Punctuation

Q. We hired an editor to edit our book (a novel), but several things just seem wrong. Here’s the quote:

“I see you got the water running.” Steve looked from the water canal to the disheveled man before him. “But what in God’s name happened to you?”

She wants to change it to

“I see you got the water running,” Steve looked from the water canal to the disheveled man before him, “but what in God’s name happened to you?”

Which is correct?

A. The first version is correct; the second one creates a run-on sentence. (I hope you got a good deal on that editor.)