UNITED STATES

FORM 10-Q

For the Quarterly Period ended June 30, 2004

For the Transition Period from ___________ to ___________

Commission file number: 000-19580

T-3 ENERGY SERVICES, INC.

(Registrant’s telephone number, including area code): (713) 996-4110

     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 [X]  No [   ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [   ]  No[X]

     At July 30, 2004, the registrant had 10,581,986 shares of common stock outstanding.

TABLE OF CONTENTS

FORM 10-Q

T-3 ENERGY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands except for share amounts)

The accompanying notes are an integral part of these consolidated financial statements.

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T-3 ENERGY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands except per share amounts)

The accompanying notes are an integral part of these consolidated financial statements.

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T-3 ENERGY SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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T-3 ENERGY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.

BASIS OF PRESENTATION

     The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included. These financial statements include the accounts of T-3 Energy Services, Inc. and its subsidiaries (T-3). All significant intercompany balances and transactions have been eliminated in consolidation. Operating results for the three and six months ended June 30, 2004, are not necessarily indicative of the results that may be expected for the year ended December 31, 2004. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. Certain reclassifications were made to previously reported amounts in the consolidated financial statements and notes to make them consistent with the current presentation format.

Stock-Based Compensation

     At June 30, 2004, the Company had a stock option plan, which is described more fully in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. The Company accounts for that plan under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per common share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” to stock-based employee plans (dollars in thousands, except per share data):

     For the purpose of estimating the fair value disclosures above, the fair value of each stock option has been estimated on the grant date with a Black-Scholes option pricing model. The following assumptions for the three months ended June 30, 2004 and 2003 were computed on a weighted average basis: risk-free interest rate of 4.12% and 3.87%, respectively, expected volatility of 42.44% and 43.21%, respectively, expected life of 4 years for each period and no expected dividends. The following assumptions for the six months ended June 30, 2004 and 2003 were computed on a weighted average basis: risk-free interest rate of 4.12% and 3.80%, respectively,

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expected volatility of 42.44% and 43.44%, respectively, expected life of 4 years for each period and no expected dividends. The effects of applying SFAS No. 123 may not be indicative of future amounts since additional future awards are anticipated and the estimation of values involves subjective assumptions that may vary materially as a result of actual events.

Write-down of Acquired Note Receivable

     Prior to the merger of the Company and Industrial Holdings, Inc. (“IHI”), IHI sold a subsidiary, Beaird Industries Inc. (“Beaird”), to an entity controlled by Don Carlin and Robert Cone, and IHI received a $3.5 million promissory note from the former subsidiary as the purchase price. Mr. Carlin is a former director, and Mr. Cone is a former executive officer and director of the Company. During the first quarter of 2003, the Company was informed by Beaird of its inability to make timely interest payments and that efforts to restructure its debt obligations had to date been unsuccessful. Accordingly, the Company wrote-down approximately 50% of the note, because management believed that the note’s net realizable value was approximately $1.7 million. In the fourth quarter of 2003, the Company learned that efforts to refinance Beaird had failed, and management determined that the note was uncollectible and wrote-off the remaining balance of the note. The first quarter of 2003 write-down amount appears in the Statement of Operations for the six months ended June 30, 2003 under the caption “Write-down of acquired note receivable”.

2.

DISCONTINUED OPERATIONS

     During the fourth quarter of 2003, the Company committed to a formal plan to sell certain non-core assets within its Products segment. The sale of these assets was consummated in February 2004. The Company received $7.4 million in cash at closing that was immediately used to pay down the term loan under its senior credit facility. The assets sold comprised substantially all of the assets of LSS – Lone Star – Houston Inc., Bolt Manufacturing Co., Inc. (d/b/a Walker Bolt Manufacturing Company) and WHIR Acquisition, Inc. (d/b/a Ameritech Manufacturing) (collectively, the “Fastener Businesses”). The Fastener Businesses primarily manufacture and distribute a broad line of standard and metric fasteners, in addition to manufacturing specialty fasteners and parts in small quantities for the commercial and aerospace industries, as well as the military. At December 31, 2003, these assets constituted a business and thus were classified as discontinued operations in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. Accordingly, the Fastener Businesses’ results of operations for 2004 and 2003 have been reported as discontinued operations. See Note 2 to the Company’s consolidated financials statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 for additional information.

     During the second quarter of 2004, the Company committed to a formal plan to sell substantially all of the remaining assets within its Products segment, except for certain assets related to the Company’s custom coatings business, along with certain assets within its Pressure Control segment. A portion of the remaining Products segment assets were sold during May and June 2004 and qualified as discontinued operations in accordance with SFAS No. 144. The Company received $1.0 million and $0.4 million, respectively, in cash at the closings. The assets sold comprised substantially all of the assets of one of the two operating divisions of Moores Pump & Services, Inc., known as “Moores Machine Shop” and TPS Total Power Systems, Inc. (“TPS”). Moores Machine Shop primarily is engaged in the manufacture and production of downhole and completion products and equipment. TPS distributes new electric motors; provides complete rewinding, repair and rebuilding for used AC/DC electric motors and generators; and repairs and manufactures used flood pumps and waste disposal pumps for governmental entities in Louisiana and Texas. The remaining assets of Moores Pump & Services, Inc. (“Moores Pump”) and Control Products of Louisiana, Inc. (“CPL”) were unsold as of June 30, 2004, but the Company intends to sell these assets during the third quarter of 2004. These assets constitute businesses and thus are also classified as discontinued operations in accordance with SFAS No. 144. Accordingly, the results of operations of Moores Machine Shop, TPS, Moores Pump and CPL for 2004 and 2003 have been reported as discontinued operations in this Form 10-Q.

     T-3 assessed the realizability of the Company’s recorded goodwill and other intangibles at December 31, 2003, in accordance with SFAS No. 142. As a result, T-3 recorded a goodwill impairment charge during the

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fourth quarter of 2003 for the Products Segment operations. At June 30, 2004, Pressure Control goodwill was allocated based on the relative fair values of the portion of the reporting unit being disposed and the portion of the reporting unit remaining. This resulted in a goodwill impairment charge of $0.3 million, related to the assets being sold within the Company’s Pressure Control segment, during the three months ended June 30, 2004. In addition to the goodwill impairment charge, the Company recorded a $0.2 million charge to other intangible assets and a $2.4 million charge to tangible assets related to the Products and Pressure Control dispositions during the three months ended June 30, 2004. Accordingly, these impairment charges have been reported as discontinued operations. T-3 reassessed the realizability of the Pressure Control segment’s recorded goodwill and other intangibles at June 30, 2004 in accordance with SFAS No. 142 and no further impairment was recorded.

     Net revenues from discontinued operations for the three months ended June 30, 2004 and 2003 were $2.5 million and $9.4 million, respectively. For the same periods, loss before benefit for income taxes was $3.5 million and $0.3 million, respectively. Net revenues from discontinued operations for the six months ended June 30, 2004 and 2003 were $8.8 million and $19.5 million, respectively. For the same periods, loss before benefit for income taxes was $3.7 million and $0.3 million, respectively.

3.

ASSETS HELD FOR SALE

     During the second quarter of 2004, the Company also sold certain assets of the spray weld division of O&M Equipment, L.P. for cash of $0.3 million. These assets did not constitute a business; however, they did qualify as assets held for sale in accordance with SFAS No. 144. Accordingly, they are presented as such on the December 31, 2003 consolidated balance sheet. The disposition of these assets resulted in a loss on sale of $50,000, which includes a $150,000 write-down of other intangible assets. The results of operations are classified in income from continuing operations for 2004 and 2003.

4.

INVENTORIES

     Inventories consist of the following (dollars in thousands):

5.

NEWLY ISSUED ACCOUNTING STANDARDS

     In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). FIN 46 requires unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse the risks and rewards of ownership among their owners and other parties involved. The provisions of FIN 46 are applicable immediately to all variable interest entities created after January 31, 2003 and require certain disclosures for all variable interest entities. In December 2003, the FASB published a revision to FIN 46 (“FIN 46R”) to clarify some of the provisions of the interpretation and to defer the effective date of implementation for certain entities created before January 31, 2003. Under the guidance of FIN 46R, entities that do not have interests in structures that are commonly referred to as special purpose entities (“SPEs”) are required to apply the provisions of the interpretation in financial statements for periods ending after March 14, 2004. The adoption of the provisions applicable to SPEs and all other variable interests obtained after January 31, 2003 did not have an impact on the Company’s consolidated financial statements. As of June 30, 2004, the Company had no variable interest entities and there was no effect on its consolidated balance sheet, statement of operations, and cash flows.

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6.

EARNINGS (LOSS) PER SHARE

     Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is the same as basic but includes dilutive stock options and warrants using the treasury stock method.

     The following tables reconcile the numerators and denominators of the basic and diluted per common share computations for net income (loss) for the three and six months ended June 30, 2004 and 2003, as follows (in thousands except per share data):

     For the three months ended June 30, 2004, there were 584,379 options and 517,862 warrants that were not included in the computation of diluted earnings per share because their inclusion would have been anti-dilutive. For the three months ended June 30, 2003, there were 580,329 options and 517,862 warrants that were not included in the computation of diluted earnings per share because their inclusion would have been anti-dilutive. The Company’s Class B, C and D warrants totaling 2,971,217 warrants expired on January 14, 2003.

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     For the six months ended June 30, 2004, there were 584,379 options and 517,862 warrants that were not included in the computation of diluted earnings per share because their inclusion would have been anti-dilutive. For the six months ended June 30, 2003, there were 580,329 options and 517,862 warrants that were not included in the computation of diluted earnings per share because their inclusion would have been anti-dilutive.

7.

REPORTABLE SEGMENTS

     The Company’s determination of reportable segments considers the strategic operating units under which the Company sells various types of products and services to various customers.

     The accounting policies of the segments are the same as those of the Company. The Company evaluates performance based on income from operations excluding certain corporate costs not allocated to the segments. Inter-segment revenues are not material. Substantially all revenues are from domestic sources and all assets are held in the United States. As discussed in Note 2, the Company sold substantially all of the remaining assets of its Products segment, except for certain assets related to the Company’s custom coatings business, and accordingly, their results of operations for 2004 and 2003 have been reported as discontinued operations. In June 2004, the Company realigned its operating segments due to the sale of substantially all of the assets of its Products reporting segment. Since the Company’s custom coatings business is insignificant to the consolidated results of the Company and also has similar economic characteristics, customers and products to the Pressure Control reporting segment, the three historical reporting segments of Pressure Control, Products and Distribution now operate under two reporting segments: Pressure Control and Distribution. Accordingly, all historical segment results reflect the new operating structure. Segment information for the three and six months ended June 30, 2004 and 2003 is as follows:

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8.

CONTINGENCIES

     The Company is, from time to time, involved in various legal actions arising in the normal course of business. Management does not believe there are any existing or potential legal actions involving the Company that will have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

     The Company’s environmental remediation and compliance costs have not been material during any of the periods presented. T-3 has been identified as a potentially responsible party (PRP) with respect to one site designated for cleanup under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) and similar state laws. The Company’s involvement at this site is believed to have been minimal. Because it is early in the process, no determination of the Company’s actual liability can be made at this time. As such, management has not currently accrued for any future remediation costs related to this site. However, based upon the Company’s involvement with this site, management does not expect that its share of remediation costs will have a material impact on its financial position, results of operations and cash flows.

     In July 2001, the Company discovered preliminary information concerning deep soil contamination at one of its leased facilities. This preliminary information is limited, and the contamination source has not yet been identified. The Company has informed the landlord of the existence of the contamination and has requested that they remediate the property as required by the lease. Management expects that the landlord will comply with its obligations under the lease to investigate the environmental condition and take any action required under applicable laws. Management does not believe that the Company has contributed to or is responsible for remediation of the site.

     At June 30, 2004, the Company had no letters of credit outstanding.

9.

SUBSEQUENT EVENTS

     On July 9, 2004, the Company sold certain assets of CPL for $0.5 million in cash. CPL primarily repairs and manufactures control valves and related equipment. As discussed in Note 2, these assets constituted a business and accordingly their results of operations have been reported as discontinued operations in 2004 and 2003.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

     The following discussion of our historical results of operations and financial condition for the three and six months ended June 30, 2004 and 2003 should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Form 10-Q and our financial statements and related management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2003 included in our Annual Report on Form 10-K.

     We have historically operated in three segments; however, during the second quarter of 2004, the Company sold substantially all of the remaining assets of its Products segment, except for certain assets related to the Company’s custom coatings business. Accordingly, the Products segment’s results of operations for 2004 and 2003 have been reported as discontinued operations. Due to this sale of substantially all of the assets of its Products segment and since the Company’s custom coatings business is insignificant to the consolidated results of the Company and also has similar economic characteristics, customers and products to the Pressure Control segment, the Company realigned its operating segments during June 2004. The three historical reporting segments of Pressure Control, Products and Distribution now operate under two reporting segments: Pressure Control and Distribution. Accordingly, all historical segment results reflect the new operating structure. Our Pressure Control segment manufactures, remanufactures and repairs high pressure, severe service products, including valves, chokes, actuators, blowout preventers, manifolds and wellhead equipment and applies custom coatings to customers’ products used primarily in the oil and gas industry. Our Distribution segment engages in the specialty distribution of pipes, valves, stud bolts, gaskets and other ancillary products. Our products and services are sold primarily to customers in the upstream and downstream oil and gas industry located in the Texas and Louisiana Gulf Coast region.

     The following table sets forth certain statistics that are reflective of recent historical market conditions:

     Demand for our products and services is cyclical and dependent upon activity in the oil and gas industry and the profitability, cash flow and willingness of oil and gas companies and drilling contractors to spend capital on the exploration, development and production of oil and gas reserves in the Gulf of Mexico and the United States Gulf Coast regions where our products and services are primarily sold. The level of exploration and production,

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our primary driver, especially in the Gulf of Mexico, is highly sensitive to current and projected oil and natural gas prices, which have historically been characterized by significant volatility. Over the last several years, the United States drilling rig count has fluctuated due to world economic and political trends that influence the supply and demand for energy, the price of oil and natural gas and the level of exploration and drilling for those commodities. The United States drilling rig count has increased steadily throughout 2003 and the first half of 2004. However, the average Gulf of Mexico rig count remained at relatively low levels throughout 2003 before a further decline in the first half of 2004.

     Our revenue growth will continue to be heavily dependent upon the timing and strength of the recovery in the Gulf of Mexico market and our gains in market share outside the Gulf of Mexico. The extent of any recovery in the Gulf of Mexico market and gains in market share outside the Gulf of Mexico are not predictable. As illustrated in the table above, the market price of oil and gas alone is not an indicator of a recovery in these markets. Many external factors, including world economic and political conditions, quotas established by OPEC (Organization of Petroleum Exporting Countries) and weather conditions, will influence the recovery and continued strength of the industry. Based on our assessment of external factors and our current levels of inquiry and quotation, we believe that continuing price and general uncertainty in the Gulf of Mexico market will cause near-term activity levels to remain flat for the second half of 2004.

     We expect that we will be able to maintain our market share in the Gulf of Mexico and high-pressure gas markets. Because of the volatility of those markets, key aspects of our strategy to build stockholder value include expanding into international markets through agency agreements or acquisitions; acquiring products and services that complement our existing Pressure Control products and services in the manufacturing and aftermarket service arenas; emphasizing inter-company coordination through bundled products and services, combined sales efforts and inter-company purchases; completing strategic add-on Pressure Control acquisitions both domestically and internationally; and internally growing the Distribution segment domestically. By diversifying our revenue base to lessen our dependence on the Gulf of Mexico market, and expanding our products and services offered to both the domestic and international onshore drilling and production markets, we will seek to enhance our revenues and profitability. We have increased our Pressure Control segment’s engineering and technical sales staff to improve our ability to service our customers and plan to introduce new high quality pressure equipment in both the domestic and international onshore and offshore oil and gas markets in the second half of 2004. We will seek to increase market penetration and revenue increases beyond 2004 from these new products and service capabilities.

Critical Accounting Policies and Estimates

     The preparation of our financial statements requires us to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Our estimation process generally relates to potential bad debts, obsolete and slow moving inventory, and the valuation of long-lived and intangible assets. Our estimates are based on historical experience and on our future expectations that we believe to be reasonable under the circumstances. The combination of these factors results in the amounts shown as carrying values of assets and liabilities in the financial statements and accompanying notes. Actual results could differ from our current estimates and those differences may be material.

     These estimates may change as events occur, as additional information is obtained and as our operating environment changes. There have been no material changes or developments in our evaluation of the accounting estimates and the underlying assumptions or methodologies that we believe to be Critical Accounting Policies and Estimates as disclosed in our Annual Report on Form 10-K for the year ending December 31, 2003.

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Results of Operations

     The following table sets forth certain operating statement data for each of our segments for each of the periods presented (in thousands). Reclassifications have been made for discontinued operations to previously reported amounts to make them consistent with current presentation format.

Three Months ended June 30, 2004 Compared with Three Months ended June 30, 2003

     Revenues. On a consolidated basis, revenues increased $0.2 million, or 0.8%, in 2004 compared to 2003. This increase was primarily attributable to the increased pipe and valve sales in our Distribution segment, a slight increase in United States drilling activity offset by the continued softness in the Gulf of Mexico drilling activity and continued pricing pressure for all our products and services.

     Revenues for the Pressure Control segment decreased $1.4 million, or 7.7%, in 2004 compared to 2003. The decrease was primarily attributable to the continued softness in the Gulf of Mexico drilling rig activity and continued pricing pressure for our products and services. This decrease was partially offset by increased revenues resulting from an improved United States onshore rig count.

     Revenues for the Distribution segment increased $1.6 million, or 16.4%, in 2004 compared to 2003 due to increased pipe and valve distribution sales.

     Cost of Revenues. On a consolidated basis, cost of revenues increased $0.8 million, or 4.3%, in 2004 compared to 2003 as a result of the increase in revenues described above. Gross profit as a percentage of revenues was 29.5% in 2004 compared to 31.9% in 2003. Gross profit margin was slightly lower on a consolidated basis in 2004 due to continued pricing pressure in both segments, fixed costs that did not decrease proportionally with the decrease of the Pressure Control group revenues and an increase in product modification

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and development expenses associated with certain high pressure equipment.

     Cost of revenues for the Pressure Control segment decreased $0.6 million, or 4.8%, in 2004 compared to 2003. The decrease is primarily a result of the decrease in revenues described above. Gross profit as a percentage of revenues was 33.1% in 2004 compared to 35.2% in 2003. Gross profit margin was slightly lower in 2004 due to continued pricing pressure, fixed costs that did not decrease proportionally and an increase in product modification and development expenses associated with certain high pressure equipment.

     Cost of revenues for the Distribution segment increased $1.4 million, or 19.0%, in 2004 compared to 2003, primarily due to the increase in revenues in 2004. Gross profit as a percentage of revenues was 24.3% in 2004 compared to 26.0% in 2003. Gross profit margin was slightly lower in 2004 due to continued pricing pressure and increased freight and general insurance costs.

     Operating expenses. On a consolidated basis, operating expenses decreased $0.5 million, or 7.0%, in 2004 compared to 2003. Operating expenses as a percentage of revenues was 22.2% in 2004 compared to 24.1% in 2003. This decrease was due to cost reduction strategies, including lower self-insured medical costs and headcount reductions.

     Operating expenses for the Pressure Control segment increased $0.2 million, or 6.0%, in 2004 compared to 2003. Operating expenses as a percentage of revenues were 16.0% in 2004 compared to 13.9% in 2003. The increase was primarily a result of the write-down of other intangible assets associated with the disposition of certain spray welding assets.

     Operating expenses for the Distribution segment decreased $0.2 million, or 8.2%, in 2004 compared to 2003. As a percentage of revenues, operating expenses decreased from 21.5% in 2003 to 16.9% in 2004, primarily because as revenues increased, operating expenses did not increase proportionally in addition to decreased costs due to cost reduction strategies such as lower self-insured medical costs, partially offset by costs associated with the expansion of the Distribution segment.

     Operating expenses for Corporate operations decreased $0.5 million, or 21.4%, in 2004 compared to 2003. This was primarily attributable to cost reduction strategies and headcount reductions.

     Interest Income. Interest income was generated from seller notes receivable that arose in conjunction with the sale by Industrial Holdings, Inc. of several business units in 2001.

     Income Taxes. Income tax expense (benefit) for 2004 was $0.6 million as compared to $0.5 million in 2003. The effective tax rate was 39.0% in 2004 compared to 34.7% in 2003, resulting from the effect of non-deductible expenses and state income taxes, net of the Federal benefit provided.

     Income from Continuing Operations. On a consolidated basis, net income from continuing operations was $0.9 million in 2004 compared with $1.0 million in 2003 as a result of the foregoing factors.

     Discontinued operations. During the fourth quarter of 2003, we committed to a formal plan to sell certain non-core assets within our Products segment, primarily certain assets of LSS – Lone Star – Houston Inc., Bolt Manufacturing Co., Inc. and WHIR Acquisition, Inc. The sale of these assets was consummated in February 2004. During the second quarter of 2004, we continued to focus more on our business strategy as it related to the Pressure Control segment and received inquiries for substantially all of the remaining assets within our Products segment, primarily Moores Machine Shop, TPS, and Moores Pump. Accordingly, we committed to formal plans to sell these remaining assets within our Products segment, along with certain assets within our Pressure Control segment, primarily CPL. The sales of the Moores Machine Shop and TPS assets were consummated during May and June 2004, respectively, and the assets of Moores Pump and CPL are expected to be sold during the third quarter of 2004. For the three months ended June 30, 2004, we recorded a loss of $2.9 million for the above dispositions. Included in this loss was a goodwill impairment charge of $0.3 million, a $0.2 million charge to other intangible assets and a $2.4 million charge to tangible assets. These assets constitute

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businesses and their results of operations were reported in discontinued operations in 2003 and 2004 in accordance with SFAS No. 144

Six Months ended June 30, 2004 Compared with Six Months ended June 30, 2003

     Revenues. On a consolidated basis, revenues decreased $2.3 million, or 4.3%, in 2004 compared to 2003. Although United States drilling activity increased from period to period and oil and natural gas prices increased slightly, the continued softness in the Gulf of Mexico rig count and increased pricing pressure in our Pressure Control segment were the major causes of the decline in our revenues. This decrease was partially offset by increased revenues from some of our Pressure Control products and services resulting from an improved United States onshore rig count.

     Revenues for the Pressure Control segment decreased $2.2 million, or 6.4%, in 2004 compared to 2003. The decrease was primarily attributable to the continued softness in the Gulf of Mexico drilling rig activity and continued pricing pressure for our products and services. This decrease was partially offset by increased revenues resulting from an improved United States onshore rig count.

     Revenues for the Distribution segment decreased $0.1 million, or 0.6%, in 2004 compared to 2003 due to increased competition and continued pricing pressure.

     Cost of Revenues. On a consolidated basis, cost of revenues decreased $1.1 million, or 2.9%, in 2004 compared to 2003 as a result of the decrease in revenues described above. Gross profit as a percentage of revenues was 30.3% in 2004 compared to 31.3% in 2003. Gross profit margin was slightly lower on a consolidated basis in 2004 because of continued pricing pressure and fixed costs that did not decrease proportionally, slightly offset by cost reduction strategies, including lower self-insured medical costs.

     Cost of revenues for the Pressure Control segment decreased $1.2 million, or 5.5%, in 2004 compared to 2003. The decrease was primarily a result of the decrease in revenues described above. Gross profit as a percentage of revenues was 33.4% in 2004 compared to 34.1% in 2003. Gross profit margin was slightly lower due to continued pricing pressure and an increase in product modification and development expenses.

     Cost of revenues for the Distribution segment increased $0.1 million, or 1.0%, in 2004 compared to 2003. Gross profit as a percentage of revenues was 25.3% in 2004 compared to 26.4% in 2003. Gross profit margin was slightly lower in 2004 due to continued pricing pressure and increased freight and general insurance costs.

     Operating expenses. On a consolidated basis, operating expenses decreased $0.8 million, or 6.0%, in 2004 compared to 2003. Operating expenses as a percentage of revenues was 23.0% in 2004 compared to 23.5% in 2003. Operating expenses decreased due to cost reduction strategies, including lower self-insured medical costs and headcount reductions offset by expenses associated with the improvement of the Pressure Control segment’s engineering and technical sales support division.

     Operating expenses for the Pressure Control segment increased $0.1 million, or 1.8%, in 2004 compared to 2003. Operating expenses as a percentage of revenues were 15.5% in 2004 compared to 14.2% in 2003. The increase was primarily a result of the write-down of other intangible assets associated with the disposition of certain spray welding assets and additional expenses associated with the improvement of our engineering and technical sales support division.

     Operating expenses for the Distribution segment decreased $0.3 million, or 6.6%, in 2004 compared to 2003. As a percentage of revenues, operating expenses decreased from 21.5% in 2003 to 20.2% in 2004, primarily due to cost reduction strategies, including lower self-insured medical costs, offset partially by costs associated with the expansion of the Distribution segment.

     Operating expenses for Corporate operations decreased $0.6 million, or 16.2%, in 2004 compared to 2003. This was primarily attributable to cost reduction strategies and headcount reductions.

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     Interest Income. Interest income was generated from seller notes receivable that arose in conjunction with the sale by Industrial Holdings, Inc. of several business units in 2001.

     Write-down of Acquired Note Receivable. In the first quarter of 2003, we wrote down a note receivable that was acquired in conjunction with the disposal by Industrial Holdings, Inc. of Beaird Industries, Inc. (“Beaird”) prior to the completion of its merger with us. During the first quarter of 2003, we were informed by Beaird of its inability to make timely payments and that its ongoing refinancing efforts to date had been unsuccessful. A reserve of approximately 50% of the note was recorded because we believed at that time that the note’s net realizable value was approximately $1.7 million at March 31, 2003. This note was fully written off in the fourth quarter of 2003 because of Beaird’s failed refinancing efforts and the unlikelihood of any future collections.

     Income Taxes. Income tax expense for 2004 was $1.0 million as compared to $0.4 million in 2003. The effective tax rate was 38.6% in 2004 compared to 40.8% in 2003, resulting from the effect of non-deductible expenses and state income taxes, net of the Federal benefit provided.

     Income from Continuing Operations. On a consolidated basis, net income from continuing operations was $1.5 million in 2004 compared with $0.6 million in 2003 as a result of the foregoing factors.

     Discontinued operations. During the fourth quarter of 2003, we committed to a formal plan to sell certain non-core assets within our Products segment, primarily certain assets of LSS – Lone Star – Houston Inc., Bolt Manufacturing Co., Inc. and WHIR Acquisition, Inc. The sale of these assets was consummated in February 2004. During the second quarter of 2004, we continued to focus more on our business strategy as it related to the Pressure Control segment and received inquiries for substantially all of the remaining assets within our Products segment, primarily Moores Machine Shop, TPS, and Moores Pump. Accordingly, we committed to formal plans to sell these remaining assets within our Products segment, along with certain assets within our Pressure Control segment, primarily CPL. The sales of the Moores Machine Shop and TPS assets were consummated during May and June 2004, respectively, and the assets of Moores Pump and CPL are expected to be sold during the third quarter of 2004. For the three months ended June 30, 2004, we recorded a loss of $2.9 million for the above dispositions. Included in this loss was a goodwill impairment charge of $0.3 million, a $0.2 million charge to other intangible assets and a $2.4 million charge to tangible assets. These assets constitute businesses and their results of operations were reported in discontinued operations in 2003 and 2004 in accordance with SFAS No. 144.

Liquidity and Capital Resources

     At June 30, 2004, we had working capital of $28.3 million, current maturities of long-term debt of $1.3 million, long-term debt of $12.1 million and stockholders’ equity of $101.3 million. Historically, our principal liquidity requirements and uses of cash have been for debt service, capital expenditures, working capital and acquisition financing, and our principal sources of liquidity and cash have been from cash flows from operations, borrowings under long-term debt arrangements and issuances of equity securities. We have historically financed acquisitions through bank borrowings, sales of equity (primarily to First Reserve) and internally generated funds.

     Net Cash Provided by Operating Activities. For the six months ended June 30, 2004, net cash provided by operating activities was $2.0 million compared to $1.6 million provided in the same period in 2003. Cash provided by operations increased in 2004 as compared to 2003 because of decreased payments on accounts payable and increased collections of accounts receivable, partially offset by increases in certain inventories to take advantage of favorable pricing and expansion of the Distribution segment.

     Net Cash Used in Investing Activities. Principal uses of cash are for capital expenditures and acquisitions. Investing activities used cash of $0.4 million in the six months ended June 30, 2004 compared to $0.7 million in the same period in 2003. For the six months ended June 30, 2004 and 2003, we made capital expenditures of approximately $1.0 million and $0.7 million, respectively.

     Net Cash Used in Financing Activities. Sources of cash from financing activities include borrowings under credit facilities and sales of equity securities. Financing activities used net cash of $11.0 million in the six

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months ended June 30, 2004 compared to $1.1 million used in the same period in 2003. During 2004, we had borrowings of $1.3 million under our long-term debt credit facilities compared to $0.7 million during 2003. During 2004, we made principal payments of $12.3 million on our long-term debt, exclusive of our revolving credit facility, compared to $1.8 million in 2003.

     Net Cash Provided by (Used In) Discontinued Operations. For the six months ended June 30, 2004, net cash provided by discontinued operations was $9.3 million compared to $0.4 million used in the same period in 2003. Cash was provided by discontinued operations in 2004 primarily because of our receipt of $7.4 million in cash in February 2004, $1.0 million in cash in May 2004 and $0.4 million in cash in June 2004 upon the sales of assets of these operations.

     Principal Debt Instruments. As of June 30, 2004, we had an aggregate of $13.4 million borrowed under our senior credit facility and debt instruments entered into or assumed in connection with acquisitions, as well as other bank financings. As of June 30, 2004, as a result of the funded debt-to-EBITDA ratio covenant, as defined in the credit agreement for our senior credit facility, our availability under our revolving credit facility was limited to $7.2 million.

     On December 17, 2001, we entered into a senior credit facility with Wells Fargo, N.A. and General Electric Capital Corporation maturing December 17, 2004. Concurrently, we entered into a $12.0 million subordinated term loan with Wells Fargo Energy Capital, Inc. maturing December 17, 2005. The senior credit facility includes a revolving credit facility of the lesser of a defined borrowing base (based upon 85% of eligible accounts receivable and 50% of eligible inventory) or $25.0 million, a term loan of $16.5 million and an optional facility for up to an additional $30.0 million in the form of a revolving credit commitment for future acquisitions based upon specific criteria. The senior credit facility’s term loan is payable in equal quarterly installments of $0.8 million. The applicable interest rate of the senior credit facility is governed by our trailing-twelve-month funded debt-to-EBITDA ratio and ranges from prime plus 1.25% or LIBOR plus 2.25% to prime plus 2.00% or LIBOR plus 3.00%. At June 30, 2004, the senior credit facility bore interest at prime plus 1.75%, with interest payable quarterly. We are required to prepay the senior credit facility under certain circumstances with the net cash proceeds of certain asset sales, insurance proceeds, equity issuances and institutional debt, and if, and for so long as, our funded debt-to-EBITDA ratio for the previous fiscal year is 2.25 to 1 or greater, with 50% of excess cash flow as determined under the senior credit agreement. In connection with the sale of certain assets of the Products segment in February 2004 (see Note 2 to our 2003 consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2003 for additional information), we used the net proceeds to pay down the term loan included in the senior credit facility. The remaining balance of the loan was concurrently paid off with other funds. In connection with the additional sales of assets of the Products segment in May and June 2004, we used the net proceeds to pay down the revolving credit facility. The senior credit facility provides, among other covenants and restrictions, that we comply with certain financial covenants, including a limitation on capital expenditures, a minimum fixed charge coverage ratio, minimum consolidated tangible net worth and a maximum funded debt-to-EBITDA ratio. As of June 30, 2004, we were in compliance with the covenants under the senior credit facility. The senior credit facility is collateralized by substantially all of our assets.

     The subordinated term loan bears interest at a fixed rate of 9.50% with interest payable quarterly. The principal balance is due in full on December 17, 2005. The effective interest rate, including amortization of loan costs, is 11.02%. The subordinated term loan provides, among other restrictions, that we maintain a minimum fixed charge coverage ratio and a maximum funded debt-to-EBITDA ratio. Under the terms of our senior credit facility, we are not currently permitted to make principal payments on the subordinated term loan. As of June 30, 2004, we were in compliance with the covenants under the subordinated term loan. The subordinated term loan is collateralized by a second lien on substantially all of our assets.

     We believe that cash generated from operations and amounts available under our senior credit facility and from other sources of debt will be sufficient to fund existing operations, working capital needs, capital expenditure requirements and financing obligations. We also believe any significant increase in capital expenditures caused by any need to increase manufacturing capacity can be funded from operations or through debt financing.

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     We intend to pursue additional acquisition candidates, but the timing, size or success of any acquisition effort and the related potential capital commitments cannot be predicted. We expect to fund future cash acquisitions primarily with cash flow from operations and borrowings, including the unborrowed portion of our senior credit facility or new debt issuances, but may also issue additional equity either directly or in connection with an acquisition. However, there can be no assurance that acquisition funds may be available at terms acceptable to us.

     A summary of our outstanding contractual obligations and other commercial commitments at June 30, 2004 is as follows (in thousands):

Forward-Looking Information and Risk Factors

     Certain information in this Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these forward-looking statements by the words “expects,” “projects,” “believes,” “anticipates,” “intends,” “plans,” “budgets,” “predicts,” “estimates” and similar expressions.

     We have based the forward-looking statements relating to our operations on our current expectations, and estimates and projections about us and about the industries in which we operate in general. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions. In addition, many of these forward-looking statements are based on assumptions about future events that may prove to be inaccurate. Actual outcomes and results may differ materially from what we have expressed or forecast in the forward-looking statements.

Because we depend on the oil and gas industry, a decline in oil and gas prices or a decrease in industry activity will negatively impact our profits.

     We are, and will continue to be, dependent upon the oil and gas industry and the level of oil and gas exploration and production. The level of exploration and production depends upon the prevailing view of future product prices. Many factors affect the supply and demand for oil and gas and therefore influence product prices, including:

•		the level of production from known reserves;
•		weather conditions;
•		the actions of the Organization of Petroleum Exporting Countries;
•		political instability in the Middle East and elsewhere;
•		the level of oil and gas inventories;
•		the cost of producing oil and gas;
•		the level of drilling activity;

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•		worldwide economic activity; and
•		governmental regulation.

     If there is a significant reduction in the demand for drilling services, cash flows of drilling contractors or production companies or drilling or well servicing rig utilization rates, then demand for our products will decline.

The oilfield service industry in which we operate is highly competitive, which may result in a loss of market share or a decrease in revenue or profit margins.

     The oilfield service industry in which we operate is highly competitive. Many of our competitors have greater financial and other resources than we do. Each of our operating units is subject to competition from a number of similarly sized or larger businesses. Factors that affect competition include price, quality and customer service. Strong competition may result in a loss of market share and a decrease in revenue and profit margins. Our success will be affected by our ability to lower our cost structure. Our forward-looking statements assume we will be successful in reducing our cost structure and adapting to the changing environment.

Availability of a skilled workforce could affect our projected results.

     The workforce and labor supply in the oilfield service industry is aging and diminishing such that there is an increasing shortage of available skilled labor. Our forward-looking statements assume we will be able to maintain a skilled workforce.

Our long-term growth depends upon technological innovation and commercialization.

     Our ability to deliver our long-term growth strategy depends in part on the commercialization of new technology. A central aspect of our growth strategy is to innovate our products and services, to obtain technologically advanced products through internal research and development and/or acquisitions, and to expand internationally. The key to our success will be our ability to commercialize the technology that we have acquired and demonstrate the enhanced value our technology brings to our customers’ operations. Our forward-looking statements have assumed successful commercialization of, and above-average growth from, these new products and services.

The cyclical nature of or a prolonged downturn in our industry could affect the carrying value of our goodwill.

     During 2003 and the second quarter 2004, we had goodwill impairments related to continuing and discontinued operations totaling $26.4 million and $0.3 million, respectively. As of June 30, 2004, we had approximately $68.0 million of goodwill after the aforementioned impairments. Our estimates of the value of our goodwill could be reduced in the future as a result of various factors, some of which are beyond our control. Any reduction in the value of our businesses may result in further impairment charges and therefore adversely affect our results.

Uninsured judgments or a rise in insurance premiums could adversely impact our results.

     Although we maintain insurance to cover potential claims and losses, we could become subject to a judgment for which we are not adequately insured. Additionally, the terrorist attacks that occurred in the U.S., as well as other factors, have generally increased the cost of insurance for companies, including ours. Significant increases in the cost of insurance and more restrictive coverage may adversely impact our results of operations.

Uninsured claims and litigation could adversely impact our results.

     In the ordinary course of business, we become the subject of various claims and litigation. We maintain insurance to cover many of our potential losses and we are subject to various self-retentions and deductibles with respect to our insurance. Although we are subject to various ongoing items of litigation, we do not believe any of

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the items of litigation we are currently subject to will result in any material uninsured losses. However, it is possible an unexpected judgment could be rendered against us in cases in which we could be uninsured and beyond the amounts we currently have reserved or anticipate incurring.

Our insurance coverage may be inadequate to cover certain contingent liabilities.

     Our business exposes us to possible claims for personal injury or death resulting from the use of our products. We carry comprehensive insurance, subject to deductibles, at levels we believe are sufficient to cover existing and future claims. However, we could be subject to a claim or liability that exceeds our insurance coverage. In addition, we may not be able to maintain adequate insurance coverage at rates we believe are reasonable.

Our operations are subject to regulation by federal, state and local governmental authorities that may limit our ability to operate our business.

     Our business is affected by governmental regulations relating to our industry segments in general, as well as environmental and safety regulations that have specific application to our business. While we are not aware of any proposed or pending legislation, future legislation may have an adverse effect on our business, financial condition, results of operations or prospects.

     We are subject to various federal, state and local environmental laws, including those governing air emissions, water discharges and the storage, handling, disposal and remediation of petroleum and hazardous substances. We have in the past and will likely in the future incur expenditures to ensure compliance with environmental laws. Due to the possibility of unanticipated factual or regulatory developments, the amount and timing of future environmental expenditures could vary substantially from those currently anticipated. Moreover, certain of our facilities have been in operation for many years and, over that time, we and other predecessor operators have generated and disposed of wastes that are or may be considered hazardous. Accordingly, although we have undertaken considerable efforts to comply with applicable laws, it is possible that environmental requirements or facts not currently known to us will require unanticipated efforts and expenditures that cannot be currently quantified.

Three of our directors may have conflicts of interest because they are also directors or officers of First Reserve Corporation. The resolution of these conflicts of interest may not be in our or our stockholders’ best interests.

     Three of our directors, Mark E. Baldwin, Joseph R. Edwards and Ben A. Guill, are also current officers or employees of First Reserve Corporation, which controls the general partner of First Reserve Fund VIII, L.P. This may create conflicts of interest because these directors have responsibilities to First Reserve Fund VIII and its owners. Their duties as directors or officers of First Reserve Corporation may conflict with their duties as directors of the Company regarding business dealings between First Reserve Corporation and the Company and other matters. The resolution of these conflicts may not always be in our or our stockholders’ best interests.

We will renounce any interest in specified business opportunities, and First Reserve Fund VIII and its director designees on our board of directors generally will have no obligation to offer us those opportunities.

     First Reserve Fund VIII has investments in other oilfield service companies that compete with the Company, and First Reserve Corporation and its affiliates, other than T-3, may invest in other such companies in the future. We refer to First Reserve Corporation, its other affiliates and its portfolio companies as the First Reserve group. Our certificate of incorporation provides that, so long as First Reserve Corporation and its affiliates continue to own at least 20% of the Company’s common stock, we renounce any interest in specified business opportunities. Our certificate of incorporation also provides that if an opportunity in the oilfield services industry is presented to a person who is a member of the First Reserve group, including any individual who also serves as First Reserve Fund VIII’s director designee of the Company:

•

no member of the First Reserve group or any of those individuals will have any obligation to

19

		communicate or offer the opportunity to the Company; and
•		such entity or individual may pursue the opportunity as that entity or individual sees fit, unless:
•		it was presented to a member of the First Reserve group in that person’s capacity as a director or officer of T-3; or
•		the opportunity was identified solely through the disclosure of information by or on behalf of T-3.

These provisions of our certificate of incorporation may be amended only by an affirmative vote of holders of at least 80% of its outstanding common stock. As a result of these charter provisions, our future competitive position and growth potential could be adversely affected.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

     Market risk generally represents the risk that losses may occur in the value of financial instruments as a result of movements in interest rates, foreign currency exchange rates and commodity prices.

     We are exposed to some market risk due to the floating interest rate under our revolving credit facility and certain of our term debt. As of June 30, 2004, our revolving credit facility had a principal balance of $1.3 million with an interest rate that floats with prime or LIBOR. A 1.0% increase in interest rates could result in a $0.01 million annual increase in interest expense on the existing principal balances.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

     As of the end of the period covered by this report, our management carried out an evaluation, with the participation of our principal executive officer (the “CEO”) and our principal financial officer (the “Corporate Controller”), of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities and Exchange Act of 1934. Based on those evaluations, the CEO and Corporate Controller believe:

i.		that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities and Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the CEO and Corporate Controller, as appropriate to allow timely decisions regarding required disclosure; and
ii.		that our disclosure controls and procedures are effective.

Changes in Internal Controls Over Financial Reporting

     There have been no significant changes in our internal controls over financial reporting during the period covered by this report that has materially affected, or are reasonably likely to materially affect, our control over financial reporting.

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PART II

Item 1. Legal Proceedings

     The Company is involved in various claims and litigation arising in the ordinary course of business. While there are uncertainties inherent in the ultimate outcome of such matters and it is impossible to currently determine the ultimate costs that may be incurred, the Company believes the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on its consolidated financial condition or results of operations.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

     None

Item 3. Defaults Upon Senior Securities

     None

Item 4. Submission of Matters to a Vote of Security Holders

a.		The Annual Meeting of Stockholders of the Company was held May 27, 2004.
b.		The following persons were elected at that meeting as Class III directors:

The Class II directors’ terms expire at the 2006 Annual Meeting of Stockholders. The Class I director, whose term expires at the 2005 Annual Meeting of Stockholders, is Mark E. Baldwin.

Item 5. Other Information

     None

Item 6. Exhibits and Reports on Form 8-K

a.

Exhibits

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b.

Reports on Form 8-K

On April 8, 2004, the Company filed a Current Report on Form 8-K disclosing the resignation of Steven J. Brading, the Company’s Vice President and Chief Financial Officer.

On June 14, 2004, the Company filed a Current Report on Form 8-K disclosing the divestitures of certain net assets within its Products segment.

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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, on the 30th day of July 2004.

			T-3 ENERGY SERVICES, INC.
	By:	/s/ MICHAEL T. MINO
		Michael T. Mino (Corporate
		Controller and Vice President)

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INDEX TO EXHIBITS

*

Filed herewith.