**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

###### **FORM 10-K**

 

**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

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

 

**COMMISSION FILE NUMBER 1-12881**

 

**LONE STAR TECHNOLOGIES, INC.**

 

(A DELAWARE CORPORATION)

 

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

 

 

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

**DALLAS, TEXAS 75248**

**(972) 770-6401**

 

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

 
| **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

 

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

 

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

 

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

 

Theaggregate market value of common stock on June 30, 2003 held bynonaffiliates of the registrant was approximately $606.3 million, based on theclosing price of the common stock on the New York Stock Exchange.

 

Asof February 16, 2004, the number of shares of common stock outstanding was28,664,915.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portionsof registrant’s Proxy Statement for its 2004 Annual Meeting of Shareholders areincorporated by reference into Part III hereof.

 

 

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# **TABLE OF 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 AND RELATED SHAREHOLDER MATTERS                 |   |
| 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                                                                    |   |
|      |                                                                                        |   |
|      | **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, AND REPORTS ON FORM 8-K                           |   |
| ITEM 16.  | SIGNATURES                                                                                  |   |

 

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**PARTI**

 

**ITEM1.  BUSINESS**

 

# **GENERAL**

 

LoneStar Technologies, Inc., a Delaware corporation, is a leading domesticmanufacturer and marketer of premium welded “oil country tubular goods”, or“OCTG”; which are steel tubular products used in the completion and productionof oil and natural gas wells. We are a major manufacturer and marketer of linepipe, which is used in the gathering and transmission of oil and natural gas.  We are a leading supplier of premium thermaltreating, end finishing, inspection, and logistics services to the oilfieldindustry.  We are also one of thelargest domestic manufacturers of high quality couplings used to connect individualsections of oilfield casing and tubing. In addition, we are a leading manufacturer of specialty tubing productsused in industrial, automotive, construction, agricultural, and heat recoverytechnology applications.  We also selloil country tubular goods and line pipe produced by other companies throughexclusive marketing arrangements.  LoneStar began producing and marketing oil country tubular goods and other tubularproducts over fifty years ago.  As usedin this report, the terms “we,” “us”, “our” and “Lone Star” refer to Lone Star Technologies,Inc. and its subsidiaries and affiliates unless the context indicatesotherwise.

 

OnOctober 1, 2002, we acquired the majority of the assets of 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.

 

OnMay 1, 2003, we acquired substantially all of the assets of Delta TubularProcessing (“Delta”), a leading provider of thermal treating and end-finishingservices for oilfield production tubing.

 

OnJune 2, 2003, we acquired certain assets of Frank’s Tubular International(since renamed Delta Tubular International, or “Delta International”), aleading provider of high-quality threading, inspection, and storage services tothe OCTG market.

 

OnOctober 8, 2003, we created a new business unit integrating the sales andmarketing functions and production assets of Delta, Delta International,Wheeling, and Bellville Tube Corporation (“Bellville”).  We believe this newly created business unit,named Star Energy Group, will enhance our ability to provide OCTG customerswith a full spectrum of pipe finishing, inspection, and logistics services.

 

**OUR STRATEGIES**

 

Webelieve that the better we serve our customers, the better we serve ourshareholders.  Our primaryresponsibility is to grow shareholder value. Thus, our goal is to be the leading provider of both oilfield tubularproducts and specialty tubing products and to increase our market presence inorder to benefit from favorable market conditions. The key elements of ourstrategy to achieve commercial leadership and operational excellence are:

 

***Achieving increased production, greaterproductivity and penetration into new markets through capital investment andcommercial alliances expansion****.*Our customers demand a broad product line and a quick delivery response.  Our operational flexibility gives us theability to match production to customer needs and has earned us the reputationof having the shortest order to delivery times in the industry.  We constantly seek to improve our productionefficiency by upgrading our manufacturing methods and processes.  By becoming more efficient, we will be ableto continue offering our products at attractive prices to an increasing numberof customers. Through our exclusive commercial alliances with several mills, wehave been able to outsource production of specific types of OCTG, line pipe,and specialty tubing, enabling us to concentrate our capital expenditures andmanufacturing expertise on our premium products and new technologies.  Expanding these alliances will enable usboth to offer a wider variety of tubular products to our customers and toincrease our offering of premium products. Through our alliances and with Star Energy Group, we now deliver theindustry’s most complete line of oilfield tubular 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’s never beenmet before.  Commercial leadershipdemands that we continually

 

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lookfor new ways to do business.  We havehistorically been successful in pioneering new production methods to expand themarket acceptance of our oil country tubular goods, line pipe, and specialtytubing products. For example, we pioneered the electric resistance welded,full-body normalized process, which, together with our extensive heat-treatingcapabilities, enables us to manufacture and sell our oil country tubular goodsand line pipe for deep wells and other critical applications. We have also developedexpandable casing products which are used in critical repair and extended reachdrilling applications 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 companies comprisingour Star Energy Group have enabled us to broaden our customer base and expandthe selection of products we offer and the markets we serve at a costsignificantly less than that required to develop these operations on ourown.  We will continue to pursuestrategic acquisitions that we believe to be beneficial to our business.

 

**INDUSTRY BACKGROUND**

 

***Oilfield Products.***  Theproduct group referred to as oil country tubular goods, or OCTG, include casingand tubing, which we manufacture, as well as drill pipe, which we do notcurrently manufacture.  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.

 

Demandfor oil country tubular goods depends on several factors most notably thenumber of oil and natural gas wells being drilled, completed and re-worked, andthe depth and drilling conditions of these wells. The level of these activitiesdepends primarily on the demand for natural gas and oil and industryexpectations of future prices of these commodities. A key indicator of domesticdemand is the average number of drilling rigs operating in the United States.According to the Baker Hughes rig count, the most commonly cited indicator ofthe level of domestic drilling activity, the average United States rig countwas 1,032 working rigs in 2003 compared to 830 and 1,156 in 2002 and 2001,respectively.  Although the average rigcount in 2003 increased by 202 working rigs over the prior year average, all ofthe increase was comprised of land-based rigs wherein the well profile (1) wasgenerally more shallow in depth, requiring less OCTG and (2) generally utilizedmore lower-grade tubulars.    Rigsdrilling offshore averaged 108 rigs during 2003 compared to 113 during2002.  At year-end, 1,126 rigs wereworking, of which 86% were drilling for natural gas.  These factors led to a significant increase in demand for lowermargin, non-premium tubulars, and conversely, flat demand for our highermargin, alloy-based premium products.

 

Theoil country tubular goods market is also affected by the level of inventoriesmaintained by manufacturers, distributors, threading companies, and endusers.  During downturns in drillingactivity, customers typically utilize the inventory of these products ratherthan purchase new products, causing demand for new production to furtherdecrease.  Conversely, in periods ofincreased drilling activity, increases in oil country tubular goods inventory levelsby distributors and end users typically occur, accelerating demand for newproduction.  However, throughout 2003,although drilling activity had increased over the prior year, distributorinventory remained at lower than anticipated levels.

 

Theamount of imported oilfield products also affects the oil country tubular goodsmarket.  According to the U.S.Department of Commerce, importedoil country tubular goods accounted for approximately 35% of the apparentdomestic oil country tubular goods consumption during 2003, and 31% during2002.  Protective tariffs on severalforeign countries were imposed in 1995. These trade tariffs covering Argentina, Italy, Japan, Korea, and Mexicowere extended in June 2001 subject to future sunset review in 2005, and toannual reviews by the Department of Commerce. The affirmative sunset review determinations have been appealed to theCourt of International Trade, and Argentina has appealed to the World TradeOrganization.  If those orders arerevoked in full or in part or the duty rates are lowered, we could be exposedto increased competition from imports that could decrease our sales andprofits, or increase our losses.  In thecase of line pipe, a successful Section 201 case implemented inMarch 2000 restricting imports of American Petroleum Institute(“API”) electric resistance welded (“ERW”) line pipe in sizes up to 16-inches in diameter expired March 1, 2003.

 

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OnNovember 10, 2003, the World Trade Organization ruled the Section 201tariffs illegal allowing the European Union nations and Japan to implementretaliatory duties against any U.S. export. Subsequently, The U.S. Administration terminated the remaining Section 201tariffs and import restrictions in December 2003.

 

Manufacturersproduce oil country tubular goods in numerous sizes, weights, grades, andthread profiles. The grade of pipe used in a particular application depends ontechnical requirements for strength, corrosion resistance, and 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 goods, have yieldstrengths of 75,000 pounds per square inch or more and are generally used inoil and natural gas wells drilled to depths in excess of 8,000 feet or for hightemperature wells, highly corrosive wells, or other critical applications.

 

Carbonand alloy grades of oil country tubular goods are available from both electricresistance welded and seamless tube producers. Electric resistance welded tubes are produced by processing flat rolledsteel into strips which are cold-formed, welded, full-body normalized orseam-annealed, and end-finished with threads and couplings. Seamless productsare produced by individually heating and piercing solid steel billets intotubes and then end- finishing those tubes into oil country tubular goods in amanner similar to electric resistance welded pipe.

 

Basedon published industry statistics, electric resistance welded products haveaccounted for approximately half of the domestic casing and tubing tonnageconsumed. Electric resistance welded, full-body normalized casing and tubingand seamless casing and tubing compete for critical applications such as deepnatural gas wells and offshore wells. Customers purchasing products for theseapplications require high-performance oil country tubular goods that cansustain enormous pressure as measured by burst, collapse, and yield strength.Operators drilling shallow wells generally purchase oil country tubular goodsbased primarily on price and availability, as these wells require lessstringent performance characteristics.

 

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

 

Couplingsare used to connect 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.***  Thespecialty tubing business includes the manufacture, marketing, and sale of abroad variety of steel tubing products, including premium and custom-madeproducts. Applications for specialty tubular products include precisionmechanical tubular products for automotive, fluid power, and other markets forvarious mechanical applications and finned tubular products for heat recoveryapplications.

 

Thedemand for precision mechanical tubulars and other specialty tubing used forautomotive, fluid power, and other mechanical applications is cyclical anddependent on the general economy, the automotive and construction industries,product inventory levels, and other factors affecting domestic goodsactivity.   Demand for precisionmechanical tubulars within the traditional markets was down significantly in2001 as a result of the recession experienced in the United States during thecalendar year.  Only the strong demandfrom the automotive sector kept demand for precision mechanical tubulars for2002 on par with 2001.  As occurred in2001, the continuing decline in the economy resulted in further decreaseddemand for precision mechanical tubing during the fourth quarter of 2002 andremained so for most of 2003.  Weexperienced a slight improvement in the latter half of the fourth quarter of 2003as general economic conditions showed some positive progress toward recovery.

 

Demandfor heat recovery tubular products, or finned tubes, depends on several factorsincluding combined-cycle electrical power plant construction, the cost ofalternative fuels for power generation and, to a lesser extent, on industrialprocessing plant and petrochemical plant construction.  Demand slowed considerably in 2002 andremained slow throughout 2003 for these products as construction of new powerplants was curtailed due to lower energy demand attributable to the slowdown inthe general economy and constraints on capital to fund the construction

 

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projects.  Beyond completion of power plants currentlyunder construction, we expect little new generating capacity to be added in thenext year.

 

***Flat Rolled Steel and Other Products******.*** We have a rolling mill which has thecapacity to produce 1.4 million tons of flat rolled steel per year.  Participation in flat rolled steel marketsallows us to maintain flexibility in procurement of lower cost steel.   Flat rolled steel, produced primarily forthe manufacture of oilfield and specialty tubing products, is also sold tofabricators of various construction and industrial products. The market forflat rolled steel is affected by a number of factors, including price, capacityutilization, and material costs.  Flatrolled steel is sold in highly competitive markets and price, quality, and availabilityare the main determinants of customer purchasing decisions.  Other products consist of tubular goods thatserve a variety of uses, such as structural piling applications in theconstruction industry.

 

**OUR OILFIELD PRODUCTS**

 

***Products.***  Wemanufacture and market premium oil country tubular goods. Our oil countrytubular goods 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.

 

**Oil Country Tubular Goods**

 

Wemanufacture premium alloy and carbon welded oil country tubular goods,including casing, which acts as a structural retainer wall in oil and naturalgas wellbores, and production tubing, which transmits hydrocarbons to thesurface. We offer casing and tubing products with the widest variety ofdiameters, grades and wall thicknesses in the United States. This varietyprovides us with a distinct competitive advantage as a single source supplierof a complete range of oilfield casing and production tubing. As a result ofour broad product range and unique heat-treating capabilities, we are able toservice nearly all typical drilling applications for oil and natural gas wells.

 

Casing,which historically represents more than 80% of the oil country tubular goodsproducts sold by us, is the structural retainer wall in oil and natural gaswellbores. It also serves to prevent pollution of nearby water reservoirs andcontamination of a well’s production. Casing is generally not removed after ithas been installed. Production tubing is installed within the casing to conveyoil and natural gas to the surface. We offer the widest grades and ranges ofoutside diameters in casing (3 1/2” to 20”) and tubing(1.9” to 3 1/2”) produced in the United States, includingproducts that have been successfully used in wells with depths of over 30,000feet.

 

Ourpremium product line includes tubulars manufactured with the electricresistance welded, full-body normalized process and other thermal techniquesthat we pioneered. Because this process gives our tubes better performancecharacteristics than typical seam-annealed casing and tubing, we are able toserve both primary markets for oil country tubular goods: deep critical wellsand shallow wells. Our premium products successfully compete both with seamlessoil country tubular goods for critical applications and with conventionalseam-annealed tubular products manufactured for shallow wells.  We also offer seamless and seam-annealedproducts through marketing arrangements with other producers.

 

Criticalapplications, such as deep natural gas wells and offshore wells, requirehigh-performance casing and tubing that can withstand enormous pressure asmeasured by burst strength, collapse strength, and yield strength.  Both major and independent oil companiesthat conduct drilling programs of this nature emphasize quality and compliancewith specific standards. In our electric resistance welded, full-bodynormalized manufacturing process, which meets and exceeds API standards, weheat treat the entire tube and not just the weld area. This process strengthensthe entire tube and makes our premium casing, tubing, and line pipeinterchangeable with seamless tubulars for nearly all critical applications.  As well profiles trended toward moreshallow-well drilling in 2003, revenues from our high-strength alloy gradeproducts fell from 66% of total OCTG revenues in 2002 and 2001 to 62% in 2003.

 

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

 

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**Line Pipe**

 

Weoffer the widest size and chemistry range of line pipe used to gather andtransmit oil and natural gas in the United States with outside diameters from 23/8” to 60”.  Historically,approximately 15% to 25% of our oilfield product revenues are from line pipesales.

 

**Couplings**

 

Withthe acquisition of Wheeling in 2002, we are able to provide a full range ofcoupling products used to connect individual sections of oilfield casing andproduction tubing from 2 3/8” to 20”, including premium grades and premiumthreads.  The demand for couplingproducts is correlative to demand for OCTG products.  Prior to its acquisition by Lone Star, Wheeling had a multi-yearpartnering arrangement with Lone Star Steel Company (“Steel”) to provide 100%of Steel’s coupling requirements.  Inaddition to Steel, which comprised approximately 43% and 47% of Wheeling’s 2003and 2002 sales respectively, Wheeling maintains distribution arrangements withother large domestic OCTG producers.

 

**Finishing**

 

Byacquiring Delta and Delta International during 2003, we took another major steptoward providing complete tubular solutions for our customers.  Delta and Delta International provide thefull-size range of OCTG finishing, including premium threading, heat-treating,upsetting, inspection, and storage services. They join Bellville and Wheeling in our newly formed Star Energy Group.

 

***Sales and Distribution.***  Ourdomestic oil country tubular goods sales distribution network includes 14non-exclusive stocking distributors that maintain and deliver product inventoryto major and independent oil and gas companies that explore for oil and naturalgas. We also sell line pipe through distributors and to end-users.Internationally, oil country tubular goods are sold through distributors andtrading companies as well as directly to end-users. Approximately 1% of theshipments of oil country tubular goods and 1% of the shipments of line pipe in2003 were to destinations outside the United States.  Our two largest customers, both distributors of our oilfieldproducts in 2003, accounted for approximately 16% and 13% respectively, of thetotal oil country tubular good tons we shipped. About 80% of the oil andnatural gas wells drilled in the United States in 2003 were located within anapproximate 750 mile radius of our mills in Texas.  The majority of our oilfield products were sold for use in Texas,Oklahoma, Louisiana, New Mexico, and Kansas, as well as the Gulf of Mexico,which is less than 250 miles from our mills.

 

***Alliance Mills.***  Inaddition to production from our mills, we have marketing agreements to sellother steel oilfield tubular products manufactured by several companies.Through commercial alliances with several mills, we have expanded our oilfieldproduct offering. These arrangements enable us to outsource production ofspecific products, allowing us to offer a wider variety of casing, tubing, andline pipe without a permanent capital investment. These alliances allow us toconcentrate our capital expenditures and manufacturing expertise on our premiumproducts, while offering our customers a complete size range of casing, tubing,and line pipe. These transactions are performed on a commission basis andthrough purchase and resale of the products. Our alliance arrangementsaccounted for approximately 17%, 21%, and 22% of our revenues from oilfieldproducts during 2003, 2002, and 2001, respectively.

 

***Competition.***  Oilcountry tubular goods and line pipe are sold in highly competitive markets.Once users of oil country tubular goods determine which performancecharacteristics are relevant, they base their purchasing decisions on fourfactors: quality, availability, service, and price. We believe that we arecompetitive in all of these areas. We successfully compete with both seamlessoil country tubular goods and seam-annealed electric resistance weldedproducts, as described above under “Business-Industry Background - OilfieldProducts.”  Our electric resistancewelded, full-body normalized casing and tubing products compete with seamlessoil country tubular goods, and we offer products with the widest variety ofdiameters, grades, and wall thicknesses in the United States.  Several domestic manufacturers producelimited lines of oil country tubular goods, and a number of foreignmanufacturers produce oil country tubular goods for export to the UnitedStates.

 

Thelevel of imports of oil country tubular goods from Canada and Taiwan wasgreatly reduced by the existence of antidumping duty orders from 1986 untilrevocation in June 2000. In addition, since 1995, the level of imports ofoil country tubular goods from Argentina, Italy, Japan, Korea, and Mexico hasbeen greatly reduced by the existence of antidumping duty orders coveringimports from these countries and a countervailing duty order covering importsfrom

 

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Italy.The orders may also have had a beneficial impact on prices for oil countrytubular goods in the domestic market. Affected parties can requestadministrative reviews of imposed duties and tariffs.  These orders against Argentina, Italy, Japan, Korea, and Mexicowere reviewed through the International Trade Commission in 2001 and wereextended for an additional five-year period at that time.  The affirmative sunset review determinationshave been appealed to the Court of International Trade, and Argentina hasappealed to the World Trade Organization. The domestic oil country tubulargoods industry filed a number of trade cases in the first half of 2002 against13 countries for unfairly imported OCTG; however, these cases were dismissed atthe International Trade Commission level by a four-to-one margin.

 

Despitethe existence of various anti-dumping duty orders, imports were 35% of apparentdomestic consumption in 2003.

 

InFebruary 2000, in response to a petition filed by domestic welded linepipe producers and their workers, including us, the United States governmentgranted relief to the line pipe industry under Section 201 of the TradeAct of 1974. The relief, effective March 1, 2000, restricted imports ofwelded line pipe not exceeding 16 inches in outside diameter to a maximum of9,000 tons from any country other than Canada and Mexico.  Imports in excess of that amount weresubject to significant tariffs.   Thesetariffs expired in March of 2003.

 

**OUR SPECIALTY TUBING PRODUCTS**

 

***Products.***  Ourspecialty tubing business includes the manufacture, marketing, and sale of avariety of tubular products. Our specialty tubular products are generally highvalue-added premium or custom products often involved in exactingapplications.  Our specialty tubingproducts include finned tubulars used in industrial processing, petrochemicalplants, and power technology applications.

 

**Precision Mechanical Tubulars**

 

Wehave one of the largest production capacities in the world for precisionmechanical tubular products using the Drawn Over Mandrel (“DOM”) manufacturingprocess. The use of the DOM manufacturing process enables us to achieve highercritical tolerances and dimensional control than other processes. Our precisionmechanical tubular product line includes a wide array of high-quality,custom-made steel tubular products with precise dimensional control and specialmetallurgical properties. Our precision mechanical tubular products have thewidest size range in the world, from 1/2” to 15” inoutside diameter, and are made from a variety of combinations of chemicalcompositions, thermal treatments, mechanical properties, and surface finishes.Product uses include the manufacture of hydraulic cylinders for constructionand farm equipment; automotive applications, such as stabilizers and intrusiontubes; and other uses, including machine parts, bearing races, down-hole pumpbarrels, heavy-lift crane boom chords, drill rods, and liner hangers. As aresult of the wide range of industrial applications for precision mechanicaltubular products, sales traditionally follow general domestic economicconditions.

 

TheDrawn Over Mandrel process uses a drawbench to pull tubing through a die andover a mandrel to shape and smooth surfaces and impart precise dimensionaltolerances to tubes. Our production facilities include seven drawbenches. Our1,000,000 pound drawbench, the largest in the Western Hemisphere, combined withour 800,000 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 than 20,000 pounds,and the products are made to exact customer specifications.

 

**Heat Recovery Tubular Products**

 

Wemanufacture custom-engineered specialty finned tubular products used in avariety of heat recovery applications. We have the major portion of domesticmanufacturing capacity of finned tubes that are used in heat recovery steamgenerators.  Finned tubes are steeltubes with various types of fins or studs welded to the outside to increase theamount of surface area for maximized recovery of heat.  Our heat recovery products are used in fueleconomizers, petrochemical plants, refineries, and combined-cycle electricalpower generation.

 

Inconnection with our production of finned tubes, we design and manufacture otherproducts relating to large-scale applied heat recovery technology, such asboiler tubing and economizers. Economizers are bundles of finned tubes arranged to maximize the amountof heat captured from boiler exhaust gases. Economizers are normally used on large boilers for office buildings,hospitals, universities, prisons, breweries, and food processing plants. Wealso

 

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manufactureand sell X-ID tubing, which has specific patterns on the interior surface ofthe tube for enhanced heat transfer.

 

**Other Specialty Tubing Products**

 

Wealso produce hot finished specialty tubing. We have developed new thick wallproducts using enhanced hot reduction technology for applications such as heavyaxles for trailers and light axles for trucks, including sport utility vehiclesthat were typically made out of seamless tubes.  This product is also used for other industrial applications.

 

***Sales and Distribution.*** Domestically, we market and sell our precision mechanical tubularsthrough 19 non-exclusive steel service centers and to end-users. Our precisionmechanical tubulars have detailed design specifications and in some cases longlead times, making annual contracts an efficient mechanism for largepurchasers. Internationally, the majority of our precision mechanical tubularsis currently sold to end-users and exports accounted for approximately 3%, 11%,and 22% in 2003, 2002, and 2001 respectively, of the shipment tonnage of ourprecision mechanical tubulars.  Wemarket and sell our finned tubes and other heat recovery products through fouroutside sales managers providing direct sales to most original equipmentmanufacturer (“OEM”) accounts and through approximately fifty independent salesrepresentative companies which sell to end-users and contractors.  Exports of finned tubulars and other heatrecovery tubes accounted for approximately 21%, 11%, and 18% of the revenuesfrom those products in 2003, 2002, and 2001, respectively.

 

***Competition.***  Themarket for specialty tubing is competitive and is served by severalmanufacturers.  We have one of thelargest capacities in the world to manufacture precision mechanical tubularsusing the DOM manufacturing process.

 

Sincethese products are made to end-user specifications and often requirejust-in-time delivery, only small quantities are imported into the UnitedStates. In contrast to the oil country tubular goods market, seamless andelectric resistance welded specialty tubing products differ in theirapplications. Electric resistance welded tubing, such as precision mechanicaltubulars, is preferred for many mechanical tubing applications because itsconsistent wall thickness requires less machining in the finishing process. Incontrast, seamless tubes are often specified in heavy gauge applications suchas boiler and pressure tubing.

 

Basedon generally available market data, we estimate that we have a major portion ofthe domestic manufacturing capacity for finned tubes used for heat recoverysteam generation.  We have onesignificant domestic competitor and a number of smaller foreign competitors.

 

**OUR FLAT ROLLED STEEL AND OTHER PRODUCTS AND SERVICES**

 

***Products and Services.***  Wealso manufacture and market flat rolled steel and other miscellaneous productsthat are secondary to our manufacture of oilfield and specialty tubingproducts. Flat rolled steel is primarily used by us in the manufacture oftubular products. We also sell flat rolled steel to fabricators of large diametertransmission pipe, storage tanks, rail cars, and a variety of otherconstruction and industrial products. Our participation in the flat rolledsteel commodity market provides us flexibility in sourcing lower cost steel forour tubular products.

 

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

 

Wealso have a stand-alone steel coil slitting business. This business includes asteel coil storage and processing business, where we provide toll slittingservices for major steel customers and also provide steel storage and customcutting. The steel coil division ships its processed steel on a just-in-timebasis principally to our finned tubing manufacturing operations and to outsidecustomers.

 

***Sales and Distribution.***  Wemanufacture and sell flat rolled steel directly to end-users and throughservice centers, primarily in the Southwestern region of the UnitedStates.  Our two largest customers ofour flat rolled steel accounted for approximately 76% of our flat rolled steelsales in 2003, as well as substantially all other sales of miscellaneoustubular products other than oilfield and specialty tubing products. One ofthese customers has steel processing facilities located adjacent to ourfacilities in Lone Star, Texas, and those facilities purchase most of theirflat rolled

 

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steelfrom us.  Sales to these two customersrepresented approximately 7%, 8%, and 8% of our total revenues for 2003, 2002,and 2001, respectively.

 

Flatrolled steel processing services are also sold to steel mills where we receiveprocessing revenues but do not purchase and resell steel.

 

***Competition.***  Ourflat rolled steel is sold in highly competitive markets generally concentratedin the Southwestern region of the United States. Sales and earnings areaffected by the cost of raw materials, use of flat rolled steel by us in themanufacture of our tubular products, demand by outside customers, and generaleconomic conditions.  Our steel coilslitting services compete against service centers located in the Midwest.

 

**FINANCIAL INFORMATION ABOUT SEGMENTS**

 

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

 

**CUSTOMERS**

 

Wesell our oilfield products through our exclusive distributors to numerousend-users, including BP, ChevronTexaco, El Paso Exploration, AnadarkoPetroleum, Devon Energy, Burlington Resources, Apache, and ExxonMobil.  We sell our finned and other heat recoverytube products to over fifty end-users, including Foster Wheeler, Chicago Tubeand Iron, Peerless, Alstom Power, Cerrey, Nooter Eriksen, and Vogt PowerInternational.  We sell our precisionmechanical tubulars to such distributors and end users as Earle M. JorgensenCompany, Marmon/Keystone, Hyva, DaimlerChrysler, Ford Motor Company, and Dana.

 

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

 

Weare committed to technologically innovative product development. With respectto oilfield products, we collaborate with customers and industry groups todevelop new grades of oil country tubular goods as well as new products, suchas expandable casing. Our expandable casing product was developed for a jointventure between Shell Oil Company and Halliburton Company and was firstsuccessfully installed in late 1999 in the Gulf of Mexico.  As of February 2004, there have beenmore than 215 successful installations totaling more than 215,000 feet ofcasing for 54 end-users in 20 countries. We have also developed slotted tubes for expandable sand screens andriser sleeves to provide new product solutions for our customers.  Our technical knowledge and high-performancecasing products are also being applied in an innovative method for drillingwells using casing instead of drill pipe. We also have used our expertise to develop high-strength, thick wall linepipe for offshore applications. In addition, we developed ultrasonic testingmethods to assure the quality of our tubing. In the specialty tubing area, ourrecent product developments include the Aeroseg finned tube, a new thermalmechanically processed Drawn Over Mandrel product called QDOM for applicationsrequiring extreme mechanical properties and thick wall products using hotreduction technology for applications such as heavy axles that are normallymade out of seamless tubes. We hold several United States patents covering someof our manufacturing processes and products.

 

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

 

**MANUFACTURING CAPABILITIES**

 

Wemanufacture our oilfield products, precision mechanical tubulars, flat rolledsteel and other products at our facilities located on an approximately2,000-acre site we own in Lone Star, Texas which contains over 2,000,000 squarefeet of manufacturing space and approximately 91,000 square feet of oilfieldproducts manufacturing facilities in Bellville, Texas.  We manufacture our finned tubular productsin approximately 364,000 square feet of manufacturing facilities onapproximately 71.5 acres that we own or lease in the Tulsa, Oklahomametropolitan area; Quebec, Canada; and Monterrey, Mexico.  Our coupling products are manufactured atthree owned facilities totaling 231,000 square feet of manufacturing space andlocated in Pine Bluff, Arkansas; Hughes Springs, Texas; and, 

 

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Houston,Texas.  Our finishing and storageservices provided by Delta and Delta International are performed at two ownedfacilities totaling 281,500 square feet across 230 acres located in Houston,Texas.

 

Theannual rated capacity of our facilities in Lone Star, Texas approximates1,250,000 flat rolled tons and 1,000,000 welded pipe tons. We have accessthrough marketing arrangements and alliances with mills for additional oilfieldtubular capacity of approximately 500,000 tons per year.  Our electric arc furnaces (“EAF”) have anestimated capacity of 360,000 ingot tons. In 2003, the precision mechanical specialty tubing facilities operatedat 51% of capacity.  The rolling millsand pipe mills generally operated at 54% and 59% of capacity, respectively,while the electric arc furnaces (“EAF”) generally operated at 57% of capacityin 2003.

 

Wheelingoperates PMC high volume finishers and CNC lathes at facilities in Pine Bluff,Arkansas, Hughes Springs, Texas, and Houston, Texas.  Wheeling also maintains finished product at its productionfacilities as well as warehouses at Steel, and a facility servicing U.S. Steeloperated by Wheeling in Birmingham, Alabama. The Houston facility was established to handle premium threads, materialthat requires third party inspections and as an entry point into the oilfieldaccessories business.  Wheeling offers awide range of eight round and buttress couplings for 2 3/8” tubing through 20” casing.

 

Delta Tubular Processing (“DTP”) is a licensed API processor forupsetting, threading, and heat treating of OCTG products to APIspecifications.  DTP has two upsettersthat are capable of upsetting tubing, two Quench and Tempering operations that canheat treat tubing and coupling stock through 3.668” outside diameter (OD), andone full-body normalizing line that can normalize tubing up to 4 1⁄2” OD.  DTP has two hydrostatic tubing testers, twohigh-speed PMC tubing threaders, one threading repair line, and one NDT(non-destructive testing) operation. The facility capacity is calculated to be 120,000 tons per year with anaverage mix of products.  DTP operateson an eighty acre tract in Houston, Texas with 150,000 square feet of buildinguse and leases an additional building with 14,500 square feet which houses itssecond heat treat line.

 

DeltaTubular International (“DTI”) is a licensed API processor for OCTG casing forsizes ranging 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 are preparing for theinstallation of a new, state-of-the-art UT line and two Okuma threaders whichwill increase these capacities.

 

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

 

Wehave a major portion of the domestic manufacturing capacity for production offinned tubes for heat recovery applications.

 

**RAW MATERIALS AND INVENTORY**

 

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

 

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

•              ashort lead time in filling our customers’ orders;

•              abroad product range offering; and

•              theability to offer our products at an effective cost.

 

Wegenerally produce oil country tubular goods and line pipe to fill specific ordersand, accordingly, we maintain the majority of our inventory in the form ofsteel slabs, steel coils, work-in-process or finished goods earmarked forspecific orders. Some work-in-process and finished goods inventories aremaintained in order to provide flexibility in responding to customer deliverydemands.

 

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Wecan use steel slabs, scrap steel, and steel coils in the manufacture of ourtubular products. We purchased steel slabs to meet approximately 80% of oursteel needs in 2003, and it was often necessary for us to commit to purchaseslabs 60 to 120 days prior to production. We anticipate again using steel slabsfor most of our production needs in 2004. Our principal raw material for ourinternally produced steel slabs is scrap steel, which is internally generatedfrom our operations and available in the spot market. The price of scrap steeland steel slabs can be volatile, is influenced by a number of competitivemarket conditions beyond our control, and is not directly related to the demandfor our products.

 

InMarch 2002, the U.S. Government imposed anti-dumping tariffs(Section 201) over a three-year period on various types of imported steel,principally steel coil, but also including steel slabs.  We procure a substantial portion of oursteel slabs principally from Mexico and Brazil.  Mexico and Canada were excluded from these tariffs.  In the first year, a 30% tariff on countriesother than Mexico and Canada that produce steel slabs was only imposed after anaggregate quota of 4.9 million tons was exceeded.  In year two, a 24% tariff was imposed after a quota of 5.4million tons was exceeded and, in the third year, an 18% tariff was to beimposed once a quota of 5.8 million tons was exceeded.  These actions reduced foreign imports ofsteel coils and increased the cost of flat rolled steel.   In addition, higher steel coil costsresulted in increased demand for steel slabs. This increased demand caused prices for steel slabs to increase beginningin the second half of 2002.  Steelprices remained higher and volatile for most of 2003 compared to 2002.  While the cost of steel slabs fell 4% in thefourth quarter of 2003 from the third quarter, the price of steel coils roseduring the fourth quarter such that the total average cost of our steel duringthe quarter was only down 3% from the third quarter.  Higher steel costs are expected for at least the first half of2004 as well.

 

Rawmaterials for our specialty tubing products are readily available from multiplesources. Steel coils and wire rod are the primary raw materials used in themanufacture of our finned tubular products, and steel coils are the principalraw material used in the manufacture of our precision mechanical tubulars. Weusually produce our specialty tubing products to meet 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.

 

Wemanufacture flat rolled steel primarily for use in producing oilfield andprecision mechanical tubulars, but also for sale to third parties. Wemanufacture flat rolled steel using both purchased steel slabs and internallyproduced slabs.

 

**EMPLOYEES**

 

AtDecember 31, 2003, Lone Star Technologies employed approximately 2,270employees.  Of this number,approximately 940 employees, all at Steel, are a part of collective bargainingagreements through three unions, the International Bricklayers of America (“BricklayersUnion”); Security, Police & Fire Professionals of America (“SecurityUnion”); and the United Steel Workers of America (“Steel Workers Union”).

 

Theagreement between Steel and the Bricklayers Union has an expiration date of May31, 2005 and covers five brick masons. The agreement between Steel and the Security Union has an expirationdate of September 30, 2006 and covers ten security professionals.  The agreement between Steel and the SteelWorkers Union has an expiration date of May 31, 2005 and covers 866 productionand maintenance employees.  The Companywould describe its relationship with these bargaining units as good.

 

Theagreement between Star Tubular Services Inc. (“STSI”), a wholly-ownedsubsidiary of Steel, and the Steel Workers Union expired in February 2004.  The expired agreement covered 59 warehouseand maintenance employees.  The wagesand benefits have remained intact. Steel gave notice to the Steel Workers Union that the contract is nolonger in effect.  The Steel WorkersUnion was further advised that the agreement’s arbitration process andprocedure was also terminated.  Steelconsiders the current relationship with the associated workforce acceptable andthe employees continue to work without a contract.

 

Wehave dedicated necessary resources and made the commitment to design andimplement a health and safety program that will meet the Occupational Safety& Health Administration’s (OSHA) Voluntary Protection Program (VPP) Starcriteria at our facilities in Lone Star, Texas.  The VPP safety management program goes beyond OSHA standards toprotect workers more effectively than simple compliance.  We have also implemented a behavior-basedsafety program that is employee driven to improve safety performance.

 

Weendeavor to provide asafe and healthful work environment for our employees, contractors, vendors,and visitors to our facilities.  Wecontinuously monitor and update our safety programs and strive to exceedOSHA requirements.

 

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Weutilize a variety of video and classroom teaching methods to train ouremployees on both OSHA required topics as well as facility-specific matters.

 

**FOREIGN OPERATIONS**

 

Ourexport sales to destinations outside the United States were approximately $13.3million in 2003, $24.0 million in 2002, and $45.3 million in 2001.  We own a manufacturing facility in Quebec,Canada and lease a manufacturing facility in Monterrey, Mexico.  Long-lived assets maintained in Quebec,Canada were $3.1 million and $2.8 million at December 31, 2003 and 2002,respectively.  Long-lived assetsmaintained in Monterey, Mexico were $1.6 million and $2.1 million atDecember 31, 2003 and 2002, respectively. Our export sales of $13.3 million to destinations outside the United Statesincluded $5.7 million from these foreign facilities in 2003.

 

# **ENVIRONMENTAL**

 

***Oilfield Products. ***Steel’s operations are subject to extensiveenvironmental regulations with respect to air emissions, wastewater and stormwater discharges, and waste management. Our environmental protection and improvement expenditures wereapproximately $3.6 million during the past three years, including expendituresrelated to energy efficiency efforts, asbestos abatement, secondary containmentupgrades, PCB-contaminated electrical equipment elimination, waste disposalsite closures, and out-of-service facility remediation projects.

 

Inconnection with the cleanup of several offsite commercial waste managementsites, 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,formerly the Texas Natural Resource Conservation Commission (TNRCC), is in theprocess of determining what, if any, corrective action is required to addressthe remaining non-RCRA solid waste management units.

 

TheTCEQ conducted an extensive review of Steel’s waste management practices during2003 to evaluate compliance with applicable requirements for industrial solidwaste.  The review was closed with nofurther response required from Steel and no notice of violation.

 

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 audits are conductedsystematically of Steel’s operations in accordance with the Texas AuditPrivilege Act.  We do not expect futureenvironmental expenditures necessary to comply with existing environmentalrules and regulations to have a material impact on our financial position oroperations.

 

***Star Energy Group.***  The operations of DTP, DTI, Bellville, andWheeling are also subject to environmental regulations in the area of airemissions, wastewater and storm water discharges and waste management.  The companies possess or have applied for,necessary authorizations for air emissions, wastewater and storm waterdischarges, and waste management.  Allfacilities are classified as either Small Quantity Generators or ConditionallyExempt Small Quantity Generators. Wastes are temporarily stored onsite, but are disposed or recycledoffsite by a third party.  There are noonsite waste disposal units.

 

***Specialty Tubing.*** Fintube is also subject to environmental regulations in the area of airemissions, wastewater and storm water discharges, and waste management, andpossesses necessary authorizations for such activities.  Wastes are temporarily stored onsite, butare disposed or recycled offsite by a third party.  Fintube does not use onsite waste disposal units.

 

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**INTERNET WEBSITE POSTINGS**

 

Ourinternet website is www.lonestartech.com. We make available through our internet website our annual report on Form10-K, quarterly reports on Form 10-Q, current reports on Form 8-K andamendments to those reports filed or furnished pursuant to Section 13(a)or 15(d) of the Securities Exchange Act of 1934 as soon as reasonablypracticable after we electronically file such material with, or furnish it to,the Securities and Exchange Commission.

 

Inaddition, our code of business conduct and ethics, Corporate Governance Guidelines,and Charter of the Audit, Corporate Governance, and Human Resources Committeesare available on our website and in print to any shareholder who requests aprinted copy.

 

**ITEM2.  PROPERTIES**

 

Wemanufacture our oilfield products, precision mechanical tubulars, flat rolledsteel and other products at our facilities located on an approximately2,000-acre site we own in Lone Star, Texas which contains over 2,000,000 squarefeet of manufacturing space.  Theoriginal facilities, constructed in the 1940’s and 1950’s have been expandedand modernized, and include two EAFs equipped with oxy-fuel burners with acombined capacity of approximately 360,000 ingot tons per year; two rollingmills, a “two-high” mill that rolls the EAF ingots into slabs and a “four-high”single stand reversing Steckel mill that produces flat rolled coils; coilslitting and handling equipment; two pipe welding mills; seven draw benches,including the largest specialty tubing drawbench in the Western Hemisphere;three heat-treating facilities; numerous types of ultrasonic andelectromagnetic testing and inspection equipment; finishing facilities at whichoil country tubular goods are threaded and couplings are applied; and varioussupport facilities including a shortline railroad and other transportation andstorage facilities.

 

Wealso have 91,000 square feet of oilfield products manufacturing facilities inBellville, Texas.  We manufacture ourfinned tubular products in approximately 364,000 square feet of manufacturingfacilities on approximately 71.5 acres that we own or lease in the Tulsa,Oklahoma metropolitan area; Quebec, Canada; and Monterrey, Mexico.   Our coupling products are manufactured atthree owned facilities totaling 267,940 square feet of manufacturing, warehouseand office space and located in Pine Bluff, Arkansas on 12.7 acres; HughesSprings, Texas on 19.4 acres; and Houston, Texas on 5.3 acres.  Our headquarters are located in leasedfacilities in Dallas, Texas.

 

DeltaTubular Processing operates in a total 117,000 square feet situated onapproximately 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 theowned acreage for pipe storage and warehousing.

 

Weown 7,000 acres in Texas that was purchased primarily for iron ore, coalreserves, or water rights and mineral interests in an additional 12,000 acresin 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.

 

**ITEM3.  LEGAL PROCEEDINGS**

 

OnAugust 16, 2001, we entered into an agreement to purchase the assets ofNorth Star Steel Company’s Tubular Products Division.  Consummation of the acquisition was subject to completion offinancing arrangements.  Due to lack ofcommon stock financing which, along with certain debt financing, was requiredby the acquisition agreement to close the acquisition, we notified Cargill,Incorporated, the parent company of North Star Steel Company, onDecember 14, 2001, that we were not able to complete the acquisition.  Later that day, Cargill, Incorporated notifiedus that it was filing a lawsuit against us seeking unspecified damages andalleging that we had breached the agreement. On March 13, 2003, the jury in the court of the Fourth JudicialDistrict of the State of Minnesota returned a verdict of $32 million in damagesagainst Lone Star.  We believe that wehave fully performed all of our obligations under the acquisition agreement andare vigorously contesting the verdict, which is on appeal.  We have set up a reserve totaling $34million which includes accrued interest of $2 million and is included innoncurrent liabilities at December 31, 2003.  We have also set aside cash of $32.2 million as restricted cash,which includes accrued interest of $0.2 million at December 31, 2003.

 

Duringthe last five years, our subsidiary, Lone Star Steel Company (“Steel”), hasbeen named as one of a number of defendants in 36 lawsuits alleging thatcertain individuals were exposed to asbestos on the defendants’ premises.  The plaintiffs are seeking unspecifieddamages.  To date several of theselawsuits have been settled for approximately

 

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$60,000in the aggregate.  Of the 36 lawsuits,twelve have been settled or are pending settlement and nine have been dismissedor are pending dismissal.  Steel did notmanufacture or distribute any products containing asbestos.  Some or all of these claims may not becovered by our insurance.  We haveaccrued for our estimated exposure to known claims, but do not know the extentto which future claims may be filed. Therefore, we cannot estimate our exposure, if any, to unassertedclaims.

 

In2003, Lone Star’s subsidiary Zinklahoma, Inc., inactive since 1989, was namedas one of a number of defendants in five lawsuits alleging that the plaintiffshad contracted mesothelioma as the result of exposure to asbestos in productsmanufactured by the defendants and John Zink Company (“Zink”).  Two of these lawsuits have been dismissed.  Lone Star acquired the stock of Zink in 1987and, in 1989, sold the assets of the former Zink to Koch Industries, Inc.(“Koch”) and renamed the now-inactive subsidiary “Zinklahoma, Inc.”  Lone Star retained, and agreed to indemnifyKoch 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 eight lawsuits in whichthe plaintiffs, one of whom has mesothelioma, allege exposure to asbestos inZink’s products and three personal injury lawsuits resulting from a 2001explosion and flash fire at a flare stack and crude unit atmosphericheater.  Zink allegedly manufactured theflare and related components for the flare stack in the early 1970s.  Koch is seeking indemnification from LoneStar with respect to these eleven lawsuits. The costs of defending and settling the lawsuits alleging exposure toasbestos in Zink’s products have been borne by Zink’s insurance carrier.  Lone Star believes that Koch’s indemnityclaim with respect to the 2001 explosion and flash fire is covered by itsinsurance, subject to a deductible, and has notified its insurance carrier ofthat claim.

 

Steel’sworkers’ compensation insurance was with one insurance carrier from 1992through 2001.  In March 2002 thatcarrier was declared insolvent and placed in receivership.  Since then, the Texas Property and CasualtyInsurance Guaranty Association (“TPCIGA”) has been paying the insolventcarrier’s obligations under those insurance policies, as required by Texas law.  Through February 2, 2004 TPCIGA hadpaid $1.6 million in claims under those policies, and it estimates that it willpay an additional $2.0 million in claims over the next few years, for anestimated total of $3.6 million.

 

Ofthis total, about $2.3 million relate to claims that are more than the policydeductibles (the “excess claims”), and the remaining $1.3 million relate toclaims that are less than the policy deductibles (the “deductibleclaims”).  TPCIGA is entitled by law torecover from the insured the amount of certain insurance claims paid by it ifthe insured’s net worth is more than $50 million on December 31 of theyear before the insurance carrier became insolvent.  Because Steel’s net worth on December 31, 2001 was more than$50 million, TPCIGA asserts that Steel owes it the $1.6 million for claims paidso far and that it can recover from Steel the estimated future claim paymentsof about $2.0 million as they are paid. Steel contends, however, that part of TPCIGA’s claim for reimbursement -the $2.3 million of “excess claims” - is without merit because Steel and itslegal counsel believe that the Texas law in question does not apply to workers’compensation insurance.  Steel intendsto defend vigorously against this claim.

 

Steelbelieves that it is most likely liable for the estimated $1.3 million of deductible claims, but Steelcontends that this potential liability is reduced by a $0.9 million deposit that Steel paid to the insurancecarrier before its impairment.  Thiscontention is being contested by TPCIGA. Steel is uncertain how much, if any, of the deposit is recoverable fromthe receiver, and it is difficult to evaluate Steel’s deductible reimbursementdefense since it involves the interpretation of a statute that would be a caseof first impression.  Therefore, Steelhas not recognized a liability in the balance sheet for the estimated $2.3million of TPCIGA past and future payments of excess claims.  It also has not recognized a liability inthe event that Steel is unable to either recover or offset the $0.9 milliondeposit amount.

 

**ITEM 4.****     SUBMISSION OF MATTERS TO AVOTE OF SHAREHOLDERS**

 

None.

 

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**PARTII**

 

**ITEM 5.****                                                     MARKETFOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS**

 

LoneStar’s Common Stock trades on the New York Stock Exchange under the symbolLSS.  The following table summarizes therange of trading prices by quarter for the last two years:

 
|           |   | **2003** |   | **2002** |   |
|----------------|--------|----------|--------|----------|--------|
|           |   | **High** |   | **Low**  |   | **High** |   | **Low** |   |
| First quarter  |   | $        | 22.09  |     | $      | 12.00 |   | $ | 22.92 |   | $ | 13.63 |   |
| Second quarter |   | $        | 25.25  |     | $      | 19.85 |   | $ | 30.25 |   | $ | 19.90 |   |
| Third quarter  |   | $        | 21.12  |     | $      | 13.00 |   | $ | 23.15 |   | $ | 10.68 |   |
| Fourth quarter |   | $        | 16.86  |     | $      | 12.91 |   | $ | 16.20 |   | $ | 9.75 |   |

 

Asof February 16, 2004, we had 2,794 common shareholders of record.  We have not paid dividends on our commonstock since becoming a public company and have no present plan to do so.

 

Informationrequired under this item with respect to securities authorized for issuanceunder equity compensation plans is contained in Lone Star’s proxy statement forthe 2004 Annual Meeting of Shareholders, and is incorporated herein byreference.

 

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**ITEM6.  SELECTED FINANCIAL DATA**

 

***($ and shares in millions, exceptper share and employee data)***

 
|                                                                         |   | **2003(1)** |   | **2002(2)** |   | **2001** |   | **2000(3)** |   | **1999** |   |
|------------------------------------------------------------------------------|--------|-------------|--------|-------------|--------|----------|--------|-------------|--------|----------|--------|
|                                                                         |   |        |   |        |   |     |   |        |   |     |   |
| Oilfield products revenues                                                   |   | $           | 364.8  |        | $      | 304.2    |   | $           | 401.9  |     | $      | 362.0 |   | $ | 187.3 |   |
| Specialty tubing products revenues                                           |   | 121.8       |   | 165.4       |   | 187.7    |   | 220.9       |   | 126.6    |   |
| Flat rolled and other tubular revenues                                       |   | 47.5        |   | 54.1        |   | 60.6     |   | 62.4        |   | 48.1     |   |
| Total revenues                                                               |   | $           | 534.1  |        | $      | 523.7    |   | $           | 650.2  |     | $      | 645.3 |   | $ | 362.0 |   |
|                                                                         |   |        |   |        |   |     |   |        |   |     |   |
| Gross profit                                                                 |   | $           | 5.2    |        | $      | 7.4      |   | $           | 69.3   |     | $      | 85.9 |   | $ | 12.8 |   |
| Selling, general, and administrative  expenses                               |   | (61.5       | )      | (69.2       | )      | (36.1    | )      | (33.7       | )      | (15.5    | )      |
| Operating income (loss)                                                      |   | $           | (56.3  | )           | $      | (61.8    | )      | $           | 33.2   |     | $      | 52.2 |   | $ | (2.7 | ) |
|                                                                         |   |        |   |        |   |     |   |        |   |     |   |
| Net income (loss)                                                            |   | $           | (68.2  | )           | $      | (69.2    | )      | $           | 16.4   |     | $      | 38.6 |   | $ | (5.5 | ) |
|                                                                         |   |        |   |        |   |     |   |        |   |     |   |
| Net income (loss) per common share - basic                                   |   | $           | (2.40  | )           | $      | (2.52    | )      | $           | 0.67   |     | $      | 1.59 |   | $ | (0.24 | ) |
| Net income (loss) per common share -  diluted                                |   | $           | (2.40  | )           | $      | (2.52    | )      | $           | 0.66   |     | $      | 1.59 |   | $ | (0.24 | ) |
| Common shares used for diluted EPS                                           |   | 28.4        |   | 27.5        |   | 25.0     |   | 24.3        |   | 22.5     |   |
|                                                                         |   |        |   |        |   |     |   |        |   |     |   |
| Current assets                                                               |   | $           | 272.6  |        | $      | 341.8    |   | $           | 325.1  |     | $      | 257.5 |   | $ | 172.1 |   |
| Total assets                                                                 |   | $           | 575.6  |        | $      | 612.9    |   | $           | 580.8  |     | $      | 515.3 |   | $ | 351.1 |   |
| Current liabilities                                                          |   | $           | 88.4   |        | $      | 59.9     |   | $           | 66.1   |     | $      | 91.7 |   | $ | 85.2 |   |
| Noncurrent liabilities                                                       |   | $           | 241.3  |        | $      | 240.4    |   | $           | 199.4  |     | $      | 167.8 |   | $ | 70.0 |   |
| Total liabilities                                                            |   | $           | 329.7  |        | $      | 300.3    |   | $           | 265.5  |     | $      | 259.5 |   | $ | 155.2 |   |
| Shareholders’ equity                                                    |   | $           | 245.9  |        | $      | 312.6    |   | $           | 315.3  |     | $      | 255.8 |   | $ | 195.9 |   |
|                                                                         |   |        |   |        |   |     |   |        |   |     |   |
| Shares outstanding                                                           |   | 28.7        |   | 28.5        |   | 25.2     |   | 23.7        |   | 22.6     |   |
|                                                                         |   |        |   |        |   |     |   |        |   |     |   |
| **Other Financial and Operating Data:**                                      |   |        |   |        |   |     |   |        |   |     |   |
| Cash flows from operating activities                                         |   | $           | (40.6  | )           | $      | (12.4    | )      | $           | 31.3   |     | $      | (8.6 | ) | $ | 28.1 |   |
| Cash flows from investing activities                                         |   | $           | (48.0  | )           | $      | (54.0    | )      | $           | (14.7  | )        | $      | (96.6 | ) | $ | (11.7 | ) |
| Cash flows from financing activities                                         |   | $           | 0.5    |        | $      | 81.5     |   | $           | 63.2   |     | $      | 109.7 |   | $ | (15.1 | ) |
| Earnings before interest, taxes,  depreciation and amortization(4)           |   | $           | (28.7  | )           | $      | (37.9    | )      | $           | 50.7   |     | $      | 74.2 |   | $ | 14.0 |   |
| Capital expenditures                                                         |   | $           | 14.4   |        | $      | 15.9     |   | $           | 25.2   |     | $      | 23.3 |   | $ | 7.2 |   |
| Active employees                                                             |   | 2,270       |   | 1,900       |   | 1,892    |   | 2,358       |   | 1,554    |   |
|                                                                         |   |        |   |        |   |     |   |        |   |     |   |
| **Reconciliation of EBITDA (as defined)(4) to  Cash Flows from Operations:** |   |        |   |        |   |     |   |        |   |     |   |
| Cash flows from operating activities                                         |   | $           | (40.6  | )           | $      | (12.4    | )      | $           | 31.3   |     | $      | (8.6 | ) | $ | 28.1 |   |
| Non-cash charge for stock compensation                                       |   | (1.1        | )      | 0.1         |   | 0.2      |   | (0.7        | )      | —   |   |
| Net loss (gain) on asset disposals and  impairments                          |   | (0.4        | )      | 0.1         |   | —   |   | —      |   | —   |   |
| Goodwill impairment                                                          |   | (18.7       | )      | —      |   | —   |   | —      |   | —   |   |
| Changes in working capital                                                   |   | (15.2       | )      | (11.4       | )      | 2.7      |   | 63.4        |   | (22.0    | )      |
| Other balance sheet changes                                                  |   | 33.2        |   | (23.8       | )      | 5.8      |   | 5.9         |   | 5.1      |   |
| Interest expense, net                                                        |   | 14.0        |   | 10.2        |   | 9.9      |   | 12.4        |   | 2.8      |   |
| Income tax expense (benefit)                                                 |   | 0.1         |   | (0.7        | )      | 0.8      |   | 1.8         |   | —   |   |
| EBITDA                                                                       |   | $           | (28.7  | )           | $      | (37.9    | )      | $           | 50.7   |     | $      | 74.2 |   | $ | 14.0 |   |

 

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(1)          Includesthe results of operations of Delta and Delta International since theacquisitions became effective on May 1, 2003 and June 2, 2003,respectively.

(2)          IncludesWheeling results of operations since the acquisition became effective onOctober 1, 2002.

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

(4)          EBITDAis earnings before interest, taxes, and depreciation and amortization.  EBITDA is presented to help us describe ourability to generate income that can be used to service our debt.  EBITDA is a non-GAAP liquidity measurecommonly used in our industry and should not be considered as an alternativemeasure of our net income or cash flows from operations as computed in accordancewith GAAP.  Amounts presented may not becomparable to similar measures disclosed by other companies.

 

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**ITEM 7**.                                 **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF******

**OPERATIONS**

 

 

# **OVERVIEW**

 

*This MD&A should be read in conjunction with the othersections of this Annual Report on Form 10-K, including “Item 1: Business”;“Item 6: Selected Financial Data”; and “Item 8: Consolidated FinancialStatements and Supplementary Data.” The various sections of this MD&A containa number of forward-looking statements, all of which are based on our currentexpectations and could be affected by the uncertainties and risk factorsdescribed throughout this filing and particularly in the “Overview,”  “Principal Lines of Business, Products, andServices,” and “Significant Events” sections. Our actual results may differ materially.*

 

Themanufacture of our products is capital intensive. Utilization rates at ourmanufacturing facilities in Lone Star, Texas increased only slightly in 2003compared to 2002 as demand for our premium alloy-grade oilfield products didnot increase to the levels we had anticipated, though the working rig countincreased significantly throughout the year. The change in mix resulted in our average OCTG sales price falling 2% in2003 compared to the prior year even though total shipments of OCTG increased28% during the same period.  Otherwise,prices were generally higher in 2003 compared to 2002, except for alloy-gradecasing products.  Specialty tubing demand continued to remaindepressed throughout most of 2003 with the overall general flatness in thedomestic economy, although sales were up in the fourth quarter of 2003 comparedto the third quarter, and the amount of customer inquiry level increased in thelatter half of the fourth quarter. Shipments of flat rolled steel were down 16% in 2003 compared to2002.  Revenues were down 12% as averageprices increased 5% during 2003 over the prior year.

 

Overall,total shipment volumes were down 3% in 2003 compared to the prior year.  The reduced production volumes had anegative impact on the cost of our products sold throughout the year as fixedand semi-fixed costs were absorbed by fewer units produced.

 

Historically,our oilfield products have accounted for the majority of our totalrevenues.  For fiscal year 2003, theywere 68% of total revenues.   As aresult, our revenues are largely dependent upon the state of the oil and gasindustry, which has historically been volatile.  Oil and natural gas prices were higher on average throughout 2003compared to 2002 as higher energy demand and relatively low supply maintainedupward pressure on pricing.  Thisprompted domestic U.S. rig counts to climb throughout the first half of 2003 from862 rigs at the end of 2002 and subsequently stabilize around an average of1,100 rigs during the second half of 2003. However, drilling continued to be biased toward lower-risk, shallowdevelopmental fields such as shale areas in Texas and coal seam methane plays.Shallow wells use mainly carbon-grade OCTG, which generally has lower marginsthan our alloy-grade premium products.  Further,shallow wells require proportionally fewer tons per foot of well depth thandeeper wells 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 for35% of the total apparent OCTG consumption in 2003 compared to 31% in 2002, aretypically more accepted for these less critical shallow well applications.

 

Demandfor our oilfield products depends on a number of factors including the numberof oil and natural gas wells being drilled, completed and re-worked and thedepth and drilling conditions of these wells. Baker Hughes reported the average domestic rig count increased in 2003to 1,032 working rigs, or by 24% compared to the previous year average of 830working rigs.  Although most of thedrilling has skewed towards shallow-well developmental fields, beginning in thesecond half of 2003 there was a sustained increase in the number of rigsdrilling deeper than 15,000 feet, wherein the need for higher-margin, premiumalloy-grade products increases.  Duringthe fourth quarter of 2003, there were 155 to 160 rigs drilling deeper than15,000 feet compared to a range of 125 to 130 rigs drilling at that depthduring the first half of 2003. While we have not seen a corresponding increasein orders for premium alloy-grade OCTG used in deeper wells, we believe thistrend will positively impact demand for these products as deeper well activityprogresses.

 

Theinventory level maintained by our distributors is another key indicator ofsupply and demand for our oilfield products. As a proxy for industry OCTG inventory on-hand, we analyze levels at ourowned warehousing operations where we maintain inventories for distributors andend-users on a fee basis.  We thencompare these inventories to the active domestic rig count.   We noted a historically large gap betweenthe total inventories held at our warehousing operations and the rig countsthat began in the fourth quarter of 2002 and continued throughout 2003.  We believe that this trend in lowerinventories is due to several factors including distributors becoming moreefficient in their inventory management practices and the shallow wellenvironment which requires shorter lead times in supplying end-users thandeeper, more technically challenging drilling. We believe that as end-users continue their trend towards deeper well drilling,the demand for our premium alloy-grade products will increase.

 

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Steelcosts are approximately 55% of our total cost of sales and are the largestsingle component of product cost. Accordingly, increases in steel costs and our ability to pass thoseincreases on to our customers through product pricing have a significant impacton our results from operations.   During2003, we announced several OCTG price increases totaling approximately $135 perton.  However, only about one-third ofthe announced price increases were realized or impacted program sales.  Additionally, we had a similar realizationof announced price increases for line pipe during the year.  At the end of 2003, as a response to significantlyhigher raw material costs from our vendors, namely steel and natural gas, weimplemented surcharges to balance these higher costs.  We initially announced a surcharge of $42 per ton effectiveJanuary 1, 2004 for all oilfield product shipments which was subsequentlyreplaced by a $60 per ton surcharge beginning February 1, 2004 as ourprincipal steel sources announced further steel price increases and largersurcharges.  We implemented similarprice increases and surcharges of like or greater magnitude for our specialtytubing products.  We believe thesemeasures are essential as industry observers expect substantial steel pricevolatility to continue.

 

Ourfuture operating results may fluctuate significantly depending upon a number offactors, including industry conditions, the level of oil and gas drillingactivity, competition from domestic and foreign manufacturers, and costs of ourraw materials.  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.

 

Thelevel of production volume through our various facilities has a significanteffect on the cost of manufacturing. Key variable costs include costs of laborand raw materials, including scrap steel, steel slabs, wire rod, steel coils,electricity, and natural gas.  Most ofour finned tubes and other heat recovery products are manufactured in specificconfigurations as ordered.  Accordingly,our manufacturing costs for heat recovery products are to some extent factoredinto product prices on an order-by-order basis.

 

Wehave entered into marketing alliances and manufacturing arrangements withseveral companies. These alliances and arrangements involve the marketing oftheir products which provides us access to additional manufacturingcapacity.  Our exclusive commercialalliances with these mills allows us to outsource production of specific typesof OCTG, line pipe, and specialty tubing and enables us to concentrate ourcapital expenditures and manufacturing expertise on our premium products andnew technologies.  We will continue toexplore opportunities to expand our global alliance partners to enable us tooffer our customers a wider variety of tubular products at competitive priceswhile enhancing our margins, and to focus our production on higher-marginpremium products.

 

**PRINCIPAL LINES OF BUSINESS, PRODUCTS, ANDSERVICES**

 

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

 

Weexpect demand for our oilfield products to increase throughout 2004 as higheroil and gas prices are expected to sustain the growth in the number of activedrilling rigs.  The U.S. EnergyInformation Agency (“EIA”) projected that the average West Texas Intermediate(WTI) crude oil prices should remain in the $28 to $30 per barrel range, priorto OPEC’s announcement in February 2004 to cut crude output by one millionbarrels per day, or about 10%.  OPEC’sdecision is expected to provide further upward pressure on WTI crude oil pricesthroughout 2004.  The EIA expects U.S.petroleum demand to grow at an approximate 2% growth rate in 2004 and 2005 duein part to the accelerating growth of the domestic economy and high natural gasprices.   U.S. natural gas spot priceswere consistently above $5 per million Btu during 2003 and the EIA expects itto average just under $5 per million Btu price during 2004 and 2005 whilenatural gas storage levels remain only slightly above historic averages.  We believe that these are positiveindicators of increasing and sustainable demand for our oilfield products in2004.

 

*Specialty Tubing Products* - Our specialty tubing product segmentincludes precision mechanical tubulars and finned tubular products.  Our precision mechanical tubulars consist ofa wide array of high-quality, custom-made steel tubular products with precisedimensional control and special metallurgical properties which are manufacturedby the “Drawn Over Mandrel” process. This process allows us to achieve highercritical tolerances and dimensional control than other processes. Theseproducts are used for several industrial applications, including themanufacture of hydraulic cylinders for construction and farm equipment;automotive applications, such as stabilizers and intrusion

 

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tubes;and other uses, including machine parts, bearing races, down-hole pump barrels,heavy-lift crane boom chords, drill rods, and liner hangers.

 

Demandfor precision mechanical tubulars within the traditional markets remaineddepressed throughout most of 2003 due to the continuing stagnation in theindustrial economic sector.  However,during the fourth quarter of 2003, revenues from precision mechanical tubularswere up 8% from the third quarter as the overall domestic economy began to showsigns of improvement.   The Institute ofSupply Management Index, a widely followed monthly survey of manufacturingactivity, reached a level not seen in twenty years.  We believe that demand for our precision mechanical tubingproducts in 2004 will continue to be positively impacted by the recovery in thegeneral domestic economy.

 

Ourfinned tubular products are used in heat recovery applications such as fueleconomizers, petrochemical plants, refineries, and combined-cycle electricalpower generation plants.   Demand fordomestically produced finned tubulars and related products continued to benegatively impacted in 2003 as a result of curtailed and cancelledcombined-cycle natural-gas power plant construction projects throughout NorthAmerica, and the continued stagnation in the industrial economy over most of2003.  With few exceptions, demand fornew power plant construction projects is not likely to return in the near termuntil existing capacity is utilized. However, the EIA believes that the natural gas share of electricitygeneration is projected to increase from 17 percent in 2001 to 29 percent by2025.  Further, since reorganizing ourfinned tubular business around new marketing and commercial business linesdirected at more traditional heat recovery markets including fuel economizersand traditional boiler applications, we have recently experienced increasedcustomer inquiry activity related to the improvement in the general industrialeconomy.

 

*Flat Rolled Steel and Other Products* - We manufacture and market flat rolledsteel, which is primarily used in the manufacture of our oil country tubularproducts. 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 to end-users and throughservice centers primarily in the Southwestern region of the United States.

 

Wesell flat rolled steel in highly competitive markets, with price, quality, andavailability primarily determining customer purchase decisions.  Flat rolled steel processing services arealso sold to steel mills where we receive processing revenues but do not taketitle to the steel.

 

**SIGNIFICANT EVENTS**

 

Asa result of the economic slowdown that began in 2001 and continued well into2003, many of our specialty tubing customers cut back capital expenditurebudgets and investment in inventories. These cut backs contributed to the decrease in our specialty tubingrevenues beginning in late 2001 and through 2003.

 

Tohelp counter the financial impact of the reduction in specialty tubing revenue,we undertook a series of initiatives to streamline our cost structure andre-align our operations with the marketplace and industry conditions.  These initiatives included workforcereductions both at our East Texas mill and Tulsa operations, consolidation ofexcess facilities, and a re-focus of our manufacturing capabilities on moretraditional heat recovery markets. These cost and productivity initiatives yielded between $5 million and$6 million in annual savings and we have additional plans company-wide tofurther reduce costs and improve our performance in 2004 including:

 

•                  A new company-wide cost and profitabilityimprovement plan of an annualized value of approximately $20 million by the endof 2004;

•                  Implementation of product surcharges andprice increases to mitigate raw material cost increases along with arealization of previously announced price increases;

•                  Improvedpricing within our precision mechanical tubular products related to improvingdomestic industrial demand benefiting our specialty tubing products; and

•                  The continued growth of higher marginactivities from recently acquired businesses.

 

Asa result of the decrease in revenues from our Tulsa operations along with ananticipated lower growth in future revenues from this operation, we took anon-cash charge of $18.7 million in the fourth quarter for the impairment ofthe operation’s recorded goodwill.  SeeNote C in the Notes to Consolidated Financial Statements in this Form 10-K.

 

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InMay and June 2003, we completed our acquisitions of Delta and DeltaInternational, respectively.  Delta andDelta International are leaders in providing OCTG end-finishing and inspectionservices.  The results of operations for2003 include the results of Delta and Delta International since theirrespective dates of acquisition.  SeeNote K in the Notes to Consolidated Financial Statements.

 

# **CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

Management’sDiscussion and Analysis, Results of Operations, and Financial Condition arebased on the related consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States of America.  Thepreparation of the financial statements requires the use of estimates and judgmentsthat affect the reported amounts of assets, liabilities, revenues, andexpenses.  Lone Star evaluates itsestimates primarily based 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***

 

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

 

***Bad Debts***

 

Ourcustomers are concentrated in markets and industries that are subject tovolatility.  In addition, we sell asubstantial amount of products to a few customers.  We maintain a reserve for known and unknown bad debts.  We evaluate credit risk and the adequacy ofour reserve by monitoring the age of our accounts receivable and the creditworthiness of our customers.  Inaddition, we monitor the overall status of the industries where our productsand services are utilized.  Typically,this reserve is not subject to significant fluctuations from period toperiod.  However, the incurrence of anunusual amount of bad debt could alter our exposure and the related reserve.

 

***Environmental Obligations***

 

Ourbusiness 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, thisreserve is not subject to significant fluctuations from period to period; althoughgiven the nature of environmental exposure, significant changes in the reserveare possible.

 

***Revenue Recognition***

 

Productrevenues are recognized as sales when revenue is earned and is realized orrealizable.  This includes satisfyingthe following criteria:  the arrangementwith the customer is evident, usually through the receipt of a purchase order;the sales price is fixed or determinable; delivery has occurred, which mayinclude delivery to the customer storage warehouse location at one of oursubsidiaries in which instance, the risk of loss has been passed to thecustomer; and collectibility is reasonably assured.  Freight and shipping that is billed to customers is included innet sales, and the cost of shipping is included in cost of sales.  We have marketing agreements to sell steeloilfield tubular products manufactured by other companies.  Revenue is recorded on a gross basis forcertain transactions with alliance mills

 

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whenwe are the primary obligor and we have general inventory and credit risk, andcertain other transactions are recorded net.

 

***Impairment of Long-Lived Assets***

 

Long-livedassets, which include property, goodwill, intangible assets, and certain otherassets, comprise a significant amount of our total assets.  We make judgments and estimates inconjunction with the carrying value of these assets, including amounts to becapitalized, depreciation and amortization methods, and useful lives.Additionally, the carrying values of these assets are periodically reviewed forimpairment or whenever events or changes in circumstances indicate that thecarrying amounts may not be recoverable. An impairment loss is recorded in the period in which it is determinedthat the carrying amount is not recoverable. This requires us to make long-termforecasts of our future revenues and costs related to the assets subject toreview. These forecasts require assumptions about demand for our products andservices, future market conditions, and technological developments. Significantand unanticipated changes to these assumptions could require a provision forimpairment in a future period.

 

***Pension and Postretirement BenefitObligations***

 

Accountingfor pensions and other postretirement benefit plans requires management to makeseveral estimates and assumptions (see Note I in the Notes to ConsolidatedFinancial Statements).   These includethe expected rate of return from investment of the plans’ assets, projectedincreases in medical costs and the expected retirement age of employees as wellas 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 theseestimates based on the company’s historical experience and other informationthat it deems pertinent under the circumstances (for example, expectations offuture stock market performance).  Management engages an independent consulting actuarial firm to aid it inselecting appropriate assumptions and valuing its pension related liabilities.

 

LoneStar’s net pension benefit expense, which is included in “Cost of goods sold”on our Consolidated Results of Operations, was $5.4 million for the year endedDecember 31, 2003.  In recordingthis amount, Lone Star assumed a long-term investment rate of return of8%.   Changes to this rate of returnassumption would result in a change to the pension credit and, as a result, anequal change in cost of goods sold.  Changes that are reasonably likely to occur in assumptions concerningretirement age, projected earnings and mortality would not be expected to havea material effect on Lone Star’s net pension benefit expense or net pensionliability in the future.   The netpension liability is recorded at its net present value using a discount rate of6.25% that is based on the current interest rate environment; therefore,management has little discretion in this assumption.

 

LoneStar’s net cost for other postretirement benefits, which is also included incost of goods sold, was $1.6 million for the year ended December 31,2003.  In recording this expense andvaluing the net liability for other postretirement benefits, which is includedin “Other Benefits” as disclosed in Note I, management estimated futureincreases in health-care costs.   Thisand other assumptions, along with the effect of a one percentage point changein them, are described in Note I.

 

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**RESULTS OF OPERATIONS**

 

***Net Revenues***

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

 
|                                 |   | **($ in  millions)** |   |
|--------------------------------------|--------|----------------------|--------|
|                                 |   | **2003**             |   | **2002** |   | **2001** |   |
|                                 |   | **$**                |   | **%** |   | **$** |   | **%** | ** ** | **$** |   | **%** | ** ** |
| Oilfield products                    |   | 364.8                |   | 68 |   | 304.2 |   | 58 |   | 401.9 |   | 62 |   |
| Specialty tubing products            |   | 121.8                |   | 23 |   | 165.4 |   | 32 |   | 187.7 |   | 29 |   |
| Flat rolled steel and other products |   | 47.5                 |   | 9 |   | 54.1 |   | 10 |   | 60.6 |   | 9 |   |
| Consolidated net revenues            |   | 534.1                |   | 100 |   | 523.7 |   | 100 |   | 650.2 |   | 100 |   |

 
|                                 |   | **2003** |   | **2002** |   | **2001** |   |
|--------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                 |   | **Tons** |   | **%**    |   | **Tons** |   | **%** |   | **Tons** |   | **%** |   |
| Oilfield products                    |   | 496,200  |   | 68       |   | 457,600  |   | 60 |   | 580,300 |   | 65 |   |
| Specialty tubing products            |   | 104,900  |   | 14       |   | 143,800  |   | 19 |   | 154,100 |   | 17 |   |
| Flat rolled steel and other products |   | 132,700  |   | 18       |   | 158,700  |   | 21 |   | 161,000 |   | 18 |   |
| Total shipments                      |   | 733,800  |   | 100      |   | 760,100  |   | 100 |   | 895,400 |   | 100 |   |

 

Theincrease in oilfield product revenues in 2003 compared to 2002 was due in partto a 28% increase in total OCTG shipments slightly offset by a 2% decrease inaverage OCTG revenue per ton.  Thisincrease in revenues was primarily related to increased demand for ourlower-margin carbon-grade OCTG products, which typically are used in moreshallow wells, resulting in a reduced mix of higher priced products.  Shallow wells require proportionally fewertons per foot of well depth than deeper wells as the initial surface casing isgenerally smaller in diameter, fewer intermediate casing strings are needed,and generally the wall thickness of the casing is less. Average revenues per ton of our alloy-grade OCTG in 2003 did not changefrom 2002 despite several announced price increases.  Shipments of carbon-grade OCTG increased by 42% in 2003 comparedto the prior year while shipments of premium alloy-grade OCTG increased 19%over the same period as the average rig count increased by 24% from 2002 to2003.   The number of working rigs isthe most commonly followed indicator of demand for oilfield products.

 

Linepipe revenues, which were approximately 16% of total oilfield product segmentrevenues in 2003, were down 31% on a 31% decrease in shipment volumes in 2003compared to 2002.  Although averagerevenue per ton did not change, the decrease in shipments is due principally tothe termination of a commercial alliance arrangement for seam-annealed linepipe in 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.

 

Oilfieldproduct revenues in 2002 included only three months of revenues of ourSeptember 2002 Wheeling acquisition and none from our 2003 Delta and DeltaInternational acquisitions.  In 2003,these three operations contributed approximately 10% of the total oilfieldproduct revenues.

 

Revenuesfrom specialty tubing products decreased in 2003 compared to the prior year asthe general industrial economy remained in a contraction through most of theyear.   Total specialty tubing shipmentsdecreased 27% and revenues decreased 26% in 2003 compared to 2002.  Average revenue per ton shipped decreased by1% 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 originalequipment manufacturers (“OEM”) that relocate to countries with substantiallylower operating rates than the United States continued to reduce demand fordomestic specialty tubing products.  Similarly, excess capacity in the North Americanelectricity generating market and foreign competitors continue to negativelyimpact sales of our heat recovery tubulars.

 

Revenuesfrom our flat rolled steel segment decreased in 2003 compared to 2002 as ourtwo principal 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, flat rolled revenuesincreased to $14.3 million, a 61% increase compared to the third quarter of2003, due principally to the tightening domestic steel supply during the fourthquarter.

 

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***Gross Margin***

 

Thefollowing table shows cost of sales and the related gross margin percentages(“GM%”) for the last three years:

 
|               |   | **($in  millions)** |   |
|--------------------|--------|---------------------|--------|
|               |   | **2003**            |   | **2002** |   | **2001** |   |
|               |   | **$**               |   | **GM%** |   | **$** |   | **GM%** | ** ** | **$** |   | **GM%** | ** ** |
| Cost of goods sold |   | 528.9               |   | 1.0 | % | 516.3 |   | 1.4 | % | 580.9 |   | 10.7 | % |

 

Grossmargin declined slightly in 2003 compared to 2002, but remained just abovebreak-even as significantly higher raw material costs, namely steel and naturalgas, combined with a difficult year in product pricing, reduced margins acrossall product lines.  Although we announcedseveral OCTG price increases totaling approximately $135 per ton during theyear, only about one-third of these announced price increases were realized orimpacted existing customer programs.  Wehad similar low realization of announced line pipe and specialty tubing priceincreases during 2003.  Our inability torealize price increases was principally due to an increase in foreign importsand competitive pressures domestically and internationally.  For OCTG, imports increased from an averageof 31% of the apparent consumption of domestic OCTG in 2002 to 35% in 2003.

 

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

 

Thefollowing table presents consolidated selling, general, and administrative(“SG&A”) expenses and the related percentage of total consolidated revenuesfor the last three years:

 
|                                 |   | **($in  millions)** |   |
|--------------------------------------|--------|---------------------|--------|
|                                 |   | **2003**            |   | **2002** |   | **2001** |   |
|                                 |   | **$**               |   | **%****of  Rev.** |   | **$** |   | **%****of  Rev.** |   | **$** |   | **%****of  Rev.** |   |
| Selling, general, and administrative |   | 61.5                |   | 11.5 | % | 69.2 |   | 13.2 | % | 36.1 |   | 5.6 | % |

 

Excludingthe impact of significant non-recurring charges of $18.7 million for a goodwillimpairment in 2003 and a $32 million charge for an unfavorable litigationjudgment in 2002, SG&A expenses increased by $5.6 million in 2003 comparedto 2002.  This increase was dueprincipally to the inclusion of $4.7 million of SG&A expenses from a full year of Wheeling’s operations anda partial year of DTP's and DTI’s operations in 2003.  In comparison, for 2002, total SG&A expense included only $0.4 million of Wheeling SG&Acosts.  The remaining increase in 2003compared to 2002 is due to expenditures for our Sarbanes-Oxley Section 404readiness initiative and additional legal costs related to our appeal of theCargill judgment.  These increases werepartially offset by our initiatives to reduce costs and improve profitabilityimplemented during 2003 totaling between $5 million and $6 million.

 

***Interest Expense***

 

Interestexpense increased in 2003 compared to 2002 by $2.7 million, principally as aresult of interest accruing on the $32 million unfavorable judgment againstLone Star in 2002.

 

***Income Taxes***

 

 Lone Star’s effective tax rate is affected bythe carryforward of net operating losses (“NOL”) recognized or not recognizedin a particular year and the full valuation allowance placed against theassociated net deferred tax assets.  In2003, the tax benefit at the U.S. statutory rate of 35% was reduced by $25.5million of NOL benefit not recognized in the current period as managementbelieves that it is more likely than not the related tax benefits would not berealized.  The ultimate realization ofour deferred tax assets depends upon our ability to generate sufficient taxableincome in the future.  Accordingly, dueto the uncertainty regarding possible utilization of NOL’s and the sensitivityof our earnings to the level of domestic drilling activity, we record avaluation allowance to fully reserve the computed net deferred tax assets.  The income tax expense for the year endedDecember 31, 2003 consists of state income taxes.

 

***2002 Compared With 2001***

 

***Net revenues*** of $523.7 million for the year ended December 31,2002 were down 19% from 2001.  Oilfieldproducts revenues decreased by $97.7 million, or 24%, to $304.2 million, andshipment volumes were off by 21% from the prior year.  Demand for oilfield products is generally correlated to thenumber of rigs drilling.  There were anaverage

 

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of830 active rigs in 2002 compared to 1,156 in 2001, or a decrease of 28%.  Drilling activity decreased steadily throughthe first quarter of 2002 and although the average domestic rig count for thesecond quarter of 2002 was slightly lower than for the first quarter, it didincrease by nearly 100 rigs from the low of 738 rigs at the beginning ofApril according to Baker Hughes. However, after the 100 rig increase, the average domestic rig countremained flat through the third quarter and ended the year at an average of 830active domestic rigs.  Although averageoilfield product prices were up slightly over 2001, the increases wereexclusive to the first three quarters of 2002 as average oilfield productprices declined 6% from the third quarter 2002 to the fourth quarter dueprincipally to a higher percentage of lower priced line pipe and carbon-gradeOCTG in the product mix.

 

Specialtytubing product revenues decreased in 2002 to $165.4 million, a 12% decline from2001 revenues of $187.7 million due primarily to the general decline ofeconomic conditions during 2002. Revenues from heat recovery tubular goods and related products were down31% from 2001 to $59.0 million as a result of delays and cancellations in powerplant construction projects.  Precisionmechanical tubulars accounted for approximately 52% of the total specialtytubing segment in 2002 and shipments were up in 2002 to 79,321 tons, or 6% over2001.   There was also a 6% increase in precision mechanical tubularrevenues.

 

Flatrolled steel and other tubular products revenues were down 11% to $54.1million.  This decrease is attributableto a decrease in average selling prices and fewer shipments in 2002 compared to2001.  Lower average prices were due toa higher mix of lower priced products in this segment.

 

***Gross profit*** for 2002 was $7.4 million compared to $69.3million in 2001.  This decrease isprimarily due to higher unit costs associated with decreased productionvolumes, increases in steel costs and reduced overall revenues from oilfieldand specialty tubing products.  Steelcosts, which comprise approximately 55% of our total cost of sales, wererelatively stable during 2001 but increased nearly 30% in the fourth quarter2002 from the first half of 2002.  Thesehigher steel costs contributed to a significant reduction in gross margins andoperating losses in the third and fourth quarters of 2002 as compared to 2001.

 

***Selling, general, and administrativeexpenses***increased significantly in 2002 by $33.1 million, or 92% to $69.2 millioncompared to $36.1 million in 2001.  Theincrease is attributable to a $32 million charge incurred as a result of a juryverdict against Lone Star on March 13, 2003 - see Item 3, LegalProceedings.  The remaining differencerelates to significant adjustments to our staffing including employmentreductions of approximately 15% before acquisitions, or approximately $3.4million, offset by increases in selling costs of approximately $0.8 million,increase in healthcare costs of approximately $1.4 million, increase inacquisition-related costs of approximately $0.8 million, and increase inprofessional fees of approximately $1.2 million.

 

***Interest income*** decreased slightly in 2002 to $2.5 millionfrom $2.9 million in 2001 due to lower average interest rates on invested cash.

 

***Interest expense*** consists of interest on the $150 million, 9%senior subordinated notes less amounts capitalized.  Interest expense decreased slightly in 2002 to $12.7 million from$12.8 million in 2001 due principally to greater interest capitalization in2002 versus 2001.

 

***Income tax benefit.***  LoneStar’s effective tax rate is affected by the carryforward of NOL’s recognizedor not recognized in a particular year and the full valuation allowance placedagainst its net deferred tax assets.  In2002, the tax benefit at the U.S. statutory rate of 35% was reduced by $24.5million of NOL benefit not recognized in the current period as managementbelieves that it is more likely than not the related tax benefits would not berealized.  The ultimate realization ofour deferred tax assets depends upon our ability to generate sufficient taxableincome in the future.  Accordingly, dueto the uncertainty regarding possible utilization of NOL’s and the sensitivityof our earnings to the level of domestic drilling activity, we record avaluation allowance to fully reserve the computed net deferred tax assets.  The income tax benefit for 2002 primarilyconsists of the recognition of state income tax benefits.

 

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# **LIQUIDITY ANDCAPITAL RESOURCES**

 

***Overview***

 

Wehave historically funded our business by issuing securities and through ouroperating activities.  We believe thesesources of funds will provide the liquidity necessary to fund our cashrequirements during 2004.  The followingtable shows our capital resources ($ in millions):

 
|                      |   | **2003** |   | **2002** |   |
|---------------------------|--------|----------|--------|----------|--------|
| Cash and cash equivalents |   | $        | 33.3   |     | $      | 120.5 |   |
| Restricted cash           |   | $        | 32.2   |     | $      | — |   |
| Working capital           |   | $        | 184.2  |     | $      | 281.9 |   |
| Unused credit facility    |   | $        | 125.0  |     | $      | 100.0 |   |

 

AtDecember 31, 2003, our cash balance was $33.3 million.  We used $40.6 million in operating cash flowduring the year ended December 31, 2003, an increase in cash used of $28.2million compared to 2002.  Severaltransactions that occurred in 2003 had a material impact on our liquidity andcapital resources.  In April 2003,we put up a cash deposit totaling $32 million to collateralize a bond for abreach of contract judgment on appeal. These funds are reported in our balance sheet as restricted cash.  In May 2003, we acquired substantially allof the assets of Delta Tubular Processing (“Delta”) for $14.0 million in cashplus acquisition costs.  InJune 2003, we acquired certain assets of Frank’s Tubular International(since renamed Delta Tubular International, or “Delta International”) for $18.9million in cash plus acquisition costs. These transactions reduced our working capital by approximately $65million in 2003 compared to 2002.

 

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

 

Cashprovided by (used in) operating activities was ($40.6) million, ($12.4)million, and $31.3 million for 2003, 2002, and 2001, respectively.  Cash from operations in 2003 decreasedprincipally due to the net loss of $68.2 million and establishment of a cashdeposit of $32 million held as restricted cash, offset by increased accountspayable and accrued liabilities.    Thefollowing table shows our sources and uses of cash from operations ($ inmillions):

 
|                                                 |   | **2003** |   | **2002** |   | **2001** |   |
|------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Cash flows from operating activities:                |   |     |   |     |   |     |   |
| Cash received from customers                         |   | $        | 526.0  |     | $      | 535.6    |   | $ | 675.0 |   |
| Cash paid to suppliers and employees                 |   | (555.7   | )      | (540.0   | )      | (633.0   | )      |
| Interest received                                    |   | 1.2      |   | 2.5      |   | 2.9      |   |
| Interest paid                                        |   | (14.0    | )      | (13.7    | )      | (13.1    | )      |
| Income taxes (paid) refunded                         |   | —   |   | 1.0      |   | (0.8     | )      |
| Miscellaneous cash (paid) received                   |   | 1.9      |   | 2.2      |   | 0.3      |   |
|                                                 |   |     |   |     |   |     |   |
| Net cash provided by (used in) operating  activities |   | $        | (40.6  | )        | $      | (12.4    | )      | $ | 31.3 |   |

 

Cashreceived from customers decreased by 2% in 2003 compared to 2002 as days salesoutstanding (DSO) increased to 49 days in 2003 compared to 42 days for 2002 and40 days in 2001.  Cash paid to suppliersand employees increased by 3% in 2003 compared to 2002, principally as a resultof increased raw material costs in 2003.  Cash received from customers and cash paid to suppliers and employees in2001 are greater due to 24% greater revenues in 2001 compared to 2002, and to aDSO of 40 in 2001 compared to a DSO of 42 in 2002.  Further, excluding our acquisition of Wheeling, inventories werereduced in 2002 compared to 2001 by $6.4 million in response to the generaldecline in the domestic U.S. economy including the associated decrease indemand for oilfield and heat recovery products.

 

Cashused in investing activities was $48.0 million, $54.0 million and $14.7 millionfor 2003, 2002, and 2001, respectively. Cash used in 2003 relates principally to our acquisitions of Delta andDelta International and capital expenditures. Cash used in 2002 relates to our acquisition of Wheeling and capitalexpenditures to improve the efficiencies and effectiveness of our productioncapabilities and to install new computer-based enterprise resource planningsystems.  Cash used in 2001 primarilyrelates to higher capital expenditures to expand our finned tubular productscapacity in Mexico and Canada and to install new computer-based enterpriseresource planning systems.

 

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Cashprovided by financing activities was $0.5 million, $81.5 million, and $63.2million in 2003, 2002, and 2001, respectively. Cash provided in 2003 from proceeds of stock option exercises totaling$1.3 million was offset by purchases of treasury stock of $0.8 million. Cashprovided in 2002 relates to proceeds from the offering of 3.3 million shares ofLone Star common stock totaling $82.8 million, partially offset by $1.3 millionpurchase of treasury shares.  Cashprovided by financing activities in 2001 was generated from the proceeds of thesale of $150 million senior subordinated notes and $50.8 million of commonstock, offset by repayments on the revolving credit facilities and term loans.

 

InDecember 2003, Lone Star amended and restated its $100 million credit facility(“Amended Credit Facility”) to increase the total available borrowings to $125million and extend the expiration date to November 2006.  Borrowings under the Amended Credit Facilitycan be used for general corporate purposes. Under the agreement, Lone Star can borrow an amount based on apercentage of eligible accounts receivable and inventories reduced byoutstanding letters of credit, which totaled $0.8 million at December 31,2003.  The availability under theAmended Credit Facility was $124.2 million at December 31, 2003.  Borrowings under the Amended Credit Facilityare collateralized 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.  AtDecember 31, 2003 and 2002, no amount was outstanding under its creditfacility.  For 2003, we were incompliance with the facility’s covenants and we do not anticipatenon-compliance in the foreseeable future.

 

OnApril 23, 2002, Lone Star sold 3.3 million shares of common stock under apreviously filed universal shelf registration statement.  Proceeds to Lone Star were $82.8million.  Lone Star used the remainingnet proceeds from this sale to acquire other complementary businesses, to makecompatible asset investments, and provide funds for working capital and othergeneral corporate purposes.

 

OnOctober 16, 2002, Lone Star filed a universal shelf registration statementthat became effective on April 18, 2003 to sell from time to time up to atotal of $136.0 million of debt securities, preferred stock, common stock,depository shares and warrants.  LoneStar has an aggregate of approximately $250.0 million of registered securitiesavailable, including a previously filed universal shelf registration statement.

 

OnMay 29, 2001, we issued $150.0 million 9% senior subordinated notes dueJune 1, 2011 to qualified institutional buyers.  Interest on the outstanding senior subordinated notes accrues ata rate of 9% per year, payable semi-annually in arrears on each June 1 andDecember 1, commencing December 1, 2001.  We used the proceeds received from the senior notes to pay downthe revolving lines of credit, term loans, slab consignment obligations and forgeneral corporate purposes.  The notesare fully and unconditionally guaranteed by each of our current and futuredomestic restricted subsidiaries.

 

OnMay 2, 2001, we sold 1.2 million shares of our common stock under a previouslyfiled universal shelf registration statement. The proceeds to us were $50.8 million. Proceeds of the sale were used to extinguish debt associated with creditfacilities at our subsidiaries, Lone Star Steel Company (Steel) and FintubeTechnologies, Inc. (Fintube), and for general corporate purposes.

 

Weoperate in capital intensive businesses. We have made, and we expect we will berequired to make, significant capital expenditures each year for recurringmaintenance necessary to keep manufacturing facilities operational, to complywith environmental and other legal requirements and to improve our informationsystems. Additionally, we regularly make capital expenditures for technologicalimprovements and for research and development projects. If funding isinsufficient at any time in the future, we may be unable to develop or enhanceour products or services, take advantage of business opportunities or respondto competitive pressures.  Our capitalexpenditures budget for 2004 is approximately $17 million.

 

Ouroperations are subject to environmental compliance and permitting requirementsof various foreign, federal, state and provincial governmental agencies. Webelieve that the cost of maintaining compliance with environmental requirementswill fall within our contemplated operating and capital expenditure plans,averaging $1.0 million to $2.0 million annually in the foreseeable future.

 

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**OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATECONTRACTUAL OBLIGATIONS**

 

AtDecember 31, 2003, we had contractual cash obligations to repay debt, tomake payments under leases, purchase obligations, and commercial commitments inthe form of unused lines of credit. Payments due under these long-term obligations are as follows ($ in millions):

 
|                          |   | **Obligations  Due By Period** |   |
|-------------------------------|--------|--------------------------------|--------|
| **Contractual Obligations**   |   | **Total**                      |   | **Less Than  One Year** |   | **1 - 3  Years** |   | **3 - 5  Years** |   | **More  Than Five  Years** |   |
| Long term debt obligations    |   | $                              | 150.0  |   | $ | — |   | $ | — |   | $ | — |   | $ | 150.0 |   |
| Operating lease obligations   |   | 4.5                            |   | 1.6 |   | 2.6 |   | 0.3 |   | — |   |
| Purchase obligations          |   | 18.5                           |   | 10.9 |   | 7.6 |   | — |   | — |   |
|                          |   |                           |   |   |   |   |   |   |   |   |   |
| Total Contractual Obligations |   | $                              | 173.0  |   | $ | 12.5 |   | $ | 10.2 |   | $ | 0.3 |   | $ | 150.0 |   |

 

Commercialcommitment expirations are as follows ($ in millions):

 
|                   |   | **Commitment  Expiration by Period** |   |
|------------------------|--------|--------------------------------------|--------|
|                   |   | **Total**                            |   | **Less Than  One Year** |   | **1 - 3 Years** |   | **3 - 5  Years** |   | **More  Than Five  Years** |   |
| Unused credit facility |   | $                                    | 125.0  |   | $ | — |   | $ | 125.0 |   | $ | — |   | $ | — |   |   |
|                        |        |                                      |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

TheFASB issued Statement of Financial Accounting Standards No. 145, *Rescission of FASB Statements No. 4, 44, and 64,Amendment of FASB Statement No. 13, and Technical Corrections* (“SFASNo. 145”), in April 2002 and is effective for fiscal years beginning afterMay 15, 2002.  SFAS No. 145 amends existing authoritative pronouncements to makevarious technical corrections, clarify meanings, or describe theirapplicability under changed conditions.  Upon our adoption of SFAS No. 145 in 2003, the extraordinary loss of$0.6 million recorded in 2001 was reclassified as other expense.

 

TheFASB issued Statement of Financial Accounting Standards No. 146, *Accounting for Costs Associated with Exit or DisposalActivities* (“SFAS No. 146”), in June 2002.  SFAS No. 146 requires the recognition ofcosts associated with exit or disposal activities when they are incurred ratherthan at the date of a commitment to an exit or disposal plan.  SFAS No. 146 is applied to exit or disposalactivities initiated after December 31, 2002.  The adoption of SFAS No. 146 did not have a material effect onour results of operations or financial position.

 

InNovember 2002, the FASB issued FASB Interpretation No. 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*(“FIN 45”).  This interpretationelaborates on the disclosures to be made by a guarantor in its interim andannual financial statements about its obligations under certain guarantees thatit has issued.  It also clarifies that aguarantor is required to recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee.  The disclosure requirementsof this interpretation are effective for interim and annual periods afterDecember 15, 2002.  The initialrecognition and initial measurement requirements of this interpretation areeffective prospectively for guarantees issued or modified afterDecember 31, 2002.  Theinterpretation’s expanded disclosures are in included in the Notes toConsolidated Financial Statements.   Theadoption of the initial recognition and measurement requirements of FIN 45 didnot have a material effect on our results of operations or financial position.

 

InDecember 2002, the FASB issued Statement of Financial Accounting StandardsNo. 148, *Accounting for Stock-BasedCompensation - Transition and Disclosure - an amendment of FASB Statement No.123* (“SFAS No. 148”).  SFASNo. 148 amends SFAS No. 123, *Accounting forStock-Based Compensation*, to provide alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No.123 to require prominent disclosures in both annual and interim financialstatements about the method of accounting for stock-based employee 

 

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compensationand the effect of the method used on reported results.  We have included additional disclosures inaccordance with SFAS No. 148 in the Notes to the Financial Statements.  We have not elected to make a voluntarychange to the fair value based method of accounting for stock-basedcompensation.

 

InJanuary 2003, the FASB issued FASB Interpretation No. 46, *Consolidation of Variable Interest Entities, anInterpretation of ARB No. 51*(“FIN 46”), which addressesconsolidation by business enterprises of variable interest entities, or VIEs,either: (1) that do not have sufficient equity investment at risk to permit theentity to finance its activities without additional subordinated financial support,or (2) in which the equity investors lack an essential characteristic of acontrolling financial interest. In December 2003, the FASB completeddeliberations of proposed modifications to FIN 46 (“Revised Interpretations”)resulting in multiple effective dates based on the nature as well as thecreation date of the VIE. We do not expect the adoption of this Interpretationto have a material impact on our results of operations or financial position.

 

InApril 2003, the FASB issued Statement of Financial Accounting StandardsNo. 149, *Amendment of Statement 133 onDerivative Instruments and Hedging Activities* (“SFAS No. 149”). SFASNo. 149 amends and clarifies the accounting for derivative instruments,including certain derivative instruments embedded in other contracts, and forhedging activities under SFAS No. 133, *Accountingfor Derivative Instruments and Hedging Activities*.  SFAS No. 149 is generally effective forcontracts entered into or modified after June 30, 2003 and for hedgingrelationships designated after June 30, 2003. The adoption of SFAS 149 didnot have a material effect on our results of operations or financial position.

 

InMay 2003, the FASB issued Statement of Financial Accounting Standards No. 150, *Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity*(“SFAS No. 150”).SFAS No. 150 requires that certain financial instruments, which under previousguidance were accounted for as equity, must now be accounted for asliabilities. The financial instruments affected include mandatorily redeemablestock, certain financial instruments that require or may require the issuer tobuy back some of its shares in exchange for cash or other assets and certainobligations that can be settled with shares of stock.  For public entities, SFAS 150 is effective for mandatorilyredeemable financial instruments entered into or modified after May 31, 2003and is effective for all other financial instruments as of the first interimperiod beginning after June 15, 2003. For mandatorily redeemablenon-controlling interests that would not have to be classified as liabilitiesby a subsidiary under the exception in paragraph 9 of SFAS 150, but would beclassified as liabilities by the parent, the classification and measurement provisionsof SFAS 150 are deferred indefinitely. The measurement provisions of SFAS 150are also deferred indefinitely for other mandatorily redeemable non-controllinginterests that were issued before November 4, 2003. The adoption of SFAS150 did not have a material effect on our results of operations or financialposition.

 

**FORWARD-LOOKING INFORMATION**

 

Thestatements included in this Annual Report regarding future financialperformance and results and the other statements that are not historical factsare forward-looking statements.  Thewords “believes,” “intends,” “expects,” “anticipates,” “projects,” “estimates,”“predicts,” and similar expressions are also intended to identifyforward-looking statements.  Suchstatements involve risks, uncertainties and assumptions, including, but notlimited to, industry and market conditions, environmental liabilities,competitive pricing, practices and conditions, availability and pricing of rawmaterials, fluctuations in prices of crude oil and natural gas, the tradeenvironment, the impact of current and future laws and governmental regulations(particularly environmental laws and regulations), and other factors discussedin this Annual Report and in other filings with the Securities and ExchangeCommission.  Should one or more of theserisks or uncertainties materialize, or should underlying assumptions proveincorrect, actual outcomes may vary materially from those indicated.

 

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

 

Weare exposed to certain risks associated with the change in foreign currencyrates, interest rates and commodity prices. We seek to minimize the potential adverse impact of those market risksthrough the use of appropriate management techniques including the limited useof derivative financial instruments.

 

Ouroperations in Mexico and Canada are accounted for in the local currencies,converted to the U.S. dollar equivalent based on published exchange rates forthe period reported and are therefore subject to risk of exchange ratefluctuations.  We believe that ourcurrent risk exposure to exchange rate movements is not significant.

 

Ourinvestments in cash equivalents, the weighted average maturity of which is lessthan one year, are subject to interest rate risk.  The value of these securities would decline in the event ofincreases in market interest rates.  Wemanage this risk by investing in securities with short-term maturities andvarying maturity dates.  In addition, weintend to hold these securities until maturity and, as a result, avoid thelosses resulting from sudden changes in interest rates.

 

Tothe extent that we borrow against our credit facility, we are exposed tointerest rate risk arising from the variable-rate nature of the facility. Therewere no borrowings on this facility at December 31, 2003.  In the past, we have used interest rateswaps to effectively fix a portion of the interest rates on our variable ratecredit facilities.  We did not have any interestrate swaps at December 31, 2003. Our senior subordinated notes accrue interest at a fixed rate of9%.  The fair value of the notes issensitive to changes in interest rates. The fair value of Lone Star’s senior subordinated debt based on quoted marketprices was $149.3 million and $137.4 million at December 31, 2003 and2002, respectively.

 

Weare subject to commodity price risk, primarily with respect to purchases ofsteel and natural gas.  Purchased steelrepresents a significant portion of our cost of goods sold.  As a result, fluctuations in the cost ofpurchased steel, which can be volatile and cyclical in nature, have asignificant impact on our margins both positively and negatively.  Our steel costs have risen significantlysince the end of 2003.  We have beensuccessful in passing these higher steel costs on to our customers.  However, there can be no assurance that wewill continue to be able to do so in the future.

 

Wepurchase natural gas for our operations and therefore have a limited marketrisk in natural gas prices.  As aresult, our earnings could be affected by changes in the price of naturalgas.  As market conditions dictate, wemay enter into contracts to acquire a significant portion of our natural gasrequirements over periods ranging from six to eighteen months.  Our remaining requirements are purchased onthe market at the current value.

 

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**ITEM 8.****     CONSOLIDATED FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

 
|   | Independent Auditors’  Report - Deloitte & Touche LLP                                                    |   |
|--------|-------------------------------------------------------------------------------------------------------------------|--------|
|   | Report of  Independent Public Accountants - Arthur Andersen LLP                                                   |   |
|   | Consolidated Results  of Operations  for the years ended December 31, 2003, 2002, and 2001                   |   |
|   | Consolidated Balance Sheets  at December 31, 2003 and 2002                                                   |   |
|   | Consolidated  Statements of Cash Flows,  for the years ended December 31, 2003, 2002, and 2001               |   |
|   | Consolidated  Statements of Shareholders’ Equity  for the years ended December 31, 2003, 2002, and 2001 |   |
|   | Notes to Consolidated  Financial Statements                                                                       |   |
|   | Schedule II  - Valuation and Qualifying Accounts                                                             |   |

 

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**INDEPENDENT AUDITORS’ REPORT**

 

Tothe Shareholders and Board of Directors of Lone Star Technologies, Inc. andsubsidiaries (the “Company”):

 

Wehave audited the accompanying consolidated balance sheets of Lone StarTechnologies, Inc. and subsidiaries as of December 31, 2003 and 2002, andthe related consolidated statements of operations, shareholders’ equity andcash flows for the years ended December 31, 2003 and 2002.  The financial statements of Lone StarTechnologies, Inc. for the year ended December 31, 2001 were audited byother auditors who have ceased operations. Those auditors expressed anunqualified opinion on those financial statements in their report datedJanuary 22, 2002.  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 auditing standards generally acceptedin the United States of America.  Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

Inour opinion, such 2003 and 2002 financial statements present fairly, in allmaterial respects, the financial position of Lone Star Technologies, Inc. andsubsidiaries at December 31, 2003 and 2002, and the results of theiroperations and their cash flows for the years ended December 31, 2003 and2002, in conformity with accounting principles generally accepted in the UnitedStates of America.

 

Asdiscussed in Note C to the financial statements, in 2002 the Company changedits method of accounting for goodwill and other intangible assets to conform toStatement of Financial Accounting Standards (“SFAS”) No. 142.  The financialstatements of Lone Star Technologies, Inc. for the year ended December 31,2001 were audited by other auditors who have ceased operations. As described inNote C, these financial statements have been revised to include thetransitional disclosures required by Statement of Financial Accounting StandardNo. 142, “Goodwill and Other Intangible Assets”, which was adopted by the Companyas of January 1, 2002.  Our auditprocedures with respect to the disclosures in Note C with respect to 2001included (a) agreeing the previously reported net income to the previouslyissued financial statements and the adjustments to reported net incomerepresenting amortization expense recognized in those periods related togoodwill and intangible assets that are no longer being amortized as a resultof initially applying Statement No. 142 (including any related tax effects) tothe Company’s underlying records obtained from management, and (b) testing themathematical accuracy of the reconciliation of adjusted net income to reportednet income, and the related earnings-per-share amounts.

 

Asdiscussed in Note A, during 2003, the Company adopted SFAS No. 145 and as aresult, reclassified the extraordinary loss of $0.6 million recorded in 2001 toother expense.  Our audit procedureswith respect to the reclassification for 2001 included testing the mathematicalaccuracy of the addition to other expense of $0.6 million and the reduction ofincome before income tax of the same amount and noted that the extraordinaryloss line item was deleted.

 

Inour opinion, the disclosures and reclassification for 2001 presented anddiscussed in Notes C and A, are appropriate. However, we were not engaged to audit, review, or apply any proceduresto the 2001 financial statements of the Company other than with respect to suchdisclosures and reclassifications and, accordingly, we do not express anopinion or any other form of assurance on the 2001 financial statements takenas a whole.

 

 

DELOITTE& TOUCHE LLP

 

Dallas,Texas

March 12,2004

 

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**THIS REPORT IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHURANDERSEN LLP. THE REPORT HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP NOR HASARTHUR ANDERSEN LLP PROVIDED A CONSENT TO THE INCLUSION OF ITS REPORT IN THISFORM 10-K.**

 

 

**REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS**

 

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

 

Wehave audited the accompanying consolidated balance sheets of Lone Star (aDelaware corporation) and subsidiaries as of December 31, 2001 and 2000,and the related consolidated statements of income, shareholders’ equity, andcash flows for each of the three years in the period ended December 31,2001.  These financial statements andthe schedules referred to below are the responsibility of Lone Star’smanagement.  Our responsibility is toexpress an opinion on these financial statements and schedules based on ouraudits.

 

Weconducted our audits in accordance with auditing standards generally acceptedin the United States.  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position of LoneStar and subsidiaries as of December 31, 2001 and 2000, and the results oftheir operations and their cash flows for the three years endedDecember 31, 2001, in conformity with accounting principles generallyaccepted in the United States.

 

Ouraudits were made for the purpose of forming an opinion on the basicconsolidated financial statements taken as a whole.  The schedules listed in the index to consolidated financialstatements are presented for the purpose of complying with the Securities andExchange Commission’s rules and are not a part of the basic consolidatedfinancial statements.  These scheduleshave been subjected to the auditing procedures applied in our audits of the basicconsolidated financial statements and, in our opinion, fairly state in allmaterial respects the financial data required to be set forth therein inrelation to the basic consolidated financial statements taken as a whole.

 

 

ARTHURANDERSEN LLP

 

Dallas,Texas,

January 22,2002

 

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**LONE STAR TECHNOLOGIES, INC.**

**CONSOLIDATED RESULTS OF OPERATIONS**

***($ and shares in millions, except pershare data)***

 
|                                                |   | **For the  Years Ended December 31,** |   |
|-----------------------------------------------------|--------|---------------------------------------|--------|
|                                                |   | **2003**                              |   | **2002** |   | **2001** |   |
|                                                |   |                                  |   |   |   |   |   |
| Net revenues                                        |   | $                                     | 534.1  |   | $ | 523.7 |   | $ | 650.2 |   |
| Cost of goods sold                                  |   | 528.9                                 |   | 516.3 |   | 580.9 |   |
| Gross profit                                        |   | 5.2                                   |   | 7.4 |   | 69.3 |   |
| Selling, general, and administrative  expenses      |   | 61.5                                  |   | 69.2 |   | 36.1 |   |
| Operating income (loss)                             |   | (56.3                                 | )      | (61.8 | ) | 33.2 |   |
| Interest income                                     |   | 1.4                                   |   | 2.5 |   | 2.9 |   |
| Interest expense                                    |   | (15.4                                 | )      | (12.7 | ) | (12.8 | ) |
| Other income (expense), net                         |   | 2.2                                   |   | 2.1 |   | (6.1 | ) |
| Income (loss) before income tax                     |   | (68.1                                 | )      | (69.9 | ) | 17.2 |   |
| Income tax benefit (expense)                        |   | (0.1                                  | )      | 0.7 |   | (0.8 | ) |
| Net income (loss)                                   |   | $                                     | (68.2  | ) | $ | (69.2 | ) | $ | 16.4 |   |
|                                                |   |                                  |   |   |   |   |   |
| **Per common share – basic:**                  |   |                                  |   |   |   |   |   |
| Net income (loss) available to common  shareholders |   | $                                     | (2.40  | ) | $ | (2.52 | ) | $ | 0.67 |   |
|                                                |   |                                  |   |   |   |   |   |
| **Per common share – diluted:**                |   |                                  |   |   |   |   |   |
| Net income (loss) available to common  shareholders |   | $                                     | (2.40  | ) | $ | (2.52 | ) | $ | 0.66 |   |
|                                                |   |                                  |   |   |   |   |   |
| **Weighted average shares outstanding**             |   |                                  |   |   |   |   |   |
| Basic                                               |   | 28.4                                  |   | 27.5 |   | 24.7 |   |
| Diluted                                             |   | 28.4                                  |   | 27.5 |   | 25.0 |   |

 

See Notes to Consolidated Financial Statements.

 

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**LONE STAR TECHNOLOGIES, INC.**

**CONSOLIDATED BALANCE SHEETS**

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

 
|                                                                                                                      |   | **December  31,** |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|
|                                                                                                                      |   | **2003**          |   | **2002** |   |
| **ASSETS**                                                                                                                |   |              |   |   |   |
|                                                                                                                      |   |              |   |   |   |
| Current Assets:                                                                                                           |   |              |   |   |   |
| Cash and cash equivalents                                                                                                 |   | $                 | 33.3   |   | $ | 120.5 |   |
| Accounts receivable, less allowances of $1.7  and $1.6, respectively                                                      |   | 71.8              |   | 60.2 |   |
| Inventories                                                                                                               |   | 152.8             |   | 148.5 |   |
| Other current assets                                                                                                      |   | 14.7              |   | 12.6 |   |
| Total current assets                                                                                                      |   | 272.6             |   | 341.8 |   |
|                                                                                                                      |   |              |   |   |   |
| Property, plant, and equipment, net                                                                                       |   | 220.0             |   | 204.4 |   |
| Goodwill                                                                                                                  |   | 40.9              |   | 55.1 |   |
| Restricted cash                                                                                                           |   | 32.2              |   | — |   |
| Other noncurrent assets                                                                                                   |   | 9.9               |   | 11.6 |   |
|                                                                                                                      |   |              |   |   |   |
| Total assets                                                                                                              |   | $                 | 575.6  |   | $ | 612.9 |   |
|                                                                                                                      |   |              |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                             |   |              |   |   |   |
|                                                                                                                      |   |              |   |   |   |
| Current Liabilities:                                                                                                      |   |              |   |   |   |
| Accounts payable                                                                                                          |   | $                 | 60.4   |   | $ | 37.5 |   |
| Accrued liabilities                                                                                                       |   | 28.0              |   | 22.4 |   |
| Total current liabilities                                                                                                 |   | 88.4              |   | 59.9 |   |
|                                                                                                                      |   |              |   |   |   |
| Senior subordinated debt                                                                                                  |   | 150.0             |   | 150.0 |   |
| Postretirement benefit obligations                                                                                        |   | 44.5              |   | 45.6 |   |
| Other noncurrent liabilities                                                                                              |   | 46.8              |   | 44.8 |   |
| Total liabilities                                                                                                         |   | 329.7             |   | 300.3 |   |
|                                                                                                                      |   |              |   |   |   |
| Commitments and Contingencies (See Note J)                                                                                |   |              |   |   |   |
|                                                                                                                      |   |              |   |   |   |
| 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:  28,660,903 and 28,539,014, respectively) |   | 28.7              |   | 28.5 |   |
| Capital surplus                                                                                                           |   | 355.1             |   | 352.7 |   |
| Accumulated other comprehensive loss                                                                                      |   | (32.2             | )      | (32.1 | ) |
| Accumulated deficit                                                                                                       |   | (103.4            | )      | (35.2 | ) |
| Treasury stock, at cost (174,107 and  105,844 shares, respectively)                                                       |   | (2.3              | )      | (1.3 | ) |
| Total shareholders’ equity                                                                                           |   | 245.9             |   | 312.6 |   |
|                                                                                                                      |   |              |   |   |   |
| Total liabilities and shareholders’ equity                                                                           |   | $                 | 575.6  |   | $ | 612.9 |   |

 

See Notes to Consolidated Financial Statements.

 

35

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**LONE STAR TECHNOLOGIES, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

***($ in millions)***

 
|                                                                                                                            |   | **For the  Years Ended December 31,** |   |
|---------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                                                            |   | **2003**                              |   | **2002** |   | **2001** |   |
|                                                                                                                            |   |                                  |   |   |   |   |   |
| **Cash flows from operating activities:**                                                                                       |   |                                  |   |   |   |   |   |
| Net income (loss)                                                                                                               |   | $                                     | (68.2  | ) | $ | (69.2 | ) | $ | 16.4 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities, net of acquired  companies: |   |                                  |   |   |   |   |   |
| Depreciation and amortization                                                                                                   |   | 25.4                                  |   | 21.8 |   | 23.0 |   |
| Loss on early extinguishment of debt                                                                                            |   | —                                |   | — |   | 0.6 |   |
| Non-cash charge for stock compensation                                                                                          |   | 1.1                                   |   | (0.1 | ) | (0.2 | ) |
| Net loss (gain) on property disposals and  impairments                                                                          |   | 0.4                                   |   | (0.1 | ) | — |   |
| Goodwill impairment                                                                                                             |   | 18.7                                  |   | — |   | — |   |
| Accounts receivable                                                                                                             |   | (8.1                                  | )      | 11.9 |   | 24.8 |   |
| Inventories                                                                                                                     |   | (4.0                                  | )      | 6.4 |   | (9.9 | ) |
| Accounts payable and accrued liabilities                                                                                        |   | 27.3                                  |   | (6.9 | ) | (17.6 | ) |
| Litigation reserves                                                                                                             |   | 2.0                                   |   | 32.0 |   | — |   |
| Restricted cash                                                                                                                 |   | (32.2                                 | )      | — |   | — |   |
| Other                                                                                                                           |   | (3.0                                  | )      | (8.2 | ) | (5.8 | ) |
|                                                                                                                            |   |                                  |   |   |   |   |   |
| Net cash provided by (used in) operating  activities                                                                            |   | (40.6                                 | )      | (12.4 | ) | 31.3 |   |
|                                                                                                                            |   |                                  |   |   |   |   |   |
| **Cash flows from investing activities:**                                                                                       |   |                                  |   |   |   |   |   |
| Capital expenditures                                                                                                            |   | (14.4                                 | )      | (15.9 | ) | (25.2 | ) |
| Sale of short-term investments                                                                                                  |   | —                                |   | — |   | 0.1 |   |
| Sale of marketable securities                                                                                                   |   | —                                |   | — |   | 10.4 |   |
| Proceeds from sale of property, plant and  equipment                                                                            |   | 0.4                                   |   | 0.2 |   | — |   |
| Cash paid for acquisitions, net of cash  received                                                                               |   | (34.0                                 | )      | (38.3 | ) | — |   |
|                                                                                                                            |   |                                  |   |   |   |   |   |
| Net cash used in investing activities                                                                                           |   | (48.0                                 | )      | (54.0 | ) | (14.7 | ) |
|                                                                                                                            |   |                                  |   |   |   |   |   |
| **Cash flows from financing activities:**                                                                                       |   |                                  |   |   |   |   |   |
| Net proceeds from issuance of senior  subordinated debt                                                                         |   | —                                |   | — |   | 145.9 |   |
| Debt issuance costs                                                                                                             |   | —                                |   | — |   | (1.0 | ) |
| Net (payments) borrowings under revolving  credit facilities                                                                    |   | —                                |   | — |   | (96.2 | ) |
| Principal payments on term notes                                                                                                |   | —                                |   | — |   | (40.0 | ) |
| Proceeds from exercise of options                                                                                               |   | 1.3                                   |   | — |   | 4.4 |   |
| Net proceeds from stock offering                                                                                                |   | —                                |   | 82.8 |   | 50.1 |   |
| Purchase of treasury stock                                                                                                      |   | (0.8                                  | )      | (1.3 | ) | — |   |
|                                                                                                                            |   |                                  |   |   |   |   |   |
| Net cash provided by financing activities                                                                                       |   | 0.5                                   |   | 81.5 |   | 63.2 |   |
|                                                                                                                            |   |                                  |   |   |   |   |   |
| Effect of foreign exchange rate changes on  cash                                                                                |   | 0.9                                   |   | (1.1 | ) | — |   |
|                                                                                                                            |   |                                  |   |   |   |   |   |
| Net change in cash and cash equivalents                                                                                         |   | (87.2                                 | )      | 14.0 |   | 79.8 |   |
| Cash and cash equivalents, beginning of  year                                                                                   |   | 120.5                                 |   | 106.5 |   | 26.7 |   |
|                                                                                                                            |   |                                  |   |   |   |   |   |
| Cash and cash equivalents, end of year                                                                                          |   | $                                     | 33.3   |   | $ | 120.5 |   | $ | 106.5 |   |
|                                                                                                                            |   |                                  |   |   |   |   |   |
| **Supplemental cash flow disclosure:**                                                                                          |   |                                  |   |   |   |   |   |
| Interest paid                                                                                                                   |   | $                                     | 13.9   |   | $ | 13.7 |   | $ | 13.1 |   |
| Income taxes paid (refunded), net                                                                                               |   | $                                     | — |   | $ | (1.0 | ) | $ | 0.8 |   |

 

See Notes to Consolidated Financial Statements.

 

36

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**LONE STAR TECHNOLOGIES, INC.**

**CONSOLIDATED STATEMENTS OF SHAREHOLDERS’EQUITY**

***($ in millions)***

 
|                                    |   | **Common  Stock** |   | **Capital  Surplus** |   | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Accumulated  Earnings  (Deficit)** |   | **Treasury  Stock** |   | **Total** |   |
|-----------------------------------------|--------|-------------------|--------|----------------------|--------|------------------------------------------------------|--------|--------------------------------------|--------|---------------------|--------|-----------|--------|
|                                    |   |              |   |                 |   |                                                 |   |                                 |   |                |   |      |   |
| **Balance, January 1, 2001**            |   | $                 | 23.8   |                 | $      | 221.5                                                |   | $                                    | (3.6   | )                   | $      | 17.6      |   | $ | (3.5 | ) | $ | 255.8 |   |
|                                    |   |              |   |                 |   |                                                 |   |                                 |   |                |   |      |   |
| Net income                              |   | —            |   | —               |   | —                                               |   | 16.4                                 |   | —              |   | 16.4      |   |
| Other comprehensive income (loss):      |   |              |   |                 |   |                                                 |   |                                 |   |                |   |      |   |
| Minimum pension liability adjustment    |   | —            |   | —               |   | (12.2                                                | )      | —                               |   | —              |   | (12.2     | )      |
| Foreign currency translation adjustment |   | —            |   | —               |   | (0.1                                                 | )      | —                               |   | —              |   | (0.1      | )      |
| Comprehensive income                    |   |              |   |                 |   |                                                 |   |                                 |   |                |   | 4.1       |   |
| Stock issuance for acquisition          |   | 1.1               |   | 49.0                 |   | —                                               |   | —                               |   | —              |   | 50.1      |   |
| Employee benefit plan stock issuance    |   | 0.3               |   | 1.5                  |   | —                                               |   | —                               |   | 3.5                 |   | 5.3       |   |
|                                    |   |              |   |                 |   |                                                 |   |                                 |   |                |   |      |   |
| **Balance, December 31, 2001**          |   | 25.2              |   | 272.0                |   | (15.9                                                | )      | 34.0                                 |   | —              |   | 315.3     |   |
|                                    |   |              |   |                 |   |                                                 |   |                                 |   |                |   |      |   |
| Net loss                                |   | —            |   | —               |   | —                                               |   | (69.2                                | )      | —              |   | (69.2     | )      |
| Other comprehensive income (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 |   |

 

See Notes to Consolidated Financial Statements.

 

37

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**Lone Star Technologies, Inc.**

**Notes to ConsolidatedFinancial Statements**

 

Lone Star Technologies, Inc. (“Lone Star”, orthe “Company”), a Delaware corporation, is a management and holding companywith six principal operating subsidiaries, Lone Star Steel Company (“Steel”),Fintube Technologies, Inc. (“Fintube”), Bellville Tube Company, L.P.(“Bellville”), Wheeling Machine Products, Inc. (“Wheeling”), acquired October 1, 2002, Delta Tubular Processing(“Delta”), acquired May 1, 2003 and, Delta Tubular International (“DeltaInternational”), acquired June 2, 2003. Steel manufactures and globally markets oilfield tubular products to theoil and gas drilling industry, mechanical tubing products to automotive, fluidpower, and other markets for various mechanical applications, and flat rolledsteel and other tubular products to domestic industrial markets.  Fintube manufactures specialty finnedtubular products used in a variety of heat recovery applications includingcombined-cycle electrical power generation. Bellville manufactures oilfield tubular products.  Wheeling manufactures couplings used toconnect individual sections of oilfield casing and tubing.  Delta and Delta International provide oilcountry tubular processing services including threading and inspectionservices.

 

Lone Star’s consolidated revenues are not seasonal.  However, demand for oilfield products issubject to significant fluctuations due to the volatility of oil and gas pricesand domestic drilling activity as well as other factors including competitionfrom imports.  Demand for mechanicaltubing and finned tubular products is primarily subject to fluctuations ingeneral economic conditions.

 

**ACCOUNTING POLICIES - NOTE A**

 

***Principles of consolidation***.  Theconsolidated financial statements include the accounts of Lone Star and itswholly-owned subsidiaries.  Allsignificant intercompany accounts and transactions have been eliminated inconsolidation.  In the Notes toConsolidated Financial Statements, all dollar and share amounts in tabulationare in millions of dollars and shares, respectively, 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 include commercial bank accountsand highly liquid investments in a fund consisting of U. S. government andrelated agencies obligations with original maturities of less than threemonths.

 

AtDecember 31, 2003, Lone Star had restricted cash of $32.2 million relatedto a cash deposit that collateralizes a bond for a breach of contract judgmenton appeal.  See Commitments andContingencies - Note J.

 

***Inventories*** are stated at the lower of cost or marketvalue.  Cost is determined using thelast-in, first-out (“LIFO”) method for approximately 90% and 84% of theCompany’s total current inventories after LIFO reserve at December 31,2003 and 2002, respectively.  The costof remaining inventories is determined using the first-in, first-out (“FIFO”)method.  Inventories include rawmaterials, labor, overhead and certain supplies.

 

***Property, plant, and equipment*** are stated at cost.  Significant betterments and improvements arecapitalized if they extend the useful life of the asset, while maintenance andrepairs are expensed when incurred. Depreciation is provided on the straight-line method over the estimateduseful lives of depreciable assets as follows:

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

 

***Impairment of long-lived assets.***** **In accordancewith SFAS No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets*, Lone Star periodicallyevaluates the recoverability of long-lived assets whenever events and changesin circumstances indicate that the carrying amount of an asset may not be fullyrecoverable.  At December 31, 2003,the Company believes that its long-lived assets have not been impaired.

 

***Income taxes***.  Lone Star applies the provisions of SFAS No.109, *Accounting for Income Taxes*,which utilizes an asset and liability approach for financial accounting andincome tax reporting.  Deferred taxliabilities or assets are recognized for the estimated future tax effectsattributable to temporary differences and carryforwards and are adjusted

 

38

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whenevertax rates or other provisions of income tax statutes change.  Deferred tax assets are reduced, if deemednecessary, by a valuation allowance for any tax benefits that are not expectedto be realized.

 

***Revenue recognition***. Product revenues are recognized as sales when revenue is earned and isrealized or realizable.  This includessatisfying the following criteria:  thearrangement with the customer is evident, usually through the receipt of apurchase order; the sales price is fixed or determinable; delivery hasoccurred, which may include delivery to the customer storage warehouse locationat one of the Company’s subsidiaries in which instance, the risk of loss hasbeen passed to the customer; and collectibility is reasonably assured.  Freight and shipping that is billed tocustomers is included in net sales, and the cost of shipping is included incost of sales.  The Company hasmarketing agreements to sell steel oilfield tubular products manufactured byother companies.  Revenue is recorded ona gross 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.

 

***Stock-Based Employee Compensation. ***The Company accounts for stock-basedcompensation utilizing the intrinsic value method in accordance with theprovisions 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 I for further information.

 

Theweighted average fair value per option granted in 2003, 2002, and 2001 was$9.70, $9.65, and $20.78, respectively. The fair value of each option grant is estimatedon the date of grant using the Black-Scholes option pricing model with thefollowing weighted average assumptions for grants in 2003, 2002, and 2001,respectively: risk-free interest rates of 2.93%, 4.79%, and 4.77%; volatilityof 61.86%, 62.25%, and 54.10%; and, expected lives of five years for all optiongrants without payment of dividends. Had compensation cost for this plan been determined consistent with SFASNo. 123, net income and earnings per share would have been reduced to thefollowing pro forma amounts:

 
|                                                                                                                                                |   | **2003** |   | **2002** |   | **2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Net income (loss) as reported                                                                                                                       |   | $        | (68.2  | )        | $      | (69.2    | )      | $ | 16.4 |   |
| Add:   Stock-based employee compensation expense included in reported net  income (loss), net of related tax effects                           |   | 1.1      |   | 0.9      |   | 0.7      |   |
| Deduct:   Total stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |   | (7.7     | )      | (7.5     | )      | (7.0     | )      |
|                                                                                                                                                |   |     |   |     |   |     |   |
| Pro forma net income (loss)                                                                                                                         |   | $        | (74.8  | )        | $      | (75.8    | )      | $ | 10.1 |   |
|                                                                                                                                                |   |     |   |     |   |     |   |
| Basic earnings (loss) per share                                                                                                                     |   |     |   |     |   |     |   |
| as reported                                                                                                                                         |   | $        | (2.40  | )        | $      | (2.52    | )      | $ | 0.67 |   |
| pro forma                                                                                                                                           |   | $        | (2.63  | )        | $      | (2.76    | )      | $ | 0.41 |   |
| Diluted earnings (loss) per share                                                                                                                   |   |     |   |     |   |     |   |
| as reported                                                                                                                                         |   | $        | (2.40  | )        | $      | (2.52    | )      | $ | 0.66 |   |
| pro forma                                                                                                                                           |   | $        | (2.63  | )        | $      | (2.76    | )      | $ | 0.40 |   |

 

***Foreign currency translation.***** **In accordancewith Statement of Financial Accounting Standards No. 52, *Foreign Currency Translation*(“SFAS No.52”), one of Lone Star’s international operations uses the respective localcurrency as their functional currency while another international operationuses the U.S. Dollar as its functional currency. Revenue and expenses from theCompany’s international operations are translated using the monthly averageexchange rates in effect for the period in which the items occur. The Company’sinternational operation that has the U.S. Dollar as its functional currencytranslates monetary assets and liabilities using current rates of exchange atthe balance sheet date and translates non-monetary assets and liabilities usinghistorical rates of exchange. Gains and

 

39

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lossesfrom remeasurement for such operations are included in other income, net andhave historically not been significant. The Company’s international operationthat does not have the U.S. Dollar as its functional currency translates assetsand liabilities at current rates of exchange in effect at the balance sheetdate. The resulting gains and losses from translation for such subsidiary isincluded as a component of shareholders’ equity.

 

***Business and Credit Risk.***  LoneStar sells products to numerous customers primarily in the oil and gas drillingindustry.  Although this concentrationcould affect the Company’s overall exposure to credit risk, management believesthat the Company is exposed to minimal risk since the majority of its businessis conducted with major companies within the industry.  The Company performs on-going creditevaluations of its customers and generally does not require collateral whenextending credit. The Company maintains a reserve for potential credit losses.Such losses have historically been within management’s expectations.  The Company does not have financialinstruments with off-balance sheet risk.

 

LoneStar maintains cash and cash equivalents with various financial institutions.As part of its cash and risk management processes, the Company performsperiodic evaluations of the relative credit standing of the financialinstitutions.  Lone Star has notsustained credit losses from instruments held at financial institutions.

 

***Use of Estimates. ***Preparationof the consolidated 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.  Significant estimateshave been made to reserve for warranty claims and environmental obligations asfollows:

 

LoneStar’s products are used in applications which are subject to inherent risksincluding well failures, performance deficiencies, line pipe leaks, personalinjury, property damage, environmental contamination or loss ofproduction.  The Company warrants itsproducts to meet certain specifications. Actual or claimed deficiencies from these specifications may give riseto claims and the Company maintains a reserve for asserted and unassertedwarranty claims.  The warranty claimexposure is evaluated using historical claim trends and information availableon specifically known claims. The Company also maintains product and excessliability insurance subject to certain deductibles that limit the exposure tothese claims.  The Company considers theextent of insurance coverage in its 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 couldalter the Company’s exposure and the related reserve.  The following table identifies changes in warranty reserves fromDecember 31, 2001 to December 31, 2003:

 
| Balance at December 31, 2001                                          |   | $      | 3.0    |   |
|-----------------------------------------------------------------------|--------|--------|--------|--------|
| Add:   accruals for warranties during the period                 |   | 2.9    |   |
| Accruals related to pre-existing warranties  and changes in estimates |   | (0.1   | )      |
| Deduct:   settlements made during the period                     |   | (3.7   | )      |
| Balance at December 31, 2002                                          |   | $      | 2.1    |   |
| Add: accruals for warranties during the  period                       |   | 2.0    |   |
| Accruals related to pre-existing warranties  and changes in estimates |   | 0.2    |   |
| Deduct:   settlements made during the period                     |   | (1.9   | )      |
|                                                                  |   |   |   |
| Balance at December 31, 2003                                          |   | $      | 2.4    |   |

 

LoneStar is subject to numerous environmental regulations and is activelyremediating a few known exposures and conducting post-closure monitoringactivities.  The Company maintains anenvironmental reserve to cover the costs of expected remediation andpost-closure monitoring and estimates the range of cost for the remediation andpost-closure based on historical experience, results of monitoring and theknown extent of exposure.  The Companyevaluates the range of exposure and records the reserve at the most probableamount 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.

 

40

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***Fair Value of Financial Instruments.*********The carrying amount of cash and cashequivalents, trade receivables and payables approximates fair value because ofthe short maturity of those instruments. The fair value of Lone Star’s senior subordinated debt based on quotedmarket prices was $149.3 million and $137.4 million at December 31, 2003and 2002, respectively.

 

Asof December 31, 2003 and 2002, the Company had outstanding letters ofcredit of $0.8 million and $2.1 million, respectively, which approximates fairvalue.

 

***New Accounting Pronouncements.***  TheFASB issued Statement of Financial Accounting Standards No. 145, *Rescission of FASB Statements No. 4, 44, and 64,Amendment of FASB Statement No. 13, and Technical Corrections*,(“SFAS No. 145”) in April 2002 and is effective for fiscal years beginningafter May 15, 2002.  SFAS No. 145 amends existing authoritative pronouncements to makevarious technical corrections, clarify meanings, or describe theirapplicability under changed conditions.  Upon the Company’s adoption of SFAS No. 145 in 2003, the extraordinaryloss of $0.6 million recorded in 2001 was reclassified as other expense.

 

TheFASB issued Statement of Financial Accounting Standards No. 146, *Accounting for Costs Associated with Exit or DisposalActivities*, (“SFAS No. 146”) in June 2002.  SFAS No. 146 requires the recognition ofcosts associated with exit or disposal activities when they are incurred ratherthan at the date of a commitment to an exit or disposal plan.  SFAS No. 146 is to be applied prospectivelyto exit or disposal activities initiated after December 31, 2002, withearlier application encouraged.  Theadoption of SFAS No. 146 did not have a material effect on Lone Star’s resultsof operations or financial position.

 

InNovember 2002, the FASB issued FASB Interpretation No. 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*,(FIN 45).  This interpretationelaborates on the disclosures to be made by a guarantor in its interim andannual financial statements about its obligations under certain guarantees thatit has issued.  It also clarifies that aguarantor is required to recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee.  The disclosure requirementsof this interpretation are effective for interim and annual periods afterDecember 15, 2002.  The initialrecognition and initial measurement requirements of this interpretation areeffective prospectively for guarantees issued or modified afterDecember 31, 2002.  Theinterpretation’s expanded disclosures are included in the financial statements.  The adoption of the initial recognition andmeasurement requirements of FIN 45 did not have a material effect on LoneStar’s results of operations or financial position.

 

InDecember 2002, the FASB issued Statement of Financial Accounting StandardsNo. 148, *Accounting for Stock-BasedCompensation - Transition and Disclosure - an amendment of FASB Statement No.123*, (“SFAS No. 148”).  SFASNo. 148 amends SFAS No. 123, *Accounting forStock-Based Compensation*, to provide alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No.123 to require prominent disclosures in both annual and interim financialstatements about the method of accounting for stock-based employee compensationand the effect of the method used on reported results.  Lone Star has included additionaldisclosures in accordance with SFAS No. 148 earlier in this Note.  The Company has not elected to make avoluntary change to the fair value based method of accounting for stock-basedcompensation.

 

InJanuary 2003, the FASB issued FASB Interpretation No. 46, or FIN 46, *Consolidation of Variable Interest Entities, anInterpretation of ARB No. 51*, which addresses consolidation bybusiness enterprises of variable interest entities, or VIEs, either: (1) thatdo not have sufficient equity investment at risk to permit the entity tofinance its activities without additional subordinated financial support, or(2) in which the equity investors lack an essential characteristic of acontrolling financial interest. In December 2003, the FASB completeddeliberations of proposed modifications to FIN 46 (“Revised Interpretations”)resulting in multiple effective dates based on the nature as well as thecreation date of the VIE. Lone Star does not expect the adoption of thisInterpretation to have a material impact on its results of operations orfinancial position.

 

InApril 2003, the FASB issued SFAS No. 149, *Amendmentof Statement 133 on Derivative Instruments and Hedging Activities*. SFASNo. 149 amends and clarifies the accounting for derivative instruments,including certain derivative instruments embedded in other contracts, and forhedging activities under SFAS No. 133, *Accountingfor Derivative*

 

41

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*Instruments and Hedging Activities*. SFAS No. 149 is generally effective for contracts entered into ormodified after June 30, 2003 and for hedging relationships designatedafter June 30, 2003. The adoption of SFAS 149 did not have a materialeffect on Lone Star’s results of operations or financial position.

 

InMay 2003, the FASB issued SFAS No. 150, *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity*. SFAS No. 150 requires that certain financial instruments,which under previous guidance were accounted for as equity, must now beaccounted for as liabilities. The financial instruments affected includemandatorily redeemable stock, certain financial instruments that require or mayrequire the issuer to buy back some of its shares in exchange for cash or otherassets and certain obligations that can be settled with shares of stock.  For public entities, SFAS 150 is effectivefor mandatorily redeemable financial instruments entered into or modified afterMay 31, 2003 and is effective for all other financial instruments as of thefirst interim period beginning after June 15, 2003. For mandatorilyredeemable non-controlling interests that would not have to be classified asliabilities by a subsidiary under the exception in paragraph 9 of SFAS 150, butwould be classified as liabilities by the parent, the classification andmeasurement provisions of SFAS 150 are deferred indefinitely. The measurementprovisions of SFAS 150 are also deferred indefinitely for other mandatorilyredeemable non-controlling interests that were issued before November 4,2003. The adoption of SFAS 150 did not have a material effect on Lone Star’sresults of operations or financial position.

** **

**BUSINESSSEGMENTS  - NOTE B**

 

LoneStar currently has six operating subsidiaries that have separate managementteams and infrastructures 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 2003, 2002, or 2001.  Direct foreign revenues as a percent oftotal revenues were approximately 2% in 2003, 5% in 2002, and 8% in 2001.

 

Theaccounting policies of each segment are the same as those described in Note Aof Notes to Consolidated 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 andcouplings that are manufactured and marketed globally to the oil and gasdrilling industry.  The oilfield segmentincludes premium alloy and carbon welded oil country tubular goods, includingcasing, which acts as a structural retainer wall in oil and natural gaswellbores, and production tubing, which transmits hydrocarbons to thesurface.  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, testing, and storage services.

 

***Specialty tubing.***  LoneStar’s specialty tubing business includes the manufacture, marketing and saleof a variety of custom-engineered tubular products used in exactingapplications, such as the manufacture of hydraulic cylinders for constructionand farm equipment, automotive applications, such as stabilizers and intrusiontubes; and other uses, including machine parts, bearing races, down-hole pumpbarrels, heavy lift crane boom chords, drill rods and liner hangers.  Finned tubulars are used in fueleconomizers, industrial processing, petrochemical plants, refineries and powertechnology applications.

 

***Flat rolled steel and other tubular goods.***  Flatrolled steel is manufactured principally for use by the Company in themanufacture of tubular products.  TheCompany also sells flat rolled steel to fabricators of large diameter pipe,storage tanks, rail cars and a variety of other construction and industrialproducts.  Lone Star also providestransportation, storage and other services to a variety of industries.

 

42

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

 
|                            |   | **Oilfield** |   | **Specialty  Tubing** |   | **Flat  Rolled  Steel and  Other  Tubular  Goods** |   | **Corporate/  Other** |   | **Total** |   |
|---------------------------------|--------|--------------|--------|-----------------------|--------|----------------------------------------------------|--------|-----------------------|--------|-----------|--------|
| 2003                            |   |         |   |                  |   |                                               |   |                  |   |      |   |
| Revenues                        |   | $            | 364.8  |                  | $      | 121.8                                              |   | $                     | 47.5   |      | $      | — |   | $ | 534.1 |   |
| Segment operating income (loss) |   | (8.2         | )      | (39.7                 | )      | (1.5                                               | )      | (6.9                  | )      | (56.3     | )      |
| Depreciation and amortization   |   | 15.1         |   | 9.3                   |   | 0.9                                                |   | 0.1                   |   | 25.4      |   |
| Total assets                    |   | 326.5        |   | 154.0                 |   | 16.2                                               |   | 78.9                  |   | 575.6     |   |
| 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                                               | )      | (37.3                 | )      | (61.8     | )      |
| Depreciation and amortization   |   | 11.2         |   | 9.5                   |   | 1.1                                                |   | —                |   | 21.8      |   |
| Total assets                    |   | 256.4        |   | 208.0                 |   | 18.8                                               |   | 129.7                 |   | 612.9     |   |
| Capital expenditures            |   | 9.1          |   | 6.8                   |   | —                                             |   | —                |   | 15.9      |   |
|                            |   |         |   |                  |   |                                               |   |                  |   |      |   |
| 2001                            |   |         |   |                  |   |                                               |   |                  |   |      |   |
| Revenues                        |   | $            | 401.9  |                  | $      | 187.7                                              |   | $                     | 60.6   |      | $      | — |   | $ | 650.2 |   |
| Segment operating income (loss) |   | 35.7         |   | 8.0                   |   | (5.8                                               | )      | (4.7                  | )      | 33.2      |   |
| Depreciation and amortization   |   | 11.8         |   | 9.7                   |   | 1.2                                                |   | 0.3                   |   | 23.0      |   |
| Total assets                    |   | 243.0        |   | 197.2                 |   | 24.5                                               |   | 116.1                 |   | 580.8     |   |
| Capital expenditures            |   | 12.3         |   | 11.8                  |   | 0.9                                                |   | 0.2                   |   | 25.2      |   |

 

**GOODWILL AND OTHERINTANGIBLE ASSETS- NOTE C**

 

Allacquisitions in 2003 and 2002 have been accounted for under the purchase methodof accounting, and accordingly, the purchase price has been allocated to theassets acquired and the liabilities assumed based upon fair values at the dateof the acquisition.  The excess purchaseprice over the fair value of the tangible and intangible net assets acquiredhas been recorded as goodwill.

 

TheCompany adopted SFAS No. 142 on January 1, 2002 and subsequently ceasedgoodwill amortization.  The Companycompleted the first step of the transitional goodwill impairment test at thebeginning of 2002, and completes the annual goodwill impairment test during thefourth quarter of each subsequent year. The Company estimates the fair value of each reporting unit using apresent value method that discounts estimated future cash flows. The cash flowestimates incorporate assumptions on future cash flow growth, terminal values,and discount rates.  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 thisevaluation, an impairment of goodwill had occurred because of a significantdecline in actual and forecasted cash flows. Accordingly, an impairment charge of $18.7 million within the Company’sSpecialty Tubing segment was recognized for the year ended December 31,2003.

 

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Goodwillallocated to Lone Star’s reportable segments as of December 31, 2003 and2002 and changes in the carrying amount of goodwill for the year endedDecember 31, 2003 are as follows:

 
|                                |   | **Oilfield** |   | **Specialty  Tubing** |   | **Total** |   |
|-------------------------------------|--------|--------------|--------|-----------------------|--------|-----------|--------|
| Balance at December 31, 2002        |   | $            | 9.2    |                  | $      | 45.9      |   | $ | 55.1 |   |
| Goodwill acquired during the period |   | 4.5          |   |                  |   | 4.5       |   |
| Impairment loss                     |   | —       |   | (18.7                 | )      | (18.7     | )      |
|                                |   |         |   |                  |   |      |   |
| Balance at December 31, 2003        |   | $            | 13.7   |                  | $      | 27.2      |   | $ | 40.9 |   |

 

Intangibleassets other than goodwill that are subject to amortization are amortized on astraight-line basis over their respective estimated useful lives.  The non-compete agreements and licenseagreements are amortized over four to five years.   The other amortizable intangible assets are amortized over fiveto ten years.  The components ofintangible assets were as follows:

 
|                         |   | **2003**                   |   | **2002**                      |   |
|------------------------------|--------|----------------------------|--------|-------------------------------|--------|
|                         |   | **Gross Carrying  Amount** |   | **Accumulated  Amortization** |   | **Gross Carrying  Amount** |   | **Accumulated  Amortization** |   |
| Amortized intangible assets: |   |                       |   |                          |   |   |   |   |   |
| Non-compete agreements       |   | $                          | 1.3    |                          | $      | (0.7 | ) | $ | 0.9 |   | $ | (0.5 | ) |
| License agreements           |   | 0.6                        |   | (0.6                          | )      | 0.6 |   | (0.5 | ) |
| Other                        |   | 0.5                        |   | (0.3                          | )      | 0.3 |   | (0.2 | ) |
|                         |   | $                          | 2.4    |                          | $      | (1.6 | ) | $ | 1.8 |   | $ | (1.2 | ) |

 

Aggregateamortization expense related to intangible assets, other than goodwill, was$0.4 million, $0.3 million, and $0.5 million for the years endedDecember 31, 2003, 2002, and 2001, respectively.

 

Theestimated future amortization expense related to purchased intangible assets atDecember 31, 2003 is as follows:

 
| **Fiscal Year:** |   |   |   |
|------------------|--------|--------|--------|
| 2004             |   | $      | 0.3    |   |
| 2005             |   | 0.1    |   |
| 2006             |   | 0.1    |   |
| 2007             |   | 0.1    |   |
| 2008             |   | 0.1    |   |
| Thereafter       |   | 0.1    |   |
|             |   |   |   |
| Total            |   | $      | 0.8    |   |

 

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Inaccordance with SFAS No. 142, the financial statements for the prior years havenot been restated.  A pro formareconciliation of net income as if SFAS No. 142 had been adopted for the yearended December 31, 2001 is presented below:

 
|                                   |   | **2001** |   |
|----------------------------------------|--------|----------|--------|
|                                   |   |     |   |
| Reported net income (loss)             |   | $        | 16.4   |   |
| Add back:   goodwill amortization |   | 2.1      |   |
|                                   |   |     |   |
| Adjusted net income (loss)             |   | $        | 18.5   |   |
|                                   |   |     |   |
| Basic net income (loss) per share:     |   |     |   |
| Reported net income (loss)             |   | $        | 0.67   |   |
| Add back:   goodwill amortization |   | 0.08     |   |
|                                   |   |     |   |
| Adjusted net income (loss)             |   | $        | 0.75   |   |
|                                   |   |     |   |
| Diluted net income (loss) per share:   |   |     |   |
| Reported net income (loss)             |   | $        | 0.66   |   |
| Add back:   goodwill amortization |   | 0.08     |   |
|                                   |   |     |   |
| Adjusted net income (loss)             |   | $        | 0.74   |   |

 

**DEBT - NOTE D**

 

InOctober 2001, Lone Star entered into a three-year $100 million seniorsecured credit facility (the “Credit Facility”) for use by Lone Star and itsdomestic subsidiaries.  InDecember 2003, the Credit Facility was amended and restated (“AmendedCredit Facility”) to increase the total available borrowings to $125 millionand extend the expiration date to November 2006.  Borrowings under the Amended Credit Facility can be used forgeneral corporate purposes.  Under theagreement, the Company can borrow an amount based on a percentage of eligibleaccounts receivable and inventories reduced by outstanding letters of credit,which totaled $0.8 million at December 31, 2003.  The availability under the Amended Credit Facility was $124.2million at December 31, 2003. Borrowings under the Amended Credit Facility are collateralized bysubstantially all of the Company’s assets, other than real estate.  At the Company’s option, the interest rateis the prime lending rate or the LIBOR plus the applicable additionalinterest.  At December 31, 2003 and2002, no amount was outstanding under the Amended Credit Facility.

 

In2000, Fintube had a senior credit facility providing a $20 million revolvingline of credit and a $39 million term loan used to finance a portion of thepurchase price in the Fintube acquisition. In August 2001, the Fintube credit facility was paid in full earlyand terminated, resulting in the write off of $0.6 million in deferredfinancing costs.  The write-off totaling$0.6 million was initially recognized as an extraordinary item for the yearended December 31, 2001, and subsequently reclassed in 2003 to otherexpenses in accordance with SFAS 145. In addition, the Company terminated an interest rate swap agreementrelated to the Fintube credit facility. The settlement of the interest rate swap resulted in a $0.8 millioncharge included in other expenses for the year ended December 31, 2001.

 

Steelengages in slab consignment 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 slab inventory based onusage within specified time periods. These inventory financing transactions have been accounted for asproduct financing arrangements. Inventory financed under these arrangements is recorded as inventory bySteel.  At December 31, 2003 and2002, there were $15.6 million and $11.7 million, respectively, included inaccounts payable under these financing arrangements.

 

OnMay 29, 2001, Lone Star issued $150.0 million 9% senior subordinated notes dueJune 1, 2011 to qualified institutional buyers (the “Senior Notes”).  Interest on the outstanding Senior Notesaccrues at a rate of 9% per year, payable semi-annually in arrears on eachJune 1 and December 1.  LoneStar used the proceeds received from the Senior Notes to pay down the revolvinglines of credit, term loans, slab consignment obligations, and for generalcorporate purposes.

 

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TheSenior Notes are fully and unconditionally (as well as jointly and severally)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 L).  Each of theGuarantor Subsidiaries and the Non-Guarantor Subsidiary is wholly owned by theCompany.

 

Totalinterest incurred by the Company was $15.4 million, $12.7 million, and $12.8million for the years ended December 31, 2003, 2002, and 2001,respectively.  Total interestcapitalized for the years ended December 31, 2003, 2002, and 2001 was $0.6million, $1.0 million, and $0.7 million, respectively.

 

**SHAREHOLDERS’ EQUITY - NOTE E**

 

OnApril 23, 2002, Lone Star sold 3.3 million shares of common stock under apreviously filed universal shelf registration statement.  Net proceeds to Lone Star were $82.8 millionand were used to acquire Wheeling, Delta and Delta International, and providefunds for working capital and other general corporate purposes.

 

OnMay 2, 2001, Lone Star sold 1.2 million shares of its common stock under apreviously filed universal shelf registration statement.  The proceeds to Lone Star were $50.8million.  Proceeds of the sale were usedto extinguish debt associated with credit facilities at Steel and Fintube andfor general corporate purposes.

 

Beginningin October 2002, Lone Star’s Board of Directors authorized the open marketpurchase of the Company’s common stock from time to time for a total investmentnot to exceed $8.0 million.  Since theinception of the stock buy-back program, a total of 160,600 shares at a cost of$2.0 million, or an average price of $12.61 per share have been repurchased astreasury shares.  The 174,107 and105,844 treasury shares held as of December 31, 2003 and 2002,respectively, are reported at their acquired cost.

 

Thefollowing table (in whole shares) identifies changes in common stock issued andtreasury stock from January 1, 2001 to December 31, 2003:

 
|                       |   | **Issued** |   | **Treasury  Stock** |   | **Outstanding** |   |
|----------------------------|--------|------------|--------|---------------------|--------|-----------------|--------|
| Balance, January 1, 2001   |   | 23,822,101 |   | (168,322            | )      | 23,653,779      |   |
| Stock offering             |   | 1,150,000  |   | —              |   | 1,150,000       |   |
| Employee benefit plans     |   | 229,494    |   | 168,009             |   | 397,503         |   |
| Balance, December 31, 2001 |   | 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      |   |

 

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**ADDITIONAL BALANCE SHEET INFORMATION - NOTE F**

 
|                                            |   | **At  December 31,** |   |
|-------------------------------------------------|--------|----------------------|--------|
|                                            |   | **2003**             |   | **2002** |   |
| **Inventories**                                 |   |                 |   |   |   |
| Finished goods                                  |   | $                    | 55.4   |   | $ | 52.5 |   |
| Work in process                                 |   | 66.9                 |   | 48.5 |   |
| Raw materials                                   |   | 55.0                 |   | 63.2 |   |
| Materials, supplies, and other                  |   | 22.6                 |   | 24.1 |   |
| ***Total inventories  at FIFO***                |   | 199.9                |   | 188.3 |   |
| Reserve to reduce inventories to LIFO value     |   | (44.1                | )      | (35.8 | ) |
| ***Total inventories***                         |   | 155.8                |   | 152.5 |   |
| Amount included in other noncurrent assets      |   | (3.0                 | )      | (4.0 | ) |
| ***Inventories,  current***                     |   | $                    | 152.8  |   | $ | 148.5 |   |
|                                            |   |                 |   |   |   |
| ***Other current assets***                      |   |                 |   |   |   |
| Insurance and other deposits                    |   | $                    | 5.6    |   | $ | 4.6 |   |
| Other                                           |   | 9.1                  |   | 8.0 |   |
| ***Total other  current assets***               |   | $                    | 14.7   |   | $ | 12.6 |   |
|                                            |   |                 |   |   |   |
| ***Property, plant, and equipment***            |   |                 |   |   |   |
| Land and land improvements                      |   | $                    | 18.2   |   | $ | 14.0 |   |
| Buildings, structures, and improvements         |   | 32.0                 |   | 24.9 |   |
| Machinery and equipment                         |   | 418.2                |   | 375.8 |   |
| Construction in progress                        |   | 10.5                 |   | 27.5 |   |
| ***Total property,  plant, and equipment***     |   | 478.9                |   | 442.2 |   |
| Less accumulated depreciation and  amortization |   | (258.9               | )      | (237.8 | ) |
| ***Property, plant,  and equipment, net***      |   | $                    | 220.0  |   | $ | 204.4 |   |
|                                            |   |                 |   |   |   |
| ***Other noncurrent assets***                   |   |                 |   |   |   |
| Inventory (supplies and spare parts)            |   | $                    | 3.0    |   | $ | 4.0 |   |
| Deferred financing costs                        |   | 4.5                  |   | 5.3 |   |
| Other                                           |   | 2.4                  |   | 2.3 |   |
| ***Total other  noncurrent assets***            |   | $                    | 9.9    |   | $ | 11.6 |   |
|                                            |   |                 |   |   |   |
| ***Accrued liabilities***                       |   |                 |   |   |   |
| Accrued compensation                            |   | $                    | 9.3    |   | $ | 8.2 |   |
| Warranty reserves                               |   | 2.4                  |   | 2.1 |   |
| Environmental reserves                          |   | 0.7                  |   | 0.8 |   |
| Pension obligations                             |   | 5.0                  |   | 2.5 |   |
| Other                                           |   | 10.6                 |   | 8.8 |   |
| ***Total accrued  liabilities***                |   | $                    | 28.0   |   | $ | 22.4 |   |
|                                            |   |                 |   |   |   |
| ***Other noncurrent liabilities***              |   |                 |   |   |   |
| Environmental reserves                          |   | $                    | 8.8    |   | $ | 8.9 |   |
| Litigation reserves                             |   | 34.0                 |   | 32.0 |   |
| Other                                           |   | 4.0                  |   | 3.9 |   |
| ***Total other  noncurrent liabilities***       |   | $                    | 46.8   |   | $ | 44.8 |   |

 

During2002, the Company experienced reductions of inventory that resulted in theliquidation of previous inventory LIFO layers, the effect of which was notsignificant to the results of operations.

 

47

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**EARNINGS PER SHARE - NOTE G**

 

Basicearnings per share is computed by dividing net income by the weighted averagenumber of shares of common stock outstanding.  Diluted earnings per share is computed by dividing net income by theweighted average number of shares of common stock outstanding and otherdilutive securities.

 
|                                                 |   | **2003** |   | **2002** |   | **2001** |   |
|------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Numerator:                                           |   |     |   |     |   |     |   |
| Net income (loss)                                    |   | $        | (68.2  | )        | $      | (69.2    | )      | $ | 16.4 |   |
|                                                 |   |     |   |     |   |     |   |
| Denominator:                                         |   |     |   |     |   |     |   |
| Weighted-average shares used to compute  basic EPS   |   | 28.4     |   | 27.5     |   | 24.7     |   |
| Effect of dilutive securities:                       |   |     |   |     |   |     |   |
| Stock options                                        |   | —   |   | —   |   | 0.3      |   |
| Weighted-average shares used to compute  diluted EPS |   | 28.4     |   | 27.5     |   | 25.0     |   |
|                                                      |        |          |        |          |        |          |        |  |  |  |

 

Asa result of the losses incurred in 2003 and 2002, no equivalent sharesattributable to options were considered in computing diluted EPS as suchoptions would be anti-dilutive.  In2001, options to purchase 0.2 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.

 

**INCOME TAXES - NOTE H**

 

Incometax expense was $0.1 million and $0.8 million in 2003 and 2001, respectively;and, for 2002, income tax benefit was $0.7 million, including federalalternative minimum tax (“AMT”) and state and foreign income taxes.  There was no deferred income tax expense orbenefit for 2003, 2002, or 2001.

 

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

 
|                                                  |   | **2003** |   | **2002** |   | **2001** |   |
|-------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Benefit (expense) at U.S. statutory rate              |   | $        | 23.8   |     | $      | 24.5     |   | $ | (6.2 | ) |
| State and other income taxes, net of  federal benefit |   | (0.1     | )      | 0.7      |   | (0.3     | )      |
| Goodwill impairment charge                            |   | (6.5     | )      | —   |   | —   |   |
| Change in valuation allowance                         |   | (19.0    | )      | (23.7    | )      | 5.7      |   |
| Other                                                 |   | 1.7      |   | (0.8     | )      | —   |   |
| Total income tax benefit (expense)                    |   | $        | (0.1   | )        | $      | 0.7      |   | $ | (0.8 | ) |

 

AtDecember 31, 2003, Lone Star had federal tax net operating losscarryforwards (NOL’s) of approximately $320.4 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 by Lone Star and itssubsidiaries.  If not utilized, theNOL’s will expire in varying amounts between years 2004 and 2023, and theirfuture availability may be limited if Lone Star or a member of the consolidatedgroup experiences an ownership change of more than 50 percentage points, asdefined by IRS regulations.  Lone Star’scommon stock is publicly traded, and management cannot assure that futuretrading will not result in an ownership change, as defined by IRS regulations,which would limit the availability of the NOL’s.  The Company has an AMT credit carryforward totaling $1.6 millionthat may be carried forward indefinitely under U.S. law.

 

48

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Thefollowing table discloses the components of the deferred tax amounts atDecember 31, 2003 and 2002:

 
|                                        |   | **2003** |   | **2002** |   |
|---------------------------------------------|--------|----------|--------|----------|--------|
| **Deferred tax assets:**                    |   |     |   |     |   |
| Postretirement benefit accruals             |   | $        | 16.9   |     | $      | 16.4 |   |
| Environmental reserves                      |   | 3.3      |   | 3.3      |   |
| Other expense accruals and reserves         |   | 5.0      |   | 5.3      |   |
| Inventories                                 |   | 11.0     |   | 5.6      |   |
| Other                                       |   | 0.8      |   | 0.8      |   |
| Net operating loss carryforwards            |   | 112.1    |   | 101.8    |   |
| Alternative minimum tax credit carryforward |   | 1.6      |   | 1.6      |   |
| Total deferred tax assets                   |   | 150.7    |   | 134.8    |   |
| **Deferred tax liabilities:**               |   |     |   |     |   |
| Property, plant and equipment               |   | (38.6    | )      | (41.7    | )      |
|                                        |   |     |   |     |   |
| Net deferred tax assets                     |   | 112.1    |   | 93.1     |   |
| Less valuation allowance                    |   | (112.1   | )      | (93.1    | )      |
| Net deferred tax amount                     |   | $        | — |     | — |   |
|                                             |        |          |        |          |        |  |  |

 

Theultimate realization of the deferred tax asset depends on the Company’s abilityto generate sufficient taxable income in the future.  Management believes it is more likely than not that the netdeferred tax asset will not be realized by future operating results.  Because of the uncertainty regarding possibleutilization of NOL’s and the sensitivity of earnings to the level of domesticdrilling activity, valuation allowances were recorded to fully reserve thecomputed net deferred tax assets.

 

**EMPLOYEE BENEFIT PLANS - NOTE I**

 

***Defined contribution plans*****.**  Definedcontribution plans are available to substantially all full-time employees underwhich participants can make voluntary pretax contributions.  For nonbargaining unit employees, matchingcontributions are provided within specified limits.  Steel makes contributions at rates specified under collectivebargaining agreements for its bargaining unit employees.  Contributions totaled $3.3 million, $2.9million, and $3.0 million for the years ended December 31, 2003, 2002, and2001, respectively.

 

***Nonqualified deferred compensation plan*****.**  TheCompany has a nonqualified compensation plan for certain management personneland highly compensated employees of Lone Star and its participating affiliatesthat provides eligible employees the opportunity to defer a specifiedpercentage of their cash compensation. Participants may elect to defer up to 25% of total compensation and LoneStar will match 50% of the amount deferred by each employee with the matchingnot to exceed $25,000.  The obligationincluded in other noncurrent liabilities was $2.1 million and $1.6 million atDecember 31, 2003 and 2002, respectively.

 

***Employee stock purchase plan***.  TheCompany has an employee stock purchase plan for all eligible employees.  Eligible employees include all regularfull-time employees of Lone Star and its subsidiaries who have been employedfor at least 12 months.  Eligibleemployees may defer up to 5% of their compensation for each quarter for thepurchase of Lone Star common stock. Shares are purchased at the end of each quarter at a price equal to thelower of: (a) 90% of the market price of Lone Star’s common stock on the firstday of the quarter, or (b) 90% of the market price of Lone Star’s common stockon the last day of the quarter.  Themaximum number of Lone Star shares that may be purchased for all participantsunder the plan is 200,000 shares, of which 165,212 shares were available to beissued at December 31, 2003.

 

***Long-term incentive plan***. Lone Star has a long-term incentive plan which provides for the issuanceof up to 6,700,000 shares of common stock to key employees and outsidedirectors through the granting of incentive and nonqualified stock options,stock appreciation rights, restricted stock grants, and performance unitgrants.  The option

 

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priceis the average of the high and low market price on the date of the grant.  Options are generally exercisable for tenyears with one-fourth of the shares becoming exercisable on the one-yearanniversary of the grant date and an additional one-fourth becoming exercisableon the same anniversary date over the next three years.  If the optionee’s employment is terminatedunder certain circumstances after a change of control of Lone Star occursbefore an option’s fourth anniversary, the option may be exercised in fullearlier.  Also, accelerated vesting ofoptions can occur upon death or retirement from employment of an optionholder.  The following discloses thestock option activity for the years shown:

 
|                           |   | **Shares Under  Option** |   | **Weighted  Average  Exercise  Price** |   |
|--------------------------------|--------|--------------------------|--------|----------------------------------------|--------|
| Outstanding, December 31, 2000 |   | 1,653,725                |   | $                                      | 23.43  |   |
| Granted                        |   | 484,375                  |   | 38.27                                  |   |
| Exercised                      |   | (265,375                 | )      | 16.46                                  |   |
| Cancelled/forfeited            |   | (12,250                  | )      | 34.22                                  |   |
| 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  |   |

 

AtDecember 31, 2003, 2,112,437 shares were available for grant and optionsfor 1,535,913 shares were exercisable. The following table summarizes information with respect to optionsoutstanding and exercisable at December 31, 2003:

 
|                             |       | **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                    |   |                                     | 56,600     |   | $ | 7.90 |   | 1.3 |   | 56,600 |   | $ | 7.90 |   |
| 11.06                            | —     | 16.52                    |   |                                     | 1,071,625  |   | 14.84 |   | 7.5 |   | 463,000 |   | 13.78 |   |
| 16.75                            | —     | 23.39                    |   |                                     | 305,875    |   | 20.87 |   | 5.1 |   | 209,375 |   | 19.81 |   |
| 27.19                            | —     | 39.27                    |   |                                     | 1,039,750  |   | 34.45 |   | 6.0 |   | 712,250 |   | 34.13 |   |
| 41.11                            | —     | 50.06                    |   |                                     | 139,375    |   | 47.58 |   | 6.8 |   | 94,688 |   | 48.24 |   |
| $6.88                            | —     | $50.06                   |   |                                     | 2,613,225  |   | $ | 24.95 |   | 6.4 |   | 1,535,913 |   | $ | 25.94 |   |

 

LoneStar also issued 21,500, 72,750, and 125,500 shares of restricted stock grantsto certain employees, with a value of $0.4 million, $1.1 million, and $5.5million during 2003, 2002, and 2001, respectively.  For restricted stock grants issued prior to December 31,2001, the shares vest ratably over a four-year period.  For restricted stock grants issued afterDecember 31, 2001, the shares vest ratably over a four-year periodbeginning on the second anniversary of date of grant.  The fair value of restricted stock is charged to Shareholders’Equity and amortized to expense over the

 

50

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requisitevesting periods.  The Company recognizedcompensation expense related to these awards of $1.1 million, $0.9 million, and$0.7 million in 2003, 2002, and 2001, respectively.

 

***Defined Benefit Pension and PostretirementBenefit Plans*****.**  Steel has three defined benefit pensionplans covering a substantial portion 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.

 

During1996 and 1998, the three pension plans were amended so that new employees donot participate in the defined benefit plan. New employees are eligible to participate in one of the definedcontribution retirement plans, as are substantially all other employees.

 

Steelalso sponsors an unfunded defined benefit postretirement health care plan foreligible bargaining unit employees and a limited number of other retireeseligible under special early retirement programs.  These health care plan benefits are limited to eligible retireesand their spouses until 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.

 

Thefollowing represents the amounts recognized in the consolidated balance sheetsat December 31, 2003 and 2002:

 
|                                             |   | **Pension  Benefits** |   | **Other  Benefits** |   |
|--------------------------------------------------|--------|-----------------------|--------|---------------------|--------|
|                                             |   | **2003**              |   | **2002**            |   | **2003** |   | **2002** |   |
| Postretirement benefit obligations -  current    |   | $                     | 3.7    |                | $      | 1.2 |   | $ | 1.3 |   | $ | 1.3 |   |
| Postretirement benefit obligations -  noncurrent |   | 30.1                  |   | 31.8                |   | 14.4 |   | 13.8 |   |
| Other noncurrent assets - intangible asset       |   | (1.0                  | )      | (1.1                | )      | — |   | — |   |
| Accumulated other comprehensive loss             |   | (31.9                 | )      | (30.8               | )      | — |   | — |   |
| Net amount recognized                            |   | $                     | 0.9    |                | $      | 1.1 |   | $ | 15.7 |   | $ | 15.1 |   |

 

Netperiodic benefit expense for 2003, 2002, and 2001, included the followingcomponents:

 
|                                 |   | **Pension  Benefits** |   | **Other  Benefits** |   |
|--------------------------------------|--------|-----------------------|--------|---------------------|--------|
|                                 |   | **2003**              |   | **2002**            |   | **2001** |   | **2003** |   | **2002** |   | **2001** |   |
| Service cost                         |   | $                     | 1.0    |                | $      | 0.9 |   | $ | 0.9 |   | $ | 0.6 |   | $ | 0.6 |   | $ | 0.5 |   |
| Interest cost                        |   | 5.8                   |   | 5.2                 |   | 5.4 |   | 1.0 |   | 0.9 |   | 0.8 |   |
| Expected return on plan asset        |   | (4.2                  | )      | (5.0                | )      | (5.5 | ) | — |   | — |   | — |   |
| Amortization of prior service cost   |   | 0.1                   |   | 0.2                 |   | 0.2 |   | — |   | — |   | — |   |
| Recognized net actuarial loss (gain) |   | 2.7                   |   | 0.8                 |   | — |   | — |   | (0.1 | ) | (0.1 | ) |
| ***Net periodic  benefit expense***  |   | $                     | 5.4    |                | $      | 2.1 |   | $ | 1.0 |   | $ | 1.6 |   | $ | 1.4 |   | $ | 1.2 |   |

 

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Thefollowing table sets forth the changes in the plans’ benefit obligations,assets and funded status at December 31, 2003 and 2002:

 
|                                              |   | **Pension  Benefits** |   | **Other Benefits** |   |
|---------------------------------------------------|--------|-----------------------|--------|--------------------|--------|
|                                              |   | **2003**              |   | **2002**           |   | **2003** |   | **2002** |   |
| **Change in Projected Benefit Obligation**        |   |                  |   |               |   |   |   |   |   |
| Benefit obligation at beginning of year           |   | $                     | 86.9   |               | $      | 80.6 |   | $ | 15.0 |   | $ | 13.3 |   |
| Service cost                                      |   | 1.0                   |   | 0.9                |   | 0.6 |   | 0.6 |   |
| Interest cost                                     |   | 5.8                   |   | 5.2                |   | 1.0 |   | 0.9 |   |
| Actuarial loss (gain)                             |   | 6.2                   |   | 6.5                |   | (0.6 | ) | 2.0 |   |
| Benefits paid                                     |   | (6.4                  | )      | (6.3               | )      | (1.1 | ) | (1.8 | ) |
| Projected benefit obligation at end of year       |   | $                     | 93.5   |               | $      | 86.9 |   | $ | 14.9 |   | $ | 15.0 |   |
|                                              |   |                  |   |               |   |   |   |   |   |
| **Change in Plan Assets**                         |   |                  |   |               |   |   |   |   |   |
| Fair value of plan assets at beginning of year    |   | $                     | 53.4   |               | $      | 57.1 |   | $ | — |   | $ | — |   |
| Actual return on plan assets                      |   | 6.8                   |   | (4.1               | )      | — |   | — |   |
| Employer contributions                            |   | 5.6                   |   | 6.7                |   | 1.1 |   | 1.8 |   |
| Benefits paid                                     |   | (6.4                  | )      | (6.3               | )      | (1.1 | ) | (1.8 | ) |
| Fair value of plan assets at end of year          |   | $                     | 59.4   |               | $      | 53.4 |   | $ | — |   | $ | — |   |
|                                              |   |                  |   |               |   |   |   |   |   |
| **Reconciliation of Funded Status**               |   |                  |   |               |   |   |   |   |   |
| Unfunded status - obligation in excess of  assets |   | $                     | 34.1   |               | $      | 33.5 |   | $ | 14.9 |   | $ | 15.0 |   |
| Unrecognized actuarial gain (loss)                |   | (32.2                 | )      | (31.3              | )      | 0.8 |   | 0.1 |   |
| Unrecognized prior service cost                   |   | (1.0                  | )      | (1.1               | )      | — |   | — |   |
| Net amount recognized                             |   | $                     | 0.9    |               | $      | 1.1 |   | $ | 15.7 |   | $ | 15.1 |   |

 

TheAccumulated Benefit Obligation for all defined benefit pension plans was $93.2million and $86.4 million at December 31, 2003 and 2002, respectively.

 

Thefollowing weighted average assumptions were used in determining net periodicbenefit expense and benefit obligations:

 
|                                                 |   | **For the  Year Ended** |   |
|------------------------------------------------------|--------|-------------------------|--------|
|                                                 |   | **2003**                |   | **2002** |   | **2001** |   |
| **Net Periodic Benefit Expense**                     |   |                    |   |   |   |   |   |
| Discount rate                                        |   | 6.75                    | %      | 6.75 | % | 6.75 | % |
| Expected long-term investment return on plan  assets |   | 8.00                    | %      | 8.00 | % | 9.00 | % |
| Rate of compensation increase                        |   | 4.00                    | %      | 4.00 | % | 4.00 | % |
|                                                 |   |                    |   |   |   |   |   |
| **Benefit Obligations**                              |   |                    |   |   |   |   |   |
| Discount rate                                        |   | 6.25                    | %      | 6.75 | % | 7.50 | % |
| Rate of compensation increase                        |   | 3.00                    | %      | 4.00 | % | 4.00 | % |

 

Thereturn on plan assets reflects the weighted-average of the expected long-termrates of return for the broad categories of investments held in the plans.  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.

 

Pensioncontributions to be paid in 2004 are estimated to be $10.0 million, reflectingquarterly contributions to certain plans as required by the IRS CodeSection 412.

 

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Assumedhealth care cost trend rates have a significant effect on the amounts reportedfor the health care plans.  The annualrate of increase in the per capita costs of covered health care benefits isassumed to decrease from 10% to an ultimate trend rate of 5% by the year2010.  Increasing the assumed medicalcost trend rates by one percentage point in each year would have resulted in a$1.2 million increase in the benefit obligation as of December 31, 2003,and a $0.2 million increase in the aggregate of the service cost and interestcost components of net periodic benefit expense for 2003.  A 1% decrease in the assumed trend rateswould have resulted in a $1.0 million decrease in the benefit obligation and a$0.2 million decrease in expense.

 

LoneStar’s investment strategy for its pension plans is to preserve the capital ofthe pension plans’ assets and maximize investment earnings in excess ofinflation with acceptable levels of volatility while meeting the pension plans’goal of providing, protecting, and enhancing the economic well-being of LoneStar employees, retirees, and their beneficiaries.  This investment strategy will be achieved through targetallocation for each asset class with a maximum and minimum range around each target.  No investments will be made in securitieswhich fall outside of the categories listed below.  Without limiting the general scope of the foregoing, privateplacements and the securities of Lone Star Technologies, Inc. are specificallyexcluded and not deemed appropriate investments.  Target allocations for 2004 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 | % |

 

Theallocations are rebalanced as considered necessary by the Company’s pensionplan committee to correspond with anticipated change in investingconditions.  The following table setsforth the percentage of fair value of total assets by asset category as of theCompany’s measurement date:

 
|                            |   | **Fiscal  Year** |   |
|---------------------------------|--------|------------------|--------|
| **Asset Category**              |   | **2003**         |   | **2002** |   |
| Domestic equity securites       |   | 43               | %      | 40 | % |
| International equity securities |   | 16               | %      | 15 | % |
| Fixed income securities         |   | 40               | %      | 44 | % |
| Cash investments                |   | 1                | %      | 1 | % |
| Total                           |   | 100              | %      | 100 | % |

 

***Profit sharing plans*****.**  LoneStar and its subsidiaries have profit sharing plans for substantially allemployees that provide for payment of a specified percentage of quarterlyoperating earnings.  Total payments toemployees were $0.4 million, $0.4 million, and $3.2 million for 2003, 2002, and2001, respectively.

 

**COMMITMENTS AND CONTINGENCIES - NOTE J**

 

Asof December 31, 2003, the Company has long-term purchase commitmentstotaling $18.5 million to acquire natural gas at specified minimum volumes andat fixed prices through September 2005.

 

Equipmentis leased under various operating leases. Rental expense totaled $4.5 million, $5.0 million, and $5.0 million in2003, 2002, and 2001, respectively. Future minimum lease payments under noncancelable operating leases withinitial or remaining terms in excess of one year are as follows: 2004, $1.6million; 2005, $1.2 million; 2006, $0.9 million; 2007, $0.5 million; 2008, $0.2million; and thereafter, $0.1 million.

 

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LoneStar’s operations are subject to numerous environmental laws.  The three major areas of regulation are airquality, water quality, and solid and hazardous waste management.  The primary governmental oversight agenciesinclude the Texas Commission on Environmental Quality and the EnvironmentalProtection Agency.  The Company isengaged in various ongoing environmental monitoring and compliance programs,voluntary remediation activities, and capital improvement projects.  Estimated expenditures for certainremediation programs are included in accrued liabilities and other noncurrentliabilities as shown in Note F and are computed on a non-discounted basis.  Included in other noncurrent liabilities areenvironmental reserves of $8.8 million and $8.9 million at December 31,2003 and 2002, respectively.  Currentreserves of $0.7 million and $0.8 million are included in accrued liabilitiesat December 31, 2003 and 2002, respectively.  The Company believes that adequate accruals have been maderelated to all known environmental matters.

 

OnAugust 16, 2001, Lone Star entered into an agreement to purchase theassets of North Star Steel Company’s Tubular Steel Division.  Consummation of the acquisition was subjectto completion of financing arrangements. Due to lack of common stock financing which, along with certain debtfinancing, was required by the acquisition agreement to close the acquisition,Lone Star notified Cargill, Incorporated, the parent company of North StarSteel Company, on December 14, 2001, that it was not able to complete theacquisition.  Later that day, Cargill,Incorporated notified Lone Star that it was filing a lawsuit against Lone Starseeking unspecified damages and alleging that Lone Star had breached theagreement.  On March 13, 2003, thejury in Minnesota returned a verdict of $32 million in damages against LoneStar.  The Company believes it has fullyperformed all of its obligations under the acquisition agreement and isvigorously contesting the verdict.  LoneStar has set up a reserve of $34 million which includes accrued interest of$2.0 million and is included in noncurrent liabilities at December 31,2003.

 

Duringthe last five years, Steel has been named as one of a number of defendants in36 lawsuits alleging that certain individuals were exposed to asbestos on thedefendants’ premises.  The plaintiffsare seeking unspecified damages.  Todate several of these lawsuits have been settled for approximately $60,000 inthe aggregate.  Of the 36 lawsuits,twelve have been settled or are pending settlement and nine have been dismissedor are 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 its exposure, if any, tounasserted claims.

 

In2003, Lone Star’s subsidiary Zinklahoma, Inc., inactive since 1989, was namedas one of a number of defendants in five lawsuits alleging that the plaintiffshad contracted mesothelioma as the result of exposure to asbestos in productsmanufactured by the defendants and John Zink Company (“Zink”).  Two 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 eight lawsuits in whichthe plaintiffs, one of whom has mesothelioma, allege exposure to asbestos inZink’s products and three personal injury lawsuits resulting from a 2001explosion and flash fire 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 eleven lawsuits. The costs of defending and settling the lawsuits alleging exposure toasbestos in Zink’s products have been borne by Zink’s insurance carrier.  Lone Star believes that Koch’s indemnityclaim with respect to the 2001 explosion and flash fire is covered by itsinsurance, subject to a deductible, and has notified its insurance carrier ofthat claim.

 

Steel’sworkers’ compensation insurance was with one insurance carrier from 1992through 2001.  In March 2002 thatcarrier was declared insolvent and placed in receivership.  Since then, the Texas Property and CasualtyInsurance Guaranty Association (“TPCIGA”) has been paying the insolventcarrier’s obligations under those insurance policies, as required by Texaslaw.  Through February 2, 2004TPCIGA had paid $1.6 million in claims under those policies, and it estimatesthat it will pay an additional $2.0 million in claims over the next few years,for an estimated total of $3.6 million.

 

54

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Ofthis total, about $2.3 million relate to claims that are more than the policydeductibles (the “excess claims”), and the remaining $1.3 million relate toclaims that are less than the policy deductibles (the “deductibleclaims”).  TPCIGA is entitled by law torecover from the insured the amount of certain insurance claims paid by it ifthe insured’s net worth is more than $50 million on December 31 of theyear before the insurance carrier became insolvent.  Because Steel’s net worth on December 31, 2001 was more than$50 million, TPCIGA asserts that Steel owes it the $1.6 million for claims paidso far and that it can recover from Steel the estimated future claim paymentsof about $2.0 million as they are paid. Steel contends, however, that part of TPCIGA’s claim for reimbursement -the $2.3 million of “excess claims” - is without merit because Steel and itslegal counsel believe that the Texas law in question does not apply to workers’compensation insurance.  Steel intendsto defend vigorously against this claim.

 

Steelbelieves that it is most likely liable for the estimated $1.3 million ofdeductible claims, but Steel contends that this potential liability is reducedby a $0.9 million deposit that Steel paid to the insurance carrier before itsimpairment.  This contention is beingcontested by TPCIGA.  Steel is uncertainhow much, if any, of the deposit is recoverable from the receiver, and it isdifficult to evaluate Steel’s deductible reimbursement defense since itinvolves the interpretation of a statute that would be a case of firstimpression.  Therefore, Steel has notrecognized a liability in the balance sheet for the estimated $2.3 million ofTPCIGA past and future payments of excess claims.  It also has not recognized a liability in the event that Steel isunable to either recover or offset the $0.9 million deposit amount.

 

LoneStar and its subsidiaries are parties to a number of other lawsuits andcontroversies which are not discussed herein. Management of Lone Star and its operating companies, based upon theiranalysis of known facts and circumstances and reports from legal counsel, doesnot believe that any such matter will have a material adverse effect on theresults of operations, financial condition or cash flows of Lone Star and itssubsidiaries, taken as a whole.

 

**ACQUISITIONS – NOTE K**

 

***Wheeling.***  OnOctober 1, 2002, Lone Star purchased the majority of the assets ofWheeling Machine Products, Inc. and Wheeling Machine Products of Texas, Inc.(collectively, “Wheeling”), in cash for a base purchase price of $21.2 millionplus a $16.7 million adjustment for working capital and approximately $0.4 millionin acquisition related expenses (the “Wheeling Acquisition”).  The Wheeling Acquisition was effectiveOctober 1, 2002.  The results ofWheeling’s operations have been included in the consolidated financialstatements since that date.  Theacquired business is a leading domestic supplier of couplings used to connectindividual sections of oilfield casing and tubing.   No goodwill was recognized in the acquisition.  The net purchase price was allocated asfollows:

 

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

 

***Delta. ***On May 1,2003, Lone Star purchased substantially all of the assets of Delta, a leadingprovider of high-quality customized oil country tubular processing services,for a base purchase price of approximately $14.0 million in cash andapproximately $0.2 million in acquisition related expenses.  The acquisition of Delta is intended toimprove Lone Star’s competitive position in the oilfield segment and allow forcertain cost synergies.  In connectionwith the purchase, $4.1 million was allocated to goodwill and $0.4 millionallocated to amortizable intangible assets. The amortizable intangible assets are being amortized over theirestimated useful lives of five to ten years. Delta’s results of operations have been included in the consolidatedfinancial statements since the date of acquisition.

 

55

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Thefollowing table summarizes the estimated fair values of the assets acquired andliabilities 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   |   |

 

## ***DeltaInternational****.*  On June 2, 2003, Lone Star purchased certain assets ofFrank’s Tubular International (“Frank’s”), a leading provider of high-qualitythreading and inspection services, for a base purchase price of $18.9 millionin cash and approximately $0.9 million in acquisition related expenses.  Subsequent to the acquisition, Lone Starchanged the name of Frank’s to Delta Tubular International.  The acquisition of Delta International furtherenhances Lone Star’s competitive position within the oilfield segment by offeringcustomers 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 was allocatedto amortizable intangible assets, which is being amortized over its estimateduseful life of five years.  DeltaInternational’s results of operations have been included in the consolidatedfinancial statements since the date of acquisition.

 

Thefollowing table summarizes the estimated fair values of the assets acquired andliabilities 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   |   |

 

Theoperating results of the Wheeling, Delta, and Delta International acquisitionshave been included in the Consolidated Statements of Income from the effectivedates of acquisition.  The unaudited proforma results below assume the acquisitions occurred on January 1, 2001:

 

|                            |   | **For the  Year Ended** |   |
|---------------------------------|--------|-------------------------|--------|
|                            |   | **2003**                |   | **2002** |   | **2001** |   |
|                            |   |                    |   |   |   |   |   |
| Net sales                       |   | $                       | 540.2  |   | $ | 554.1 |   | $ | 703.9 |   |
| Net income (loss)               |   | (69.3                   | )      | (71.7 | ) | 20.9 |   |
|                            |   |                    |   |   |   |   |   |
| Basic income (loss) per share   |   | $                       | (2.44  | ) | $ | (2.61 | ) | $ | 0.84 |   |
| Diluted income (loss) per share |   | (2.44                   | )      | (2.61 | ) | 0.83 |   |

 

Thepreceding pro forma results include adjustments to eliminate intercompany salesand give effect to amortization of goodwill, interest expense and otherpurchase price adjustments.  The proforma results are not necessarily indicative of the operating results thatwould have occurred if the acquisitions had been consummated as of thebeginning of the periods presented, nor are they necessarily indicative offuture operating results.

 

56

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**GUARANTOR SUBSIDIARIES - NOTE L**

 

Thefollowing condensed, consolidating financial statements of the Company includethe accounts of the Company, the combined accounts of the GuarantorSubsidiaries and the accounts of the Non-Guarantor Subsidiary.  Each of the Guarantor Subsidiaries andNon-Guarantor Subsidiary is wholly-owned by the Company.  Given the size of the Non-GuarantorSubsidiary relative to the Company on a consolidated basis, separate financialstatements of the respective Guarantor Subsidiaries are not presented because managementhas determined that such information is not material in assessing the GuarantorSubsidiaries.

 

**CONDENSEDCONSOLIDATING BALANCE SHEETAT DECEMBER 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         |   | 65.4                        |   | 0.6                           |   | (1.6             | )      | 71.8             |   |
| Inventories                                      |   | —      |   | 152.2                       |   | 0.6                           |   | —           |   | 152.8            |   |
| Other current assets                             |   | 4.2         |   | 10.0                        |   | 0.5                           |   | —           |   | 14.7             |   |
| Total current assets                             |   | 44.6        |   | 227.9                       |   | 1.7                           |   | (1.6             | )      | 272.6            |   |
|                                             |   |        |   |                        |   |                          |   |             |   |             |   |
| 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  |                        | $      | 488.7                         |   | $                | 3.4    |             | $      | (350.3 | ) | $ | 575.6 |   |
|                                             |   |        |   |                        |   |                          |   |             |   |             |   |
| **Liabilities  & Shareholders’ Equity** |   |        |   |                        |   |                          |   |             |   |             |   |
| Accounts payable                                 |   | $           | 0.2    |                        | $      | 53.2                          |   | $                | 8.6    |             | $      | (1.6 | ) | $ | 60.4 |   |
| Accrued liabilities                              |   | 1.7         |   | 25.9                        |   | 0.4                           |   | —           |   | 28.0             |   |
| Total current liabilities                        |   | 1.9         |   | 79.1                        |   | 9.0                           |   | (1.6             | )      | 88.4             |   |
|                                             |   |        |   |                        |   |                          |   |             |   |             |   |
| Senior subordinated debt                         |   | 150.0       |   | —                      |   | —                        |   | —           |   | 150.0            |   |
| Other noncurrent liabilities                     |   | 36.0        |   | 165.6                       |   | —                        |   | (110.3           | )      | 91.3             |   |
| Total liabilities                                |   | 187.9       |   | 244.7                       |   | 9.0                           |   | (111.9           | )      | 329.7            |   |
| Total shareholders’ equity                  |   | 245.9       |   | 244.0                       |   | (5.6                          | )      | (238.4           | )      | 245.9            |   |
| Total liabilities & equity                   |   | $           | 433.8  |                        | $      | 488.7                         |   | $                | 3.4    |             | $      | (350.3 | ) | $ | 575.6 |   |

 

57

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**CONDENSEDCONSOLIDATING RESULTS OF OPERATIONSFOR THE YEAR 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       |   | 6.8         |   | 53.8                        |   | 0.9                           |   | —           |   | 61.5             |   |
| Operating income (loss)                    |   | (6.8        | )      | (48.9                       | )      | (0.9                          | )      | 0.3              |   | (56.3            | )      |
|                                       |   |        |   |                        |   |                          |   |             |   |             |   |
| Equity in subsidiaries’ income (loss) |   | (47.6       | )      | —                      |   | —                        |   | 47.6             |   | —           |   |
| Interest income (expense), net             |   | (14.2       | )      | 0.2                         |   | —                        |   | —           |   | (14.0            | )      |
| 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 | ) |

 

**CONDENSEDCONSOLIDATING CASH FLOW STATEMENTFOR THE YEAR 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 |   |

 

58

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**CONDENSEDCONSOLIDATING BALANCE SHEETAT DECEMBER 31, 2002**

 
|                                             |   | **Company** |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiary** |   | **Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------|--------|-------------|--------|-----------------------------|--------|-------------------------------|--------|------------------|--------|------------------|--------|
|                                             |   |        |   |                        |   |                          |   |             |   |             |   |
| **Assets**                                       |   |        |   |                        |   |                          |   |             |   |             |   |
| Cash and cash equivalents                        |   | $           | 119.3  |                        | $      | 1.0                           |   | $                | 0.2    |             | $      | — |   | $ | 120.5 |   |
| Accounts receivable, net                         |   | 3.9         |   | 57.5                        |   | 2.7                           |   | (3.9             | )      | 60.2             |   |
| Inventories                                      |   | —      |   | 148.4                       |   | 0.4                           |   | (0.3             | )      | 148.5            |   |
| Other current assets                             |   | 1.4         |   | 11.0                        |   | 0.2                           |   | —           |   | 12.6             |   |
| Total current assets                             |   | 124.6       |   | 217.9                       |   | 3.5                           |   | (4.2             | )      | 341.8            |   |
|                                             |   |        |   |                        |   |                          |   |             |   |             |   |
| Investment in subsidiary                         |   | 174.4       |   | —                      |   | —                        |   | (174.4           | )      | —           |   |
| Property, plant, and equipment, net              |   | 0.2         |   | 202.1                       |   | 2.1                           |   | —           |   | 204.4            |   |
| Goodwill                                         |   | 3.5         |   | 51.6                        |   | —                        |   | —           |   | 55.1             |   |
| Other noncurrent assets                          |   | 198.2       |   | 6.3                         |   | —                        |   | (192.9           | )      | 11.6             |   |
| Total assets                                     |   | $           | 500.9  |                        | $      | 477.9                         |   | $                | 5.6    |             | $      | (371.5 | ) | $ | 612.9 |   |
|                                             |   |        |   |                        |   |                          |   |             |   |             |   |
| **Liabilities  & Shareholders’ Equity** |   |        |   |                        |   |                          |   |             |   |             |   |
| Accounts payable                                 |   | $           | 2.6    |                        | $      | 28.1                          |   | $                | 7.6    |             | $      | (0.8 | ) | $ | 37.5 |   |
| Accrued liabilities                              |   | 1.8         |   | 20.0                        |   | 0.6                           |   | —           |   | 22.4             |   |
| Total current liabilities                        |   | 4.4         |   | 48.1                        |   | 8.2                           |   | (0.8             | )      | 59.9             |   |
|                                             |   |        |   |                        |   |                          |   |             |   |             |   |
| Senior subordinated debt                         |   | 150.0       |   | —                      |   | —                        |   | —           |   | 150.0            |   |
| Other noncurrent liabilities                     |   | 33.9        |   | 249.4                       |   | —                        |   | (192.9           | )      | 90.4             |   |
| Total liabilities                                |   | 188.3       |   | 297.5                       |   | 8.2                           |   | (193.7           | )      | 300.3            |   |
| Total shareholders’ equity                  |   | 312.6       |   | 180.4                       |   | (2.6                          | )      | (177.8           | )      | 312.6            |   |
| Total liabilities & equity                   |   | $           | 500.9  |                        | $      | 477.9                         |   | $                | 5.6    |             | $      | (371.5 | ) | $ | 612.9 |   |

 

**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       |   | 37.2        |   | 30.9                        |   | 1.1                           |   | —           |   | 69.2             |   |
| Operating income (loss)                    |   | (37.2       | )      | (23.0                       | )      | (1.3                          | )      | (0.3             | )      | (61.8            | )      |
|                                       |   |        |   |                        |   |                          |   |             |   |             |   |
| Equity in subsidiaries’ income (loss) |   | (22.6       | )      | —                      |   | —                        |   | 22.6             |   | —           |   |
| Interest expense                           |   | (12.7       | )      | —                      |   | —                        |   | —           |   | (12.7            | )      |
| 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 | ) |

 

59

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**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 |   |

 

**CONDENSED CONSOLIDATINGINCOME STATEMENT**

**FOR THEYEAR ENDED DECEMBER 31, 2001**

 
|                                |   | **Company** |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiary** |   | **Eliminations** |   | **Consolidated** |   |
|-------------------------------------|--------|-------------|--------|-----------------------------|--------|-------------------------------|--------|------------------|--------|------------------|--------|
|                                |   |        |   |                        |   |                          |   |             |   |             |   |
| Net Revenues                        |   | $           | — |                        | $      | 653.5                         |   | $                | 9.7    |             | $      | (13.0 | ) | $ | 650.2 |   |
| Cost of Goods Sold                  |   | —      |   | 583.7                       |   | 10.2                          |   | (13.0            | )      | 580.9            |   |
| Gross profit                        |   | —      |   | 69.8                        |   | (0.5                          | )      | —           |   | 69.3             |   |
| Selling, general and administrative |   | (0.4        | )      | 35.7                        |   | 0.8                           |   | —           |   | 36.1             |   |
| Operating income (loss)             |   | 0.4         |   | 34.1                        |   | (1.3                          | )      | —           |   | 33.2             |   |
|                                |   |        |   |                        |   |                          |   |             |   |             |   |
| Equity in subsidiaries’ income |   | 19.7        |   | —                      |   | —                        |   | (19.7            | )      | —           |   |
| Interest income (expense), net      |   | 1.2         |   | (11.1                       | )      | —                        |   | —           |   | (9.9             | )      |
| Other income (expense), net         |   | (4.9        | )      | (1.1                        | )      | (0.1                          | )      | —           |   | (6.1             | )      |
| Income (loss) before income tax     |   | 16.4        |   | 21.9                        |   | (1.4                          | )      | (19.7            | )      | 17.2             |   |
| Income tax (expense) benefit        |   | —      |   | (0.8                        | )      | —                        |   | —           |   | (0.8             | )      |
| Net income (loss)                   |   | $           | 16.4   |                        | $      | 21.1                          |   | $                | (1.4   | )                | $      | (19.7 | ) | $ | 16.4 |   |

 

60

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**CONDENSEDCONSOLIDATING CASH FLOW STATEMENT**

**FOR THEYEAR ENDED DECEMBER 31, 2001**

 
|                                                 |   | **Company** |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiary** |   | **Eliminations** |   | **Consolidated** |   |
|------------------------------------------------------|--------|-------------|--------|-----------------------------|--------|-------------------------------|--------|------------------|--------|------------------|--------|
| Net cash provided by (used in) operating  activities |   | $           | (6.3   | )                           | $      | 41.0                          |   | $                | (3.4   | )                | $      | — |   | $ | 31.3 |   |
| Net cash provided by (used in) investing  activities |   | 10.3        |   | (23.9                       | )      | (1.0                          | )      | —           |   | (14.7            | )      |
| Net cash provided by (used in) financing  activities |   | 76.3        |   | (17.0                       | )      | 4.3                           |   | —           |   | 63.2             |   |
| Net change in cash                                   |   | 80.3        |   | 0.1                         |   | (0.1                          | )      | —           |   | 79.8             |   |
| Cash beginning balance                               |   | 25.3        |   | 0.4                         |   | 0.5                           |   | —           |   | 26.7             |   |
| Cash ending balance                                  |   | $           | 105.6  |                        | $      | 0.5                           |   | $                | 0.4    |             | $      | — |   | $ | 106.5 |   |

 

**QUARTERLY FINANCIAL SUMMARY (UNAUDITED)  - NOTE M**

 
|                                      |   | **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 | ) |

 
|                                      |   | **2002 -  Quarter Ended** |   |
|-------------------------------------------|--------|---------------------------|--------|
|                                      |   | **First**                 |   | **Second** |   | **Third** |   | **Fourth** |   | **Total  Year** |   |
| Net revenues                              |   | $                         | 123.2  |   | $ | 150.1 |   | $ | 142.7 |   | $ | 107.7 |   | $ | 523.7 |   |
| Gross profit                              |   | 5.0                       |   | 8.9 |   | 0.8 |   | (7.3 | ) | 7.4 |   |
| Net loss                                  |   | (5.9                      | )      | (2.4 | ) | (10.4 | ) | (50.5 | ) | (69.2 | ) |
|                                      |   |                      |   |   |   |   |   |   |   |   |   |
| **Per common share - basic and diluted**  |   |                      |   |   |   |   |   |   |   |   |   |
| Net loss available to common shareholders |   | $                         | (0.23  | ) | $ | (0.08 | ) | $ | (0.37 | ) | $ | (1.77 | ) | $ | (2.52 | ) |

 

61

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**LONE STAR TECHNOLOGIES, INC.****Schedule II - Valuation andQualifying Accounts****December31, 2001, 2002, and 2003*($ 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, 2001*                 |   |                                 |   |                                |   |                            |   |           |   |                           |   |
| Allowance for doubtful accounts                |   | $                                    | 2.0    |                                | $      | 0.7                             |   | $              | — |                           | $      | (0.9 | ) | $ | 1.8 |   |
| Valuation allowance on net deferred tax assets |   | 74.5                                 |   | —                              |   | —                          |   | (5.1           | )      | 69.4                           |   |
|                                           |   |                                 |   |                                |   |                            |   |           |   |                           |   |
| *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                          |   |
|                                                |        |                                      |        |                                     |        |                                 |        |                |        |                                |        |  |  |  |  |  |

 

**ITEM9.****                                                   CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL**

**DISCLOSURE**

 

None.

 

**ITEM 9A.****                                          CONTROLSAND PROCEDURES**

 

Undersupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of the effectiveness of the design and operation of our disclosurecontrols and procedures, as defined in Rules 13a-15(b) and 15d-15(b) under theSecurities Exchange Act of 1934, as of the end of the period covered by thisAnnual Report on Form 10-K (the “Evaluation Date”); and whether any change hasoccurred in the Company’s internal control over financial reporting pursuant toExchange Act Rules 13a-15(d) and 15d-15(d). Based on this evaluation, our principal executive officer and principalfinancial officer concluded as of the Evaluation Date that our disclosurecontrols and procedures were effective such that the material informationrequired to be included in our Securities and Exchange Commission (“SEC”)reports is recorded, processed, summarized and reported within the time periodsspecified in SEC rules and forms relating to Lone Star, including ourconsolidated subsidiaries, and was accumulated and communicated to them byothers within those entities, as appropriate during the period when this reportwas being prepared in order to allow timely decisions regarding requireddisclosure.

 

Inaddition, there was no change in our internal control over financial reportingidentified in connection with our evaluation that has materially affected, oris reasonably likely to materially affect, our internal control over financialreporting.

 

62

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**PART III**

 

**ITEM 10.****                            DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

Informationrequired under this item is contained in Lone Star’s proxy statement for the2004 Annual Meeting of Shareholders, and is incorporated herein by reference.

 

**ITEM 11.****                            EXECUTIVECOMPENSATION**

 

Informationrequired under this item is contained in Lone Star’s proxy statement for the2004 Annual Meeting of Shareholders, and is incorporated herein by reference.

 

**ITEM12.****                           SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDERMATTERS**

 

Informationrequired under this item with respect to beneficial owners of more than 5percent of outstanding common stock, directors and executive officers andsecurities authorized for issuance under equity compensation plans is containedin Lone Star’s proxy statement for the 2004 Annual Meeting of Shareholders, andis incorporated herein by reference.

 

**ITEM 13.****                            CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

Informationrequired under this item with respect to directors and executive officers iscontained in Lone Star’s proxy statement for the 2004 Annual Meeting ofShareholders, and is incorporated herein by reference.

 

**ITEM 14.****                            PRINCIPALACCOUNTING FEES AND SERVICES**

 

Informationwith respect to fees and services related to the Company’s independentauditors, Deloitte & Touche LLP, and the disclosure of the AuditCommittee’s pre-approval policies and procedures are contained in Lone Star’sproxy statement for the 2004 Annual Meeting of Shareholders, and areincorporated herein by reference.

 

**PARTIV**

 

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

 
| (a)1.  | Financial Statements  - the following Consolidated Financial Statements are filed as part of this  report: |
|--------|------------------------------------------------------------------------------------------------------------|
|   | •                                                                                                     | Reports of  Independent Public Accountants |
|   | •                                                                                                     | Consolidated Results  of Operations -  for the years ended December 31, 2003, 2002, and 2001 |
|   | •                                                                                                     | Consolidated Balance Sheets  at December 31, 2003 and 2002 |
|   | •                                                                                                     | Consolidated  Statements of Cash Flows -  for the years ended December 31, 2003, 2002, and 2001 |
|   | •                                                                                                     | Consolidated  Statements of Shareholders’ Equity -  at December 31, 2003, 2002, and 2001 |
|   | •                                                                                                     | Notes to  Consolidated Financial Statements |
| 2.     | Schedule II  - Valuation and 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.

 

63

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3.         Index to Exhibits

 

***Description***

 
| 2.1 |   | Asset  Purchase Agreement dated as of November 16, 1999 by and among Lone Star,  Fintube Technologies, Inc. and Fintube Limited Partnership (incorporated by  reference to the same numbered Exhibit to Form 8-K of Lone Star as filed on  January 18, 2000.)                                                                                                                                                                   |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.2 |   | First  Amendment to Asset Purchase Agreement dated as of January 1, 2000 by and  among Lone Star, Fintube Technologies, Inc. and Fintube Limited Partnership  (incorporated by reference to the same numbered Exhibit to Form 8-K of Lone  Star as filed on January 18, 2000.)                                                                                                                                                  |
| 2.3 |   | Asset  Purchase Agreement dated as of March 7, 2000 by and among Lone Star,  Bellville Acquisition, Inc. and Bellville Tube Corporation (incorporated by  reference to Exhibit 2.1 to Form 8-K of Lone Star as filed on April 14,  2000.)                                                                                                                                                                                       |
| 2.4 |   | First  Amendment to Asset Purchase Agreement dated as of March 31, 2000 by and  among Lone Star, Bellville Acquisition, Inc. and Bellville Tube Corporation  (incorporated by reference to Exhibit 2.2 to Form 8-K of Lone Star as filed  on April 14, 2000.)                                                                                                                                                                   |
| 2.5 |   | Purchase  and Sale Agreement among North Star Steel Company, Universal Tubular  Services, Inc., Cargill, Incorporated, Lone Star Technologies, Inc., and Star  Seamless, Inc., dated as of August 16, 2001 (incorporated by reference  to Exhibit 2.1 to Form 8-K of Lone Star as filed on August 17, 2001).                                                                                                                    |
| 2.6 |   | Asset  Purchase Agreement, dated September 9, 2002, among Lone Star, Wheeling  Acquisition Corporation (a wholly-owned subsidiary of Lone Star), Wheeling  and Nassau Holding Corporation, as Owner of Wheeling (incorporated by  reference to Exhibit 2.1 to Form 8-K of Lone Star dated September 30,  2002 and filed on October 7, 2002).                                                                               |
| 2.7 |   | Amendment  to Asset Purchase Agreement, dated September 30, 2002, among Lone Star,  Wheeling Acquisition Corporation (a wholly-owned subsidiary of Lone Star),  Wheeling and Nassau Holding Corporation (incorporated by reference to Exhibit  2.2 to Form 8-K of Lone Star dated September 30, 2002 and filed on  October 7, 2002).                                                                                       |
| 3.1 |   | Certificate  of Incorporation of Registrant (incorporated by reference to Exhibit 3(a) to  Form S-4 Registration Statement of Lone Star as filed on April 4, 1986,  File No. 33-4581).                                                                                                                                                                                                                                               |
| 3.2 |   | Certificate  of Amendment to Certificate of Incorporation dated September 30, 1986  (incorporated by reference to Exhibit 3.2 to Form S-3 Registration Statement  of Lone Star as filed on February 4, 2000, File No. 333-96207).                                                                                                                                                                                               |
| 3.3 |   | Agreement  and Plan of Merger dated March 6, 1986, among Steel, a Texas  corporation, Lone Star, a Delaware corporation, and Lone Star Steel Company  Merging Corporation, a Delaware corporation (incorporated by reference to  Exhibit II to Form S-4 Registration Statement of Lone Star as filed on  April 4, 1986, File No. 33-4581).                                                                                      |
| 3.4 |   | By-Laws  as adopted March 6, 1986, as amended effective September 30, 1986  and March 15, 1990 (incorporated by reference to Exhibit 3.5 to Form S-3  Registration Statement of Lone Star as filed on February 4, 2000, file  No. 333-96207).                                                                                                                                                                         |
| 3.5 |   | Certificate  of Amendment to Certificate of Incorporation dated May 20, 1998 (incorporated  by reference to Exhibit 3.4 to Form 10-Q for the quarter ended June 30,  1998).                                                                                                                                                                                                                                                          |
| 4.1 |   | Statement  of Resolution establishing Cumulative Preferred Stock, Series A (par value $1  per share), dated September 9, 1988 (incorporated by reference to  Exhibit 3(c) of Form 10-K of Lone Star filed April 7, 1989).                                                                                                                                                                                                       |
| 4.2 |   | Lone  Star Indenture with Bankers Trust Company, Trustee, with respect to  $50,000,000 8% Convertible Subordinated Debentures Due 2002 (Eurobonds),  dated August 26, 1987 (incorporated by reference to Exhibit 4(c) of Form  10-K of Lone Star as filed on April 7, 1989).                                                                                                                                                    |
| 4.3 |   | Stock  Registration Agreement dated January 1, 2000 among Lone Star  Technologies, Inc., Fintube Limited Partnership, Yorktown Energy Partners,  Brown University Third Century Fund, Warburg, Dillon, Reed, L.L.C. and  Ticonderoga Partners and the stockholders named therein (incorporated by  reference to Exhibit 4.1 to Form S-3 Registration Agreement of Lone Star as  filed on February 4, 2000, File No. 333-96207). |
| 4.4 |   | Letter  Agreement dated October 19, 2000 by Alpine Capital, L.P., Keystone, Inc.  and The Anne T. and Robert M. Bass Foundation to Lone Star (incorporated by  reference to Exhibit 4.6 to Amendment No. 2 to Form S-3 Registration  Statement of Lone Star as filed on October 30, 2000, File No.  333-41130).                                                                                                                 |

 

64

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| 4.5     |   | Indenture  dated as of May 29, 2001 among Lone Star, Environmental Holdings, Inc.,  Zinklahoma, Inc., Lone Star Steel Company, Lone Star Logistics, Inc., Lone  Star Steel International, Inc., Lone Star Steel Sales Company, Rotac, Inc.,  T&N Lone Star Warehouse Co., Texas   & Northern Railway Company, Lone Star ST Holdings, Inc., Fintube  Technologies, Inc., Fintube Canada, Inc., Bellville Tube Corporation, and  Wells Fargo Bank Minnesota, National Association (incorporated by reference  to Exhibit 4.3 to Form S-4 Registration Statement of Lone Star as filed on  June 27, 2001, File No. 333-63944). |
|---------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.6     |   | Exchange  and Registration Rights Agreement dated May 29, 2001, among Lone Star,  Goldman, Sachs & Co., Salomon Smith Barney Inc., Banc of America  Securities LLC, CIBC World Markets Corp., Dresdner Kleinwort Wasserstein  Securities LLC, RBC Dominion Securities Corporation, and The  Robinson-Humphrey Company, LLC (incorporated by reference to Exhibit 4.4 to  Form S-4 Registration Statement of Lone Star as filed on June 27, 2001,  File No. 333-63944).                                                                                                                                                               |
| 4.7     |   | Letter  Agreement dated October 16, 2002 by Keystone, Inc., Alpine Capital L.P.,  and the Anne T. and Robert M. Bass Foundation to Lone Star (incorporated by  references to Exhibit 4.11 to Form S-3 Registration Statement of Lone Star as  filed on October 16, 2002.  File  No. 333-100579).                                                                                                                                                                                                                                                                                                                               |
| 10.1    |   | Amended  1985 Long-Term Incentive Plan (incorporated by reference to Exhibit A of  Proxy Statement of Lone Star as filed on October 22, 1993).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.1(a) |   | Amendments  to the Amended 1985 Long-Term Incentive Plan adopted on May 8, 1997  (incorporated by reference to Exhibit 10.1(a) to Form 10-Q of Lone Star for  the quarter ended June 30, 1997). *                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.1(b) |   | Amendments  to the Amended 1985 Long-Term Incentive Plan adopted on May 14, 1998  (incorporated by reference to same numbered Exhibit to Form 10-Q for the  quarter ended June 30, 1998). *                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.1(c) |   | Amendments  to the Amended 1985 Long-Term Incentive Plan adopted on May 11, 1999  (incorporated by reference to same numbered Exhibit to Form 10-Q for the  quarter ended June 30, 1999). *                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.1(d) |   | Amendment  to the Amended 1985 Long-Term Incentive Plan adopted on May 9, 2000  (incorporated by reference to same numbered Exhibit to Form 10-Q for the  quarter ended June 30, 2000.) *                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 10.1(e) |   | Amendments  to the Amended 1985 Long-Term Incentive Plan adopted on May 8, 2001  (incorporated by reference to same numbered exhibit to Form 10-Q for the  quarter ended June 30, 2001). *                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.1(f) |   | Amendment  to the 1985 Long-Term Incentive Plan adopted on May 9, 2002 (incorporated by  reference to same numbered exhibit to Form 10-Q for the quarter ended  June 30, 2002). *                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.1(g) |   | Amendments  to the 1985 Long-Term Incentive Plan adopted on May 13, 2003. *                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.2    |   | Employment  Retention Policy adopted May 8, 1997, letter agreements dated May 22, 1997  between Lone Star and John P. Harbin, Charles J. Keszler and Robert F. Spears  and between Steel and W. Byron Dunn and letter agreement dated  September 25, 1997 between Lone Star and Rhys J. Best (incorporated by  reference to same numbered Exhibit to Form 10-K for the year ended  December 31, 1997).*                                                                                                                                                                                                                             |
| 10.3    |   | Contract  for Electric Service dated September 30, 1996 between Southwestern  Electric Power Company and Steel (incorporated by reference to Exhibit 10.21  to Form 10-K for the year ended December 31, 1996).                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.4    |   | Credit  Agreement dated as of October 2, 1997 by and among Steel and the banks  named therein (incorporated by reference to Exhibit 10.23 to Form 10-K for  the year ended December 31, 1997).                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.5    |   | Cost  Sharing Agreement dated as of July 1, 1997 between Lone Star and Steel  (incorporated by reference to Exhibit 10.24 to Form 10-K for the year ended  December 31, 1997).                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.6    |   | Compromise  and Settlement Agreement and Release dated July 31, 1997 between Lone  Star and Guaranty Federal Bank, F.S.B. (incorporated by  reference to Exhibit 10.26 to Form 10-K for the year ended December 31,  1997).                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.7    |   | Consulting  Agreement dated as of July 23, 1998 between Lone Star and John P. Harbin  (incorporated by reference to Exhibit 10.27 to Form 10-Q for the quarter  ended September 30, 1998).*                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.8    |   | Phantom  Stock Deferred Compensation Plan adopted on September 22, 1998  (incorporated by reference to Exhibit 10.28 to Form 10-Q for the quarter  ended September 30, 1998).*                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.9    |   | Financing  Agreement dated March 12, 1999 between Steel and The CIT Group/Business  Credit, Inc. (incorporated by reference to Exhibit 10.30 to Form 10-Q for the  quarter ended March 31, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.10   |   | Subordination  Agreement dated March 12, 1999 between Lone Star and The CIT  Group/Business Credit, Inc. (incorporated by reference to Exhibit 10.31 to  Form 10-Q for the quarter ended March 31, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.11   |   | Intercreditor  Agreement dated March 12, 1999 among Lone Star, Steel and The CIT  Group/Business Credit, Inc. (incorporated by reference to Exhibit 10.32 to  Form 10-Q for the quarter ended March 31, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                      |

 

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| 10.12    |   | Amendment  agreement dated December 28, 1999 to Financing Agreement dated  March 12, 1999 between Steel and The CIT Group/Business Credit, Inc.  (incorporated by reference to Exhibit 10.33 to Form 10-K for the year ended  December 31, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|----------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.13(a) |   | Limited  Guaranty dated December 28, 1999 of Lone Star in favor of The CIT  Group/Business Credit, Inc., as Agent (incorporated by reference to Exhibit  10.34 to Form 10-K for the year ended December 31, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.14(b) |   | Limited  Guaranty dated as of March 31, 2000 by and between the CIT  Group/Business Credit, Inc., as agent, and Lone Star (incorporated by  reference to Exhibit 2.3 to Form 8-K of Lone Star as filed on April 14,  2000).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.15(c) |   | Stock  Pledge Agreement dated as of March 31, 2000 by and between the CIT  Group/Business Credit, Inc., as agent, and Lone Star (incorporated by  reference to Exhibit 2.4 to Form 8-K of Lone Star as filed on April 14,  2000).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.16    |   | Credit  Agreement dated as of January 3, 2000 among Fintube Technologies, Inc.  (“Fintube”), the financial institutions named in the Agreement (“Lenders”)  and Bank of America, N.A., as Agent for the Lenders (incorporated by  reference to Exhibit 10.35 to Form 10-Q for the quarter ended June 30,  2000).                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.17    |   | Employee  Stock Purchase Plan adopted on May 9, 2000 (incorporated by reference to  Exhibit 10.36 to Form 10-Q for the quarter ended June 30, 2000).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.18    |   | Deferred  Compensation Plan adopted by Lone Star’s Board of Directors on May 9, 2000  and as amended by Lone Star’s Board of Directors on December 3, 2002  (incorporated by reference to Exhibit 10.18 to Form 10-K for the year ended  December 31, 2002). *                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.19    |   | Amendment  agreement dated September 29, 2000 to Financing Agreement dated  March 12, 1999 between Steel and The CIT Group/Business Credit, Inc.  (incorporated by reference to Exhibit 10.38 to Form 10-Q for the quarter  ended September 30, 2000).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.20    |   | Amendment  agreement dated October 25, 2000 to Financing Agreement dated  March 12, 1999 between Steel and The CIT Group/Business Credit, Inc.  (incorporated by reference to Exhibit 10.39 to Form 10-K for the year ended  December 31, 2000).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.21    |   | Modification  Agreement dated September __, 2000 to Credit Agreement dated as of  January 3, 2000 among Fintube, the Lenders and Bank of America, N.A., as  Agent for the Lenders (incorporated by reference to Exhibit 10.40 to Form  10-K for the year ended December 31, 2000).                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.22    |   | Second  Modification Agreement dated February 20, 2001 to Credit Agreement dated  as of January 3, 2000 among Fintube, the Lenders and Bank of America,  N.A., as Agent for the Lenders (incorporated by reference to Exhibit 10.41 to  Form 10-K for the year ended December 31, 2000).                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 10.23    |   | Employment  Agreement dated May 7, 2001 between Lone Star and Rhys J. Best (incorporated  by reference to Exhibit 99.1 to Form 8-K of Lone Star as filed on May 9,  2001).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.24    |   | Purchase  Agreement dated May 23, 2001 among Lone Star, Goldman, Sachs & Co.,  Salomon Smith Barney Inc., Banc of America Securities LLC, RBC Dominion  Securities Corporation, and The Robinson-Humphrey Company, LLC (incorporated  by reference to Exhibit 10.10 to Form S-4 Registration Statement of Lone Star  as filed on June 27, 2001, File No. 333-63944).                                                                                                                                                                                                                                                                                                                                                                           |
| 10.25    |   | Consulting  Employment Agreement dated January 1, 2000, among Fintube Technologies,  Inc., Jerry E. Ryan, and Lone Star (incorporated by reference to Exhibit  10.42 to Form 10-Q for the quarter ended March 31, 2001).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.26    |   | Employment  Agreement dated January 1, 2000 between Fintube Technologies, Inc. and  Larry Sims (incorporated by reference to Exhibit 10.43 to Form 10-Q for the  quarter ended March 31, 2001).*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.27    |   | Amended  and Restated Financing Agreement dated October 8, 2001 among The CIT  Group/Business Credit, Inc. (as Agent and Lender), the Lenders party thereto,  and Lone Star, Lone Star Steel Company, Fintube Technologies, Inc., Lone Star  Logistics, Inc., T&N Lone Star Warehouse Co., Texas & Northern  Railway Company, Fintube Canada, Inc. and Bellville Tube Corporation (as  Borrowers), and Environmental Holdings, Inc., Zinklahoma, Inc., Lone Star  Steel International, Inc., Lone Star Steel Sales Company, Rotac, Inc., and  Lone Star ST Holdings, Inc. (as Guarantors) (incorporated by reference to  Exhibit 10.13 to Amendment No. 2 to Form S-4 of Lone Star as filed on  October 9, 2001, File No. 333-63944). |
| 10.28    |   | First  Amendment, dated as of December 31, 2001, to Amended and Restated  Financing Agreement dated October 8, 2001 (incorporated by reference to  Exhibit 10.31 to Form 10-Q for the quarter ended March 31, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.29    |   | Second  Amendment, dated March 13, 2002, to Amended and Restated Financing  Agreement dated October 8, 2001 (incorporated by reference to Exhibit  10.32 to Form 10-Q for the quarter ended March 31, 2002).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

 

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| 10.30 |   | Third  Amendment, dated as of September 30, 2002, to Amended and Restated  Financing Agreement dated October 8, 2001 (incorporated by reference to  Exhibit 10.33 to Form 10-Q for the quarter ended September 30, 2002).  |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.31 |   | Fourth  Amendment, dated as of September 30, 2002, to Amended and Restated  Financing Agreement dated October 8, 2001 (incorporated by reference to  Exhibit 10.34 to Form 10-Q for the quarter ended September 30, 2002). |
| 10.32 |   | Fifth  Amendment, dated as of May 5, 2003, to Amended and Restated Financing  Agreement dated October 8, 2001 (incorporated by reference to Exhibit  10.1 to Form 10-Q for the quarter ended June 30, 2003).                    |
| 10.33 |   | Sixth  Amendment, dated as of August 29, 2003, to Amended and Restated  Financing Agreement dated October 8, 2001.                                                                                                              |
| 10.34 |   | Seventh  Amendment, dated as of December 16, 2003, to Amended and Restated  Financing Agreement dated October 8, 2001.                                                                                                          |
| 14.1  |   | Code  of Ethics for Senior Financial Officers adopted by Lone Star’s Board of  Directors on March 20, 2003 (incorporated by reference to Exhibit 99.1  to Form 10-K for the year ended December 31, 2002).                 |
| 21    |   | List  of Subsidiaries.                                                                                                                                                                                                                    |
| 23    |   | Consent  of Deloitte & Touche LLP.                                                                                                                                                                                                    |
| 24    |   | Powers  of Attorney.                                                                                                                                                                                                                      |
| 31.1  |   | Certification  of Mr. Rhys J. Best pursuant to Rule 13a-14 of the Securities Exchange Act of  1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                            |
| 31.2  |   | Certification  of Mr. Charles J. Keszler pursuant to Rule 13a-14 of the Securities Exchange  Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                                                      |
| 32    |   | Certification  pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                               |
| *     |   | Management  contract or compensatory plan or arrangement.                                                                                                                                                                                 |
| (b)   |   | Reports  on Form 8-K:                                                                                                                                                                                                                     |

 
| **Date of Report**      |   | **Date Filed**          |   | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|-------------------------|--------|-------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| October 6,  2003   |   | October 7,  2003   |   | Disclosure  furnishing Lone Star’s press release regarding its preliminary financial  results for the third quarter of 2003.   Notwithstanding its listing here, the information furnished shall not  be deemed ‘filed’ for purposes of Section 18 of the Securities Exchange  Act of 1934, as amended, or otherwise subject to the liabilities of that  section, nor incorporated by reference in any filing with the Securities Act  of 1933, as amended, except as expressly set forth by specific reference in  such a filing. |
| October 15,  2003  |   | October 16,  2003  |   | Disclosure  furnishing Lone Star’s press release regarding its results of operations for  the third quarter of 2003.   Notwithstanding its listing here, the information furnished shall not  be deemed ‘filed’ for purposes of Section 18 of the Securities Exchange  Act of 1934, as amended, or otherwise subject to the liabilities of that  section, nor incorporated by reference in any filing with the Securities Act  of 1933, as amended, except as expressly set forth by specific reference in  such a filing.         |
| December 16,  2003 |   | December 22,  2003 |   | Amendment  to senior secured credit facility.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |

 

67

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**ITEM16.**               **SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Actof 1934, the Registrant has duly caused this report to be signed on its behalfby the undersigned, thereunto duly authorized.

 
|                            |   | **LONE STAR TECHNOLOGIES, INC.** |
|---------------------------------|--------|----------------------------------|
|                            |   |                             |
| Date:  March 12, 2004 |   | By:                              |   | /s/ Charles J. Keszler |
|                            |   | (Charles J. Keszler)             |
|                            |   | Vice President and Chief         |
|                            |   | Financial Officer                |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities and on the dates indicated.

 
| ***Signature***                         |                    |   | ***Title***                             |   | ***Date***          |
|-----------------------------------------|-------------------------|--------|-----------------------------------------|--------|---------------------|
|                                    |                    |   |                                    |   |                |
| /s/  Rhys J. Best                       |                    | ,      | Chairman,  Director, Chief              |   | March 12, 2004 |
| (Rhys  J. Best)                         |                    |   | Executive  Officer and President        |   |                |
| (Principal  Executive Officer)          |                    |   |                                    |   |                |
|                                    |                    |   |                                    |   |                |
| /s/  Charles J. Keszler                 |                    | ,      | Vice  President and Chief               |   | March 12, 2004 |
| (Charles  J. Keszler)                   |                    |   | Financial  Officer (Principal Financial |   |                |
|                                    |                    |   | and  Accounting Officer)                |   |                |
|                                    |                    |   |                                    |   |                |
| /s/  Frederick B. Hegi, Jr.             | *                       | ,      | Director                                |   | March 12, 2004 |
| (Frederick  B. Hegi, Jr.)               |                    |   |                                    |   |                |
|                                    |                    |   |                                    |   |                |
| /s/  Robert L. Keiser                   | *                       | ,      | Director                                |   | March 12, 2004 |
| (Robert  L. Keiser)                     |                    |   |                                    |   |                |
|                                    |                    |   |                                    |   |                |
| /s/  Robert Kelley                      | *                       | ,      | Director                                |   | March 12, 2004 |
| (Robert  Kelley)                        |                    |   |                                    |   |                |
|                                    |                    |   |                                    |   |                |
| /s/  M. Joseph McHugh              | *                       | ,      | Director                                |   | March 12, 2004 |
| (M.  Joseph McHugh)                     |                    |   |                                    |   |                |
|                                    |                    |   |                                    |   |                |
| /s/  Thomas M. Mercer, Jr.              | *                       | ,      | Director                                |   | March 12, 2004 |
| (Thomas  M. Mercer, Jr.)                |                    |   |                                    |   |                |
|                                    |                    |   |                                    |   |                |
|                                    |                    | ,      | Director                                |   | March 12, 2004 |
| (Alfred  M. Micallef)                   |                    |   |                                    |   |                |
|                                    |                    |   |                                    |   |                |
| /s/  Jerry E. Ryan                      | *                       | ,      | Director                                |   | March 12, 2004 |
| (Jerry  E. Ryan)                        |                    |   |                                    |   |                |
|                                    |                    |   |                                    |   |                |
| *By:                                    | /s/  Charles J. Keszler |   |                                    |   |                |
| (Charles  J. Keszler, Attorney-in-Fact) |                    |   |                                    |
|                                         |                         |        |                                         |        |                     |  |  |

 

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