Lufkin Industries 10Q 2008 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission File Number: 0-02612

LUFKIN INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

TEXAS	75-0404410
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

601 SOUTH RAGUET, LUFKIN, TEXAS	75904
(Address of principal executive offices)	(Zip Code)

(936) 634-2211

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes_X_ No____

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer X Accelerated filer Non-accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ___No X

There were 14,705,855 shares of Common Stock, $1.00 par value per share, outstanding as of November 7, 2007.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

LUFKIN INDUSTRIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Thousands of dollars, except share and per share data)

	September 30,			December 31,
Assets	2007			2006
Current Assets:
Cash and cash equivalents	$	82,943		$	57,797
Receivables, net		83,366			90,585
Inventories		102,357			85,630
Deferred income tax assets		9,363			7,919
Other current assets		3,752			1,521
Total current assets		281,781			243,452

Property, plant and equipment, net		119,564			113,081
Prepaid pension costs		57,280			56,856
Goodwill, net		11,931			11,732
Other assets net		4,226			3,948
Total assets	$	474,782		$	429,069

Liabilities and Shareholders' Equity

Current liabilities:
Accounts payable	$	22,675		$	24,375
Accrued liabilities:
Payroll and benefits		10,619			9,810
Warranty expenses		4,101			3,668
Taxes payable		7,920			7,665
Other		19,614			15,977
Total current liabilities		64,929			61,495

Deferred income tax liabilities		33,987			28,022
Postretirement benefits		7,187			8,475
Other liabilities		5,889			2,937

Shareholders' equity:

Common stock, $1.00 par value per share; 60,000,000 shares authorized;
15,500,472 and 15,322,903 shares issued and outstanding, respectively		15,500			15,323
Capital in excess par		46,550			38,173
Retained earnings		324,856			280,198
Treasury stock, 795,278 and 395,278 shares, respectively, at cost		(26,120	)		(4,083	)
Accumulated other comprehensive income/(loss)		2,004			(1,471	)
Total shareholders' equity		362,790			328,140
Total liabilities and shareholders' equity	$	474,782		$	429,069

See notes to condensed consolidated financial statements.

LUFKIN INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
(In thousands of dollars, except per share and share data)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2007			2006			2007			2006

Sales	$	146,880		$	158,802		$	439,466		$	439,882

Cost of Sales		105,864			120,115			318,074			326,604

Gross Profit		41,016			38,687			121,392			113,278

Selling, general and administrative expenses		13,999			12,966			43,243			38,202

Operating income		27,017			25,721			78,149			75,076

Interest income		975			427			2,806			1,284
Interest expense		(30	)		(55	)		(101	)		(118	)
Other income, net		1,154			80			1,883			119

Earnings before income tax provision		29,116			26,173			82,737			76,361

Income tax provision		10,045			8,779			28,376			26,345

Net earnings		19,071			17,394			54,361			50,016


Net earnings per share
Basic	$	1.28		$	1.17		$	3.63		$	3.37
Diluted	$	1.26		$	1.15		$	3.58		$	3.31

Dividends per share	$	0.23		$	0.18		$	0.65		$	0.44

Weighted average number of shares outstanding:
Basic		14,921,594			14,885,395			14,967,894			14,822,904
Diluted		15,084,317			15,145,128			15,168,205			15,110,807

See notes to condensed consolidated financial statements.

LUFKIN INDUSTRIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands of dollars)

	Nine Months Ended
	September 30,
	2007			2006
Cash flows from operating activities:
Net earnings	$	54,361		$	50,016
Adjustments to reconcile net earnings to cash
provided by operating activities:
Depreciation and amortization		10,544			8,633
Deferred income tax provision/(benefit)		(558	)		(1,211	)
Excess tax benefit from share-based compensation		(2,706	)		(2,810	)
Share-based compensation expense		2,596			2,004
Pension income		(2,443	)		(2,175	)
Postretirement benefits		(464	)		106
Gain on disposition of property, plant and equipment		(627	)		(63	)
Changes in:
Receivables, net		8,645			(1,384	)
Inventories		(14,239	)		(14,330	)
Other current assets		(909	)		2,869
Accounts payable		(3,551	)		3,736
Accrued liabilities		14,010			(4,686	)
Net cash provided by operating activities		64,659			40,705

Cash flows from investing activites:
Additions to property, plant and equipment		(14,649	)		(20,755	)
Proceeds from disposition of property, plant and equipment		1,188			140
Increase in other assets		(339	)		(366	)
Net cash used in investing activities		(13,800	)		(20,981	)

Cash flows from financing activites:
Payments on short-term notes payable		-			(285	)
Dividends paid		(9,704	)		(6,536	)
Excess tax benefit from share-based compensation		2,706			2,810
Proceeds from exercise of stock options		2,792			2,301
Purchases of treasury stock		(22,037	)		-
Net cash used in financing activities		(26,243	)		(1,710	)

Effect of translation on cash and cash equivalents		530			54

Net increase in cash and cash equivalents		25,146			18,068

Cash and cash equivalents at beginning of period		57,797			25,822

Cash and cash equivalents at end of period	$	82,943		$	43,890

See notes to condensed consolidated financial statements.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Lufkin Industries, Inc. and its consolidated subsidiaries (the “Company”) and have been prepared pursuant to the rules and regulations for interim financial statements of the Securities and Exchange Commission. Certain information in the notes to the condensed consolidated financial statements normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America has been condensed or omitted pursuant to these rules and regulations. In the opinion of management, all adjustments, consisting of normal recurring accruals unless specified, necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods included in this report have been included. For further information, including a summary of major accounting policies, refer to the consolidated financial statements and related footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The results of operations for the three and nine months ended September 30, 2007, are not necessarily indicative of the results that may be expected for the full fiscal year.

2. Receivables

The following is a summary of the Company’s receivable balances (in thousands of dollars):

	September 30,			December 31,
	2007			2006

Accounts receivable	$	82,850		$	90,508
Notes receivable		455			472
Other receivables		714			292
Gross receivables		84,019			91,272

Allowance for doubtful accounts receivable		(266	)		(215	)
Allowance for doubtful notes receivable		(387	)		(472	)
Net receivables	$	83,366		$	90,585

Bad debt expense related to receivables was negligible in the three months ended September 30, 2007 and 2006, and in the nine months ended September 30, 2007 and 2006.

3. Other Current Accrued Liabilities

The following is a summary of the Company's other current accrued liabilities balances (in thousands of dollars):

	September 30,		December 31,
	2007		2006

Customer prepayments	$	13,416	$	9,411
Deferred compensation plans		4,601		4,069
Accrued professional services		695		1,057
Other accrued liabilities		902		1,440
Total other current accrued liabilities	$	19,614	$	15,977

4. Property, Plant & Equipment

The following is a summary of the Company's property, plant and equipment balances (in thousands of dollars):

	September 30,			December 31,
	2007			2006

Land	$	3,505		$	3,482
Land improvements		9,368			8,543
Buildings		77,814			75,082
Machinery and equipment		231,073			219,783
Furniture and fixtures		5,159			5,007
Computer equipment and software		14,280			14,027
Total property, plant and equipment		341,199			325,924
Less accumulated depreciation		(221,635	)		(212,843	)
Total property, plant and equipment, net	$	119,564		$	113,081

Depreciation expense related to property, plant and equipment was $3.7 million and $3.0 million in the three months ended September 30, 2007 and 2006, respectively, and $10.5 million and $8.6 million in the nine months ended September 30, 2007 and 2006, respectively.

5. Inventories

Inventories used in determining cost of sales were as follows (in thousands of dollars):

	September 30,		December 31,
	2007		2006
Gross inventories @ FIFO:
Finished goods	$	8,288	$	6,903
Work in progress		23,667		20,977
Raw materials & component parts		101,241		88,882
Total gross inventories @ FIFO		133,196		116,762
Less reserves:
LIFO		29,210		28,888
Valuation		1,629		2,244
Total inventories as reported	$	102,357	$	85,630

Gross inventories on a FIFO basis before adjustments for reserves shown above that were accounted for on a LIFO basis were $86.5 million and $82.7 million at September 30, 2007, and December 31, 2006, respectively.

6. Net Earnings Per Share

Net earnings per share amounts are based on the weighted average number of shares of common stock and common stock equivalents outstanding during the period. The weighted average number of shares used to compute basic and diluted net earnings per share for the three and nine months ended September 30, 2007 and 2006, are illustrated below (in thousands of dollars, except share and per share data):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2007		2006		2007		2006
Numerator:
Numerator for basic and diluted earnings per
share-net earnings	$	19,071	$	17,394	$	54,361	$	50,016

Denominator:
Denominator for basic net earnings per share
weighted-average shares		14,921,594		14,885,395		14,967,894		14,822,904
Effect of dilutive securities: employee stock
options		162,723		259,733		200,311		287,903
Denominator for diluted net earnings per share
adjusted weighted-average shares
assumed conversions		15,084,317		15,145,128		15,168,205		15,110,807

Basic net earnings per share	$	1.28	$	1.17	$	3.63	$	3.37
Diluted net earnings per share	$	1.26	$	1.15	$	3.58	$	3.31

Weighted options to purchase a total of 196,805 and 127,500 shares of the Company’s common stock for the three months ended September 30, 2007 and 2006, respectively, and 186,671 and 115,478 shares of the Company’s common stock for the nine months ended September 30, 2007 and 2006, respectively, were excluded from the calculation of fully diluted earnings per share because their effect on fully diluted earnings per share for the period would have been antidilutive.

7. Legal Proceedings

A class action complaint was filed in the U.S. District Court for the Eastern District of Texas on March 7, 1997, by an employee and a former employee which alleged race discrimination in employment. Certification hearings were conducted in Beaumont, Texas in February 1998 and in Lufkin, Texas in August 1998. In April 1999, the District Court issued a decision that certified a class for this case, which included all black employees employed by the Company from March 6, 1994, to the present. The case was closed from 2001 to 2003 while the parties unsuccessfully attempted mediation. Trial for this case began in December 2003, but was postponed by the District Court and was completed in October 2004. The only claims made at trial were those of discrimination in initial assignments and promotions.

On January 13, 2005, the District Court entered its decision finding that the Company discriminated against African-American employees in initial assignments and promotions. The District Court also concluded that the discrimination resulted in a shortfall in income for those employees and ordered that the Company pay those employees back pay to remedy such shortfall, together with pre-judgment interest in the amount of 5%. On August 29, 2005, the District Court determined that the backpay award for the class of affected employees would be $3.4 million (including interest to January 1, 2005) and provided a formula for attorney fees that the Company estimates will result in a total not to exceed $2.5 million. In addition to back pay with interest, the District Court (i) enjoined and ordered the Company to cease and desist all racially biased assignment and promotion practices and (ii) ordered the Company to pay court costs and expenses.

The Company has reviewed this decision with its outside counsel and on September 19, 2005, appealed the decision to the U.S. Court of Appeals for the Fifth Circuit. On April 3, 2007, the Company appeared before the appellate court in New Orleans for oral argument in this case. The three justices in this case will now prepare their decision and the Company anticipates that the decision will be issued in the fourth quarter of 2007. The Company believes that after a full and fair review of the evidence, the Court of Appeals will determine that the plaintiffs have not established their claims of discrimination by the Company against the plaintiffs and will enter a decision to that effect and will dismiss the case against the Company. At this time, the Company has concluded that an unfavorable ultimate outcome is not probable. If the District Court’s decision is reversed and remanded for a new trial, the Company will vigorously defend itself on retrial. While the ultimate outcome and impact of these claims against the Company cannot be predicted with certainty, the Company believes that the resolutions of these proceedings will not have a material adverse effect on its consolidated financial position. However, should the Company be unsuccessful in its appeal, the final determination could have a material impact on the Company’s reported earnings, results of operations and cash flows in a future reporting period.

There are various other claims and legal proceedings arising in the ordinary course of business pending against or involving the Company wherein monetary damages are sought. It is management’s opinion that the Company’s liability, if any, under such claims or proceedings would not materially affect its consolidated financial position, results of operations or cash flow.

8. Comprehensive Income

Comprehensive income includes net income and changes in the components of accumulated other comprehensive income/(loss) during the periods presented. The Company’s comprehensive income is as follows (in thousands of dollars):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2007			2006			2007			2006

Net earnings		19,071			17,394			54,361			50,016

Other comprehensive income, before tax:

Change in foreign currency translation

Foreign currency translation adjustments		2,433			(127	)		4,621			1,316

Defined benefit pension plans:

Amortization of prior service cost included
in net periodic benefit cost		141			-			424			-
Amortization of unrecognized transition
asset included in net periodic benefit cost		(232	)		-			(695	)		-
Amortization of unrecognized net loss
included in net periodic benefit cost		25			-			76			-
Net loss arising during period		(31	)		-			(2,385	)		-

Total defined benefit pension plans		(97	)		-			(2,580	)		-

Defined benefit postretirement plans:

Amortization of unrecognized net gain
included in net periodic benefit cost		(57	)		-			(170	)		-
Net gain arising during period		-			-			987			-

Total defined benefit postretirement plans		(57	)		-			817			-

Total other comprehensive income, before tax		2,279			(127	)		2,858			1,316

Income tax benefit related to items of other
comprehensive income		54			-			617			-

Total other comprehensive income/(loss), net of tax		2,333			(127	)		3,475			1,316

Total comprehensive income	$	21,404		$	17,267		$	57,836		$	51,332

Accumulated other comprehensive income/(loss) in the consolidated balance sheet consists of the following (in thousands of dollars):

			Defined			Defined		Accumulated
	Foreign		Benefit			Benefit		Other
	Currency		Pension			Postretirement		Comprehensive
	Translation		Plans			Plans		Income/(Loss)

Balance, Dec. 31, 2006	$	2,958	$	(5,758	)	$	1,329	$	(1,471	)

Current-period change		4,621		(1,677	)		531		3,475

Balance, September 30, 2007		7,579		(7,435	)		1,860		2,004

9. Stock Repurchase Plans

During the third quarter of 2007, the Company repurchased shares pursuant to several plans approved by the Board of Directors, under which the Company was authorized to spend up to an aggregate of $35.0 million for repurchases of its common stock, including (1) an authorization of $3.0 million made in the third quarter of 1999, (2) an authorization of $2.0 million made in the second quarter of 2003 and (3) an authorization of $30.0 million made in the third quarter of 2007. Repurchased shares are added to treasury stock and are available for general corporate purposes including the funding of the Company’s stock option plans. During the third quarter of 2007, 400,000 shares were repurchased under the above plans at an aggregate price of $22.0 million, or an average price of $55.09. No shares were repurchased in the first half of 2007. As of September 30, 2007, 284,678 shares had been repurchased at an aggregate price of $3.0 million, or $10.54 per share under the 1999 plan, 35,817 shares had been repurchased at an aggregate price of $2.0 million, or $55.84 per share under the 2003 plan and 362,131 shares had been repurchased at an aggregate price of $19.9 million, or $55.00 per share under the 2007 plan. As of September 30, 2007, the Company held 795,278 shares of treasury stock at an aggregate cost of approximately $26.1 million. At September 30, 2007, approximately $10.1 million of repurchase authorizations remained under the 2007 plan.

10. Segment Data

The Company operates with three business segments - Oil Field, Power Transmission and Trailer. The three operating segments are supported by a common corporate group. Corporate expenses and certain assets are allocated to the operating segments based primarily upon historical third-party revenues. Inter-segment sales and transfers are accounted for as if the sales and transfers were to third parties at current market prices, as available. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in the footnotes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The following is a summary of key segment information (in thousands of dollars):

Three Months Ended September 30, 2007

				Power
	Oil Field			Transmission			Trailer			Corporate		Total

Gross sales	$	97,081		$	41,533		$	9,441		$	-	$	148,055
Inter-segment sales		(479	)		(646	)		(50	)		-		(1,175	)
Net sales	$	96,602		$	40,887		$	9,391		$	-	$	146,880

Operating income (loss)	$	19,652		$	8,061		$	(696	)	$	-	$	27,017
Other income (expense), net		589			(98	)		621			987		2,099
Earnings (loss) before
income tax provision	$	20,241		$	7,963		$	(75	)	$	987	$	29,116

Three Months Ended September 30, 2006

				Power
	Oil Field			Transmission			Trailer		Corporate		Total

Gross sales	$	110,264		$	32,172		$	19,537	$	-	$	161,973
Inter-segment sales		(681	)		(2,490	)		-		-		(3,171	)
Net sales	$	109,583		$	29,682		$	19,537	$	-	$	158,802

Operating income (loss)	$	22,957		$	2,712		$	52	$	-	$	25,721
Other income (expense), net		14			(17	)		10		445		452
Earnings (loss) before
income tax provision	$	22,971		$	2,695		$	62	$	445	$	26,173

Nine Months Ended September 30, 2007

				Power
	Oil Field			Transmission			Trailer			Corporate		Total

Gross sales	$	293,247		$	117,931		$	33,547		$	-	$	444,725
Inter-segment sales		(2,186	)		(2,944	)		(129	)		-		(5,259	)
Net sales	$	291,061		$	114,987		$	33,418		$	-	$	439,466

Operating income (loss)	$	60,023		$	20,553		$	(2,427	)	$	-	$	78,149
Other income (expense), net		1,167			(33	)		618			2,836		4,588
Earnings (loss) before
income tax provision	$	61,190		$	20,520		$	(1,809	)	$	2,836	$	82,737

Nine Months Ended September 30, 2006

				Power
	Oil Field			Transmission			Trailer			Corporate		Total

Gross sales	$	295,439		$	97,381		$	56,761		$	-	$	449,581
Inter-segment sales		(2,547	)		(7,150	)		(2	)		-		(9,699	)
Net sales	$	292,892		$	90,231		$	56,759		$	-	$	439,882

Operating income (loss)	$	62,580		$	13,051		$	(555	)	$	-	$	75,076
Other income (expense), net		(16	)		(97	)		9			1,389		1,285
Earnings (loss) before
income tax provision	$	62,564		$	12,954		$	(546	)	$	1,389	$	76,361

11. Goodwill and Intangible Assets

Goodwill

The changes in the carrying amount of goodwill for the nine months ended September 30, 2007, are as follows (in thousands of dollars):

			Power
	Oil Field		Transmission		Trailer		Total

Balance as of 12/31/06	$	9,432	$	2,300	$	-	$	11,732

Foreign currency translation		15		184		-		199
Balance as of 9/30/07	$	9,447	$	2,484	$	-	$	11,931

Goodwill impairment tests were performed in the first quarter of 2007 and no impairment losses were recorded.

Intangible Assets

Balances and related accumulated amortization of intangible assets are as follows (in thousands of dollars):

	September 30,			December 31,
	2007			2006
Intangible assets subject to amortization:
Non-compete agreements
Original balance	$	463		$	463
Foreign currency translation		33			20
Accumulated amortization		(355	)		(285	)

Ending balance	$	141		$	198

12. Stock Option Plans

On January 1, 2006, the Company adopted SFAS 123-Revised 2004 (“SFAS 123R”), “Share-Based Payment,” using the modified prospective method. SFAS 123R is a revision of SFAS No. 123 “Accounting for Stock-Based Compensation,” and supersedes APB No. 25, “Accounting for Stock Issued to Employees.” This Statement requires that the cost of employee services received in exchange for stock based on the grant-date fair value be measured and that the cost be recognized over the period during which the employee is required to provide service in exchange for the award. Excess tax benefits, as defined in SFAS 123R, will be recognized as additional paid-in-capital.

Under the modified prospective method, the Company began recognizing expense on January 1, 2006, on any unvested awards granted prior to the adoption date of January 1, 2006, expected to vest over the remaining vesting period of the awards. New awards granted after the adoption date will be expensed pro-ratably over the vesting period of the award.

The Company currently has three stock compensation plans that are affected by SFAS 123R. The 1990 Stock Option Plan, the 1996 Nonemployee Director Stock Option Plan and the 2000 Incentive Stock Compensation Plan provide for the granting of stock options to officers, employees and non-employee directors at an exercise price equal to the fair market value of the stock at the date of grant. The 2000 Incentive Stock Compensation Plan also provides for other forms of stock-based compensation such as restricted stock, but none have been granted to date. Options granted to employees vest over two to four years and are exercisable up to ten years from the grant date. Upon retirement, any unvested options become exercisable immediately. Options granted to directors vest at the grant date and are exercisable up to ten years from the grant date.

The following table is a summary of the stock-based compensation expense recognized under SFAS 123R for the three and nine months ended September 30, 2007 and 2006 (in thousands of dollars):

	Three Months Ended		Nine Months Ended
	September 30,		September 30,
	2007	2006	2007	2006

Stock-based compensation expense	$ 326	$ 410	$ 2,596	$ 2,004
Tax benefit	(121)	(156)	(961)	(761)
Stock-based compensation expense, net of tax	$ 205	$ 254	$ 1,635	$ 1,243

The fair value of each option grant during the first nine months of 2007 and 2006 was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

	2007			2006

Expected dividend yield		1.30% - 1.38	%		0.69% - 0.91	%
Expected stock price volatility		42.00% - 45.00	%		44.12% - 45.35	%
Risk free interest rate		4.56% - 4.85	%		4.52% - 5.01	%
Expected life options		3 - 6 years			6 - 8 years
Weighted-average fair value per share at grant date	$	23.28		$	28.16

The expected life of options was determined based on the exercise history of employees and directors since the inception of the plans. The expected volatility is based upon the historical weekly and daily stock price for the prior number of years equivalent to the expected life of the stock option. The expected dividend yield was based on the dividend yield of the Company’s common stock at the date of the grant. The risk free interest rate was based upon the yield of U.S. Treasuries which terms were equivalent to the expected life of the stock option.

A summary of stock option activity under the plans during the nine months ended September 30, 2007, is presented below:

						Weighted-
				Weighted-		Average		Aggregate
				Average		Remaining		Intrinsic
				Exercise		Contractual		Value
Options	Shares			Price		Term		($000's)

Outstanding at January 1, 2007		743,761		$	29.06
Granted		51,000			62.05
Exercised		(177,569	)		15.72
Forfeited or expired		(8,187	)		38.67
Outstanding at September 30, 2007		609,005		$	35.58		7.2	$	13,220
Exercisable at September 30, 2007		294,226		$	31.16		6.5	$	7,657

As of September 30, 2007, there was $2.5 million of total unrecognized compensation expense related to non-vested stock options. That cost is expected to be recognized over a weighted-average period of 1.5 years. The intrinsic value of stock options exercised in the first nine months of 2007 was $8.4 million.

13. Recently Issued Accounting Pronouncements

Management believes the impact of recently issued standards, which are not yet effective, will not have a material impact on the Company's condensed consolidated condensed financial statements upon adoption.

14. Retirement Benefits

The Company has a qualified noncontributory pension plan covering substantially all U.S. employees. The benefits provided by this plan are measured by length of service, compensation and other factors, and are currently funded by trusts established under the plans. Funding of retirement costs for these plans complies with the minimum funding requirements specified by the Employee Retirement Income Security Act, as amended. In addition, the Company has two unfunded non-qualified deferred compensation pension plans for certain U.S. employees. The Pension Restoration Plan provides supplemental retirement benefits. The benefit is based on the same benefit formula as the qualified pension plan except that it does not limit the amount of a participant's compensation or maximum benefit. The Company also provides a Supplemental Executive Retirement Plan that credits an individual with 0.5 years of service for each year of service credited under the qualified plan. The benefits calculated under the non-qualified pension plans are offset by the participant's benefit payable under the qualified plan. The liabilities for the non-qualified deferred compensation pensions plans are included in "Other current accrued liabilities" and “Other liabilities” on the consolidated condensed balance sheet.

The Company sponsors two defined benefit postretirement plans that cover both salaried and hourly employees. One plan provides medical benefits, and the other plan provides life insurance benefits. Both plans are contributory, with retiree contributions adjusted periodically. The Company accrues the estimated costs of the plans over the employees’ service periods. The Company's postretirement health care plan is unfunded. For measurement purposes, the submitted claims medical trend was assumed to be 9.25% in 1997. Thereafter, the Company’s obligation is fixed at the amount of the Company’s contribution for 1997. Measures of the accumulated postretirement benefit obligation and net periodic postretirement benefit cost do not reflect any amount associated with the subsidy because the Company’s plan is not actuarially equivalent to Medicare Part D and is not expected to receive any subsidy.

The Company also has qualified defined contribution retirement plans covering substantially all of its U.S. and Canadian employees. For U.S. employees, the Company makes contributions of 75% of employee contributions up to a maximum employee contribution of 6% of employee earnings. Employees may contribute up to an additional 18% (in 1% increments), which is not subject to match by the Company. For Canadian employees, the Company makes contributions of 3%-8% of an employee’s salary with no individual employee match required. All obligations of the Company are funded through September 30, 2007. In addition, the Company provides an unfunded non-qualified deferred compensation defined contribution plan for certain U.S. employees. The Company's and individual's contributions are based on the same formula as the qualified contribution plan except that it does not limit the amount of a participant's compensation or maximum benefit. The contribution calculated under the non-qualified defined contribution plan is offset by the Company's and participant's contributions under the qualified plan. The Company’s expense for these plans totaled $0.8 million and $0.7 million in the three months ended September 30, 2007 and 2006, respectively, and $2.3 million and $2.1 million in the nine months ended September 30, 2007 and 2006, respectively. The liability for the non-qualified deferred defined contribution plan is included in "Other current accrued liabilities" on the consolidated condensed balance sheet.

Components of Net Periodic Benefit Cost (in thousands of dollars)

	Pension Benefits						Other Benefits
Three Months Ended September 30,	2007			2006			2007			2006

Service cost	$	1,363		$	1,295		$	44		$	43
Interest cost		2,433			2,276			114			126
Expected return on plan assets		(4,411	)		(4,115	)		-			-
Amortization of prior service cost		141			142			-			-
Amortization of unrecognized net (gain) loss		25			15			(57	)		(39	)
Amortization of unrecognized transition asset		(232	)		(232	)		-			-
Net periodic benefit cost (income)	$	(681	)	$	(619	)	$	101		$	130

	Pension Benefits						Other Benefits
Nine Months Ended September 30,	2007			2006			2007			2006

Service cost	$	4,089		$	3,884		$	131		$	205
Interest cost		7,294			6,827			343			525
Expected return on plan assets		(13,234	)		(12,344	)		-			-
Amortization of prior service cost		424			425			-			-
Amortization of unrecognized net (gain) loss		76			46			(170	)		35
Amortization of unrecognized transition asset		(695	)		(695	)		-			-
Net periodic benefit cost (income)	$	(2,046	)	$	(1,857	)	$	304		$	765

Employer Contributions

The Company previously disclosed in its financial statements for the year ended December 31, 2006, that it expected to make contributions of $160,000 to its pension plans in 2007. The Company also disclosed that it expected contributions of $772,000 to be made to its postretirement plan in 2007. As of September 30, 2007, the Company has made contributions of $23,000 to its pension plans and has made contributions of $918,000 to its postretirement plan. The Company presently anticipates making additional contributions of $8,000 to its pension plans and $115,000 to its postretirement plan during the last three months of 2007.

15. Adoption of FIN 48

The Company adopted FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes- an interpretation of FASB Statement No. 109”, on January 1, 2007. As of January 1, 2007, the Company had approximately $3,382,000 of total gross unrecognized tax benefits. Of this total, $2,898,000 (net of the federal benefit on state issues) represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the net effective income tax rate in any future period. As of September 30, 2007, the Company had approximately $2,500,000 of total gross unrecognized tax benefits.

The Company has unrecognized tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next twelve months. These unrecognized tax benefits relate to deductions for certain accrued liabilities. The Company has initiated the procedural steps to resolve these uncertain tax positions and estimates the range of possible change to be $150,000 to $250,000.

The Company conducts business globally and, as a result, Lufkin Industries, Inc. and its subsidiaries file income tax returns in the U.S. federal and state jurisdictions, and various foreign jurisdictions. For U.S. federal purposes, tax years prior to 2002 are closed to assessment and the 2002 tax year is open to examination only to the extent of certain refund claims filed. The 2003 through 2006 tax years remain open to examination by U.S. federal and state authorities. The Company is currently under IRS examination for the 2002-2004 tax years for its amendments to those tax years, the originally filed and amended 2005 tax return and the originally filed 2006 tax return. This examination is in the preliminary stage and the Company has no reasonable basis to conclude that any unrecognized tax benefits associated with these years will significantly increase or decrease within the next twelve months. Statutes for years prior to 2003 remain subject to review in certain US state jurisdictions; however, the outcome of any future audit is not expected to have a material effect on the Company’s results of operations. The Company also remains subject to income tax examinations in the following material international jurisdictions: Canada (2002-2006), France (2004-2006) and Argentina (2001-2005).

Lufkin’s continuing practice is to recognize interest and penalties related to income tax matters in administrative costs. The Company had $146,000 accrued for interest and penalties at December 31, 2006. Interest of $19,000 and $106,000 was accrued during the three and nine months ended September 30, 2007, respectively.

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

Overview

General

Lufkin Industries is a global supplier of oil field, power transmission and trailer products. Through its Oil Field segment, the Company manufactures and services artificial reciprocating rod lift equipment and related products, 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 speed increasing and reducing gearboxes for industrial applications. Through its Trailer segment, the Company manufactures various highway trailers, including flatbed and dump trailers. While these markets are price-competitive, technological and quality differences can provide product differentiation.

The Company’s strategy is to differentiate its products through additional value-added capabilities. Examples of these capabilities are high-quality engineering, customized designs, rapid manufacturing response to demand through plant capacity, inventory and vertical integration, superior quality and customer service, and an international network of service locations. In addition, the Company’s strategy is to maintain a low debt-to-equity ratio in order to quickly take advantage of growth opportunities and pay dividends even during unfavorable business cycles.

In support of the above strategy, the Company has been making capital investments in Oil Field to increase manufacturing capacity and capabilities in its three main manufacturing facilities in Lufkin, Texas, Canada and Argentina. These investments should reduce production lead times and improve quality. Investments also continue to be made to expand the Company’s presence in automation products and international service, as with the recently opened service facility in Oman.

In Power Transmission, the Company continues to expand its gear repair network by opening and expanding facilities in various locations in the US and Canada. The Company is making targeted capital investments in the U.S. and France to expand capacity and reduce manufacturing lead times as well as certain capital investments targeting cost reductions.

Trends/Outlook

Oilfield

Demand for pumping unit equipment primarily depends on the level of new onshore oil well and workover drilling activity as well as the depth and fluid conditions of that drilling. Drilling activity is driven by the available cash flow of the Company’s customers as well as their long-term perceptions of the level and stability of the price of oil. The higher energy prices experienced since 2004 have increased the demand for pumping units and related service and products from higher drilling activity, activation of idle wells and the upgrading of existing wells. During 2007, demand in the North American market has been negatively affected, compared to 2006 levels, by the impact of lower natural gas prices on coal-bed methane and other unconventional gas production that use rod pumps to de-water wells, drilling program delays from M&A activity, cost control efforts deferring or reducing capital spending programs and the competitive pressure from lower-priced pumping units in areas traditionally served by the used unit market. Traditionally, as pumping unit demand increases and availability of used equipment diminishes, demand for new equipment increases, as was experienced in 2006. Increasingly in 2007, lower-priced imported pumping units have entered the North American market in place of used equipment and reduced the incremental demand for the Company’s new pumping units. However, the demand for pumping units, oilfield services and automation equipment continue to increase in international markets. While a majority of the segment’s revenues are in North America, international opportunities continue to increase as new drilling increases and existing fields mature, requiring increased use of pumping units for artificial lift, especially in the South American, Russian and Middle Eastern markets.

Power Transmission

Power Transmission services many diverse markets, with high-speed gearing for markets such as petrochemicals, refineries, offshore production and transmission of oil and slow-speed gearing for the gas, rubber, sugar, paper, steel, plastics, mining, cement and marine propulsion, each of which has its own unique set of drivers. Favorable conditions for one market may be unfavorable for another market. Generally, if general global industrial capacity utilizations are not high, spending on new equipment lags. Also impacting demand are government regulations involving safety and environmental issues that can require capital spending. Recent market demand increases have come from energy-related markets such as refining, petrochemical, drilling, coal, marine and power generation in response to higher global energy prices. These market trends are expected to continue throughout 2007, assuming energy prices stay at recent levels.

Trailer

The Company primarily sells its trailer products in the United States to small and medium size fleet freight-hauling companies through a dealer network. Demand in this market is driven by the available cash flow or financing capabilities of the industry, age of the trailer fleets, changes in government regulations, availability of quality used trailers and the medium-term outlook for freight volumes. The profitability of the freight-hauling market is driven by freight volumes, fuel prices, wage levels and insurance costs. Due to poor market conditions, the Company decided in the third quarter of 2006 not to participate in the van market until market conditions support better operating margins. This will give Trailer the capability to expand manufacturing capacity of flatbed and dump trailers quickly in response to market demand. However, recent flatbed and dump trailer demand has decreased due to the reduced activity in the home and road construction markets as well as reduced profitability from higher fuel prices. In the third quarter of 2007, industry order rates and backlog for flatbed trailers decreased over 50% and for dump trailers over 25% compared to comparable 2006 levels.

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, as well as debt/equity levels, short-term debt levels, and cash balances.

Overall, sales for the three months ended September 30, 2007, decreased 7.5% to $146.9 million from $158.8 million for the three months ended September 30, 2006. This decline was primarily driven by lower sales of van trailers related to the Company’s decision to suspend that product line and lower sales of new oil field equipment in the North American market. However, sales for the nine months ended September 30, 2007, decreased slightly to $439.5 million from $439.9 million for the nine months ended September 30, 2006, or 0.1%.

Gross margin for the three months ended September 30, 2007, increased to 27.9% from 24.4% for the three months ended September 30, 2006, primarily due to improved margins in Power Transmission from high-speed units. Gross margin for the nine months ended September 30, 2007, increased to 27.6% from 25.8% for the nine months ended September 30, 2006, from improved Power Transmission margins and the favorable mix effect of increased higher-margin Power Transmission sales offsetting reduced lower-margin Trailer sales. Additional segment data on gross margin is provided later in this section.

The changes in sales and gross margin primarily drove the changes in net earnings, but increases in selling, general and administrative, or S, G & A, expenses had a negative impact on net earnings. S, G & A expenses as a percentage of revenue increased to 9.5% for the three months ended September 30, 2007, from 8.2% for the three months ended September 30, 2006, and increased to 9.8% for the nine months ended September 30, 2007, from 8.7% for the nine months ended September 30, 2006. These increases were related to increases in personnel-related expenses in response to prior and expected sales growth and higher stock option expense. The Company reported net earnings of $19.1 million or $1.26 per share (diluted) for the three months ended September 30, 2007, compared to net earnings of $17.4 million or $1.15 per share (diluted) for the three months ended September 30, 2006, and net earnings of $54.4 million or $3.58 per share (diluted) for the nine months ended September 30, 2007, compared to net earnings of $50.0 million or $3.31 per share (diluted) for the nine months ended September 30, 2006.

Debt/equity (long-term debt net of current portion as a percentage of total equity) levels were 0.0% as of September 30, 2007, and September 30, 2006. The Company had no short-term debt at September 30, 2007 and December 31, 2006. Cash balances at September 30, 2007, were $82.9 million, up from $57.8 million at December 31, 2006, due to higher net earnings offsetting capital expenditures and treasury stock purchases and dividends.

Three Months Ended September 30, 2007, Compared to Three Months Ended September 30, 2006

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/
	2007		2006		(Decrease)			(Decrease)
Sales
Oil Field	$	96,602	$	109,583	$	(12,981	)		(11.8	)
Power Transmission		40,887		29,682		11,205			37.8
Trailer		9,391		19,537		(10,146	)		(51.9	)
Total	$	146,880	$	158,802	$	(11,922	)		(7.5	)

Gross Profit
Oil Field	$	25,981	$	28,810	$	(2,829	)		(9.8	)
Power Transmission		13,996		8,143		5,853			71.9
Trailer		1,039		1,734		(695	)		(40.1	)
Total	$	41,016	$	38,687	$	2,329			6.0

Oil Field

Oil Field sales decreased to $96.6 million, or 11.8%, for the three months ended September 30, 2007, from $109.6 million for the three months ended September 30, 2006. Decreased sales of new pumping units in the North American market were partially offset by higher sales of new pumping units in the Middle East and Argentina markets. Oil Field’s backlog decreased to $63.7 million as of September 30, 2007, from $79.7 million at September 30, 2006. This decrease is primarily related to the weaker demand for new pumping units in the North American market.

Gross margin (gross profit as a percentage of sales) for the Oil Field segment increased slightly to 26.9% for three months ended September 30, 2007, compared to 26.3% for the three months ended September 30, 2006, or 0.6 percentage points. This increase was primarily caused by higher margins on international pumping unit sales and the results of cost reduction initiatives related to prior-period capital spending.

Direct selling, general and administrative expenses for Oil Field increased to $4.2 million, or 6.5%, for the three months ended September 30, 2007, from $3.9 million for the three months ended September 30, 2006. This increase is due to higher employee-related expenses in support of increased sales levels. Direct selling, general and administrative expenses as a percentage of sales also increased to 4.3% for the three months ended September 30, 2007, from 3.6% for the three months ended September 30, 2006.

Power Transmission

Sales for the Company’s Power Transmission segment increased to $40.9 million, or 37.8%, for the three months ended September 30, 2007, compared to $29.7 million for the three months ended September 30, 2006. This growth was the result of increased sales of high-speed units to the energy-related markets, such as power generation and oil and gas drilling, production and refining from both the U.S. and France manufacturing facilities and marine units for the river-transportation market. Power Transmission backlog at September 30, 2007, increased to $120.3 million from $81.8 million at September 30, 2006, primarily from sales of new units for the energy-related and marine markets.

Gross margin for the Power Transmission segment increased to 34.2% for the three months ended September 30, 2007, compared to 27.4% for the three months ended September 30, 2006, from increased sales of higher-margin high-speed units and reduced warranty expenses.

Direct selling, general and administrative expenses for Power Transmission increased to $4.2 million, or 8.5%, for the three months ended September 30, 2007, from $3.9 million for the three months ended September 30, 2006. This increase is due to higher employee-related expenses in support of increased sales volumes. Direct selling, general and administrative expenses as a percentage of sales, however, decreased to 10.4% for the three months ended September 30, 2007, from 13.1% for the three months ended September 30, 2006.

Trailer

Trailer sales for the three months ended September 30, 2007, decreased to $9.4 million, or 51.9%, from $19.5 million for the three months ended September 30, 2006. This decrease is primarily related to the decline in new van trailer sales, representing 90% of the sales decline. New van sales were impacted by the Company’s decision in 2006 not to take additional orders for van trailers due to poor market conditions. Sales for flatbed and dump trailers were also down due to weakness in the home construction market, low demand in the road construction market and reduced Gulf-coast clean-up efforts from lower hurricane activity. Backlog for the Trailer segment decreased to $8.6 million at September 30, 2007, compared to $31.7 million at September 30, 2006. The backlog decrease was primarily from lower van trailer backlog related to the decision to not take additional van trailer orders as well as from lower flatbed and dump orders.

Trailer gross margin increased to 11.1% for the three months ended September 30, 2007, from 8.9% for the three months ended September 30, 2006, or 2.2 percentage points. This increase was primarily due to the favorable mix effect of lower van trailer sales, which traditionally had lower gross margins than flatbed or dump trailers.

Direct selling, general and administrative expenses for Trailer decreased to $0.4 million, or 18.7%, for the three months ended September 30, 2007, from $0.5 million for the three months ended September 30, 2006, from lower personnel-related expenses in response to reduced volumes. However, direct selling, general and administrative expenses as a percentage of sales increased to 4.0% for the three months ended September 30, 2007, from 2.3% for the three months ended September 30, 2006.

Corporate/Other

Corporate administrative expenses, which are allocated to the segments primarily based on historical third-party revenues, increased to $5.2 million, or 11.3%, for the three months ended September 30, 2007, from $4.7 million for the three months ended September 30, 2006, primarily from higher employee-related expenses.

Net interest income, interest expense and other income and expense for the three months ended September 30, 2007, totaled $2.1 million of income compared to income of $0.5 million for the three months ended September 30, 2006, primarily due to an increase in interest income from higher cash balances and the favorable impact of the stronger Canadian currency on U.S. dollar-denominated liabilities.

Pension income, which is reported as a reduction of cost of sales, increased to $0.8 million for the three months ended September 30, 2007, or 12%, compared to $0.7 million for the three months ended September 30, 2006. Pension income in 2007 is expected to increase to approximately $3.2 million from $2.9 million in 2006.

The net tax rate for the three months ended September 30, 2007, was 34.5% compared to 33.5% in the three months ended September 30, 2006. The net tax rate for the three months ended September 30, 2006, benefited from prior-period estimate adjustments. The 2007 effective tax rate is expected to be approximately 34.5 to 35.0%.

Nine Months Ended September 30, 2007, Compared to Nine Months Ended September 30, 2006

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/
	2007		2006		(Decrease)			(Decrease)
Sales
Oil Field	$	291,061	$	292,892	$	(1,831	)		(0.6	)
Power Transmission		114,987		90,231		24,756			27.4
Trailer		33,418		56,759		(23,341	)		(41.1	)
Total	$	439,466	$	439,882	$	(416	)		(0.1	)

Gross Profit
Oil Field	$	79,587	$	79,664	$	(77	)		(0.1	)
Power Transmission		38,823		28,774		10,049			34.9
Trailer		2,982		4,840		(1,858	)		(38.4	)
Total	$	121,392	$	113,278	$	8,114			7.2

Oil Field

Oil Field sales decreased slightly to $291.1 million, or 0.6%, for the nine months ended September 30, 2007, from $292.9 million for the nine months ended September 30, 2006. Increased sales of oilfield services, automation equipment and new pumping units in the Middle East and Argentina markets was offset by lower sales of new pumping units in the North American market. Oil Field’s backlog decreased to $63.7 million as of September 30, 2007, from $67.1 million at December 31, 2006. This decrease is related to the weaker demand for new pumping units in the North American market.

Gross margin (gross profit as a percentage of sales) for the Oil Field segment increased slightly to 27.3% for nine months ended September 30, 2007, compared to 27.2% for the nine months ended September 30, 2006, or 0.1 percentage points.

Direct selling, general and administrative expenses for Oil Field increased to $12.9 million, or 13.3%, for the nine months ended September 30, 2007, from $11.4 million for the nine months ended September 30, 2006. This increase is due to higher employee-related expenses in support of increased sales levels. Direct selling, general and administrative expenses as a percentage of sales also increased to 4.4% for the nine months ended September 30, 2007, from 3.9% for the nine months ended September 30, 2006.

Power Transmission

Sales for the Company’s Power Transmission segment increased to $115.0 million, or 27.4%, for the nine months ended September 30, 2007, compared to $90.2 million for the nine months ended September 30, 2006. This growth was the result of increased sales of high-speed units to the energy-related markets, such as power generation and oil and gas drilling, production and refining from both the U.S. and France manufacturing facilities and marine units for the river-transportation market. Power Transmission backlog at September 30, 2007, increased to $120.3 million from $95.6 million at December 31, 2006, primarily from sales of new units for the marine and oil-drilling markets.

Gross margin for the Power Transmission segment increased to 33.8% for the nine months ended September 30, 2007, compared to 31.9% for the nine months ended September 30, 2006, from increased plant efficiencies and fixed cost coverage from higher production volumes.

Direct selling, general and administrative expenses for Power Transmission increased to $13.1 million, or 15.9%, for the nine months ended September 30, 2007, from $11.3 million for the nine months ended September 30, 2006. This increase is due to higher employee-related expenses in support of increased sales volumes. Direct selling, general and administrative expenses as a percentage of sales, however, decreased to 11.4% for the nine months ended September 30, 2007, from 12.5% for the nine months ended September 30, 2006.

Trailer

Trailer sales for the nine months ended September 30, 2007, decreased to $33.4 million, or 41.1%, from $56.8 million for the nine months ended September 30, 2006. This decrease is primarily related to the decline in new van trailer sales, representing over 85% of the sales decline. New van sales were impacted by the Company’s decision in 2006 not to take additional orders for van trailers due to poor market conditions. Sales for flatbed and dump trailers were also down due to weakness in the home construction market, low demand in the road construction market and reduced Gulf-coast clean-up efforts from lower hurricane activity. Backlog for the Trailer segment decreased to $8.6 million at September 30, 2007, compared to $18.4 million at December 31, 2006. The backlog decrease was primarily from lower flatbed and dump orders as well as from lower van trailer backlog related to the decision to not take additional van trailer orders.

Trailer gross margin increased slightly to 8.9% for the nine months ended September 30, 2007, from 8.5% for the nine months ended September 30, 2006, or 0.4 percentage points. This increase was primarily due to the favorable mix effect of lower van trailer sales, which traditionally had lower gross margins than flatbed or dump trailers, being partially offset by plant reconfiguration costs in the first quarter of 2007 and lower plant utilization impacting fixed cost coverage.

Direct selling, general and administrative expenses for Trailer decreased to $1.3 million, or 31.9%, for the nine months ended September 30, 2007, from $1.9 million for the nine months ended September 30, 2006, from lower general liability legal and claims expenses and revised bad debt estimates of notes receivables. Direct selling, general and administrative expenses as a percentage of sales increased to 3.8% for the nine months ended September 30, 2007, from 3.3% for the nine months ended September 30, 2006.

Corporate/Other

Corporate administrative expenses, which are allocated to the segments primarily based on historical third-party revenues, increased to $16.0 million, or 17.1%, for the nine months ended September 30, 2007, from $13.6 million for the nine months ended September 30, 2006, primarily from the higher employee-related and stock option expenses.

Net interest income, interest expense and other income and expense for the nine months ended September 30, 2007, totaled $4.6 million of income compared to income of $1.3 million for the nine months ended September 30, 2006, primarily due to an increase in interest income from higher cash balances and the favorable impact of the stronger Canadian currency on U.S. dollar-denominated liabilities.

Pension income, which is reported as a reduction of cost of sales, increased to $2.4 million for the nine months ended September 30, 2007, or 12%, compared to $2.2 million for the nine months ended September 30, 2006, primarily from expected asset returns exceeding expected expense increases. Pension income in 2007 is expected to increase to approximately $3.2 million from $2.9 million in 2006.

The net tax rate for the nine months ended September 30, 2007, was 34.3% compared to 34.5% in the nine months ended September 30, 2006. The 2007 effective tax rate is expected to be approximately 34.5 to 35.0%.

Liquidity and Capital Resources

The Company has historically relied on cash flows from operations and third-party borrowing 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 credit agreements will be sufficient to fund its operations, including planned capital expenditures, dividend payments and stock repurchases, through December 31, 2007.

The Company’s cash balance totaled $82.9 million at September 30, 2007, compared to $57.8 million at December 31, 2006. For the nine months ended September 30, 2007, net cash provided by operating activities was $64.7 million, net cash used in investing activities totaled $13.8 million, net cash used in financing activities amounted to $26.2 million and the favorable effect of currency translation was $0.5 million. Significant components of cash provided by operating activities included net earnings, adjusted for non-cash expenses, of $60.7 million, and a decrease in working capital of $4.0 million. This working capital decrease was primarily due to reduced receivables balances of $9.1 million from reduced sales volumes and the timing of estimated income and property tax payments of $9.6 million. An increase in inventory balances of $14.2 million from higher production activity in Power Transmission and Oil Field automation products partially offset these decreases. Net cash used in investing activities included net capital expenditures totaling $14.6 million, asset disposal proceeds of $1.2 million and an increase in other assets of $0.4 million, primarily from the increased cash value of executive life policies. Capital expenditures in the first nine months of 2007 were primarily for the expansion of manufacturing capacity and efficiency improvements in the Oil Field and Power Transmission segments. Capital expenditures for 2007 are projected to be approximately $20.0 to $25.0 million, primarily for the expansion of manufacturing capacity and equipment replacement for efficiency improvements in the Oil Field and Power Transmission segments and will be funded by operating cash flows. Significant components of net cash used by financing activities included treasury stock purchases of $22.0 million, dividend payments of $9.7 million, or $0.65 per share, partially offset by the impact of stock option exercises, including the excess tax benefit from actual gains on stock option exercises of $5.5 million.

The Company has a three-year $27.5 million credit facility with a domestic bank (the “Bank Facility”) consisting of an unsecured revolving line of credit that provides up to $17.5 million of committed borrowing along with an additional $10.0 million discretionary line of credit. This Bank Facility expires on December 31, 2008. Borrowings under the Bank Facility bear interest, at the Company’s option, at the greater of (i) the prime rate, (ii) the base CD rate plus an applicable margin or (iii) the Federal Funds Effective Rate plus an applicable margin or the London Interbank Offered Rate plus an applicable margin, depending on certain ratios as defined in the Bank Facility. As of September 30, 2007, no debt was outstanding under the Bank Facility and the Company was in compliance with all financial covenants under the terms of the Bank Facility. Deducting outstanding letters of credit of $6.9 million, $20.6 million of borrowing capacity was available at September 30, 2007.

Recently Issued Accounting Pronouncements

Management believes the impact of recently issued standards, which are not yet effective, will not have a material impact on the Company's condensed consolidated financial statements upon adoption.

Critical Accounting Policies and Estimates

The discussion and analysis of financial condition and results of operations are based upon the Company’s condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. The Company evaluates its estimates on an ongoing basis, based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in preparation of its consolidated statements.

The Company extends credit to customers in the normal course of business. Management performs ongoing credit evaluations of our customers and adjusts credit limits based upon payment history and the customer’s current credit worthiness. An allowance for doubtful accounts has been established to provide for estimated losses on receivable collections. The balance of this allowance is determined by regular reviews of outstanding receivables and historical experience. As the financial condition of customers change, circumstances develop or additional information becomes available, adjustments to the allowance for doubtful accounts may be required.

Revenue is not recognized until it is realized or realizable and earned. The criteria to meet this guideline are: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price to the buyer is fixed or determinable and collectibility is reasonably assured. In some cases, a customer is not able to take delivery of a completed product and requests that the Company store the product for defined period of time. The Company will process a Bill-and-Hold invoice and recognize revenue at the time of the storage request if all of the following criteria are met:

l	The customer has accepted title and risk of loss;
l	The customer has provided a written purchase order for the product;
l	The customer, not the Company, requested the product to be stored and to be invoiced under a Bill-and-Hold arrangement. The customer must also provide the business purpose for the storage request;
l	The customer must provide a storage period and future shipping date;
l	The Company must not have retained any future performance obligations on the product;
l	The Company must segregate the stored product and not make it available to use on other orders; and
l	The product must be completed and ready for shipment.

The Company has made significant investments in inventory to service its customers. On a routine basis, the Company uses estimates in determining the level of reserves required to state inventory at the lower of cost or market. Management’s estimates are primarily influenced by market activity levels, production requirements, the physical condition of products and technological innovation. Changes in any of these factors may result in adjustments to the carrying value of inventory. Also, the Company accounts for a significant portion of its inventory under the LIFO method. The LIFO reserve can be impacted by changes in the LIFO layers and by inflation index adjustments. Generally, annual increases in the inflation rate or the FIFO value of inventory cause the value of the LIFO reserve to increase.

Long-lived assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company assesses the recoverability of long-lived assets by determining whether the carrying value can be recovered through projected undiscounted cash flows, based on expected future operating results. Future adverse market conditions or poor operating results could result in the inability to recover the current carrying value and thereby possibly requiring an impairment charge in the future.

Goodwill acquired in connection with business combinations represent the excess of consideration over the fair value of net assets acquired. The Company performs impairment tests on the carrying value of goodwill at least annually or whenever events or changes in circumstances indicate the carrying value of goodwill may be greater than fair value, such as significant underperformance relative to historical or projected operating results and significant negative industry or economic trends. The Company’s fair value is primarily determined using discounted cash flows, which requires management to make judgments about future operating results, working capital requirements and capital spending levels. Changes in cash flow assumptions or other factors which negatively impact the fair value of the operations would influence the evaluation and may result in a determination that goodwill is impaired and a corresponding impairment charge.

Deferred tax assets and liabilities are recognized for the differences between the book basis and tax basis of the net assets of the Company. In providing for deferred taxes, management considers current tax regulations, estimates of future taxable income and available tax planning strategies. Changes in state, federal and foreign tax laws as well as changes in the financial position of the Company could also affect the carrying value of deferred tax assets and liabilities. If management estimates that some or all of any deferred tax assets will expire before realization or that the future deductibility is not more-likely-than-not, a valuation allowance would be recorded.

The Company is subject to claims and legal actions in the ordinary course of business. The Company maintains insurance coverage for various aspects of its businesses and operations. The Company retains a portion of the insured losses that occur through the use of deductibles. Management regularly reviews estimates of reported and unreported insured and non-insured claims and legal actions and provides for losses through reserves. As circumstances develop and additional information becomes available, adjustments to loss reserves may be required.

The Company sells certain of its products to customers with a product warranty that provides repairs at no cost to the customer or the issuance of credit to the customer. The length of the warranty term depends on the product being sold, but ranges from one year to five years. The Company accrues its estimated exposure to warranty claims based upon historical warranty claim costs as a percentage of sales multiplied by prior sales still under warranty at the end of any period. Management reviews these estimates on a regular basis and adjusts the warranty provisions as actual experience differs from historical estimates or other information becomes available.

The Company offers defined benefit plans and other benefits upon the retirement of its employees. Assets and liabilities associated with these benefits are calculated by third-party actuaries under the rules provided by various accounting standards, with certain estimates provided by management. These estimates include the discount rate, expected rate of return of assets and the rate of increase of compensation and health claims. On a regular basis, management reviews these estimates by comparing them to actual experience and those used by other companies. If a change in an estimate is made, the carrying value of these assets and liabilities may have to be adjusted. The impact of changes in these estimates does not differ significantly from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Forward-Looking Statements and Assumptions

This quarterly report on Form 10-Q contains forward-looking statements and information, within the meaning of the Private Securities Litigation Reform Act of 1995, that are based on management’s beliefs as well as assumptions made by and information currently available to management. When used in this report, the words “anticipate,” “believe,” “estimate,” “expect,” “plan,” “schedule,” “could,” “may,” “might,” “should,” “project” or similar expressions are intended to identify forward-looking statements. Similarly, statements that describe the Company’s future plans, objectives or goals are also forward-looking statements. Such statements reflect the Company’s current views with respect to certain events and are subject to certain assumptions, risks and uncertainties, many of which are outside the control of the Company. Undue reliance should not be place on forward-looking statements. These risks and uncertainties include, but are not limited to:

l	oil price volatility;
l	declines in domestic and worldwide oil and gas drilling;
l	capital spending levels of oil producers;
l	the cyclicality of the trailer industry;
l	availability and prices for raw materials;
l	the inherent dangers and complexities of our operations;
l	uninsured judgments or a rise in insurance premiums;
l	the inability to effectively integrate acquisitions;
l	labor disruptions and increasing labor costs;
l	the availability of qualified and skilled labor;
l	disruption of our operating facilities or management information systems;
l	the impact on foreign operations of war, political disruption, civil disturbance, economic and legal sanctions and
l	changes in global trade policies;
l	currency exchange rate fluctuations in the markets in which the Company operates;
l	changes in the laws, regulations, policies or other activities of governments, agencies and similar organizations
l	where such actions may affect the production, licensing, distribution or sale of the Company’s products, the cost
l	thereof or applicable tax rates;
l	costs related to legal and administrative proceedings, including adverse judgments against the Company if the
l	Company fails to prevail in reversing such judgments; and
l	general industry, political and economic conditions in the markets where the Company procures material,
l	components and supplies for the production of the Company’s principal products or where the Company’s
l	products are produced, distributed or sold.

Additional information about risks and uncertainties that could cause actual results to differ materially from forward-looking statements is contained in Part I, Item 1A. “Risk Factors” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. All forward-looking statements attributable to the Company or persons acting on the Company’s behalf are expressly qualified in their entirety by these factors. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, believed, estimated or expected. The forward-looking statements included in this report are only made as of the date of this report and, except as required by securities laws, the Company disclaims any obligation to publicly update forward-looking statements to reflect subsequent events or circumstances.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The Company’s financial instruments include cash, accounts receivable, accounts payable, invested funds and debt obligations. The book value of accounts receivable, short-term debt and accounts payable are considered to be representative of their fair market value because of the short maturity of these instruments. The Company’s accounts receivable are not concentrated in one customer or industry and are not viewed as an unusual credit risk.

The Company does not utilize financial or derivative instruments for trading purposes or to hedge exposures to interest rates, foreign currency rates or commodity prices. Due to the low level of current debt exposure, the Company does not have any significant exposure to interest rate fluctuations. However, if the Company drew on its line of credit under its Bank Facility, the Company would have exposure since the interest rate is variable. In addition, the Company primarily invoices and purchases in the same currency as the functional currency of its operations, which minimizes exposure to currency rate fluctuations.

The Company is exposed to currency fluctuations with debt and receivables denominated in U.S. dollars between the Company’s U.S. entity and its French and Canadian entities. As of September 30, 2007, there was a net inter-company receivable of 0.1 million euros and net debt of $8.4 million Canadian dollars. As of September 30, 2007, if the U.S. dollar strengthened by 10% over these currencies, the net income impact would be $0.5 million of expense and if the U.S. dollar weakened by 10% over these currencies, the net income impact would be $0.5 million of income. Also, certain assets and liabilities, primarily employee and tax related, denominated in the local currency of foreign operations whose functional currency is the U.S. dollar are exposed to fluctuations in currency rates. As of September 30, 2007, if the U.S. dollar strengthened by 10% over these currencies, the net income impact would be $0.1 million of expense and if the U.S. dollar weakened by 10% over these currencies, the net income impact would be $0.1 million of income.

Item 4. Controls and Procedures.

Based on their evaluation of the Company’s disclosure controls and procedures as of September 30, 2007, the Chief Executive Officer of the Company, Douglas V. Smith, and the Chief Financial Officer of the Company, R. D. Leslie, have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934) are effective to ensure that information required to be disclosed in reports that the Company files or submits under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and effective to ensure that information required to be disclosed in such reports is accumulated and communicated to the Company’s management, including the Company’s principal executive officer and principal financial officer, to allow timely decisions regarding disclosure.

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2007, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II- OTHER INFORMATION

Item 1. Legal Proceedings.

A class action complaint was filed in the U.S. District Court for the Eastern District of Texas on March 7, 1997, by an employee and a former employee who alleged race discrimination in employment. Certification hearings were conducted in Beaumont, Texas in February 1998 and in Lufkin, Texas in August 1998. In April 1999, the District Court issued a decision that certified a class for this case, which included all black employees employed by the Company from March 6, 1994, to the present. The case was closed from 2001 to 2003 while the parties unsuccessfully attempted mediation. Trial for this case began in December 2003, but was postponed by the District Court and was completed in October 2004. The only claims made at trial were those of discrimination in initial assignments and promotions.

Item 1A. Risks Factors.

In addition to other information set forth in this quarterly report, the factors discussed in Part I, Item 1A. “Risk Factors" in the Company's Annual Report on Form 10-K for the year ended December 31, 2006, which could materially affect the Company's business, financial condition and/or operating results, should be carefully considered. The risks described in the Company's Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that it currently deems to be immaterial also may materially adversely affect the Company's business, financial condition and/or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

A summary of the Company’s repurchase activity for the three months ended September 30, 2007, is as follows:

Issuers Purchases of Equity Securities

					Total Number of		Approximate Dollar
	Total Number		Average		Shares Purchased as		Value of Shares That
	of Shares		Price Paid		Part of Publicly		May Yet Be Purchased
Period	Purchased (1)		per Share		Announced Plans		Under the Plans

July 1 - July 31		-	$	-		-	$	32,121,001
August 1 - August 31		350,000		54.85		350,000		12,923,565
September 1 - September 30		50,000		56.78		50,000		10,084,369

Total		400,000	$	55.09		400,000	$	10,084,369

(1) August repurchases consist of 2,052 shares repurchased under the 1999 plan, 35,817 shares repurchased under the 2003 plan and 312,131 shares repurchased under the 2007 plan. September repurchases consist of 50,000 shares repurchased under the 2007 plan.

Item 6. Exhibits.

Exhibit Number		Description

3.1		Amended and Restated Bylaws of Lufkin Industries, Inc., included as Exhibit 3.1 to Form 8-K filed October 9, 2007 (File No. 0-02612), which exhibit is incorporated herein by reference.

10.1		Amended and Restated Lufkin Industries, Inc. Incentive Stock Compensation Plan 2000, included as Exhibit 10.1 to Form 8-K filed August 7, 2007 (File No. 0-02612), which exhibit is incorporated herein by reference.

*31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.

*31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.

*32.1		Section 1350 Certification of Chief Executive Officer.

*32.2		Section 1350 Certification of Chief Financial Officer.

* Filed herewith

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: November 9, 2007

LUFKIN INDUSTRIES, INC.

By: /s/ R. D. Leslie

R.D. Leslie

Signing on behalf of the registrant and as

Vice President/Treasurer/Chief Financial Officer

(Principal Financial and Accounting Officer)

INDEX TO EXHIBITS

Exhibit Number		Description

3.1		Amended and Restated Bylaws of Lufkin Industries, Inc., included as Exhibit 3.1 to Form 8-K filed October 9, 2007 (File No. 0-02612), which exhibit is incorporated herein by reference.

10.1		Amended and Restated Lufkin Industries, Inc. Incentive Stock Compensation Plan 2000, included as Exhibit 10.1 to Form 8-K filed August 7, 2007 (File No. 0-02612), which exhibit is incorporated herein by reference.

*31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.

*31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.

*32.1		Section 1350 Certification of Chief Executive Officer.

*32.2		Section 1350 Certification of Chief Financial Officer.

* Filed herewith

Positive
Negative
Uncertain
Constraining
Legalese
Litigious
Readability	H.S. freshman Avg

Lufkin Industries (LUFK) Inactive 10-Q2008 Q2 Quarterly report

Content analysis