**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 THEFISCAL YEAR ENDED DECEMBER 31, 2004**

 

**COMMISSIONFILE NUMBER 1-12881**

 

**LONE STAR TECHNOLOGIES, INC.**

(A DELAWARE CORPORATION)

 

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

 

**15660 N. DALLAS PARKWAY, SUITE 500DALLAS, TEXAS 75248(972) 770-6401**

** **

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

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

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months, and (2) has been subject to such filing requirements for the past 90days.  Yesý.  Noo.

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Exchange Act Rule12b-2).  Yesý.  Noo.

 

The aggregate market value of common stock on June 30, 2004 held bynonaffiliates of the registrant was approximately $790.9 million, based on theclosing price of the common stock on the New York Stock Exchange.

 

As of February 8, 2005, the number of shares of common stockoutstanding was 29,289,655.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of registrant’sProxy Statement for its 2005 Annual Meeting of Shareholders are incorporated byreference into Part III hereof.

 

 

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# **TABLEOF CONTENTS**

# ** **

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

 

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**PART I**

 

**ITEM 1. ****BUSINESS**

 

# **GENERAL**

# ** **

**Lone Star Technologies,Inc., a Delaware corporation, is:**

** **

•                  aleading domestic manufacturer and marketer of premium welded “oil countrytubular goods”, or “OCTG”, which are steel tubular products used in thecompletion of and production from oil and natural gas wells;

•                  amajor manufacturer and marketer of line pipe, which is used in the gatheringand transmission of oil and natural gas;

•                  aleading supplier of premium thermal treating, end finishing, inspection, andlogistics services to the oilfield industry;

•                  oneof the largest domestic manufacturers of high quality couplings used to connectindividual sections of oilfield casing and tubing;

•                  aleading manufacturer of specialty tubing products used in industrial,automotive, construction, agricultural, and heat recovery technologyapplications; and

•                  amarketer of oil country tubular goods and line pipe produced by other companiesthrough exclusive marketing arrangements.

 

**Lone Star began producingand marketing oil country tubular goods and other tubular products over 50years ago, and the holding company was incorporated in 1986.  As used in this report, the terms “we,” “us”,“our” and “Lone Star” refer to Lone Star Technologies, Inc. and itssubsidiaries and affiliates unless the context indicates otherwise.**

** **

**Lone Star’s operatingcompanies include Lone Star Steel Company (“Steel”), a manufacturer of oilfieldtubulars, specialty tubing products, and flat-rolled steel, and FintubeTechnologies, Inc. (“Fintube”), a manufacturer of specialty tubulars used inheat recovery technology applications. In October 2003 we created a new business unit, Star Energy Group, toenhance our ability to provide OCTG customers with a full spectrum of pipefinishing, inspection, and logistics services. Star Energy Group integrated the sales and marketing functions andproduction assets of four companies we acquired between 2000 and 2003:**

** **

•                  WheelingMachine Products, Inc. and Wheeling Machine Products of Texas, Inc.(collectively, “Wheeling”), one of the largest domestic suppliers of couplingsused to connect individual sections of oilfield casing and tubing;

•                  DeltaTubular Processing (“DTP”), a leading provider of thermal treating andend-finishing services for oilfield production tubing;

•                  Frank’sTubular International (since renamed Delta Tubular International, or “DTI”), aleading provider of high-quality threading, inspection, and storage services tothe OCTG market; and

•                  BellvilleTube Company, L.P. (“Bellville”), an OCTG manufacturer.

 

# **RISK FACTORS**

# ** **

In addition to important factors described elsewhere in this report,Lone Star cautions current and potential investors that the following riskfactors, among others, sometimes have affected, and in the future could affect,Lone Star’s actual results and could cause such results during fiscal 2005, andbeyond, to differ materially from those expressed in any forward-lookingstatements made by or on behalf of Lone Star. If any of the following risks actually occurs, our business, financialcondition or results of operations could be materially adversely affected andyou may lose all of your investment.

 

### ***The volatility of oil and gas markets affects demand for ourprincipal products, and downturns in these markets could cause our revenues todecrease. ***Proceeds from thesale of casing, tubing, line pipe, couplings and OCTG finishing services to theoil and gas industry constitute the majority of our revenues.  Downturns in the oil and gas markets andgeneral economic conditions could cause demand for our principal products andservices to decrease, which would adversely affect our revenues and results ofoperations.

### ** **

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Demand for our oilfield products and services depends primarily uponthe number of oil and natural gas wells being drilled, completed and re-workedat any given time and the depth and drilling conditions of these wells.  The level of these activities dependsprimarily on expectations as to future prices for natural gas and oil.  Natural gas and oil prices are subject tosignificant fluctuations in response to relatively minor changes in supply,market uncertainty and a variety of additional factors that are beyond ourcontrol.  These factors include:

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

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

#### **•**                  politicalinstability or armed conflict in oil and gas producing regions;

#### **•**                  the price andamounts of imports of oil and gas casing, tubing and line pipe;

#### **•**                  the availabilityof alternative fuels;

#### **•**                  the availabilityof pipeline capacity;

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

#### **•**                  domestic andforeign governmental regulations, especially trade laws and taxes; and

#### **•**                  the overalleconomic environment, including the demand for electricity.

#### ** **

We expect natural gas and oil prices and the domestic rig count tocontinue to be volatile in the future.  Adownturn in the oil and gas market could decrease demand for our products andservices and cause our revenues to decrease.

 

### ***Our precision mechanical tubulars and other businesses aresensitive to economic downturns, which could cause our revenues to decrease.*** We manufacture and sell high quality steel tubing in theform of precision mechanical tubulars used by our customers in the manufactureof products such as automotive stabilizers, hydraulic cylinders andcranes.  The demand for these productsand, in turn, for our precision mechanical tubulars, is dependent on thegeneral economy, the automotive and construction industries, product inventorylevels and other factors affecting domestic goods activity.  If we are not able to adequately predictdemand and if our precision mechanical tubulars inventories (or the inventoriesof other precision tubular manufacturers) become excessive, there could be amaterial adverse effect on price levels, the quantity of precision mechanicaltubulars sold by us and our revenues.

### ** **

### ***The competition for raw materials we use inour business and the volatility of our raw material costs could reduce ourprofits and constrain our operations, which would reduce our revenues.***  Purchased steel represents the largest portion of our costof goods sold.  Our raw material costs in2004 relating to purchased steel increased dramatically over the prioryear.  The price and availability of steelslabs, coils, scrap and wire rod that we use in our manufacturing processes arehighly competitive and cyclical.  Thefollowing factors, most of which are beyond our control, affect the price ofsteel:

### ** **

#### **•**                  supply and demandfactors;

#### **•**                  freight costs andtransportation availability;

#### **•**                  inventory levelsof brokers and distributors;

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

#### **•**                  trade duties andtaxes; and

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

#### ** **

Changes in steel prices can affect the pricing levels of ourproducts.  We seek to maintain our profitmargin by attempting to increase the price of our products in response to anincrease in steel costs and by sourcing steel from our flat rolled steeldivision, but we do not always succeed in passing these price increases throughto our customers.  As a result, wetypically have a limited ability to recover increases in steel costs.  While we endeavor to maintain flexibility inprocurement of steel for our specialty tubular products, any failure to obtainsufficient steel slabs and coils would constrain our operations.

 

In the welded oil and gas casing and tubing and line pipe market, wecompete against manufacturers that may be able to purchase or producesemi-finished steel, hot rolled coils or scrap at a lower cost than wecan.  Our Lone Star Steel subsidiarysatisfies its raw material requirements and those of our Bellville subsidiaryby purchasing semi-finished steel, using purchased and internally generatedscrap to make hot rolled coils in its melt shop and hot strip mill andpurchasing coils.  Our Wheelingsubsidiary typically purchases its coupling stock from domestic seamlessoilfield tubular manufacturers.  OurFintube subsidiary must also compete with manufacturers that may be able topurchase or produce coils more cost-effectively than we can.  We may not be able to satisfy our subsidiaries’raw material requirements as cost-effectively as our competitors, which maylead to reduced sales.

 

4

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### ***Excessive inventory levels of oilfield products could reducedemand for our products and adversely affect our sales.*** Industry-wide inventory levels of tubular goods for the oiland gas industry can vary significantly from period to period depending onindustry cycles.  These changes can havea direct adverse effect on the demand for new production of oilfield productswhen customers draw from existing inventory rather than purchase newproducts.  As a result, our oilfieldproducts sales and results of operations may vary significantly from period toperiod.  Excessive inventories could havea material adverse effect on price levels and the quantity of oil and gascasing, tubing, line pipe 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 government import trade restrictionscould increase foreign competition in our industry and decrease our sales andour profits, particularly in the case of oil and gas casing and tubing and linepipe.***  The domestic steel industryhistorically has faced significant competition from foreign steelproducers.  The level of imports of OCTG,which has varied significantly over time, affects the domestic market for thesegoods.  High levels of imports reduce thevolume sold by domestic producers and tend to suppress selling prices, both ofwhich have an adverse impact on our business.

### ** **

The level of imports of oil and gas casing and tubing and line pipe isaffected by numerous factors, including:

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

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

#### **•**                  the purchasingpattern of distributors and end users;

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

#### **•**                  the relativevalue of the United States dollar.

#### ** **

Many foreign steel producers are owned, controlled or subsidized bytheir governments and their decisions with respect to production and sales maybe influenced more by political and economic policy considerations than byprevailing market conditions.  Actionsmotivated by these factors could increase competition and cause our sales todecrease.

 

Anti-dumping and countervailing duty orders applicable to our industryare limited to specific countries, are largely under appeal and may be revokedas a result of periodic “sunset reviews.” In addition, an individual exporter may obtain revocation as to itselfunder specific circumstances.  In June2000 the United States government completed sunset reviews of orders coveringCanada and Taiwan and revoked both orders. While the United States government completed sunset reviews of orderscovering Argentina, Italy, Japan, Korea and Mexico in June 2001 and kept thoseorders in place, the orders remain subject to future sunset reviews beginningin 2006, and to annual reviews by the Department of Commerce.  The affirmative sunset review determinationshave been appealed to the Court of International Trade, and Argentina has appealedto the World Trade Organization.  Ifthose orders are revoked in full or in part or the duty rates are lowered, wecould be exposed to increased competition from imports that could decrease oursales and profits.

 

In March 2004, the domestic line pipe industry filed anti-dumping casesagainst imports of line pipe from China, Korea, and Mexico.  Despite mixed preliminary dumping findings bythe Department of Commerce in October 2004, high margins against China andMexico and low or *de minimis*marginsagainst Korea, the industry withdrew the petitions in February 2005 based onthe significant profitability improvements in the industry in 2004.  However, the withdrawal of the petitions maylead to higher import levels, which could negatively impact our line pipeshipments levels and prices.  Suchincreased competition could decrease our sales and profits and have a materialadverse effect on our business, operating results or financial condition.

 

The United States’ or any other government’s future actions regardingimport duties or other trade restrictions on imports of oil and gas casing,tubing products, line pipe or other steel products could reduce our sales of suchproducts.

 

5

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### ***Difficulties in integrating potential acquisitions couldadversely affect our business, operating results and financial condition.*** We regularly evaluate potential acquisition opportunitiesto support and strengthen our business. We might not be able to locate suitable acquisition candidates, acquirecandidates on acceptable terms or integrate acquired businesses successfully.

### ** **

Future acquisitions may require us to incur additional debt andcontingent liabilities, which may materially and adversely affect our business,operating results and financial condition. In addition, we may issue shares of our common stock in order toconsummate future acquisitions.  Suchissuances might have a dilutive effect on our current equity holders.  Furthermore, the process of integratingacquired businesses effectively involves the following risks:

#### **•**                  assimilatingoperations and products may be unexpectedly difficult;

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

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

#### **•**                  we may lose keyemployees 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, that provide us exclusivedistribution rights of their products in specific geographic regions,principally marketing and sales of oilfield tubular products in the United States.  These mills produce specific products thatexpand our product offerings to our customers and allow us to concentrate ourcapital expenditures and manufacturing expertise on our more premium products.  These alliances accounted for 18% of ourtotal oilfield products segment revenues in 2004.  A loss of one or more of these alliancerelationships could reduce our ability to offer these specific products to ourcustomers and therefore, adversely affect our business, financial condition,and our revenues.

 

### ***We are subject to numerous lawsuits concerning exposure toasbestos on our premises which could adversely affect our financial condition.*** During the last six years our Lone Star Steel subsidiaryhas been named as one of a number of defendants in 42 lawsuits alleging thatcertain individuals were exposed to asbestos on the defendants’ premises.  Three pending asbestos-related claims havebeen asserted against another of our subsidiaries.  We did not manufacture or distribute anyproducts containing asbestos.  Some orall of these claims may not be covered by our insurance.  Although we have accrued for our estimatedexposure to known claims, we do not know the extent to which future claims maybe filed, and therefore we cannot estimate our exposure, if any, to unassertedclaims.

### ** **

### ***Failure to renew or reach acceptable new collectivebargaining agreements could result in labor disruptions which could adverselyaffect our business, financial condition and revenues.*** Our subsidiaries are subject to three collective bargainingagreements.  At December 31, 2004, LoneStar Technologies and its subsidiaries had approximately 2,422 employees, ofwhom approximately 994, all at our Lone Star Steel subsidiary, are part ofcollective bargaining agreements with three unions.  The majority of these union workers areproduction and maintenance workers represented by the United Steel Workers ofAmerica under a contract which expires on May 31, 2005.  The two other agreements, covering anaggregate of approximately 15 of our warehouse and plant security workers as ofDecember 31, 2004, expire on May 31, 2005 and September 30, 2006,respectively.  A collective bargainingagreement covering 48 warehouse and maintenance employees of Star TubularServices, a subsidiary of Lone Star Steel, expired in February 2004 and theemployees have worked without a contract since that time.

### ** **

Collective bargaining agreements with our employees generally coverwages, health care benefits and retirement plans, seniority, job classes andwork rules.  Failure to renew theseagreements upon expiration or to establish new collective bargaining agreementson terms acceptable to us could result in work stoppages or other labordisruptions which could adversely impact our customer relationships, financialcondition and results of operations.

 

### ***We would have greater taxable income, and therefore besubject to increased federal income taxes, if we lose our federal tax netoperating loss carryforwards due to our, or the consolidated group with whom wefile tax returns, experiencing an ownership change of more than 50%.****   *We had federal income tax netoperating loss carryforwards of approximately $263 million atDecember 31, 2004 that, if not utilized to reduce our taxable income, willexpire in varying amounts between years 2005 and 2023.  Our ability to use these net operating losscarryforwards to reduce taxable income is dependent upon our not experiencingan ownership change of more than 50 percentage points as defined by IRSregulations.  Lone Star’s common stock ispublicly traded, and management cannot assure that future trading will notresult in an ownership change, as defined by IRS regulations, which would limitthe availability of our net operating loss carryforwards.  In addition, a portion of our net operatingloss carryforwards relates to our former subsidiary, American Federal Bank,F.S.B., and is subject to an agreement with the Federal Deposit InsuranceCorporation under which we may be required to pay that government agency forcertain tax benefits relating to the use of the net operating losscarryforwards.

### ** **

### ***Our significant shareholders, whose interests may not bealigned with yours, will be able to significantly influence the outcome ofshareholder votes.***   As of December31, 2004 a significant shareholder group collectively owned approximately 16.8%of our common stock.  Accordingly, theseshareholders, as a group, will be able to significantly influence the outcomeof shareholder votes, including votes concerning the election of directors, theadoption or amendment of provisions in our certificate of incorporation orbylaws, and the approval of mergers and other significant corporatetransactions, and their interests may not be aligned with yours.  One of the eight members of our Board ofDirectors serves on our Board at the request of this significant shareholdergroup.  The existence of these 

### ** **

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### **levels of ownership concentrated in a few persons makes itless likely that any other holder of common stock will be able to affect ourmanagement or direction.  These factorsmay also have the effect of delaying or preventing a change in our managementor voting control or our acquisition by a third party.**

### ** **

### ***We have unfunded pension plan liabilities of at least $29.3million, which could result in claims against our assets if the plans’ assetsare insufficient to satisfy pension obligations.***  Our three defined benefit pension plans forour Lone Star Steel subsidiary’s bargaining unit employees were underfunded byan aggregate of approximately $29.3 million as of December 31, 2004 using aninvestment return assumption of 8% per annum and a discount rate of 6.25% perannum.  Moreover, if the plans wereterminated under the distress termination provisions of the Employee RetirementIncome Security Act of 1974, as amended, or ERISA, the Pension Benefit GuarantyCorporation, or PBGC, would have claims against our assets for the amountnecessary to satisfy the plans’ unfunded benefit liabilities under the PBGC’sactuarial assumptions, which amount may be greater than $29.3 million as ofDecember 31, 2004.

### ** **

### ***Various governmental regulations and environmental risksapplicable to our business may require us to take actions which will adverselyaffect our results of operations. ***Our business issubject to numerous federal, state, provincial, local and foreign laws andregulations, including regulations with respect to air emissions, wastewaterdischarges and the generation, handling, storage, transportation, treatment anddisposal of waste materials.  Although webelieve we are in substantial compliance with all applicable laws andregulations, legal requirements are frequently changed and subject tointerpretation, and the presently unpredictable ultimate cost of compliancewith these requirements could affect our operations.  We may be required to make significantexpenditures to comply with governmental laws and regulations.  Existing laws or regulations, as currentlyinterpreted or reinterpreted in the future, or future laws or regulations,could have a material adverse effect on our results of operations and financialcondition.

### ** **

### ***Potential casualties and product liability claims relatingto the products we manufacture, service and sell to the oil and gas industryand industries using heat recovery applications could harm our 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 ourspecialty tubing products could result in death, personal injury, propertydamage, pollution, damage to equipment and facilities or inefficient heatrecovery.  We warrant our oilfieldproducts, specialty tubing, and the commercial alliance products we sell ordistribute to be free of various defects. Actual or claimed defects in our products and services may give rise toclaims against us for losses and expose us to claims for damages.  Our insurance may be inadequate orunavailable to protect us in the event of a claim or our insurance coverage maybe canceled or otherwise terminated.

### ** **

### ***Market volatility and downturns of industries that use ourFintube products for heat recovery applications could reduce demand for thoseproducts and adversely affect our revenues.***   Our Fintube subsidiary is the largestdomestic specialty tubing manufacturer of heat recovery finned tubulars, whichare used in various applications including fuel economizers, petrochemicalplants, refineries and combined-cycle electrical power generation plants.  Our Fintube business is therefore dependenton power plant construction, the cost of alternative fuels for power generationand, to a lesser extent, industrial plant processing and petrochemical plantconstruction.  Demand for these productshas been down since fourth quarter 2001 as construction of new power plants wascurtailed due to lower energy demand attributable to the slowdown in thegeneral economy and constraints on capital to fund the constructionprojects.  Power plant constructioncurtailments and cancellations are expected to continue.  This construction activity and thecorresponding demand for our Fintube products are also related to natural gasand oil prices and are therefore subject to the volatility of the oil and gasmarket.  Demand for these productsfluctuates significantly in response to a number of economic, market and otherfactors, most of which are beyond our control. A decrease in demand for these Fintube products could adversely affectour results of operations.  Someadditional factors affecting demand are:

#### **•**                  the level ofconsumer and industrial demand for electrical power generation;

#### **•**                  fluctuations inconstruction levels of gas-fired, combined-cycle power generation plants;

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

#### **•**                  worldwide anddomestic supplies of natural gas;

#### **•**                  weatherconditions; and

•                  domestic and foreign governmentalregulations and taxes.

 

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**OUR STRATEGIES**

** **

We believe that thebetter we serve our customers, the better we serve our shareholders.  Our primary responsibility is to growshareholder value.  Thus, our goal is tobe the leading provider of both oilfield tubular products and specialty tubingproducts and to increase our market presence in order to benefit from favorablemarket conditions. The key elements of our strategy to achieve commercialleadership and operational excellence are:

 

***Achieving increased production, greaterproductivity and penetration into new markets through capital investment andcommercial alliances expansion****.* Our customers demand a broad productline 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 constantlyseek to improve our production efficiency by upgrading our manufacturingmethods 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 premiumproducts and new technologies.  Expandingthese alliances will enable us both to offer a wider variety of tubularproducts to our customers and to increase our offering of premium products.  For example, we initiated two new alliancesduring the year, one with a Russian tubular producer and the other with aBrazilian tubular producer, both of which further expand our productoffering.  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 think ofLone Star first when they have a need, even if it is a need that has never beenmet before.  Commercial leadershipdemands that we continually look for new ways to do business.  We have historically been successful inpioneering new production methods to expand the market acceptance of our oilcountry tubular goods, line pipe, and specialty tubing products. For example,we pioneered the electric resistance welded, full-body normalized process,which, together with our extensive heat-treating capabilities, enables us tomanufacture and sell our oil country tubular goods and line pipe for deep wellsand 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 have produced and soldslotted tubes for expandable sand screens and new riser sleeves to providesolutions for completion in unconsolidated sand formations and subseacompletions, respectively.  We willcontinue to invest in new equipment technologies and develop new products forthe markets we serve.

 

***Growing through strategic acquisitions****.* Our acquisitions of the companiescomprising our Star Energy Group have enabled us to broaden our customer baseand expand the selection of products we offer and the markets we serve at acost significantly less than that required to develop these operations on ourown.  We will continue to pursuestrategic acquisitions that we believe to be beneficial to our business.

 

**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 currentlymanufacture drill pipe.  Casing acts as astructural 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.

 

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Demand for oil country tubular goods depends on several factors mostnotably the number of oil and natural gas wells being drilled, completed and re-worked,and the depth and drilling conditions of these wells. The level of theseactivities depends primarily on the demand for natural gas and oil and theexpectation of future prices of these commodities. A key indicator of domesticdemand is the average number of drilling rigs operating in the UnitedStates.  According to the Baker Hughesrig count, the most commonly cited indicator of the level of domestic drillingactivity, the average United States rig count was 1,192 working rigs in 2004compared to 1,032 and 830 in 2003 and 2002, respectively, the highest annualaverage in the last fifteen years.

 

**

 

Rigs drilling offshore in the United States in 2004 fell to an average97 rigs compared to 108 rigs during 2003 and 113 rigs during 2002, though theaverage for the final month of 2004 and through the first month of 2005 rose to105 rigs indicating a possible positive trend toward deeper drilling.  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 979 at the end of 2004, an increaseof 16% from the end of 2003.  At year-end2004, 1,243 rigs were working, of which 85% were drilling for natural gas.

 

Further impacting demandfor oilfield products in 2004 were rising natural gas and crude oilprices.  Average 2004 natural gas pricesat the Henry Hub increased nearly 7% over the 2003 average.  The average price of West Texas Intermediatecrude oil increased 31% in 2004 compared to 2003.  These factors led to continuing strong demandfor our oilfield products.

 

The oil country tubulargoods market is also affected by the level of inventories maintained bymanufacturers, distributors, threading companies, and end users.  During downturns in drilling activity,customers typically utilize the inventory of these products rather thanpurchase new products, causing demand for new production to further decrease.  Conversely, in periods of increased drillingactivity, increases in oil country tubular goods inventory levels bydistributors and end users typically occur, accelerating demand for newproduction.  However, throughout 2004although drilling activity had increased over the prior year, distributorinventory remained at lower than anticipated levels, especially in the fourthquarter of 2004 as distributors remained cautious purchasing inventory for spotresale due principally to uncertainties about future OCTG pricing.

 

The amount of importedoilfield products also affects the oil country tubular goods market.  According to statistics from the U.S.Department of Commerce, imported oil country tubular goods accounted forapproximately 40% of the apparent domestic oil country tubular goods consumptionin 2004 and 35% in 2003.

 

Protective tariffs on oilcountry tubular goods from Argentina, Japan, Korea, Italy and Mexico remain ineffect from successful 1995 trade suits. The protective tariffs are subject to sunset review in 2006.  The quantity of imported electric resistancewelded (“ERW”) line pipe in sizes up to 16-inches in diameter accounted for 57%of total consumption in 2004 and 56% in 2003. The industry filed trade cases against China, Korea, and Mexico in March2004 but the cases were subsequently dropped on February 1, 2005 prior tohearings being scheduled by the International Trade Commission.  These cases could possibly be renewed in thefuture.

 

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Manufacturers produce oilcountry tubular goods in numerous sizes, weights, grades, and thread profiles.The grade of pipe used in a particular application depends on technicalrequirements for strength, corrosion resistance, and other performancecharacteristics. Oil country tubular goods are generally classified by “carbon”and “alloy” grades. Carbon grades of oil country tubular goods have yieldstrengths of 75,000 pounds per square inch or less and are generally used inoil and natural gas wells drilled to depths less than 8,000 feet. Alloy gradesof oil country tubular goods, often referred to as premium oil country tubulargoods, have yield strengths of 75,000 pounds per square inch or more and aregenerally used in oil and natural gas wells drilled to depths in excess of8,000 feet or for high temperature wells, highly corrosive wells, or othercritical applications.

 

Carbon and alloy gradesof oil country tubular goods are available from both electric resistance weldedand seamless tube producers.  Electricresistance welded tubes are produced by processing flat rolled steel intostrips which are cold-formed, welded, full-body normalized or seam-annealed,and end-finished with threads and couplings. Seamless products are produced byindividually heating and piercing solid steel billets into tubes and thenend-finishing those tubes into oil country tubular goods in a manner similar toelectric resistance welded pipe.

 

Based on publishedindustry statistics, electric resistance welded products have accounted forapproximately half of total consumption of oil country tubular goods.  Electric resistance welded, full-bodynormalized casing and tubing and seamless casing and tubing compete forcritical applications such as deep natural gas wells and offshore wells.Customers purchasing products for these applications require high-performanceoil country tubular goods that can sustain enormous pressure as measured byburst, collapse, and yield strength. Operators drilling shallow wells generallypurchase oil country tubular goods based primarily on price and availability,as these wells require less stringent performance characteristics.

 

Line pipe products areused for surface production flow lines and gathering and transmission of oil,natural gas, and fluids. Line pipe is primarily produced in welded form. Linepipe markets are dependent not only on the factors which influence the oilcountry tubular goods market, but also on pipeline construction activity, linepipe replacement requirements, new residential construction, and utilitypurchasing programs.

 

Couplings are used toconnect individual sections of oilfield casing and tubing.  We manufacture a full product size range ofhigh quality couplings including both standard oilfield API grades as well aspremium connections.  The market forcouplings is dependent on the same factors that impact the oil country tubulargoods market.

 

***Specialty Tubing Products.***  The specialty tubing business includes themanufacture, marketing, and sale of a broad variety of steel tubing products,including premium and custom-made products. Applications for specialty tubularproducts include precision mechanical tubular products for automotive, fluidpower, and other markets for various mechanical applications and finned tubularproducts for heat recovery applications.

 

The demand for precisionmechanical tubulars and other specialty tubing used for automotive, fluidpower, and other mechanical applications is cyclical and dependent on thegeneral economy, the automotive and construction industries, product inventory levels,and other factors affecting general domestic industrial activity.  Demand for precision mechanical tubularswithin the traditional markets significantly increased in 2004 as a result ofthe overall economic improvement experienced in the United States during theyear.  The increased demand across mostmanufacturing sectors boosted the demand for precision mechanical tubulars in2004 at a rate significantly higher than what was experienced in 2002 and 2003.  We experienced a slight decrease in the latterhalf of the fourth quarter of 2004 due to expected seasonality.

 

Demand for heat recoverytubular products, or finned tubes, depends on several factors includingindustrial processing plant and petrochemical plant construction, the cost ofalternative fuels for power generation and combined-cycle electrical powerplant construction.  Demand forcombined-cycle electrical generated power slowed considerably in 2002 andremained slow throughout 2003 and 2004 as construction of new power plants wascurtailed due to lower energy demand attributable to the slowdown in thegeneral economy, high natural gas prices, and constraints on capital to fundnew plant construction.  Also, the finalassembly of power plant components continues to move to lower cost foreignlabor 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 inhighly competitive markets and price, quality, and availability are the maindeterminants of customer purchasing decisions. Other products consist of tubular goods that serve a variety of uses,such as structural piling applications in the construction industry.

 

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**OUR OILFIELD PRODUCTS**

 

We manufacture and marketpremium oil country tubular goods. Our oil country tubular goods, also referredto as OCTG, include casing and production tubing but not drill pipe. We alsomanufacture and market line pipe and couplings and we provide a complete lineof oilfield tubular finishing services including threading and inspection.

 

**OilCountry Tubular Goods –**We manufacture premium alloy andcarbon welded oil country tubular goods, including casing, which acts as astructural retainer wall in oil and natural gas wellbores, and productiontubing, which transmits 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 offercasing and tubing products with the widest variety of diameters, grades andwall thicknesses in the United States. This variety provides us with a distinctcompetitive advantage as a single source supplier of a complete range ofoilfield casing and production tubing. As a result of our broad product rangeand unique heat-treating capabilities, we are able to service nearly alltypical drilling applications for oil and natural gas wells.

 

Casing, whichhistorically represents 75% to 80% of our oil country tubular goods revenues,is the structural retainer wall in oil and natural gas wellbores. It alsoserves to prevent pollution of nearby water reservoirs and contamination of awell’s production. Casing is generally not removed after it has been installed.Production tubing is installed within the casing to convey oil and natural gasto the surface. We offer the widest range of grades and outside diameters incasing (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.

 

Our premium product lineincludes tubulars manufactured with the electric resistance welded, full-bodynormalized process and other thermal techniques that we pioneered. Because thisprocess gives our tubes better performance characteristics than typical seam-annealedcasing and tubing, we are able to serve both primary markets for oil countrytubular goods: deep critical wells and shallow wells. Our premium productssuccessfully compete both with seamless oil country tubular goods for criticalapplications and with conventional seam-annealed tubular products manufacturedfor shallow wells.  We also offerseamless and seam-annealed products through our alliance marketing arrangementswith other producers.

 

Critical applications,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 oil companies thatconduct drilling programs of this nature emphasize quality and compliance withspecific standards. In our electric resistance welded, full-body normalizedmanufacturing process, which meets and exceeds API standards, we heat treat theentire tube and not just the weld area. This process strengthens the entiretube and makes our premium casing, tubing, and line pipe interchangeable withseamless tubulars for nearly all critical applications.  Revenues from our high-strength alloy gradeproducts increased slightly to 64% of total OCTG revenues in 2004 from 62% in2003.

 

Operators drillingshallow wells generally purchase oil country tubular goods based primarily onprice and availability, as wells of this nature require less stringentperformance characteristics. We compete in this market, which is servedprimarily by producers of seam-annealed oil country tubular goods, with ourWildcatTM brand of oil country tubular goods and other brands produced throughour exclusive alliance mills.

 

**LinePipe –**We offer the widest size and chemistry range of linepipe used to gather and transmit oil and natural gas in the United States withoutside diameters from 2 3/8” to 60”. Historically, approximately 15% to 20% of our oilfield product revenuesare from line pipe sales.

 

**Couplings–**Through our Wheeling subsidiary, part of our Star EnergyGroup, we produce a full range of coupling products used to connect individualsections of oilfield casing and production tubing from 2 3/8” to 20”, includingpremium grades and premium threads.  Thedemand for coupling products is correlative to demand for OCTG products.  Prior to its acquisition by Lone Star,Wheeling had a multi-year partnering arrangement with Steel to provide 100% ofSteel’s coupling requirements.  Inaddition to Steel, which comprised approximately 41%, 43%, and 47% of Wheeling’s2004, 2003, and 2002 sales respectively, Wheeling maintains contractdistribution arrangements with other large domestic OCTG producers and sellscoupling products to certain distributors of OCTG products.

 

**Finishing–**By acquiring DTP and DTI during 2003, we took another majorstep toward providing complete tubular solutions for our customers.  DTP and DTI provide the full-size range ofOCTG finishing, including premium 

 

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threading, heat-treating,upsetting, inspection, and storage services. They join Bellville and 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 theshipments of oil country tubular goods and line pipe in 2004 were todestinations outside the United States. Our three largest customers, all distributors of our oilfield productsin 2004, accounted for approximately 15%, 14%, and 12% respectively, of thetotal oil country tubular good tons we shipped. About 75% of the oil andnatural gas wells drilled in the United States in 2004 were located within anapproximate 750 mile radius of our mills in Texas.  The majority of our oilfield products weresold for use in Texas, Oklahoma, Louisiana, New Mexico, and Kansas, as well asthe Gulf 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 arrangementsenable us to outsource production of specific products, allowing us to offer awider variety of casing, tubing, and line pipe without a permanent capitalinvestment. These alliances allow us to concentrate our capital expendituresand manufacturing expertise on our premium products, while offering ourcustomers a complete size range of casing, tubing, and line pipe. Thesetransactions are performed on a commission basis and through purchase andresale of the products.  Our alliancearrangements accounted for approximately 18%, 17%, and 21% of our revenues fromoilfield products during 2004, 2003, and 2002, 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-IndustryBackground – Oilfield Products.”  Ourelectric resistance welded, full-body normalized casing and tubing productscompete with seamless oil country tubular goods, and we offer products with thewidest variety of diameters, grades, and wall thicknesses in the UnitedStates.  Several domestic manufacturersproduce limited lines of oil country tubular goods, and a number of foreignmanufacturers produce oil country tubular goods for export to the UnitedStates.

 

The level of imports of oil country tubular goods has been reduced bythe existence of anti-dumping duty orders. Since 1995, the level of imports of oil country tubular goods fromArgentina, Italy, Japan, Korea, and Mexico has been greatly reduced by theexistence of anti-dumping duty orders covering imports from thesecountries.  The orders may also have hada beneficial impact on prices for oil country tubular goods in the domesticmarket. Affected parties can request administrative reviews of imposed dutiesand tariffs.  The protective tariffs aresubject to sunset review in 2006.

 

Despite the existence of various anti-dumping duty orders, imports were40% of apparent domestic consumption in 2004 and 35% in 2003.

 

In March 2004, thedomestic industry, including us, filed petitions alleging the dumping of linepipe from China, Mexico, and Korea.  InFebruary 2005, the industry withdrew the petitions and the investigations were terminated.

 

**OUR SPECIALTY TUBING PRODUCTS**

 

Our specialty tubingbusiness includes the manufacture, marketing, and sale of a variety of tubularproducts. Our specialty tubular products are generally high value-added premiumor custom products often involved in exacting applications.  Our specialty tubing products include finnedtubulars used in industrial processing, petrochemical plants, and powertechnology applications.

 

 **PrecisionMechanical Tubulars –**We have one of the largest productioncapacities in the world for precision mechanical tubular products using theDrawn Over Mandrel (“DOM”) manufacturing process. The use of the DOMmanufacturing process enables us to achieve higher critical tolerances anddimensional control than other processes. Our precision mechanical tubular productline includes a wide array of high-quality, custom-made steel tubular productswith precise dimensional control and special metallurgical properties. Ourprecision mechanical tubular 

 

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products have the widestsize 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.

 

The Drawn Over Mandrelprocess 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.

 

**HeatRecovery Tubular Products –**We manufacture custom-engineeredspecialty finned tubular products used in a variety of heat recoveryapplications. We have the major portion of domestic manufacturing capacity offinned tubes that are used in heat recovery steam generators.  Finned tubes are steel tubes with varioustypes of fins or studs welded to the outside to increase the amount of surfacearea for maximized recovery of heat.  Ourheat recovery products are used in fuel economizers, petrochemical plants,refineries, and combined-cycle electrical power generation.

 

In connection with ourproduction of finned tubes, we design and manufacture other products relatingto large-scale applied heat recovery technology, such as boiler tubing andeconomizers.  Economizers are bundles offinned tubes arranged to maximize the amount of heat captured from boilerexhaust gases.  Economizers are normallyused on large boilers for office buildings, hospitals, universities, prisons,breweries, and food processing plants. We also manufacture and sell X-IDtubing, which has specific patterns on the interior surface of the tube forenhanced heat transfer.

 

**OtherSpecialty Tubing Products –**We also produce hot finishedspecialty tubing. We have developed new thick wall products using enhanced hotreduction technology for applications such as heavy axles for trailers andlight axles for trucks, including sport utility vehicles that were typicallymade out of seamless tubes.  This productis also used for other industrial applications.

 

***Sales and Distribution.***  Domestically, we market and sell ourprecision mechanical tubulars through major non-exclusive steel service centersand directly to end-users.  Our precisionmechanical tubulars have detailed design specifications and are manufactured toextremely precise processing requirements. Our closely controlled manufacturing process results in an efficient lowcost sourcing solution for large purchasers. Internationally, the majority ofour precision mechanical tubulars is currently sold to end-users and exportsaccounted for approximately 7%, 3%, and 11% in 2004, 2003, and 2002respectively, of the shipment volume of our precision mechanical tubulars.  We market and sell our finned tubes and otherheat recovery products through four outside sales managers providing directsales to most original equipment manufacturer (“OEM”) accounts and throughapproximately 50 independent sales representative companies which sell toend-users and contractors. Since reorganizing our heat recovery tubularproducts around new marketing and commercial lines directed at more traditionalheat recovery markets including fuel economizers and traditional boilerapplications, we have experienced increased activity related to the improvinggeneral domestic industrial economy. Exports of finned tubulars and other heatrecovery tubes accounted for approximately 16%, 21%, and 11% of the revenuesfrom those products in 2004, 2003, and 2002, respectively.

 

***Competition.***  The market for specialty tubing is competitiveand is served by several manufacturers. We have one of the largest capacities in the world to manufactureprecision mechanical tubulars using the DOM manufacturing process.

 

Since these products aremade to end-user specifications and often require just-in-time delivery, onlysmall quantities are imported into the United States. In contrast to the oilcountry tubular goods market, seamless and electric resistance welded specialtytubing products differ in their applications. Electric resistance weldedtubing, such as precision mechanical tubulars, is preferred for many mechanicaltubing applications because its consistent wall thickness requires lessmachining in the finishing process. In contrast, seamless tubes are oftenspecified in heavy gauge applications such as boiler and pressure tubing.

 

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Based on generallyavailable market data, we estimate that we have a major portion of the domesticmanufacturing capacity for finned tubes used for heat recovery steamgeneration.  We have one significantdomestic competitor and a number of smaller 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 the capacity to produce 1.25 milliontons of flat rolled steel per year. Participation in flat rolled steel markets allows us to maintainflexibility in procurement of lower cost steel.   Flat rolled steel, produced primarily forthe manufacture of oilfield and specialty tubing products, is also sold tofabricators of large diameter transmission pipe, storage tanks, rail cars, anda variety of other construction and industrial products.

 

We also market otherproducts such as tubulars for use in structural and piling applications in theconstruction industry, and we provide transportation, storage, and otherservices.

 

We also have a supplementrystand-alone steel coil slitting business. This business includes a steel coilstorage and processing business, where we provide toll slitting services formajor steel customers and also provide steel storage and custom cutting. Thesteel coil division ships its processed steel on a just-in-time basisprincipally to our finned tubing manufacturing operations and to outsidecustomers.

 

***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 flat rolled steel accounted forapproximately 69% of our flat rolled steel sales in 2004, as well assubstantially all other sales of miscellaneous tubular products other thanoilfield and specialty tubing products. One of these customers has steelprocessing facilities located adjacent to our facilities in Lone Star, Texas,and those facilities purchase most of their flat rolled steel from us.  Sales to these two customers representedapproximately 7% of our total revenues in 2004 and 2003 and 8% in 2002.

 

We also provide flat rolled steel processing services to steel millswhere we receive processing revenues 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 coil slitting services competeagainst service centers located in the Midwest.

 

**FINANCIAL INFORMATION ABOUT SEGMENTS**

 

For financial informationfor each segment regarding revenues, profits or losses (as applicable) andtotal assets, see “Business Segments – Note B” of the Notes to ConsolidatedFinancial Statements.

 

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**CUSTOMERS**

 

We sell our oilfieldproducts through our exclusive distributors to numerous end-users, includingBP, ChevronTexaco, El Paso Exploration, Anadarko Petroleum, Devon Energy,Burlington Resources, Apache, and ExxonMobil. We sell our finned and other heatrecovery tube products to over 50 end-users, including Foster Wheeler, ChicagoTube and Iron, Peerless, Alstom Power, Cerrey, Nooter Eriksen, and VogtPower International.  We sell ourprecision mechanical tubulars to such distributors and end users as Chicago Tubeand Iron, Earle M. Jorgensen Company, Marmon/Keystone, Hyva, DaimlerChrysler,Ford Motor Company, and Dana.

 

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

 

We are committed totechnologically innovative product development. With respect to oilfieldproducts, we collaborate with customers and industry groups to develop newgrades of oil country tubular goods as well as new products, such as expandablecasing. Our expandable casing product was developed for a joint venture betweenShell Oil Company and Halliburton Company and was first successfully installedin late 1999 in the Gulf of Mexico.  Asof December 2004, there have been more than 290 successful installationstotaling more than 61 miles of expandable tubulars for 67 end-users in 20countries.  We have also developedslotted tubes for expandable sand screens and riser sleeves to provide newproduct solutions for our customers.  Ourtechnical knowledge and high-performance casing products are also being appliedin an innovative method for drilling wells using casing instead of drillpipe.  We also have used our expertise todevelop high-strength, thick wall line pipe for offshore applications. Inaddition, we developed ultrasonic testing methods to assure the quality of ourtubing. In the specialty tubing area, our product developments include theAeroseg finned tube, a thermal mechanically processed Drawn Over Mandrelproduct called QDOM for applications requiring extreme mechanical propertiesand thick wall products using hot reduction technology for applications such asheavy axles that are normally made out of seamless tubes.  We hold several United States patentscovering some of our manufacturing processes and products.

 

We have made significantinvestments in information technologies that provide the platform for internet-basedcommercial marketing and resource constrained production planning. We believeour information technologies capabilities will allow us to more effectively runour facilities, give our customers excellent service, and facilitate web-basedcommercial initiatives.

 

**MANUFACTURING CAPABILITIES**

 

We manufacture ouroilfield products, precision mechanical tubulars, flat rolled steel and otherproducts at our facilities located on an approximately 2,000-acre site we ownin Lone Star, Texas which contains over 2,000,000 square feet of manufacturingspace and approximately 91,000 square feet of oilfield products manufacturingfacilities in Bellville, Texas.  Wemanufacture our finned tubular products in approximately 364,000 square feet ofmanufacturing facilities on approximately 71.5 acres that we own or lease inthe Tulsa, Oklahoma metropolitan area; Quebec, Canada; and Monterrey,Mexico.   Our coupling products aremanufactured at three owned facilities totaling 231,000 square feet ofmanufacturing space and located in Pine Bluff, Arkansas; Hughes Springs, Texas;and, Houston, Texas.   Our finishing andstorage services provided by Delta and Delta International are performed at twoowned facilities totaling 281,500 square feet across 230 acres located inHouston, Texas.

 

The annual rated capacityof our facilities in Lone Star, Texas approximates 1,250,000 flat rolled tonsand 1,000,000 welded pipe tons. We have access through marketing arrangementsand alliances with mills for additional oilfield tubular capacity ofapproximately 500,000 tons per year.  Ourelectric arc furnaces (“EAF”) have an estimated capacity of 360,000 ingottons.  In 2004, the precision mechanicalspecialty tubing facilities operated at 64% of capacity.  The rolling mills and pipe mills generallyoperated at 64% and 67% of capacity, respectively, while the electric arcfurnaces (“EAF”) generally operated at 92% of capacity in 2004.

 

Wheeling operates PMC high volume finishers and CNC lathes atfacilities in Pine Bluff, Arkansas, Hughes Springs, Texas, and Houston,Texas.  Wheeling also maintains finishedproduct at its production facilities as well as warehouses at Steel, and afacility servicing U.S. Steel operated by Wheeling in Birmingham, Alabama.  The Houston facility was established to handlepremium threads, material that requires third party inspections and as an entrypoint into the oilfield accessories business. Wheeling offers a wide range of eight round and buttress couplings for 23/8” tubing through 20” casing.

 

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Delta Tubular Processing(“DTP”) is a licensed API processor for upsetting, threading, and heat treatingof OCTG products to API specifications. DTP has two upsetters that are capable of upsetting tubing, two quenchand tempering operations that can heat treat tubing and coupling stock through3.668” outside diameter (OD), and one full-body normalizing line that cannormalize tubing up to 4 1⁄2” OD.  DTP hastwo hydrostatic tubing testers, two high-speed PMC tubing threaders, onethreading repair line, and one NDT (non-destructive testing) operation.  The facility capacity is calculated to be120,000 tons per year with an average mix of products.  DTP operates on an 80-acre tract in Houston,Texas with 150,000 square feet of building use and leases an additionalbuilding with 14,500 square feet which houses its second heat treat line.

 

Delta TubularInternational (“DTI”) is a licensed API processor for OCTG casing for sizesranging from 4 1⁄2” to 20” OD. We have two Four-Function Electro MagneticInspection lines that inspect pipe ranging from 2 3/8” through 13 3/8” OD andone ultrasonic line for full body ultrasonic inspection up to 20” OD. We havethree double-ended thread lines capable of threading API and Specialty threadsfrom 4 1⁄2” through 20” OD pipe.  Ourannual rated capacity for casing threading is 225,000 tons and inspection is450,000 tons.  This facility is locatedon a 150-acre tract in Houston, Texas with 117,000 square feet of buildingusage.  We completed installation of anew, state-of-the-art UT line and two new CNC (computer numerical control)threaders in the second half of 2004, which will increase these capacities.

 

Both DTP and DTIfacilities have truck and rail access, and are located in close proximity tothe Houston Ship Channel.

 

We have a major portionof the North American manufacturing capacity for production of finned tubes forheat recovery applications.

 

**RAW MATERIALS AND INVENTORY**

 

In general, we attempt toprocure raw materials and manage our finished goods inventory in a manner thatwill provide:

 

•               significant flexibility in responding to the levels ofdemand for our various products;

•               a short lead time in filling our customers’ orders;

•               a broad product range offering; and

•               the ability to offer our products at competitive prices.

 

We generally produce oil country tubular goods and line pipe to fillspecific orders and, accordingly, we maintain the majority of our inventory inthe form of steel slabs and coils, while work-in-process or finished goods aregenerally earmarked for specific orders. Some work-in-process and finishedgoods inventories are maintained in order to provide flexibility in respondingto customer delivery demands.

 

The majority of domesticsteel mills produced at higher levels in 2004, limited at times only by theirinability to obtain adequate supplies of inputs such as coke for blast furnacesand scrap.  Prices on the domestic andglobal steel markets saw historic highs in 2004 as demand for steel surged,particularly by increased consumption in certain Asian markets.  We continue to believe that steel costs willremain volatile in 2005 and there are currently no strong indicators that steelcosts will moderate significantly in the coming year.

 

We can use steel slabs,scrap steel, and steel coils in the manufacture of our tubular products. Wepurchased steel slabs to meet approximately 63% of our steel needs in 2004,down from 80% in 2003 as we expanded our steel scrap purchases to sourcegreater amounts of internally produced flat-rolled steel from our East Texaselectric arc furnace operations. Generally, we commit to purchase slabs 60 to 90 days prior toproduction.  We anticipate again usingsteel slabs for most of our production needs in 2005. Our principal rawmaterial for our internally produced steel slabs is scrap steel, which isinternally generated from our operations and available in the spot market. Thevolatile price of steel is influenced by a number of competitive marketconditions beyond our control, and is not directly related to the demand forour products.

 

Raw materials for ourspecialty tubing products are readily available from multiple sources. Steelcoil is the primary raw material used in the manufacture of our finned tubularproducts and in the manufacture of our precision mechanical tubulars. Weusually produce our specialty tubing products to meet 

 

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specific orders and,accordingly, inventory is managed to minimize the amount of finished goods onhand. Work-in-process inventories are maintained in order to provideflexibility in responding to customer needs.

 

We manufacture flatrolled steel primarily for use in producing oilfield and precision mechanicaltubulars, but also for sale to third parties. We manufacture flat rolled steel using both purchased steel slabs andinternally produced slabs on our rolling mill.

 

**EMPLOYEES**

 

At December 31, 2004,Lone Star Technologies employed approximately 2,422 employees.  Of this number, approximately 994 employees,all at Steel, are a part of collective bargaining agreements with three unions,the International Bricklayers of America (“Bricklayers Union”); Security,Police & Fire Professionals of America (“Security Union”); and the UnitedSteel Workers of America (“Steel Workers Union”).

 

The collective bargainingagreement between Steel and the Bricklayers Union has an expiration date of May31, 2005 and covers three brick masons. The agreement between Steel and the Security Union has an expiration dateof September 30, 2006 and covers twelve security professionals.  The agreement between Steel and the SteelWorkers Union has an expiration date of May 31, 2005 and covers 979 productionand maintenance employees.  Steel hasbegun discussions with the Steel Workers Union to identify the location andstart date for the negotiations.  TheCompany considers its relationship with these bargaining units as good.

 

The agreement betweenStar Tubular Services, Inc. (“STSI”), a wholly-owned subsidiary of Steel, andthe Steel Workers Union expired in February 2004.  The expired agreement covered 48 warehouseand maintenance employees.  The wageshave remained intact; however, the benefits have been adjusted to a similarplan of the salaried employees of Steel. Steel and the Steel Workers Union representing the 48 STSI employeeshave reached a tentative settlement agreement to resume negotiations during2005.  We cannot predict the outcome ofthese contract negotiations.  Steelconsiders the current relationship with the associated workforce acceptable andthe employees continue to work without a contract.

 

We are committed to providing a clean, safe workplace through theestablishment and support of health and safety programs that meet or exceed theOccupational Safety & Health Administration’s (“OSHA”) standards.  We have developed safety procedures that areutilized in the training of new employees as well as promote the specifichazards related to each specific operation. We have also implemented a behavior-based safety program that isemployee driven to improve safety performance.

 

On July 29, 2004, theTexas Workers’ Compensation Commission (“TWCC”) notified Steel that we had beenidentified as a hazardous employer, and that the designation is in effect untilJuly 29, 2005.  TWCC determined thatSteel’s number of injury cases with eight or more lost workdays during theperiod from October 1, 2002 through September 30, 2003, exceeded theexpectation for steel pipe and tube manufacturers (SIC Code 3317).  Prior to the receipt of this notification,Steel had re-implemented its early return-to-work program.  There was a 46% reduction in the number ofcases with eight or more lost workdays in the subsequent 12-month period.  Steel continues its efforts to identify andcorrect workplace hazards and reduce at-risk behaviors.

 

We endeavor to provide asafe and healthful work environment for our employees, contractors, vendors,and visitors to our facilities.  Wefrequently evaluate and update our programs to ensure compliance.  We encourage all employees to be involved inour safety efforts.  We utilize a varietyof methods to increase the skills and knowledge of our employees to improvesafety performance.

 

**FOREIGN OPERATIONS**

 

Our export sales todestinations outside the United States were approximately $30.0 million in2004, $13.3 million in 2003, and $24.0 million in 2002.  We own a manufacturing facility in Quebec,Canada and lease a manufacturing facility in Monterrey, Mexico.  Long-lived assets maintained in Quebec,Canada were $3.0 million, $3.1 million, and $2.8 million at December 31, 2004,2003, and 2002, respectively.  Long-livedassets maintained in Monterey, Mexico were $1.5 million, $1.6 million, and $2.1million at December 31, 2004, 2003, and 2002, respectively.  Our export sales of $30.0 million todestinations outside the United States included $5.9 million from these foreignfacilities in 2004.

 

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# **ENVIRONMENTAL**

# ** **

# ***Oilfield Products. ***Steel’soperations are subject to extensive environmental regulations with respect toair emissions, wastewater and storm water discharges, and wastemanagement.  Our environmental protectionand improvement expenditures totaled approximately $3.2 million over the pastthree years, including expenditures related to energy efficiency efforts,asbestos abatement, wastewater treatment system and secondary containmentupgrades, waste disposal site closures, and out-of-service facility remediationprojects.  We are nearing the completionof installing an acid recovery unit at our specialty tubing operations. Thisunit will recover and recycle sulfuric acid generated during pickling ofspecialty tubing and reduce risks associated with offsite shipments of thehazardous 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 topotential liability for such cleanup costs. Cost estimates have been obtained for each of the cleanup actions, andour share has been determined.  Basedupon these estimates, we do not believe our liability, individually or in theaggregate, will be material to our financial position and our results ofoperations.**

# ** **

# **Thesolid waste units that received wastes defined as hazardous waste under theResource Conservation and Recovery Act (RCRA) have been closed.  The two RCRA units requiring continuedmonitoring are undergoing post-closure care. Lone Star has submitted a letter to the Texas Commission onEnvironmental Quality (TCEQ) guaranteeing the remaining cost of post-closurecare (estimated to be approximately $380,000), which meets our financialassurance requirements.  The TCEQ is inthe process of determining what, if any, corrective action is required toaddress the remaining non-RCRA solid waste management units.**

# ** **

# **Wepossess necessary authorizations for air emissions, wastewater and storm waterdischarges and waste management.  We arepresently in substantial compliance with our permits and applicable air, waterand waste management rules and regulations. We have an environmental management system in place, which conforms tothe internationally recognized ISO 14001:1996 standard, to assist inmaintaining compliance and improving performance.  In addition, third party compliance auditsare conducted systematically of Steel’s operations in accordance with the TexasAudit Privilege Act.  We do not expectfuture environmental expenditures necessary to comply with existingenvironmental rules and regulations to have a material impact on our financialposition or operations.**

# ** **

***Star Energy Group.***  Theoperations of DTP, DTI, Bellville, and Wheeling are also subject toenvironmental regulations in the area of air emissions, wastewater and stormwater discharges and waste management. The companies possess or have applied for, necessary authorizations forair emissions, wastewater and storm water discharges, and wastemanagement.  All facilities areclassified as either Small Quantity Generators or Conditionally Exempt SmallQuantity Generators.  Wastes aretemporarily stored onsite, but are disposed or recycled offsite by a thirdparty.  There are no onsite wastedisposal units.

 

***Specialty Tubing.***  The operations at Steel to produce specialtytubing and Fintube are also subject to environmental regulations in the area ofair emissions, wastewater and storm water discharges, and waste management, andpossess necessary authorizations for such activities.  Wastes at Fintube are temporarily storedonsite, but are disposed or recycled offsite by a third party.  Fintube does not use onsite waste disposalunits.

 

**INTERNET WEBSITE POSTINGS**

 

Our internet website is www.lonestartech.com.  We make available through our internetwebsite our annual report on Form 10-K, quarterly reports on Form 10-Q, currentreports on Form 8-K and amendments to those reports filed or furnished pursuantto Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon asreasonably practicable after we electronically file such material with, orfurnish it to, the Securities and Exchange Commission.

 

In addition, our code of business conduct and ethics, CorporateGovernance Guidelines, and Charters of the Audit, Corporate Governance, andHuman Resources Committees are available on our website and in print to anyshareholder who requests a printed copy.

 

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**ITEM 2.  PROPERTIES**

 

We manufacture our oilfield products, precision mechanical tubulars,flat rolled steel and other products at our facilities located on anapproximately 2,000-acre site we own in Lone Star, Texas which contains over2,000,000 square feet of manufacturing space. The original facilities, constructed in the 1940’s and 1950’s, have beenexpanded and modernized, and include two EAFs equipped with oxy-fuel burners;two rolling mills, a “two-high” mill that rolls the EAF ingots into slabs and a“four-high” single stand reversing Steckel mill that produces flat rolledcoils; coil slitting and handling equipment; two pipe welding mills; seven drawbenches, including the largest specialty tubing drawbench in the WesternHemisphere; 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 oilfield products manufacturingfacilities in Bellville, Texas.  Wemanufacture our finned tubular products in approximately 364,000 squarefeet of manufacturing facilities on approximately 71.5 acres that we own orlease in the Tulsa, Oklahoma metropolitan area; Quebec, Canada; and Monterrey,Mexico.   Our coupling products aremanufactured at three owned facilities totaling 267,940 square feet ofmanufacturing, warehouse and office space and located in Pine Bluff, Arkansason 12.7 acres; Hughes Springs, Texas on 19.4 acres; and Houston, Texas on 5.3acres. 

 

Delta Tubular Processing operates in a total 117,000 square feetsituated on approximately 150 acres of land that we own in Houston, Texas.  Delta Tubular International utilizes 165,000square feet located on approximately 80 acres of land that we own in Houston,Texas.  Both facilities utilize the ownedacreage for pipe storage and warehousing.

 

We own 7,000 acres in Texas that was purchased primarily for iron ore,coal reserves, or water rights; and, mineral interests in an additional 12,000acres in Oklahoma and 60,000 acres in Texas. No minerals have been recovered from these properties for many yearsbecause their use is no longer required in our operations.  We own nominal oil and gas interests in anadditional 18,000 acres in Texas.  Ourheadquarters are located in leased facilities in Dallas, Texas.

 

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**ITEM 3.  LEGAL PROCEEDINGS**

 

In August 2001, Lone Starentered into an agreement to purchase the assets of North Star Steel Company’sTubular Steel Division.  Consummation ofthe acquisition was subject to completion of financing arrangements.  Due to lack of common stock financing which,along with certain debt financing, was required by the acquisition agreement toclose the acquisition, Lone Star notified Cargill, Incorporated, the parentcompany of North Star Steel Company, on December 14, 2001, that it was not ableto complete the acquisition.  Later thatday, Cargill, Incorporated notified Lone Star that it was filing a lawsuitagainst Lone Star seeking unspecified damages and alleging that Lone Star hadbreached the agreement.  On March 13,2003, the jury in Minnesota returned a verdict of $32 million in damagesagainst Lone Star.  On June 1, 2004, theMinnesota Court of Appeals affirmed the judgment.  The Minnesota Supreme Court decided on August17, 2004 that it would not review the Court of Appeals’ decision.  At September 30, 2004, Lone Star had areserve totaling $35 million which included accrued interest of $3million.  Lone Star paid Cargill $32million on October 1, 2004 and $2 million on October 6, 2004 to satisfy thejudgment.  After the $34 million payment,approximately $1 million of accrued interest remains in the reserve, whichrepresents pre-judgment interest that Lone Star is contesting in the Minnesotacourts.

 

During the last sixyears, Steel has been named as one of a number of defendants in 42 lawsuitsalleging that certain individuals were exposed to asbestos on the defendants’premises.  The plaintiffs are seekingunspecified damages.  To date several ofthese lawsuits have been settled for approximately $300,000 in the aggregate.  Of the 42 lawsuits, sixteen have been settledor are pending settlement and twelve have been dismissed or are pendingdismissal.  Steel did not manufacture ordistribute any products containing asbestos. Some or all of these claims may not be covered by the Company’sinsurance.  The Company has accrued forthe estimated exposure to known claims, but does not know the extent to whichfuture claims may be filed.  Therefore,the Company cannot estimate its exposure, if any, to unasserted claims.

 

Beginning in 2003, LoneStar’s subsidiary Zinklahoma, Inc., inactive since 1989, has been named as oneof a number of defendants in seven lawsuits alleging that the plaintiffs hadcontracted mesothelioma as the result of exposure to asbestos in productsmanufactured by the defendants and John Zink Company (“Zink”).  Three of these lawsuits have beendismissed.  Lone Star acquired the stockof Zink in 1987 and, in 1989, sold the assets of the former Zink to KochIndustries, Inc. (“Koch”) and renamed the now-inactive subsidiary “Zinklahoma,Inc.”  Lone Star retained, and agreed toindemnify Koch against, certain pre-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 thebusiness as John Zink Company, LLC (“Zink LLC”).  In addition, Zink LLC has been named in sixlawsuits in which the plaintiffs, two of whom have mesothelioma, allegeexposure to asbestos in Zink’s products (three of these have been dismissed)and three personal injury lawsuits resulting from a 2001 explosion and flash fireat a flare stack and crude unit atmospheric heater.  Zink allegedly manufactured the flare andrelated components for the flare stack in the early 1970s.  Koch is seeking indemnification from LoneStar with respect 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 Starbelieves that Koch’s indemnity claim with respect to the 2001 explosion andflash fire is covered by its insurance, subject to a deductible, and hasnotified its insurance carrier of that claim.

 

**ITEM 4.  SUBMISSION OFMATTERS TO A VOTE OF SHAREHOLDERS**

 

None.

 

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**PART II**

 

**ITEM 5.**                                   MARKET FORREGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

 

Lone Star’s Common Stocktrades on the New York Stock Exchange under the symbol LSS.  The following table summarizes the range oftrading prices by quarter for the last two years:

 

| ** **     | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First quarter  |       | $        | 19.98      |     | $          | 14.07 |   | $ | 22.09 |   | $ | 12.00 |   |
| Second quarter |       | $        | 28.25      |     | $          | 17.10 |   | $ | 25.25 |   | $ | 19.85 |   |
| Third quarter  |       | $        | 37.92      |     | $          | 26.13 |   | $ | 21.12 |   | $ | 13.00 |   |
| Fourth quarter |       | $        | 40.00      |     | $          | 24.86 |   | $ | 16.86 |   | $ | 12.91 |   |

 

As of February 8, 2005, we had 2,673 common shareholders ofrecord.  We have not paid dividends onour common stock since becoming a public company and have no present plan to doso.

 

Information required under this item with respect to securitiesauthorized for issuance under equity compensation plans is contained in LoneStar’s proxy statement for the 2005 Annual Meeting of Shareholders, and isincorporated herein by reference.

 

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** ITEM 6. SELECTED FINANCIAL DATA**

 

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

 
| ** **                                                         | ** ** | **2004** | ** ** | **2003(1)** | ** ** | **2002(2)** | ** ** | **2001** | ** ** | **2000 (3)** | ** ** |
|--------------------------------------------------------------------|------------|----------|------------|-------------|------------|-------------|------------|----------|------------|--------------|------------|
|                                                               |       |     |       |        |       |        |       |     |       |         |       |
| Oilfield  products revenues                                        |       | $        | 695.4      |        | $          | 364.8       |       | $        | 304.2      |         | $          | 401.9 |   | $ | 362.0 |   |
| Specialty tubing  products revenues                                |       | 175.1    |       | 121.8       |       | 165.4       |       | 187.7    |       | 220.9        |       |
| Flat rolled and  other tubular revenues                            |       | 96.3     |       | 47.5        |       | 54.1        |       | 60.6     |       | 62.4         |       |
| Total revenues                                                     |       | $        | 966.8      |        | $          | 534.1       |       | $        | 523.7      |         | $          | 650.2 |   | $ | 645.3 |   |
|                                                               |       |     |       |        |       |        |       |     |       |         |       |
| Gross profit                                                       |       | $        | 162.0      |        | $          | 5.2         |       | $        | 7.4        |         | $          | 69.3 |   | $ | 85.9 |   |
| Selling,  general, and administrative expenses                     |       | (44.6    | )          | (41.8       | )          | (68.2       | )          | (35.7    | )          | (33.7        | )          |
| Goodwill  impairment charge                                        |       | —   |       | (18.7       | )          | —      |       | —   |       | —       |       |
| Operating income  (loss)                                           |       | $        | 117.4      |        | $          | (55.3       | )          | $        | (60.8      | )            | $          | 33.6 |   | $ | 52.2 |   |
|                                                               |       |     |       |        |       |        |       |     |       |         |       |
| Net income  (loss)                                                 |       | $        | 101.0      |        | $          | (68.2       | )          | $        | (69.2      | )            | $          | 16.4 |   | $ | 38.6 |   |
|                                                               |       |     |       |        |       |        |       |     |       |         |       |
| Net income  (loss) per common share - basic                        |       | $        | 3.51       |        | $          | (2.40       | )          | $        | (2.52      | )            | $          | 0.67 |   | $ | 1.59 |   |
| Net income  (loss) per common share - diluted                      |       | $        | 3.46       |        | $          | (2.40       | )          | $        | (2.52      | )            | $          | 0.66 |   | $ | 1.59 |   |
| Common shares  used for diluted EPS                                |       | 29.2     |       | 28.4        |       | 27.5        |       | 25.0     |       | 24.3         |       |
|                                                               |       |     |       |        |       |        |       |     |       |         |       |
| Working capital                                                    |       | $        | 288.1      |        | $          | 184.2       |       | $        | 281.9      |         | $          | 259.0 |   | $ | 165.8 |   |
| Total assets                                                       |       | $        | 646.7      |        | $          | 574.7       |       | $        | 612.1      |         | $          | 580.3 |   | $ | 514.4 |   |
| Long-term debt                                                     |       | $        | 150.0      |        | $          | 150.0       |       | $        | 150.0      |         | $          | 150.0 |   | $ | 136.2 |   |
| Total  liabilities                                                 |       | $        | 292.2      |        | $          | 328.8       |       | $        | 299.5      |         | $          | 265.0 |   | $ | 258.6 |   |
| Shareholders’  equity                                         |       | $        | 354.5      |        | $          | 245.9       |       | $        | 312.6      |         | $          | 315.3 |   | $ | 255.8 |   |
|                                                               |       |     |       |        |       |        |       |     |       |         |       |
| Shares issued                                                      |       | 29.2     |       | 28.7        |       | 28.5        |       | 25.2     |       | 23.7         |       |
|                                                               |       |     |       |        |       |        |       |     |       |         |       |
| **Other  Financial and Operating Data:**                           |       |     |       |        |       |        |       |     |       |         |       |
| Cash flows from  operating activities                              |       | $        | 61.7       |        | $          | (40.6       | )          | $        | (12.4      | )            | $          | 31.3 |   | $ | (8.6 | ) |
| Cash flows from  investing activities                              |       | $        | (71.4      | )           | $          | (48.0       | )          | $        | (54.0      | )            | $          | (14.7 | ) | $ | (96.6 | ) |
| Cash flows from  financing activities                              |       | $        | 6.4        |        | $          | 0.5         |       | $        | 81.5       |         | $          | 63.2 |   | $ | 109.7 |   |
| Earnings before  interest, taxes, depreciation and amortization(4) |       | $        | 147.2      |        | $          | (27.7       | )          | $        | (36.9      | )            | $          | 51.1 |   | $ | 74.2 |   |
| Capital  expenditures                                              |       | $        | 13.0       |        | $          | 14.4        |       | $        | 15.9       |         | $          | 25.2 |   | $ | 23.3 |   |
| Active employees                                                   |       | 2,422    |       | 2,270       |       | 1,900       |       | 1,892    |       | 2,358        |       |

 

Seefootnotes at page 23 of this Form 10-K.

 

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**Reconciliationof EBITDA (as defined)(4) to Cash Flows from Operations:**

 
| ** **                                          | ** ** | **2004** | ** ** | **2003(1)** | ** ** | **2002(2)** | ** ** | **2001** | ** ** | **2000 (3)** | ** ** |
|-----------------------------------------------------|------------|----------|------------|-------------|------------|-------------|------------|----------|------------|--------------|------------|
| Cash flows from  operating activities               |       | $        | 61.7       |        | $          | (40.6       | )          | $        | (12.4      | )            | $          | 31.3 |   | $ | (8.6 | ) |
| Non-cash charge  for stock compensation             |       | (1.6     | )          | (1.1        | )          | 0.1         |       | 0.2      |       | (0.7         | )          |
| Net loss (gain)  on asset disposals and impairments |       | (0.1     | )          | (0.4        | )          | 0.1         |       | —   |       | —       |       |
| Goodwill  impairment                                |       | —   |       | (18.7       | )          | —      |       | —   |       | —       |       |
| Changes in  working capital                         |       | 63.0     |       | (11.5       | )          | (8.6        | )          | 5.5      |       | 61.9         |       |
| Other balance  sheet changes                        |       | 5.8      |       | 29.5        |       | (26.6       | )          | 3.0      |       | 7.4          |       |
| Interest  expense, net                              |       | 15.0     |       | 15.0        |       | 11.2        |       | 10.3     |       | 12.4         |       |
| Income tax  expense (benefit)                       |       | 3.4      |       | 0.1         |       | (0.7        | )          | 0.8      |       | 1.8          |       |
| EBITDA                                              |       | $        | 147.2      |        | $          | (27.7       | )          | $        | (36.9      | )            | $          | 51.1 |   | $ | 74.2 |   |

 

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(1)          Includes the results of operations of DTP andDTI since the acquisitions became effective on May 1, 2003 and June 2, 2003,respectively.

(2)          Includes Wheeling results of operations since the acquisition becameeffective on October 1, 2002.

(3)          Includes the results of operations of Fintube and Bellville since theacquisitions became effective on January 1, 2000 and April 1, 2000,respectively.

(4)          EBITDA is a measure of our liquidity that is not required by orpresented in accordance with GAAP. EBITDA should not be considered as an alternative to cash flow fromoperating activities as a measure of our liquidity or as an alternative to netincome, operating income, or any other performance measures derived inaccordance with GAAP.

 

EBITDArepresents earnings before interest, taxes, depreciation, andamortization.  We use 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 consider EBITDA in isolation or as a substitute for analysisof our results as reported under 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.  We compensate for these limitations byrelying primarily on our GAAP results and by using EBITDA only supplementally.

 

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**ITEM 7.****                                                    ****MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

# **OVERVIEW**

# ** **

*ThisMD&A should be read in conjunction with the other sections of this AnnualReport on Form 10-K, including “Item 1: Business”; “Item 6: Selected FinancialData”; and “Item 8: Consolidated Financial Statements and Supplementary Data.”The various sections of this MD&A contain a number of forward-lookingstatements, all of which are based on our current expectations and could beaffected by the uncertainties and risk factors described throughout this filingand particularly in the “Overview,” and “Principal Lines of Business, Products,and Services” sections.  Our actualresults may differ materially.*

 

Our financial results areimpacted by our ability to anticipate and to take action in response toindustry-wide trends.  Our principal rawmaterial costs in 2004, steel slabs and coils, increased an average 82% overthe prior year.  The average cost ofpurchasing steel scrap, which comprised approximately 20% of our total steelraw material tonnage purchased in 2004, increased approximately 109% in 2004over the 2003 average cost.  As a resultof higher steel costs, increasing natural gas costs, and improved demand forour products, we initiated price increases and raw material surchargesbeginning in the first quarter of 2004. During the second quarter of 2004 our surcharges and base price weremerged into one price subject to possible change at the time of shipment.  Similar pricing policies remain in effecttoday as our principal raw material costs aggressively increased throughout2004 and into 2005.

 

The manufacture of ourproducts is capital intensive. Utilization rates at our manufacturingfacilities in Lone Star, Texas increased steadily in 2004 compared to 2003 asshipment volumes increased for nearly all product categories within ouroilfield segment.  Shipment volumes ofour premium alloy-grade tubing and casing increased 33% in 2004 compared to2003 shipment volumes, while the average price increased 53% over the prioryear average.  Similarly, 2004 shipmentvolumes of our carbon-based tubing and casing increased 12% over 2003 volumes,while average pricing increased 70% compared to the 2003 average price.

 

Shipment volumesincreased in all principal business segments with total overall volume up 20%in 2004 compared to the prior year.  Theincreased production volumes had a positive effect on the cost of our productssold throughout the year as fixed and semi-fixed costs were absorbed by thelarger number of tons produced and shipped.

 

Historically, ouroilfield products have accounted for the majority of our total revenues.  For fiscal year 2004, they were 72% of totalrevenues.   As a result, our revenues arelargely dependent upon the state of the oil and gas industry, which hashistorically been volatile.  Oil andnatural gas prices were higher on average throughout 2004 compared to 2003 and2002 as higher energy demand, relatively low supply, and geopoliticalinstabilities maintained upward pressure on pricing.  This prompted increased domesticdrilling.  The U.S. active rig countsrose throughout the first half of 2004 from 1,126 rigs at the end of 2003 to1,201 rigs at the end of the first half of 2004 to 1,243 rigs by the end of2004.  However, the majority of drillingcontinued to be biased toward lower-risk, shallow developmental fields such asshale areas in Texas and coal seam methane plays.  Shallow wells typically use mainlycarbon-grade OCTG, which generally have lower margins than our alloy-gradepremium products.   Further, shallowwells require proportionally fewer tons per foot of well depth than deeperwells as the initial surface casing is generally smaller in diameter, fewerintermediate casing strings are needed, and generally the wall thickness of thecasing is less.  In addition, imports,which accounted for approximately 40% of the total apparent OCTG consumption in2004 compared to 35% and 31% in 2003 and 2002, respectively, are typically moreaccepted for these less critical shallow well applications.

 

Demand for our oilfieldproducts depends on a number of factors including the number of oil and naturalgas wells being drilled, completed and re-worked and the depth and drillingconditions of these wells.  Baker Hughesreported the average domestic rig count increased in 2004 to 1,192 workingrigs, or by 16% compared to the previous year’s average of 1,032 workingrigs.  Although most of the drilling hascontinued to be biased toward shallow-well developmental fields, there was asustained increase in the number of rigs drilling deeper than 15,000 feet,where the need for premium alloy-grade products increases.  Rigs drilling deeper than 15,000 feet haveincreased from a range of 165 to 170 rigs during the second half of 2003 toapproximately 185 rigs for the first half of 2004, and to approximately 205rigs during the second half of 2004.  Webelieve this trend will positively impact demand for our higher marginalloy-grade products as deeper well activity progresses.

 

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Demand for our specialtytubing products increased during 2004 along with the overall improvement in thegeneral domestic economy.  Total shipmentvolumes for the segment improved in 2004 by approximately 13% over the prioryear and current trends indicate continued improving industrial demand as weproceed into 2005.  Revenues of specialtytubing products increased nearly 44% in 2004 compared to 2003 on increaseddemand and higher average price per ton.  Shipments of flat rolled steel were up nearly29% in 2004 compared to 2003 as a tight domestic supply of flat-rolled steelstimulated demand for our flat-rolled products. Revenues of flat-rolled products were up nearly 103% as the increaseddemand and market conditions drove significant increases in pricing.

 

Approximately 82% and 90%of our inventory on-hand at December 31, 2004 and 2003, respectively, isaccounted for under the Last-In, First-Out (“LIFO”) method.  The LIFO reserve is determined at year-endwhen inventory levels and pricing are finalized.  Cost of goods sold includes a LIFO provisionof $63.4 million and $8.3 million for the years ended December 31, 2004 and2003, respectively.  The increase in theLIFO provision from 2003 to 2004 is due to the significant increase in ourprincipal raw material costs, which is steel purchased as slabs, in coil form,and/or scrap.  Steel costs representedapproximately 55% of our total cost of goods sold at the beginning of 2004 andincreased to approximately 65% by the end of 2004 due to the rapid rise in theprice of steel.  Steel is the largestsingle component of product cost.  Increasesin steel costs and our ability to pass those increases on to our customersthrough product pricing have a significant impact on our results fromoperations.

 

Our future operatingresults may fluctuate significantly depending upon a number of factors,including industry conditions, the level of oil and gas drilling activity,competition from domestic and foreign manufacturers, and costs of our rawmaterials.  Sales of our finned tubularproducts are affected by the level of domestic and foreign demand for powergeneration, the relative state of the general industrial economy, as well asdomestic and foreign competition.

 

The level of productionvolume through our various facilities has a significant effect on the cost ofmanufacturing.  As shipment volumesincrease, a larger portion of fixed and semi-fixed costs are absorbed overgreater units of production thereby reducing the impact of these costs on costof goods sold.  Key variable costsinclude costs of labor and raw materials, including scrap steel, steel slabs,steel coils, electricity, and natural gas. Most of our finned tubes and other heat recovery products aremanufactured to customer specifications. Accordingly, our manufacturing costs for heat recovery products are tosome extent factored into product prices on an order-by-order basis.

 

We have entered intomarketing alliances and manufacturing arrangements with several companies.These alliances and arrangements involve the sale and marketing of theirproducts which provide us access to additional manufacturing capacity.  Our exclusive commercial alliances with thesemills allow us to outsource production of specific types of OCTG, line pipe,and specialty tubing and enable us to concentrate our capital expenditures andmanufacturing expertise on our premium products and new technologies.  We will continue to explore opportunities toexpand our global alliance partners to enable us to offer our customers a widervariety of tubular products at competitive prices while enhancing our margins,and to focus our production on higher-margin premium products.

 

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

 

*Oilfield Products –* Our oilfield productsand services consist of (1) casing, which acts as a structural retainerwall in oil and natural gas wellbores, (2) production tubing, whichtransmits hydrocarbons to the surface, (3) line pipe, which is used ingathering and transmitting hydrocarbons, (4) couplings, which are used toconnect individual sections of oilfield casing and tubing, and (5) OCTGfinishing services, including threading, thermal treating, upsetting,non-destructive testing, inspection, and storage services.

 

We expect demand for ouroilfield products to continue to remain strong throughout 2005 as both crudeoil prices and natural gas prices are expected to sustain the number of activedrilling rigs.   The U.S. Energy InformationAgency (“EIA”) has projected that the average West Texas Intermediate (WTI)crude oil price should remain in the low- to mid-$40’s per barrel rangethroughout 2005-2006.  During 2004, U.S.petroleum demand increased 2.4% over the prior year, the largest increase infive years, despite the significant increase in prices.  The EIA expects U.S. petroleum demand to growat an approximate average of 1.7% growth rate in 2005 and 2006.  U.S. natural gas spot prices averaged around $6per thousand cubic feet (“mcf”) during 2004 and ended the month of December2004 at $6.77 per mcf.  The EIA expectsnatural gas spot prices to range from $5.45 - $5.75 per mcf during 2005 and2006 due to high crude oil prices and a relatively tight natural gas supply todemand condition.  We believe that theseare positive indicators of increasing and sustainable demand for our oilfieldproducts in 2005.

 

*Specialty Tubing Products* – Our specialtytubing product segment includes two principal product groups:  (1) precision mechanical tubulars and (2)finned tubular products.  Our precisionmechanical tubulars consist of a wide array of high-quality, custom-made steeltubular products with precise dimensional control and special metallurgical 

 

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properties which aremanufactured by the “Drawn Over Mandrel” process. This process allows us toachieve higher critical tolerances and dimensional control than otherprocesses. These products are used for several industrial applications,including 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.

 

Demand for our precisionmechanical tubular products improved in 2004 with shipment volume increasingapproximately 22% over fiscal year 2003 as the general domestic economycontinued to improve throughout the year. The composite Purchasing Managers’ Index remains above 50 percent whichgenerally indicates that the manufacturing economy is expanding.  We believe that demand for our precisionmechanical tubing products in 2005 will continue to be positively impacted bythe improving general domestic economy.

 

Our finned tubularproducts are used in heat recovery applications such as fuel economizers,petrochemical plants, refineries, and combined-cycle electrical powergeneration plants.   Demand fordomestically produced finned tubulars and related products fell slightly in2004 and shipment volumes decreased 15% from 2003.  Since reorganizing our finned tubularbusiness around new marketing and commercial business lines directed at moretraditional heat recovery markets including fuel economizers and traditionalboiler applications, we have experienced increased customer activity related toimprovements in the general industrial economy. However, with few exceptions, demand for our finned products forinstallation in new power plant construction projects is not likely to improve untilexisting electrical power generation capacity is more fully utilized.

 

*Flat Rolled Steel and Other Products* – Wemanufacture and market flat rolled steel, which is primarily used in themanufacture of our oil country tubular products and precision mechanicaltubular products. We also sell flat rolled steel to fabricators of large-diametertransmission pipe, storage tanks, rail cars and a variety of other constructionand industrial products. Our other products are principally used for structuraland piling applications in the construction industry.  We sell flat rolled steel directly toend-users and through service centers primarily in the Southwestern region ofthe United States.

 

We sell flat rolled steel in highly competitive markets, with price,quality, and availability primarily determining customer purchasedecisions.  Flat rolled steel processingservices are also sold to steel mills where we receive processing revenues butdo not take title to the steel.

 

# **CRITICALACCOUNTING POLICIES AND ESTIMATES**

# ** **

Management’s Discussionand Analysis, Results of Operations, and Financial Condition are based on therelated consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America.  The preparation of thefinancial statements requires the use of estimates and judgments that affectthe reported amounts of assets, liabilities, revenues, and expenses.  Lone Star evaluates its estimates primarilybased on historical experience and business knowledge.  These estimates are evaluated by managementand revised as circumstances change.   Adiscussion of the significant estimates made by Lone Star follows:

 

***Warranty Claims***

 

Our products are used in applications that are subject to inherentrisks including well failures, performance deficiencies, line pipe leaks,personal injury, property damage, environmental contamination, or loss of oiland gas production.  We warrant ourproducts to meet certain specifications. Actual or claimed deficiencies in meeting these specifications may giverise to claims.  We maintain a reservefor asserted and unasserted warranty claims. The warranty claim exposure is evaluated using historical claim trends andinformation available on specifically asserted claims. We also maintain productand excess liability insurance subject to certain deductibles that limits ourexposure to these claims.  We considerthe extent of insurance coverage in our estimate of the reserve.  Typically, this reserve is not subject tosignificant fluctuations from period to period. However, the incurrence of an unusual amount of claims could alter ourexposure and the related reserve.

 

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***Bad Debts***

 

Our customers are concentrated in markets and industries that aresubject to volatility.  In addition, wesell a substantial amount of products to a few customers, none of whichindividually comprise more than 10% of total net revenues.  We maintain a reserve for known and estimatedunknown bad debts.  We evaluate creditrisk and the adequacy of our reserve by monitoring the age of our accountsreceivable and the credit worthiness of our customers.  In addition, we monitor the overall status ofthe industries where our products and services are utilized.  Typically, this reserve is not subject tosignificant fluctuations from period to period. However, the incurrence of an unusual amount of bad debt could alter ourexposure and the related reserve.

 

***Environmental Obligations***

 

Our business is subject to numerous environmental regulations.  We are actively remediating a few knownexposures and conducting post closure monitoring activities.  Our environmental department monitors thestatus of our environmental exposures and compliance with regulations throughvarious means.  We maintain anenvironmental reserve to cover the costs of expected remediation and postclosure monitoring.  We estimate therange of cost for the remediation and post closure based on historicalexperience, results of monitoring and the known extent of exposure.  We evaluate the range of exposure and recordthe reserve at the most probable amount within that range. Typically, this reserveis not subject to significant fluctuations from period to period; althoughgiven the nature of environmental exposure, significant changes in the reserveare possible.

 

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

*** ***

Long-lived assets, which include property, goodwill, intangible assets,and certain other assets, comprise a significant amount of our totalassets.  We make judgments and estimatesin conjunction with the carrying value of these assets, including amounts to becapitalized, depreciation and amortization methods, and useful lives.Additionally, the carrying value of goodwill is reviewed annually forimpairment or whenever events or changes in circumstances indicate that thecarrying amount may not be recoverable.  The carrying values of all other long-livedassets are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amounts may not be recoverable.  An impairment loss is recorded in the periodin which it is determined that the carrying amount is not recoverable. Thisrequires us to make long-term forecasts of our future revenues and costsrelated to the assets subject to review. These forecasts require assumptionsabout demand for our products and services, future market conditions, andtechnological developments. Significant and unanticipated changes to theseassumptions could require a provision for impairment in a future period.

 

***Pensionand Postretirement Benefit Obligations***

*** ***

Accounting for pensionsand other postretirement benefit plans requires management to make severalestimates and assumptions (see Note J in the Notes to Consolidated FinancialStatements).   These include the expected rate of return from investmentof the plans’ assets, projected increases in medical costs and the expectedretirement age of employees as well as their projected mortality.   Inaddition, the amounts recorded are affected by changes in the interest rateenvironment because the associated liabilities are discounted to their presentvalue.   Management makes these estimates based on Lone Star’s historicalexperience 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.

 

Lone Star’s net pensionbenefit expense, which is included in “Cost of goods sold” on our ConsolidatedResults of Operations, was $4.8 million for the year ended December 31,2004.  In recording this amount, Lone Star assumed a 

 

27

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long-term investment rateof return of 8%.   Changes to this rate of return assumption would resultin a change to the pension credit and, as a result, an equal change in cost ofgoods sold.   Changes that are reasonably likely to occur in assumptionsconcerning retirement age, projected earnings and mortality would not beexpected to have a material effect on Lone Star’s net pension benefit expenseor net pension liability in the future.   The net pension liability isrecorded at its net present value using a discount rate of 6.00% that is basedon the current interest rate environment.

 

Lone Star’s net cost forother postretirement benefits, which is also included in cost of goods sold,was $1.4 million for the year ended December 31, 2004.  In recording this expense and valuing the netliability for other postretirement benefits, which is included in “OtherBenefits” as disclosed in Note J, management estimated future increases in health-carecosts.   This and other assumptions, along with the effect of a onepercentage point change in them, are described in Note J.

 

**RESULTSOF OPERATIONS**

 

***Net Revenues***

Our revenues are derivedfrom three business segments: oilfield products, specialty tubing products, andflat rolled steel and other products.  In the last three years, net revenues and shipments by segment were asfollows:

 
| ** **                            | ** ** | **($ in millions)** | ** ** |
|---------------------------------------|------------|--------------------------|------------|
| ** **                            | ** ** | **2004**                 | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                            | ** ** | **$**                    | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| Oilfield  products                    |       | 695.4                    |       | 72 |   | 364.8 |   | 68 |   | 304.2 |   | 58 |   |
| Specialty tubing  products            |       | 175.1                    |       | 18 |   | 121.8 |   | 23 |   | 165.4 |   | 32 |   |
| Flat rolled  steel and other products |       | 96.3                     |       | 10 |   | 47.5 |   | 9 |   | 54.1 |   | 10 |   |
| Total net  revenues                   |       | 966.8                    |       | 100 |   | 534.1 |   | 100 |   | 523.7 |   | 100 |   |

 
| ** **                            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **                            | ** ** | **Tons** | ** ** | **%**    | ** ** | **Tons** | ** ** | **%** | ** ** | **Tons** | ** ** | **%** | ** ** |
| Oilfield  products                    |       | 592,900  |       | 67       |       | 496,200  |       | 68 |   | 457,600 |   | 60 |   |
| Specialty tubing  products            |       | 118,400  |       | 14       |       | 104,900  |       | 14 |   | 143,800 |   | 19 |   |
| Flat rolled  steel and other products |       | 171,100  |       | 19       |       | 132,700  |       | 18 |   | 158,700 |   | 21 |   |
| Total shipments                       |       | 882,400  |       | 100      |       | 733,800  |       | 100 |   | 760,100 |   | 100 |   |

 

*2004Compared to 2003* – Revenues from our oilfield productsincreased by 91% over fiscal year 2003 on significant increases in bothshipment volume and average pricing.  Thetable below illustrates the impact of volume changes and average price changeson net revenues from oilfield products for the year ended 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      |   |

 

Average pricing of ouroilfield products increased nearly 60% in 2004 over the prior year.  Average pricing for OCTG and line pipeincreased 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 OCTG products increasednearly 91% on 70% increase in average pricing. Line pipe revenues, which were 15% of our total oilfield productrevenues in 2004, were up 85% over the prior year on a 74% increase in averagepricing and a 6% increase in shipment volume. Our increases in average oilfieldproduct pricing are due principally to our success in implementing priceincreases along with raw material surcharges, both of which were necessary asthe cost of our principal raw materials, steel slabs and coils, increased anaverage 82% in 2004 compared to the prior year. 

 

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Demand for our oilfieldproducts also increased in 2004. Shipment volumes of our high-strength alloy-grade OCTG and carbon-basedOCTG increased 33% and 12%, respectively, as high crude oil and natural gasprices stimulated the number of working drilling rigs to their highest annualaverage in fifteen years.

 

Specialty tubing productrevenues increased nearly 44% in 2004 compared to 2003 as average pricingincreased more than 27% and shipment volumes were up nearly 13%.  The table below summarizes the impact ofvolume and average price changes on specialty tubing products for the yearended December 31, 2004 ($ in millions).

 

| ** **                     | ** ** | **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 prices of our specialty tubingproducts and instituted raw material surcharges as a result of the significantincreases in our principal raw material cost, steel, and improved demand asindicated by our increased shipment volume. Sales of our precision mechanical tubulars, which accounted for 75% ofour total specialty tubing segment revenues in 2004, increased by 57% comparedto 2003.  Average pricing of ourprecision mechanical tubulars increased 30% and shipment volumes grew by 22%over the prior year as general industrial demand continued to increasethroughout 2004 along with the improvement in the domestic economy.   Heat recovery tubular goods revenuesincreased 14% compared to the prior year as average pricing increased 33% dueprincipally to product price increases related to increases in raw materialcosts, namely steel.  Total tons shippeddecreased by 15% as excess capacity in the North American electricitygenerating market and foreign competition continue to negatively impact salesof our heat recovery tubulars.

 

Sales of flat-rolled andother products increased by nearly 103% compared to 2003 as the tight domesticsteel market drove significant increases in demand for flat-rolled steel andpushed prices to new high levels.  Totalshipment volume in tons increased by 29% with average pricing up over 57%.  The table below illustrates the impact ofvolume and average price changes on flat-rolled and other products for the yearended 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       |   |

 

*2003Compared to 2002 –*The increase in oilfield product revenuesin 2003 compared to 2002 was due in part to a 28% increase in total OCTGshipments slightly offset by a 2% decrease in average OCTG selling price perton.  This increase in revenues wasprimarily related to increased demand for our lower-margin carbon-grade OCTGproducts, which typically are used in more shallow wells, resulting in areduced mix of higher priced products. Shallow wells require proportionally fewer tons per foot of well depththan deeper wells as the initial surface casing is generally smaller indiameter, fewer intermediate casing strings are needed, and generally the wallthickness of the casing is less.  Averageselling price per ton of our alloy-grade OCTG in 2003 did not change from 2002despite several announced price increases. Shipments of carbon-grade OCTG increased by 42% in 2003 compared to theprior year while shipments of premium alloy-grade OCTG increased 19% over thesame period even though the average rig count increased by 24% from 2002 to2003.   The number of working rigs is themost commonly followed indicator of demand for oilfield products.

 

Line pipe revenues, whichwere approximately 16% of total oilfield product segment revenues in 2003, weredown 31% on a 31% decrease in shipment volumes in 2003 compared to 2002.  Although average sales price per ton did notchange, the decrease in shipments is due principally to the termination of acommercial alliance arrangement for 

 

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seam-annealed line pipein the second half of 2002, which accounted for approximately 79,800 tonsshipped in 2002 and only 3,400 tons in 2003.  This alliance produced only nominal operating profits in 2002.

 

Oilfield product revenuesin 2002 included only three months of revenues of our September 2002 Wheelingacquisition and none from our 2003 DTP and DTI acquisitions.  In 2003, these three operations contributedapproximately 10% of the total oilfield product revenues.

 

Revenues from specialtytubing products decreased in 2003 compared to the prior year as the generalindustrial economy remained in a contraction through most of the year.   Total specialty tubing shipments decreased27% and revenues decreased 26% in 2003 compared to 2002.  Average sales price per ton shipped decreasedby 1% in 2003 compared to 2002 as the over capacity within the industry thatpreceded the decline in the industrial economy placed downward pressure onpricing.  The trend of original equipmentmanufacturers (“OEM”) that relocate to countries with substantially loweroperating rates than the United States continued to reduce demand for domesticspecialty tubing products.   Similarly,excess capacity in the North American electricity generating market and foreigncompetitors continued to negatively impact sales of our heat recovery tubulars.

 

Revenues from our flatrolled and other products segment decreased in 2003 compared to 2002 as our twoprincipal customers, who accounted for 76% and 73% of total flat rolledrevenues in 2003 and 2002, respectively, decreased their purchase of our flatrolled products by 28% in 2003 compared to 2002.  However, in the fourth quarter of 2003, flatrolled revenues increased to $14.3 million, a 61% increase compared to thethird quarter of 2003, due principally to the tightening domestic steel supplyduring the fourth quarter of 2003.

 

***Gross Margin***

 

At December 31, 2004,2003, and 2002, we valued 82%, 90%, and 84%, respectively, of our inventoriesat the lower of cost or market determined on the last-in, first-out (“LIFO”)inventory valuation method.  In periodsof increasing costs, the LIFO method generally results in higher cost of goodssold than under the first-in, first-out (“FIFO”) method.  Likewise, in periods of decreasing costs theresults are generally the opposite. Steel costs increased dramatically in 2004 which negatively impactedgross profit under the LIFO method as compared to what gross profit would havebeen had we used the FIFO method.

 

The following tableillustrates the comparative effect of LIFO and FIFO accounting on ourconsolidated results of operations.  Thistable is provided solely for the purpose of providing comparisons to othercompanies that may use the FIFO method 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, 2004, 2003, and 2002 ($ in millions).

 
| ** **          | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **          | ** ** | **LIFO** | ** ** | **FIFO** | ** ** | **LIFO** | ** ** | **FIFO** | ** ** | **LIFO** | ** ** | **FIFO** | ** ** |
| Cost of goods  sold |       | $        | 804.8      |     | $          | 741.4    |       | $ | 528.9 |   | $ | 520.6 |   | $ | 516.3 |   | $ | 501.7 |   |
| Net income  (loss)  |       | 101.0    |       | 162.3    |       | (68.2    | )          | (59.9 | ) | (69.2 | ) | (54.6 | ) |
|                     |            |          |            |          |            |          |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following table showscost of sales and the related gross margin percentages (“GM%”) for the lastthree years ($ in millions):

 
| ** **          | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **          | ** ** | **$**    | ** ** | **GM%**  | ** ** | **$**    | ** ** | **GM%** | ** ** | **$** | ** ** | **GM%** | ** ** |
| Cost of goods  sold |       | 804.8    |       | 16.8     | %          | 528.9    |       | 1.0 | % | 516.3 |   | 1.4 | % |

 

 

*2004Compared 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 in the first quarter of 2004, webegan instituting price increases across all product segments as well asimplemented raw material surcharges in response to rapidly increasing steelcosts and rising natural gas costs. During the second quarter of 2004 our surcharges and base price weremerged into one price subject to possible change at the time of shipment.  We continue to closely monitor our rawmaterial costs including their impact on our margins and examine the need tofurther raise product prices as raw material costs increase and as appropriatewith market demand.  For 2004, theincrease in shipment volumes across all three reporting segments absorbed alarger amount of fixed and semi-fixed costs over greater units of productionthereby reducing the impact of fixed and semi-fixed costs on cost of goodssold.

 

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*2003Compared to 2002 –*Gross margin declined slightly in 2003compared to 2002, but remained just above break-even as significantly higherraw material costs, namely steel and natural gas, combined with a difficultyear in product pricing to reduce margins across all product lines.  Although we announced several OCTG priceincreases totaling approximately $135 per ton during the year, only aboutone-third of these announced price increases were realized or impacted existingcustomer programs.  We had similar lowrealization of announced line pipe and specialty tubing price increases during2003.  Our inability to realize priceincreases was principally due to an increase in foreign imports and competitivepressures domestically and internationally. For OCTG, imports increased from an average of 31% of the apparentconsumption of domestic OCTG in 2002 to 35% in 2003.

 

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

 

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

 
| ** **                            | ** ** | **2004** | ** ** | **2003**       | ** ** | **2002** | ** ** |
|---------------------------------------|------------|----------|------------|----------------|------------|----------|------------|
| ** **                            | ** ** | **$**    | ** ** | **% of  Rev.** | ** ** | **$**    | ** ** | **% of  Rev.** | ** ** | **$** | ** ** | **% of  Rev.** | ** ** |
| Selling,  general, and administrative |       | 44.6     |       | 4.6            | %          | 41.8     |       | 7.8 | % | 68.2 |   | 13.0 | % |

 

*2004 Compared to 2003* – In 2004,SG&A costs increased less than 7%, but fell to 4.6% of revenues principallydue to the significant increase in our revenues.  The increase in SG&A costs is principallydue to increases in wages, salaries, and related benefits of approximately $2.8million related to the increase in our operating rates and business activities;and, increases in audit and consulting fees related to public companycompliance requirements, principally Sarbanes-Oxley Section 404, and otherprofessional fees of approximately $1.8 million.  These increases were partially offset byreductions in other SG&A expenses related to taxes other than income,reductions in information technology operating costs, and reductions in othermiscellaneous SG&A expenses totaling $1.4 million.

 

*2003 Compared to 2002* – Excludingthe impact of a significant charge of $18.7 million for a goodwill impairmentin 2003 and a $32 million charge for the unfavorable Cargill litigationjudgment in 2002 (See Item 3., Legal Proceedings), SG&A expenses increasedby $5.6 million in 2003 compared to 2002.  This increase was due principally to the inclusion of $4.7 million ofSG&A expenses from a full year of Wheeling’s operations and a partial yearof DTP’s and DTI’s operations in 2003. In comparison, for 2002, total SG&A expense included only $0.4million of Wheeling SG&A costs.  Theremaining increase in 2003 compared to 2002 is due to expenditures for ourSarbanes-Oxley Section 404 readiness initiative and additional legal costsrelated to our appeal of the Cargill judgment. These increases were partially offset by our initiatives to reduce costsand improve profitability implemented during 2003.

 

***Interest Expense***

 

Interest expense increased in 2004 by $0.4 million, principally as aresult of incrementally higher interest costs associated with higher steelcosts as part of our product financing arrangements.  Interest expense increased in 2003 comparedto 2002 by $2.7 million, principally as a result of interest accruing on the$32 million unfavorable judgment against Lone Star in 2002.

 

***Income Taxes***

 

Lone Star’s effective taxrate is affected by the carryforward of net operating losses (“NOL”) recognizedor not recognized in a particular year and the full valuation allowance placedagainst the associated net deferred tax assets.  In 2004, NOL’s totalling $46.9 million wereutilized to reduce our federal income tax expense.  In 2003, a tax benefit at the U.S. statutoryrate of 35% was reduced by $25.5 million of NOL benefit not recognized in thatperiod as management believed that it was more likely than not the related taxbenefits would not be realized.  Theultimate realization of our deferred tax assets depends upon our ability togenerate sufficient taxable income in the future.  Accordingly, due to the uncertainty regardingpossible utilization of NOL’s and the sensitivity of our earnings to the levelof domestic drilling activity, we record a valuation allowance to fully reservethe computed net deferred tax assets.  Weevaluate the amount recorded as a valuation allowance quarterly and asconditions change.  The income taxexpense for the years ended December 31, 2004 and 2003 consists of state incometaxes.

 

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# **LIQUIDITYAND CAPITAL RESOURCES**

# ** **

***Overview***

 

We have historicallyfunded our business through our operating results.  We believe these sources of funds willprovide the liquidity necessary to fund our cash requirements during 2005.  The following table shows our capitalresources ($ in millions):

 

| ** **                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
| Cash and cash  equivalents            |       | $        | 30.2       |     | $          | 33.3 |   |
| Total  investments in debt securities |       | $        | 59.1       |     | $          | — |   |
| Restricted cash                       |       | $        | —     |     | $          | 32.2 |   |
| Working capital                       |       | $        | 288.1      |     | $          | 184.2 |   |
| Unused credit  facility               |       | $        | 120.9      |     | $          | 124.2 |   |

 

At December 31, 2004, ourcash and cash equivalents and investments in debt securities totaled $89.3million, compared to $33.3 million of only cash and cash equivalents atDecember 31, 2003.  Our cash and cashequivalents include commercial bank accounts and highly liquid money marketinstruments issued by corporations, banks and the U.S. government or its agencieswith original maturities of less than three months.  Our investments in debt securities consist ofU.S. government and related agency debt obligations, debt securities of publiccompanies, and municipal securities with maturities at purchase less than twoyears.  These investments in debtsecurities generally earn higher yields than the yields of our cash and cashequivalents.  Our total cash equivalentsand investments in debt securities, the combined weighted average maturity ofwhich is less than one year, are classified as either held-to-maturity as wehave the positive intent and ability to hold them to maturity, oravailable-for-sale (See *Investments – Note D*to the Notes to Consolidated Financial Statements).  The increase in working capital was primarilydue to the increase in accounts receivable of $52.8 million and our investmentsin debt securities totaling $59.1 million, both of which are directly relatedto our increase in net revenues in 2004, and $35.8 million in other currentassets which includes inventory deposits of $28.7 million, offset by thedecrease in inventories on-hand of $24.5 million and the increase in currentliabilities of $3.5 million.  In 2003,our liquidity and capital resources were affected by our putting up a cash deposittotaling $32.0 million to collateralize a bond for a breach of contractjudgment on appeal.  On October 1, 2004,$34.0 million was paid to the plaintiffs in response to the Minnesota SupremeCourt’s decision that it would not review a lower court’s affirmation of thejudgment.  Of these funds, $32.0 millionwas released from the bond and $2.0 million in interest was paid (See Item 3.,Legal Proceedings).

 

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

 

Cash provided by (usedin) operating activities was $61.7 million, $(40.6) million, and $(12.4)million for 2004, 2003, and 2002, respectively. Cash provided from operations increased $102.3 million for the yearended December 31, 2004, which is primarily attributable to net income of$101.0 million.  The following tablesummarizes our sources and uses of cash from operations ($ in millions):

 
| ** **                                           | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Cash flows from  operating activities:               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash received  from customers                        |       | $          | 914.0      |       | $          | 525.2      |       | $ | 536.3 |   |
| Cash paid to  suppliers and employees                |       | (804.6     | )          | (554.9     | )          | (540.7     | )          |
| Interest  received                                   |       | 1.7        |       | 1.2        |       | 2.5        |       |
| Interest paid                                        |       | (17.0      | )          | (14.0      | )          | (13.7      | )          |
| Income taxes  (paid) refunded                        |       | (1.8       | )          | —     |       | 1.0        |       |
| Litigation  settlement paid                          |       | (32.0      | )          | —     |       | —     |       |
| Miscellaneous  cash (paid) received                  |       | 1.4        |       | 1.9        |       | 2.2        |       |
|                                                 |       |       |       |       |       |       |       |
| Net cash  provided by (used in) operating activities |       | $          | 61.7       |       | $          | (40.6      | )          | $ | (12.4 | ) |

 

Cash received fromcustomers increased 74% in 2004 compared to 2003 principally due to increasesin demand for our products and to higher average sales prices.  Days sales outstanding (“DSO”) decreased to36 days in 2004 compared to 44 days in 2003. DSO is calculated using the average accounts receivable balance for eachfiscal year.  Cash paid to suppliers andemployees increased 45% in 2004 compared to 2003, principally as a result ofsignificant increases in raw material costs in 2004, namely steel and naturalgas, but also due in part to 

 

32

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greater levels ofproduction requiring larger quantities of raw materials.  Cash received from customers in 2003decreased by 2% compared to 2002, although DSO decreased slightly to 44 days in2003 compared to 45 days in 2002.  Cash paidto suppliers and employees increased by 3% in 2003 compared to 2002, principallyas a result of higher raw material costs in 2003.

 

Interest paid in 2004increased principally due to $2.0 million of interest paid related to thelitigation settlement in 2004 (See Item 3. Legal Proceedings).

 

Cash used in investingactivities was $71.4 million, $48.0 million and $54.0 million for 2004, 2003,and 2002, respectively.  During 2004,cash used in investing was due to the purchase of investments in debtsecurities totaling $88.6 million and $13.0 million of investments in capitalexpenditures, offset by proceeds from the sale of property of $0.7 million andproceeds from the sale of investments classified as available-for-salesecurities totaling $29.5 million. Primarily, the investments in capital expenditures were related to theexpansion of our production capabilities at our Star Energy Groupfacilities.  Cash used in 2003 relatedprincipally to our acquisitions of DTP and DTI and capital expenditures.  Cash used in 2002 relates to our acquisitionof Wheeling and capital expenditures to improve the efficiencies andeffectiveness of our production capabilities and to install new computer-basedenterprise resource planning systems.

 

Cash provided by financing activities was $6.4 million, $0.5 million,and $81.5 million in 2004, 2003, and 2002, respectively.  In 2004, cash was provided from the proceedsof exercising stock options.  Cashprovided in 2003 from proceeds of stock option exercises totaling $1.3 millionwas offset by purchases of treasury stock of $0.8 million. Cash provided in 2002relates to proceeds from the offering of 3.3 million shares of Lone Star commonstock totaling $82.8 million, partially offset by $1.3 million purchase oftreasury shares.

 

In December 2003, LoneStar amended and restated its $100 million credit facility to increase thetotal available borrowings to $125 million and extend the expiration date toNovember 2006.  Borrowings under thecredit facility can be used 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, theinterest rate is the prime lending rate or the LIBOR plus the applicableadditional interest.  Under theagreement, Lone Star can borrow an amount based on a percentage of eligibleaccounts receivable and inventories reduced by outstanding letters of credit,which totaled $4.1 million at December 31, 2004.  The credit facility remains undrawn and thetotal availability was $120.9 million at December 31, 2004.  For 2004, 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 of the assets of DeltaTubular Processing (“DTP”) for $14.0 million in cash plus acquisitioncosts.  In June 2003, we acquired certainassets of Frank’s Tubular International (since renamed Delta TubularInternational, or “DTI”) for $18.9 million in cash plus acquisition costs.

 

On April 23, 2002, LoneStar sold 3.3 million shares of common stock under a previously filed universalshelf registration statement.  Proceedsto Lone Star were $82.8 million.  LoneStar used the remaining net proceeds from this sale to acquire othercomplementary businesses, to make compatible asset investments, and providefunds for working capital and other general corporate purposes.

 

On October 16, 2002, LoneStar filed a universal shelf registration statement that became effective onApril 18, 2003 to sell from time to time up to a total of $136.0 million ofdebt securities, preferred stock, common stock, depository shares andwarrants.  Lone Star has an aggregate ofapproximately $250.0 million of registered securities available, including apreviously filed universal shelf registration statement.

 

We operate in capital intensive businesses. We have made, and we expectwe will be required to make, significant capital expenditures each year forrecurring maintenance necessary to keep manufacturing facilities operational,to comply with environmental and other legal requirements and to improve ourinformation systems. Additionally, we regularly make capital expenditures fortechnological improvements and for research and development projects. Iffunding is insufficient at any time in the future, we may be unable to developor enhance our products or services, take advantage of business opportunitiesor respond to competitive pressures.  Ourcapital expenditures budget for 2005 is approximately $11 million.

 

Our operations aresubject to environmental compliance and permitting requirements of variousforeign, federal, state and provincial governmental agencies. We believe thatthe cost of maintaining compliance with environmental 

 

33

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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, 2004, we had contractual cash obligations to repaydebt, to make payments under leases, purchase obligations, and commercialcommitments in the form of unused lines of credit.  Payments due under these long-termobligations are as follows ($ in millions):

 
| ** **                             | ** ** | **Obligations Due By Period (1)** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **Total**                         | ** ** | **2005** | ** ** | **2006  to  2007** | ** ** | **2008  to  2009** | ** ** | **Thereafter** | ** ** |
| Contractual  Obligations               |       |                              |       |   |   |   |   |   |   |   |   |
| Long-term debt  obligations (2)        |       | $                                 | 237.8      |   | $ | 13.5 |   | $ | 27.0 |   | $ | 27.0 |   | $ | 170.3 |   |
| Operating lease  obligations           |       | 8.4                               |       | 2.3 |   | 3.9 |   | 2.2 |   | — |   |
| Purchase  obligations                  |       | 9.1                               |       | 9.1 |   | — |   | — |   | — |   |
| Other long-term  obligations  (3) |       | 7.9                               |       | 7.9 |   | — |   | — |   | — |   |
|                                   |       |                              |       |   |   |   |   |   |   |   |   |
| Total  Contractual Obligations         |       | $                                 | 263.2      |   | $ | 32.8 |   | $ | 30.9 |   | $ | 29.2 |   | $ | 170.3 |   |

 

----

(1)          The table does notinclude an estimate for income taxes which we are required to make but notrequired to include above.

 

(2)          The long-term debtobligations represent our cash debt service obligations, including bothinterest at a fixed rate of 9.0% and principal.

 

(3)          Other long-termobligations represent cash contributions to our pension plan.

 

Commercial commitment expirations are as follows ($ in millions):

 
| ** **              | ** ** | **Commitment Expiration by Period** | ** ** |
|-------------------------|------------|-------------------------------------|------------|
| ** **              | ** ** | **Total**                           | ** ** | **2005** | ** ** | **2006  to  2007** | ** ** | **2008  to  2009** | ** ** | **Thereafter** | ** ** |
| Unused credit  facility |       | $                                   | 125.0      |   | $ | — |   | $ | 125.0 |   | $ | — |   | $ | — |   |
|                         |            |                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

##### ** **

In November 2004,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standard (“SFAS”) No. 151, *InventoryCosts—An Amendment of ARB No. 43, Chapter 4* (“SFAS 151”).  SFAS 151 amends the guidance in ARBNo. 43, Chapter 4, *InventoryPricing*, to clarify the accounting for abnormal amounts of idlefacility expense, freight, handling costs, and wasted material (spoilage).  Among other provisions, the new rule requiresthat items such as idle facility expense, excessive spoilage, double freight,and rehandling costs be recognized as current-period charges regardless ofwhether they meet the criterion of “so abnormal” as stated in ARBNo. 43.  Additionally, SFAS 151requires that the allocation of fixed production overhead to the costs ofconversion be based on the normal capacity of the production facilities.  SFAS 151 is effective for fiscal yearsbeginning after June 15, 2005 and we are required to adopt it beginning onJanuary 1, 2006.  We are currentlyevaluating the effect that the adoption of SFAS 151 will have on ourconsolidated results of operations and financial condition but do not expectSFAS 151 to have a material impact.

 

In December 2004,the FASB issued SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123R”), which replaces SFASNo. 123, *Accounting for Stock-BasedCompensation*, (“SFAS 123”) and supercedes APB OpinionNo. 25, *Accounting for Stock Issued toEmployees*.  SFAS 123Rrequires all share-based payments to employees, including grants of employeestock options, to be recognized in the financial statements based on their fairvalues beginning with the first interim or annual period after June 15,2005, with early adoption encouraged. The pro forma disclosures previouslypermitted under SFAS 123 no longer will be an alternative to financialstatement recognition.  

 

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We are required to adoptSFAS 123R in the third quarter of fiscal 2005, beginning July 1,2005.  Under SFAS 123R, we mustdetermine the appropriate fair value model to be used for valuing share-basedpayments, the amortization method for compensation cost and the transitionmethod to be used at date of adoption. The transition methods include prospective and retroactive adoption options.  Under the retroactive option, prior periodsmay be restated either as of the beginning of the year of adoption or for allperiods presented.  The prospectivemethod requires that compensation expense be recorded for all unvested stockoptions and restricted stock at the beginning of the first quarter of adoptionof SFAS 123R, while the retroactive methods would record compensationexpense for all unvested stock options and restricted stock beginning with thefirst period restated.  We are evaluatingthe requirements of SFAS 123R and expect that the adoption ofSFAS 123R will have a material impact on our consolidated results ofoperations and earnings per share.  Wehave not yet determined the method of adoption or the effect of adoptingSFAS 123R, and we have not determined whether the adoption will result inamounts that are similar to the current pro forma disclosures underSFAS 123.

 

In December 2004,the FASB issued SFAS No. 153, *Exchangesof Nonmonetary Assets—An Amendment of APB Opinion No. 29, Accounting forNonmonetary Transactions* (“SFAS 153”).  SFAS 153 eliminates the exception fromfair value measurement for nonmonetary exchanges of similar productive assetsin paragraph 21(b) of APB Opinion No. 29, *Accounting for Nonmonetary Transactions*, and replaces itwith an exception for exchanges that do not have commercial substance.  SFAS 153 specifies that a nonmonetaryexchange has commercial substance if the future cash flows of the entity areexpected to change significantly as a result of the exchange.  SFAS 153 is effective for fiscal periodsbeginning after June 15, 2005 and we are required to adopt it beginning onJanuary 1, 2006.  We are currently evaluatingthe effect that the adoption of SFAS 153 will have on our consolidatedresults of operations and financial condition but we do not expect it to have amaterial impact.

 

**FORWARD-LOOKING INFORMATION**

 

The statements includedin this Annual Report regarding future financial performance and results andthe other statements that are not historical facts are forward-lookingstatements.  The words “believes,” “intends,”“expects,” “anticipates,” “projects,” “estimates,” “predicts,” and similarexpressions are also intended to identify forward-looking statements.  Such statements involve risks, uncertaintiesand assumptions, including, but not limited to, industry and market conditions,environmental liabilities, competitive pricing, practices and conditions,availability and pricing of raw materials, fluctuations in prices of crude oiland natural gas, the trade environment, the impact of current and future lawsand governmental regulations (particularly environmental laws and regulations),and other factors discussed in this Annual Report and in other filings with theSecurities and Exchange Commission. Should one or more of these risks or uncertainties materialize, orshould underlying assumptions prove incorrect, actual outcomes may varymaterially from those indicated.

 

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**ITEM 7A.               QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We are exposed to certainrisks associated with the change in foreign currency rates, interest rates andcommodity prices.  We seek to minimizethe potential adverse impact of those market risks through the use ofappropriate management techniques including the limited use of derivativefinancial instruments.

 

Our operations in Mexicoand Canada are accounted for in the local currencies, converted to the U.S.dollar equivalent based on published exchange rates for the period reported andare therefore subject to risk of exchange rate fluctuations.  We believe that our current risk exposure toexchange rate movements is not significant.

 

Our investments in cashequivalents, the weighted average maturity of which is less than three months,and our investments in debt securities, the weighted average maturity of whichis less than one year, are subject to interest rate risk.  The value of these securities would declinein the event of increases in market interest rates.  We manage this risk by investing insecurities that have relatively short-term maturities and with varying maturitydates.  In addition, we intend to holdthese securities until maturity and, as a result, avoid the losses resultingfrom sudden changes in interest rates.

 

To the extent that weborrow against our credit facility, we are exposed to interest rate riskarising from the variable-rate nature of the facility. There were no borrowingson this facility at December 31, 2004.  Inthe past, we have used interest rate swaps to effectively fix a portion of theinterest rates on our variable rate credit facilities.  We did not have any interest rate swaps atDecember 31, 2004 and 2003.  Our seniorsubordinated notes accrue interest at a fixed rate of 9%.  The fair value of the notes is sensitive tochanges in interest rates.  The fairvalue of Lone Star’s senior subordinated debt based on quoted market prices was$156.8 million and $149.3 million at December 31, 2004 and 2003, respectively.

 

We are subject tocommodity price risk, primarily with respect to purchases of steel and naturalgas.  Purchased steel represents asignificant portion of our cost of goods sold. As a result, fluctuations in the cost of purchased steel, which can bevolatile and cyclical in nature, have a significant impact on our margins bothpositively and negatively.  Our steelcosts have risen significantly since the end of 2003.  We have been successful in passing thesehigher steel costs on to our customers. However, there can be no assurance that we will continue to be able todo so in the future.

 

We purchase natural gasfor our operations and therefore have a limited market risk in natural gasprices.  As a result, our earnings couldbe affected by changes 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 requirements are purchased onthe market at the current value.  Ournatural gas purchase commitments at December 31, 2004 totaled $9.1 million.

 

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**ITEM 8.  CONSOLIDATEDFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

 
| Report  of Independent Registered Public Accounting Firm                                                     |   |
|--------------------------------------------------------------------------------------------------------------|--------|
| Management’s  Report on Internal Controls over Financial Reporting                                      |   |
| Report  of Independent Registered Public Accounting Firm                                                     |   |
| Consolidated Results  of Operations for the years ended December 31, 2004, 2003, and 2002                    |   |
| Consolidated Balance Sheets  at December 31, 2004 and 2003                                                   |   |
| Consolidated  Statements of Cash Flows, for the years ended December 31, 2004, 2003, and  2002               |   |
| Consolidated  Statements of Shareholders’ Equity for the years ended December 31, 2004,  2003, and 2002 |   |
| Notes to  Consolidated Financial Statements                                                                  |   |
| Schedule  II - Valuation and Qualifying Accounts                                                             |   |

 

37

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**REPORT OFINDEPENDENT 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, 2004 and2003, and the related consolidated results of operations, statements ofshareholders’ equity and cash flows for each of the three years in the periodended December 31, 2004.  These financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial 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, 2004 and 2003, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2004, in conformity with accounting principles generally acceptedin the United States of America.

 

We have also audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the effectiveness of theCompany’s internal control over financial reporting as of December 31, 2004,based on the criteria established in *InternalControl – Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated February 28, 2005expressed an unqualified opinion on management’s assessment of theeffectiveness of the Company’s internal control over financial reporting and anunqualified opinion on the effectiveness of the Company’s internal control overfinancial reporting.

 

DELOITTE & TOUCHE LLP

Dallas, Texas

February 28, 2005

 

38

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**MANAGEMENT’SREPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

To the Board of Directorsand Shareholders of Lone Star Technologies, Inc.:

 

The management of Lone Star Technologies, Inc. and subsidiaries (“LoneStar”) is responsible for establishing and maintaining adequate internalcontrol over financial reporting, as such term is defined in Exchange Act Rules13a-15(f).  Lone Star’s internal controlsystem was designed to provide reasonable assurance to the company’s managementand board of directors regarding the preparation and fair presentation ofpublished financial statements.

 

All internal controlsystems, no matter how well designed, have inherent limitations.  Therefore, even those systems determined tobe effective can provide only reasonable assurance with respect to financialstatement preparation and presentation.

 

Lone Star’s management,including its principal executive officer and principal financial officer,assessed the effectiveness of the company’s internal control over financialreporting as of December 31, 2004.  Inmaking this assessment, it used the criteria set forth by the Committee ofSponsoring Organizations of the Treadway Commission (COSO) in *Internal Control – Integrated Framework*.  Based on our assessment we believe that, asof December 31, 2004, the company’s internal control over financial reportingis effective based on those criteria.

 

Lone Star’s independentregistered public accounting firm, Deloitte & Touche LLP, has issued anaudit report on our assessment of the company’s internal control over financialreporting, which is included herein.

 

Lone Star Technologies,Inc.

Dallas, Texas

February 28, 2005

 

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

 

39

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Shareholders of Lone Star 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, 2004, based oncriteria established in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. The Company’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting 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, 2004, 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, 2004,based on the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheet as of December 31, 2004 and therelated consolidated results of operations, statements of shareholders’ equityand cash flows for the year ended December 31, 2004 of the Company and ourreport dated February 28, 2005 expressed an unqualified opinion on thosefinancial statements.

 

DELOITTE & TOUCHE LLP

Dallas, Texas

February 28, 2005

 

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**LONESTAR TECHNOLOGIES, INC.**

**CONSOLIDATEDRESULTS OF OPERATIONS**

***($ and shares in millions, except per sharedata)***

 
| ** **                                          | ** ** | **For the Years Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                          | ** ** | **2004**                             | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                |       |                                 |       |   |   |   |   |
| Net revenues                                        |       | $                                    | 966.8      |   | $ | 534.1 |   | $ | 523.7 |   |
| Cost of goods  sold                                 |       | 804.8                                |       | 528.9 |   | 516.3 |   |
| Gross profit                                        |       | 162.0                                |       | 5.2 |   | 7.4 |   |
| Selling,  general, and administrative expenses      |       | 44.6                                 |       | 41.8 |   | 68.2 |   |
| Goodwill  impairment charge                         |       | —                               |       | 18.7 |   | — |   |
| Operating income  (loss)                            |       | 117.4                                |       | (55.3 | ) | (60.8 | ) |
| Interest income                                     |       | 1.8                                  |       | 1.4 |   | 2.5 |   |
| Interest expense                                    |       | (16.8                                | )          | (16.4 | ) | (13.7 | ) |
| Other income,  net                                  |       | 2.0                                  |       | 2.2 |   | 2.1 |   |
| Income (loss)  before income tax                    |       | 104.4                                |       | (68.1 | ) | (69.9 | ) |
| Income tax  benefit (expense)                       |       | (3.4                                 | )          | (0.1 | ) | 0.7 |   |
| Net income  (loss)                                  |       | $                                    | 101.0      |   | $ | (68.2 | ) | $ | (69.2 | ) |
|                                                |       |                                 |       |   |   |   |   |
| **Per  common share - basic:**                      |       |                                 |       |   |   |   |   |
| Net income  (loss) available to common shareholders |       | $                                    | 3.51       |   | $ | (2.40 | ) | $ | (2.52 | ) |
| ** **                                          | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Per  common share - diluted:**                    |       |                                 |       |   |   |   |   |
| Net income  (loss) available to common shareholders |       | $                                    | 3.46       |   | $ | (2.40 | ) | $ | (2.52 | ) |
|                                                |       |                                 |       |   |   |   |   |
| **Weighted  average shares outstanding**            |       |                                 |       |   |   |   |   |
| Basic                                               |       | 28.7                                 |       | 28.4 |   | 27.5 |   |
| Diluted                                             |       | 29.2                                 |       | 28.4 |   | 27.5 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

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**LONE STAR TECHNOLOGIES, INC.**

**CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                    | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                    | ** ** | **2004**         | ** ** | **2003** | ** ** |
| **ASSETS**                                                                                                    |       |             |       |   |   |
|                                                                                                          |       |             |       |   |   |
| Current Assets:                                                                                               |       |             |       |   |   |
| Cash and cash  equivalents                                                                                    |       | $                | 30.2       |   | $ | 33.3 |   |
| Short-term  investments                                                                                       |       | 46.4             |       | — |   |
| Accounts  receivable, less allowances of $1.3 and $1.7, respectively                                          |       | 122.6            |       | 69.8 |   |
| Inventories                                                                                                   |       | 128.3            |       | 152.8 |   |
| Other current  assets                                                                                         |       | 51.6             |       | 15.8 |   |
| Total current  assets                                                                                         |       | 379.1            |       | 271.7 |   |
|                                                                                                          |       |             |       |   |   |
| Investments                                                                                                   |       | 12.7             |       | — |   |
| Property, plant,  and equipment, net                                                                          |       | 205.8            |       | 220.0 |   |
| Goodwill                                                                                                      |       | 40.9             |       | 40.9 |   |
| Restricted cash                                                                                               |       | —           |       | 32.2 |   |
| Other noncurrent  assets                                                                                      |       | 8.2              |       | 9.9 |   |
|                                                                                                          |       |             |       |   |   |
| Total assets                                                                                                  |       | $                | 646.7      |   | $ | 574.7 |   |
|                                                                                                          |       |             |       |   |   |
| **LIABILITIES AND SHAREHOLDERS' EQUITY**                                                                      |       |             |       |   |   |
|                                                                                                          |       |             |       |   |   |
| Current  Liabilities:                                                                                         |       |             |       |   |   |
| Accounts payable                                                                                              |       | $                | 53.9       |   | $ | 59.5 |   |
| Accrued  liabilities                                                                                          |       | 37.1             |       | 28.0 |   |
| Total current  liabilities                                                                                    |       | 91.0             |       | 87.5 |   |
|                                                                                                          |       |             |       |   |   |
| Senior  subordinated debt                                                                                     |       | 150.0            |       | 150.0 |   |
| Postretirement  benefit obligations                                                                           |       | 40.1             |       | 44.5 |   |
| Other noncurrent  liabilities                                                                                 |       | 11.1             |       | 46.8 |   |
| Total  liabilities                                                                                            |       | 292.2            |       | 328.8 |   |
|                                                                                                          |       |             |       |   |   |
| 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: 29,240,866 and 28,660,903,  respectively) |       | 29.2             |       | 28.7 |   |
| Capital surplus                                                                                               |       | 363.0            |       | 355.1 |   |
| Accumulated  other comprehensive loss                                                                         |       | (32.6            | )          | (32.2 | ) |
| Accumulated  deficit                                                                                          |       | (2.4             | )          | (103.4 | ) |
| Treasury stock,  at cost (195,958 and 174,107 shares, respectively)                                           |       | (2.7             | )          | (2.3 | ) |
| Total  shareholders' equity                                                                                   |       | 354.5            |       | 245.9 |   |
|                                                                                                          |       |             |       |   |   |
| Total  liabilities and shareholders' equity                                                                   |       | $                | 646.7      |   | $ | 574.7 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

42

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**LONESTAR TECHNOLOGIES, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

***($ in millions)***

 
| ** **                                                                                                                      | ** ** | **For the Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2004**                             | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| **Cash  flows from operating activities:**                                                                                      |       |                                 |       |   |   |   |   |
| Net income  (loss)                                                                                                              |       | $                                    | 101.0      |   | $ | (68.2 | ) | $ | (69.2 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities, net of acquired companies: |       |                                 |       |   |   |   |   |
| Depreciation and  amortization                                                                                                  |       | 27.8                                 |       | 25.4 |   | 21.8 |   |
| Non-cash charge  for stock compensation                                                                                         |       | 1.6                                  |       | 1.1 |   | (0.1 | ) |
| Net loss (gain)  on property disposals and impairments                                                                          |       | 0.1                                  |       | 0.4 |   | (0.1 | ) |
| Goodwill  impairment                                                                                                            |       | —                               |       | 18.7 |   | — |   |
| Accounts  receivable                                                                                                            |       | (52.8                                | )          | (7.1 | ) | 11.7 |   |
| Inventories                                                                                                                     |       | 24.5                                 |       | (4.0 | ) | 6.4 |   |
| Other current  assets                                                                                                           |       | (35.8                                | )          | (2.8 | ) | (3.3 | ) |
| Accounts payable  and accrued liabilities                                                                                       |       | 1.9                                  |       | 27.2 |   | (7.2 | ) |
| Litigation  reserves                                                                                                            |       | (33.0                                | )          | 2.0 |   | 32.0 |   |
| Restricted cash                                                                                                                 |       | 32.2                                 |       | (32.2 | ) | — |   |
| Other                                                                                                                           |       | (5.8                                 | )          | (1.1 | ) | (4.4 | ) |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| Net cash  provided by (used in) operating activities                                                                            |       | 61.7                                 |       | (40.6 | ) | (12.4 | ) |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| **Cash  flows from investing activities:**                                                                                      |       |                                 |       |   |   |   |   |
| Capital  expenditures                                                                                                           |       | (13.0                                | )          | (14.4 | ) | (15.9 | ) |
| Purchase of  investments                                                                                                        |       | (88.6                                | )          | — |   | — |   |
| Proceeds from  sale of property, plant and equipment                                                                            |       | 0.7                                  |       | 0.4 |   | 0.2 |   |
| Proceeds from  sales of investments                                                                                             |       | 29.5                                 |       | — |   | — |   |
| Cash paid for  acquisitions, net of cash received                                                                               |       | —                               |       | (34.0 | ) | (38.3 | ) |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| Net cash used in  investing activities                                                                                          |       | (71.4                                | )          | (48.0 | ) | (54.0 | ) |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| **Cash  flows from financing activities:**                                                                                      |       |                                 |       |   |   |   |   |
| Proceeds from  exercise of options                                                                                              |       | 6.4                                  |       | 1.3 |   | — |   |
| Net proceeds  from stock offering                                                                                               |       | —                               |       | — |   | 82.8 |   |
| Purchase of  treasury stock                                                                                                     |       | —                               |       | (0.8 | ) | (1.3 | ) |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| Net cash  provided by financing activities                                                                                      |       | 6.4                                  |       | 0.5 |   | 81.5 |   |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| Effect of  foreign exchange rate changes on cash                                                                                |       | 0.2                                  |       | 0.9 |   | (1.1 | ) |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| Net change in  cash and cash equivalents                                                                                        |       | (3.1                                 | )          | (87.2 | ) | 14.0 |   |
| Cash and cash  equivalents, beginning of year                                                                                   |       | 33.3                                 |       | 120.5 |   | 106.5 |   |
| *** ***                                                                                                                    | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash  equivalents, end of year                                                                                         |       | $                                    | 30.2       |   | $ | 33.3 |   | $ | 120.5 |   |
|                                                                                                                            |       |                                 |       |   |   |   |   |
| **Supplemental  cash flow disclosure:**                                                                                         |       |                                 |       |   |   |   |   |
| Interest paid                                                                                                                   |       | $                                    | 17.0       |   | $ | 13.9 |   | $ | 13.7 |   |
| Income taxes  paid (refunded), net                                                                                              |       | $                                    | 1.8        |   | $ | — |   | $ | (1.0 | ) |

 

See Notes to ConsolidatedFinancial Statements.

 

43

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**LONESTAR TECHNOLOGIES, INC.**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS' EQUITY**

***($ in millions)***

 
| ** **                               | ** ** | **Common  Stock** | ** ** | **Capital  Surplus** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Accumulated  Earnings  (Deficit)** | ** ** | **Treasury  Stock** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|-------------------|------------|----------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|---------------------|------------|-----------|------------|
|                                     |       |              |       |                 |       |                                                 |       |                                 |       |                |       |      |       |
| **Balance,  January 1, 2002**            |       | $                 | 25.2       |                 | $          | 272.0                                                |       | $                                    | (15.9      | )                   | $          | 34.0      |       | $ | — |   | $ | 315.3 |   |
|                                     |       |              |       |                 |       |                                                 |       |                                 |       |                |       |      |       |
| Net loss                                 |       | —            |       | —               |       | —                                               |       | (69.2                                | )          | —              |       | (69.2     | )          |
| Other  comprehensive loss:               |       |              |       |                 |       |                                                 |       |                                 |       |                |       |      |       |
| Minimum pension  liability adjustment    |       | —            |       | —               |       | (14.9                                                | )          | —                               |       | —              |       | (14.9     | )          |
| Foreign currency  translation adjustment |       | —            |       | —               |       | (1.3                                                 | )          | —                               |       | —              |       | (1.3      | )          |
| Comprehensive  loss                      |       |              |       |                 |       |                                                 |       |                                 |       |                |       | (85.4     | )          |
| Stock offering                           |       | 3.3               |       | 79.5                 |       | —                                               |       | —                               |       | —              |       | 82.8      |       |
| Employee benefit  plan stock issuance    |       | —            |       | 1.2                  |       | —                                               |       | —                               |       | —              |       | 1.2       |       |
| Acquisition of  treasury stock           |       | —            |       | —               |       | —                                               |       | —                               |       | (1.3                | )          | (1.3      | )          |
|                                     |       |              |       |                 |       |                                                 |       |                                 |       |                |       |      |       |
| **Balance,  December 31, 2002**          |       | 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 |   |

 

See Notes to ConsolidatedFinancial Statements.

 

44

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**LONE STAR TECHNOLOGIES, INC.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

Lone Star Technologies,Inc. (“Lone Star”, or the “Company”), a Delaware corporation, is a managementand holding company with six principal operating subsidiaries, Lone Star SteelCompany (“Steel”), Fintube Technologies, Inc. (“Fintube”), Bellville TubeCompany, L.P. (“Bellville”), Wheeling Machine Products, Inc.  (“Wheeling”), acquired October 1, 2002, DeltaTubular Processing, Inc. (“DTP”), acquired May 1, 2003 and, Delta TubularInternational, Inc. (“DTI”), acquired June 2, 2003.  Steel manufactures and globally marketsoilfield tubular products to the oil and gas drilling industry, mechanicaltubing products to automotive, fluid power, and other markets for variousmechanical applications, and flat rolled steel and other tubular products todomestic industrial markets.  Fintubemanufactures specialty finned tubular products used in a variety of heatrecovery applications including combined-cycle electrical powergeneration.  Bellville manufacturesoilfield tubular products.  Wheelingmanufactures couplings used to connect individual sections of oilfield casingand tubing.  Delta and DeltaInternational provide oil country tubular processing services includingthreading and inspection services.

 

Lone Star’s consolidatedrevenues are not seasonal.  However,demand for oilfield products is subject to significant fluctuations due to thevolatility of oil and gas prices and domestic drilling activity as well asother factors including 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 significant intercompany accounts andtransactions have been eliminated in consolidation.  In the Notes to Consolidated FinancialStatements, all dollar and share amounts in tabulation are in millions ofdollars and shares, respectively, except per share data and unless otherwisenoted.  Certain prior year amounts havebeen reclassified 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.

 

At December 31, 2003,Lone Star had restricted cash of $32.2 million related to a cash deposit thatcollateralized a bond for a breach of contract judgment.  See Commitments and Contingencies – Note K.

 

***Investments.***Lone Star accounts forits investments in debt securities under Statement of Financial AccountingStandard No. 115, *Accounting for CertainInvestments in Debt and Equity Securities* (“SFAS No. 115”). UnderSFAS No. 115, investments for which Lone Star has the positive intent and theability to hold to maturity are reported at amortized cost, which approximatesfair market value at December 31, 2004. Those classified as available-for-sale are reported at fair value withunrealized gains and losses recorded in comprehensive income.

 

***Inventories*** arestated at the lower of cost or market value. Cost is determined using the last-in, first-out (“LIFO”) method forapproximately 82% and 90% of the Company’s total current inventories after LIFOreserve at December 31, 2004 and 2003, respectively.  The cost of remaining inventories isdetermined using the first-in, first-out (“FIFO”) method.  Inventories include raw materials and certainsupplies.

 

***Property, plant, and equipment***are stated at cost.  Significantbetterments and improvements are capitalized if they extend the useful life ofthe asset, while maintenance and repairs are expensed when incurred.  Depreciation is provided on the straight-linemethod over the estimated useful lives of depreciable assets as follows:

 

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

 

45

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***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 December31, 2004, the Company believes that its long-lived assets have not beenimpaired.

 

***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 liabilitiesor assets are recognized for the estimated future tax effects attributable totemporary differences and carryforwards and are adjusted whenever tax rates orother provisions of income tax statutes change. Deferred tax assets are reduced, if deemed necessary, by a valuationallowance for any tax benefits that are not expected to be realized.  A full valuation has been maintained for alltax benefits, principally consisting of federal tax net operating losscarryforwards.

 

***Revenue recognition***.  Product revenues are recognized as sales whenrevenue is earned and is realized or realizable.  This includes satisfying the followingcriteria:  the arrangement with thecustomer is evident, usually through the receipt of a purchase order; the salesprice 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 billed to customers isincluded in net sales, and the cost of freight and shipping is included in costof sales.  The Company has marketingagreements to sell steel oilfield tubular products manufactured by othercompanies.  Revenue is recorded on agross basis for certain transactions with alliance mills when the Company isthe 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 monthly average exchange rates in effect for the period in which theitems occur. The Company’s international operation that has the U.S. Dollar asits functional currency translates monetary assets and liabilities usingcurrent rates of exchange at the balance sheet date and translates non-monetaryassets and liabilities using historical rates of exchange. Gains and lossesfrom remeasurement for such operations are included in other income, on a netbasis and 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 concentration could affect the Company’s overall exposureto credit risk, management believes that the Company is exposed to minimal risksince the majority of its business is conducted with major companies within theindustry.  The Company performs on-goingcredit evaluations of its customers and generally does not require collateralwhen extending credit. The Company maintains a reserve for potential creditlosses. Such losses have historically been within management’sexpectations.  The Company does not havefinancial instruments with off-balance sheet risk.

 

Lone Star maintains cashand cash equivalents and investments in debt securities with various financialinstitutions. As part of its cash and risk management processes, the Companyperforms periodic evaluations of the relative credit standing of the financialinstitutions.  Lone Star has notsustained credit losses from instruments held at financial institutions.

 

***Stock-Based Employee Compensation. ***The Company accountsfor 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 is recognizedfor fixed option plans because the exercise prices of employee stock optionsequal or exceed the market prices of the underlying stock on the dates ofgrant.  As permitted, the Company haselected to adopt the disclosure only provisions of SFAS No. 123, *Accounting for Stock-Based Compensation*.  Refer to Note J for further information.

 

46

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The weighted average fairvalue per option granted in 2004, 2003, and 2002 was $8.58, $9.70, and $9.65,respectively. The fair value of each option grant is estimated on the date ofgrant using the Black-Scholes option pricing model with the following weightedaverage assumptions for grants in 2004, 2003, and 2002, respectively: risk-freeinterest rates of 2.61%, 2.93%, and 4.79%; volatility of 63.19%, 61.86%, and62.25%; expected lives of 3.5 years, 5.0 years, and 5.0 years; and, all optiongrants without payment of dividends.  Hadcompensation cost for this plan been determined consistent with SFAS No. 123,net income and earnings per share would have been reduced to the following proforma amounts:

 
| ** **                                                                                                                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income  (loss) as reported                                                                                                                |       | $        | 101.0      |     | $          | (68.2    | )          | $ | (69.2 | ) |
| Add: Stock-based  employee compensation expense included in reported net income (loss), net of  related tax effects                           |       | 1.6      |       | 1.1      |       | 0.9      |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (7.5     | )          | (7.7     | )          | (7.5     | )          |
|                                                                                                                                          |       |     |       |     |       |     |       |
| Pro forma net  income (loss)                                                                                                                  |       | $        | 95.1       |     | $          | (74.8    | )          | $ | (75.8 | ) |
|                                                                                                                                          |       |     |       |     |       |     |       |
| Basic earnings  (loss) per share                                                                                                              |       |     |       |     |       |     |       |
| as reported                                                                                                                                   |       | $        | 3.51       |     | $          | (2.40    | )          | $ | (2.52 | ) |
| pro forma                                                                                                                                     |       | $        | 3.31       |     | $          | (2.63    | )          | $ | (2.76 | ) |
| Diluted earnings  (loss) per share                                                                                                            |       |     |       |     |       |     |       |
| as reported                                                                                                                                   |       | $        | 3.46       |     | $          | (2.40    | )          | $ | (2.52 | ) |
| pro forma                                                                                                                                     |       | $        | 3.26       |     | $          | (2.63    | )          | $ | (2.76 | ) |

 

***Fair Value of Financial Instruments.***The carrying amount of cash and cash equivalents, tradereceivables and payables approximates fair value because of the short maturityof those instruments.  The estimated fairvalue of Lone Star’s investments in debt securities based on quoted marketprices was $59.1 million at December 31, 2004. The estimated fair value of Lone Star’s senior subordinated debt basedon quoted market prices was $156.8 million and $149.3 million at December 31,2004 and 2003, respectively.  Theseestimated fair values may not be representative of actual values of thefinancial instruments that could have been realized as of year-end or that willbe realized in the future.

 

As of December 31, 2004and 2003, the Company had outstanding letters of credit of $4.1 million and$0.8 million, respectively, which approximates fair value.

 

***AccumulatedOther Comprehensive Income.***  As of December 31, 2004, accumulated othercomprehensive income consisted of $32.5 million related to minimum pensionliability adjustments and $0.1 million related to cumulative translationadjustments.

 

***Use of Estimates. ***Preparation of theconsolidated financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, disclosures ofcontingent assets and liabilities, and the reported amounts of revenues andexpenses. The Company’s estimates are primarily based on historical experienceand business knowledge and are revised as circumstances change.  However, actual results could differ fromthose estimates.

 

Lone Star’s products are used in applications which are subject toinherent risks including but not limited to well failures, performancedeficiencies, line pipe leaks, personal injury, property damage, environmentalcontamination or loss of oil and gas production.  The Company warrants its products to meetcertain specifications.  Actual orclaimed deficiencies from these specifications may give rise to claims and theCompany maintains a reserve for asserted and unasserted warranty claims.  The warranty claim exposure is evaluatedusing historical claim trends and information available on specifically knownclaims. The Company also maintains product and excess liability insurancesubject to certain deductibles that limit the exposure to these claims.  The Company considers the extent of insurancecoverage in its estimate of the reserve. Typically, this reserve is not subject to significant fluctuations fromperiod-to-period.  

 

47

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However, the incurrence of an unusual amount of claims could alter theCompany’s exposure and the related reserve. The following table identifies changes in warranty reserves from January1, 2002 to December 31, 2004:

 
| ** **                                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Beginning  balance                                      |       | $        | 2.4        |     | $          | 2.1      |       | $ | 3.0 |   |
| Warranty expense  accruals                              |       | 3.1      |       | 2.0      |       | 2.9      |       |
| Changes in estimates  to pre-existing warranty accruals |       | —   |       | 0.2      |       | (0.1     | )          |
| Warranty  settlements                                   |       | (3.1     | )          | (1.9     | )          | (3.7     | )          |
| Ending balance                                          |       | $        | 2.4        |     | $          | 2.4      |       | $ | 2.1 |   |

 

Lone Star is subject to numerous environmental regulations and isactively remediating a few known exposures and conducting post-closuremonitoring activities.  The Companymaintains an environmental reserve to cover the costs of expected remediationand post-closure monitoring and estimates the range of cost for the remediationand post-closure monitoring based on historical experience, results ofmonitoring and the known extent of exposure. The Company evaluates the range of exposure and records the reserve atthe most probable amount within that range. Typically, this reserve is not subject to significant fluctuations fromperiod-to-period.  However, given thenature of environmental exposures, significant changes in the reserve arepossible.

 

***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 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 rule requires that items such as idlefacility expense, excessive spoilage, double freight, and rehandling costs berecognized as current-period charges regardless of whether they meet thecriterion of “so abnormal” as stated in ARB No. 43.  Additionally, SFAS 151 requires that theallocation of fixed production overhead to the costs of conversion be based onthe normal capacity of the production facilities.  SFAS 151 is effective for fiscal yearsbeginning after June 15, 2005 and is required to be adopted by Lone Starbeginning on January 1, 2006.  LoneStar is currently evaluating the effect that the adoption of SFAS 151 willhave on its consolidated results of operations and financial condition but doesnot expect SFAS 151 to have a material impact.

 

In December 2004,the FASB issued SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123R”), which replaces SFASNo. 123, *Accounting for Stock-BasedCompensation*, (“SFAS 123”) and supercedes APB OpinionNo. 25, *Accounting for Stock Issued toEmployees*.  SFAS 123Rrequires all share-based payments to employees, including grants of employeestock options, to be recognized in the financial statements based on their fairvalues beginning with the first interim or annual period after June 15,2005, with early adoption encouraged. The pro forma disclosures previouslypermitted under SFAS 123 no longer will be an alternative to financialstatement recognition.  Lone Star isrequired to adopt SFAS 123R in the third quarter of fiscal 2005, beginningJuly 1, 2005.  Under SFAS 123R,Lone Star must determine the appropriate fair value model to be used forvaluing share-based payments, the amortization method for compensation cost andthe transition method to be used at date of adoption.  The transition methods include prospectiveand retroactive adoption options.  Underthe retroactive option, prior periods may be restated either as of the beginningof the year of 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 all unvestedstock options and restricted stock beginning with the first periodrestated.  Lone Star is evaluating therequirements of SFAS 123R and expects that the adoption of SFAS 123Rwill have a material impact on Lone Star’s consolidated results of operationsand earnings per share.  Lone Star hasnot yet determined the method of adoption or the effect of adoptingSFAS 123R, and it has not determined whether the adoption will result inamounts that are similar to the current pro forma disclosures underSFAS 123.

 

In December 2004,the FASB issued SFAS No. 153, *Exchangesof Nonmonetary Assets—An Amendment of APB Opinion No. 29, Accounting forNonmonetary Transactions* (“SFAS 153”).  SFAS 153 eliminates the exception fromfair value measurement for nonmonetary exchanges of similar productive assetsin paragraph 21(b) of APB Opinion No. 29, *Accounting for Nonmonetary Transactions*, and replaces itwith an exception for exchanges that do not have 

 

48

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commercialsubstance.  SFAS 153 specifies thata nonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange.  SFAS 153 is effective for fiscal periodsbeginning after June 15, 2005 and is required to be adopted by Lone Starbeginning on January 1, 2006.  LoneStar is currently evaluating the effect that the adoption of SFAS 153 willhave on its consolidated results of operations and financial condition but doesnot expect it to have a material impact.

 

**BUSINESSSEGMENTS  - NOTE B**

** **

Lone Star currently hassix operating subsidiaries that have separate management teams andinfrastructures that offer different products and services.  The subsidiaries have been aggregated underthree reportable segments:  oilfield,specialty tubing, and flat rolled steel and other tubular goods.  Management evaluates segment performancebased primarily on revenue and earnings from operations and segments areorganized around the products and services provided to the customers eachsegment serves.  No single customercomprised more than 10% of total net revenues in 2004, 2003, or 2002.  Direct foreign revenues as a percent of totalrevenues were 3% in 2004, 2% in 2003, and 5% in 2002.  Foreign assets as a percent of total assetswere less than 1% at December 31, 2004, 2003, and 2002, respectively.

 

The accounting policiesof each segment are the same as those described in Note A of Notes toConsolidated Financial Statements. Intersegment sales and transfers are not significant.  Interest expense, interest income, otherincome and 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.  Theoilfield segment includes premium alloy and carbon welded oil country tubulargoods, including casing, which acts as a structural retainer wall in oil andnatural gas wellbores, and production tubing, which transmits hydrocarbons tothe surface.  Line pipe is used to gatherand transmit oil and natural gas. Couplings are used to connect individual sections of oilfield casing andtubing.  The oilfield segment alsoincludes end-finishing, heat treating, inspection, and storage services.

 

***Specialty tubing.***  Lone Star’s specialty tubing businessincludes the manufacture, marketing and sale of a variety of custom-engineeredtubular products used in exacting applications, such as the manufacture ofhydraulic cylinders for construction and farm equipment, automotiveapplications, such as stabilizers and intrusion tubes; and other uses,including machine parts, bearing races, down-hole pump barrels, heavy liftcrane boom chords, drill rods and liner hangers.  Finned tubulars are used in fuel economizers,industrial processing, petrochemical plants, refineries and combined cycleelectrical power 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 also sells flat rolled steel tofabricators of large diameter pipe, storage tanks, rail cars and a variety ofother construction and industrial products. Lone Star also provides transportation, storage and other services to avariety of industries.

 

49

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The following tablespresent information on the segments.  The“Corporate / Other” column includes corporate related items and otherinsignificant nonsegments.

 
| ** **                       | ** ** | **Oilfield** | ** ** | **Specialty  Tubing** | ** ** | **Flat  Rolled  Steel and  Other  Products** | ** ** | **Corporate  / Other** | ** ** | **Total** | ** ** |
|----------------------------------|------------|--------------|------------|-----------------------|------------|----------------------------------------------|------------|------------------------|------------|-----------|------------|
| **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      |       |
|                             |       |         |       |                  |       |                                         |       |                   |       |      |       |
| **2002**                         |       |         |       |                  |       |                                         |       |                   |       |      |       |
| Revenues                         |       | $            | 304.2      |                  | $          | 165.4                                        |       | $                      | 54.1       |      | $          | — |   | $ | 523.7 |   |
| Segment  operating income (loss) |       | (8.6         | )          | (13.5                 | )          | (2.4                                         | )          | (36.3                  | )          | (60.8     | )          |
| Depreciation and  amortization   |       | 11.2         |       | 9.5                   |       | 1.1                                          |       | —                 |       | 21.8      |       |
| Total assets                     |       | 255.6        |       | 208.0                 |       | 18.8                                         |       | 129.7                  |       | 612.1     |       |
| Capital  expenditures            |       | 9.1          |       | 6.8                   |       | —                                       |       | —                 |       | 15.9      |       |
|                                  |            |              |            |                       |            |                                              |            |                        |            |           |            |  |  |  |  |  |  |  |

 

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

 

All acquisitions in 2003and 2002 have been accounted for under the purchase method of accounting, andaccordingly, the purchase price has been allocated to the assets acquired andthe liabilities assumed based upon fair values at the date of theacquisition.  The excess purchase priceover the fair value of the tangible and intangible net assets acquired has beenrecorded as goodwill.

 

The Company adopted SFASNo. 142 on January 1, 2002 and subsequently ceased goodwill amortization.  The Company completed the first step of thetransitional goodwill impairment test at the beginning of 2002, and completesthe annual goodwill impairment test during the fourth quarter of eachsubsequent year.  The Company estimatesthe fair value of each reporting unit using a present value method thatdiscounts estimated future cash flows. The cash flow estimates incorporate assumptionson future cash flow growth, terminal values, and discount rates.

 

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

 

As of both December 31,2004 and 2003, Lone Star’s Oilfield and Specialty Tubing segments included$13.7 million and $27.2 million of goodwill, respectively.  There were no changes in the carrying amountof goodwill for the year ended December 31, 2004.

 

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Intangible assets otherthan goodwill that are subject to amortization are amortized on a straight-linebasis over their respective estimated useful lives.  The non-compete agreements and licenseagreements are amortized over four to five years.   The other amortizable intangible assets areamortized over five to ten years.  Thecomponents of intangible assets were as follows:

 
| ** **                    | ** ** | **2004**                   | ** ** | **2003**                      | ** ** |
|-------------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **                    | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Amortized intangible  assets: | ** ** | ** **                 | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Non-compete  agreements       |       | $                          | 1.3        |                          | $          | (0.9 | ) | $ | 1.3 |   | $ | (0.7 | ) |
| Other                         |       | 0.5                        |       | (0.4                          | )          | 0.5 |   | (0.3 | ) |
|                          |       | $                          | 1.8        |                          | $          | (1.3 | ) | $ | 1.8 |   | $ | (1.0 | ) |
|                               |            |                            |            |                               |            |  |  |  |  |  |  |  |  |  |  |  |

 

Aggregate amortizationexpense related to intangible assets, other than goodwill, was $0.3 million,$0.4 million, and $0.3 million for the years ended December 31, 2004, 2003, and2002, respectively.

 

The estimated futureamortization expense related to purchased intangible assets at December 31,2004 is as follows:

 

| **Fiscal Year:** | ** ** | ** ** | ** ** |
|------------------|------------|------------|------------|
| 2005             |       | $          | 0.1        |   |
| 2006             |       | 0.1        |       |
| 2007             |       | 0.1        |       |
| 2008             |       | 0.1        |       |
| 2009             |       | —     |       |
| Thereafter       |       | 0.1        |       |
|             |       |       |       |
| Total            |       | $          | 0.5        |   |

 

**INVESTMENTS – NOTE D**

 

Investments inheld-to-maturity and available-for-sale debt securities were as follows atDecember 31, 2004:

 
| ** **                                                    | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
|---------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------------|------------|
| **Held-to-Maturity  Securities (carried at amortized cost):** |       |                |       |                         |       |                          |       |                      |       |
| U.S. government  and agencies                                 |       | $                   | 8.4        |                         | $          | —                        |       | $                         | —     |   | $ | 8.4 |   |
| Debt securities  of public companies                          |       | 6.7                 |       | —                       |       | —                        |       | 6.7                       |       |
|                                                          |       | 15.1                |       | —                       |       | —                        |       | 15.1                      |       |
|                                                          |       |                |       |                         |       |                          |       |                      |       |
| **Available-for-Sale  Securities (carried at fair value):**   |       |                |       |                         |       |                          |       |                      |       |
| Municipal  securities                                         |       | 44.0                |       | —                       |       | —                        |       | 44.0                      |       |
|                                                          |       |                |       |                         |       |                          |       |                      |       |
| Total investment  in debt securities                          |       | $                   | 59.1       |                         | $          | —                        |       | $                         | —     |   | $ | 59.1 |   |

 

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Lone Star accounts forits investments in debt securities under Statement of Financial AccountingStandard No. 115, *Accounting for CertainInvestments in Debt and Equity Securities* (“SFAS No. 115”). UnderSFAS No. 115, investments for which Lone Star has the positive intent and theability to hold to maturity are reported at amortized cost, which approximatesfair market value at December 31, 2004. Those classified as available-for-sale are reported at fair value withunrealized gains and losses recorded in comprehensive income.  The weighted average maturities of theCompany’s held-to-maturity and available-for-sale securities were approximately1.3 years and 38 days, respectively, at December 31, 2004.

 

Contractual maturities ofheld-to-maturity and available-for-sale securities at December 31, 2004 were asfollows:

 

| ** **                 | ** ** | **Amortized  Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|----------------------------|------------|---------------------|------------|---------------------------|------------|
| Due in less than  one year |       | $                   | 46.4       |                      | $          | 46.4 |   |
| Due in 1 - 2  years        |       | 12.7                |       | 12.7                      |       |
|                       |       | $                   | 59.1       |                      | $          | 59.1 |   |

 

Proceeds from sales of available-for-salesecurities were $29.5 million in fiscal 2004. No realized gain or loss was recognized upon the sale of thesesecurities in 2004.  The specificidentification method is used to account for gains and losses onavailable-for-sale securities.  A summaryof the carrying values and balance sheet classification of all held-to-maturityand available-for-sale securities was as follows at December 31, 2004:

 

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

 

**DEBT - NOTE E**

 

In October 2001, LoneStar entered into a three-year $100 million senior secured credit facility (the“Credit Facility”) for use by Lone Star and its domestic subsidiaries.  In December 2003, the Credit Facility wasamended and restated (“Amended Credit Facility”) to increase the totalavailable borrowings to $125 million and extend the expiration date to November2006.  Borrowings under the AmendedCredit Facility can be used for general corporate purposes.  Under the agreement, the Company can borrowan amount based on a percentage of eligible accounts receivable and inventoriesreduced by outstanding letters of credit, which totaled $4.1 million atDecember 31, 2004.  The availabilityunder the Amended Credit Facility was $120.9 million at December 31, 2004.  Borrowings under the Amended Credit Facilityare collateralized by substantially all of the Company’s assets, other thanreal estate.  At the Company’s option,the interest rate is the prime lending rate or the LIBOR plus the applicableadditional interest.  At December 31,2004 and 2003, no amount was outstanding under the Amended Credit Facility.

 

Steel engages in slabconsignment and sales agreements with third parties.  Under these agreements, Steel arranges forthird parties to purchase slabs from vendors that manufacture the slabs and thethird party consigns the slab inventory to Steel.  Steel is then required to repurchase the slabinventory based on usage within specified time periods.  These inventory financing transactions havebeen accounted for as product financing arrangements.  Inventory financed under these arrangementsis recorded as inventory by Steel.  AtDecember 31, 2004 and 2003, there were $8.0 million and $15.6 million,respectively, included in accounts payable under these financing arrangements.

 

On May 29, 2001, LoneStar issued $150.0 million 9% senior subordinated notes due June 1, 2011 toqualified institutional buyers (the “Senior Notes”).  Interest on the outstanding Senior Notesaccrues at a rate of 9% per year, payable semi-annually in arrears on each June1 and December 1.

 

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The Senior Notes are fully and unconditionally (as well as jointly andseverally) guaranteed on an unsecured, senior subordinated basis by each subsidiary of the Company (the “GuarantorSubsidiaries”) other than Aletas y Birlos S.A., de C.V. (the “Non-GuarantorSubsidiary”) (see Note M).  Each of theGuarantor Subsidiaries and the Non-Guarantor Subsidiary is wholly owned by theCompany.

 

Total interest incurred including amortization of deferred financingcosts was $16.8 million, $16.4 million, and $13.7 million for the years endedDecember 31, 2004, 2003, and 2002, respectively.  Total interestcapitalized for the years ended December 31, 2003 and 2002 was $0.6 million and$1.0 million, respectively.  No interestwas capitalized for the year ended December 31, 2004.

 

**SHAREHOLDERS’EQUITY – NOTE F**

** **

On April 23, 2002, Lone Star sold 3.3 million shares of common stockunder a previously filed universal shelf registration statement.  Netproceeds to Lone Star were $82.8 million and were used to acquire Wheeling,Delta and Delta International, and provide funds for working capital and othergeneral corporate purposes.

 

Under a previously authorized stock buy-back program, a total of160,600 shares at a cost of $2.0 million, or a weighted average price of $12.61,were repurchased as treasury shares.  Theadditional shares held at December 31, 2004 and December 31, 2003 result fromthe Company’s withholding of an equivalent number of shares for federal taxesrelated to the Company’s long-term incentive employee benefit plan.  The 195,958 and 174,107 treasury shares heldas of December 31, 2004 and December 31, 2003, respectively, are reported attheir acquired cost.

 

The following table (in whole shares) identifies changes in commonstock issued and treasury stock from January 1, 2002 to December 31, 2004:

 
| ** **                  | ** ** | **Issued** | ** ** | **Treasury  Stock** | ** ** | **Outstanding** | ** ** |
|-----------------------------|------------|------------|------------|---------------------|------------|-----------------|------------|
| Balance, January  1, 2002   |       | 25,201,595 |       | (313                | )          | 25,201,282      |       |
| Stock offering              |       | 3,250,000  |       | —              |       | 3,250,000       |       |
| Employee benefit  plans     |       | 87,419     |       | (4,931              | )          | 82,488          |       |
| Treasury stock  purchase    |       | —     |       | (100,600            | )          | (100,600        | )          |
| Balance,  December 31, 2002 |       | 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      |       |

 

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**EARNINGS PER SHARE - NOTE G**

 

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

 
| ** **                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Numerator:                                           |       |     |       |     |       |     |       |
| Net income  (loss)                                   |       | $        | 101.0      |     | $          | (68.2    | )          | $ | (69.2 | ) |
|                                                 |       |     |       |     |       |     |       |
| Denominator:                                         |       |     |       |     |       |     |       |
| Weighted-average  shares used to compute basic EPS   |       | 28.7     |       | 28.4     |       | 27.5     |       |
| Effect of dilutive  securities:                      |       |     |       |     |       |     |       |
| Stock options                                        |       | 0.5      |       | —   |       | —   |       |
| Weighted-average  shares used to compute diluted EPS |       | 29.2     |       | 28.4     |       | 27.5     |       |
|                                                      |            |          |            |          |            |          |            |  |  |  |

 

As a result of the losses incurred in 2003 and 2002, 2.3 million and2.6 million options, respectively, were excluded in computing diluted EPS assuch options would be anti-dilutive.  In2004, options to purchase 1.1 million shares of Lone Star stock were excludedfrom the calculation of diluted earnings per share because the exercise priceof these options was greater than the average market price of the common sharesfor the year, and therefore the effect would have been anti-dilutive.

 

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**ADDITIONAL BALANCE SHEETINFORMATION – NOTE H**

 
| ** **                                      | ** ** | **At December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------|------------|
| ** **                                      | ** ** | **2004**            | ** ** | **2003** | ** ** |
| ***Inventories***                               |       |                |       |   |   |
| Finished goods                                  |       | $                   | 47.4       |   | $ | 55.4 |   |
| Work in process                                 |       | 100.0               |       | 66.9 |   |
| Raw materials                                   |       | 67.6                |       | 55.0 |   |
| Materials,  supplies, and other                 |       | 22.8                |       | 22.6 |   |
| ***Total  inventories at FIFO***                |       | 237.8               |       | 199.9 |   |
| Reserve to  reduce inventories to LIFO value    |       | (107.5              | )          | (44.1 | ) |
| ***Total  inventories***                        |       | 130.3               |       | 155.8 |   |
| Amount included  in other noncurrent assets     |       | (2.0                | )          | (3.0 | ) |
| ***Inventories,  current***                     |       | $                   | 128.3      |   | $ | 152.8 |   |
|                                            |       |                |       |   |   |
| ***Other  current assets***                     |       |                |       |   |   |
| Insurance and  other deposits                   |       | $                   | 9.2        |   | $ | 5.6 |   |
| Inventory  deposit                              |       | 28.7                |       | — |   |
| Other                                           |       | 13.7                |       | 10.2 |   |
| ***Total  other current assets***               |       | $                   | 51.6       |   | $ | 15.8 |   |
|                                            |       |                |       |   |   |
| ***Property,  plant, and equipment***           |       |                |       |   |   |
| Land and land  improvements                     |       | $                   | 18.2       |   | $ | 18.2 |   |
| Buildings,  structures, and improvements        |       | 34.4                |       | 32.0 |   |
| Machinery and  equipment                        |       | 431.6               |       | 418.2 |   |
| Construction in  progress                       |       | 5.5                 |       | 10.5 |   |
| ***Total  property, plant, and equipment***     |       | 489.7               |       | 478.9 |   |
| Less accumulated  depreciation and amortization |       | (283.9              | )          | (258.9 | ) |
| ***Property,  plant, and equipment, net***      |       | $                   | 205.8      |   | $ | 220.0 |   |
|                                            |       |                |       |   |   |
| ***Other  noncurrent assets***                  |       |                |       |   |   |
| Inventory  (supplies and spare parts)           |       | $                   | 2.0        |   | $ | 3.0 |   |
| Deferred  financing costs                       |       | 3.8                 |       | 4.5 |   |
| Other                                           |       | 2.4                 |       | 2.4 |   |
| ***Total  other noncurrent assets***            |       | $                   | 8.2        |   | $ | 9.9 |   |
|                                            |       |                |       |   |   |
| ***Accrued  liabilities***                      |       |                |       |   |   |
| Accrued  compensation                           |       | $                   | 14.4       |   | $ | 9.3 |   |
| Warranty  reserves                              |       | 2.4                 |       | 2.4 |   |
| Environmental  reserves                         |       | 1.8                 |       | 0.7 |   |
| Pension  obligations                            |       | 3.7                 |       | 5.0 |   |
| Other                                           |       | 14.8                |       | 10.6 |   |
| ***Total  accrued liabilities***                |       | $                   | 37.1       |   | $ | 28.0 |   |
|                                            |       |                |       |   |   |
| ***Other  noncurrent liabilities***             |       |                |       |   |   |
| Environmental  reserves                         |       | $                   | 7.4        |   | $ | 8.8 |   |
| Litigation  reserves                            |       | —              |       | 34.0 |   |
| Other                                           |       | 3.7                 |       | 4.0 |   |
| ***Total  other noncurrent liabilities***       |       | $                   |  11.1 |   | $ |  46.8 |   |
|                                                 |            |                     |            |  |  |  |  |  |

 

During 2004, inventory quantities were reduced. This reduction resultedin a liquidation of LIFO inventory layers, the effect of which increased netincome by approximately $17.9 million or $0.61 per diluted share.

 

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**INCOME TAXES - NOTE I**

 

Income tax expense was $3.4 million and $0.1 million in 2004 and 2003,respectively; and, for 2002, income tax benefit was $0.7 million, includingfederal alternative minimum tax (“AMT”) and state and foreign incometaxes.  There was no deferred income taxexpense or benefit for 2004, 2003, or 2002.

 

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

 
| ** **                                            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Benefit  (expense) at U.S. statutory rate             |       | $        | (36.5      | )        | $          | 23.8     |       | $ | 24.5 |   |
| State and other  income taxes, net of federal benefit |       | (3.4     | )          | (0.1     | )          | 0.7      |       |
| Goodwill  impairment charge                           |       | —   |       | (6.5     | )          | —   |       |
| Change in  valuation allowance                        |       | 36.6     |       | (19.0    | )          | (23.7    | )          |
| Other                                                 |       | (0.1     | )          | 1.7      |       | (0.8     | )          |
| Total income tax  benefit (expense)                   |       | $        | (3.4       | )        | $          | (0.1     | )          | $ | 0.7 |   |

 

At December 31, 2004, Lone Star had federal tax net operating losscarryforwards (NOL’s) of approximately $263 million available to offset futurepayments of federal income taxes, a portion of which may be related to AmericanFederal Bank, a former subsidiary of Lone Star and subject to an agreement withthe Federal Deposit Insurance Corporation (FDIC) whereby Lone Star may berequired to pay the FDIC for certain tax benefits.  The NOL’s are available for utilization byLone Star and its subsidiaries.  If notutilized, the NOL’s will expire in varying amounts between years 2005 and 2023,and their future availability may be limited if Lone Star or a member of theconsolidated group experiences an ownership change of more than 50 percentagepoints, as defined by IRS regulations. Lone Star’s common stock is publicly traded, and management cannotassure that future trading will not result in an ownership change, as definedby IRS regulations, which would limit the availability of the NOL’s.  The Company has an AMT credit carryforwardtotaling $2.8 million that may be carried forward indefinitely under U.S. law.

 

The following table discloses the components of the deferred taxamounts at December 31, 2004 and 2003:

 
| ** **                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| **Deferred  tax assets:**                    |       |     |       |     |       |
| Postretirement  benefit accruals             |       | $        | 15.0       |     | $          | 16.9 |   |
| Environmental  reserves                      |       | 3.2      |       | 3.3      |       |
| Other expense  accruals and reserves         |       | 4.7      |       | 5.0      |       |
| Inventories                                  |       | 18.5     |       | 11.0     |       |
| Other                                        |       | 1.5      |       | 0.8      |       |
| Net operating  loss carryforwards            |       | 65.2     |       | 112.1    |       |
| Alternative  minimum tax credit carryforward |       | 2.8      |       | 1.6      |       |
| Total deferred  tax assets                   |       | 110.9    |       | 150.7    |       |
| ** **                                   |       |     |       |     |       |
| **Deferred  tax liabilities:**               |       |     |       |     |       |
| Property, plant  and equipment               |       | (35.4    | )          | (38.6    | )          |
|                                         |       |     |       |     |       |
| Net deferred tax  assets                     |       | 75.5     |       | 112.1    |       |
| Less valuation  allowance                    |       | (75.5    | )          | (112.1   | )          |
| Net deferred tax  amount                     |       | $        | —     |     | —     |   |
|                                              |            |          |            |          |            |  |  |

 

The ultimate realization of the deferred tax asset depends on theCompany’s ability to generate sufficient taxable income in the future.  Management believes it is more likely thannot that the net deferred tax asset will not be realized by future operatingresults.  Because of the uncertaintyregarding possible utilization of NOL’s and the sensitivity of earnings to thelevel of domestic drilling activity, valuation allowances were recorded tofully reserve the computed net deferred tax assets.  The Company evaluates the amount recorded asa valuation allowance quarterly and as conditions change.

 

56

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**EMPLOYEE BENEFIT PLANS -NOTE J**

 

***Defined contribution plans*.**  Defined contribution plans are available tosubstantially all full-time employees under which participants can makevoluntary pretax contributions.  Fornonbargaining unit employees, matching contributions are provided withinspecified limits.  Steel makescontributions at rates specified under collective bargaining agreements for itsbargaining unit employees.  Contributionstotaled $3.4 millon, $3.3 million, and $2.9 million for the years endedDecember 31, 2004, 2003, and 2002, respectively.

 

***Nonqualified deferred compensation plan*.**  The Company has a nonqualified compensationplan for certain management personnel and highly compensated employees of LoneStar and its participating affiliates that provides eligible employees theopportunity to defer a specified percentage of their 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 to exceed $25,000.  The obligation included in other noncurrentliabilities was $2.7 million and $2.1 million at December 31, 2004 and 2003,respectively.

 

***Employee stock purchase plan***.  The Company has an employee stock purchaseplan for all eligible employees. Eligible employees include all regular full-time employees of Lone Starand its subsidiaries who have been employed for at least 12 months.  Eligible employees may defer up to 5% oftheir compensation for each quarter for the purchase of Lone Star commonstock.  Shares are purchased at the endof each quarter at a price equal to the lower of: (a) 90% of the market priceof Lone Star’s common stock on the first day of the quarter, or (b) 90% of themarket price of Lone Star’s common stock on the last day of the quarter.  The maximum number of Lone Star shares thatmay be purchased for all participants under the plan is 200,000 shares, ofwhich 163,409 shares were available to be issued at December 31, 2004.

 

***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 optionprice is the average of the high and low market price on the date of the grant.  Options are generally exercisable for ten yearswith one-fourth of the shares becoming exercisable on the one-year anniversaryof the grant date and an additional one-fourth becoming exercisable on the sameanniversary date over the next three years. In 2004, 293,500 options were granted to certain key employees thatbecome fully exercisable on the one-year anniversary of the grant date and areexercisable for five years.  For alloptions granted, if the optionee’s employment is terminated under certaincircumstances after a change of control of Lone Star occurs before an option’sfourth anniversary, the option may be exercised in full earlier.  Also, accelerated vesting of options canoccur upon death or retirement from employment of an option holder.  The following discloses the stock option activityfor the years shown (not in millions):

 

| ** **                      | ** ** | **Shares Under  Option** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|---------------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| Outstanding,  December 31, 2001 |       | 1,860,475                |       | $                                      | 28.66      |   |
| Granted                         |       | 555,000                  |       | 16.90                                  |       |
| Exercised                       |       | (1,500                   | )          | 27.19                                  |       |
| Cancelled/forfeited             |       | (65,250                  | )          | 29.82                                  |       |
| 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      |   |

 

57

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At December 31, 2004,1,674,803 shares were available for future grant.  At December 31, 2004, 2003, and 2002,1,442,706, 1,535,913, and 1,100,351 options, respectively, were exercisable.  The following table summarizes informationwith respect to options outstanding and exercisable at December 31, 2004 (notin millions):

 
| ** **                                       | ** ** | **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** | ** ** |
|                                             |       |                    |       |                                   |       |   |   |   |   |   |   |
| $6.88   -   $8.81  |       | 40,000                  |       | $                                      | 8.13       |   | 0.4 |   | 40,000 |   | $ | 8.13 |   |
| 11.06   -   16.52  |       | 712,550                 |       | 15.41                                  |       | 7.3 |   | 274,675 |   | 14.97 |   |
| 16.75   -   23.39  |       | 603,625                 |       | 19.33                                  |       | 4.6 |   | 142,250 |   | 20.45 |   |
| 27.19   -   39.27  |       | 1,012,500               |       | 34.51                                  |       | 5.4 |   | 887,500 |   | 34.42 |   |
| 41.11   -   50.06  |       | 114,375                 |       | 47.04                                  |       | 5.9 |   | 98,281 |   | 47.42 |   |
| $6.88   -   $50.06 |       | 2,483,050               |       | $                                      | 25.49      |   | 5.7 |   | 1,442,706 |   | $ | 29.50 |   |

 

Lone Star also issued137,500, 21,500, and 72,750 shares of restricted stock grants to certainemployees, with a value of $2.5 million, $0.4 million, and $1.1 million during2004, 2003, and 2002, respectively.  Theshares generally vest ratably over a four-year period beginning on the secondanniversary of date of grant.  The fairvalue of restricted stock is charged to Shareholders’ Equity and amortized toexpense over the requisite vesting periods. In 2004, of the 137,500 shares of restricted stock grants, 120,000shares were granted to certain key employees with accelerated vestingprovisions based on the achievement of certain performance objectives.  If the performance objectives are met,one-third of the shares become vested on the first anniversary of date of grantwith the remaining two-thirds becoming vested on the second anniversary of dateof grant.  The Company recognized compensationexpense related to all awards of $1.6 million, $1.1 million, and $0.9 millionin 2004, 2003, and 2002, respectively.

 

***Defined Benefit Pension and PostretirementBenefit Plans*.** Steel has three defined benefit pension plans covering a substantialportion of its bargaining unit employees.  Retirement benefits are based on years ofservice at progressively increasing flat-rate amounts.  A special initial lump-sum pension paymentequal to 13 weeks of vacation pay is also paid following retirement.  It is generally the Company’s policy to fundthe minimum required contributions each year as required by applicableregulations.

 

During 1996 and 1998, thethree pension plans were amended so that new employees do not participate inthe defined benefit plans.  New employeesare eligible to participate in one of the defined contribution retirementplans, as are substantially all other employees.

 

Steel also sponsors anunfunded defined benefit postretirement health care plan for eligiblebargaining unit employees and a limited number of other retirees eligible underspecial early retirement programs.  Thesehealth care plan benefits are limited to eligible retirees and their spousesuntil age 65, at which time coverage terminates.  Certain other postretirement benefits,primarily life insurance, are also provided. The anticipated costs of these postretirement benefits are accrued overthe employees’ years of service.

 

58

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The following representsthe amounts recognized in the consolidated balance sheets at December 31, 2004and 2003:

 
| ** **                                       | ** ** | **Pension Benefits** | ** ** | **Other Benefits** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                                       | ** ** | **2004**             | ** ** | **2003**           | ** ** | **2004** | ** ** | **2003** | ** ** |
| Postretirement  benefit obligations - current    |       | $                    | 1.7        |               | $          | 3.7 |   | $ | 2.0 |   | $ | 1.3 |   |
| Postretirement  benefit obligations - noncurrent |       | 27.3                 |       | 30.1               |       | 12.8 |   | 14.4 |   |
| Other noncurrent  assets - intangible asset      |       | (0.8                 | )          | (1.0               | )          | — |   | — |   |
| Accumulated  other comprehensive loss            |       | (32.5                | )          | (31.9              | )          | — |   | — |   |
| Net amount  recognized                           |       | $                    | (4.3       | )                  | $          | 0.9 |   | $ | 14.8 |   | $ | 15.7 |   |

 

Net periodic benefitexpense for 2004, 2003, and 2002, included the following components:

 
| ** **                            | ** ** | **Pension Benefits** | ** ** | **Other Benefits** | ** ** |
|---------------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                            | ** ** | **2004**             | ** ** | **2003**           | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Service cost                          |       | $                    | 1.0        |               | $          | 1.0 |   | $ | 0.9 |   | $ | 0.5 |   | $ | 0.6 |   | $ | 0.6 |   |
| Interest cost                         |       | 5.7                  |       | 5.8                |       | 5.2 |   | 0.9 |   | 1.0 |   | 0.9 |   |
| Expected return  on plan assets       |       | (4.8                 | )          | (4.2               | )          | (5.0 | ) | — |   | — |   | — |   |
| Amortization of  prior service cost   |       | 0.2                  |       | 0.1                |       | 0.2 |   | — |   | — |   | — |   |
| Recognized net  actuarial loss (gain) |       | 2.7                  |       | 2.7                |       | 0.8 |   | — |   | — |   | (0.1 | ) |
| Net periodic  benefit expense         |       | $                    | 4.8        |               | $          | 5.4 |   | $ | 2.1 |   | $ | 1.4 |   | $ | 1.6 |   | $ | 1.4 |   |

 

The following table sets forth the changes in the plans’ benefitobligations, assets, and funded status at December 31, 2004 and 2003:

 
| ** **                                        | ** ** | **Pension Benefits** | ** ** | **Other Benefits** | ** ** |
|---------------------------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                                        | ** ** | **2004**             | ** ** | **2003**           | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Change  in Projected Benefit Obligation**       |       |                 |       |               |       |   |   |   |   |
| Benefit  obligation at beginning of year          |       | $                    | 93.5       |               | $          | 86.9 |   | $ | 14.9 |   | $ | 15.0 |   |
| Service cost                                      |       | 1.0                  |       | 1.0                |       | 0.5 |   | 0.6 |   |
| Interest cost                                     |       | 5.7                  |       | 5.8                |       | 0.9 |   | 1.0 |   |
| Plan  participants' contributions                 |       | —               |       | —             |       | 0.1 |   | — |   |
| Actuarial loss  (gain)                            |       | 3.3                  |       | 6.2                |       | 6.2 |   | (0.6 | ) |
| Benefits paid                                     |       | (6.5                 | )          | (6.4               | )          | (2.3 | ) | (1.1 | ) |
| Projected  Benefit Obligation at end of year      |       | $                    | 97.0       |               | $          | 93.5 |   | $ | 20.3 |   | $ | 14.9 |   |
|                                              |       |                 |       |               |       |   |   |   |   |
| **Change  in Plan Assets**                        |       |                 |       |               |       |   |   |   |   |
| Fair value of  plan assets at beginning of year   |       | $                    | 59.4       |               | $          | 53.4 |   | $ | — |   | $ | — |   |
| Actual return on  plan assets                     |       | 4.8                  |       | 6.8                |       | — |   | — |   |
| Employer  contributions                           |       | 10.0                 |       | 5.6                |       | 2.2 |   | 1.1 |   |
| Plan  participants' contributions                 |       | —               |       | —             |       | 0.1 |   | — |   |
| Benefits paid                                     |       | (6.5                 | )          | (6.4               | )          | (2.3 | ) | (1.1 | ) |
| Fair value of  plan assets at end of year         |       | $                    | 67.7       |               | $          | 59.4 |   | $ | — |   | $ | — |   |
|                                              |       |                 |       |               |       |   |   |   |   |
| **Reconciliation  of Funded Status**              |       |                 |       |               |       |   |   |   |   |
| Unfunded status  - obligation in excess of assets |       | $                    | 29.3       |               | $          | 34.1 |   | $ | 20.3 |   | $ | 14.9 |   |
| Unrecognized  actuarial gain (loss)               |       | (32.8                | )          | (32.2              | )          | (5.5 | ) | 0.8 |   |
| Unrecognized  prior service cost                  |       | (0.8                 | )          | (1.0               | )          | — |   | — |   |
| Net amount  recognized                            |       | $                    | (4.3       | )                  | $          | 0.9 |   | $ | 14.8 |   | $ | 15.7 |   |

 

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The Accumulated BenefitObligation for all defined benefit pension plans was $96.7 million and $93.2million at December 31, 2004 and 2003, respectively.

 

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

 
| ** **                                           | ** ** | **Pension Benefits** | ** ** | **Other Benefits** | ** ** |
|------------------------------------------------------|------------|----------------------|------------|--------------------|------------|
| ** **                                           | ** ** | **2004**             | ** ** | **2003**           | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Net  Periodic Benefit Expense**                    |       |                 |       |               |       |   |   |   |   |   |   |   |   |
| Discount rate                                        |       | 6.25                 | %          | 6.75               | %          | 6.75 | % | 6.25 | % | 6.75 | % | 6.75 | % |
| Expected  long-term investment return on plan assets |       | 8.00                 | %          | 8.00               | %          | 8.00 | % | — |   | — |   | — |   |
| Rate of  compensation increase                       |       | 3.00                 | %          | 4.00               | %          | 4.00 | % | — |   | — |   | — |   |
|                                                 |       |                 |       |               |       |   |   |   |   |   |   |   |   |
| **Benefit  Obligations**                             |       |                 |       |               |       |   |   |   |   |   |   |   |   |
| Discount rate                                        |       | 6.00                 | %          | 6.25               | %          | 6.75 | % | 6.00 | % | 6.25 | % | 6.75 | % |
| Rate of  compensation increase                       |       | 3.00                 | %          | 3.00               | %          | 4.00 | % | — |   | — |   | — |   |

 

The return on plan assetsreflects the weighted-average of the expected long-term rates of return for thebroad categories of investments held in the plans.  The expected long-term rate of return isadjusted when there are fundamental changes in expected returns on the planassets.  The Company uses an annualmeasurement date of November 30th.

 

The Company’s pension contributions to be paid in 2005 are estimated tobe $7.9 million, reflecting quarterly contributions to certain plans asrequired by Internal Revenue Code Section 412.

 

The Company’s expectedfuture benefit payments for each of the next five years and in the aggregatefor the following five years thereafter are as follows:

 

| **Expected Future Benefit  Payments** | ** ** | **Pension  Benefits** | ** ** | **Other  Benefits** | ** ** |
|---------------------------------------|------------|-----------------------|------------|---------------------|------------|
| 2005                                  |       | $                     | 7.0        |                | $          | 2.0 |   |
| 2006                                  |       | 7.1                   |       | 1.8                 |       |
| 2007                                  |       | 7.1                   |       | 1.6                 |       |
| 2008                                  |       | 7.1                   |       | 1.7                 |       |
| 2009                                  |       | 7.3                   |       | 1.8                 |       |
| 2010 through  2014                    |       | 37.5                  |       | 10.4                |       |
|                                       |            |                       |            |                     |            |  |  |

 

Assumed health care costtrend rates have a significant effect on the amounts reported for the healthcare plans.  The annual rate of increasein the per capita costs of covered health care benefits is assumed to decreasefrom 10% to an ultimate trend 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 $1.6million increase in the benefit obligation as of December 31, 2004, and a $0.1million increase in the aggregate of the service cost and interest costcomponents of net periodic benefit expense for 2004.  A 1% decrease in the assumed trend rateswould have resulted in a $1.4 million decrease in the benefit obligation and a$0.1 million decrease in expense.

 

Lone Star’s investmentstrategy for its pension plans is to preserve the capital of the pension plans’assets and maximize investment earnings in excess of inflation with acceptablelevels of volatility while meeting the pension plans’ goal of providing,protecting, and enhancing the economic well-being of Lone Star employees,retirees, and their beneficiaries.  Thisinvestment strategy will be achieved through target allocation for each assetclass with a maximum and minimum range around each target.  No investments will be made in securitiesthat fall outside of the categories listed below.  Without limiting the general scope of theforegoing, private placements and the securities of Lone Star Technologies,Inc. are specifically excluded and not deemed appropriate investments.

 

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Target investmentallocations for 2005 are 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 | % |

 

The allocations arerebalanced as considered necessary by the Company’s pension plan committee tocorrespond with anticipated change in investing conditions.   The following table sets forth thepercentage of fair value of total assets by asset category as of the Company’smeasurement date:

 

| ** **                       | ** ** | **Fiscal Year** | ** ** |
|----------------------------------|------------|-----------------|------------|
| **Asset Category**               | ** ** | **2004**        | ** ** | **2003** | ** ** |
| Domestic equity  securites       |       | 37              | %          | 43 | % |
| International  equity securities |       | 16              | %          | 16 | % |
| Fixed income  securities         |       | 45              | %          | 40 | % |
| Cash investments                 |       | 2               | %          | 1 | % |
| Total                            |       | 100             | %          | 100 | % |

 

***Profit sharing plans*.**  Certain Lone Star subsidiaries have profitsharing plans for their employees that provide for payment of a specifiedpercentage of quarterly operating earnings. Total payments to employees were $0.8 million, $0.4 million, and $0.4million for 2004, 2003, and 2002, respectively.

 

**COMMITMENTS AND CONTINGENCIES - NOTE K**

 

As of December 31, 2004,the Company has long-term purchase commitments totaling $9.1 million to acquirenatural gas at specified minimum volumes and at fixed prices through October2005.

 

Equipment is leased undervarious operating leases.  Rental expensetotaled $4.5 million, $4.5 million, and $5.0 million in 2004, 2003, and 2002,respectively.  Future minimum leasepayments under noncancelable operating leases with initial or remaining termsin excess of one year are as follows: 2005, $2.3 million; 2006, $2.1 million;2007, $1.8 million; 2008, $1.4 million; and thereafter, $0.8 million.

 

Lone Star’s operationsare subject to numerous environmental laws. The three major areas of regulation are air quality, water quality, andsolid and hazardous waste management. The primary governmental oversight agencies include the Texas Commissionon Environmental Quality and the Environmental Protection Agency.  The Company is engaged in various ongoingenvironmental monitoring and compliance programs, voluntary remediationactivities, and capital improvement projects. Estimated expenditures for certain remediation programs are included inaccrued liabilities and other noncurrent liabilities as shown in Note H and arecomputed on a non-discounted basis. Included in other noncurrent liabilities are environmental reserves of$7.4 million and $8.8 million at December 31, 2004 and 2003, respectively.  Current reserves of $1.8 million and $0.7million are included in accrued liabilities at December 31, 2004 and 2003,respectively.  The Company believes thatadequate accruals have been made related to all known environmental matters.

 

In August 2001, Lone Starentered into an agreement to purchase the assets of North Star Steel Company’sTubular Steel Division.  Consummation ofthe acquisition was subject to completion of financing arrangements.  Due to lack of common stock financing which,along with certain debt financing, was required by the acquisition agreement toclose the acquisition, Lone Star notified Cargill, Incorporated, the parentcompany of North Star Steel Company, on December 14, 2001, that it was not ableto complete the acquisition.  Later thatday, Cargill, Incorporated notified Lone Star that it was filing a lawsuitagainst Lone Star seeking unspecified damages and alleging that Lone Star hadbreached the agreement.  On March 13,2003, the jury in Minnesota returned a verdict of $32 million in damagesagainst Lone Star.  On June 1, 2004, theMinnesota Court of Appeals affirmed the judgment.  The Minnesota Supreme 

 

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Court decided on August17, 2004 that it would not review the Court of Appeals’ decision.  At September 30, 2004, Lone Star had areserve totaling $35 million which included accrued interest of $3million.  Lone Star paid Cargill $32million on October 1, 2004 and $2 million on October 6, 2004 to satisfy thejudgment.  After the $34 million payment,approximately $1 million of accrued interest remains in the reserve, whichrepresents pre-judgment interest that Lone Star is contesting in the Minnesotacourts.

 

During the last sixyears, Steel has been named as one of a number of defendants in 42 lawsuitsalleging that certain individuals were exposed to asbestos on the defendants’premises.  The plaintiffs are seekingunspecified damages.  To date several ofthese lawsuits have been settled for approximately $300,000 in theaggregate.  Of the 42 lawsuits, sixteenhave been settled or are pending settlement and twelve have been dismissed orare pending dismissal.  Steel did notmanufacture or distribute any products containing asbestos.  Some or all of these claims may not becovered by the Company’s insurance.  TheCompany has accrued for the estimated exposure to known claims, but does notknow the extent to which future claims may be filed.  Therefore, the Company cannot estimate itsexposure, if any, to unasserted claims.

 

Beginning in 2003, LoneStar’s subsidiary Zinklahoma, Inc., inactive since 1989, has been named as oneof a number of defendants in seven lawsuits alleging that the plaintiffs hadcontracted mesothelioma as the result of exposure to asbestos in productsmanufactured by the defendants and John Zink Company (“Zink”).  Three of these lawsuits have beendismissed.  Lone Star acquired the stockof Zink in 1987 and, in 1989, sold the assets of the former Zink to KochIndustries, Inc. (“Koch”) and renamed the now-inactive subsidiary “Zinklahoma,Inc.”  Lone Star retained, and agreed toindemnify Koch against, certain pre-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 thebusiness as John Zink Company, LLC (“Zink LLC”).  In addition, Zink LLC has been named in sixlawsuits in which the plaintiffs, two of whom have mesothelioma, allegeexposure to asbestos in Zink’s products (three of these have been dismissed)and three personal injury lawsuits resulting from a 2001 explosion and flashfire at a flare stack and crude unit atmospheric heater.  Zink allegedly manufactured the flare andrelated components for the flare stack in the early 1970s.  Koch is seeking indemnification from LoneStar with respect 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 Starbelieves that Koch’s indemnity claim with respect to the 2001 explosion andflash fire is covered by its insurance, subject to a deductible, and hasnotified its insurance carrier of that claim.

 

Steel’s workers’compensation insurance was with one insurance carrier from 1992 through2001.  In March 2002, that carrier wasdeclared insolvent and placed in receivership. Since then, the Texas Property and Casualty Insurance GuarantyAssociation (“TPCIGA”) has been paying the insolvent carrier’s obligationsunder those insurance policies, as required by Texas law.  TPCIGA asserted that it was entitled torecover from Steel what it has paid and will pay 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 its subsidiaries are parties to a number of otherlawsuits and controversies which are not discussed herein.  Management of Lone Star and its operatingcompanies, based upon their analysis of known facts and circumstances andreports from legal counsel, does not believe that any such matter will have amaterial adverse effect on the results of operations, financial condition orcash flows of Lone Star and its subsidiaries, taken as a whole.

 

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**ACQUISITIONS – NOTE L**

 

***Wheeling.***  On October 1, 2002, Lone Star purchased themajority of the assets of Wheeling Machine Products, Inc. and Wheeling MachineProducts of Texas, Inc. (collectively, “Wheeling”), in cash for a base purchaseprice of $21.2 million plus a $16.7 million adjustment for working capital andapproximately $0.4 million in acquisition related expenses (the “WheelingAcquisition”).  The Wheeling Acquisitionwas effective October 1, 2002.  Theresults of Wheeling’s operations have been included in the consolidatedfinancial statements since that date. The acquired business is a leading domestic supplier of couplings usedto connect individual sections of oilfield casing and tubing.   No goodwill was recognized in theacquisition.  The net purchase price wasallocated as follows:

 

| Current assets              |   | $    | 17.3   |   |
|-----------------------------|--------|------|--------|--------|
| Net property and  equipment |   | 21.4 |   |
| Other assets                |   | 0.2  |   |
| Liabilities  assumed        |   | (0.6 | )      |
| Net purchase  price         |   | $    | 38.3   |   |

 

***DTP. ***On May 1, 2003, Lone Star purchased substantiallyall of the assets of Delta Tubular Products, a leading provider of high-qualitycustomized oil country tubular processing services, for a base purchase priceof approximately $14.0 million in cash and approximately $0.2 million inacquisition related expenses.  Theacquisition of DTP is intended to improve Lone Star’s competitive position inthe oilfield segment and allow for certain cost synergies.  In connection with the purchase,$4.1 million was allocated to goodwill and $0.4 million allocated toamortizable intangible assets.  Theamortizable intangible assets are being amortized over their estimated usefullives of five to ten years.  DTP’sresults of operations have been included in the consolidated financialstatements since the date of acquisition. The following table summarizes the estimated fair values of the assetsacquired and liabilities assumed at the date of acquisition:

 

| Current assets              |   | $    | 2.9    |   |
|-----------------------------|--------|------|--------|--------|
| Net property and  equipment |   | 7.7  |   |
| Other assets                |   | 0.4  |   |
| Goodwill                    |   | 4.1  |   |
| Liabilities  assumed        |   | (0.9 | )      |
| Net purchase  price         |   | $    | 14.2   |   |

 

***DTI****.*  On June 2, 2003, Lone Star purchased certainassets of Frank’s Tubular International (“Frank’s”), a leading provider ofhigh-quality threading and inspection services, for a base purchase price of $18.9million in cash and approximately $0.9 million in acquisition relatedexpenses.  Subsequent to the acquisition,Lone Star changed the name of Frank’s to Delta Tubular International, orDTI.  The acquisition of DTI furtherenhances Lone Star’s competitive position within the oilfield segment byoffering customers a broad range of oilfield services and allows for costsynergies.  In connection with thepurchase, $0.4 million was allocated to goodwill and $0.2 million wasallocated to amortizable intangible assets, which is being amortized over itsestimated useful life of five years.  DTI’sresults of operations have been included in the consolidated financialstatements since the date of acquisition. The following table summarizes the estimated fair values of the assetsacquired and liabilities assumed at the date of acquisition:

 

| Current assets              |   | $    | 1.0    |   |
|-----------------------------|--------|------|--------|--------|
| Net property and  equipment |   | 18.5 |   |
| Other assets                |   | 0.2  |   |
| Goodwill                    |   | 0.4  |   |
| Liabilities  assumed        |   | (0.3 | )      |
| Net purchase  price         |   | $    | 19.8   |   |

 

63

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***Pro Forma Results. ***Theoperating results of the Wheeling, DTP, and DTI acquisitions have been includedin the Consolidated Statements of Income from the effective dates ofacquisition.  The unaudited pro formaresults below assume the acquisitions occurred on January 1, 2002:

 

| ** **                       | ** ** | **For the Year Ended** | ** ** |
|----------------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **2003**               | ** ** | **2002** | ** ** |
|                             |       |                   |       |   |   |
| Net sales                        |       | $                      | 540.2      |   | $ | 554.1 |   |
| Net income  (loss)               |       | (69.3                  | )          | (71.7 | ) |
|                             |       |                   |       |   |   |
| Basic income  (loss) per share   |       | $                      | (2.44      | ) | $ | (2.61 | ) |
| Diluted income  (loss) per share |       | (2.44                  | )          | (2.61 | ) |

 

The preceding pro forma results include adjustments to eliminateintercompany sales and give effect to amortization of goodwill, interestexpense and other purchase price adjustments. The pro forma results are not necessarily indicative of the operatingresults that would have occurred if the acquisitions had been consummated as ofthe beginning of the periods presented, nor are they necessarily indicative offuture operating results.

 

64

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**GUARANTOR SUBSIDIARIES –NOTE M**

 

The following condensed,consolidating financial statements of the Company include the accounts of theCompany, the combined accounts of the Guarantor Subsidiaries and the accountsof the Non-Guarantor Subsidiary.  Each ofthe Guarantor Subsidiaries and Non-Guarantor Subsidiary is wholly-owned by theCompany.  Given the size of theNon-Guarantor Subsidiary relative to the Company on a consolidated basis,separate financial statements of the respective Guarantor Subsidiaries are notpresented because management has determined that such information is notmaterial in assessing the Guarantor Subsidiaries.

 

**CONDENSEDCONSOLIDATING BALANCE SHEET**

**ATDECEMBER 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 |   |

 

65

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**CONDENSEDCONSOLIDATING BALANCE SHEET**

**ATDECEMBER 31, 2003**

 
| ** **                                 | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------|------------|-------------|------------|-----------------------------|------------|-------------------------------|------------|------------------|------------|------------------|------------|
|                                       |       |        |       |                        |       |                          |       |             |       |             |       |
| **Assets**                                 |       |        |       |                        |       |                          |       |             |       |             |       |
| Cash and cash  equivalents                 |       | $           | 33.0       |                        | $          | 0.3                           |       | $                | —     |             | $          | — |   | $ | 33.3 |   |
| Accounts  receivable, net                  |       | 7.4         |       | 63.4                        |       | 0.6                           |       | (1.6             | )          | 69.8             |       |
| Inventories                                |       | —      |       | 152.2                       |       | 0.6                           |       | —           |       | 152.8            |       |
| Other current  assets                      |       | 4.2         |       | 11.1                        |       | 0.5                           |       | —           |       | 15.8             |       |
| Total current  assets                      |       | 44.6        |       | 227.0                       |       | 1.7                           |       | (1.6             | )          | 271.7            |       |
|                                       |       |        |       |                        |       |                          |       |             |       |             |       |
| Investment in  subsidiaries                |       | 238.4       |       | —                      |       | —                        |       | (238.4           | )          | —           |       |
| Property, plant,  and equipment, net       |       | 0.2         |       | 218.3                       |       | 1.5                           |       | —           |       | 220.0            |       |
| Goodwill                                   |       | 3.5         |       | 37.4                        |       | —                        |       | —           |       | 40.9             |       |
| Other noncurrent  assets                   |       | 147.1       |       | 5.1                         |       | 0.2                           |       | (110.3           | )          | 42.1             |       |
| Total assets                               |       | $           | 433.8      |                        | $          | 487.8                         |       | $                | 3.4        |             | $          | (350.3 | ) | $ | 574.7 |   |
|                                       |       |        |       |                        |       |                          |       |             |       |             |       |
| **Liabilities & Shareholders' Equity** |       |        |       |                        |       |                          |       |             |       |             |       |
| Accounts payable                           |       | $           | 0.2        |                        | $          | 52.3                          |       | $                | 8.6        |             | $          | (1.6 | ) | $ | 59.5 |   |
| Accrued  liabilities                       |       | 1.7         |       | 25.9                        |       | 0.4                           |       | —           |       | 28.0             |       |
| Total current  liabilities                 |       | 1.9         |       | 78.2                        |       | 9.0                           |       | (1.6             | )          | 87.5             |       |
|                                       |       |        |       |                        |       |                          |       |             |       |             |       |
| Senior  subordinated debt                  |       | 150.0       |       | —                      |       | —                        |       | —           |       | 150.0            |       |
| Other noncurrent  liabilities              |       | 36.0        |       | 165.6                       |       | —                        |       | (110.3           | )          | 91.3             |       |
| Total  liabilities                         |       | 187.9       |       | 243.8                       |       | 9.0                           |       | (111.9           | )          | 328.8            |       |
| Total  shareholders' equity                |       | 245.9       |       | 244.0                       |       | (5.6                          | )          | (238.4           | )          | 245.9            |       |
| Total liabilities  & equity            |       | $           | 433.8      |                        | $          | 487.8                         |       | $                | 3.4        |             | $          | (350.3 | ) | $ | 574.7 |   |

 

66

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**CONDENSEDCONSOLIDATING INCOME STATEMENT**

**FOR THEYEAR 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  (expense), 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) benefit          |       | (3.4        | )          | —                      |       | —                        |       | —           |       | (3.4             | )          |
| Net income  (loss)                     |       | $           | 101.0      |                        | $          | 124.3                         |       | $                | (0.7       | )                | $          | (123.6 | ) | $ | 101.0 |   |

 

 

**CONDENSEDCONSOLIDATING RESULTS OF OPERATIONS**

**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) benefit          |       | —      |       | (0.1                        | )          | —                        |       | —           |       | (0.1             | )          |
| Net income  (loss)                     |       | $           | (68.2      | )                           | $          | (46.1                         | )          | $                | (1.8       | )                | $          | 47.9 |   | $ | (68.2 | ) |

 

67

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**CONDENSEDCONSOLIDATING RESULTS OF OPERATIONS**

**FOR THEYEAR ENDED DECEMBER 31, 2002**

** **
| ** **                             | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------|------------|-------------|------------|-----------------------------|------------|-------------------------------|------------|------------------|------------|------------------|------------|
|                                   |       |        |       |                        |       |                          |       |             |       |             |       |
| Net revenues                           |       | $           | —     |                        | $          | 528.6                         |       | $                | 8.3        |             | $          | (13.2 | ) | $ | 523.7 |   |
| Cost of goods  sold                    |       | —      |       | 520.7                       |       | 8.5                           |       | (12.9            | )          | 516.3            |       |
| Gross profit                           |       | —      |       | 7.9                         |       | (0.2                          | )          | (0.3             | )          | 7.4              |       |
| Selling,  general, and administrative  |       | 36.2        |       | 30.9                        |       | 1.1                           |       | —           |       | 68.2             |       |
| Operating income  (loss)               |       | (36.2       | )          | (23.0                       | )          | (1.3                          | )          | (0.3             | )          | (60.8            | )          |
|                                   |       |        |       |                        |       |                          |       |             |       |             |       |
| Equity in  subsidiaries' income (loss) |       | (22.6       | )          | —                      |       | —                        |       | 22.6             |       | —           |       |
| Interest expense                       |       | (13.7       | )          | —                      |       | —                        |       | —           |       | (13.7            | )          |
| Interest income                        |       | 2.5         |       | —                      |       | —                        |       | —           |       | 2.5              |       |
| Other income  (expense), net           |       | 0.1         |       | 1.7                         |       | —                        |       | 0.3              |       | 2.1              |       |
| Income (loss)  before income taxes     |       | (69.9       | )          | (21.3                       | )          | (1.3                          | )          | 22.6             |       | (69.9            | )          |
| Income tax  (expense) benefit          |       | 0.7         |       | —                      |       | —                        |       | —           |       | 0.7              |       |
| Net income  (loss)                     |       | $           | (69.2      | )                           | $          | (21.3                         | )          | $                | (1.3       | )                | $          | 22.6 |   | $ | (69.2 | ) |

 

68

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**CONDENSEDCONSOLIDATING CASH FLOW STATEMENT**

**FOR THEYEAR ENDED DECEMBER 31, 2004**

 
| ** **                                           | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|-------------|------------|-----------------------------|------------|-------------------------------|------------|------------------|------------|------------------|------------|
| Net cash  provided by (used in) operating activities |       | $           | (15.3      | )                           | $          | 76.9                          |       | $                | 0.1        |             | $          | — |   | $ | 61.7 |   |
| Cash flows from  investing activities:               |       |        |       |                        |       |                          |       |             |       |             |       |
| Capital  expenditures                                |       | (0.1        | )          | (12.9                       | )          | —                        |       | —           |       | (13.0            | )          |
| Proceeds from  sale of PP&E                      |       | —      |       | 0.7                         |       | —                        |       | —           |       | 0.7              |       |
| Purchase of  investments                             |       | (88.6       | )          | —                      |       | —                        |       | —           |       | (88.6            | )          |
| Proceeds from  sales of investments                  |       | 29.5        |       | —                      |       | —                        |       | —           |       | 29.5             |       |
| Net cash  provided by (used in) investing activities |       | (59.2       | )          | (12.2                       | )          | —                        |       | —           |       | (71.4            | )          |
| 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                        | )          | 0.1                           |       | —           |       | (3.1             | )          |
| Cash beginning  balance                              |       | 33.0        |       | 0.3                         |       | —                        |       | —           |       | 33.3             |       |
| Cash ending  balance                                 |       | $           | 30.0       |                        | $          | (0.1                          | )          | $                | 0.1        |             | $          | — |   | $ | 30.2 |   |

 

**CONDENSEDCONSOLIDATING CASH FLOW STATEMENT**

**FOR THEYEAR ENDED DECEMBER 31, 2003**

 
| ** **                                           | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|-------------|------------|-----------------------------|------------|-------------------------------|------------|------------------|------------|------------------|------------|
| Net cash  provided by (used in) operating activities |       | $           | (39.9      | )                           | $          | (0.7                          | )          | $                | —     |             | $          | — |   | $ | (40.6 | ) |
| 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              |       |
| Acquisitions,  net of cash received                  |       | (34.0       | )          | —                      |       | —                        |       | —           |       | (34.0            | )          |
| Net cash  provided by (used in) investing activities |       | (34.1       | )          | (13.8                       | )          | (0.1                          | )          | —           |       | (48.0            | )          |
| 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  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 |   |

 

69

----

 

**CONDENSEDCONSOLIDATING CASH FLOW STATEMENT**

**FOR THEYEAR ENDED DECEMBER 31, 2002**

 
| ** **                                           | ** ** | **Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|-------------|------------|-----------------------------|------------|-------------------------------|------------|------------------|------------|------------------|------------|
| Net cash  provided by (used in) operating activities |       | $           | 2.9        |                   | $          | (14.9                         |    )  | $                | (0.4       |    )        | $          | — |      | $ | (12.4 |    ) |
| Cash flows from  investing activities:               |       |        |       |                        |       |                          |       |             |       |             |       |
| Capital  expenditures                                |       | —      |       | (15.6                       | )          | (0.3                          | )          | —           |       | (15.9            | )          |
| Proceeds from  sale of PP&E                      |       | —      |       | 0.2                         |       | —                        |       | —           |       | 0.2              |       |
| Acquisitions,  net of cash received                  |       | (38.3       | )          | —                      |       | —                        |       | —           |       | (38.3            | )          |
| Net cash  provided by (used in) investing activities |       | (38.3       | )          | (15.4                       | )          | (0.3                          | )          | —           |       | (54.0            | )          |
| Cash flows from  financing activities:               |       |        |       |                        |       |                          |       |             |       |             |       |
| Advances from  parent                                |       | (32.5       | )          | 32.0                        |       | 0.5                           |       | —           |       | —           |       |
| Proceeds from  issuance of stock                     |       | 82.8        |       | —                      |       | —                        |       | —           |       | 82.8             |       |
| Purchase of  treasury stock                          |       | (1.3        | )          | —                      |       | —                        |       | —           |       | (1.3             | )          |
| Net cash  provided by financing activities           |       | 49.0        |       | 32.0                        |       | 0.5                           |       | —           |       | 81.5             |       |
| Effect of  exchange rate changes                     |       | —      |       | (1.1                        | )          | —                        |       | —           |       | (1.1             | )          |
| Net change in  cash                                  |       | 13.6        |       | 0.6                         |       | (0.2                          | )          | —           |       | 14.0             |       |
| Cash beginning  balance                              |       | 105.6       |       | 0.5                         |       | 0.4                           |       | —           |       | 106.5            |       |
| Cash ending  balance                                 |       | $           | 119.2      |                        | $          | 1.1                           |       | $                | 0.2        |             | $          | — |   | $ | 120.5 |   |

 

**QUARTERLY FINANCIAL SUMMARY(UNAUDITED)  – NOTE N**

 
| ** **                                   | ** ** | **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 |   |
|                                         |       |                     |       |   |   |   |   |   |   |   |   |

 
| ** **                                 | ** ** | **2003 - Quarter Ended** | ** ** |
|--------------------------------------------|------------|--------------------------|------------|
| ** **                                 | ** ** | **First**                | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** | **Total  Year** | ** ** |
| Net revenues                               |       | $                        | 128.1      |   | $ | 141.3 |   | $ | 132.0 |   | $ | 132.7 |   | $ | 534.1 |   |
| Gross profit                               |       | 4.3                      |       | 3.4 |   | (2.4 | ) | (0.1 | ) | 5.2 |   |
| Net loss                                   |       | (7.9                     | )          | (9.2 | ) | (17.1 | ) | (34.0 | ) | (68.2 | ) |
|                                       |       |                     |       |   |   |   |   |   |   |   |   |
| **Per  common share - basic and diluted**  |       |                     |       |   |   |   |   |   |   |   |   |
| Net loss  available to common shareholders |       | $                        | (0.28      | ) | $ | (0.32 | ) | $ | (0.60 | ) | $ | (1.20 | ) | $ | (2.40 | ) |

 

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**LONESTAR TECHNOLOGIES, INC.**

**ScheduleII - Valuation and Qualifying Accounts**

**December31, 2002, 2003, and 2004**

***($ 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, 2002*                 |       |                                 |       |                                |       |                            |       |           |       |                           |       |
| Allowance for  doubtful accounts                |       | $                                    | 1.8        |                                | $          | 0.1                             |       | $              | —     |                           | $          | (0.3 | ) | $ | 1.6 |   |
| Valuation  allowance on net deferred tax assets |       | 69.4                                 |       | —                              |       | 23.7                            |       | —         |       | 93.1                           |       |
|                                            |       |                                 |       |                                |       |                            |       |           |       |                           |       |
| *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                                |       | —                              |       | —                          |       | (36.6          | )          | 75.5                           |       |
|                                                 |            |                                      |            |                                     |            |                                 |            |                |            |                                |            |  |  |  |  |  |

 

**ITEM 9.****                                  ****CHANGES IN AND DISAGREEMENTSWITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

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

 

(a)           Evaluation of disclosure control andprocedures.

 

Under supervision andwith the participation of our management, including our principal executiveofficer and principal financial officer, we conducted an evaluation of theeffectiveness of the design and operation of our disclosure controls andprocedures, as defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as of the end of the period covered by this Annual Reporton Form 10-K (the “Evaluation Date”); and whether any change has occurred inthe Company’s internal control over financial reporting pursuant to ExchangeAct Rules 13a-15(d) and 15d-15(d).  Basedon this evaluation, our principal executive officer and principal financialofficer concluded as of the Evaluation Date that our disclosure controls andprocedures were effective such that the material information required to beincluded in our Securities and Exchange Commission (“SEC”) reports is recorded,processed, summarized and reported within the time periods specified in SECrules and forms relating to Lone Star, including our consolidated subsidiaries,and was accumulated and communicated to them by others within those entities,as appropriate during the period when this report was being prepared in orderto allow timely decisions regarding required disclosure.

 

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

 

Management’s report oninternal control over financial reporting, which appears on page 39 of thisAnnual Report, is incorporated herein by reference.

 

Management’s assessmentof the effectiveness of internal control over financial reporting as ofDecember 31, 2004, was audited by Deloitte & Touche LLP, an independentregistered public accounting firm, as stated in its report which appears onpage 40 of this Annual Report, which is incorporated herein by reference.

 

(c)           Changes in internal control overfinancial reporting.

 

There was no change inour internal control over financial reporting that occurred in the fourthquarter of 2004 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**ITEM 9B.               OTHER INFORMATION**

 

None.

 

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** **

**PART III**

 

**ITEM 10.****                           ****DIRECTORS AND EXECUTIVEOFFICERS OF THE REGISTRANT**

 

Information required under this item is contained in Lone Star’s proxystatement for the 2005 Annual Meeting of Shareholders, and is incorporatedherein by reference.

 

**ITEM 11.****                           ****EXECUTIVE COMPENSATION**

 

Information required under this item is contained in Lone Star’s proxystatement for the 2005 Annual Meeting of Shareholders, and is incorporatedherein by reference.

 

**ITEM 12.****                           ****SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS**

 

Information required under this item with respect to beneficial ownersof more than 5 percent of outstanding common stock, directors and executiveofficers and securities authorized for issuance under equity compensation plansis contained in Lone Star’s proxy statement for the 2005 Annual Meeting ofShareholders, and is incorporated herein by reference.

 

**ITEM 13.****                           ****CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS**

 

Information requiredunder this item with respect to directors and executive officers is containedin Lone Star’s proxy statement for the 2005 Annual Meeting of Shareholders, andis incorporated herein by reference.

 

**ITEM 14.****                           ****PRINCIPAL ACCOUNTING FEESAND SERVICES**

 

Information with respectto fees and services related to the Company’s independent auditors,Deloitte & Touche LLP, and the disclosure of the Audit Committee’spre-approval policies and procedures are contained in Lone Star’s proxystatement for the 2005 Annual Meeting of Shareholders, and are incorporatedherein by reference.

 

**PART IV**

 

**ITEM 15.****                           ****EXHIBITS, FINANCIALSTATEMENT SCHEDULES, AND REPORTS ON FORM 8-K**

 

 (a)1.            Financial Statements - the following ConsolidatedFinancial Statements are filed as part of this report:

•      Reportsof Independent Public Accountants

•      ConsolidatedResults of Operations - for the years ended December 31, 2004, 2003, and 2002

•      ConsolidatedBalance Sheets at December 31, 2004 and 2003

•      ConsolidatedStatements of Cash Flows - for the years ended December 31, 2004, 2003, and2002

•      ConsolidatedStatements of Shareholders’ Equity - at December 31, 2004, 2003, and 2002

•      Notesto Consolidated Financial Statements

 

2.               Schedule II - Valuationand Qualifying Accounts

 

Note:         Allschedules not filed herein for which provision is made under rules ofRegulation S-X have been omitted as not applicable or not required or theinformation required has been included in the notes to the consolidatedfinancial statements.

 

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3.         Index to Exhibits

 

***Description***

 

2.1                                   AssetPurchase Agreement dated as of November 16, 1999 by and among Lone Star,Fintube Technologies, Inc. and Fintube Limited Partnership (incorporated byreference to the same numbered Exhibit to Form 8-K of Lone Star as filed onJanuary 18, 2000).

2.2                                   FirstAmendment to Asset Purchase Agreement dated as of January 1, 2000 by and amongLone Star, Fintube Technologies, Inc. and Fintube Limited Partnership(incorporated by reference to the same numbered Exhibit to Form 8-K of LoneStar as filed on January 18, 2000).

2.3                                   AssetPurchase Agreement dated as of March 7, 2000 by and among Lone Star, BellvilleAcquisition, Inc. and Bellville Tube Corporation (incorporated by reference toExhibit 2.1 to Form 8-K of Lone Star as filed on April 14, 2000).

2.4                                   FirstAmendment to Asset Purchase Agreement dated as of March 31, 2000 by and amongLone Star, Bellville Acquisition, Inc. and Bellville Tube Corporation(incorporated by reference to Exhibit 2.2 to Form 8-K of Lone Star as filed onApril 14, 2000).

2.5                                   Purchaseand 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 toForm 8-K of Lone Star as filed on August 17, 2001).

2.6                                   AssetPurchase Agreement, dated September 9, 2002, among Lone Star, WheelingAcquisition Corporation (a wholly-owned subsidiary of Lone Star), Wheeling andNassau Holding Corporation, as Owner of Wheeling (incorporated by reference toExhibit 2.1 to Form 8-K of Lone Star dated September 30, 2002 and filed onOctober 7, 2002).

2.7                                   Amendmentto 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 Exhibit2.2 to Form 8-K of Lone Star dated September 30, 2002 and filed on October 7,2002).

3.1                                   Certificateof Incorporation of Registrant (incorporated by reference to Exhibit 3(a) toForm S-4 Registration Statement of Lone Star as filed on April 4, 1986, FileNo. 33-4581).

3.2                                   Certificateof Amendment to Certificate of Incorporation dated September 30, 1986(incorporated by reference to Exhibit 3.2 to Form S-3 Registration Statement ofLone Star as filed on February 4, 2000, File No. 333-96207).

3.3                                   Agreementand Plan of Merger dated March 6, 1986, among Steel, a Texas corporation, LoneStar, a Delaware corporation, and Lone Star Steel Company Merging Corporation,a Delaware corporation (incorporated by reference to Exhibit II to Form S-4Registration Statement of Lone Star as filed on April 4, 1986, File No. 33-4581).

3.4                                   Amendedand 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 onSeptember 24, 2004).

3.5                                   Certificateof Amendment to Certificate of Incorporation dated May 20, 1998 (incorporatedby reference to Exhibit 3.4 to Form 10-Q for the quarter ended June 30, 1998).

4.1                                   Statementof Resolution establishing Cumulative Preferred Stock, Series A (par value $1per 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                                 StockRegistration Agreement dated January 1, 2000 among Lone Star Technologies,Inc., Fintube Limited Partnership, Yorktown Energy Partners, Brown UniversityThird Century Fund, Warburg, Dillon, Reed, L.L.C. and Ticonderoga Partners andthe stockholders named therein (incorporated by reference to Exhibit 4.1 toForm S-3 Registration Agreement of Lone Star as filed on February 4, 2000, FileNo. 333-96207).

4.3                                   LetterAgreement dated October 19, 2000 by Alpine Capital, L.P., Keystone, Inc. andThe Anne T. and Robert M. Bass Foundation to Lone Star (incorporated byreference to Exhibit 4.6 to Amendment No. 2 to Form S-3 Registration Statementof Lone Star as filed on October 30, 2000, File No. 333-41130).

 

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4.4                                   Indenturedated as of May 29, 2001 among Lone Star, Environmental Holdings, Inc.,Zinklahoma, Inc., Lone Star Steel Company, Lone Star Logistics, Inc., Lone StarSteel International, Inc., Lone Star Steel Sales Company, Rotac, Inc., T&NLone Star Warehouse Co., Texas  &Northern Railway Company, Lone Star ST Holdings, Inc., Fintube Technologies,Inc., Fintube Canada, Inc., Bellville Tube Corporation, and Wells Fargo BankMinnesota, National Association (incorporated by reference to Exhibit 4.3 toForm S-4 Registration Statement of Lone Star as filed on June 27, 2001, FileNo. 333-63944).

4.5                                   Exchangeand 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, RBCDominion Securities Corporation, and The Robinson-Humphrey Company, LLC(incorporated by reference to Exhibit 4.4 to Form S-4 Registration Statement ofLone Star as filed on June 27, 2001, File No. 333-63944).

4.6                                   LetterAgreement dated October 16, 2002 by Keystone, Inc., Alpine Capital L.P., andthe Anne T. and Robert M. Bass Foundation to Lone Star (incorporated by referencesto Exhibit 4.11 to Form S-3 Registration Statement of Lone Star as filed onOctober 16, 2002.  File No. 333-100579).

10.1                             Amended1985 Long-Term Incentive Plan (incorporated by reference to Exhibit A of ProxyStatement of Lone Star as filed on October 22, 1993).*

10.1(a)               Amendments to theAmended 1985 Long-Term Incentive Plan adopted on May 8, 1997 (incorporated byreference to Exhibit 10.1(a) to Form 10-Q of Lone Star for the quarter endedJune 30, 1997). *

10.1(b)              Amendments to theAmended 1985 Long-Term Incentive Plan adopted on May 14, 1998 (incorporated byreference to same numbered Exhibit to Form 10-Q for the quarter ended June 30,1998). *

10.1(c)               Amendments to theAmended 1985 Long-Term Incentive Plan adopted on May 11, 1999 (incorporated byreference to same numbered Exhibit to Form 10-Q for the quarter ended June 30,1999). *

10.1(d)              Amendment to theAmended 1985 Long-Term Incentive Plan adopted on May 9, 2000 (incorporated byreference to same numbered Exhibit to Form 10-Q for the quarter ended June 30,2000.) *

10.1(e)               Amendments to theAmended 1985 Long-Term Incentive Plan adopted on May 8, 2001 (incorporated byreference to same numbered exhibit to Form 10-Q for the quarter ended June 30,2001). *

10.1(f)                 Amendment to the1985 Long-Term Incentive Plan adopted on May 9, 2002 (incorporated by referenceto same numbered exhibit to Form 10-Q for the quarter ended June 30, 2002). *

10.1(g)              Amendments to the1985 Long-Term Incentive Plan adopted on May 13, 2003 (incorporated byreference to same numbered exhibit to Form 10-K for the year ended December 31,2003). *

10.1(h)              2004 Long-TermIncentive Plan (incorporated by reference to Appendix A to the Proxy Statementof Lone Star filed on March 19, 2004). *

10.2                             EmploymentRetention Policy adopted May 8, 1997, letter agreements dated May 22, 1997between Lone Star, Charles J. Keszler and Robert F. Spears and between Steeland W. Byron Dunn and letter agreement dated September 25, 1997 between LoneStar and Rhys J. Best (incorporated by reference to same numbered Exhibit toForm 10-K for the year ended December 31, 1997).*

10.3                             Contractfor Electric Service dated September 30, 1996 between Southwestern ElectricPower Company and Steel (incorporated by reference to Exhibit 10.21 to Form10-K for the year ended December 31, 1996).

10.4                             CostSharing 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 endedDecember 31, 1997).

10.5                             Compromiseand Settlement Agreement and Release dated July 31, 1997 between Lone Star andGuaranty Federal Bank, F.S.B. (incorporatedby reference to Exhibit 10.26 to Form 10-K for the year ended December 31,1997).

10.6                             PhantomStock Deferred Compensation Plan adopted on September 22, 1998 (incorporated byreference to Exhibit 10.28 to Form 10-Q for the quarter ended September 30,1998).*

10.7                           EmployeeStock Purchase Plan adopted on May 9, 2000 (incorporated by reference toExhibit 10.36 to Form 10-Q for the quarter ended June 30, 2000).*

10.8                           SecondAmended and Restated Deferred Compensation Plan adopted by Lone Star’s Board ofDirectors on September 21, 2004 (incorporated by reference to Exhibit 10.36 toForm 8-K of Lone Star as filed on December 16, 2004).

10.9                           EmploymentAgreement dated May 7, 2001 between Lone Star and Rhys J. Best (incorporated byreference to Exhibit 99.1 to Form 8-K of Lone Star as filed on May 9, 2001). *

 

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10.10                     Purchase Agreement dated May 23,2001 among Lone Star, Goldman, Sachs & Co., Salomon Smith Barney Inc., Bancof America Securities LLC, RBC Dominion Securities Corporation, and TheRobinson-Humphrey Company, LLC (incorporated by reference to Exhibit 10.10 toForm S-4 Registration Statement of Lone Star as filed on June 27, 2001, FileNo. 333-63944).

10.11                     Consulting Employment Agreementdated January 1, 2000, among Fintube Technologies, Inc., Jerry E. Ryan, andLone Star (incorporated by reference to Exhibit 10.42 to Form 10-Q for thequarter ended March 31, 2001).*

10.12                     EmploymentAgreement dated January 1, 2000 between Fintube Technologies, Inc. and LarrySims (incorporated by reference to Exhibit 10.43 to Form 10-Q for the quarterended March 31, 2001).*

10.13                     Amended andRestated Financing Agreement dated October 8, 2001 among The CIT Group/BusinessCredit, 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, FintubeCanada, Inc. and Bellville Tube Corporation (as Borrowers), and EnvironmentalHoldings, Inc., Zinklahoma, Inc., Lone Star Steel International, Inc., LoneStar Steel Sales Company, Rotac, Inc., and Lone Star ST Holdings, Inc. (asGuarantors) (incorporated by reference to Exhibit 10.13 to Amendment No. 2 toForm S-4 of Lone Star as filed on October 9, 2001, File No. 333-63944).

10.14                     FirstAmendment, dated as of December 31, 2001, to Amended and Restated FinancingAgreement dated October 8, 2001 (incorporated by reference to Exhibit 10.31 toForm 10-Q for the quarter ended March 31, 2002).

10.15                     SecondAmendment, dated March 13, 2002, to Amended and Restated Financing Agreementdated October 8, 2001 (incorporated by reference to Exhibit 10.32 to Form 10-Qfor the quarter ended March 31, 2002).

10.16                     ThirdAmendment, dated as of September 30, 2002, to Amended and Restated FinancingAgreement dated October 8, 2001 (incorporated by reference to Exhibit 10.33 toForm 10-Q for the quarter ended September 30, 2002).

10.17                     FourthAmendment, dated as of September 30, 2002, to Amended and Restated FinancingAgreement dated October 8, 2001 (incorporated by reference to Exhibit 10.34 toForm 10-Q for the quarter ended September 30, 2002).

10.18                     FifthAmendment, dated as of May 5, 2003, to Amended and Restated Financing Agreementdated October 8, 2001 (incorporated by reference to Exhibit 10.1 to Form 10-Qfor the quarter ended June 30, 2003).

10.19                     SixthAmendment, dated as of August 29, 2003, to Amended and Restated FinancingAgreement dated October 8, 2001 (incorporated by reference to same numberedexhibit to Form 10-K for year ended December 31, 2003).

10.20                     SeventhAmendment, dated as of December 16, 2003, to Amended and Restated FinancingAgreement dated October 8, 2001 (incorporated by reference to same numberedexhibit to Form 10-K for year ended December 31, 2003).

10.21                     EighthAmendment, dated as of September 21, 2004, to Amended and Restated FinancingAgreement dated October 8, 2001 (incorporated by reference to Exhibit 10.35 toForm 10-Q for quarter ended September 30, 2004).

10.22                     Compensationand benefits outline for Joe Alvarado dated May 7, 2004 and related letteragreement dated October 8, 2004 between Lone Star and Joe Alvarado. *

10.23                     Form of DirectorStock Option Agreement (incorporated by reference to Exhibit 10.1 to Form  8-K of Lone Star as filed on September 24,2004). *

10.24                     Form ofDirector Restricted Stock Unit Award (incorporated by reference to Exhibit 10.2to Form 8-K of Lone Star as filed on September 24, 2004). *

10.25                     Form ofEmployee Stock Option Agreement with One-Year Vesting (incorporated byreference to Exhibit 10.3 to Form 8-K of Lone Star as filed on September 24,2004). *

10.26                     Form ofEmployee Stock Option Agreement with Four-Year Vesting (incorporated byreference to Exhibit 10.4 to Form 8-K of Lone Star as filed on September 24,2004). *

10.27                     Form ofEmployee Restricted Stock Agreement (incorporated by reference to Exhibit 10.5to Form 8-K of Lone Star as filed on September 24, 2004). *

14.1                           Code ofEthics for Senior Financial Officers adopted by Lone Star’s Board of Directorson March 20, 2003 (incorporated by reference to Exhibit 99.1 to Form 10-K forthe year ended December 31, 2002).

21            List of Subsidiaries.

23            Consent of Deloitte & Touche LLP.

24                                                            Powersof Attorney.

 

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31.1                           Certificationof Rhys J. Best pursuant to Rule 13a-14 of the Securities Exchange Act of 1934as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2                           Certificationof Charles J. Keszler pursuant to Rule 13a-14 of the Securities Exchange Act of1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32                                    Certificationpursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

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*                                           Managementcontract or compensatory plan or arrangement.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
|                | **LONE STAR TECHNOLOGIES, INC.** |
|---------------------|----------------------------------|
|                |                             |
| Date: March 1, 2005 | By:                              |   | /s/ Charles J.  Keszler |
|                |                             | (Charles J.  Keszler) |
|                |                             | Vice President  and Chief Financial Officer |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the dates indicated.

 
| **Signature**                 | ** ** | **Title**                                                        | ** **                 | **Date** |
|-------------------------------|------------|------------------------------------------------------------------|----------------------------|----------|
|                          |       |                                                             |                       |     |
| /s/ Rhys J. Best              | ,          |                                                             | Chairman, Director,  Chief |     | March 1, 2005 |
| (Rhys J. Best)                |       | Executive Officer and  President  (Principal Executive Officer)  |                       |     |
|                          |       |                                                             |                       |     |
|                          |       |                                                             |                       |     |
| /s/ Charles J. Keszler        | ,          |                                                             | Vice President and  Chief  |     | March 1, 2005 |
| (Charles J. Keszler)          |       | Financial Officer  (Principal Financial  and Accounting Officer) |                       |     |
|                          |       |                                                             |                       |     |
|                          |       |                                                             |                       |     |
| /s/ Frederick B. Hegi,  Jr. * | ,          |                                                             | Director                   |     | March 1, 2005 |
| (Frederick B. Hegi,  Jr.)     |       |                                                             |                       |     |
|                          |       |                                                             |                       |     |
| /s/ Robert L. Keiser *        | ,          |                                                             | Director                   |     | March 1, 2005 |
| (Robert L. Keiser)            |       |                                                             |                       |     |
|                          |       |                                                             |                       |     |
| /s/ Robert Kelley *           | ,          |                                                             | Director                   |     | March 1, 2005 |
| (Robert Kelley)               |       |                                                             |                       |     |
|                          |       |                                                             |                       |     |
| /s/ M. Joseph McHugh *        | ,          |                                                             | Director                   |     | March 1, 2005 |
| (M. Joseph McHugh)            |       |                                                             |                       |     |
|                          |       |                                                             |                       |     |
| /s/ Thomas M. Mercer,  Jr. *  | ,          |                                                             | Director                   |     | March 1, 2005 |
| (Thomas M. Mercer, Jr.)       |       |                                                             |                       |     |
|                          |       |                                                             |                       |     |
| /s/ Alfred M. Micallef  *     | ,          |                                                             | Director                   |     | March 1, 2005 |
| (Alfred M. Micallef)          |       |                                                             |                       |     |
|                          |       |                                                             |                       |     |
| /s/ Jerry E. Ryan *           | ,          |                                                             | Director                   |     | March 1, 2005 |
| (Jerry E. Ryan)               |       |                                                             |                       |     |

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

 

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