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Lufkin Industries, Inc. (NASDAQ:LUFK)

Q4 2012 Earnings Call

February 14, 2013 10:00 am ET

Executives

Anne Pearson – Dennard-Lascar Associates

John F. Glick – President and Chief Executive Officer

Christopher L. Boone – Chief Financial Officer, Vice President, Principal Accounting Officer, Treasurer

Analysts

Robin Schumacher – Citigroup

Collin Gerry – Raymond James & Associates, Inc.

Jeff Tillery – Tudor, Pickering, Holt & Co

Blake Hutchinson – Howard Weil, Inc.

Neal Dingmann – SunTrust Robinson Humphrey

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Lufkin Industries’ Fourth Quarter Earnings Call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, February 14, 2013. I would now like to turn the conference over to Anne Pearson, with Dennard-Lascar Associates. Please go ahead.

Anne Pearson

Thank you Ian and good morning everyone.

With me today are Jay Glick, Lufkin’s President and CEO and Chris Boone, Vice President and CFO. Before I turn the call over to Jay, I have a couple of quick housekeeping items. If you’d like to be on our email distribution list for future news releases, please call us at 713-529-6600 and we would be glad to add you. If you’d like to listen to a reply of today’s call, it will be available by recorded phone replay until February 28 and also by webcast replay by going to the IR section of Lufkin’s website. This information was also provided in this morning’s news release.

A reminder that the information reported on this call speaks only as of today February 14, 2013. So please be aware that any time sensitive information may no longer be accurate at the time of a replay. Also be aware that today’s conference call may contain certain forward-looking statements. The assumption that these forward-looking statements are based on, are assumptions that are beyond the company’s ability to control or estimate precisely. Get in some cases, they may be subject to rapid and material changthey may be subject to rapid and material changes, actual results may differ materially.

With that I’ll turn the call over to Jay.

John F. Glick

Thank you very much Ann and good morning to everyone. Thanks for being with us today. In addition to the forward-looking statements and the remainders that Ann just covered, she wanted me to remind everybody on the call that today is Valentine’s Day. So if you haven’t made the arrangements for flowers, chocolates, or something more exotic as there is still time after the call.

Let me start with an outline of the call and I want to open with a brief look at the full year and the operating achievements that we realized and faced a number of challenges over the last 12 months. Then we’ll look at Q4 performance, Chris will provide a detailed breakdown of our fourth quarter financial results, and I will close with an outlook for the first quarter and full year and provide initial revenue, EPS, and capital spending guidance for the year.

In 2012, we made significant headway in each of our three core strategies: one, we expanded our global reach through the completion of the new Romanian facility, which will enable us to serve the Eastern Hemisphere markets more efficiently. The cost and logistical advantages of the Romanian location will improve our service to customers in the regions and drive revenue and profit growth in both of our business segments.

In addition to the international expansion during 2012, we also open new service centers to better support customers in the Bakken and Eagleford plays. Secondly, we increased our portfolio of products and services in artificial lift, particularly in areas of technology that delivered greater value to our customers, we did this to the acquisition of one UK-based and two Ireland-based companies in early 2012. Thirdly, we increased our capacity in factories and added debt to our professional ranks to support the future growth of the company.

The progress we made in our strategic initiatives resulted in record financial performance last year, specifically record bookings of more than $1.3 billion, record revenues of nearly $1.3 billion, which were up 37% from 2011 levels, and record net earnings of $81.9 million. Earnings were up 24% year-over-year although the cost of expanding our capacity and the capabilities to operate as a larger, more global company; we are dragged on bottom line performance during the year.

Performance from our Oilfield Division was particularly strong, new business booked orders for the full year increased 47% from 2011 levels to more than $1.1 billion.

Oil Field revenues grew by 46% to nearly $1.1 billion through both organic growth and through the two major acquisitions. The acquisitions of Quinn’s downhole rod pump and progressive cavity pump business, which was completed in late 2011 and Zenith acquisition, Zenith manufactured downhole gauges and optimization hardware and software for electrical submersible pumps and we acquired both of those in early 2012. We are particularly pleased with the growth of our automation business, which had a record year for both top and bottom line performance. We also delivered strong top line performance from our core pumping unit business.

In our Power Transmission division, we delivered a 5% year-over-year growth in revenues despite some performance issues early in the year and we realized sequential growth as the year progressed. Growth in this division was led by strong demand for high-speed gear drives for oil and gas, petrochem and power generation infrastructure projects. And we had a very encouraging performance from our European operations in the Power Transmission division, which delivered a 28% increase in the orders booked year-over-year.

We have successfully integrated the five acquisitions we’ve made in our Oil Field division over the last 18 months and we’ve been very pleased with the contribution they’re making to our top and bottom lines. The Quinn and Pentagon acquisitions have allowed us to expand in the growing Canadian market and the three technology acquisitions; Datac, RealFlex and Zenith will enable the introduction of the next-generation of automation products for artificial lift production optimization during the course of this year. The first generation of the new IWELL and SKATA products are currently on field trials with the introduction plan for Q2 2013.

Organic growth combined with these acquisitions has allowed us to move into fourth place in the total market share among all participants in the Artificial Lift segment.

During 2012, Spears & Associates calculated that the Artificial Lift market grew by 23% to $11 billion. The Spears study estimated that rod lift which is left in this traditional strength grew from a 25% share of the total Artificial Lift market in 2011 to a 31% share in 2012, largely at the expense of electrical submersible pumps, which decreased from a 54% share of the market to a 46% share.

In large measure, this reflects the preferrers the rod lift in unconventional oil production like the shale plays that are dominating the U.S. energy production these days. Spears estimates that that total market will grow another 18% in 2013 to nearly $13 billion, total artificial lift market. We expect rod lift to continue to grow in popularity of unconventional plays of North America and in the expanding international markets for both unconventional and conventional oil and gas production in coming years.

We delivered record numbers in 2012, despite a number of challenges that are rose as we expanded capacity to meet growing demand and position the company to operate its back-office and financial systems, securely and efficiently across the broader array of international operating units.

In previous calls, we have discussed the challenges associated with hiring and training hundreds of new workers, getting them up to speed from a productivity standpoint, adding shifts and sourcing enough high-quality third-party castings to fulfill our demand. As we entered 2013, we remain focused on productivity improvement in all phases of our operation. We expect productivity gains to drive better margin performance this year and beyond, and Chris will address some of the productivity gains we’ve seen this year in the Oilfield sector in his discussions.

Establishing the infrastructure to support a growing global platform is another challenge we faced in 2012. From IT to legal, to accounting and finance, and through operational support, we added a significant talent during last year. We still have several areas to address in 2013, but we have put many talented people in important roles to support continued growth.

While we made headway in the SAP conversion and overcome many of the start-up problems that we are so disrupted in the first half of the year, we still have work to do to extract more value from the system, particularly in the areas of white collar efficiency and manufacturing process management. Because of the importance of SAPs, our global ERP platform, we are devoting significant resources to ensuring we have realized the project’s full benefit.

I want to address our international markets. Although the U.S. oil demand underpinned our successful performance in 2012, we look to the international markets to be strong drivers in 2013.

With the construction now complete on the Romanian facility, initial component production is underway. Engineering and manufacturing are working there to work through each unit size to prove the all range of Lufkin’s pumping unit products that will be produced in Romania, and we will do that one frame size or one unit size at a time.

The supply chain per cash thing is in place for several unit sizes. Tooling and fixtures are being verified in initial production, the supply chain effort to complete raw material vendors had – of non-cash raw materials of other purchase components continues to be focused.

In February, our Romanian site was audited and recommended by the American Petroleum Institute to Monogram products that API specifications 11E. This stringent onsite evaluation inclusive of the API specification and the ISO 29001 confirmed our capability to produce high quality products worthy of carrying the API monogram. We expect the license to be formally issued in March and that’s the big launch point there being able to manufacture complete units there. Probably the biggest international challenge we faced through much of 2012 was the labor on rest in Argentina. our factory was not immune to labor problems, but the larger labor issues across the Argentina economy had a greater impact on our operations, resulting in the late order placement and difficulties getting access to field locations for service and product delivery.

Although the critical climate was more stable in the fourth quarter, Argentina is expected to remain an area of uncertainty in 2013. In North America, we continued to confront low natural gas prices, which impacted the sales of our gas lift, plunger lift and hydraulic lift products. And we expect those segments to continue to face headwinds in 2013 due to low gas prices.

The pricing environment for our products and services also continues to be a challenge while the aggressive discounting we saw during 2011 moderated in 2012, price levels remain weaker than normal during a period in which demand is strong and capacity is being added. Consequently, our 2013 forecast focuses on improvements in margins through cost control and productivity gains and assumes literal improvement on the pricing front.

Now I would like to turn to the fourth quarter results. On a consolidated basis, looking at performance versus our late October guidance, we beat the top end of our revenue guidance of $340 million to $350 million with a combined revenue of $356 million. On an adjusted basis, we are within our EPS guidance of $0.80 to $0.90 per share with fourth quarter adjusted earnings of $0.87 per share. Due bookings from the two divisions combined total $289.5 million and our consolidated company backlog was $323.5 million at the end of the year, up from $272 million the year earlier, but down 17% from the end of the third quarter.

Looking in detail of our Oilfield Division, as expected activities slowed sequentially in North America. However, new business bookings were only impacted in two areas; one was the service bookings, which were off 1.8% in the U.S., but were up significantly in Canada almost doubling. The other was hydraulic lift bookings, which were up 20% due to contract delays in Mexico that continued slowdown in activity in the coalbed methane markets in the Rockies.

Despite the drawdown in North American drilling rigs, we were pleased to see pumping unit bookings increased 10% sequentially. Although, we were down 13% from Q4 2011, which had benefited from risk year end budget spending that we didn’t see this year.

As we said in last quarter’s call, 2012 budgets were spent at a more rapid rate earlier in 2012 and in 2011. So many of the normal end of the year buying patterns were different in 2012, what we see in most years. We attribute the sequential improvement in pumping unit bookings in part to greater rig efficiencies, as well as orders for 2013 projects being placed late in 2012, or a little earlier than we expected them.

Also, bookings totaled $245 million for the fourth quarter and U.S. orders accounted for 65% of that. We ended the year with an Oilfield backlog of $223.7 million, which was up 36% from the year end 2011.

Oilfield Division revenues were up 2.2% sequentially in Q4. The following areas is accounted for both of the increase. First, U.S. automation business was up $3.4 million for 10.6%; Romania which contributed $9.4 million in the quarter is the second factor; thirdly Quinn, which was a $5.7 million sequentially, or 13.3%; and finally Argentina, which was up $3 million or 11.3% sequentially.

After weathering the negative impact of labor and risk on deliveries in the first three quarters of the 2012, Argentina experienced minimal disruptions in Q4. These sequential revenue increases were partly offset by weaker North American sales in three areas. First US pumping unit sales were up by $2.3 million or 2.3%; pumping unit sales in Canada were also weaker but offset by higher automation sales into that country; hydraulic lift was impacted as I mentioned previously by a project in Mexico that should be resolved in Q2 of 2013.

US pumping unit service revenues were up by $650,000 or 2.8% and Zenith, our down hold technology data acquisition was up $3.1 million up 21.4% sequentially because of projects in Venezuela and China being delayed into 2013.

A portion of the fourth quarter sales in Romania was automation product. That coupled with strong automation performance in the U.S., Canada which I referred to previously, and Latin America underscores the ongoing shift by our customers to employ technology to deliver greater value and efficiency in artificial life production. As I cited in my full year overview, we have solved a lot of the productivity and sourcing issues in our Oilfield division, manufacturing facilities and those are the items that really impacted margins earlier in the year.

Excluding the impact of inventory adjustments that Chris will touch on in more detail in a moment, Oilfield’s overall gross margin improved sequentially by 150 basis points and 230 basis points versus a year ago and Chris will sharpen the focus a little bit more on that number when he talks about the pumping and manufacturing in just a second.

But this reflects the combination of better manufacturing performance and the continuing shift in the product mix to large unit sizes. That said, we believe we still have significant opportunities for additional productivity and efficiency gains in our U.S. Oilfield manufacturing operation that will drive further improvements in our operating margins.

Again, we are not counting on pricing improvements to help us much this year, but we are confident that we can achieve additional margin gains through continued operational improvements and through the continued focus on people and processes.

Looking now at power transmission division in the fourth quarter, we realized significant improvements in our manufacturing operations both in the U.S. and Europe. Those improvements combined with the better product mix help to increase margin sequentially by 670 basis points to 21.5%. Margins were still below year ago levels and are also well below where we wanted to be. Power transmission is focusing on project pricing, project cost management and sharp execution as the key sources for margin improvement going into this year.

Our Q4 bookings in power transmission totaled $44.3 million, up from $43.1 million in the fourth quarter of 2011, but down sequentially from $48.2 million in Q3 due to the timing of order placements for oil and gas infrastructure projects that split into 2013. And as we’ve mentioned in the past, this was a very lumpy business with unpredictable schedules for booking some of these large projects.

Energy related projects continue to lead the new book business booked. Oil and gas projects accounted for one third of the new business, petrochemical and refining represented 24%, and power generation contributed 11%. Sales from these energy sectors typically carried better margins than the more general industrial markets. We expect these sectors to remain active sources for new business during 2013.

Lufkin France delivered strong sequential growth in bookings, up 18% quarter-on-quarter. Revenues from our French operation also came in well ahead of forecast. For the full year, energy related bookings and power transmission were 63% of the total $198 million. Oil and gas represented 38% of the total bookings, power generation contributed 12%, petrochemical accounted for 10% and refining 3%.

We ended 2012 with a PT backlog of almost $100 billion, which was down about 7% from the end of 2011. PC revenues for the fourth quarter totaled $59.3 million, which was up 17% sequentially and up just ahead from a year ago. But the sequential and year-on-year revenue increases were led by international and Canadian jobs in the oil and gas and power generation sectors.

Chris will now walk you through the fourth quarter financial results in more detail.

Christopher L. Boone

Thanks Jay and good morning everyone. As usual, I will begin with a recap of our financial results for the quarter ended December 31, 2012 then I will cover key expense items for the quarter and our expectations for the first quarter and full year.

On an adjusted basis, fourth quarter net earnings were $29.5 million or $0.87 per share. On a non-adjusted basis net earnings in the fourth quarter were $25.4 million, or $0.75 per diluted share. The adjusted net earnings exclude the $0.07 negative impact of legal and settlement costs of our previously disclosed intellectual property case. The $0.06 negative impact of year-end inventory adjustments at our U.S. pumping unit factory that arose during our 2012 ERP conversions and the $0.01 positive tax impact from the final review of acquisition costs, that compared with adjusted net earnings of $24.6 million, or $0.80 per share for the same period last year.

The adjusted figure last year excluded the impact of a $0.13 per share charge for acquisition-related expenses and litigation expenses related to the class action lawsuit. Consolidated revenues were $355.7 million, which is an increase of 27% from a year ago and up 5% sequentially. Consolidated adjusted gross margin on the fourth quarter was 25.3% of revenues, which was up from 24.9% a year ago and up significantly from the 23.3% gross margin in the third quarter.

Consolidated operating income was $46.7 million in the fourth quarter, up 18.8% from the prior year quarter and 10.4% sequentially on an adjusted basis. EBITDA was $57.8 million, or 16.2% of revenue in the fourth quarter, up 25.6% from the prior year’s fourth quarter and up 10% sequentially on an adjusted basis. Looking at fourth quarter financial results by division starting with Oilfield; Oilfield revenues totaled $296.4 million, which was up 35% from a year ago and up 2% from the prior quarter.

Oilfield operating income was $44.8 million, which was up 38.3% from a year ago and up 3.2% from the previous quarter again on adjusted basis. Bringing fourth quarter Oilfield revenue down by product line, Rod lift pumping unit sales totaled $132.7 million, which was up 9.2% versus the fourth quarter of 2011. Automation contributed $62.7 million, which was up 70.7% from a year ago. Acquisitions we made early – 2012 accounted for about $12.1 million or about $0.5 million of the year-over-year increase.

Pumping unit service generated $38.4 million of Oilfield revenue, up 12.5% from a year ago. Gas and plunger lift sales represented $11.3 million of total Oilfield revenue, which was up 14% from the fourth quarter last year. Foundry contributed $2.8 million, which was down 44.2% from a year ago, which reflects the shifting of available capacity to internal needs. And Quinn’s contributed $48.5 million to the quarter versus $13.1 million a year ago. We purchase Quinn’s in December of 2011, so the year-over-year comparison is not relevant.

On a sequential basis, new rod lift pumping unit sales were down 4.4%. Automation sales were up 10.2%. Pumping unit service revenues increased 5.8%. Gas and plunger lift sales declined 3.9%. Foundry revenues declined 18.1%. And Quinn’s revenue increased 13.3%.

Oilfield gross margin before the inventory adjustment was 26.1%, up from 24% a year ago and from 24.7% at the third quarter on an adjusted basis. Lower field service utilization due to the industry slowdown, cost is about one point of gross margin in the fourth quarter. The U.S. pumping unit gross margin improved by over three points sequentially, excluding the inventory adjustment. That gives us the higher confidence in our second half margin expectations.

For the first quarter of 2013, we expect the Oilfield gross margin to be in the range of 23% to 24%. This sequential decline is related to the Romanian startup costs, the mix effect of lower automation sales and the impact of lower utilization on North American manufacturing and service operations from the slow start of the year. We expect margins to improve in the second quarter with gross margins in the high 20% range in the second half of 2013.

Turning now to Power Transmission, PT sales totaled $59.3 million, which was up 1% from a year ago, and up 18% versus the third quarter. Operating income from Power Transmission was $5.1 million versus $7 million a year-ago and negative $1.2 million in the third quarter, on an adjusted basis.

Looking at PT revenue break-down by products, new units represented $40.3 million of revenue, this was down 8.9% from a year-ago, but up 8.1% versus Q3. Repair had a strong fourth quarter generating $16.5 million of revenue, which was up $27.6 million from a year-ago, and up 49% sequentially. Bearings contributed $2.4 million, up 45% from a year-ago and up 21% versus the third quarter.

Gross margin for Power Transmission was 21.5% versus 28.5% a year-ago and 14.8% in the prior quarter. For the first quarter of 2013, we expect gross margins on the 20% to 22% range. Gross margins in the first quarter will be impacted by the traditional lower manufacture activity levels that we see. For the full year, we expect gross margins to improve to around the mid 20% range.

Looking at key individual expense items in the fourth quarter, selling, general and administrative expenses excluding the impact of special items increased $43.3 million, and as a percent of sales SG&A was 12.2% versus 10.8% for the prior quarter. We expect SG&A to be in the range of $43 million to $45 million in the first quarter and a $185 million to $195 million for the full year.

Depreciation and amortization was $11.7 million versus $6.9 million a year ago, and $10.7 million in the third quarter. We expect first quarter D&A to be in the range of $12 million to $13 million we start picking up depreciation on the Romanian plant. For the full year we expect about $50 million of D&A.

Interest and other expense in Q4 was up slightly versus the prior quarter at approximately $3.6 million. It should average around $3 million per quarter at 2013 before they get packed of any currency swings. Capital expenditures in the fourth quarter were $24 million, this brought total year CapEx to $85 million.

As of December 31, we had a $302 million term loan outstanding and $25 drawn on our revolving credit facility, plus letters of credit of $10.4 million leaving a $139.6 million available under our credit facility at the end of the year. We paid dividends of $4.2 million or $0.125 per share during the fourth quarter.

Our net effective tax rate for the fourth quarter was 31% excluding the adjustment on acquisition expenses. This lower rate resulted from our full year tax rate excluding the impact of acquisition expense coming in at 33.2% versus the prior estimate of 34%. We believe 34% is still a good modeling rate for 2013 on the core tax rate. The first quarter tax rate though should get a one time benefit of the 2012 R&D tax credit that was retroactively enacted at January, but will not be reflected into the first quarter.

That concludes the financial overview, so I’ll turn it back to you Jay.

John F. Glick

Thanks, Chris. Before we go to your questions I would like to briefly cover our outlook for the first quarter and the full year and provide additional revenue and EPS guidance for the quarter and year. I will close with our CapEx spending plans for 2013.

Looking ahead to 2013 in oilfield, we expect revenue to slow in Q1, primarily due to the slow pace of restarting North American field activity following to slowdown experience in Q4. Based on feedback from our customers, we expect to see a sequential increase in revenues throughout the year driven by continued strength in the Bakken, Eagle Ford, West Texas and a recovering California.

We expect international markets to gain momentum as we go through the year with Latin America, the Arabian Gulf and North Africa leading the way. In particular, Oman, Kuwait, Libya, we hope Egypt, Bahrain and Mexico should be source of the growth along with Colombia and Venezuela. We believe Argentina will be somewhat less volatile in 2013 than it was last year given (inaudible) emphasis on increased production coupled with the improved oil price agreements between the government and oil companies operating in Argentina, but I would caution that Argentina is always a wild card.

As I mentioned earlier, we expect Romanian production to ramp up steadily from the start of the year through the end of the year. While we will probably see limited production in Q1, production of complete units can commence after the API licenses in place in March. Start-up costs and the low utilization impact to Q1 results, as Chris just mentioned, as we train workers, [put] machines and then also with the higher depreciation levels there.

We’re currently forecasting revenues of $50 million to $60 million from the Romanian facility in 2013 with that figure growing to $70 million to $80 million next year. Once the factory is fully staffed and the workers were trained, we expect a run rate of around $100 million a year from Romania.

I want to deal with the bookings topic here for just a moment. And as I do so I want to point out that in addition to the $323 million that we reflect in our backlog, we had on the books at the end of December another $91 million and call off orders that will be delivered over the next one to two years, but they’re not shown in our backlog number. We’ve conservatively elected not to recognize these numbers in our financial backlog because of uncertainties on the timing of the products and the services. In most cases, we recognized only the portion of those call-off orders that represent one quarter’s worth of business in front of us. So I think that’s an important note.

These contracts are largely for North America and international customers and they represent a very strong, stable slate of business that will underpin a portion of our new business bookings several years out. The practice of initiating long-term call-off contracts is growing, particularly in the Eastern Hemisphere.

For 2013, we expect margins to benefit from continued improvement and execution along with a better mix of higher margin products. Margin improvements through pricing represent upside of the guidance we’re giving. In Power Transmission, we expect modest revenue growth, the continued improvements in manufacturing performance and should drive a stronger bottom line contributions from power transmission. Upside opportunities exist for products and services offered in our active market refining in petrochemical sectors.

This morning in our earnings release, we provided initial fiscal 2000 year revenue guidance of $1.4 billion to $1.45 billion as a range, and EPS guidance in the range of $3.50 to $3.80 per diluted share for the full year. Our guidance again assumes very limited pricing for material cost changes.

For the first quarter, we expect revenues in the range of $295 million to $305 million, and in earnings in the range of $0.40 to $0.50 per diluted share. In addition, our Board of Directors has approved that $87 million capital spending plan for 2013, with the Romania plant nearing completion there are really no material CapEx amount allocated for Romania. The big ticket items for this year include the installation of our chrome plating facility and our Quinn’s operation in Canada to expand capacity there and the addition of a new high-speed test band in our Lufkin France operation. CapEx plans are also in place for several smaller machine tool additions that target debottlenecking capacity constraints and manufacturing areas of our factories.

In summary, we continued to be very encouraged by the opportunities we see in 2013 in both divisions particularly on the oilfield side. The current oil price environment that should support strong levels of drilling both in the U.S., shale and in most international oil provinces around the world are in place, we view the revised short-term energy outlook released by two days ago by the EIA, as additional confirmation, the growing global demand for oil will support solid fundamentals to our industry. For those of you that didn’t see that I think they increased the demand forecast by about 1 million barrels a day for 2013 and 1.4 million barrels a day for 2014.

In addition to that recent surveys indicate that global E&P spending is expected to increase about 10% this year, and international spending is expected to increase about 13%. We think the ongoing weakness of the U.S. natural gas prices may affect drive more spending abroad as people seek better returns on their investments. And that would be a strong positive for existing operations in France as well as our new operations in Romania.

Now with that operator we will take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is from the line of Robin Schumacher with Citi. Please go ahead.

Robin Schumacher – Citigroup

Thank you, Jay. Good morning.

John F. Glick

Good morning, Robin.

Robin Schumacher – Citigroup

In terms of what you are seeing here in the first six weeks of the first quarter that contrasted with the fourth quarter, is there any change, or is the sequential improvement through the year, really kind of based on rising rig count, or other factors, so in another words, it just any change in terms of the order inflow here in the first quarter versus the slowdown you saw on the fourth?

John F. Glick

Yeah, I think what has surprised us a little bit as we put our forecast together was the extent to which the slowdown began to impact us in the late Q4, and the overhang of slow activity is we went into January and even into early February. And it really takes a number of forms, but service work has been slow particularly with certain large customers we’ve done work with.

Our automation products have slowdown a little bit as one of our major customers in the Eagle Ford has been very slow and restarting activities. So it’s generally associated with just the short downtrend we saw in Q4, and people being very gradual and deliberate about startup. We can all speculate on reasons for the slowdown, but I think a lot of it has to do just uncertainty about access and other things in the marketplace.

Robin Schumacher – Citigroup

Okay. And then in just where are we in terms of, you’ve basically doubled your hourly workforce last year, and in terms of the efficiency of all that increase in capacity relative to this current slowdown. Is that impacting margins, I mean is there a little bit of an under absorption issue now?

John F. Glick

Yes, utilization issues were a problem and will be a problem in parts of PT and for that matter, in parts of Oilfield during this quarter as things have slowed. But I think there are two things I would point to, one the sequential improvement in power transmission was really driven by in large major manufacturing performance improvements that they have made and we're just kind of. Sitting at tip of the ice berg of what they can. So, we’re so we are encouraged by the incremental improvements, but we this we serve a running room to make those – say, improve those numbers even more particularly on the productivity side. Likewise, Chris alluded to the fact that we had a 3 point margin gain attributable to manufacturing performance improvements in our pumping unit business in Lufkin, the operation we refer to is the Buck Creek operation, and that's encouraging but we still again are below levels that we all believe we can achieve later in the year. So I guess from a credibility point of view we are encouraged by what we're seeing in the impact it’s side of the numbers but in a practical sense we have very well defined plans autoyield, more improvement as we go into FY2013.

Robin Schumacher – Citigroup

Okay and then, the SAP implementation and the functioning of the SAP across the company in terms of production in inventories. I think you still have some work together but how close are you to having that. Implementation and functioning of SIP across the company in terms of production and SIP. I think you still have some work to do there but how close are you to having that, where you need it to be?

John F. Glick

Yes that's a good question, let me see if I can kind of characterize some of the aspects of SAP briefly, the filed a lawsuit against IBM, or Bosch, what we perceived to be a botched implementation. So I want to be a little more guarded than how much detail we go into, but let me start by saying that we really have SAP installed and running our North American operations, the legacy lost in part of Canada, Quinn is not in SAP nor is Pentagon, but the legacy lost in Canada operation is in, the U.S. operation for Lufkin is under SAP, and we have Romania up and running on SAP.

I would characterize the current situation is we are able to operate all of our core businesses and we’re getting some improvements in reporting capabilities. We’ve corrected a number of errors over the summer and into the fall that were really complicating life and we’ve also corrected and created a report that allow monitoring of manufacturing performance and increasingly allow us to monitor spending at a more detailed level.

So we’re making headway, we can see through some of the resources, we’ve added that there is still great white-collar efficiencies to be gained. There is a lot of knowledge that we can get once we can accumulate and consolidate data little more quickly but SAP continues to be an issue that is sub optimal in terms of our ability to do the things that we could do prior to the implementation.

We’ve gained a lot – I think we’re operationally getting very close to getting back to where we were but it has been a long slog.

Robin Schumacher – Citigroup

Okay, well thanks a lot, Jake.

John F. Glick

Okay Robert.

Operator

Thank you. Our next question is from the line of Collin Gerry with Raymond James. Please go ahead.

Collin Gerry – Raymond James & Associates, Inc.

Good morning guys.

John F. Glick

Hey, good morning, Collin. How are you?

Collin Gerry – Raymond James & Associates, Inc.

I am doing well. I was thinking about your customer base and I was having a conversation with E&P guys. It seems that coming out of nape and a lot of these E&P conference and what’s going on the marketplace right now? The 2013 is really shaping out to be the year, the Permian, if we take the last couple of years with the Bakken and the Eagle Ford, I mean the Permian just going (inaudible)?

John F. Glick

Yeah.

Collin Gerry – Raymond James & Associates, Inc.

Talk to me about how that affects your business. I mean is your market share is as strong in the Permian as it was in the Bakken or is it the same size pumps? I know historically the larger pumps are typically the higher margin, I think to the same side as well, so I don’t know why they won’t be the same side pumps. But just, is there any new ones to your business from a Permian Basin markets?

John F. Glick

Yeah. I think if you exactly share, which of our customers you might have been talking to, but one of the things we’re noticing as we extend contracts and work with our service teams in the Permian is that, Permian is the production is moving into areas that are requiring larger units, more service intensive as more horizontal work as you well know going on in the Permian now and our key customers there are all participating in that.

To the extent that technology comes into play that well costs go up and the risk aversion increases, that all plays into the reliability and value arguments as we sell products. So I think that the movement in the Permian is really a positive for us, particularly with a couple of the major customers we have out there, where Permian differs a little bit from Bakken or Eagle Ford. There is greater abundance of small service companies to do service on installs and maintenance type activities. But again, on some of the sophisticated wells that are being developed there, I think there will be a preference for having higher reliability and higher quality of service delivered of those new wells that they come on stream.

Collin Gerry – Raymond James & Associates, Inc.

Okay, that’s interesting. The second part of my question is on the automation side. I’ve always thought of that is the huge differentiator for you guys and you guys have really made some acquisitions to even take it to the next level. And we’ve talked in the past that when you’re going to bring the new kind of next generation product to market, I think it’s late 2013 type event. Can you maybe give us some color as you take a step back and look bigger picture, what percentage of revenues would you like to see the automation business be as a percent of oilfield revenues?

John F. Glick

Yeah, I could see it be a lot bigger than it is. Well, we’re delighted with the rate of growth on that business. But clearly it is the part of the business that I think delivers the highest value to our customers. So we think everyone should use it. We think there’re a lot of things that we can add to the capabilities of our automation of products as we go forward that deliver increasingly more valuable sources of data and ultimately better production from these wells, have a longer reservoir life, all of which we’ve kind of talked about in the past.

Where we are right now? I should have had this call on Tuesday of next week and I’ve got a meeting in Houston on Monday with our automation team to get updated and they’re meeting this week in preparation for those discussions. But we know that our first generation product is out on test right now. It’s going well. As I said in the text, we expect to have that in service and take it to market in the second quarter of 2013. There is a next generation product, half of that that we have scheduled for later in the year. The first round of [IOL] incorporates some of the incorporates the new SCADA system that came with Datac, RealFlex.

That’s what we’re going to introduce in the second quarter, and what we’re feeling trailing right now. But the one that we’ll introduce later in the year, the next generation and this will probably be, mid-to-late fourth quarter incorporates some of those Zenith technology and the gauge feedback into the system.

So, we’re pleased with the progress we’re making. And that’s kind of the same schedule we’ve talked about since Zenith and Datac acquisitions were made. And I think the proof is going to be in the putting when those products have to seal.

Collin Gerry – Raymond James & Associates, Inc.

Maybe another way to ask that question. And then, that’s excellent color. That’s on the time table and much appreciated, but if I just look at the numbers, it looks like automation grew about 50% this year and like pumping units grew 25%. And I think those two big drivers of your business.

John F. Glick

Yeah. Yeah, that’s pretty close.

Collin Gerry – Raymond James & Associates, Inc.

And service is going to be bumping around, service is going to do its own thing, but of those two businesses, do you think that automation can continue to grow at twice the rate as the pumping unit business?

John F. Glick

I think for a period of time it can. There are two reasons, one there is always the upgrade opportunities on, right, installs that we’ve already made. Two, we put our automation on non-Lufkin units in some cases. Clearly, they don’t work as well when you do that. But, I mean the production doesn’t improve as much as it would have, it was on a Lufkin pumping unit, but we still have that market and then there is the big retrofit market that’s out there in addition to (inaudible) right now about 80% of what we do in automation. In North America, it is on new drills. Internationally that ratio is a little different.

And one other driver is as we see again, it’s migration over time from the traditional standard controller to the variable speed drive option, which began – the variable speed systems provide significantly better efficiencies, but there also a much higher revenue price per. So again the market shift over time to variable speed drive systems also helps drive quite a bit of revenue growth as well.

Collin Gerry – Raymond James & Associates, Inc.

Yeah, just to follow-up on that point, what percentage of the market do you think variable speed drive, or they are the only one who is doing, what percentage of your revenue is variable speed drive? Is it still very early or is that kind of in the 50-50 range, or is there?

John F. Glick

No, I think we’re still early, there are a lot of variable speed drives really introduced two or three years ago, there were some early adopters then. But it really is one of those technologies column where those people use it and particularly as they use it on some of the shale production where you may want to vary the rate significantly over time. The VSP is come into play in a big way.

Likewise, on heavy oil, where steam plugs going on and you are trying to work with different viscosities over the course of the – over the life of the well. The VSP allows you to bid some Rockwell mitigation things that again extend the life of the producing equipment pretty significantly by avoiding fore-set crashes into the rod string and that sort of thing.

Collin Gerry – Raymond James & Associates, Inc.

All right, guys. Thanks so much.

John F. Glick

Thanks, Collin.

Operator

Thank you. Our next question comes from the line of Jeff Tillery with Tudor, Pickering. Please go ahead.

Jeff Tillery – Tudor, Pickering, Holt & Co

Hi, good morning.

John F. Glick

Good morning, Jeff.

Jeff Tillery – Tudor, Pickering, Holt & Co

I was trying to think through they way you guys feel the kind of degree of optimism around the orders as we step through this year, you are kind of back on the way I’m thinking about it is Q1 revenues or I mean roughly in the ballpark of where orders were in the second half of last year? And then kind of the revenue guidance for the full year would imply more or like a 30% per quarter revenue exceeding. What bookings have been in the second half of last year? And so, I guess, is that drive with how you see the order expansion playing out here in the first and second quarter?

John F. Glick

Yeah, I guess one thing you need to think about is what we have talked about on the call-off orders, you need to factor that in, it rather than just going by a backlog because, or the rate of bookings because we’re not recognizing some of that in our bookings. So that’s the main reason we called out today is, it’s a piece of the puzzle what I think everyone needs to factor in. But yeah, we think that that the fundamentals in terms of demand have really not changed much for the full year, but we are seeing as I think a number of our competitors are seeing a very soft ending to 2012 and Q4 and for us that occurred really late in the quarter.

Jeff Tillery – Tudor, Pickering, Holt & Co

Okay.

John F. Glick

And then a very slow ramp back up. But we’re talking to people that are slow now. I don’t talk about our customers. They’re expect to us or stay ready because we don’t plan to be anchor down like this for very much longer.

Jeff Tillery – Tudor, Pickering, Holt & Co

And your order expectation is that different much in terms of that pace between North America and International?

John F. Glick

Yeah, I think we see international coming on stream, certainly second half of the year in a bigger way than it has probably because Romania will be in place. And also probably because we have a number of contracts that bids are out on that we expect to answers here fairly quickly too, which we thought we would have answers before in Q4 close and we are still kind of waiting. And then we think Latin America has the upside in 2013, but it didn’t have in 2012, so those are the big growth areas Eastern Hemisphere and Latin America.

Jeff Tillery – Tudor, Pickering, Holt & Co

And then kind of same question around power transmission, the last couple of times, we’ve seen backlog ended the year at this level, translated into more like a kind of $160 million, $170 million revenue in the forward year. Do we see more kind of quick book in turn type business in 2013, is that what allows you to think about revenues growing in 2013 there?

John F. Glick

The kind of book in turn opportunities we have in PT really are limited to aftermarket in parts business. The bearing business is reasonably quick turnaround. And then the other one would be some of the powergen businesses we can do fairly quick turns it’s a more standardized design. But I think really with power transmission, we are seeing as we started this year some of the projects that moved to the right firming up. But the real question in my mind is always, what is the outlook for some of these big refinery expansions, some of the petrochemical spending that we read about and then we are currently bidding on right now.

Is that going to materialize on our real short-term basis or is it going to be subject to a lot of cost analysis and bid delays or order placement delays. And I think we just don’t know enough about that, what we see in PT right now is that we think a flattish forecast is a conservative number to put out. We clearly see upside in oil and gas, we see big upside in petrochem, we see some upside in powergen, we’ve really traveled back on our expectations early in the year for power gen and that is one that as the year unfolds could materialize at a faster rate. GE have a contract that they announced a couple of weeks ago that would certainly use some of our load gears with their gas turbines. So those are the things that I guess would be short-term pipe items. But really, our forecast for (inaudible) is I think a fairly conservative one going forward.

Christopher L. Boone

And does it – most of your lease for new equipment, the first half is pretty much on the book. Obviously, the key is getting the bookings in the first quarter and the second quarter that will help the second half.

Jeff Tillery – Tudor, Pickering, Holt & Co

That makes sense. Just to circle back to one thing, Jay, on the – in the oil field, kind of these the booking – the know revenue that’s not booked in the backlog, that $90 million figure?

John F. Glick

Yes

Jeff Tillery – Tudor, Pickering, Holt & Co

How has that trended over the last six month of so? Is that $90 million kind of unusually high or has that been pretty flat?

John F. Glick

Well, it has ebbs and flows because of the size of some of these contracts. It is frankly – probably in the middle of fairway as to where it has been. But we clearly have big lumps from that and there are actually two big lumps that we’re about ready to book. So that number is going to go up significantly here in this quarter.

So to answer your question, Jeff, it’s really not a usually high number, not an unusually low number. It’s kind of in the middle, but it can vary between, I don’t know, 150, 180 and probably down to 35 to 40.

Christopher L. Boone

But just a number, we felt it’s kind of over the last few years it’s been a greater part of our business and it’s something we needed to do a better job disclosing just the way, again our conservative methodology of when we realize parts of the call off end of the backlog.

John F. Glick

Yeah, I think the real issue is that more and more customers seem to be moving to that and we haven’t changed our treatment of that, but the number of customers that are adopting that is the order method is gone up and it will go more as we continue to grow the business in the Eastern Hemisphere.

Operator

Thank you. Our next question is from the line of Blake Hutchinson with Howard Weil. Please go ahead.

Blake Hutchinson – Howard Weil, Inc.

Good morning.

John F. Glick

Good morning, Blake.

Blake Hutchinson – Howard Weil, Inc.

Just wanted to first test kind of some of the assumptions to make sure looking at this the right way in terms of your annual guidance, just doing the simple math wanted to clarify that you felt comfortable that by the back half of the year we will be approaching or exceeding a $400 million revenue run rate.

John F. Glick

Yes.

Blake Hutchinson – Howard Weil, Inc.

Okay, excellent. And then, Chris, your commentary and Jay’s as well with regard to that that improvement in the new equipment margins, does that suggest that during this period they were lagging margins and some of the other sub-segments that we should consider perhaps easier to gain improvements from over the year.

John F. Glick

Like I said, the field service side was probably the easiest, they have fairly fixed workforce in the short-term and so you get a pretty quick impact on that. When you have a revenue drop, you basically don’t see a lot of drop in your expenses, just what we saw and some parts of the fourth quarter and we were staying into the first quarter. So that’s when revenue picks back up, you kind of get an immediate margin boost back again.

Blake Hutchinson – Howard Weil, Inc.

Okay.

John F. Glick

Romania, as we’ve said, Romania had, again, we’re still in the ramp up. It was forecasted in the Q4 and we’ve been telling people, would be an impact of Q1 as well, but that again will improve as the year goes on. So those are probably the two big [one bet] on top of what we talked about as evidence we’ve seen of the improved execution at the U.S. facilities.

John F. Glick

Blake, were you really questioning the Q1 margin guidance or…

Blake Hutchinson – Howard Weil, Inc.

No, no. I was really just trying to get the improvement there on the new equipment order front in Q4, certainly impressive. I just wanted to, as we try to think about margin growth throughout the year that there are some places, there were lagers elsewhere that there should be some easy fixes, which help get some glimpse of why margin guidance is, I wouldn’t say, by any means in hand, but maybe easier to obtain.

John F. Glick

Yeah. I think one of the things that, I think we address a little bit in Q1 that one of the things that I think causes our guidance to be a little bit lower is the slower automation startup. So we’re missing – not missing, but we have a lower contribution coming in from that group and that’s purely on the basis of handful of customers who have slowed down a lot here in the first quarter. So we know that’s going to be an issue in terms of product mix, but again that dissipates or reverses as we go through the rest of the year.

Blake Hutchinson – Howard Weil, Inc.

Okay. And, if we start to get some new unit flow in Romania in the back half of the year, I mean, do we at some point catch-up to that being maybe not accretive, but at least in line with overall margins?

John F. Glick

Yes. Yes is the answer. And I think as we get the utilization up and as the volume of business through there increases that will be a positive.

Blake Hutchinson – Howard Weil, Inc.

Okay. And then just talking about this $91 million in extra bookings and just trying to decide for what that means, I guess you classified it mainly as an international phenomena, just to clarify, does this change the way that some of the major customers usually come in and put bulk orders are doing business in the U.S. as well and then maybe a commentary around just kind of where we are in terms of the channel to market right now. Do you feel that these type of customers are holding inventory or that your channel to market is relatively just in time right now and so when activity picks up, the order flow will in kind?

John F. Glick

Okay. Let me respond to both parts of that. Number one, there are a few customers who do this domestically and again they give us an order and we elect to treat it this way because just to mitigate the uncertainties associated with the call of arrangement. So we have a few U.S. customers, but I think our issue is – maybe my earlier reference on the international front is, it is done in a broader way internationally. So these big projects expand multi years for service, then install a length to the unit sale are typically a little more prevalent internationally, so that’s the first thing.

Secondly, I don’t think it really does affect the channel to market aspect, because normally they are doing this because they don’t want to hold the inventory and we work closely with them, because we don’t want to hold the inventory either. So we are really work in a call off arrangement constantly that being in tweaked and adjustment on timing. And that’s the reason we don’t like putting more than a quarter out in front of us, because we don’t want to have that timing disrupting our opportunity to sell into other areas if those opportunities arise and if we had the backlog clogged up with jobs that may or may not be timed correctly, it could get the way of our ability to “sell” to somebody that had an urgent need. So there are several reasons around why we do at the way we do it, but it is not kind of math in inventory in either their system or ours.

Operator

(Operator Instructions) Our next question is from the line of Neal Dingmann with SunTrust. Please go ahead.

Neal Dingmann – SunTrust Robinson Humphrey

Good morning, gentlemen.

John F. Glick

Hi, Neal.

Neal Dingmann – SunTrust Robinson Humphrey

Hi, great color today, just two quick ones and just you mentioned about the Quinn’s and Zenith and that the ramp that you’ve had or you’re not beginning to see. I’m wondering about or when you look at the OFS, what type of pricing pressure you’re still seeing kind of what I would call more in the core U.S. rod lift business?

John F. Glick

Yeah. I mean it is still there, Neal and we still have a pretty enormous gap between our price and our competitors’ price. I think the price gap we have today is really based on maybe as a perception of quality and service differences between the products and that sort of thing. And I hope over some longer period of time, prices will get more traction, but we have had that hope for a couple of years and I haven’t seen much evidence of it.

Neal Dingmann – SunTrust Robinson Humphrey

Right, right. and then the last thing, and you’ve talked a lot about the second part, just the ramp that you impressed, mentioned kind of in the guidance expectations, I guess besides the $90 million that’s out there and a lot. What bookings and backlog you mentioned kind of the – I guess the revenue you’re certainly at least in the first half around that, you’re obviously expecting a pretty healthy ramp despite backlog and bookings being down a little bit sequentially. Just one, the confidence sounds like is kind of broad, it is more PT backend, is that – am I understanding that right Jay or may be just a little color on …

John F. Glick

Yeah

Neal Dingmann – SunTrust Robinson Humphrey

…why you have the certainty on that despite that bookings backlog down a little?

John F. Glick

Sure let me, kind of name off the items that I think will support that. One is we talk about Romania. Romania continues to ramp throughout the year. Secondly, the Chrome Shop expansion that Quinn gives us more capacity to make more down-hole pumps. So, again the second half of the year that should be open in late Q3, that should really expand our capabilities out of Quinn.

Thirdly, we’ve got I think a lot of upsides still on automation, both our core automation product as well as the Zenith product. So, it’s really those three areas, and then just general you know increase in demand for rod lift as North American drilling operations become more productive, more pad drilling. I think the numbers of pumping units that would be set for drilling rig operating, it will go up.

Neal Dingmann – SunTrust Robinson Humphrey

Got it, got it. That’s a great color. Thank you guys in excellent quarter.

John F. Glick

Okay. Thanks, Leo.

Operator

Thank you and we have no further questions at this time. I will turn it back to management for any closing remarks.

John F. Glick

Okay. We appreciate everyone’s attention today, and all the interest from the call. We look forward to speaking with everyone at the end of Q2. Thanks – Q1, thanks very much. Bye.

Operator

Ladies and gentlemen this concludes the Lufkin Industries’ fourth quarter earnings conference call. Information about the replay of this conference can be found in this morning’s news release. Thank you for your participation. You may now disconnect.

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