Lufkin Industries (LUFK) 10-Q 2007 Q1 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 June 30, 2006

or

(  ) 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 o

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  o                                 Accelerated filer x                               Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o          No  x 

There were 14,882,091 shares of Common Stock, $1.00 par value per share, outstanding as of August 3, 2006, not including 399,278 shares classified as Treasury Stock.

Table of Contents

EX-31.1

EX-31.2

EX-32.1

EX-32.2

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements.

LUFKIN INDUSTRIES, INC

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(Thousands of dollars, except share and per share data)

	June 30,			December 31,
Assets	2006			2005
Current Assets:
Cash and cash equivalents	$	31,390		$	25,822
Receivables, net		81,864			80,609
Inventories		87,602			74,635
Deferred income tax assets		4,712			4,185
Other current assets		5,219			4,650
Total current assets		210,787			189,901
Property, plant and equipment, net		101,369			92,980
Prepaid pension costs		63,516			62,065
Goodwill, net		11,664			11,495
Other assets net		3,528			3,354
Total assets	$	390,864		$	359,795
Liabilities and Shareholders' Equity
Current liabilities:
Short-term notes payable	$	60		$	271
Accounts payable		26,803			20,794
Accrued liabilities:
Payroll and benefits		7,370			7,946
Warranty expenses		3,757			3,245
Taxes payable		4,717			14,391
Other		9,260			9,626
Total current liabilities		51,967			56,273
Deferred income tax liabilities		32,435			31,049
Postretirement benefits		11,469			11,394
Shareholders' equity:
Common stock, $1.00 par value per share; 60,000,000 shares authorized;
15,281,369 and 15,124,644 shares issued and outstanding, respectively		15,281			15,125
Capital in excess par		35,255			31,705
Retained earnings		245,192			216,427
Treasury stock, 399,278 and 399,278 shares, respectively, at cost		(4,124	)		(4,124	)
Accumulated other comprehensive income:
Cumulative translation adjustment		3,389			1,946
Total shareholders' equity		294,993			261,079
Total liabilities and shareholders' equity	$	390,864		$	359,795

See accompanying notes to consolidated financial statements.

1

LUFKIN INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF EARNINGS

AND COMPREHENSIVE INCOME (UNAUDITED)

(In thousands of dollars, except per share and share data)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2006			2005			2006			2005
Sales	$	147,690		$	121,689		$	281,080		$	223,077
Cost of Sales		108,539			93,666			206,489			172,602
Gross Profit		39,151			28,023			74,591			50,475
Selling, general and administrative expenses		13,099			11,589			25,236			22,346
Operating income		26,052			16,434			49,355			28,129
Interest income		446			83			856			245
Interest expense		(29	)		(37	)		(63	)		(80	)
Other income (expense), net		21			(189	)		39			(378	)
Earnings before income tax provision		26,490			16,291			50,187			27,916
Income tax provision		9,035			5,865			17,565			10,050
Net earnings		17,455			10,426			32,622			17,866
Change in foreign currency translation
adjustment		1,317			(726	)		1,443			(1,226	)
Total comprehensive income	$	18,772		$	9,700		$	34,065		$	16,640
Net earnings per share
Basic	$	1.18		$	0.73		$	2.21		$	1.26
Diluted	$	1.16		$	0.71		$	2.16		$	1.23
Dividends per share	$	0.15		$	0.09		$	0.26		$	0.18
Weighted average number of shares outstanding:
Basic		14,808,539			14,234,337			14,791,140			14,132,675
Diluted		15,090,563			14,656,909			15,092,071			14,526,304

See accompanying notes to consolidated financial statements.

2

LUFKIN INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands of dollars)

	Six Months Ended
	June 30,
	2006			2005
Cash flows form operating activities:
Net earnings	$	32,622		$	17,866
Adjustments to reconcile net earnings to cash
provided by operating activities:
Depreciation and amortization		5,612			5,797
Deferred income tax provision		750			1,433
Excess tax benefit from share-based compensation		(2,685	)		-
Share-based compensation expense		1,594			-
Pension income		(1,450	)		(1,224	)
Postretirement benefits		75			190
(Gain) loss on disposition of property, plant and equipment		(57	)		49
Changes in:
Receivables, net		(620	)		(7,961	)
Inventories		(12,226	)		(24,823	)
Other current assets		2,398			(911	)
Accounts payable		5,232			5,182
Accrued liabilities		(13,286	)		2,315
Net cash provided by (used in) operating activities		17,959			(2,087	)
Cash flows from investing activities:
Additions to property, plant and equipment		(13,129	)		(4,205	)
Proceeds from disposition of property, plant and equipment		111			125
Increase in other assets		(208	)		(185	)
Acquisition of other companies		-			(3	)
Net cash used in investing activities		(13,226	)		(4,268	)
Cash flows from financing activities:
Proceeds from (payments of) short-term notes payable		(224	)		878
Dividends paid		(3,855	)		(2,559	)
Excess tax benefit from share-based compensation		2,685			-
Proceeds from exercise of stock options		2,142			4,426
Net cash provided by financing activities		748			2,745
Effect of translation on cash and cash equivalents		87			(70	)
Net increase (decrease) in cash and cash equivalents		5,568			(3,680	)
Cash and cash equivalents at beginning of period		25,822			17,097
Cash and cash equivalents at end of period	$	31,390		$	13,417

See accompanying notes to consolidated financial statements.

3

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited 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 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, 2005. The results of operations for the three and six months ended June 30, 2006, 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):

	June 30,			December 31,
	2006			2005
Accounts receivable	$	81,975		$	80,602
Notes receivable		484			516
Other receivables		292			250
Gross receivables		82,751			81,368
Allowance for doubtful accounts receivable		(403	)		(263	)
Allowance for doubtful notes receivable		(484	)		(496	)
Net receivables	$	81,864		$	80,609

Bad debt expense related to receivables was $0.0 million and $0.5 million in the three months ended June 30, 2006 and 2005, respectively, and $0.0 million and $0.6 million in the six months ended June 30, 2006 and 2005, respectively.

3. Other Current Accrued Liabilities

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

	June 30,		December 31,
	2006		2005
Customer prepayments	$	2,124	$	3,245
Deferred compensation plans		4,966		4,811
Other accrued liabilities		2,170		1,570
Total other current accrued liabilities	$	9,260	$	9,626

4

4. Property, Plant & Equipment (P. P. & E.)

The following is a summary of the Company's P. P. & E. balances (in thousands of dollars):

	June 30,			December 31,
	2006			2005
Land	$	3,292		$	3,219
Land improvements		7,901			7,829
Buildings		74,309			70,752
Machinery and equipment		205,238			195,730
Furniture and fixtures		4,287			4,076
Computer equipment and software		13,797			13,468
Total property, plant and equipment		308,824			295,074
Less accumulated depreciation		(207,455	)		(202,094	)
Total property, plant and equipment, net	$	101,369		$	92,980

Depreciation expense related to property, plant and equipment was $2.9 million and $2.8 million in the three months ended June 30, 2006 and 2005, respectively, and $5.6 million and $5.7 million in the six months ended June 30, 2006 and 2005, respectively.

5. Inventories

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

	June 30,		December 31,
	2006		2005
Gross inventories @ FIFO:
Finished goods	$	7,380	$	5,647
Work in progress		17,503		17,664
Raw materials & component parts		90,481		77,039
Total gross inventories @ FIFO		115,364		100,350
Less reserves:
LIFO		26,282		24,544
Valuation		1,480		1,171
Total inventories as reported	$	87,602	$	74,635

Gross inventories on a FIFO basis before adjustments for reserves shown above that were accounted for on a LIFO basis were $82.4 million and $75.6 million at June 30, 2006, and December 31, 2005, respectively.

5

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 six months ended June 30, 2006 and 2005, are illustrated below (in thousands of dollars, except share and per share data):

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2006		2005		2006		2005
Numerator:
Numerator for basic and diluted earnings per share-net earnings	$	17,455	$	10,426	$	32,622	$	17,866
Denominator:
Denominator for basic net earnings per share weighted-average shares		14,808,539		14,234,337		14,791,140		14,132,675
Effect of dilutive securities: employee stock options		282,024		422,572		300,931		393,629
Denominator for diluted net earnings per share adjusted weighted-
average shares and assumed conversions		15,090,563		14,656,909		15,092,071		14,526,304
Basic net earnings per share	$	1.18	$	0.73	$	2.21	$	1.26
Diluted net earnings per share	$	1.16	$	0.71	$	2.16	$	1.23

Weighted options to purchase a total of 121,874 and 14,000 shares of the Company’s common stock for the three months ended June 30, 2006 and 2005, respectively, and 109,367 and 14,000 shares of the Company’s common stock for the six months ended June 30, 2006 and 2005, respectively, were excluded from the calculation of fully diluted earnings per share because their effect on fully diluted earnings per share for the period were 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 January 26, 2006, the Court of Appeals notified the parties that the case had been docketed and a decision is expected before the end of 2006. 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 and cash flows in a future reporting period.

6

8. 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 third-party revenues. Inter-segment sales and transfers are accounted for as if the sales and transfers were to third parties, that is, 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, 2005. The following is a summary of key segment information (in thousands of dollars):

Three Months Ended June 30, 2006
				Power
	Oil Field			Transmission			Trailer			Corporate		Total
Gross sales	$	97,682		$	33,314		$	19,975		$	-	$	150,971
Inter-segment sales		(941	)		(2,339	)		(1	)		-		(3,281	)
Net sales	$	96,741		$	30,975		$	19,974		$	-	$	147,690
Operating income (loss)	$	20,799		$	5,726		$	(473	)	$	-	$	26,052
Other income (expense), net		(29	)		(20	)		1			486		438
Earnings (loss) before
income tax provision	$	20,770		$	5,706		$	(472	)	$	486	$	26,490

Three Months Ended June 30, 2005
				Power
	Oil Field			Transmission			Trailer			Corporate		Total
Gross sales	$	78,539		$	27,643		$	20,691		$	-	$	126,873
Inter-segment sales		(2,340	)		(2,843	)		(1	)		-		(5,184	)
Net sales	$	76,199		$	24,800		$	20,690		$	-	$	121,689
Operating income (loss)	$	14,218		$	3,070		$	(854	)	$	-	$	16,434
Other income (expense), net		(212	)		16			1			52		(143	)
Earnings (loss) before
income tax provision	$	14,006		$	3,086		$	(853	)	$	52	$	16,291

7

8. Segment Data (Continued)

Six Months Ended June 30, 2006
				Power
	Oil Field			Transmission			Trailer			Corporate		Total
Gross sales	$	185,176		$	65,209		$	37,224		$	-	$	287,609
Inter-segment sales		(1,867	)		(4,660	)		(2	)		-		(6,529	)
Net sales	$	183,309		$	60,549		$	37,222		$	-	$	281,080
Operating income (loss)	$	39,623		$	10,339		$	(607	)	$	-	$	49,355
Other income (expense), net		(30	)		(81	)		(1	)		944		832
Earnings (loss) before
income tax provision	$	39,593		$	10,258		$	(608	)	$	944	$	50,187

Six Months Ended June 30, 2005
				Power
	Oil Field			Transmission			Trailer			Corporate		Total
Gross sales	$	143,244		$	50,371		$	37,122		$	-	$	230,737
Inter-segment sales		(4,324	)		(3,335	)		(1	)		-		(7,660	)
Net sales	$	138,920		$	47,036		$	37,121		$	-	$	223,077
Operating income (loss)	$	24,114		$	5,629		$	(1,614	)	$	-	$	28,129
Other income (expense), net		(365	)		(24	)		1			175		(213	)
Earnings (loss) before
income tax provision	$	23,749		$	5,605		$	(1,613	)	$	175	$	27,916

9. Goodwill and Intangible Assets

Goodwill

The changes in the carrying amount of goodwill for the six months ended June 30, 2006, are as follows (in thousands of dollars):

			Power
	Oil Field		Transmission		Trailer		Total
Balance as of 12/31/05	$	9,432	$	2,063	$	-	$	11,495
Foreign currency translation		3		166		-		169
Balance as of 6/30/06	$	9,435	$	2,229	$	-	$	11,664

Goodwill impairment tests were performed in the first quarter of 2006 and no impairment losses were recorded.

8

9. Goodwill and Intangible Assets (Continued)

Intangible Assets

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

	June 30,			December 31,
	2006			2005
Intangible assets subject to amortization:
Non-compete agreements
Original balance	$	463		$	463
Foreign currency translation		36			31
Accumulated amortization		(239	)		(193	)
Ending balance	$	260		$	301

10. 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. The fair value will be estimated using an option-pricing model. 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 allows 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 six months ended June 30, 2006, and under APB Opinion No. 25 for the three and six months ended June 30, 2005 (in thousands of dollars):

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2006			2005		2006			2005
Stock-based compensation expense	$	888		$	513	$	1,594		$	984
Tax benefit		(337	)		185		(606	)		354
Stock-based compensation expense, net of tax	$	551		$	328	$	988		$	630

9

10. Stock Option Plans (Continued)

The following table presents the pro forma effect on net earnings and earnings per share for the three and six months ended June 30, 2005, if the Company had applied the fair value recognition provisions of SFAS 123 to the Company’s stock options (in thousands of dollars except per share data):

	Three Months			Six Months
	Ended			Ended
	June 30, 2005			June 30, 2005
Net earnings, as reported	$	10,426		$	17,866
Add: Total stock-based employee compensation expense
included in reported net income, net of tax		-			-
Deduct: Total stock-based employee compensation
expense determined under SFAS 123 for all awards,
net of tax		(328	)		(630	)
Pro forma net earnings	$	10,098		$	17,236
Net earnings per share:
As reported	$	0.73		$	1.26
Pro forma	$	0.71		$	1.22
Diluted net earnings per share
As reported	$	0.71		$	1.23
Pro forma	$	0.69		$	1.19

The fair value of each option grant during the first six months of 2006 and 2005 was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

	2006			2005
Expected dividend yield		0.69% - 0.91	%		1.17% - 1.75	%
Expected stock price volatility		44.12% - 45.35	%		38.62% - 39.45	%
Risk free interest rate		4.52% - 5.01	%		4.04% - 4.19	%
Expected life options		6 - 8 years			8 years
Weighted-average fair value per share at grant date		$ 28.16			$  9.48

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 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.

10

10. Stock Option Plans (Continued)

A summary of stock option activity under the plans during the six months ended June 30, 2006, is presented below:

						Weighted-
				Weighted-		Average		Aggregate
				Average		Remaining		Intrinsic
				Exercise		Contractual		Value
Options	Shares			Price		Term		($000's)
Outstanding at January 1, 2006		797,720		$	18.35
Granted		51,000			64.56
Exercised		(156,725	)		13.67
Forfeited or expired		-			-
Outstanding at June 30, 2006		691,995		$	22.82		7.6	$	25,596
Exercisable at June 30, 2006		299,026		$	20.93		6.8	$	11,671

A summary of the status of the Company's nonvested shares as of June 30, 2006, and changes during the six months ended June 30, 2006, is presented below:

				Weighted-
				Average
				Grant Date
Nonvested Shares	Shares			Fair Value
Nonvested at January 1, 2006		413,743		$	8.70
Granted		51,000			28.16
Vested		(71,774	)		15.45
Forfeited		-			-
Nonvested at June 30, 2006		392,969		$	9.97

As of June 30, 2006, there was $3.0 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 1.1 years. The total fair value of shares vested during the six months ended June 30, 2006, was $1.1 million.

11. Recently Issued Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in income Taxes- an interpretation of FASB Statement No. 109.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecogntion, classification, interest and penalties, accounting in interim periods, disclosure and transition. In accordance with FIN 48, the evaluation of a tax position is a two-step process. The first step requires determining whether it is more likely than not that a tax position will be sustained upon examination or appeals based on the technical merits of the position. The second step requires that a tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Differences between tax positions taken in a tax return and amounts recognized in the financial statements will generally result in an increase in a liability for income taxes payable and/or an increase in a deferred tax liability. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which the threshold is met and previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which the threshold is no longer met. FIN 48 is effective for fiscal years beginning after December 15, 2006, but earlier adoption is permitted. The Company is currently evaluating the impact, if any, the adoption of FIN 48 will have on its consolidated financial position or results of operations.

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

11

12. Retirement Benefits

The Company has a qualified noncontributory pension plan covering substantially all U.S. employees. The benefits provided by these plans 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 pensions 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 accrued liabilities" on the Consolidated 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 employee’s 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.

The Company also has qualified defined contribution retirement plans covering substantially all of its 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. All obligations of the Company are funded through June 30, 2006. 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 $0.7 million and $0.6 million in the three months ended June 30, 2006 and 2005, respectively, and $1.4 million and $1.0 million in the six months ended June 30, 2006 and 2005, respectively. The liability for the non-qualified deferred defined contribution plan is included in "Other accrued liabilities" on the Consolidated Balance Sheet.

On December 8, 2003, the “Medicare Prescription Drug, Improvement and Modernization Act of 2003” (the “Act”) was signed into law. The Act introduces a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. 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.

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12. Retirement Benefits (Continued)

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

	Pension Benefits						Other Benefits
Three Months Ended June 30,	2006			2005			2006			2005
Service cost	$	1,225		$	1,211		$	16		$	75
Interest cost		2,099			2,364			75			179
Expected return on plan assets		(4,149	)		(3,927	)		-			-
Amortization of prior service cost		142			78			-			-
Amortization of unrecognized net (gain) loss		(115	)		1			(91	)		17
Amortization of unrecognized transition asset		(232	)		(216	)		-			-
Net periodic benefit cost (income)	$	(1,030	)	$	(489	)	$	-		$	271

	Pension Benefits						Other Benefits
Six Months Ended June 30,	2006			2005			2006			2005
Service cost	$	2,590		$	2,353		$	86		$	130
Interest cost		4,552			4,754			251			348
Expected return on plan assets		(8,230	)		(7,862	)		-			-
Amortization of prior service cost		283			156			-			-
Amortization of unrecognized net (gain) loss		31			2			(78	)		17
Amortization of unrecognized transition asset		(464	)		(432	)		-			-
Net periodic benefit cost (income)	$	(1,238	)	$	(1,029	)	$	259		$	495

During the second quarter of 2006, certain assumptions such as turnover, mortality and renewal rates were updated to reflect recent trends. The projected benefit obligations of the pension plans reduced to $169.4 million from $182.4 and the accumulated postretirement benefit obligation reduced to $9.5 million from $13.1 million. Increases in the turnover rate of employees and  lower retiree medical plan renewal rates drove the majority of these reductions. These projected obligation reductions resulted in a higher annual projection of net periodic benefit income from the pension plans by approximately $1.7 million, or $0.07 per diluted share, and a reduced annual projected net periodic cost from the postretirement plans by approximately $0.5 million, or $0.02 per diluted share.

Employer Contributions

The Company previously disclosed in its financial statements for the year ended December 31, 2005, that it did not expect to make any contributions to its pension plans in 2006. The Company also disclosed that it expected Company premium contributions of $325,000 to be made to its postretirement plan in 2006. As of June 30, 2006, the Company has made contributions of $18,000 to its pension plans and has made Company premium contributions of $179,000 to its postretirement plan. The Company presently anticipates making contributions of $50,000 to its pension plans and an additional $186,000 to its postretirement plan during the last six months of 2006.

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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 van, float 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 expanded its domestic and international Oil Field service operations through acquisitions and internal growth. The Company has also made capital investments to increase Oil Field manufacturing capacity in its three main manufacturing facilities to meet growing demand and reduce order lead-time.

In addition, the Company has expanded its Power Transmission capabilities through new gear repair facilities in the U.S. and Canada and through new high-speed gearbox manufacturing capabilities in its French operation. Capital investments targeting cost reductions and shorter manufacturing lead times are also being made in the Power Transmission segment.

Trends/Outlook

Oil Field

Demand for pumping unit equipment primarily depends on the level of onshore oil well 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 recent demand for pumping units has also been impacted by the use of artificial lift in natural gas and coal bed methane applications as higher energy prices have made certain extraction methods more economical. In addition, the availability of used pumping unit equipment impacts the demand for new pumping units, especially in the North American market. The higher energy prices experienced in 2004, 2005 and the first half of 2006 have increased the demand for new pumping units and related service and products from higher drilling activity, activation of idle wells and the upgrading of existing wells. 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. Demand levels experienced in 2005 and the second half of 2006 are expected to continue throughout the remainder of 2006 assuming energy prices stay at recent levels.

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, then 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 and power generation in response to higher global energy prices. These market trends should continue throughout the remainder of 2006 assuming energy prices stay at recent levels.

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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. In the last several years, the freight-hauling market has been severely depressed due to low freight volumes and higher operating costs. This led freight haulers to significantly lower orders for new trailers and extend the life of existing trailers. During 2004 and 2005, the freight market improved as freight-hauling demand and freight pricing increased and aging trailers required replacement. However, the recent demand for van trailers has not increased enough to meet trailer industry capacity, increasing price competition. Van demand has been impacted by freight haulers focusing purchases on new tractors before new diesel emission requirements are required on new tractors beginning in 2007. Recent flatbed and dump trailer demand has increased significantly due to the increased activity in the home and road construction markets and the rebuilding effort resulting from the 2005 hurricanes.

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 June 30, 2006, increased to $147.7 million from $121.7 million for the three months ended June 30, 2005, or 21.4%, and increased to $281.1 million for the six months ended June 30, 2006, from $223.1 million for the six months ended June 30, 2005, or 26.0%. This growth was primarily driven by increased sales of new oil field equipment, but also by growth in Power Transmission sales. Additional segment data on sales is provided later in this section.

Gross margin for the three months ended June 30, 2006, increased to 26.5% from 23.0% for the three months ended June 30, 2005, and increased to 26.5% for the six months ended June 30, 2006, from 22.6% for the six months ended June 30, 2005. This overall gross margin improvement was primarily due to the full impact of price increases implemented in 2005 and 2006 to compensate for the increased raw material prices experienced by all segments in 2004. 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 net earnings also benefited from leverage on selling, general and administrative expenses. The Company reported net earnings of $17.5 million, or $1.16 per share (diluted), for the three months ended June 30, 2006, compared to net earnings of $10.4 million, or $0.71 per share (diluted), for the three months ended June 30, 2005, and $32.6 million, or $2.16 per share (diluted), for the six months ended June 30, 2006 compared to net earnings of $17.9 million, or $1.23 per share (diluted).

Debt/equity (long-term debt net of current portion as a percentage of total equity) levels were 0.0% at June 30, 2006 and December 31, 2005. Short-term debt was $0.1 million at June 30, 2006, down from $0.3 million at December 31, 2005. Cash balances at June 30, 2006, were $31.4 million, up from $25.8 million at December 31, 2005, due to higher net earnings offsetting increased capital expenditures.

15

Three Months Ended June 30, 2006, Compared to Three Months Ended June 30, 2005

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

	Three Months Ended
	June 30,				Increase/			% Increase/
	2006		2005		(Decrease)			(Decrease)
Sales
Oil Field	$	96,741	$	76,199	$	20,542			27.0
Power Transmission		30,975		24,800		6,175			24.9
Trailer		19,974		20,690		(716	)		(3.5	)
Total	$	147,690	$	121,689	$	26,001			21.4
Gross Profit
Oil Field	$	26,714	$	18,874	$	7,840			41.5
Power Transmission		10,977		7,772		3,205			41.2
Trailer		1,460		1,377		83			6.0
Total	$	39,151	$	28,023	$	11,128			39.7

Oil Field

Oil Field sales increased to $96.7 million, or 27.0%, for the three months ended June 30, 2006, from $76.2 million for the three months ended June 30, 2005. The benefit of the stronger Canadian dollar in 2006 contributed 1.3 percentage points of this increase. Increased sales of new pumping units account for a majority of the balance of the increase of 25.7 percentage points. Sales of new pumping units in the U.S. and Canada, and related service, increased from higher drilling and production primarily in the North America and Middle East markets. Also, sales of automation equipment continued to increase due to market share growth from new product offerings. In addition, sales growth was impacted from price increases instituted throughout 2005 in response to dramatic raw material price increases experienced in 2004 in addition to price increases instituted in 2006. Oil Field’s backlog increased to $91.0 million as of June 30, 2006, from $65.8 million at June 30, 2005. This backlog increase was primarily due to increased bookings of new pumping units in the North America and Middle East markets.

Gross margin (gross profit as a percentage of sales) for the Oil Field segment increased to 27.6% for three months ended June 30, 2006, compared to 24.8% for the three months ended June 30, 2005, or 2.8 percentage points. Throughout 2005, sales prices were increased to recover higher material costs incurred in 2004, but the benefit of these price increases were not fully realized in the first half of 2005. This margin improvement was partially offset by employee training costs associated with manufacturing facility expansions in the U.S., Canada and Argentina and higher inbound freight costs.

Direct selling, general and administrative expenses for Oil Field increased to $4.0 million, or 40.5%, for the three months ended June 30, 2006, from $2.8 million for the three months ended June 30, 2005. This increase is due to higher employee-related expenses in support of increased current and expected sales volumes, insurance claims, third-party commissions and the impact of expensing stock options. Direct selling, general and administrative expenses as a percentage of sales also increased to 4.1% for the three months ended June 30, 2006, from 3.7% for the three months ended June 30, 2005.

Power Transmission

Sales for the Company’s Power Transmission segment increased to $31.0 million, or 24.9%, for the three months ended June 30, 2006, compared to $24.8 million for the three months ended June 30, 2005. 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 production and refining, and from the new U.S. gear repair facilities. Power Transmission backlog at June 30, 2006, increased to $77.8 million from $60.2 million at June 30, 2005, primarily from sales of new units for the energy-related markets.

Gross margin for the Power Transmission segment increased to 35.4% for the three months ended June 30, 2006, compared to 31.3% for the three months ended June 30, 2005, from the benefit of price increases and from increased sales of higher-margin high-speed units.

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Direct selling, general and administrative expenses for Power Transmission increased to $3.7 million, or 14.1%, for the three months ended June 30, 2006, from $3.3 million for the three months ended June 30, 2005. This increase is due to higher employee-related expenses in support of increased sales volumes and the impact of expensing stock options. However, direct selling, general and administrative expenses as a percentage of sales decreased to 12.1% for the three months ended June 30, 2006, from 13.2% for the three months ended June 30, 2005, from leverage on higher sales volumes.

Trailer

Trailer sales for the three months ended June 30, 2006, decreased to $20.0 million, or 3.5%, from $20.7 million for the three months ended June 30, 2005. This decrease resulted from lower sales of new van trailers and used trailers, partially offset by higher sales of new flatbed and dump trailers. Sales growth in flatbed and dump trailers was strong due to the introduction of new models and demand from the home and road construction market. New van sales were impacted by the Company not booking lower margin orders as competitors lowered prices in response to industry overcapacity. Backlog for the Trailer segment increased to $39.5 million at June 30, 2006, compared to $31.6 million at June 30, 2005. The backlog increase was primarily from orders for new flatbed trailers as described above.

Trailer gross margin increased to 7.3% for the three months ended June 30, 2006, from 6.7% for the three months ended June 30, 2005, or 0.6 percentage points. This margin improvement was due to higher selling prices for and the favorable mix impact of higher-margin flatbed and dump trailers, partially offset by increases in aluminum costs for van trailers.

Direct selling, general and administrative expenses for Trailer decreased to $0.7 million, or 33.5%, for the three months ended June 30, 2006, from $1.1 million for the three months ended June 30, 2005. In the second quarter of 2005, bad debt expense was increased due to a disputed receivable. This also caused direct selling, general and administrative expenses as a percentage of sales to decrease to 3.6% for the three months ended June 30, 2006, from 5.3% for the three months ended June 30, 2005.

Corporate/Other

Corporate administrative expenses, which are allocated to the segments primarily based on historical third-party revenues, increased to $4.6 million, or 6.0%, for the three months ended June 30, 2006, from $4.4 million for the three months ended June 30, 2005, primarily from the impact of expensing stock options.

Investment income, interest expense and other income and expense for the three months ended June 30, 2006, totaled $0.4 million of income compared to an expense of $0.1 million for the three months ended June 30, 2005, primarily due to an increase in investment income from higher cash balances.

Pension income, which is reported as a reduction of cost of sales, increased to $1.1 million for the three months ended June 30, 2006, or 86%, compared to $0.6 million for the three months ended June 30, 2005. This increase is due to the remeasurement of the projected benefit obligation, which lowered by approximately 7% from December 31, 2005. Certain assumptions, like turnover, mortality and retirement age, were updated to reflect more recent trends. Pension income in 2006 is expected to increase to approximately $2.9 million from $2.1 million in 2005 for the reasons mentioned above.

The net tax rate for the three months ended June 30, 2006, was 34.1% compared to 36.0% in the three months ended June 30, 2005. This net tax rate was the result of the effective tax rate of 36.0% benefitting from a one-time reduction of certain deferred tax balances of $0.4 million to reflect the impact of the new Texas margin tax, enacted in the second quarter of 2006, which will replace the existing Texas franchise tax.

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Six Months Ended June 30, 2006, Compared to Six Months Ended June 30, 2005

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

	Six Months Ended
	June 30,				Increase/		% Increase/
	2006		2005		(Decrease)		(Decrease)
Sales
Oil Field	$	183,309	$	138,920	$	44,389		32.0
Power Transmission		60,549		47,036		13,513		28.7
Trailer		37,222		37,121		101		0.3
Total	$	281,080	$	223,077	$	58,003		26.0
Gross Profit
Oil Field	$	50,853	$	33,200	$	17,653		53.2
Power Transmission		20,631		15,015		5,616		37.4
Trailer		3,107		2,260		847		37.5
Total	$	74,591	$	50,475	$	24,116		47.8

Oil Field

Oil Field sales increased to $183.3 million, or 32.0%, for the six months ended June 30, 2006, from $138.9 million for the six months ended June 30, 2005. The benefit of the stronger Canadian dollar in 2006 contributed 1.2 percentage points of this increase. Increased sales of new pumping units account for a majority of the balance of the increase of 30.8 percentage points. Sales of new pumping units in the U.S. and Canada, and related service, increased from higher drilling and production primarily in the North America and Middle East markets. Also, sales of automation equipment continued to increase due to market share growth from new product offerings. In addition, sales growth was impacted from price increases instituted throughout 2005 in response to dramatic raw material price increases experienced in 2004 in addition to price increases instituted in 2006. Oil Field’s backlog increased to $91.0 million as of June 30, 2006, from $67.5 million at December 31, 2005. This backlog increase was primarily due to increased bookings of new pumping units in the North America and Middle East markets.

Gross margin (gross profit as a percentage of sales) for the Oil Field segment increased to 27.7% for six months ended June 30, 2006, compared to 23.9% for the six months ended June 30, 2005, or 3.8 percentage points. Throughout 2005, sales prices were increased to recover higher material costs incurred in 2004, but the benefit of these price increases were not fully realized in the first half of 2005. This margin improvement was partially offset by employee training costs associated with manufacturing facility expansions in the U.S., Canada and Argentina and higher inbound freight costs.

Direct selling, general and administrative expenses for Oil Field increased to $7.5 million, or 35.5%, for the six months ended June 30, 2006, from $5.6 million for the six months ended June 30, 2005. This increase is due to higher employee-related expenses in support of increased current and expected sales volumes, insurance claims, third-party commissions and the impact of expensing stock options. Direct selling, general and administrative expenses as a percentage of sales also increased to 4.1% for the six months ended June 30, 2006, from 4.0% for the six months ended June 30, 2005.

Power Transmission

Sales for the Company’s Power Transmission segment increased to $60.5 million, or 28.7%, for the six months ended June 30, 2006, compared to $47.0 million for the six months ended June 30, 2005. The effect of the weaker euro in 2006 negatively impacted sales growth by 1.6 percentage points. The net growth of 30.3% was the result of increased sales of high-speed units to the energy-related markets, such as power generation and oil and gas production and refining, and from the new gear repair facilities. Power Transmission backlog at June 30, 2006, increased to $77.8 million from $60.2 million at June 30, 2005, primarily from sales of new units for the energy-related markets.

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Gross margin for the Power Transmission segment increased to 34.1% for the six months ended June 30, 2006, compared to 31.9% for the six months ended June 30, 2005, from the benefit of price increases and from increased sales of higher-margin high-speed units.

Direct selling, general and administrative expenses for Power Transmission increased to $7.4 million, or 11.6%, for the six months ended June 30, 2006, from $6.6 million for the six months ended June 30, 2005. This increase is due to higher employee-related expenses in support of increased sales volumes and the impact of expensing stock options. However, direct selling, general and administrative expenses as a percentage of sales decreased to 12.2% for the six months ended June 30, 2006, from 14.1% for the six months ended June 30, 2005, from leverage on higher sales volumes.

Trailer

Trailer sales for the six months ended June 30, 2006, increased slightly to $37.2 million, or 0.3%, from $37.1 million for the six months ended June 30, 2005. Higher sales of new flatbed and dump trailers was offset by lower sales of new van trailers and used trailers. Sales growth in flatbed and dump trailers was strong due to the introduction of new models and demand from the home and road construction market. New van sales were impacted by the Company not booking lower margin orders as competitors lowered prices in response to industry overcapacity. Backlog for the Trailer segment increased to $39.5 million at June 30, 2006, compared to $25.5 million at December 31, 2005. The backlog increase was primarily from orders for new flatbed trailers, as described above, and new van trailers. The backlog for new van trailers at December 31, 2005, were lower than average due to the timing of booking certain orders.

Trailer gross margin increased to 8.3% for the six months ended June 30, 2006, from 6.1% for the six months ended June 30, 2005, or 2.2 percentage points. This margin improvement was due to higher selling prices for, and the favorable mix impact of, higher-margin flatbed and dump trailers, partially offset by increases in aluminum costs for van trailers and plant inefficiencies from flatbed and dump trailer production ramp-up.

Direct selling, general and administrative expenses for Trailer decreased to $1.4 million, or 16.3%, for the six months ended June 30, 2006, from $1.7 million for the six months ended June 30, 2005. In the first half of 2005, bad debt expense was increased due to a disputed receivable. This also caused direct selling, general and administrative expenses as a percentage of sales to decrease to 3.7% for the six months ended June 30, 2006, from 4.5% for the six months ended June 30, 2005.

Corporate/Other

Corporate administrative expenses, which are allocated to the segments primarily based on historical third-party revenues, increased to $8.9 million, or 5.0%, for the six months ended June 30, 2006, from $8.5 million for the six months ended June 30, 2005, primarily from the impact of expensing stock options.

Investment income, interest expense and other income and expense for the six months ended June 30, 2006, totaled $0.8 million of income compared to an expense of $0.2 million for the six months ended June 30, 2005, primarily due to an increase in investment income from higher cash balances.

Pension income, which is reported as a reduction of cost of sales, increased to $1.5 million for the six months ended June 30, 2006, or 16%, compared to $1.2 million for the six months ended June 30, 2005. This increase is due to the remeasurement of the projected benefit obligation, which lowered by approximately 7% from December 31, 2005. Certain assumptions, like turnover, mortality and retirement age, were updated to reflect more recent trends. Pension income in 2006 is expected to increase to approximately $2.9 million from $2.1 million in 2005 for the reasons mentioned above.

The net tax rate for the six months ended June 30, 2006, was 35.0% compared to 36.0% in the six months ended June 30, 2005. This net tax rate was the result of the effective tax rate of 36.0% benefitting from a one-time reduction of certain deferred tax balances of $0.4 million to reflect the impact of the new Texas margin tax, enacted in the second quarter of 2006, which will replace the existing Texas franchise tax.

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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, 2006.

The Company’s cash balance totaled $31.4 million at June 30, 2006, compared to $25.8 million at December 31, 2005. For the six months ended June 30, 2006, net cash provided by operating activities was $17.9 million, net cash used in investing activities totaled $13.2 million and net cash provided by financing activities amounted to $0.7 million. Significant components of cash provided by operating activities include net earnings, adjusted for non-cash expenses, of $36.4 million and an increase in working capital of $18.5 million. This increase was primarily due to higher Oil Field inventory balances, which used $12.2 million, from higher sales volume compared to the prior quarter and from tax payments, which used $12.7 million. These increases were partially offset by increased accounts payable balances, which provided $5.2 million, from higher production activity. Net cash used in investing activities included net capital expenditures totaling $13.0 million and an increase in other assets of $0.2 million. Capital expenditures in the first six months of 2006 were primarily for the expansion of manufacturing capacity and efficiency improvements in the Oil Field and Power Transmission segments. Capital expenditures for 2006 are projected to be in the range of $30.0 million to $35.0 million, primarily for the expansion of manufacturing capacity and efficiency improvements in the Oil Field and Power Transmission segments. Significant components of net cash provided by financing activities included the impact of stock option exercises of $4.8 million, partially offset by the repayment of short-term notes payable of $0.2 million and dividend payments of $3.9 million, or $0.26 per share.

Total debt balances at June 30, 2006, consisted of $60,000 of short-term notes payable. As of June 30, 2006, the Company had no outstanding debt associated with the Bank Facility discussed below and $60,000 of short-term bank debt associated with a French bank for the working capital needs of its French operation. Total debt decreased by $0.2 million from short-term note repayments during the six months ended June 30, 2006.

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. Borrowing under the Bank Facility bear interest, at the Company’s option, at either 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 June 30, 2006, 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 $5.0 million, $22.5 million of borrowing capacity was available at June 30, 2006.

The Company currently has a stock repurchase plan under which the Company is authorized to spend up to $19.1 million for repurchases of its common stock. Pursuant to this plan, the Company has repurchased a total of 1,656,740 shares of its common stock at an aggregate purchase price of $17.0 million. Repurchased shares are added to treasury stock and are available for general corporate purposes including the funding of the Company’s stock option plans. No shares were repurchased in the first half of 2006. As of June 30, 2006, the Company held 399,278 shares of treasury stock at an aggregate cost of approximately $4.1 million. Authorizations of approximately $2.1 million remained at June 30, 2006.

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The following table summarizes the Company’s expected cash outflow from financial contracts and commitments as of June 30, 2006. Information on recurring purchases of materials for use in manufacturing and service operations has not been included. These amounts are not long-term in nature (less than three months) and are generally consistent from year to year.

(In thousands of dollars)			Payments due by period
			Less than		1 - 3		3 - 5		More than
Contractual obligations	Total		1 year		years		years		5 years
Operating lease obligations	$	2,243	$	276	$	1,088	$	825	$	54
Contractual commitments
for capital expenditures		11,018		11,018		-		-		-
Total	$	13,261	$	11,294	$	1,088	$	825	$	54

Since the Company has no significant tax loss carryforwards, the Company expects to make quarterly estimated tax payments in 2006 based on taxable income levels. Also, the Company has various retirement plans for which the Company has committed a certain level of benefit. The Company expects to make contributions to its pension, defined contribution and post-retirement health and life plans of approximately $3.2 million in 2006, depending on participation levels in these plans.

Recently Issued Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in income Taxes- an interpretation of FASB Statement No. 109.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecogntion, classification, interest and penalties, accounting in interim periods, disclosure and transition. In accordance with FIN 48, the evaluation of a tax position is a two-step process. The first step requires determining whether it is more likely than not that a tax position will be sustained upon examination or appeals based on the technical merits of the position. The second step requires that a tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Differences between tax positions taken in a tax return and amounts recognized in the financial statements will generally result in an increase in a liability for income taxes payable and/or an increase in a deferred tax liability. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which the threshold is met and previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which the threshold is no longer met. FIN 48 is effective for fiscal years beginning after December 15, 2006, but earlier adoption is permitted. The Company is currently evaluating the impact, if any, the adoption of FIN 48 will have on its consolidated financial position or results of operations.

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

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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:

·   The customer has accepted title and risk of loss;

·   The customer has provided a written purchase order for the product;

·   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;

·   The customer must provide a storage period and future shipping date;

·   The Company must not have retained any future performance obligations on the product;

·   The Company must segregate the stored product and not make it available to use on other orders; and

·   The product must be complete 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 probable, 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.

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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 a defined benefit plan 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, 2005.

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” and similar expressions are intended to identify 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:

·   oil prices;

·   capital spending levels of oil producers;

·   the cyclicality of the trailer industry;

·   availability and prices for raw materials;

·   the inherent dangers and complexities of our operations;

·   uninsured judgments or a rise in insurance premiums;

·   the inability to effectively integrate acquisitions;

·   labor disruptions and increasing labor costs;

·   the availability of qualified and skilled labor;

·   disruption of our operating facilities or management information systems;

·   the impact on foreign operations of war, political disruption, civil disturbance, economic and legal sanctions and changes in global trade policies;

·   currency exchange rate fluctuations in the markets in which the Company operates;

·   changes in the laws, regulations, policies or other activities of governments, agencies and similar organizations where such actions may affect the production, licensing, distribution or sale of the Company’s products, the cost thereof or applicable tax rates;

·   costs related to legal and administrative proceedings, including adverse judgments against the Company if the Company fails to prevail in reversing such judgments; and

·   general industry, political and economic conditions in the markets where the Company procures material, components and supplies for the production of the Company’s principal products or where the Company’s products are produced, distributed or sold.

.

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 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 denominated in U.S. dollars owed to the Company’s U.S. entity by its French and Canadian entities. As of June 30, 2006, this inter-company debt was comprised of 0.1 million euros and $9.7 million Canadian dollars. As of June 30, 2006, if the U.S. dollar strengthened by 10% over these currencies, the net income impact would be $0.6 million of expense and if the U.S. dollar weakened by 10% over these currencies, the net income impact would be $0.6 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 June 30, 2006, if the U.S. dollar strengthened by 10% over these currencies, the net income impact would be $0.0 million of expense and if the U.S. dollar weakened by 10% over these currencies, the net income impact would be $0.0 million of income.

Item 4.   Controls and Procedures.

Based on their evaluation of the Company’s disclosure controls and procedures as of June 30, 2006, 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.

There were no changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2006, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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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 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 January 26, 2006, the Court of Appeals notified the parties that the case had been docketed and a decision is expected before the end of 2006. 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 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.

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, 2005, which could materially affect the Company's business, financial condition or future 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.

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Item 4. Submission of Matters to a Vote of Security Holders.

(a)   The Company held its Annual Meeting of Stockholders on May 3, 2006, in Lufkin, Texas to elect four directors.

(b)   Directors elected at the Annual Meeting:

Douglas V. Smith

Simon W. Henderson

John F. Anderson

Susan V. Baer

  Directors with terms of office continuing after the Annual Meeting:

Directors with terms expiring in 2007:

John H. Lollar

Bob H. O’Neal

Thomas E. Wiener

Directors with terms expiring in 2008:

H. J. Trout, Jr.

J. T. Jongebloed

(c)   The Annual Meeting was held to elect to elect four directors. All of the nominated directors were elected and will serve a three-year term expiring in 2009. The number of votes cast for, against or withheld, as well as the number of abstentions and broker non-votes, for each nominated director are as follows:

	Votes in		Votes		Votes				Broker Non-
	Favor		Against		Withheld		Abstentions		Votes
Douglas V. Smith		12,645,063		-		200,702		-		-
Simon H. Henderson		12,654,536		-		191,229		-		-
John F. Anderson		12,784,445		-		61,320		-		-
Suzanne V. Baer		12,577,561		-		268,204		-		-

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Item 6.  Exhibits.

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

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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: August 7, 2006

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 OF EXHIBITS

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