10-K 1 form10_k.htm FORM 10K form10_k.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

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

For the fiscal year ended    December 31, 2007

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

For transition period from                                               to

Commission file number  0-2612

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)

                                                Registrant's telephone number, including area code         (936) 634-2211             

Securities registered pursuant to Section 12(b) of the Act:  None
Securities registered pursuant to Section 12(g) of the Act:

Common Stock, Par Value $1 Per Share
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.          Yes     X     No          

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.        Yes           No     X    

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    X    

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

Large accelerated filer      X                                                                                         Accelerated filer ______
Non-accelerated filer ______                                                                                     Smaller reporting company ______

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

The aggregate market value of the Company's voting stock held by non-affiliates as of the last business day of the Company’s most recently completed second fiscal quarter, June 29, 2007, was $974,544,012.

There were 14,639,806 shares of Common Stock, $1.00 par value per share, outstanding as of February 27, 2008, not including 914,278 shares classified as Treasury Stock.


DOCUMENTS INCORPORATED BY REFERENCE

The information called for by Items 10, 11, 12, 13 and 14 of Part III of this annual report on Form 10-K are incorporated by reference from the registrant’s definitive proxy statement to be filed pursuant to Regulation 14A.

 
 
 
 

PART I

Item 1.  Business

Lufkin Industries, Inc. (the “Company”) was incorporated under the laws of the State of Texas on March 4, 1902, and since that date has maintained its principal office and manufacturing facilities in Lufkin, Texas.  The Company employed approximately 2,700 people at December 31, 2007, including approximately 1,850 that were paid on an hourly basis.  Certain operations are subject to a union contract that expires in October 2008. The Company is divided into three operating segments: Oil Field, Power Transmission and Trailer.

In January 2008, the Company announced the decision to suspend its participation in the commercial trailer markets and to develop a plan to run-out existing inventories, fulfill contractual obligations and close all trailer facilities during 2008. See the Trailer section below for more information.

Oil Field

Products:
The Oil Field segment manufactures and services artificial reciprocating rod lift equipment, commonly referred to as pumping units, and related products.
Pumping Units- Four basic types of pumping units are manufactured: an air-balanced unit; a beam-balanced unit; a crank-balanced unit; and a Mark II Unitorque unit.  The basic differences between the four types relate to the counterbalancing system.  The depth of a well and the desired fluid production determine the type of counterbalancing configuration that is required.  There are numerous sizes and combinations of Lufkin oil field pumping units within the four basic types.
Service- Through a network of service centers, the Company transports and repairs pumping units. The service centers also refurbish used pumping units.
Automation- The Company designs, manufactures, installs and services computer control equipment and analytical services for pumping units that lower production costs and optimize well efficiency.
Foundry Castings- As part of the Company’s vertical integration strategy, the Oil Field segment operates an iron foundry to produce castings for new pumping units. In order to maximize utilization of this facility, castings for third parties are also produced.

Raw Materials & Labor:
Oil Field purchases a variety of raw materials in manufacturing its products. The principal raw materials are structural and plate steel, round alloy steel and iron castings from both its own foundry and third-party foundries. Casting costs are subject to change from raw material prices on scrap iron and pig iron in addition to natural gas and electricity prices. Due to the many configurations of its products and thus sizes of raw material used, Oil Field does not enter into long-term contracts for raw materials but generally does not experience shortages of raw materials. During the period of 2005 through 2007, Oil Field did not experience any significant material shortages or rapid price increases. Raw material prices are not expected to decline in the short-term nor are shortages expected. Certain materials like steel round and bearings have continued to experience price increases and longer lead times. Raw material prices may continue to increase and availability may decrease with little notice.

The nature of the products manufactured and serviced generally requires skilled labor. Oil Field’s ability to increase capacity could be limited by its ability to hire and train qualified personnel. Also, the main U.S. manufacturing facilities are unionized, so any labor disruption could have a significant impact on Oil Field’s ability to maintain production levels. The current labor contract expires in October 2008.

Markets:
Demand for pumping unit equipment primarily depends on the level of new onshore oil well and workover drilling activity as well as the depth and fluid conditions of that drilling. Drilling activity is driven by the available cash flow of the Company’s customers as well as their long-term perceptions of the level and stability of the price of oil. The higher energy prices experienced since 2004 have increased the demand for pumping units and related service and products from higher drilling activity, activation of idle wells and the upgrading of existing wells. During 2007, demand in the North American market has been negatively affected, compared to 2006 levels, by the impact of lower natural gas prices on coal-bed methane and other unconventional gas production that use rod pumps to de-water wells, drilling program delays from M&A activity, cost control efforts deferring or reducing capital spending programs and the competitive pressure from lower-priced pumping units in areas traditionally served by the used unit market. Traditionally, as pumping unit demand increases and availability of used equipment diminishes, demand for new equipment increases, as was experienced in 2006. Increasingly in 2007, lower-priced imported pumping units have entered the North American market in place of used equipment and reduced the incremental demand for the Company’s new pumping units. However, the demand for pumping units, oilfield services and automation equipment continue to increase in international markets. While a majority of the segment’s revenues are in North America, international opportunities continue to increase as new drilling increases and existing fields mature, requiring increased use of pumping units for artificial lift, especially in the South American, Russian and Middle Eastern markets. An Oilfield customer and its related subsidiaries represented 14.9%, 11.6% and 8.2% of consolidated company sales in 2007, 2006 and 2005, respectively. The loss of this customer would have a material adverse effect on this segment.

Competition:
The primary global competitor for new pumping units and automation equipment is Weatherford, but Chinese manufacturers of pumping units are increasingly present in the market. Used pumping units are also an important factor in the North American market, as customers will generally attempt to satisfy requirements through used equipment before purchasing new equipment.  While the Company believes that it is one of the larger manufacturers of sucker rod pumping units in the world, manufacturers of other types of units (submersibles and hydraulics) have a significant share of the total artificial lift market. While Weatherford is the Company’s single largest competitor in the service market, small independent operators provide significant competitive pressures.

Because of the competitive nature of the business and the relative age of many of the product designs, price, delivery time, product quality and customer service are important factors in winning orders. To this end, the Company maintains strategic levels of inventories in order to ensure delivery times and invests in new capital equipment to maintain quality and price levels.

Power Transmission

Products:
The Power Transmission segment designs, manufactures and services speed increasing and reducing gearboxes for industrial applications. Speed increasers convert lower speed and higher torque input to higher speed and lower torque output while speed reducers convert higher speed and lower torque input to lower speed and higher torque output. The Company produces numerous sizes and designs of gearboxes depending on the end use. While there are standard designs, the majority of gearboxes are customized for each application.
High-Speed Gearboxes- Single stage gearboxes with pitch line velocities equal to or greater than 35 meters per second or rotational speeds greater than 4500 rpm or multi-stage gearboxes with at least one stage having a pitch line velocity equal to or greater than 35 meters per second and other stages having pitch line velocities equal to or greater than 8 meters per second. These gearboxes require extremely high precision manufacturing and testing due to the stresses on the gearing. The ratio of increasers to reducers is fairly even. These gearboxes more typically service the energy related markets of petrochemicals, refineries, offshore production and transmission of oil and gas.
Low-Speed Gearboxes- Gearboxes which do not meet the pitch line or rotational speed criteria of high-speed gearboxes are classified as low-speed gearboxes. The majority of low-speed gearboxes are reducers. While still requiring close tolerances, these gearboxes do not require the same precision of manufacturing and testing. These gearboxes more typically service commodity-related industries like rubber, sugar, paper, steel, plastics, mining and cement as well as marine propulsion.
Parts- The Company manufactures capital spares for customers in conjunction with the production of new gearboxes, as well as producing parts for aftermarket service.
Repair & Service- The Company provides on and off-site repair and service for not only its own products but also those manufactured by other companies. Repair work is performed in dedicated facilities due to the high turn-around times required.

Raw Materials & Labor:
Power Transmission purchases a variety of raw materials in manufacturing its products. The principal raw materials are steel plate, round alloy steel, iron castings and steel forgings. Due to the customized nature of its products, Power Transmission generally does not enter into long-term contracts for raw materials. Though raw material shortages are infrequent, lead times can be long due to the custom nature of many of its orders. Raw material prices are not expected to decline in the short-term and may continue to increase with little notice. Certain materials like steel round and bearings have continued to experience price increases and longer lead times. Raw material and component part shortages are not expected in the short-term, but certain supplier lead-times have grown, especially bearing suppliers.

The nature of the products manufactured and serviced generally requires skilled labor. Power Transmission’s ability to increase capacity could be limited by its ability to hire and train qualified personnel. Also, the main U.S. manufacturing facilities are unionized, so any labor disruption could have a significant impact on Power Transmission’s ability to maintain production levels. The current labor contract expires in October 2008.

Markets:
Power Transmission services many diverse markets, with high-speed gearing for markets such as petrochemicals, refineries, offshore production and transmission of oil and low-speed gearing for the gas, rubber, sugar, paper, steel, plastics, mining, cement and marine propulsion, each of which has its own unique set of drivers. Favorable conditions for one market may be unfavorable for another market. Generally, if general global industrial capacity utilizations are not high, spending on new equipment lags. Also impacting demand are government regulations involving safety and environmental issues that can require capital spending. Recent market demand increases have come from energy-related markets such as refining, petrochemical, drilling, coal, marine and power generation in response to higher global energy prices. These market trends are expected to continue throughout 2008, assuming energy prices stay at or near recent levels.

Competition:
Despite the highly technical nature of the products in this segment, there are many competitors. While several North American competitors have de-emphasized the market, many European companies remain in the market. Competitors include Flender Graffenstaden, BHS, Renk, Kreiter GearTech, Rientjes, Falk, and Horsburgh & Scott. While price is an important factor, proven designs, workmanship and engineering support are critical factors. Due to this, the Company outsources very little of the design and manufacturing processes.

Trailer

Products:
The Trailer segment manufactures various highway trailers for the freight-hauling market.
Vans- General-purpose dry-freight vans. Historically these have been the highest production trailer in the segment. However, due to van trailer manufacturing over-capacity and the entry of additional competitors, van trailer pricing reached a level that did not yield acceptable returns on the capital employed. In the third quarter of 2006, the Company announced its decision not to accept additional orders for new van trailers. After the existing backlog of van trailers was manufactured by early 2007, the van trailer manufacturing capacity was redeployed for additional flatbed and dump production.
Flatbeds- Flatbed style trailers used in hauling heavier loads that do not require protection from outdoor elements.
Dumps- Trailers designed to haul bulk materials like gravel or sand.
Parts- Through a network of company-owned branches, both trailers produced by the Company and by others are supported by replacement parts.

Raw Materials & Labor:
Trailer purchases a variety of raw materials in manufacturing its products. The principal raw materials are aluminum, structural and plate steel, axles, suspensions, tires, plywood and hardwood flooring. Trailer had annual contracts for aluminum for van production in order to mitigate price fluctuations, but due to the configurable nature of its products, Trailer does not have long-term purchase contracts on its other raw material purchases. Raw material shortages have been infrequent. Raw material prices are not expected to decline in the short-term nor are shortages expected.

The nature of the products manufactured generally requires skilled labor. Trailer’s ability to increase capacity could be limited by its ability to hire and train qualified personnel. Also, the main U.S. manufacturing facilities are unionized, so any labor disruption could have a significant impact on Trailer’s ability to maintain production levels. The current labor contract expires in October 2008.

Markets:
The Company primarily sells its trailer products in the United States to small and medium size fleet freight-hauling companies through a dealer network. Demand in this market is driven by the available cash flow or financing capabilities of the industry, age of the trailer fleets, changes in government regulations, availability of quality used trailers and the medium-term outlook for freight volumes. The profitability of the freight-hauling market is driven by freight volumes, fuel prices, wage levels and insurance costs. Due to poor market conditions, the Company decided in the third quarter of 2006 not to participate in the van market until market conditions support better operating margins. This decision gave Trailer the capability to expand manufacturing capacity of flatbed and dump trailers quickly in response to market demand. However, recent flatbed and dump trailer demand has decreased due to the reduced activity in the home and road construction markets as well as reduced profitability from higher fuel prices. In 2007, industry order rates and backlog for flatbed trailers decreased over 40% and for dump trailers over 25% compared to 2006 levels. In the fourth quarter of 2007, industry order rates and backlog for flatbed and dump trailers decreased almost 50% compared to the fourth quarter of 2006. Due to these market conditions, in January 2008, the Company announced the decision to suspend its participation in the commercial trailer markets and to develop a plan to run-out existing inventories, fulfill contractual obligations and close all trailer facilities during 2008.

Competition:
The trailer market is highly competitive with relatively low barriers to entry. The majority of the cost of a new trailer comes from purchased materials of aluminum, steel, tires, axles and wood flooring. Since there is minimal product differentiation in this market, price is the key driver. The companies with the highest market share are Great Dane and Wabash, along with several other large manufacturers like Utility, Stoughton, Fontaine, Vanguard and Hyundai. The Company does not have a significant market share in the trailer market.

See Note 16 in Notes to Consolidated Financial Statements included in this report for financial information about the Company’s business segments and geographic areas.

Federal Regulation and Environmental Matters

The Company’s operations are subject to various federal, state and local laws and regulations, including those related to air emissions, wastewater discharges, the handling of solid and hazardous wastes and occupational safety and health.  Environmental laws have, in recent years, become more stringent and have generally sought to impose greater liability on a larger number of potentially responsible parties.  While the Company is not currently aware of any situation involving an environmental claim that would likely have a material adverse effect on its business, it is always possible that an environmental claim with respect to one or more of the Company’s current businesses or a business or property that one of our predecessors owned or used could arise that could have a material adverse effect. The Company’s operations have incurred, and will continue to incur, capital and operating expenditures and other costs in complying with these laws and regulations in both the United States and abroad. However, the Company does not anticipate the future costs of environmental compliance will have a material adverse effect on its business, financial results or results of operations.

Available Information

The Company makes available, free of charge, through our website, www.lufkin.com, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after it electronically files such material with, or furnishes such material to, the Securities and Exchange Commission.


 
 
 
 

Item 1A.  Risk Factors.

The risks described below are those which the Company believes are the material risks that it faces.  Any of the risk factors described below could significantly and adversely affect its business, prospects, financial condition and results of operations.

A decline in domestic and worldwide oil and gas drilling activity would adversely affect the Company’s results of operations.

The Oil Field segment is materially dependent on the level of oil and gas drilling activity in North America and worldwide, which in turn depends on the level of capital spending by major, independent and state-owned exploration and production companies.  This capital spending is driven by current prices for oil and gas and the perceived stability and sustainability of those prices.  Oil and gas prices have been subject to significant fluctuation in recent years in response to changes in the supply and demand for oil and gas, market uncertainty, world events, governmental actions, and a variety of additional factors that are beyond the Company’s control, including:

·  
the level of North American and worldwide oil and gas exploration and production activity;

·  
worldwide economic conditions, particularly economic conditions in North America;

·  
oil and gas production costs;

·  
weather conditions;

·  
the expected costs of developing new reserves;

·  
national government political requirements and the policies of OPEC;

·  
the price and availability of alternative fuels;

·  
the effect of worldwide energy conservation measures;

·  
environmental regulation; and

·  
tax policies.


The business of the Trailer segment is highly cyclical, which could adversely affect its business and results of operations.

The truck trailer manufacturing industry historically has been and is expected to continue to be cyclical, as well as affected by overall economic conditions.  New trailer production for the trailer industry reached its most recent peak of approximately 306,000 units in 1999, falling to approximately 140,000 by 2001, rebounding to approximately 280,000 units in 2006 and falling to approximately 217,000 in 2007.  Customers historically have replaced trailers in cycles that run from five to 12 years, depending on service and trailer type.  Poor economic conditions can adversely affect demand for new trailers and in the past have led to an overall aging of trailer fleets beyond this typical replacement cycle. Due to poor market conditions, the Company decided in the third quarter of 2006 not to participate in the van market, and, in January 2008, announced the decision to suspend participation in the commercial trailer markets and to develop a plan to run-out existing inventories, fulfill contractual obligations and close all trailer facilities in 2008.

Increases in the prices of our raw materials could adversely affect our margins and results of operations.

The Company uses large amounts of steel, iron and electricity in the manufacture of its products.  The price of these raw materials has a significant impact on the cost of producing products.  Steel and electricity prices have increased significantly in the last five years, caused primarily by higher energy prices and increased global demand.  Since most of the Company’s suppliers are not currently parties to long-term contracts with us, the Company is vulnerable to fluctuations in prices of such raw materials.  Factors such as supply and demand, freight costs and transportation availability, inventory levels of brokers and dealers, the level of imports and general economic conditions may affect the price of cast iron and steel. Raw material prices may increase significantly in the future.  Certain items such as steel round, bearings and aluminum have continued to experience price increases, price volatility and longer lead times. If the Company is unable to pass future raw material price increases on to its customers, margins, results of operations, cash flow and financial condition could be adversely affected.

Interruption in our supply of raw materials could adversely affect our results of operations.

The Company relies on various suppliers to supply the components utilized to manufacture our products.  The availability of the raw materials is not only a function of the availability of steel and iron, but also the alloy materials that are utilized by our suppliers. To date, these shortages have not caused a material disruption in availability or our manufacturing operations.  However, material disruptions may occur in the future.  Raw material shortages and allocations may result in inefficient operations and a build-up of inventory, which can negatively affect the Company’s working capital position.  The loss of any of the Company’s suppliers or their inability to meet its price, quality, quantity and delivery requirements could have an adverse effect on the Company’s business and results of operations.

The inherent dangers and complexity of the Company’s operations could subject it to substantial liability claims that could adversely affect our results of operations.
 
The products that the Company manufactures and the services that it provides are complex, and the failure of this equipment to operate properly or to meet specifications may greatly increase our customers’ costs.  In addition, many of these products are used in inherently hazardous industries, such as the oil and gas drilling and production industry where an accident or product failure can cause personal injury or loss of life, damage to property, equipment, or the environment, regulatory investigations and penalties and the suspension of the end-user’s operations.   If the Company’s products or services fail to meet specifications or are involved in accidents or failures, we could face warranty, contract, or other litigation claims for which it may be held responsible and its reputation for providing quality products may suffer.
 
The Company’s insurance may not be adequate in risk coverage or policy limits to cover all losses or liabilities that we may incur or be responsible.  Moreover, in the future we may not be able to maintain insurance at levels of risk coverage or policy limits that we deem adequate or at premiums that are reasonable for us, particularly in the recent environment of significant insurance premium increases.  Further, any claims made under the Company’s policies will likely cause its premiums to increase.
 
Any future damages deemed to be caused by the Company’s products or services that are assessed against it and that are not covered by insurance, or that are in excess of policy limits or subject to substantial deductibles, could have a material adverse effect on our results of operations and financial condition.  Litigation and claims for which we are not insured can occur, including employee claims, intellectual property claims, breach of contract claims, and warranty claims.
 
We may not be able to successfully integrate future acquisitions, which will cause us to fail to realize expected returns.
 
The Company continually explores opportunities to acquire related businesses, some of which could be material to the Company. The ability to continue to grow, however, may depend upon identifying and successfully acquiring attractive companies, effectively integrating these companies, achieving cost efficiencies and managing these businesses as part of the Company.  The Company may not be able to effectively integrate the acquired companies and successfully implement appropriate operational, financial and management systems and controls to achieve the benefits expected to result from these acquisitions.  The Company’s efforts to integrate these businesses could be affected by a number of factors beyond its control, such as regulatory developments, general economic conditions and increased competition.  In addition, the process of integrating these businesses could cause the interruption of, or loss of momentum in, the activities of our existing business.  The diversion of management’s attention and any delays or difficulties encountered in connection with the integration of these businesses could negatively impact the Company’s business and results of operations.  Further, the benefits that the Company anticipates from these acquisitions may not develop.
 
Labor disputes, increasing labor costs and the expiration of our current labor contract could have a material adverse effect on our business.

The Company’s main U.S. manufacturing facilities are unionized and the current labor contract with respect to those facilities expires in October 2008.  The Company cannot assure that any disputes, work stoppages or strikes will not arise in the future.  In 2002, a strike involving union employees, which continued for approximately 14 consecutive days, resulted in operating losses for us.  In addition, when our existing collective bargaining agreement expires, the Company cannot assure that it will be able to reach a new agreement with its employees or that any new agreement will be on substantially similar terms as the existing agreement.  Labor costs may increase significantly as a result of the negotiations for any new labor agreement.  Future disputes with and labor concessions to the Company’s employees could have a material adverse effect upon its results of operations and financial position.

The inability to hire and retain qualified employees may hinder our growth.

The ability to provide high-quality products and services depends in part on the Company’s ability to hire and retain skilled personnel in the areas of management, product engineering, servicing and sales.  Competition for such personnel is intense and competitors can be expected to attempt to hire the Company’s skilled employees from time to time.  In particular, the Company’s business and results of operations could be materially adversely affected if it is unable to retain the customer relationships and technical expertise provided by the Company’s management team and professional personnel.

Significant competition in the industries in which the Company operates may result in its competitors offering new or better products and services or lower prices, which could result in a loss of customers and a decrease in revenues.

The industries in which the Company operates are highly competitive.  The Company competes with other manufacturers and service providers of varying sizes, some of which may have greater financial and technological resources than it does.  As an example, barriers to entry in the standard truck trailer manufacturing industry are low.  As a result, it is possible that additional competitors could enter the trailer market at any time.  In the recent past, the manufacturing over-capacity and high leverage of some of our competitors in the trailer industry, along with the bankruptcies and financial stresses that affected the industry, contributed to significant pricing pressures. This pricing pressure led to the Company’s decision in 2006 not to accept additional orders for van trailers. In January 2008, the Company announced the decision to suspend its participation in the commercial trailer markets and to develop a plan to run-out existing inventories, fulfill contractual obligations and close all trailer facilities.

If the Company is unable to compete successfully with other manufacturers and service providers, it could lose customers and its revenues may decline.  In addition, competitive pressures in the industry may affect the market prices of the Company’s new and used equipment, which, in turn, may adversely affect its sales margins, results of operations, cash flow and financial condition.

Disruption of our manufacturing operations or management information systems would have an adverse effect on our financial condition and results of operations.

While the Company owns numerous facilities domestically and internationally, its primary manufacturing facilities in and around Lufkin, Texas accounts for a significant percentage of its manufacturing output.  An unexpected disruption in the Company’s production at these facilities or in its management information systems for any length of time would have an adverse effect on our business, financial condition and results of operations.

The Company has foreign operations that would be adversely impacted in the event of war, political disruption, civil disturbance, economic and legal sanctions and changes in global trade policies.

The Company has operations in certain international areas, including parts of the Middle East and South America, that are subject to risks of war, political disruption, civil disturbance, economic and legal sanctions (such as restrictions against countries that the U.S. government may deem to sponsor terrorism) and changes in global trade policies.  The Company’s operations may be restricted or prohibited in any country in which these risks occur.  In particular, the occurrence of any of these risks could result in the following events, which in turn, could materially and adversely impact the Company’s results of operations:
 
·  
disruption of oil and natural gas exploration and production activities;
 
·  
restriction of the movement and exchange of funds;
 
·  
inhibition of our ability to collect receivables;
 
·  
enactment of additional or stricter U.S. government or international sanctions; and
 
·  
limitation of our access to markets for periods of time.
 
Results of operations could be adversely affected by actions under U.S. trade laws.
 
Although the Company is a U.S.-based manufacturing and services company, it does own and operate international manufacturing operations that support its U.S.-based business.  If actions under U.S. trade laws were instituted that limited the Company’s access to these products, the ability to meet its customer specifications and delivery requirements would be reduced.  Any adverse effects on the Company’s ability to import products from its foreign subsidiaries could have a material adverse effect on our results of operations.
 
The Company is subject to currency exchange rate risk, which could adversely affect its results of operations.

The Company is subject to currency exchange rate risk with debt denominated in U.S. dollars owed to its U.S. entity by its Canadian subsidiary.  The Company cannot assure that future currency exchange rate fluctuations will not have an adverse affect on its results of operations.

 
Our funding policy for our pension plan is to accumulate plan assets that, over the long-run, will approximate the present value of projected benefit obligations. Our pension cost is materially affected by the discount rate used to measure pension obligations, the level of plan assets available to fund those obligations at the measurement date and the expected long-term rate of return on plan assets. Our pension plan is supported by pension fund investments that are volatile and subject to financial market risk, including fixed income, domestic and foreign equity securities, real estate and hedge funds. Significant changes in investment performance or a change in the portfolio mix of invested assets could result in corresponding increases and decreases in the valuation of plan assets or in a change of the expected rate of return on plan assets. A change in the discount rate would result in a significant increase or decrease in the valuation of pension obligations, affecting the reported funded status of our pension plans as well as the net periodic pension cost in the following fiscal years. Similarly, changes in the expected return on plan assets could result in significant changes in the net periodic pension cost for subsequent fiscal years.

The Company’s common stock has experienced, and may continue to experience, price volatility.

The trading price of the Company’s common stock has been and may continue to be subject to large fluctuations.  The Company’s common stock price may increase or decrease in response to a number of events and factors, including:

·  
trends in the Company’s industries and the markets in which it operates;

·  
changes in the market price of the products the Company sells;

·  
the introduction of new technologies or products by the Company or its competitors;

·  
changes in expectations as to the Company’s future financial performance, including financial estimates by securities analysts and investors;

·  
operating results that vary from the expectations of securities analysts and investors;

·  
announcements by the Company or its competitors of significant contracts, acquisitions, strategic partnerships, joint ventures, financings or capital commitments;

·  
changes in laws and regulations; and

·  
general economic and competitive conditions.


Item 1B. Unresolved Staff Comments.

None

Item 2.  Properties

The Company's major manufacturing facilities are located in and near Lufkin, Texas, are company-owned and include approximately 150 acres, a foundry, machine shops, structural shops, assembly shops and warehouses.  The facilities by segment are:

Oilfield:
   
Pumping Unit Manufacturing
240,000 sq. ft.
 
Foundry Operations
687,000 sq. ft.
 
     
Power Transmission:
   
New Unit Manufacturing
458,000 sq. ft.
 
Repair Operations
84,000 sq. ft.
 
     
Trailer Manufacturing
388,000 sq. ft.
 
     
Corporate Facilities
  33,000 sq. ft.
 

Also, the Company has numerous service centers throughout the U.S. to support the Oil Field, Power Transmission and Trailer segments. The majority of these locations are company-owned, with some leased. None of these leases qualify as capital leases.
 
Internationally, there are company-owned facilities for the production and servicing of pumping units and power transmission products. The facilities by segment are:

Oilfield (Pumping unit manufacturing and repair):
   
Nisku, Alberta, Canada
66,000 sq. ft.
 
Comodoro Rivadia, Argentina
125,000 sq. ft.
 
     
Power Transmission (New unit manufacturing and repair):
   
Fougerolles, France
377,000 sq. ft.
 

Also, the Company has several international service centers to support the Oil Field segment. The majority of these locations are owned by the Company, with some leased. None of these leases qualify as capital leases.

Item 3.  Legal Proceedings

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

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

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

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

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

None


 
 
 

PART II

Item 5.  Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Common Stock Information

The Company's common stock is traded on the NASDAQ Stock Market (National Market) under the symbol “LUFK.” As of January 31, 2008, there were approximately 431 record holders of its common stock. This number does not include any beneficial owners for whom shares of common stock may be held in “nominee” or “street” name. The following table sets forth, for each quarterly period during fiscal 2007 and 2006, the high and low sales price per share of the Company’s common stock and the dividends paid per share on the Company’s common stock.

   
2007
   
2006
 
   
Stock Price
         
Stock Price
       
Quarter
 
High
   
Low
   
Dividend
   
High
   
Low
   
Dividend
 
                                     
First
  $ 63.07     $ 50.23     $ 0.21     $ 68.67     $ 45.56     $ 0.11  
Second
    67.43       55.81       0.21       71.47       50.21       0.15  
Third
    73.25       50.73       0.23       65.21       49.05       0.18  
Fourth
    62.90       50.84       0.23       61.46       50.66       0.18  
 
The Company has paid cash dividends for 68 consecutive years.  Total dividend payments were $13.1 million, $9.2 million and $5.5 million in 2007, 2006 and 2005, respectively.
 
Equity Compensation Plan Information
 
The following table sets forth securities of the Company authorized for issuance under equity compensation plans at December 31, 2007.
 

Plan Category
 
Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)
   
Weighted-average exercise price of outstanding options, warrants and rights (b)
   
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
 
                   
Equity compensation plans approved by security holders
    659,143     $ 30.87       1,158,868  
                         
Equity compensation plans not approved by security holders
    -       -       -  
                         
Total
    659,143     $ 30.87       1,158,868  
                         
 
2,200,000 shares were authorized for issuance pursuant to the 1990 Stock Option Plan, 300,000 shares were authorized for issuance pursuant to the 1996 Nonemployee Director Stock Option Plan and 2,800,000 shares were authorized for issuance pursuant to the Incentive Stock Compensation Plan 2000. In May 2007, shareholders approved the addition of 1,000,000 shares to the 2000 plan. Awards may be granted pursuant to the Incentive Stock Compensation Plan 2000 include options, restricted stock, performance awards, phantom shares, bonus shares and other stock-based awards.
 
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
 
During the fourth quarter of 2007, the Company repurchased shares pursuant to a plan approved by the Board of Directors in the third quarter of 2007, under which the Company was authorized to spend up to an aggregate of $30.0 million for repurchases of its common stock. Repurchased shares are added to treasury stock and are available for general corporate purposes including the funding of the Company’s stock option plans. During the fourth quarter of 2007, 100,000 shares were repurchased under the above plan at an aggregate price of $5.5 million, or an average price of $54.61. As of December 31, 2007, 500,000 shares had been repurchased at an aggregate price of $25.4 million, or $54.91 per share under the 2007 plan. As of December 31, 2007, the Company held 895,278 shares of treasury stock at an aggregate cost of approximately $31.6 million. At December 31, 2007, approximately $4.6 million of repurchase authorizations remained under the 2007 plan.
 
 
 
A summary of the Company’s repurchase activity for the three months ended December 31, 2007, is as follows:

 
Issuers Purchases of Equity Securities
 
                         
               
Total Number of
   
Approximate Dollar
 
   
Total Number
   
Average
   
Shares Purchased as
   
Value of Shares That
 
   
of Shares
   
Price Paid
   
Part of Publicly
   
May Yet Be Purchased
 
Period
 
Purchased
   
per Share
   
Announced Plans
   
Under the Plans
 
                         
October 1 - October 31
    -     $ -       -     $ 10,084,369  
November 1- November 30
    -       -       -       10,084,369  
December 1 - December 31
    100,000       54.61       100,000       4,623,918  
                                 
Total
    100,000     $ 54.61       100,000     $ 4,623,918  

As of December 31, 2007, 500,000 shares had been repurchased at an aggregate price of $25.4 million, or $54.91 per share under the 2007 plan. As of December 31, 2007, the Company held 895,278 shares of treasury stock at an aggregate cost of approximately $31.6 million. At December 31, 2007, approximately $4.6 million of repurchase authorizations remained under the 2007 plan.

Item 6.  Selected Financial Data

Five Year Summary of Selected Consolidated Financial Data

The following table sets forth certain selected historical consolidated financial data and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes thereto included elsewhere in this annual report on Form 10-K.  The following information may not be indicative of future operating results.

(In millions, except per share data)
 
2007
   
2006
   
2005
   
2004
   
2003
 
                               
Sales
  $ 597.2     $ 605.5     $ 492.2     $ 356.3     $ 262.3  
                                         
Net earnings
    74.2       73.0       44.5       14.4       9.7  
                                         
Net earnings  per share:
                                       
   Basic
    4.98       4.92       3.10       1.06       0.74  
   Diluted
    4.92       4.83       3.03       1.04       0.73  
                                         
Total assets
    500.7       429.1       359.8       300.3       263.7  
                                         
Cash dividends per share
    0.88       0.62       0.38       0.36       0.36  

Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

General

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

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

In support of the above strategy, the Company has been making capital investments in Oil Field to increase manufacturing capacity and capabilities in its three main manufacturing facilities in Lufkin, Texas, Canada and Argentina. These investments should reduce production lead times and improve quality. Investments also continue to be made to expand the Company’s presence in automation products and international service, as with the recently opened service facility in Oman. In Power Transmission, the Company continues to expand its gear repair network by opening and expanding facilities in various locations in the U.S. and Canada. The Company is making targeted capital investments in the U.S. and France to expand capacity and reduce manufacturing lead times as well as certain capital investments targeting cost reductions. In Trailer, due to poor current and forecasted market conditions, in January 2008, the Company announced the decision to suspend its participation in the commercial trailer markets and to develop a plan to run-out existing inventories, fulfill contractual obligations and close all trailer facilities during 2008.

Trends/Outlook

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

Power Transmission
Power Transmission services many diverse markets, with high-speed gearing for markets such as petrochemicals, refineries, offshore production and transmission of oil and slow-speed gearing for the gas, rubber, sugar, paper, steel, plastics, mining, cement and marine propulsion, each of which has its own unique set of drivers. Favorable conditions for one market may be unfavorable for another market. Generally, if general global industrial capacity utilizations are not high, spending on new equipment lags. Also impacting demand are government regulations involving safety and environmental issues that can require capital spending. Recent market demand increases have come from energy-related markets such as refining, petrochemical, drilling, coal, marine and power generation in response to higher global energy prices. These market trends are expected to continue throughout 2008, assuming energy prices stay at recent levels.

Trailer
The Company primarily sells its trailer products in the United States to small and medium size fleet freight-hauling companies through a dealer network. Demand in this market is driven by the available cash flow or financing capabilities of the industry, age of the trailer fleets, changes in government regulations, availability of quality used trailers and the medium-term outlook for freight volumes. The profitability of the freight-hauling market is driven by freight volumes, fuel prices, wage levels and insurance costs. Due to poor market conditions, the Company decided in the third quarter of 2006 not to participate in the van market until market conditions support better operating margins. Recent flatbed and dump trailer demand has decreased due to the reduced activity in the home and road construction markets as well as reduced profitability from higher fuel prices. In 2007, industry order rates and backlog for flatbed trailers decreased over 40% and for dump trailers over 25% compared to comparable 2006 levels. In the fourth quarter of 2007, industry order rates and backlog for flatbed and dump trailers decreased almost 50% compared to comparable 2006 levels. Projected market conditions for 2008 do not indicate significant improvement over current market levels, which would cause Trailer to yield unacceptable returns in these future periods. Due to these market conditions, in January 2008, the Company announced the decision to suspend its participation in the commercial trailer markets and to develop a plan to run-out existing inventories, fulfill contractual obligations and close all trailer facilities in 2008.

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 year ended December 31, 2007, decreased to $597.2 million from $605.5 million for the year ended December 31, 2006, or 1.4%. Sales for 2005 were $492.2 million. This decline in 2007 was primarily driven by decreased sales of van trailers related to the decision in 2006 to cease production of that product line. Additional segment data on sales is provided later in this section.

Gross margin for the year ended December 31, 2007, increased to 27.9% from 25.8% for the year ended December 31, 2006, and 23.0% for year ended December 31, 2005. This overall gross margin improvement from 2006 was primarily due to the favorable mix effect of decreased lower-margin trailer sales being offset by increased sales of higher-margin power transmission products. The gross margin improvement in 2006 over 2005 was primarily related to certain cost reductions related to capital expenditures and improved margins in Power Transmission due to increased sales of higher-margin energy-related high-speed units. Additional segment data on gross margin is provided later in this section.

The improvement in gross margin in 2007 was offset by higher selling, general and administrative expenses and a higher net tax rate. The net tax rate in 2006 was 30.3% due to the benefits of research and experimentation tax credits, current and deferred state tax rate adjustments and other estimate revisions. The Company reported net earnings of $74.2 million or $4.92 per share (diluted) for the year ended December 31, 2007, compared to net earnings of $73.0 million or $4.83 per share (diluted) for the year ended December 31, 2006. Net income of $44.5 million or $3.03 per share (diluted) was reported for the year ended December 31, 2005.

Debt/equity (long-term debt net of current portion as a percentage of total equity) levels were 0.0% as of December 31, 2007, December 31, 2006 and December 31, 2005. Cash balances at December 31, 2007, were $95.7 million, up from $57.8 million at December 31, 2006, due to higher net earnings and lower capital expenditures offsetting increased treasury stock purchases and higher dividends.



 
 
 

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006:

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

               
Increase/
   
% Increase/
 
Year Ended December 31
 
2007
   
2006
   
(Decrease)
   
(Decrease)
 
                         
Sales
                       
Oil Field
  $ 397,354     $ 401,200     $ (3,846 )     (1.0 )
Power Transmission
    158,452       124,922       33,530       26.8  
Trailer
    41,381       79,370       (37,989 )     (47.9 )
Total
  $ 597,187     $ 605,492     $ (8,305 )     (1.4 )
                                 
Gross Profit
                               
Oil Field
  $ 109,091     $ 109,414     $ (323 )     (0.3 )
Power Transmission
    52,476       41,024       11,452       27.9  
Trailer
    4,801       5,811       (1,010 )     (17.4 )
Total
  $ 166,368     $ 156,249     $ 10,119       6.5  

Oil Field
 
Oil Field sales decreased slightly to $397.4 million, or 1.0%, for the year ended December 31, 2007, from $401.2 million for the year ended December 31, 2006. Increased sales of oil field services, automation equipment and new pumping units in the Middle East and Argentina markets was offset by lower sales of new pumping units in the North American market. Oil Field’s backlog increased to $76.9 million as of December 31, 2007, from $67.1 million at December 31, 2006. This increase is related to increased orders for the Argentina and Middle East markets, partially offset by weaker demand for new pumping units in the North American market.
 
Gross margin (gross profit as a percentage of sales) for the Oil Field segment increased slightly to 27.5% for the year ended December 31, 2007, compared to 27.3% for the year ended December 31, 2006, or 0.2 percentage points.
 
Direct selling, general and administrative expenses for Oil Field increased to $17.5 million, or 12.1%, for the year ended December 31, 2007, from $15.6 million for the year ended December 31, 2006. This increase is due to higher employee-related expenses in support of increased sales levels. Direct selling, general and administrative expenses as a percentage of sales also increased to 4.4% for the year ended December 31, 2007, from 3.9% for the year ended December 31, 2006.

Power Transmission

Sales for the Company’s Power Transmission segment increased to $158.5 million, or 26.8%, for the year ended December 31, 2007, compared to $124.9 million for the year ended December 31, 2006. This growth was the result of increased sales of high-speed units to the energy-related markets, such as power generation and oil and gas drilling, production and refining from both the U.S. and France manufacturing facilities and low-speed marine units for the coastal, river and inland-waterway transportation market. Power Transmission backlog at December 31, 2007, increased to $122.2 million from $95.6 million at December 31, 2006, primarily from sales of new units for the marine and oil-drilling markets.

Gross margin for the Power Transmission segment increased to 33.1% for the year ended December 31, 2007, compared to 32.8% for the year ended December 31, 2006, from increased plant efficiencies and fixed cost coverage from higher production volumes and the benefit of greater sales of high-speed units.
 
Direct selling, general and administrative expenses for Power Transmission increased to $18.3 million, or 17.4%, for the year ended December 31, 2007, from $15.6 million for the year ended December 31, 2006. This increase is due to higher employee-related expenses in support of increased sales volumes. Direct selling, general and administrative expenses as a percentage of sales, however, decreased to 11.6% for the year ended December 31, 2007, from 12.5% for the year ended December 31, 2006.

Trailer

Trailer sales for the year ended December 31, 2007, decreased to $41.4 million, or 47.9%, from $79.4 million for the year ended December 31, 2006. This decrease is primarily related to the decline in new van trailer sales, representing over 78% of the sales decline. New van sales were impacted by the Company’s decision in 2006 not to take additional orders for van trailers due to poor market conditions. Sales for flatbed and dump trailers were also lower due to weakness in the home construction market, low demand in the road construction market and reduced Gulf Coast clean-up efforts from lower hurricane activity. Backlog for the Trailer segment decreased to $3.4 million at December 31, 2007, compared to $18.4 million at December 31, 2006. The backlog decrease was primarily from lower flatbed and dump orders as well as from lower van trailer backlog related to the decision to not take additional van trailer orders.
 
Trailer gross margin increased to 11.6% for the year ended December 31, 2007, from 7.3% for the year ended September 30, 2006, or 4.3 percentage points. This increase was primarily due to the favorable mix effect of lower van trailer sales, which traditionally had lower gross margins than flatbed or dump trailers, being partially offset by plant reconfiguration costs in the first quarter of 2007 and lower plant utilization impacting fixed cost coverage.

Direct selling, general and administrative expenses for Trailer decreased to $1.6 million, or 34.6%, for the year ended December 31, 2007, from $2.4 million for the year ended December 31, 2006, from lower general liability legal and claims expenses. Direct selling, general and administrative expenses as a percentage of sales increased to 3.9% for the year ended December 31, 2007, from 3.1% for the year ended December 31, 2006.

Corporate/Other

Corporate administrative expenses, which are allocated to the segments primarily based on historical third-party revenues, increased to $21.6 million, or 11.8%, for the year ended December 31, 2007, from $19.3 million for the year ended December 31, 2006, primarily from the higher employee-related expenses and stock option expenses.
 
Net interest income, interest expense and other income and expense for the year ended December 31, 2007, totaled $5.4 million of income compared to income of $1.5 million for the year ended December 31, 2006, primarily due to an increase in interest income from higher cash balances and the favorable impact of the stronger Canadian currency on U.S. dollar-denominated liabilities.

Pension income, which is reported as a reduction of cost of sales, increased to $3.3 million for the year ended December 31, 2007, or 12%, compared to $2.9 million for the year ended December 31, 2006, primarily from expected asset returns exceeding expected expense increases.
 
The net tax rate for the year ended December 31, 2007, was 34.2% compared to 30.3% for the year ended December 31, 2006. The lower net tax rate in 2006 was the result of several items. A tax initiative to claim research and experimentation tax credits for the 2002 through 2005 tax years and the recent legislation passed to allow a research and experimentation tax credit for the 2006 tax year produced a significant benefit to the tax rate. A lower effective state tax rate, and the related benefit to deferred tax balances, combined with the favorable impact on state deferred tax balances due to the new Texas margin tax also produced a benefit to the net tax rate. Other items such as lower international tax rates and revisions to prior period estimates produced additional benefits to the net tax rate.


 
 
 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005:

The following table summarizes the Company’s sales and gross profit by operating segment (in thousands of dollars):
 
               
Increase/
   
% Increase/
 
Year Ended December 31
 
2006
   
2005
   
(Decrease)
   
(Decrease)
 
                         
Sales
                       
Oil Field
  $ 401,200     $ 307,075     $ 94,125       30.7  
Power Transmission
    124,922       106,616       18,306       17.2  
Trailer
    79,370       78,476       894       1.1  
Total
  $ 605,492     $ 492,167     $ 113,325       23.0  
                                 
Gross Profit
                               
Oil Field
  $ 109,414     $ 76,578     $ 32,836       42.9  
Power Transmission
    41,024       32,300       8,724       27.0  
Trailer
    5,811       4,463       1,348       30.2  
Total
  $ 156,249     $ 113,341     $ 42,908       37.9  

Oil Field
 
Oil Field sales increased to $401.2 million, or 30.7%, for the year ended December 31, 2006, from $307.1 million for the year ended December 31, 2005. The benefit of the stronger Canadian dollar in 2006 and new service centers contributed 1.3 percentage points of this increase. Increased sales of new pumping units accounted for a majority of the balance of the increase of 29.3 percentage points. Sales of new pumping units 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. Sales growth also 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 remained at $67.1 million as of December 31, 2006, from $67.5 million at December 31, 2005. Despite higher sales volumes, backlog levels have not increased due to a targeted effort to reduce lead times through higher manufacturing capacity.
 
Gross margin (gross profit as a percentage of sales) for the Oil Field segment increased to 27.3% for year ended December 31, 2006, compared to 24.9% for the year ended December 31, 2005, or 2.4 percentage points. Gross margins benefited from certain cost reduction related to capital expenditures and the full-year impact of price increases instituted in 2005. This margin improvement was partially offset by employee training and other expansion-related 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 $15.6 million, or 30.5%, for the year ended December 31, 2006, from $12.0 million for the year ended December 31, 2005. This increase is due to higher employee-related expenses in support of increased current and expected sales volumes, third-party commissions and the impact of expensing stock options. Direct selling, general and administrative expenses as a percentage of sales remained at 3.9% for the year ended December 31, 2006, compared to 3.9% for the year ended December 31, 2005.

Power Transmission

Sales for the Company’s Power Transmission segment increased to $124.9 million, or 17.2%, for the year ended December 31, 2006, compared to $106.6 million for the year ended December 31, 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 gear repair facilities. Power Transmission backlog at December 31, 2006, increased to $95.6 million from $53.4 million at December 31, 2005, primarily from sales of new units for the energy-related markets.
Gross margin for the Power Transmission segment increased to 31.9% for the year ended December 31, 2006, compared to 31.5% for the year ended December 31, 2005, from the benefit of price increases and from increased sales of higher-margin high-speed units, partially offset by higher manufacturing overhead costs.

Direct selling, general and administrative expenses for Power Transmission increased to $15.6 million, or 15.5%, for the year ended December 31, 2006, from $13.5 million for the year ended December 31, 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 12.5% for the year ended December 31, 2006, from 12.7% for the year ended December 31, 2005, from leverage on higher sales volumes.

Trailer

Trailer sales for the year ended December 31, 2006, increased to $79.4 million, or 1.1%, from $78.5 million for the year ended December 31, 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 have lowered prices in response to industry manufacturing overcapacity and trucking industry issues such as soft freight demand and driver shortages. In light of current conditions in the trailer van market, the Company has declined to take additional orders for van trailers in order to expand manufacturing capacity for the production of flatbed and dump trailers and will be converting part of the Trailer factory to the production of oil field equipment. Backlog for the Trailer segment decreased to $18.4 million at December 31, 2006, compared to $25.5 million at December 31, 2005. The backlog decrease was primarily from lower van trailer backlog related to the decision to not take additional van trailer orders, partially offset by increased orders for new flatbed trailers, as described above.
 
Trailer gross margin increased to 7.3% for the year ended December 31, 2006, from 5.7% for the year ended December 31, 2005, or 1.6 percentage points. This included the impact of the van-related equipment and inventory expenses, which reduced margins by approximately a 1.2 percentage points. This increase 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 $2.4 million, or 12.3%, for the year ended December 31, 2006, from $2.8 million for the year ended December 31, 2005. In 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 3.1% for the year ended December 31, 2006, from 3.6% for the year ended December 31, 2005.
 
Corporate/Other

Corporate administrative expenses, which are allocated to the segments primarily based on historical third-party revenues, increased to $19.3 million, or 21.9%, for the year ended December 31, 2006, from $15.9 million for the year ended December 31, 2005, primarily from the impact of expensing stock options and higher employee-related expenses.
 
Interest income, interest expense and other income and expense for the year ended December 31, 2006, totaled $1.5 million of income compared to income of $0.1 million for the year ended December 31, 2005, primarily due to an increase in interest income from higher cash balances.

Pension income, which is reported as a reduction of cost of sales, increased to $2.9 million for the year ended December 31, 2006, or 37%, compared to $2.1 million for the year ended December 31, 2005. This increase is primarily due to higher expected returns from increased asset balances. Pension income in 2007 is expected to increase slightly to $3.2 million.
 
The net tax rate for the year ended December 31, 2006, was 30.3% compared to 35.7% in the year ended December 31, 2005. This lower net tax rate was the result of several items. A tax initiative to claim research and experimentation tax credits for the 2002 through 2005 tax years and the recent legislation passed to allow a research and experimentation tax credit for the 2006 tax year produced a significant benefit to the tax rate. A lower effective state tax rate, and the related benefit to deferred tax balances, combined with the favorable impact on state deferred tax balances due to the new Texas margin tax also produced a benefit to the net tax rate. Other items such as the lower international tax rates and revisions to prior period estimates produced additional benefits to the net tax rate.
 
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, 2008, and the foreseeable future.
 
The Company’s cash balance totaled $95.7 million at December 31, 2007, compared to $57.8 million at December 31, 2006. For the year ended December 31, 2007, net cash provided by operating activities was $90.3 million, net cash used in investing activities totaled $18.1 million, net cash used in financing activities amounted to $34.1 million and the unfavorable effect of foreign currency translation was $0.2 million. Significant components of cash provided by operating activities included net earnings, adjusted for non-cash expenses, of $89.8 million and an increase in working capital of $3.8 million. This working capital increase was primarily due to higher inventory balances, which used $7.5 million, primarily from increased Power Transmission inventory related to higher sales volumes compared to the prior year. Net cash used in investing activities included net capital expenditures totaling $17.9 million. Capital expenditures in 2007 were primarily for the expansion of manufacturing capacity and efficiency improvements in the Oil Field and Power Transmission segments. Capital expenditures for 2008 are projected to be approximately $50.0 to $53.0 million, primarily for the expansion of manufacturing capacity and efficiency improvements in the Oil Field and Power Transmission segments and will be funded by operating cash flows. Significant components of net cash used by financing activities included the repurchase of common stock of $27.5 million and dividend payments of $13.1 million, or $0.88 per share, partially offset by the impact of stock option exercises, including the excess tax benefit from actual gains on stock option exercises, of $6.5 million.
 
The Company has a three-year credit facility with a domestic bank (the “Bank Facility”) consisting of an unsecured revolving line of credit that provides up to $40.0 million of aggregate borrowing. This Bank Facility expires on December 31, 2010. 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 December 31, 2007, no debt was outstanding under the Bank Facility. The Company was in compliance with all financial covenants under the terms of the Bank Facility. Deducting outstanding letters of credit of $7.1 million, $32.9 million of borrowing capacity was available at December 31, 2007.

During 2007, the Company repurchased shares pursuant to several plans approved by the Board of Directors, under which the Company was authorized to spend up to an aggregate of $35.0 million for repurchases of its common stock, including (1) an authorization of $3.0 million made in the third quarter of 1999, (2) an authorization of $2.0 million made in the second quarter of 2003 and (3) an authorization of $30.0 million made in the third quarter of 2007. Repurchased shares are added to treasury stock and are available for general corporate purposes including the funding of the Company’s stock option plans. During 2007, 500,000 shares were repurchased under the above plans at an aggregate price of $27.5 million, or an average price of $54.99. As of December 31, 2007, 284,678 shares had been repurchased at an aggregate price of $3.0 million, or $10.54 per share under the 1999 plan, 35,817 shares had been repurchased at an aggregate price of $2.0 million, or $55.84 per share under the 2003 plan and 462,131 shares had been repurchased at an aggregate price of $25.4 million, or $54.91 per share under the 2007 plan. During the fourth quarter of 2007, 100,000 shares were repurchased at an aggregate price of approximately $5.5 million, or $54.61 per share under the 2007 plan. As of December 31, 2007, the Company held 895,278 shares of treasury stock at an aggregate cost of approximately $31.6 million. At December 31, 2007, approximately $4.6 million of repurchase authorizations remained under the 2007 plan. While this repurchase authorization has no expiration date, the Company expects to spend this remaining authorization in 2008.

The following table summarizes the Company’s expected cash outflows from financial contracts and commitments as of December 31, 2007. 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
  $ 3,020     $ 1,118     $ 1,261     $ 440     $ 201  
Contractual commitments for capital expenditures
    10,936       10,414       522       -       -  
                                         
Total
  $ 13,956     $ 11,532     $ 1,783     $ 440     $ 201  
                                         

Since the Company has no significant tax loss carryforwards, the Company expects to make quarterly estimated tax payments in 2008 based on taxable income levels. Also, the Company has various qualified retirement plans for which the Company has committed a certain level of benefit. The Company expects to make contributions to its pension plans of approximately $0.3 million and to its post-retirement health and life plans of approximately $0.6 million in 2008, depending on participation levels in these plans.

As discussed in Note 6 of the Consolidated Financial Statements, included in the Lufkin Consolidated Balance Sheet at December 31, 2007 is approximately $2.7 million of liabilities associated with uncertain tax positions in the jurisdictions in which Lufkin conducts business. Due to the uncertain and complex application of tax regulations, combined with the difficulty in predicting when tax audits throughout the world may be concluded, Lufkin cannot make reliable estimates of the timing of cash outflows relating to these liabilities.

Recently Issued Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157 “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. Prior to SFAS 157, there were different definitions of fair value and limited and dispersed guidance for applying those definitions. SFAS 157 retains the exchange price notion of fair value and clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability. SFAS 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement and establishes a fair value hierarchy that distinguishes between market participant assumptions developed based on market data obtained from independent sources and the reporting entity’s own assumptions. SFAS 157 also clarifies that market participant assumptions should include assumptions about risk and the effect of a restriction on the sale or use of an asset. SFAS 157 expands disclosures about the use of fair value to measure assets and liabilities in interim and annual periods and the inputs used to measure fair value. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The provisions of SFAS 157 should be applied prospectively as of the beginning of the fiscal year in which it is initially applied except for certain types of financial instruments. In February 2008, the Financial Accounting Standards Board issued FASB Staff Position (“FSP”) No. FAS 157-1 and No. FAS 157-2, which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years, and removes certain leasing transactions from the scope of SFAS 157. The Company is currently evaluating the impact, if any, the adoption of SFAS 157 will have on the fair value measurement of certain investments in its qualified pension plan, but does not expect any significant impact on its consolidated financial position or results of operations.

In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 (revised 2007) “Business Combinations” (“SFAS 141R”), replacing Statement of Financial Accounting Standards No. 141 “Business Combinations” (“SFAS 141”). SFAS 141R broadens the scope of SFAS 141 by applying the acquisition method of accounting to all transactions and other events in which one entity obtains control over one or businesses and not just business combinations in which control was obtained by transferring consideration. SFAS 141R also modifies the application of the acquisition method. SFAS 141R requires acquired assets and liabilities to be measured at fair value at the acquisition date versus the cost-allocation process used under SFAS 141. This change will require acquisition-related costs and restructuring costs that are expected but not legally obligated to be recognized separately from the acquisition. SFAS 141R also provides revised guidance on accounting for step acquisitions, assets and liabilities arising from contingencies, measuring goodwill and gains from bargain purchases and contingent consideration at the acquisition date. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.

In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 160 “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 amends ARB 51 and clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS 160 also modifies the income statement presentation of noncontrolling interests, establishes methods of accounting for changes in ownership interests and requires expanded disclosures of noncontrolling interests. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, and is to be applied prospectively as of the beginning of the fiscal year in which SFAS 160 is initially applied, except for the presentation and disclosure requirements which are retrospective for all periods. The Company does not expect the adoption of SFAS 160 to have a significant impact 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 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.

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 a 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 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.

The Company adopted FIN 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, Accounting for Income Taxes, by prescribing 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. The application of income tax law is inherently complex. The Company is required to determine if an income tax position meets the criteria of more-likely-than-not to be realized based on the merits of the position under tax laws, in order to recognize an income tax benefit. This requires the Company to make many assumptions and judgments regarding merits of income tax positions and the application of income tax law. Additionally, if a tax position meets the recognition criteria of more-likely-than-not the Company is required to make judgments and assumptions to measure the amount of the tax benefits to recognize based on the probability of the amount of tax benefits that would be realized if the tax position was challenged by the taxing authorities. Interpretations and guidance surrounding income tax laws and regulations change over time. As a consequence, changes in assumptions and judgments can materially affect amounts recognized in the consolidated financial statements.

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 more-likely-than-not, a valuation allowance would be recorded.

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

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

The Company offers defined benefit plans and other benefits upon the retirement of its employees. Assets and liabilities associated with these benefits are calculated by third-party actuaries under the rules provided by various accounting standards, with certain estimates provided by management. These estimates include the discount rate, expected rate of return of assets and the rate of increase of compensation and health claims. On a regular basis, management reviews these estimates by comparing them to actual experience and those used by other companies. If a change in an estimate is made, the carrying value of these assets and liabilities may have to be adjusted. Differences in the discount rate and expected long-term rate of return on plan assets within reasonably likely ranges would have had the following estimated impact on 2007 results:
 
   
Pension
   
Other
 
(Thousands of dollars)
 
Benefits
   
Benefits
 
             
Discount rate
           
             
Effect of change on net periodic benefit cost (income):
           
             
.25 percentage point increase
  $ (118 )   $ (6 )
.25 percentage point decrease
    121       6  
                 
Effect of change on PBO/APBO:
               
                 
.25 percentage point increase
  $ 5,044     $ 172  
.25 percentage point decrease
    (4,810 )     (166 )
                 
Long-term rate of return on plan assets
               
                 
Effect of change on net periodic benefit cost (income):
               
                 
.25 percentage point increase
  $ (551 )   $ -  
.25 percentage point decrease
    551       -  
                 
 
 
 
 

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

·  
oil prices;
·  
declines in domestic and worldwide oil and gas drilling;
·  
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’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.
 
These and other risks are described in greater detail in “Risk Factors” included elsewhere in this annual report on Form 10-K. All forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by these factors.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, believed, estimated or expected.  The Company undertakes no obligations to update or revise its forward-looking statements, whether as a result of new information, future events or otherwise.

 
 
 


 
Item 7A.  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 lack of current debt, 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 intercompany debt denominated in U.S. dollars owed to the Company’s U.S. entity by its Canadian subsidiary. As of December 31, 2007, this inter-company debt was comprised of 8.0 million Canadian dollars. As of December 31, 2007, if the U.S. dollar strengthened by 10% over the Canadian dollar, the net income impact would be $0.5 million of expense and if the U.S. dollar weakened by 10% over the Canadian dollar, the net income impact would be $0.5 million of income. Also, certain assets and liabilities, primarily employee and tax related in Argentina, 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 December 31, 2007, if the U.S. dollar strengthened by 10% over these currencies, the net income impact would be $0.1 million of expense and if the U.S. dollar weakened by 10% over these currencies, the net income impact would be $0.1 million of income.

Item 8.  Financial Statements and Supplementary Data
 
Management’s Report on Internal Control over Financial Reporting
 
The management of Lufkin Industries, Inc. (the “Company”), is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) promulgated under the Securities Exchange Act of 1934, as amended). The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in “Internal Control- Integrated Framework.”
 
Based on this assessment, management believes that, as of December 31, 2007, the Company’s internal control over financial reporting is effective based on those criteria.
 
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2007, has been audited by Deloitte & Touche LLP, an independent registered accounting firm, as stated in their report which appears herein.
 
Index to Financial Statements

Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Earnings
Consolidated Statements of Shareholders’ Equity & Comprehensive Income
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements



 
 
 


 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
To the Board of Directors and Stockholders of Lufkin Industries, Inc.
 
We have audited the accompanying consolidated balance sheets of Lufkin Industries, Inc. and subsidiaries (the "Company") as of December 31, 2007 and 2006, and the related consolidated statements of earnings, shareholders' equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2007.  Our audits also included the financial statement schedule listed in the Index at Item 15.  We also have audited the Company’s internal control over financial reporting as of December 31, 2007 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting.  Our responsibility is to express an opinion on these financial statements and the financial statement schedule, and an opinion on the Company's internal control over financial reporting based on our audits.
 
 We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects.  Our audits of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances.  We believe that our audits provide a reasonable basis for our opinions.
 
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
 
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis.  Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America.  Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.  Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 
As discussed in Note 1 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standard (“SFAS”) 123(R), Share-Based Payment, on January 1, 2006.  In addition, the Company adopted SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans on December 31, 2006 as discussed in Note 1 to the consolidated financial statements.  Furthermore, as discussed in Note 6 to the consolidated financial statements, the Company adopted Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes- an Interpretation of SFAS No. 109 on January 1, 2007.
 
 
DELOITTE & TOUCHE LLP
 
Houston, Texas
February 29, 2008

 
 
 

LUFKIN INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS

 
December 31, 2007 and 2006
(Thousands of dollars, except share and per share data)
 
   
2007
   
2006
 
Assets
           
Current Assets:
           
Cash and cash equivalents
  $ 95,748     $ 57,797  
Receivables, net
    93,634       90,585  
Income tax receivable
    4,637       -  
Inventories
    95,821       85,630  
Deferred income tax assets
    1,615       7,919  
Other current assets
    1,412       1,521  
Total current assets
    292,867       243,452  
                 
Property, plant and equipment, net
    120,129       113,081  
Prepaid pension costs
    71,571       56,856  
Goodwill, net
    11,990       11,732  
Other assets, net
    4,099       3,948  
Total assets
  $ 500,656     $ 429,069  
                 
Liabilities and Shareholders' Equity
               
                 
Current liabilities:
               
Accounts payable
  $ 23,977     $ 24,375  
Accrued liabilities:
               
Payroll and benefits
    11,444       9,810  
Warranty expenses
    3,641       3,668  
Taxes payable
    7,131       7,665  
Other
    21,941       15,977  
Total current liabilities
    68,134       61,495  
                 
Deferred income tax liabilities
    34,600       28,022  
Postretirement benefits
    7,303       8,475  
Other liabilities
    5,966       2,937  
Commitments and contingencies
    -       -  
                 
Shareholders' equity:
               
                 
Common stock, $1.00 par value per share; 60,000,000 shares authorized;
               
15,534,184 and 15,322,903 shares issued and outstanding, respectively
    15,534       15,323  
Capital in excess par
    48,315       38,173  
Retained earnings
    341,315       280,198  
Treasury stock, 895,278 and 395,278 shares, respectively, at cost
    (31,580 )     (4,083 )
Accumulated other comprehensive income (loss)
    11,069       (1,471 )
Total shareholders' equity
    384,653       328,140  
Total liabilities and shareholders' equity
  $ 500,656     $ 429,069  
                 
 
See notes to consolidated financial statements.


 
 
 


LUFKIN INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF EARNINGS



Years ended December 31, 2007, 2006 and 2005
(Thousands of dollars, except per share data)

   
2007
   
2006
   
2005
 
                   
Sales
  $ 597,187     $ 605,492     $ 492,167  
                         
Cost of sales
    430,819       449,243       378,826  
                         
Gross profit
    166,368       156,249       113,341  
                         
Selling, general and administrative expenses
    59,034       52,994       44,135  
                         
Operating income
    107,334       103,255       69,206  
                         
Interest income
    3,751       1,893       563  
Interest expense
    (285 )     (160 )     (159 )
Other income (expense), net
    1,926       (259 )     (335 )
                         
Earnings before income tax provision
    112,726       104,729       69,275  
                         
Income tax provision
    38,515       31,735       24,731  
                         
Net earnings
    74,211       72,994       44,544  
                         
                         
Net earnings per share
                       
Basic
  $ 4.98     $ 4.92     $ 3.10  
Diluted
  $ 4.92     $ 4.83     $ 3.03  
                         

See notes to consolidated financial statements.

 
 
 

LUFKIN INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY & COMPREHENSIVE INCOME

 
                                       
Accumulated
       
   
 
                                 
Other
       
Years Ended December 31,
 
Common
         
 
               
 
   
Compre-
       
2007, 2006 and 2005
 
Stock
   
 
   
Capital
   
 
   
 
   
Compre-
   
hensive
       
(Thousands of dollars,
 
Shares, net
   
Common
   
In Excess
   
Retained
   
Treasury
   
hensive
   
Income
   
 
 
except share data) 
   of Treasury      Stock      of Par      Earnings     Stock     Income     
 (Loss)
    Total  
                                                 
Balance, Jan. 1, 2005
    13,980,680       14,472       19,488       177,374       (5,075 )           2,673       208,932  
                                                               
Comprehensive income:
                                                             
Net earnings
                            44,544               44,544               44,544  
Other comprehensive income, net of tax:
                                                               
Foreign currency translation
                                                               
adjustments
                                            (727 )             (727 )
Other comprehensive income
                                            (727 )     (727 )        
Comprehensive income
                                            43,817                  
Cash dividends
                            (5,491 )                             (5,491 )
Exercise of stock options
    744,686       653       12,217               951                       13,821  
Balance, Dec. 31, 2005
    14,725,366       15,125       31,705       216,427       (4,124 )             1,946       261,079  
                                                                 
Comprehensive income:
                                                               
                                                                 
Net earnings
                            72,994               72,994               72,994  
Other comprehensive income, net of tax:
                                                               
Foreign currency translation
                                                               
adjustments
                                            1,012       1,012       1,012  
Total comprehensive income
                                          $ 74,006                  
                                                                 
Initial application of FAS 158:
                                                               
Defined benefit pension plans
                                                    (5,758 )        
Defined benefit postretirement plans
                                                    1,329          
                                                                 
Total initial application of FAS 158:
                                                    (4,429 )     (4,429 )
                                                                 
Cash dividends
                            (9,223 )                             (9,223 )
Stock-based compensation
                    2,908                                       2,908  
Exercise of stock options
    202,259       198       3,560               41                       3,799  
Balance, Dec. 31, 2006
    14,927,625     $ 15,323     $ 38,173     $ 280,198     $ (4,083 )           $ (1,471 )   $ 328,140  
                                                                 
Comprehensive income:
                                                               
                                                                 
Net earnings
                            74,211               74,211               74,211  
Other comprehensive income, net of tax:
                                                               
Foreign currency translation
                                                               
adjustments
                                            5,057       5,057       5,057  
Defined benefit pension plans
                                            6,979       6,979       6,979  
Defined benefit post-retirement plans
                                            504       504       504  
Total comprehensive income
                                          $ 86,751                  
                                                                 
Cash dividends
                            (13,094 )                             (13,094 )
Treasury stock purchases
    (500,000 )                             (27,497 )                     (27,497 )
Stock-based compensation
                    3,682                                       3,682  
Exercise of stock options
    211,281       211       6,460                                       6,671  
Balance, Dec. 31, 2007
    14,638,906     $ 15,534     $ 48,315     $ 341,315     $ (31,580 )           $ 11,069     $ 384,653  
                                                                 
 
See notes to consolidated financial statements.
 
 
 
 


LUFKIN INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS



Years ended December 31, 2007, 2006 and 2005
(Thousands of dollars)
   
2007
   
2006
   
2005
 
Cash flows form operating activities:
                 
Net earnings
  $ 74,211     $ 72,994     $ 44,544  
Adjustments to reconcile net earnings to cash provided by operating activities:
                 
Depreciation and amortization
    14,524       11,950       11,376  
Deferred income tax provision/benefit
    8,795       (4,520 )     (2,041 )
Excess tax benefit from share-based compensation
    (3,031 )     (3,525 )     -  
Share-based compensation expense
    3,682       2,908       -  
Pension income
    (3,257 )     (2,901 )     (2,115 )
Postretirement benefits/obligation
    (400 )     (123 )     747  
(Gain) loss on disposition of property, plant and equipment
    (450 )     (123 )     92  
Changes in:
                       
Receivables, net
    (1,141 )     (9,440 )     (19,905 )
Income tax receivable
    (4,573 )     -       -  
Inventories
    (7,549 )     (10,490 )     (20,360 )
Other current assets
    179       3,553       (3,533 )
Accounts payable
    (2,425 )     3,039       (2,367 )
Accrued liabilities
    11,745       4,044       17,242  
Net cash provided by operating activities
    90,310       67,366       23,680  
                         
Cash flows from investing activites:
                       
Additions to property, plant and equipment
    (19,253 )     (31,241 )     (15,803 )
Proceeds from disposition of property, plant and equipment
    1,395       236       187  
Increase in other assets
    (231 )     (680 )     (833 )
Acquisition of other companies
    -       -       (3 )
Net cash used in investing activities
    (18,089 )     (31,685 )     (16,452 )
                         
Cash flows from financing activites:
                       
Payments of short-term notes payable
    -       (288 )     (1,530 )
Dividends paid
    (13,094 )     (9,223 )     (5,491 )
Excess tax benefit from share-based compensation
    3,031       3,525       -  
Proceeds from exercise of stock options
    3,467       2,192       8,564  
Purchases of treasury stock
    (27,497 )     -       -  
Net cash provided by (used in) financing activities
    (34,093 )     (3,794 )     1,543  
                         
Effect of translation on cash and cash equivalents
    (177 )     88       (46 )
                         
Net increase in cash and cash equivalents
    37,951       31,975       8,725  
                         
Cash and cash equivalents at beginning of period
    57,797       25,822       17,097  
                         
Cash and cash equivalents at end of period
  $ 95,748     $ 57,797     $ 25,822  
                         

See notes to consolidated financial statements.

 
 
 


LUFKIN INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) Corporate Organization and Summary of Significant Accounting Policies
Lufkin Industries, Inc. and its consolidated subsidiaries (collectively, the “Company”) manufacture and sell oil field pumping units, power transmission products and highway trailers throughout the world.

Principles of consolidation:  The consolidated financial statements include the accounts of Lufkin Industries, Inc. and its consolidated subsidiaries after elimination of all inter-company accounts and transactions.

Use of estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.  Actual results could differ from those estimates.

Foreign currencies:  Assets and liabilities of foreign operations where the applicable foreign currency is the functional currency are translated into U.S. dollars at the exchange rate in effect at the end of each accounting period, with any resulting gain or loss reflected in accumulated other comprehensive income in the shareholders’ equity section of the balance sheet.  Income statement accounts are translated at the average exchange rates prevailing during the period.  Gains and losses resulting from balance sheet remeasurement of foreign operations where the U.S. dollar is the functional currency are included in the consolidated statement of earnings as incurred.

Any gains or losses on transactions denominated in a foreign currency are included in the consolidated statements of earnings as incurred.

Cash equivalents: The Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents.

Revenue recognition: 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.  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:

Amounts billed for shipping are classified as sales and costs incurred for shipping are classified as cost of sales in the consolidated statements of earnings.

Accounts & Notes Receivable and Allowance for Doubtful Accounts: Accounts and notes receivable are stated at the historical carrying amount net of write-offs and allowance for doubtful accounts. The Company establishes an allowance for doubtful accounts based on historical experience and any specific customer issues that the Company has identified. Uncollected receivables are generally reserved before being past due over one year or when the Company has determined that the balance will not be collected.

Inventories:  The Company reports its inventories by using the last-in, first-out (LIFO) and the first-in, first-out (FIFO) methods less reserves necessary to report inventories at the lower of cost or estimated market.  Inventory costs include material, labor and factory overhead. 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.
 
Property, plant and equipment (P. P. & E.):  The Company records investments in these assets at cost.  Improvements are capitalized, while repair and maintenance costs are charged to operations as incurred.  Gains or losses realized on the sale or retirement of these assets are reflected in income.  The Company periodically reviews its P. P. & E. for possible impairment whenever events or changes in circumstance might indicate that the carrying amount of an asset may not be recoverable. An impairment loss is recognized if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Depreciation for financial reporting purposes is provided on a straight-line method based upon the estimated useful lives of the assets.  Accelerated depreciation methods are used for tax purposes.  The following is a summary of the Company’s P. P. & E. useful lives:
 

 
Useful Life
 
(in years)
       
Land
 
-
 
Land improvements
  10.0
-
  25.0
Buildings
  12.5
-