NS Group, Inc. 10-K

UNITED STATES 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, 2005

Commission file number: 1-9838

NS GROUP, INC.

(Exact name of registrant as specified in its charter)


Kentucky (State or other jurisdiction of incorporation or organization)		61-0985936 (I.R.S. Employer Identification No.)

530 West Ninth Street, Newport, Kentucky (Address of principal executive offices)		41071 (Zip Code)

(859) 292-6809
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class		Name of each exchange on which registered

Common Stock, no par value Preferred Stock Purchase Rights		New York Stock Exchange New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.


Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of June 30, 2005, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $718.8 million based on the closing sale price as reported on the New York Stock Exchange.

The number of shares outstanding of the registrant’s Common Stock, no par value, was 22,422,957 at February 24, 2006.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2006 Annual Meeting of shareholders are incorporated into Part III.

The matters discussed or incorporated by reference in this Report on Form 10-K that are forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) involve risks and uncertainties. These risks and uncertainties may cause the actual results or performance of NS Group, Inc. to differ materially from any future results or performance expressed or implied by such forward-looking statements. See Item 1A. Risk Factors and the introductory paragraphs of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of this report for a discussion of risks and uncertainties.

PART I

ITEM 1. BUSINESS

General

NS Group, Inc. was incorporated in Kentucky in 1980. As used herein, the terms “Company,” “NS Group,” “we,” “us” and “our” refer to NS Group, Inc. and its wholly-owned subsidiaries – Koppel Steel Corporation (Koppel or Seamless), Newport Steel Corporation (Newport or Welded), Erlanger Tubular Corporation (Erlanger), and Northern Kentucky Management, Inc.

During the quarter ended March 31, 2001, we implemented restructuring initiatives involving certain operations of our businesses. One initiative was to purchase hot-rolled coils rather than manufacture them at our welded tubular operations. As a result, we discontinued the production of hot-rolled coils by closing the melt shop and hot strip mill operations at our welded tubular facilities in Wilder, Kentucky effective March 31, 2001. In addition, on June 30, 2001 we ceased the manufacturing of special bar quality products at our Koppel, Pennsylvania facility. See Note 2 to the Consolidated Financial Statements.

Our business strategy encompasses the following long-term goals:

	•		to be a leading specialty steel tubular supplier to energy customers.

	•		to seek rational expansion to meet our customers’ tubular needs.

	•		to establish a culture that rapidly adapts to changing business environments.

	•		to grow and achieve superior returns on capital employed.

See Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations.

We conduct our business within a single reportable business segment, which we refer to as Energy Products. Our products include seamless and welded tubular goods, which are primarily used in oil and natural gas drilling and production operations, and are referred to as oil country tubular goods, or OCTG. We also produce seamless and welded line pipe products used in the transmission of oil and natural gas, as well as a limited amount of other tubular products.

OCTG products are produced in numerous diameters, gauges, grades and end finishes. We manufacture most of our OCTG products to American Petroleum Institute (API) specifications. The grade of pipe used in a particular application depends on technical requirements for strength, corrosion resistance and other performance qualities. OCTG products are generally classified into groupings of alloy and carbon grades. Alloy grades of OCTG products have higher yield strength than carbon grades and, therefore, are generally used in favor of carbon grades in deeper wells and unconventional drilling environments. The majority of our welded tubular product shipments are carbon grade, and the majority of our seamless product shipments are alloy grade. In 2005, approximately 68% of our net sales was alloy grade compared to 61% and 50% in 2004 and 2003, respectively.

OCTG products are manufactured by both welded and seamless producers. Welded products are produced by processing flat rolled steel into strips that are cold-formed, welded and seam-annealed. At our finishing operations, we can heat treat and end finish our product with threads and couplings. Seamless products are produced by individually heating and piercing solid steel billets into pipe and then end finishing the pipe. The seamless manufacturing process involves higher conversion costs than the welded process and seamless products are generally priced higher than comparable welded products.

Demand for our OCTG products is cyclical in nature, being 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 has been historically a function of the current and anticipated prices of oil and natural gas. 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 imports of OCTG products. Total domestic shipments of OCTG products were 2.7 million tons in 2005, 2.6 million tons in 2004 and 2.2 million tons in 2003. (Source for OCTG data: Preston Pipe and Tube Report.)

Demand for line pipe is only partially dependent on oil and natural gas drilling activities. Line pipe demand is also dependent on factors such as the level of pipeline construction activity, line pipe replacement requirements, new residential construction and gas utility purchasing programs. Overall, total domestic shipments of line pipe (excluding exports) were 0.9 million tons in 2005, 1.1 million tons in 2004 and 1.2 million tons in 2003. Total domestic shipments of line pipe product 16 inches in diameter and smaller, the product sizes that we produce, were 0.5 million tons in 2005, 0.6 million tons in 2004 and 0.6 million tons in 2003. (Source for line pipe data: Preston Pipe and Tube Report)

Import levels of OCTG into the United States can significantly affect U.S. OCTG manufacturers and the market. High levels of imports reduce the volume sold by U.S. producers and tend to put downward pressure on selling prices. 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.

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. These duties are subject to sunset reviews in July 2006.

Under the U.S. Continued Dumping and Subsidy Offset Act (CDSOA), tariffs collected on dumped imports are required to be directed to the industries harmed. These payments are made to cover certain operating expenses and investment in manufacturing facilities. In September 2002, the World Trade Organization (WTO) ruled that such payments violate international trade rules. The U.S. Trade Representative appealed this ruling; however, the WTO upheld the ruling in January 2003.

We cannot predict the U.S. government’s future actions regarding these 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 see continued high levels of competition from imports.

Products

Our seamless OCTG products are used as production tubing, casing and drill pipe. Production tubing is placed within the well and is used to convey oil and natural gas to the surface. Casing forms the structural wall of oil and natural gas wells to provide support and prevent collapse during drilling operations and is generally not removed after it has been installed in a well. Drill pipe is used and may be reused to drill several wells. Our seamless OCTG products are primarily sold as a finished upset, threaded and coupled, alloy grade product. Our seamless production tubing and casing are commonly used in deeper wells, unconventional drilling environments or off-shore drilling. The majority of our seamless OCTG product sales are of production tubing. Our seamless products range in size from 1.9 inches to 5 inches in outside diameter.

Our welded OCTG products are used primarily as casing in oil and natural gas wells during drilling operations. We sell our welded OCTG products in both a plain end (unthreaded) condition as well as a threaded and coupled product in both alloy and carbon grades. Our welded tubular products range in size from 4.5 to 16.0 inches in outside diameter.

Our OCTG products are inspected and tested to ensure that they meet or exceed API specifications. Products that do not meet specification are classified as less than prime products and are sold for use in other applications at substantially reduced prices.

Our line pipe products are used primarily in gathering lines for the transportation of oil and natural gas at the drilling site and in transmission lines by both gas utility and transmission companies.

We also sell a limited amount of other products, including standard pipe, piling and steel billets.

Markets and Distribution

We market and sell our energy related tubular products throughout the active drilling and production areas of North America, including the southwest, western and Appalachian regions of the United States, as well as the western regions of Canada.

Customers

Our OCTG and line pipe products are used by major and independent oil and natural gas exploration and production companies in drilling and production applications. Line pipe products are also used by gas utility and transmission companies. Substantially all of our OCTG products are sold to domestic distributors. Line pipe products are sold to both domestic distributors and directly to end users. We have long-standing relationships with many of our larger customers. Two of our customers, Bourland and Leverich Supply Co. Inc. and Champions Pipe & Supply, Inc., accounted for approximately 23% and 13%, respectively, of total sales in 2005.

Competition

The markets for our tubular products are highly competitive and cyclical. Principal competitors in our primary markets include domestic and foreign integrated producers, mini-mills and welded OCTG tubular product processing companies. We believe that the principal competitive factors affecting our business are price, quality and customer service.

Our principal competitors include Lone Star Steel Company, Maverick Tube Corporation, IPSCO Steel, Inc., United States Steel Corporation and a number of foreign companies.

Manufacturing

Our seamless tubular products are manufactured at our facilities located in Ambridge, Pennsylvania. We manufacture welded tubular products at our facilities located in Wilder, Kentucky. During 2005, we made capital investments of $8.5 million, which primarily represented replacement and rehabilitation projects. The rated annual capacities of our seamless and welded tubular facilities are 250,000 tons and 570,000 tons, respectively. Capacity utilization for the seamless tubular facilities was 100% during 2005 compared to 98% in 2004. Capacity utilization of the welded tubular facilities was 39% during both 2005 and 2004.

We process and finish our tubular products at our facilities located at: the Port of Catoosa, near Tulsa, Oklahoma; Baytown, Texas, located near Houston, Texas; and our facilities located in Koppel and Ambridge, Pennsylvania. Our finishing processes include upsetting, which is a forging process that thickens tube ends; heat treating, which is a furnace operation designed to strengthen the steel; straightening; non-destructive testing; coating for rust prevention; and threading. We also utilize a number of third party facilities to process and finish our tubular products. During 2005, we increased our internal heat treating capacity by 110,000 tons per year, or 65%, to 280,000 tons per year, in order to lower our costs and meet the growing demand in the marketplace for alloy grade products.

All of our tube-making and finishing facilities are located on or near major rivers or waterways, enabling us to transport our tubular products into the Southwest by barge. We ship substantially all of our seamless and welded OCTG products destined for the southwest region by barge, which is normally a lower cost alternative to shipping by rail or truck.

We manufacture our seamless tubular products in a mini-mill environment. The term mini-mill connotes a mill that typically uses steel scrap as its basic raw material and offers a limited range of products. At our Seamless facilities, steel scrap is melted in an electric arc furnace and poured into continuous casting machines which cast 5 ¹/2 inch round billets. These billets are reheated, pierced and rolled to specific size and wall thickness. With our current operations producing 5 ¹/2 inch round billets only, the estimated annual capacity of the Seamless facility’s melt shop is 450,000 tons. Capacity utilization during 2005 was 68% compared to 63% in 2004. Our environmental air permit provides for annual melt shop production up to 598,000 tons.

At our Welded facility, the manufacturing process begins by feeding steel coils into the material handling equipment of one of two welded pipe-making facilities where they are fed through a series of rolls that cold-form it into a tubular configuration. The resultant tube is welded in-line by a high-frequency electric resistance welder and cut into designated lengths. After exiting the mill, the products are straightened, inspected, tested and end-finished.

Raw Materials and Energy

The primary raw material used in our Seamless facility is steel scrap, which we acquire principally from industrial, automotive, demolition, railroad and other steel scrap sources. We purchase steel scrap either through scrap brokers or directly in the open market. While the potential for periodic disruptions in supply exists, we believe that supplies of steel scrap will be available in sufficient quantities for the foreseeable future.

At our Welded facility, hot-rolled coils are the primary raw material used. We purchase hot-rolled steel coil primarily from three domestic steel producers, with the majority of coils being purchased from Nucor Corporation. We order steel coils according to our business forecasts for our Welded operations. The cost of the steel coils represents the major cost component of cost of sales for our welded products. The steel industry is highly cyclical in nature and steel coil prices are influenced by numerous factors beyond our control, including general economic conditions, raw material costs, energy costs, import duties and other trade restrictions. While the potential for periodic disruptions in supply exists, we believe that supplies of steel coils will be available in sufficient quantities for the foreseeable future. In order to ensure a portion of our expected steel coil needs, we sometimes enter into fixed volume and basic price contracts with steel coil suppliers.

Our Seamless facilities consume a significant amount of electricity and natural gas. From time to time we enter into contracts for electricity and natural gas for certain of our facilities in order to assure firm supply and/or pricing. We believe our operations have access to an adequate supply of electricity and natural gas.

Environmental Matters

Our business 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 with those laws. 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 a result, we are from time to time involved in administrative and judicial proceedings and administrative inquiries related to environmental matters.

We have a closed hazardous waste landfill on our property in Wilder, Kentucky that is being monitored according to a post-closure permit that was approved by the Kentucky Division of Waste Management. We have accrued the estimated costs for the post-closure care of the landfill and funds have been set aside to pay these costs.

We operate a steel mini-mill that produces dust that contains lead, cadmium and chromium, and is classified as a hazardous waste. Dust produced by our electric arc furnace is collected through emission control systems and recycled at EPA-approved facilities.

In late 2001, the EPA designated Imperial Adhesives, Inc., a former subsidiary of the Company, as one of a number of potentially responsible parties (PRP) 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 associated with the site 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 our ultimate liability exposure. We believe that the reasonably foreseeable resolution of this matter will not have a material adverse effect on our consolidated financial statements.

We believe that we are currently in compliance in all material respects with applicable environmental regulations. We cannot predict the level of required capital expenditures or operating costs that may result from compliance with future environmental regulations.

Capital expenditures for the next twelve months relating to environmental control facilities are expected to be approximately $0.8 million. However, such expenditures could be influenced by new or revised environmental regulations and laws or new information or developments with respect to our operating facilities.

We have accrued liabilities of $5.0 million and $3.7 million for environmental remediation obligations at December 31, 2005 and 2004, respectively. Based upon our evaluation of available information, we do 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 our consolidated results of operations, financial position or cash flows. However, we cannot predict with certainty that new information or developments with respect to our environmental contingency matters, individually or in the aggregate, will not have a material adverse effect on our consolidated results of operations, financial position or cash flows.

Employees

As of December 31, 2005, we had 1,227 employees comprised of 224 salaried employees and 1,003 hourly employees. Substantially all of our hourly employees are represented by the United Steelworkers of America under collective bargaining agreements which expire in May 2006, April 2009 and May 2010 for the Erlanger, Newport and Koppel operations, respectively.

Available Information

We file annual, quarterly and current reports, proxy statements, and other documents with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934. The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including NS Group, that file electronically with the SEC. The public can obtain any documents that we file with the SEC at http://www.sec.gov.

We also make available free of charge on or through our website at www.nsgrouponline.com our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

ITEM 1A. RISK FACTORS

Before you invest in our securities, you should be aware that they are subject to various risks. We have described below the risks that we consider material. You should consider carefully these risk factors together with all of the other information included in this Annual Report on Form 10-K and the other documents we file with the SEC. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected.

If fluctuations in natural gas and oil prices cause the number of natural gas and oil wells being drilled in the United States and globally to decrease, demand for our products could also decrease, which would cause our earnings to be reduced.

Our energy products, which consist primarily of OCTG, constitute substantially all of our sales. Demand for our products depends primarily upon the worldwide number of natural gas and oil wells being drilled, completed and re-worked, as well as the depth and drilling conditions of these wells. The level of these activities is primarily dependent on current and anticipated natural gas and oil prices, which are volatile. Many factors, such as the supply and demand for natural gas and oil, general economic conditions, political instability or armed conflict in worldwide natural gas and oil producing regions and global weather patterns affect these prices.

The cost of steel coil and scrap may rise to a level where we are not able to offset our increased costs with price increases, which would reduce our gross margin.

The price and availability of steel coils and scrap that we use in our manufacturing processes are highly competitive and volatile. Purchased steel, in the form of hot-rolled coils and steel scrap, represents the largest portion of our cost of goods sold. Various factors, most of which are beyond our control, affect the price and availability of steel coils and scrap. These factors include:

	•		supply and demand factors;

	•		freight costs and transportation availability;

	•		inventory levels of brokers and distributors;

	•		the level of imports and exports; and

	•		general economic conditions.

We may attempt to increase the price of our finished products in response to increases in steel coil and scrap costs. However, increases in the prices of our products may not fully compensate for such purchased steel coil and scrap price increases. As a result, we may be unable to fully recover increases in purchased steel prices, and our earnings may be reduced or we may have to curtail or suspend operations for an unknown period of time. Furthermore, we compete against manufacturers that may be able to purchase or produce their steel requirements at costs lower than ours, which may limit our ability to compete on the basis of price.

Demand for steel coils and scrap may increase to a level where we may be unable to obtain sufficient supplies of raw materials to meet our customer demand, which would reduce our sales.

The worldwide demand for steel coils and scrap could increase significantly for various reasons. Strong U.S. and international economic growth could significantly increase demand for steel coils and scrap. Also, demand by foreign countries and the value of the U.S. dollar relative to certain foreign currencies may result in increased U.S. exports of steel products and a decline in imports.

If the supply of steel coils and scrap were to decrease and/or the demand was to increase, we may be unable to obtain enough raw materials to meet customer demand. If this were to occur, we may be required to curtail or suspend operations for an unknown period of time.

High levels of imports of OCTG and line pipe products into the United States would reduce the demand for our products and could cause us to lower prices for our products, which would decrease our earnings.

High levels of imports of OCTG and line pipe products reduce the volume sold by domestic producers and tend to suppress selling prices, which would result in decreased earnings for our business. We believe that import levels are affected by, among other things:

	•		currency exchange rates;

	•		overall world demand for OCTG and line pipe products;

	•		freight costs and availability;

	•		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.

Antidumping and countervailing duty orders could be modified or revoked. These orders, which impose special duties designed to offset unfair pricing and foreign government subsidization, are subject to annual administrative reviews that may be requested by various foreign and domestic parties and may be revoked as a result of periodic “sunset reviews.” An individual exporter may also obtain revocation applicable only to itself under certain circumstances.

We cannot predict the U.S. government’s future actions regarding duties, tariffs or any other trade restrictions on imports of OCTG and line pipe products.

If industry-wide OCTG inventory levels are high, customers may draw from inventory rather than purchase new products, which would reduce our sales and earnings.

Above-normal industry inventory levels and upward fluctuations in months of supply of inventory, which defines the level of inventory in terms of current market demand, have had in prior periods, and may have in the future, an adverse impact on our earnings. High industry-wide inventory levels of OCTG products reduce the demand for production of OCTG products because customers can draw from inventory rather than purchase new products. This reduction in demand could result in a corresponding reduction in prices and sales, both of which could contribute to a decrease in earnings. Industry-wide inventory levels of OCTG products can change significantly from period to period.

Our operations and/or the market in general can be adversely impacted by weather and weather related events, particularly in the Gulf region of the United States.

Our geographically dispersed facilities are subject to various types of weather and weather related events which could affect our operations. For example, hurricanes could affect operations in the Gulf of Mexico and flooding of the Ohio and Mississippi rivers could affect river traffic. Any of these matters could have a significant impact on our operations and/or on our customers’ operations. We maintain various insurance coverages to protect us against such potential events, however, we may incur losses in excess of our insurance coverages, incur other uninsured costs, or we may not be able to maintain insurance coverage at adequate levels or acceptable costs in the future.

We depend on a limited number of suppliers for a significant portion of our steel.

A loss of any of our major suppliers or an interruption of production at one or more of our major suppliers could require us to purchase steel from alternative suppliers on less advantageous terms which may result in the loss of sales or reduce our gross margins. Moreover, we may be unable to secure alternative sources. At our Welded operations, we depend primarily on three suppliers for our steel coils with one supplier accounting for the majority of our purchases.

Energy shortages could result in production interruptions which could reduce our sales and earnings.

Our Seamless operations consume large amounts of electricity and natural gas, and the successful operation of these and our other production facilities depend on a reliable supply of these energy resources. Prolonged shortages could substantially disrupt our production, which would result in delays in shipments or loss of sales, either of which would reduce our operating profits.

We depend on a limited number of distributors.

The loss of any significant distributor could result in a decline in our sales and earnings. In 2005, our top three distributors accounted for approximately 45% of our net sales. Our distributors are not bound to us by exclusive distribution contracts and may offer products and services that compete with our products and services.

Increased costs as a result of work stoppages and other labor problems would decrease our gross margins.

Failure to renew any of our collective bargaining agreements could impair our ability to manufacture our products and result in increased costs and/or decreased sales and earnings. These collective bargaining agreements may not be renewed upon expiration, and new collective bargaining agreements may not be established on terms acceptable to us. As of December 31, 2005, we had 1,227 employees, including 1,003 hourly employees. Substantially all of our hourly employees are represented by the United Steelworkers of America. The collective bargaining agreements generally cover wages, health care benefits, retirement plans, seniority, job classes and work rules.

The use of our products by our customers involves risks that expose us to potential product liability losses for injuries and damage resulting from the use of our products.

The drilling for, and transmission of, natural gas and oil involves a variety of risks, including well failures, line pipe leaks and fires. As a result, losses, including loss of life, personal injury, property damage, pollution and loss of production or suspension of operations, may result or be alleged to result from defects in our products, subjecting us to claims for damages. We maintain insurance coverage against potential product liability claims in amounts we believe to be adequate. However, we may incur product liability losses in excess of our insurance coverage, incur other uninsured costs, or we may not be able to maintain insurance coverage at adequate levels or acceptable costs in the future.

If we lack funding to make ongoing capital investments in our business, we may be unable to further develop our business or compete effectively.

We may not have sufficient internally generated cash or acceptable external financing to make necessary capital expenditures in the future. If funding is insufficient, we may be unable to further develop or enhance our products or services, take advantage of business opportunities or respond to competitive pressures. We operate in an industry that requires substantial capital investment. In order to remain competitive, we must maintain our facilities, comply with environmental and other legal requirements, and periodically upgrade for technological improvements. We believe our competitors will continue to invest heavily in their facilities in order to achieve increased production efficiencies and improve product quality.

Some of our competitors have substantially greater assets, greater access to financial resources and larger sales organizations than we do, and we may not be able to compete effectively with these companies.

We may not be able to compete successfully in the future. Our ability to compete depends on high product performance, short lead-time and timely delivery, competitive pricing and superior customer service and support. We operate in a highly competitive industry, and some of our competitors are larger and have greater financial and marketing resources and business diversification than us. These companies may be better able than us to successfully endure downturns in the energy sector. The OCTG market is commodity-based in nature and, as a result, product pricing is particularly competitive.

Compliance with and changes in various governmental regulations and environmental risks applicable to our business may require us to take actions that will increase our costs and capital expenditure requirements.

New governmental laws and regulations may be enacted that would require us to make significant capital expenditures and result in decreased earnings. Existing laws or regulations, as currently interpreted or reinterpreted in the future, or future laws or regulations, may also require us to make significant additional expenditures, which would result in decreased earnings or an increase in capital spending requirements. Our business is subject to numerous federal, state, and local laws and regulations, including regulations with respect to air emissions, wastewater discharges and the generation, handling, storage, transportation, treatment and disposal of waste materials. Although we believe we are in substantial compliance with all applicable laws and regulations, legal requirements are frequently changed and subject to interpretation. Accordingly, the ultimate cost of compliance with these requirements or their effect on our operations could significantly exceed our expectations.

Our revolving credit facility contains restrictive covenants that could limit our ability to operate our business in the most efficient manner.

Restrictive covenants in our revolving credit facility may place us at a competitive disadvantage in relation to our competitors and failure to comply with these covenants could require us to repay our borrowings before their due dates or limit our borrowing under the facility. These restrictive covenants, among other things, limit our ability to:

	•		incur additional indebtedness;

	•		make investments, including capital expenditures;

	•		create liens;

	•		engage in transactions with affiliates;

	•		dispose of assets;

	•		issue or sell stock of our subsidiaries;

	•		pay dividends or distributions; and

	•		engage in mergers, consolidations and transfers of substantially all of our assets.

If we are unable to generate sufficient cash from operations or obtain external financing, we may not be able to meet our working capital requirements or pay the principal or interest due on any future borrowings.

If we are unable to generate sufficient cash from operations to cover our fixed charges and other cash requirements in the future, we will be required to use the availability under our working capital facility or obtain additional external financing. If this were to occur, we may not have sufficient availability under our working capital facility or we may have difficulty in obtaining additional external financing.

Provisions in our charter documents and Kentucky law could delay or prevent a change in control of NS Group, even if that change would be beneficial to our shareholders.

The existence of some provisions in our corporate documents and Kentucky law could delay or prevent a change in control of NS Group. Our articles of incorporation and bylaws contain provisions that may make acquiring control of NS Group difficult, including:

	•		provisions limiting the right to call special meetings of our shareholders;

	•		provisions regulating the ability of our shareholders to bring matters for action at annual meetings of our shareholders; and

	•		the authorization to issue and set the terms of preferred stock.

We also have a shareholder rights plan that would cause extreme dilution to any person or group who attempts to acquire a significant interest in NS Group without advance approval of our board of directors.

Volatility in the price of our common stock could result in a lower trading price than you paid.

The market price of our common stock may be adversely affected by factors such as actual or anticipated fluctuations in our operating results, changes in the energy industry or in the economy in general, changes in financial estimates by securities analysts, general market conditions and other factors. Broad market fluctuations may adversely affect the market price of our common stock. Therefore, the market price of our common stock may decline below the price you paid.

Our ability to pay principal, interest and/or dividends on offered securities is limited.

We are a holding company, with our principal assets consisting of the stock of our subsidiaries. Our ability to pay principal and interest on any debt securities or dividends on any preferred or common stock depends significantly on the cash flows of our subsidiaries. Furthermore, we have not paid any dividends on our common stock since 1992, and we do not anticipate paying dividends on our common stock at any time in the foreseeable future. As a result, any positive return on your investment in our common stock will depend upon appreciation in the market price of the common stock.

ITEM 1B. UNRESOLVED STAFF COMMENTS

There were no unresolved comments from the Staff of the U.S. Securities and Exchange Commission at December 31, 2005.

ITEM 2. PROPERTIES

Our principal operating properties are listed below. We believe our facilities are adequate and suitable for our present level of operations.

Operating Properties

Koppel, Pennsylvania — We own approximately 227 acres of real estate upon which are located a melt shop, heat treating facility, machine and fabricating shops, storage and repair facilities and administrative offices aggregating approximately 500,000 square feet. The melt shop and administrative offices support the Seamless operations in Ambridge, Pennsylvania. The facilities are served by rail lines.

Ambridge, Pennsylvania — We own approximately 45 acres of real estate upon which are located a seamless tube making facility and seamless tube finishing facilities aggregating approximately 659,000 square feet. The facilities are located adjacent to rail lines and river barge facilities.

Baytown, Texas — We own approximately 55 acres of real estate upon which are located a tubular processing facility and barge facilities. Located on the property are eight buildings aggregating approximately 82,000 square feet which house the various finishing operations.

Wilder, Kentucky — We own approximately 250 acres of real estate upon which are located two welded pipe mills, a river barge facility, machine and fabricating shops and storage and repair facilities aggregating approximately 675,000 square feet, as well as administrative offices. The facilities are served by rail lines.

Tulsa, Oklahoma — We lease approximately 36 acres of real estate upon which is located our Erlanger tubular processing facility. The facility is located at the Tulsa Port of Catoosa where barge facilities are in close proximity. Located on this property are six buildings aggregating approximately 119,000 square feet, which house the various finishing operations. The facilities are served by rail lines. The lease expires June 30, 2011.

Assets Held for Sale

In connection with our restructuring decisions in 2001, certain equipment and facilities were designated as held for sale. In 2002, we sold the related hot strip mill equipment. In 2004, we sold our Newport, Kentucky melt shop, which included an electric arc furnace, continuous slab caster and related storeroom supplies and spare parts. In 2005, we sold the bar mill and blooming mill used at our Koppel operations. As of December 31, 2005, there were no assets remaining to be sold.

Information regarding encumbrances on our properties is included in Note 6 to the Consolidated Financial Statements.

ITEM 3. LEGAL PROCEEDINGS

We are subject to various claims, lawsuits and administrative proceedings arising in the ordinary course of business with respect to workers compensation, health care and product liability coverage, each of which is self-insured to certain levels, as well as commercial and other matters. Reference is made to Part I, Item 1, Environmental Matters, concerning certain proceedings we are involved in with the U.S. Environmental Protection Agency (EPA). Based upon our evaluation of available information, we do not believe that any such matters will have, individually or in the aggregate, a material adverse effect upon our consolidated results of operations, financial position or cash flows.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock and associated preferred stock purchase rights are listed on the New York Stock Exchange under the trading symbol NSS. As of February 24, 2006, there were approximately 110 holders of record of our common stock. We have not declared or paid cash dividends on our common stock since 1992. The following table sets forth, for the calendar quarters indicated, the high and low per share sales prices of our common stock as reported on the New York Stock Exchange.


	Stock Price
	2005				2004
	High		Low		High		Low
1st Quarter	$	36.25	$	25.03	$	13.63	$	8.57
2nd Quarter		34.85		24.52		16.91		11.04
3rd Quarter		43.78		32.24		19.50		14.59
4th Quarter		43.70		30.76		29.94		16.10

Equity Compensation Plan Information

Securities authorized for issuance under equity compensation plans at December 31, 2005 are as follows:


	Number of securities to		Weighted-average		Number of securities remaining
	be issued upon exercise		exercise price of		available for future issuance
	of outstanding options		outstanding options		under equity
Plan Category	and rights		and rights		compensation plans (a)
Equity compensation plans approved by security holders (b)		250,906	$	14.93		1,005,200
Equity compensation plans not approved by security holders		29,335	$	8.51		—

Total		280,241	$	14.26		1,005,200

(a) Excludes securities reflected in the first column, “Number of securities to be issued upon exercise of outstanding options and rights.”

(b) Includes 21,000 restricted stock units granted in May 2004.

See Note 9 to the consolidated financial statements for additional information.

Issuer Purchases of Equity Securities

On October 21, 2005, our Board of Directors approved a share repurchase program for up to 2.25 million shares of our common stock. The repurchases may be made by us from time to time in open market purchases or through privately negotiated transactions through December 31, 2006. As of December 31, 2005, the maximum number of shares remaining to be purchased under this program is 2,124,600.

Repurchases of equity securities during the fourth quarter of 2005 are listed in the following table.


					Total Number of		Maximum Number
					Shares Purchased as		of Shares That May
					Part of Publicly		Yet Be Purchased
	Total Number of		Average Price Paid		Announced Plans or		Under the Plans or
Period	Shares Purchased		per Share		Programs		Programs
October		59,500	$	34.99		59,500		2,190,500
November		65,900	$	35.76		65,900		2,124,600
December		—		—		—		2,124,600

Total		125,400	$	35.39		125,400

ITEM 6. SELECTED FINANCIAL DATA


	Years Ended December 31,
(Dollars in thousands, except per share amounts)	2005			2004			2003			2002			2001

Statement of Operations Data


Net sales	$	600,895		$	467,262		$	258,987		$	192,408		$	315,458
Restructuring charges		—			(1,897	)		(77	)		(2,046	)		(56,224	)
Operating income (loss)		138,585			79,017			(18,196	)		(34,140	)		(50,167	)
Net income (loss)		127,095			74,633			(17,329	)		(39,930	)		(55,977	)
Net income (loss) per common share — diluted		5.62			3.45			(0.83	)		(1.93	)		(2.68	)
Dividends per common share		—			—			—			—			—
Average shares outstanding — diluted (000’s)		22,604			21,638			20,774			20,647			20,889

Balance Sheet Data


Working capital	$	267,472		$	136,791		$	45,076		$	42,993		$	126,690
Total assets		413,962			266,902			165,860			180,294			260,484
Revolving credit facility		—			—			14,936			—			—
Current portion of long-term debt		36			41			40			33,555			33
Long-term debt		375			421			461			482			68,070
Shareholders’ equity		307,843			174,323			88,608			104,383			143,662

Cash Flow Data


Capital expenditures		8,535			3,760			1,137			2,422			2,198
Depreciation and amortization		6,140			5,687			7,274			12,281			14,681
Cash flows provided (used) by:
Operating activities		119,487			29,010			(13,599	)		(20,558	)		28,887
Investing activities		(7,183	)		3,572			5,040			10,846			4,173
Financing activities		1,876			(4,266	)		(18,170	)		(35,787	)		(3,355	)

Other Data


Product tons shipped		440,800			474,500			428,900			323,300			478,900
Tubular
Other		6,300			5,200			1,700			600			23,900
Employees		1,227			1,174			1,115			1,150			1,198

ITEM 7. 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 those enumerated in Item 1A. Risk Factors of this Annual Report on Form 10-K.

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 audited financial statements included in this Annual Report on Form 10-K.

OVERVIEW

Our Business Strategy

Our business strategy encompasses the following components:

To be a leading specialty steel tubular provider to energy customers – We seek to be a premier supplier to the energy industry by providing our customers with a quality product at a competitive price and with industry leading customer service. We establish and measure ourselves against key performance indicators in carrying out this strategy.

To seek rational expansion to meet our customers’ tubular needs – We seek to broaden our ability to meet our customers’ needs by (i) selectively increasing our manufacturing and finishing capabilities and (ii) growing our product offerings. For example, in 2005 we increased our internal heat treat capacity by 65% in order to meet the growing needs of our customers for alloy grade product.

To establish a culture that rapidly adapts to changing business environments – The energy tubular business is highly cyclical in nature. In addition, our major costs, such as steel raw materials, can fluctuate widely due to reasons that may be largely beyond our control. As such, we pursue a low-cost manufacturing philosophy and we seek to establish a culture that rapidly adapts to changing environments. Therefore, we aim to enter into business relationships that can inexpensively flex volumes upward and downward. For example, we believe purchasing steel coils for our welded tubular operations on both a spot market and contractual basis provides us with maximum flexibility as to price and availability.

To grow and achieve superior returns on capital employed – We measure growth in terms of sales dollars, operating income and net income; however, our primary profitability measure is return on capital employed. We are committed to providing increased shareholder value by reinvesting in both internal and external opportunities, as well as returning capital directly to shareholders in achieving this goal. For example, we plan on investing over $40 million in 2006 in order to lower costs and improve manufacturing reliability and efficiencies. In addition, in October 2005, we announced a 2.25 million share repurchase program that expires December 31, 2006. Also, we have a “pay for performance” philosophy, under which a portion of our employees’ total compensation is at risk and tied to both individual performance and Company performance, as measured by return on capital employed and pre-tax earnings.

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. 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 tubular facilities located near Newport, Kentucky. The primary geographic market for our products is the southwestern, western and Appalachian regions of the United States, as well as western regions of Canada. We also operate tubular finishing facilities in the southwest United States, where we can provide further finishing processes to our products.

Economic and Industry-Wide Factors that Affect our Business

Demand for Our Products

Over 90% 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 products. 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. Shipments by domestic producers of OCTG products may also 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.

The average number of oil and gas drilling rigs operating in the United States (rig count), domestic shipments of OCTG products (excluding exports), OCTG imports and inventories for 2005, 2004 and 2003 were as follows:


	2005		2004		2003
Average natural gas price per mcf	$	8.62	$	6.14	$	5.39

Average U.S. rig count		1,383		1,192		1,029

Domestic OCTG shipments		2.7		2.6		2.2
(millions of tons)

OCTG imports		1.6		1.1		0.8
(millions of tons)

OCTG inventories		2.1		1.7		1.4
(millions of tons at year-end)

Inventory tons per rig		1,428		1,341		1,254
(at year-end)

Source: Baker Hughes, Preston Pipe and Tube Report and Company estimates

The following charts provide graphic illustration of certain information in the above table.



Source: Baker Hughes, NYMEX		Source: Preston Pipe and Tube Report

Economic conditions in the United States resulted in real GDP growth of 4.4% in 2004. Real GDP growth for 2005 remained strong at 3.5%, which provided continued support for natural gas demand and prices, and resulting in the highest level of rig count activity in 20 years. In addition, natural gas supply disruptions in the Gulf of Mexico brought about by hurricane activity during 2005 elevated the need for drilling for natural gas. For 2005, rigs drilling for natural gas represented approximately 86% of the 1,383 rigs, and 2005 total average rig count increased 16% over 2004. Based upon current settlement prices for natural gas futures, economists’ forecasts of real GDP growth in 2006, as well as other factors, we estimate the rig count will average 1,550 in 2006. The rig count as of March 3, 2006 was 1,531.

The amount of OCTG inventory in the marketplace also affects demand for our products. U.S. end-users obtain OCTG from domestic and foreign tubular producers and from draw-downs of inventory from the end-user, distributor or tubular producers. While the absolute levels of OCTG inventories at December 31, 2005 increased by 24% over 2004, to 2.1 million tons, the amount of inventory tons per rig increased only 6.5%, to 1,428, which we believe represents a reasonable level of inventory relative to active rigs. Therefore, we believe that current OCTG inventory levels in the marketplace will not have a detrimental effect on our 2006 shipments assuming our estimate of 2006 drilling 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-wide demand for OCTG;

	•		freight costs;

	•		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.

According to published industry reports, imports of OCTG products in 2005 comprised an estimated 38% of the total domestic market, compared to 30% in 2004 and 26% in 2003.

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.

Costs of Our Products

As a manufacturer of tubular steel products, the costs of our products include 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 steel scrap, which in 2005 represented approximately 21% of the cost of products sold for our seamless products. At our Welded facility, purchased steel coil is the primary raw material, which represented approximately 78% of the cost of products sold for our welded products. As a result, 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:

	•		supply and demand factors, both domestic and global;

	•		freight costs and transportation availability;

	•		inventory levels of brokers and distributors;

	•		the level of imports and exports; and

	•		general economic conditions.

Our quarterly average cost per net ton of purchased steel scrap, used in our Seamless operations, for the past three years was as follows:

The following chart illustrates the average market price of steel coil, which is used in our Welded operations, for the periods presented, as reported by the publication American Metal Market. Such prices are illustrative of trends that we have experienced with our purchased steel coil.

The steel component of our cost of products sold lags steel purchase price changes by approximately four to six months.

A number of the above-mentioned factors 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. Strong U.S. and international economic growth in 2004, led by China, significantly increased demand for steel scrap. Demand by foreign countries and the fall in the value of the U.S. dollar also resulted in historically high levels of U.S. exports of steel scrap. In addition, export restrictions placed on steel scrap by certain foreign countries affected worldwide supply in 2004. These factors resulted in an 88% increase in our average purchased steel scrap cost per ton in 2004 as compared to 2003. While 2005 steel scrap costs declined by 12% from 2004, supply and demand fundamentals for steel scrap did not change significantly, resulting in continued historically high costs for 2005.

Steel coils were also in high demand in 2004 as a result of strong global economic growth. U.S. supply was affected by the relatively low level of imports, which 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 were steel industry specific factors that contributed to increased steel coil costs such as rising costs of raw materials used by integrated steel companies. These factors contributed to the imposition of surcharges and base price increases from steel suppliers in 2004 to all steel consuming industries, including the OCTG industry. Our average 2004 purchased hot-rolled coil costs increased by $292 per ton over 2003. Although purchased coil costs have declined significantly from the peak prices incurred in the third quarter of 2004, coil prices remained at historically high levels in 2005, due in part to the continuance of several of the above factors. Our average purchased coil cost for 2005 increased by $15 per ton over our average purchased coil cost for 2004.

Based upon our view of the factors that impact the price of steel scrap and coils, we currently believe our 2006 purchased steel scrap and coil costs per ton will approximate our 2005 purchased cost per ton.

In addition to significantly higher steel prices, buyers of steel products, including the OCTG industry, have experienced instances of extended lead times on delivery of products and cancellation of steel purchase orders. In order to ensure a portion of our expected steel coil needs for the second half of 2004 and for 2005 and 2006, we entered into supply agreements with our major supplier.

While our customers have purchased our products at higher prices, thus compensating us for higher raw material costs, there can be no assurance that our customers will continue to pay higher prices for our tubular products, and that raw material supply will be consistently available to meet our customer demand. A decline in demand for our products may result in lower selling prices which could result in an inability to fully recover our investment in inventory.

The effects of inflation did not have a material effect on our results of operations in the past three years.

Restructuring of Operations

In 2001, we implemented restructuring initiatives involving certain operations of our business. One initiative was to purchase hot-rolled coils rather than manufacture them at our welded tubular operations. As a result, we discontinued the production of hot-rolled coils and closed our melt shop and hot strip mill operations at our welded tubular facilities in Wilder, Kentucky, effective March 31, 2001. In addition, we exited the special bar quality business in June 2001, which was operated from our Koppel, Pennsylvania facility.

Consequently, in the first quarter of 2001, we recorded $56.2 million of restructuring charges, including $43.4 million from asset impairment losses related to machinery, equipment and related spare parts inventories to be sold. The restructuring charges included a $0.6 million write-down of special bar quality finished goods inventories that was included in cost of products sold. See Note 2 of Notes to Consolidated Financial Statements for additional information.

In the fourth quarter of 2002, we recorded $2.0 million of additional restructuring charges related to the 2001 restructuring. The charges included a $1.2 million impairment loss on assets held for sale and $0.8 million primarily related to an increase in the estimate of post-closure costs for our closed landfill, net of employee separation accrual reversals.

In the fourth quarter of 2003, we recorded $0.1 million of additional restructuring charges resulting from an increase in the estimated cancellation costs of operating contracts.

In the first quarter of 2004, we recorded $1.9 million in additional restructuring charges primarily related to the settlement of an operating contract for $4.7 million in April 2004.

As of December 31, 2005, we have no assets of the restructured operations classified as Assets Held for Sale and we consider all material aspects of the restructuring actions to be complete.

Results of Operations - 2005 Compared to 2004

Net Sales


					Change
					2005 vs 2004
	2005		2004		Amount			%
Net sales
Seamless products	$	382,003	$	267,354	$	114,649			42.9
Welded products		218,892		199,908		18,984			9.5

	$	600,895	$	467,262	$	133,633			28.6

Revenue per ton (tubular)
Seamless products	$	1,610	$	1,144	$	466			40.7
Welded products	$	1,062	$	830	$	232			28.0

Tubular tons shipped
Seamless products		234,600		233,600		1,000			0.4
Welded products		206,200		240,900		(34,700	)		(14.4	)

		440,800		474,500		(33,700	)		(7.1	)

Average rig count		1,383		1,192		191			16.0

The increase in net sales in 2005 of 28.6% over 2004 was primarily attributable to significant increases in revenue per ton for both our seamless and welded tubular products, despite a slight decrease in total shipments. The increase in average revenue per ton was primarily due to price increases resulting from the increase in demand for tubular products as evidenced by the 16.0% increase in average rig count for the year. Although our seamless tubular facility was operating at full capacity for 2005 and 2004, seamless shipments in 2005 were negatively impacted by an estimated loss of 3,000 tons due to the effects of hurricanes Katrina and Rita. The increase in imports of carbon grade products over the prior year negatively affected our welded product shipment levels.

Gross Profit


					Change
					2005 vs 2004
	2005		2004		Amount		%
Gross profit	$	161,534	$	99,174	$	62,360		62.9
Gross profit %		26.9		21.2				26.9

Gross profit in 2005 improved primarily as a result of significant increases in prices partially offset by higher steel coil costs and a decline in welded tubular shipments. Gross profit percentage increased due to increased pricing and a greater mix of shipments of higher value-added products.

Selling, General and Administrative Expenses


					Change
					2005 vs 2004
	2005		2004		Amount		%
Selling, general and administrative	$	22,949	$	18,260	$	4,689		25.7

Selling, general and administrative expenses in 2005 were higher by $4.7 million compared to 2004, but decreased as a percentage of net sales to 3.8% in 2005 from 3.9% in 2004. The increase in expenses related primarily to general and product liability claims, increases in salaries and personnel and increases in discretionary projects, including costs incurred in connection with information system planning.

Results of Operations - 2004 Compared to 2003

Net Sales


					Change
					2004 vs 2003
	2004		2003		Amount			%
Net sales
Seamless products	$	267,354	$	142,356	$	124,998			87.8
Welded products		199,908		116,631		83,277			71.4

	$	467,262	$	258,987	$	208,275			80.4

Revenue per ton (tubular)
Seamless products	$	1,144	$	816	$	328			40.2
Welded products	$	830	$	458	$	372			81.2

Tubular tons shipped
Seamless products		233,600		174,400		59,200			33.9
Welded products		240,900		254,500		(13,600	)		(5.3	)

		474,500		428,900		45,600			10.6

Average rig count		1,192		1,029		163			15.8

The increase in net sales in 2004 of 80.4% over 2003 was primarily attributable to significant increases in revenue per ton for both our welded and seamless tubular products and a 10.6% increase in shipments, which included a change in product mix toward higher priced seamless products. The increase in 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 increase in shipments was caused by higher consumption of OCTG products as a result of increased drilling activity during the year.

Gross Profit (Loss)


						2004 vs 2003
	2004		2003			Amount		%
Gross profit (loss)	$	99,174	$	(3,965	)	$	103,139	nm

Gross profit (loss) %		21.2		(1.5	)			nm

Our gross profit for 2004 was $99.2 million, as compared to a gross loss for 2003 of $4.0 million, an increase of $103.2 million. Our gross profit percent in 2004 was 21.2%. Gross profit improved over 2003 as a result of significant increases in prices as well as higher production and shipment levels, which benefited gross profit and gross profit percent through higher absorption of fixed costs. Generally, we were able to achieve increased pricing during the year in advance of incurring, through cost of sales, the dramatic increases that we experienced throughout the year in raw material costs, particularly, hot-rolled coil costs. Our overall gross profit percent began to moderate beginning in the fourth quarter of 2004 as peak purchased coil costs, used in manufacturing our welded tubular products, began to be recognized in cost of sales.

Restructuring Charges

We recorded $1.9 million of restructuring charges in 2004 related primarily to the settlement of an operating contract that was cancelled in connection with the restructuring of our operations in 2001.

Selling, General and Administrative Expenses


					Change
					2004 vs 2003
	2004		2003		Amount		%
Selling, general and administrative	$	18,260	$	14,721	$	3,539		24.0

Selling, general and administrative expenses in 2004 were higher by $3.5 million compared to 2003, but decreased as a percentage of net sales to 3.9% in 2004 from 5.7% in 2003. Decreases experienced in discretionary spending and product claims were more than offset by $2.9 million of accruals for profit sharing and incentive plans, as well as increases in professional fees pertaining to Sarbanes-Oxley requirements in 2004.

Investment Income, Interest Expense, Other, Net

Our investment income was $2.9 million in 2005, compared to $0.2 million in 2004, and a loss of $0.1 million in 2003. Investment income increased in 2005 as a result of increases in average invested cash balances and interest rates. Investment income in 2004 increased as a result of an increase in average invested cash balances. Impairment losses on long-term investments were $0.1 million in 2003.

Our recorded interest expense in 2005 consists primarily of amortization of deferred financing costs and unused commitment and letter of credit fees.

During 2004 and 2003, we reduced our interest expense by paying off our revolving credit facility in 2004 and redeeming $33.8 million in principal of our 13 ¹/2% senior secured notes in July 2003. The pay off of the revolving credit facility in 2004 was funded from operations. The senior note retirements in 2003 were funded from existing cash and investment balances and borrowings under our credit facility.

Other, net for 2003 includes $4.0 million of cash receipts from favorable claim settlements with electrode suppliers relating to purchases in prior years.

Income Taxes

In 2005, our provision for income taxes resulted in a combined federal and state effective tax rate of approximately 10.0%. This rate reflects the utilization of available federal and state net operating loss carryforwards that had been fully reserved by valuation allowances at December 31, 2004. This primarily contributed to a reduction in our deferred tax asset valuation allowance of $31.0 million for 2005. In addition, the effective rate was impacted by the reversal of certain tax valuation allowances associated with deferred tax assets which reverse in periods after December 31, 2005. The reversal of these other tax valuation allowances decreased income tax expense by $5.0 million in 2005. The deferred tax asset balance includes $4.5 million related to state net operating losses and $1.2 million related to tax credit carryforwards. The state net operating losses expire between 2008 and 2023. The state tax credits are not limited by expiration dates. We have recorded deferred tax assets related to these carryforwards. In estimating the amount of the valuation allowance required, we have considered projected taxable income related to the reversal of temporary differences based on the provisions of enacted tax law. We estimate that our combined federal and state effective tax rate for 2006 will approximate 39.0%.

In 2004, our provision for Income taxes resulted in a combined federal and state effective tax rate of approximately 4.4%. This rate reflects the utilization of available federal and state net operating loss carryforwards that had been fully reserved by valuation allowances at December 31, 2003.

We exhausted our federal income tax refund capability in 1999, and accordingly, tax benefits from operating losses in 2003 were offset by valuation allowances, resulting in no net federal tax benefit being recorded for the loss. The $0.2 million tax benefit recorded in 2003 resulted from reclassifying to income the deferred tax benefits related to our long-term investments that were sold in 2003.

LIQUIDITY AND CAPITAL RESOURCES

Overview

Our principal sources of liquidity have historically included cash flow from operating activities, our revolving credit facility 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 currently use our cash on hand and cash flows from operations to fund our working capital needs.

We estimate that our capital spending in 2006 will be approximately $43.0 million, which will significantly enhance our manufacturing reliability, reduce costs and improve our information and financial reporting systems. The timing of completion of these capital projects is dependant upon our ability to adequately staff the projects and the ability of our suppliers to meet our timing requirements. We believe we will be able to fund these capital expenditures from available cash on hand or cash flows from operations.

At December 31, 2005, we had long-term debt of $0.4 million; therefore our long-term financing commitments are minimal. We have a board authorized share repurchase program for up to 2.25 million shares. Repurchases under the program are discretionary and the authorization expires December 31, 2006.

Based upon our current market outlook, we believe our sources of cash, including amounts currently on hand, will be sufficient to meet our anticipated cash requirements for 2006.

Working Capital

Working capital at December 31, 2005 was $267.5 million, an increase of $130.7 million from the $136.8 million at December 31, 2004, and the ratio of current assets to current liabilities at December 31, 2005 was 3.9 to 1 compared to 2.7 to 1 at December 31, 2004. Increases in our cash and equivalents, accounts receivable and inventories, partially offset by increased income taxes payable, accounted for $123.7 million of the increase in working capital. There were no borrowings on our credit facility at December 31, 2005 and 2004.

Operating Cash Flows

Cash provided by operating activities in 2005 was $119.5 million. We had operating income of $138.6 million, which included depreciation and amortization charges of $6.1 million. Operating cash flows supported a $9.2 million net increase in our operating assets and liabilities. Major components of the changes in our operating assets and liabilities included a $5.5 million increase in accounts receivable and a $16.8 million increase in inventories, partially offset by increases of $12.8 million and $3.8 million in income taxes payable and deferred revenues, respectively. The increase in our accounts receivable and deferred revenue balances was primarily the result of increased pricing of our products. Our investment in inventory increased because of higher quantities of finished products on hand to meet anticipated increases in shipment levels.

Cash provided by operating activities in 2004 was $29.0 million. We had operating income of $79.0 million, which included depreciation and amortization charges of $5.7 million. Operating cash flows supported a $51.7 million net increase in our operating assets and liabilities. Major components of the changes in our operating assets and liabilities included a $26.9 million increase in accounts receivable and a $53.2 million increase in inventories, partially offset by increases of $16.6 million, $9.1 million and $5.6 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 investment in inventory 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 $6.3 million as a result of accruals for hourly and salaried profit sharing and incentive plans at December 31, 2004. Most of our profit sharing and incentive plans are based on annual results, and therefore were not 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 $2.9 million primarily as a result of a contract settlement payment.

Cash used by operating activities in 2003 was $13.6 million. This use of cash was primarily the result of an operating loss of $18.2 million, which included depreciation and amortization charges of $7.3 million. In addition, changes in our operating assets and liabilities resulted in a use of cash of $4.7 million in 2003. Major components of these changes included a $14.6 million increase in accounts receivable and a $10.7 million increase in inventories, partially offset by increases of $15.9 million and $4.7 million in accounts payable and accrued liabilities, respectively. The increase in our accounts receivable balance was the result of higher sales in the fourth quarter of 2003 as compared to sales in the fourth quarter of 2002. The increase in inventories and accounts payable was the result of increased business levels and incremental investments made in anticipation of raw material cost increases. Accrued liabilities increased principally as the result of a $5.3 million increase in deferred revenue resulting from the higher level of business activity. We made $4.5 million in interest payments in 2003, or $4.8 million less than we paid in 2002, due to the payoff of our senior secured notes in 2003. Operating cash flows in 2003 included cash receipts of $4.0 million related to antitrust litigation against manufacturers of graphite electrodes used in the steel-making process.

Investing Cash Flows

Cash flows used in investing activities were $7.2 million in 2005, while cash flows provided by investing activities were $3.6 million in 2004 and $5.0 million in 2003. Capital expenditures were $8.5 million, $3.8 million and $1.1 million in 2005, 2004 and 2003, respectively. These capital expenditures were primarily related to maintenance and improvements to our tubular manufacturing facilities.

We received proceeds from sales of assets held for sale of $1.4 million, $6.7 million and $0.5 million in 2005, 2004 and 2003, respectively. We also received proceeds of $3.8 million from the sale of long-term investments in 2003.

Financing Cash Flows

We had no outstanding loans under our credit facility as of December 31, 2005 and 2004. Participants in our benefit plans exercised stock options in 2005 which provided cash of $6.5 million. On October 21, 2005, our Board of Directors approved a share repurchase program for up to 2.25 million shares of our common stock. The repurchases may be made by us from time to time in open market purchases or through privately negotiated transactions through December 31, 2006. During the fourth quarter we purchased 125,400 shares for $4.4 million.

In 2004 we paid off all existing loans under our credit facility and also benefited from the exercise of stock options, which generated cash of $10.9 million. 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.

Long-term debt maturities for each of the next five years are less than $0.1 million.

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 shelf registration was declared effective by the SEC in September 2002. We have not sold any securities pursuant to the shelf registration. We believe the shelf registration affords us the financial flexibility to react to future opportunities in the market. Under the Securities Offering Reform of 2005, we may continue to use this shelf registration statement through November 30, 2008.

See Note 6 to the consolidated financial statements for more information on our credit facility and shelf registration.

In 2005 and 2004 we utilized tax operating loss carryforwards to reduce the amount of taxes we would otherwise be required to pay. As of December 31, 2005, these carryforwards were utilized and as such, beginning in 2006, our tax expense and payments will more closely approximate statutory rates. You should read Note 12 to the Consolidated Financial Statements for further information concerning our federal tax status.

Contractual Obligations and Other Cash Requirements

The following table summarizes our expected cash outflows resulting from contractual obligations. Except for the purchase obligations included below, we have not included information for recurring purchases of materials used in our manufacturing operations that closely reflect our levels of production and are not long-term in nature (less than three months). Certain obligations are described more fully in the Notes to the Consolidated Financial Statements.


	Payments due by period
Contractual obligations
(In thousands)	Total		2006		2007-2008		2009-2010		Thereafter
Long-term debt	$	411	$	40	$	80	$	80	$	211
Restructuring liabilities		2,643		959		298		183		1,203
Employee benefit plans		8,307		803		1,615		1,676		4,213
Asset retirement obligations		1,275		—		—		—		1,275
Purchase obligations		63,835		62,748		1,087		—		—
Operating leases		847		171		350		261		65

Total	$	77,318	$	64,721	$	3,430	$	2,200	$	6,967

We have a $50.0 million revolving credit facility that expires in March 2007. As of December 31, 2005, we had no loans outstanding under the credit facility. We had outstanding letters of credit in the amount of $1.9 million, reducing the amount of funds available under the credit facility to approximately $48.1 million as of December 31, 2005. The facility is secured by a first priority lien on substantially all of our inventories, accounts receivable and property, plant and equipment. See Note 6 to the consolidated financial statements for additional information.

We currently purchase electricity for two of our facilities pursuant to contracts that expire in 2006. Amounts paid under these contracts are not included in the table because they can vary based on the level of our operations. We estimate total payments in 2006 will approximate $1.6 million under these contracts.

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. In 2005 we decreased our reserves for warranty claims by $0.2 million as new claims and changes in estimates of existing claims of $3.0 million were offset by $3.2 million of settlements. See Note 13 to the 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 affect on our cash flows. See Note 4 to the consolidated financial statements for a description of accrued liabilities.

Critical Accounting Policies and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these 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. We evaluate the appropriateness of these estimations and judgments on an ongoing basis. 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. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

Product revenues are recognized as sales when revenue is earned and is realized or realizable. This includes satisfying the following criteria: the arrangement with the customer is evident, usually through the receipt of a purchase order; the sales price is fixed or determinable; delivery has occurred; the risk of loss has been passed to the customer; and collectibility is reasonably assured. Revenues are also recognized when, at the customer’s request, the goods are set aside in storage at the Company’s facilities and paid for in full. Freight and shipping billed to customers is included in net sales, and the cost of freight and shipping is included in cost of products sold.

Accounts Receivable Allowances

We evaluate the collectibility of our receivables based on a combination of factors. We regularly analyze our customer accounts and, when we become aware of a specific customer’s inability to meet its financial obligations to us, such as in the case of bankruptcy filings or deterioration of the customer’s operating results or financial position, we record a specific reserve for bad debt to reduce the related receivable to the amount we reasonably believe is collectible.

We also maintain a reserve for customer claims for returns of defective materials. This reserve is recorded as a percentage of sales and estimated based upon historical experience. The adequacy of reserve estimates is periodically reviewed by comparison to actual experience. Claims in any future period could differ from our estimates and impact the net sales we report.

Inventory Valuation

We value our inventories at the lower of cost or market and regularly review the book value to determine if items are properly valued. We record adjustments to the value of our inventory based on sales and production forecasts. These adjustments are estimates, which can vary significantly, either favorably or unfavorably, from actual amounts if future costs or levels of business activity differ from our expectations. Generally, we do not experience issues with slow-moving or obsolete inventory due to the nature of our products. If we are not able to achieve our expectations of the net realizable value of the inventory at its current value, we would have to adjust our reserves accordingly.

Long-Lived Asset Impairment

We evaluate our long-lived assets used in operations, consisting of property, plant and equipment, when indicators of impairment, such as reductions in demand or significant economic factors are present. When such indicators of impairment exist, an evaluation is performed to determine whether the carrying value of an asset is impaired based on a comparison to the undiscounted estimated future cash flows from the asset. The evaluations involve a significant amount of judgment since the results are based on estimated future events. Because of the uncertainty inherent in these factors, we cannot predict when or if future impairment charges will be recorded.

Deferred Tax Assets and Liabilities

Our annual tax rate is determined based on our income, statutory tax rates and the tax impacts of items treated differently for tax purposes than for financial reporting purposes. Tax law requires certain items to be included in the tax return at different times than the items are reflected in the financial statements. As a result, our annual tax rate reflected in our financial statements is different than reported on our tax return. Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences are temporary, reversing over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities.

Deferred tax assets generally represent items that can be used as a tax deduction or credit in future years for which we have already recorded the tax benefit in our income statement. Deferred tax liabilities generally represent tax expense recognized in our consolidated financial statements for which payment has been deferred, or expenditures which we have already taken a deduction for in our tax return but have not yet been recognized in our consolidated financial statements.

Inherent in determining our annual tax rate are judgments regarding business plans, planning opportunities and expectations about future outcomes. Realization of certain deferred tax assets is dependent upon generating sufficient taxable income in the appropriate jurisdiction prior to the expiration of the carryforward periods. Although realization is not assured, management believes it is more likely than not that our deferred tax assets, net of valuation allowances, will be realized.

Changes in existing tax laws, tax rates and their related interpretations may also affect our ability to successfully manage the impacts of regulatory matters. We establish reserves when necessary for tax positions that management believes are supportable, but are potentially subject to successful challenge by the applicable taxing authority. We review these in light of the changing facts and circumstances and adjust them when significant changes in risk warrant it.

Our accounting represents management’s best estimate of future events that can be appropriately reflected in the accounting estimates. Certain changes or future events, such as changes in tax legislation and geographic mix of earnings could have an impact on our estimates and effective tax rate.

Employee Benefits Plans

We record liabilities and expense for deferred compensation agreements, salary continuation agreements (SCA) and postretirement health benefit costs based on actuarial valuations. All benefits paid under the agreements are unfunded and benefits are paid from operating cash flows. The net present value of the benefits provided under the deferred compensation agreements were accrued over the period of the employee’s active employment from the time the contract was signed to the employee’s retirement date using a discount rate of eleven percent, which approximated our incremental borrowing rate at that time.

Inherent in the valuations for the SCA and postretirement health benefits are key assumptions including assumptions about discount rates. These assumptions are updated on an annual basis at the beginning of each fiscal year. We are required to consider current market conditions, including changes in interest rates, in making these assumptions. To develop our discount rate, we considered the available yields on high-quality fixed-income investments with maturities corresponding to our benefit obligations. We used discount rates of 5.50% and 5.75% to determine the SCA and postretirement health benefit liability as of December 31, 2005 and 2004, respectively. The decline in the discount rate used to estimate the SCA and postretirement health benefit liability is a result of declining long-term interest rates in the United States. Changes in the related SCA and postretirement health benefit costs may occur in the future due to changes in the assumptions, primarily changes in the discount rate.

Restructuring Reserves

Our restructuring reserves reflect many estimates, including those pertaining to settlements of contractual obligations and environmental remediation obligations. We reassess the reserve requirements for completing the restructuring program at the end of each reporting period. Actual experience has been and may continue to be different from these estimates. Additional charges may be required in the future if the estimates of environmental remediation costs differ from our estimates. Refer to Notes 2 and 10 to our consolidated financial statements for more information related to restructuring reserves and associated environmental reserves.

Reserves for Contingencies

We have other potential exposures, such as workers compensation claims, environmental claims, product liability and litigation. Establishing loss reserves or valuation allowances for these matters requires us to estimate and make judgments with regard to risk exposure and ultimate liability. We establish accruals for these exposures; however, if our exposure exceeds our estimates, we could be required to record additional charges.

Asset Retirement Obligations

Legal obligations associated with the retirement of long-lived assets are recognized as a liability in our consolidated financial statements. These obligations are measured and recorded at their estimated fair value.

In determining asset retirement obligations, we must make significant judgments and estimates to calculate fair value. Fair value is developed through consideration of estimated retirement costs in today’s dollars, inflated to the anticipated retirement date and then discounted back to the date the asset retirement obligation was incurred. Changes in assumptions and estimates included within the calculations of asset retirement obligations could result in significantly different results than those identified and recorded in the consolidated financial statements.

RECENTLY ISSUED ACCOUNTING STANDARDS

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 123(R), ''Share-Based Payment’’, which is a revision of SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant, and to be expensed over the applicable vesting period. Pro forma disclosure of the income statement effects of share-based payments is no longer an alternative. SFAS No. 123(R) is effective for all stock-based awards granted on or after January 1, 2006. In addition, companies must also recognize compensation expense related to any awards that are not fully vested as of the effective date. Compensation expense for the unvested awards will be measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of SFAS No. 123. We have elected the modified prospective method of adoption. We do not expect the adoption of SFAS 123(R) to have a material effect on our consolidated results of operations, financial position or cash flows.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs”, to amend the guidance in Chapter 4, Inventory Pricing, of FASB Accounting Research Bulletin No. 43, Restatement and Revision of Accounting Research Bulletins, which will become effective for us on January 1, 2006. SFAS 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). The statement requires that those items be recognized as current-period charges. Additionally, SFAS 151 requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. We do not expect the adoption of SFAS 151 to have a material effect on our consolidated results of operations, financial position or cash flows.

OTHER MATTERS

You should read Note 10 to the Consolidated Financial Statements for information pertaining to commitments and contingencies.

The collective bargaining agreement at Erlanger expires in May 2006 and covers 154 hourly employees. While we expect to negotiate a renewal of the contract, failure to renew the contract could impair our ability to manufacture certain of our products and result in increased costs and/or decreased sales and earnings.

ITEM 7A. 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 products 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. 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” 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. As of December 31, 2005, we had no borrowings outstanding under our credit facility.

MANAGEMENT’S REPORTS TO NS GROUP SHAREHOLDERS

Management’s Responsibility for Financial Statements

The accompanying consolidated financial statements have been prepared by the management of NS Group, Inc., in conformity with accounting principles generally accepted in the United States of America and, in the judgment of management, present fairly and consistently the Company’s consolidated results of operations, financial position and cash flows. These statements necessarily include amounts that are based on management’s best estimates and judgments. The financial information contained elsewhere in this report is consistent with that contained in the consolidated financial statements.

Management Report on Internal Control Over Financial Reporting

The management of NS Group, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. NS Group, Inc.’s internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements.

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

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control — Integrated Framework”. Based on the results of this assessment, management concluded that, as of December 31, 2005, the Company’s internal control over financial reporting was effective.

NS Group, Inc.’s independent registered public accounting firm has issued an attestation report on our assessment of the Company’s internal control over financial reporting, which appears herein.

/s/ René J. Robichaud
René J. Robichaud
President and Chief Executive Officer

/s/ Thomas J. Depenbrock
Thomas J. Depenbrock
Vice President — Finance, Treasurer
and Chief Financial Officer

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of NS Group, Inc.
Newport, Kentucky

We have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that NS Group, Inc. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

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

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

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

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2005 of the Company and our report dated March 8, 2006 expressed an unqualified opinion on those consolidated financial statements and financial statement schedule.

/s/ DELOITTE & TOUCHE LLP
Cincinnati, Ohio
March 8, 2006

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of NS Group, Inc.
Newport, Kentucky

We have audited the accompanying consolidated balance sheets of NS Group, Inc. and subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 8. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of NS Group, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 8, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP
Cincinnati, Ohio
March 8, 2006

NS GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS


	Years Ended December 31,
(In thousands, except per share amounts)	2005			2004			2003

Net sales	$	600,895		$	467,262		$	258,987
Cost of products sold		439,361			368,088			262,952

Gross profit (loss)		161,534			99,174			(3,965	)

Selling, general and administrative expense		22,949			18,260			14,721
Restructuring charges		—			1,897			77
Trade case receipts		—			—			(567	)

Operating income (loss)		138,585			79,017			(18,196	)

Investment income (loss)		2,933			205			(117	)
Interest expense		(621	)		(1,071	)		(3,391	)
Other, net		311			(62	)		4,206

Income (loss) before income taxes		141,208			78,089			(17,498	)
Provision (benefit) for income taxes		14,113			3,456			(169	)

Net income (loss)	$	127,095		$	74,633		$	(17,329	)


Net income (loss) per common share —
Basic	$	5.70		$	3.53		$	(0.83	)

Diluted	$	5.62		$	3.45		$	(0.83	)


Weighted average shares outstanding —
Basic		22,303			21,162			20,774
Diluted		22,604			21,638			20,774

See notes to consolidated financial statements.

NS GROUP, INC.

CONSOLIDATED BALANCE SHEETS


	December 31,
(In thousands)	2005			2004
ASSETS
Current assets:
Cash and equivalents	$	145,124		$	30,944
Accounts receivable, less allowances of $1,563 and $1,492, respectively		59,658			54,134
Inventories		136,635			119,817
Operating supplies and prepaid expenses		11,534			9,498
Deferred income taxes		7,885			1,625
Other current assets		—			2,379

Total current assets		360,836			218,397
Property, plant and equipment, net		48,515			44,260
Other assets		4,611			2,190
Assets held for sale		—			2,055

Total assets	$	413,962		$	266,902


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	41,385		$	41,061
Accrued liabilities and other		23,029			23,998
Accrued income taxes		10,563			1,969
Deferred revenue		17,407			13,641
Current portion of restructuring liabilities		944			896
Current portion of long-term debt		36			41

Total current liabilities		93,364			81,606
Long-term debt		375			421
Deferred income taxes		1,770			1,788
Other long-term liabilities		10,610			8,764

Total liabilities		106,119			92,579


Shareholders’ equity:
Preferred stock, no par value, 2,000 shares authorized, none outstanding		—			—
Common stock, no par value, 40,000 shares authorized, 25,129 and 25,111 shares issued		293,936			287,897
Treasury stock, at cost, 2,709 and 3,205 shares		(26,413	)		(27,085	)
Unearned compensation		(564	)		(307	)
Accumulated other comprehensive income		29			58
Retained earnings (deficit)		40,855			(86,240	)

Shareholders’ equity		307,843			174,323

Total liabilities and shareholders’ equity	$	413,962		$	266,902

See notes to consolidated financial statements.

NS GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS


	Years Ended December 31
(In thousands)	2005			2004			2003
CASH FLOWS — OPERATING ACTIVITIES
Net income (loss)	$	127,095		$	74,633		$	(17,329	)
Adjustments to reconcile net income (loss) to net cash flows provided (used) by operating activities:
Depreciation and amortization		5,849			5,403			6,672
Amortization of deferred finance costs		291			284			602
Loss on disposal of assets		460			—			—
Amortization of unearned compensation		237			124			—
Deferred income taxes		(6,278	)		163			(77	)
Restructuring charges, including asset impairment		—			—			308
Loss on sales of investments		—			—			347
Other, net		988			145			568
Changes in operating assets and liabilities:
Accounts receivable, net		(5,524	)		(26,873	)		(14,608	)
Inventories		(16,818	)		(53,249	)		(10,694	)
Other current assets		(2,324	)		(650	)		1,178
Accounts payable		(736	)		16,554			16,016
Accrued liabilities		(342	)		4,878			2,849
Accrued income taxes		12,823			1,969			(109	)
Deferred revenue		3,766			5,629			678

Net cash flows provided (used) by operating activities		119,487			29,010			(13,599	)


CASH FLOWS — INVESTING ACTIVITIES
Purchases of property, plant and equipment		(8,535	)		(3,760	)		(1,137	)
Proceeds from sales of assets held for sale		1,352			6,679			479
Purchase of short-term investments		(10,933	)		—			—
Maturity of short-term investments		10,933			—			—
Sales of available-for-sale securities		—			—			3,751
Changes in other		—			653			1,947

Net cash flows provided (used) by investing activities		(7,183	)		3,572			5,040


CASH FLOWS — FINANCING ACTIVITIES
Repayments of long-term debt		(51	)		(39	)		(33,802	)
Net borrowings (repayments) under revolving credit facility		—			(14,936	)		14,936
Increase (decrease) in other notes payable		—			(106	)		106
Proceeds from option and warrant exercises		6,469			10,925			1,029
Purchase of treasury stock		(4,542	)		—			(28	)
Payment of financing costs		—			(110	)		(411	)

Net cash flows provided (used) by financing activities		1,876			(4,266	)		(18,170	)


Increase (decrease) in cash and equivalents		114,180			28,316			(26,729	)
Cash and equivalents at beginning of period		30,944			2,628			29,357

Cash and equivalents at end of period	$	145,124		$	30,944		$	2,628


Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	8		$	410		$	4,543
Cash paid (received) during the period for income taxes	$	7,583		$	1,250		$	(670	)

See notes to consolidated financial statements.

NS GROUP, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY


														Accumulated
														Other			Retained
	Common Stock				Treasury Stock						Unearned			Comprehensive			Earnings
(In thousands)	Shares		Amount		Shares			Amount			Compensation			Income (Loss)			(Deficit)			Total
Balance, December 31, 2002		24,860	$	282,935		4,213		$	(35,572	)	$	759		$	(328	)	$	(143,411	)	$	104,383
Net loss																		(17,329	)		(17,329	)
Reclassification of investment losses to income statement															488						488
Net unrealized loss on investments															(63	)					(63	)

Comprehensive loss																					(16,904	)
Exercise of common stock warrants		187		749								(308	)								441
Stock option plans		43		477		(21	)		152			125						(66	)		688

Balance, December 31, 2003		25,090	$	284,161		4,192		$	(35,420	)	$	576		$	97		$	(160,806	)	$	88,608
Net income																		74,633			74,633
Net unrealized loss on investments															(39	)					(39	)

Comprehensive income																					74,594
Vesting of deferred compensation				626								(626	)								—
Issuance of restricted stock units				381								(381	)								—
Amortization of unearned compensation												74									74
Tax benefit related to stock options exercised				74																	74
Stock option plans		21		2,655		(987	)		8,335			50						(67	)		10,973

Balance, December 31, 2004		25,111	$	287,897		3,205		$	(27,085	)	$	(307	)	$	58		$	(86,240	)	$	174,323
Net income																		127,095			127,095
Net unrealized loss on investments															(29	)					(29	)

Comprehensive income																					127,066
Restricted stock grants		17		494								(494	)								—
Amortization of unearned compensation												237									237
Tax benefit related to stock options exercised				4,141																	4,141
Purchase of treasury stock						132			(4,638	)											(4,638	)
Stock option plans		1		1,404		(628	)		5,310												6,714

Balance, December 31, 2005		25,129	$	293,936		2,709		$	(26,413	)	$	(564	)	$	29		$	40,855		$	307,843

See notes to consolidated financial statements.

NS GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of NS Group, Inc. and its wholly-owned subsidiaries (the Company): Koppel Steel Corporation (Koppel), Newport Steel Corporation (Newport), Erlanger Tubular Corporation (Erlanger), and Northern Kentucky Management, Inc. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications were made to conform the prior year amounts to the presentation in the current year.

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.

Cash and Equivalents

Cash includes currency on hand and demand deposits with financial institutions. Cash equivalents consist primarily of money market mutual funds, commercial paper and U.S. treasury securities with an original term of three months or less.

Inventories

Inventories are stated at the lower of FIFO (first-in, first-out) cost or market, or the lower of average cost or market. The Company records a provision for excess and obsolete inventory whenever such impairment has been identified. Inventory costs include labor, material and manufacturing overhead.

Inventories consist of the following:


	December 31,
(In thousands)	2005		2004
Raw materials	$	33,970	$	49,054
Semi-finished and finished products		102,665		70,763

	$	136,635	$	119,817

Property, Plant and Equipment

Property, plant and equipment are recorded on a cost basis. Expenditures for additions, betterments and renewals are capitalized. Maintenance and repair expenditures, which do not improve or extend productive life, are expensed as incurred. Depreciation is calculated using a straight-line method over the estimated useful lives of the assets. Useful lives of the assets are 30 to 40 years for buildings and 5 to 12 years for machinery and equipment. Costs incurred in the application development stage to develop internal-use software are capitalized and amortized over the estimated useful life of the software.

The Company periodically evaluates property, plant and equipment for indicators of potential impairment such as reductions in demand or significant economic factors. When such indicators of impairment exist, a review is performed to determine whether the carrying value of an asset is impaired based on a comparison to the undiscounted estimated future cash flows from the asset. If the comparison indicates that there is impairment, the impaired asset is written down to fair value.

Property, plant and equipment consist of the following:


	December 31,
(In thousands)	2005			2004
Land and improvements	$	8,910		$	8,836
Buildings		18,027			16,259
Machinery and equipment		178,625			174,516
Construction in progress		4,231			2,401

		209,793			202,012
Accumulated depreciation		(161,278	)		(157,752	)

	$	48,515		$	44,260

At December 31, 2005, the Company has $1.1 million of accounts payable capitalized in property, plant and equipment which are not reflected in the statement of cash flows.

Treasury Stock

The Company’s purchases of shares of its common stock are recorded as treasury stock at cost and result in a reduction of shareholders’ equity. When treasury shares are reissued, the Company uses average cost to value treasury shares. If the shares are reissued for a price higher than their cost the difference is credited to common shares; if the shares are issued for less than their cost the difference is charged to retained earnings (deficit).

Revenue Recognition

Other, net

The Company received settlements of $0.1 million and $4.0 million in 2005 and 2003, respectively, as the result of antitrust litigation against manufacturers of graphite electrodes used in the steel-making process.

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.

If the Company accounted for stock-based compensation using the fair value recognition provisions of Statement of Financial Accounting Standard (SFAS) No. 123, “Accounting for Stock-Based Compensation”, net income (loss) and diluted income (loss) per share would have been as follows:


	Years Ended December 31,
(In thousands, except per share amounts)	2005			2004			2003
Net income (loss) — as reported	$	127,095		$	74,633		$	(17,329	)
Add: Stock-based employee compensation included in reported net income (loss), net of related tax benefits		213			122			125
Less: Stock-based employee compensation expense determined under the fair value method for all awards, net of related tax benefits		(760	)		(1,215	)		(2,406	)

Net income (loss) — pro forma	$	126,548		$	73,540		$	(19,610	)


Diluted income (loss) per share — as reported	$	5.62		$	3.45		$	(0.83	)
Effect of stock-based employee compensation expense determined under the fair value method for all awards, net of related tax benefits		(0.02	)		(0.06	)		(0.11	)


Diluted income (loss) per share — pro forma	$	5.60		$	3.39		$	(0.94	)

The fair values of the granted options were determined using the Black-Scholes option pricing model with the following weighted average assumptions for 2005, 2004 and 2003, respectively: no common stock dividends; expected volatility of 65%, 65%, and 77%; risk-free interest rates of 4.0%, 4.4%, and 3.1%; and an expected life of 6 years in 2005 and 7 years for 2004 and 2003.

Income Taxes

Deferred income tax balances represent the estimated future tax effects of temporary differences between the financial reporting basis and the tax basis of certain assets and liabilities. As appropriate, valuation allowances are established to reduce deferred tax assets to amounts that are more likely than not to be realized.

Environmental Remediation and Compliance

Environmental remediation costs are accrued, except to the extent capitalizable, when incurrence of such costs is probable and the costs can be reasonably estimated. Environmental compliance costs include maintenance and operating costs associated with pollution control facilities, costs of ongoing monitoring programs, permit costs and other similar costs. Such costs are expensed as incurred.

Earnings (Loss) Per Share

Basic earnings or 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 is computed by dividing net income or loss by the weighted average number of common shares outstanding plus dilutive common stock equivalents. The following table reconciles the number of common shares outstanding at December 31 of each year to the number of weighted average basic common shares outstanding and the number of weighted average diluted common shares outstanding for the purposes of calculating basic and diluted earnings per common share. The table also provides the number of shares of common stock potentially issuable at the end of each period and the number of potentially issuable shares excluded from the diluted earnings per share computation for each period.


(In thousands)	2005			2004			2003
Number of common shares outstanding at year-end		22,420			21,906			20,898
Effect of using weighted average common shares outstanding		(117	)		(744	)		(124	)

Weighted average basic common shares outstanding		22,303			21,162			20,774

Dilutive effect of common stock options and restricted stock units		301			476			—

Weighted average diluted common shares outstanding		22,604			21,638			20,774


Potentially issuable shares		280			872			—
Number of potentially issuable shares excluded from diluted common shares outstanding		—			—			1,789

Recently Adopted Accounting Standards

On December 31, 2005, the Company adopted Financial Accounting Standards Board (FASB) Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47) an interpretation of SFAS No. 143. This interpretation clarifies the definition of conditional asset retirement obligations used in SFAS No. 143 and clarifies when a company would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The adoption of FIN 47 did not have a material effect on the Company’s consolidated results of operations, financial position or cash flows.

Recently Issued Accounting Standards

On December 16, 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment”, which is a revision of SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant, and to be expensed over the applicable vesting period. Pro forma disclosure of the income statement effects of share-based payments is no longer an alternative. SFAS No. 123(R) is effective for all stock-based awards granted on or after January 1, 2006. In addition, companies must also recognize compensation expense related to any awards that are not fully vested as of the effective date. Compensation expense for the unvested awards will be measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of SFAS No. 123. The Company has elected the modified prospective method of adoption. The Company does not expect the adoption of SFAS 123(R) to have a material effect on its consolidated results of operations and earnings per share. However, the adoption of SFAS 123(R) could have a material impact on the Company’s consolidated results of operations and earnings per share depending on the number and fair value of future awards.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs”, to amend the guidance in Chapter 4, Inventory Pricing, of FASB Accounting Research Bulletin No. 43, Restatement and Revision of Accounting Research Bulletins, which will become effective for the Company on January 1, 2006. SFAS 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). The statement requires that those items be recognized as current-period charges. Additionally, SFAS 151 requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The Company does not expect the adoption of SFAS 151 to have a material effect on its consolidated results of operations, financial position or cash flows.

Note 2: RESTRUCTURING CHARGES

During the quarter ended March 31, 2001, the Company implemented restructuring initiatives involving certain operations of its business. One initiative was to purchase hot-rolled coils rather than manufacture them at the Company’s welded tubular operations. As a result, the Company discontinued the production of hot-rolled coils and closed its melt shop and hot strip mill operations at its welded tubular facilities in Wilder, Kentucky, effective March 31, 2001. In addition, the Company decided to exit the special bar quality business by June 30, 2001, which was operated from its Koppel, Pennsylvania facility.

Consequently, in the first quarter of 2001, the Company recorded $56.2 million of restructuring charges, including $43.4 million resulting primarily from asset impairment losses related to machinery, equipment and related spare parts inventories to be sold. The restructuring charges include a $0.6 million write-down of special bar quality finished goods inventories that was included in cost of products sold.

Following is a summary of the accrued restructuring liabilities and activity through December 31, 2005:


(In thousands)	2005			2004			2003
Balance, beginning of year	$	2,675		$	5,562		$	6,669
Cash payments		(32	)		(4,784	)		(1,184	)
Accruals		—			1,897			77

Balance, end of year	$	2,643		$	2,675		$	5,562

At December 31, 2005, $0.9 million of the total restructuring liabilities is included in current liabilities and represents the estimated costs for environmental remediation and monitoring costs of a closed landfill and an operating contract. The remaining $1.7 million of restructuring liabilities is included in Other long-term liabilities, of which $1.4 million is for the estimated post-closure monitoring and maintenance costs of the closed landfill and $0.3 million is for the estimated costs to fulfill a natural gas transportation contract into 2009. As of December 31, 2005, the Company had $1.6 million in a restricted trust account, which is included in Other assets in the consolidated balance sheets, for the post-closure care of the closed landfill. The Company considers the restructuring activities substantially complete at December 31, 2005.

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 for $4.7 million in April 2004. In the fourth quarter of 2003, the Company recorded $0.1 million of additional restructuring charges resulting from an increase in the estimated cancellation costs of operating contracts.

Assets Held for Sale

In connection with the restructuring decisions in 2001, certain equipment and facilities were designated as held for sale. The Company had previously sold the related hot strip mill equipment in 2002. In 2004, the melt shop at the Company’s Newport, Kentucky, facilities, which included an electric arc furnace, continuous slab caster and related storeroom supplies and spare parts were sold. In 2005, the bar mill and blooming mill used at the Company’s Koppel operations was sold. As of December 31, 2005, there are no assets previously classified as Assets Held for Sale remaining to be sold.

Note 3: SEGMENT INFORMATION/CONCENTRATIONS

The Company operates in a single reportable segment, which it refers to as Energy Products and consists of (i) seamless and welded tubular goods used primarily in oil and natural gas drilling and production operations (oil country tubular goods, or OCTG); and (ii) line pipe used in the transmission of oil, natural gas and other fluids. Energy Products reflect the aggregation of two business units which have similar economic characteristics and similar 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. Corporate general and administrative expenses are fully absorbed by the segment.

Net sales by product category are as follows:


	Years ended December 31,
	2005		2004		2003
Seamless products	$	382,003	$	267,354	$	142,356
Welded products		218,892		199,908		116,631

	$	600,895	$	467,262	$	258,987

Concentrations

The Company’s operations are conducted principally in the United States. The Company grants trade credit to customers, the most significant of which are distributors serving the oil and natural gas exploration and production industries. Sales to the Company’s two largest customers accounted for 23% and 13% of net sales in 2005. Sales to the Company’s three largest customers accounted for 32%, 12% and 11% of net sales in 2004 and sales to the Company’s two largest customers accounted for 20% and 13% of net sales in 2003. The Company’s largest customers accounted for $20.4 million and $28.1 million of the Company’s accounts receivable balances at December 31, 2005 and 2004, respectively.

The Company’s welded operations depend primarily on three suppliers for its steel coils with one supplier accounting for the majority of its purchases. If the Company would suffer the loss of a significant customer or supplier, the effect could result in reduced sales or a delay in manufacturing and would adversely affect operating results.

Approximately 90% of the Company’s 1,003 hourly employees are represented by the United Steelworkers of America. The collective bargaining agreements for Erlanger, Newport and Koppel expire in May 2006, April 2009 and May 2010, respectively. The contract for the Erlanger employees covers approximately 154 employees.

Note 4: ACCRUED LIABILITIES AND OTHER LONG-TERM LIABILITIES

Accrued liabilities and other consist of the following:


	December 31,
(In thousands)	2005		2004
Payroll and benefits	$	13,006	$	12,485
Workers’ compensation		4,426		5,555
Customer claims		1,328		1,558
Personal property and sales and use taxes		2,648		2,640
Environmental remediation		1,433		1,506
Other		188		254

	$	23,029	$	23,998

Other long-term liabilities consist of the following:


	December 31,
(In thousands)	2005		2004
Accrued employee benefits	$	7,635	$	6,986
Long-term restructuring liabilities		1,700		1,778
Asset retirement obligations		1,275		—

	$	10,610	$	8,764

Note 5: GAINS AND LOSSES ON LONG-TERM INVESTMENTS

The Company’s long-term investments in 2003 consisted of corporate bonds. These investments were classified as available for sale and carried at fair value, based on quoted market prices. The cost of securities sold was based on the specific identification method.

Long-term investments were periodically reviewed to determine if declines in fair value below cost basis were other-than-temporary. Significant and sustained decreases in quoted market prices, a series of historic and projected operating losses by the investee or other factors were considered as part of the review. The Company recognized impairment losses of $0.1 million in 2003. Realized gains and losses and impairments were included in Investment income (loss) in the consolidated statements of operations. Gross realized gains and losses in 2003 were $73 thousand and $420 thousand, respectively.

Unrealized gains and losses on available for sale securities are included, net of tax, in accumulated other comprehensive income (loss) within shareholders’ equity until sold. At December 31, 2005, the Company had $29 thousand of unrealized gains associated with $1.6 million of securities being held in trust for the payment of environmental remediation costs. See Note 2 – Restructuring Charges for additional information.

Comprehensive losses consist of unrealized losses associated with securities held in trust for the payment of environmental remediation costs.

Note 6: DEBT AND CREDIT FACILITY

Borrowings at December 31, 2005 and 2004 consist of other long term debt of $0.4 million. These amounts are net of $36 thousand and $41 thousand classified as current.

The Company has a revolving credit facility that provides up to $50.0 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 December 31, 2005, the Company was in compliance with the covenants of the credit facility. The credit facility expires in March 2007.

At December 31, 2005, the Company had $1.9 million of letters of credit outstanding under the credit facility and approximately $48.1 million in borrowing availability. The letters of credit were issued as collateral for the Company’s self-insured workers compensation program. The facility is secured by a first priority lien on substantially all of the Company’s inventories, accounts receivable and property, plant and equipment and related intangibles.

Maturities of long-term debt for the next five years are less than $0.1 million per year.

In the second quarter of 2003, the Company redeemed the remaining $33.8 million of its outstanding 13.5% senior secured notes (Notes). The Notes were redeemed at par plus accrued interest, and was funded from existing cash balances and borrowings under the Company’s credit facility.

In July 2002, the Company 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 shelf registration was declared effective by the SEC in September 2002. There have been no securities sold pursuant to the shelf registration. The Company believes the shelf registration allows financial flexibility for it to react to future opportunities in the market. Under the Securities Offering Reform of 2005, the Company may continue to use this shelf registration statement through November 30, 2008.

Note 7: FINANCIAL INSTRUMENTS

The following methods and assumptions were used to estimate the fair value of financial instruments:

Current assets and liabilities — The carrying amounts approximate fair value because of the short maturity of these instruments.

Long-term debt — The fair value of long-term debt was estimated by calculating the present value of the remaining interest and principal payments on the debt to maturity. The present value computation uses a discount rate based upon current market rates. The carrying amount and fair value of long-term debt were $0.4 million and $0.2 million, respectively, at December 31, 2005. The carrying amount and fair value of long-term debt were $0.5 million and $0.3 million, respectively, at December 31, 2004.

Note 8: CAPITAL STOCK

Preferred Stock

The Company’s authorized stock includes two million shares of Class A Preferred Stock, issuable in one or more series. The rights, preferences, privileges and restrictions of any series of Class A Preferred Stock, the number of shares constituting any such series and the designation thereof, are subject to determination by the Board of Directors.

One million shares of the Class A Preferred Stock were designated as Series B Junior Participating Preferred Stock, par value $10 per share, in connection with a Shareholder Rights Plan (Plan) adopted in November 1998. Pursuant to the Plan, one Preferred Stock Purchase Right (Right) is attached to each outstanding share of common stock of the Company.

The Plan includes provisions which are intended to protect shareholders against certain unfair and abusive takeover attempts by anyone acquiring or tendering for 20% or more of the Company’s common stock. The Company may redeem the Rights for one-half cent per Right at any time before a 20% position has been acquired. The Rights expire in November 2008.

Common Stock

On October 21, 2005, the Board of Directors approved a share repurchase program for up to 2.25 million shares of the Company’s common stock. The repurchases may be made by the Company from time to time in open market purchases or through privately negotiated transactions through December 31, 2006. During the fourth quarter the Company purchased 125,400 shares for $4.4 million and the shares were recorded as treasury shares.

In 2003, the Company issued 187,184 shares of its common shares as a result of the exercise of all remaining outstanding common stock warrants related to the Company’s senior notes. The warrants were exercisable at $4.00 per share and resulted in proceeds of $0.7 million.

Note 9: STOCK COMPENSATION PLANS

The Company has stock-based compensation plans under which non-employee directors and certain employees may receive incentive and non-qualified stock options and other equity-based awards. Stock options have generally been granted at fair market value on the date of grant, have ten year terms and become exercisable beginning one to three years after the grant date.

In 2005, the Company issued 17,400 shares of restricted stock to certain directors and officers under the NS Group, Inc. Amended and Restated Non-Employee Director Equity Plan and the NS Group, Inc. Equity Plan, respectively. The restricted stock fully vests three years from the date of grant. The market value of the restricted stock on the date of grant was $494,000 and is being amortized on a straight line basis to expense over the vesting period.

In 2004, the Company granted 31,500 Restricted Stock Units (RSUs) to certain officers under the NS Group, Inc. Equity Plan. The units vest in equal 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.

Presented below is a summary of the status of the Company’s stock options and related transactions:


	2005					2004					2003
				Weighted					Weighted					Weighted
				Average					Average					Average
				Exercise					Exercise					Exercise
	Shares			Price		Shares			Price		Shares			Price
Outstanding, beginning of period		840,288		$	10.65		1,789,412		$	10.75		1,807,290		$	10.82
Granted		56,400			28.39		89,500			12.10		152,000			7.97
Exercised		(618,895	)		10.61		(1,007,772	)		10.84		(82,613	)		4.77
Expired/Cancelled		(18,552	)		13.18		(30,852	)		14.44		(87,265	)		12.92

Outstanding, end of period		259,241			14.44		840,288			10.65		1,789,412			10.75


Exercisable, end of period		102,996			10.95		571,594			10.82		1,313,161			11.31


Available for grant		1,005,200					1,079,000					582,010


Weighted average fair value of options granted				$	17.67				$	8.12				$	5.79

The following table summarizes the status of stock options outstanding and exercisable at December 31, 2005:


Options Outstanding							Options Exercisable
			Weighted		Weighted				Weighted
			Average		Average				Average
			Exercise		Remaining				Exercise
Range of Exercise Prices	Shares		Price		Life - yrs		Shares		Price
$7.77 - $14.38		190,341	$	10.09		7.0		90,496	$	10.03
$17.63 - $28.39		68,900		26.44		8.5		12,500		17.63

		259,241		14.44		7.4		102,996		10.95

In 2005, treasury stock was acquired in consideration for common shares issued as a result of a cashless stock option transaction. The options were exercisable at an average exercise price of $8.99 per share for 10,666 common shares of the Company resulting in the issuance of 7,997 common shares.

In a similar transaction in 2003, options with an exercise price of $3.75 per share for 18,720 common shares of the Company resulted in the issuance of 5,359 common shares. In connection with this transaction, the Company incurred certain costs that were included in the cost of treasury shares.

Note 10: COMMITMENTS AND CONTINGENCIES

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 coverage (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 results of operations, financial position or cash flows.

Environmental

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.

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 closed hazardous waste landfill on its property in Wilder, Kentucky that is being monitored according to a post-closure permit that was approved by the Kentucky Division of Waste Management. The Company has accrued the estimated costs for the post-closure care of the landfill and escrowed the funds.

In late 2001, the 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. The Company believes that the reasonably foreseeable resolution of this matter will not have a material adverse effect on its consolidated results of operations, financial position or cash flows.

The Company had accrued liabilities of $5.0 million and $3.7 million, at December 31, 2005 and 2004, 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 results of operations, financial position or cash flows.

Other

The Company has entered into a fixed volume and base price contract with its major supplier of steel coils for 2006 for a portion of its estimated raw material requirements.

The Company leases the real estate for its finishing facilities in Catoosa, Oklahoma. The lease payments amount to $0.1 million per year through 2011.

The Company has change of control severance agreements (Agreements) with certain of its key employees. The Agreements contain provisions that would entitle each affected employee to receive an amount ranging from two to three times the employee’s base salary plus two to three times the employee’s five year average bonus, and continuation of certain benefits, if there is a change of control of the Company, as defined, and a termination of employment. If a change of control had occurred as of December 31, 2005, obligations under these Agreements would be approximately $5.2 million. In addition, concurrent with a change of control of the Company, amounts that are sufficient to pay the benefits due under the deferred compensation agreements and salary continuation agreements, would be required to be funded by the Company.

Note 11: EMPLOYEE BENEFIT PLANS

Defined Contribution Plans

Newport has a profit sharing plan for its bargaining unit employees which generally requires mandatory contributions at a specified percentage of its pretax profits. Also, the Company has a defined contribution plan covering substantially all of its employees. The expense of these plans was $1.0 million, $1.7 million, and $0.4 million for 2005, 2004 and 2003, respectively.

Koppel’s bargaining unit employees at its seamless operations in Pennsylvania are participants in the Steelworkers Pension Trust (SPT), a multi-employer pension plan. Koppel does not administer this plan and contributions are determined in accordance with provisions of negotiated labor contracts. Based upon current available information, Koppel would not have a withdrawal liability if it withdrew from the SPT. Contributions to and expenses for this plan were $0.7 million and $0.6 million in 2005, respectively. Contributions to and expenses for this plan were each $0.6 million in 2004 and 2003.

Deferred Compensation Agreements

Certain retired employees of the Company have individual deferred compensation agreements that provide for monthly payments for life, with payments for a minimum of ten years. The net present value of the benefits expected to be provided to the employee under the agreements was accrued over the period of the employee’s active employment from the time the contract was signed to the employee’s retirement date using a discount rate of eleven percent, which approximated the Company’s incremental borrowing rate at that time. As of December 31, 2005 and 2004, the Company had accrued liabilities for benefits payable under these agreements of $5.0 million and $5.1 million, respectively, and recorded expense of $0.6 million, $0.6 million, and $0.5 million, for these agreements in 2005, 2004 and 2003, respectively. Since the above agreements are unfunded, the Company’s contributions will equal the benefit payments paid which are expected to be approximately $0.7 million in each of the next five years.

Salary Continuation Agreements and Postretirement Heath Benefits

The Company and certain active officers have entered into Salary Continuation Agreements (SCA). The SCA’s provide for monthly payments that begin at the employee’s retirement date and are calculated as a percentage of the employee’s salary and will be paid for life, with a minimum of ten years. The projected unit credit cost method is used for determining the cost of these agreements for financial reporting purposes. The benefits vest when the employee reaches age 62.

Retirees who are receiving payments under their deferred compensation agreement and the employees who have an SCA are also eligible to receive postretirement health care benefits from their retirement date until they reach Medicare eligibility.

SCA and post-retirement benefit costs are as follows:


	Years Ended December 31,
	SCA						Health
(In thousands)	2005		2004		2003		2005		2004		2003
Service cost	$	395	$	349	$	286	$	20	$	18	$	11
Interest cost on projected benefit obligation		161		130		106		21		21		23
Amortization of transition obligation		5		—		—		28		28		28

Actuarial expense for year	$	561	$	479	$	392	$	69	$	67	$	62

Reconciliation of the beginning and ending balances of the SCA and post-retirement health plans funded status were:


	SCA						Health
(In thousands)	2005			2004			2005			2004
Change in benefit obligation:
Benefit obligation at beginning of year	$	2,806		$	2,086		$	389		$	346
Service cost		395			349			20			18
Interest cost		161			130			21			21
Actuarial (gain) loss		131			241			(3	)		25
Benefits paid		—			—			(31	)		(21	)

Benefit obligation at end of year	$	3,493		$	2,806		$	396		$	389


Reconciliation to balance sheet:
Funded (unfunded) status	$	(3,493	)	$	(2,806	)	$	(396	)	$	(389	)
Unrecognized transition obligation		—			—			252			280
Unrecognized net (gain) loss		458			332			(7	)		(4	)

Net liability recognized at December 31	$	(3,035	)	$	(2,474	)	$	(151	)	$	(113	)


	SCA						Health
	2005			2004			2005			2004
Weighted average assumptions used to determine benefit obligations at December 31:
Discount rate		5.50	%		5.75	%		5.50	%		5.75	%
Rate of compensation increase		3.00	%		3.00	%		—			—
Weighted average assumptions used to determine net periodic cost for the years ended December 31:
Discount rate		5.75	%		6.00	%		5.75	%		6.00	%

The Company uses a November 30 measurement date for the SCA and postretirement health plans.

The assumed health care cost trend rate used to measure the postretirement health benefit obligation at December 31, 2005, was 10% and is assumed to decrease gradually to 8% by the year 2010. A one-percentage point change in assumed health care cost trend rates would have the following effect on the postretirement costs and obligation:


(In thousands)	1% Increase		1% Decrease
Effect on total service and interest costs	$	4	$	(4	)
Effect on postretirement benefit obligation	$	30	$	(27	)

The income tax provision (benefit) differs from the amount computed by applying the statutory federal income tax rate to income (loss), before income taxes for the following reasons:


	Years ended December 31,
(In thousands)	2005			2004			2003
Income tax provision (benefit) at statutory tax rate of 35%	$	49,423		$	27,331		$	(6,108	)
Change in taxes resulting from:
State income taxes, net of federal effect		2,301			2,538			(567	)
Change in valuation allowance		(36,251	)		(26,378	)		6,714
Extraterritorial income exclusion		(530	)		—			—
Domestic production deduction		(352	)		—			—
Other, net		(478	)		(35	)		(208	)

Provision (benefit) for income taxes	$	14,113		$	3,456		$	(169	)

The components of deferred tax assets and liabilities are as follows:


	December 31,
(In thousands)	2005			2004
Deferred tax assets:
Benefit plan accruals	$	6,095		$	5,989
Operating loss carryforward		4,511			33,332
Reserves and accruals		4,028			3,900
Alternative minimum tax and other tax credit carryforwards		1,588			4,051
Inventory		826			760
Valuation allowance		(3,389	)		(40,703	)

Total deferred tax assets		13,659			7,329


Deferred tax liabilities:
Depreciation		(7,046	)		(7,492	)
Prepaid expenses		(498	)		—

Total deferred tax liabilities		(7,544	)		(7,492	)


Net deferred tax assets (liabilities)	$	6,115		$	(163	)

For federal income tax purposes, the Company has alternative minimum tax credit carryforwards of approximately $0.3 million, which are not limited by expiration dates. The Company has general business credit carryforwards of approximately $0.1 million that expire in the years 2008 through 2011. The deferred tax asset balance includes $4.5 million related to state net operating losses (NOL) and $1.2 million related to tax credit carryforwards. The state NOL’s expire between 2008 and 2023. The state tax credits are not limited by expiration dates. The Company has recorded deferred tax assets related to these carryforwards. In estimating the amount of the valuation allowance required, the Company has considered projected taxable income related to the reversal of temporary differences based on the provisions of enacted tax law.

Note 13: 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 considers the extent of insurance coverage in its estimate of the reserve. The incurrence of an unusually large dollar claim or a large number of claims could alter the Company’s exposure and the related reserves.

The following table identifies changes in warranty reserves for the years ended December 31, 2005 and 2004:


(In thousands)	2005			2004
Balance, beginning of the period	$	2,051		$	3,057
Accruals for warranties during the period		3,026			1,888
Change in estimates		—			(250	)
Settlements made during the period		(3,244	)		(2,644	)

Balance, end of the period	$	1,833		$	2,051

The balances at December 31, 2005 and 2004 include $0.5 million and $0.4 million, respectively, of valuation accounts that are reported against accounts receivable balances in the consolidated balance sheets.

Note 14: QUARTERLY FINANCIAL DATA (Unaudited)

Quarterly results of operations for the years ended December 31, 2005 and 2004 were as follows:

(In thousands, except per share amounts)

First

Second

Third

Fourth

2005

Quarter

Net sales

139,024

167,823

139,863

154,185

Gross profit

28,463

45,796

39,985

47,290

Net income

19,333

37,221

30,756

39,785

Net income per common share —

Basic

0.88

1.67

1.37

1.77

Diluted

0.86

1.65

1.35

1.76


	First		Second		Third		Fourth
2004	Quarter		Quarter		Quarter		Quarter
Net sales	$	84,517	$	109,433	$	122,120	$	151,192
Gross profit		11,715		25,626		29,706		32,127
Net income		5,041		20,604		24,712		24,276
Net income per common share —
Basic	$	0.24	$	0.98	$	1.17	$	1.12
Diluted	$	0.24	$	0.96	$	1.14	$	1.10

Restructuring charges of $1.9 million, or $0.09 per share, were recorded in the first quarter of 2004 primarily as the result of an increase in estimated costs to settle operating contracts cancelled in the Company’s restructuring in 2001.

NS GROUP, INC. AND SUBSIDIARIES

SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS


	Allowance for			Allowance for
	Doubtful			Cash
(In thousands)	Accounts (1)			Discounts (1)
Balance, December 31, 2002	$	407		$	184
Additions charged to costs and expenses		1,185			4,606
Deductions (2)		(1,136	)		(4,394	)

Balance, December 31, 2003		456			396
Additions charged to costs and expenses		1,445			8,388
Deductions (2)		(1,222	)		(7,971	)

Balance, December 31, 2004		679			813
Additions charged to costs and expenses		1,386			9,977
Deductions (2)		(1,325	)		(9,967	)

Balance, December 31, 2005	$	740		$	823


(1)		Deducted from accounts receivable balances in our consolidated balance sheets

(2)		Net charges of nature for which reserves were created

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

None.

ITEM 9A. CONTROLS AND PROCEDURES

Our Chief Executive Officer and the Chief Financial Officer have reviewed our disclosure controls and procedures as of December 31, 2005. Based on that review, they have concluded that these controls and procedures were, in design and operation, effective.

There have been no changes in internal control over financial reporting that occurred during the fourth quarter of 2005 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management’s report on internal control over financial reporting can be found in Item 8. Financial Statements and Supplementary Data of this Report. The independent registered public accounting firm’s attestation report on management’s assessment of internal control over financial reporting can also be found in Item 8.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information relating to directors, including identification of the Audit Committee, the Audit Committee’s financial expert, and executive officers of the Company is contained in the definitive Proxy Statement for the Annual Meeting of Shareholders of NS Group, Inc. to be held on May 10, 2006 (“Proxy”), and is incorporated herein by reference. See also the information regarding executive officers of the registrant set forth in Part I of the Proxy under the caption “Executive Officers of the Registrant” in reliance on General Instruction G to Form 10-K.

We have adopted a code of ethics that applies to all our directors, officers, and employees. This code is publicly available on our website at http://www.nsgrouponline.com. Amendments to the code of ethics and any grant of a waiver from a provision of the code requiring disclosure under applicable SEC rules will be disclosed on our website. Our corporate governance guidelines and the charters of our Audit Committee, Nominating/Corporate Governance Committee and Compensation Committee are available on our website under the “Corporate Governance” section. These materials may also be requested in print by writing to our Investor Relations Department at 530 West Ninth Street, Newport, Kentucky 41071.

ITEM 11. EXECUTIVE COMPENSATION

Information relating to executive compensation and the Company’s equity compensation plans is contained in the Proxy, and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information with respect to beneficial ownership of NS Group, Inc. common stock by each director and all directors and officers of the Company as a group is contained in the Proxy, and is incorporated herein by reference.

Information relating to any person who beneficially owns in excess of 5 percent of the total outstanding shares of NS Group, Inc. common stock is contained in the Proxy, and is incorporated herein by reference.

Information with respect to compensation plans under which equity securities are authorized for issuance is contained in the Proxy, and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information required under this item with respect to directors and executive officers is contained in the Proxy, and is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

Information with respect to fees and services related to the Company’s independent registered public accounting firm, Deloitte & Touche LLP, and the disclosure of the Audit Committee’s pre-approval policies and procedures are contained in the Proxy and are incorporated herein by reference.

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES


(a)	(1	)	Consolidated Financial Statements required by this item are presented and listed in Part II, Item 8.

	(2	)	Consolidated Financial Statement Schedule required by this item is presented and listed in Part II, Item 8.

	(3	)	Reference is made to the Index to Exhibits, which is included herein as part of this report.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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: March 8, 2006	By:	/s/ Thomas J. Depenbrock

	Thomas J. Depenbrock, Vice President — Finance,
	Treasurer and Chief Financial Officer

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints René J. Robichaud and Thomas J. Depenbrock, and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities to sign any and all amendments to this Annual Report on Form 10-K and any other documents and instruments incidental thereto, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents and/or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

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


Date: March 8, 2006	By:	/s/ René J. Robichaud

	René J. Robichaud, President and Chief
	Executive Officer and Director
	(Principal Executive Officer)

Date: March 8, 2006	By:	/s/ Thomas J. Depenbrock

	Thomas J. Depenbrock, Vice President — Finance,
	Treasurer and Chief Financial Officer
	(Principal Financial Officer)

Date: March 8, 2006	By:	/s/ Gerard J. Brinkman

	Gerard J. Brinkman,
	Corporate Controller
	(Principal Accounting Officer)

INDEX TO EXHIBITS


Number		Description
3.1(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.

4.1		Rights Agreement dated November 17, 1998 between the Company and Registrar and Transfer Company, filed as Exhibit 1 to the Company’s Form 8-K dated November 5, 1998, File No. 1-9838, and incorporated herein by this reference.

10.1		The Company’s Amended Employee Incentive Stock Option Plan, filed as Exhibit 10(a) to the Company’s Form 10-K for the fiscal year ended September 30, 1989, File No. 1-9838, and incorporated herein by this reference.*

10.2		The Company’s Executive Compensation Short-Term Incentive Plan, filed as Exhibit 10.2 to the Company’s Form 10-K for the year ended December 31, 2003, File No. 1-9838, and incorporated herein by reference.*

10.3		The Company’s Non-Qualified Stock Option and Stock Appreciation Rights Plan of 1988, filed as Exhibit 1 to the Company’s Proxy Statement dated January 13, 1989, File No. 1-9838, and incorporated herein by this reference.*

10.4		The Company’s 1993 Incentive Stock Option Plan, filed as Exhibit 1 to the Company’s Proxy Statement dated December 22, 1992, File No. 1-9838, and incorporated herein by this reference.*

10.5		The Company’s Amended and Restated 1995 Stock Option and Stock Appreciation Rights Plan, filed as Exhibit A to the Company’s Proxy Statement dated December 21, 1998, File No. 1-9838, and incorporated herein by this reference.*

10.6		Form of Change of Control Severance Agreement, filed as Exhibit 10.6 to the Company’s Form 10-K for the year ended December 31, 2003, File No. 1-9838, and incorporated herein by reference.*

10.7		Form of Salary Continuation Agreement, filed herewith*


Number		Description
10.8		Employment Agreement between the Company and René J. Robichaud, dated March 1, 2002, filed as Exhibit 10.1 to the Company’s Form 10-Q for quarterly period ended March 31, 2002, File No. 1-9838, and incorporated herein by this reference.*

10.9		The Company’s Amended and Restated 2000 Non-Employee Director Stock Option Plan (amended and restated as of February 2002) filed as Exhibit 10.4 to the Company’s Form 10-Q for the three months ended June 30, 2002, File No. 1-9838, and incorporated herein by this reference.*

10.10		Trust Under NS Group, Inc., Salary Continuation Plan, between NS Group, Inc. and Huntington National Bank, Trustee, dated August 8, 2001 filed as Exhibit 10.1 to the Company’s Form 10-Q for the three months ended September 30, 2001, File No. 1-9838, and incorporated herein by this reference.*

10.11		Financing and Security Agreement Between Newport Steel Corporation and Koppel Steel Corporation and The CIT Group/Business Credit, Inc. dated March 29, 2002, filed as Exhibit 4.1 to the Company’s Form 10-Q for the quarterly period ended March 31, 2002, File No. 1-9838, and incorporated by this reference.

10.12		Amendment No. 1 to Financing and Security Agreement Between The CIT Group/Business Credit, Inc. and Newport Steel Corporation and Koppel Steel Corporation, dated May 19, 2003, filed as Exhibit 10.1 to the Company’s Form 10-Q for the quarterly period ended June 30, 2003, File No.1-9838, and incorporated by this reference.

10.13		Amended and Restated Guaranty Agreement of NS Group, Inc. and Erlanger Tubular Corporation and Northern Kentucky Management, Inc., dated June 20, 2003, filed as Exhibit 10.2 to the Company’s Form 10-Q for the quarterly period ended June 30, 2003, File No. 1-9838, and incorporated by this reference.

10.14		Amendment No. 2 to Financing and Security Agreement Between The CIT Group/Business Credit, Inc. and Newport Steel Corporation and Koppel Steel Corporation, dated December 29, 2003, filed as Exhibit 10.14 to the Company’s Form 10-K for the year ended December 31, 2003, File No. 1-9838, and incorporated herein by this reference.

10.15		The Company’s Equity Plan, filed as Appendix C to the Company’s Proxy Statement dated March 12, 2004, File No. 1-9838, and incorporated herein by this reference.*


Number		Description
10.16		The Company’s Non-Employee Director Equity Plan, filed as Appendix D to the Company’s Proxy Statement dated March 12, 2004, File No. 1-9838, and incorporated herein by this reference.*

10.17		Amendment No. 3 to Financing and Security Agreement Between The CIT Group/Business Credit, Inc. and Newport Steel Corporation and Koppel Steel Corporation, dated March 31, 2004, filed as Exhibit 10.1 to the Company’s Form 10-Q for the quarterly period ended March 31, 2004, File No. 1-9838, and incorporated herein by this reference.

10.19		Form of NS Group, Inc. Non-Employee Director Equity Plan Nonqualified Stock Option Agreement, filed as Exhibit 10.2 to the Company’s Form 10-Q for the quarterly period ended September 30, 2004, File No. 1-9838, and incorporated herein by this reference.*

10.20		Form of NS Group, Inc. Equity Plan Restricted Stock Units Agreement, filed as Exhibit 10.3 to the Company’s Form 10-Q for the quarterly period ended September 30, 2004, File No. 1-9838, and incorporated herein by this reference.*

10.21		Form of NS Group, Inc. Equity Plan Nonqualified Stock Option Agreement, filed as Exhibit 10.4 to the Company’s Form 10-Q for the quarterly period ended September 30, 2004, File No. 1-9838, and incorporated herein by this reference.*

10.22		Form of NS Group, Inc. Equity Plan Incentive Stock Option Agreement, filed as Exhibit 10.5 to the Company’s Form 10-Q for the quarterly period ended September 30, 2004, File No. 1-9838, and incorporated herein by this reference.*

10.23		Amendment No. 4 to Financing and Security Agreement between The CIT Group/Business Credit, Inc. and Newport Steel Corporation and Koppel Steel Corporation, dated September 10, 2004, filed as Exhibit 10.16 to the Company’s Form 8-K for the report date September 10, 2004, File No. 1-9838, and incorporated herein by this reference.

10.24		The Company’s Amended and Restated Non-Employee Director Equity Plan, filed as Exhibit A to the Company’s Proxy Statement dated March 7, 2005, File No. 1-9838, and incorporated herein by this reference.*

10.25		The Company’s Executive Long-Term Incentive Program, filed as Item 1.01 to the Company’s Form 8-K dated May 11, 2005, File No. 1-9838, and incorporated herein by this reference.*

10.26		Form of NS Group, Inc. Equity Plan Performance Units Agreement, filed as Exhibit 10.1 to the Company’s Form 8-K dated May 11, 2005, File No. 1-9838, and incorporated herein by this reference.*


Number		Description
10.27		Form of NS Group, Inc. Equity Plan Restricted Shares Agreement, filed as Exhibit 10.2 to the Company’s Form 8-K dated May 11, 2005, File No. 1-9838, and incorporated herein by this reference.*

10.28		Form of NS Group, Inc. Amended and Restated Non-Employee Director Equity Plan Non-Qualified Stock Option Agreement, filed as Exhibit 10.3 to the Company’s Form 8-K dated May 11, 2005, File No. 1-9838, and incorporated herein by this reference.*

10.29		Form of NS Group, Inc. Amended and Restated Non-Employee Director Equity Plan Restricted Shares Agreement, filed as Exhibit 10.4 to the Company’s Form 8-K dated May 11, 2005, File No. 1-9838, and incorporated herein by this reference.*

12.1		Computation of Ratio of Earnings to Fixed Charges, filed herewith.

21		Subsidiaries of the Company, filed herewith.

23.1		Independent Registered Public Accounting Firm’s consent, filed herewith.

24.1		Power of Attorney (contained on Signature Page).

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 of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 and Exchange Act Rule 13a-14(b), furnished herewith.

32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 and Exchange Act Rule 13a-14(b), furnished herewith.


*		Indicates management contracts or compensatory plans or arrangements in which one or more directors or executive officers of the Company participates or is a party.


		Page
PART I

Item 1.	Business	3
Item 1A.	Risk Factors	9
Item 1B.	Unresolved Staff Comments	15
Item 2.	Properties	16
Item 3.	Legal Proceedings	17
Item 4.	Submission of Matters to a Vote of Security Holders	17

PART II

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	17
Item 6.	Selected Financial Data	19
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	41
Item 8.	Financial Statements and Supplementary Data	43
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	73
Item 9A.	Controls and Procedures	73

PART III

Item 10.	Directors and Executive Officers of the Registrant	74
Item 11.	Executive Compensation	74
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	74
Item 13.	Certain Relationships and Related Transactions	74
Item 14.	Principal Accounting Fees and Services	75

PART IV

Item 15.	Exhibits and Financial Statement Schedules	75
Exhibit 10.7
Exhibit 12.1
Exhibit 21
Exhibit 23.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2


		Index to Consolidated Financial Statements and Schedule

		Consolidated Financial Statements

		Management’s Reports to NS Group Shareholders			44
		Report of Independent Registered Public Accounting Firm			45
		Consolidated Statements of Operations			48
		Consolidated Balance Sheets			49
		Consolidated Statements of Cash Flows			50
		Consolidated Statements of Shareholders’ Equity			51
		Notes to Consolidated Financial Statements			52

		Financial Statement Schedule

		Schedule II Valuation and Qualifying Accounts			73


Date: March 8, 2006	By:	/s/ Clifford R. Borland

	Clifford R. Borland, Chairman of the Board,
	Director

Date: March 8, 2006	By:	/s/ David A. B. Brown

	David A. B. Brown, Director

Date: March 8, 2006	By:	/s/ J. C. Burton

	J. C. Burton, Director

Date: March 8, 2006	By:	/s/ Patrick J. B. Donnelly

	Patrick J. B. Donnelly, Director

Date: March 8, 2006	By:	/s/ George A. Helland, Jr.

	George A. Helland, Jr., Director

Date: March 8, 2006	By:	/s/ John F. Schwarz

	John F. Schwarz, Director