I think that's quite successful. We feel very good. To your point, it's gotten up to $1.2 billion. When I look out the rest of the year and we kind of probability adjust, it's possible we could have a two handle on the backlog again. I think the backdrop is pretty strong, and we feel good about our prospects and where we are on some of these pre-backlog opportunities.
Great. Then in terms of pricing, I think you mentioned inflation. Your pricing is in excess of inflation to some degree. How much of that is just driven by what you're able to do and then, to some degree, maybe industry pricing and everybody's working their way to get that pricing action?
Well, a portion of it is just how you contract, Mike. There are several contracts out there that have inflationary aspects, either escalations or ability to surcharge through for power escalation. One thing that's very clear is you are seeing power escalate, in many geographies in the world for various reasons. Having the right contracting to be able to recover that, I think is quite important. Aside from that, it's just a matter of just having at the very low levels to have to grind it out and work through it. It's, as you know, a very local industry and inflation is a big driver behind the pricing in this industry.
Great. Thank you.
Thank you. Our next question comes from the line of Jeff Zekauskas from JPMorgan. Your line is open.
Thanks very much. I don't have a question on developments in your deal, but I have a question on the structure of the deal. Could you close the deal without Chinese approval? That is, if there were regulatory delays in China, and you didn't hear from them.
Well, Jeff, I figured you'd be the one that would try and find a way around it. I would say this much, I don't want to get into any depth on any of these discussions, but in our BCA, we list nine regulatory agencies that are required to close the deal, and that is a public document. You can go pull that information and see the nine required to actually close. Obviously, we have to follow with others that are very important, but of those others, they are not required to close the deal, per the BCA.
Okay. If you received regulatory approval from China on, I don't know, October 23rd, could the deal still be closed on the 24th?
Yeah, I don't want to get into any specifics, Jeff, on either hypothetical situations or views of regulatory decisions. At this stage, unfortunately, it's something we're working very constructively and we're having good dialogues across all global regulators, and we will continue to update you guys on events as they are warranted and relevant. At this point, I don't want to get into any specifics, especially with any specific regulators.
Okay, great. Thank you so much.
Thank you. Our next question comes from Laurence Alexander, from Jefferies. Your line is open.
Hi. A few hopefully short ones. About a decade ago, you guys used to talk about having about a 1% tailwind for organic growth just from energy efficiency investments. Are you seeing the industrial appetite for those come back? Related to that, a couple of years ago, you were talking about how over, say, a three or four year period, you might have line of sight to about a 3% annual tailwind from onsites starting up on average, not each year. Is the current backlog and the trends you're seeing in line with that, or better than you would have expected when you were making those comments?
I'll start, Laurence, with your second question and then go to your first. You're absolutely right. We had laid out, back in our strategy probably four years ago, that based on our backlog, we anticipated 3% EPS. We stuck with EPS because as you know, each contract can be a little bit different on how the revenue is reported. We said a 3% EPS growth rate that we see extending out three plus years. As you may recall, earlier this year, we extended that another year based on the winds. We still believe that we can see a 3% EPS, plus or minus neighborhood of improvement over the next three to four years based on this current backlog.
If our backlog starts to increase, we can reassess that. This was based on a roughly $1.5 billion continually replenishing backlog, which is where we still are right now, give or take. I'd say yes, those dynamics we still see valid over the next 3 to 4 years, and if we continue to maintain this level of backlog, that should continue out more years. From your first question, as you may recall, a lot of the energy efficiency, I'd say, we were seeing many years ago were for reducing natural gas consumption. For instance, if someone had a natural gas-fired burner, any type of combustion operation you do, you want to eliminate inert gas, meaning nitrogen primarily. By displacing and burning in an oxygen environment, you would accomplish that.
Given that natural gas, at least in the U.S., is much cheaper, those applications are less than what they were probably a decade ago. I would still say in emerging markets, anyone using higher cost hydrocarbons, especially oil, that application is still very valid. More what I would say we're seeing displace that is environmental reasons for NOx and SOx reduction. By burning in a better environment, you can reduce that. You see that a lot also in the glass industry, where it gets into even more so with throughput improvements in addition to environmental. I would say the original main drivers have shifted, they're still relevant in certain markets and in certain end markets, and we're still seeing some improvements with that energy efficiency.
Have you received any clarification from the managers of the different equity indexes as to whether or not you'll belong in which ones you'll belong in? Will there be a technical period post the deal closing where it will be ambiguous?
Yeah. They can't tell us until post-close, as you probably know. They're not able to make the decision. You could probably look at other deals as you know, like DowDuPont and some other relevant situations. They're not able to make any announcements until the deal is consummated and they review that, and then they make their decision for index inclusion.
Perfect. Thanks.
Obviously, we're pursuing both the New York Stock Exchange, S&P 500, as you can imagine, and the DAX in the Frankfurt exchange.
Right. Thanks.
Thank you. The next question is from David Begleiter from Deutsche Bank. Your line is open.
Hey, good morning.
Morning.
Matt, just on the U.S. packaged gas strength, can you give a little more detail as to where and what's driving that and how long you think this is, I think you said low double digits right now, is sustainable?
Hi, David. High single digit, actually, all in. What we're probably seeing is mid-single digit plus on gas, then we're still double digit on hard goods right now. It's funny, I asked the same question internally here, and the answer is it still is pretty broad-based. Clearly, manufacturing, you look at industrial production and you look at some of the subcategories of industrial production like metal fabrication, construction, equipment. They're doing quite well. They drive a lot of welding, shielding gases. Think argon is a big driver in that area. That continues to do well. Construction does well. We're also seeing a variety across many other end markets. Some resilient markets, healthcare, some of the packaged gases we deliver into hospitals. Also aerospace, as Juan had mentioned, even refining things for gas analytics.
It still is pretty broad-based, and packaged gas, as we've always said, tends to be a very good proxy with industrial production, especially the subcategories in the manufacturing category. At this point, there's no one market I could point to that I would say is more strong or weaker than the other, it's fairly broad-based.
Very good. Matt, could you just go through the merchant operating rates by region?
Sure. When you look at the U.S., right now, we're still probably high 70s in base merchant in the LIN and LOX, but argon continues to remain tight. As you know, it's more based on oxygen base loads, and as I mentioned, demand is high in met fab, so argon is still tight across most of North America. Brazil is still probably mid-70s, and that's just as much a function of we still have some on-site customers under take-or-pay that we do over. It's probably base molecules are constricting even as much, if not more, than the liquefaction capacity there. When I look at Europe, we continue to see some improvements. We're getting up to, say, mid-70s now for LIN and LOX. argon, a little bit less than that. Europe is running well. Asia is one that is a little tighter in some areas.
It's kind of overall probably in the 80s as we're seeing good demand that continues to be strong across several countries in Asia. I'd say trends are going well, but we're able to get good utilization out of our asset base globally. Clearly, we have room to expand, if needed, in all of our markets.
Thank you.
Thank you. The next question is from P.J. Juvekar from Citi. Your line is open.
Good morning, Matt.
Good morning, PJ.
I had a question on pricing related to your earlier question. Pricing was up in packaged gases in both North America and Europe. Do you think that packaged gases pricing leads merchant pricing? In that sense that you see it first in packaged gases, which are shorter term contracts compared to merchant?
Well, I could say this much on Europe, just to add to that. Part of that pricing is not only recovering inflation in the packaged gas side, but also we do have a refrigerant business there in Italy, and as you can imagine, part of that pass-through is both power and fluorine and refrigerants and also some of that price. It's a combination of packaged gases in our refrigerant business in Southern Europe. I would say that, I don't know if I'd call it a leader, but I would say packaged gases tend to be much tighter correlated with inflation. As you know, in package, the contracts are not very long. They could be one, two, three years, or they might just be purchase orders.
They are the most sensitive and probably the most elastic as far as pricing, but they also tend to be repriced more to inflation faster. In some cases, especially hard goods, where you know we operate primarily as a distributor in hard goods, these hard goods can be sourced from various countries, from various locations. As you may get cost creep, whether it's through tariffs or other various raw material items like metals, then that has to be recaptured in the pricing to recover that inflation. You're seeing some of that as well in packaged gases to recover those hard goods higher costs. It's a combination, I'd say, of all that.
I don't know if I'd say it's a leader, but I would definitely say it's probably most closely tied timing-wise to inflation, given the short duration of contracts and given their exposure to a variety of both hard goods and gases.
Great. Thank you for that. You won two on-site projects in Asia and one in North America. Can you talk about those? As you look forward to second half of 2018 and then in 2019, can you size the impact of new projects starting up?
I'll start with the starting up. It's not a number we've disclosed, as you can imagine. Generally, we've been on average probably a third, a third, a third. The average build cycle is three years. I don't see next year drastically different than that. Could be a little bit lower because, as you know, this year we had a couple large startups, including our largest project ever. I think the startup next year, we still believe will overall reach that 3% number in that range I talked about before for EPS growth. The backlog reduction, somewhere in that neighborhood of a third or maybe a little less. As far as the ones we won, chemicals and electronics primarily. As we had mentioned, when you look at the U.S., still seeing strong chemicals activity across the spectrum.
Investments continue to be made, and this was an asset related to that investment. In Asia, one in chemicals and one in electronics. As we had mentioned in prior calls, these continue to be kind of the strongest growth end markets, primarily in Asia and North America, as you know, and we continue to see good opportunities. If I look at our pre-backlog, the major three markets related to that are still electronics, chemicals, and energy to an extent. Those are right now, I would say, probably in the best build cycle. Hopefully we'll start seeing things in manufacturing and some of the other end markets soon.
Great. Thank you for that.
Thank you. The next question is from Steve Byrne from Bank of America Merrill Lynch. Your line is open.
Matt, just continuing on that commentary, how would you characterize that pre-backlog geographically?
Well, right now, Stephen, as you look at our current backlog, it's about half Asia, half North America in terms of where we stand. When I look at the pre-backlog, it's probably not too distant from that. We were more heavily North America for a period of time. Asia had built up. If anything now, we could be a little bit higher North America. Again, these are projects that have been actively worked on for the last anywhere from year to two years, and we'll have to see which ones ultimately come to fruition. It changes based on where we are in the, and I'll say the starting gate and contract negotiations. Again, U.S. Gulf Coast and Asia are the two primaries.
Just a question about the disruption in Brazil from the trucking impasse. Is it fair to say that some of your customers down in Brazil are still impacted by the lack of a settled trucking freight rate? Maybe conversely to that, do you compete with anyone in the merchant business down there that is struggling in that they have some outsourcing of that merchant trucking?
Well, I would just say high-level, everybody was affected by the trucking. It was not discriminatory in any way, and the industrial production number for the month, as I mentioned, at -7%, pretty much characterized and validated that effect. From that perspective, we were all affected. If I look at now, things seem to have gotten back to normal. Clearly for a smaller company, it may be more difficult, but When I look at the broad scheme of things, I think we're all pretty much back to normal there. We haven't heard of any additional issues. Normal is still a challenging situation, as we know, given the political uncertainty. I don't think there's any residual issues right now, large or small customers. We'll have to see what happens over the next several months.
Okay, thank you.
Thank you. The next question is from Michael Harrison from Seaport Global Securities. Your line is open.
Hey, good morning.
Good morning.
Speaking of trucking issues, we're hearing a lot about rising freight and logistics costs, particularly in the U.S. Can you just remind us as you think about your merchant and packaged gas fleet in the U.S., I guess North America overall, how much of that is in-house versus outsourced? How much inflation have you seen from either rising labor or fuel costs? How confident do you feel you are in your ability to pass that through to customers?
Okay, Mike. I'll start with just the diesel. That's a structure of a pass-through surcharge that is a contractual component. As I mentioned earlier, passing through inflation can be very contractual, and diesel is a classic example of that. These are aspects that you contract to recover. From that perspective, there is a lag. It's usually two, three months, but that's something that will go up and down with the diesel cost. As far as truckers, you're absolutely right. The costs are going up. It is tight to get truckers, but this is not, I would say, anything new. We go through this in cycles, as you know, with how the economy, especially in the U.S., is going. When the economy's going strong, there tends to be more shortages of truckers, and when the economy is softer, you're able to get some.
Things like Amazon and FedEx and UPS will continue to absorb more drivers, just in general. When I look at Praxair, this is something that we've had to manage since our inception, we always keep a balance, as you mentioned, of in-house drivers versus outsourced of both contract and common carriers. We'll use both. That percentage of in-house can range anywhere from 50%-75%. It flexes up and down just based on conditions. We will use outside truckers for surge capacity and also ongoing variable. Clearly, they got to meet our safety standards, and that's a big part of getting them trained, getting them as part of our culture. It takes some time for us to get them to be the right drivers. It's something we're used to. We've got a great team that does this day in, day out.
From my perspective, while it's challenging, while it's tough, there's nothing I've seen overly concerning about this current trend versus any prior trends.
All right. Appreciate the detail there. Just in terms of the U.S. on-site business, it looks like U.S. refinery utilization is running very strong. I was wondering if you can comment in a little more detail on the strength you're seeing in hydrogen, and did you see any planned outages that were pushed out as refiners look to run harder? Thanks.
As you may recall, on first quarter, we had some significant turnarounds that we mentioned and that occurred. Those were ones that we believe were pushed out from 2017. You had a combination, as you know, of strong refining margins coupled with the hurricane toward the back end of the year. That pushed a lot of turnarounds into Q1. The vast majority of our customers were back and running hard, like you said, although this quarter we did have two large customers that were having some outages. They are back running now. From that perspective, I'd say right now we're seeing pretty strong demand and strong volumes. The refiners from my perspective, want to run. hydrogen is doing well, as so is oxygen and nitrogen, which both go to refineries as well.
At this stage, things are running well, we'll just have to see how things go forward.
Thanks very much.
Thank you. The next question is from Jim Sheehan from SunTrust. Your line is open.
Good morning. This is Pete on for Jim.
Morning, Pete.
Could you quantify the margin impact in Europe from the CO2 disruption? Given that strong pricing growth of 3%, do you expect that the margin uplift there will accelerate in the back half of the year?
Well, we didn't disclose that, but I'd say consolidated, it might have shaved close to anywhere between a half a penny and a penny off total results. You could probably back into what that might have meant from a Europe perspective. Yes, when you look at that price of 3%, as you may recall, inflation's been challenging in Europe, but we're starting to see some signs. There are some tightness of certain products, and I think that is driving a little bit of the inflation as well. Our team's done a good job to go out there and get back some of this pent-up inflation. Power has been a big area. You may recall when you look at pass-through, we had 4% this quarter. I think last quarter we were a similar number, low single digits.
We've started to see power as, I'd say, the initial area of inflation, and it's kind of creeping through in other areas. Our team needed to get ahead of it, and they did. When I look at that, I think that's a good result. Now, as you can imagine, this second quarter is the high season for CO2. We had the outages during the difficult time. As I mentioned in the prepared remarks, most of our sources are back and running to normal rates, but we see a normal seasonal decline at this point, just given the seasonality. We feel we should be able to manage this now, given the balance. I think we have time for one more question.
Thank you. Our last question comes from the line of Kevin McCarthy from Vertical Research. Your line is open.
Morning, this is Matt on for Kevin. Thank you for squeezing me in.
Sure, Matt.
Merchant price in China has improved, and I think company utilization rates, as you had mentioned in Asia, were kind of in the low 80 range, but seems like industry utilization rates in China in particular, somewhere in the 50% range. Are we just catching up to a more normalized level of pricing here and then going to expect to balance out, or should we expect continued price traction as utilization rates kind of continue to tighten?
From my perspective, Matt, I think it's, I guess, your former of trying to catch up. You go back the last several years, it's no secret that there was a large excess supply of merchant product in the China market. A lot of that was driven by both capacity in the, what I'll call industrial gas, but also capacity in the non-industrial gas, meaning steel mills that had byproduct coming off of their captive plants. This drove both, not just low utilization rates, but just more supply than demand. Pricing in China was one of the lower pricings around the world, given this. While China, throughout the years, has had inflation, you could debate it, but anywhere from mid to high single digits, the pricing, and you just look back at our history, was not reflected of that.
I would say at this point now, you've had some structural supply impacts that have been favorable, where capacity, especially related to the steel mills, has come out as steel mills have been shuttered. Remains to see in how much more that will happen. I think that seems to have slowed, but you also have demand improving, and the combination of that has allowed us to capture some of this pent-up inflation from several years to get pricing that is closer to what we would expect. Because you got to remember, in China, it has some of the highest mill rates in the world. You've got to take that into consideration when you look at merchant pricing, because power, as you know, is one of our biggest inputs.
From that perspective, we need to get pricing more in line with what the recent inflation has been and what the costs are to serve that business. I think that's what's been happening as we've seen some both structural improvements and demand improvements.
Thanks. If I may just slide one more in. Can you remind us your stance as it relates to pursuing Chinese coal gasification projects? Your competitor's comments make it sound like competition for those has picked up.
Well, I could say this. Our stand has been the same for the last decade plus. We've been quite clear that whether it's China coal gasification projects or other projects, we will pursue ones that meet our density strategy, that meet our return criteria. Not just financial return, but also who we're partnered with and our technology and matching that up. That's something we've participated in in south part of China, eastern part of China, in integrated industrial parks, and we've had longstanding, strong relationships with customers over a decade on that front. We have not pursued moving upstream, or we have not pursued going into regions where we were not able to achieve the density model. We've been quite consistent as far back as I've been here, and we feel good about how we're doing that.
All right. Thank you.
Thank you again for participating in our second quarter earnings call. If you have any further questions, please feel free to reach out to me directly.
Ladies and gentlemen, thank you for participating in today's conference. This does