Results of Operations

The Company recorded net income for the three-month period ended September 30, 2009 of $312,000 and a net loss for the nine-month period ended September 30, 2009 of $3.9 million. The 2009 nine-month results includes a $742,000 negative tax adjustment primarily for the reconciliation of tax balances at June 30, 2009 to the 2008 tax returns prepared during the three-month period ended June 30, 2009 and 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 nine-month periods ended September 30, 2009 and 2008 is as follows:

                                                      For the                         For the
                                              Three-month period ended        Nine-month period ended
(dollars in thousands)                             September 30,                   September 30,
                                               2009             2008            2009             2008
Net sales:
Stainless steel                            $      18,622    $      42,094   $     78,032       $ 127,882
Tool steel                                         1,136           10,393          6,028          31,159
High-strength low alloy steel                      2,565            2,564          7,675           9,509
High-temperature alloy steel                       1,488            1,763          4,383           6,253
Conversion services                                  277              541            873           1,514
Other                                              1,198              284          1,244           1,649

Total net sales                                   25,286           57,639         98,235         177,966
Cost of products sold                             22,571           51,040         94,527         150,837
Selling and administrative expenses                2,258            2,852          9,101           8,561

Operating income (loss)                    $         457    $       3,747   $     (5,393 )     $  18,568

Market Segment Information



                                                     For the                          For the
                                             Three-month period ended         Nine-month period ended
(dollars in thousands)                            September 30,                    September 30,
                                              2009             2008            2009             2008
Net sales:
Service centers                           $       8,393    $      26,826   $     39,042    $       89,910
Forgers                                           7,778           14,299         31,169            34,459
Rerollers                                         1,940            9,532          9,904            30,011
Original equipment manufacturers                  4,980            3,751         13,176            14,987
Wire redrawers                                      720            2,406          2,827             5,467
Conversion services                                 277              541            873             1,514
Miscellaneous                                     1,198              284          1,244             1,618


Total net sales                           $      25,286    $      57,639   $     98,235    $      177,966


Tons Shipped                                      5,562           10,808         22,010            33,998

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

Net sales for the three- and nine-month periods ended September 30, 2009 decreased $32.4 million and $79.7 million, respectively, as compared to the similar periods in 2008. The decrease for the three- and nine-month periods ended September 30, 2009 is primarily due to the decline in consolidated tons shipped of 49% and 35%, respectively, and lower surcharges. In addition, the Company sold excess scrap that generated $1.1 million of revenues during each of the three-month periods ended September 30, 2009 and 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 nine-month periods ended September 30, 2009 in comparison to the three- and nine-month periods ended September 30, 2008.

Cost of products sold, as a percentage of net sales, was 89.3% and 88.6% for the three-month periods ended September 30, 2009 and 2008, respectively, and was 96.2% and 84.8% for the nine-month periods ended September 30, 2009 and 2008, respectively. Cost of products sold for the nine-month period ended September 30, 2009 include $3.9 million of the unusual charges outlined above, representing 4.0% of net sales. The remaining increase is primarily due to higher operation costs resulting from lower production volumes.

Selling and administrative expenses decreased by $594,000 in the three-month period ended September 30, 2009 and increased by $540,000 in the nine-month period ended September 30, 2009 as compared to the similar periods in 2008. The increased cost in the nine-month period primarily relates to $2.1 million of the unusual charges outlined above. These costs were partially offset by a $1.2 million decrease in labor costs, of which $478,000 was recognized in the three-month period September 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 nine-month periods ended September 30, 2008 of 28.1% and 32.0%, respectively. The effective income tax 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 nine-month periods ended September 30, 2009 and 2008 is as follows:

Universal Stainless & Alloy Products Segment



                                                      For the                         For the
                                              Three-month period ended        Nine-month period ended
(dollars in thousands)                             September 30,                   September 30,
                                               2009             2008            2009             2008
Net sales:
Stainless steel                            $      13,123    $      29,168   $     57,352       $  85,379
Tool steel                                         1,096           10,161          5,835          29,863
High-strength low alloy steel                      1,084              729          2,746           2,956
High-temperature alloy steel                         514              818          1,641           2,316
Conversion services                                  152              329            546             982
Other                                              1,185              252          1,225           1,524


                                                  17,154           41,457         69,345         123,020
Intersegment                                       4,515           10,777         15,888          30,504


Total net sales                                   21,669           52,234         85,233         153,524
Material cost of sales                             8,999           30,722         39,710          82,715
Operation cost of sales                           11,060           16,314         41,651          51,040
Selling and administrative expenses                1,550            1,933          6,777           5,940


Operating income (loss)                    $          60    $       3,265   $     (2,905 )     $  13,829

Net sales for the three- and nine-month periods ended September 30, 2009 for this segment, which consists of the Bridgeville and Titusville facilities, decreased by $30.6 million, or 58.5%, in comparison to the three-month period ended September 30, 2008 and by $68.3 million, or 44.5%, in comparison to the similar 2008 nine-month period. Tons shipped declined 49% for the three-month period ended September 30, 2009 in comparison to the similar 2008 period. Tons shipped declined 33% for the nine-month period ended September 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 nine-month periods ended September 30, 2009 in comparison to the three- and nine-month periods ended September 30, 2008. In addition, the Company sold excess scrap that generated $1.1 million of other revenues during the three-month periods ended September 30, 2009 and June 30, 2008.

Operating income decreased by $3.2 million, or 98.2%, for the three-month period ended September 30, 2009 as compared to September 30, 2008 and by $16.7 million, or 121.0%, for the nine-month period ended September 30, 2009 in comparison to the similar 2008 nine-month period. The results for the nine-month period ended September 30, 2009 include $5.0 million of the unusual charges outlined above, representing 5.8% of net sales. Excluding the impact of the unusual charges, material costs, as a percentage of sales, dropped from 58.8% and 53.9% for the three- and nine-month periods ended September 30, 2008, respectively, to 41.5% and 43.9% for the three- and nine-month periods ended September 30, 2009, respectively. This improvement is directly related to a better alignment of material costs and related surcharges assessed and yield improvements recognized on 2009 shipments of semi-finished products. Operation costs, as a percentage of sales, increased to 51.0% and 48.1% for the three- and nine-month periods ended September 30, 2009, respectively, from 31.2% and 33.2% for the three- and nine-month periods ended September 30, 2008, respectively. These increases are primarily due to lower production volumes.

Dunkirk Specialty Steel Segment



                                                      For the                           For the
                                              Three-month period ended          Nine-month period ended
(dollars in thousands)                             September 30,                     September 30,
                                               2009             2008              2009             2008
Net sales:
Stainless steel                            $      5,499    $       12,926     $     20,680       $  42,503
Tool steel                                           40               232              193           1,296
High-strength low alloy steel                     1,481             1,835            4,929           6,553
High-temperature alloy steel                        974               945            2,742           3,937
Conversion services                                 125               212              327             532
Other                                                13                32               19             125


                                                  8,132            16,182           28,890          54,946
Intersegment                                        354               758            1,184           3,220


Total net sales                                   8,486            16,940           30,074          58,166
Material cost of sales                            4,524            11,219           19,663          36,184
Operation cost of sales                           2,857             4,974           10,575          14,622
Selling and administrative expenses                 708               919            2,324           2,621


Operating income (loss)                    $        397    $         (172 )   $     (2,488 )     $   4,739

Net sales for the three- and nine-month periods ended September 30, 2009 decreased by $8.5 million, or 49.9%, in comparison to the three-month period ended September 30, 2008 and by $28.1 million, or 48.3%, in comparison to the similar 2008 nine-month period. Tons shipped decreased 33% and 30%, respectively, for the three- and nine-month periods ended September 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 nine-month periods ended September 30, 2009 in comparison to the three- and nine-month periods ended September 30, 2009.

Operating income increased by $569,000 for the three-month period ended September 30, 2009 as compared to September 30, 2008. This improvement is directly related to a better alignment of material costs and related surcharges assessed, yield improvements and a $211,000 reduction in selling and administrative expenses. Operating income decreased by $7.2 million, resulting in a loss of $2.5 million for the nine-month period ended September 30, 2009 in comparison to the similar 2008 nine-month period. The results for the nine-month period ended September 30, 2009 include $1.0 million of the unusual charges outlined above, representing 3.2% of net sales. Excluding the impact of the unusual charges, material costs, as a percentage of sales, were 62.9% for the nine-month period ended September 30, 2009 in comparison to 62.2% for the similar 2008 period. Operation costs, as a percentage of sales, increased to 33.7% and 34.7% for the three- and nine-month periods ended September 30, 2009, respectively, from 29.4% and 25.1% for the three- and nine-month periods ended September 30, 2008, respectively. 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 September 30, 2009, working capital approximated $97.1 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 $8.2 million has been expended to date. In addition, a significant portion of the $25.3 million reduction in managed working capital, defined as accounts receivable, inventory and accounts payable, has been converted to cash at September 30, 2009. Accounts receivable decreased $15.3 million as a result of decreased sales for the three-month period ended September 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 $20.7 million decrease in inventory is primarily due to the shipment of higher cost material, a 38% 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 $33 million at September 30, 2009. The $12.5 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 8.9:1 at September 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 8.4% at September 30, 2009 due to acquisition of the Term Loan.

Cash received from sales of $29.5 million and $113.9 million for the three- and nine-month periods ended September 30, 2009 and of $58.4 million and $170.8 million for the three- and nine-month periods ended September 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         Nine-month period ended
  (dollars in thousands)           September 30,                    September 30,
                               2009             2008            2009             2008
  Raw material purchases   $       6,301    $      28,332   $     31,389    $       84,838
  Employment costs                 5,924            8,658         22,284            28,837
  Utilities                        2,926            4,420         12,269            14,374
  Other                            4,371           10,084         22,734            30,924


  Total uses of cash       $      19,522    $      51,494   $     88,676    $      158,973

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.

                             September     December     September     December
                               2009          2008         2008          2007
             Nickel         $      7.93   $     4.39   $      8.07   $    11.79
             Chrome         $      0.90   $     0.96   $      1.78   $     1.66
             Molybdenum     $     14.44   $     9.85   $     32.93   $    32.54
             Carbon scrap   $      0.15   $     0.11   $      0.25   $     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, the Company received a refund related to its 2008 federal income tax return during the three-month period ended September 30, 2009 of $1.4 million. As a result, other uses of cash reflects a net receipt of $1.3 million for income taxes for the nine-month period ended September 30, 2009 in comparison to net payments of $5.9 million from the same period in 2008.

The Company had capital expenditures for the nine-month period ended September 30, 2009 of $10.3 million compared with $9.6 million for the same period in 2008. $8.2 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. The Term Loan is being used to fund the capital expenditures for the melt shop upgrade. Accordingly, all of the $316,000 interest on the loan has been capitalized. At September 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 September 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 effectively fixed at 4.515%. The Company recorded a liability of $189,000, equal to the fair market value of the swap agreement at September 30, 2009. The change in fair market value, net of tax, is reported as other comprehensive loss within stockholders' equity.

In July 2009, the Company entered into nickel futures contracts to minimize the price change impact of anticipated purchases of nickel over the life of a customer short-term supply agreement which is designated as and accounted for as a cash flow hedge. The effective portion of the change in the fair value of the nickel futures contracts is recorded in accumulated other comprehensive income (loss).

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

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 September 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 September 30, 2009.