Lufkin Industries 10Q 2006 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2005

¨	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 twelve months (or for such shorter period as 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 an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨

There were 14,520,288 shares of Common Stock, $1.00 par value per share, outstanding as of August 2, 2005, not including 402,278 shares classified as Treasury Stock.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

CONSOLIDATED BALANCE SHEETS

UNAUDITED

(In thousands of dollars)


	June 30, 2005			December 31, 2004
ASSETS
Current assets:
Cash and cash equivalents	$	13,417		$	17,097
Receivables, net		68,310			61,038
Inventories		78,804			54,637
Deferred income tax assets		2,522			2,447
Other current assets		2,023			1,117

Total current assets		165,076			136,336

Property, plant and equipment, at cost		285,717			284,300
Less accumulated depreciation		198,894			194,745

		86,823			89,555

Prepaid pension costs		61,174			59,950
Goodwill, net		11,536			11,790
Other assets, net		2,749			2,638

Total assets	$	327,358		$	300,269

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Short-term notes payable	$	2,588		$	1,976
Accounts payable		28,107			23,706
Accrued liabilities:
Payroll and benefits		6,946			6,240
Warranty expenses		2,434			2,729
Taxes payable		4,646			5,213
Other		8,943			9,241

Total current liabilities		53,664			49,105

Deferred income tax liabilities		32,876			31,584
Postretirement benefits		10,837			10,648
Shareholders’ equity:
Common stock, $1.00 par value per share; 60,000,000 shares authorized; 14,814,706 and 14,471,958 shares issued, respectively		14,815			14,472
Capital in excess of par		25,606			19,488
Retained earnings		192,682			177,374
Treasury stock, 442,278 and 491,278 shares, respectively, at cost		(4,569	)		(5,075	)
Accumulated other comprehensive income:
Cumulative translation adjustment		1,447			2,673

Total shareholders’ equity		229,981			208,932

Total liabilities and shareholders’ equity	$	327,358		$	300,269

See accompanying notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF EARNINGS

AND COMPREHENSIVE INCOME (UNAUDITED)

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


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Sales	$	121,689		$	84,528		$	223,077		$	153,157

Cost of sales		93,666			69,472			172,602			126,071

Gross profit		28,023			15,056			50,475			27,086

Selling, general and administrative expenses		11,589			9,256			22,346			18,589

Operating income		16,434			5,800			28,129			8,497

Interest income		83			43			245			149
Interest expense		(37	)		(36	)		(80	)		(73	)
Other income (expense), net		(189	)		(327	)		(378	)		(296	)

Earnings before income tax provision		16,291			5,480			27,916			8,277

Income tax provision		5,865			1,999			10,050			3,063

Net earnings		10,426			3,481			17,866			5,214

Change in foreign currency translation adjustment		(726	)		(239	)		(1,226	)		(556	)

Total comprehensive income	$	9,700		$	3,242		$	16,640		$	4,658

Net earnings per share:
Basic	$	0.73		$	0.26		$	1.26		$	0.39

Diluted	$	0.71		$	0.25		$	1.23		$	0.38

Dividends per share	$	0.09		$	0.09		$	0.18		$	0.18

Weighted average number of shares outstanding:
Basic		14,234,337			13,497,576			14,132,675			13,414,054
Diluted		14,656,909			13,855,882			14,526,304			13,765,404

See accompanying notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands of dollars)


	Six Months Ended June 30,
	2005			2004
Cash flows from operating activities:
Net earnings	$	17,866		$	5,214
Adjustments to reconcile net earnings to cash provided by operating activities:
Depreciation and amortization		5,797			5,759
Deferred income tax provision		1,433			1,072
Pension income		(1,224	)		(1,629	)
Post – Retirement Benefits		190			—
Loss on disposition of property, plant and equipment		49			22
Changes in:
Receivables, net		(7,961	)		(3,246	)
Inventories		(24,823	)		(12,757	)
Other current assets		(911	)		(516	)
Accounts payable		5,182			5,690
Accrued liabilities		2,315			(783	)

Net cash used in operating activities		(2,087	)		(1,174	)

Cash flows from investing activities:
Additions to property, plant and equipment		(4,205	)		(3,266	)
Proceeds from disposition of property, plant and equipment		125			61
(Increase) decrease in other assets		(185	)		(87	)
Acquisition of other companies		(3	)		(7	)

Net cash used in investing activities		(4,268	)		(3,299	)

Cash flows from financing activities:
Proceeds from short-term notes payable		878			785
Payments on long-term notes payable		—			(120	)
Dividends paid		(2,559	)		(2,423	)
Proceeds from exercise of stock options		4,426			3,253
Net cash provided by financing activities		2,745			1,495

Effect of translation on cash and cash equivalents		(70	)		(56	)

Net decrease in cash and cash equivalents		(3,680	)		(3,034	)
Cash and cash equivalents at beginning of period		17,097			19,408

Cash and cash equivalents at end of period	$	13,417		$	16,374

See accompanying notes to consolidated financial statements

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 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 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, 2004. The results of operations for the three and six months ended June 30, 2005, are not necessarily indicative of the results that may be expected for the full fiscal year.

In March 2005, the Company’s Board of Directors approved a 2-for-1 stock split to be effected by issuing one additional share of common stock for every outstanding share of common stock. The additional shares were distributed on April 19, 2005, to stockholders of record at the close of business on April 4, 2005. All prior period shares outstanding, earnings per share and prices per share have been adjusted to reflect the stock split.

2. Acquisitions

The Company completed the acquisition on November 1, 2004, of the operating assets and commercial operations of Black Widow Oil Field Services located in Medicine Hat, Alberta, Canada, to further expand its oil field service presence in Canada. The aggregate purchase price for this acquisition was $0.3 million in cash. The Company has substantially completed the purchase allocation process for this acquisition, but additional adjustments may be made in 2005 as final valuations and analysis of fair values are completed. Any additional adjustments made in 2005 are not expected to be significant.

3. Receivables

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


	June 30, 2005			December 31, 2004
Accounts receivable	$	68,579		$	61,182
Notes receivable		27			32

Total receivables		68,606			61,214
Allowance for doubtful accounts		(296	)		(176	)

Net receivables	$	68,310		$	61,038

Bad debt expense related to receivables was $0.5 million and $0.2 million in the three months ended June 30, 2005 and 2004, respectively, and $0.6 million and $0.3 million in the six months ended June 30, 2005 and 2004, respectively.

4. Property, Plant & Equipment

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


	June 30, 2005			December 31, 2004
Land	$	3,200		$	3,231
Land improvements		7,264			7,042
Buildings		69,750			69,232
Machinery and equipment		188,606			187,741
Furniture and fixtures		4,038			4,095
Computer equipment and software		12,859			12,959

Total property, plant and equipment		285,717			284,300
Less accumulated depreciation		(198,894	)		(194,745	)

Total property, plant and equipment, net	$	86,823		$	89,555

Depreciation expense related to property, plant and equipment was $2.8 million and $2.8 million in the three months ended June 30, 2005 and 2004, respectively, and $5.7 million and $5.7 million in the six months ended June 30, 2005 and 2004, respectively.

5. Inventories

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


	June 30, 2005		December 31, 2004
Gross inventories @ FIFO:
Finished goods	$	8,628	$	7,770
Work in process		16,857		10,604
Raw materials & component parts		76,925		58,399

Total gross inventories @ FIFO		102,410		76,773
Less reserves:
LIFO		22,497		20,985
Valuation		1,109		1,151

Total inventories as reported	$	78,804	$	54,637

Gross inventories on a FIFO basis before adjustments for reserves shown above that were accounted for on a LIFO basis were $76.8 million and $57.3 million at June 30, 2005, and December 31, 2004, 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 six months ended June 30, 2005 and 2004, are illustrated below (in thousands of dollars, except share and per share data):


	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
Numerator:
Numerator for basic and diluted earnings per share-net earnings	$	10,426	$	3,481	$	17,866	$	5,214

Denominator:
Denominator for basic net earnings per share-weighted-average shares		14,234,337		13,497,576		14,132,675		13,414,054
Effect of dilutive securities: employee stock options		422,572		358,306		393,629		351,350

Denominator for diluted net earnings per share-adjusted weighted-average shares and assumed conversions		14,656,909		13,855,882		14,526,304		13,765,404

Basic net earnings per share	$	0.73	$	0.26	$	1.26	$	0.39

Diluted net earnings per share	$	0.71	$	0.25	$	1.23	$	0.38

Options to purchase a total of 14,000 and 57,548 shares of the Company’s common stock at June 30, 2005 and 2004, 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, promotions and compensation.

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%. The Company’s preliminary estimate is that the total amount of back pay that it would be required to pay to the class of affected employees could total up to $6 million (including interest). 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, (ii) ordered the Company to pay court costs and (iii) agreed to consider a request for awarding plaintiffs’ attorneys’ fees against the Company. On January 27, 2005, the plaintiffs moved for an interim award of attorney fees and costs, which they estimated to be $6.5 million, but to date the District Court has not ruled on this request.

7. Legal Proceedings (continued)

The Company has reviewed this decision with its outside counsel and intends to appeal the decision to the U.S. Court of Appeals for the Fifth Circuit. The Company believes that after a full and fair review by the appeals court 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.

8. Segment Data

The Company operates with three business segments – Oil Field, Power Transmission and Trailer. The Company’s Corporate group provides administrative services to the three business segments. 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, 2004. The following is a summary of key segment information (in thousands of dollars):


	Three Months Ended June 30, 2005									Corporate		Total
	Oil Field			Power 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


	Three Months Ended June 30, 2004									Corporate		Total
	Oil Field			Power Transmission			Trailer			Corporate		Total
Gross sales	$	52,026		$	19,025		$	14,176		$	—	$	85,227
Inter-segment sales		(407	)		(292	)		—			—		(699	)

Net sales	$	51,619		$	18,733		$	14,176		$	—	$	84,528

Operating income (loss)	$	5,635		$	1,008		$	(843	)	$	—	$	5,800
Other income (expense), net		(296	)		(87	)		1			62		(320	)

Earnings (loss) before income tax provision	$	5,339		$	921		$	(842	)	$	62	$	5,480

8. Segment Data (Continued)


	Six Months Ended June 30, 2005									Corporate		Total
	Oil Field			Power 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


	Six Months Ended June 30, 2004									Corporate		Total
	Oil Field			Power Transmission			Trailer			Corporate		Total
Gross sales	$	94,739		$	36,554		$	23,308		$	—	$	154,601
Inter-segment sales		(746	)		(683	)		(15	)		—		(1,444	)

Net sales	$	93,993		$	35,871		$	23,293		$	—	$	153,157

Operating income (loss)	$	10,148		$	591		$	(2,242	)	$	—	$	8,497
Other income (expense), net		(373	)		9			6			138		(220	)

Earnings (loss) before income tax provision	$	9,775		$	600		$	(2,236	)	$	138	$	8,277

9. Goodwill and Intangible Assets

Goodwill

The changes in the carrying amount of goodwill for the six months ended June 30, 2005, are as follows:


(In thousands of dollars)	Oil Field			Power Transmission			Trailer		Total
Balance as of 12/31/04	$	9,427		$	2,363		$	—	$	11,790
Goodwill acquired during year		3			—			—		3
Impairment losses		—			—			—		—
Goodwill written off related to sale of
business unit		—			—			—		—
Foreign currency translation		(2	)		(255	)		—		(257	)

Balance as of 6/30/05	$	9,428		$	2,108		$	—	$	11,536

Goodwill impairment tests were performed in the first quarter of 2005 and no impairment losses were recorded.

Intangible Assets

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


	June 30, 2005			December 31, 2004
Intangible assets subject to amortization:
Non-compete agreements
Original balance	$	463		$	463
Foreign currency translation		19			29
Accumulated amortization		(147	)		(100	)

Ending balance	$	335		$	392

Intangible assets not subject to amortization:
None		—			—

10. Stock Option Plans

The Company accounts for its stock option plans under APB Opinion No. 25 under which no compensation cost has been recognized. Had compensation cost for these plans been accounted for consistent with SFAS No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation- Transition and Disclosure,” the Company’s net earnings and net earnings per share would have been reduced to the following pro forma amounts (in thousands except per share data):


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Net earnings, as reported	$	10,426		$	3,481		$	17,866		$	5,214

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(328	)		(225	)		(630	)		(487	)

Pro forma net earnings	$	10,098		$	3,256		$	17,236		$	4,727

Net earnings per share:
As reported	$	0.73		$	0.26		$	1.26		$	0.39

Pro forma	$	0.71		$	0.24		$	1.22		$	0.35

Diluted net earnings per share
As reported	$	0.71		$	0.25		$	1.23		$	0.38

Pro forma	$	0.69		$	0.24		$	1.19		$	0.34

The effects of applying SFAS No. 123 to the pro forma disclosure amounts may not be indicative of future amounts. SFAS No. 123 does not apply to options awarded prior to 1995, and additional awards in future years are anticipated. The fair value of each option grant during the first six months of 2004 and 2003 was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:


2005 Grants	Expected dividend yield	1.17% - 1.75%
	Expected stock price volatility	38.62% - 39.45%
	Risk free interest rate	4.04% - 4.19%
	Expected life of options	8 years

2004 Grants	Expected dividend yield	2.25% - 2.35%
	Expected stock price volatility	38.80% - 38.82%
	Risk free interest rate	4.10% - 4.57%
	Expected life of options	10 years

Options granted during the three months ended June 30, 2005, had a weighted average fair value of $13.73 per option and a weighted average exercise price of $30.65 per option. Options granted during the six months ended June 30, 2005, had a weighted average fair value of $9.48 per option and a weighted average exercise price of $22.67 per option.

11. Recently Issued Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151 (“SFAS 151”), “Inventory Costs, an amendment of ARB No. 43, Chapter 4.” This Statement amends ARB 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) should be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005, but early application is permitted during fiscal years after the date this Statement is issued. The Company is currently in the process of evaluating the impact of SFAS 151 on the Company’s consolidated financial position or results of operations.

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 152 (“SFAS 152”), “Accounting for Real Estate Time-Sharing Transactions.” This Statement provides that real estate time-sharing transactions should be accounted for as non-retail land sales as discussed in the recently issued SOP 04-02, “Accounting for Real Estate Time-Sharing Transactions.” SFAS 152 amends FASB Statement No. 66, “Accounting for Sales of Real Estate,” to reference SOP 04-02 and amends FASB Statement No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects” to state that the guidance for incidental operations and costs incurred to sell real estate projects does not apply to real estate time-sharing transactions. SFAS 152 is effective for financial statements for fiscal years beginning after June 15, 2005. Restatement of previously issued financial statements is not permitted. The Company does not expect the adoption of SFAS 152 to impact the Company’s consolidated financial position or results of operations.

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 153 (“SFAS 153”), “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No, 29.” This Statement addresses the measurement of exchanges of nonmonetary assets. It eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. This Statement specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for nonmonetary asset exchanges occurring in fiscal years beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date this Statement is issued. The Company does not expect the adoption of SFAS 153 to impact the Company’s consolidated financial position or results of operations.

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123-Revised 2004 (“SFAS 123R”), “Share-Based Payment,” 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. SFAS 123R initially was to be adopted as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. However, on April 15, 2005, the Securities and Exchange Commission announced a new rule that amended the adoption date for SFAS 123R. The new rule allows companies to implement SFAS 123R at the beginning of their next fiscal year that begins after June 15, 2005. As noted in Footnote 10 of the Notes to Consolidated Financial Statements, the Company does not currently record compensation expense for stock-based compensation. Although the Company continues to evaluate SFAS 123R and related transition matters, the adoption of SFAS 123R is expected to impact net earnings by approximately $0.6 million ($0.04 per diluted share), $0.3 million ($0.02 per diluted share) and $0.02 million ($0.01 per diluted share) for the years ending December 31, 2006, 2007 and 2008, respectively, for stock options previously granted.

11. Recently Issued Accounting Pronouncements (continued)

In March 2005, the Financial Accounting Standards Board issued FASB Interpretation No. 47 (“Interpretation 47”), “Accounting for Conditional Asset Retirement Obligations,” Interpretation 47 clarifies that the term “conditional asset retirement obligation” as used in SFAS No. 143 “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of an entity. If an entity has sufficient information to reasonably estimate the fair value of an asset retirement obligation, it must recognize a liability at the time the liability is incurred. If the liability’s fair value cannot be reasonably estimated, that fact and the reasons shall be disclosed. Interpretation 47 is effective no later than the end of fiscal years ending after December 15, 2005 (December 31, 2005, for calendar-year enterprises). An entity shall recognize the cumulative effect of initially applying this Interpretation as a change in accounting principle. The Company is currently in the process of evaluating the impact of Interpretation 47 on the Company’s consolidated financial position or results of operations.

In May 2005, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 154 (“SFAS 154”), “Accounting Changes and Error Corrections.” This Statement requires retrospective application for voluntary changes in accounting principle unless it is impracticable to do so. Statement 154’s retrospective application requirement replaces APB Opinion No. 20, “Accounting Changes” requirement to recognize most voluntary changes in accounting principle by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for accounting changes and corrections of errors occurring in fiscal periods beginning after the date this Statement is issued. The Company does not expect the adoption of SFAS 154 to impact the Company’s consolidated financial position or results of operations.

12. Retirement Benefits

The Company has a noncontributory pension plan covering substantially all employees. The benefits provided by this plan are measured by length of service, compensation and other factors, and are currently funded by a trust established under the plan. Funding of retirement costs for this plan complies with the minimum funding requirements specified by the Employee Retirement Income Security Act of 1974, as amended.

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 and the Company’s obligation is fixed at the 1997 contribution level.

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.

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


	Pension Benefits						Other Benefits
Three Months Ended June 30,	2005			2004			2005		2004
Service cost	$	1,171		$	1,027		$	75	$	55
Interest cost		2,323			2,195			179		177
Expected return on plan assets		(3,927	)		(3,947	)		—		—
Amortization of prior service cost		78			78			—		—
Amortization of unrecognized net (gain) loss		—			—			17		3
Amortization of unrecognized transition asset		(232	)		(231	)		—		—

Net periodic benefit cost (income)	$	(587	)	$	(878	)	$	271	$	235


	Pension Benefits						Other Benefits
Six Months Ended June 30,	2005			2004			2005		2004
Service cost	$	2,273		$	2,058		$	130	$	110
Interest cost		4,671			4,516			348		354
Expected return on plan assets		(7,861	)		(7,896	)		—		—
Amortization of prior service cost		156			156			—		—
Amortization of unrecognized net (gain) loss		—			—			17		6
Amortization of unrecognized transition asset		(463	)		(463	)		—		—

Net periodic benefit cost (income)	$	(1,224	)	$	(1,629	)	$	495	$	470

12. Retirement Benefits (Continued)

Employer Contributions

The Company previously disclosed in its financial statements for the year ended December 31, 2004, that it did not expect to make any contributions to the pension plan in 2005. The Company also disclosed that it expected contributions of $450,000 to be made to its postretirement plan in 2005. As of June 30, 2005, the Company has made no contributions to its pension plan and has made contributions of $178,000 to its postretirement plan. The Company presently anticipates making no contributions to its pension plan and an additional $175,000 to its postretirement plan during the last six months of 2005.

Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.

Overview

Lufkin Industries, Inc. (the “Company”) 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 and low-speed increasing and reducing gearboxes for industrial applications. Through its Trailer segment, the Company manufactures and services 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, during the fourth quarter of 2004, the Company completed the acquisition of the operating assets and commercial operations of Black Widow Oilfield Services located in Drayton Valley, Alberta, Canada to further expand its service presence in Canada. In addition to acquisitions, the Company has been making capital investments within the Oil Field segment in both more efficient replacement equipment and capacity expansion to meet the growing demand for its products and generate cost savings.

Within the Power Transmission segment, additional gear repair facilities have been opened to serve the Midwest and Northeast US markets following the successful expansion into the Southeast US market. Capital investments targeting cost reductions and shorter manufacturing lead times are also being made in the Power Transmission segment.

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 quarter ended June 30, 2005, increased to $121.7 million, or 44.0%, from $84.5 million for the quarter ended June 30, 2004, and sales for the six months ended June 30, 2005, increased to $223.1 million, or 45.7%, from $153.2 million for the six months ended June 30, 2004. This growth was primarily driven by increased sales of new oil field equipment but also higher sales of new Power Transmission gearboxes and new trailers. Additional segment data on sales is provided later in this section.

Gross margin for the quarter ended June 30, 2005, increased to 23.0% from 17.8% for the quarter ended June 30, 2004, and gross margin for the six months ended June 30, 2005, increased to 22.6% from 17.7% for the six months ended June 30, 2004. This overall gross margin increase was primarily due to improved fixed cost leverage, plant efficiency improvements from higher volumes and price increases implemented in 2004 and 2005 in response to the rapid material cost increases experienced in 2004. Additional segment data on gross margin is provided later in this section.

The increase in sales and gross margin primarily drove the changes in net earnings, but was partially offset by increases in selling, general and administrative expenses. However, greater sales volumes did provide leverage on selling, general and administrative expenses, which improved overall net margins. The Company reported net earnings of $10.4 million, or $0.71 per share (diluted), for the quarter ended June 30, 2005, compared to net earnings of $3.5 million, or $0.25 per share (diluted), for the quarter ended June 30, 2004, and net earnings of $17.9 million, or $1.23 per share (diluted), for the six months ended June 30, 2005, compared to net earnings of $5.2 million, or $0.38 per share (diluted), for the six months ended June 30, 2004.

Debt/equity (long-term debt net of current portion as a percentage of total equity) levels remained at 0.0% at June 30, 2005. Short-term debt was $2.6 million at June 30, 2005, up from $2.0 million at December 31, 2004, due to additional borrowing by the Company’s French subsidiary to cover working capital requirements. Cash balances at June 30, 2005, were $13.4 million, down from $17.1 million at December 31, 2004. Inventory levels increased in support of higher backlog levels and to replenish strategic inventory levels.

Three Months Ended June 30, 2005, Compared to the Three Months Ended June 30, 2004:

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


	Three Months Ended June 30,				Increase/ (Decrease)		%Increase/ (Decrease)
	2005		2004		Increase/ (Decrease)		%Increase/ (Decrease)
Sales
Oil Field	$	76,199	$	51,619	$	24,580	47.6
Power Transmission		24,800		18,733		6,067	32.4
Trailer		20,690		14,176		6,514	46.0

Total	$	121,689	$	84,528	$	37,161	44.0

Gross Profit
Oil Field	$	18,874	$	9,741	$	9,133	93.8
Power Transmission		7,772		4,871		2,901	59.6
Trailer		1,377		444		933	210.1

Total	$	28,023	$	15,056	$	12,967	86.1

Oil Field sales increased to $76.2 million, or 47.6%, for the quarter ended June 30, 2005, from $51.6 million for the quarter ended June 30, 2004. The added sales from 2004 acquisitions and the benefit of the stronger Canadian dollar in the second quarter of 2005 contributed 1.9 percentage points of this increase. Increased sales of new pumping units account for a majority of the balance of the increase of 45.7 percentage points. Sales of new pumping units in the U.S., Canada and Argentina, and related service, increased from higher drilling and production activity associated with higher energy prices and from higher use of pumping units to pump water from gas fields. In addition, sales of automation equipment continued to increase due to market share growth from new product offerings. Commercial casting sales from the foundry operation grew significantly from the prior year as general economic levels in the U.S. continued to improve, especially in the industrial and construction-related markets. In addition, sales growth was impacted from price increases instituted throughout 2004 in response to dramatic raw material price increases. Oil Field’s backlog increased to $65.8 million as of June 30, 2005, from $44.0 million at June 30, 2004. This backlog increase was from increased bookings of new pumping units in the U.S., Canada and Argentina markets and from foundry machine tool casting orders.

Gross margin (gross profit as a percentage of revenue) for the Oil Field segment increased to 24.8% for quarter ended June 30, 2005, compared to 18.9% for the quarter ended June 30, 2004, or 5.9 percentage points. During the second quarter of 2004, the benefit of higher plant utilization was offset by higher raw material prices, especially steel, higher fuel prices in the service operations and plant inefficiencies in the foundry operation associated with rapid production ramp-up for the volume increases. Throughout 2004 and 2005, sales prices were increased to recover higher material costs and plant efficiencies improved, contributing to the improved gross margin in the second quarter of 2005 and enabling the segment to return to margin levels of past years. In addition, higher production volumes improved plant utilization and fixed cost coverage.

Direct selling, general and administrative expenses for the Oil Field remained at $2.8 million for the quarter ended June 30, 2005, compared to the quarter ended June 30, 2004.

Sales for the Company’s Power Transmission segment increased to $24.8 million, or 32.4%, for the quarter ended June 30, 2005, compared to $18.7 million for the quarter ended June 30, 2004. The benefit of the stronger euro on the sales of the French division and the opening of new gear repair facilities contributed 1.9 percentage points of this increase. The additional 30.4 percentage points of growth was the result of increased sales of new high-speed units and gear repair to energy-related markets, such as offshore drilling and refining. The Company’s Power Transmission backlog at June 30, 2005, increased to $60.2 million from $36.2 million at June 30, 2004, from new high-speed units for the reasons noted above.

Gross margin for the Power Transmission segment increased to 31.3% for the quarter ended June 30, 2005, compared to 26.0% for the quarter ended June 30, 2004, or 5.3 percentage points. This increase resulted from the favorable impact of higher volumes on plant efficiencies and fixed cost coverage as well as from the benefit of increased selling prices. Also, increased inter-segment production in support of the Oil Field segment provided additional manufacturing volume that contributed to greater and fixed cost absorption and improved gross margins.

Direct selling, general and administrative expenses for Power Transmission increased $0.5 million to $3.3 million, or 15.7%, for the quarter ended June 30, 2005, from $2.8 million for the quarter ended June 30, 2004, due to greater engineering costs and third-party commissions in support of higher sales volumes.

Trailer sales for the quarter ended June 30, 2005, increased to $20.7 million, or 46.0%, from $14.2 million for the quarter ended June 30, 2004. This increase resulted from higher sales of all models of new trailers. Freight industry demand has continued to improve due to replacement trailer demand and from increases in freight volume levels. Sales growth in flatbeds was particularly strong due to the introduction of new models and demand from the construction market. Backlog for the Trailer segment increased to $31.6 million at June 30, 2005, compared to $29.0 million at June 30, 2004. The backlog increase was primarily from orders for new flatbed trailers for the reasons mentioned above.

Trailer gross margin increased to 6.7% for the quarter ended June 30, 2005, from 3.1% for the quarter ended June 30, 2004, or 3.6 percentage points. This margin improvement was due to higher selling prices on new trailers and the favorable mix impact of higher-margin flatbed trailers, partially offset by plant inefficiencies from rapid production ramp-up.

Direct selling, general and administrative expenses for Trailer increased to $1.1 million for the quarter ended June 30, 2005, from $0.5 million for the quarter ended June 30, 2004 from higher bad debt expense associated with a disputed receivable that is currently in litigation.

Corporate administrative expenses, which are allocated to the segments primarily based on third-party revenues, increased to $4.4 million, or 27.9%, for the quarter ended June 30, 2005, from $3.2 million for the quarter ended June 30, 2004, primarily from higher employee-related, legal and audit expenses.

Investment income, interest expense and other income and expense for the quarter ended June 30, 2005, totaled $0.1 million of expense compared to expense of $0.3 million for the quarter ended June 30, 2004, due to various miscellaneous income items.

Pension income, which is reported as a reduction of cost of sales, decreased to $0.6 million for the quarter ended June 30, 2005, or 33%, compared to $0.9 million for the quarter ended June 30, 2004. For the full year, pension income is expected to be approximately $2.4 million compared to $3.4 million for 2004, or a 29% increase. This decrease is due to lower expected returns on plan assets from lowering the expected return rate from 8.5% to 8.0% and from lowering the discount rate from 6.25% to 6.0%.

The effective tax rate for the quarter ending June 30, 2005, was 36.0% compared to 36.5% for the quarter ended June 30, 2004, due to the favorable impact of the new manufacturing income deduction.

Six Months Ended June 30, 2005, Compared to the Six Months Ended June 30, 2004:

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


	Six Months Ended June 30,				Increase/ (Decrease)		% Increase/ (Decrease)
	2005		2004		Increase/ (Decrease)		% Increase/ (Decrease)
Sales
Oil Field	$	138,920	$	93,993	$	44,927	47.8
Power Transmission		47,036		35,871		11,165	31.1
Trailer		37,121		23,293		13,828	59.4

Total	$	223,077	$	153,157	$	69,920	45.7

Gross Profit
Oil Field	$	33,200	$	17,945	$	15,255	85.0
Power Transmission		15,015		8,726		6,289	72.1
Trailer		2,260		415		1,845	444.6

Total	$	50,475	$	27,086	$	23,389	86.4

Oil Field sales increased to $138.9 million, or 47.8%, for the six months ended June 30, 2005, from $94.0 million for the six months ended June 30, 2004. The added sales of 2004 acquisitions and the benefit of the stronger Canadian dollar in the first six months of 2005 contributed 2.0 percentage points of this increase. Increased sales of new pumping units account for a majority of the balance of the increase of 45.8 percentage points. Sales of new pumping units in the U.S., Canada and Argentina, and related service, increased from higher drilling and production activity associated with higher energy prices and from higher use of pumping units to pump water from gas fields. In addition, sales of automation equipment continued to increase due to market share growth from new product offerings. Commercial casting sales from the foundry operation grew significantly from the prior year as general economic levels in the U.S. continued to improve, especially in the industrial and construction-related markets. In addition, sales growth was impacted from price increases instituted throughout 2004 in response to dramatic raw material price increases. Oil Field’s backlog increased to $65.8 million as of June 30, 2005, from $61.6 million at December 31, 2004. This backlog increase was from increased bookings of new pumping units in the U.S., Canada and Argentina markets and from foundry machine tool casting orders.

Gross margin (gross profit as a percentage of revenue) for the Oil Field segment increased to 23.9% for six months ended June 30, 2005, compared to 19.1% for the six months ended June 30, 2004, or 4.8 percentage points. The benefit of higher plant utilization from increased volumes in the first half of 2004 was offset by higher raw material prices, especially steel, higher fuel prices in the service operations and plant inefficiencies in the foundry operation associated with rapid production ramp-up for the volume increases. Throughout 2004 and 2005, sales prices were increased to recover higher material costs and plant efficiencies improved, contributing to the improved gross margin in the first half of 2005. In addition, higher production volumes improved plant utilization and fixed cost coverage.

Direct selling, general and administrative expenses the Oil Field increased to $5.6 million, or 7.4%, for the six months ended June 30, 2005, from $5.2 million for the for six months ended June 30, 2004. Increased selling expenses contributed the majority of this increase in support of higher sales volumes.

Sales for the Company’s Power Transmission segment increased to $47.0 million, or 31.1%, for the six months ended June 30, 2005, compared to $35.9 million for the six months ended June 30, 2004. The benefit of the stronger euro on the sales of the French division and the opening of new gear repair facilities contributed 2.7 percentage points of this increase. The additional 28.5 percentage points of growth was the result of increased sales of new high-speed units and gear repair to energy-related markets, such as offshore drilling and refining. The Company’s Power Transmission backlog at June 30, 2005, increased to $60.2 million from $40.1 million at December 31, 2004, from new high-speed units for the reasons noted above.

Gross margin for the Power Transmission segment increased to 31.9% for the six months ended June 30, 2005, compared to 24.3% for the six months ended June 30, 2004, or 7.6 percentage points. This increase resulted from the favorable impact of higher volumes on plant efficiencies and fixed cost coverage as well as from the benefit of increased selling prices. Also, increased inter-segment production in support of the Oil Field segment provided additional manufacturing volume that contributed to improved gross margins.

Direct selling, general and administrative expenses for Power Transmission increased $0.5 million to $6.6 million, or 8.9%, for the six months ended June 30, 2005, from $6.1 million for the six months ended June 30, 2004, due to higher employee-related expenses in support of increased sales volumes.

Trailer sales for the six months ended June 30, 2005, increased to $37.1 million, or 59.4%, from $23.3 million for the six months ended June 30, 2004. This increase resulted from higher sales of all models of new trailers. Freight industry demand has continued to improve due to replacement trailer demand and from increases in freight volume levels. Sales growth in flatbeds was particularly strong due to the introduction of new models and demand from the construction market. Backlog for the Trailer segment increased to $31.6 million at June 30, 2005, compared to $11.5 million at December 31, 2004. The backlog increase was primarily from orders for new van and flatbed trailers for the reasons mentioned above.

Trailer gross margin increased to 6.1% for the six months ended June 30, 2005, from 1.8% for the six months ended June 30, 2004, or 4.3 percentage points. This margin improvement was due to higher selling prices on new trailers and the favorable mix impact of higher-margin flatbed and dump trailers, partially offset by plant inefficiencies from rapid production ramp-up.

Direct selling, general and administrative expenses for Trailer increased to $1.7 million for the six months ended June 30, 2005, from $1.0 million for the six months ended June 30, 2004, from higher bad debt expense associated with a disputed receivable that is currently in litigation.

Corporate administrative expenses, which are allocated to the segments primarily based on third-party revenues, increased to $8.5 million, or 34.5%, for the six months ended June 30, 2005, from $6.3 million for the six months ended June 30, 2004, primarily from higher employee-related, legal and audit expenses.

Investment income, interest expense and other income and expense for the quarter ended June 30, 2005, totaled $0.2 million of expense compared to expense of $0.2 million for the six months ended June 30, 2005.

Pension income, which is reported as a reduction of cost of sales, decreased to $1.2 million for the six months ended June 30, 2005, or 25%, compared to $1.6 million for the six months ended June 30, 2004. For the full year, pension income is expected to be approximately $2.4 million compared to $3.4 million for 2004, or a 29% decrease. This decrease is due to lower expected returns on plan assets from lowering the expected return rate from 8.5% to 8.0% and from lowering the discount rate from 6.25% to 6.0%.

The effective tax rate for the six months ending June 30, 2005, was 36.0% compared to 37.0% for the quarter ended June 30, 2004, due to the favorable impact of the new manufacturing income deduction.

Liquidity and Capital Resources

The Company has historically relied on cash flows from operations and third-party borrowings to finance its operations, including acquisitions, dividend payments and stock repurchases.

The Company’s cash balance totaled $13.4 million at June 30, 2005, compared to $17.1 million at December 31, 2004. For the six months ended June 30, 2005, net cash used in operating activities was $2.1 million, net cash used in investing activities totaled $4.3 million and net cash provided by financing activities amounted to $2.7 million. Significant components of cash used in operating activities include net earnings adjusted for non-cash expenses of $24.1 million, offset by a net increase in working capital of $26.2 million. This increase was primarily due to higher inventory and higher accounts receivable, which consumed $24.8 million and $8.0 million, respectively. The inventory increase was primarily due to higher inventory levels in all segments to support higher sales volumes and to replace strategic inventory sold in previous periods. Accounts receivable increased in all segments from higher sales. Higher accounts payable balances, related to higher activity and inventory levels, partially offset these items by $5.2 million. Net cash used in investing activities included net capital expenditures totaling $4.1 million and an increase in other assets of $0.2 million. Capital expenditures for 2005 are projected to be in the range of $18.0 million to $20.0 million, primarily for the expansion of manufacturing capacity and efficiency improvements in the Oil Field segment. Significant components of net cash provided by financing activities included proceeds from short-term notes payable of $0.9 million, proceeds from the exercise of stock options of $4.4 million and dividend payments of $2.6 million, or $0.18 per share.

Total debt balances at June 30, 2005, consisted of $2.6 million of short-term notes payable. This debt is associated with the Company’s French operations. As of June 30, 2005, the Company had no outstanding debt associated with the Bank Facility discussed below. Total debt increased by $0.6 million from short-term borrowings during the six months ended June 30, 2005.

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 borrowings along with an additional $10.0 million discretionary line of credit. This Bank Facility expires on June 30, 2007. Borrowings 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, 2005, no amounts were outstanding under the Bank Facility and the Company was in compliance with all financial covenants under the terms of the Bank Facility.

In addition, the Company has short-term borrowing capabilities with a French bank for the working capital needs of its French operation. Specific accounts receivable are provided as security, with repayment due 15 days after the date the accounts receivable are due from the customer. Interest is calculated at the three-month EURIBOR rate plus an applicable margin. As of June 30, 2005, $2.6 million was outstanding under this borrowing arrangement.

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. No shares were repurchased during the quarter or six months ended June 30, 2005. Repurchased shares are added to treasury stock and are available for general corporate purposes, including the funding of the Company’s stock option plans. As of June 30, 2005, the Company held 442,278 shares of treasury stock at an aggregate cost of approximately $4.6 million. Authorizations of approximately $2.1 million remained at June 30, 2005.

The following table summarizes the Company’s expected cash outflows from financial contracts and commitments as of June 30, 2005. Information on recurring purchases of materials for use in manufacturing and service operations have not been included. These amounts are not long-term in nature (less than three months) and are generally consistent from year to year.


			Payments due by period
(In thousands of dollars)	Total		Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years
Operating lease obligations	$	1,909	$	232	$	972	$	540	$	165
Contractual commitments for capital expenditures		4,276		4,276		—		—		—

Total	$	6,185	$	4,508	$	972	$	540	$	165

Since the Company has no significant tax loss carryforwards, the Company expects to make quarterly estimated tax payments in 2005 based on taxable income levels. Also, the Company has various retirement plans for which the Company has committed a certain level of benefits. The defined benefit plan is overfunded and no contributions are expected in the short-term. The Company expects to make contributions to its defined contribution and post-retirement health and life plans of approximately $2.5 million annually, depending on participation levels in these plans.

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, 2005.

Recently Issued Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123-Revised 2004 (“SFAS 123R”), “Share-Based Payment,” 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. SFAS 123R initially was to be adopted as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. However, on April 15, 2005, the Securities and Exchange Commission announced a new rule that amended the adoption date for SFAS 123R. The new rule allows companies to implement SFAS 123R at the beginning of their next fiscal year that begins after June 15, 2005. As noted in Footnote 10 of the Notes to Consolidated Financial Statements, the Company does not record compensation expense for stock-based compensation. Although the Company continues to evaluate SFAS 123R and related transition matters, the adoption of SFAS 123R is expected to impact net earnings by approximately $0.6 million ($0.04 per diluted share), $0.3 million ($0.02 per diluted share) and $0.02 million ($0.01 per diluted share) for the years ending December 31, 2006, 2007 and 2008, respectively, for stock options previously granted.

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.

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:

•

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.

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.

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, 2004.

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. These risks and uncertainties include, but are not limited to, (i) oil prices, (ii) capital spending levels of oil producers, (iii) availability and prices for raw materials, (iv) currency exchange rate fluctuations in the markets in which the Company operates, (v) 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, (vi) costs related to legal and administrative proceedings, including adverse judgments against the Company if the Company fails to prevail in reversing such judgments, and (vii) general industry, political and economic conditions in the markets where the Company’s 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. 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 Company undertakes no obligations to update or revise its forward-looking statements, whether as a result of new information, future events or otherwise.

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 believes the carrying values of its long-term debt obligations approximate fair values because the interest rates on these obligations are comparable to what the Company believes it could currently obtain for debt with similar terms and maturities. 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 interest rate risk 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, 2005, this inter-company debt was comprised of 0.9 million euros and 7.2 million Canadian dollars. As of June 30, 2005, if the U.S. dollar strengthens by 10% over these currencies, the net income impact would be $0.4 million of expense and if the U.S. dollar weakens by 10% over these currencies, the net income impact would be $0.4 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, 2005, if the U.S. dollar strengthens by 10% over these currencies, the net income impact would be $0.1 million of expense and if the U.S. dollar weakens 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 June 30, 2005, 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 Rule 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 that occurred during the Company’s last fiscal quarter 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.

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

(a)	The Company held its Annual Meeting of Stockholders on May 4, 2005, in Lufkin, Texas to elect two directors.

(b)	Directors elected at the Annual Meeting:

H. J. Trout, Jr.

J. T. Jongebloed

Directors with terms of office continuing after the Annual Meeting:

Directors with terms expiring in 2006:

Douglas V. Smith

Simon W. Henderson

John F. Anderson

Directors with terms expiring in 2007:

John H. Lollar

Bob H. O’Neal

Thomas E. Wiener

(c) The Annual Meeting was held to elect to elect two directors. All of the nominated directors were elected and will serve a three-year term expiring in 2008. 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 Favor	Votes Against	Votes Withheld	Abstentions	Broker Non-Votes
H. J. Trout, Jr.	6,029,475	—	120,151	—	—

J. T. Jongebloed	5,886,000	—	263,626	—	—

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(a) Certification of Chief Financial Officer.

32.1		Section 1350 Certification of Chief Executive Officer.

32.2		Section 1350 Certification of Chief Financial Officer.

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 8, 2005

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(a) Certification of Chief Financial Officer.

32.1		Section 1350 Certification of Chief Executive Officer.

32.2		Section 1350 Certification of Chief Financial Officer.

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

Lufkin Industries (LUFK) Inactive 10-Q2006 Q1 Quarterly report

Content analysis