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LUFK > SEC Filings for LUFK > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for LUFKIN INDUSTRIES INC

Form 10-Q for LUFKIN INDUSTRIES INC


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

The discussion below and the other sections of this report contain forward-looking statements. These forward-looking statements reflect the expectations, beliefs, plans and objectives of management about future financial performance and assumptions underlying management's judgment concerning the matters discussed and, accordingly, involve estimates, assumptions, judgments and uncertainties. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to any differences include, but are not limited to, those discussed below and elsewhere in this report, particularly in Item 1A "Risk Factors" and below in "Cautionary Statement Regarding Forward - Looking Statements and Assumptions."

Lufkin Industries, Inc. (the "Company") is a global supplier of oilfield and power transmission products. Through its Oilfield segment, the Company manufactures and services artificial lift products, technology, services and solutions, including automated control equipment and analytical products for artificial lift equipment, which are used to extract crude oil and other fluids from wells. Through its Power Transmission segment, the Company manufactures and services high-speed and low-speed increasing and reducing gearboxes for energy and industrial applications. While these markets are price-competitive, technological and quality differences can provide product differentiation.

The Company's objective is to extend its position as a leading global supplier of high quality, mission critical artificial lift and power transmission products, and related aftermarket services. The Company intends to accomplish its objective and capitalize on long-term industry growth trends through the execution of the following strategies:

? Position the Company as the preferred source for artificial lift solutions. The Company believes it offers one of the industry's broadest portfolios of artificial lift products, including reciprocating rod, gas, plunger and hydraulic lift equipment, progressive cavity pumps, or PCPs, and measurement and control equipment for all types of artificial lift, including ESPs. The Company has developed a specialized optimization team which focuses on assisting producers with well completion design and production management. The Company is integrating its portfolio of artificial lift products, automation technologies, global service team and optimization team to deliver complete artificial lift solutions to its customers. The Company believes that the combination of its more than 80 years of artificial lift experience and its optimization expertise will allow its customers to offset the diminishing artificial lift knowledge base in their organizations.

? Continue to expand the Company's global reach. The Company intends to continue to expand its global reach by establishing manufacturing, engineering and service platforms on three continents, which will in turn support a network of regional service centers in areas with high actual or potential demand for artificial lift solutions. These platforms include:

o Lufkin, Texas, which supports its operations in the United States and Canada;

o Comodoro Rivadavia, Argentina, which supports its operations in South America; and

o Ploiesti, Romania and Eastern France, which support or will support the Company's operations in Europe, the Middle East, North Africa and elsewhere in the Eastern Hemisphere.

The Company also plans to exploit new market opportunities by deploying sales, distribution, service and manufacturing resources in markets where it believes it is currently under-represented. The Company believes that this strategy has already strengthened its customer relationships and that further expansion will allow it to respond more quickly to its customers' needs. The Company also expects that a broad geographical footprint will improve its support logistics and reduce its costs.

? Expand the Company's portfolio of artificial lift products and solutions through acquisitions and internal development. The Company intends to continue to selectively pursue acquisitions that increase its exposure to the most important growth trends in the industry, fill critical product gaps and expand its geographic scope. Since the beginning of 2009 the Company has successfully acquired and integrated several businesses across both its segments, including Pentagon and Quinn's reciprocating down-hole pump and PCP businesses. In 2012, the Company completed the acquisitions of Datac, RealFlex and Zenith. The Company believes these transactions demonstrate its ability to identify and complete strategic transactions that are consistent with its long-term strategy.


? Develop the next generation of automation solutions. As producers increasingly focus on maximizing the production from existing wells and deploy their capital resources in newer, unconventional plays where reservoir pressures deplete more rapidly, the Company is developing the technologies that will allow its customers to automatically control surface and down-hole pumps, based on real time temperature, pressure and flow data, to optimize artificial lift performance across a variety of well conditions, thereby maximizing recovery rates. The Company's optimization team provides expertise to help producers design full field optimization programs in order to produce their reserves at a lower cost and with greater reliability. This expertise includes the selection of the appropriate artificial lift and automation technology, facility layout and field electrification. As automation technology evolves, the Company intends to take advantage of opportunities to retrofit existing equipment and then provide its customers with ongoing upgrades.

Trends/Outlook

The Company's business is largely dependent on the level of capital expenditures in the energy industry, which affects the drilling of new wells, the use of artificial lift technologies to improve the recovery from existing wells and the construction of new energy infrastructure. The Company believes the significant trends impacting its industry include the following:

? World oil and natural gas consumption continues to increase, driven by growing economies in emerging markets;

? Growing economies are creating the need for large-scale energy infrastructure projects, such as refineries and LNG facilities; and

? Natural gas is gaining market share as a source of fuel for power generation.

In addition, the following trends are influencing demand for artificial lift solutions:

? Producers are increasingly focused on optimizing the ultimate recoveries from mature oilfields, such as the Permian Basin in west Texas and in central California;

? North American exploration and production activity is shifting toward unconventional plays such as the Bakken and Eagle Ford Shale formations, which often require some form of artificial lift earlier in the production life of the well than production from a conventional reservoir does. This trend towards shale exploration is expected to spread globally in coming years; and

? Producers are facing a shortage of experienced personnel due to retirements, and are increasingly relying on outside expertise.

We believe the long-term outlook for the global energy industry is favorable. According to the U.S. Energy Information Administration, or EIA, oil was the single most significant component of world energy consumption in 2010, representing 34% of total demand. Forecasts published by the EIA anticipate that worldwide demand for oil will grow 28% from 87.4 million barrels per day in 2010 to 112.2 million barrels per day in 2035.

As more readily accessible oil reserves are depleted, producers have been required to make increasing investments in order to maintain their production and increase their reserves to meet the growing demand for energy resources worldwide. As a result, many producers are focused on extending the ultimate recovery from existing producing wells, through enhanced oil recovery methods such as infill drilling, CO2 injection and artificial lift, as a profitable alternative to finding and developing new reservoirs. The benefits of enhanced oil recovery can be dramatic. For example, according to BP, the average recovery factor for a typical oil reservoir is only 35%, and a 5% increase in the average recovery factor for all reservoirs would add an estimated 300 to 600 billion additional barrels of oil to the global reserve pool, an amount equal to the total reserves that have been attributable to all discoveries over the last 20 years.

In their search for new reserves, oil and gas producers are increasingly turning to unconventional reservoirs such as shale formations. Due to their geologic characteristics, shale reservoirs have a natural pressure that typically declines more rapidly than a conventional reservoir's. As a result, the Company expects that current trends in shale development will result in increased demand for artificial lift solutions worldwide.

According to Spears, the global artificial lift market was approximately $8.9 billion in 2011 and is expected to be $11.0 billion in 2012, a 23% increase. The market share of rod lift and other non-ESP forms of artificial lift is expected to increase to 54% from 46% in 2011, according to Spears, and the Company expects this trend to continue as land-based oil drilling in unconventional plays continues to grow.


During the third quarter of 2012, WTI oil prices recovered to the $90-$95 per barrel range, although prices have since decreased to approximately $85 per barrel. Additionally, certain of the Company's customers consumed an outsize portion of their annual capital budgets for 2012 in the first nine months of 2012 due to higher-than-anticipated capital spending during such period, which will likely reduce such customers' activity levels for the remainder of 2012. While oil-directed rig counts decreased slightly during the third quarter of 2012, the Company expects overall oil drilling activity to remain at roughly current levels for the balance of 2012 and 2013. Significant declines in the oil-directed rig count in future periods would have a negative impact on the sales of artificial lift equipment and services.

The Power Transmission segment also benefits from many of these industry trends. Approximately two-thirds of the products the Company sells in this segment are for applications in the oil and gas, refining and power generation industries. The Company believes growing global populations and energy consumption will create increased demand for energy infrastructure, and with it increased demand for custom engineered, mission critical gearboxes. The Company also believes that the combination of engineering knowledge, specialized machine tools, mechanical test capabilities and reliability that is required in the power transmission industry constitute a significant barrier to entry to potential new competitors and limit the competitive landscape to a relatively small number of suppliers. However, the market for these products has slowed recently as customers have delayed the release of orders for larger energy infrastructure projects due to global economic uncertainties.

Summary of Results

The Company generally monitors its performance through analysis of sales, gross margin (gross profit as a percentage of sales) and net earnings.

Overall, sales for the third quarter of 2012 increased to $340.3 million from $231.7 million for the third quarter of 2011, or 46.9%. This increase was primarily driven by higher sales of Oilfield products and services in the North American markets driven by increased oil-focused drilling activities in unconventional resource plays and the acquisitions completed in the fourth quarter of 2011 and the first quarter of 2012.

Gross margin for the third quarter of 2012 remained at 23.3% compared to the third quarter of 2011, due primarily to lower margins in Power Transmission offsetting improved margins in Oilfield.

Higher selling, general and administrative expenses negatively impacted net earnings, with these expenses increasing to $37.0 million during the third quarter of 2012 from $29.9 million during the third quarter of 2011. This increase was primarily related to resources added from the acquisitions and higher costs of the new ERP system and related post-implementation support costs. As a percentage of sales, selling, general and administrative expenses decreased to 10.8% during the third quarter of 2012 compared to 12.9% during the third quarter of 2011.

The Company reported net earnings of $26.3 million, or $0.78 per share (diluted), for the third quarter of 2012, compared to net earnings of $14.4 million, or $0.47 per share (diluted), for the third quarter of 2011.

While the results of the third quarter of 2012 improved sequentially and compared to the prior year quarter, the Company continues to face headwinds for several reasons. Within the Oilfield segment, third quarter 2012 results were negatively impacted by reduced natural gas-directed drilling activities due to sustained low U.S. natural gas prices. Also Oilfield results in Argentina continue to be negatively affected by local inflation, labor disruptions and higher wage costs from new national labor contracts, which may also negatively impact earnings in future periods. In addition, although Oilfield manufacturing productivity in the third quarter of 2012 improved sequentially, results were negatively impacted by additional labor costs associated with efforts to increase capacity and improve efficiency at certain North American plants to meet increased demand for our products.

The Power Transmission segment third quarter 2012 results were negatively affected by cost overruns related to a new product design. Additionally, overall end markets for Power Transmission equipment continue to show signs of weakness due to lower energy prices and the global economic outlook, which may negatively impact results for the balance of 2012 and future periods.


Three Months Ended September 30, 2012, Compared to Three Months Ended September 30, 2011

The following table summarizes the Company's sales and gross profit by operating segment (in thousands of dollars):

Three Months Ended

                          September 30,           Increase/       % Increase/
                       2012          2011        (Decrease)       (Decrease)
Sales
Oilfield             $ 289,927     $ 183,505     $   106,422              58.0
Power Transmission      50,418        48,209           2,209               4.6
Total                $ 340,345     $ 231,714     $   108,631              46.9

Gross Profit
Oilfield             $  71,753     $  41,607     $    30,146              72.5
Power Transmission       7,507        12,283          (4,776 )           (38.9 )
Total                $  79,260     $  53,890     $    25,370              47.1

Oilfield

Oilfield sales increased to $289.9 million, or 58.0%, for the quarter ended September 30, 2012, from $183.5 million for the quarter ended September 30, 2011. New pumping unit sales for the third quarter of 2012 were $138.8 million, up $38.5 million, or 38.4%, compared to $100.3 million during the third quarter of 2011, primarily from higher North American demand from increased oil drilling in the Bakken, Eagle Ford and Permian plays. For the third quarter of 2012, pumping unit service sales of $36.3 million were up $2.0 million, or 5.9%, compared to $34.3 million during the third quarter of 2011 from higher installation and general field activity. Automation sales of $56.9 million during the third quarter of 2012 were up $22.6 million, or 65.9%, compared to $34.3 million during the third quarter of 2011 from higher product sales and revenues attributable to the Datac, Realflex and Zenith acquisitions completed in the first quarter of 2012. Sales from gas and plunger lift equipment of $11.8 million during the third quarter of 2012 were up $2.6 million, or 27.9%, compared to $9.2 million in the third quarter of 2011. Sales from Quinn's, which was acquired in the fourth quarter of 2011, were $42.8 million for the third quarter of 2012. Commercial casting sales of $3.4 million during the third quarter of 2012 were down $2.1 million, or 37.9%, compared to $5.5 million during the third quarter of 2011, as available capacity was directed towards internal production. Oilfield's backlog decreased to $274.8 million as of September 30, 2012 from $306.7 million at June 30, 2012. The decrease was due to lower orders for pumping units in the North American market and seasonal Latin America orders booked in the second quarter of 2012.

Gross margin (gross profit as a percentage of sales) for Oilfield increased to 24.7% for quarter ended September 30, 2012, compared to 22.7% for the quarter ended September 30, 2011, due primarily to the favorable impact of higher plant utilization on fixed cost coverage and improved pricing in the Oilfield segment.

Direct selling, general and administrative expenses for Oilfield increased to $19.7 million, or 29.5%, for the quarter ended September 30, 2012, from $15.2 million for the quarter ended September 30, 2011. This increase was due to resources added from the acquisitions completed in the fourth quarter of 2011 and the first quarter of 2012, as well as related acquisition expenses incurred in the third quarter of 2011. Direct selling, general and administrative expenses as a percentage of sales decreased to 6.8% for the quarter ended September 30, 2012, from 8.3% for the quarter ended September 30, 2011, due to greater leverage from higher sales levels.

Power Transmission

Power Transmission sales increased to $50.4 million, or 4.6%, for the quarter ended September 30, 2012, compared to $48.2 million for the quarter ended September 30, 2011. New unit sales of $37.3 million during the third quarter of 2012 were up $1.8 million, or 5.2%, compared to $35.5 million during the third quarter of 2011, from increased shipments to the oil and gas sector. Repair and service sales of $11.1 million for the quarter ended September 30, 2012, were down $0.1 million, or 1.2%, compared to $11.2 million for the quarter ended September 30, 2011, primarily due to weaker sales of replacement parts for drilling and completion equipment. Bearing sales of $2.0 million for the quarter ended September 30, 2012 were up $0.5 million, or 31.4%, as compared to the sales of $1.5 million for the quarter ended September 30, 2011, due to improvements in the oil and gas sector. Power Transmission backlog at September 30, 2012 decreased to $114.8 million from $117.0 million at June 30, 2012, primarily from the shipment of certain orders delayed from the second quarter.


Gross margin for Power Transmission decreased to 14.8% for the quarter ended September 30, 2012, compared to 25.5% for the quarter ended September 30, 2011. This decrease is primarily related to cost overruns on certain newly-designed low speed units and lower capacity utilization in the U.S. manufacturing facility.

Direct selling, general and administrative expenses for Power Transmission decreased to $5.9 million, or 22.7%, for the quarter ended September 30, 2012, from $7.7 million for the quarter ended September 30, 2011, due to lower personnel-related expenses. Direct selling, general and administrative expenses as a percentage of sales decreased to 11.8% for the quarter ended September 30, 2012, from 15.9% for the quarter ended September 30, 2011.

Corporate/Other

Corporate administrative expenses, which are allocated to the segments primarily based on budgeted sales levels, were $11.3 million for the quarter ended September 30, 2012, an increase of $4.3 million, or 60.2%, from $7.0 million for the quarter ended September 30, 2011, primarily due to higher employee related expenses, higher support and depreciation on the new ERP system and post-implementation support on the new ERP system.

Interest income, interest expense and other income and expense for the quarter ended September 30, 2012 increased to $3.3 million of expense compared to $0.1 million of expense for the quarter ended September 30, 2011. This increase in expense is related to higher interest expense related to the new debt financing put in place in connection with the Company's 2011 acquisitions.

The net tax rate for the quarter ended September 30, 2012 was 32.5% compared to 39.4% for the quarter ended September 30, 2011. This decrease is primarily due to the favorable benefit of income earned in lower-tax jurisdictions in 2012 and the unfavorable impact of the non-deductibility of certain acquisition-related expenses in 2011.

Nine Months Ended September 30, 2012, Compared to Nine Months Ended September 30, 2011

The following table summarizes the Company's sales and gross profit by operating segment (in thousands of dollars):

Nine Months Ended

                          September 30,           Increase/       % Increase/
                       2012          2011        (Decrease)       (Decrease)
Sales
Oilfield             $ 779,238     $ 516,149     $   263,089              51.0
Power Transmission     146,288       136,721           9,567               7.0
Total                $ 925,526     $ 652,870     $   272,656              41.8

Gross Profit
Oilfield             $ 191,195     $ 120,046     $    71,149              59.3
Power Transmission      31,895        37,402          (5,507 )           (14.7 )
Total                $ 223,090     $ 157,448     $    65,642              41.7

Oilfield

Oilfield sales increased to $779.2 million, or 51.0%, for the nine months ended September 30, 2012, from $516.1 million for the nine months ended September 30, 2011. New pumping unit sales for the nine months ended September 30, 2012, were $366.2 million, up $84.2 million, or 29.9%, compared to $282.0 million during the nine months ended September 30, 2011, primarily from higher North American demand from increased oil drilling in the Bakken, Eagle Ford and Permian plays. For the nine months ended September 30, 2012, pumping unit service sales of $105.4 million were up $10.5 million, or 11.1%, compared to $94.9 million during the nine months ended September 30, 2011, from higher installation and general field activity. Automation sales of $140.5 million during the nine months ended September 30, 2012, were up $42.4 million, or 43.3%, compared to $98.1 million during the nine months ended September 30, 2011, primarily from the Datac, Realflex and Zenith acquisitions completed in the first quarter of 2012. Sales from gas and plunger lift equipment of $32.4 million during the nine months ended September 30, 2012, were up $7.2 million, or 28.4%, compared to $25.2 million in the nine months ended September 30, 2011. Sales from Quinn's for the nine months ended September 30, 2012, which was acquired in the fourth quarter of 2011, were $122.3 million. Commercial casting sales of $12.5 million during the nine months ended September 30, 2012, were down $3.6 million, or 22.4%, compared to $16.1 million during the nine months ended September 30, 2011, as available capacity was directed towards internal production. Oilfield's backlog increased to $274.8 million as of September 30, 2012 from $164.2 million at December 31, 2011. The increase was due to higher orders for pumping units in the North American market and seasonal Latin America orders.


Gross margin (gross profit as a percentage of sales) for Oilfield increased to 24.4% for nine months ended September 30, 2012, compared to 23.3% for the nine months ended September 30, 2011, due primarily to the favorable impact of higher plant utilization on fixed cost coverage and improved pricing in the Oilfield segment.

Direct selling, general and administrative expenses for Oilfield increased to $64.5 million, or 65.3%, for the nine months ended September 30, 2012, from $39.0 million for the nine months ended September 30, 2011. This increase was primarily due to resources added from the acquisitions completed in the fourth quarter of 2011 and the first quarter of 2012, as well as higher related acquisition expenses incurred in the first half of 2012 than the third quarter of 2011. Direct selling, general and administrative expenses as a percentage of sales increased to 8.3% for the nine months ended September 30, 2012, from 7.6% for the nine months ended September 30, 2011.

Power Transmission

Power Transmission sales increased to $146.3 million, or 7.0%, for the nine months ended September 30, 2012, compared to $136.7 million for the nine months ended September 30, 2011. New unit sales of $102.5 million during the nine months ended September 30, 2012, were up $5.8 million, or 6.0%, compared to $96.7 million during the nine months ended September 30, 2011. Repair and service sales of $37.9 million for the nine months ended September 30, 2012, were up $1.9 million, or 5.5%, compared to $36.0 million for the nine months ended September 30, 2011. Bearing sales of $5.9 million for the nine months ended September 30, 2012 were up $1.8 million, or 43.6%, as compared to the sales of $4.1 million for the nine months ended September 30, 2011, due to improvements in the oil and gas sector. Power Transmission backlog at September 30, 2012 increased to $114.8 million from $107.4 million at December 31, 2011, primarily from increased bookings of new units for the energy-related markets.

Gross margin for Power Transmission decreased to 21.8% for the nine months ended September 30, 2012, compared to 27.4% for the nine months ended September 30, 2011, or 5.6 percentage points. This decrease is primarily related to production inefficiencies in the U.S. manufacturing facility and cost overruns on new low speed unit designs.

Direct selling, general and administrative expenses for Power Transmission decreased to $20.6 million, or 9.0%, for the nine months ended September 30, 2012, from $22.6 million for the nine months ended September 30, 2011, primarily from lower personnel-related expenses. Direct selling, general and administrative expenses as a percentage of sales decreased to 14.1% for the nine months ended September 30, 2012, from 16.6% for the nine months ended September 30, 2011.

Corporate/Other

Corporate administrative expenses, which are allocated to the segments primarily based on budgeted sales levels, were $37.9 million for the nine months ended September 30, 2012, an increase of $14.5 million, or 62.1%, from $23.4 million for the nine months ended September 30, 2011, primarily due to higher employee related expenses, higher support and depreciation on the new ERP system and post-implementation support on the new ERP system.

Interest income, interest expense and other income and expense for the nine months ended September 30, 2012 increased to $10.5 million of expense compared to $0.4 million of expense for the nine months ended September 30, 2011. This increase in expense is related to higher interest expense related to the new debt financing put in place in connection with the Company's 2011 acquisitions.

The net tax rate for the nine months ended September 30, 2012 was 37.0% compared to 37.1% for the nine months ended September 30, 2011.

Liquidity and Capital Resources

The Company has historically relied on cash flows from operations and third-party borrowings to finance its operations, including acquisitions, dividend payments and stock repurchases. The Company believes that its cash flows from operations and its available borrowing capacity under its Bank Facility described below will be sufficient to fund its operations, including planned capital expenditures, dividend payments and stock repurchases, through December 31, 2012, and for the foreseeable future.

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