Lufkin Industries, Inc., Q1 2008 Earnings Call Transcript

Lufkin Industries, Inc. (LUFK)

Q1 2008 Earnings Call

April 16, 2008 10:00 am ET

Executives

Jay F. Glick - President and Chief Executive Officer

Bob Leslie - Vice President, Treasurer and Chief Finical Officer

Chris Boone - Corporate Controller and CFO Designee

Analysts

Collin Gerry - Raymond James

Byron Pope - Tudor, Pickering, Holt

Michael Cohen - C. K. Cooper

Presentation

Operator

Good day and welcome to the Lufkin Industries Conference Call. Today's call is being recorded. At this time for opening remarks and introduction, I'd like to turn the call over to President and Chief Executive Officer, Mr. Jay Glick. Please go ahead, sir.

Jay Glick - President and Chief Executive Officer

Thank you, Melissa, and good morning. Welcome to the Lufkin Industries' first quarter conference call for the period ending March 31, 2008. With me this morning are Bob Leslie, Vice President, Treasurer and Chief Finical Officer; and Chris Boone, Corporate Controller and CFO Designee. After my remarks, Chris will provide you with more details on our finical results. Following that, we will respond to any specific questions you may have.

I would like to first read our Safe Harbor language. The conference call today may contain certain forward-looking statements, including, by way of illustration and not of limitation, statements relating to liquidity, revenues and expenses and margins. The Company strongly encourages listeners to note that some or all of these assumptions, upon which such forward-looking statements are based, are beyond the Company's ability to control or estimate precisely, and may in some cases be subject to rapid and material changes.

As stated in today's press release, Lufkin Industries had a net income of $15.6 million or $1.06 per diluted share for the first quarter of 2008. This compares to 17.8 million or $1.17 per diluted share for the first quarter of 2007.

First quarter 2008 results included a $0.05 per diluted share gain related to the LIFO gains from our run-out on the Trailer inventories as that business has ramped down. These gains were not included in our guidance for the first quarter earnings per share in the range of $0.90 to $1.

Our first quarter results provided a very solid start to 2008. The pace of new orders received in our core Oil Field and Power Transmission divisions was up 19% over the last year's average quarterly rate. More significant was a relative strength of the US market for our oilfield equipment, which I will address in more detail a bit later.

As we did last quarter, for ease of comparison, it's best to exclude the Trailer division in year-on–year comparisons. Looking at Quarter One performance on that basis less Trailer, revenues were up year-on-year from 135 million in Q1 2007 to 141 million in Q1 2008 or an increase of 4.4%. Overall, backlog grew 16.4% sequentially and 32.8% on a comparable quarter basis to 235.7 million on the strength of improved bookings in both Power Transmission and Oil Field divisions. Adjusting for trailer, the comparable quarter increase is 45.2%.

Cash generation in the company was on plan for the quarter and we are well positioned to fund our capital projects and pursue attractive acquisitions. Chris Boon will elaborate on the company's cash position in his remarks.

We're pleased with the first quarter results. The rate at which we booked new orders was very encouraging in both Oil Field and Power Transmission. I will address those divisions in more detail momentarily, but first I want to address the status of our Trailer division and our efforts to complete orders, redeploy resources including critical personnel from that division to other divisions that can immediately utilize them and ultimately the status on our efforts to close that operation.

Thanks to the excellent work on the part of the management team and our trailer workforce, the process has run very smoothly with progress slightly ahead of schedule. While we have not fully completed the wind-down of the division, our confidence level that this action will improve the company's finical performance has increased.

Let me turn to the Power Transmission division. New orders totaled $55.6 million in Quarter One, up sequentially from 45.4 million and 41.6 million in comparable period '07. We continue to see strong demand from our energy markets comprised of oil and gas, refining, petrochemical and power generation. In addition, demand for marine gears continues to grow driven by the surge in offshore supply boat construction and new construction for the inland-waterway barge tugs.

Our order book in Power Transmission stands at $138 million, up 12% sequentially from 122 million and up 34% on a comparable quarter basis. The challenges facing this division really relate to the need to rapidly increase production in order to stay ahead of our customers' demands.

The capital projects that have been commissioned during the past two years will be critical to this effort. We continue to upgrade capacity through targeted capital investment and the application of lean production techniques to improve productivity as well as product and service quality.

Moving now to our Oil Field Division, I am pleased to report that demand for Lufkin’s oilfield products and services was up from Quarter 4, which is normally our strongest quarter. New orders rose from 119 million to $121 million sequentially with comparable period growth of 31%. Particularly encouraging was a 67% sequential growth in US bookings. Of the new orders received in the oilfield division during the quarter, 74% are to be installed in the United States. This increase in US bookings is due to three factors: first of all, higher capital spending in artificial lift. Secondly, a return of a few customers who were on the sidelines during Q2 and Q3 of 2007. And thirdly, the return of some customers who have been - who have recalibrated the price value proposition after less than satisfactory reliability and service experiences with alternative suppliers.

Bookings from Canada continue weak, down slightly from the rate we saw during 2007. I would point out that Canada represents less than 3.5% of our oilfield booking. So we are not particularly exposed in that market.

As we look ahead to other international markets, we have a number of projects currently under bid, which we expect to result in orders during Q2 and Q3 in both Latin America and the Eastern Hemisphere. Consequently, we see future quarters returning to a more balanced 60/40 split between US and international bookings.

As pleased as we are with the success we enjoyed in the United States during Q1, it in no way alters our belief, but our longer-term focus on international markets is critical to supplementing our strong domestic position.

As a result of the Q1 bookings, the oilfield division backlog increased 26% sequentially to $97 million. This follows an increase in Q4 '07 of 20%. Therefore, as we enter Quarter 2, we are positioned to ramp up our shipments of oilfield products. As with Power Transmission, focus throughout the Oilfield division is on bringing on new capital assets into production and implementing lean production practices to improve productivity and product quality.

Overall, the company began the year as we expected with strong core markets and improving operational performance. Based on the strength of our order book together with the projects we see on the horizon, our view for 2008 is for continued top line growth in both oilfield and power transmission. We continue to keep a watchful eye on the US and global economic outlooks and their potential to impact the drivers of energy, supply and demand that determine the ultimate market demand for our products as well as the global commodity prices on critical raw materials used in these products.

We will also follow closely the global commodity prices on critical raw materials used in our products, particularly steel prices, which has shown significant price volatility in recent months, and take the necessary step to protect our margins from the effects of inflation on those commodity prices.

Barring any sudden dislocation in any of these areas, we are providing guidance for Quarter 2 earnings in the range of $1.30 to $1.40 per diluted share, reflecting the favorable impact of increased revenues as a result of our increased order intake and the attended increase in manufacturing activity.

In addition, we have raised our guidance for the full year 2008 for earnings in the range of $5.10 to $5.30 per diluted share.

Chris Boone will now provide a more detailed explanation of Lufkin’s financial performance during the quarter.

Chris Boone - Corporate Controller and CFO Designee

Thank you, Jay. Good morning to all conference call participants. Thank you for your interest in Lufkin Industries.

As Jay indicated, net income in the first quarter of 2008 was 15.6 million or $1.06 per diluted share. This compares to the reported net income of the first quarter of 2007 of 17.8 million or $1.17 per diluted share, and reported net income of the fourth quarter of 2007 of 19.8 million or $1.34 per diluted share. The net income of the first quarter of 2008 includes a $0.05 per diluted share net benefit from the liquidation of LIFO reserves associated with the Trailer run-out.

First quarter 2008 revenues were 147 million, down 1.1 million or 0.7% from the first quarter 2007 level of 148.1 million. Continued growth in Power Transmission offset expected decline from trailer revenue.

Oilfield revenues were basically flat at 100.9 million for the first quarter of 2008, down 400,000 or 0.4% from the first quarter of 2007. The breakdown of this change is: new unit revenue of 55.7 million, down 3 million or 5.1% primarily from lower North American demand offsetting international growth as compared to the first quarter 2007 levels; service revenue of 21 million, up 1.9 million or 5.8% from growth in the US market; automation revenue was 18.4 million, up 4.2 million or 29.1% from growth in international sales; and commercial casting revenue of 5.9 million, down 2.6 million or 31.3% from lower sales to the machine tool market.

On a sequential basis, oilfield revenue was down 5.4 million or 5.1%. The breakdown of this change is: new unit revenue down 6.1 million or 9.9% primarily from lower Canadian demand and the timing of certain international shipments; service down 400,000 or 2.1% from normal seasonal weather issues in the US; automation revenue up 1.7 million or 10.3% from the same growth in international sales; and commercial casting revenue down 500,000 or 8.3% again from lower sales to the machine tool market.

Power Transmission revenue was up to 40.2 million for the first quarter of 2008, up 6.5 million or 19.2% compared to the first quarter of 2007. The breakdown of this change is: new unit revenue of 31.5 million, up 5.9 million or 23% from increased high-speed units for the oil and gas markets and increased marine units; repair and service revenue up 8.6 million or 600,000 or 7.1%.

On a sequential basis, Power Transmission revenue was down 3.3 million or 7.6%. The breakdown of this change is: new unit revenue down 1.7 million or 5.1%, primarily from shipment delays pushing revenue into the second quarter of 2008; and repair and service revenue down 1.6 million or 15.6% from the non-recurrence of holiday shutdown service work and the timing of certain repair bookings.

Trailer revenue was 5.9 million for the first quarter of 2008, down 7.2 million or 54.6% as compared to the first quarter of 2007, and was down 2 million or 25.4% on a sequential basis. This expected decline is the direct result of the January 2008 decision to suspend operations of this segment and develop a plan to cease operations. This process should generally be complete during the second quarter of 2008, which will then trigger discontinued operation accounting.

The total gross margin for the first quarter of 2008 was 28.1%, up from 27% in the first quarter of 2007 and flat on a sequential basis. Without the benefit of the Trailer net LIFO reserve liquidations, gross margin in the first quarter of 2008 would have been 27.3%.

Gross margin in oilfield was 28% in the first quarter of 2008, compared to 27.6% in the first quarter of 2007, and 27.8% in the first quarter of 2007. Gross margin in the Power Transmission was 30.3% in the first quarter of 2008, compared to 33.3% in the first quarter of 2007, and 31.4% in the fourth quarter of 2007. This decline in Power Transmission is primarily from the unfavorable mix effect of increased marine unit sales, higher steel prices, and inefficiencies associated with the training of transferred Trailer employees.

Gross margin in Trailer was 15.8% in the first quarter of 2008, benefiting from a net $1.2 million LIFO reserve reduction.

First quarter 2008 SG&A expenses increased to 17.5 million, up 3 million or 20.5% from the first quarter of 2007 level of 14.5 million. On a sequential basis, SG&A expenses increased 1.7 million or 11%. This increase was related to increased foreign sales commissions, trailer-related general liability claims and legal expenses, higher personnel-related expenses in support of current and future operating levels, and certain incremental cost associated with management changes. The quarterly run rate of SG&A expenses for the remainder of 2008 is expected to average approximately $16 million. As a percent of revenue, first quarter 2008 SG&A expenses were 11.9% compared to 9.8% in the first quarter of 2007 and 10% in the fourth quarter of 2007.

EBITDA in the first quarter of 2008 was 28 million or 19.1% of revenue as compared to 29.7 million or 20% in the first quarter of 2007 and 34.2 million or 21.7% in the fourth quarter of 2007. Depreciation and amortization in the first quarter of 2008 was 3.9 million and is expected to continue at this approximate rate during the balance of 2008.

The company ended the quarter with $103.3 million in cash and cash equivalents as compared to $95.8 million in December 1, 2007, up 7.5 million. Growth in inventory levels in Power Transmission due to product shipment delays was offset by the benefit of the timing of US federal estimated tax payments.

Capital expenditures in the first quarter of 2008 were 4.9 million. Several major capital projects have recently been approved or are expected to be approved in the next month. The company is in the process of reviewing the timing of cash expenditures for planned capital spending, but is still expected to spend in the $40 million range during 2008.

Also, during the first quarter of 2008, the company paid dividends of $3.7 million or $0.25 per share versus $0.02 per share or 8.7% increase over the fourth quarter 2007 dividend level. Additionally, the company repurchased 20,000 shares of its common stock for 1.1 million. Repurchase authorizations of 3.5 million remained as of March 31, 2008. The company ended the first quarter of 2008 with no short- or long-term debt and continues to have in place a $40 million credit facility with JPMorgan Chase that is scheduled to retire on December 31, 2010.

This concludes the financial overview for the first quarter of 2008 and I would like to turn it back to Jay.

Jay Glick - President and Chief Executive Officer

Thanks Chris. Thank you for your interest in Lufkin Industries and your participation today.

Before we close and turn it to questions, I would like to recognize the fact that this is Bob Leslie’s last conference call. He retires next month and he has been sitting here uncharacteristically mute for the last 20 minutes or so. I want to publicly recognize the great work that Bob has done during his time at Lufkin Industries, not only on these conference calls, but the professional leadership he has provided to the company during his 15-year tenure. Participants may want to contact Bob later regarding lining up golf dates rather than using question time for that, but I will trust the groups’ discretion and will turn it back to Melissa.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And, we will go first to Collin Gerry with Raymond James.

Collin Gerry

Guys, are you there?

Jay F. Glick

Yes, we are.

Collin Gerry

Okay, sorry. Yeah, thank you. Good morning and I will let go Jay's sentiment as far as congratulating Bob. Looks like you are going out on a good note. I don't know how good of a sign it is if your stock is up 11% on the day that you are actually, you know, this is your last conference call, you can take that may be two ways. So we will take it at the positive side.

Bob Leslie

We will take it positive as well.

Collin Gerry

Yeah, alright. Getting into the details on the revenue breakdown and you all gave us a lot of detail there and maybe I miss this. On the oilfield side, could you just kind of give us for the quarter what was the international and what was the US component. I know you did it kind of went through the service and automation side, but I am thinking more just regionally?

Chris Boon

Just for the overall breakdown in oilfield, it was about 32% international and that's for all product lines.

Collin Gerry

That's for all product lines. Okay. And do you have handy the -- on just the oilfield side or maybe we could followup after offline?

Chris Boon

Yes, the oilfield product, I mean that included service and automation.

Collin Gerry

Okay.

Bob Leslie

Those numbers were just oilfield.

Collin Gerry

Okay, perfect. Alright. So, the big story I guess for the quarter is the backlog surged to a pretty good spike on oilfield side. Two questions there. #1. How does that run rate kind of go out? I mean, is this mostly stuff going to be delivered in the second quarter and the third quarter? I know historically kind of [you all's] competitive advantage has been on the timing side. Has there been any kind of shift there as far as taking on a little bit more orders or a little bit more duration, kind of just walk us through that dynamic?

Jay F. Glick

I think you are safe in your statement that it's mainly going to shift in Quarter Two and Three. I think we may have had a couple of orders that stretch in the Quarter Four, but we are heavily weighted in Q2 and 3 in oilfield. And there has been no change really Collin in our quick turnaround capabilities or anything like that.

Collin Gerry

Okay. Kind of along those lines, we kind of get anecdotes from the field every once in a while about seeing some competition from the Chinese market and so on and so forth on pump-jacks. But based on the numbers, it would certainly seem to us that [you all's] market share has maintained a pretty strong presence. How are you seeing that kind of market share dynamic play out? Is there increased competition on the lower-end or you are just chasing the higher-end stuff, maybe walk through those dynamics for us.

Bob Leslie

Well, we had really good bookings across the range. We saw some Churchill bookings come in. We saw some smaller units and then we saw our traditional large 640 in larger units demand being strong. So I don’t know that it's -- I think point 3 of my discussion really kind of summarizes our position and that is that we have seen the return of a couple of clients who re-calibrated the value equation in view of how the equipment performed and I think we are hoping to see that continue the more experienced people have with some of the imported equipment.

Collin Gerry

Okay. So it sounds like the differentiation between your stuff and maybe some of the competition is starting to bear fruit or show itself?

Jay F. Glick

That's the feedback we get from customers and from our service group, both.

Collin Gerry

Okay. And then last question and I'll turn it over to -- for some other participants. I noticed this time around you mentioned a little bit more on the operational side, some lean manufacturing stuff. As we look at margins going forward, is that maybe an implication that we could see some support or some expansion there outside of just pricing gains but more just on the efficiency in internal operation side and maybe when would you see that?

Jay F. Glick

We are really counting on that because we think that's essential for our future growth. I think you should begin to see some of that the late Quarter Two but certainly second half of the year. We are planning on that being a major factor in our financial improvement.

Collin Gerry

Okay. Thanks guys and congratulations again, Bob.

Bob Leslie

Thank you very much.

Operator

We will take our next question from Byron Pope with Tudor, Pickering, Holt.

Byron Pope

Good morning guys. Jay, I think I heard you mention that you had solid demand for both the smaller units and the larger units, but I just wanted to ask, maybe follow-on to that. Are you seeing any noticed uptick on a regional basis? Are you seeing increased activity in West Texas? I know there had been a fairly dramatic fall-off in the demand for smaller units maybe in the Powder River. So I was hoping you could speak to any trends you might be seeing from an activity perspective in terms of certain basins?

Jay F. Glick

Yeah, Byron, it is a good question. We have seen kind of general ramp-ups in demand across the US. But looking at the numbers prior to the conference call this morning, I was struck by the growth in the Rocky Mountains, particularly the northern tier of the Rocky Mountains and California was strong, West Texas was strong, maybe much stronger than we had seen in prior quarters, but the Rocky's was a section that surprised me the most.

Byron Pope

Okay. And then, if I think about the guidance for the full year, I just want to make sure I am thinking about this the right way. It sounded like you are heavily weighted in terms of orders for Q2-Q3, but if I work through the math, your full year guidance 5.10 to 5.30, you did $1.06 in Q1. Your guidance for Q2, $1.30 to $1.40. So, it implies kind of a flattish progression in the back half of the year and I just want to make sure I am thinking about that the correct way and is that the right way to think about it given that you normally do see a pronounced uptick when you get to Q3 and Q4 on the international side?

Jay F. Glick

I think we are expecting to see volumes continue to ramp up. We see a pretty significant jump between Q1 and Q2. And then after Q2, I think we still see some things firming up. A lot of what's going to happen in Q3 and 4 is going to be determined with our Q2 bookings. So, we are going to keep a pretty watchful eye on that. But frankly, we anticipate things continuing to move up throughout the year.

Byron Pope

Okay. Thanks guys.

Jay F. Glick

Welcome.

Operator

(Operator Instructions). And, we will go next to Michael Cohen with C. K. Cooper.

Michael Cohen

Hi. Good morning. We've spent quite a bit of time last quarter's call speaking about the cadence of the bookings from the fourth quarter to the first quarter and I am still a little unclear. I came in quite a bit low on the revenue side and is part of that solid revenue number in the first quarter related to some of the timing of the bookings per se in addition to some of the North Americans, the US strength?

Jay F. Glick

Yes. One of the things that happens particularly in oilfield is we are able to book in and out business pretty rapidly and obviously the service component of that is also kind of an immediate booking and shipment, so both of those things factored in to Q1 revenue being a bit ahead of plan. I think we were pleasantly surprised by the strength of the domestic market and that’s really the quick turnaround market for us.

Michael Cohen

Okay. So that’s less, if you will, the hardware side of the business and more of the service and the automation?

Jay F. Glick

Well, both. I mean, we are able to turn pumping units around fairly quickly, so our lead times on converting an order to revenue on the pumping unit side is still fairly short and clearly service is very short and automation, we are able to sell from stock in a lot of instances. So those are relatively quicker. But I wouldn’t want to leave the impression that we have long lead times on our pumping unit product.

Michael Cohen

Okay. And just one last question qualitatively, are you finding that the service and the automation components of your package offering are being more readily accepted and adopted along with the pumping units? Is that an easier sell for you now?

Jay F. Glick

I think we’re finding every quarter that more and more customers recognize the value in our automation product as they use it and see the efficiencies that it gives them. I think our service department has always been regarded pretty highly by customers. So I don’t think there is any real change there and I guess the thing I would stress again is the linkage between those three, between service, automation and our units sales continues to increase particularly in international markets where our customers want that package, not just the unit and not just the service, but really the package that includes automation.

Michael Cohen

Okay. So we should see, I mean if we’re saying that the second and third quarter typically are more or the back-end of the year are more heavily weighted towards the international markets and that is known fact the push in the E&P spending focus and we should see some more of those synergies towards the back half of the year?

Jay F. Glick

I think that’s -- yeah, I think that’s a fair statement.

Michael Cohen

Okay. Thank you.

Jay F. Glick

You are welcome.

Operator

And it appears we have no further questions at this time. I would like to turn the call back over to Mr. Jay Glick for any additional or closing remark.

Jay F. Glick

Okay, thanks Melissa. I think that’s all from our side. Again, I’d like to express our appreciation for all the participants and we look forward to talking to you again at the end of Q2.

Operator

And, once again that does conclude today’s call. We do appreciate your participation. You may disconnect at this time.

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