**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

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

 

**FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005**

 

**COMMISSION FILE NUMBER 1-12881**

 

**LONE STAR TECHNOLOGIES, INC.**

(A DELAWARE CORPORATION)

 

I.R.S. EMPLOYER IDENTIFICATION NUMBER: **75-2085454**

 

**15660 N. DALLAS PARKWAY, SUITE 500**

**DALLAS, TEXAS 75248**

**(972) 770-6401**

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

| ** **                     | ** ** | **Name of each  exchange** |
|--------------------------------|------------|----------------------------|
| **Title  of each class**       | ** ** | **on  which registered**   |
|                           |       |                       |
| Common  Stock, par value $1.00 |       | New York Stock Exchange    |

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act. Yes    ý  No    o.

 

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 of Section 15(d) of the Act. Yes    o  No    ý.

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes    ý  No    o.

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K.    o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2). Yes    ý  No    o.

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). Yes    o  No    ý

 

Theaggregate market value of common stock on June 30, 2005 held by nonaffiliatesof the registrant was approximately $1,363.5 million, based on the closingprice of the common stock on the New York Stock Exchange.

 

As of February 13, 2006, the number of sharesof common stock outstanding was 30,643,846.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portionsof registrant’s Proxy Statement for its 2005 Annual Meeting of Shareholders areincorporated by reference into Part III hereof.

 

 

----

 

# **TABLEOF CONTENTS**

 
|         |   |                                                                                                                 | **Page** |
|--------------|--------|----------------------------------------------------------------------------------------------------------------------|----------|
| **PART I**   |
|         |   |                                                                                                                 |     |
| ITEM 1.      |   | BUSINESS                                                                                                             | 3        |
|         |   |                                                                                                                 |     |
| ITEM 1A.     |   | RISK FACTORS                                                                                                         | 17       |
|         |   |                                                                                                                 |     |
| ITEM 1B.     |   | UNRESOLVED STAFF COMMENTS                                                                                            | 17       |
|         |   |                                                                                                                 |     |
| ITEM 2.      |   | PROPERTIES                                                                                                           | 17       |
|         |   |                                                                                                                 |     |
| ITEM 3.      |   | LEGAL PROCEEDINGS                                                                                                    | 19       |
|         |   |                                                                                                                 |     |
| ITEM 4.      |   | SUBMISSION OF MATTERS TO A  VOTE OF SHAREHOLDERS                                                                     | 19       |
|         |   |                                                                                                                 |     |
| **PART II**  |
|         |   |                                                                                                                 |     |
| ITEM 5.      |   | MARKET FOR REGISTRANT’S  COMMON EQUITY, RELATED SHAREHOLDER  MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES | 20       |
|         |   |                                                                                                                 |     |
| ITEM 6.      |   | SELECTED FINANCIAL DATA                                                                                              | 21       |
|         |   |                                                                                                                 |     |
| ITEM 7.      |   | MANAGEMENT’S DISCUSSION AND  ANALYSIS  OF FINANCIAL CONDITION AND RESULTS OF OPERATION                          | 23       |
|         |   |                                                                                                                 |     |
| ITEM 7A.     |   | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                          | 36       |
|         |   |                                                                                                                 |     |
| ITEM 8.      |   | CONSOLIDATED  FINANCIAL STATEMENTS  AND SUPPLEMENTARY DATA                                                           | 37       |
|         |   |                                                                                                                 |     |
| ITEM 9.      |   | CHANGES IN  AND DISAGREEMENTS WITH ACCOUNTANTS  ON ACCOUNTING AND FINANCIAL DISCLOSURE                               | 71       |
|         |   |                                                                                                                 |     |
| ITEM 9A.     |   | CONTROLS AND  PROCEDURES                                                                                             | 71       |
|         |   |                                                                                                                 |     |
| ITEM 9B.     |   | OTHER INFORMATION                                                                                                    | 72       |
|         |   |                                                                                                                 |     |
| **PART III** |
|         |   |                                                                                                                 |     |
| ITEM 10.     |   | DIRECTORS  AND EXECUTIVE OFFICERS  OF THE REGISTRANT                                                                 | 72       |
|         |   |                                                                                                                 |     |
| ITEM 11.     |   | EXECUTIVE  COMPENSATION                                                                                              | 72       |
|         |   |                                                                                                                 |     |
| ITEM 12.     |   | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS  AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS                     | 72       |
|         |   |                                                                                                                 |     |
| ITEM 13.     |   | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS                                                                      | 72       |
|         |   |                                                                                                                 |     |
| ITEM 14.     |   | PRINCIPAL  ACCOUNTING FEES AND SERVICES                                                                              | 72       |
|         |   |                                                                                                                 |     |
| **PART IV**  |
|         |   |                                                                                                                 |     |
| ITEM 15.     |   | EXHIBITS AND  FINANCIAL STATEMENT SCHEDULES                                                                          | 73       |
|         |   |                                                                                                                 |     |
| SIGNATURES   | 77     |

 

2

----

 

**PART I**

 
| **ITEM 1.** | **BUSINESS** |
|-------------|--------------|

 

# **GENERAL**

# ** **

**LoneStar Technologies, Inc., a Delaware corporation, is:**

** **

•                  a leading domestic manufacturer and marketerof high quality welded “oil country tubular goods”, or “OCTG”, which are steeltubular products used in the completion of and production from oil and naturalgas wells;

 

•                  a major manufacturer and marketer of linepipe, which is used in the gathering and transmission of oil and natural gas;

 

•                  a major supplier of high quality threading,thermal treating, end finishing, inspection, and logistics services to theoilfield industry;

 

•                  one of the largest domestic manufacturers ofhigh quality couplings used to connect individual sections of oilfield casingand tubing;

 

•                  a leading manufacturer of specialty tubingproducts used in industrial, automotive, construction, agricultural, and heatrecovery technology applications;

 

•                  a marketer of oil country tubular goods andline pipe produced by other companies through exclusive marketing arrangements;and

 

•                  a manufacturer and supplier of hot rolledsteel to the domestic market.

 

**LoneStar began producing and marketing oil country tubular goods and other tubularproducts over 50 years ago, and the holding company was incorporated in 1986. Asused in this report, the terms “we,” “us”, “our” and “Lone Star” refer to LoneStar Technologies, Inc. and its subsidiaries and affiliates unless the contextindicates otherwise.**

** **

**LoneStar’s operating companies include Lone Star Steel Company (“Steel”), amanufacturer of oilfield tubulars, specialty tubing products, and flat-rolledsteel, and Fintube Technologies, Inc. (“Fintube”), a manufacturer of specialtytubulars used in heat recovery technology applications. In October 2003 wecreated a new business unit, Star Energy Group, to enhance our ability toprovide OCTG customers with a full spectrum of pipe finishing, inspection, andlogistics services. Star Energy Group integrated the sales and marketingfunctions and production assets of four companies we acquired between 2000 and2003:**

** **

•                  Wheeling Machine Products, Inc. and WheelingMachine Products of Texas, Inc. (collectively, “Wheeling”), one of the largestdomestic suppliers of couplings used to connect individual sections of oilfieldcasing and tubing;

 

•                  Delta Tubular Processing (“DTP”), a leadingprovider of thermal treating and end-finishing services for oilfield productiontubing;

 

•                  Frank’s Tubular International (since renamedDelta Tubular International, or “DTI”), a leading provider of high-qualitythreading, inspection, and storage services to the OCTG market; and

 

•                  Bellville Tube Company, L.P. (“Bellville”), anOCTG manufacturer.

 

# **RISK FACTORS**

# ** **

In addition to important factors describedelsewhere in this report, Lone Star cautions current and potential investorsthat the following risk factors, among others, sometimes have affected, and inthe future could affect, Lone Star’s actual results and could cause suchresults during fiscal 2006, and beyond, to differ materially from thoseexpressed in any forward-looking statements made by or on behalf of Lone Star. Ifany of the following risks actually occur, our business, financial condition orresults of operations could be materially adversely affected and you may loseall of your investment.

 

### ***The volatility of oil and gas marketsaffects demand for our principal products, and downturns in these markets couldcause our revenues to decrease.***Proceedsfrom the sale of casing, tubing, line pipe, couplings and OCTG finishingservices to the oil and gas industry constitute the majority of our revenues. Downturnsin the oil and gas markets and general economic conditions could cause demandfor our principal products and services to decrease, which would adverselyaffect our revenues and results of operations.

### ** **

Demand for our oilfield products and servicesdepends primarily upon the number of oil and natural gas wells being drilled,

 

3

----

 

completed and re-worked at any given time andthe depth and drilling conditions of these wells. The level of these activitiesdepends primarily on expectations as to future prices for natural gas and oil. Naturalgas and oil prices are subject to significant fluctuations in response torelatively minor changes in supply, market uncertainty and a variety ofadditional factors that are beyond our control. These factors include:

 

#### **•**                  worldwide and domestic supplies of and demand for oil and natural gas;

#### ** **

#### **•**                  domestic and foreign natural gas and oil production;

#### ** **

#### **•**                  political instability or armed conflict in oil and gas producingregions;

#### ** **

#### **•**                  the price and amounts of imports of oil and gas casing, tubing and linepipe;

#### ** **

#### **•**                  the availability of alternative fuels;

#### ** **

#### **•**                  the availability of pipeline capacity;

#### ** **

#### **•**                  weather conditions;

#### ** **

#### **•**                  domestic and foreign governmental regulations, especially trade lawsand taxes; and

#### ** **

#### **•**                  the overall economic environment, including the demand for electricity.

#### ** **

We expect natural gas and oil prices and thedomestic rig count to continue to be volatile in the future. A downturn in theoil and gas market could decrease demand for our products and services andcause our revenues to decrease.

 

### ***Our precision mechanical tubulars andother businesses are sensitive to economic downturns, which could cause ourrevenues to decrease.***Wemanufacture and sell high quality steel tubulars in the form of precisionmechanical tubulars used by our customers in the manufacture of products suchas automotive stabilizers, hydraulic cylinders and cranes. The demand for theseproducts and, in turn, for our precision mechanical tubulars, is dependent onthe general economy, the automotive and construction industries, productinventory levels and other factors affecting domestic goods activity. If we arenot able to adequately predict demand and if our precision mechanical tubularsinventories (or the inventories of other precision tubular manufacturers)become excessive, there could be a material adverse effect on price levels, thequantity of precision mechanical tubulars sold by us and our revenues.

### ** **

### ***The competition for raw materials weuse in our business and the volatility of our raw material costs could reduce ourprofits and constrain our operations, which would reduce our revenues.***Purchased steel, including slabs, scrap, steel additives, coils, pipe,and related fittings, represents over 60% of cost of goods sold. The price andavailability of steel slabs, coils, scrap and pipe from commercial allianceswith other pipe mills that we use in our manufacturing processes and to supplyour customers, are highly competitive and cyclical. The following factors, mostof which are beyond our control, affect the price of steel:

### ** **

#### **•**                  supply and demand factors;

#### ** **

#### **•**                  freight costs and transportation availability;

#### ** **

#### **•**                  inventory levels of brokers and distributors;

#### ** **

#### **•**                  the price and availability of imported steel pipe and tubing;

#### ** **

#### **•**                  trade duties and taxes;

#### ** **

#### **•**                  market consolidation; and

#### ** **

#### **•**                  labor disputes.

#### ** **

Changes in steel prices can affect the pricinglevels of our products. We seek to maintain our profit margin by attempting toincrease the price of our products in response to an increase in steel costsand by sourcing steel from our flat rolled steel business, but we do not alwayssucceed in passing these price increases through to our customers. As a result,we do not always have the ability to recover increases in steel costs. While weendeavor to maintain flexibility in procurement of steel for our tubularproducts, failure to obtain sufficient steel slabs, coils and scrap wouldconstrain our operations.

 

Changes in energy costs also contribute to thevolatility of our business, as electricity and natural gas are approximately5-10% of cost of goods sold. Natural gas prices rose significantly during thesecond half of 2005 in part related to the impact of the hurricanes. We haveonly transferred some of these natural gas cost increases through to ourcustomers in the form of higher product prices.

 

In the welded oil and gas casing and tubingand line pipe market, we compete against manufacturers that may be able topurchase or produce semi-finished steel, hot rolled coils or scrap at a lowercost than we can. Our Steel subsidiary satisfies its raw material requirementsand those of our Bellville subsidiary by purchasing semi-finished steel, usingpurchased and internally generated scrap to make hot rolled coils in its meltshop and hot strip mill and by purchasing coils. Our Wheeling subsidiarytypically purchases its coupling stock from domestic seamless oilfield tubularmanufacturers. Our Fintube subsidiary must also compete with manufacturers thatmay be able to purchase or produce coils more cost-effectively than we can. Wemay not be able to satisfy our subsidiaries’ raw material requirements ascost-effectively as our competitors,

 

4

----

 

which may lead to reduced sales.

 

### ***Excessive inventory levels ofoilfield products could reduce demand for our products and adversely affect oursales.***Industry-wide inventory levels oftubular goods for the oil and gas industry can vary significantly from periodto period depending on industry cycles. These changes can have a direct adverseeffect on the demand for new production of oilfield products when customersdraw from existing inventory rather than purchase new products. As a result,our oilfield products sales and results of operations may vary significantlyfrom period to period. Excessive inventories could have a material adverseeffect on price levels and the quantity of oil and gas casing, tubing, linepipe and couplings sold by us. In addition, any excess domestic capacity maynot necessarily be substantially absorbed during periods of increased domesticdrilling activity since foreign producers of oilfield products may increasetheir exports to the United States market.

### ** **

### ***Easing of United States governmentimport trade restrictions could increase foreign competition in our industryand decrease our sales and our profits, particularly in the case of oil and gascasing and tubing and line pipe.***Thedomestic steel industry historically has faced significant competition fromforeign steel producers. The level of imports of OCTG, which has varied significantlyover time, affects the domestic market for these goods, and were athistorically high levels in 2005. High levels of imports reduce the volume soldby domestic producers and tend to suppress selling prices, both of which havean adverse impact on our business.

### ** **

The level of imports of oil and gas casing andtubing and line pipe is affected by numerous factors, including:

 

#### **•**                  overall world demand for oil and gas casing and tubing and line pipe;

#### ** **

#### **•**                  domestic and foreign inventory levels of casing, tubing and line pipe;

#### ** **

#### **•**                  the purchasing pattern of distributors and end users;

#### ** **

#### **•**                  domestic and foreign trade policy; and

#### ** **

#### **•**                  the relative value of the United States dollar.

#### ** **

Many foreign steel producers are owned,controlled or subsidized by their governments and their decisions with respectto production and sales may be influenced more by political and economic policyconsiderations than by prevailing market conditions. Actions motivated by thesefactors could increase competition and cause our sales to decrease. In 2005,approximately 47% of the apparent domestic consumption was supplied by importedOCTG.

 

Anti-dumping and countervailing duty ordersapplicable to OCTG are limited to specific countries, are largely under appealand may be revoked as a result of periodic “sunset reviews.”  In addition, an individual exporter mayobtain revocation as to itself under specific circumstances. In June 2000 theUnited States government completed sunset reviews of orders covering Canada andTaiwan and revoked both orders. The United States government will conductsunset reviews of orders covering Argentina, Italy, Japan, Korea and Mexicobeginning in mid-2006. If those orders are revoked in full or in part or theduty rates are lowered, we could be exposed to increased competition fromimported OCTG that could decrease our sales and profits.

 

Imports of line pipe in 2004 and 2005 havebeen at historically high levels. The levels of these imports could increasefurther in 2006. Such increased competition could decrease our sales andprofits and have a material adverse effect on our line pipe business, operatingresults or financial condition.

 

The United States’ or any other government’sfuture actions regarding import duties or other trade restrictions on importsof oil and gas casing, tubing products, line pipe or other steel products couldreduce our sales of such products.

 

### ***Difficulties in integrating potentialacquisitions could adversely affect our business, operating results andfinancial condition.***Weregularly evaluate potential acquisition opportunities to support andstrengthen our business. We might not be able to locate suitable acquisitioncandidates, acquire candidates on acceptable terms or integrate acquiredbusinesses successfully.

### ** **

Future acquisitions may require us to incuradditional debt and contingent liabilities, which may materially and adverselyaffect our business, operating results and financial condition. In addition, wemay issue shares of our common stock in order to consummate future acquisitions.Such issuances might have a dilutive effect on our current equity holders. Furthermore,

 

5

----

 

the process of integrating acquired businesseseffectively involves the following risks:

 

#### **•**                  assimilating operations and products may be unexpectedly difficult;

#### ** **

#### **•**                  management’s attention may be diverted from other business concerns;

#### ** **

#### **•**                  we may enter markets in which we have limited or no direct experience;and

#### ** **

#### **•**                  we may lose key employees of an acquired business.

#### ** **

***Our commercial alliances with other OCTG, line pipe, and specialtytubing mills may not continue, which could adversely affect our business,financial condition, and revenues.***We maintain commercial relationships withseveral tubular producers, which we do not own, some of which provide usexclusive distribution rights of their products in specific geographic regions,principally marketing and sales of oilfield tubular products in the UnitedStates. These mills produce specific products that expand our product offeringsto our customers and allow us to concentrate our capital expenditures andmanufacturing expertise on our more high quality products. These alliancesaccounted for 17% of our total oilfield products segment revenues in 2005. Aloss of one or more of these alliance relationships could reduce our ability tooffer these specific products to our customers and therefore adversely affectour business, financial condition, and revenues.

 

### ***We are subject to numerous lawsuitsconcerning exposure to asbestos on our premises which could adversely affectour financial condition.***During thelast seven years our Lone Star Steel subsidiary has been named as one of anumber of defendants in 47 lawsuits alleging that certain individuals wereexposed to asbestos on the defendants’ premises. Seven pending asbestos-relatedclaims have been asserted against another of our subsidiaries. We did notmanufacture or distribute any products containing asbestos. Some or all ofthese claims may not be covered by our insurance. Although we have accrued forour estimated exposure to known claims, we do not know the extent to whichfuture claims may be filed, and therefore we cannot estimate our exposure, ifany, to unasserted claims.

### ** **

### ***Failure to renew or reach acceptablenew collective bargaining agreements could result in labor disruptions whichcould adversely affect our business, financial condition and revenues.***Our subsidiaries are subject to three collective bargaining agreements.At December 31, 2005, Lone Star had approximately 2,699 employees, of whomapproximately 1,073, all at our Steel subsidiary, are part of collectivebargaining agreements with three unions. The majority of these union workersare production, warehouse, and maintenance workers represented by the UnitedSteel, Paper and Forrestry, Rubber, Manufacturing and Energy, Allied IndustrialServices Workers International Union under a contract which expires on July 31,2008 at Steel and Star Tubular Services, Inc. (“STSI”), a wholly-ownedsubsidiary of Steel. Our agreement with the Security, Police & FireProfessionals of America, covering an aggregate of approximately 13 of ourwarehouse and plant security workers as of December 31, 2005, expires onSeptember 30, 2006. The collective bargaining agreement between Steel and theInternational Bricklayers of America expired May 31, 2005 and covers four brickmasons. The brick masons and Steel will meet to discuss the terms of anagreement in February 2006.

### ** **

Collective bargaining agreements with ouremployees generally cover wages, health care benefits and retirement plans,seniority, job classes and work rules. Failure to renew these agreements uponexpiration or to establish new collective bargaining agreements on termsacceptable to us could result in work stoppages or other labor disruptionswhich could adversely impact our customer relationships, financial conditionand results of operations.

 

We may be subject to work stoppages at our facilities or our customersmay be subjected to work stoppages, which could seriously impact theprofitability of our business. As of December 31, 2005, approximately 40% ofour work force was unionized. If our unionized workers were to engage in astrike, work stoppage or other slowdown in the future, we could experience asignificant disruption of our operations, which could have a material adverseeffect on us. In addition, if a greater percentage of our work force becomesunionized, our business and financial results could be materially adverselyaffected. Many of our direct or indirect customers have unionized work forces. Strikes,work stoppages, or slowdowns experienced by these customers could result in areduction in orders for our products.

 

### ***We would have greater taxable income,and therefore be subject to increased federal income taxes, if we lose ourfederal tax net operating loss carryforwards due to our, or the consolidatedgroup with whom we file tax returns, experiencing an ownership change of morethan 50%.***We had federal income tax netoperating loss carryforwards of approximately $78 million at December 31,2005 that, if not utilized to reduce our taxable income, will expire in varyingamounts between years 2022 and 2023. Our ability to use these net operatingloss carryforwards to reduce taxable income is dependent upon our notexperiencing an ownership change of more than 50 percentage points as definedby IRS regulations. Lone Star’s common stock is publicly traded, and managementcannot assure that future trading will not result in an ownership change, asdefined by IRS regulations, which would limit the availability of our netoperating loss carryforwards. In addition, a portion of our net operating losscarryforwards relates to our former subsidiary, American Federal Bank, F.S.B.,and is subject to an agreement with the Federal Deposit Insurance Corporationunder which we may be required to pay that government agency for certain taxbenefits relating to the use of the net operating loss carryforwards.

 

6

----

 

### ***We have unfunded pension planliabilities of at least $27.6 million, which could result in claims against ourassets if the plans’ assets are insufficient to satisfy pension obligations.***Our three defined benefit pension plans for our Lone Star Steelsubsidiary’s bargaining unit employees were underfunded by an aggregate ofapproximately $27.6 million as of December 31, 2005 using an investment returnassumption of 8% per annum and a discount rate of 5.75% per annum. Moreover, ifthe plans were terminated under the distress termination provisions of theEmployee Retirement Income Security Act of 1974, as amended, or ERISA, thePension Benefit Guaranty Corporation, or PBGC, would have claims against ourassets for the amount necessary to satisfy the plans’ unfunded benefit liabilitiesunder the PBGC’s actuarial assumptions, which amount may be greater than $27.6million as of December 31, 2005.

### ** **

### ***Various governmental regulations andenvironmental risks applicable to our business may require us to take actionswhich will adversely affect our results of operations.***Our business is subject to numerous federal, state,  local and foreign laws and regulations,including regulations with respect to air emissions, wastewater discharges andthe generation, handling, storage, transportation, treatment and disposal ofwaste materials. Although we believe we are in substantial compliance with allapplicable laws and regulations, legal requirements are frequently changed andsubject to interpretation, and the presently unpredictable ultimate cost ofcompliance with these requirements could affect our operations. We may berequired to make significant expenditures to comply with governmental laws andregulations. Existing laws or regulations, as currently interpreted orreinterpreted in the future, or future laws or regulations, could have amaterial adverse effect on our results of operations and financial condition.

### ** **

### ***Potential casualties and productliability claims relating to the products we manufacture, service and sell tothe oil and gas industry and industries using our specialty tubulars could harmour business.***The oil and gas casing, tubing,coupling and line pipe products we manufacture and service are sold primarilyfor use in oil and gas drilling and transmission activities, which are subjectto inherent risks, including well failures, line pipe leaks and fires, thatcould result in death, personal injury, property damage, pollution or loss ofproduction. In addition, defects in our specialty tubing products could resultin death, personal injury, property damage, pollution, damage to equipment andfacilities or inefficient heat recovery. We warrant our oilfield products,specialty tubing, and the commercial alliance products we sell or distribute tobe free of various defects. Actual or claimed defects in our products andservices may give rise to claims against us for losses and expose us to claimsfor damages. Our insurance may be inadequate or unavailable to protect us inthe event of a claim or our insurance coverage may be canceled or otherwiseterminated.

### ** **

### ***Market volatility and downturns ofindustries that use our Fintube products for heat recovery applications couldreduce demand for those products and adversely affect our revenues.***Our Fintube subsidiary is one of the largest domestic specialty tubingmanufacturers of heat recovery finned tubulars, which are used in variousapplications including fuel economizers, petrochemical plants, refineries andcombined-cycle electrical power generation plants. Our Fintube business is thereforedependent on power plant construction, the cost of alternative fuels for powergeneration and, to a lesser extent, industrial plant processing andpetrochemical plant construction. Demand for these products has been down sincefourth quarter 2001 as construction of new power plants was curtailed due tolower energy demand attributable to the slowdown in the general economy andconstraints on capital to fund the construction projects. Power plantconstruction curtailments and cancellations are expected to continue. Thisconstruction activity and the corresponding demand for our Fintube products arealso related to natural gas, coal, and oil prices and are therefore subject tothe volatility of the oil and gas market. Demand for these products fluctuatessignificantly in response to a number of economic, market and other factors,most of which are beyond our control.

### ** **

### **A further decrease in demand for theseFintube products could adversely affect our results of operations includingpossible asset impairments and associated losses. Some additional factorsaffecting demand are:**

### ** **

#### **•**                  the level of consumer and industrial demand for electrical powergeneration;

#### ** **

#### **•**                  fluctuations in construction levels of gas-fired, combined-cycle powergeneration plants;

#### ** **

#### **•**                  the price and amount of imports of foreign boiler tubes, finned tubesand other products;

#### ** **

#### **•**                  worldwide and domestic supplies of natural gas;

#### ** **

#### **•**                  weather conditions; and

#### ** **

•                  domestic and foreign governmental regulationsand taxes.

 

**OUR STRATEGIES**

** **

Webelieve that the better we serve our customers, the better we serve ourshareholders. Our primary responsibility is to grow shareholder value. Thus,our goal is to be the leading provider of both oilfield tubular products andspecialty tubing products and to increase our market presence in order tobenefit from favorable market conditions. The key elements of our strategy toachieve commercial leadership and operational excellence are:

 

7

----

 

***Achieving increased production, greaterproductivity and penetration into new markets through capital investment andcommercial alliances expansion****.*Our customers demand a broad product line and a quick delivery response. Ouroperational flexibility gives us the ability to match production to customerneeds and has earned us the reputation of having the shortest order to deliverytimes in the industry. We constantly seek to improve our production efficiencyby upgrading our manufacturing methods and processes. By becoming moreefficient, we will be able to continue offering our products at attractiveprices to an increasing number of customers. Through our exclusive commercialalliances with several mills, we have been able to outsource production ofspecific types of OCTG, line pipe, and specialty tubing, enabling us toconcentrate our capital expenditures and manufacturing expertise on our highquality products and new technologies. Expanding these alliances will enable usboth to offer a wider variety of tubular products to our customers and toincrease our offering of high quality products. Through our alliances and withStar Energy Group, we now deliver the industry’s most complete line of oilfieldtubular products and services.

 

***Continuing to develop and market newproduct applications and technologies****.* We have the products, the engineeringcapabilities, and the commitment to provide solutions so customers should thinkof Lone Star first when they have a need, even if it is a need that has neverbeen met before. Commercial leadership demands that we continually look for newways to do business. We have historically been successful in pioneering newproduction methods to expand the market acceptance of our oil country tubulargoods, line pipe, and specialty tubing products. For example, we pioneered theelectric resistance welded, full-body normalized process, which, together withour extensive heat-treating capabilities, enables us to manufacture and sellhigh strength alloy grade oil country tubular goods and line pipe for deepwells and other critical applications. We have also developed expandable casingproducts which are used in critical repair and extended reach drillingapplications to save time and costs for our customers. In addition, we haveproduced and sold slotted tubes for expandable sand screens and new risersleeves to provide solutions for completion in unconsolidated sand formationsand subsea completions, respectively. We will continue to invest in newequipment technologies and develop new products for the markets we serve.

 

***Growing through strategic acquisitions****.* Our acquisitions of the companies comprisingour Star Energy Group have enabled us to broaden our customer base and expandthe selection of products we offer and the markets we serve at a costsignificantly less than that required to develop these operations on our own. Wewill continue to pursue strategic acquisitions that we believe to be beneficialto our business. We will continue to pursue corporate development activities inoilfield and specialty tubing related businesses through acquisitions andstrategic alliances, both domestically and internationally.

 

**INDUSTRY BACKGROUND**

 

***Oilfield Products.***The product group referred to as oil countrytubular goods, or OCTG, includes casing and tubing, which we manufacture, aswell as drill pipe. We do not currently manufacture drill pipe. Casing acts asa structural retainer wall in oil and natural gas wellbores to provide supportand prevent caving during drilling operations and is used to protect water-bearingformations during the drilling of a well. Casing is generally not removed afterit has been installed in a well. Tubing, which is used to transmit oil andnatural gas to the surface, may be replaced during the life of a producingwell.

 

Demand for oil country tubular goods dependson several factors, most notably the number of oil and natural gas wells beingdrilled, completed and re-worked, and the depth and drilling conditions ofthese wells. The level of these activities depends primarily on the demand fornatural gas and oil and the expectation of future prices of these commodities.A key indicator of domestic demand is the average number of drilling rigsoperating in the United States. According to the Baker Hughes rig count, themost commonly cited indicator of the level of domestic drilling activity, theaverage United States rig count was 1,383 working rigs in 2005, the highestannual average in the last 19 years, compared to 1,192 and 1,032 in 2004 and2003, respectively. This was despite the fact that rigs drilling offshore inthe United States in 2005 fell to an average 93 rigs compared to 97 rigs during2004 and 108 rigs during 2003, driven in part by a decrease in drilling effortsfollowing Hurricane Katrina in the Gulf Coast.

 

8

----

 

 

Further supporting this assertion, the numberof rigs drilling at depths of 8,000 feet and deeper, which is the general depthin which alloy-grade OCTG is employed, was 77% of the active rigs at the end of2005. At year-end 2005, 1,471 rigs were working, of which 84% were drilling fornatural gas.

 

Furtherimpacting demand for oilfield products in 2005 were rising natural gas andcrude oil prices. Average 2005 natural gas prices at the Henry Hub increasednearly 47% over the 2004 average to $8.58 per MM BTU. The average price of WestTexas Intermediate crude oil increased 40% in 2005 compared to 2004 to $56.60per barrel WTI. These factors led to continuing strong demand for our oilfieldproducts.

 

Theoil country tubular goods market is also affected by the level of inventoriesmaintained by manufacturers, distributors, threading companies, and end users. Duringdownturns in drilling activity, customers typically utilize the inventory ofthese products rather than purchase new products, causing demand for newproduction to further decrease. Conversely, in periods of increased drillingactivity, increases in oil country tubular goods inventory levels bydistributors and end users typically occur, which can accelerate demand for newproduction. However, throughout 2005 although drilling activity had increasedover the prior year, distributor inventory remained at lower than anticipatedlevels. At the end of 2005, industry observers estimated industry-wide OCTGinventories to be at levels of approximately 5.5 months supply.

 

Theamount of imported oilfield products also affects the oil country tubular goodsmarket. According to statistics from the U.S. Department of Commerce, importedoil country tubular goods accounted for approximately 47% of the apparentdomestic oil country tubular goods consumption in 2005 and 40% in 2004.

 

Protectivetariffs on oil country tubular goods from Argentina, Japan, Korea, Italy andMexico remain in effect from successful 1995 trade suits. The protective tariffsare subject to sunset review in mid-2006. The quantity of imported electricresistance welded (“ERW”) line pipe in sizes up to 16-inches in diameteraccounted for over 50% of total consumption in 2005 and 2004.

 

Manufacturersproduce oil country tubular goods in numerous sizes, weights, grades, andthread profiles. The grade of pipe used in a particular application depends ontechnical requirements for strength, corrosion resistance, and otherperformance characteristics. Oil country tubular goods are generally classifiedby “carbon” and “alloy” grades. Carbon grades of oil country tubular goods haveyield strengths of 75,000 pounds per square inch or less and are generally usedin oil and natural gas wells drilled to depths less than 8,000 feet. Alloy gradesof oil country tubular goods, often referred to as high quality oil countrytubular goods, have yield strengths of 75,000 pounds per square inch or moreand are generally used in oil and natural gas wells drilled to depths in excessof 8,000 feet or for high temperature wells, highly corrosive wells, or othercritical applications.

 

Carbonand alloy grades of oil country tubular goods are available from both electricresistance welded and seamless tube producers. Electric resistance welded tubesare produced by processing flat rolled steel into strips which are cold-formed,welded, full-body normalized or seam-annealed, and end-finished with threadsand couplings. Seamless products are produced by individually heating andpiercing solid steel billets into tubes and then end-finishing those tubes intooil country tubular goods in a manner similar to electric resistance weldedpipe.

 

9

----

 

Basedon published industry statistics, electric resistance welded products haveaccounted for approximately half of total consumption of oil country tubulargoods. Electric resistance welded, full-body normalized casing and tubing andseamless casing and tubing compete for critical applications such as deepnatural gas wells and offshore wells. Customers purchasing products for theseapplications require high-performance oil country tubular goods that cansustain enormous pressure as measured by burst, collapse, and yield strength.Recently significant demand for alloy grade OCTG has been associated withproduction of natural gas in unconventional formations, which utilize hydraulicfracturing techniques to complete the wells. Operators drilling shallow wellsgenerally purchase oil country tubular goods based primarily on price andavailability, as these wells require less stringent performancecharacteristics.

 

Linepipe products are used for surface production flow lines and gathering andtransmission of oil, natural gas, and fluids. Line pipe is primarily producedin welded form. Line pipe markets are dependent not only on the factors whichinfluence the oil country tubular goods market, but also on pipelineconstruction activity, line pipe replacement requirements, new residentialconstruction, and utility purchasing programs.

 

Couplingsare used to connect individual sections of oilfield casing and tubing. The enduser demand for couplings is dependent on the same factors that impact the oilcountry tubular goods market.

 

***Specialty Tubing Products.***The specialty tubing business includes themanufacture, marketing, and sale of a broad variety of steel tubing products,including high quality and custom-made products. Applications for specialtytubular products include precision mechanical tubular products for automotive,fluid power, construction, drilling, agricultural and other industrial marketsfor various mechanical tubing applications, as well as finned tubular productsfor heat recovery applications.

 

Thedemand for precision mechanical tubulars and other specialty tubing used forautomotive, fluid power, and other mechanical applications is cyclical anddependent on the general economy, the automotive and construction industries,product inventory levels, and other factors affecting general domesticindustrial activity. After an increase in demand within the traditional marketsfor precision mechanical tubulars in 2004, the demand in 2005 remained steadyas a result of the overall relatively strong economic conditions experienced inthe United States during the year. In 2005, Lone Star Steel experienced areduction in the level of revenues from its specialty tubing Drawn Over Mandrel(“DOM”) products due in part to the allocation of some of this tubular capacityto higher margin oilfield products.

 

Demandfor heat recovery tubular products, or finned tubes, depends on several factorsincluding industrial processing plant and petrochemical plant construction, thecost of alternative fuels for power generation and combined-cycle electricalpower plant construction. Demand for combined-cycle electrical generated powerslowed considerably in 2002, and remained slow since, as construction of newpower plants has significantly decreased due in part to constraints on capitalto fund new plant construction and the movement of final assembly of powerplant components to lower cost foreign labor markets.

 

***Flat Rolled Steel and Other Products******.***The market for flat rolled steel is affectedby a number of factors, including price, capacity utilization, and materialcosts. Flat rolled steel is sold in highly competitive markets and price,quality, and availability are the main determinants of customer purchasingdecisions. Other products consist of tubular goods that serve a variety ofuses, such as structural piling applications in the construction industry.

 

**OUR OILFIELD PRODUCTS**

 

Wemanufacture and market high quality oil country tubular goods. Our oil countrytubular goods, also referred to as OCTG, include casing and production tubingbut not drill pipe. We also manufacture and market line pipe and couplings andwe provide a complete line of oilfield tubular finishing services includingthreading and inspection.

 

**Oil Country Tubular Goods –**We manufacture high quality alloy and carbonwelded oil country tubular goods, including casing, which acts as a structuralretainer wall in oil and natural gas wellbores, and production tubing, whichtransmits hydrocarbons to the surface. We also market and sell under exclusivearrangements oil country tubular goods produced by other manufacturers that werefer to as alliance mills. We offer casing and tubing products with the widestvariety of diameters, grades and wall thicknesses in the United States. Thisvariety provides us with a distinct competitive advantage as a single sourcesupplier of a complete range of oilfield casing and production tubing. As aresult of our broad product range and unique heat-treating capabilities, we areable to service nearly all typical drilling applications for oil and naturalgas wells.

 

Casing,which historically represents 75% to 80% of our oil country tubular goodsrevenues, is the structural retainer wall in oil and natural gas wellbores. Italso serves to prevent pollution of nearby water reservoirs and contaminationof a well’s production. Casing is generally not removed after it has beeninstalled. Production tubing is installed within the casing to

 

10

----

 

conveyoil and natural gas to the surface. We offer the widest range of grades andoutside diameters in casing (3 1/2” to 20”) and tubing (1.9” to 3 1/2”)produced in the United States, including products that have been successfullyused in wells with depths of over 30,000 feet.

 

Ourhigh quality product line includes tubulars manufactured with the electricresistance welded, full-body normalized process and other thermal techniquesthat we pioneered. Because this process gives our tubes better performancecharacteristics than typical seam-annealed casing and tubing, we are able toserve both primary markets for oil country tubular goods: deep critical wellsand shallow wells. Our high quality products successfully compete both withseamless oil country tubular goods for critical applications and withconventional seam-annealed tubular products manufactured for shallow wells. Wealso offer seamless and seam-annealed products through our alliance marketingarrangements with other producers.

 

Criticalapplications, such as deep natural gas wells and offshore wells, require high-performancecasing and tubing that can withstand enormous pressure as measured by burststrength, collapse strength, and yield strength. Both major and independent oilcompanies that conduct drilling programs of this nature emphasize quality andcompliance with specific standards. In our electric resistance welded, full-bodynormalized manufacturing process, which meets and exceeds API standards, weheat-treat the entire tube and not just the weld area. This process strengthensthe entire tube and makes our high quality casing, tubing, and line pipe interchangeablewith seamless tubulars for nearly all critical applications. Revenues from ourhigh-strength alloy grade products increased slightly to 71% of total OCTGrevenues in 2005 from 64% in 2004.

 

Operatorsdrilling shallow wells generally purchase oil country tubular goods basedprimarily on price and availability, as wells of this nature require lessstringent performance characteristics. We compete in this market, which isserved primarily by producers of seam-annealed oil country tubular goods, withour WildcatTM brand of oil country tubular goods and other brands producedthrough our exclusive alliance mills.

 

**Line Pipe –**We offer the widest size and chemistry range of line pipe used to gatherand transmit oil and natural gas in the United States with outside diametersfrom 2 3/8” to 60”. Historically, approximately 15% to 20% of our oilfieldproduct revenues are from line pipe sales.

 

**Couplings –**Through our Wheeling subsidiary, part of our Star Energy Group, weproduce a full range of coupling products used to connect individual sectionsof oilfield casing and production tubing from 2 3/8” to 20”, including highquality grades and high quality threads. We manufacture couplings in bothstandard oilfield API grades as well as high quality connections. The demandfor coupling products is correlative to demand for OCTG products. Prior to itsacquisition by Lone Star, Wheeling had a multi-year partnering arrangement withSteel to provide 100% of Steel’s coupling requirements. In addition to Steel,which comprised approximately 59%, 41%, and 43% of Wheeling’s 2005, 2004, and2003 sales respectively, Wheeling maintains contract distribution arrangementswith other large domestic OCTG producers and sells coupling products to certaindistributors of OCTG products.

 

**Finishing –**By acquiring DTP and DTI during 2003, we took another major step towardproviding complete tubular solutions for our customers. DTP and DTI provide thefull-size range of OCTG finishing, including high quality threading,heat-treating, upsetting, inspection, and storage services. They join Bellvilleand Wheeling as part of our Star Energy Group.

 

***Sales and Distribution.***Our domestic oil country tubular goods salesdistribution network includes 14 non-exclusive stocking distributors thatmaintain and deliver product inventory to major and independent oil and gascompanies that explore for oil and natural gas. We also sell line pipe throughdistributors and to end-users. Internationally, oil country tubular goods aresold through distributors and trading companies as well as directly toend-users. Less than 1% each of the shipments of oil country tubular goods andline pipe in 2005 were to destinations outside the United States. Our threelargest customers, all distributors of our oilfield products in 2005, accountedfor approximately 14%, 13%, and 13%, respectively, of the total oil countrytubular good tons we shipped. About 75% of the oil and natural gas wellsdrilled in the United States in 2005 were located within an approximate 750 mileradius of our mills in Texas. The majority of our oilfield products were soldfor use in Texas, Oklahoma, Louisiana, New Mexico, and Kansas, as well as theGulf of Mexico, which is less than 250 miles from our mills.

 

***Alliance Mills.***In addition to production from our mills, wehave marketing agreements to sell other steel oilfield tubular productsmanufactured by several companies. Through commercial alliances with severalmills, we have expanded our oilfield product offering. These arrangements enableus to outsource production of specific products, allowing us to offer a widervariety of casing, tubing, and line pipe without a permanent capitalinvestment. These alliances allow us to concentrate our capital expendituresand manufacturing expertise on our high quality products, while offering ourcustomers a complete size range of casing, tubing, and line pipe. Thesetransactions are performed on a commission basis and through

 

11

----

 

purchaseand resale of the products. Our alliance arrangements accounted forapproximately 17%, 18%, and 17% of our revenues from oilfield products during2005, 2004, and 2003, respectively.

 

***Competition.***Oil country tubular goods and line pipe aresold in highly competitive markets. Once users of oil country tubular goodsdetermine which performance characteristics are relevant, they base theirpurchasing decisions on four factors: quality, availability, service, andprice. We believe that we are competitive in all of these areas. Wesuccessfully compete with both seamless oil country tubular goods and seam-annealedelectric resistance welded products, as described above under “Business -Industry Background - Oilfield Products.” Our electric resistance welded, full-body normalized casing and tubingproducts compete with seamless oil country tubular goods, and we offer productswith the widest variety of diameters, grades, and wall thicknesses in theUnited States. Several domestic manufacturers produce limited lines of oilcountry tubular goods, and a number of foreign manufacturers produce oilcountry tubular goods for export to the United States.

 

The level of imports of oil country tubulargoods has been reduced by the existence of anti-dumping duty orders. Since1995, the level of imports of oil country tubular goods from Argentina, Italy,Japan, Korea, and Mexico has been greatly reduced by the existence ofanti-dumping duty orders covering imports from these countries. The orders mayalso have had a beneficial impact on prices for oil country tubular goods inthe domestic market. Affected parties can request administrative reviews ofimposed duties and tariffs. The protective tariffs are subject to sunset reviewin mid-2006.

 

Despite the existence of various anti-dumpingduty orders, imports were 47% of apparent domestic consumption in 2005 and 40%in 2004.

 

**OUR SPECIALTY TUBING PRODUCTS**

 

Ourspecialty tubing business includes the manufacture, marketing, and sale of avariety of tubular products. Our specialty tubular products are generally highvalue-added high quality or custom products often involved in exactingapplications. Our specialty tubing products include finned tubulars used inindustrial processing, petrochemical plants, and power technology applications.

 

**Precision Mechanical Tubulars –**We have one of the largest productioncapacities in the world for precision mechanical tubular products using the DOMmanufacturing process. The use of the DOM manufacturing process enables us toachieve higher critical tolerances and dimensional control than otherprocesses. Our precision mechanical tubular product line includes a wide arrayof high-quality, custom-made steel tubular products with precise dimensionalcontrol and special metallurgical properties. Our precision mechanical tubularproducts have the widest size range in the world, from 1/2” to 15” in outsidediameter, and are made from a variety of combinations of chemical compositions,thermal treatments, mechanical properties, and surface finishes. Product usesinclude the manufacture of hydraulic cylinders for construction and farmequipment; automotive applications, such as stabilizers and intrusion tubes;and other uses, including machine parts, bearing races, down-hole pump barrels,heavy-lift crane boom chords, drill rods, and liner hangers. As a result of thewide range of industrial applications for precision mechanical tubularproducts, sales traditionally follow general domestic economic conditions.

 

TheDOM process uses a drawbench to pull tubing through a die and over a mandrel toshape and smooth surfaces and impart precise dimensional tolerances to tubes.Our production facilities include seven drawbenches. Our 1,000,000 pounddrawbench, the largest in the Western Hemisphere, combined with our800,000 pound drawbench enable us to access broader markets through themanufacture of larger diameter, thicker wall products. Order quantities for ourprecision mechanical tubular products are typically less than20,000 pounds, and the products are made to exact customer specifications.

 

**Heat Recovery Tubular Products –**We manufacture custom-engineered specialtyfinned tubular products used in a variety of heat recovery applications. Wehave the major portion of domestic manufacturing capacity of finned tubes thatare used in heat recovery steam generators. Finned tubes are steel tubes withvarious types of fins or studs welded to the outside to increase the amount ofsurface area for maximized recovery of heat. Our heat recovery products areused in fuel economizers, petrochemical plants, refineries, and combined-cycleelectrical power generation.

 

Inconnection with our production of finned tubes, we design and manufacture otherproducts relating to large-scale applied heat recovery technology, such asboiler tubing and economizers. Economizers are bundles of finned tubes arrangedto maximize the amount of heat captured from boiler exhaust gases. Economizersare normally used on large boilers for office buildings, hospitals,universities, prisons, breweries, and food processing plants. We alsomanufacture and sell X-ID tubing, which has specific patterns on the interiorsurface of the tube for enhanced heat transfer.

 

12

----

 

**Other Specialty Tubing Products –**We also produce hot finished specialty tubing.We have developed new thick wall products using enhanced hot reductiontechnology for applications such as heavy axles for trailers and light axlesfor trucks, including sport utility vehicles that were typically made out ofseamless tubes. This product is also used for other industrial applications.

 

***Sales and Distribution.***Domestically, we market and sell our precisionmechanical tubulars through major non-exclusive steel service centers anddirectly to end-users. Our precision mechanical tubulars have detailed designspecifications and are manufactured to extremely precise processingrequirements. Our closely controlled manufacturing process results in anefficient low cost sourcing solution for large purchasers. Internationally, themajority of our precision mechanical tubulars are currently sold to end-users. Exportsaccounted for approximately 8%, 7%, and 3% in 2005, 2004, and 2003,respectively, of the shipment volume of our precision mechanical tubulars. Wemarket and sell our finned tubes and other heat recovery products throughoutside sales managers providing direct sales to most original equipmentmanufacturer (“OEM”) accounts and through approximately 50 independent salesrepresentative companies which sell to end-users and contractors. We havereorganized our heat recovery tubular products around new marketing andcommercial lines directed at more traditional heat recovery markets includingfuel economizers and traditional boiler applications. Exports of finnedtubulars and other heat recovery tubes accounted for approximately 7%, 16%, and21% of the revenues from those products in 2005, 2004, and 2003, respectively.

 

***Competition.***The market for specialty tubing is competitiveand is served by several manufacturers. We have one of the largest capacitiesin the world to manufacture precision mechanical tubulars using the DOMmanufacturing process.

 

Sincethese products are made to end-user specifications and often require just-in-timedelivery, only small quantities are imported into the United States. Incontrast to the oil country tubular goods market, seamless and electricresistance welded specialty tubing products differ in their applications.Electric resistance welded tubing, such as precision mechanical tubulars, is preferredfor many mechanical tubing applications because its consistent wall thicknessrequires less machining in the finishing process. In contrast, seamless tubesare often specified in heavy gauge applications such as boiler and pressuretubing.

 

Basedon generally available market data, we estimate that we have a major portion ofthe domestic manufacturing capacity for finned tubes used for heat recoverysteam generation. We have one significant domestic competitor and a few smallerdomestic competitors, as well as foreign competitors.

 

**OUR FLAT ROLLED STEEL AND OTHER PRODUCTS**

 

***Products and Services.***We also manufacture and market flat rolledsteel and other miscellaneous products that are secondary to our manufacture ofoilfield and specialty tubing products. We have a rolling mill that has thecapacity to produce 1.25 million tons of flat rolled steel per year. Participationin flat rolled steel markets allows us to maintain flexibility in procurementof lower cost steel. Flat rolled steel, produced primarily for the manufactureof oilfield and specialty tubing products, is also sold to our exclusivealliance mills for conversion into tubular products and to fabricators of largediameter transmission pipe, storage tanks, rail cars, and a variety of other constructionand industrial products.

 

Wealso market other products such as tubulars for use in structural and pilingapplications in the construction industry, and we provide transportation,storage, and other services.

 

***Sales and Distribution.***We manufacture and sell flat rolled steeldirectly to end-users and through service centers, primarily in theSouthwestern region of the United States. Our two largest customers of our flatrolled steel accounted for approximately 72% of our flat rolled steel sales in2005, as well as substantially all other sales of miscellaneous tubularproducts other than oilfield and specialty tubing products. One of thesecustomers, which is an alliance mill, has steel processing facilities locatedadjacent to our facilities in Lone Star, Texas, and those facilities purchasemost of their flat rolled steel from us. Sales to these two customersrepresented approximately 5% of our total revenues in 2005 and 7% in 2004 and2003.

 

We also provide flat rolled steel slitting andprocessing services to steel mills where we receive slitting and processingrevenues but do not purchase and resell steel.

 

***Competition.***Our flat rolled steel is sold in highlycompetitive markets generally concentrated in the Southwestern region of theUnited States. Sales and earnings are affected by the cost of raw materials,use of flat rolled steel by us in the manufacture of our tubular products,demand by outside customers, and general economic conditions. Our steel coilslitting services compete against service centers located in the Midwest.

 

13

----

 

**FINANCIAL INFORMATION ABOUT SEGMENTS**

 

Forfinancial information for each segment regarding revenues, profits or losses(as applicable) and total assets, see “Business Segments – Note B” of the Notesto Consolidated Financial Statements.

 

**CUSTOMERS**

 

Wesell our oilfield products through our exclusive distributors to numerousend-users, including BP, ChevronTexaco, El Paso Exploration, AnadarkoPetroleum, Devon Energy, Burlington Resources, Apache, Shell Oil, and XTOEnergy. We sell our finned and other heat recovery tubular products to over 50end-users, including Foster Wheeler, Chicago Tube and Iron, Peerless, AlstomPower, Cerrey, Nooter Eriksen, and Vogt Power International. We sell ourprecision mechanical tubulars to such distributors and end users as ChicagoTube and Iron, Earle M. Jorgensen Company, Marmon/Keystone, Hyva,DaimlerChrysler, Ford Motor Company, and Dana.

 

**RESEARCH, DEVELOPMENT, INFORMATION TECHNOLOGY AND PATENTS**

 

Weare committed to technologically innovative product development. With respectto oilfield products, we collaborate with customers and industry groups todevelop new grades of oil country tubular goods as well as new products, suchas expandable casing. Our expandable casing product was developed for a jointventure between Shell Oil Company and Halliburton Company and was firstsuccessfully installed in late 1999 in the Gulf of Mexico. As of December 2005,there have been more than 400 successful installations totaling more than 90miles of expandable tubulars for 80 end-users in 20 countries. We have alsodeveloped slotted tubes for expandable sand screens and riser sleeves toprovide new product solutions for our customers. Our technical knowledge andhigh-performance casing products are also being applied in an innovative methodfor drilling wells using casing instead of drill pipe. We also have used ourexpertise to develop high-strength, thick wall line pipe for offshoreapplications. In addition, we developed ultrasonic testing methods to assurethe quality of our tubing. In the specialty tubing area, our productdevelopments include the Aeroseg finned tube, a thermal mechanically processedDOM product called QDOM for applications requiring extreme mechanicalproperties, and thick-wall products using hot reduction technology forapplications such as heavy axles that are normally made out of seamless tubes. Wehold several United States patents covering some of our manufacturing processesand products.

 

Wehave made significant investments in information technologies that provide theplatform for internet-based commercial marketing and resource constrainedproduction planning. We believe our information technologies capabilities willallow us to more effectively run our facilities, give our customers excellentservice, and facilitate web-based commercial initiatives.

 

**MANUFACTURING CAPABILITIES**

 

Wemanufacture our oilfield products, precision mechanical tubulars, flat rolledsteel and other products at our facilities located on an approximately 2,000-acresite we own in Lone Star, Texas, which contains over 2,000,000 square feet ofmanufacturing space, and approximately 91,000 square feet of oilfield productsmanufacturing facilities in Bellville, Texas. We manufacture our finned tubularproducts in approximately 340,000 square feet of manufacturing facilities onapproximately 62.2 acres that we own or lease in the Tulsa, Oklahomametropolitan area; Monterrey, Mexico; and Chonburi, Thailand. Our couplingproducts are manufactured at three owned facilities totaling 231,000 squarefeet of manufacturing space and located in Pine Bluff, Arkansas; HughesSprings, Texas; and Houston, Texas. Our finishing and storage services providedby DTP and DTI are performed at two owned facilities totaling 281,500 squarefeet across 230 acres located in Houston, Texas.

 

Theannual rated capacity of our facilities in Lone Star, Texas approximates1,250,000 flat rolled tons and 1,000,000 welded pipe tons. We have accessthrough marketing arrangements and alliances with mills for additional oilfieldtubular capacity of approximately 500,000 tons per year. Our electric arcfurnaces (“EAF”) have an estimated capacity of 360,000 ingot tons. In 2005, theprecision mechanical specialty tubing facilities operated at 64% of capacity. Therolling mills and pipe mills generally operated at 38% and 58% of capacity,respectively, while the EAF generally operated at 59% of capacity in 2005.

 

Wheeling operates PMC high volume finishersand CNC lathes at facilities in Pine Bluff, Arkansas, Hughes Springs, Texas,and Houston, Texas. Wheeling also maintains finished product at its productionfacilities as well as warehouses at Steel, and a facility servicing U.S. Steeloperated by Wheeling in Birmingham, Alabama. The Houston facility wasestablished to handle high quality threads and material that requires thirdparty inspections. Wheeling offers a wide range of eight round and buttresscouplings for 2 3/8” tubing through 20” casing.

 

14

----

 

DTPis a licensed API processor for upsetting, threading, and heat treating of OCTGproducts to API specifications. DTP has two forging machines that are capableof upsetting tubing, two quench and tempering operations – one at the mainplant with induction austenitizing coils and alternating tempering furnaces andone at the satellite operation with one austenitizing furnace and one temperingfurnace, that can heat treat tubing and coupling stock through 3.668” outsidediameter (“OD”), and one full-body normalizing line that can normalize tubingup to 4 1/2” OD. DTP has two hydrostatic tubing testers, two high-speed PMCtubing threaders, and one threading repair line. A Non-Destructive Testing (“NDT”)operation at the facility is operated by a third party contractor. The facilitycapacity is calculated to be 130,000 tons per year with an average mix ofproducts. DTP operates on a 150-acre tract in Houston, Texas with 150,000square feet of building space and leases an additional building with 14,500square feet which houses its second heat treat line.

 

DTIis an API licensed threader for OCTG casing for sizes ranging from 4 1/2” to 20”OD. We have two Four-Function Electro Magnetic Inspection lines that inspectpipe ranging from 2 3/8” through 13 3/8” OD and two ultrasonic lines for fullbody ultrasonic inspection up to 20” OD. We have three double-ended threadlines capable of threading API and specialty threads from 4 1/2” through 20” ODpipe. One of these double ended lines is furnished with two state of the artCNC dual axis machines installed during the second half of 2004. Our annualrated capacity for casing threading is 225,000 tons and inspection is 450,000tons. This facility is located on an 80-acre tract in Houston, Texas with117,000 square feet of building usage.

 

BothDTP and DTI facilities have truck and rail access, and are located in closeproximity to the Houston Ship Channel.

 

Wehave a major portion of the North American manufacturing capacity forproduction of finned tubes for heat recovery applications.

 

**RAW MATERIALS AND INVENTORY**

 

Ingeneral, we attempt to procure raw materials and manage our finished goodsinventory in a manner that will provide:

 

•              significantflexibility in responding to the levels of demand for our various products;

 

•              ashort lead time in filling our customers’ orders;

 

•              abroad product range offering; and

 

•              theability to offer our products at competitive prices.

 

We generally produce oil country tubular goodsand line pipe to fill specific orders and, accordingly, we maintain themajority of our inventory in the form of steel slabs and coils, while work-in-processor finished goods are generally earmarked for specific orders. Some work-in-processand finished goods inventories are maintained in order to provide flexibilityin responding to customer delivery demands.

 

Steelprices remained volatile in 2005 largely due to a continued tight balancebetween supply and demand for steel on a global basis. Although domesticallythere were no constraints on obtaining steel, most international marketsexperienced an increase in ore prices of about 76%. We continue to believe thatsteel costs could remain volatile in 2006 and there are currently no strongindicators that steel costs will moderate significantly in the coming year.

 

Wecan use steel slabs, scrap steel, and steel coils in the manufacture of ourtubular products. We purchased steel slabs to meet approximately 76% of oursteel needs in 2005, up from 63% in 2004. The increase in purchased slabs wasdriven by increased demand combined with general lower slab prices relative tocoil and scrap prices. Generally, we commit to purchase slabs 60 to 90 daysprior to production. We anticipate again using steel slabs for most of ourproduction needs in 2006. Our principal raw material for our internallyproduced steel slabs is scrap steel, which is internally generated from ouroperations and available in the spot market. The volatile price of steel isinfluenced by a number of competitive market conditions beyond our control, andis not directly related to the demand for our products.

 

Rawmaterials for our specialty tubing products are readily available from multiplesources. Steel coil is the primary raw material used in the manufacture of ourfinned tubular products and in the manufacture of our precision mechanicaltubulars. We usually produce our specialty tubing products to meet specificorders and, accordingly, inventory is managed to minimize the amount offinished goods on hand. Work-in-process inventories are maintained in order toprovide flexibility in responding to customer needs.

 

We manufacture flat rolled steel primarily foruse in producing oilfield and precision mechanical tubulars, but also for saleto third parties. We manufacture flat rolled steel using both purchased steelslabs and internally produced slabs on our rolling mill.

 

15

----

 

**EMPLOYEES**

 

AtDecember 31, 2005, Lone Star employed approximately 2,699 employees. Of thisnumber, approximately 1,073 employees, all at Steel, are a part of collectivebargaining agreements with three unions, the International Bricklayers ofAmerica (“Bricklayers Union”); Security, Police & Fire Professionals ofAmerica (“Security Union”); and the United Steel, Paper and Forrestry, Rubber,Manufacturing and Energy, Allied Industrial Services Workers InternationalUnion (“Steel Workers Union”).

 

The collective bargaining agreement betweenSteel and the Bricklayers Union expired May 31, 2005 and covered four brickmasons. The brick masons and Steel will meet to discuss the terms of a renewedagreement in February 2006. The agreement between Steel and the Security Unionhas an expiration date of September 30, 2006, and covers 13 securityprofessionals. The agreement between Steel and the Steel Workers Union has anexpiration date of July 31, 2008, and covers approximately 973 production andmaintenance employees. Steel considers its relationship with these threebargaining units to be good.

 

Theagreement between STSI, a wholly-owned subsidiary of Steel, and the SteelWorkers Union expires July 31, 2008, and covers approximately 83 warehouse andmaintenance employees. Steel considers its relationship with this bargainingunit to be good.

 

Weendeavor to provide a safe and healthful work environment for our employees,contractors, vendors, and visitors to our facilities. We frequently evaluateand update our programs to ensure compliance. We encourage all employees to beinvolved in our safety efforts. We utilize a variety of methods to increase theskills and knowledge of our employees to improve safety performance.

 

**FOREIGN OPERATIONS**

 

Ourexport sales to destinations outside the United States were approximately $33.6million in 2005, $30.0 million in 2004, and $13.3 million in 2003. We own anidle manufacturing facility in Quebec, Canada and lease manufacturingfacilities in Monterrey, Mexico and Chonburi, Thailand. Long-lived assetsmaintained in Quebec, Canada were $1.2 million, $3.0 million, and $3.1 millionat December 31, 2005, 2004, and 2003, respectively. Long-lived assetsmaintained in Monterey, Mexico were $1.3 million, $1.5 million, and $1.6million at December 31, 2005, 2004, and 2003, respectively. We commenced ourThailand operations in 2005, and our long-lived assets maintained there were$1.5 million at year-end. Our export sales of $33.6 million to destinationsoutside the United States included $5.6 million from these foreign facilitiesin 2005.

 

# **ENVIRONMENTAL**

# ** **

***Oilfield Products***. Steel’s operations are subject to extensiveenvironmental regulations with respect to air emissions, wastewater and stormwater discharges, and waste management. Our environmental protection andimprovement expenditures averaged approximately $1.2 million per year over thepast three years, including expenditures related to energy efficiency efforts,asbestos abatement, wastewater treatment system upgrades, waste disposal siteclosures, and out-of-service facility remediation projects. The sulfuric acidrecovery system was successfully installed during 2005 and has resulted in costsavings for raw materials and waste disposal and reduced risks associated withoffsite shipments of the hazardous material.

 

Inconnection with the cleanup of two offsite commercial waste management sites,we, along with many other entities, have been designated a potentiallyresponsible party (“PRP”) by the U.S. Environmental Protection Agency under theComprehensive Environmental Response, Compensation and Liability Act (“CERCLA”).CERCLA subjects PRPs to potential liability for such cleanup costs. Costestimates have been obtained for each of the cleanup actions, and our share hasbeen determined. Based upon these estimates, we do not believe our liability,individually or in the aggregate, will be material to our financial positionand our results of operations.

 

Thesolid waste units that received wastes defined as hazardous waste under theResource Conservation and Recovery Act (“RCRA”) have been closed. The two RCRAunits requiring continued monitoring are undergoing post-closure care. LoneStar has submitted a letter to the Texas Commission on Environmental Quality (“TCEQ”)guaranteeing the remaining cost of post-closure care (estimated to beapproximately $0.4 million), which meets our financial assurance requirements. TheTCEQ is in the process of determining what, if any, corrective action isrequired to address the remaining non-RCRA solid waste management units.

 

16

----

 

Wepossess necessary authorizations for air emissions, wastewater and storm waterdischarges and waste management. We are presently in substantial compliancewith our permits and applicable air, water and waste management rules andregulations. We have an environmental management system (“EMS”) in place, whichconforms to the internationally recognized ISO 14001:1996 standard, to assistin maintaining compliance and improving performance. Our EMS will be upgradedprior to May 15, 2006, to transition to the ISO14001:2004 standard. Inaddition, third party compliance audits are conducted systematically of Steel’soperations in accordance with the Texas Audit Privilege Act. We do not expectfuture environmental expenditures necessary to comply with existing environmentalrules and regulations to have a material impact on our financial position oroperations.

 

***Star Energy Group.***The operations of DTP, DTI, Bellville, andWheeling are also subject to environmental regulations in the area of airemissions, wastewater and storm water discharges and waste management. Thecompanies possess or have applied for, necessary authorizations for airemissions, wastewater and storm water discharges, and waste management. Allfacilities are classified as either Small Quantity Generators or ConditionallyExempt Small Quantity Generators. Wastes are temporarily stored onsite, but aredisposed of or recycled offsite by a third party. There are no onsite wastedisposal units.

 

***Specialty Tubing.***Steel’s specialty tubing operations andFintube’s operations are also subject to environmental regulations in the areaof air emissions, wastewater and storm water discharges, and waste management,and possess necessary authorizations for such activities. Wastes at Fintube aretemporarily stored onsite, but are disposed of or recycled offsite by a thirdparty. Fintube does not use onsite waste disposal units.

 

**INTERNET WEBSITE POSTINGS**

 

Our internet website is www.lonestartech.com. Wemake available through our internet website our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K and amendments tothose reports filed or furnished pursuant to Section 13(a) or 15(d) of theSecurities Exchange Act of 1934 as soon as reasonably practicable after weelectronically file such material with, or furnish it to, the Securities andExchange Commission (“SEC”). The internet website of the SEC is www.sec.gov.

 

In addition, our code of business conduct andethics, Corporate Governance Guidelines, and Charters of the Audit, CorporateGovernance, and Human Resources Committees are available on our website and inprint to any shareholder who requests a printed copy.

 

**NEW YORK STOCK EXCHANGE CORPORATE GOVERNANCE CERTIFICATION**

 

Lone Star is a listed company with the NewYork Stock Exchange (“NYSE”). The chief executive officer of Lone Starcertified in May 2005 to the NYSE that he is not aware of any violation by LoneStar of NYSE corporate governance listing standards as of the date of thatcertification, which was made without any exception or qualification.

 
| **ITEM 1A.** | **RISK FACTORS** |
|--------------|------------------|

 

Risk factors are set forth under “Business” onpage 3 hereof.

 
| **ITEM 1B.** | **UNRESOLVED STAFF COMMENTS** |
|--------------|-------------------------------|

 

There are no unresolved comments from theSecurities and Exchange Commission.

 
| **ITEM 2.** | **PROPERTIES** |
|-------------|----------------|

 

We manufacture our oilfield products,precision mechanical tubulars, flat rolled steel and other products at ourfacilities located on an approximately 2,000-acre site we own in Lone Star,Texas which contains over 2,000,000 square feet of manufacturing space. Theoriginal facilities, constructed in the 1940’s and 1950’s, have been expandedand modernized, and include two EAFs equipped with oxy-fuel burners; tworolling mills, a “two-high” mill that rolls the EAF ingots into slabs and a “four-high”single stand reversing Steckel mill that produces flat rolled coils; coilslitting and handling equipment; two pipe welding mills; seven draw benches,including the largest specialty tubing drawbench in the Western Hemisphere;three heat-treating facilities; numerous types of ultrasonic andelectromagnetic testing and inspection equipment; finishing facilities at whichoil country tubular goods are threaded and couplings are applied; and varioussupport facilities including a shortline railroad and other transportation andstorage facilities.

 

We also have 91,000 square feet of oilfieldproducts manufacturing facilities in Bellville, Texas. We manufacture ourfinned tubular products in approximately 364,000 square feet ofmanufacturing facilities on approximately 62.2 acres that

 

17

----

 

we own or lease in the Tulsa, Oklahomametropolitan area; Monterrey, Mexico; and Chonburi, Thailand. Our couplingproducts are manufactured at three owned facilities totaling 267,940 squarefeet of manufacturing, warehouse and office space and located in Pine Bluff,Arkansas on 12.7 acres; Hughes Springs, Texas on 19.4 acres; and Houston, Texason 5.3 acres.

 

DTP operates in a total  of approximately 117,000 square feet situatedon approximately 80 acres of land that we own in Houston, Texas. DTI utilizes165,000 square feet located on approximately 150 acres of land that we own inHouston, Texas. Both facilities utilize the owned acreage for pipe storage andwarehousing.

 

We own 7,000 acres in Texas that was purchasedprimarily for iron ore, coal reserves, or water rights; and, mineral interestsin an additional 12,000 acres in Oklahoma and 60,000 acres in Texas. Nominerals have been recovered from these properties for many years because theiruse is no longer required in our operations. We own nominal oil and gasinterests in an additional 18,000 acres in Texas. Our headquarters are locatedin leased facilities in Dallas, Texas.

 

18

----

 
| **ITEM 3.** | **LEGAL PROCEEDINGS** |
|-------------|-----------------------|

 

In2001, Lone Star entered into an agreement to purchase the assets of North StarSteel Company’s Tubular Steel Division. Consummation of the acquisition wassubject to completion of financing arrangements. Due to lack of common stock financingwhich, along with certain debt financing, was required by the acquisitionagreement to close the acquisition, Lone Star notified Cargill, Incorporated,the parent company of North Star Steel Company, on December 14, 2001, that itwas not able to complete the acquisition. Later that day, Cargill, Incorporatednotified Lone Star that it was filing a lawsuit against Lone Star seekingunspecified damages and alleging that Lone Star had breached the agreement. OnMarch 13, 2003, the jury in Minnesota returned a verdict of $32 million indamages against Lone Star. On June 1, 2004, the Minnesota Court of Appealsaffirmed the judgment. The Minnesota Supreme Court decided on August 17, 2004that it would not review the Court of Appeals’ decision. Lone Star paid Cargill$34 million in October 2004. After the $34 million payment, approximately $1million of accrued interest remained in the reserve at December 31, 2004, whichrepresented pre-judgment interest that Lone Star contested in the Minnesotacourts. On June 28, 2005, Lone Star lost that appeal and paid that interestamount in the third quarter of 2005.

 

Duringthe last seven years, Steel has been named as one of a number of defendants in47 lawsuits alleging that certain individuals were exposed to asbestos on thedefendants’ premises. The plaintiffs are seeking unspecified damages. To dateseveral of these lawsuits have been settled for approximately $300,000 in theaggregate. Of the 47 lawsuits, 22 have been settled or are pending settlementand 15 have been dismissed or are pending dismissal. Steel did not manufactureor distribute any products containing asbestos. Some or all of these claims maynot be covered by the Company’s insurance. The Company has accrued for theestimated exposure to known claims, but does not know the extent to whichfuture claims may be filed. Therefore, the Company cannot estimate itsexposure, if any, to unasserted claims.

 

Beginningin 2003, Lone Star’s subsidiary Zinklahoma, Inc., inactive since 1989, has beennamed as one of a number of defendants in seven lawsuits alleging that theplaintiffs had contracted mesothelioma as the result of exposure to asbestos inproducts manufactured by the defendants and John Zink Company (“Zink”). Five ofthese lawsuits have been dismissed and one was settled for less than $0.1million. Lone Star acquired the stock of Zink in 1987 and, in 1989, sold theassets of the former Zink to Koch Industries, Inc. (“Koch”) and renamed thenow-inactive subsidiary “Zinklahoma, Inc.” Lone Star retained, and agreed to indemnify Koch against, certainpre-closing liabilities of Zink. It is Lone Star’s understanding that Zinknever manufactured asbestos and primarily used it only in certain purchasedgaskets that were encapsulated in copper and contained in burners and flaresmade by Zink prior to 1984, when Zink ceased using asbestos-containing productsentirely. Koch continues to operate the business as John Zink Company, LLC (“ZinkLLC”).

 

Inaddition, Zink LLC has been named in ten lawsuits in which the plaintiffs, fiveof whom have mesothelioma, allege exposure to asbestos in Zink’s products (fourof these have been dismissed) and three personal injury lawsuits resulting froma 2001 explosion and flash fire at a flare stack and crude unit atmosphericheater. Zink allegedly manufactured the flare and related components for theflare stack in the early 1970s. Koch is seeking indemnification from Lone Starwith respect to these six pending lawsuits. The costs of defending and settlingthe lawsuits alleging exposure to asbestos in Zink’s products have been borneby Zink’s insurance carrier. Lone Star believes that Koch’s indemnity claimwith respect to the 2001 explosion and flash fire is covered by its insurance,subject to a deductible, and has notified its insurance carrier of that claim. Duringthe second quarter of 2005, Zink LLC was dismissed from the three personalinjury lawsuits when it was determined that Zink did not manufacture the flareand components involved in the fire.

 
| **ITEM 4.** | **SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS** |
|-------------|-----------------------------------------------------|

 

None.

 

19

----

 

**PART II**

 
| **ITEM 5.** | **MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER  MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES** |
|-------------|-------------------------------------------------------------------------------------------------------------------------|

 

LoneStar’s Common Stock trades on the New York Stock Exchange under the symbol LSS.The following table summarizes the range of trading prices by quarter for thelast two years:

 

| ** **     | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First quarter  |       | $        | 46.85      |     | $          | 29.70 |   | $ | 19.98 |   | $ | 14.07 |   |
| Second quarter |       | $        | 48.34      |     | $          | 34.69 |   | $ | 28.25 |   | $ | 17.10 |   |
| Third quarter  |       | $        | 59.17      |     | $          | 45.21 |   | $ | 37.92 |   | $ | 26.13 |   |
| Fourth quarter |       | $        | 56.66      |     | $          | 43.18 |   | $ | 40.00 |   | $ | 24.86 |   |

 

As of February 8, 2006, we had 2,499 commonshareholders of record. We have not paid dividends on our common stock sincebecoming a public company and have no present plan to do so.

 

Information required under this item withrespect to securities authorized for issuance under equity compensation plansis contained in Lone Star’s proxy statement for the 2006 Annual Meeting ofShareholders, and is incorporated herein by reference. Lone Star’s voluntarydisclosure “Supplemental Information Regarding Executive Compensation” is notincorporated herein.

 

20

----

 
| **ITEM 6.** | **SELECTED FINANCIAL DATA** |
|-------------|-----------------------------|

 

***($ and shares in millions, except per share and employeedata)***

 
| ** **                                                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003****(1)(4)** | ** ** | **2002****(2)(4)** | ** ** | **2001** | ** ** |
|--------------------------------------------------------------------|------------|----------|------------|----------|------------|--------------------|------------|--------------------|------------|----------|------------|
| **Results of Operations Data:**                                    |       |     |       |     |       |               |       |               |       |     |       |
| Oilfield products revenues                                         |       | $        | 1,009.8    |     | $          | 695.4              |       | $                  | 364.8      |     | $          | 304.2 |   | $ | 401.9 |   |
| Specialty tubing products revenues                                 |       | 181.5    |       | 175.1    |       | 121.8              |       | 165.4              |       | 187.7    |       |
| Flat rolled and other tubular revenues                             |       | 93.8     |       | 96.3     |       | 47.5               |       | 54.1               |       | 60.6     |       |
| Total revenues                                                     |       | $        | 1,285.1    |     | $          | 966.8              |       | $                  | 534.1      |     | $          | 523.7 |   | $ | 650.2 |   |
|                                                               |       |     |       |     |       |               |       |               |       |     |       |
| Gross profit                                                       |       | $        | 272.3      |     | $          | 162.0              |       | $                  | 5.2        |     | $          | 7.4 |   | $ | 69.3 |   |
| Selling, general, and administrative expenses                      |       | (50.5    | )          | (44.6    | )          | (41.8              | )          | (68.2              | )          | (35.7    | )          |
| Goodwill impairment charge                                         |       | —   |       | —   |       | (18.7              | )          | —             |       | —   |       |
| Operating income  (loss)                                           |       | $        | 221.8      |     | $          | 117.4              |       | $                  | (55.3      | )        | $          | (60.8 | ) | $ | 33.6 |   |
| Net income  (loss)                                                 |       | $        | 223.6      |     | $          | 101.0              |       | $                  | (68.2      | )        | $          | (69.2 | ) | $ | 16.4 |   |
| Net income (loss) per common share - basic                         |       | $        | 7.44       |     | $          | 3.51               |       | $                  | (2.40      | )        | $          | (2.52 | ) | $ | 0.67 |   |
| Net income (loss) per common share - diluted                       |       | $        | 7.34       |     | $          | 3.46               |       | $                  | (2.40      | )        | $          | (2.52 | ) | $ | 0.66 |   |
| Common shares used for diluted EPS                                 |       | 30.5     |       | $        | 29.2       |               | 28.4       |               | 27.5       |     | 25.0       |   |
|                                                               |       |     |       |     |       |               |       |               |       |     |       |
| **Balance Sheet Data:**                                            |       |     |       |     |       |               |       |               |       |     |       |
| Working capital                                                    |       | $        | 615.6      |     | $          | 288.1              |       | $                  | 184.2      |     | $          | 281.9 |   | $ | 259.0 |   |
| Total assets                                                       |       | $        | 979.3      |     | $          | 646.7              |       | $                  | 574.7      |     | $          | 612.1 |   | $ | 580.3 |   |
| Long-term debt                                                     |       | $        | 150.0      |     | $          | 150.0              |       | $                  | 150.0      |     | $          | 150.0 |   | $ | 150.0 |   |
| Total liabilities                                                  |       | $        | 339.1      |     | $          | 292.2              |       | $                  | 328.8      |     | $          | 299.5 |   | $ | 265.0 |   |
| Shareholders’ equity                                          |       | $        | 640.2      |     | $          | 354.5              |       | $                  | 245.9      |     | $          | 312.6 |   | $ | 315.3 |   |
|                                                               |       |     |       |     |       |               |       |               |       |     |       |
| Weighted average shares outstanding                                |       | 30.6     |       | $        | 29.2       |               | 28.7       |               | 28.5       |     | 25.2       |   |
|                                                               |       |     |       |     |       |               |       |               |       |     |       |
| **Other Financial and Operating Data:**                            |       |     |       |     |       |               |       |               |       |     |       |
| Cash flows from operating activities                               |       | $        | 148.2      |     | $          | 29.5               |       | $                  | (8.4       | )        | $          | (12.4 | ) | $ | 31.3 |   |
| Cash flows from investing activities                               |       | $        | (112.9     | )        | $          | (39.2              | )          | $                  | (80.2      | )        | $          | (54.0 | ) | $ | (14.7 | ) |
| Cash flows from financing activities                               |       | $        | 36.6       |     | $          | 6.4                |       | $                  | 0.5        |     | $          | 81.5 |   | $ | 63.2 |   |
| Earnings before  interest, taxes, depreciation and amortization(3) |       | $        | 258.4      |     | $          | 147.2              |       | $                  | (27.7      | )        | $          | (36.9 | ) | $ | 51.1 |   |
| Capital expenditures                                               |       | $        | 21.0       |     | $          | 13.0               |       | $                  | 14.4       |     | $          | 15.9 |   | $ | 25.2 |   |
| Active employees at year-end                                       |       | 2,699    |       | 2,422    |       | 2,270              |       | 1,900              |       | $        | 1,892      |   |

 

See footnotes at page 22 of this Form 10-K.

 

21

----

 

**Reconciliation of EBITDA (as defined)****(3) to Cash Flows fromOperations:**

 
| ** **                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003****(1)(4)** | ** ** | **2002****(2)(4)** | ** ** | **2001** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|--------------------|------------|--------------------|------------|----------|------------|
| Cash flows from operating activities                |       | $        | 148.2      |     | $          | 29.5               |       | $                  | (8.4       | )        | $          | (12.4 | ) | $ | 31.3 |   |
| Non–cash charge  for stock compensation        |       | (3.5     | )          | (1.6     | )          | (1.1               | )          | 0.1                |       | 0.2      |       |
| Net loss (gain)  on asset disposals and impairments |       | 0.1      |       | (0.1     | )          | (0.4               | )          | 0.1                |       | —   |       |
| Goodwill  impairment                                |       | —   |       | —   |       | (18.7              | )          | —             |       | —   |       |
| Changes in  working capital                         |       | 120.6    |       | 95.2     |       | (43.7              | )          | (8.6               | )          | 5.5      |       |
| Other balance  sheet changes                        |       | (13.9    | )          | 5.8      |       | 29.5               |       | (26.6              | )          | 3.0      |       |
| Interest  expense, net                              |       | 10.3     |       | 15.0     |       | 15.0               |       | 11.2               |       | 10.3     |       |
| Income tax  expense (benefit)                       |       | (3.4     | )          | 3.4      |       | 0.1                |       | (0.7               | )          | 0.8      |       |
| EBITDA                                              |       | $        | 258.4      |     | $          | 147.2              |       | $                  | (27.7      | )        | $          | (36.9 | ) | $ | 51.1 |   |

 

----

(1)          Includesthe results of operations of DTP and DTI since the acquisitions becameeffective on May 1, 2003 and June 2, 2003, respectively.

 

(2)          Includes Wheeling results of operations sincethe acquisition became effective on October 1, 2002.

 

(3)          EBITDA is a measure of our liquidity that isnot required by or presented in accordance with GAAP. EBITDA should not beconsidered as an alternative to cash flow from operating activities as ameasure of our liquidity or as an alternative to net income, operating income,or any other performance measures derived in accordance with GAAP.

 

EBITDArepresents earnings before interest, taxes, depreciation, and amortization. Weuse EBITDA:

 

•                  as a liquidity measure, because our existingsenior secured credit facility contains covenants relating to our fixed chargecoverage ratio that use EBITDA;

 

•                  to evaluate and price potential acquisitioncandidates, which are evaluated and priced by other issuers in our industrybased upon EBITDA;

 

•                  to facilitate company-to-company comparisonsby backing out potential differences caused by variations in capital structures(affecting interest expense), taxation, and the age and book depreciation offacilities and equipment (affecting relative depreciation expense), which mayvary for different companies for reasons unrelated to operating performance;and

 

•                  because EBITDA is a liquidity measure that iscommonly used by oilfield service and supply companies.

 

However,EBITDA has limitations as an analytical tool, and you should not considerEBITDA in isolation or as a substitute for analysis of our results as reportedunder GAAP. For example, EBITDA does not reflect:

 

•                  our cash expenditures, or future requirements,for capital expenditures or contractual commitments;

 

•                  changes in, or cash requirements for, ourworking capital needs;

 

•                  our significant interest expense, or the cashrequirements necessary to service interest and principal payments on our debts;

 

•                  any cash requirements for the replacement ofassets being depreciated and amortized, which will often have to be replaced inthe future, even though depreciation and amortization are non-cash charges; and

 

•                  the fact that other companies in our industrymay calculate EBITDA differently than we do, which limits its usefulness as acomparative measure.

 

Becauseof these limitations, you should not consider EBITDA as a measure ofdiscretionary cash available to us to invest in the growth of our business. Wecompensate for these limitations by relying primarily on our GAAP results andby using EBITDA only supplementally.

 

(4)          Amounts reflect the restatement discussed inNote A to the consolidated financial statements.

 

22

----

 
| **ITEM 7.** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION  AND RESULTS OF OPERATIONS** |
|-------------|-------------------------------------------------------------------------------------------------|

 

# **OVERVIEW**

# ** **

*This MD&A should be read in conjunction with the othersections of this Annual Report on Form 10-K, including “Item 1: Business”; “Item6: Selected Financial Data”; and “Item 8: Consolidated Financial Statements andSupplementary Data.” The various sections of this MD&A contain a number offorward-looking statements, all of which are based on our current expectationsand could be affected by the uncertainties and risk factors describedthroughout this filing (including “Business – Risk Factors”), particularlyforward-looking statements in the “Overview,” and “Principal Lines of Business,Products, and Services” sections. Our actual results may differ materially.*

 

As discussed in Note A tothe Consolidated Financial Statements, the Company’s consolidated statements ofcash flows for 2004 and 2003 have been restated. The accompanying Management’sDiscussion and Analysis gives effect to the restatement.

 

Ourfinancial results are impacted by our ability to anticipate and to take actionin response to industry-wide trends. Demand for high-strength OCTG increased in2005 as drilling activity expanded for natural gas in unconventional formationswhich require high pressure hydraulic fracturing. As a result of increasingdemand for OCTG, and particularly alloy-grade OCTG, and higher steel andnatural gas costs, we continued to increase prices for our oilfield products.

 

Themanufacture of our products is capital intensive. Utilization rates at ourmanufacturing facilities in Lone Star, Texas were approximately 85-90% in 2005as shipment volumes increased 5% from 2004 principally related to oilfieldcasing products. Shipment volumes of our high quality alloy-grade tubing andcasing increased 26% in 2005 compared to 2004 shipment volumes, while theaverage price increased 37% over the prior year average. Similarly, 2005 shipmentvolumes of our carbon-based tubing and casing increased 24% over 2004 volumes,while average pricing increased 21% compared to the 2004 average price.

 

Shipmentvolumes in our specialty tubing business segment were down 16% in 2005 comparedto the prior year in part due to our allocation of tubular production capacityto higher margin oilfield products. Shipment volumes in our flat rolled steeland other products were down 6% in 2005 from 2004 as increased supplies ofdomestic flat rolled steel reduced demand for our flat rolled products.

 

Historically,our oilfield products have accounted for the majority of our total revenues. Forfiscal year 2005, they were 79% of total revenues. As a result, our revenuesare largely dependent upon the state of the oil and gas industry, which hashistorically been volatile. Oil and natural gas prices were higher on averagethroughout 2005 compared to 2004 and 2003 as higher energy demand, relativelylow supply, and geopolitical instabilities maintained upward pressure onpricing. This prompted increased domestic drilling. According to Baker Hughes,the U.S. active rig counts rose to an average of 1,383 working rigs in 2005compared to 1,192 and 1,032 in 2004 and 2003, respectively, with 1,471 rigsworking by the end of 2005. A significant portion of the increased drilling wasbiased toward unconventional gas in tight sand and shale formations. Thesewells typically require alloy-grade OCTG, which generally have higher marginsthan our carbon-grade products. Drilling also continued in shallowdevelopmental fields such as coal seam methane geologies. Shallow wells usemainly carbon-grade OCTG. Imports, which accounted for approximately 47% of thetotal apparent OCTG consumption in 2005 compared to 40% and 35% in 2004 and 2003,respectively, are typically more accepted for these less critical shallow wellapplications. Rigs drilling offshore in the United States in 2005 fell to anaverage 93 rigs compared to 97 rigs during 2004 and 108 rigs during 2003,driven in part by a decrease in drilling following Hurricane Katrina in theGulf Coast.

 

Demandfor our oilfield products depends on a number of factors including the numberof oil and natural gas wells being drilled, completed and re-worked and thedepth and drilling conditions of these wells. The level of these activitiesdepends primarily on expectations as to future prices for natural gas and oil. Naturalgas and oil prices are subject to significant fluctuations in response to evenrelatively minor changes in supply, market uncertainty, and a variety ofadditional factors that are beyond Lone Star’s control. Therefore, no assurancecan be given regarding the extent of future demand for Lone Star’s oilfieldproducts. Baker Hughes reported the average domestic rig count increased in2005 by 16% compared to the previous year’s average. While significant domesticdrilling continues in shallower developmental gas fields, there has been asustained increase in the number of rigs drilling deeper than 15,000 feet,where the need for high quality alloy-grade products increases. According toSmith International,****rigs drillingdeeper than 15,000 feet have increased from an average of approximately 205during the second half of 2004, to a level near 220 rigs during the first halfof 2005 to approximately 230 rigs during the second half of 2005. Rigs drillingat 8,000 feet and deeper, which is the general depth where wells begin torequire alloy grade OCTG, were approximately 77% of the total active rigs atthe end of 2005 compared to 79% at the end of 2004. We believe this trend willcontinue to positively impact demand for our higher margin alloy-grade productsas deeper well activity progresses.

 

23

----

 

Demandfor our specialty tubing products decreased during 2005 in part due to ourallocation of tubular production capacity to higher margin oilfield products.Total shipment volumes for the segment declined in 2005 by approximately 16%over the prior year. Revenues of specialty tubing products increased nearly 4%in 2005 compared to 2004 on higher average price per ton partially offset bylower shipment volumes. Shipments of flat rolled steel were down by about 6% in2005 compared to 2004 as an increased domestic supply of flat-rolled steel decreaseddemand for our flat-rolled products. Revenues of flat-rolled products were downabout 3% due to the 6% decline in shipment volumes partially offset by 4%higher average prices.

 

Approximately 82% of our inventory on-hand atboth December 31, 2005 and 2004, is accounted for under the Last-In, First-Out(“LIFO”) method. The LIFO inventory reserve is determined at year-end wheninventory levels and pricing are finalized. Cost of goods sold includes a LIFOprovision impact of $24.1 million and $63.4 million for the years endedDecember 31, 2005 and 2004, respectively. Steel costs represented over 60% ofour total cost of goods sold in 2005 and 2004.

 

Ourfuture operating results may fluctuate significantly depending upon a number offactors, including industry conditions, the level of oil and gas drillingactivity, competition from domestic and foreign manufacturers, and costs of ourraw materials. Sales of our finned tubular products are affected by the levelof domestic and foreign demand for power generation, the relative state of thegeneral industrial economy, and domestic and foreign competition.

 

Thelevel of production volume through our various facilities has a significanteffect on the cost of manufacturing. As shipment volumes increase, a larger amountof fixed and semi-fixed costs are absorbed over greater units of productionthereby reducing the impact of these costs on cost of goods sold. Key variablecosts include costs of labor and raw materials, including scrap steel, steelslabs, steel coils, electricity, and natural gas. Most of our finned tubes andother heat recovery products are manufactured to customer specifications. Accordingly,our manufacturing costs for heat recovery products are to some extent factoredinto product prices on an order-by-order basis.

 

Wehave entered into marketing alliances and manufacturing arrangements withseveral companies that we do not own. These alliances and arrangements involvethe sale and marketing of their products which provide us access to additional manufacturingcapacity and products we do not make. Our exclusive commercial alliances withthese mills allow us to outsource production of specific types of OCTG, linepipe, and specialty tubing and enable us to concentrate our capitalexpenditures and manufacturing expertise on our high quality products and newtechnologies. We will continue to explore opportunities to expand our globalalliance partnerships to enable us to offer our customers a wider variety oftubular products at competitive prices while enhancing our margins, and tofocus our production on higher-margin high quality products.

 

**PRINCIPAL LINES OF BUSINESS, PRODUCTS, AND SERVICES**

 

*Oilfield Products –* Our oilfield products and services consist of (1) casing, whichacts as a structural retainer wall in oil and natural gas wellbores,(2) production tubing, which transmits hydrocarbons to the surface,(3) line pipe, which is used in gathering and transmitting hydrocarbons,(4) couplings, which are used to connect individual sections of oilfield casingand tubing, and (5) OCTG finishing services, including threading, thermaltreating, upsetting, non-destructive testing, inspection, and storage services.

 

Basedon industry reports, we expect demand for our oilfield products to continue toremain strong throughout 2006 as both crude oil prices and natural gas pricesare expected to sustain the number of active drilling rigs. The U.S. EnergyInformation Agency (“EIA”) has projected that the average West TexasIntermediate (WTI) crude oil price should increase to levels experienced at theend of 2005 to average in the low- to mid-$60’s per barrel range throughout2006 and 2007. The EIA expects U.S. petroleum demand to grow at an approximategrowth rate average of 1.7% and 1.9% in 2006 and 2007, respectively. U.S.natural gas spot prices averaged around $9 per thousand cubic feet (“mcf”)during 2005. The EIA expects natural gas spot prices to range from $7.51 -$11.25 per mcf during 2006 and 2007 due to high crude oil prices and arelatively tight natural gas supply coupled with increasing demand. We believethat these are positive indicators of increasing and sustainable demand for ouroilfield products in 2006.

 

24

----

 

*Specialty Tubing Products* – Our specialty tubing product segmentincludes two principal product groups: (1) precision mechanical tubulars and (2) finned tubular products. Ourprecision mechanical tubulars consist of a wide array of high-quality, custom-madesteel tubular products with precise dimensional control and specialmetallurgical properties which are manufactured by the DOM process. Thisprocess allows us to achieve higher critical tolerances and dimensional controlthan other processes. These products are used for several industrialapplications, including the manufacture of hydraulic cylinders for constructionand farm equipment; automotive applications, such as stabilizers and intrusiontubes; and other uses, including machine parts, bearing races, down-hole pumpbarrels, heavy-lift crane boom chords, drill rods, and liner hangers.

 

While the generaldomestic economy continued to improve throughout the year, shipment volumes forour precision mechanical tubing were down as we allocated some of our tubularmanufacturing to higher margin oilfield products. The composite Purchasing Managers’ Index remainsabove 50 percent which generally indicates that the manufacturing economy isexpanding. We believe that demand for our precision mechanical tubing productsin 2006 will continue to be positively impacted by the improving generaldomestic economy. However, automotive related demand is expected to soften, andwe will likely continue to allocate a portion of our precision mechanicaltubing capacity to higher margin oilfield products.

 

Ourfinned tubular products are used in heat recovery applications such as fueleconomizers, petrochemical plants, refineries, and combined-cycle electricalpower generation plants. Demand for domestically produced finned tubulars andrelated products fell slightly in 2005 and shipment volumes decreased 13% from2004. Since reorganizing our finned tubular business around new marketing andcommercial business lines directed at more traditional heat recovery marketsincluding fuel economizers and traditional boiler applications, we haveexperienced increased customer activity related to improvements in the generalindustrial economy. However, with few exceptions, demand for our finnedproducts for installation in new power plant construction projects is notlikely to improve until existing electrical power generation capacity is morefully utilized.

 

*Flat Rolled Steel and Other Products* – We manufacture and market flat rolledsteel, which is primarily used in the manufacture of our oil country tubularproducts and precision mechanical tubular products. We also sell flat rolledsteel to our alliance mills for the manufacture of tubular products and tofabricators of large-diameter transmission pipe, storage tanks, rail cars and avariety of other construction and industrial products. Our other products areprincipally used for structural and piling applications in the constructionindustry. We sell flat rolled steel directly to end-users and through servicecenters primarily in the Southwestern region of the United States.

 

We sell flat rolled steel in highlycompetitive markets, with price, quality, and availability primarilydetermining customer purchase decisions. Flat rolled steel processing servicesare also sold to steel mills where we receive processing revenues but do nottake title to the steel.

 

# **CRITICALACCOUNTING POLICIES AND ESTIMATES**

# ** **

Management’sDiscussion and Analysis, Results of Operations, and Financial Condition arebased on the related consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States of America. The preparation of the financial statements requiresthe use of estimates and judgments that affect the reported amounts of assets,liabilities, revenues, and expenses. Lone Star evaluates its estimatesprimarily based on historical experience and business knowledge. Theseestimates are evaluated by management and revised as circumstances change. Adiscussion of the critical accounting policies and significant estimates madeby Lone Star follows:

 

***Warranty Claims***

 

Ourproducts are used in applications that are subject to inherent risks includingwell failures, performance deficiencies, line pipe leaks, personal injury,property damage, environmental contamination, or loss of oil and gas production.We warrant our products to meet certain specifications. Actual or claimeddeficiencies in meeting these specifications may give rise to claims. Wemaintain a reserve for asserted and unasserted warranty claims. The warrantyclaim exposure is evaluated using historical claim trends and informationavailable on specifically asserted claims. We also maintain product and excessliability insurance subject to certain deductibles that limits our exposure tothese claims. We consider the extent of insurance coverage in our estimate ofthe reserve. Historically, this reserve has not been subject to significantfluctuations from period to period. However, the incurrence of an unusualamount of claims could require an increase to the related reserve.

 

***Bad Debts***

 

Our customers are concentrated in markets andindustries that are subject to volatility. In addition, we sell a substantialamount of products to a few customers, none of which individually comprisesmore than 10% of total net revenues. We maintain a reserve for known andestimated unknown bad debts. We evaluate credit risk and the adequacy of ourreserve by monitoring the age of our accounts receivable and thecreditworthiness of our customers. In addition, we monitor the overall statusof the industries where our products and services are utilized. Historically,this reserve has not been subject to

 

25

----

 

significant fluctuations from period to period.However, the incurrence of an unusual amount of bad debt could require anincrease to the related reserve.

 

***Environmental Obligations***

 

Our business is subject to numerousenvironmental regulations. We are actively remediating known exposures and conductingpost closure monitoring activities. Our environmental department monitors thestatus of our environmental exposures and compliance with regulations throughvarious means. We maintain an environmental reserve to cover the costs ofexpected remediation and post closure monitoring. We estimate the future costfor the remediation and post closure based on historical experience, results ofmonitoring and the known extent of exposure. We evaluate the range of exposureand record the reserve. Historically, this reserve has not been subject tosignificant fluctuations from period to period; although given the nature ofenvironmental exposure, significant changes in the reserve are possible.

 

***Impairmentof Goodwill and Long-Lived Assets***

*** ***

Long-lived assets, which include property,goodwill, intangible assets, and certain other assets, comprise a significantamount of our total assets. We make judgments and estimates in conjunction withthe carrying value of these assets, including amounts to be capitalized, depreciationand amortization methods, and useful lives. Additionally, the carrying value ofgoodwill is reviewed annually for impairment or whenever events or changes incircumstances indicate that the carrying amount may not be recoverable. Thecarrying values of all other long-lived assets are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountsmay not be recoverable. An impairment loss is recorded in the period in whichit is determined that the carrying amount is not recoverable. This requires usto make long-term forecasts of our future revenues and costs related to theassets subject to review. These forecasts require assumptions about demand forour products and services, future market conditions, and technologicaldevelopments. Significant changes to these assumptions or unanticipated eventscould require a provision for impairment.

 

***Pensionand Postretirement Benefit Obligations***

*** ***

Accountingfor pensions and other postretirement benefit plans requires management to makeseveral estimates and assumptions (see Note J in the Notes to ConsolidatedFinancial Statements).   These include the expected rate of return frominvestment of the plans’ assets, projected increases in medical costs and theexpected retirement age of employees as well as their projected mortality.  In addition, the amounts recorded are affected by changes in theinterest rate environment because the associated liabilities are discounted totheir present value.   Management makes these estimates based on Lone Star’shistorical experience and other information that it deems pertinent under thecircumstances (for example, expectations of future stock market performance).  Management engages an independent consulting actuarial firm to aid it inselecting appropriate assumptions and valuing its pension related liabilities.

 

LoneStar’s net pension benefit expense, which is included in “Cost of goods sold”on our Consolidated Results of Operations, was $4.7 million for the year endedDecember 31, 2005.  In recording this amount, Lone Star assumed along-term investment rate of return of 8%.   Changes to this rate ofreturn assumption would result in a change to the pension credit and, as aresult, an equal change in cost of goods sold.   Changes that arereasonably likely to occur in assumptions concerning retirement age, projectedearnings and mortality would not be expected to have a material effect on LoneStar’s net pension benefit expense or net pension liability in the future.  The net pension liability is recorded at its net present value using adiscount rate of 5.75% that is based on the current interest rate environment.

 

LoneStar’s net cost for other postretirement benefits, which is also included incost of goods sold, was $2.1 million for the year ended December 31, 2005. Inrecording this expense and valuing the net liability for other postretirementbenefits, which is included in “Other Benefits” as disclosed in Note J,management estimated future increases in healthcare costs.   This andother assumptions, along with the effect of a one percentage point change inthem, are described in Note J.

 

***IncomeTaxes***

*** ***

Significantmanagement judgment is required in determining our provision for income taxesand in determining whether deferred tax assets will be realized in full or inpart. When it is more likely than not that all or some portion of specificdeferred tax assets such as net operating losses or credit carryforwards willnot be realized, a valuation allowance must be established for the amount ofthe deferred tax assets that cannot be realized. Management considers thescheduled reversal of deferred tax items, projected future taxable income, andtax planning strategies in evaluating the realization of deferred tax assets.

 

26

----

 

Ourtax filings for various periods are subject to tax examinations by the InternalRevenue Service and other tax authorities in various jurisdictions. Theseaudits may result in assessments of additional taxes and Management regularlyassesses the likelihood of adverse outcomes resulting from these examinationsto determine the adequacy of our provision for income taxes.

 

Noprovision has been made for income taxes which may become payable upondistribution of the foreign subsidiaries’ earnings since on a cumulative basislosses have been generated.

 

RESULTS OF OPERATIONS

 

***Net Revenues***

 

Ourrevenues are derived from three business segments: oilfield products, specialtytubing products, and flat rolled steel and other products. In the last threeyears, net revenues and shipments by segment were as follows:

 
| *** ***                         | *** *** | ***($ in millions)*** | *** *** |
|--------------------------------------|--------------|----------------------------|--------------|
| ** **                           | ** **   | **2005**                   | ** **   | **2004** | ** ** | **2003** | ** ** |
| ** **                           | ** **   | **$**                      | ** **   | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| Oilfield products                    |         | 1,009.8                    |         | 79 |   | 695.4 |   | 72 |   | 364.8 |   | 68 |   |
| Specialty tubing products            |         | 181.5                      |         | 14 |   | 175.1 |   | 18 |   | 121.8 |   | 23 |   |
| Flat rolled steel and other products |         | 93.8                       |         | 7 |   | 96.3 |   | 10 |   | 47.5 |   | 9 |   |
| Total net  revenues                  |         | 1,285.1                    |         | 100 |   | 966.8 |   | 100 |   | 534.1 |   | 100 |   |

 
| ** **                           | ** ** | **2005** | ** ** | **2004** |       | **2003** |       |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **                           | ** ** | **Tons** | ** ** | **%**    | ** ** | **Tons** | ** ** | **%** | ** ** | **Tons** | ** ** | **%** | ** ** |
| Oilfield products                    |       | 665,100  |       | 72       |       | 592,900  |       | 67 |   | 496,200 |   | 68 |   |
| Specialty tubing products            |       | 99,800   |       | 11       |       | 118,400  |       | 14 |   | 104,900 |   | 14 |   |
| Flat rolled steel and other products |       | 160,900  |       | 17       |       | 171,100  |       | 19 |   | 132,700 |   | 18 |   |
| Total shipments                      |       | 925,800  |       | 100      |       | 882,400  |       | 100 |   | 733,800 |   | 100 |   |

 

*2005 Compared to 2004* – Revenues from our oilfield productsincreased by 45% over fiscal year 2004 to $1,009.8 million on significant increases in both shipment volume andaverage pricing. The table below illustrates the impact of volume changes andaverage price changes on net revenues from oilfield products for the year endedDecember 31, 2005 ($ in millions).

 

| ** **                     | ** ** | **Oilfield** | ** ** |
|--------------------------------|------------|--------------|------------|
| Year ended December 31, 2004   |       | $            | 695.4      |   |
| Change due to  shipment volume |       | 109.6        |       |
| Change due to  price           |       | 204.8        |       |
| Year ended December 31, 2005   |       | $            | 1,009.8    |   |

 

Theoilfield products segment comprised 79% of total revenues for the year endedDecember 31, 2005 compared with 72% of total revenues for the year endedDecember 31, 2004. Average pricing of our oilfield products increased 29% in2005 over the prior year. Average pricing for OCTG and line pipe increased by33% and 17%, respectively, in 2005 compared to 2004. OCTG revenues generallyaccount for approximately 75-85% of our total oilfield revenues. Sales of ourhigh-strength, alloy-grade OCTG, which comprised nearly 71% of our total OCTGrevenues, were up more than 73% as average prices increased 37%. Sales ofcarbon-grade OCTG products increased nearly 27%, on a 21% increase in averagepricing. Line pipe revenues, which were 12% of our total oilfield productrevenues in 2005, were up 15% over the prior year on a 17% increase in averagepricing. Our increases in average oilfield product pricing are due principallyto our success in implementing price increases associated with increasing demand,particularly for alloy grade OCTG. Shipment volumes of 

 

27

----

 

ourhigh-strength alloy-grade OCTG and carbon-based OCTG increased 26% and 5%respectively, as high crude oil and natural gas prices stimulated the number ofworking drilling rigs to their highest level in 19 years by the end of 2005.

 

Specialtytubing product revenues increased nearly 4% in 2005 compared to 2004 as averagepricing increased more than 23% and shipment volumes were down nearly 16%. Thetable below summarizes the impact of volume and average price changes onspecialty tubing products revenues for the year ended December 31, 2005 ($ inmillions).

 

| ** **                     | ** ** | **Specialty** | ** ** |
|--------------------------------|------------|---------------|------------|
| ** **                     | ** ** | **Tubing**    | ** ** |
| Year ended December 31, 2004   |       | $             | 175.1      |   |
| Change due to  shipment volume |       | (33.8         | )          |
| Change due to  price           |       | 40.2          |       |
| Year ended December 31, 2005   |       | $             | 181.5      |   |

 

We raised prices of our specialty tubingproducts and instituted raw material surcharges as a result of the increases inour principal raw material cost, namely steel. Average prices also increased aswe allocated tubular capacity from lower priced specialty tubing products tohigher margin oilfield products, thereby removing some lower priced specialtytubing products from the product mix in this business segment. Sales of ourprecision mechanical tubulars, which accounted for 73% of our total specialtytubing segment revenues in 2005, remained consistent with 2004 sales levels. Averagepricing of our precision mechanical tubulars increased 20% and shipment volumesdecreased by 16% over the prior year as some tubular capacity was allocated tooilfield products. Heat recovery tubular goods revenues increased 14% comparedto the prior year as average pricing increased 31% due to an increasedpercentage of sales of higher priced engineered heat recovery products, and toa lesser extent product price increases related to increases in raw materialcosts, namely steel. Total tons shipped decreased by 13% as excess capacity inthe North American electricity generating market and foreign competitioncontinue to negatively impact sales of our heat recovery tubulars.

 

Salesof flat-rolled and other products decreased by nearly 3% compared to 2004 asincreased supplies of domestic steel reduced demand for our flat-rolled steel. Totalshipment volume in tons decreased by 6% as some capacity was shifted tooilfield products, while average pricing was up about 4%. The table belowillustrates the impact of volume and average price changes on flat-rolled andother products revenues for the year ended December 31, 2005 ($ in millions).

 

| ** **                     | ** ** | **Flat Rolled** | ** ** |
|--------------------------------|------------|-----------------|------------|
| ** **                     | ** ** | **and Other**   | ** ** |
| ** **                     | ** ** | **Products**    | ** ** |
| Year ended December 31, 2004   |       | $               | 96.3       |   |
| Change due to  shipment volume |       | (5.9            | )          |
| Change due to  price           |       | 3.4             |       |
| Year ended December 31, 2005   |       | $               | 93.8       |   |

 

*2004 Compared to 2003 –*Revenues from our oilfield products increasedby 91% over fiscal year 2003 on significant increases in both shipment volumeand average pricing. The table below illustrates the impact of volume changesand average price changes on net revenues from oilfield products for the yearended December 31, 2004 ($ in millions).

 

| ** **                     | ** ** | **Oilfield** | ** ** |
|--------------------------------|------------|--------------|------------|
| Year ended December 31, 2003   |       | $            | 364.8      |   |
| Change due to  shipment volume |       | 113.4        |       |
| Change due to  price           |       | 217.2        |       |
| Year ended December 31, 2004   |       | $            | 695.4      |   |

 

28

----

 

Averagepricing of our oilfield products increased nearly 60% in 2004 over the prioryear. Average pricing for OCTG and line pipe increased by 61% and 74%,respectively, in 2004 compared to 2003. OCTG revenues generally account forapproximately 75% of our total oilfield revenues. Sales of our high-strength,alloy-grade OCTG, which comprised nearly 64% of our total OCTG revenues, wereup more than 104% as average prices increased 53%. Sales of carbon-grade OCTGproducts increased nearly 91% on 70% increase in average pricing. Line piperevenues, which were 15% of our total oilfield product revenues in 2004, wereup 85% over the prior year on a 74% increase in average pricing and a 6%increase in shipment volume. Our increases in average oilfield product pricingwere due principally to our success in implementing price increases along withraw material surcharges, both of which were necessary as the cost of ourprincipal raw materials, steel slabs and coils, increased an average 82% in2004 compared to the prior year. Demand for our oilfield products alsoincreased in 2004. Shipment volumes of our high-strength alloy-grade OCTG andcarbon-based OCTG increased 33% and 12%, respectively, as high crude oil andnatural gas prices stimulated the number of working drilling rigs to theirhighest annual average in 15 years.

 

Specialtytubing product revenues increased nearly 44% in 2004 compared to 2003 asaverage pricing increased more than 27% and shipment volumes were up nearly 13%.The table below summarizes the impact of volume and average price changes onspecialty tubing products revenues for the year ended December 31, 2004 ($ inmillions).

 

| ** **                     | ** ** | **Specialty** | ** ** |
|--------------------------------|------------|---------------|------------|
| ** **                     | ** ** | **Tubing**    | ** ** |
| Year ended December 31, 2003   |       | $             | 121.8      |   |
| Change due to  shipment volume |       | 20.0          |       |
| Change due to  price           |       | 33.3          |       |
| Year ended December 31, 2004   |       | $             | 175.1      |   |

 

Similar to oilfield products, we raised pricesof our specialty tubing products and instituted raw material surcharges as aresult of the significant increases in our principal raw material cost, namelysteel, and improved demand as indicated by our increased shipment volume. Salesof our precision mechanical tubulars, which accounted for 75% of our totalspecialty tubing segment revenues in 2004, increased by 57% compared to 2003. Averagepricing of our precision mechanical tubulars increased 30% and shipment volumesgrew by 22% over the prior year as general industrial demand continued toincrease throughout 2004 along with the improvement in the domestic economy. Heatrecovery tubular goods revenues increased 14% compared to the prior year asaverage pricing increased 33% due principally to product price increasesrelated to increases in raw material costs, namely steel. Total tons shippeddecreased by 15% as excess capacity in the North American electricitygenerating market and foreign competition continued to negatively impact salesof our heat recovery tubulars.

 

Salesof flat-rolled and other products increased by nearly 103% compared to 2003 asthe tight domestic steel market drove significant increases in demand forflat-rolled steel and pushed prices to new high levels. Total shipment volumein tons increased by 29% with average pricing up over 57%. The table belowillustrates the impact of volume and average price changes on flat-rolled andother products revenues for the year ended December 31, 2004 ($ in millions).

 

| ** **                     | ** ** | **Flat Rolled** | ** ** |
|--------------------------------|------------|-----------------|------------|
| ** **                     | ** ** | **and Other**   | ** ** |
| ** **                     | ** ** | **Products**    | ** ** |
| Year ended December 31, 2003   |       | $               | 47.5       |   |
| Change due to  shipment volume |       | 21.6            |       |
| Change due to  price           |       | 27.2            |       |
| Year ended December 31, 2004   |       | $               | 96.3       |   |

 

29

----

 

***Gross Margin***

 

AtDecember 31, 2005 and 2004, we valued 82% of our inventories at the lower ofcost or market determined on the last-in, first-out (“LIFO”) inventoryvaluation method compared with 90% at December 31, 2003. In periods ofincreasing costs, the LIFO method generally results in higher cost of goodssold than under the first-in, first-out (“FIFO”) method. Likewise, in periodsof decreasing costs the results are generally the opposite. Steel costsincreased in 2005 and 2004 which negatively impacted gross profit under theLIFO method as compared to what gross profit would have been had we used theFIFO method.

 

Thefollowing table illustrates the comparative effect of LIFO and FIFO accountingon our consolidated results of operations. This table is provided solely forthe purpose of providing comparisons to other companies that may use the FIFOmethod of inventory valuation. The supplemental FIFO earnings reflect theafter-tax effect of eliminating the LIFO reserve adjustment as disclosed in thefootnotes to the Consolidated Financial Statements for the years ended December31, 2005, 2004, and 2003 ($ in millions).

 
| ** **         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **         | ** ** | **LIFO** | ** ** | **FIFO** | ** ** | **LIFO** | ** ** | **FIFO** | ** ** | **LIFO** | ** ** | **FIFO** | ** ** |
| Cost of goods sold |       | $        | 1,012.8    |     | $          | 988.7    |       | $ | 804.8 |   | $ | 741.4 |   | $ | 528.9 |   | $ | 520.6 |   |
| Net income (loss)  |       | 223.6    |       | 238.5    |       | 101.0    |       | 162.3 |   | (68.2 | ) | (59.9 | ) |
|                    |            |          |            |          |            |          |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table shows cost of sales (as reported using the LIFO method) and therelated gross margin percentages (“GM%”) for the last three years ($ inmillions):

 
| ** **         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **         | ** ** | **$**    | ** ** | **GM%**  | ** ** | **$**    | ** ** | **GM%** | ** ** | **$** | ** ** | **GM%** | ** ** |
| Cost of goods sold |       | 1,012.8  |       | 21.2     | %          | 804.8    |       | 16.8 | % | 528.9 |   | 1.0 | % |

 

*2005 Compared to 2004 –* Margins improved in 2005 compared to 2004 asboth increased demand and higher average product pricing more than offsetincreases in raw materials including steel and natural gas. Consistent with theincrease in crude oil prices, natural gas prices, and active rig counts,increasing demand for our oilfield products has resulted in 12% increases inshipment volume for the year ended December 31, 2005 when compared to the sameperiods in the prior year. Together with 29% higher average selling prices,these factors have more than offset increases in raw materials costs includingsteel and natural gas, thus lowering their proportional impact on total cost ofgoods sold and improving gross margin percentages. We continue to closelymonitor our raw material costs, including their impact on our margins, and  to examine the need to further raise productprices as raw material costs increase and as appropriate with market demand.

 

*2004 Compared to 2003 –*Margins improved substantially in 2004compared to 2003 as both increased demand and higher average product pricingoffset increases in raw materials including steel and natural gas. Beginning inthe first quarter of 2004, we began instituting price increases across allproduct segments as well as implementing raw material surcharges in response torapidly increasing steel costs and rising natural gas costs. During the secondquarter of 2004 our surcharges and base price were merged into one pricesubject to possible change at the time of shipment. For 2004, the increase inshipment volumes across all three reporting segments absorbed a larger amountof fixed and semi-fixed costs over greater units of production thereby reducingthe impact of fixed and semi-fixed costs on cost of goods sold.

 

***Selling, General, and AdministrativeExpenses***

 

Thefollowing table presents consolidated selling, general, and administrative (“SG&A”)expenses and the related percentage of total consolidated revenues for the lastthree years ($ in millions):

 
| ** **                           | ** ** | **2005**   | ** ** | **2004**    | ** ** | **2003**   | ** ** |
|--------------------------------------|------------|------------|------------|-------------|------------|------------|------------|
| ** **                           | ** ** | ** ** | ** ** | **% of**    | ** ** | ** ** | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                           | ** ** | **$**      | ** ** | **Revenue** | ** ** | **$**      | ** ** | **Revenue** | ** ** | **$** | ** ** | **Revenue** | ** ** |
| Selling, general, and administrative |       | 50.5       |       | 3.9         | %          | 44.6       |       | 4.6 | % | 41.8 |   | 7.8 | % |

 

30

----

 

*2005 Compared to 2004* – In 2005, SG&A costs increasedapproximately 13%, but fell from approximately 5% to 4% of revenues principallydue to the significant increase in our revenues. The increase in SG&A costsis principally due to increases in wages, salaries, incentive compensation, andrelated benefits of approximately $2.9 million related to the increase in ourbusiness activities; increases in professional fees for several corporatepurposes of approximately $2.2 million; and increases in other miscellaneousSG&A expenses totaling approximately $0.8 million.

 

*2004 Compared to 2003* – In 2004, SG&A costs increased less than7%, but fell to 4.6% of revenues principally due to the significant increase inour revenues. The increase in SG&A costs is principally due to increases inwages, salaries, and related benefits of approximately $2.8 million related tothe increase in our operating rates and business activities; and, increases inaudit and consulting fees related to public company compliance requirements,principally Sarbanes-Oxley Section 404, and other professional fees ofapproximately $1.8 million. These increases were partially offset by reductionsin other SG&A expenses related to taxes other than income, reductions ininformation technology operating costs, and reductions in other miscellaneousSG&A expenses totaling $1.4 million.

 

***Interest Expense***

 

Interest expense decreased in 2005 by $0.7million, as interest expense in 2004 included the post-judgment interest on theCargill verdict as discussed in “Commitments and Contingencies – Note K” . Interestexpense increased in 2004 compared to 2003 by $0.4 million, principally as aresult of incrementally higher interest costs associated with higher steelcosts as part of our product financing arrangements.

 

***Interest Income***

 

Interest income increased by $4.0 million and$0.4 million in 2005 and 2004, respectively, as a result of greater investmentsin debt securities. Investments in debt securities were $153.5 million and$59.1 million at December 31, 2005 and 2004, respectively.

 

***Other Income, Net***

 

The increase in otherincome, net, of $6.7 million in 2005 is primarily driven by the gain recognizedon the early termination of an alliance agreement. During the second quarter of2005, the Company announced that Steel and Tubos del Caribe, S.A. (“Tubocaribe”),a Columbian manufacturer of OCTG and line pipe, had terminated their strategicalliance, following a change in ownership of Tubocaribe. The agreement was dueto expire in October 2006. As consideration for the early termination of theagreement, in the fourth quarter of 2005, Tubocaribe delivered, without chargeto Steel, an agreed quantity of OCTG with an estimated value of $7.8 million.

 

***Income Taxes***

 

Forthe year ended December 31, 2005, Lone Star’s effective tax rate is affected bymanagement’s belief that it is more likely than not that substantially all ofthe net deferred tax asset will be realized. The ultimate realization ofdeferred tax assets is dependent upon the generation of future taxable incomeduring the periods in which those temporary differences become deductible. Managementconsiders the scheduled reversal of deferred tax items, projected futuretaxable income, and tax planning strategies in making this assessment. Based onthe substantial utilization of the net deferred tax asset during 2004 and 2005and sufficient projected future taxable income, management determined that theremaining net operating losses (“NOL”) and credit carryforwards will berealized in the future. Accordingly, in 2005, NOL’s totaling $196.2 millionwere utilized to reduce our current federal income tax expense. State incometaxes, other miscellaneous items, and the elimination of the remainingvaluation allowance resulted in a net tax benefit of $3.4 million for the yearended December 31, 2005.

 

Forthe year ended December 31, 2004, Lone Star’s effective tax rate was affectedby the carryforward of NOL’s recognized or not recognized in a particular yearand the full valuation allowance placed against the associated net deferred taxassets. In 2004, NOL’s totaling $53.8 million were utilized to reduce ourfederal income tax expense. The income tax expense for the year ended December31, 2004 consisted of state income taxes and federal alternative minimum tax (“AMT”).

 

31

----

 

# **LIQUIDITYAND CAPITAL RESOURCES**

# ** **

***Overview***

 

Wehave historically funded our business through our operating results. We believethese sources of funds will provide the liquidity necessary to fund our cashrequirements during 2006. The following table shows our capital resources as atDecember 31, 2005 and 2004 ($ in millions):

 

| ** **                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Cash and cash equivalents            |       | $        | 102.2      |     | $          | 30.2 |   |
| Total investments in debt securities |       | $        | 153.5      |     | $          | 59.1 |   |
| Working capital                      |       | $        | 615.6      |     | $          | 288.1 |   |
| Unused credit facility               |       | $        | 124.7      |     | $          | 120.9 |   |

 

AtDecember 31, 2005, our cash and cash equivalents and investments in debtsecurities totaled $255.7 million, compared to $89.3 million at December 31,2004. Our cash and cash equivalents include commercial bank accounts and highlyliquid money market instruments issued by corporations, banks and the U.S.government or its agencies with original maturities of less than three months. Ourinvestments in debt securities consist of U.S. government and related agencydebt obligations, debt securities of public companies, and municipal securitieswith maturities at purchase less than two years. These investments in debtsecurities generally earn higher yields than the yields of our cash and cashequivalents. Our total cash equivalents and investments in debt securities, thecombined weighted average maturity of which is less than one year, areclassified as either held-to-maturity as we have the positive intent andability to hold them to maturity, or available-for-sale (See *Investments – Note D* to the Notes toConsolidated Financial Statements). The increase in working capital of $327.5million was primarily due to the increase in inventory of $116.7 million due toan increase in inventory levels for anticipated production and shipments.Additional increases to working capital were driven by increases to accountsreceivable of $18.7 million and investments in debt securities of $107.1million, both of which are directly related to our increase in net income in2005, and an increase in deferred tax assets of $65.3 million, offset by theincrease in current liabilities of $17.4 million and the decrease in othercurrent assets of $34.9 million related to the receipt of prepaid inventory.

 

***Discussion of Changes in Liquidity andCapital Resources***

 

Cashprovided by (used in) operating activities was $148.2 million, $29.5 million,and $(8.4) million for 2005, 2004, and 2003, respectively. Cash provided fromoperations increased $118.7 million for the year ended December 31, 2005, whichis primarily attributable to net income of $223.6 million further increased bynon-cash income statement effects of approximately $31.3 million primarilyrelated to depreciation and amortization and stock compensation charges. Anon-cash gain on the early termination of an alliance agreement of $7.8 millionwas recognized in 2005, as discussed in Note L. Cash flow was used inoperations in large part due to increases in inventory and accounts receivableof $116.7 million and $18.7 million, respectively. Other current assetsdecreased by $48.0 million in 2005, primarily driven by a decrease in inventorydeposits of $25.7 million. Changes in other balance sheet accounts of $11.5million provided the remaining cash flow from operations.

 

Interestpaid in 2005 decreased by $0.7 million due to lower interest paid related tothe litigation settlement in 2004, while interest paid in 2004 increased over2003 by $3.1 million principally due to an interest payment related to thelitigation settlement. (See Item 3. Legal Proceedings).

 

Cashused in investing activities was $112.9 million, $39.2 million and $80.2million for 2005, 2004, and 2003, respectively. During 2005, cash used ininvesting was due to the purchase of investments in debt securities totaling$324.1 million and $21.0 million of investments in capital expenditures, offsetby proceeds from the sale of property of $2.5 million and proceeds from thesale of investments of $229.7 million. During 2004, cash used in investing wasdue to the purchase of investments in debt securities totaling $88.6 millionand $13.0 million of investments in capital expenditures, offset by proceedsfrom the sale of property of $0.7 million, proceeds from the sale ofinvestments classified as available-for-sale securities totaling $29.5 million,and restricted cash of $32.2 million. The investments in capital expenditureswere related primarily to the expansion of our production capabilities at ourStar Energy Group facilities. Cash used in 2003 related principally to ouracquisitions of DTP and DTI, restricted cash, and capital expenditures.

 

Cash provided by financing activities was$36.6 million, $6.4 million, and $0.5 million in 2005, 2004, and 2003,respectively. In 2005 and 2004, cash was provided from the proceeds ofexercising stock options. Cash provided in 2003 from proceeds of stock optionexercises totaling $1.3 million was partially offset by purchases of treasurystock of $0.8 million.

 

32

----

 

InDecember 2003, Lone Star amended and restated its $100 million credit facilityto increase the total available borrowings to $125 million and extend theexpiration date to December 2006. Borrowings under the credit facility can beused for general corporate purposes. Borrowings under the credit facility arecollateralized by substantially all of Lone Star’s assets, other than realestate. At Lone Star’s option, the interest rate is the prime lending rate orthe LIBOR plus the applicable additional interest. Under the agreement, LoneStar can borrow an amount based on a borrowing base of 85% of our eligibleaccounts receivable plus the lesser of 60% of eligible inventory or $85.0million. The credit facility remains undrawn and the total availability was$124.7 million at December 31, 2005. For 2005, we were in compliance with thefacility’s covenants and we do not anticipate non-compliance in the foreseeablefuture.

 

In May 2003, we acquired substantially all ofthe assets of Delta Tubular Processing (“DTP”) for $14.0 million in cash plusacquisition costs. In June 2003, we acquired certain assets of Frank’s TubularInternational (since renamed Delta Tubular International, or “DTI”) for $18.9million in cash plus acquisition costs.

 

OnOctober 16, 2002, Lone Star filed a universal shelf registration statement thatbecame effective on April 18, 2003 to sell from time to time up to a total of$136.0 million of debt securities, preferred stock, common stock, depositoryshares and warrants. Lone Star has an aggregate of approximately $250.0 millionof registered securities available, including a previously filed universalshelf registration statement. Additionally, as a “well known seasoned issuer,”Lone Star should be able under new SEC rules to access the capital marketsthrough an automatically effective shelf registration statement.

 

We operate in capital intensive businesses. Wehave made, and we expect we will be required to make, significant capitalexpenditures each year for recurring maintenance necessary to keepmanufacturing facilities operational, to comply with environmental and otherlegal requirements and to improve our information systems. Additionally, weregularly make capital expenditures for technological improvements and forresearch and development projects. If funding is insufficient at any time inthe future, we may be unable to develop or enhance our products or services,take advantage of business opportunities or respond to competitive pressures. Ourcapital expenditures budget for 2006 is approximately $45.0 million. Dependingon business conditions and operating volumes, capital expenditures may beincreased or decreased from the estimate throughout the year.

 

Ouroperations are subject to environmental compliance and permitting requirementsof various foreign, federal, and state governmental agencies. We believe thatthe cost of maintaining compliance with environmental requirements will fallwithin our contemplated operating and capital expenditure plans, averaging $1.0million to $2.0 million annually in the foreseeable future.

 

OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONS

 

At December 31, 2005, we had contractual cashobligations to repay debt, to make payments under leases, purchase obligations,and commercial commitments in the form of unused lines of credit. Payments dueunder these long-term obligations are as follows ($ in millions):

 

 
| ** **                       | ** ** | **Obligations Due By Period (1)** | ** ** |
|----------------------------------|------------|-----------------------------------|------------|
| ** **                       | ** ** | ** **                        | ** ** | ** ** | ** ** | **2007** | ** ** | **2009** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | ** **                        | ** ** | ** ** | ** ** | **to** | ** ** | **to** | ** ** | ** ** | ** ** |
| **Contractual Obligations**      | ** ** | **Total**                         | ** ** | **2006** | ** ** | **2008** | ** ** | **2010** | ** ** | **Thereafter** | ** ** |
| Long-term debt  obligations (2)  |       | $                                 | 224.3      |   | $ | 13.5 |   | $ | 27.0 |   | $ | 27.0 |   | $ | 156.8 |   |
| Operating lease  obligations     |       | 10.5                              |       | 3.3 |   | 5.2 |   | 2.0 |   | — |   |
| Purchase  obligations            |       | 21.3                              |       | 20.4 |   | 0.9 |   | — |   | — |   |
| Other long-term  obligations (3) |       | 8.4                               |       | 8.4 |   | — |   | — |   | — |   |
| Total  Contractual Obligations   |       | $                                 | 264.5      |   | $ | 45.6 |   | $ | 33.1 |   | $ | 29.0 |   | $ | 156.8 |   |

 

----

| (1) | The table does not include an estimate for  income tax payments which we are required to make but not required to include  above.            |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | The long-term debt obligations represent our  cash debt service obligations, including both interest at a fixed rate of  9.0% and principal. |
| (3) | Other long-term obligations represent cash  contributions to our pension plan.                                                               |

 

33

----

 

Commercial commitment expirations are asfollows ($ in millions):

 
| ** **             | ** ** | **Commitment Expiration by Period** | ** ** |
|------------------------|------------|-------------------------------------|------------|
| ** **             | ** ** | ** **                          | ** ** | ** ** | ** ** | **2007** | ** ** | **2009** | ** ** | ** ** | ** ** |
| ** **             | ** ** | ** **                          | ** ** | ** ** | ** ** | **to** | ** ** | **to** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Total**                           | ** ** | **2006** | ** ** | **2008** | ** ** | **2010** | ** ** | **Thereafter** | ** ** |
| Unused credit facility |       | $                                   | 125.0      |   | $ | 125.0 |   | $ | — |   | $ | — |   | $ | — |   |
|                        |            |                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

##### **RECENT ACCOUNTING PRONOUNCEMENTS**

##### ** **

InNovember 2004, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 151, *Inventory Costs—AnAmendment of ARB No. 43, Chapter 4* (“SFAS 151”). SFAS 151amends the guidance in ARB No. 43, Chapter 4, *Inventory Pricing*, to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage). Among other provisions, the new rulerequires that items such as idle facility expense, excessive spoilage, doublefreight, and rehandling costs be recognized as current-period chargesregardless of whether they meet the criterion of “so abnormal” as stated in ARBNo. 43. Additionally, SFAS 151 requires that the allocation of fixedproduction overhead to the costs of conversion be based on the normal capacityof the production facilities. SFAS 151 is effective for fiscal yearsbeginning after June 15, 2005 and was required to be adopted by Lone Staron January 1, 2006. The adoption of SFAS 151 did not have a materialimpact on Lone Star’s consolidated results of operations and financialcondition.

 

InDecember 2004, the FASB issued SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123R”), whichreplaces SFAS No. 123, *Accounting forStock-Based Compensation*, (“SFAS 123”) and supercedes APBOpinion No. 25, *Accounting for StockIssued to Employees*. SFAS 123R requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the financial statements based on their fair values. Under SFAS123R, public companies will be required to measure the cost of employeeservices received in exchange for stock options and similar awards based on thegrant-date fair value of the award and recognize this cost in the incomestatement over the period during which an employee is required to provideservice in exchange for the award. The pro forma disclosures previously permittedunder SFAS 123 no longer will be an alternative to financial statementrecognition. Under SFAS 123R, Lone Star must determine the appropriatefair value model to be used for valuing share-based payments, the amortizationmethod for compensation cost and the transition method to be used at date ofadoption. The transition methods include modified prospective and retroactiveadoption options. Under the retroactive option, prior periods may be restatedeither as of the beginning of the year of adoption or for all periods presented.The prospective method requires that compensation expense be recorded for allunvested stock options and restricted stock at the beginning of the firstquarter of adoption of SFAS 123R, while the retroactive methods would recordcompensation expense for all unvested stock options and restricted stockbeginning with the first period restated. Lone Star adopted SFAS 123R onJanuary 1, 2006 using the modified prospective method. Under this method,Lone Star will recognize compensation cost, on a prospective basis, for theportion of outstanding awards for which the requisite service has not yet beenrendered as of January 1, 2006, based upon the grant-date fair value of thoseawards calculated under SFAS 123 for pro forma disclosure purposes. We expectthat the adoption of SFAS 123R will reduce our fiscal 2006 income byapproximately $1.7 million.

 

InDecember 2004, the FASB issued SFAS No. 153, *Exchanges of Nonmonetary Assets—An Amendment of APBOpinion No. 29, Accounting for Nonmonetary Transactions* (“SFAS 153”).SFAS 153 eliminates the exception from fair value measurement fornonmonetary exchanges of similar productive assets in paragraph 21(b) ofAPB Opinion No. 29, *Accounting forNonmonetary Transactions*, and replaces it with an exception forexchanges that do not have commercial substance. SFAS 153 specifies that anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange. LoneStar adopted  SFAS 153 on January 1,2006, and the adoption did not have a material impact on its consolidatedresults of operations and financial condition.

 

InMarch 2005, the FASB issued Interpretation No. 47, *Accounting for Conditional Asset Retirement Obligations* (“FIN47”), which clarifies that an entity is required to recognize a liability forthe fair value of a conditional asset retirement obligation when the obligationis incurred – generally upon acquisition, construction, or development and/orthrough the normal operation of the asset, if the fair value of the liabilitycan be reasonably estimated. A conditional asset retirement obligation is alegal obligation to perform an asset retirement activity in which the timingand/or method of settlement are conditional on a future event that may or maynot be within the control of the entity. If the fair value of a conditionalasset retirement obligation can be reasonably estimated, FIN 47 requires that aliability be recognized. FIN 47 is effective no later than the end of fiscalyears ending after December 15, 2005, therefore making it applicable for theyear ended December 31, 2005. The adoption of this pronouncement did not have amaterial impact on Lone Star’s financial position, results of operation, and cashflows as all material asset retirement obligations were already considered andrecorded in its environmental reserves discussed in Commitments andContingencies – Note K.

 

34

----

InMay 2005, the FASB issued SFAS No.154, *AccountingChanges and Error Corrections – A Replacement of APB Opinion No. 20 and FASBStatement No. 3*(“SFAS 154”). SFAS 154 requires the retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple, unless it is impractical to determine either the period-specificeffects or cumulative effect of the accounting change. SFAS 154 also requiresthat a change in depreciation, amortization, or depletion method for long-livednon-financial assets be accounted for as a change in accounting estimateaffected by a change in accounting principle. SFAS 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005, and we will adopt this provision, as applicable,during fiscal year 2006. We expect the adoption of SFAS 154 will not have amaterial impact on Lone Star’s results of operations or financial condition.

 

**FORWARD-LOOKING INFORMATION**

 

Thestatements included in this Annual Report regarding future financialperformance and results and the other statements that are not historical factsare forward-looking statements. The words “believes,” “intends,” “expects,” “anticipates,”“projects,” “estimates,” “predicts,” and similar expressions are also intendedto identify forward-looking statements. Such statements are “forward-lookingstatements” within the meaning of the safe harbor provisions of Section 27A ofthe Securities Act of 1933 and Section 21E of the Securities Exchange Act of1934. These forward-looking statements are based on our analysis of currentlyavailable competitive, financial and economic data and our operating plans. Theyare inherently uncertain, and events and actual results could turn out to besignificantly different from our expectations.

 

Thefollowing are some of the factors that should be considered when evaluatingthese forward-looking statements:

 

•                  fluctuations in domestic and worldwide pricesand demand for natural gas and oil;

 

•                  fluctuations in levels of natural gas andcrude oil exploration and development activities;

 

•                  fluctuations in the demand for our productsand services;

 

•                  the competition for raw materials used in ourbusiness and the volatility of our raw material costs;

 

•                  the effect of foreign competition on ourindustry, particularly oilfield products, which could be increased by an easingof U.S. government import trade restrictions;

 

•                  fluctuations in inventory levels of oilfieldproducts;

 

•                  the existence of inherent risk in oil and gasdrilling and transmission activities;

 

•                  fluctuations in levels of manufacturing andother general economic activity, particularly in the automotive and otherindustries that purchase our specialty tubulars; and

 

•                  general economic conditions.

 

Asustained increase or decrease in the price of natural gas or oil, which couldhave a material impact on exploration and production activities, could alsomaterially affect our financial position, results of operations and cash flows.These and other important factors could cause actual results to differmaterially from the forward-looking statements described in this Annual Report.Lone Star Technologies, Inc. does not undertake any obligation to update orrevise our forward-looking statements, whether as a result of new information,future events or otherwise. Should one or more of these risks or uncertaintiesmaterialize, or should underlying assumptions prove incorrect, actual outcomesmay vary materially from those indicated.

 

35

----

 
| **ITEM 7A.** | **QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK** |
|--------------|----------------------------------------------------------------|

 

Weare exposed to certain risks associated with the change in foreign currencyrates, interest rates and commodity prices. We seek to minimize the potentialadverse impact of those market risks through the use of appropriate managementtechniques including the limited use of derivative financial instruments.

 

Ouroperations in Mexico are accounted for in the local currency, converted to theU.S. dollar equivalent based on published exchange rates for the periodreported and are therefore subject to risk of exchange rate fluctuations. Webelieve that our current risk exposure to exchange rate movements is notsignificant.

 

Ourinvestments in cash equivalents, the maturity of which are three months or less,and our investments in debt securities, the weighted average maturity of whichare less than one year, are subject to interest rate risk. The value of thesesecurities would decline in the event of increases in market interest rates. Wemanage this risk by investing in securities that have relatively short-termmaturities and with varying maturity dates. In addition, we intend to hold someof these securities until maturity and, as a result, avoid the losses resultingfrom sudden changes in interest rates.

 

Tothe extent that we borrow against our credit facility, we are exposed tointerest rate risk arising from the variable-rate nature of the facility. Therewere no borrowings on this facility at December 31, 2005. In the past, we haveused interest rate swaps to effectively fix a portion of the interest rates onour variable rate credit facilities. We did not have any interest rate swaps atDecember 31, 2005 and 2004. Our senior subordinated notes accrue interest at afixed rate of 9%. The fair value of the notes is sensitive to changes ininterest rates. The fair value of Lone Star’s senior subordinated debt based onquoted market prices was $157.9 million and $156.8 million at December 31, 2005and 2004, respectively.

 

Weare subject to commodity price risk, primarily with respect to purchases ofsteel and natural gas. Purchased steel represents a significant portion of ourcost of goods sold. As a result, fluctuations in the cost of purchased steel,which can be volatile and cyclical in nature, have a significant impact on ourmargins both positively and negatively. Our steel costs have risensignificantly since the end of 2003. We have been successful in passing thesehigher steel costs on to our customers; however, there can be no assurance thatwe will continue to be able to do so in the future.

 

Wepurchase natural gas for our operations and therefore have a limited marketrisk in natural gas prices. As a result, our earnings could be affected bychanges in the price of natural gas. As market conditions dictate, we may enterinto contracts to acquire a significant portion of our natural gas requirementsover periods ranging from six to eighteen months. Our remaining requirementsare purchased on the market at the current value. Our natural gas purchasecommitments at December 31, 2005 totaled $21.3 million.

 

36

----

 
| **ITEM 8.** | **CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA** |
|-------------|--------------------------------------------------------------|

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

 
|                                                                               |   | **Page** |
|------------------------------------------------------------------------------------|--------|----------|
| Management’s Report on Internal Control  over Financial Reporting             |   | 38       |
| Reports of Independent  Registered Public Accounting Firm                          |   | 39       |
| Consolidated Results of Operations                                                 |   |     |
| for the  years ended December 31, 2005, 2004, and 2003                             |   | 41       |
| Consolidated Balance Sheets at December  31, 2005 and 2004                         |   | 42       |
| Consolidated Statements of Cash  Flows,                                            |   |     |
| for the years ended December 31,  2005, 2004 (as restated), and 2003 (as restated) |   | 43       |
| Consolidated Statements of  Shareholders’ Equity                              |   |     |
| for  the years ended December 31, 2005, 2004, and 2003                             |   | 44       |
| Notes to Consolidated Financial  Statements                                        |   | 45       |
| Schedule II - Valuation and  Qualifying Accounts                                   |   | 71       |

 

37

----

 

**MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIALREPORTING**

 

Tothe Board of Directors and Shareholders of Lone Star Technologies, Inc.:

 

The management of Lone Star Technologies, Inc.and subsidiaries (“Lone Star”) is responsible for establishing and maintainingadequate internal control over financial reporting, as such term is defined inSecurities Exchange Act Rules 13a-15(f).

 

All internal control systems, no matter howwell designed, have inherent limitations. Therefore, even those systemsdetermined to be effective can provide only reasonable assurance with respectto financial statement preparation and presentation.

 

LoneStar’s management, including its principal executive officer and principalfinancial officer, assessed the effectiveness of the company’s internal controlover financial reporting as of December 31, 2005. In making this assessment, itused the criteria set forth by the Committee of Sponsoring Organizations of theTreadway Commission (COSO) in *InternalControl – Integrated Framework*. Based on our assessment we believethat, as of December 31, 2005, the company’s internal control over financialreporting is effective based on those criteria.

 

LoneStar’s independent registered public accounting firm, Deloitte & ToucheLLP, has issued an audit report on our assessment of the company’s internalcontrol over financial reporting, which is included herein.

 

LoneStar Technologies, Inc.

Dallas,Texas

February27, 2006

 
| /s/  Rhys J. Best        |                     | /s/  Charles J. Keszler |   |
|--------------------------|--------------------------|-------------------------|--------|
|                     |                     |
| Rhys  J. Best            | Charles  J. Keszler      |
| Chief  Executive Officer | Chief  Financial Officer |

 

38

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

To the Board of Directors and Shareholders of LoneStar Technologies, Inc.:

 

Wehave audited management’s assessment, included in the accompanying “Management’sReport on Internal Control Over Financial Reporting,” that Lone StarTechnologies, Inc. and subsidiaries (the “Company”) maintained effectiveinternal control over financial reporting as of December 31, 2005, based oncriteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinions.

 

Acompany’s internal control over financial reporting is a process designed by,or under the supervision of, the company’s principal executive and principalfinancial officers, or persons performing similar functions, and effected bythe company’s board of directors, management, and other personnel to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control overfinancial reporting includes those policies and procedures that (1) pertain tothe maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2)provide reasonable assurance that transactions are recorded as necessary topermit preparation of financial statements in accordance with generallyaccepted accounting principles, and that receipts and expenditures of thecompany are being made only in accordance with authorizations of management anddirectors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

Becauseof the inherent limitations of internal control over financial reporting,including the possibility of collusion or improper management override ofcontrols, material misstatements due to error or fraud may not be prevented ordetected on a timely basis. Also, projections of any evaluation of theeffectiveness of the internal control over financial reporting to futureperiods are subject to the risk that the controls may become inadequate becauseof changes in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

 

Inour opinion, management’s assessment that the Company maintained effectiveinternal control over financial reporting as of December 31, 2005, is fairlystated, in all material respects, based on the criteria established in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.Also in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31, 2005,based on the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheet asof December 31, 2005 and the related consolidated results of operations,statements of shareholders’ equity and cash flows for the year ended December31, 2005 of the Company and our report dated March 1, 2006 expressed anunqualified opinion on those financial statements.

 

DELOITTE& TOUCHE LLP

Dallas,Texas

March1, 2006

 

39

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Shareholders of

LoneStar Technologies, Inc.:

 

Wehave audited the accompanying consolidated balance sheets of Lone StarTechnologies, Inc. and subsidiaries (the “Company”) as of December 31, 2005 and2004, and the related consolidated results of operations, statements ofshareholders’ equity and cash flows for each of the three years in the periodended December 31, 2005. These financial statements are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

Inour opinion, such consolidated financial statements present fairly, in allmaterial respects, the financial position of Lone Star Technologies, Inc. andsubsidiaries as of December 31, 2005 and 2004, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2005, in conformity with accounting principles generally acceptedin the United States of America.

 

Asdiscussed in Note A, the accompanying 2004 and 2003 consolidated statements of cashflows have been restated.

 

We have also audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theeffectiveness of the Company’s internal control over financial reporting as ofDecember 31, 2005, based on the criteria established in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated March 1, 2006 expressed an unqualified opinion onmanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting and an unqualified opinion on the effectiveness of theCompany’s internal control over financial reporting.

 

DELOITTE & TOUCHE LLP

Dallas, Texas

March 1, 2006

 

40

----

 

**LONE STAR TECHNOLOGIES, INC.**

**CONSOLIDATED RESULTS OF OPERATIONS**

***($ and shares inmillions, except per share data)***

 

 

 
| ** **                                          | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                          | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net revenues                                        |       | $                                    | 1,285.1    |   | $ | 966.8 |   | $ | 534.1 |   |
| Cost of goods sold                                  |       | 1,012.8                              |       | 804.8 |   | 528.9 |   |
| Gross profit                                        |       | 272.3                                |       | 162.0 |   | 5.2 |   |
| Selling, general, and administrative expenses       |       | 50.5                                 |       | 44.6 |   | 41.8 |   |
| Goodwill impairment charge                          |       | —                               |       | — |   | 18.7 |   |
| Operating income  (loss)                            |       | 221.8                                |       | 117.4 |   | (55.3 | ) |
| Interest income                                     |       | 5.8                                  |       | 1.8 |   | 1.4 |   |
| Interest expense                                    |       | (16.1                                | )          | (16.8 | ) | (16.4 | ) |
| Other income, net                                   |       | 8.7                                  |       | 2.0 |   | 2.2 |   |
| Income (loss)  before income tax                    |       | 220.2                                |       | 104.4 |   | (68.1 | ) |
| Income tax (benefit) expense                        |       | (3.4                                 | )          | 3.4 |   | 0.1 |   |
| Net income  (loss)                                  |       | $                                    | 223.6      |   | $ | 101.0 |   | $ | (68.2 | ) |
|                                                |       |                                 |       |   |   |   |   |
| **Per common share - basic:**                       |       |                                 |       |   |   |   |   |
| Net income  (loss) available to common shareholders |       | $                                    | 7.44       |   | $ | 3.51 |   | $ | (2.40 | ) |
|                                                |       |                                 |       |   |   |   |   |
| **Per common share - diluted:**                     |       |                                 |       |   |   |   |   |
| Net income  (loss) available to common shareholders |       | $                                    | 7.34       |   | $ | 3.46 |   | $ | (2.40 | ) |
|                                                |       |                                 |       |   |   |   |   |
| **Weighted average shares outstanding**             |       |                                 |       |   |   |   |   |
| Basic                                               |       | 30.0                                 |       | 28.7 |   | 28.4 |   |
| Diluted                                             |       | 30.5                                 |       | 29.2 |   | 28.4 |   |

 

See Notes to Consolidated Financial Statements.

 

41

----

 

**LONE STAR TECHNOLOGIES, INC.**

**CONSOLIDATED BALANCE SHEETS**

***($ in millions,except share data)***

 
| ** **                                                                                                    | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                    | ** ** | **2005**         | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                    | ** ** | ** **       | ** ** | ** ** | ** ** |
|                                                                                                          |       |             |       |   |   |
| Current Assets:                                                                                               |       |             |       |   |   |
| Cash and cash  equivalents                                                                                    |       | $                | 102.2      |   | $ | 30.2 |   |
| Short-term  investments                                                                                       |       | 153.5            |       | 46.4 |   |
| Accounts  receivable, less allowances of $1.4 and 1.3, respectively                                           |       |             |       |   |   |
|                                                                                                          |       | 141.3            |       | 122.6 |   |
| Inventories                                                                                                   |       | 245.0            |       | 128.3 |   |
| Deferred tax  asset                                                                                           |       | 65.3             |       | - |   |
| Other current  assets                                                                                         |       | 16.7             |       | 51.6 |   |
| Total current  assets                                                                                         |       | 724.0            |       | 379.1 |   |
|                                                                                                          |       |             |       |   |   |
| Investments                                                                                                   |       | -                |       | 12.7 |   |
| Property, plant, and equipment, net                                                                           |       | 197.5            |       | 205.8 |   |
| Goodwill                                                                                                      |       | 40.9             |       | 40.9 |   |
| Other noncurrent assets                                                                                       |       | 16.9             |       | 8.2 |   |
| Total assets                                                                                                  |       | $                | 979.3      |   | $ | 646.7 |   |
|                                                                                                          |       |             |       |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                |       |             |       |   |   |
|                                                                                                          |       |             |       |   |   |
| Current Liabilities:                                                                                          |       |             |       |   |   |
| Accounts payable                                                                                              |       | $                | 54.7       |   | $ | 53.9 |   |
| Accrued  liabilities                                                                                          |       | 53.7             |       | 37.1 |   |
| Total current  liabilities                                                                                    |       | 108.4            |       | 91.0 |   |
|                                                                                                          |       |             |       |   |   |
| Senior subordinated debt                                                                                      |       | 150.0            |       | 150.0 |   |
| Postretirement benefit obligations                                                                            |       | 39.0             |       | 40.1 |   |
| Deferred tax liability                                                                                        |       | 28.5             |       | — |   |
| Other noncurrent liabilities                                                                                  |       | 13.2             |       | 11.1 |   |
| Total  liabilities                                                                                            |       | 339.1            |       | 292.2 |   |
|                                                                                                          |       |             |       |   |   |
| Commitments and Contingencies (See Note K)                                                                    |       |             |       |   |   |
|                                                                                                          |       |             |       |   |   |
| Shareholders’ Equity:                                                                                    |       |             |       |   |   |
| Preferred stock,  $1 par value (authorized: 10,000,000 shares, issued: none)                                  |       |             |       |   |   |
|                                                                                                          |       | -                |       | - |   |
| Common stock, $1  par value (authorized: 80,000,000 shares, issued: 30,600,205 and 29,240,866,  respectively) |       | 30.6             |       | 29.2 |   |
| Capital surplus                                                                                               |       | 422.1            |       | 363.0 |   |
| Accumulated  other comprehensive loss                                                                         |       | (33.3            | )          | (32.6 | ) |
| Retained  earnings (accumulated deficit)                                                                      |       | 221.2            |       | (2.4 | ) |
| Treasury stock,  at cost (10,862 and 195,958 shares, respectively)                                            |       | (0.4             | )          | (2.7 | ) |
| Total  shareholders’ equity                                                                              |       | 640.2            |       | 354.5 |   |
| Total  liabilities and shareholders’ equity                                                              |       | $                | 979.3      |   | $ | 646.7 |   |

 

See Notes to Consolidated Financial Statements.

 

42

----

 

**LONE STAR TECHNOLOGIES, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

***($ in millions)***

 

 
| ** **                                                                                                                      | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                      | ** ** | ** **                           | ** ** | **Restated  Note A** | ** ** | **Restated  Note A** | ** ** |
| **Cash flows from operating activities:**                                                                                       |       |                                 |       |   |   |   |   |
| Net income  (loss)                                                                                                              |       | $                                    | 223.6      |   | $ | 101.0 |   | $ | (68.2 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities, net of acquired companies: |       |                                 |       |   |   |   |   |
| Depreciation and  amortization                                                                                                  |       | 27.9                                 |       | 27.8 |   | 25.4 |   |
| Non–cash charge  for stock compensation                                                                                    |       | 3.5                                  |       | 1.6 |   | 1.1 |   |
| Net loss (gain)  on property disposals and impairments                                                                          |       | (0.1                                 | )          | 0.1 |   | 0.4 |   |
| Gain on early  termination of alliance agreement                                                                                |       | (7.8                                 | )          | — |   | — |   |
| Deferred taxes                                                                                                                  |       | (13.3                                | )          | — |   | — |   |
| Goodwill  impairment                                                                                                            |       | —                               |       | — |   | 18.7 |   |
| Changes in  operating assets and liabilities:                                                                                   |       |                                 |       |   |   |   |   |
| Accounts  receivable                                                                                                            |       | (18.7                                | )          | (52.8 | ) | (7.1 | ) |
| Inventories                                                                                                                     |       | (116.7                               | )          | 24.5 |   | (4.0 | ) |
| Other current  assets                                                                                                           |       | 48.0                                 |       | (35.8 | ) | (2.8 | ) |
| Accounts payable  and accrued liabilities                                                                                       |       | 17.4                                 |       | 1.9 |   | 27.2 |   |
| Litigation  reserves                                                                                                            |       | (1.0                                 | )          | (33.0 | ) | 2.0 |   |
| Other                                                                                                                           |       | (14.6                                | )          | (5.8 | ) | (1.1 | ) |
| Net cash  provided by (used in) operating activities                                                                            |       | 148.2                                |       | 29.5 |   | (8.4 | ) |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| **Cash flows from investing activities:**                                                                                       |       |                                 |       |   |   |   |   |
| Capital  expenditures                                                                                                           |       | (21.0                                | )          | (13.0 | ) | (14.4 | ) |
| Purchase of  investments                                                                                                        |       | (324.1                               | )          | (88.6 | ) | — |   |
| Restricted cash                                                                                                                 |       | —                               |       | 32.2 |   | (32.2 | ) |
| Proceeds from  sale of property, plant and equipment                                                                            |       | 2.5                                  |       | 0.7 |   | 0.4 |   |
| Proceeds from  sales of investments                                                                                             |       | 229.7                                |       | 29.5 |   | — |   |
| Cash paid for  acquisitions, net of cash received                                                                               |       | —                               |       | — |   | (34.0 | ) |
| Net cash used in  investing activities                                                                                          |       | (112.9                               | )          | (39.2 | ) | (80.2 | ) |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| **Cash flows from financing activities:**                                                                                       |       |                                 |       |   |   |   |   |
| Proceeds from  exercise of options                                                                                              |       | 36.6                                 |       | 6.4 |   | 1.3 |   |
| Purchase of  treasury stock                                                                                                     |       | —                               |       | — |   | (0.8 | ) |
| Net cash  provided by financing activities                                                                                      |       | 36.6                                 |       | 6.4 |   | 0.5 |   |
| Effect of  foreign exchange rate changes on cash                                                                                |       | 0.1                                  |       | 0.2 |   | 0.9 |   |
| Net change in  cash and cash equivalents                                                                                        |       | 72.0                                 |       | (3.1 | ) | (87.2 | ) |
| Cash and cash  equivalents, beginning of year                                                                                   |       | 30.2                                 |       | 33.3 |   | 120.5 |   |
| Cash and cash  equivalents, end of year                                                                                         |       | $                                    | 102.2      |   | $ | 30.2 |   | $ | 33.3 |   |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| **Supplemental cash flow disclosure:**                                                                                          |       |                                 |       |   |   |   |   |
| Interest paid                                                                                                                   |       | $                                    | 16.3       |   | $ | 17.0 |   | $ | 13.9 |   |
| Income taxes  paid, net                                                                                                         |       | $                                    | 4.9        |   | $ | 1.8 |   | $ | — |   |

 

See Notes to Consolidated Financial Statements.

 

43

----

 

**LONE STAR TECHNOLOGIES, INC.**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS' EQUITY**

*($ in millions)*

 

 
| ** **                                 | ** ** | ** ** | ** ** | ** **  | ** ** | **Accumulated**   | ** ** | **Retained**     | ** ** | ** **   | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------|------------|-------------|------------|-------------------|------------|------------------|------------|--------------|------------|------------|------------|
| ** **                                 | ** ** | ** ** | ** ** | ** **  | ** ** | **Other**         | ** ** | **Earnings**     | ** ** | ** **   | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Common** | ** ** | **Capital** | ** ** | **Comprehensive** | ** ** | **(Accumulated** | ** ** | **Treasury** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Stock**  | ** ** | **Surplus** | ** ** | **Loss**          | ** ** | **Deficit)**     | ** ** | **Stock**    | ** ** | **Total**  | ** ** |
| **Balance, January 1, 2003**               |       | $          | 28.5       |        | $          | 352.7             |       | $                | (32.1      | )            | $          | (35.2      | )          | $ | (1.3 | ) | $ | 312.6 |   |
| Net loss                                   |       | —     |       | —      |       | —            |       | (68.2            | )          | —       |       | (68.2      | )          |
| Other comprehensive income (loss):         |       |       |       |        |       |              |       |             |       |         |       |       |       |
| Minimum pension  liability adjustment      |       | —     |       | —      |       | (1.0              | )          | —           |       | —       |       | (1.0       | )          |
| Foreign currency  translation adjustment   |       | —     |       | —      |       | 0.9               |       | —           |       | —       |       | 0.9        |       |
| Comprehensive  loss                        |       |       |       |        |       |              |       |             |       |         |       | (68.3      | )          |
| Employee benefit plan stock issuance       |       | 0.2        |       | 2.4         |       | —            |       | —           |       | (0.2         | )          | 2.4        |       |
| Acquisition of treasury stock              |       | —     |       | —      |       | —            |       | —           |       | (0.8         | )          | (0.8       | )          |
|                                       |       |       |       |        |       |              |       |             |       |         |       |       |       |
| **Balance, December 31, 2003**             |       | 28.7       |       | 355.1       |       | (32.2             | )          | (103.4           | )          | (2.3         | )          | 245.9      |       |
| Net income                                 |       | —     |       | —      |       | —            |       | 101.0            |       | —       |       | 101.0      |       |
| Other comprehensive income (loss):         |       |       |       |        |       |              |       |             |       |         |       |       |       |
| Minimum pension  liability adjustment      |       | —     |       | —      |       | (0.6              | )          | —           |       | —       |       | (0.6       | )          |
| Foreign currency  translation adjustment   |       | —     |       | —      |       | 0.2               |       | —           |       | —       |       | 0.2        |       |
| Comprehensive  income                      |       | —     |       | —      |       | —            |       | —           |       | —       |       | 100.6      |       |
| Employee benefit plan stock issuance       |       | 0.5        |       | 7.9         |       | —            |       | —           |       | (0.4         | )          | 8.0        |       |
|                                       |       |       |       |        |       |              |       |             |       |         |       |       |       |
| **Balance, December 31, 2004**             |       | 29.2       |       | 363.0       |       | (32.6             | )          | (2.4             | )          | (2.7         | )          | 354.5      |       |
| Net income                                 |       | —     |       | —      |       | —            |       | 223.6            |       | —       |       | 223.6      |       |
| Other comprehensive income (loss):         |       |       |       |        |       |              |       |             |       |         |       |       |       |
| Minimum pension  liability adjustment      |       | —     |       | —      |       | (0.8              | )          | —           |       | —       |       | (0.8       | )          |
| Foreign currency  translation adjustment   |       | —     |       | —      |       | 0.1               |       | —           |       | —       |       | 0.1        |       |
| Comprehensive income                       |       | —     |       | —      |       | —            |       | —           |       | —       |       | 222.9      |       |
| Tax benefit from exercise of stock options |       | —     |       | 23.7        |       | —            |       | —           |       | —       |       | 23.7       |       |
| Employee benefit plan stock issuance       |       | 1.4        |       | 35.4        |       | —            |       | —           |       | 2.3          |       | 39.1       |       |
|                                       |       |       |       |        |       |              |       |             |       |         |       |       |       |
| **Balance, December 31, 2005**             |       | $          | 30.6       |        | $          | 422.1             |       | $                | (33.3      | )            | $          | 221.2      |       | $ | (0.4 | ) | $ | 640.2 |   |

 

See Notes to Consolidated Financial Statements.

 

44

----

 

**Lone Star Technologies, Inc.**

**Notes toConsolidated Financial Statements**

 

LoneStar Technologies, Inc. (“Lone Star”, or the “Company”), a Delawarecorporation, is a management and holding company with six principal operatingsubsidiaries, Lone Star Steel Company (“Steel”), Fintube Technologies, Inc. (“Fintube”),Bellville Tube Company, L.P. (“Bellville”), Wheeling Machine Products, Inc. (“Wheeling”),Delta Tubular Processing, Inc. (“DTP”), acquired May 1, 2003 and, DeltaTubular International, Inc. (“DTI”), acquired June 2, 2003. Steel manufacturesand globally markets oilfield tubular products to the oil and gas drilling industry,mechanical tubing products to automotive, fluid power, and other markets forvarious mechanical applications, and flat rolled steel and other tubularproducts to domestic industrial markets. Fintube manufactures specialty finnedtubular products used in a variety of heat recovery applications includingcombined-cycle electrical power generation. Bellville manufactures oilfieldtubular products. Wheeling manufactures couplings used to connect individualsections of oilfield casing and tubing. DTP and DTI provide oil country tubularprocessing services including threading and inspection services.

 

LoneStar’s consolidated revenues are not seasonal. However, demand for oilfieldproducts is subject to significant fluctuations due to the volatility of oiland gas prices and domestic drilling activity as well as other factorsincluding competition from imports. Demand for mechanical tubing and finnedtubular products is primarily subject to fluctuations in general economicconditions.

 

**ACCOUNTING POLICIES - NOTE A**

 

***Principles of consolidation*****.**The consolidated financial statements includethe accounts of Lone Star and its wholly-owned subsidiaries. All significantintercompany accounts and transactions have been eliminated in consolidation. Inthe Notes to Consolidated Financial Statements, all dollar and share amounts intabulation are in millions of dollars and shares, respectively, except pershare data and unless otherwise noted. Certain prior year amounts have beenreclassified to conform to the current year’s presentation.

 

***Cash and cash equivalents*****.**Lone Star’s cash and cash equivalents includecommercial bank accounts and highly liquid investments in a fund consisting ofU. S. government and related agencies obligations with original maturities ofless than three months.

 

***Investments.***Lone Star accounts for its investments in debtsecurities under Statement of Financial Accounting Standard No. 115, *Accounting for Certain Investments in Debt and EquitySecurities* (“SFAS No. 115”). Under SFAS No. 115, investments forwhich Lone Star has the positive intent and the ability to hold to maturity areclassified as held-to-maturity securities and are reported at amortized cost,which approximates fair market value at December 31, 2005 and 2004. Thoseclassified as available-for-sale are reported at fair value with unrealizedgains and losses recorded in comprehensive income.

 

***Inventories*** are stated at the lower of cost or marketvalue. Cost is determined using the last-in, first-out (“LIFO”) method forapproximately 82% of the Company’s total current inventories after LIFO reservefor the years ended December 31, 2005 and 2004. The cost of remaininginventories is determined using the average cost method. Inventories includeraw materials and certain supplies.

 

***Property, plant, and equipment*** are stated at cost. Significant bettermentsand improvements are capitalized if they extend the useful life of the asset,while maintenance and repairs are expensed when incurred. Depreciation isprovided on the straight-line method over the estimated useful lives ofdepreciable assets as follows:

 

| Land  improvements                      | 3 - 39 Years |
|-----------------------------------------|--------------|
| Buildings,  structures and improvements | 4 - 30 Years |
| Machinery and  equipment                | 3 - 30 Years |

 

45

----

 

***Impairment of long-lived assets.***In accordance with Statement of FinancialAccounting Standard (“SFAS”) No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*, Lone Starperiodically evaluates the recoverability of long-lived assets whenever eventsand changes in circumstances indicate that the carrying amount of an asset maynot be fully recoverable. At December 31, 2005, the Company believes that itslong-lived assets have not been impaired.

 

***Income taxes***. Lone Star applies the provisions of SFAS No. 109, *Accounting for Income Taxes*, whichutilizes an asset and liability approach for financial accounting and incometax reporting. Deferred tax liabilities or assets are recognized for theestimated future tax effects attributable to temporary differences andcarryforwards and are adjusted whenever tax rates or other provisions of incometax statutes change. Deferred tax assets are reduced, if deemed necessary, by avaluation allowance for any tax benefits that are not expected to be realized.

 

***Revenue recognition***. Product revenues are recognized as saleswhen revenue is earned and is realized or realizable. This includes satisfyingthe following criteria:  the arrangementwith the customer is evident, usually through the receipt of a purchase order; thesales price is fixed or determinable; delivery has occurred, which may includedelivery to the customer storage warehouse location at one of the Company’ssubsidiaries, in which instance, the risk of loss has been passed to thecustomer; and collectibility is reasonably assured. Freight and shipping billedto customers is included in net sales, and the cost of freight and shipping isincluded in cost of sales. The Company has marketing agreements to sell steeloilfield tubular products manufactured by other companies. Revenue is recordedon a gross basis for certain transactions with alliance mills when the Companyis the primary obligor and has general inventory and credit risk, and certainother transactions are recorded net.

 

***Foreign currency translation.***In accordance with SFAS No. 52, *Foreign Currency Translation*,**one of Lone Star’s internationaloperations uses the local currency as its functional currency while anotherinternational operation uses the U.S. Dollar as its functional currency.Revenue and expenses from the Company’s international operations are translatedusing the average exchange rates in effect for the period in which the itemsoccur. The Company’s international operation that has the U.S. Dollar as itsfunctional currency translates monetary assets and liabilities using currentrates of exchange at the balance sheet date and translates non-monetary assetsand liabilities using historical rates of exchange. Gains and losses fromremeasurement for such operations are included in other income, on a net basisand have historically not been significant. The Company’s internationaloperation that does not have the U.S. Dollar as its functional currencytranslates assets and liabilities at current rates of exchange in effect at thebalance sheet date. The resulting gains and losses from translation for suchsubsidiary are included as a component of shareholders’ equity.

 

***Business and Credit Risk.***Lone Star sells products to numerous customersprimarily in the oil and gas drilling industry. Although this concentrationcould affect the Company’s overall exposure to credit risk, management believesthat the Company is exposed to minimal risk since the majority of its businessis conducted with major companies within the industry. The Company performson-going credit evaluations of its customers and generally does not requirecollateral when extending credit. The Company maintains a reserve for potentialcredit losses. Such losses have historically been within management’sexpectations. The Company does not have financial instruments with off-balancesheet risk.

 

LoneStar maintains cash and cash equivalents and investments in debt securitieswith various financial institutions. As part of its cash and risk managementprocesses, the Company performs periodic evaluations of the relative creditstanding of the financial institutions. Lone Star has not sustained creditlosses from instruments held at financial institutions.

 

***Stock-Based Employee Compensation.***Through December 31, 2005, the Company accountedfor stock-based compensation utilizing the intrinsic value method in accordancewith the provisions of Accounting Principles Board Opinion No. 25 (“APB 25”), *Accounting for Stock Issued to Employees*and related Interpretations. Accordingly, no compensation expense wasrecognized for fixed option plans because the exercise prices of employee stockoptions equal or exceed the market prices of the underlying stock on the datesof grant. As permitted, the Company elected to adopt the disclosure only provisionsof SFAS No. 123, *Accounting forStock-Based Compensation*. Refer to Note J for further information. LoneStar was required to adopt SFAS No. 123(R), *Share-BasedPayment,* on January 1, 2006.

 

46

----

 

Theweighted average fair value per option granted in 2004 and 2003 was $8.58 and$9.70, respectively. No options were granted in 2005. The fair value of eachoption grant is estimated on the date of grant using the Black-Scholes optionpricing model with the following weighted average assumptions for grants in2004 and 2003, respectively: risk-free interest rates of 2.61% and 2.93%;volatility of 63.19% and 61.86%; expected lives of 3.5 years and 5.0 years;and, all option grants without payment of dividends. Had compensation cost forthis plan been determined consistent with SFAS No. 123, net income and earningsper share would have been reduced to the following pro forma amounts:

 

 
| ** **                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income (loss) as reported          |       | $        | 223.6      |     | $          | 101.0    |       | $ | (68.2 | ) |
| Add: Stock-ased  employee              |       |     |       |     |       |     |       |
| compensation  expense included         |       |     |       |     |       |     |       |
| in reported net  income (loss), net of |       |     |       |     |       |     |       |
| related tax  effects                   |       | 3.5      |       | 1.6      |       | 1.1      |       |
| Deduct: Total  stock-ased employee     |       |     |       |     |       |     |       |
| compensation  expense                  |       |     |       |     |       |     |       |
| determined under  fair value based     |       |     |       |     |       |     |       |
| method for all  awards, net of         |       |     |       |     |       |     |       |
| related tax  effects                   |       | (7.3     | )          | (7.5     | )          | (7.7     | )          |
| Pro forma net  income (loss)           |       | $        | 219.8      |     | $          | 95.1     |       | $ | (74.8 | ) |
| Basic earnings (loss) per share        |       |     |       |     |       |     |       |
| as reported                            |       | $        | 7.44       |     | $          | 3.51     |       | $ | (2.40 | ) |
| pro forma                              |       | $        | 7.33       |     | $          | 3.31     |       | $ | (2.63 | ) |
| Diluted earnings (loss) per share      |       |     |       |     |       |     |       |
| as reported                            |       | $        | 7.34       |     | $          | 3.46     |       | $ | (2.40 | ) |
| pro forma                              |       | $        | 7.21       |     | $          | 3.26     |       | $ | (2.63 | ) |

 

***Fair Value of Financial Instruments.*********The carrying amount of cash and cash equivalents,trade receivables and payables approximates fair value because of the shortmaturity of those instruments. The estimated fair value of Lone Star’sinvestments in debt securities based on quoted market prices was $153.4 millionand $59.1 million at December 31, 2005 and 2004, respectively. The estimatedfair value of Lone Star’s senior subordinated debt based on quoted marketprices was $157.9 million and $156.8 million at December 31, 2005 and 2004,respectively. These estimated fair values may not be representative of actualvalues of the financial instruments that could have been realized as ofyear-end or that will be realized in the future.

 

Asof December 31, 2005 and 2004, the Company had outstanding letters of credit of$0.3 million and $4.1 million, respectively, which approximates fair value.

 

***Accumulated Other Comprehensive Loss.***As of December 31, 2005 and 2004, accumulatedother comprehensive loss consisted of $33.3 million and $32.5 million,respectively, related to minimum pension liability adjustments and $0.1 millionrelated to cumulative translation adjustment in 2004.

 

***Use of Estimates.***Preparation of the consolidated financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities, disclosures of contingent assets and liabilities,and the reported amounts of revenues and expenses. The Company’s estimates areprimarily based on historical experience and business knowledge and are revisedas circumstances change. However, actual results could differ from thoseestimates.

 

Lone Star’s products are used in applicationswhich are subject to inherent risks including but not limited to well failures,performance deficiencies, line pipe leaks, personal injury, property damage,environmental contamination or loss of oil and gas production. The Companywarrants its products to meet certain specifications. Actual or claimeddeficiencies from these specifications may give rise to claims and the Companymaintains a reserve for asserted and unasserted warranty claims. The warrantyclaim exposure is evaluated using historical claim trends and informationavailable on specifically known claims. The Company also maintains product andexcess liability insurance subject to certain deductibles that limit theexposure to these claims. The Company considers the extent of insurancecoverage in its estimate of the reserve. Typically, this reserve is not subjectto significant fluctuations from period-to-period. However, the incurrence of anunusual

 

47

----

 

amount of claims could alter the Company’sexposure and the related reserve. The following table identifies changes inwarranty reserves from January 1, 2003 to December 31, 2005:

 
| ** **                                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Beginning balance                                       |       | $        | 2.4        |     | $          | 2.4      |       | $ | 2.1 |   |
| Warranty expense  accruals                              |       | 8.0      |       | 3.1      |       | 2.0      |       |
| Changes in  estimates to pre-existing warranty accruals |       | (0.2     | )          | —   |       | 0.2      |       |
| Warranty  settlements                                   |       | (7.2     | )          | (3.1     | )          | (1.9     | )          |
| Ending balance                                          |       | $        | 3.0        |     | $          | 2.4      |       | $ | 2.4 |   |

 

Lone Star is subject to numerous environmentalregulations and is actively remediating known exposures and conductingpost-closure monitoring activities. The Company maintains an environmentalreserve to cover the costs of expected remediation and post-closure monitoringand estimates the cost for the remediation and post-closure monitoring based onhistorical experience, results of monitoring and the known extent of exposure. TheCompany evaluates the range of exposure and records the reserve at the mostprobable amount within that range. Typically, this reserve is not subject tosignificant fluctuations from period-to-period. However, given the nature ofenvironmental exposures, significant changes in the reserve are possible.

 

***Statementsof Cash Flows Restatement.*** Subsequent to the issuance ofthe 2004 financial statements, the Company’s management determined that it hadnot reflected the change in the Company’s restricted cash account as a cashflow from investing activities but had included the change as a cash flow fromoperating activities.  As a result, forthe 2004 and 2003 periods, the change in restricted cash in the ConsolidatedStatements of Cash Flows has been reclassified from operating activities toinvesting activities. This had no impact on the Consolidated Results ofOperations or Consolidated Balance Sheets.

 

Consolidated Statementsof Cash Flows

 
| ** **                                                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net cash  provided by (used in) operating activities, as previously reported |       | 61.7     |       | (40.6    | )          |
| Net cash  provided by (used in) operating activities, as restated            |       | 29.5     |       | (8.4     | )          |
| Net cash  provided by (used in) investing activities, as previously reported |       | (71.4    | )          | (48.0    | )          |
| Net cash  provided by (used in) investing activities, as restated            |       | (39.2    | )          | (80.2    | )          |

 

***New Accounting Pronouncements.***In November 2004, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 151, *Inventory Costs—An Amendment of ARB No. 43,Chapter 4* (“SFAS 151”). SFAS 151 amends the guidance inARB No. 43, Chapter 4, *InventoryPricing*, to clarify the accounting for abnormal amounts of idlefacility expense, freight, handling costs, and wasted material (spoilage). Amongother provisions, the new rule requires that items such as idle facilityexpense, excessive spoilage, double freight, and rehandling costs be recognizedas current-period charges regardless of whether they meet the criterion of “soabnormal” as stated in ARB No. 43. Additionally, SFAS 151 requiresthat the allocation of fixed production overhead to the costs of conversion bebased on the normal capacity of the production facilities. SFAS 151 iseffective for fiscal years beginning after June 15, 2005 and was requiredto be adopted by Lone Star on January 1, 2006. The adoption of SFAS 151did not have a material impact on Lone Star’s consolidated results ofoperations and financial condition.

 

InDecember 2004, the FASB issued SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123R”), whichreplaces SFAS No. 123, *Accounting forStock-Based Compensation*, (“SFAS 123”) and supercedes APBOpinion No. 25, *Accounting for StockIssued to Employees*. SFAS 123R requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the financial statements based on their fair values. Under SFAS123R, public companies will be required to measure the cost of employeeservices received in exchange for stock options and similar awards based on thegrant-date fair value of the award and recognize this cost in the income statementover the period during which an employee is required to provide service inexchange for the award. The pro forma disclosures previously permitted underSFAS 123 no longer will be an alternative to financial statementrecognition. Under SFAS 123R, Lone Star must determine the appropriatefair value model to be used for valuing share-based payments, the amortizationmethod for compensation cost and the transition method to be used at date ofadoption. The transition methods include modified prospective and retroactiveadoption options. Under the retroactive option, prior periods may be restatedeither as of the beginning of the 

 

48

----

 

yearof adoption or for all periods presented. The prospective method requires thatcompensation expense be recorded for all unvested stock options and restrictedstock at the beginning of the first quarter of adoption of SFAS 123R,while the retroactive methods would record compensation expense for allunvested stock options and restricted stock beginning with the first periodrestated. Lone Star adopted SFAS 123R on January 1, 2006 using themodified prospective method. Under this method, Lone Star will recognizecompensation cost, on a prospective basis, for the portion of outstandingawards for which the requisite service has not yet been rendered as of January1, 2006, based upon the grant-date fair value of those awards calculated underSFAS 123 for pro forma disclosure purposes. We expect that the adoption of SFAS123R will reduce our fiscal 2006 income by approximately $1.7 million.

 

InDecember 2004, the FASB issued SFAS No. 153, *Exchanges of Nonmonetary Assets—An Amendment of APBOpinion No. 29, Accounting for Nonmonetary Transactions* (“SFAS 153”).SFAS 153 eliminates the exception from fair value measurement fornonmonetary exchanges of similar productive assets in paragraph 21(b) ofAPB Opinion No. 29, *Accounting forNonmonetary Transactions*, and replaces it with an exception forexchanges that do not have commercial substance. SFAS 153 specifies that anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange. LoneStar adopted  SFAS 153 on January 1,2006, and the adoption did not have a material impact on its consolidatedresults of operations and financial condition.

 

InMarch 2005, the FASB issued Interpretation No. 47, *Accounting for Conditional Asset Retirement Obligations* (“FIN47”), which clarifies that an entity is required to recognize a liability forthe fair value of a conditional asset retirement obligation when the obligationis incurred – generally upon acquisition, construction, or development and/orthrough the normal operation of the asset, if the fair value of the liabilitycan be reasonably estimated. A conditional asset retirement obligation is alegal obligation to perform an asset retirement activity in which the timingand/or method of settlement are conditional on a future event that may or maynot be within the control of the entity. If the fair value of a conditionalasset retirement obligation can be reasonably estimated, FIN 47 requires that aliability be recognized. FIN 47 is effective no later than the end of fiscalyears ending after December 15, 2005, therefore making it applicable for theyear ended December 31, 2005. The adoption of this pronouncement did not have amaterial impact on Lone Star’s financial position, results of operation, andcash flows as all material asset retirement obligations were already consideredand recorded in its environmental reserves discussed in Commitments andContingencies – Note K.

 

InMay 2005, the FASB issued SFAS No.154, *AccountingChanges and Error Corrections – A Replacement of APB Opinion No. 20 and FASBStatement No. 3*(“SFAS 154”). SFAS 154 requires the retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple, unless it is impractical to determine either the period-specificeffects or cumulative effect of the accounting change. SFAS 154 also requiresthat a change in depreciation, amortization, or depletion method for long-livednon-financial assets be accounted for as a change in accounting estimateaffected by a change in accounting principle. SFAS 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005, and we will adopt this provision, as applicable,during fiscal year 2006. We expect the adoption of SFAS 154 will not have amaterial impact on Lone Star’s results of operations or financial condition.

 

**BUSINESSSEGMENTS — NOTE B**

** **

LoneStar currently has six operating subsidiaries that have separate managementteams and infrastructures that offer different products and services. Thesubsidiaries have been aggregated under three reportable segments:  oilfield, specialty tubing, and flat rolledsteel and other tubular goods. Management evaluates segment performance basedprimarily on revenue and earnings from operations and segments are organizedaround the products and services provided to the customers each segment serves.No single customer comprised more than 10% of total net revenues in 2005, 2004,or 2003. Direct foreign revenues as a percent of total revenues were  3% in 2005 and 2004 and 2% in 2003. Foreignassets as a percent of total assets were less than 1% at December 31, 2005,2004, and 2003, respectively.

 

Theaccounting policies of each segment are the same as those described in Note Aof the Notes to Consolidated Financial Statements. Intersegment sales andtransfers are not significant. Interest expense, interest income, other incomeand expense, and income taxes have not been allocated to the segments.

 

***Oilfield.***Oilfield products are comprised of casing,tubing, line pipe and couplings that are manufactured and marketed globally tothe oil and gas drilling industry. The oilfield segment includes high qualityalloy and carbon welded oil country tubular goods, including casing, which actsas a structural retainer wall in oil and natural gas wellbores, and productiontubing, which transmits hydrocarbons to the surface. Line pipe is used togather and transmit oil and natural gas. Couplings are used to connectindividual sections of oilfield casing and tubing. The oilfield segment alsoincludes end-finishing, heat treating, inspection, and storage services.

 

49

----

 

***Specialty tubing.***Lone Star’s specialty tubing business includesthe manufacture, marketing and sale of a variety of custom-engineered tubular productsused in exacting applications, such as the manufacture of hydraulic cylindersfor construction and farm equipment; automotive applications, such asstabilizers and intrusion tubes; and other uses, including machine parts,bearing races, down-hole pump barrels, heavy lift crane boom chords, drill rodsand liner hangers. Finned tubulars are used in fuel economizers, industrialprocessing, petrochemical plants, refineries and combined cycle electricalpower generation.

 

***Flat rolled steel and other tubular goods.***Flat rolled steel is manufactured principallyfor use by the Company in the manufacture of tubular products. The Company alsosells flat rolled steel to fabricators of large diameter pipe, storage tanks,rail cars and a variety of other construction and industrial products. LoneStar also provides transportation, storage and other services to a variety ofindustries.

 

Thefollowing tables present information on the segments. The “Corporate / Other”column includes corporate related items and other insignificant nonsegments.

 
| ** **                       | ** ** | ** **   | ** ** | ** **    | ** ** | **Flat**      | ** ** | ** **    | ** ** | ** ** | ** ** |
|----------------------------------|------------|--------------|------------|---------------|------------|---------------|------------|---------------|------------|------------|------------|
| ** **                       | ** ** | ** **   | ** ** | ** **    | ** ** | **Rolled**    | ** ** | ** **    | ** ** | ** ** | ** ** |
| ** **                       | ** ** | ** **   | ** ** | ** **    | ** ** | **Steel and** | ** ** | ** **    | ** ** | ** ** | ** ** |
| ** **                       | ** ** | ** **   | ** ** | **Specialty** | ** ** | **Other**     | ** ** | **Corporate** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **Oilfield** | ** ** | **Tubing**    | ** ** | **Products**  | ** ** | **/ Other**   | ** ** | **Total**  | ** ** |
| **2005**                         |       |         |       |          |       |          |       |          |       |       |       |
| Revenues                         |       | $            | 1,009.8    |          | $          | 181.5         |       | $             | 93.8       |       | $          | — |   | $ | 1,285.1 |   |
| Segment  operating income (loss) |       | 229.5        |       | (4.1          | )          | 3.3           |       | (6.9          | )          | 221.8      |       |
| Depreciation and  amortization   |       | 18.6         |       | 8.5           |       | 0.7           |       | 0.1           |       | 27.9       |       |
| Total assets                     |       | 485.7        |       | 143.2         |       | 20.3          |       | 330.1         |       | 979.3      |       |
| Capital  expenditures            |       | 17.7         |       | 3.1           |       | —        |       | 0.2           |       | 21.0       |       |
|                             |       |         |       |          |       |          |       |          |       |       |       |
| **2004**                         |       |         |       |          |       |          |       |          |       |       |       |
| Revenues                         |       | $            | 695.4      |          | $          | 175.1         |       | $             | 96.3       |       | $          | — |   | $ | 966.8 |   |
| Segment  operating income (loss) |       | 105.8        |       | (1.5          | )          | 19.5          |       | (6.4          | )          | 117.4      |       |
| Depreciation and  amortization   |       | 16.9         |       | 9.9           |       | 0.9           |       | 0.1           |       | 27.8       |       |
| Total assets                     |       | 359.1        |       | 164.5         |       | 25.0          |       | 98.1          |       | 646.7      |       |
| Capital  expenditures            |       | 11.0         |       | 1.9           |       | —        |       | 0.1           |       | 13.0       |       |
|                             |       |         |       |          |       |          |       |          |       |       |       |
| **2003**                         |       |         |       |          |       |          |       |          |       |       |       |
| Revenues                         |       | $            | 364.8      |          | $          | 121.8         |       | $             | 47.5       |       | $          | — |   | $ | 534.1 |   |
| Segment  operating income (loss) |       | (8.2         | )          | (39.7         | )          | (1.5          | )          | (5.9          | )          | (55.3      | )          |
| Depreciation and  amortization   |       | 15.1         |       | 9.3           |       | 0.9           |       | 0.1           |       | 25.4       |       |
| Total assets                     |       | 325.6        |       | 154.0         |       | 16.2          |       | 78.9          |       | 574.7      |       |
| Capital  expenditures            |       | 10.5         |       | 3.8           |       | —        |       | 0.1           |       | 14.4       |       |

 

**GOODWILL AND OTHER INTANGIBLE ASSETS – NOTE C**

 

Allacquisitions in 2003 have been accounted for under the purchase method ofaccounting, and accordingly, the purchase price has been allocated to theassets acquired and the liabilities assumed based upon fair values at the dateof the acquisition. The excess purchase price over the fair value of thetangible and intangible net assets acquired has been recorded as goodwill.

 

TheCompany completes the annual goodwill impairment test during the fourth quarterof each subsequent year. The Company estimates the fair value of each reportingunit using a present value method that discounts estimated future cash flows.The cash flow estimates incorporate assumptions on future cash flow growth,terminal values, and discount rates. Lone Star’s annual goodwill impairmentmeasurement date is December 1.

 

50

----

 

In2003, because the fair value of the Fintube unit was below its carrying value,application of SFAS No. 142 required the completion of the second step of thegoodwill impairment test, comparing the implied fair value of Fintube’sgoodwill with its carrying value. After performing this evaluation animpairment charge of $18.7 million within the Company’s Specialty Tubingsegment was recognized for the year ended December 31, 2003.

 

As of both December 31,2005 and 2004, Lone Star’s Oilfield and Specialty Tubing segments included$14.9 million and $26.0 million of goodwill, respectively. There were nochanges in the carrying amount of goodwill for the years ended December 31,2005 and 2004.

 

**Lone Star Technologies, Inc.**

**Notes to ConsolidatedFinancial Statements**

 

Intangibleassets other than goodwill that are subject to amortization are amortized on astraight-line basis over their respective estimated useful lives. Thenon-compete agreements are amortized over contractual lives of four to fiveyears. The other amortizable intangible assets are amortized over five to tenyears. The components of intangible assets were as follows:

 

| ** **                   | ** ** | **2005**                        | ** ** | **2004**                      | ** ** |
|------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                   | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Amortized intangible assets: |       |                            |       |                          |       |   |   |   |   |
| Non-compete agreements       |       | $                               | 1.3        |                          | $          | (1.1 | ) | $ | 1.3 |   | $ | (0.9 | ) |
| Other                        |       | 0.5                             |       | (0.4                          | )          | 0.5 |   | (0.4 | ) |
|                         |       | $                               | 1.8        |                          | $          | (1.5 | ) | $ | 1.8 |   | $ | (1.3 | ) |

 

Aggregateamortization expense related to intangible assets, other than goodwill, was$0.2 million, $0.3 million, and $0.4 million for the years ended December 31,2005, 2004, and 2003, respectively.

 

Theestimated future amortization expense related to purchased intangible assets atDecember 31, 2005 is as follows:

 

| **Fiscal Year:** | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| 2006                  |       | $          | 0.1        |   |
| 2007                  |       | 0.1        |       |
| 2008                  |       | 0.1        |       |
| Total                 |       | $          | 0.3        |   |

 

**INVESTMENTS — NOTE D**

 

Investmentsin held-to-maturity and available-for-sale debt securities were as follows at December 31,2005:

 
| ** **                          | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
|-------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| **Held-to-Maturity Securities**     |       |                |       |                         |       |                          |       |                           |       |
| **(carried at amortized cost):**    |       |                |       |                         |       |                          |       |                           |       |
| U.S. government and agencies        |       | $                   | 6.0        |                         | $          | —                        |       | $                              | —     |   | $ | 6.0 |   |
| Debt securities of public companies |       | 17.0                |       | —                       |       | 0.1                           |       | 16.9                           |       |
|                                |       | 23.0                |       | —                       |       | 0.1                           |       | 22.9                           |       |
| **Available-for-Sale Securities**   |       |                |       |                         |       |                          |       |                           |       |
| **(carried at fair value):**        |       |                |       |                         |       |                          |       |                           |       |
| Municipal securities                |       | 33.2                |       | —                       |       | —                        |       | 33.2                           |       |
| Debt securities                     |       | 97.3                |       | —                       |       | —                        |       | 97.3                           |       |
|                                |       | 130.5               |       | —                       |       | —                        |       | 130.5                          |       |
|                                     |            |                     |            |                              |            |                               |            |                                |            |  |  |  |  |

 

51

----

 

Theamortized cost of investment in held-to-maturity and available-for-sale debtsecurities equaled fair value at December 31, 2004. The weighted averagematurities of the Company’s held-to-maturity and available-for-sale securitieswere approximately 153 days and 15 days, respectively, at December 31,2005 and 1.3 years and 38 days, respectively, at December 31, 2004. Thecontractual maturities of held-to-maturity and available-for-sale securities atDecember 31, 2005 were all due in less than one year.

 

Proceedsfrom sales of available-for-sale securities were $229.7 million and $29.5million in fiscal 2005 and 2004, respectively. No realized gain or loss wasrecognized upon the sale of these securities in 2005 and 2004. The specificidentification method is used to account for gains and losses onavailable-for-sale securities. A summary of the carrying values and balancesheet classification of all held-to-maturity and available-for-sale securitieswas as follows at December 31, 2005:

 
| ** **                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Held-to-maturity securities   |       | $        | 23.0       |     | $          | 2.4 |   |
| Available-for-sale securities |       | 130.5    |       | 44.0     |       |
| Short-term investments        |       | 153.5    |       | 46.4     |       |
|                          |       |     |       |     |       |
| Held-to-maturity securities   |       | —   |       | 12.7     |       |
| Investments, non-current      |       | —   |       | 12.7     |       |
| Total investments             |       | $        | 153.5      |     | $          | 59.1 |   |

 

**DEBT — NOTE E**

 

InOctober 2001, Lone Star entered into a three-year $100 million seniorsecured credit facility (the “Credit Facility”) for use by Lone Star and itsdomestic subsidiaries. In December 2003, the Credit Facility was amendedand restated (“Amended Credit Facility”) to increase the total availableborrowings to $125 million and extend the expiration date to December 2006.Borrowings under the Amended Credit Facility can be used for general corporatepurposes. Under the agreement, the Company can borrow an amount based on aborrowing base of 85% of eligible accounts receivable plus the lesser of 60% ofeligible inventory or $85.0 million. The availability under the Amended CreditFacility was $124.7 million at December 31, 2005. Borrowings under theAmended Credit Facility are collateralized by substantially all of the Company’sassets, other than real estate. At the Company’s option, the interest rate isthe prime lending rate or the LIBOR plus the applicable additional interest. TheAmended Credit Facility restricts Lone Star’s payment of dividends. At December 31,2005 and 2004, no amount was outstanding under the Amended Credit Facility.

 

Steelengages in slab consignment and sales agreements with third parties. Underthese agreements, Steel arranges for third parties to purchase slabs fromvendors that manufacture the slabs and the third party consigns the slabinventory to Steel. Steel is then required to repurchase the slab inventorybased on usage within specified time periods. These inventory financingtransactions have been accounted for as product financing arrangements. Inventoryfinanced under these arrangements is recorded as inventory by Steel. At December 31,2004, there was $8.0 million included in accounts payable under these financingarrangements. There were no amounts recorded in accounts payable for financedinventory at December 31, 2005.

 

OnMay 29, 2001, Lone Star issued $150.0 million 9% senior subordinated notesdue June 1, 2011 to qualified institutional buyers (the “Senior Notes”). Intereston the outstanding Senior Notes accrues at a rate of 9% per year, payablesemi-annually in arrears on each June 1 and December 1. Commencing June 1,2006, the Company has the option to redeem the Senior Notes at 104.5% of theirprincipal amount (which percentage decreases to 103% on June 1, 2007,101.5% on June 1, 2008 and 100% on June 1, 2009 and thereafter) plus,in each case, accrued and unpaid interest. The Senior Notes restricts Lone Star’spayment of dividends.

 

The Senior Notes are fullyand unconditionally (as well as jointly and severally) guaranteed on anunsecured, senior subordinated basis by each subsidiary of the Company (the “GuarantorSubsidiaries”) other than Aletas y Birlos S.A., de C.V. (see Note M) andFintube (Thailand) Limited (the “Non-Guarantor Subsidiaries”). Each of thesubsidiaries is wholly owned by the Company.

 

Total interest incurredincluding amortization of deferred financing costs was $16.1 million, $16.8million, and $16.4 million for the years ended December 31, 2005, 2004, and2003, respectively. Total interest capitalized for the year ended December 31,2003 was $0.6 million. No interest was capitalized for the years ended December 31,2005 and 2004.

 

52

----

 

**SHAREHOLDERS’ EQUITY — NOTE F**

** **

Under a previously authorized stock buy-back program,a total of 160,600 shares at a cost of $2.0 million, or a weighted averageprice of $12.61, were repurchased as treasury shares. The additional sharesheld in treasury at December 31, 2005 and December 31, 2004 resultfrom the Company’s withholding of an equivalent number of shares for federaltaxes related to the Company’s long-term incentive employee benefit plan. Forthe year ended December 31, 2005, 217,000 shares were utilized for thesatisfaction of stock issuances under the Company’s long-term incentive plan. The10,862 and 195,958 treasuryshares held as of December 31, 2005 and December 31, 2004,respectively, are reported at their acquired cost.

 

The following table (in wholeshares) identifies changes in common stock issued and treasury stock from January 1,2003 to December 31, 2005:

 

| ** **                      | ** ** | **Issued** | ** ** | **Treasury  Stock** | ** ** | **Outstanding** | ** ** |
|---------------------------------|------------|------------|------------|---------------------|------------|-----------------|------------|
| Balance, January 1, 2003   |       | 28,539,014 |       | (105,844            | )          | 28,433,170      |       |
| Employee benefit plans          |       | 121,889    |       | (8,263              | )          | 113,626         |       |
| Treasury stock purchase         |       | —     |       | (60,000             | )          | (60,000         | )          |
| Balance, December 31, 2003 |       | 28,660,903 |       | (174,107            | )          | 28,486,796      |       |
| Employee benefit plans          |       | 579,963    |       | (21,851             | )          | 558,112         |       |
| Treasury stock purchase         |       | —     |       | —              |       | —          |       |
| Balance, December 31, 2004 |       | 29,240,866 |       | (195,958            | )          | 29,044,908      |       |
| Employee benefit plans          |       | 1,359,339  |       | 185,096             |       | 1,544,435       |       |
| Treasury stock purchase         |       | —     |       | —              |       | —          |       |
| Balance, December 31, 2005 |       | 30,600,205 |       | (10,862             | )          | 30,589,343      |       |

 

**EARNINGS PER SHARE — NOTE G**

 

Basic earnings per share iscomputed by dividing net income by the weighted average number of shares ofcommon stock outstanding. Diluted earnings per share is computed by dividingnet income by the weighted average number of shares of common stock outstandingand other dilutive securities.

 
| ** **                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Numerator:                                          |       |     |       |     |       |     |       |
| Net income (loss)                                   |       | $        | 223.6      |     | $          | 101.0    |       | $ | (68.2 | ) |
|                                                |       |     |       |     |       |     |       |
| Denominator:                                        |       |     |       |     |       |     |       |
| Weighted-average shares used to compute basic EPS   |       | 30.0     |       | 28.7     |       | 28.4     |       |
| Effect of dilutive securities:                      |       |     |       |     |       |     |       |
| Stock options and restricted stock                  |       | 0.5      |       | 0.5      |       | —   |       |
| Weighted-average shares used to compute diluted EPS |       | 30.5     |       | 29.2     |       | 28.4     |       |
|                                                     |            |          |            |          |            |          |            |  |  |  |

 

As a result of the lossesincurred in 2003, 2.3 million options were excluded in computing diluted EPS assuch options would be anti-dilutive. In 2004, options to purchase 1.1 millionshares of Lone Star stock were excluded from the calculation of dilutedearnings per share as inclusion of such options would have been anti-dilutive.

 

53

----

 

**ADDITIONAL BALANCESHEET INFORMATION — NOTE H**

 
| ** **                                     | ** ** | **At December 31,** | ** ** |
|------------------------------------------------|------------|-------------------------------|------------|
| ** **                                     | ** ** | **2005**                      | ** ** | **2004** | ** ** |
| ***Inventories***                              |       |                          |       |   |   |
| Finished goods                                 |       | $                             | 115.1      |   | $ | 47.4 |   |
| Work in process                                |       | 122.1                         |       | 100.0 |   |
| Raw materials                                  |       | 120.4                         |       | 67.6 |   |
| Materials, supplies, and other                 |       | 24.7                          |       | 22.8 |   |
| ***Total inventories at FIFO***                |       | 382.3                         |       | 237.8 |   |
| Reserve to reduce inventories to LIFO value    |       | (131.6                        | )          | (107.5 | ) |
| ***Total inventories***                        |       | 250.7                         |       | 130.3 |   |
| Amount included in other noncurrent assets     |       | (5.7                          | )          | (2.0 | ) |
| ***Inventories, current***                     |       | $                             | 245.0      |   | $ | 128.3 |   |
| *** ***                                   |       |                          |       |   |   |
| ***Other current assets***                     |       |                          |       |   |   |
| Insurance and other deposits                   |       | $                             | 3.6        |   | $ | 9.2 |   |
| Inventory deposit                              |       | 3.0                           |       | 28.7 |   |
| Deferred compensation                          |       | 3.3                           |       | 2.5 |   |
| Other                                          |       | 6.8                           |       | 11.2 |   |
| ***Total other current assets***               |       | $                             | 16.7       |   | $ | 51.6 |   |
| *** ***                                   |       |                          |       |   |   |
| ***Property, plant, and equipment***           |       |                          |       |   |   |
| Land and land improvements                     |       | $                             | 18.0       |   | $ | 18.2 |   |
| Buildings, structures, and improvements        |       | 33.0                          |       | 34.4 |   |
| Machinery and equipment                        |       | 447.5                         |       | 431.6 |   |
| Construction in progress                       |       | 9.3                           |       | 5.5 |   |
| ***Total property, plant, and  equipment***    |       | 507.8                         |       | 489.7 |   |
| Less accumulated depreciation and amortization |       | (310.3                        | )          | (283.9 | ) |
| ***Property, plant, and equipment,  net***     |       | $                             | 197.5      |   | $ | 205.8 |   |
| *** ***                                   |       |                          |       |   |   |
| ***Other noncurrent assets***                  |       |                          |       |   |   |
| Inventory (supplies and spare parts)           |       | $                             | 5.7        |   | $ | 2.0 |   |
| Insurance and other deposits                   |       | 4.3                           |       | — |   |
| Deferred financing costs                       |       | 3.0                           |       | 3.8 |   |
| Other                                          |       | 3.9                           |       | 2.4 |   |
| ***Total other noncurrent assets***            |       | $                             | 16.9       |   | $ | 8.2 |   |
| *** ***                                   |       |                          |       |   |   |
| ***Accrued liabilities***                      |       |                          |       |   |   |
| Accrued compensation                           |       | $                             | 20.0       |   | $ | 14.4 |   |
| Warranty reserves                              |       | 3.0                           |       | 2.4 |   |
| Environmental reserves                         |       | 1.3                           |       | 1.8 |   |
| Pension obligations                            |       | 4.1                           |       | 3.7 |   |
| Taxes payable                                  |       | 7.8                           |       | — |   |
| Other                                          |       | 17.5                          |       | 14.8 |   |
| ***Total accrued liabilities***                |       | $                             | 53.7       |   | $ | 37.1 |   |
| *** ***                                   |       |                          |       |   |   |
| ***Other noncurrent liabilities***             |       |                          |       |   |   |
| Environmental reserves                         |       | $                             | 7.9        |   | $ | 7.4 |   |
| Other                                          |       | 5.3                           |       | 3.7 |   |
| ***Total other noncurrent  liabilities***      |       | $                             | 13.2       |   | $ | 11.1 |   |

 

54

----

 

During 2004, inventoryquantities were reduced. This reduction resulted in a liquidation of LIFOinventory layers, the effect of which increased net income by approximately$17.9 million or $0.61 per diluted share. There were no reductions of LIFOinventory layers in 2005. There was a LIFO increment of $96.8 million in 2005and $12.1 million in 2003.

 

**INCOME TAXES — NOTE I**

 

Income tax benefit was $3.4million in 2005 and income tax expense was $3.4 million and $0.1 million in2004 and 2003, respectively; including federal alternative minimum tax (“AMT”)and state and foreign income taxes. For 2005, 2004, and 2003 substantially allof the income from continuing operations was earned domestically.

 

The income tax provision fromcontinuing operations consisted of the following (in millions):

 
| ** **                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current                            |       |     |       |     |       |     |       |
| Federal                            |       | $        | 2.9        |     | $          | 1.2      |       | $ | — |   |
| State                              |       | 7.0      |       | 2.2      |       | 0.1      |       |
| Total Current                      |       | $        | 9.9        |     | $          | 3.4      |       | $ | 0.1 |   |
|                               |       |     |       |     |       |     |       |
| Deferred                           |       |     |       |     |       |     |       |
| Federal                            |       | $        | (12.9      | )        | —     |     | —     |   |
| State                              |       | (0.4     | )          | —   |       | —   |       |
| Total Deferred                     |       | $        | (13.3      | )        | $          | —   |       | $ | — |   |
|                               |       |     |       |     |       |     |       |
| Total income tax (benefit) expense |       | $        | (3.4       | )        | $          | 3.4      |       | $ | 0.1 |   |

 

A reconciliation of the U.S.federal statutory rate to actual income tax benefit (expense) is as follows:

 
| ** **                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Benefit (expense) at U.S. statutory rate             |       | $        | 77.1       |     | $          | 36.5     |       | $ | (23.8 | ) |
| State and other income taxes, net of federal benefit |       | 4.6      |       | 3.4      |       | 0.1      |       |
| Goodwill impairment charge                           |       | —   |       | —   |       | 6.5      |       |
| Change in valuation allowance                        |       | (83.2    | )          | (36.6    | )          | 19.0     |       |
| Other                                                |       | (1.9     | )          | 0.1      |       | (1.7     | )          |
| Total income tax (benefit) expense                   |       | $        | (3.4       | )        | $          | 3.4      |       | $ | 0.1 |   |

 

At December 31, 2005,Lone Star had federal tax net operating loss carryforwards (“NOL’s”) ofapproximately $78 million available to offset future payments of federal incometaxes, a portion of which may be related to American Federal Bank, aformer subsidiary of Lone Star and subject to an agreement with the FederalDeposit Insurance Corporation (“FDIC”) whereby Lone Star may be requiredto pay the FDIC for certain tax benefits. The NOL’s are available forutilization by Lone Star and its subsidiaries. If not utilized, the NOL’s willexpire in varying amounts between years 2022 and 2023, and their futureavailability may be limited if Lone Star or a member of the consolidatedgroup experiences an ownership change of more than 50 percentage points, asdefined by IRS regulations. Lone Star’s common stock is publicly traded, andmanagement cannot assure that future trading will not result in an ownershipchange, as defined by IRS regulations, which would limit the availability ofthe NOL’s. The Company has an AMT credit carryforward totaling $6.8 millionthat may be carried forward indefinitely under U.S. law.

 

55

----

 

The following table disclosesthe components of the deferred tax amounts at December 31, 2005 and 2004:

 
| ** **                                  | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|
| **Deferred tax assets:**                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Postretirement benefit accruals             |       | $          | 5.5        |       | $          | 15.0 |   |
| Environmental reserves                      |       | 3.5        |       | 3.2        |       |
| Other expense accruals and reserves         |       | 10.2       |       | 4.7        |       |
| Inventories                                 |       | 11.8       |       | 18.5       |       |
| Other                                       |       | 1.2        |       | 1.5        |       |
| Pension liability                           |       | 10.0       |       | 10.5       |       |
| Net operating loss carryforwards            |       | 30.4       |       | 65.2       |       |
| Alternative minimum tax credit carryforward |       | 6.8        |       | 2.8        |       |
| Total deferred tax assets                   |       | 79.4       |       | 121.4      |       |
| **Deferred tax liabilities:**               |       |       |       |       |       |
| Property, plant and equipment               |       | (39.8      | )          | (35.4      | )          |
|                                        |       |       |       |       |       |
| Net deferred tax assets                     |       | 39.6       |       | 86.0       |       |
| Less valuation allowance                    |       | (2.8       | )          | (86.0      | )          |
| Net deferred tax amount                     |       | $          | 36.8       |       | $          | — |   |

 

In assessing the realizationof deferred tax assets, management considers whether it is more likely than notthat some portion or all of the deferred tax assets will be realized. Theultimate realization of deferred tax assets is dependent upon the generation offuture taxable income during the periods in which those temporary differencesbecome deductible. Management considers the scheduled reversal of deferred taxitems, projected future taxable income, and tax planning strategies in makingthis assessment. Based on the substantial utilization of the Company’s netdeferred tax asset during 2004 and 2005, management determined that there wassufficient projected future taxable income to realize the remaining federal netoperating losses (“NOL”) and credit carryforwards in the near future. As of December 31,2005, management believes it is more likely than not that all of the netdeferred tax assets will be realized with the exception of loss carryforwardsin foreign and certain state jurisdictions for which a valuation allowance hasbeen provided.

 

As of December 31, 2004,management believed that it was more likely than not that the net deferred taxassets would not be realized by future operating results. Because of theuncertainty regarding possible utilization of NOL’s and the sensitivity ofearnings to the level of domestic drilling activity, valuation allowances wererecorded to fully reserve the computed net deferred tax assets at December 31,2004.

 

No provision has been madefor income taxes which may become payable upon distribution of the foreignsubsidiaries’ earnings since on a cumulative basis losses have been generated.

 

**EMPLOYEEBENEFIT PLANS — NOTE J**

 

***Defined contribution plans*****.**Defined contribution plans are available tosubstantially all full-time employees under which participants can makevoluntary pre-tax contributions. For non-bargaining unit employees, matchingcontributions are provided within specified limits. Through September 2005,Steel made contributions at rates specified under collective bargaining agreementsfor its bargaining unit employees. Contributions totaled $3.4 million, $3.4million, and $3.3 million for the years ended December 31, 2005, 2004, and2003, respectively.

 

***Nonqualified deferred compensationplan*****.**The Company has anonqualified compensation plan for certain management personnel and highlycompensated employees of Lone Star and its participating affiliates thatprovides eligible employees the opportunity to defer a specified percentage oftheir cash compensation. Participants may elect to defer up to 50% oftotal compensation and Lone Star will match 50% of the amount deferred by eachemployee with the matching not

 

56

----

 

toexceed $25,000. The obligation included in other noncurrent liabilities was$3.4 million and $2.7 million at December 31, 2005 and 2004, respectively.

 

***Employee stock purchase plan***. The Company has an employee stock purchaseplan for all eligible employees. Eligible employees include all regularfull-time employees of Lone Star and its subsidiaries who have been employedfor at least 12 months. Eligible employees may defer up to 5% of theircompensation for each quarter for the purchase of Lone Star common stock. Sharesare purchased at the end of each quarter at a price equal to the lower of: (a) 90%of the market price of Lone Star’s common stock on the first day of thequarter, or (b) 90% of the market price of Lone Star’s common stock on thelast day of the quarter. The maximum number of Lone Star shares that may bepurchased for all participants under the plan is 200,000 shares, of which149,417 shares were available to be issued at December 31, 2005.

 

***Long-term incentive plan***. Lone Star has a long-term incentive planwhich provides for the issuance of up to 6,700,000 shares of common stock tokey employees and outside directors through the granting of incentive andnonqualified stock options, stock appreciation rights, restricted stock grants,and performance unit grants. The option price is the average of the high andlow market price on the date of the grant. Options are generally exercisablefor ten years with one-fourth of the shares becoming exercisable on theone-year anniversary of the grant date and an additional one-fourth becomingexercisable on the same anniversary date over the next three years. In 2004,293,500 options were granted to certain key employees that become fullyexercisable on the one-year anniversary of the grant date and are exercisablefor five years. For all options granted, if the optionee’s employment isterminated under certain circumstances after a change of control of Lone Staroccurs before an option’s fourth anniversary, the option may be exercisedin full earlier. Also, accelerated vesting of options can occur upon death orretirement from employment of an option holder. The following discloses thestock option activity for the years shown (not in millions):

 

| ** **                          | ** ** | **Shares Under  Option** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|-------------------------------------|------------|-------------------------------|------------|----------------------------------------|------------|
| Outstanding, December 31, 2002 |       | 2,348,725                     |       | 25.85                                  |       |
| Granted                             |       | 447,000                       |       | 17.77                                  |       |
| Exercised                           |       | (87,750                       | )          | 13.65                                  |       |
| Cancelled/forfeited                 |       | (94,750                       | )          | 24.00                                  |       |
| Outstanding, December 31, 2003 |       | 2,613,225                     |       | 24.95                                  |       |
| Granted                             |       | 394,000                       |       | 18.19                                  |       |
| Exercised                           |       | (449,025                      | )          | 14.35                                  |       |
| Cancelled/forfeited                 |       | (75,150                       | )          | 34.71                                  |       |
| Outstanding, December 31, 2004 |       | 2,483,050                     |       | 25.49                                  |       |
| Granted                             |       | —                        |       | —                                 |       |
| Exercised                           |       | (1,450,351                    | )          | 25.23                                  |       |
| Cancelled/forfeited                 |       | (35,125                       | )          | 16.15                                  |       |
| Outstanding, December 31, 2005 |       | 997,574                       |       | $                                      | 26.20      |   |
|                                     |            |                               |            |                                        |            |  |

 

57

----

 

AtDecember 31, 2005, 1,588,904 shares were available for future grant. At December 31,2005, 2004, and 2003, 647,825, 1,442,706, and 1,535,913 options, respectively,were exercisable. The following table summarizes information with respect tooptions outstanding and exercisable at December 31, 2005 (not inmillions):

 
| ** **                              | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**           | ** ** |
|-----------------------------------------|------------|------------------------------|------------|----------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number of  Shares**   | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life (Yrs.)** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                                    |       |                         |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| $                                       | 11.06      |                         | —     |                                   | $          | 16.52 |   | 296,500 |   | $ | 15.84 |   | 6.7 |   | 70,875 |   | $ | 16.05 |   |
| 16.75                                   |       | —                       |       | 23.39                                  |       | 277,949 |   | 20.42 |   | 5.3 |   | 172,575 |   | 21.03 |   |
| 27.19                                   |       | —                       |       | 39.27                                  |       | 321,250 |   | 34.01 |   | 4.7 |   | 302,500 |   | 34.41 |   |
| 41.11                                   |       | —                       |       | 50.06                                  |       | 101,875 |   | 47.49 |   | 4.9 |   | 101,875 |   | 47.49 |   |
| $                                       | 11.06      |                         | —     |                                   | $          | 50.06 |   | 997,574 |   | $ | 26.20 |   | 5.5 |   | 647,825 |   | $ | 30.89 |   |

 

LoneStar also issued 152,950, 137,500, and 21,500 shares of restricted stock grantsto certain employees, with a value at grant date of $7.1 million, $2.5 million,and $0.4 million during 2005, 2004, and 2003, respectively. The sharesgenerally vest ratably over a four or five year period beginning on the secondanniversary of date of grant. The fair value of restricted stock is charged toShareholders’ Equity and amortized to expense over the requisite vestingperiods. In 2005, shares were granted to certain key employees with acceleratedvesting provisions based on the achievement of certain performance objectives. Ifthe performance objectives are met, one-third of the shares become vested onthe first, second, and third anniversary date of the grant. In 2004, of the137,500 shares of restricted stock grants, 120,000 shares were granted tocertain key employees with accelerated vesting provisions based on theachievement of certain performance objectives. If the performance objectivesare met, one-third of the shares become vested on the first anniversary of dateof grant with the remaining two-thirds becoming vested on the secondanniversary of date of grant. The Company recognized compensation expenserelated to all awards of $3.5 million, $1.6 million, and $1.1 million in 2005,2004, and 2003, respectively, which included recognition of expense in 2004related to the acceleration of vesting for achievement of certain 2004performance objectives.

 

***Defined Benefit Pension and Postretirement Benefit Plans*****.**Steel has three defined benefit pension planscovering substantially all of its bargaining unit employees. Retirementbenefits are based on flat-rate amounts for years of service. A special initiallump-sum pension payment equal to 13 weeks of vacation pay is also paidfollowing retirement. It is generally the Company’s policy to fund the minimumrequired contributions each year as required by applicable regulations.

 

During 1996 and 1998, thethree pension plans were amended so that new employees hired after the dates ofsuch amendments did not participate in the defined benefit plans. However,existing employees continued to accrue pension benefits under the plans. Newemployees were only eligible to participate in one of the defined contributionretirement plans. In September 2005, two of the three largest pensionplans were again amended so that substantially all of such employees wereeligible to begin accruing defined pension benefits under the plans. Concurrentwith the implementation of the defined benefit plan amendments, the Companydiscontinued making employer contributions to the defined contributionretirement plans for these employees.

 

Steelalso sponsors an unfunded defined benefit postretirement health care plan foreligible bargaining unit employees and a limited number of other retireeseligible under special early retirement programs. These health care planbenefits are limited to eligible retirees until age 65, at which time coverageterminates. The employee spouses’ coverage benefit term is limited to theearlier of five years from the date of employee retirement or the spouseattaining age 65. The Company also provides a postretirement benefit for lifeinsurance to its bargaining unit employees. The anticipated costs of thesepostretirement benefits are accrued over the employees’ years of service.

 

58

----

 

Thefollowing represents the amounts recognized in the consolidated balance sheetsat December 31, 2005 and 2004:

 
| ** **                                      | ** ** | **Pension Benefits** | ** ** | **Other Benefits** | ** ** |
|-------------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **2005**                  | ** ** | **2004**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Postretirement benefit obligations - current    |       | $                         | 2.0        |                    | $          | 1.7 |   | $ | 2.1 |   | $ | 2.0 |   |
| Postretirement benefit obligations - noncurrent |       | 24.9                      |       | 27.3                    |       | 14.2 |   | 12.8 |   |
| Other noncurrent assets - intangible asset      |       | (0.6                      | )          | (0.8                    | )          | (1.6 | ) | — |   |
| Accumulated other comprehensive loss            |       | (33.8                     | )          | (32.5                   | )          | — |   | — |   |
| Net amount recognized                           |       | $                         | (7.5       | )                       | $          | (4.3 | ) | $ | 14.7 |   | $ | 14.8 |   |

 

Netperiodic benefit expense for 2005, 2004, and 2003, included the followingcomponents:

 

| ** **                                    | ** ** | **Pension Benefits** | ** ** | **Other Benefits** | ** ** |
|-----------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                                    | ** ** | **2005**                  | ** ** | **2004**                | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Service cost                                  |       | $                         | 1.5        |                    | $          | 1.0 |   | $ | 1.0 |   | $ | 0.7 |   | $ | 0.5 |   | $ | 0.6 |   |
| Interest cost                                 |       | 5.6                       |       | 5.7                     |       | 5.8 |   | 1.2 |   | 0.9 |   | 1.0 |   |
| Expected return on plan assets                |       | (5.4                      | )          | (4.8                    | )          | (4.2 | ) | — |   | — |   | — |   |
| Amortization of prior service cost            |       | 0.2                       |       | 0.2                     |       | 0.1 |   | — |   | — |   | — |   |
| Expected cost of special termination benefits |       | 0.1                       |       | —                  |       | — |   | — |   | — |   | — |   |
| Recognized net actuarial loss (gain)          |       | 2.7                       |       | 2.7                     |       | 2.7 |   | 0.2 |   | — |   | — |   |
| Net periodic benefit expense                  |       | $                         | 4.7        |                    | $          | 4.8 |   | $ | 5.4 |   | $ | 2.1 |   | $ | 1.4 |   | $ | 1.6 |   |

 

59

----

 

The following table setsforth the changes in the plans’ benefit obligations, assets, and funded statusat December 31, 2005 and 2004:

 
| ** **                                       | ** ** | **Pension Benefits** | ** ** | **Other Benefits** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **2005**                  | ** ** | **2004**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Change in Projected Benefit Obligation**       | ** ** | ** **                | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Benefit obligation at beginning of year          |       | $                         | 97.0       |                    | $          | 93.5 |   | $ | 20.3 |   | $ | 14.9 |   |
| Service cost                                     |       | 1.5                       |       | 1.0                     |       | 0.6 |   | 0.5 |   |
| Interest cost                                    |       | 5.6                       |       | 5.7                     |       | 1.2 |   | 0.9 |   |
| Plan participants’ contributions            |       | —                    |       | —                  |       | 0.1 |   | 0.1 |   |
| Amendments                                       |       | —                    |       | —                  |       | 1.6 |   | — |   |
| Expected cost of special termination benefits    |       | 0.1                       |       | —                  |       | — |   | — |   |
| Actuarial loss                                   |       | 4.1                       |       | 3.3                     |       | 3.3 |   | 6.2 |   |
| Benefits paid                                    |       | (6.6                      | )          | (6.5                    | )          | (2.3 | ) | (2.3 | ) |
| Projected Benefit Obligation at end of year      |       | $                         | 101.7      |                    | $          | 97.0 |   | $ | 24.8 |   | $ | 20.3 |   |
|                                             |       |                      |       |                    |       |   |   |   |   |
| **Change in Plan Assets**                        |       |                      |       |                    |       |   |   |   |   |
| Fair value of plan assets at beginning of year   |       | $                         | 67.7       |                    | $          | 59.4 |   | $ | — |   | $ | — |   |
| Actual return on plan assets                     |       | 5.1                       |       | 4.8                     |       | — |   | — |   |
| Employer contributions                           |       | 7.9                       |       | 10.0                    |       | 2.2 |   | 2.2 |   |
| Plan participants’ contributions            |       | —                    |       | —                  |       | 0.1 |   | 0.1 |   |
| Benefits paid                                    |       | (6.6                      | )          | (6.5                    | )          | (2.3 | ) | (2.3 | ) |
| Fair value of plan assets at end of year         |       | $                         | 74.1       |                    | $          | 67.7 |   | $ | — |   | $ | — |   |
|                                             |       |                      |       |                    |       |   |   |   |   |
| **Reconciliation of Funded Status**              |       |                      |       |                    |       |   |   |   |   |
| Unfunded status - obligation in excess of assets |       | $                         | 27.6       |                    | $          | 29.3 |   | $ | 24.8 |   | $ | 20.3 |   |
| Unrecognized actuarial gain (loss)               |       | (34.5                     | )          | (32.8                   | )          | (8.6 | ) | (5.5 | ) |
| Unrecognized prior service cost                  |       | (0.6                      | )          | (0.8                    | )          | (1.5 | ) | — |   |
| Net amount recognized                            |       | $                         | (7.5       | )                       | $          | (4.3 | ) | $ | 14.7 |   | $ | 14.8 |   |

 

The Accumulated BenefitObligation for all defined benefit pension plans was $101.0 million and $96.7million at December 31, 2005 and 2004, respectively.

 

The following weightedaverage assumptions were used in determining net periodic benefit expense andbenefit obligations:

 

| ** **                                          | ** ** | **Pension Benefits** | ** ** | **Other Benefits** | ** ** |
|-----------------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                                          | ** ** | **2005**                  | ** ** | **2004**                | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Net Periodic Benefit Expense**                    |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| Discount rate                                       |       | 6.00                      | %          | 6.25                    | %          | 6.75 | % | 6.00 | % | 6.25 | % | 6.75 | % |
| Expected long-term investment return on plan assets |       | 8.00                      | %          | 8.00                    | %          | 8.00 | % | — |   | — |   | — |   |
| Rate of compensation increase                       |       | 3.00                      | %          | 3.00                    | %          | 4.00 | % | — |   | — |   | — |   |
|                                                |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| **Benefit Obligations**                             |       |                      |       |                    |       |   |   |   |   |   |   |   |   |
| Discount rate                                       |       | 5.75                      | %          | 6.00                    | %          | 6.25 | % | 5.75 | % | 6.00 | % | 6.25 | % |
| Rate of compensation increase                       |       | 3.50                      | %          | 3.00                    | %          | 3.00 | % | — |   | — |   | — |   |

 

Thereturn on plan assets reflects the weighted-average of the expected long-termrates of return for the broad categories of investments held in the plans. Theexpected long-term rate of return is adjusted when there are fundamentalchanges in expected returns on the plan assets. The Company uses an annualmeasurement date of November 30th.

 

60

----

 

The Company’s pensioncontributions to be paid in 2006 are estimated to be $8.4 million, reflectingquarterly contributions to certain plans as required by Internal Revenue Code Section 412,and the 2006 contribution for other benefits is estimated to be $2.1 million.

 

TheCompany’s expected future benefit payments for each of the next five years andin the aggregate for the following five years thereafter are as follows:

 

| **Expected Future Benefit Payments** | ** ** | **Pension  Benefits** | ** ** | **Other Benefits** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|
| 2006                                                |       | $                     | 7.0        |                    | $          | 2.1 |   |
| 2007                                                |       | 7.0                   |       | 1.9                     |       |
| 2008                                                |       | 7.1                   |       | 2.0                     |       |
| 2009                                                |       | 7.3                   |       | 2.3                     |       |
| 2010                                                |       | 7.4                   |       | 2.4                     |       |
| 2011 through 2015                                   |       | 31.6                  |       | 13.4                    |       |
|                                                     |            |                       |            |                         |            |  |  |

 

Assumedhealth care cost trend rates have a significant effect on the amounts reportedfor the health care plans. The annual rate of increase in the per capita costsof covered health care benefits is assumed to decrease from 10% to an ultimatetrend rate of 5% by the year 2011. Increasing the assumed medical cost trendrates by one percentage point in each year would have resulted in a $2.1million increase in the benefit obligation as of December 31, 2005, and a$0.2 million increase in the aggregate of the service cost and interest costcomponents of net periodic benefit expense for 2005. A 1% decrease in theassumed trend rates would have resulted in a $1.8 million decrease in thebenefit obligation and a $0.2 million decrease in expense.

 

LoneStar’s investment strategy for its pension plans is to preserve the capital ofthe pension plans’ assets and maximize investment earnings in excess ofinflation with acceptable levels of volatility while meeting the pension plans’goal of providing, protecting, and enhancing the economic well-being of LoneStar employees, retirees, and their beneficiaries. This investment strategywill be achieved through target allocation for each asset class with amaximum and minimum range around each target. No investments will be made insecurities that fall outside of the categories listed below. Without limitingthe general scope of the foregoing, private placements and the securities ofLone Star Technologies, Inc. are specifically excluded and not deemedappropriate investments.

 

Targetinvestment allocations for 2005 were as follows:

 

| ** **                      | ** ** | ** ** | ** ** | **Range** | ** ** |
|---------------------------------|------------|------------|------------|-----------|------------|
| **Asset Category**         | ** ** | **Target** | ** ** | **Min%**  | ** ** | **Max%** | ** ** |
| Domestic equity securities      |       | 40         | %          | 30        | %          | 50 | % |
| International equity securities |       | 10         | %          | 0         | %          | 20 | % |
| Fixed income securities         |       | 48         | %          | 35        | %          | 65 | % |
| Cash investments                |       | 2          | %          | 0         | %          | 5 | % |

 

61

----

 

Theallocations are rebalanced as considered necessary by the Company’s pensionplan committee to correspond with anticipated change in investing conditions. Thefollowing table sets forth the percentage of fair value of total assets byasset category as of the Company’s measurement date:

 

| ** **                      | ** ** | **Fiscal Year** | ** ** |
|---------------------------------|------------|----------------------|------------|
| **Asset Category**         | ** ** | **2005**             | ** ** | **2004** | ** ** |
| Domestic equity securities      |       | 47                   | %          | 37 | % |
| International equity securities |       | 8                    | %          | 16 | % |
| Fixed income securities         |       | 40                   | %          | 45 | % |
| Cash investments                |       | 5                    | %          | 2 | % |
| Total                           |       | 100                  | %          | 100 | % |

 

***Profit sharing plans*.**Certain Lone Star subsidiaries have profit sharing plans for theiremployees that provide for payment of a specified percentage of quarterlyoperating earnings. Total payments to employees were $5.9 million, $0.8million, and $0.4 million in 2005, 2004, and 2003, respectively.

 

**COMMITMENTS AND CONTINGENCIES — NOTE K**

 

Asof December 31, 2005, the Company has long-term purchase commitmentstotaling $21.3 million to acquire natural gas at specified minimum volumes andat fixed prices through January 2007.

 

Equipmentis leased under various operating leases. Rental expense totaled $5.8 million,$4.5 million, and $4.5 million in 2005, 2004, and 2003, respectively. Futureminimum lease payments under noncancelable operating leases with initial orremaining terms in excess of one year are as follows: 2006, $3.3 million; 2007,$3.0 million; 2008, $2.2 million; 2009, $1.4million; and thereafter, $0.6million.

 

LoneStar’s operations are subject to numerous environmental laws. The three majorareas of regulation are air quality, water quality, and solid and hazardous wastemanagement. The primary governmental oversight agencies include the TexasCommission on Environmental Quality and the Environmental Protection Agency. TheCompany is engaged in various ongoing environmental monitoring and complianceprograms, voluntary remediation activities, and capital improvement projects. Estimatedfuture expenditures for certain remediation programs are included in accruedliabilities and other noncurrent liabilities as shown in Note H and arecomputed on a non-discounted basis. Included in other noncurrent liabilitiesare environmental reserves of $7.9 million and $7.4 million at December 31,2005 and 2004, respectively. Current reserves of $1.3 million and $1.8 millionare included in accrued liabilities at December 31, 2005 and 2004,respectively. The Company believes that adequate accruals have been maderelated to all known environmental matters.

 

In2001, Lone Star entered into an agreement to purchase the assets of North StarSteel Company’s Tubular Steel Division. Consummation of the acquisition wassubject to completion of financing arrangements. Due to lack of common stockfinancing which, along with certain debt financing, was required by theacquisition agreement to close the acquisition, Lone Star notified Cargill,Incorporated, the parent company of North Star Steel Company, on December 14,2001, that it was not able to complete the acquisition. Later that day,Cargill, Incorporated notified Lone Star that it was filing a lawsuit againstLone Star seeking unspecified damages and alleging that Lone Star had breachedthe agreement. On March 13, 2003, the jury in Minnesota returned a verdictof $32 million in damages against Lone Star. On June 1, 2004, theMinnesota Court of Appeals affirmed the judgment. The Minnesota Supreme Courtdecided on August 17, 2004 that it would not review the Court of Appeals’decision. Lone Star paid Cargill $34 million in October 2004 to satisfythe judgment. After the $34 million payment, approximately $1 million ofaccrued interest remained in the reserve at December 31, 2004, whichrepresented pre-judgment interest that Lone Star contested in the Minnesotacourts. On June 28, 2005, Lone Star lost that appeal and paid thatinterest amount in the third quarter of 2005.

 

Duringthe last seven years, Steel has been named as one of a number of defendants in47 lawsuits alleging that certain individuals were exposed to asbestos on thedefendants’ premises. The plaintiffs are seeking unspecified damages. To dateseveral of these lawsuits have been settled for approximately $300,000 in theaggregate. Of the 47 lawsuits, 22 have been settled or are pending settlementand 15 have been dismissed or are pending dismissal. Steel did not manufactureor distribute any products containing asbestos. Some or all of these claims may notbe covered by the Company’s insurance. The Company has accrued for theestimated exposure to known claims, but does not know the extent to whichfuture claims may be filed. Therefore, the Company cannot estimate itsexposure, if any, to unasserted claims.

 

62

----

 

Beginningin 2003, Lone Star’s subsidiary Zinklahoma, Inc., inactive since 1989, hasbeen named as one of a number of defendants in seven lawsuits alleging that theplaintiffs had contracted mesothelioma as the result of exposure to asbestos inproducts manufactured by the defendants and John Zink Company (“Zink”). Five ofthese lawsuits have been dismissed and one was settled for less than $0.1million. Lone Star acquired the stock of Zink in 1987 and, in 1989, sold theassets of the former Zink to Koch Industries, Inc. (“Koch”) and renamedthe now-inactive subsidiary “Zinklahoma, Inc.”  Lone Star retained, and agreed to indemnifyKoch against, certain pre-closing liabilities of Zink. It is Lone Star’sunderstanding that Zink never manufactured asbestos and primarily used it onlyin certain purchased gaskets that were encapsulated in copper and contained inburners and flares made by Zink prior to 1984, when Zink ceased using asbestos-containingproducts entirely. Koch continues to operate the business as John Zink Company,LLC (“Zink LLC”).

 

Inaddition, Zink LLC has been named in ten lawsuits in which the plaintiffs, fiveof whom have mesothelioma, allege exposure to asbestos in Zink’s products (fourof these have been dismissed) and three personal injury lawsuits resulting froma 2001 explosion and flash fire at a flare stack and crude unit atmosphericheater. Zink allegedly manufactured the flare and related components for the flarestack in the early 1970s. Koch is seeking indemnification from Lone Star withrespect to these six pending lawsuits. The costs of defending and settling thelawsuits alleging exposure to asbestos in Zink’s products have been borne byZink’s insurance carrier. Lone Star believes that Koch’s indemnity claim withrespect to the 2001 explosion and flash fire is covered by its insurance,subject to a deductible, and has notified its insurance carrier of that claim. Duringthe second quarter of 2005, Zink LLC was dismissed from the three personalinjury lawsuits when it was determined that Zink did not manufacture the flareand components involved in the fire.

 

Steel’sworkers’ compensation insurance was with one insurance carrier from 1992through 2001. In March 2002, that carrier was declared insolvent andplaced in receivership. Since then, the Texas Property and Casualty InsuranceGuaranty Association (“TPCIGA”) has been paying the insolvent carrier’sobligations under those insurance policies, as required by Texas law. TPCIGAasserted that it was entitled to recover from Steel what it has paid and willpay under those policies. Steel paid TPCIGA $1.9 million on October 4,2004 in full settlement and release of all past, present, and future claimspaid by TPCIGA under those policies.

 

Lone Star and itssubsidiaries are parties to a number of other lawsuits and controversies in thenormal course of business, which are not discussed herein. Management of LoneStar and its operating companies, based upon their analysis of known facts andcircumstances and reports from legal counsel, does not believe that any suchmatter or matters in the aggregate will have a material adverse effect on theresults of operations, financial condition or cash flows of Lone Star and itssubsidiaries, taken as a whole.

 

**EARLY TERMINATION OF ALLIANCE AGREEMENT — NOTE L**

 

During the second quarter of 2005, the Company announced that Steel andTubos del Caribe, S.A. (“Tubocaribe”), a Columbian manufacturer of OCTG andline pipe, had terminated their strategic alliance, following a change inownership of Tubocaribe. The agreement was due to expire in October 2006.

 

As consideration for the early termination of the agreement, in thefourth quarter of 2005, Tubocaribe delivered, without charge to Steel, anagreed quantity of OCTG with an estimated value of $7.8 million. A gain wasrecognized in the second quarter of 2005 for the $7.8 million and is includedin “Other income” in Lone Star’s consolidated results of operation for the yearended December 31, 2005.

 

**ACQUISITIONS — NOTE M**

 

On May 1, 2003 and June 2, 2003, respectively, Lone Starpurchased certain assets of Delta Tubular Products (“DTP”) and Frank’s TubularInternational (“Frank’s” or “DTI”), for a net purchase price of $14.2 million and$19.8 million, respectively.

 

63

----

 

***Pro Forma Results.***The operating results of the DTP and DTIacquisitions have been included in the Consolidated Statements of Income fromthe effective dates of acquisition. The unaudited pro forma results belowassume the acquisitions occurred on January 1, 2003:

 

| ** **             | ** ** | **For the Year  Ended  2003** | ** ** |
|------------------------|------------|-----------------------------------------|------------|
|                   |       |                                    |       |
| Net sales              |       | $                                       | 540.2      |   |
| Net loss               |       | (69.3                                   | )          |
|                   |       |                                    |       |
| Basic loss per share   |       | $                                       | (2.44      | ) |
| Diluted loss per share |       | (2.44                                   | )          |

 

The preceding pro formaresults include adjustments to eliminate intercompany sales and give effect toamortization of goodwill, interest expense and other purchase price adjustments.The pro forma results are not necessarily indicative of the operating resultsthat would have occurred if the acquisitions had been consummated as of thebeginning of the periods presented, nor are they necessarily indicative offuture operating results.

 

64

----

 

**GUARANTORSUBSIDIARIES — NOTE N**

 

Thefollowing condensed, consolidated financial statements of the Company includethe accounts of the Company, the combined accounts of the GuarantorSubsidiaries and the combined accounts of the Non-Guarantor Subsidiaries. Eachof the Guarantor Subsidiaries and Non-Guarantor Subsidiaries is wholly-owned bythe Company. For additional information relating to the restatement of theconsolidated statements of cash flows in 2004 and 2003, see Note A.

 

**CONDENSEDCONSOLIDATING BALANCE SHEET**

**AT DECEMBER 31,2005**

 
| ** **                                           | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|-------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
|                                                 |       |        |       |                        |       |                            |       |             |       |             |       |
| **Assets**                                           |       |        |       |                        |       |                            |       |             |       |             |       |
| Cash and cash equivalents                            |       | $           | 101.1      |                        | $          | 0.9                             |       | $                | 0.2        |             | $          | — |   | $ | 102.2 |   |
| Short-term investments                               |       | 153.5       |       | —                      |       | —                          |       | —           |       | 153.5            |       |
| Accounts receivable, net                             |       | 14.1        |       | 143.4                       |       | 0.2                             |       | (16.4            | )          | 141.3            |       |
| Inventories                                          |       | —      |       | 244.1                       |       | 0.9                             |       | —           |       | 245.0            |       |
| Other current assets                                 |       | 68.0        |       | 13.5                        |       | 0.5                             |       | —           |       | 82.0             |       |
| Total current assets                                 |       | 336.7       |       | 401.9                       |       | 1.8                             |       | (16.4            | )          | 724.0            |       |
|                                                 |       |        |       |                        |       |                            |       |             |       |             |       |
| Investment in subsidiaries                           |       | 492.3       |       | —                      |       | —                          |       | (492.3           | )          | —           |       |
| Property, plant, and equipment, net                  |       | 0.6         |       | 195.9                       |       | 1.0                             |       | —           |       | 197.5            |       |
| Goodwill                                             |       | 3.5         |       | 37.4                        |       | —                          |       | —           |       | 40.9             |       |
| Advances to parent                                   |       | —      |       | 10.9                        |       | —                          |       | (10.9            | )          | —           |       |
| Other noncurrent assets                              |       | 3.0         |       | 13.6                        |       | 0.3                             |       | —           |       | 16.9             |       |
| Total assets                                         |       | $           | 836.1      |                        | $          | 659.7                           |       | $                | 3.1        |             | $          | (519.6 | ) | $ | 979.3 |   |
|                                                 |       |        |       |                        |       |                            |       |             |       |             |       |
| **Liabilities & Shareholders’ Equity** |       |        |       |                        |       |                            |       |             |       |             |       |
| Accounts payable                                     |       | $           | 0.3        |                        | $          | 61.1                            |       | $                | 9.7        |             | $          | (16.4 | ) | $ | 54.7 |   |
| Accrued liabilities                                  |       | 3.2         |       | 50.4                        |       | 0.1                             |       | —           |       | 53.7             |       |
| Total current liabilities                            |       | 3.5         |       | 111.5                       |       | 9.8                             |       | (16.4            | )          | 108.4            |       |
|                                                 |       |        |       |                        |       |                            |       |             |       |             |       |
| Senior subordinated debt                             |       | 150.0       |       | —                      |       | —                          |       | —           |       | 150.0            |       |
| Advances from parent                                 |       | 10.9        |       | —                      |       | —                          |       | (10.9            | )          | —           |       |
| Other noncurrent liabilities                         |       | 31.5        |       | 49.2                        |       | —                          |       | —           |       | 80.7             |       |
| Total liabilities                                    |       | 195.9       |       | 160.7                       |       | 9.8                             |       | (27.3            | )          | 339.1            |       |
| Total shareholders’ equity                      |       | 640.2       |       | 499.0                       |       | (6.7                            | )          | (492.3           | )          | 640.2            |       |
| Total liabilities & equity                  |       | $           | 836.1      |                        | $          | 659.7                           |       | $                | 3.1        |             | $          | (519.6 | ) | $ | 979.3 |   |

 

65

----

 

**CONDENSEDCONSOLIDATING BALANCE SHEET**

**AT DECEMBER 31,2004**

 
| ** **                                           | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|-------------|------------|-----------------------------|------------|-------------------------------|------------|------------------|------------|------------------|------------|
|                                                 |       |        |       |                        |       |                          |       |             |       |             |       |
| **Assets**                                           |       |        |       |                        |       |                          |       |             |       |             |       |
| Cash and cash equivalents                            |       | $           | 30.0       |                        | $          | 0.1                           |       | $                | 0.1        |             | $          | — |   | $ | 30.2 |   |
| Short-term investments                               |       | 46.4        |       | —                      |       | —                        |       | —           |       | 46.4             |       |
| Accounts receivable, net                             |       | 20.4        |       | 122.7                       |       | 2.4                           |       | (22.9            | )          | 122.6            |       |
| Inventories                                          |       | —      |       | 127.5                       |       | 0.8                           |       | —           |       | 128.3            |       |
| Other current assets                                 |       | 1.4         |       | 51.9                        |       | 1.3                           |       | (3.0             | )          | 51.6             |       |
| Total current assets                                 |       | 98.2        |       | 302.2                       |       | 4.6                           |       | (25.9            | )          | 379.1            |       |
|                                                 |       |        |       |                        |       |                          |       |             |       |             |       |
| Investment in subsidiaries                           |       | 344.4       |       | —                      |       | —                        |       | (344.4           | )          | —           |       |
| Investments                                          |       | 12.7        |       | —                      |       | —                        |       | —           |       | 12.7             |       |
| Property, plant, and equipment, net                  |       | 0.3         |       | 204.3                       |       | 1.2                           |       | —           |       | 205.8            |       |
| Goodwill                                             |       | 3.5         |       | 37.4                        |       | —                        |       | —           |       | 40.9             |       |
| Advances from parent                                 |       | 51.8        |       | —                      |       | —                        |       | (51.8            | )          | —           |       |
| Other noncurrent assets                              |       | 3.8         |       | 4.1                         |       | 0.3                           |       | —           |       | 8.2              |       |
| Total assets                                         |       | $           | 514.7      |                        | $          | 548.0                         |       | $                | 6.1        |             | $          | (422.1 | ) | $ | 646.7 |   |
|                                                 |       |        |       |                        |       |                          |       |             |       |             |       |
| **Liabilities & Shareholders’ Equity** |       |        |       |                        |       |                          |       |             |       |             |       |
| Accounts payable                                     |       | $           | 3.3        |                        | $          | 64.8                          |       | $                | 11.7       |             | $          | (25.9 | ) | $ | 53.9 |   |
| Accrued liabilities                                  |       | 5.2         |       | 31.2                        |       | 0.7                           |       | —           |       | 37.1             |       |
| Total current liabilities                            |       | 8.5         |       | 96.0                        |       | 12.4                          |       | (25.9            | )          | 91.0             |       |
|                                                 |       |        |       |                        |       |                          |       |             |       |             |       |
| Senior subordinated debt                             |       | 150.0       |       | —                      |       | —                        |       | —           |       | 150.0            |       |
| Advances from parent                                 |       | —      |       | 51.8                        |       | —                        |       | (51.8            | )          | —           |       |
| Other noncurrent liabilities                         |       | 1.7         |       | 49.5                        |       | —                        |       | —           |       | 51.2             |       |
| Total liabilities                                    |       | 160.2       |       | 197.3                       |       | 12.4                          |       | (77.7            | )          | 292.2            |       |
| Total shareholders’ equity                      |       | 354.5       |       | 350.7                       |       | (6.3                          | )          | (344.4           | )          | 354.5            |       |
| Total liabilities & equity                  |       | $           | 514.7      |                        | $          | 548.0                         |       | $                | 6.1        |             | $          | (422.1 | ) | $ | 646.7 |   |

 

66

----

 

**CONDENSED CONSOLIDATING RESULTS OF OPERATIONS**

**FOR THE YEAR ENDED DECEMBER 31, 2005**

 
| ** **                                 | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------|------------|-------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
|                                       |       |        |       |                        |       |                            |       |             |       |             |       |
| Net revenues                               |       | $           | —     |                        | $          | 1,351.8                         |       | $                | 6.2        |             | $          | (72.9 | ) | $ | 1,285.1 |   |
| Cost of goods sold                         |       | —      |       | 1,079.4                     |       | 6.3                             |       | (72.9            | )          | 1,012.8          |       |
| Gross profit (loss)                        |       | —      |       | 272.4                       |       | (0.1                            | )          | —           |       | 272.3            |       |
| Selling, general and administrative        |       | 6.9         |       | 43.3                        |       | 0.3                             |       | —           |       | 50.5             |       |
| Operating income (loss)                    |       | (6.9        | )          | 229.1                       |       | (0.4                            | )          | —           |       | 221.8            |       |
| Equity in subsidiaries’ income (loss) |       | 235.5       |       | —                      |       | —                          |       | (235.5           | )          | —           |       |
| Interest expense, net                      |       | (8.6        | )          | (1.7                        | )          | —                          |       | —           |       | (10.3            | )          |
| Other income, net                          |       | 0.2         |       | 8.5                         |       | —                          |       | —           |       | 8.7              |       |
| Income (loss) before income tax            |       | 220.2       |       | 235.9                       |       | (0.4                            | )          | (235.5           | )          | 220.2            |       |
| Income tax benefit                         |       | 3.4         |       | —                      |       | —                          |       | —           |       | 3.4              |       |
| Net income (loss)                          |       | $           | 223.6      |                        | $          | 235.9                           |       | $                | (0.4       | )                | $          | (235.5 | ) | $ | 223.6 |   |

 

**CONDENSED CONSOLIDATING RESULTS OF OPERATIONS**

**FOR THE YEAR ENDED DECEMBER 31, 2004**

 
| ** **                                 | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------|------------|-------------|------------|-----------------------------|------------|-------------------------------|------------|------------------|------------|------------------|------------|
|                                       |       |        |       |                        |       |                          |       |             |       |             |       |
| Net revenues                               |       | $           | —     |                        | $          | 1,008.6                       |       | $                | 5.9        |             | $          | (47.7 | ) | $ | 966.8 |   |
| Cost of goods sold                         |       | —      |       | 846.0                       |       | 6.5                           |       | (47.7            | )          | 804.8            |       |
| Gross profit (loss)                        |       | —      |       | 162.6                       |       | (0.6                          | )          | —           |       | 162.0            |       |
| Selling, general and administrative        |       | 6.4         |       | 37.9                        |       | 0.3                           |       | —           |       | 44.6             |       |
| Operating income (loss)                    |       | (6.4        | )          | 124.7                       |       | (0.9                          | )          | —           |       | 117.4            |       |
| Equity in subsidiaries’ income (loss) |       | 123.6       |       | —                      |       | —                        |       | (123.6           | )          | —           |       |
| Interest expense, net                      |       | (13.4       | )          | (1.6                        | )          | —                        |       | —           |       | (15.0            | )          |
| Other income, net                          |       | 0.6         |       | 1.2                         |       | 0.2                           |       | —           |       | 2.0              |       |
| Income (loss) before income tax            |       | 104.4       |       | 124.3                       |       | (0.7                          | )          | (123.6           | )          | 104.4            |       |
| Income tax expense                         |       | (3.4        | )          | —                      |       | —                        |       | —           |       | (3.4             | )          |
| Net income (loss)                          |       | $           | 101.0      |                        | $          | 124.3                         |       | $                | (0.7       | )                | $          | (123.6 | ) | $ | 101.0 |   |

 

67

----

 

**CONDENSED CONSOLIDATING RESULTS OFOPERATIONS**

**FOR THEYEAR ENDED DECEMBER 31, 2003**

 
| ** **                                 | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------|------------|-------------|------------|-----------------------------|------------|-------------------------------|------------|------------------|------------|------------------|------------|
|                                       |       |        |       |                        |       |                          |       |             |       |             |       |
| Net revenues                               |       | $           | —     |                        | $          | 561.0                         |       | $                | 5.7        |             | $          | (32.6 | ) | $ | 534.1 |   |
| Cost of goods sold                         |       | —      |       | 556.1                       |       | 5.7                           |       | (32.9            | )          | 528.9            |       |
| Gross profit                               |       | —      |       | 4.9                         |       | —                        |       | 0.3              |       | 5.2              |       |
| Selling, general, and administrative       |       | 5.8         |       | 35.1                        |       | 0.9                           |       | —           |       | 41.8             |       |
| Goodwill impairment charge                 |       | —      |       | 18.7                        |       | —                        |       | —           |       | 18.7             |       |
| Operating income (loss)                    |       | (5.8        | )          | (48.9                       | )          | (0.9                          | )          | 0.3              |       | (55.3            | )          |
| Equity in subsidiaries’ income (loss) |       | (47.6       | )          | —                      |       | —                        |       | 47.6             |       | —           |       |
| Interest income (expense), net             |       | (15.2       | )          | 0.2                         |       | —                        |       | —           |       | (15.0            | )          |
| Other income (expense), net                |       | 0.4         |       | 2.7                         |       | (0.9                          | )          | —           |       | 2.2              |       |
| Income (loss) before income tax            |       | (68.2       | )          | (46.0                       | )          | (1.8                          | )          | 47.9             |       | (68.1            | )          |
| Income tax expense                         |       | —      |       | (0.1                        | )          | —                        |       | —           |       | (0.1             | )          |
| Net income (loss)                          |       | $           | (68.2      | )                           | $          | (46.1                         | )          | $                | (1.8       | )                | $          | 47.9 |   | $ | (68.2 | ) |

 

68

----

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOW**

**FOR THE YEAR ENDED DECEMBER 31, 2005**

 
| ** **                              | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------|------------|-------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| Net cash provided by (used in)          |       |        |       |                        |       |                            |       |             |       |             |       |
| operating activities                    |       | $           | (6.4       | )                           | $          | 154.8                           |       | $                | (0.2       | )                | $          | — |   | $ | 148.2 |   |
| Cash flows from investing activities:   |       |        |       |                        |       |                            |       |             |       |             |       |
| Capital expenditures                    |       | (0.1        | )          | (20.9                       | )          | —                          |       | —           |       | (21.0            | )          |
| Proceeds from sale of PP&E          |       | —      |       | 2.5                         |       | —                          |       | —           |       | 2.5              |       |
| Purchase of investments                 |       | (324.1      | )          | —                      |       | —                          |       | —           |       | (324.1           | )          |
| Proceeds from sales of investments      |       | 229.7       |       | —                      |       | —                          |       | —           |       | 229.7            |       |
| Net cash used in                        |       |        |       |                        |       |                            |       |             |       |             |       |
| investing activities                    |       | (94.5       | )          | (18.4                       | )          | —                          |       | —           |       | (112.9           | )          |
| Cash flows from financing activities:   |       |        |       |                        |       |                            |       |             |       |             |       |
| Advances from parent, net               |       | 62.6        |       | (62.6                       | )          | —                          |       | —           |       | —           |       |
| Payment of preferred stock              |       | 70.0        |       | (70.0                       | )          |                            |       |             |       |             |       |
| Dividends to parent                     |       | 2.8         |       | (2.8                        | )          | —                          |       | —           |       | —           |       |
| Proceeds from exercise of options       |       | 36.6        |       | —                      |       | —                          |       | —           |       | 36.6             |       |
| Net cash provided by (used in)          |       |        |       |                        |       |                            |       |             |       |             |       |
| financing activities                    |       | 172.0       |       | (135.4                      | )          | —                          |       | —           |       | 36.6             |       |
| Effect of exchange rate changes on cash |       | —      |       | —                      |       | 0.1                             |       | —           |       | 0.1              |       |
| Net change in cash                      |       | 71.1        |       | 1.0                         |       | (0.1                            | )          | —           |       | 72.0             |       |
| Cash beginning balance                  |       | 30.0        |       | (0.1                        | )          | 0.3                             |       | —           |       | 30.2             |       |
| Cash ending balance                     |       | $           | 101.1      |                        | $          | 0.9                             |       | $                | 0.2        |             | $          | — |   | $ | 102.2 |   |

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOW**

**FOR THE YEAR ENDED DECEMBER 31, 2004**

 
| ** **                              | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------|------------|-------------|------------|-----------------------------|------------|-------------------------------|------------|------------------|------------|------------------|------------|
| Net cash provided by (used in)          |       |        |       |                        |       |                          |       |             |       |             |       |
| operating activities                    |       | $           | (47.5      | )                           | $          | 76.9                          |       | $                | 0.1        |             | $          | — |   | $ | 29.5 |   |
| Cash flows from investing activities:   |       |        |       |                        |       |                          |       |             |       |             |       |
| Capital expenditures                    |       | (0.1        | )          | (12.9                       | )          | —                        |       | —           |       | (13.0            | )          |
| Proceeds from sale of PP&E          |       | —      |       | 0.7                         |       | —                        |       | —           |       | 0.7              |       |
| Restricted cash                         |       | 32.2        |       | —                      |       | —                        |       | —           |       | 32.2             |       |
| Purchase of investments                 |       | (88.6       | )          | —                      |       | —                        |       | —           |       | (88.6            | )          |
| Proceeds from sales of investments      |       | 29.5        |       | —                      |       | —                        |       | —           |       | 29.5             |       |
| Net cash used in                        |       |        |       |                        |       |                          |       |             |       |             |       |
| investing activities                    |       | (27.0       | )          | (12.2                       | )          | —                        |       | —           |       | (39.2            | )          |
| Cash flows from financing activities:   |       |        |       |                        |       |                          |       |             |       |             |       |
| Advances from parent, net               |       | 58.6        |       | (58.6                       | )          | —                        |       | —           |       | —           |       |
| Dividends to parent                     |       | 6.5         |       | (6.5                        | )          | —                        |       | —           |       | —           |       |
| Proceeds from exercise of options       |       | 6.4         |       | —                      |       | —                        |       | —           |       | 6.4              |       |
| Net cash provided by (used in)          |       |        |       |                        |       |                          |       |             |       |             |       |
| financing activities                    |       | 71.5        |       | (65.1                       | )          | —                        |       | —           |       | 6.4              |       |
| Effect of exchange rate changes on cash |       | —      |       | —                      |       | 0.2                           |       | —           |       | 0.2              |       |
| Net change in cash                      |       | (3.0        | )          | (0.4                        | )          | 0.3                           |       | —           |       | (3.1             | )          |
| Cash beginning balance                  |       | 33.0        |       | 0.3                         |       | —                        |       | —           |       | 33.3             |       |
| Cash ending balance                     |       | $           | 30.0       |                        | $          | (0.1                          | )          | $                | 0.3        |             | $          | — |   | $ | 30.2 |   |

 

69

----

 

**CONDENSED CONSOLIDATING STATEMENT OF CASH FLOW**

**FOR THE YEAR ENDED DECEMBER 31, 2003**

 
| ** **                                          | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------|------------|-------------|------------|-----------------------------|------------|-------------------------------|------------|------------------|------------|------------------|------------|
| Net cash used in operating                          |       |        |       |                        |       |                          |       |             |       |             |       |
| activities                                          |       | $           | (7.7       | )                           | $          | (0.7                          | )          | $                | —     |             | $          | — |   | $ | (8.4 | ) |
| Cash flows from investing activities:               |       |        |       |                        |       |                          |       |             |       |             |       |
| Capital expenditures                                |       | (0.1        | )          | (14.2                       | )          | (0.1                          | )          | —           |       | (14.4            | )          |
| Proceeds from sale of PP&E                      |       | —      |       | 0.4                         |       | —                        |       | —           |       | 0.4              |       |
| Restricted cash                                     |       | (32.2       | )          | —                      |       | —                        |       | —           |       | (32.2            | )          |
| Acquisitions, net of cash received                  |       | (34.0       | )          | —                      |       | —                        |       | —           |       | (34.0            | )          |
| Net cash used in investing activities               |       | (66.3       | )          | (13.8                       | )          | (0.1                          | )          | —           |       | (80.2            | )          |
| Cash flows from financing activities:               |       |        |       |                        |       |                          |       |             |       |             |       |
| Advances from parent                                |       | 82.4        |       | (83.0                       | )          | 0.6                           |       | —           |       | —           |       |
| Issuance of preferred stock                         |       | (105.0      | )          | 105.0                       |       | —                        |       | —           |       | —           |       |
| Proceeds from exercise of options                   |       | 1.3         |       | —                      |       | —                        |       | —           |       | 1.3              |       |
| Dividends to parent                                 |       | 9.8         |       | (9.8                        | )          | —                        |       | —           |       | —           |       |
| Purchase of treasury stock                          |       | (0.8        | )          | —                      |       | —                        |       | —           |       | (0.8             | )          |
| Net cash (used in) provided by financing activities |       | (12.3       | )          | 12.2                        |       | 0.6                           |       | —           |       | 0.5              |       |
| Effect of exchange rate changes                     |       | —      |       | 1.6                         |       | (0.7                          | )          | —           |       | 0.9              |       |
| Net change in cash                                  |       | (86.3       | )          | (0.7                        | )          | (0.2                          | )          | —           |       | (87.2            | )          |
| Cash beginning balance                              |       | 119.3       |       | 1.0                         |       | 0.2                           |       | —           |       | 120.5            |       |
| Cash ending balance                                 |       | $           | 33.0       |                        | $          | 0.3                           |       | $                | —     |             | $          | — |   | $ | 33.3 |   |

 

**QUARTERLY FINANCIAL SUMMARY (UNAUDITED)  — NOTE O**

 
| ** **                                  | ** ** | **2005 - Quarter Ended** | ** ** |
|---------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                  | ** ** | **First**                               | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** | **Total  Year** | ** ** |
| Net revenues                                |       | $                                       | 297.8      |   | $ | 325.7 |   | $ | 324.1 |   | $ | 337.5 |   | $ | 1,285.1 |   |
| Gross profit                                |       | 55.3                                    |       | 70.8 |   | 69.8 |   | 76.4 |   | 272.3 |   |
| Net income                                  |       | 38.9                                    |       | 63.5 |   | 50.3 |   | 70.9 |   | 223.6 |   |
|                                        |       |                                    |       |   |   |   |   |   |   |   |   |
| **Per common share - basic**                |       |                                    |       |   |   |   |   |   |   |   |   |
| Net income available to common shareholders |       | $                                       | 1.32       |   | $ | 2.14 |   | $ | 1.66 |   | $ | 2.32 |   | $ | 7.44 |   |
| **Per common share - diluted**              |       |                                    |       |   |   |   |   |   |   |   |   |
| Net income available to common shareholders |       | $                                       | 1.30       |   | $ | 2.09 |   | $ | 1.63 |   | $ | 2.28 |   | $ | 7.34 |   |

 
| ** **                                  | ** ** | **2004 - Quarter Ended** | ** ** |
|---------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                  | ** ** | **First**                               | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** | **Total  Year** | ** ** |
| Net revenues                                |       | $                                       | 179.8      |   | $ | 246.2 |   | $ | 272.2 |   | $ | 268.6 |   | $ | 966.8 |   |
| Gross profit                                |       | 23.2                                    |       | 47.9 |   | 41.4 |   | 49.5 |   | 162.0 |   |
| Net income                                  |       | 8.0                                     |       | 32.2 |   | 26.8 |   | 34.0 |   | 101.0 |   |
|                                        |       |                                    |       |   |   |   |   |   |   |   |   |
| **Per common share - basic**                |       |                                    |       |   |   |   |   |   |   |   |   |
| Net income available to common shareholders |       | $                                       | 0.28       |   | $ | 1.13 |   | $ | 0.93 |   | $ | 1.17 |   | $ | 3.51 |   |
| **Per common share - diluted**              |       |                                    |       |   |   |   |   |   |   |   |   |
| Net income available to common shareholders |       | $                                       | 0.28       |   | $ | 1.11 |   | $ | 0.91 |   | $ | 1.15 |   | $ | 3.46 |   |

 

70

----

 

**LONE STARTECHNOLOGIES, INC.**

**Schedule II - Valuationand Qualifying Accounts**

**December 31,2003, 2004, and 2005**

***($ in millions)***

 
| ** **                                     | ** ** | **Balance at  Beginning  of Period** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Charged  to Other  Accounts** | ** ** | **Deductions** | ** ** | **Balance  at End  of Period** | ** ** |
|------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------|------------|----------------|------------|------------------------------------------|------------|
|                                           |       |                                           |       |                                          |       |                                 |       |           |       |                                     |       |
| *Year ended December 31, 2003*            |       |                                           |       |                                          |       |                                 |       |           |       |                                     |       |
| Allowance for doubtful accounts                |       | 1.6                                            |       | 0.5                                           |       | —                               |       | (0.4           | )          | 1.7                                      |       |
| Valuation allowance on net deferred tax assets |       | 93.1                                           |       | —                                        |       | 19.0                                 |       | —         |       | 112.1                                    |       |
|                                           |       |                                           |       |                                          |       |                                 |       |           |       |                                     |       |
| *Year ended December 31, 2004*            |       |                                           |       |                                          |       |                                 |       |           |       |                                     |       |
| Allowance for doubtful accounts                |       | 1.7                                            |       | 0.1                                           |       | —                               |       | (0.5           | )          | 1.3                                      |       |
| Valuation allowance on net deferred tax assets |       | 112.1                                          |       | —                                        |       | —                               |       | (26.1          | )          | 86.0                                     |       |
|                                           |       |                                           |       |                                          |       |                                 |       |           |       |                                     |       |
| *Year ended December 31, 2005*            |       |                                           |       |                                          |       |                                 |       |           |       |                                     |       |
| Allowance for doubtful accounts                |       | 1.3                                            |       | 0.2                                           |       | —                               |       | (0.1           | )          | 1.4                                      |       |
| Valuation allowance on net deferred tax assets |       | 86.0                                           |       | —                                        |       | —                               |       | (83.2          | )          | 2.8                                      |       |

 
| **ITEM 9.** | **CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING  AND FINANCIAL DISCLOSURE** |
|-------------|-------------------------------------------------------------------------------------------|

 

None.

 
| **ITEM 9A.** | **CONTROLS AND PROCEDURES** |
|--------------|-----------------------------|

 

(a)          Evaluation of disclosure control and procedures.

 

Undersupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of the effectiveness of the design and operation of our disclosurecontrols and procedures, as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as of the end of the period covered bythis Annual Report on Form 10-K (the “Evaluation Date”); and whether anychange has occurred in the Company’s internal control over financial reportingpursuant to Exchange Act Rules 13a-15(d) and 15d-15(d). Based on thisevaluation, our principal executive officer and principal financial officerconcluded as of the Evaluation Date that our disclosure controls and procedureswere effective.

 

(b)         Management’s report on internal control over financial reporting.

 

Management’sreport on internal control over financial reporting, which appears on page 38of this Annual Report, is incorporated herein by reference.

 

Management’sassessment of the effectiveness of internal control over financial reporting asof December 31, 2005, was audited by Deloitte & Touche LLP, anindependent registered public accounting firm, as stated in its report whichappears on page 39 of this Annual Report, which is incorporated herein byreference.

 

(c)          Changes in internal control over financial reporting.

 

Therewas no change in our internal control over financial reporting that occurred inthe fourth quarter of 2005 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

71

----

 
| **ITEM 9B.** | **OTHER INFORMATION** |
|--------------|-----------------------|

 

None.

 

**PART III**

 
| **ITEM 10.** | **DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT** |
|--------------|--------------------------------------------------------|

 

Information required underthis item is contained in Lone Star’s proxy statement for the 2006 AnnualMeeting of Shareholders, and is incorporated herein by reference.

 
| **ITEM 11.** | **EXECUTIVE COMPENSATION** |
|--------------|----------------------------|

 

Information required underthis item is contained in Lone Star’s proxy statement for the 2006 AnnualMeeting of Shareholders, and is incorporated herein by reference. Lone Star’svoluntary disclosure “Supplemental Information Regarding Executive Compensation”is not incorporated herein.

 
| **ITEM 12.** | **SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT AND RELATED SHAREHOLDER MATTERS** |
|--------------|-----------------------------------------------------------------------------------------------------|

 

Information required underthis item with respect to beneficial owners of more than 5% of outstandingcommon stock, directors and executive officers and securities authorized forissuance under equity compensation plans is contained in Lone Star’s proxystatement for the 2006 Annual Meeting of Shareholders, and is incorporatedherein by reference. Lone Star’s voluntary disclosure “Supplemental InformationRegarding Executive Compensation” is not incorporated herein.

 
| **ITEM 13.** | **CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS** |
|--------------|----------------------------------------------------|

 

Informationrequired under this item with respect to directors and executive officers iscontained in Lone Star’s proxy statement for the 2006 Annual Meeting ofShareholders, and is incorporated herein by reference.

 
| **ITEM 14.** | **PRINCIPAL ACCOUNTING FEES AND SERVICES** |
|--------------|--------------------------------------------|

 

Informationwith respect to fees and services related to the Company’s independentauditors, Deloitte & Touche LLP, and the disclosure of the AuditCommittee’s pre-approval policies and procedures are contained in Lone Star’sproxy statement for the 2006 Annual Meeting of Shareholders, and areincorporated herein by reference.

 

72

----

 

**PART IV**

 
| **ITEM 15.** | **EXHIBITS AND FINANCIAL STATEMENT SCHEDULES** |
|--------------|------------------------------------------------|

 

1.               FinancialStatements - the following Consolidated Financial Statements are filed as part ofthis report:

•                  Reportsof Independent Registered Public Accounting Firm

•                  Management’sReport on Internal Control over Financial Reporting

•                  ConsolidatedResults of Operations - for theyears ended December 31, 2005, 2004, and 2003

•                  ConsolidatedBalance Sheets - at December 31, 2005 and 2004

•                  ConsolidatedStatements of Cash Flows - forthe years ended December 31, 2005, 2004, and 2003

•                  ConsolidatedStatements of Shareholders’ Equity - at December 31, 2005, 2004, and 2003

•                  Notesto Consolidated Financial Statements

 

2.               Schedule II- Valuation and Qualifying Accounts

 

Note:                   All schedules not filed herein for whichprovision is made under rules of Regulation S-X have been omitted as notapplicable or not required or the information required has been included in thenotes to the consolidated financial statements.

 

3.               Indexto Exhibits

 

***Description***

 
| 2.1 | Asset Purchase Agreement dated as of November 16, 1999 by and  among Lone Star, Fintube Technologies, Inc. and Fintube Limited  Partnership (incorporated by reference to the same numbered Exhibit to  Form 8-K of Lone Star as filed on January 18, 2000).                                                                                |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.2 | First Amendment to Asset Purchase Agreement dated as of  January 1, 2000 by and among Lone Star, Fintube Technologies, Inc.  and Fintube Limited Partnership (incorporated by reference to the same  numbered Exhibit to Form 8-K of Lone Star as filed on  January 18, 2000).                                                              |
| 2.3 | Asset Purchase Agreement dated as of March 7, 2000 by and among  Lone Star, Bellville Acquisition, Inc. and Bellville Tube Corporation  (incorporated by reference to Exhibit 2.1 to Form 8-K of Lone Star  as filed on April 17, 2000).                                                                                                    |
| 2.4 | First Amendment to Asset Purchase Agreement dated as of March 31,  2000 by and among Lone Star, Bellville Acquisition, Inc. and Bellville  Tube Corporation (incorporated by reference to Exhibit 2.2 to  Form 8-K of Lone Star as filed on April 17, 2000).                                                                                |
| 2.5 | Purchase and Sale Agreement among North Star Steel Company, Universal  Tubular Services, Inc., Cargill, Incorporated, Lone Star  Technologies, Inc., and Star Seamless, Inc., dated as of  August 16, 2001 (incorporated by reference to Exhibit 2.1 to  Form 8-K/A of Lone Star as filed on August 17, 2001).                    |
| 2.6 | Asset Purchase Agreement, dated September 9, 2002, among Lone  Star, Wheeling Acquisition Corporation (a wholly-owned subsidiary of Lone  Star), Wheeling and Nassau Holding Corporation, as Owner of Wheeling  (incorporated by reference to Exhibit 2.1 to Form 8-K of Lone Star  dated September 30, 2002 and filed on October 7, 2002). |
| 2.7 | Amendment to Asset Purchase Agreement, dated September 30, 2002,  among Lone Star, Wheeling Acquisition Corporation (a wholly-owned subsidiary  of Lone Star), Wheeling and Nassau Holding Corporation (incorporated by  reference to Exhibit 2.2 to Form 8-K of Lone Star dated September 30,  2002 and filed on October 7, 2002).         |
| 3.1 | Certificate of Incorporation of Registrant (incorporated by reference  to Exhibit 3(a) to Form S-4 Registration Statement of Lone  Star as filed on April 4, 1986, File No. 33-4581).                                                                                                                                                       |
| 3.2 | Certificate of Amendment to Certificate of Incorporation dated  September 30, 1986 (incorporated by reference to Exhibit 3.2 to  Form S-3 Registration Statement of Lone Star as filed on  February 4, 2000, File No. 333-96207).                                                                                                           |
| 3.3 | Agreement and Plan of Merger dated March 6, 1986, among Steel, a  Texas corporation, Lone Star, a Delaware corporation, and Lone Star Steel  Company Merging Corporation, a Delaware corporation (incorporated by                                                                                                                                               |

 

73

----

 
|    | reference to Exhibit II to Form S-4 Registration Statement  of Lone Star as filed on April 4, 1986, File No. 33-4581).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|---------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.4     | Amended and Restated Bylaws, as amended and restated on September 21,  2004 (incorporated by reference to Exhibit 3.1 to Form 8-K of Lone  Star as filed on September 24, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 3.5     | Certificate of Amendment to Certificate of Incorporation dated May 20,  1998 (incorporated by reference to Exhibit 3.4 to Form 10-Q for the  quarter ended June 30, 1998).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 4.1     | Statement of Resolution establishing Cumulative Preferred Stock, Series A  (par value $1 per share), dated September 9, 1988 (incorporated by  reference to Exhibit 3(c) of Form 10-K of Lone Star filed April 7,  1989).                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.2     | Stock Registration Agreement dated January 1, 2000 among Lone  Star Technologies, Inc., Fintube Limited Partnership, Yorktown Energy  Partners, Brown University Third Century Fund, Warburg, Dillon, Reed, L.L.C.  and Ticonderoga Partners and the stockholders named therein (incorporated by  reference to Exhibit 4.1 to Form S-3 Registration Agreement of Lone  Star as filed on February 4, 2000, File No. 333-96207).                                                                                                                                                                                                                                       |
| 4.3     | Indenture dated as of May 29, 2001 among Lone Star, Environmental  Holdings, Inc., Zinklahoma, Inc., Lone Star Steel Company, Lone  Star Logistics, Inc., Lone Star Steel International, Inc., Lone  Star Steel Sales Company, Rotac, Inc., T&N Lone Star Warehouse Co.,  Texas & Northern Railway Company, Lone Star ST Holdings, Inc.,  Fintube Technologies, Inc., Fintube Canada, Inc., Bellville Tube  Corporation, and Wells Fargo Bank Minnesota, National Association (incorporated  by reference to Exhibit 4.4 to Form S-4 Registration Statement of  Lone Star as filed on June 27, 2001, File No. 333-63944). |
| 4.4     | Exchange and Registration Rights Agreement dated May 29, 2001,  among Lone Star, Goldman, Sachs & Co., Salomon Smith Barney Inc.,  Banc of America Securities LLC, CIBC World Markets Corp., Dresdner Kleinwort  Wasserstein Securities LLC, RBC Dominion Securities Corporation, and The  Robinson-Humphrey Company, LLC (incorporated by reference to Exhibit 4.5  to Form S-4 Registration Statement of Lone Star as filed on June 27,  2001, File No. 333-63944).                                                                                                                                                                                            |
| 10.1    | Amended 1985 Long-Term Incentive Plan (incorporated by reference to Exhibit A  of Proxy Statement of Lone Star as filed on October 22, 1993).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.1(a) | Amendments to the Amended 1985 Long-Term Incentive Plan adopted on May 8,  1997 (incorporated by reference to Exhibit 10.1(a) to Form 10-Q  of Lone Star for the quarter ended June 30, 1997). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.1(b) | Amendments to the Amended 1985 Long-Term Incentive Plan adopted on May 14,  1998 (incorporated by reference to same numbered Exhibit to Form 10-Q  for the quarter ended June 30, 1998). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.1(c) | Amendments to the Amended 1985 Long-Term Incentive Plan adopted on May 11,  1999 (incorporated by reference to same numbered Exhibit to Form 10-Q  for the quarter ended June 30, 1999). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.1(d) | Amendment to the Amended 1985 Long-Term Incentive Plan adopted on May 9,  2000 (incorporated by reference to same numbered Exhibit to Form 10-Q  for the quarter ended June 30, 2000.) *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.1(e) | Amendments to the Amended 1985 Long-Term Incentive Plan adopted on May 8,  2001 (incorporated by reference to same numbered exhibit to Form 10-Q  for the quarter ended June 30, 2001). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.1(f) | Amendment to the 1985 Long-Term Incentive Plan adopted on May 9,  2002 (incorporated by reference to same numbered exhibit to Form 10-Q  for the quarter ended June 30, 2002). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.1(g) | Amendments to the 1985 Long-Term Incentive Plan adopted on May 13,  2003 (incorporated by reference to same numbered exhibit to Form 10-K  for the year ended December 31, 2003). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.1(h) | 2004 Long-Term Incentive Plan (incorporated by reference to Appendix A  to the Proxy Statement of Lone Star filed on March 19, 2004). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.2    | Employment Retention Policy adopted May 8, 1997, letter  agreements dated May 22, 1997 between Lone Star, Charles J. Keszler and  Robert F. Spears and between Steel and W. Byron Dunn and letter agreement  dated September 25, 1997 between Lone Star and Rhys J. Best  (incorporated by reference to Exhibit 10.3 to Form 10-K for the year  ended December 31, 1997).*                                                                                                                                                                                                                                                                                                |
| 10.3    | Contract for Electric Service dated September 30, 1996 between  Southwestern Electric Power Company and Steel (incorporated by reference to Exhibit 10.21  to Form 10-K for the year ended December 31, 1996).                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.4    | Cost Sharing Agreement dated as of July 1, 1997 between Lone Star  and Steel (incorporated by reference to Exhibit 10.24 to Form 10-K  for the year ended December 31, 1997).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.5    | Compromise and Settlement Agreement and Release dated July 31,  1997 between Lone Star and Guaranty Federal Bank, F.S.B. (incorporated by reference to Exhibit 10.26 to Form 10-K for  the year ended December 31, 1997).                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.6    | Phantom Stock Deferred Compensation Plan adopted on September 22,  1998 (incorporated by reference to Exhibit 10.28 to Form 10-Q for  the quarter ended September 30, 1998).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |

 

74

----

| 10.7  | Employee Stock  Purchase Plan adopted on May 9, 2000 (incorporated by reference to Exhibit  10.36 to Form 10-Q for the quarter ended June 30, 2000).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|-------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.8  | Second Amended  and Restated Deferred Compensation Plan adopted by Lone Star’s Board of  Directors on September 21, 2004 (incorporated by reference to Exhibit 10.36  to Form 8-K of Lone Star as filed on December 16, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.9  | Employment  Agreement dated May 7, 2001 between Lone Star and Rhys J. Best (incorporated  by reference to Exhibit 99.1 to Form 8-K of Lone Star as filed on May 9,  2001). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.10 | Purchase  Agreement dated May 23, 2001 among Lone Star, Goldman, Sachs & Co.,  Salomon Smith Barney Inc., Banc of America Securities LLC, RBC Dominion  Securities Corporation, and The Robinson-Humphrey Company, LLC (incorporated  by reference to Exhibit 10.20 to Form S-4 Registration Statement of Lone Star  as filed on June 27, 2001, File No. 333-63944).                                                                                                                                                                                                                                                                                                                                                                      |
| 10.11 | Employment  Agreement dated January 1, 2000 between Fintube Technologies, Inc. and Larry  Sims (incorporated by reference to Exhibit 10.43 to Form 10-Q for the quarter  ended March 31, 2001).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.12 | Amended and  Restated Financing Agreement dated October 8, 2001 among The CIT  Group/Business Credit, Inc. (as Agent and Lender), the Lenders party thereto,  and Lone Star, Lone Star Steel Company, Fintube Technologies, Inc., Lone Star  Logistics, Inc., T&N Lone Star Warehouse Co., Texas & Northern  Railway Company, Fintube Canada, Inc. and Bellville Tube Corporation (as  Borrowers), and Environmental Holdings, Inc., Zinklahoma, Inc., Lone Star  Steel International, Inc., Lone Star Steel Sales Company, Rotac, Inc., and  Lone Star ST Holdings, Inc. (as Guarantors) (incorporated by reference to  Exhibit 10.13 to Amendment No. 2 to Form S-4 of Lone Star as filed on October  9, 2001, File No. 333-63944). |
| 10.13 | First Amendment,  dated as of December 31, 2001, to Amended and Restated Financing Agreement  dated October 8, 2001 (incorporated by reference to Exhibit 10.31 to Form  10-Q for the quarter ended March 31, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.14 | Second  Amendment, dated March 13, 2002, to Amended and Restated Financing Agreement  dated October 8, 2001 (incorporated by reference to Exhibit 10.32 to Form  10-Q for the quarter ended March 31, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.15 | Third Amendment,  dated as of September 30, 2002, to Amended and Restated Financing Agreement  dated October 8, 2001 (incorporated by reference to Exhibit 10.33 to Form  10-Q for the quarter ended September 30, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.16 | Fourth  Amendment, dated as of September 30, 2002, to Amended and Restated Financing  Agreement dated October 8, 2001 (incorporated by reference to Exhibit 10.34  to Form 10-Q for the quarter ended September 30, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.17 | Fifth Amendment,  dated as of May 5, 2003, to Amended and Restated Financing Agreement dated  October 8, 2001 (incorporated by reference to Exhibit 10.1 to Form 10-Q for  the quarter ended June 30, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.18 | Sixth Amendment,  dated as of August 29, 2003, to Amended and Restated Financing Agreement  dated October 8, 2001 (incorporated by reference to Exhibit 10.33 to Form  10-K for year ended December 31, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.19 | Seventh  Amendment, dated as of December 16, 2003, to Amended and Restated Financing  Agreement dated October 8, 2001 (incorporated by reference to Exhibit 10.34 to  Form 10-K for year ended December 31, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.20 | Eighth  Amendment, dated as of September 21, 2004, to Amended and Restated Financing  Agreement dated October 8, 2001 (incorporated by reference to Exhibit 10.35  to Form 10-Q for quarter ended September 30, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.21 | Ninth Amendment,  dated as of December 31, 2005, to Amended and Restated Financing Agreement  dated October 8, 2001 (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.22 | Form of Director  and Officer Restricted Stock Agreement (incorporated by reference to Exhibit  10.2 to Form 8-K of Lone Star as filed on March 7, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.23 | First Amendment,  dated December 15, 2005, to Second Amended and Restated Deferred Compensation  Plan (incorporated by reference to Exhibit 10.1 to Form 8-K of Lone Star as  filed on December 21, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.24 | Compensation and  benefits outline for Joe Alvarado dated May 7, 2004 and related letter  agreement dated October 8, 2004 between Lone Star and Joe Alvarado  (incorporated by reference to Exhibit 10.22 to Form 10-K of Lone Star as  filed on March 2, 2005). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.25 | Form of Director  Stock Option Agreement (incorporated by reference to Exhibit 10.1 to Form 8-K  of Lone Star as filed on September 24, 2004). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.26 | Form of Director  Restricted Stock Unit Award (incorporated by reference to Exhibit 10.2 to  Form 8-K of Lone Star as filed on September 24, 2004). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.27 | Form of Employee  Stock Option Agreement with One-Year Vesting (incorporated by reference to  Exhibit 10.3 to Form 8-K of Lone Star as filed on September 24, 2004). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.28 | Form of Employee  Stock Option Agreement with Four-Year Vesting (incorporated by reference to  Exhibit 10.4 to Form 8-K of Lone Star as filed on September 24, 2004). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.29 | Form of Employee  Restricted Stock Agreement (incorporated by reference to Exhibit 10.5 to Form  8-K of Lone Star as filed on September 24, 2004). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 14.1  | Code of Ethics  for Senior Financial Officers adopted by Lone Star’s Board of Directors on  March 20, 2003 (incorporated by reference to Exhibit 99.1 to Form 10-K for  the year ended December 31, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

 

75

----

 
| 21   | List of  Subsidiaries.                                                                                                                                                     |
|------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 23   | Consent of  Deloitte & Touche LLP.                                                                                                                                     |
| 24   | Powers of  Attorney.                                                                                                                                                       |
| 31.1 | Certification of  Rhys J. Best pursuant to Rule 13a-14 of the Securities Exchange Act of 1934  as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.       |
| 31.2 | Certification of  Charles J. Keszler pursuant to Rule 13a-14 of the Securities Exchange Act of  1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32   | Certification  pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                     |

----

| * | Management contract or compensatory plan or arrangement. |
|---|----------------------------------------------------------|

 

76

----

 

**SIGNATURES**

 

Pursuant to the requirementsof Section 13 or 15(d) of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                         | **LONE STAR TECHNOLOGIES, INC.** |
|------------------------------|---------------------------------------|
|                         |                                  |
|                         |                                  |
| Date: February 28, 2006 | By:                                   | /s/ Charles J. Keszler |   |
|                         |                                  | Charles J. Keszler |   |
|                         |                                  | Vice President and Chief   Financial Officer |   |

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, this report has been signed below bythe following persons on behalf of the Registrant and in the capacities and onthe dates indicated.

 
| **Signature**                       | ** ** | **Title**                              | ** **                | **Date** | ** ** |
|-------------------------------------|------------|----------------------------------------|---------------------------|----------|------------|
|                                |       |                                   |                      |     |       |
| /s/ Rhys J. Best                    | ,          |                                   | Chairman, Director, Chief |     |       | February 28, 2006 |   |
| (Rhys J. Best)                      |       | Executive Officer and President        |                      |     |       |   |
|                                |       | (Principal Executive Officer)          |                      |     |       |   |
|                                |       |                                   |                      |     |       |   |
| /s/ Charles J. Keszler              | ,          |                                   | Vice President and Chief  |     |       | February 28, 2006 |   |
| (Charles J. Keszler)                |       | Financial Officer (Principal Financial |                      |     |       |   |
|                                |       | and Accounting Officer)                |                      |     |       |   |
|                                |       |                                   |                      |     |       |   |
| /s/ Dan O. Dinges *                 | ,          |                                   | Director                  |     |       | February 28, 2006 |   |
|  (Dan O. Dinges)               |       |                                   |                      |     |       |   |
|                                |       |                                   |                      |     |       |   |
| /s/ Frederick B. Hegi, Jr. *   | ,          |                                   | Director                  |     |       | February 28, 2006 |   |
|  (Frederick B. Hegi, Jr.) |       |                                   |                      |     |       |   |
|                                |       |                                   |                      |     |       |   |
| /s/ Robert L. Keiser *              | ,          |                                   | Director                  |     |       | February 28, 2006 |   |
|  (Robert L. Keiser)            |       |                                   |                      |     |       |   |
|                                |       |                                   |                      |     |       |   |
|  /s/ Robert Kelley *           | ,          |                                   | Director                  |     |       | February 28, 2006 |   |
|  (Robert Kelley)               |       |                                   |                      |     |       |   |
|                                |       |                                   |                      |     |       |   |
|  /s/ M. Joseph McHugh *        | ,          |                                   | Director                  |     |       | February 28, 2006 |   |
| (M. Joseph McHugh)                  |       |                                   |                      |     |       |   |
|                                |       |                                   |                      |     |       |   |
| /s/ Alfred M. Micallef *            | ,          |                                   | Director                  |     |       | February 28, 2006 |   |
| (Alfred M. Micallef)                |       |                                   |                      |     |       |   |
|                                |       |                                   |                      |     |       |   |
| /s/ David A. Reed *                 | ,          |                                   | Director                  |     |       | February 28, 2006 |   |
| (David A. Reed)                     |       |                                   |                      |     |       |   |
|                                |       |                                   |                      |     |       |   |
| /s/ Jerry E. Ryan *                 | ,          |                                   | Director                  |     |       | February 28, 2006 |   |
| (Jerry E. Ryan)                     |       |                                   |                      |     |       |   |

 

----

| *By:   | /s/ Charles J. Keszler                  |   |   |   |   |
|--------|-----------------------------------------|--------|--------|--------|--------|
|   | (Charles J.  Keszler, Attorney-in-Fact) |   |   |   |

 

77

----