Universal Stainless & Alloy Products (USAP) 10-Q 2004 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2004

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from            to            

Commission File Number 0-25032

UNIVERSAL STAINLESS & ALLOY PRODUCTS, INC.

(Exact name of Registrant as specified in its charter)

DELAWARE	25-1724540
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

600 Mayer Street

Bridgeville, PA 15017

(Address of principal executive offices, including zip code)

(412) 257-7600

(Registrant’s telephone number, including area code)

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 by Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

As of November 5, 2004, there were 6,322,890 shares outstanding of the Registrant’s Common Stock, $0.001 par value per share.

UNIVERSAL STAINLESS & ALLOY PRODUCTS, INC.

This Quarterly Report on Form 10-Q contains historical information and forward-looking statements that reflect the Company’s current views with respect to future events and financial performance. Statements looking forward in time, including statements regarding future growth, cost savings, expanded production capacity, broader product lines, greater capacity to meet customer quality, reliability, price and delivery needs, enhanced competitive posture, effect of new accounting pronouncements and no material financial impact from litigation or contingencies are included in this Form 10-Q pursuant to the “safe harbor” provision of the Private Securities Litigation Reform Act of 1995.

The Company’s actual results will be affected by a wide range of factors including the concentrated nature of the Company’s customer base to date and the Company’s dependence on its significant customers; the receipt, pricing and timing of future customer orders; changes in product mix; the limited number of raw material and energy suppliers and significant fluctuations that may occur in raw material and energy prices; the Company’s reliance on certain critical manufacturing equipment; the ability to acquire the ESR Building prior to the expiration of the Armco Lease; the Company’s ongoing requirement for continued compliance with environmental laws; and the ultimate outcome of the Company’s current and future litigation matters. Many of these factors are not within the Company’s control and involve known and unknown risks and uncertainties that may cause the Company’s actual results in future periods to be materially different from any future performance suggested herein. Any unfavorable change in the foregoing or other factors could have a material adverse effect on the Company’s business, financial condition and results of operations.

Further, the Company operates in an industry sector where securities values may be volatile and may be influenced by economic and other factors beyond the Company’s control.

DESCRIPTION		PAGE NO.
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Condensed Statements of Operations	3
	Consolidated Condensed Balance Sheets	4
	Consolidated Condensed Statements of Cash Flows	5
	Notes to the Unaudited Consolidated Condensed Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	15
Item 4.	Controls and Procedures	15
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	16
Item 6.	Exhibits	16
SIGNATURES		17

2

Part I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

UNIVERSAL STAINLESS & ALLOY PRODUCTS, INC.

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except Per Share Information)

(Unaudited)

	For the Three-month period ended September 30,						For the Nine-month period ended September 30,
	2004			2003			2004			2003
Net sales	$	33,297		$	18,625		$	83,630		$	50,162
Cost of products sold		27,701			17,296			71,576			47,917
Selling and administrative expenses		1,873			1,507			5,348			4,425
Operating income (loss)		3,723			(178	)		6,706			(2,180	)
Interest expense		(108	)		(100	)		(302	)		(289	)
Other income		566			24			577			74
Income (loss) before taxes		4,181			(254	)		6,981			(2,395	)
Income tax provision (benefit)		1,436			(133	)		2,443			(1,251	)
Net income (loss)	$	2,745		$	(121	)	$	4,538		$	(1,144	)
Earnings (loss) per share – Basic	$	0.44		$	(0.02	)	$	0.72		$	(0.18	)
Earnings (loss) per share – Diluted	$	0.43		$	(0.02	)	$	0.71		$	(0.18	)
Weighted average shares of Common Stock outstanding
Basic		6,305,456			6,289,485			6,300,229			6,286,271
Diluted		6,400,188			6,289,485			6,363,656			6,286,271

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

3

UNIVERSAL STAINLESS & ALLOY PRODUCTS, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

(Dollars in Thousands)

	September 30, 2004			December 31, 2003
	(Unaudited)
ASSETS
Current assets
Cash and cash equivalents	$	549		$	4,735
Accounts receivable, (less allowance for doubtful accounts of $373 and $163, respectively)		22,629			12,690
Inventory		33,808			22,281
Deferred taxes		1,125			1,222
Other current assets		1,973			3,063
Total current assets		60,084			43,991
Property, plant and equipment, net		40,225			40,176
Other assets		472			758
Total assets	$	100,781		$	84,925
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Trade accounts payable	$	11,787		$	6,792
Outstanding checks in excess of bank balance		939			813
Accrued employment costs		2,818			833
Current portion of long-term debt		1,931			1,944
Other current liabilities		1,030			195
Total current liabilities		18,505			10,577
Bank revolver		4,597			—
Long-term debt		4,150			5,599
Deferred taxes		9,451			9,313
Total liabilities		36,703			25,489
Commitments and contingencies		—			—
Stockholders’ equity
Senior Preferred Stock, par value $0.001 per share; 1,980,000 shares authorized; 0 shares issued and outstanding		—			—
Common Stock, par value $0.001 per share; 10,000,000 shares authorized; 6,575,791` and 6,564,306 shares issued		7			7
Additional paid-in capital		28,433			28,329
Retained earnings		37,269			32,731
Treasury Stock at cost; 269,900 common shares held		(1,631	)		(1,631	)
Total stockholders’ equity		64,078			59,436
Total liabilities and stockholders’ equity	$	100,781		$	84,925

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

4

UNIVERSAL STAINLESS & ALLOY PRODUCTS, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(Unaudited)

	For the Nine-month period ended September 30,
	2004			2003
Cash flows from operating activities:
Net income (loss)	$	4,538		$	(1,144	)
Adjustments to reconcile to net cash (used in) provided by operating activities:
Depreciation and amortization		2,336			2,319
Deferred taxes		480			670
Tax benefit from exercise of stock options		8			—
Changes in assets and liabilities:
Accounts receivable, net		(9,939	)		(2,167	)
Inventory		(11,527	)		(188	)
Trade accounts payable		4,995			2,559
Accrued employment costs		1,985			243
Refundable taxes		1,405			(930	)
Other, net		553			227
Net cash (used in) provided by operating activities		(5,166	)		1,589
Cash flow from investing activities:
Capital expenditures		(2,377	)		(713	)
Net cash used in investing activities		(2,377	)		(713	)
Cash flows from financing activities:
Net borrowings under revolving line of credit		4,597			—
Proceeds from deferred loan agreement		—			200
Repayments of long-term debt		(1,462	)		(1,451	)
Increase in outstanding checks in excess of bank balance		126			235
Proceeds from the issuance of common stock		96			25
Net cash provided by (used in) financing activities		3,357			(991	)
Net decrease in cash and cash equivalents		(4,186	)		(115	)
Cash and cash equivalents at beginning of period		4,735			3,308
Cash and cash equivalents at end of period	$	549		$	3,193
Supplemental disclosure of cash flow information:
Interest paid	$	291		$	255
Income taxes (refunded) paid	$	(87	)	$	7

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

5

UNIVERSAL STAINLESS & ALLOY PRODUCTS, INC.

NOTES TO THE UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

Note 1 - Basis of Presentation

The accompanying unaudited consolidated condensed financial statements of operations for the three- and nine- month periods ended September 30, 2004 and 2003, balance sheets as of September 30, 2004 and December 31, 2003, and statements of cash flows for the nine-month periods ended September 30, 2004 and 2003, have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, these statements should be read in conjunction with the audited financial statements as of and for the year ended December 31, 2003. In the opinion of management, the accompanying unaudited, condensed consolidated financial statements contain all adjustments, all of which were of a normal recurring nature, necessary to present fairly, in all material respects, the consolidated financial position at September 30, 2004 and December 31, 2003 and the consolidated results of operations and of cash flows for the periods ended September 30, 2004 and 2003, and are not necessarily indicative of the results to be expected for the full year.

Note 2 – Common Stock

The reconciliation of the weighted average number of shares of Common Stock outstanding utilized for the earnings per common share computations are as follows:

	For the Three-month period ended September 30,		For the Nine-month period ended September 30,
	2004	2003	2004	2003
Weighted average number of shares of Common Stock outstanding	6,305,456	6,289,485	6,300,229	6,286,271
Effect of dilutive securities	94,732	—	63,427	—
Weighted average number of shares of Common Stock outstanding, as adjusted	6,400,188	6,289,485	6,363,656	6,286,271

The Company had 9,206 and 3,794 common stock equivalents outstanding for the three- and nine-month periods ended September 30, 2003, respectively, which were not included in the common share computations for earnings (loss) per share as the common stock equivalents are anti-dilutive.

Note 3 – Stock-Based Compensation Plans

The following table illustrates the effect on net income (loss) and earnings per share between the Company’s use of the intrinsic value method and the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee and director compensation (dollars, except per share amounts, in thousands):

	For the Three-month period ended September 30,						For the Nine-month period ended September 30,
	2004			2003			2004			2003
Net income (loss), as reported	$	2,745		$	(121	)	$	4,538		$	(1,144	)
Total stock-based compensation expense determined under fair-value based method, net of taxes		(45	)		(21	)		(131	)		(65	)
Pro forma net income (loss)	$	2,700		$	(142	)	$	4,407		$	(1,209	)
Earnings (loss) per common share:
Basic – as reported	$	0.44		$	(0.02	)	$	0.72		$	(0.18	)
Basic – pro forma	$	0.43		$	(0.02	)	$	0.70		$	(0.19	)
Diluted – as reported	$	0.43		$	(0.02	)	$	0.71		$	(0.18	)
Diluted – pro forma	$	0.42		$	(0.02	)	$	0.69		$	(0.19	)

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Note 4 – New Accounting Pronouncements

No new accounting pronouncements have been issued during the nine-month period ended September 30, 2004 that would have a material impact on the Company’s financial statements. Further, there have been no changes in the Company that would impact the accounting pronouncements disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

Note 5 - Inventory

The major classes of inventory are as follows (dollars in thousands):

	September 30, 2004		December 31, 2003
Raw materials and supplies	$	4,242	$	2,265
Semi-finished and finished steel products		27,147		17,743
Operating materials		2,419		2,273
Total inventory	$	33,808	$	22,281

Note 6 - Property, Plant and Equipment

Property, plant and equipment consists of the following (dollars in thousands):

	September 30, 2004			December 31, 2003
Land and land improvements	$	1,014		$	953
Buildings		6,203			5,987
Machinery and equipment		51,583			49,801
Construction in progress		459			141
		59,259			56,882
Accumulated depreciation		(19,034	)		(16,706	)
Property, plant and equipment, net	$	40,225		$	40,176

Property, plant and equipment includes certain buildings and structures located in Bridgeville, PA that were previously leased from Armco, which merged with and into AK Steel in 1999 (“Armco”). In 2003, the Company exercised its option to purchase all of the property permitted under the capital lease with Armco for $1.

The ESR building, which houses the Company’s four electro-slag remelting furnaces and ancillary equipment in Bridgeville, was not included in the option to purchase. The Company will continue to operate the equipment in the ESR building under a lease with Armco that was extended to March 8, 2005. The Company has entered into negotiations with AK Steel to purchase the ESR building. In the event the ESR building is not purchased, or the lease is not extended beyond March 8, 2005, the relocation of the ESR equipment would have an adverse material effect on the financial condition of the Company.

In 2003, the Company entered into a $200,000 Deferred Loan Agreement maturing on December 31, 2006 with the City of Dunkirk, New York. No principal or interest payments will be required under the Deferred Loan Agreement provided the Company hires 30 new employees and more than 50% of those jobs are made available to certain Dunkirk City residents. The Company believes it will meet the conditions of the Deferred Loan Agreement. Therefore, the proceeds have been applied to reduce the acquisition cost of new equipment at the Company’s Dunkirk facility.

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Note 7 – Commitments and Contingencies

The Company, as well as other steel companies, is subject to demanding environmental standards imposed by federal, state and local environmental laws and regulations. The Company is not aware of any environmental condition that currently exists at any of its facilities that would cause a material adverse effect on the financial condition of the Company.

In connection with the Company’s June 2, 1995 agreement with Armco to purchase certain assets and a parcel of real property located in Titusville, Armco agreed to indemnify the Company up to $3,000,000 in the aggregate for liabilities under environmental laws arising out of conditions on or under the Titusville property existing prior to June 2,1995. Armco also agreed to indemnify the Company for any liabilities arising out of environmental conditions existing off-site as of June 2, 1995, and that indemnification is not subject to the $3,000,000 limitation.

The Company has filed no claims against Armco since the inception of the acquisition agreement. In addition, management is not aware of any financial difficulties being experienced by AK Steel, as successor to Armco, that would prevent its performance under the acquisition agreement.

In connection with the acquisition of the Dunkirk facility, Dunkirk Specialty Steel entered into an order with the New York State Department of Environmental Conservation (“NY DEC”) that precludes NY DEC from bringing any action against the Company relating to existing environmental conditions as of February 14, 2002. There can be no assurance that any other party will not assert any claims with respect to environmental conditions at the Dunkirk facility, or that the Company will have the financial resources to discharge any liabilities if legally compelled to do so.

On June 29, 2001, suit was filed against the Company in the Court of Common Pleas of Allegheny County, Pennsylvania by Teledyne Technologies, Incorporated (“Teledyne”). The suit alleges that steel product manufactured by the Company was defective and the Company was or should have been aware of the defects. Teledyne has alleged that the defective steel supplied by the Company caused certain crankshafts sold by Teledyne for use in aircraft engines to be defective. As a result, Teledyne is claiming damages relating to the recall, replacement and repair of aircraft engines.

In 2002, Teledyne was unsuccessful in its pursuit of a similar claim brought against another specialty steel producer who supplied the same steel product. After in-depth investigation, it is the Company’s position that the suit is without merit and it intends to vigorously defend that position. Additionally, the Company believes that it has insurance coverage that is available for this claim. At this time, the Company is engaged in discovery and believes that the final disposition of this suit will not have a material adverse effect on the financial condition and the results of operations of the Company.

On April 7, 2003, United States Aviation Underwriters, Inc. (“USAU”), a New York corporation, as managers and on behalf of United States Aircraft Insurance Group (“USAIG”), the Company’s Aircraft Products Liability insurance carrier, filed suit in the Court of Common Pleas of Allegheny County, Pennsylvania asking the court for a declaratory judgment as to what actual liability and obligations were applicable to USAIG relating to the insurance policy issued to the Company, and the allegations made by Teledyne. The Company and USAU reached a settlement agreement as of May 1, 2004 regarding the allocation of certain potential costs associated with the Teledyne claim and have agreed to jointly file a motion to have the declaratory suit dismissed. On July 27, 2004, the suit brought by USAU was dismissed.

The Company maintains a supply contract agreement with Talley Metals Technology, Inc. a subsidiary of Carpenter Technology Corporation (“Talley Metals”). While the initial term of the agreement expired December 31, 2002, the agreement continues to automatically renew with the placement of new orders each month and requires a 90-day notice to terminate. In addition, Talley Metals is required under the agreement to purchase a minimum of 1,000 tons of stainless reroll billet products each calendar month and average at least 1,250 tons per month during the last twelve-month period. The value of the contract on a monthly basis will depend on product mix and key raw material prices. Due to market conditions during 2003, the Company waived Talley Metals’ requirement to purchase the monthly minimum quantity of stainless reroll billets.

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Note 8 - Business Segments

The Company is comprised of two business segments: Universal Stainless & Alloy Products, which consists of the Bridgeville and Titusville facilities, and Dunkirk Specialty Steel, the Company’s wholly owned subsidiary located in Dunkirk, New York. The Universal Stainless & Alloy Products manufacturing process involves melting, remelting, treating and hot and cold rolling of semi-finished and finished specialty steels. Dunkirk Specialty Steel’s manufacturing process involves hot rolling and finishing of specialty steel bar, rod and wire products. The segment data are as follows (dollars in thousands):

	For the Three-month period ended September 30,						For the Nine-month period ended September 30,
	2004			2003			2004			2003
Net sales:
Universal Stainless & Alloy Products	$	31,199		$	16,168		$	75,526		$	43,068
Dunkirk Specialty Steel		9,484			5,225			24,264			15,404
Intersegment		(7,386	)		(2,768	)		(16,160	)		(8,310	)
Consolidated total	$	33,297		$	18,625		$	83,630		$	50,162
Operating income (loss):
Universal Stainless & Alloy Products	$	2,900		$	554		$	5,198		$	(475	)
Dunkirk Specialty Steel		1,163			(732	)		1,848			(1,705	)
Intersegment		(340	)		—			(340	)		—
Consolidated total	$	3,723		$	(178	)	$	6,706		$	(2,180	)
Interest expense and other financing costs:
Universal Stainless & Alloy Products	$	72		$	64		$	198		$	179
Dunkirk Specialty Steel		36			36			104			110
Consolidated total	$	108		$	100		$	302		$	289
Other income (expense)
Universal Stainless & Alloy Products	$	1		$	15		$	10		$	55
Dunkirk Specialty Steel		565			9			567			19
Consolidated total	$	566		$	24		$	577		$	74

	September 30, 2004		December 31, 2003
Total assets:
Universal Stainless & Alloy Products	$	80,488	$	65,025
Dunkirk Specialty Steel		17,558		11,128
Corporate assets		2,735		8,772
	$	100,781	$	84,925

Dunkirk Specialty Steel’s other income for the three- and nine-month period ended September 30, 2004 included $565,000, net of expenses, related to the delayed receipt of the remaining 2003 import duties awarded the Company under the Continued Dumping and Subsidy Act of 2000 (CDSOA). A substantial portion of the Company’s $604,000 award was withheld at the end of 2003 pending the outcome of a lawsuit challenging the distribution method of the import duties. In September 2004, U.S. Customs notified the Company that a favorable court ruling in July 2004 permits the Company to collect the balance of its 2003 award and participate in future distributions. The Company received the balance of the funds due in October 2004.

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

Results of Operations

An analysis of the Company’s operations for the three- and nine-month periods ended September 30, 2004 and 2003 is as follows (dollars in thousands):

	For the Three-month period ended September 30,					For the Nine-month period ended September 30,
	2004		2003			2004		2003
Net sales:
Stainless steel	$	26,529	$	14,215		$	65,586	$	38,064
Tool steel		4,277		2,828			11,185		7,328
High-strength low alloy steel		1,160		619			3,085		1,958
High-temperature alloy steel		473		608			1,795		1,750
Conversion services		707		247			1,635		845
Other		151		108			344		217
Total net sales		33,297		18,625			83,630		50,162
Cost of products sold		27,701		17,296			71,576		47,917
Selling and administrative expenses		1,873		1,507			5,348		4,425
Operating income (loss)	$	3,723	$	(178	)	$	6,706	$	(2,180	)

Market Segment Information

	For the Three-month period ended September 30,				For the Nine-month period ended September 30,
	2004		2003		2004		2003
Net sales:
Service centers	$	13,443	$	7,478	$	35,616	$	22,333
Rerollers		9,208		5,246		21,465		13,285
Forgers		6,232		3,052		15,181		7,054
Original equipment manufacturers		2,263		1,423		6,101		3,844
Wire redrawers		1,307		1,095		3,346		2,615
Conversion services		707		247		1,635		845
Miscellaneous		137		84		286		186
Total net sales	$	33,297	$	18,625	$	83,630	$	50,162
Tons shipped		13,470		9,600		34,667		25,658

Three- and nine-month periods ended September 30, 2004 as compared to the similar period in 2003

Net sales for the three- and nine-month periods ended September 30, 2004 increased $14.7 million and $33.5 million, respectively, as compared to the similar periods in 2003. These increases are primarily due to increased shipments within each market segment as well as the adoption of surcharge mechanisms for additional raw material components and other price increases implemented during 2004. In addition, the 2004 financial results have benefited from greater demand of higher value-added niche products due to improved economic conditions. Shipments of aerospace, power generation, petrochemical and tool steel products for the three- and nine-month periods ended September 30, 2004 have increased substantially in comparison to the same prior year periods.

Cost of products sold, as a percentage of net sales, was 83.2% and 92.9% for the three-month periods ended September 30, 2004 and 2003, respectively, and was 85.6% and 95.5% for the nine-month periods ended September 30, 2004 and 2003, respectively. The decreases are primarily due to increased production volumes, improved mix of products shipped and higher selling prices, partially offset by higher raw material, labor, utility and other manufacturing supply costs.

10

Selling and administrative expenses increased by $366,000 and $923,000 in the three- and nine-month periods ended September 30, 2004, respectively, as compared to similar periods in 2003. These increases are primarily due to higher employment costs. In addition, the Company increased its bad debt reserve by $176,000 as a result of a customer filing for Chapter 11 bankruptcy protection during the three-month period ended September 30, 2004.

Interest expense and other financing costs increased by $8,000 and $13,000 for the three- and nine-month periods ended September 30, 2004 as compared to the similar periods in 2003. The increases were primarily due to an increased use of the revolving line of credit, partially offset by the continued reduction in long-term debt outstanding.

Other income for the three- and nine-month periods ended September 30, 2004 included $565,000, net of expenses, related to the delayed receipt of the remaining 2003 import duties awarded the Company under the Continued Dumping and Subsidy Act of 2000 (CDSOA). A substantial portion of the Company’s $604,000 award was withheld at the end of 2003 pending the outcome of a lawsuit challenging the distribution method of the import duties. In September 2004, U.S. Customs notified the Company that a favorable court ruling in July 2004 permits the Company to collect the balance of its 2003 award and participate in future distributions. The Company received the balance of the funds due in October 2004.

During the three-month period ended September 30, 2004, the Company’s estimated annual effective income tax rate decreased from 36.0%, which was utilized through June 30, 2004, to 35.0%. The effective income rate utilized in the current period reflects the anticipated effect of the Company’s permanent tax deductions against expected income levels in 2004. The reduction increased net income by $70,000 for the three-month period ended September 30, 2004.

Business Segment Results

An analysis of the net sales and operating income for the reportable segments for the three- and nine-month periods ended September 30, 2004 and 2003 is as follows (dollars in thousands):

Universal Stainless & Alloy Products Segment

	For the Three-month period ended September 30,				For the Nine-month period ended September 30,
	2004		2003		2004		2003
Net sales:
Stainless steel	$	18,373	$	9,805	$	45,469	$	24,865
Tool steel		4,155		2,744		10,902		6,924
High-strength low alloy steel		575		313		1,387		1,184
High-temperature alloy steel		451		438		1,526		1,463
Conversion services		632		208		1,356		716
Other		146		108		298		202
		24,332		13,616		60,938		35,354
Intersegment		6,867		2,552		14,588		7,714
Total net sales		31,199		16,168		75,526		43,068
Material cost of sales		14,999		6,247		33,923		15,887
Operation cost of sales		11,990		8,362		32,733		24,733
Selling and administrative expenses		1,310		1,005		3,672		2,923
Operating income (loss)	$	2,900	$	554	$	5,198	$	(475	)

Net sales for the three- and nine-month periods ended September 30, 2004 for this segment, which consists of the Bridgeville and Titusville facilities, increased by $15.0 million, or 93%, in comparison to the three-month period ended September 30, 2003 and $32.5 million, or 75%, in comparison to the similar 2003 nine-month period. These increases are primarily due to increased shipments within each market segment as well as the adoption of surcharge mechanisms for additional raw material components and other price increases implemented during 2004. In addition, the 2004 financial results have benefited from greater demand of higher value-added niche products due to improved economic conditions. Shipments of aerospace, power generation, petrochemical and tool steel products for the three- and nine-month periods ended September 30, 2004 have increased substantially in comparison to the same prior year periods.

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Operating income for the Universal Stainless & Alloy Products segment increased by $2.3 million for the three-month period ended September 30, 2004 as compared to September 30, 2003 and increased by $5.7 million for the nine-month period ended September 30, 2004. The increases are primarily due to increased production volumes, improved mix of products shipped and higher selling prices, partially offset by higher raw material, labor, utility and other manufacturing supply costs.

Dunkirk Specialty Steel Segment

	For the Three-month period ended September 30,					For the Nine-month period ended September 30,
	2004		2003			2004		2003
Net sales:
Stainless steel	$	8,156	$	4,410		$	20,117	$	13,199
Tool steel		122		84			283		404
High-strength low alloy steel		585		306			1,698		774
High-temperature alloy steel		22		170			269		287
Conversion services		75		39			279		129
Other		5		—			46		15
		8,965		5,009			22,692		14,808
Intersegment		519		216			1,572		596
Total net sales		9,484		5,225			24,264		15,404
Material cost of sales		4,716		3,170			12,095		8,723
Operation cost of sales		3,042		2,285			8,645		6,884
Selling and administrative expenses		563		502			1,676		1,502
Operating income (loss)	$	1,163	$	(732	)	$	1,848	$	(1,705	)

Net sales for the three- and nine-month periods ended September 30, 2004 for this segment increased by $4.3 million, or 82%, in comparison to the three-month period ended September 30, 2003 and $8.9 million, or 58%, in comparison to the similar 2003 nine-month period. These increases are primarily due to increased shipments within each market segment as well as the adoption of surcharge mechanisms for additional raw material components and other price increases implemented during 2004. In addition, the 2004 financial results have benefited from greater demand of higher value-added niche products due to improved economic conditions. Shipments of aerospace, power generation, and petrochemical products for the three- and nine-month periods ended September 30, 2004 have increased substantially in comparison to the same prior year periods.

Operating income increased by $1.9 million for the three-month period ended September 30, 2004 as compared to September 30, 2003 and increased by $3.6 million for the nine-month period ended September 30, 2004. The increases are primarily due to increased production volumes, improved mix of products shipped and higher selling prices, partially offset by higher raw material, labor, utility and other manufacturing supply costs.

Liquidity and Capital Resources

The Company has financed its operating activities through cash on hand at the beginning of the period and additional borrowings. At September 30, 2004, working capital approximated $41.6 million, as compared to $33.4 million at December 31, 2003. The ratio of current assets to current liabilities decreased from 4.2:1 at December 31, 2003 to 3.3:1 at September 30, 2004. The debt to capitalization ratio was 14.3% at September 30, 2004 and 11.3% at December 31, 2003.

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Cash received from sales of $73.6 million and $48.5 million for the nine-month periods ended September 30, 2004 and 2003 represent the primary source of cash from operations. An analysis of the primary uses of cash from operations is as follows:

	For the Nine-month period ended September 30,
	2004		2003
Raw material purchases	$	40,284	$	17,005
Employment costs		17,994		14,337
Utilities		9,004		7,092
Other		11,488		8,488
Total uses of cash from operations	$	78,770	$	46,922

Cash used to fund raw material purchases, employment costs and utilities increased during the nine-month period ended September 30, 2004 in comparison to the similar year-ago period primarily due to increased sales and higher transaction prices. 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 impacting raw material costs for the nine-month periods ended September 30, 2003 and 2004.

	December 2002		September 2003		December 2003		September 2004
Nickle	$	3.26	$	4.52	$	6.43	$	6.02
Chrome	$	0.33	$	0.47	$	0.54	$	0.68
Molybdenum	$	3.51	$	6.14	$	7.10	$	18.14
Carbon Scrap	$	0.06	$	0.08	$	0.09	$	0.17

The market values for these raw materials, most notably carbon scrap, have continued to increase in 2004. The Company began to calculate its nickel surcharge using an $0.18 per pound premium over the London Metal Exchange (LME) prices on February 4, 2004, implemented an iron surcharge component on February 16, 2004, expanded the use of surcharges to include tool steel products on May 1, 2004 and implemented a manganese surcharge component on June 1, 2004. The nickel surcharge premium per pound was increased from $0.18 to $0.23 on August 1, 2004. In addition, the Company has experienced higher energy, transportation and manufacturing supply costs during 2004. In response, the Company has announced several sales price increases during 2004. There can be no assurance that these sales price increases will completely offset the Company’s rising costs.

The Company had capital expenditures for the nine-month period ended September 30, 2004 of $2.4 million. These funds have been primarily used to purchase additional annealing furnaces, saws and a reheat furnace for the Company’s Universal Rolling mill located at its Bridgeville facility to meet the increased market demand for the Company’s products.

Effective January 1, 2003, the Company entered into a $200,000 Deferred Loan Agreement maturing on December 31, 2006 with the City of Dunkirk, New York. No principal or interest payments will be required under the Deferred Loan Agreement provided the Company hires 30 new employees and more than 50% of those jobs are made available to certain Dunkirk City residents. The Company believes it will meet the conditions of the Deferred Loan Agreement. Therefore, the proceeds have been applied to reduce the acquisition cost of new equipment at the Company’s Dunkirk facility.

The Company satisfies its capital requirements primarily through the sale of Common Stock and the issuance of long-term debt. 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.

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At September 28, 2004, the Company increased its revolving line of credit with PNC Bank from $6.5 million to $15 million to finance increased working capital requirements in response to the growing demand for the Company’s products and increased production capacity created as a result of its capital expenditures. At September 30, 2004 the Company had $10.4 million available for borrowings. The Company is in compliance with its covenants as of September 30, 2004.

The Company anticipates that it will fund its 2004 working capital requirements, its capital expenditures and the stock repurchase program primarily from funds generated from operations and borrowings. The Company’s long-term liquidity requirements, including capital expenditures, are expected to be financed by a combination of internally generated funds, borrowings and other sources of external financing if needed.

2004 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 2004 sales will range from $32 to $37 million and that its earnings per diluted share will range from $0.32 to $0.37 before the impact of any monies the Company may receive related to the CDSOA for the current year. In the fourth quarter of 2003, sales were $18.8 million and the Company incurred a net loss per diluted share of $0.04. The following factors were considered in developing these estimates:

• The Company’s total backlog approximated $60 million on September 30, 2004, as compared to $49 million on June 30, 2004 reflecting continued strength in all of the Company’s markets.

• Capital improvements implemented in the second and third quarters of 2004, including the addition of a reheat furnace to increase throughput at the Bridgeville blooming mill, should fully benefit the fourth quarter of 2004.

• Sales from the Dunkirk Specialty Steel segment are expected to approximate the 2004 third quarter sales of $9.5 million. Additional sales are dependent upon the level of inventory management initiatives implemented by the service center industry near the end of the year.

• The Company expects raw material costs to remain volatile for the balance of the year. Its electricity costs will increase by approximately $200,000 per month in the fourth quarter due to a recent Public Utility Commission ruling that has reduced the number of off-peak power hours available to conduct its melting operations at the Bridgeville facility. The Company has retained a consultant to recommend energy-saving initiatives and is currently negotiating its 2005 energy contract.

New Accounting Pronouncements

No new accounting pronouncements have been issued during the three-month period ended September 30, 2004 that would have a material impact on the Company’s financial statements. Further the Company has reviewed the status of its accounting pronouncements and believes there are no significant changes from that disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, except as provided in this Form 10-Q.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company has reviewed the status of its market risk and believes there are no significant changes from that disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, except as provided in this Form 10-Q in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 4. CONTROLS AND PROCEDURES

An evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective as of September 30, 2004 to ensure that information required to be disclosed in reports that we file or submit under the Securities and Exchange Act of 1934 is recorded, processed, summarized and reported in accordance with the rules and forms of the Securities and Exchange Commission. During the quarter ended September 30, 2004, there were no significant changes in our internal controls or in other factors that could significantly affect internal controls.

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Part II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

On June 29, 2001, suit was filed against the Company in the Court of Common Pleas of Allegheny County, Pennsylvania by Teledyne Technologies, Incorporated (“Teledyne”). The suit alleges that steel product manufactured by the Company was defective and the Company was or should have been aware of the defects. Teledyne has alleged that the defective steel supplied by the Company caused certain crankshafts sold by Teledyne for use in aircraft engines to be defective. As a result, Teledyne is claiming damages relating to the recall, replacement and repair of aircraft engines.

In 2002, Teledyne was unsuccessful in its pursuit of a similar claim brought against another specialty steel producer who supplied the same steel product. After in-depth investigation, it is the Company’s position that the suit is without merit and it intends to vigorously defend that position. Additionally, the Company believes that it has insurance coverage that is available for this claim. At this time, the Company is engaged in discovery and believes that the final disposition of this suit will not have a material adverse effect on the financial condition and the results of operations of the Company.

On April 7, 2003, United States Aviation Underwriters, Inc. (“USAU”), a New York corporation, as managers and on behalf of United States Aircraft Insurance Group (“USAIG”), the Company’s Aircraft Products Liability insurance carrier, filed suit in the Court of Common Pleas of Allegheny County, Pennsylvania asking the court for a declaratory judgment as to what actual liability and obligations were applicable to USAIG relating to the insurance policy issued to the Company, and the allocations made by Teledyne. The Company and USAU reached a settlement agreement as of May 1, 2004 regarding the allocation of certain potential costs associated with the Teledyne claim and have agreed to jointly file a motion to have the declaratory suit dismissed. On July 27, 2004, the suit brought by USAU was dismissed.

Item 6. EXHIBITS

10.1	Eighth Amendment to the Second Amended and Restated Credit Agreement, dated as of September 28, 2004, between the Company and PNC Bank, National Association (filed herewith).
10.2	Third Amended and Restated Revolving Credit Note, dated as of September 28, 2004, by and between the Company and PNC Bank, National Association (filed herewith).
10.3	Amendment No. 1 to Second Amended and Restated Security Agreement and Collateral Assignment, dated as of September 28, 2004, by and between the Company and PNC Bank, National Association (filed herewith).
31.1	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
31.2	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.1	Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

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SIGNATURES

Pursuant to the requirements 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.

	UNIVERSAL STAINLESS & ALLOY PRODUCTS, INC.
Date: November 9, 2004
	/s/ C. M. McAninch
	Clarence M. McAninch President and Chief Executive Officer (Principal Executive Officer)
Date: November 9, 2004
	/s/ Richard M. Ubinger
	Richard M. Ubinger Vice President of Finance, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)

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