Results of Operations

An analysis of the Company's operations for the three- and nine-month periods
ended September 30, 2008 and 2007 is as follows (dollars in thousands):



                                                         For the                         For the
                                                 Three-month period ended        Nine-month period ended
                                                      September 30,                   September 30,
                                                  2008             2007            2008            2007
Net sales:
Stainless steel                               $      42,094    $      45,510   $     127,882    $  130,208
Tool steel                                           10,393            7,281          31,159        20,822
High-strength low alloy steel                         2,564            6,006           9,509        19,812
High-temperature alloy steel                          1,763            2,637           6,253         7,737
Conversion services                                     541              446           1,514         1,427
Other                                                   284              128           1,649           297

Total net sales                                      57,639           62,008         177,966       180,303
Cost of products sold                                51,040           50,875         150,837       143,337
Selling and administrative expenses                   2,852            2,990           8,561         8,951

Operating income                              $       3,747    $       8,143   $      18,568    $   28,015

Market Segment Information



                                                         For the                         For the
                                                 Three-month period ended        Nine-month period ended
                                                      September 30,                   September 30,
                                                  2008             2007            2008            2007
Net sales:
Service centers                               $      26,826    $      31,451   $      89,910    $   93,154
Forgers                                              14,299           13,852          34,459        40,170
Rerollers                                             9,532           10,199          30,011        26,049
Original equipment manufacturers                      3,751            4,452          14,987        13,869
Wire redrawers                                        2,406            1,424           5,467         5,337
Conversion services                                     541              446           1,514         1,427
Miscellaneous                                           284              184           1,618           297

Total net sales                               $      57,639    $      62,008   $     177,966    $  180,303

Tons Shipped                                         10,808           11,372          33,998        33,856

Three- and nine-month periods ended September 30, 2008 as compared to the similar periods in 2007

Net sales for the three- and nine-month periods ended September 30, 2008 decreased $4.4 million and $2.3 million, respectively, as compared to the similar periods in 2007. The decrease for the three-month period ended September 30, 2008 is primarily due to a 5% decrease in tonnage shipped, shifts in the product mix and lower raw material surcharges. A decline in shipments of aerospace products to service centers and rerollers partially offset increased shipments of power generation products to forgers, tool steel plate products to service centers and rod product to wire redrawers. The decrease for the nine-month period ended September 30, 2008 is primarily due to the same shifts in product mix experienced in the most recent quarter and the assessment of lower surcharges partially offset by the sale of excess scrap that generated $1.1 million of other revenue during the three-month period ended June 30, 2008.

Cost of products sold, as a percentage of net sales, was 88.6% and 82.0% for the three-month periods ended September 30, 2008 and 2007, respectively, and was 84.8% and 79.5% for the nine-month periods ended September 30, 2008 and 2007, respectively. The increase for the three- and nine-month periods ended September 30, 2008 in comparison to the prior year periods is primarily due to the shift in product mix described above and the reduction in raw material surcharges assessed on product shipments. In addition, a $586,000 charge was recognized in the three-month period ended September 30, 2008 related to the relocation of the round bar finishing line from Bridgeville to Dunkirk. The balance of the relocation cost, estimated at $214,000, will be recognized by December 31, 2008.

Selling and administrative expenses for the three- and nine-month periods ended September 30, 2008 decreased by $138,000 and by $390,000 as compared to the similar periods in 2007. The current year decrease is primarily due to one-time charges incurred in 2007 partially offset by higher employment costs, including stock-based compensation expense. During the three-month period ended June 30, 2007, a lawsuit between the Company and Teledyne Technologies Incorporated ("Teledyne") was settled resulting in an $800,000 charge. The current quarter decrease is primarily due to the timing of professional services provided.

Interest expense and other financing costs decreased by $155,000 for the three-month period ended September 30, 2008 as compared to September 30, 2007 and decreased by $522,000 for the nine-month period ended September 30, 2008 as compared to the nine-month period ended September 30, 2007. The decreases were primarily due to not having to borrow on the Company's revolving credit facility since August 2007 and the December 2007 retirement of the PNC Term Loan.

The effective income tax rate utilized in the three- and nine-month periods ended September 30, 2008 was 28.1% and 32.0%, respectively, as compared to 31.6% and 34.0% for the three-and nine-month periods ended September 30, 2007. The reduction in the effective income tax rate from 33.0% at June 30, 2008 is the result of lowering the Company's annual income estimate and an increase in the Company's permanent tax deductions related to state investment tax credits that will be generated from capital improvements made at the Dunkirk facility in 2008. The reduction in the 2007 effective income rate from 35.0% at June 30, 2007 reflects an increase in the Company's permanent tax deductions related to an increase in the manufacturer's production activities deduction against expected income levels in 2007.

Business Segment Results

An analysis of net sales and operating income for the reportable segments for the three- and nine-month periods ended September 30, 2008 and 2007 is as follows (dollars in thousands):

Universal Stainless & Alloy Products Segment



                                                         For the                         For the
                                                 Three-month period ended        Nine-month period ended
                                                      September 30,                   September 30,
                                                  2008             2007            2008            2007
Net sales:
Stainless steel                               $      29,168    $      31,211   $      85,379    $   87,011
Tool steel                                           10,161            6,748          29,863        19,018
High-strength low alloy steel                           729            2,560           2,956        10,382
High-temperature alloy steel                            818            1,207           2,316         3,353
Conversion services                                     329              305             982           957
Other                                                   252              107           1,524           229

                                                     41,457           42,138         123,020       120,950
Intersegment                                         10,777           13,797          30,504        38,244

Total net sales                                      52,234           55,935         153,524       159,194
Material cost of sales                               30,722           32,170          82,715        83,085
Operation cost of sales                              16,314           17,506          51,040        52,556
Selling and administrative expenses                   1,933            2,022           5,940         6,311

Operating income                              $       3,265    $       4,237   $      13,829    $   17,242

Net sales for the three- and nine-month periods ended September 30, 2008 for this segment, which consists of the Bridgeville and Titusville facilities, decreased by $3.7 million, or 6.6%, in comparison to the three-month period ended September 30, 2007 and $5.7 million, or 3.6%, in comparison to the similar 2007 nine-month period. Tons shipped declined 6% for the three-month period ended September 30, 2008 in comparison to the similar 2007 period. Higher shipments of tool steel plate to service centers partially offset lower shipments of semi-finished products to rerollers, including intersegment sales to the Dunkirk Specialty Steel Segment, and of bar products to service centers. Tons shipped declined 3% for the nine-month period ended September 30, 2008 in comparison to the similar 2007 period. Higher shipments of tool steel plate to service centers partially offset lower shipments of semi-finished products to forgers and bar products to service centers. Lower raw material surcharges also impacted sales, led by a decrease in average nickel prices during the three- and nine-month periods ended September 30, 2008 in comparison to the similar periods in 2007. In addition, the sale of excess scrap in the second quarter of 2008 generated $1.1 million of other revenue.

Operating income decreased by $972,000, or 22.9% for the three-month period ended September 30, 2008 as compared to September 30, 2007, and by $3.4 million, or 19.8%, for the nine-month period ended September 30, 2008 in comparison to the similar 2007 nine-month period. These results were primarily impacted by the reduction in shipments described above and higher material costs. Material costs, excluding inventory reserve adjustments, as a percentage of net sales increased from 56.1% and 51.9% for the three- and nine-month periods ended September 30, 2007 to 59.4% and 53.7% for the three- and nine-month periods ended September 30, 2008. The inventory reserve balance, primarily comprised of lower-of-cost-or-market reserves, was $1.3 million at December 31, 2007, $1.8 million at June 30, 2008, and $1.5 million at September 30, 2008. This compares to $1.4 million at December 31, 2006, $1.0 million at June 30, 2007, and $1.8 million at September 30, 2007. In addition, operating income for the nine-month period ended September 30, 2007 was negatively impacted by an $800,000 settlement of a lawsuit between the Company and Teledyne.

Dunkirk Specialty Steel Segment



                                                         For the                          For the
                                                Three-month period ended          Nine-month period ended
                                                      September 30,                    September 30,
                                                 2008               2007           2008             2007
Net sales:
Stainless steel                              $     12,926       $     14,299   $      42,503    $      43,197
Tool steel                                            232                533           1,296            1,804
High-strength low alloy steel                       1,835              3,446           6,553            9,430
High-temperature alloy steel                          945              1,430           3,937            4,384
Conversion services                                   212                141             532              470
Other                                                  32                 21             125               68

                                                   16,182             19,870          54,946           59,353
Intersegment                                          758              1,398           3,220            3,676

Total net sales                                    16,940             21,268          58,166           63,029
Material cost of sales                             11,219             13,130          36,184           36,374
Operation cost of sales                             4,974              4,145          14,622           13,451
Selling and administrative expenses                   919                968           2,621            2,640

Operating (loss) income                      $       (172 )     $      3,025   $       4,739    $      10,564

Net sales for the three- and nine-month periods ended September 30, 2008 for this segment decreased by $4.3 million, or 20.3%, in comparison to the three-month period ended September 30, 2007 and by $4.9 million, or 7.7%, in comparison to the similar 2007 nine-month period. Tons shipped decreased 16% and 4%, respectively, for the three- and nine-month periods ended September 30, 2008 in comparison to the similar 2007 periods. Higher shipments of rod and wire products to service centers and OEMs as well as finished bar products to OEMs, offset lower shipments of aerospace finished bar products to service centers.

Operating income for the three- and nine-month periods ended September 30, 2008 was impacted by a $586,000 charge for the relocation of the Company's round bar finishing line from the Bridgeville to the Dunkirk facility and is expected to become operational before the end of 2008. Excluding the impact of the relocation charge, operating income decreased by $2.6 million, or 86.3%, and by $5.2 million, or 49.6%, in comparison to the three-and nine-month periods ended September 30, 2007 primarily due to the impact from lower production volumes and lower raw material surcharges. Material costs, excluding inventory reserve adjustments, as a percentage of net sales increased from 58.8% and 55.9% for the three- and nine-month periods ended September 30, 2007 to 63.7% and 62.3% for the three- and nine-month periods ended September 30, 2008. The inventory reserve balance, primarily comprised of lower-of-cost-or-market reserves, was $927,000 at December 31, 2007, $450,000 at June 30, 2008, and $866,000 at September 30, 2008. This compares to $200,000 at December 31, 2006, $691,000 at June 30, 2007, and $1.3 million at September 30, 2007.

Liquidity and Capital Resources

The Company has financed its operating activities through cash on hand at the beginning of the period. At September 30, 2008, working capital approximated $94.4 million as compared to $85.9 million at December 31, 2007. Accounts receivable increased $6.4 million, or 23%, as a result of a 16% increase in sales for the three-month period ended September 30, 2008 in comparison to the three-month period ended December 31, 2007. Accounts receivable levels in comparison to quarterly sales increased from 50 days of sales outstanding at December 31, 2007 to 53 days at September 30, 2008. The increase in inventory, principally raw materials, was more than offset by the increase in accounts payable. These increases are a result of increased melting activity and the impact of accelerating the receipt of operating supplies in the event of a work stoppage at the Bridgeville facility. Inventory levels in comparison to quarterly cost of sales declined from 143 days at December 31, 2007 to 124 days at September 30, 2008. The decline is primarily attributable to lower sales activity in the fourth quarter of 2007. The ratio of current assets to current liabilities decreased from 4.7:1 at December 31, 2007 to 4.2:1 at September 30, 2008. The debt to total capitalization ratio was 1.1% at September 30, 2008 and 1.4% at December 31, 2007.

Cash received from sales of $58.4 million and $170.8 million for the three- and nine-month periods ended September 30, 2008 and of $61.8 million and $174.5 million for the three- and nine-month periods ended September 30, 2007 represents the primary source of cash from operations. An analysis of the primary uses of cash is as follows (dollars in thousands):

                                       For the                         For the
                               Three-month period ended        Nine-month period ended
                                    September 30,                   September 30,
                                2008             2007            2008            2007
   Raw material purchases   $      28,332    $      23,903   $      84,838    $   76,532
   Employment costs                 8,658            8,112          28,837        27,002
   Utilities                        4,420            4,303          14,374        14,581
   Other                           10,084           10,140          30,924        36,862

   Total uses of cash       $      51,494    $      46,458   $     158,973    $  154,977

Cash used in raw material purchases increased in 2008 in comparison to 2007 primarily due to higher quantities of molybdenum purchased to support increased production of tool steel plate and of rod product to support increased shipments of wire products in Dunkirk. In addition, the Company experienced increased carbon scrap costs due to the higher market price of iron in 2008 as compared to 2007. The Company continuously monitors market price fluctuations of its key raw materials. The following table reflects the average market value per pound for selected months during the last twenty-one-month period.

                             September     December     September     December
                               2008          2007         2007          2006
             Nickel         $      8.07   $    11.79   $     13.40   $    15.68
             Chrome         $      1.78   $     1.66   $      1.28   $     0.64
             Molybdenum     $     32.93   $    32.54   $     31.77   $    24.87
             Carbon scrap   $      0.25   $     0.14   $      0.14   $     0.10

The market prices for these raw materials and others continue to fluctuate based on supply and demand, market disruptions and other factors. During the three-month period ended September 30, 2008, the average market prices for nickel, chrome and carbon scrap decreased by 21%, 18% and 26%, respectively, due to reduced global demand for stainless steel products. In the month of October 2008, the average market prices for these materials decreased by 32%, 13% and 52%, respectively, from the September 2008 average prices. The Company maintains sales price surcharge mechanisms, priced at time of shipment, to mitigate the risk of substantial raw material cost fluctuations. There can be no assurance that these sales price adjustments will completely offset the Company's raw material costs.

Increased employment costs are primarily due to increased payouts under the Company's profit sharing and other incentive compensation plans, and higher employee-related insurance costs. Lower utility costs are primarily due to reduced consumption of electricity resulting from a decrease in vacuum-arc remelting production at the Bridgeville and Titusville facilities. The decrease in other uses of cash, the majority of which is cash for outside conversion services, plant maintenance and production supplies, is directly attributable to support lower production volumes. In addition, payments for income taxes for the nine-month period ended September 30, 2008 decreased by $3.4 million over the same period in 2007.

The Company had capital expenditures for the nine-month period ended September 30, 2008 of $9.6 million compared with $6.4 million for the same period in 2007. The 2008 expenditures were primarily for Bridgeville plant improvements, the construction of a high temperature annealing system as well as certain planned infrastructure investments and equipment upgrades related to the round bar finishing line at the Dunkirk facility. Most of the 2007 expenditures were used to refurbish and equip an office building at the Bridgeville Facility that now represents the Company's corporate office.

The Company maintains a credit agreement with PNC Bank for a $15.0 million revolving credit facility with the term expiring June 30, 2009. At September 30, 2008, the Company had all of its $15.0 million revolving line of credit with PNC Bank available for borrowings. The Company is required to be in compliance with three financial covenants: minimum leverage ratio, minimum debt service ratio and minimum tangible net worth. The Company is in compliance with its covenants as of September 30, 2008.

The Company does not maintain off-balance sheet arrangements other than operating leases nor does it participate in non-exchange traded contracts requiring fair value accounting treatment or material related-party transaction arrangements.

The Company anticipates that it will fund its 2008 working capital requirements and its capital expenditures primarily from funds generated from operations, borrowings and stock issuances resulting from the exercise of outstanding stock options. We have performed an evaluation of our current cash investments and debt agreements as well as customer credit exposure in response to the current global credit market crisis. We believe that our exposure is limited to customer credit and we have not identified any specific customer that may expose the Company to a material adverse change to its results of operations, business and financial condition. We will continue to monitor the economic and credit market crisis and take appropriate actions to limit our exposure. Financing the Company's long-term liquidity requirements, including capital expenditures, are expected from a combination of internally generated funds, borrowings and other sources of external financing, if needed.

Critical Accounting Policies

Revenue recognition is the most critical accounting policy of the Company. Revenue from the sale of products is recognized when both risk of loss and title have transferred to the customer, which in most cases coincides with shipment of the related products, and collection is reasonably assured. The Company manufactures specialty steel product to customer purchase order specifications and in recognition of requirements for product acceptance. Material certification forms are executed, indicating compliance with the customer purchase orders, before the specialty steel products are packed and shipped to the customer. Occasionally customers request that the packed products be held at the Company's facility beyond the stated shipment date. In these situations, the Company receives written confirmation of the request, acknowledgement that title has passed to the customer and that normal payment terms apply. The impact on revenue was less than 1% of net sales in each period presented.

Revenue from conversion services is recognized when the performance of the service is complete. Invoiced shipping and handling costs are also accounted for as revenue.

In addition, management constantly monitors the ability to collect its unpaid sales invoices and the valuation of its inventory. The allowance for doubtful accounts includes specific reserves for the value of outstanding invoices issued to customers currently operating under the protection of the federal bankruptcy law and other amounts that are deemed potentially not collectible along with a reserve equal to 15% of 90-day or older balances not specifically reserved. However, the total reserve will not be less than 1% of trade accounts receivable. An inventory reserve is provided for material on hand for which management believes cost exceeds fair market value and for material on hand for more than one year not assigned to a specific customer order.

Long-lived assets are reviewed for impairment annually by each operating facility. An impairment write-down will be recognized whenever events or changes in circumstances indicate that the carrying value may not be recoverable through estimated future undiscounted cash flows.

Based on management's assessment of the carrying values of such long-lived assets, no impairment reserve had been deemed necessary as of September 30, 2008 and 2007. Retirements and disposals are removed from cost and accumulated depreciation accounts, with the gain or loss reflected in operating income.

In addition, management assesses the need to record a valuation allowance to reduce deferred tax assets to the amount that is more likely than not to be realized. The Company believes it will generate sufficient income in addition to taxable income generated from the reversal of its temporary differences to utilize the deferred tax assets recorded at September 30, 2008.

2008 Outlook

These are forward-looking statements for purposes of the Private Securities Litigation Reform Act of 1995 and actual results may vary.

The Company estimates that fourth quarter 2008 sales will range from $45 to $55 million and that diluted EPS will range from breakeven to $0.15. The Company's initial forecast estimated the diluted EPS range to be $0.20 to $0.35. The revised estimates compare with sales of $49.6 million and diluted EPS of $0.65 in the fourth quarter of 2007. The following factors were considered in developing these estimates:

• The Company's total backlog at September 30, 2008 approximated $101 million compared to $97 million at June 30, 2008. The increased backlog is primarily attributable to tool steel plate and electro-slag remelted products.

• The Company's initial forecast was based on average September raw material costs. In the month of October 2008, the average market prices for nickel, chrome and carbon scrap decreased by 32%, 13% and 52%, respectively, from the September 2008 average prices due to reduced global demand for stainless steel products. The revised EPS estimate is based on October raw material costs and may be further impacted if raw material costs continue to decline.

• Sales from the Dunkirk Specialty Steel segment are expected to approximate $10 to $12 million on lower shipments compared to the fourth quarter of 2007. The anticipated reduction in shipments is a result of lower demand from the effect of the Boeing labor situation on demand for aerospace products and very conservative buying patterns of service centers. Based on October raw material values, Dunkirk is now expected to generate an operating loss between $1 to $2 million for the quarter.

• Under the Continued Dumping and Subsidy Act of 2000 (the CDSOA), the Company files claims each year to receive its appropriate share of the import duties collected by the U.S. Treasury. The Company's 2008 fourth quarter estimates do not include any receipts under the CDSOA program. During the three-month period ended December 31, 2007, the Company received $586,000, net of expenses incurred, equivalent to $0.06 per diluted share.