##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 COMMISSION FILE NUMBER 1-9838 NS GROUP, INC.  Kentucky
    
    61-0985936(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 530 West Ninth Street, Newport, Kentucky 41071
(Address, including zip code, of principal executive offices) Registrants telephone number, including area code (859) 292-6809 Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes þ  No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes þ  No o At October 29, 2004, there were 21,548,097 shares outstanding of the Companys
common stock.




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##### Table of Contents



NS GROUP, INC. INDEX  
 Page No.PART I
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsCondensed Consolidated Statements of Operations
    
    
    3Condensed Consolidated Balance Sheets
    
    
    4Condensed Consolidated Statements of Cash Flows
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    15Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4.
    
    Controls and Procedures
    
    
    27PART II
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    27Item 6.
    
    Exhibits
    
    
    27EX-10.1EX-10.2EX-10.3EX-10.4EX-10.5EX-12.1EX-31.1EX-31.2EX-32.1EX-32.2
 2




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PART I  FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS 
 NS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts) (Unaudited) Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net sales
    
    $
    122,120
    
    
    $
    73,577
    
    
    $
    316,070
    
    
    $
    189,961Cost of products sold
    
    
    92,414
    
    
    
    72,367
    
    
    
    249,023
    
    
    
    196,202Gross profit (loss)
    
    
    29,706
    
    
    
    1,210
    
    
    
    67,047
    
    
    
    (6,241
    )Selling, general and administrative
    
    
    4,176
    
    
    
    3,233
    
    
    
    12,520
    
    
    
    11,516Restructuring charges
    
    
    
    
    
    
    
    
    
    
    1,897
    
    
    
    Operating income (loss)
    
    
    25,530
    
    
    
    (2,023
    )
    
    
    52,630
    
    
    
    (17,757
    )Investment income (loss)
    
    
    37
    
    
    
    41
    
    
    
    92
    
    
    
    (122
    )Interest expense
    
    
    (197
    )
    
    
    (280
    )
    
    
    (868
    )
    
    
    (3,075
    )Other income, net
    
    
    212
    
    
    
    52
    
    
    
    194
    
    
    
    159Income (loss) before income taxes
    
    
    25,582
    
    
    
    (2,210
    )
    
    
    52,048
    
    
    
    (20,795
    )Provision for income taxes
    
    
    870
    
    
    
    
    
    
    
    1,691
    
    
    
    Net income (loss)
    
    $
    24,712
    
    
    $
    (2,210
    )
    
    $
    50,357
    
    
    $
    (20,795
    )Net income (loss) per common share -Basic
    
    $
    1.17
    
    
    $
    (0.11
    )
    
    $
    2.40
    
    
    $
    (1.00
    )Diluted
    
    $
    1.14
    
    
    $
    (0.11
    )
    
    $
    2.35
    
    
    $
    (1.00
    )Weighted average shares outstanding -Basic
    
    
    21,160
    
    
    
    20,859
    
    
    
    21,004
    
    
    
    20,735Diluted
    
    
    21,740
    
    
    
    20,859
    
    
    
    21,469
    
    
    
    20,735
 See accompanying notes to condensed consolidated financial statements. 3




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NS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands) September 30,
    
    December 31,2004
    
    2003ASSETS
    
    (Unaudited)Current assetsCash and equivalents
    
    $
    16,818
    
    
    $
    2,628Accounts receivable, net
    
    
    47,834
    
    
    
    27,261Inventories
    
    
    109,645
    
    
    
    66,568Operating supplies and other
    
    
    9,963
    
    
    
    9,734Assets held for sale
    
    
    
    
    
    
    7,000Total current assets
    
    
    184,260
    
    
    
    113,191Property, plant and equipment, at cost
    
    
    200,350
    
    
    
    198,713Less accumulated depreciation
    
    
    (156,384
    )
    
    
    (152,759
    )43,966
    
    
    
    45,954Other assets
    
    
    4,462
    
    
    
    4,981Assets held for sale
    
    
    1,795
    
    
    
    1,734Total assets
    
    $
    234,483
    
    
    $
    165,860LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesAccounts payable
    
    $
    35,513
    
    
    $
    24,507Accrued expenses and other liabilities
    
    
    24,435
    
    
    
    16,861Deferred revenue
    
    
    18,603
    
    
    
    8,012Revolving credit facility
    
    
    
    
    
    
    14,936Other notes payable
    
    
    653
    
    
    
    106Current portion of restructuring liabilities
    
    
    762
    
    
    
    3,653Current portion of long-term debt
    
    
    40
    
    
    
    40Total current liabilities
    
    
    80,006
    
    
    
    68,115Long-term debt
    
    
    431
    
    
    
    461Deferred income taxes
    
    
    424
    
    
    
    424Postretirement benefits
    
    
    6,749
    
    
    
    6,343Restructuring liabilities
    
    
    2,043
    
    
    
    1,909Total liabilities
    
    
    89,653
    
    
    
    77,252Shareholders equity
    
    
    
    
    
    
    Preferred stock, no par value, 2,000 shares authorized
    
    
    
    
    
    
    Common stock, no par value, 40,000 shares authorized,
25,110 and 25,090, shares issued
    
    
    285,966
    
    
    
    284,787Treasury stock, at cost, 3,591 and 4,192 shares
    
    
    (30,347
    )
    
    
    (35,420
    )Unearned compensation
    
    
    (339
    )
    
    
    (50
    )Accumulated other comprehensive income
    
    
    64
    
    
    
    97Accumulated deficit
    
    
    (110,514
    )
    
    
    (160,806
    )Shareholders equity
    
    
    144,830
    
    
    
    88,608Total liabilities and shareholders equity
    
    $
    234,483
    
    
    $
    165,860
 See accompanying notes to condensed consolidated financial statements. 4




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NS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited) Nine Months EndedSeptember 30,2004
    
    2003CASH FLOWS  OPERATING ACTIVITIESNet income (loss)
    
    $
    50,357
    
    
    $
    (20,795
    )Adjustments to reconcile net income (loss) to cash flows
provided (used) by operating activities:Depreciation and amortization
    
    
    4,029
    
    
    
    5,299Amortization of debt discount and finance costs
    
    
    303
    
    
    
    531Loss on sales of securities
    
    
    
    
    
    
    453Restructuring charges
    
    
    1,897
    
    
    
    Gain on sale of long term investment
    
    
    (279
    )
    
    
    Changes in operating assets and liabilities:Accounts receivable, net
    
    
    (20,573
    )
    
    
    (16,188
    )Inventories
    
    
    (43,077
    )
    
    
    (6,345
    )Other current assets
    
    
    851
    
    
    
    2,163Accounts payable
    
    
    11,006
    
    
    
    19,770Accrued liabilities
    
    
    6,521
    
    
    
    124Deferred revenue
    
    
    10,591
    
    
    
    5,497Income taxes payable
    
    
    1,041
    
    
    
    Restructuring liabilities
    
    
    (4,788
    )
    
    
    (878
    )Other, net
    
    
    584
    
    
    
    644Cash provided (used) by operating activities
    
    
    18,463
    
    
    
    (9,725
    )CASH FLOWS  INVESTING ACTIVITIESPurchases of property, plant and equipment
    
    
    (2,041
    )
    
    
    (728
    )Proceeds from sales of assets held for sale
    
    
    6,918
    
    
    
    479Proceeds from sales of long term investments
    
    
    653
    
    
    
    3,693Other
    
    
    
    
    
    
    1,947Cash provided by investing activities
    
    
    5,530
    
    
    
    5,391CASH FLOWS  FINANCING ACTIVITIESRepayments of long-term debt
    
    
    (30
    )
    
    
    (33,793
    )Net borrowing (repayments) under credit facility
    
    
    (14,936
    )
    
    
    12,504Repayment of other notes payable
    
    
    (533
    )
    
    
    (520
    )Proceeds from exercise of stock options
    
    
    5,806
    
    
    
    949Deferred financing costs
    
    
    (110
    )
    
    
    (351
    )Additions to cost of treasury shares
    
    
    
    
    
    
    (28
    )Cash used by financing activities
    
    
    (9,803
    )
    
    
    (21,239
    )Increase (decrease) in cash and equivalents
    
    
    14,190
    
    
    
    (25,573
    )Cash and equivalents at beginning of period
    
    
    2,628
    
    
    
    29,357Cash and equivalents at end of period
    
    $
    16,818
    
    
    $
    3,784Supplemental disclosure of cash flow information -Cash paid during the period for interest
    
    $
    393
    
    
    $
    4,137Cash paid (recovered) during the period for income taxes
    
    $
    650
    
    
    $
    (560
    )Note issued for payment of insurance premium
    
    $
    1,080
    
    
    $
    943
 See accompanying notes to condensed consolidated financial statements. 5




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NS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The condensed consolidated financial statements include the accounts of NS
Group, Inc. and its wholly owned subsidiaries (collectively referred to as the
Company). The significant subsidiaries are Newport Steel Corporation
(Newport) and Koppel Steel Corporation (Koppel). All significant
intercompany balances and transactions have been eliminated. The accompanying condensed consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America for interim financial information and with the rules
and regulations of the Securities and Exchange Commission (SEC). Accordingly,
they do not include all of the information and footnotes for complete financial
statements as required by accounting principles generally accepted in the
United States of America. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for a fair
presentation have been included in the financial statements. Operating results
for an interim period are not necessarily indicative of the results that may be
expected for a full year. Reference should be made to NS Group, Inc.s Annual
Report on Form 10-K for the year ended December 31, 2003 for additional
footnote disclosure, including a summary of significant accounting policies.
Certain reclassifications have been made to prior period balances in order to
conform to the current period presentation. Use of Estimates The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires that
management make certain estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes.
Actual results could differ from those recorded estimates. Earnings and Loss Per Share Basic earnings and loss per share is computed by dividing net income or
loss by the weighted-average number of common shares outstanding for the
period. Diluted earnings or loss per share reflects the potential dilution from
common shares issuable through stock options, restricted stock units and
warrants, as appropriate. 6




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The following is a reconciliation of the average shares outstanding used
to compute basic and diluted earnings per share for the three and nine months
ended September 30, 2004: Three Months
    
    Nine MonthsEnded
    
    EndedSeptember 30,
    
    September 30,(in thousands)
    
    2004
    
    2004Basic weighted average common shares
outstanding
    
    
    21,160
    
    
    
    21,004Effect of dilutive securities
    
    
    580
    
    
    
    465Diluted weighted average common shares
outstanding
    
    
    21,740
    
    
    
    21,469
 For the quarter and nine months ended September 30, 2004, 0.2 million of
stock options were not included in the computation of diluted earnings per
share because the exercise price was greater than the average market price of
the common shares for the period and, therefore, the effect would be
antidilutive. Securities that could potentially result in dilution of basic
loss per share, through the issuance of 1.8 million of the Companys common
shares for the quarter and nine months ended September 30, 2003, were not
included in the computation of diluted loss per share because to do so would be
antidilutive. Stock-Based Compensation The Company accounts for stock-based compensation using the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. Stock
options granted in all periods shown were exercisable at prices equal to the
fair market value of the Companys common stock on the dates the options were
granted; accordingly, no compensation expense has been recognized for the stock
options granted. The fair values of the granted options are determined using
the Black-Scholes option pricing model using assumptions that are evaluated and
revised, as necessary, to reflect market conditions and experience. The following table sets forth grants made during the nine months ended
September 30, 2004 and 2003: Nine Months EndedSeptember 30, 2004
    
    September 30, 2003RestrictedStock
    
    Stock
    
    StockOptions
    
    Units
    
    OptionsNon-employee directors
    
    
    32,000
    
    
    
    
    
    
    
    32,000Executive officers
    
    
    
    
    
    
    31,500
    
    
    
    65,000Senior managers
    
    
    57,500
    
    
    
    
    
    
    
    55,00089,500
    
    
    
    31,500
    
    
    
    152,000
 7




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The restricted stock units (RSUs) vest in annual increments over three
years. The market value of the RSUs on the date of grant was $380,000 and is
being amortized on a
straight-line basis to expense over the vesting period. The unamortized
balance of the unearned compensation is included as a separate component of
shareholders equity. If the Company accounted for stock-based compensation using the fair value
recognition provisions of Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation, net income (loss) and diluted net
income (loss) per common share would have been as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(in thousands, except per share amounts)
    
    2004
    
    2003
    
    2004
    
    2003Net income (loss)  as reported
    
    $
    24,712
    
    
    $
    (2,210
    )
    
    $
    50,357
    
    
    $
    (20,795
    )Add: Stock-based employee compensation
included in reported net income (loss)
    
    
    31
    
    
    
    31
    
    
    
    92
    
    
    
    94Deduct: Stock-based employee compensation
expense determined under the fair value
method for all awards, net of related tax
effects
    
    
    (425
    )
    
    
    (455
    )
    
    
    (1,191
    )
    
    
    (1,902
    )Net income (loss)  pro forma
    
    $
    24,318
    
    
    $
    (2,634
    )
    
    $
    49,258
    
    
    $
    (22,603
    )Net income (loss) per common share:Basic  as reported
    
    $
    1.17
    
    
    $
    (0.11
    )
    
    $
    2.40
    
    
    $
    (1.00
    )Basic  pro forma
    
    $
    1.15
    
    
    $
    (0.13
    )
    
    $
    2.35
    
    
    $
    (1.09
    )Diluted  as reported
    
    $
    1.14
    
    
    $
    (0.11
    )
    
    $
    2.35
    
    
    $
    (1.00
    )Diluted  pro forma
    
    $
    1.12
    
    
    $
    (0.13
    )
    
    $
    2.29
    
    
    $
    (1.09
    )
 NOTE 2: RESTRUCTURING LIABILITIES AND ASSETS HELD FOR SALE Restructuring Liabilities In 2001, the Company completed certain restructuring initiatives involving
certain operations of its businesses. The Company discontinued the
manufacturing of hot-rolled coils at its welded tubular facilities in Wilder,
Kentucky and exited the special bar quality business that was operated from its
Koppel, Pennsylvania facility. As a result of these actions, in March 2001,
the Company recorded restructuring charges of $56.2 million, including $42.8
million of asset impairment losses and $12.8 million of accruals for estimated
employee related costs and facilities closing costs. 8




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Following is a summary of accrued restructuring liabilities and activity
for the nine months ended September 30, 2004: (in thousands)
    
    Current
    
    Noncurrent
    
    TotalBalance, December 31, 2003
    
    $
    3,653
    
    
    $
    1,909
    
    
    $
    5,562Cash payments
    
    
    (4,654
    )
    
    
    
    
    
    
    (4,654
    )Accruals
    
    
    1,687
    
    
    
    210
    
    
    
    1,897Reclassifications
    
    
    76
    
    
    
    (76
    )
    
    
    Balance, September 30, 2004
    
    $
    762
    
    
    $
    2,043
    
    
    $
    2,805
 In the first quarter of 2004, the Company recorded $1.9 million in
additional restructuring charges primarily related to the settlement of an
operating contract. The restructuring liabilities were significantly reduced
in April 2004 as a result of the Companys $4.7 million payment related to the
above-mentioned settlement. The current restructuring liabilities at September
30, 2004 represent the estimated costs for environmental remediation and
monitoring costs of a closed landfill and an operating contract. The
non-current restructuring liabilities are primarily related to estimated
post-closure maintenance and monitoring costs of the landfill over the next
thirty years. At September 30, 2004, the Company had $1.7 million of
investments being held in a trust account to fund the costs of the closed
landfill. Assets Held for Sale Assets of the closed operations, consisting of machinery and equipment,
spare parts and supply inventories, are classified as Assets Held for Sale in
the Companys condensed consolidated balance sheets. The assets include the
Companys best estimates of the amounts expected to be realized on the sale of
the assets. While the estimates are based on an analysis of the facilities,
including valuations by independent appraisers, the amounts the Company will
ultimately realize could differ materially from the amounts assumed in
reviewing for impairment. The assets have been and are currently being actively
marketed by an outside broker. In October 2003, the Company entered into a contract to sell the majority
of its assets held for sale related to its welded tubular operations. The $7.0
million net sales price for the assets approximated the recorded book value of
the assets and was reclassified to current Assets Held for Sale in the December
31, 2003 consolidated balance sheet. In accordance with the contract, the
Company received the proceeds during the first six months of 2004. 9




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NOTE 3: COMPREHENSIVE INCOME (LOSS) The Companys other comprehensive income (loss) consists of unrealized
gains and losses on available-for-sale securities. Comprehensive income
(losses) for the periods presented were as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    24,712
    
    
    $
    (2,210
    )
    
    $
    50,357
    
    
    $
    (20,795
    )Net unrealized gains (losses)
    
    
    
    
    
    
    (70
    )
    
    
    (33
    )
    
    
    600Comprehensive income (loss)
    
    $
    24,712
    
    
    $
    (2,280
    )
    
    $
    50,324
    
    
    $
    (20,195
    )
 NOTE 4: BUSINESS SEGMENT INFORMATION The Company reports its operations in one reportable segment  the Energy
Products segment. The Energy Products segment consists primarily of welded and
seamless tubular products used in oil and natural gas drilling and production
operations (oil country tubular goods, or OCTG) and welded and seamless line
pipe used in the transmission of oil, natural gas and other fluids. The Energy
Products segment reflects the aggregation of the Companys welded and seamless
business units as they have similar economic characteristics such as products
and services, manufacturing processes, customers and distribution channels, and
is consistent with both internal management reporting and resource and
budgetary allocations. Three customers accounted for 32%, 12% and 12%, respectively, of the
Energy Products segments sales for the nine months ended September 30, 2004
and four customers accounted for 19%, 12%, 11% and 10%, respectively, of sales
for the nine months ended September 30, 2003. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Net salesWelded products
    
    $
    50,589
    
    
    $
    34,314
    
    
    $
    134,542
    
    
    $
    87,660Seamless products
    
    
    71,531
    
    
    
    39,263
    
    
    
    181,528
    
    
    
    102,301$
    122,120
    
    
    $
    73,577
    
    
    $
    316,070
    
    
    $
    189,961
 September 30,
    
    December 31,2004
    
    2003AssetsEnergy Products
    
    $
    208,880
    
    
    $
    150,385Corporate
    
    
    25,603
    
    
    
    15,475$
    234,483
    
    
    $
    165,860
 10




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All corporate selling, general and administrative expenses are fully
allocated to the Energy Products segment. Corporate assets consist primarily
of cash, real estate, and assets held for sale. NOTE 5: INVENTORIES  Inventories consist of the following:September 30,
    
    December 31,(in thousands)
    
    2004
    
    2003Raw materials
    
    $
    32,497
    
    
    $
    20,514Semi-finished and
finished products
    
    
    77,148
    
    
    
    46,054$
    109,645
    
    
    $
    66,568
 NOTE 6: PRODUCT WARRANTIES The Companys products are used in applications which are subject to
inherent risks including well failures, performance deficiencies, line pipe
leaks, personal injury, property damage, environmental contamination or loss of
production. The Company warrants its products to meet certain specifications
and actual or claimed deficiencies from these specifications may give rise to
claims. The Company maintains reserves for asserted and unasserted warranty
claims. The warranty claim exposure is evaluated using historical claim trends
and information available on specifically known claims. The Company also
maintains product and excess liability insurance subject to certain deductibles
that may limit the exposure to these claims. The Company considers the extent
of insurance coverage in its estimate of the reserve. The incurrence of an
unusually large or high number of claims could alter the Companys exposure and
the related reserves. The following table identifies changes in warranty reserves for 2004 and 2003: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Balance, beginning of period
    
    $
    2,073
    
    
    $
    2,906
    
    
    $
    3,057
    
    
    $
    1,842Accruals for warranties during
the period
    
    
    294
    
    
    
    153
    
    
    
    1,056
    
    
    
    833Accruals related to changes in
estimates
    
    
    (54
    )
    
    
    1
    
    
    
    (449
    )
    
    
    863Settlements made during the period
    
    
    (736
    )
    
    
    (209
    )
    
    
    (2,087
    )
    
    
    (687
    )Balance, end of period
    
    $
    1,577
    
    
    $
    2,851
    
    
    $
    1,577
    
    
    $
    2,851
 11




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##### Table of Contents



NOTE 7: PENSION AND OTHER POSTRETIREMENT BENEFITS The components of periodic benefit costs for pension and postretirement
benefit expense are as follows: Three Months Ended
    
    Nine Months Ended(in thousands)
    
    September 30,
    
    September 30,Pension
    
    2004
    
    2003
    
    2004
    
    2003Service cost
    
    $
    88
    
    
    $
    72
    
    
    $
    263
    
    
    $
    215Interest cost
    
    
    32
    
    
    
    26
    
    
    
    97
    
    
    
    79$
    120
    
    
    $
    98
    
    
    $
    360
    
    
    $
    294Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,Postretirement Benefits
    
    2004
    
    2003
    
    2004
    
    2003Service cost
    
    $
    4
    
    
    $
    4
    
    
    $
    13
    
    
    $
    10Interest cost
    
    
    6
    
    
    
    5
    
    
    
    17
    
    
    
    17Amortization of
transition obligation
    
    
    7
    
    
    
    6
    
    
    
    21
    
    
    
    20$
    17
    
    
    $
    15
    
    
    $
    51
    
    
    $
    47
 NOTE 8: DEBT AND REVOLVING CREDIT FACILITY The Company has a revolving credit facility that provides up to $50
million under a borrowing formula that is based upon eligible inventory and
accounts receivable, subject to certain reserves and satisfaction of certain
conditions to each draw under the facility. Interest rates on the facility vary
according to the amount of loans outstanding and range from the prime rate plus
1.00% to prime plus 1.75% with respect to domestic rate loans, and from the
LIBOR rate plus 2.50% to LIBOR plus 3.25% with respect to LIBOR rate loans. The
credit agreement contains financial and other covenants, including a minimum
level of earnings, as defined in the agreement, and limitations on certain
types of transactions, including the ability of the Companys subsidiaries to
declare and pay dividends. At September 30, 2004, the Company was in compliance
with these covenants. The credit facility expires in March 2007. At September 30, 2004, the Company had no loans and $6.6 million of
letters of credit outstanding under the credit facility and approximately $42.9
million in additional borrowing availability based on the borrowing formula.
The letters of credit were issued against the credit facility as collateral for
the Companys self-insured workers compensation program. The weighted average
interest rate on the credit facility borrowings was 3.78% at December 31, 2003.
The facility is secured by a first priority lien on substantially all of the
Companys inventories, accounts receivable, property, plant and equipment and
related intangibles. 12




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##### Table of Contents



NOTE 9: SHELF REGISTRATION In July 2002, the Company filed a universal shelf registration statement
with the SEC for the issuance and the sale from time to time to the public of
up to $100 million in securities, including debt, preferred stock, common stock
and warrants. The SEC declared the registration statement effective in
September 2002. The Company may sell the securities in one or more separate
offerings in amounts, at prices and on terms to be determined at the time of
sale. No securities have been sold pursuant to the shelf registration. If and
when the Company offers any securities under this registration statement, the
Company will prepare and make available a prospectus supplement that includes
the specific terms of the securities being offered. NOTE 10: COMMITMENTS AND CONTINGENCIES The Company has various commitments for the purchase of materials,
supplies and energy arising in the ordinary course of business. Legal Matters The Company is subject to various claims, lawsuits and administrative
proceedings arising in the ordinary course of business with respect to
environmental matters, workers compensation, health care and product liability
coverages (each of which is self-insured to certain levels), as well as
commercial and other matters. The Company accrues for the cost of such matters
when the incurrence of such costs is probable and can be reasonably estimated.
Based upon its evaluation of available information, management does not believe
that any such matters will have, individually or in the aggregate, a material
adverse effect upon the Companys consolidated financial position, results of
operations or cash flows. In March 2001, in connection with its restructuring, Newport closed its
electric arc furnace operation and as such, ceased using oxygen and argon that
was provided under a supply agreement with Air Products and Chemicals, Inc.
(Air Products). In connection with a suit in 2001 brought by Air Products
against Newport for breach of contract, the Company agreed in March 2004 to a
settlement and mutual release of all claims and paid $4.7 million to Air
Products in April 2004. Environmental Matters The Company is subject to federal, state and local environmental laws and
regulations, including, among others, the Resource Conservation and Recovery
Act (RCRA), the Clean Air Act, the 1990 Amendments to the Clean Air Act and
the Clean Water Act, and all regulations promulgated in connection therewith.
Such laws and regulations include those concerning the discharge of
contaminants as air emissions or waste water effluents and the disposal of
solid and/or hazardous wastes such as electric arc furnace dust. As such, the
Company is from time to time involved in administrative and judicial
proceedings and administrative inquiries related to environmental matters. 13




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##### Table of Contents



The Company operates a steel mini-mill at its Koppel, Pennsylvania
facility that produces dust that contains lead, cadmium and chromium, and is
classified as a hazardous waste. Dust produced by its electric arc furnace is
collected through emission control systems and recycled at EPA-approved
facilities. The Company has a hazardous waste landfill on its property in Wilder,
Kentucky that is being monitored according to a post-closure permit that was
approved by Kentucky Division of Waste Management. The Company has accrued the
estimated costs for the post-closure care of the landfill. In late 2001, the U.S. Environmental Protection Agency (EPA) designated
Imperial Adhesives, Inc., a former subsidiary of the Company, as one of a
number of potentially responsible parties under the Comprehensive Environmental
Response, Compensation and Liability Act (CERCLA) at an environmental
remediation site. The EPA has contended that any company linked to a CERCLA
site is potentially liable for costs under the legal doctrine of joint and
several liability. This environmental remediation site involves a municipal
waste disposal facility owned and operated by an independent operator. A
preliminary study of the site is ongoing. Consequently, it is too early to
determine the Companys ultimate liability exposure. The Company had accrued liabilities of $3.4 million and $3.9 million at
September 30, 2004 and December 31, 2003, respectively, for environmental
remediation obligations. Based upon its evaluation of available information,
management does not believe that any of the environmental contingency matters
discussed above are likely, individually or in the aggregate, to have a
material adverse effect upon the Companys consolidated financial position,
results of operations or cash flows. However, the Company cannot predict with
certainty that new information or developments with respect to its
environmental contingency matters, individually or in the aggregate, will not
have a material adverse effect on the Companys consolidated financial
position, results of operations or cash flows. 14




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##### Table of Contents



NS GROUP, INC. 
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We make forward-looking statements in this report, which represent our
expectations or beliefs about future events and financial performance. You can
identify these statements by forward-looking words such as expect, believe,
anticipate, goal, plan, intend, estimate, may, will or similar
words. Forward-looking statements are subject to known and unknown risks,
uncertainties and assumptions, including:  
    
    worldwide and domestic supplies of and demand for natural gas and oil;
    
    fluctuations in industry-wide tubular inventory levels;
    
    domestic competitive pressures;
    
    the level and pricing of imports and the presence or absence of
governmentally imposed trade restrictions;
    
    steel coil and steel scrap price volatility;
    
    manufacturing efficiencies;
    
    costs of compliance with environmental regulations;
    
    asserted and unasserted claims;
    
    the ability to maintain an internal control framework compliant
with Sarbanes-Oxley Section 404;
    
    general economic conditions; and
    
    other risks and uncertainties described under Risk Factors
included in Exhibit 99.1 of our Annual Report on Form 10-K for the year
ended December 31, 2003. In light of these risks, uncertainties and assumptions, the future events
discussed in this report might not occur. In addition, actual results could
differ materially from those suggested by the forward-looking statements.
Accordingly, you should not place undue reliance on the forward-looking
statements, which speak only as of the date on which they are made. We may not
update these forward-looking statements, even though our situation may change
in the future, unless we are obligated under federal securities laws to update
and disclose material developments related to previously disclosed information.
We qualify all of our forward-looking statements by these cautionary
statements. For a more complete understanding of our business activities and financial
results, you should read the analysis of financial condition and results of
operations together with the condensed consolidated financial statements
included in this report. 15




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OVERVIEW Our Products and Facilities We are a domestic producer of seamless and welded tubular steel products
serving the energy industry. We conduct our business within a single
reportable business segment, which we refer to as the Energy Products segment.
Our tubular products, commonly referred to as oil country tubular goods
(OCTG), are used primarily in oil and natural gas drilling exploration and
production operations. We also manufacture line pipe, which is used as
gathering lines for the transmission of petrochemicals and hydrocarbons. Our products are manufactured and sold under two brands. Our Koppel brand
is our seamless tubular product manufactured at our facility located near
Koppel, Pennsylvania. Our Newport brand is our welded tubular product
manufactured at our facilities located near Newport, Kentucky. The primary
geographic market for our products is the southwestern and Appalachian regions
of the United States and western regions of Canada. We also operate tubular
finishing facilities in the southwest United States, where we can provide
further finishing processes to our product. You should read Note 4 to the condensed consolidated financial statements
included in this report for additional information pertaining to segment data,
including concentrations. Economic and Industry-Wide Factors that Affect our Business Demand for Our Products Approximately 86% of our revenues are derived from the sale of OCTG.
Therefore, our revenue is directly dependent on the demand for OCTG, which is
highly cyclical in nature. There are a number of factors that we monitor to
assist us in estimating the future demand for our OCTG product. Demand for our
OCTG products is dependent on the number and depth of oil and natural gas wells
being drilled in the United States and globally. The level of drilling
activity is, among other things, dependent on the current and anticipated
supply and demand for oil and natural gas. Oil and natural gas prices are
volatile and can have a substantial effect upon drilling levels and resulting
demand for our energy related products. In addition, shipments by domestic
producers of OCTG products may be positively or negatively affected by the
amount of inventory held by producers, distributors and end-users, as well as
by imports of OCTG products. 16




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##### Table of Contents



The average number of oil and natural gas drilling rigs in operation in
the United States is referred to as rig count. For the periods presented, on
average, approximately 86% of the rigs were drilling for natural gas. The
average rig counts for the periods below are as follows: ChangeAverage Rig Count for Period
    
    2004 vs 2003Period
    
    2004
    
    2003
    
    Amount
    
    %1Q
    
    
    1,118
    
    
    
    897
    
    
    
    221
    
    
    
    24.62Q
    
    
    1,165
    
    
    
    1,028
    
    
    
    137
    
    
    
    13.33Q
    
    
    1,229
    
    
    
    1,088
    
    
    
    141
    
    
    
    13.04Q
    
    
    
    
    
    
    1,109Year
    
    
    
    
    
    
    1,029
 (Source: Baker Hughes) Historically strong natural gas prices, driven by natural gas supply/demand
fundamentals, have resulted in improving rig count during 2004. The rig count
as of October 29, 2004 was 1,251. Based upon current settlement prices for
natural gas futures, we expect the current high level of drilling activity will
continue through the remainder of 2004 and into 2005. Levels of OCTG inventories in the marketplace are also an indicator of
future demand for our products. U.S. end-users obtain OCTG from domestic and
foreign tubular producers and from drawdown of inventory held by the end-user,
distributor or tubular producers. Based on published inventory reports, while
inventory levels increased in the first nine months of 2004, the current level
of inventory per rig remains near historically low levels. Imports Imports command a significant portion of the domestic OCTG market. We
believe import levels are affected by, among other things:  
    
    currency exchange rates;
    
    overall world demand for OCTG;
    
    the trade practices of foreign governments and producers; and
    
    the presence or absence of antidumping, countervailing duty or
other U.S. government orders that raise the cost or impose limits on
imports. We estimate imports of OCTG products for the first nine months of 2004
comprised approximately 28% of the total domestic market, compared to 24% in
the comparable period in 2003. Since 1995, the U.S. government has been imposing duties on imports of
various OCTG products from Argentina, Italy, Japan, Korea and Mexico in
response to antidumping and countervailing duty cases filed by several U.S.
companies. In June 2001, the ITC voted to continue these duties for five more
years. We cannot predict the U.S. governments future actions regarding duties
and tariffs or any other future actions regarding import duties or other trade
restrictions on imports of OCTG and line pipe products. We expect to continue
to experience high levels of competition from imports. 17




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##### Table of Contents



Costs of Our Products As a manufacturer of tubular steel products, the costs of our products
includes steel raw material costs, direct and indirect labor, energy costs and
other direct and indirect manufacturing costs. The primary raw material used
in our seamless operations is purchased steel scrap, which represented
approximately 20% of cost of goods sold for our seamless products in the first
nine months of 2004. At our welded facility, purchased steel coil is the
primary raw material, which represented approximately 73% of cost of goods sold
for our welded products in the first nine months of 2004. The steel industry,
which is highly cyclical and volatile in nature, can affect our costs both
positively and negatively. Various factors, most of which are beyond our
control, affect the price of steel scrap and coils. These factors include:  
    
    steel supply and demand factors, both domestic and global;
    
    freight costs and transportation availability;
    
    steel inventory levels of brokers and distributors;
    
    the level of steel imports and exports; and
    
    general economic conditions. A number of the above-mentioned economic factors have combined to result
in significant increases in the cost of steel scrap and hot-rolled coils
beginning late in the fourth quarter of 2003 and continuing into 2004. Our
purchased steel scrap costs per ton were as follows: QuarterYear
    
    1Q
    
    2Q
    
    3Q
    
    4Q2004
    
    $
    222
    
    
    $
    180
    
    
    $
    239
    
    
    $
    2003
    
    $
    111
    
    
    $
    115
    
    
    $
    120
    
    
    $
    138
 The cost of purchased steel scrap increased significantly in the third
quarter of 2004 as compared to the second quarter of 2004 due to several
supply/demand related factors. We currently estimate that our cost of purchased
steel scrap in the fourth quarter of 2004 will approximate $276 per ton, which
would represent an all-time high for our seamless business. The increase in steel scrap costs has contributed to an increase in
hot-rolled coil costs used in the manufacturing of our welded tubular products.
Also, steel coils are in high demand as a result of strong global economic
growth. U.S. supply has also been reduced due to the relatively low level of
imports, which has occurred for several reasons, including the low value of the
U.S. dollar relative to certain foreign currencies, and the high cost of ocean
freight. In addition, there are industry specific factors that have
constrained steel coil supply such as a tight supply of raw materials for
integrated steel companies. These factors have contributed to the imposition of
surcharges and base price increases from steel suppliers to all steel consuming
industries, including our industry. As a result of these factors, our third quarter 2004 purchased steel coil
costs were approximately $97 per ton and $370 per ton greater than the second
quarter of 2004 and the
third quarter of 2003, respectively. We believe that our purchased steel
coil costs for the 18




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##### Table of Contents



fourth quarter of 2004 will be approximately $65 per ton and
$398 per ton greater than the third quarter of 2004 and the fourth quarter of
2003, respectively. In addition to significantly higher steel prices, buyers of steel
products, including the OCTG industry, have experienced extended lead times on
delivery of products and instances of cancellation of steel purchase orders.
In order to ensure a portion of our expected steel coil needs for the second
half of 2004, we entered into a supply agreement at fixed volumes and base
prices with our major supplier. The base amount of this commitment is
approximately $40 million. Similarly, we entered into a fixed volume and base
price contract with the same supplier for a portion of our estimated
requirements for 2005. The base amount of the 2005 commitment is approximately
$89 million, excluding raw material surcharges and extras. Since January 2004 the OCTG industry has been passing these increases in
steel costs through to its customers in the form of base price increases as
well as surcharges. These surcharges have essentially matched surcharges
imposed by steel coil producers, as they attempt to recover increases in their
steel raw material costs. We imposed surcharges on our shipments in January
through April 2004 in the amounts of $20, $60, $115 and $140 per ton,
respectively. Effective with May 2004 shipments, our invoices for shipments
have reflected one price, inclusive of any surcharge. Our third quarter average revenue per ton for our welded and seamless
products increased $58 per ton and $158 per ton, respectively, over the second
quarter of 2004. Based on our expectation of customer demand for our products,
we estimate that our average revenue per ton for our welded and seamless
products in the fourth quarter of 2004 will increase by over $80 and $160 per
ton, respectively, over the amounts reported for the third quarter of 2004.
While our customers are currently placing orders at higher prices, there can be
no assurance that they will continue to pay higher prices for our tubular
products or that raw material supply will be consistently available to meet
demand. A decline in demand for our product could result in lower selling
prices which could result in an inability to fully recover our investment in
inventory. 19




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##### Table of Contents



RESULTS OF OPERATIONS Our financial results and other data for the three and nine months ended
September 30, 2004 and 2003 are summarized in the following table. Dollars are
in thousands except for per share amounts and revenue per ton. Three Months Ended
    
    Change
    
    Nine Months Ended
    
    ChangeSeptember 30,
    
    2004 vs 2003
    
    September 30,
    
    2004 vs 20032004
    
    2003
    
    $
    
    %
    
    2004
    
    2003
    
    $
    
    %Net salesWelded products
    
    $
    50,589
    
    
    $
    34,314
    
    
    $
    16,275
    
    
    
    47.4
    
    
    $
    134,542
    
    
    $
    87,660
    
    
    $
    46,882
    
    
    
    53.5Seamless products
    
    
    71,531
    
    
    
    39,263
    
    
    
    32,268
    
    
    
    82.2
    
    
    
    181,528
    
    
    
    102,301
    
    
    
    79,227
    
    
    
    77.4$
    122,120
    
    
    $
    73,577
    
    
    $
    48,543
    
    
    
    66.0
    
    
    $
    316,070
    
    
    $
    189,961
    
    
    $
    126,109
    
    
    
    66.4Gross profit (loss)
    
    $
    29,706
    
    
    $
    1,210
    
    
    $
    28,496
    
    
    
    2,355.0
    
    
    $
    67,047
    
    
    $
    (6,241
    )
    
    $
    73,288
    
    
    
    1,174.3Selling, general and
administrative
    
    $
    4,176
    
    
    $
    3,233
    
    
    $
    943
    
    
    
    29.2
    
    
    $
    12,520
    
    
    $
    11,516
    
    
    $
    1,004
    
    
    
    8.7Operating income (loss)
    
    $
    25,530
    
    
    $
    (2,023
    )
    
    $
    27,553
    
    
    
    1,362.0
    
    
    $
    52,630
    
    
    $
    (17,757
    )
    
    $
    70,387
    
    
    
    396.4Net income (loss)
    
    $
    24,712
    
    
    $
    (2,210
    )
    
    $
    26,922
    
    
    
    1,218.2
    
    
    $
    50,357
    
    
    $
    (20,795
    )
    
    $
    71,152
    
    
    
    342.2Net income (loss) per
diluted share
    
    $
    1.14
    
    
    $
    (0.11
    )
    
    $
    1.25
    
    
    
    1,136.4
    
    
    $
    2.35
    
    
    $
    (1.00
    )
    
    $
    3.35
    
    
    
    335.0Revenue per tonWelded products
    
    $
    920
    
    
    $
    467
    
    
    $
    453
    
    
    
    97.0
    
    
    $
    764
    
    
    $
    451
    
    
    $
    313
    
    
    
    69.4Seamless products
    
    $
    1,210
    
    
    $
    837
    
    
    $
    373
    
    
    
    44.6
    
    
    $
    1,058
    
    
    $
    800
    
    
    $
    258
    
    
    
    32.3Tons shippedWelded products
    
    
    55,000
    
    
    
    73,400
    
    
    
    (18,400
    )
    
    
    (25.1
    )
    
    
    176,100
    
    
    
    194,400
    
    
    
    (18,300
    )
    
    
    (9.4
    )Seamless products
    
    
    59,100
    
    
    
    46,900
    
    
    
    12,200
    
    
    
    26.0
    
    
    
    171,500
    
    
    
    127,800
    
    
    
    43,700
    
    
    
    34.2114,100
    
    
    
    120,300
    
    
    
    (6,200
    )
    
    
    (5.2
    )
    
    
    347,600
    
    
    
    322,200
    
    
    
    25,400
    
    
    
    7.9Average rig count
    
    
    1,229
    
    
    
    1,088
    
    
    
    141
    
    
    
    13.0
    
    
    
    1,173
    
    
    
    1,001
    
    
    
    172
    
    
    
    17.2
 Net Sales The increase in net sales for the three-month comparable period was
attributable to the significant increase in revenue per ton for both our welded
and seamless products, as well as a change in product mix toward higher-priced
seamless products. Net sales for the comparable nine month periods increased
for the same reasons, as well as an increase in shipments. The increase in
shipments was caused by higher consumption of OCTG products in light of
increased drilling activity during the first nine months of 2004 as compared to
the first nine months of 2003. The increase in the average revenue per ton was
primarily due to price increases resulting from the increase in demand for
tubular products as well as the pass through of increased steel costs in the
form of surcharges and base price increases. The change in mix to a higher
level of seamless product shipments is partially the result of a product shift
from our welded manufacturing facility to our seamless manufacturing facility, 20




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as well as a decline in demand for our welded products, which we believe
resulted in part from the significant increase in selling prices. Gross Profit (Loss) Our gross margins for the three and nine months ended September 30, 2004
improved by $28.5 million and $73.3 million, respectively, from the comparable
periods of 2003 due to a number of factors. The three and nine month periods
benefited from lower-priced inventory on hand at the beginning of the periods
relative to current replacement cost which, when coupled with significantly
higher selling prices, resulted in higher than normal margins. However, 2004
third quarter gross margins for our welded operations declined from the 2004
second quarter, and we expect a further decline in gross margins for our welded
operations in the 2004 fourth quarter, as higher-priced inventory costs are
charged to cost of goods sold. Also, the periods benefited from higher
absorption of fixed costs due to the higher operating levels in 2004 and, for
the nine-month comparable periods, a $1.2 million decrease in depreciation
expense as the result of our initial investment in machinery and equipment of
our seamless operations becoming fully depreciated in the second quarter of
2003. Selling, General and Administrative Expenses Selling, general and administrative expenses for the three and nine months
ended September 30, 2004 increased from the comparable periods in 2003, but
represented 3.4% and 4.4% of 2004 and 2003 third quarter sales, respectively,
and 4.0% and 6.1% of 2004 and 2003 nine month sales, respectively. Decreases
experienced in discretionary spending, product claims and wages from the first
nine months of 2003 were more than offset by $4.8 million of accruals for
profit sharing and incentive plans, as well as increases in professional fees
pertaining to Sarbanes-Oxley requirements, in the first nine months of 2004. Restructuring Charges We recorded additional restructuring charges of $1.9 million in the first
quarter of 2004 related primarily to an increase in the accrued liability for
the settlement of an operating contract that was cancelled in 2001 in
connection with the restructuring of our operations. Investment Income, Interest Expense and Other Income, Net Investment income was negligible in 2004 as we have had minimal
interest-bearing investments. The net investment loss for the nine months
ended September 30, 2003 includes $0.5 million of realized losses on sales of
investments. Interest expense for the three and nine months ended September 30, 2004,
was $0.1 million and $2.2 million lower, respectively, than the comparable
periods in 2003 because of the payoff of the revolving credit facility in 2004
and redemption of the remaining $33.8 million in principal of our 13 1/2%
senior secured notes in July 2003. 21




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Other income, net for the three months ended September 30, 2004, includes
a $0.3 million gain on the sale of land held as investment property. Income Taxes We exhausted our federal income tax refund capability in 1999, and
accordingly, tax benefits from operating losses are offset by valuation
allowances, resulting in no net federal tax benefit being recorded for losses.
Income tax expense for the first nine months of 2004 is computed at an
estimated combined federal and state effective tax rate of approximately 3.2%
and assumes utilization of regular and alternative minimum tax net operating
loss carryforwards. See Liquidity and Capital Resources  Other for further
discussion regarding our net operating loss carryforwards. LIQUIDITY AND CAPITAL RESOURCES Overview Our principal sources of liquidity have historically included cash flow
from operating activities, our revolving credit facilities and other sources of
financing through the capital markets. Our business is highly cyclical in
nature, and therefore our cash flows from operating activities can vary
significantly. We consider working capital items such as accounts receivable,
inventory, accounts payable and accrued liabilities as critical components to
managing our liquidity. We are currently dependent on cash flows from
operations and our credit facility to fund our working capital needs. As of September 30, 2004, we had $6.6 million of letters of credit
outstanding under our $50.0 million revolving credit facility and approximately
$42.9 million in borrowing availability based on the borrowing formula. The
facility expires in March 2007. See Note 8 to the condensed consolidated
financial statements for additional information. We are subject to various claims, lawsuits and administrative proceedings
arising in the ordinary course of business with respect to environmental
matters, workers compensation, health care and product liability (each of
which is self-insured to certain levels) as well as commercial and other
matters. We accrue for the cost of such matters when the incurrence of such
costs is probable and can be reasonably estimated. See Note 6 to the condensed
consolidated financial statements for further discussion of product warranty
claims. While the ultimate amount and timing of payment for loss
contingencies can be difficult to determine, we do not believe that such
amounts and the timing of payment will result in a material adverse effect on
our cash flows. In the first quarter of 2004, we reached a settlement agreement pertaining
to a dispute over an operating contract cancelled in connection with our
restructuring in 2001. This settlement agreement was satisfied with our
payment of $4.7 million in April 2004. See Notes 2 and 10 to the condensed
consolidated financial statements for further discussion. 22




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In 2003, we entered into a contract to sell a significant portion of our
assets held for sale. In accordance with the contract, we received full
proceeds of approximately $7.0 million for these assets in the first six months
of 2004. Based upon our current outlook, we believe cash flows from operations,
together with our credit facility and other sources, including the capital
markets, will be sufficient to meet our
anticipated working capital and capital expenditure requirements for at
least the next twelve months. Working Capital Working capital at September 30, 2004 was $104.3 million compared to $45.1
million at December 31, 2003, and the ratio of current assets to current
liabilities at September 30, 2004 was 2.3 to 1.0 compared to 1.7 to 1.0 at
December 31, 2003. The increase in working capital was primarily due to
increases in accounts receivable and inventories in excess of increases in
accounts payable and accrued liabilities, resulting from a substantial increase
in business activity, shipment volumes, pricing and inventory costs. At
September 30, 2004, we had cash of $16.8 million and no borrowings against our
credit facility, compared to cash of $2.6 million and borrowings of $14.9
million at December 31, 2003. Operating Cash Flows Cash provided by operating activities in the first nine months of 2004 was
$18.5 million. We had operating income of $52.6 million for the period, which
included depreciation and amortization charges of $4.0 million. Operating
earnings were used to support a $37.8 million net increase in our operating
assets and liabilities, including an increase in cash of $14.2 million. Major
components of the changes in our operating assets and liabilities included a
$20.6 million increase in accounts receivable and a $43.1 million increase in
inventories, partially offset by increases of $11.0 million, $6.5 million and
$10.6 million in accounts payable, accrued liabilities and deferred revenue,
respectively. The increase in our accounts receivable balance was primarily
the result of increased pricing, as well as an increase in shipment levels.
Our inventory balance increased because of higher quantities of our seamless
products on hand to meet increased shipment levels as well as an overall
increase in the steel raw material costs component of inventory, particularly
in our welded operations. Higher steel raw material costs also contributed to
the increase in our accounts payable. Accrued liabilities increased as a result
of an increase in accruals for profit sharing and incentive plans of $4.8
million. Most of our profit sharing and incentive plans are based on annual
results, and therefore, will not be paid until the first quarter of 2005. The
increase in deferred revenue resulted from significantly increased selling
prices and a higher level of business activity. Restructuring liabilities
decreased $4.8 million primarily as a result of a settlement payment on a
contract. 23




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Cash used by operating activities for the nine months ended September 30,
2003 was $9.7 million. This use of cash was primarily the result of an
operating loss of $17.8 million, which included depreciation and amortization
charges of $5.3 million. In addition, changes in our operating assets and
liabilities resulted in net sources of cash of $4.8 million in the first nine
months of 2003. Major components of these changes were a $16.2 million increase
in accounts receivable and a $6.3 million increase in inventories, offset by
increases of $19.8 million and $5.5 million in accounts payable and deferred
revenue, respectively. The increases in our accounts receivable and deferred
revenue balances were the result of higher sales in the third quarter of 2003
as compared with sales in the fourth quarter of 2002. The increase in
inventories was to meet increases in customer demand. The increase in accounts
payable was directly related to the higher production levels experienced in
third quarter of 2003. Investing Cash Flows Cash flows from investing activities in the first nine months of 2004
provided $5.5 million, resulting from $7.6 million in net proceeds from the
sales of assets held for sale and investments. For the first nine months of
2003, investing cash flows provided $5.4 million primarily as a result of sales
of investments. Capital investments were $2.0 million and $0.7 million for the
first nine months of 2004 and 2003, respectively, and we currently estimate
capital spending for 2004 to be approximately $4.0 million, primarily for cost
improvement projects and maintenance capital. Financing Cash Flows We paid off all existing loans under our credit facility during the first
nine months of 2004. We had no outstanding
loans under the facility as of September 30, 2004. In addition, in the first
nine months of 2004, we received $5.8 million in cash proceeds from the
exercise of stock options, $5.5 million of which was received in the third
quarter. In the second quarter of 2003 we redeemed the remaining $33.8 million
of our outstanding 13 1/2% senior secured notes that were due on July 15, 2003.
The notes were redeemed at par plus accrued interest and were funded from
existing cash balances and borrowings under our credit facility. 24




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Other Our ability to utilize net operating loss carryforwards (NOLs) to fully
offset our taxable income is impacted by Section 382 of the U.S. Internal
Revenue Code (Code). Under the Code, NOL utilization is limited after a
change in ownership, as defined, occurs. Trading activity by greater than 5%
owners of our stock can cause the definition of a change in ownership under
the Code to be met. While we do not expect that a change in ownership under
the Code will occur in the near future. However, we cannot determine with
certainty if, or when, such a change may occur. If such a change in
ownership occurs, the utilization of our NOLs could become limited in future
periods, which would impact the recognition of our income tax provision and
payments. In July 2002 we filed a universal shelf registration statement for the
issuance and sale from time to time to the public of up to $100 million in
securities, including debt, preferred stock, common stock and warrants. The SEC
declared the shelf registration effective in September 2002. No securities
have been sold under this registration statement. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of consolidated financial statements requires us to make
estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to allowance for bad debts, inventories, long-lived assets,
income taxes, customer claims, product liability, postretirement benefits,
restructuring liabilities, assets held for sale, environmental contingencies
and litigation. We base our estimates on historical experience and on various
other assumptions that we believe are reasonable under the circumstances.
Actual results may differ from these estimates under different assumptions or
conditions. The critical accounting policies that we believe affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements are included in Item 7. Managements Discussion And
Analysis of Financial Condition And Results of Operations of our Form 10-K for
the year ended December 31, 2003, and have not changed materially since that
time. 25




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OTHER MATTERS You should read Note 10 to the notes to condensed consolidated financial
statements for information pertaining to commitments and contingencies. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have not used derivative financial instruments for any purpose during
the periods shown, including trading or speculating on changes in interest
rates or commodity prices of materials. Purchased steel, in the form of hot-rolled coils and steel scrap,
represents the largest portion of our cost of goods sold. The price and
availability of steel coils and scrap that we use in our manufacturing
processes are highly competitive and volatile. Various factors, most of which
are beyond our control, affect the supply and price of steel coils and scrap.
We believe that changes in steel coil and scrap costs have had a significant
impact on our earnings, and we expect that future changes will continue to
significantly impact our earnings. Reference is made to Overview  Economic
and Industry-Wide Factors that Affect our Business  Costs of Our Products in
Item 2 for additional comments regarding steel costs. We are exposed to market risk for changes in interest rates for borrowings
under our revolving credit facility. Borrowings under the credit facility bear
interest at variable rates, and the fair value of the borrowings are not
significantly affected by changes in market interest rates. At September 30,
2004, we had no borrowings against our credit facility. We purchase natural gas and electricity for our operations and, therefore,
have a market risk related to gas and electricity purchases in the open market
at spot prices. The prices of such purchases and futures positions are subject
to wide fluctuations due to unpredictable factors such as weather, government
policies and demand for natural gas and competitive fuels. As a result, our
earnings could be affected by changes in the price and availability of gas and
electricity. As market conditions dictate, we from time to time will lock in
future gas and electricity prices using fixed price contracts. 26




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ITEM 4. CONTROLS AND PROCEDURES Disclosure controls and procedures:Our management, with the participation
of our Chief Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) or 15d-15(e) promulgated under the Securities Exchange Act of 1934)
as of the end of the period covered by this report. Any controls and
procedures, no matter how well designed and operated, can provide only
reasonable, not absolute, assurance of achieving the desired control
objectives, and management is required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures. Based on this
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that,as of the end of such period,our disclosure controls and procedures
provided reasonable assurance that the disclosure controls and procedures are
effective for gathering, recording, analyzing, summarizing and disclosing the
information we are required to disclose in the reports we file under the
Securities Exchange Act of 1934, within the time periods specified in the SECs
rules and forms. Internal control over financial reporting:Our management, with the
participation of our Chief Executive Officer and Chief Financial Officer, also
conducted an evaluation of our internal control over financial reporting to
determine whether any changes occurred during the period covered by this report
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting. Based on that evaluation, there
has been no such change during the period covered by this report. 
 PART II  OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS Refer to Legal Matters in Note 10 to our condensed consolidated
financial statements included in Part I, Item 1 for a discussion of recent
developments related to our legal proceedings. 
 ITEM 6. EXHIBITS  a)
    
    Exhibits  Reference is made to the Index to Exhibits, which is
incorporated herein by reference. 27




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. NS GROUP, INC.Date: November 3, 2004
    
    By: /s/ René J. RobichaudRené J. RobichaudPresident and Chief Executive OfficerDate: November 3, 2004
    
    By: /s/ Thomas J. DepenbrockThomas J. DepenbrockVice President  Finance,Treasurer and Chief Financial Officer(Principal Financial Officer)Date: November 3, 2004
    
    By: /s/ Gerard J. BrinkmanGerard J. BrinkmanCorporate Controller(Principal Accounting Officer)
 28




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INDEX TO EXHIBITS Number
    
    Description3.1(a)
    
    Amended and Restated Articles of Incorporation of the Company, filed as
Exhibit 3.1 to Amendment No. 1 to the Companys Form S-1 dated January 17,
1995, File No. 33-56637, and incorporated herein by this reference.3.1(b)
    
    Articles of Amendment to the Amended and Restated Articles of
Incorporation, dated November 4, 1998, filed as Exhibit 3.1 to the
Companys Form 10-Q for the quarter ended September 30, 2001, File No.
1-9838, and incorporated herein by this reference.3.2
    
    Amended and Restated By-Laws of the Company, dated July 30, 2003, filed
as Exhibit 3.2 to the Companys Form 10-Q for the fiscal quarter ended
June 30, 2003, File No. 1-9838, and incorporated herein by this reference.10.1(1)
    
    Letter Agreement with Nucor Corporation dated October 8, 2004, filed herewith10.2
    
    Form of NS Group, Inc. Non-Employee Director Equity Plan Nonqualified
Stock Option Agreement, filed herewith10.3
    
    Form of NS Group, Inc. Equity Plan Restricted Stock Units Agreement, filed herewith10.4
    
    Form of NS Group, Inc. Equity Plan Nonqualified Stock Option Agreement, filed herewith10.5
    
    Form of NS Group, Inc. Equity Plan Incentive Stock Option Agreement, filed herewith12.1
    
    Computation of Ratio of Earnings to Fixed Charges, filed herewith.31.1
    
    Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a), filed herewith.31.2
    
    Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a), filed herewith.32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350 and Exchange Act Rule 13a-14(b), filed herewith.32.2
    
    Certification Pursuant to 18 U.S.C. Section 1350 and Exchange Act Rule 13a-14(b), filed herewith.
  (1)
    
    Confidential treatment requested as to certain
portions, which portions are omitted and filed separately with
the Securities and Exchange Commission. 29