Results of Operations

The Company recorded a net loss for the three- and six-month periods ended June 30, 2009 of $400,000 and $4.2 million, respectively, The 2009 six-month results include the following unusual charges (totaling $6.0 million pre-tax) recorded during the three-month period ended March 31, 2009, primarily due to the deepening recession and economic uncertainty:

• $1.9 million increase to the bad debt reserve due to the inability of a privately held service center customer to pay amounts owed on 2008 business and a related $0.5 million increase to inventory reserves;

• $1.5 million due to a decline in raw material values and the consumption of high cost material during the quarter;

• $1.0 million write-down of stock inventory;

• $0.9 million attributed to the reduction of operating levels; and

• $0.2 million resulting from a 20% reduction in salaried employees.

An analysis of the Company's operations for the three- and six-month periods ended June 30, 2009 and 2008 is as follows:

                                                         For the                         For the
                                                 Three-month period ended        Six-month period ended
(dollars in thousands)                                   June 30,                       June 30,
                                                  2009             2008           2009             2008
Net sales:
Stainless steel                               $      25,648    $      43,760   $    59,410       $  85,788
Tool steel                                            1,563           11,659         4,892          20,766
High-strength low alloy steel                         2,367            2,934         5,110           6,945
High-temperature alloy steel                            876            3,344         2,895           4,490
Conversion services                                     292              448           596             973
Other                                                    17            1,337            46           1,365


Total net sales                                      30,763           63,482        72,949         120,327
Cost of products sold                                28,092           53,018        71,956          99,797
Selling and administrative expenses                   2,106            2,634         6,843           5,709


Operating income (loss)                       $         565    $       7,830   $    (5,850 )     $  14,821

Three- and six-month periods ended June 30, 2009 as compared to the similar periods in 2008

Net sales for the three- and six-month periods ended June 30, 2009 decreased $32.7 million and $47.4 million, respectively, as compared to the similar periods in 2008. The decrease for the three- and six-month periods ended June 30, 2009 is primarily due to the decline in consolidated tons shipped of 40% and 29%, respectively, lower surcharges, plus the sale of excess scrap that generated $1.1 million of revenue during the three-month period ended June 30, 2008. The decline in shipments, which impacted each of the Company's end markets, is attributed to the impact of general economic conditions and the resultant destocking activities within the service center industry. Lower raw material surcharges were recognized as a result of lower raw material prices experienced during the three- and six-month periods ended June 30, 2009 in comparison to the three- and six-month periods ended June 30, 2008.

Cost of products sold, as a percentage of net sales, was 91.3% and 83.5% for the three-month periods ended June 30, 2009 and 2008, respectively, and was 98.6% and 82.9% for the six-month periods ended June 30, 2009 and 2008, respectively. The results for the six-month period ended June 30, 2009 include $3.9 million of the unusual charges outlined above, representing 5.3% of net sales. The remaining increase is primarily due higher raw material costs in relation to sales prices and higher operation costs due to lower production volumes.

Market Segment Information



                                                         For the                        For the
                                                 Three-month period ended        Six-month period ended
(dollars in thousands)                                   June 30,                       June 30,
                                                  2009             2008            2009           2008
Net sales:
Service centers                               $      13,117    $      33,850   $     30,649    $   63,084
Forgers                                              10,420           11,142         23,391        20,160
Rerollers                                             1,960            9,240          7,964        20,479
Original equipment manufacturers                      3,797            5,795          8,196        11,236
Wire redrawers                                        1,160            1,692          2,107         3,061
Conversion services                                     292              448            596           973
Miscellaneous                                            17            1,315             46         1,334


Total net sales                               $      30,763    $      63,482   $     72,949    $  120,327


Tons Shipped                                          6,855           11,423         16,448        23,190

Selling and administrative expenses decreased by $528,000 in the three-month period ended June 30, 2009 and increased by $1.1 million in the six-month period ended June 30, 2009 as compared to the similar periods in 2008. The increased cost in the six-month period primarily relates to $2.1 million of the unusual charges outlined above. These costs were partially offset by a $674,000 decrease in labor costs, of which $428,000 was recognized in the three-month period June 30, 2009, primarily resulting from a 20% workforce reduction enacted in March, 2009 and a reduction in the accrual for incentive compensation.

The Company accelerated the preparation of its 2008 federal and state income tax returns in order to receive the anticipated refunds earlier in 2009. As a result, the Company recorded a $742,000 negative tax adjustment primarily for the reconciliation of tax balances at June 30, 2009 to the tax returns. Approximately $200,000 of this adjustment is the cumulative adjustment related to the reduction of the estimated annual effective income tax rate utilized in the three-month period ended March 31, 2009 from 40.3% to 37.2% at June 30, 2009. In addition, the Company has determined that $370,000 of this adjustment relates to prior periods and is not considered material to any prior period or the current year to require the restatement of prior period financial statements. The revised tax rate of 37.2% compares to an effective income tax rate in the three- and six-month periods ended June 30, 2008 of 33.0%. The effective income rate in the current period reflects a projected net operating loss and benefits related to federal and state loss carry backs and carry forwards, whereas the prior year had taxable income and benefited from the domestic manufacturing deduction and investment tax credits generated from capital improvements made at the Dunkirk facility in 2008.

Business Segment Results

An analysis of net sales and operating income for the reportable segments for the three- and six-month periods ended June 30, 2009 and 2008 is as follows:

Universal Stainless & Alloy Products Segment



                                                         For the                         For the
                                                 Three-month period ended        Six-month period ended
(dollars in thousands)                                   June 30,                       June 30,
                                                  2009             2008           2009             2008
Net sales:
Stainless steel                               $      18,234    $      28,901   $    44,229       $  56,211
Tool steel                                            1,531           11,278         4,739          19,702
High-strength low alloy steel                           647            1,114         1,662           2,227
High-temperature alloy steel                            393              929         1,127           1,498
Conversion services                                     206              296           394             653
Other                                                    11            1,262            40           1,272


                                                     21,022           43,780        52,191          81,563
Intersegment                                          5,857            9,312        11,373          19,727


Total net sales                                      26,879           53,092        63,564         101,290
Material cost of sales                               10,445           28,654        30,711          51,993
Operation cost of sales                              14,131           16,936        30,591          34,726
Selling and administrative expenses                   1,354            1,869         5,227           4,007


Operating income (loss)                       $         949    $       5,633   $    (2,965 )     $  10,564

Net sales for the three- and six-month periods ended June 30, 2009 for this segment, which consists of the Bridgeville and Titusville facilities, decreased by $26.2 million, or 49.4%, in comparison to the three-month period ended June 30, 2008 and by $37.7 million, or 37.2%, in comparison to the similar 2008 six-month period. Tons shipped declined 33% for the three-month period ended June 30, 2009 in comparison to the similar 2008 period. A 19% increase in power generation shipments was more than offset by declining shipments to the remaining end markets served. Tons shipped declined 26% for the six-month period ended June 30, 2009 in comparison to the similar 2008 period. The decline in shipments, which impacted each of the segment's end markets, is attributed to the impact of general economic conditions and the resultant destocking activities within the service center industry. Lower raw material surcharges were recognized as a result of lower raw material prices experienced during the three- and six-month periods ended June 30, 2009 in comparison to the three- and six-month periods ended June 30, 2008. In addition, sales for the three- and six-month periods ended June 30, 2008 benefitted from the sale of excess scrap that generated $1.1 million of revenue.

Operating income decreased by $4.7 million, or 83.2%, for the three-month period ended June 30, 2009 as compared to June 30, 2008 and by $13.5 million, or 128.1%, for the six-month period ended June 30, 2009 in comparison to the similar 2008 six-month period. The results for the six-month period ended June 30, 2009 include $5.0 million of the unusual charges outlined above, representing 7.8% of net sales. Excluding the impact of the unusual charges, material costs, as a percentage of sales, dropped from 54.0% and 51.3% for the three- and six-month periods ended June 30, 2008 to 38.9% and 44.7% for the three- and six-month periods ended June 30, 2009. This improvement is directly related to a better alignment of material costs and related surcharges assessed, a $1.2 million increase to its lower-of-cost-or-market reserve in the three- and six-month periods ended June 30, 2008 and yield improvements recognized on shipments late in the quarter. Operation costs, as a percentage of sales, increased to 52.6% and 47.1% for the three- and six-month periods ended June 30, 2009 from 31.9% and 34.3% for the three- and six-month periods ended June 30, 2008. These increases are primarily due to lower production volumes.

Dunkirk Specialty Steel Segment



                                                           For the                         For the
                                                  Three-month period ended         Six-month period ended
(dollars in thousands)                                    June 30,                        June 30,
                                                   2009               2008           2009             2008
Net sales:
Stainless steel                                $      7,414       $     14,859   $     15,181       $ 29,577
Tool steel                                               32                381            153          1,064
High-strength low alloy steel                         1,720              1,820          3,448          4,718
High-temperature alloy steel                            483              2,415          1,768          2,992
Conversion services                                      86                152            202            320
Other                                                     6                 75              6             93


                                                      9,741             19,702         20,758         38,764
Intersegment                                            465              1,474            830          2,462


Total net sales                                      10,206             21,176         21,588         41,226
Material cost of sales                                6,345             13,126         15,139         24,965
Operation cost of sales                               3,493              5,159          7,718          9,648
Selling and administrative expenses                     752                765          1,616          1,702


Operating income (loss)                        $       (384 )     $      2,126   $     (2,885 )     $  4,911

Net sales for the three- and six-month periods ended June 30, 2009 decreased by $11.0 million, or 51.8%, in comparison to the three-month period ended June 30, 2008 and by $19.6 million, or 47.6% in comparison to the similar 2008 six-month period. Tons shipped decreased 31% and 30%, respectively, for the three- and six-month periods ended June 30, 2009 in comparison to the similar 2008 periods. The decline in shipments, which impacted each of the segment's end markets, is attributed to the impact of general economic conditions and the resultant destocking activities within the service center industry. Lower raw material surcharges were recognized as a result of lower raw material prices experienced during the three- and six-month periods ended June 30, 2009 in comparison to the three- and six-month periods ended June 30, 2009.

Operating income decreased by $2.5 million, or 118.4%, for the three-month period ended June 30, 2009 as compared to June 30, 2008 and by $7.8 million, or 158.8%, for the six-month period ended June 30, 2009 in comparison to the similar 2008 six-month period. The results for the six-month period ended June 30, 2009 include $1.0 million of the unusual charges outlined above, representing 2.3% of net sales. Excluding the impact of the unusual charges, material costs, as a percentage of sales, increased to 62.2% and 66.7% for the three- and six-month periods ended June 30, 2009 from 62.0% and 60.6% for the three- and six-month periods ended June 30, 2008 This is a direct result of utilizing higher cost feedstock in relation to the surcharges assessed. Operation costs, as a percentage of sales, increased to 34.2% and 35.1% for the three- and six-month periods ended June 30, 2009 from 24.4% and 23.4% for the three- and six-month periods ended June 30, 2008. These increases are primarily due to lower production volumes.

Liquidity and Capital Resources

The Company has financed its operating activities through cash on hand at the beginning of the period, cash provided by operations and borrowings. At June 30, 2009, working capital approximated $97.4 million as compared to $94.8 million at December 31, 2008. The increase is primarily attributable to an increase in cash resulting from the receipt of a $12 million five-year term loan from PNC Bank ("Term Loan") to fund its Melt Shop investment of which $7.6 million has been expended to date. In addition, a significant portion of the $19.4 million reduction in managed working capital, defined as accounts receivable, inventory and accounts payable, has been converted to cash at June 30, 2009. Accounts receivable decreased $13.2 million as a result of decreased sales for the three-month period ended June 30, 2009 in comparison to the three-month period ended December 31, 2008 and a $1.9 million increase in the bad debt reserve, partially offset by customers extending payment terms to preserve cash due to economic conditions. The $18.0 million decrease in inventory is primarily due to the shipment of higher cost material, a 22% reduction in the quantity of work-in-process inventory, lower material values and the impact of curtailing operations to match the reduction in the Company's backlog, which decreased from $75 million at December 31, 2008 to $38 million at June 30, 2009. The $11.8 million decrease in accounts payable is also related to lower material values and the impact of curtailing operations. The ratio of current assets to current liabilities increased to 9.3:1 at June 30, 2009 from 4.9:1 at December 31, 2008. The debt to total capitalization ratio increased from 1.0% at December 31, 2008 to 8.5% at June 30, 2009 due to the issuance of the Term Loan.

Cash received from sales of $40.2 million and $84.4 million for the three- and six-month periods ended June 30, 2009 and of $63.2 million and $112.4 million for the three- and six-month periods ended June 30, 2008 represent the primary source of cash from operations. An analysis of the primary uses of cash is as follows:

                                        For the                        For the
                                Three-month period ended        Six-month period ended
    (dollars in thousands)              June 30,                       June 30,
                                 2009             2008            2009           2008
    Raw material purchases   $       8,739    $      32,185   $     25,088    $   56,506
    Employment costs                 7,141            8,335         16,360        20,179
    Utilities                        4,352            4,842          9,343         9,954
    Other                            7,277           13,149         18,363        20,840


    Total uses of cash       $      27,509    $      58,511   $     69,154    $  107,479

Cash used in raw material purchases decreased in 2009 in comparison to 2008 primarily due to a reduction in the quantity of purchased materials due to curtailing operations and by lower unit transaction costs. 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 18-month period.

                                 June      December     June      December
                                 2009        2008       2008        2007
                 Nickel         $  6.79   $     4.39   $ 10.23   $    11.79
                 Chrome         $  0.78   $     0.96   $  2.19   $     1.66
                 Molybdenum     $ 10.34   $     9.85   $ 33.22   $    32.54
                 Carbon scrap   $  0.09   $     0.11   $  0.34   $     0.14

The market values for these raw materials and others continue to fluctuate based on supply and demand, market disruptions and other factors. 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 and energy costs.

Decreased employment costs are primarily due to lower production volumes and decreased payout under the Company's profit sharing plan, which were partially offset by higher employee-related insurance costs. Lower utility costs are primarily due to reduced consumption of electricity resulting from decreased production volumes. 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 lower production volumes. In addition, payments for income taxes for the six-month period ended June 30, 2009 decreased $3.7 million from the same period in 2008.

The Company had capital expenditures for the six-month period ended June 30, 2009 of $7.6 million compared with $5.4 million for the same period in 2008. $5.7 million of the 2009 expenditures relate to the Bridgeville melt shop upgrade. The 2008 expenditures were primarily for Bridgeville plant improvements and construction of a high-temperature annealing furnace in Dunkirk.

On February 27, 2009, the Company entered into a new unsecured credit agreement with PNC Bank which provides for a $12.0 million Term Loan scheduled to mature on February 28, 2014 and a $15.0 million revolving credit facility with the term expiring June 30, 2012. At June 30, 2009, the Company had all of its $15.0 million revolving line of credit with PNC Bank available for borrowings. The Company is in compliance with its covenants as of June 30, 2009.

The Company also executed an interest rate swap with PNC Bank, with a notional amount of $12.0 million, to convert the LIBOR floating rate under the Term Loan to a fixed interest rate for the life of the loan. Under the agreement, the Company's interest rate is currently fixed at 4.515%. The Company recorded a liability of $87,000, equal to the fair market value of the swap agreement at June 30, 2009. The change in fair market value, net of tax, is reported as other comprehensive loss within stockholders' equity.

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

The Company anticipates that it will fund its 2009 working capital requirements and its capital expenditures primarily from funds generated from operations and the Term Loan. Financing of the Company's long-term liquidity requirements, including capital expenditures, is expected from a combination of internally generated funds, borrowings, stock issuance or 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. Customer claims are accounted for primarily as a reduction to gross sales after the matter has been researched and an acceptable resolution has been reached.

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 June 30, 2009 and 2008. 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 June 30, 2009.