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Lufkin Industries, Inc. (NASDAQ:LUFK)

Q3 2012 Earnings Call

October 29, 2012 10:00 am ET

Executives

Anne Pearson – DRG&L

John F. Glick – President, Chief Executive Officer & Director

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

Analyst

Robin Shoemaker – Citi

Collin Gerry – Raymond James

Brian Uhlmer – Global Hunter Securities, LLC

Blake Hutchinson – Howard Weil, Inc.

Neal Dingmann – Suntrust Robinson Humphrey

Rhett Carter – Tudor, Pickering, Holt & Co.

Operator

Welcome to the Lufkin Industries third quarter earnings conference call. During today’s presentation all parties will be in a listen only mode. Following the presentation the conference will be open for questions. (Operator Instructions) This conference is being recorded today, Monday October 9, 2012. All reply information can be found in the company’s press release. I’d now like to turn the conference over to Ms. Anne Pearson, DRG&L Investor Relations.

Anne Pearson – DRG&L

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 list for future news releases please call us at 713-529-6600 and we’d be glad to add you to that blast email list. If you’d like to listen to a reply of today’s call it will be available by a recorded phone replay until November 11th 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 in full.

A reminder that the information reported on this call speaks only as of today October 29, 2012 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 call may contain certain forward-looking statements. The assumptions in these statements are based on and are beyond the company’s ability to control or estimate precisely. In some cases they 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

I’d like to open with the operational highlights from our latest quarter. I’ll then ask Chris to provide a detail breakdown of our third quarter financial performance. Following that I will close with our outlook for the fourth quarter and early next year and then provide an update for our revenue and EPS guidance.

Looking first at oil field, we were very pleased with revenue performance from our oil field unit in the third quarter. We delivered top line growth in that segment of 15% versus the second quarter and 58% versus the year ago. As expected, our international markets did very well during the quarter with Egypt, Canada and Latin America all posting higher sales. We beat our top line guidance despite the customer driven delays in a large automation shipment I’ll talk more about in a moment.

Automation delivered its best revenue quarter ever with sequential growth of 29% and the Zenith Oilfield gage & automation company we acquired earlier this year also performed real well last quarter. The integration of Zenith’s products and technology into our overall automation business continues to go well. We are realizing the benefits of cross selling within the combined sales teams. We see additional opportunities for sales pull through in automation in the quarters ahead as customers become more aware of the full array of solutions we have to offer.

Likewise, Canada’s based Quinn’s which we acquired last December delivered an 18.4% revenue growth in its downhole rod pumping business which exceeded our expectations for that unit. Our main rod lift pumping business grew 14.4% 3Q versus 2Q demonstrating the progress we are making in growing our manufacturing capabilities to meet the increased demand we have seen over the last three years.

Looking at our top line performance year-to-date from the oilfield division, revenues are 51% greater than the first nine months of 2011 and we delivered increases in all product lines with the exception of external foundry sales which decreased as we utilized more of our foundry capacity to satisfy internal demand for castings from our oilfield group.

Third quarter margins for oilfield improved by 200 basis points from a year ago but sequentially they slipped due to a combination of factors. First, we encountered a delay in a large automation order in Romania that was forecast to ship during the third quarter but was held up due to a customer driven delay. We had the equipment ready to install but the customer’s completion programs were running behind schedule. Consequently we were not able to realize the service revenue or the product sales on the schedule we anticipated.

Additionally, though we made progress as the quarter progressed on reducing overtime and more tightly controlling spending, particularly at our US unit operation, we still experienced bleed through effects from higher second quarter spending in July and early August that impacted the third quarter overall. As we’ve described in the last couple of calls, we’ve converted our ERP system from Bond SAP. One of the objectives of this change was to provide improved management tools for running our global operations including better tools for managing manufacturing performance and spending.

In September, most of the management reports of spending control tools were finally available and we began to realize the benefits very quickly. We are confident those tools coupled with the improving skill level of our machinist as they move up in the learning curve, will result in a return to our historically high productivity levels. Lastly, third quarter oilfield margins were also impacted by a change in our product mix. In automation for example, we shipped more lower margin products during the quarter than we have in recent quarters. So while we have had stellar revenue during the quarter in automation we had slightly softer margins. Mixed also impacted Canada which I’ll address in a moment.

In our pumping unit service business we experienced slightly lower utilization rates due to reduced field activity late in the quarter. It’s worth noting that a number of our North American customers cited the fact that robust spending earlier in the year had meant they were slowing spending to stay within the 2012 budgets. I’ll address this later when we talk about the fourth quarter, but we expect tighter budgets to factor in to Q4 activity levels and we aren’t anticipating the normal year end spending increases that we typically see when operators use budget surpluses later in the year. It appears those budget surpluses were spent at a faster rate this year leaving no surplus.

During Q3 we saw the impact of this in our field service groups and in our Canadian operations where the seasonal recovery has been anemic. I should note that we were pleased that our Quinn business in Canada showed strength in spite of the overall weak Canadian market. Our surface rod unit revenues in Canada also held up during the quarter albeit with weaker margins due in part to a mix of smaller units.

While revenues held up new order bookings for rod lifts in Canada were down. Customers shortened planning horizons and are clearly taking a wait and see approach before placing the orders. On the whole bookings through Q3 we were aligned with our forecast. Year-to-date bookings in the oilfield are running at a $1.2 billion pace. We were coming off a record level in Q2 that included three large orders in Argentina which covered multiple quarter requirements along with very strong US bookings, several of which were placed early.

This early placement would confirm customer feedback that budgets were spent earlier in the year. So, as we noted in our last call we knew the bookings for Q3 would be sequentially lower. We continue to be very pleased by the trends we see in the US in the Bakken, Eagle Ford and Permian in our automation line, in our Quinn downhole rod pump business and internationally particularly in the Eastern Hemisphere.

Let me switch now to power transmission. The third quarter was tougher than we expected. Top line performance was about 4% ahead of a year ago but down 5% on a sequential basis. Both revenues and margins in the third quarter were below expectations and Chris will supply the details. So while we’re pleased by the year-over-year increase in volume in PT shipments, we still have a lot of work to do to improve our manufacturing performance and project execution.

Additional benefits from improvements of utilization rates particularly in the US and an improving product mix will help sure up the divisional operating income in the fourth quarter. New orders received in power transmission were down slightly from the previous quarter but up 5% from a year ago. The mix of orders received should be positive for margin improvement in future quarters. The largest volumes of new orders were from the oil and gas refining and petrochemical sectors. Q3 bookings in oil and gas and petrochem increased by more than $4 million each versus second quarter and refining was up about $500,000 sequentially. Bookings from these sectors typically carry better margins than other industrial markets and that should help drive stronger PT margins in 2013.

On a consolidated basis looking at performance versus our late July guidance we slightly beat our top line guidance of $330 million to $340 million and despite the margin compression in both divisions we still came in near the top of our guidance range of $0.70 to $0.80 per share with Q3 earnings of $0.78 a share. New bookings from the two divisions combined totaled $306.2 million which drove our combined company backlog to $389.6 million up 34% from a year ago but about 8% behind Q2 levels.

Looking in more detail at bookings, in oilfield new order bookings totaled $258 million which was 66% higher than a year ago but down 27% from the record levels in the second quarter. As I mentioned earlier, second quarter benefitted by three large orders in Argentina and the multi quarter orders placed early in North America. The year-over-year increase was mainly due to strong performance in both our legacy automation group and the recently acquired automation companies along with stronger pumping unit orders across most of our geographic market.

We expect automation to continue to have good traction because our customers increasingly recognize the economic benefits of using our automation products to maximize production and reduce operating costs. The year-over-year growth in bookings from the Bakken, Eagle Ford and Permian show the underlying strength in demand for pumping units in these markets. While Q4 demand could flatten or decline slightly as budgets are tightened we expect the trend in these plays to be very positive as we progress through 2013. Likewise, we expect the international demand for artificial lift to grow at a steady pace throughout 2013 particularly in the Eastern Hemisphere since we will service that market more competitively from our new Romanian operation.

Our oilfield backlog increased 65% from a year ago and was down 10% sequentially to $274.8 million at the end of the third quarter. North American accounted for 80% of the Q3 bookings versus 73% in prior quarters and 82% in the third quarter of last year. Sequentially most of the increase was from the US where we saw sizeable increases in automation and pumping unit orders. North America accounted for 70% of the oilfield backlog at the end of the third quarter versus 71% at the end of the prior quarter which reflects the strong international orders covering multiple quarter orders which we received earlier in the year.

Looking at the biggest contributors to oilfield bookings in more detail starting with rod lift. As expected, new pumping unit orders and parts declined by 58% versus the very strong second quarter but they were up by almost 13% versus the year ago to $90 million. Pumping unit orders were led by continued strong demand in the Bakken, Eagle Ford and the Permian. Automation was the standout with new bookings from our legacy automation group plus contributions from Zenith and Datac and RealFlex totaling $70 million. This was an increase of 35% from prior quarters and up 154% from the third quarter last year which was prior to the automation acquisitions.

Gas and plunger lift bookings totaled $10.6 million which slipped 11% sequentially but were up 40% versus the year ago. The sequential slip reflects the continued weakness in the gas market that these products are used in. We’re pleased with the year-over-year growth but much work remains to readjust our focus to more liquid rich sectors. Any recovery in gas production will stimulate much stronger demand for this sector and our artificial lift portfolio.

Quinn’s had a strong third quarter. New bookings of $42.8 million which was up 18.5% from the prior quarter. Looking at key contributors to power transmission in the third quarter, we booked $48.2 million of new orders in power transmission in the third quarter which was up 5% versus the year ago and down 1% versus the second quarter. The PT business is tied largely to the energy related infrastructure projects. The timing of order placing for that equipment continues to move to the right as customers are taking a hard look at demand for downstream products and adjusting the timing of project execution.

We saw very substantial sequential improvements in new bookings from Lufkin France in the third quarter, more than 60% higher than the prior quarter driven largely by energy infrastructure products for high speed gear drives for compressors and pump packages. US gear manufacturing was also up 10.5% but these gains in gear unit orders were more than offset by weaker bookings in North American after market and lower demand for lose gears used in pressure pumping packages in offshore drilling applications. As a result, power transmission’s backlog declined 2% from the end of the second quarter to $114.8 million and was down 7% from the year ago.

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

Christopher L. Boone

As usual I’ll begin with a recap of our financial results for the quarter ended September 30, 2012 and then I will cover key expense items for the quarter and our expectations for the fourth quarter. Net earnings for the latest quarter totaled $26.3 million or $0.78 per share with adjusted net earnings of $18.1 million or $0.59 per share for the same period last year. The adjusted figure last year excluded a $0.12 per share charge for acquisition related expenses.

Consolidated revenues were $340.3 million which was an increase of 47% from a year ago and up 11% sequentially. Consolidated growth margin was 23.3% which was flat from a year ago but down from 25.5% in the second quarter. Consolidated operating income was $42.3 million which represents a 48% increase year-over-year and a 11% increase versus the second quarter on an adjusted basis. EBITDA was $52.6 million or 15.5% of revenue versus $34.6 million a year ago and $48.3 million in the second quarter on an adjusted basis.

Looking at the third quarter financial results by division starting with oilfields, oilfield revenues totaled $289.9 million which was up 58% from a year ago and up 15% from the second quarter. Oilfield operating income was $43.4 million which was up 69% from a year ago and up 25% from the previous quarter on an adjusted basis. Breaking third quarter oilfield revenues down by product line, new rod lift pumping unit sales totaled $138.8 million which was an increase of 38.4% versus the third quarter of 2011. Automation products contributed $56.9 million which is up 65.9% year-over-year. As Jay mentioned this is automation’s best revenue quarter ever. Acquisitions we made earlier this year accounted for about $15.4 million of the year-over-year increase.

Pumping unit service contributed $36.3 million of oilfield revenue which was up 5.9% from a year ago. Gas and plunger lift sales generated $11.8 million which was up 27.9% from the same quarter last year. Foundry contributed $3.4 million down 37.9% from a year ago. Quinn’s contributed $42.8 million in the quarter. We purchased Quinn’s in December of 2011. On a sequential basis comparison new rod lift pumping unit sales rose 14.4%, automation sales were 28.8% higher, pumping unit services revenues were flat versus the second quarter, gas and plunger lift sales increased 8.3% sequentially, foundry revenues declined 24.1% and Quinn’s revenue increased 18.4% reflecting the unusually strong summer quarter we had in Canada.

Oilfield gross margin before special items was 24.7% up from 22.7% a year ago but down from 25.3% in the prior quarter on an adjusted basis. Our third quarter growth margin for oilfield was short of our late July guidance of 26% to 27% for the reasons Jay has already discussed. For the fourth quarter we expect oilfield division gross margin to be in the range of 26% to 27% as we realize the benefit of improved operational performance and slightly better pricing as the impact of prior price moves continues to be realized.

Now turning to power transmission; power transmission sales for the third quarter totaled $50.4 million which was up 5% from a year ago but down 4% sequentially. Operating income from power transmission was -$1.2 million versus the $3 million year ago and $3.1 million in the second quarter on an adjusted basis. Looking at PT revenue breakdown by product, new units accounted for $37.3 million of third quarter power transmission revenue, this was up 5.2% from the year ago and a 3.5% increase from the second quarter. Repair generated $11.1 million of revenue which was down 1.2% from a year ago and down 21.8% sequentially. Bearings contributed $2 million of third quarter PT revenues which was up 31.4% from a year ago and down 5% from the second quarter.

Gross margin from power transmission decreased 14.8% versus 25.5% a year ago and 26.5% in the prior quarter on an adjusted basis for the reasons I just outlined. Both the revenues and the margins in the third quarter were significantly impacted by three factors. The largest was a product pricing problem on a low speed turbine sugar mill product in Mexico. This was a brand new design and the first time we built one of these and we experienced some engineering snags that drove substantial cost overruns on this project. Combined with design and assembly problems with another low speed project, these accounted for about half the margin miss.

Second, we also continued to experience overall utilization problems that negatively affected our overhead absorption in power transmission in Q3. Third, demand began to soften for higher margin aftermarket and component gears for frac pumps used in the well completion phase of drilling in the shale plays. For the fourth quarter our targeted gross margin is in the range of 21% to 23% for power transmission. It’s sequential improvement is due to a better mix of speed products and the non-recurrence of new low speed unit product introductions and improved operational performance.

Looking at key individual expense items in the third quarter selling, general and administrative expenses excluding the impact of special items declined by 7% from the second quarter to $37 million and as a percent of sales SG&A was 10.9% last quarter down from 13.1% in the second quarter. Our guidance from July was higher at $41million to $42 million. The lower SG&A level in Q3 reflects lower IT consulting expenses than expected an accrual adjustments [inaudible] in line with 2012 performance.

We expect SG&A to be back up in the neighborhood of $41 million to $42 million in the fourth quarter. SG&A in the fourth quarter will be impacted by higher equity compensation expense due to the immediate expensing of equity grants to certain retirement eligible employees. Depreciation and amortization was $10.7 million versus $6 million a year ago and $10.6 million in the second quarter. The fourth quarter run rate should be slightly higher. The majority of the depreciation of the Romania facility will not start until the first quarter of next year.

Interest expense was approximately $3 million in the third quarter. Capital expenditures for the third quarter totaled $22.7 million, about half of this was for Romania. For the year we expect total cap ex to be in the range of $80 million to $90 million. The net spend in the fourth quarter will be impacted by the timing of state aid reimbursement in Romania.

As of September 30th we have $306.1 million term loan outstanding and $25 million drawn on our revolving credit facility. After letters of credit of $9.9 million we had $140.1 billion available under our credit facilities at the end of the third quarter. We paid dividends of $4.1 million or $0.125 at the end of the quarter. Our net effective tax rate was 32.5% reflecting the adjustment of our base tax rate from 35% to 34% on a year-to-date basis before the impact of acquisition expenses. This lower rate is from higher foreign earnings in lower tax jurisdictions. 34% is a good modeling rate for the fourth quarter but there may be opportunities to realize a lower rate upon the completion of final annual estimates. We believe 34% is a good modeling rate for 2013 as well.

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

John F. Glick

Before we go to your questions I would like to come back to our outlook for the fourth quarter and into the first part of next year and also update our guidance for the remainder of the year. let me begin with power transmission. The delays in large projects and slower flow of business from fracing drilling sectors served by our aftermarket groups will mean lower bookings in the short term but the backlog of orders in-house should result in higher levels of activity in our manufacturing operations in the fourth quarter.

As a result, we are moderating our expectations for top line performance and new bookings for the division for the remainder of the year and into early 2013. We expect PT to supplement our oilfield manufacturing efforts for the quarter which will boost factory utilizations in that division and help absorb overhead. In the longer term we expect power transmission to benefit from low natural gas prices and the funded domestic oil production and these factors will drive investments in refining, petrochemical processing and gas fired electrical generating stations. The list of projects under evaluation is very encouraging.

Before I address the oilfield outlook I want to emphasize we’re focused on cost control and manufacturing execution because it applies to both divisions. Given the lower than expected margins from power transmission and oilfield last quarter we’re going to be laser focused on cost reduction by improving productivity and reducing overtime moving quality product through our factory at a pace that will enable us to meet expected demand growth next year and generate the returns our investors have come to expect from Lufkin. We believe we are strategically well positioned to enjoy strong markets in both divisions and we’re encouraged by the improvements we saw in performance in September.

Turning to oilfield we believe the pace of bookings in Q4 will not be as robust as we had expected at the time of our midyear forecast due to tightening budgets. Fourth quarter revenues will be up sequentially from third quarter levels. We expect factory utilization to remain high but we also expect benefit from productivity improvements and improving skill levels of our work force. As previously mentioned several E&P companies have informed us their budgets for the year have been largely exhausted.

With ongoing economic and politic uncertainties a number of our customers are taking a cautious wait and see approach to commitments. Meanwhile, like us, they’re focused on cost containment and working to stay within their budgets. The fact that our customers are focused on costs means we have to stay price competitive but it also means that Lufkin’s competitive strengths of products and service reliability, technical support, lower operating costs, and higher production rates over the life of the well are valued even more highly.

As we look to 2013 we recognize the recent pull backs in oil prices have had an impact on our customers’ short term plans. The industry that has had a lot of experience in managing cyclical risks and most certainly associated with oil price fluctuations will adjust to this. Against the backdrop of economic weakness in Europe, an uncertain economic recovery in North America and the potential for a slowing Chinese economy, we share the views that the next few quarters could be affected by the psychological impact of the pull back in WTI prices from the high 90s range to a slightly lower range. We expect demand for our products to remain strong given the steep decline curve on most of new unconventional wells but we know there will be month-to-month fluctuations.

Now that pressure pumping capacity is in place we expect well completion s to be more closely tied to the right count. Despite these short term factors the medium to longer term factors are very positive for the industry and for Lufkin. As the presidential campaigns have highlighted, thanks to unconventional oil production the US is poised to have greater energy security than in any time since the 1950s. Economic benefits for the funded competitive domestic energy sources have been highlighted by both parties.

Lufkin’s artificial lift products are central to the production of these new sources of energy. We also subscribe to the growing view that these same production techniques will migrate to international plays and stimulate increasing demand for our products and services in those markets. So, we see a long horizon of growth recognizing the pattern of growth won’t be at an even linear slope.

Overall, we expect North American demand to grow as we move through 2013 with continued strength coming out of the Bakken, Eagle Ford and Permian basin. We will continue to ramp up manufacturing and servicing capacity to meet that growing demand profitability and to offer our customers the kind of quality and short lead times on which we have built a solid reputation over many decades.

Internationally, we expect demand to grow more slowly with North Africa, the Middle East and Latin America leading the way. Our operations in Argentina did not experience the degree of plant disruptions in the third quarter as we experienced in the second although we were impacted by labor dispute disruptions in the field.

As we noted last quarter, the impact of economic problems in Argentina on our operations remains a source of uncertainty. We were hopeful with the new labor contract reached earlier this year will quell at least some of the agitation. We continue to believe the Argentinean market holds tremendous promise particularly if unconventional plays are capped, so we’re taking a very long term view of this market.

Our new Romania facility is largely complete though we continue to commission machine tools. We began manufacturing houses and covers for pumping unit reducers during the month of October. We will expand production throughout the quarter. The operation will increase pumping unit capacity by $50 million to $60 million in 2013 with 2014 capacity reaching $80 million to $100 million.

To summarize, the strength of both North American and international markets on the oilfield side continues to be encouraging even though we recognize that bookings could slow in the near term. We are leveraged to oil and liquids production so we are very well positioned to capitalize on the continued biased oil and NGLs. Continued low natural gas prices are impacting our gas business but that represents less than 4% of our overall revenues.

This morning in our earning release we provided fourth quarter revenue guidance in the range of $340 million to $350 million and EPS guidance of $0.80 to $0.90 per share. Lower oil prices, tight budgets and the slowing global economy and general uncertainty about the short term supply and demand imbalances in the global oil markets we believe is causing customers to reach for the pause button.

For the full year we expect consolidated revenues to range between $1.26 billion and $1.27 billion. We now expect full year earnings to be between $2.80 and $2.90 per share before adjusting for acquisition related expenses and other special items which is below our July guidance of $3.00 to $3.20 a share. As we look ahead to 2013 we see continue growth in oilfield revenues with revenues about equal to our current bookings run rate for oilfield and flat to slightly up for power transmission. We expect continued sequential growth in EPS assuming oil prices remain above $85 a barrel.

Now operator, we’re ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robin Shoemaker – Citi.

Robin Shoemaker – Citi

Just in terms of the customer psychology here, clearly they’ve spent their budget, are they giving you any indication about 2013 whether they expect to pick up again or whether this cautious kind of mood kind of lingers?

John F. Glick

We’re in the process of compiling budgets for ’13 as we speak and kind of the early work on that would suggest that customers are really pausing in the fourth quarter. I think we may still see a wait and see attitude in Q1 but on balance, the forecast we’re getting from our customer base suggests 2013 is going to be a strong year, stronger than 2012 albeit kind of ramping towards the second half of the year.

Robin Shoemaker – Citi

Is any of this hitting the pause button affecting the pricing dynamics?

John F. Glick

I think it’s not affecting the pricing dynamics a lot. I believe in Canada we saw a little bit of that last quarter. In North America we’ve actually been able to move prices up on some of the renewal of longer term contracts. I think the problem we’re going to have in the short term is significant moves above where we are today so as we’ve said for a while we really believe the opportunities are going to come from better performance and execution in our factors and productivity gains there versus being able to move prices up very significantly.

Robin Shoemaker – Citi

Just one other thing, on the power transmission side, these cost overruns which hurt your margins in the third quarter, you indicated a higher gross margin in the fourth but not back to the levels you were in the first half. Are the cost overruns in this project, low speed gear project lingering beyond the third quarter?

Christopher L. Boone

No, not on the low speed ones. I think the problem in PT was frankly they had two projects that were just really negative to margins in the way they were priced and in some design problems that cropped up on the assembly and test operations. I think you’re seeing in Q4 just a recognition that we’ve got lower volumes in PT in terms of activity levels, part of which will be offset by some of the work we’re doing in oilfield but the recovery rate for PT will probably not be as high as we saw in the first half of the year.

PP

This is also, as we said, seeing some lower aftermarket sales again, with a lot of it going to the frac pump business that is depressing activity in some of our repair operations.

John F. Glick

That’s very true, the frac pump products we make typically carry good margins and they’re highly standardized so we don’t have much of an engineering cost associated with them and then that business has really dried up over the last two quarters.

Operator

Your next question comes from Collin Gerry – Raymond James.

Collin Gerry – Raymond James

I guess I’ll start with a follow up on the margin front. So strong oilfield revenue fell through this quarter and margin bumped down sequentially a little bit and then we have them bumping back up I mean, not insignificantly next quarter. You went through it but bigger picture, what are some of these issues that are causing you volatility in the margins? I’m really trying to see maybe if we can get a little bit of an outlook of what we think a more normalized margin will look like as we start ’13?

John F. Glick

I’ll give you my cut and then I’ll let Chris go into some of the specifics. My cut is that for next quarter again, we ought to see again continued improvement in execution in the factories and I know this has been a long tail but we are really now beginning to see partly through SAP reports helping us manage that better and partly by just getting people down on the learning curve, we’re starting to see better execution at our [inaudible] where we make domestic pumping units and a little bit of improvement in PT but I think there’s still a lot to be worked on that front.

We have material costs pretty much under control. We’ve done well I think with our supply chain development. There will be a little improvement I think next quarter with some of these long term contracts that we’ve renegotiated with slightly higher prices so that will be a bit of a help. But I think most of the advantage is going to come from execution. One of the problems that I think complicates looking at this is just the number of moving parts that go into the oilfield margins and the fact that we had very high purchase content rolling through some of our automation products caused our margins to be a little lower there than we planned and then we talked about Canada being down in Q3. I think that will improve a little bit in Q4 but not significantly.

Then I think as we get into next year, the help that we foresee is in continued better execution here and being able to bring Romania on stream to reduce some of the overtime spending associated with the ramp up we’ve had to do in 2012, ought to help the margins of standard. Chris, let me turn it over to you for anything on this.

Christopher L. Boone

I think you’ve covered the main points.

Collin Gerry – Raymond James

As I think about starting ’13 should we think about that 26% to 27% range or is there some kind of year end getting a lot of product out the door, kind of a seasonal bump in the Q4 number that should then normalize as we go into 2013?

Christopher L. Boone

I think the 27% range is about right to start the year. Again, we haven’t finished our full analysis on ’13 yet it’s all preliminary at this point.

Collin Gerry – Raymond James

I just wanted to follow up on one other guidance item that you gave us, the SG&A is set to bump up quite a bit in the fourth quarter if I heard you right, due to stock based comp.

Christopher L. Boone

That typically happens every fourth quarter.

Collin Gerry – Raymond James

As we go into next year, can you quantify that? Is that $3 million that should then be backed out? I guess I’m trying to get some questions on the SG&A front, a normalized rate as we start ’13?

Christopher L. Boone

It adds about $1.5 million or so into that kind of extra expense that hits the fourth quarter.

Collin Gerry – Raymond James

I’m just trying to think, there’s a lot of moving parts on the margin front and some of the profitability there, taking a step back the overall trend in the business if I look at the booking side of things, very lumpy internationally and things kind of came down in North America. You went through the outlook in North America and what’s going on there. Internationally, it was lump to the downside this quarter, is there any reason to be hopeful for the next couple of quarters? I know it tends to bump around quite a bit.

John F. Glick

There are certainly some projects that could come in in the fourth quarter. We haven’t really made any heroic assumptions on in our planning for this quarter that really had to do with Middle East projects that may come in. But, international is always lumpy and as we’ve discussed in the past, Latin America could be lump in Q1 or Q2, this year it was very lumpy in Q2. North America is getting to be a little lumpier because of these multi quarter projects however, just on that topic, when we last saw oil prices retreat we also saw the order size come down and the planning horizon pull in. I think we’re seeing that in Canada now and I think that may well happen in North America during this quarter. When that happens North America may not be as lumpy but it may also be characterized as more buying for need rather than buying for forecast and that’s something that we’ll certainly be watching this quarter.

Operator

Your next question comes from Brian Uhlmer – Global Hunter Securities, LLC.

Brian Uhlmer – Global Hunter Securities, LLC

I’m kind of wondering in looking forward we had talked about total capacity and capacity moving up through ’13 and if we view the next quarter and a half as transitory on the order front, when we ramp up to that capacity flow through when we can expect to hit these mid 30%, 32%, 33% oilfield gross margins? Is the capacity there in your mind that what with this pause it is going to be beneficial to really lay out the plant how you want it and gaining some efficiencies so when a ramp does come at the back half of ’13 we can really accelerate. Can you kind of walk through that progression?

John F. Glick

I think I would say the following: number one, having the slower pace growth will help us control things like overtime spending and some of the breakneck spending that’s gone on to meet the levels of demand we’ve seen just with the existing resources. That moderating will help spending control and I think help execution a little bit. Bringing Romania online during this quarter and into next year again, will give us the ability to take some of the load off our North American operations and again, regain even better control, tighter control on spending and be able to service the eastern Hemisphere market from a more cost effective location.

Cost effective from a logistical perspective, cheaper transportation costs, as well as cost effective from an overall operating cost perspective. Those are the things that I would look for during the first couple of quarters of next year building towards the numbers you outlined later in the year where we ought to see margins really hit their peak mid 2013.

Christopher L. Boone

Another area that will help us is the fourth quarter is certainly going to have less of a mix of automation in it than we had originally forecasted for the fourth quarter, some of that just domestic spending and some of it is delays in some of the automation in Romania that we’ve talked about. That mix effect and that growth in automation should again, help the weighted margin as well.

Brian Uhlmer – Global Hunter Securities, LLC

I kind of missed this on the low speed PT project, number one that has shipped out the door so we’ve recognized all the negative impact on that? Number two, are there follow on orders that are expected that you’re going to gain lessons learned from that and then that’s going to benefit you guys longer term? Or, the issues were purely transitory with the pricing and the understanding what it is going to take to get it done? I wanted to take it a little deeper than what came out when Robin was talking to you guys?

John F. Glick

I think on the sugar mill project specifically, that product will be something that we will sell more of in the future including there will be some different pricing assumptions and different costs. They incurred a lot of costs because of the prototype nature of that first unit but that is a product that the design we hope to sell more in the future. The other low speed product as a right angle cooling pump drive that was for a refinery in Saudi Arabia and that is one that was purely a one off project unlikely to repeat. Both of them have shipped though so the bad news was taken during the quarter but one of the designs I suspect will have a longer life.

Operator

Your next question comes from Blake Hutchinson – Howard Weil, Inc.

Blake Hutchinson – Howard Weil, Inc.

Just going back to the comment you kind of snuck in there at the wire, you mentioned that the revenue run rate for oilfield would probably equate roughly to kind of the bookings run rate that we’ve seen thus far this year, I take it was thus far this year, does that tell us your thought here is kind of plus or minus $300 million or so on oilfield and given the near term versus medium term dynamics you’ve laid out would you say that we have to kind of take maybe a step back for first half in terms of top line in oilfield before things improve or is this more of a flattening out around those booking run rates?

John F. Glick

I think for next year we’re probably looking more like $1.2 million in that neighborhood for oilfield and again, we don’t have everything finalized. But, our forecast assumptions are kind of based on oil prices being somewhere between $80 and $85 a barrel and that’s kind of where we’re coming down right now. In terms of how that plays out in terms of the sequence quarter-to-quarter growth I think we’re probably going to start 2013 at kind of current levels and build from there versus I don’t see a real sharp pull back in Q1. We may have a little softer North America, hopefully we’ll have a little stronger international in Q1. But, I think the second half of ’13 as you’ve just mentioned will be stronger than the first half. Again, we’ve seen that every year for the last three years I believe, with second half being significantly stronger than first half.

Blake Hutchinson – Howard Weil, Inc.

I just want to make sure, there’s been a lot of Q&A around oilfield margin and a lot of numbers thrown out there and some talking about achieving 30% margins by the back half of the year. Just to give you guys a chance to address that and making sure that we all come away with the right kind of bogey or the right goal for the year for you guys leaving this call, is that a number you feel is obtainable with the market you see or would you caution us again in kind of plugging that into our model?

John F. Glick

I think it’s unlikely with oil prices fluctuating in the range they are today. I think if oil prices strengthen significantly the second half of the year that number is a possibility but a lot of it is going to depend on what happens with the performance in the market. I don’t think 32% is likely but I think in the 30% and slightly above is probably a range we could get again, assuming oil prices strengthen or remain fairly consistently in the mid to high $90s.

Blake Hutchinson – Howard Weil, Inc.

To clarify again, that’s more with what you feel you have in hand on the manufacturing front than really any commentary on pricing power and things like that?

John F. Glick

I think getting to the high 20s is doable with what we have in hand with manufacturing improvements. I think bumping above 30 is going to require some external price moves.

Operator

Your next question comes from Neal Dingmann – Suntrust Robinson Humphrey.

Neal Dingmann – Suntrust Robinson Humphrey

I guess my question is more on the oil services obviously, it looked like you kind of talked about the front end this year going to the back end for next year and then when Chris broke down the services especially, some of these new acquisitions, it sounded like they’re doing quite well. So I guess is it fair to say on the rod lift and somewhat what I call your more traditional business that you’ve had for a while again, maybe if you could tell us a little bit why it seemed like you had even more weakness there than what the overall rig count would reflect? And just wondering how you and Chris are thinking about debt [inaudible] or forecasts just for the rod lift in some of that business going forward?

John F. Glick

I’ll start off and then I’ll let Christ add his input. It seems to me on the oilfield side on the traditional products the difficulty we face that we’ve talked about the last couple of quarters is just the challenge of the significant ramp up in activity that we’ve done to try and satisfy the market demand for rods and units from our single operation in North America here at Lufkin coupled with the problems we’ve had in Argentina. So in a way we’ve really been in a brute force issue in North America where we’ve spent a lot of money to keep that top line and market share and satisfy customer demand without being able to drive as much of that bottom line as we’ve historically done.

Meanwhile, we’ve got all the issues in Latin America kind of dragging an anchor behind us that’s compromising our oilfield pumping unit margins. Again, as we look ahead some of the support and help we’ll get from Romania should certainly take pressure off the North American manufacturing operations and give us a lower cost basis for operating to support the Eastern Hemisphere. So I think that’s really what you see.

Then on the ILS, gas lift, plunger lift side and a little bit on our PHL product, they’ve really been hit harder by the drop in gas activity than we expected them to be earlier in the year when we first set up full year guidance. Those operations in those products have really struggled in the market. Again, any help with the gas prices should benefit that group but meanwhile we think there’s some opportunities to shift those to more liquid based plays and maybe stem some of the bleeding in those two areas.

Neal Dingmann – Suntrust Robinson Humphrey

If I could just add a last question as far as, as you look at the margins now you’ve obviously had solid acquisitions, are you all still active in that market? Are there some things that are catching your attention? Would you be active buyers out there given the weakness and major opportunities you’re seeing? So just your comments on the M&A market?

John F. Glick

Clearly, if there’s a small bolt on we might be excited about that. I don’t think we’ll do anything the size of Quinn or Zenith but clearly we’re always in the market for something that would add to our automation capabilities and equally our field service capabilities. Sometimes it’s easier to acquire than to build and when those opportunities come along we’d be interested in pursuing them.

Operator

(Operator Instructions) Your next question comes from Rhett Carter – Tudor, Pickering, Holt & Co.

Rhett Carter – Tudor, Pickering, Holt & Co.

Just talking about the Romanian facility rollout into 2013 you guys talked about $50 million to $60 million revenue uplift there. I think that comes in a little bit lower than maybe what you guys had originally anticipated. Is that true and if so, what’s guiding that?

John F. Glick

I think the real issue is we’ve said all along that we wouldn’t hit the full revenue capacity in year one and I think we’ve been fairly consistent over the last several quarters with the $50 to $60 range and I still think that’s pretty solid. Clearly, $80 to $100 is more a longer term run rate but we won’t hit that during our first year.

Rhett Carter – Tudor, Pickering, Holt & Co.

That’s just coming with start ups and additional potential snags there or getting things rolling basically? It’s really hiring and training people to get to a three shift operation.

Christopher L. Boone

And as we learned last year, you have to be very careful about ramping up especially, the foundry supply chain. Putting too much on that supply chain at once can overwhelm them.

Rhett Carter – Tudor, Pickering, Holt & Co.

Just another one on oilfield margins would it be possible to quantitatively or qualitatively talk about the mix of the impact between the Texas facility, Argentinean issues, and then just overall product mix? What was the biggest contributor and where do you see the biggest room for self help?

Christopher L. Boone

The largest was still going to be the US manufacturing pumping unit. Unfortunately it was sort of spread all around, there wasn’t just one single area that individually was huge but certainly the largest of them was there. Again, we did see the benefits that we hoped with the new employees which was getting a higher production and getting overtime reduced but we’re still not hitting all the productivity levels we’re targeting. We’re still working machine down time, preventive maintenance, still working on getting certain overhead spending rates down to historical levels and so those areas are still in what is a process.

We had some risk in all these areas it’s just I guess you could say every one of them - we didn’t have none of them individually turn out a little better than where we had expected them. Argentina was a little weaker than we had expected and again, some of that was really due to just small individually things kind of day-by-day that impacted efficiencies at the plant whether it was our own workforce or third party. The Quinn operations also one were ramping up and again, that workforce there is getting better trained but we’ve been having to do some outsourcing of certain materials there while we were ramping up that workforce.

That should be again, improving now that we’ve got a lot of the second shift filled and it’s getting clear of more extensive outsourcing in certain parts and we’re trying to utilize some of our gas lift plunger lift facilities to make certain parts for Quinn’s while they have a little bit of weaker markets. All of those types of things are going on but again, individually none of them were significant in the overall, they all sort of added up.

John F. Glick

There was really no silver bullet but there are a lot of things that we’re encouraged by, particularly in Buck Creek here. I think we can see some things that clearly will help us going forward and we ought to see some of the benefit of those earlier rather than later.

Rhett Carter – Tudor, Pickering, Holt & Co.

Last one for me, within North American bookings can you break out Canada versus US?

John F. Glick

You’re talking about during the quarter?

Rhett Carter – Tudor, Pickering, Holt & Co.

Yes.

Christopher L. Boone

US bookings were around – again, the Quinn’s data I have to do a quick guess, but it was around $170 or so for US and about $30 or so for Canada.

Operator

I’m showing no further questions at this time. I’d like to turn the conference back over to Mr. Glick for any further remarks.

John F. Glick

Let me just close by saying we appreciate everyone participating today. Again, I want to emphasize for any of you on the east coast we hope you come through Sandy unscathed and we all get back to business here in the next day or so. Thanks very much.

Operator

Ladies and gentlemen this does conclude the Lufkin Industries’ third quarter earnings conference call. We’d like to thank you very much for your participation. You may now disconnect.

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