10-Q 1 y54974e10-q.txt SPECIAL METALS CORPORATION SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 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 No. 000-22029 SPECIAL METALS CORPORATION -------------------------- (Exact name of registrant as specified in its charter) Delaware 25-1445468 ------------------------------- ------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4317 Middle Settlement Road New Hartford, NY 13413 ---------------------- (Address of principal executive offices) (Zip Code) (315) 798-2900 -------------- (Registrant's telephone number, including area code) Not Applicable -------------- (Former name, former address and former fiscal year, if changed since last report) 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 ------- ------- As of November 1, 2001, there were 15,479,000 shares of the Registrant's common stock, par value $.01 per share, outstanding. SPECIAL METALS CORPORATION QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2001 INDEX

1 Part I. Financial Information Item 1. Financial Statements Special Metals Corporation Condensed Consolidated Balance Sheets (Unaudited - In thousands, except share amounts)

See accompanying notes to condensed consolidated financial statements. 2 Special Metals Corporation Condensed Consolidated Statements of Operations and Retained Earnings (Accumulated Deficit) (Unaudited - In thousands, except per share amounts)

See accompanying notes to condensed consolidated financial statements. 3 Special Metals Corporation Condensed Consolidated Statements of Cash Flows (Unaudited - In thousands)

See accompanying notes to condensed consolidated financial statements. 4 Special Metals Corporation Notes To Condensed Consolidated Financial Statements September 30, 2001 (Unaudited) NOTE 1 - ACCOUNTING POLICIES The accompanying unaudited condensed consolidated financial statements of Special Metals Corporation (the "Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Results for the period ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. For further information, refer to the financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. NOTE 2 - INVENTORIES Inventories consist of the following (in thousands):

5 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) September 30, 2001 (Unaudited) NOTE 3 - BUSINESS SEGMENT INFORMATION Segment information for the nine months ended September 30, 2001 and 2000 is as follows.

6 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) September 30, 2001 (Unaudited) NOTE 4 - CONTINGENCIES ENVIRONMENTAL MATTERS The Company's facilities are engaged in activities regulated by extensive federal, state, local and foreign environmental and worker safety and health laws and regulations, including those relating to air emissions, wastewater discharges, the handling and disposal of solid and hazardous wastes and the release of hazardous substances (collectively, "Environmental Laws"). In the United States, for example, such laws include the Federal Clean Air Act, Clean Water Act, Resource Conservation and Recovery Act ("RCRA"), Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), and analogous state laws. The Company uses substantial quantities of substances that are considered hazardous or toxic under Environmental Laws. The Company's operations pose a continuing risk of accidental releases of, and worker exposure to, hazardous or toxic substances. There is also a risk that Environmental Laws, or the enforcement thereof, may become more stringent in the future and that the Company may be subject to legal proceedings brought by private parties or government agencies with respect to environmental matters. Although the Company believes that it is in substantial compliance with applicable requirements of Environmental Laws, there can be no assurance that some, or all, of the risks discussed under this heading will not result in liabilities that are material to the Company's business, results of operations, financial condition or cash flows. The Company's facilities have been used for industrial purposes for a substantial period and, over such time, these facilities have used substances or generated and disposed of wastes which are hazardous. The Company currently faces potential material environmental remediation liabilities in connection with certain sites at which the Company's wastes have been allegedly released or otherwise come to be located. At September 30, 2001, the Company had total reserves of approximately $9.3 million to cover future costs arising from known environmental liabilities for investigation, remediation and operation and maintenance of remediation systems, including costs relating to its own properties and to certain sites at which the Company's wastes have allegedly been identified. However, the Company's actual future expenditures for remediation of environmental conditions existing at its properties and at offsite waste-disposal locations cannot be conclusively determined at this time. Furthermore, additional locations at which wastes generated by the Company may have been released or disposed, of which the Company is currently unaware, may in the future become the subject of remediation for which the Company may be liable, in whole or in part. Accordingly, it is possible that the Company could become subject to environmental liabilities in the future that could result in a material adverse effect on the Company's business, results of operations, financial condition or cash flows. The Company's policy is to continually strive to improve environmental performance. From time to time, the Company may be subject to regulatory enforcement under various Environmental Laws, resolution of which typically involves the establishment of compliance programs and may involve the payment of penalties. The Company's 2001 capital budget provides $1.8 million for environmental protection and compliance matters. The Company incurred capital expenditures for environmental matters of $0.6 million during the nine months ended September 30, 2001. The Company does not expect future costs of compliance with currently enacted and proposed Environmental Laws to have a material impact on its liquidity and capital resources. However, changes in Environmental Laws which result in the imposition of stricter standards or requirements or more rigorous enforcement of existing Environmental Laws could result in expenditures in excess of amounts estimated to be required for such matters. 7 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) September 30, 2001 (Unaudited) The following is a summary of the more significant environmental matters or proceedings in which the Company is currently involved: Asbestos Exposure Actions. Huntington Alloys, a domestic subsidiary of the Company ("Huntington"), is a co-defendant in various consolidated and unconsolidated actions by plaintiffs, including former employees of Huntington and former employees of contractors to Huntington, alleging exposure to asbestos at Huntington's West Virginia facility. Plaintiffs' counsel have also informed Huntington that they intend to add similar claims by additional plaintiffs. Insurance coverage is available for some of these proceedings. Jurisdiction over all asbestos cases pending in the State of West Virginia has been transferred to the Mass Litigation Panel, a panel set up by the West Virginia Supreme Court of Appeals to streamline the processes and procedures for resolving asbestos cases. The Mass Litigation Panel has set a group of 60 plaintiffs for trial in January 2002, two of whom, have asserted claims against Huntington. Huntington is in the process of conducting discovery as to these two claims. In July of 2001, the West Virginia Supreme Court of Appeals issued a mandate to the presiding judge of the Mass Litigation Panel to commence all trials necessary to dispose of all asbestos litigation in the State of West Virginia by July 1, 2002. The presiding judge is currently in the process of developing a plan to attempt to comply with this mandate. The Company is not able to reasonably estimate what the ultimate loss, if any, will be with respect to these matters. However, the damages sought by plaintiffs in these actions, if Huntington were required to pay them, could have a material adverse effect on the business, financial condition, results of operations or cash flows of the Company. Manganese Exposure Actions. Huntington is a defendant in seven cases seeking damages for alleged health problems resulting from exposure to manganese in welding products. The cases are at various stages of pleading and discovery. One of the cases involves numerous plaintiffs. The Company does not believe that these proceedings are likely to have a material adverse effect on the business, financial condition, results of operations or cash flows of the Company, but there can be no assurance that this will be the case. Toxic Tort Exposure Actions. Huntington is a defendant in six toxic tort exposure cases involving numerous plaintiffs. Discovery has not yet been conducted with respect to these claims. The Company does not believe that these proceedings are likely to have a material adverse effect on the business, financial condition, results of operations or cash flows of the Company, but there can be no assurance that this will be the case. Ludlow Landfill. The Company has been identified as a potentially responsible party ("PRP") under CERCLA at the Ludlow Landfill in Clayville, New York, due to the Company's alleged generation of certain industrial wastes, including wastes contaminated by polychlorinated biphenyls ("PCBs"), which were disposed at the landfill (the "Ludlow Site"). CERCLA imposes strict, joint and several liability upon, inter alia, generators of wastes disposed at a contaminated site, for investigation and remedial costs. 8 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) September 30, 2001 (Unaudited) The Company assumed responsibility for remediation of the Ludlow Site and has completed remediation except for that of an adjoining property known as the "North Gravel Pit." The discovery of PCB contamination in the North Gravel Pit has required further investigation and remediation. The Company's engineers have submitted to the New York State Department of Environmental Conservation (the "DEC") a report detailing their investigation pursuant to the work plan and recommending a remedial alternative. The Company has established a reserve based on the recommended remedial alternative. The Company has received comments from the DEC objecting to the recommended remedial alternative. In light of such comments, the Company has proposed a second recommended remedial alternative. The cost of the second remedial alternative is essentially the same as that for which the reserve was established. The Company is also responsible for post-closure operations and maintenance at the remainder of the Ludlow Site, including groundwater monitoring, through 2027. These operations and maintenance costs are estimated at approximately $70,000 per year. In addition, the Company may be required to conduct certain post-closure activities. The Company and the DEC disagree concerning the DEC's outstanding natural resources damage claim. The DEC has requested additional annual biota sampling for a period in excess of the post-closure operations and maintenance period, to be incorporated in a revised post-closure operations and maintenance plan. The Company has disputed this request. In July of 1999, the DEC decided not to pursue further at that time its request for the Company to undertake biota sampling. The DEC retains the right to sample biota. The DEC may renew its request for the inclusion of biota sampling in the post-closure operations and maintenance plan. Though the Company does not believe it likely that liabilities at the Ludlow Site will have a material adverse effect on the Company's business, results of operations, financial condition or cash flows, this possibility cannot be excluded. Universal Waste Site. The owners and operators of the Universal Waste Site, Utica, New York, conducted a preliminary site assessment pursuant to a consent order with the DEC, which also conducted a separate preliminary site assessment. The Company believes that at least four other PRPs have been identified with respect to the contamination at the site. The DEC is dividing the site into two separate sites, the Utica Alloys site (1.5 acre occupied by the industrial concern known as Utica Alloys, Inc.) and the Universal Waste site (the remainder of the original site). The Company has not been obligated to become involved in the investigation. Based upon the limited information available to it, the Company has established a reserve of $575,000. However, because of the preliminary nature of the investigation, it is not possible at this time to provide a reasonable estimate of the ultimate cost of any investigative or remedial work which will be required, or the Company's share, if any, of such costs. Therefore, it is possible that liabilities could arise in respect of this site that could have a material adverse effect on the business, results of operations, financial condition or cash flows of the Company. Huntington and Burnaugh RCRA Facility Assessments. The Huntington, West Virginia, and Burnaugh, Kentucky facilities of Huntington have been subject to site inspections pursuant to RCRA. Draft reports issued by the respective inspecting agencies recommended environmental investigation at Huntington and Burnaugh. 9 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) September 30, 2001 (Unaudited) The Huntington report was never issued in final form. No action has been taken by the inspecting agency since January 1996 in the case of Huntington. Burnaugh has been listed as one of over 1,700 high priority facilities. The Kentucky Division of Waste Management has revised the RCRA Facility Assessment report for Burnaugh and considers it to be a finalized document. A Voluntary Investigation Workplan submitted by the Company has been approved by the Division. The investigation is now underway. A revised Voluntary Investigation Workplan for three Solid Waste Management Units has been proposed to and approved by the Division. If an investigation is ultimately required in Huntington, and when such is completed in Burnaugh, the Company could also be required to undertake significant remediation, the cost of which could have a material adverse effect on the business, financial condition, results of operations or cash flows of the Company. Huntington West Pickle House. The Company's Huntington, West Virginia facility of Huntington installed a wet scrubber exhaust system to remove ammonia vapor directly from an ammonia/water solution tank within its West Pickle House. The system is now operational. Pennsauken Landfill / Puchack Well Field. Huntington is a third-party defendant in a lawsuit filed in New Jersey Superior Court (the "Pennsauken Action"). The plaintiffs in the Pennsauken Action, the Township of Pennsauken and the Pennsauken Solid Waste Management Authority, filed the Pennsauken Action in 1991 against various defendants seeking to hold the defendants liable for the costs of remediation of the Pennsauken Landfill, the Puchack Well Field and/or surrounding areas. In September of 1999, two defendants in the Pennsauken Action filed a third-party complaint against numerous third-party defendants, one of which is Huntington. Several of the named third-party defendants, including Huntington, had previously been PRP's at the nearby Superfund site known as the Swope Oil Field. Huntington was a de minimis participant in the Swope Oil Field site and has, to date, paid less than $70,000 for its share of the remediation. The third-party complaint in the Pennsauken Action alleges that contamination at the Swope Oil Field migrated via groundwater to the Pennsauken Landfill, the Puchack Well Field and/or surrounding areas. The third-party plaintiffs assert that if they are found to be liable for remediation of those sites, Huntington and the other third-party defendants which were PRP's at the Swope Oil Field are in turn liable to the third-party plaintiffs. The claims against Huntington and the other Swope third-party defendants have been severed and stayed, pending the resolution of the underlying action. It is not possible at this time to provide a reasonable estimate of the cost of any investigative or remedial work which may be required, or Huntington's share of such cost, if any. Wiggin Tube Degreaser. Special Metals Wiggin Ltd., a United Kingdom subsidiary of the Company ("Wiggin"), may be required to make an expenditure of approximately $1.5 million to upgrade its degreasing operations at its facility in Hereford, England in order to reduce emissions of volatile organic compounds. This expenditure is unlikely to be incurred before 2003. 10 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) September 30, 2001 (Unaudited) Wiggin Electrical Switchgear. The Company expects that the Hereford, England facility of Wiggin will need to institute a phased program over ten years to replace its electrical switchgear, including oil-filled manual direct switchgear, air breakers and all other oil-filled switchgear. A program to replace the oil-filled manual direct switches began in 2000 (at a cost of $0.3 million incurred in that year) and will be completed by 2002, at a remaining estimated cost of $0.5 million. The cost of a program to replace the remainder of the electrical switchgear is estimated to be approximately $4.6 million, to be incurred during the period from 2002 through 2009. Wiggin Water Drainage Arrangements. The U.K. Environment Agency has informed Wiggin that they are considering improvements for the water drainage arrangements at the Hereford, England facility of Wiggin. They may request that Wiggin separate its process and storm water drainage systems. Wiggin Dust Emission. A dust extractor for Wiggin's aerofall shot blast unit at its facility in Hereford, England was improperly fitted by an outside contractor resulting in emissions in violation of Wiggin's authorization under the Environmental Protection Act of 1990. An Enforcement Notice has, accordingly, been issued by the Environmental Agency. The Notice requires Wiggin to take action aimed at avoiding another violation of its authorization. It is not known whether the Agency will take further administrative action. Tremont City Landfill Site. The Company recently received notice from the United States Environmental Protection Agency (the "EPA") that Huntington has been identified as one of 37 PRPs under CERCLA at the Tremont City Landfill Site in Clark County, Ohio. Because of the preliminary nature of this matter, it is not possible at this time to provide a reasonable estimate of the ultimate cost of any work which may be required at the Tremont City Landfill Site, or the Company's share, if any, of such costs. Though the Company does not believe it likely that liabilities, if any, at the Tremont City Landfill Site will have a material adverse effect on the Company's business, results of operations, financial condition or cash flows, this possibility cannot be excluded. New Hartford Storm Water Treatment System. A cooling tower at the Company's facility in New Hartford, New York was inadvertently drained into the facility's storm water treatment system. The DEC was notified of this event. The Company entered into an Order On Consent/Stipulation with the DEC agreeing to pay a penalty of $7,500. A portion of the penalty ($3,500) was suspended pending satisfactory compliance with a schedule of steps aimed at reducing the likelihood of a reoccurrence. The Company has complied with the schedule. INCO The Company has filed a lawsuit against Inco Limited ("Inco") and certain of its subsidiaries, (together with Inco, the "Sellers"). The Company has claims pending against the Sellers alleging that the Sellers made fraudulent misrepresentations in connection with the Company's October 1998 acquisition of the capital stock of the companies which comprised the Inco Alloys International high performance nickel alloys business unit of Inco (the "IAI Acquisition"), and that the Sellers breached the terms of the related Stock Purchase Agreement. The Sellers have filed a counterclaim against the Company seeking in excess of $13 million, which the Sellers claim is owed by the Company under the terms of the Stock Purchase Agreement. The Company intends to vigorously defend against the counterclaim. The lawsuit is still in the discovery stage. At this point in the 11 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) September 30, 2001 (Unaudited) proceeding, it is not possible to know if the Company will recover significant damages from the Sellers, or may ultimately be required to pay any or all of the amount sought by the Sellers. OTHER MATTERS From time to time, the Company is involved in legal proceedings relating to claims arising out of its operations in the normal course of business. Except as discussed above, the Company does not believe that it is presently a party to any proceedings that are likely to have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. 12 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) September 30, 2001 (Unaudited) NOTE 5 - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share for the three month and nine month periods ended September 30, 2000 and 2001:

Potential common shares resulting from stock options and convertible preferred stock were excluded from the calculation of diluted earnings per share because their inclusion would have had an antidilutive effect on earnings per share. 13 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) September 30, 2001 (Unaudited) NOTE 6 - COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) for the three month and nine month periods ended September 30, 2000 and 2001 consisted of the following:

Accumulated other comprehensive loss consists of the following at December 31, 2000 and September 30, 2001:

14 NOTE 7 - FINANCIAL INSTRUMENTS AND RISK MANAGEMENT Effective January 1, 2001, the Company adopted the Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133")." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The intended use of the derivative and its designation as either a fair value hedge or cash flow hedge determines when the gains or losses on the derivatives are to be reported in earnings and when they are to be reported as a component of other comprehensive income. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. As part of its risk management strategy, the Company has entered into financial instrument transactions which attempt to manage and reduce the impact of changes in commodity prices, foreign currency exchange rates, and interest rates. Financial instruments utilized include forward purchase contracts, forward currency and currency option contracts, and interest rate swap agreements. During the quarter ended September 30, 2001, the Company recorded net losses to accumulated other comprehensive income of $847,000, net of tax, for the change in fair value of derivatives designated as effective hedges. Additionally, losses of $159,000, net of tax, were reclassified from accumulated other comprehensive income to earnings due to the settlement of derivatives. The Company also recorded other expense of $1,507,000 related to its hedging instruments. NOTE 8 - EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). This statement changes the accounting for goodwill and intangible assets. Under SFAS 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually, or more frequently if impairment indicators arise, for impairment. Separable intangible assets which have finite lives will continue to be amortized over their useful lives, with no maximum life. With respect to goodwill and intangible assets acquired prior to July 1, 2001, companies are required to adopt SFAS 142 in their fiscal year beginning after December 15, 2001. The Company anticipates adopting SFAS 142 in fiscal 2002 and has not yet determined the impact on the overall financial condition of the Company, if any, which may result. Amortization of existing goodwill is $0.1 million annually. The Company has also considered SFAS No. 141 ("Business Combinations"), SFAS No. 142 ("Accounting for Asset Retirement Obligations") and SFAS No. 144 ("Accounting for the Impairment or Disposal of Long-Lived Assets") and has determined that each is not applicable to the Company's current operations. 15 NOTE 9 - LONG TERM DEBT In March of 2001, the Company entered into an amendment of its senior credit facility, which modified certain financial covenants through the quarter ending March 31, 2002. As of the quarter ending June 30, 2002, the Company believes it likely will not be able to meet certain financial covenants set forth in the first amendment. Consequently, in accordance with generally accepted accounting principles and the Financial Accounting Standards Board Emerging Issues Task Force ("EITF") pronouncement EITF 86-30 ("Classification of Obligations When A Violation Is Waived By The Creditor"), as of September 30, 2001, substantially all of the Company's long-term debt is being reclassified to current debt in the consolidated balance sheet. The Company is pursuing efforts to restructure or modify the terms of the Company's debt under the credit agreement and believes it has sufficient liquidity to fund operating requirements in the interim. 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Statements included in this Management Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report that do not relate to present or historical conditions are "forward looking statements" within the meaning of that term in Section 21E of the Securities Exchange Act of 1934, as amended. Additional oral or written statements may be made from time to time, and such statements may be included in documents filed with the Securities and Exchange Commission. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the actual results, performance or achievements of the Company to be materially different from those expressed or implied by such forward-looking statements. Such factors include economic slowdowns and recessions (especially in the aerospace industry, in which a substantial portion of the Company's customers are concentrated); the demand for the Company's products; the availability and pricing of raw materials used in the manufacture of the Company's products; the pricing of natural gas and electricity; the reliable operation of the Company's manufacturing facilities and equipment; the Company's ability to evaluate, finance and integrate acquired businesses, products and companies into the Company's existing business and operations; the Company's ability to effectively compete in the industries in which it does business; the Company's possible inability to restructure or modify the terms of its debt; the Company's ability to successfully negotiate new labor agreements and otherwise maintain favorable relations with its employees, a majority of whom are unionized; the Company's ability to comply with existing and future environmental laws and regulations, the accuracy of its current estimates of existing environmental liabilities and the possibility that currently unknown environmental liabilities may be discovered. OVERVIEW The Company manufactures high-performance nickel-based alloys, superalloys and special alloys which are highly engineered metal alloys designed to withstand extremes of heat, stress, and corrosion. The Company conducts its business through three principal operating segments. The Premium Alloys Division manufactures a comprehensive range of premium grade, nickel-based and cobalt-based wrought superalloy and special alloy long products in billet and bar forms, which are used primarily in jet engines. This division also produces shape memory alloys, known as Nitinol, which is used primarily in medical and dental applications, and powder metallurgy superalloy products used principally in military and the latest generation of large commercial jet engines. The Huntington Alloys Division manufactures nickel-based alloys in a broad range of product forms, including billet, bar, rod, sheet, strip, plate, tubulars, and rod-in-coil. The division also manufactures and sells nickel-based welding consumables and high-performance nickel-based alloy and stainless steel wire products. The Wiggin Alloys Division manufactures nickel-based alloys in billet, bar, rod, extruded section, narrow strip, wire, foil, sheet, rod-in-coil, and tubular product forms. The organization also includes a network of distribution facilities and service centers throughout Europe. Net Sales. For the nine months ended September 30, 2001, the Premium Alloys Division, the Huntington Alloys Division, and the Wiggin Alloys Division accounted for 25.4%, 51.7%, and 22.9%, respectively, of the Company's net sales of $559.0 million. Net sales include sales of the Company's high-performance nickel-based alloy, superalloy, and special alloy products, as well as revenue earned from toll conversion. Sales of the Company's products are made under conventional purchase orders, one-year supply contracts, long-term firm price contracts and indexed price contracts. Long-term firm price and indexed price contracts have become more prevalent in the superalloy industry because jet engine manufacturers are required to provide firm price quotations to airlines for jet engines to be delivered several years into the future. To the extent that it has entered into long-term agreements, the Company has sought pricing terms which are either indexed or otherwise accommodate changes in product and raw material markets. Export sales represent a significant portion of the Company's business. During the nine months ended September 30, 2001, sales by domestic businesses of the Company to purchasers outside of the United States totaled 15.9% of the Company's total net sales. 17 Cost of Goods Sold. The high-performance nickel-based alloy, superalloy and special alloy industry is characterized by high capital investment and fixed costs, therefore profitability is significantly affected by changes in volume. Variable costs such as raw materials, labor, supplies and energy (primarily electricity and natural gas) generally account for more than 70 percent of the Company's cost of goods sold. Fixed costs, which include indirect overhead and depreciation, constitute the remainder of the Company's cost of goods sold. The Company has undertaken in previous years and continues to focus on initiatives to maintain and improve its efficiency and cost position. The Company consumes large amounts of electricity and natural gas in the manufacture of its products. The prices for electricity, natural gas, and other energy resources are subject to market conditions and may be volatile. As a result, any increase in the cost of such resources may have a material adverse effect on the Company's business, financial condition, results of operations or cash flows. See " - Forward Looking Statements." The financial performance of the Company's U.S. domestic operations was adversely impacted by significantly higher natural gas costs during 2000 and in the nine months ended September 30, 2001. The Company's superalloy and special alloy products are comprised of varying amounts of nickel and nickel-bearing scrap (often representing 50% or greater). Therefore, product costs are impacted more by the supply and price of nickel and nickel-bearing scrap than by other materials. The price the Company pays for nickel is usually based upon quoted prices on the London Metals Exchange (the "LME") plus a premium due to quality, location, and volume purchased. Certain of the Company's long-term sales agreements, referred to as indexed price sales contracts, provide for certain price adjustments to reflect changes in the cost of raw materials, principally nickel. Most of the Company's product sales orders are expected to be made under firm price contracts which do not provide for raw material price adjustments. In an attempt to mitigate the risks associated with raw material price fluctuations and to match raw material purchases with firm price contracts, the Company often enters into forward contracts to manage its exposure to changes in nickel prices and also enters into contracts for the purchase of scrap with customers. As a result, in the short term, changes in the prices of raw materials do not necessarily impact the current period revenue and cost of sales. A substantial majority of the nickel forward contracts result in the Company taking possession of the inventory; however, certain of these contracts are settled in cash. For the nickel forward contracts settled in cash, the Company makes or receives payment equal to the net change in value of the contract at its maturity. Substantially all contracts are designated as hedges of the Company's firm sales commitments, are timed to correspond to the commitment period, and are effective in hedging the Company's exposure to changes in nickel prices during that cycle. At September 30, 2001, the Company had open purchase contracts with a notional principal value of approximately $52.9 million. The fair value of the material covered by these contracts, based on the September 30, 2001 price quoted on the LME, was approximately $41.8 million. Unrealized gains and losses on the contracts, which have been designated as effective hedges on firm sales commitments have been deferred. Selling, General and Administrative Expenses. Selling, general and administrative expenses represent costs associated with sales and marketing, research and development, legal expenses, and general corporate administration. Certain freight and handling costs have been reclassed among net sales, cost of goods sold and selling, general and administrative expenses for the twelve month period ended December 31, 2000 and subsequent periods. This reclassification was recorded in the quarter ended September 30, 2001 in order to be consistent with the terms of EITF 00-10 regarding the classification of freight and handling costs. As a result of EITF 00-10, net sales increased $1.2 million, cost of goods sold increased $2.2 million and selling, general and administrative expenses decreased $1.0 million for the nine month period ended September 30, 2000. Net sales increased $0.8 million, cost of goods sold increased $1.5 million and selling, general and administrative expenses decreased $0.7 million for the nine month period ended September 30, 2001. 18 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, statement of operations data as a percentage of net sales.

THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THREE MONTHS ENDED SEPTEMBER 30, 2000. NET SALES. Premium Alloys. Net sales increased $8.2 million, or 21.3%, from $38.4 million in the three months ended September 30, 2000 to $46.6 million in the three months ended September 30, 2001. An increase in sales volume accounted for $6.2 million of the above increase and an increase in average realized selling prices accounted for $2.0 million. This increase in sales is primarily attributable to increased sales volume and average realized selling prices for nickel-based superalloys and special alloys from growing markets for land-based gas turbines used in electrical power generation and improved conditions in the commercial aerospace end-market. Huntington Alloys. Net sales increased $5.3 million, or 5.9%, from $90.6 million in the three months ended September 30, 2000 to $95.9 million in the three months ended September 30, 2001. An increase in total average realized selling prices accounted for $10.1 million of the above increase, offset by a decrease in sales volume which accounted for $(4.8) million. The Company realized increased average realized selling prices for nickel-based superalloys and special alloys from growing markets for land-based gas turbines used in electrical power generation and improved conditions in the commercial aerospace end-market. However, this increase was offset by reduced sales volume and average realized selling prices for the Company's products used in consumer-related goods (most notably, in the automotive and appliance industries) and continued weakness in the chemical processing industry. Wiggin Alloys. Net sales increased $5.1 million, or 15.2%, from $33.6 million in the three months ended September 30, 2000 to $38.7 million in the three months ended September 30, 2001. An increase in sales volume accounted for $6.5 million of the above increase, offset by a decrease in total average realized selling prices which accounted for $(1.4) million. The Company realized increased sales volume for nickel-based superalloys and special alloys due to improved conditions in the commercial aerospace end-market. 19 COST OF GOODS SOLD. Premium Alloys. Cost of goods sold decreased $0.9 million, or 2.3%, from $38.1 million in the three months ended September 30, 2000 to $37.2 million in the three months ended September 30, 2001. As a percentage of net sales, cost of goods sold decreased from 99.1% in the three months ended September 30, 2000 to 79.8% in the three months ended September 30, 2001, primarily as a result of fixed costs being absorbed over a higher volume of sales, the impact of increased selling prices as mentioned above and lower raw material costs, principally nickel. Huntington Alloys. Cost of goods sold decreased $5.7 million, or 5.8%, from $97.4 million in the three months ended September 30, 2000 to $91.7 million in the three months ended September 30, 2001. As a percentage of net sales, cost of goods sold decreased from 107.6% in the three months ended September 30, 2000 to 95.7% in the three months ended September 30, 2001, primarily as a result of the impact of increased selling prices as mentioned above and lower raw material costs, principally nickel. Wiggin Alloys. Cost of goods sold increased $5.0 million, or 15.9%, from $31.0 million in the three months ended September 30, 2000 to $36.0 million in the three months ended September 30, 2001. As a percentage of net sales, cost of goods sold increased from 92.2% in the three months ended September 30, 2000 to 92.8% in the three months ended September 30, 2001. Corporate. Cost of goods sold not allocated to an operating segment increased $0.1 million, from $1.4 million in the three months ended September 30, 2000 to $1.5 million in the three months ended September 30, 2001. Cost of goods sold included in this category consists principally of the amortization of deferred financing costs and amortization of the covenant not to compete and certain other costs associated with the IAI Acquisition. GROSS PROFIT (LOSS). Premium Alloys. Gross profit (loss) increased $9.1 million, from $0.3 million in the three months ended September 30, 2000 to $9.4 million in the three months ended September 30, 2001. Huntington Alloys. Gross profit (loss) increased $11.0 million, or 160.6%, from $(6.8) million in the three months ended September 30, 2000 to $4.2 million in the three months ended September 30, 2001. Wiggin Alloys. Gross profit (loss) increased $0.1 million, or 6.6%, from $2.6 million in the three months ended September 30, 2000 to $2.7 million in the three months ended September 30, 2001. SELLING, GENERAL AND ADMINISTRATIVE. Premium Alloys. Selling, general and administrative expenses decreased $1.0 million, or 45.7%, from $2.2 million in the three months ended September 30, 2000 to $1.2 million in the three months ended September 30, 2001 as a result of reduced sales, marketing, administrative and research expenditures as well as a reallocation of costs to other segments. Selling, general and administrative expenses as a percentage of net sales decreased from 5.9% in the three months ended September 30, 2000 to 2.7% in the three months ended September 30, 2001. Huntington Alloys. Selling, general and administrative expenses increased $0.4 million, or 9.8%, from $3.5 million in the three months ended September 30, 2000 to $3.9 million in the three months ended September 30, 2001 as a result of increased sales and marketing expenditures, including costs reallocated by other segments, offset by reduced administrative and research expenditures. Selling, general and administrative expenses as a percentage of net sales increased from 3.8% in the three months ended September 30, 2000 to 4.0% in the three months ended September 30, 2001. 20 Wiggin Alloys. Selling, general and administrative expenses increased $0.1 million, or 35.3%, from $0.5 million in the three months ended September 30, 2000 to $0.6 million in the three months ended September 30, 2001 as a result of increased sales, marketing and research expenditures. Selling, general and administrative expenses as a percentage of net sales increased from 1.4% in the three months ended September 30, 2000 to 1.7% in the three months ended September 30, 2001. Corporate. Selling, general and administrative expenses not allocated to an operating segment increased $1.6 million from zero in the three months ended September 30, 2000 to $1.6 million in the three months ended September 30, 2001. This increase is primarily attributable to increased legal expenditures associated with the Company's lawsuit against Inco and certain other administrative expenses. OPERATING INCOME (LOSS). Premium Alloys. Operating income (loss) increased $10.1 million, or 524.3%, from $(1.9) million in the three months ended September 30, 2000 to $8.2 million in the three months ended September 30, 2001. Operating income (loss) as a percentage of net sales increased from (5.0)% in the three months ended September 30, 2000 to 17.5% in the three months ended September 30, 2001. Huntington Alloys. Operating income (loss) increased $10.6 million, or 103.3%, from $(10.3) million in the three months ended September 30, 2000 to $0.3 million in the three months ended September 30, 2001. Operating income (loss) as a percentage of net sales increased from (11.4%) in the three months ended September 30, 2000 to 0.4% in the three months ended September 30, 2001. Subsequent to the acquisition of the Huntington Alloys segment in October, 1998, the segment was impacted by several negative events. These included a work stoppage at the Huntington facility which lasted eleven weeks, turnover of senior management, distractions and inefficiencies related to the implementation of a new information system and unanticipated increases in the cost of raw material. These events resulted in delays in accomplishing post-merger integration programs and created distractions for the Company in responding to strategic changes in the marketplace. As the unusual events have been resolved, the Company has been able to focus on improving the profitability of the segment in late 2000 and throughout 2001. Wiggin Alloys. Operating income (loss) was $2.1 million in the three months ended September 30, 2000 and in the three months ended September 30, 2001. Operating income (loss) as a percentage of net sales decreased from 6.4% in the three months ended September 30, 2000 to 5.5% in the three months ended September 30, 2001. INTEREST EXPENSE. Interest expense decreased $1.7 million, or 20.8%, from $8.3 million in the three months ended September 30, 2000 to $6.6 million in the three months ended September 30, 2001, primarily due to a decrease in indebtedness and interest rates. OTHER EXPENSE (INCOME). Other expense (income) increased $(0.3) million, from $(0.7) million in the three months ended September 30, 2000 to $(1.0) million in the three months ended September 30, 2001. This increase is primarily attributable to an unrealized foreign currency gain of $1.6 million related to the Company's intercompany debt, which is denominated in U.S. dollars offset by the Company's adoption of SFAS No. 133 which resulted in a $1.5 million charge. 21 INCOME TAX EXPENSE (BENEFIT). Income tax expense (benefit) decreased $7.8 million, or 107.0%, from $(7.3) million in the three months ended September 30, 2000 to $0.5 million in the three months ended September 30, 2001, primarily due to the increase in income before income taxes. NET INCOME (LOSS). Net income (loss) increased $13.1 million, or 115.5%, from $(11.3) million in the three months ended September 30, 2000 to $1.8 million in the three months ended September 30, 2001 for the reasons stated above. Net income (loss) as a percentage of net sales increased from (7.0%) in the three months ended September 30, 2000 to 1.0% in the three months ended September 30, 2001. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH NINE MONTHS ENDED SEPTEMBER 30, 2000. NET SALES. Premium Alloys. Net sales increased $19.1 million, or 15.6%, from $122.7 million in the nine months ended September 30, 2000 to $141.8 million in the nine months ended September 30, 2001. An increase in sales volume accounted for $16.7 million of the above increase and an increase in average realized selling prices accounted for $2.4 million. This increase in sales is primarily attributable to increased sales volume and average realized selling prices for nickel-based superalloys and special alloys from growing markets for land-based gas turbines used in electrical power generation and improved conditions in the commercial aerospace end-market. Huntington Alloys. Net sales increased $13.7 million, or 5.0%, from $275.6 million in the nine months ended September 30, 2000 to $289.3 million in the nine months ended September 30, 2001. An increase in total average realized selling prices accounted for $30.0 million of the above increase, offset by a decrease in sales volume which accounted for $(16.3) million. The Company realized increased average realized selling prices for nickel-based superalloys and special alloys from growing markets for land-based gas turbines used in electrical power generation and improved conditions in the commercial aerospace end-market. However, this increase was offset by reduced sales volume and average realized selling prices for the Company's products used in consumer-related goods (most notably, in the automotive and appliance industries) and continued weakness in the chemical processing industry. Wiggin Alloys. Net sales increased $10.8 million, or 9.3%, from $117.1 million in the nine months ended September 30, 2000 to $127.9 million in the nine months ended September 30, 2001. An increase in sales volume accounted for $20.1 million of the above increase, offset by a decrease in total average realized selling prices which accounted for $(9.2) million. The Company realized increased sales volume for nickel-based superalloys and special alloys due to improved conditions in the commercial aerospace end-market. COST OF GOODS SOLD. Premium Alloys. Cost of goods sold increased $4.7 million, or 4.2%, from $111.7 million in the nine months ended September 30, 2000 to $116.4 million in the nine months ended September 30, 2001. As a percentage of net sales, cost of goods sold decreased from 91.0% in the nine months ended September 30, 2000 to 82.1% in the nine months ended September 30, 2001, primarily as a result of fixed costs being absorbed over a higher volume of sales, the impact of increased selling prices as mentioned above and lower raw material costs, principally nickel. 22 Huntington Alloys. Cost of goods sold decreased $18.0 million, or 6.0%, from $298.9 million in the nine months ended September 30, 2000 to $280.9 million in the nine months ended September 30, 2001. As a percentage of net sales, cost of goods sold decreased from 108.5% in the nine months ended September 30, 2000 to 97.1% in the nine months ended September 30, 2001, primarily as a result of the impact of increased selling prices as mentioned above and lower raw material costs, principally nickel. Wiggin Alloys. Cost of goods sold increased $13.1 million, or 12.3%, from $107.4 million in the nine months ended September 30, 2000 to $120.5 million in the nine months ended September 30, 2001. As a percentage of net sales, cost of goods sold increased from 91.7% in the nine months ended September 30, 2000 to 94.2% in the nine months ended September 30, 2001. Corporate. Cost of goods sold not allocated to an operating segment increased $0.3 million from $4.2 million in the nine months ended September 30, 2000 to $4.5 million in the nine months ended September 30, 2001. Cost of goods sold included in this category consists principally of the amortization of deferred financing costs and amortization of the covenant not to compete and certain other costs associated with the IAI Acquisition. GROSS PROFIT (LOSS). Premium Alloys. Gross profit (loss) increased $14.4 million, or 130.8%, from $11.0 million in the nine months ended September 30, 2000 to $25.4 million in the nine months ended September 30, 2001. Huntington Alloys. Gross profit (loss) increased $31.7 million from $(23.3) million in the nine months ended September 30, 2000 to $8.4 million in the nine months ended September 30, 2001. Wiggin Alloys. Gross profit (loss) decreased $2.3 million, or 23.6%, from $9.7 million in the nine months ended September 30, 2000 to $7.4 million in the nine months ended September 30, 2001. SELLING, GENERAL AND ADMINISTRATIVE. Premium Alloys. Selling, general and administrative expenses decreased $2.2 million, or 35.1%, from $6.3 million in the nine months ended September 30, 2000 to $4.1 million in the nine months ended September 30, 2001 as a result of reduced sales, marketing, administrative and research expenditures as well as a reallocation of costs to other segments. Selling, general and administrative expenses as a percentage of net sales decreased from 5.1% in the nine months ended September 30, 2000 to 2.9% in the nine months ended September 30, 2001. Huntington Alloys. Selling, general and administrative expenses increased $0.9 million, or 8.6%, from $10.1 million in the nine months ended September 30, 2000 to $11.0 million in the nine months ended September 30, 2001 as a result of increased sales, marketing and administrative expenditures, including costs reallocated by other segments, offset by reduced research expenditures. Selling, general and administrative expenses as a percentage of net sales increased from 3.7% in the nine months ended September 30, 2000 to 3.8% in the nine months ended September 30, 2001. Wiggin Alloys. Selling, general and administrative expenses increased $0.1 million, or 8.0%, from $1.8 million in the nine months ended September 30, 2000 to $1.9 million in the nine months ended September 30, 2001 as a result of increased sales, marketing and research expenditures. Selling, general and administrative expenses as a percentage of net sales was 1.5% in the nine months ended September 30, 2000 and in the nine months ended September 30, 2001. 23 Corporate. Selling, general and administrative expenses not allocated to an operating segment increased $4.9 million from $1.0 million in the nine months ended September 30, 2000 to $5.9 million in the nine months ended September 30, 2001. This increase is primarily attributable to increased legal expenditures associated with the Company's lawsuit against Inco and certain other administrative expenses. OPERATING INCOME (LOSS). Premium Alloys. Operating income (loss) increased $16.6 million, or 353.0%, from $4.7 million in the nine months ended September 30, 2000 to $21.3 million in the nine months ended September 30, 2001. Operating income (loss) as a percentage of net sales increased from 3.8% in the nine months ended September 30, 2000 to 15.0% in the nine months ended September 30, 2001. Huntington Alloys. Operating income (loss) decreased $(30.8) million, or 92.3%, from $(33.4) million in the nine months ended September 30, 2000 to $(2.6) million in the nine months ended September 30, 2001. Operating income (loss) as a percentage of net sales decreased from (12.1%) in the nine months ended September 30, 2000 to (0.9%) in the nine months ended September 30, 2001. Subsequent to the acquisition of the Huntington Alloys segment in October, 1998, the segment was impacted by several negative events. These included a work stoppage at the Huntington facility which lasted eleven weeks, turnover of senior management, distractions and inefficiencies related to the implementation of a new information system and unanticipated increases in the cost of raw material. These events resulted in delays in accomplishing post-merger integration programs and created distractions for the Company in responding to strategic changes in the marketplace. As the unusual events have been resolved, the Company has been able to focus on improving the profitability of the segment in late 2000 and throughout 2001. Wiggin Alloys. Operating income (loss) decreased $2.4 million, or 30.5%, from $7.9 million in the nine months ended September 30, 2000 to $5.5 million in the nine months ended September 30, 2001. Operating income (loss) as a percentage of net sales decreased from 6.8% in the nine months ended September 30, 2000 to 4.3% in the nine months ended September 30, 2001. INTEREST EXPENSE. Interest expense decreased $1.7 million, or 7.4%, from $23.0 million in the nine months ended September 30, 2000 to $21.3 million in the nine months ended September 30, 2001, primarily due to a decrease in indebtedness and interest rates. OTHER EXPENSE (INCOME). Other expense (income) increased $3.4 million from $(3.2) million in the nine months ended September 30, 2000 to $0.2 million in the nine months ended September 30, 2001. This increase is primarily attributable to an unrealized foreign currency loss of $0.5 million related to the Company's intercompany debt, which was denominated in U.S. dollars and the Company's adoption of SFAS No. 133 which resulted in a $2.4 million charge. 24 INCOME TAX EXPENSE (BENEFIT). Income tax expense (benefit) decreased $16.1 million, from $(17.8) million in the nine months ended September 30, 2000 to $(1.7) million in the nine months ended September 30, 2001, primarily due to the increase in income before income taxes. The effective tax rate decreased from 39.9% in the nine months ended September 30, 2000 to 25.9% in the nine months ended September 30, 2001 due to certain foreign losses/expenses upon which no tax benefit was provided. NET INCOME (LOSS). Net income (loss) decreased $22.1 million, from $(26.9) million in the nine months ended September 30, 2000 to $(4.8) million in the nine months ended September 30, 2001 for the reasons stated above. LIQUIDITY AND CAPITAL RESOURCES The Company's liquidity needs arise primarily from capital investments, working capital requirements, and principal and interest payments on indebtedness. The Company has historically met these liquidity requirements with funds generated from operations and from short-term and long-term debt financing (including borrowings from its principal stockholders). The Company's business is capital intensive and requires substantial expenditures for, among other things, the purchase and maintenance of equipment used in the manufacturing process and compliance with environmental laws. Net cash provided by (used in) operating activities was $(38.3) million and $39.2 million for the nine months ended September 30, 2000 and 2001, respectively. Net cash provided by operating activities for the nine months ended September 30, 2001 amounted to $39.2 million, consisting primarily of a net loss of $4.8 million offset by depreciation and amortization expense of $30.6 million and decrease in working capital of $13.3 million, which includes decreases in accounts receivable and inventory. Net cash used in operating activities for the nine months ended September 30, 2000 amounted to $38.3 million, consisting primarily of a net loss of $26.9 million, which included increases in accounts receivable and inventory, offset by depreciation and amortization expense of $30.4 million. Capital expenditures were $5.5 million and $5.7 million for the nine months ended September 30, 2000 and 2001, respectively. The Company's principal sources of funds are (i) funds generated from operations and (ii) borrowings under the Company's Senior Secured Credit Agreement with Credit Lyonnais, as agent, and other financial institutions (the "Credit Agreement"), which the Company entered into in connection with the IAI Acquisition. The Credit Agreement provides for two term loans (the "Tranche A Term Loan" and the "Tranche B Term Loan," collectively, the "Term Loans") and a $100 million revolving credit and letter of credit facility (the "Revolving Credit Facility"). Proceeds from the Term Loans and a portion of the Revolving Credit Facility were used to finance a portion of the purchase price of the IAI Acquisition. Under the Revolving Credit Facility, the Company can borrow, repay and re-borrow from time to time up to $100 million in the aggregate, subject to certain restrictions described below. The amount the Company may borrow under the Credit Agreement is reduced by the aggregate amount of any letters of credit issued for the account of the Company. The Revolving Credit Facility terminates on October 28, 2003. 25 The Tranche A Term loan is scheduled to be repaid in quarterly installments through 2003 and the Tranche B Term loan is scheduled to be repaid in quarterly installments through 2005 as follows (in thousands):

The Company has made all scheduled repayments that have come due. The Company is required to prepay amounts outstanding under the Credit Agreement out of any excess cash flow of the Company. Excess cash flow is defined as consolidated earnings before interest, taxes, depreciation and amortization ("EBITDA"), minus the sum of debt service for the year, voluntary prepayments of the Term Loans, capital expenditures, income tax expense, restricted payments (as defined), and consideration for permitted acquisitions (as defined). If the Company were to have excess cash flow, prepayments would be applied first to the Term Loans, pro rata, then to amounts outstanding under the Revolving Credit Facility and finally as cash collateral against outstanding letters of credit. So long as any amounts remain outstanding under the Tranche A Term Loan, lenders under the Tranche B Term Loan may elect not to have their portion of the Tranche B Term Loan prepaid until the Tranche A Term Loan is paid in full. The Stock Purchase Agreement regarding the IAI Acquisition (the "Stock Purchase Agreement") set forth a post-closing procedure for adjusting the purchase price. Pursuant to the Credit Agreement, the Company was required to prepay amounts outstanding under the Credit Agreement in an amount equal to any adjustments to the purchase price received by the Company. During 1999, the Company and the Sellers followed the post-closing procedure provided in the Stock Purchase Agreement for adjusting the purchase price. As a result of this process and pursuant to the terms of the Credit Agreement, on May 4, 2000 the Company prepaid $1,043,600 towards the Tranche A Term Loan and $956,400 towards the Tranche B Term Loan. In December 2000, the Company sold substantially all of the plant assets and intangible assets in its dental amalgam operation located in Ann Arbor, Michigan to Kerr Corporation for an aggregate purchase price of $1,141,000. The terms of the Company's Credit Agreement require the Company to apply the net proceeds from divested assets towards the Tranche A and Tranche B Term Loans on a pro rata basis. Pursuant to this requirement, on February 5, 2001 the Company prepaid $408,000 towards the Tranche A Term Loan and $426,000 towards the Tranche B Term Loan. On May 8, 2001, the Company prepaid an additional $105,000 towards the Tranche A Term Loan and $118,000 towards the Tranche B Term Loan. The Company's obligations under the Credit Agreement are secured by all of the assets of the Company and its domestic subsidiaries and by a pledge of the capital stock of certain subsidiaries. The Credit Agreement also contains covenants restricting the ability of the Company to, among other things, make certain restricted payments, permit liens on its assets, guarantee indebtedness or enter into certain transactions with affiliates. The Credit Agreement also requires the Company to satisfy certain financial tests relating to, among other things, the Company's minimum consolidated EBITDA, consolidated leverage ratio, interest coverage ratio and fixed charge coverage ratio. At September 30, 1999, the Company was in violation of the revised minimum EBITDA and leverage ratio financial tests included in the Credit Agreement. The lenders under the Credit Agreement (the "Senior Lenders") agreed to amend the terms of the Credit Agreement and waive the defaults provided the Company agree to pursue additional capital in the form of subordinated loans. 26 Effective December 17, 1999, the Company entered into the Subordinated Loan Agreement (the "Subordinated Loan Agreement") with Societe Industrielle de Materiaux Avances ("SIMA"), which is the owner of 38.5% of the Company's outstanding common stock. The Subordinated Loan Agreement provides for $20 million in term loans (the "Subordinated Term Loans") and a $30 million revolving credit facility (the "Subordinated Revolving Credit Facility"). Proceeds from the Subordinated Term Loans were used for working capital purposes and to make required repayments to the Senior Lenders under the Credit Agreement. Under the Subordinated Revolving Credit Facility, the Company could initially borrow ("Subordinated Revolving Loans"), repay (subject to certain restrictions) and re-borrow from time to time up to $30 million in the aggregate. As a result of the conversion of $27.6 million of Subordinated Revolving Loans to Subordinated Term Loans (as described below), the Company could borrow, repay (subject to certain restrictions) and reborrow from time to time up to $2.4 million in the aggregate until the expiration of SIMA's commitment to make Subordinated Revolving Loans to the Company on August 15, 2001. The Subordinated Term Loans and outstanding Subordinated Revolving Loans mature on July 28, 2006 (the "Maturity Date"). Amounts outstanding under the Subordinated Loan Agreement bear interest at a rate per year equal to the three-month London Interbank Offered Rate plus 1%. Accrued interest on both the Subordinated Term Loans and Subordinated Revolving Loans is to be paid in kind by addition to the principal of the Subordinated Term Loans on the last day of each calendar quarter. Effective December 29, 1999, the Company entered into the Third Amendment to Credit Agreement and Limited Waiver (the "Third Amendment"). Among other things, the Third Amendment: waived the events of default which resulted from the Company not complying with the minimum EBITDA and leverage ratio financial tests at September 30, 1999; reduced the maximum amount available to the Company under the Revolving Credit Facility from $150 million to $100 million; provided that the aggregate amount outstanding under the Revolving Credit Facility may not exceed $76 million unless Subordinated Revolving Loans are outstanding in a principal amount of at least $30 million; revised the minimum EBITDA financial tests through the period ending March 31, 2001, and suspended all other financial tests until the quarter ended June 30, 2001, at which time all financial tests as set forth in the First Amendment were to again be effective; limited capital expenditures to a maximum of $15 million in 2000 and $7.5 million during the first six months of 2001, unless capital expenditures in excess of those amounts were funded by the issuance and sale of stock of the Company to SIMA or from additional advances by SIMA of Subordinated Term Loans; and prohibited payments of dividends on the Series A Convertible Preferred Stock unless such payments were funded by the issuance and sale of stock of the Company to SIMA or from additional advances by SIMA of Subordinated Term Loans. The Third Amendment also prescribed a procedure to be followed in the event that the Company's actual consolidated EBITDA through the period ending March 31, 2001 was less than the amounts required by the revised minimum EBITDA financial tests. As of the end of each quarter during such period, if the Company's actual consolidated EBITDA for the prior twelve months was less than the minimum EBITDA levels required by the Third Amendment, any outstanding Subordinated Revolving Loans were converted to Subordinated Term Loans in an amount equal to the difference between the Company's actual consolidated EBITDA and certain amounts set forth in the Third Amendment. When the required amount was converted from Subordinated Revolving Loans to Subordinated Term Loans, the Company was deemed to have satisfied the minimum EBITDA financial test for the twelve-month period. Pursuant to this procedure, during 2000, $27.6 million of Subordinated Revolving Loans were converted to Subordinated Term Loans. The Company's obligations under the Subordinated Loan Agreement are unsecured and expressly subordinated to its obligations under the Credit Agreement. Pursuant to a Debt Subordination Agreement entered into by SIMA and the Company for the benefit of the Senior Lenders, the Company may not repay the Subordinated Term Loans until all amounts due to the Senior Lenders have been paid. Additionally, the Company may not repay Subordinated Revolving Loans if an event of default exists under the Credit Agreement or would occur as a result of the payment or if the aggregate amount outstanding under the Revolving Credit Facility exceeds $76 million. 27 At September 30, 2001, the aggregate amount outstanding under the Revolving Credit Facility was $77.5 million. However, as a result of outstanding letters of credit issued under the Revolving Credit Facility, for purposes of determining borrowing availability, the balance outstanding under the Revolving Credit Facility is deemed to be $82.9 million. The amount outstanding under the Subordinated Revolving Credit Facility was $2.4 million at September 30, 2001. The aggregate amount outstanding under the Subordinated Term Loan was $63.3 million at September 30, 2001, due to the addition of accrued interest on the SIMA loans to the principal amount of the Subordinated Term Loan, the conversion of $27.6 million of Subordinated Revolving Loans to Subordinated Term Loans and additional advances from SIMA to pay dividends on the Company's Senior Preferred Stock (as defined below). Pursuant to an amendment to the Credit Agreement dated as of March 28, 2001 (the "Fourth Amendment"), amounts outstanding on the Tranche A Term Loan and amounts outstanding under the Revolving Credit Facility bear interest at the Company's option at (i) a base rate, which is the higher of the bank's short-term commercial reference rate or the Federal Funds rate plus .50%, plus a margin of 2.00% or (ii) the Eurodollar rate, which is the reserve adjusted New York interbank offered rate, plus a margin of 3.25%. The applicable margins under the Fourth Amendment for amounts outstanding on the Tranche B Term Loan are (i) for base rate loans, 2.50% and (ii) for Eurodollar rate loans, 3.75%. Prior to the Fourth Amendment, pursuant to an amendment to the Credit Agreement dated as of March 31, 1999 (the "First Amendment"), the applicable margins for amounts outstanding on the Tranche A Term Loan and amounts outstanding under the Revolving Credit Facility were (i) for base rate loans, 1.50% and (ii) for Eurodollar rate loans, 2.75%. The applicable margins under the First Amendment for amounts outstanding on the Tranche B Term Loan were (i) for base rate loans, 2.00% and (ii) for Eurodollar rate loans, 3.25%. A commitment fee of .375% to .50% per annum, depending on the Company's leverage ratio, on the unused portion of the Revolving Credit Facility is due quarterly. In addition to modifying the interest rates for amounts outstanding under the Credit Agreement, the Fourth Amendment, among other things, revised the minimum EBITDA financial tests through the period ending March 31, 2002, and suspended all other financial tests until the quarter ended June 30, 2002, at which time all financial tests as set forth in the First Amendment will again be effective; and limited capital expenditures to a maximum of $23 million in 2001 and $7.5 million during the first three months of 2002, unless capital expenditures in excess of those amounts are funded by the issuance and sale of stock of the Company to SIMA or from additional advances by SIMA of Subordinated Term Loans. Also in accordance with the terms of the Fourth Amendment, the Company has engaged an investment banking firm to act as financial advisor with respect to its strategic options. As of the quarter ending June 30, 2002, the Company believes it likely will not be able to meet certain financial covenants set forth in the first amendment. Consequently, in accordance with generally accepted accounting principles, as of September 30, 2001, substantially all of the Company's long-term debt is being reclassified to current debt in the consolidated balance sheet. As of September 30, 2001, the Company's total outstanding debt under the credit facility was $246.4 million. The Company is pursuing efforts to restructure or modify the terms of the Company's debt under the credit agreement and believes it has sufficient liquidity to fund operating requirements in the interim. The Company's Series A Convertible Preferred Stock ("Senior Preferred Stock") accrues cumulative dividends at the rate of 6.625% per annum, payable quarterly each January 28, April 28, July 28 and October 28, (each, a "Dividend Payment Date"). For each of the April 28, July 28, October 28, 2000 and for the January 28, April 28 and July 28, 2001 Dividend Payment Dates, the Company borrowed $1,606,563 from SIMA and declared and paid a dividend to the holders of Senior Preferred Stock with the proceeds of each loan. The Company has the right to defer payment of accumulated dividends. The Company exercised the right to defer payment on each Dividend Payment Date from the issuance of the Senior Preferred Stock (October 28, 1998) through the January 28, 2000 Dividend Payment Date and on the October 28, 2001 Dividend Payment Date. The terms of the Credit Agreement prohibited the Company from paying dividends as of those Dividend Payment Dates. As of September 30, 2001, the total amount of dividends accrued and unpaid was $10.3 million. Because the Company deferred payment of dividends for six quarterly dividend periods, the number of directors constituting the Company's Board of Directors will be increased by two members, and the holders of Senior 28 Preferred Stock will have the special right, voting separately as a single class, to elect two individuals to fill the newly created directorships. A special meeting of the holders of Senior Preferred Stock is scheduled for November 20, 2001. The Company does not expect the future costs of compliance with currently enacted environmental laws and adopted or proposed regulations to have a material impact on its liquidity and capital resources. However, the imposition of more strict standards or requirements under environmental laws and the possibility of increased enforcement or discovery of previously unknown liabilities could result in expenditures in excess of amounts estimated to be required for such matters. See " - Forward Looking Statements." The Company expects that cash and cash equivalents on hand, cash flow from operations and borrowing capacity under the Credit Agreement will be adequate to meet its anticipated operating requirements and planned capital expenditures over the next 12 months. See " - Forward Looking Statements." BACKLOG As of September 30, 2001, the Company's backlog orders aggregated approximately $322.7 million, compared to approximately $252.7 million at September 30, 2000. The Company defines backlog as firm orders, which are generally subject to cancellation by the customer. Substantially all orders in the backlog at September 30, 2001 are expected to be shipped within the next 12 months. Due to the cyclical nature of order entry experienced by the Company and its dependence on the aerospace industry, there can be no assurance that order entry will continue at current levels or that current firm purchase orders will not be canceled or delayed. INFLATION Although the Company's sales and results of operations are affected by the prices of raw materials used to make its products and the cyclicality of the aerospace industry, the Company does not believe that general economic inflation has had a material effect on its results of operations for the periods presented. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the potential loss arising from adverse changes in market rates and prices, such as commodity prices, foreign currency exchange rates and interest rates. The Company is exposed to these market risks. The Company has entered into financial instrument transactions which attempt to manage and reduce the impact of changes in commodity prices, foreign currency exchange rates, and interest rates. The Company is exposed to risk from changes in the price of commodities used in production between the date of a firm sales commitment and the date of delivery. The Company purchases forward commodity contracts to manage its exposure to changes in commodity prices, primarily nickel. A substantial portion of the forward commodity contracts result in the Company actually taking possession of the material, however, certain of the forward contracts result in the Company making or receiving payments equal to the net change in the value of the contract, which fluctuates with the price of the commodity. A 10% fluctuation in the price of the underlying commodities would change the fair value of the contracts settled in cash by approximately $64,000. However, since these contracts hedge the Company's firm sales commitments, any change in the fair value of the contracts would be offset by changes in the underlying value of the transaction being hedged. 29 A portion of the Company's operations consists of manufacturing and sales activities in foreign jurisdictions, principally in Europe. As a result, the Company's financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company distributes its products. The Company enters into forward currency and currency option contracts to mitigate the effect of currency transaction exposures. An overall 10% fluctuation in exchange rates would change the fair value of these contracts by approximately $100,000. At September 30, 2001, the Company has approximately $312.2 million of variable rate long-term debt. To manage its exposure to interest rate fluctuations on its variable rate debt, the Company has entered into two interest rate swap agreements. The first agreement has a notional amount of $55,500,000 through September 15, 2003 based on LIBOR at 5.95%. The second agreement has a notional value of $55,500,000 through September 15, 2003 based on LIBOR at 5.76%. Net payments or receipts under the swap agreements are recorded as adjustments to interest expense. Under these agreements, the Company makes or receives payments equal to the difference between fixed and variable interest rate payments on the notional amount. A 1% fluctuation in interest rates would change future interest expense on the $201.2 million of debt that is not covered by the swap agreements by approximately $2.0 million. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Reference is made to Item 3 of the Company's Annual Report on Form 10-K for the year ended December 31, 2000 and to Note 4 of the Notes to Condensed Consolidated Financial Statements included in Part I of this Report for descriptions of certain legal and environmental matters. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION (A) PRESS RELEASES The Company issued a press release dated November 12, 2001 disclosing certain information, including certain results of operations and earnings for the fiscal quarter ended September 30, 2001. The Company issued a press release dated November 6, 2001 announcing that it had reached an agreement with the United Steelworkers of America, District 8 - Local Union No. 40 on a new three-year contract in the Huntington, West Virginia facility. 30 The Company issued a press release dated November 5, 2001 announcing a distribution partnership with BIBUS Metals AG for the supply of nickel alloy forms to Lithuania, Latvia, Estonia, Poland, Czech Republic, Slovak Republic, Hungary, Romania and the countries comprising the former Yugoslavia. The Company issued a press release dated September 28, 2001 announcing the appointment of two new members to its Board of Directors, effective September 7, 2001. The Company issued a press release dated July 5, 2001 announcing the appointment of Dennis L. Wanlass to the position of Vice President and Chief Financial Officer. (B) RESIGNATION OF ROBERT F. DROPKIN Effective October 8, 2001, Robert F. Dropkin resigned as a Director of the Company. Mr. Dropkin continues to serve as Vice President, Secretary and Chief Legal Counsel of the Company. (C) FORWARD-LOOKING STATEMENTS Certain statements in this Report and in future filings by the Company with the Securities and Exchange Commission, in the Company's press releases and in oral statements made by or with the approval of an authorized executive officer of the Company constitute "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the actual results, performance or achievements of the Company to be materially different from those expressed or implied by such forward-looking statements. Such factors include economic slowdowns and recessions (especially in the aerospace industry, in which a substantial portion of the Company's customers are concentrated); the demand for the Company's products; the availability and pricing of raw materials used in the manufacture of the Company's products; the pricing of natural gas and electricity; the reliable operation of the Company's manufacturing facilities and equipment; the Company's ability to evaluate, finance and integrate acquired businesses, products and companies into the Company's existing business and operations; the Company's ability to effectively compete in the industries in which it does business; the Company's possible inability to restructure or modify the terms of its debt; the Company's ability to successfully negotiate new labor agreements and otherwise maintain favorable relations with its employees, a majority of whom are unionized; the Company's ability to comply with existing and future environmental laws and regulations, the accuracy of its current estimates of existing environmental liabilities and the possibility that currently unknown environmental liabilities may be discovered. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS (B) REPORTS ON FORM 8-K The Company did not file any reports on Form 8-K during the fiscal quarter ended September 30, 2001. 31 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. SPECIAL METALS CORPORATION Date: November 14, 2001 By: /s/ T. Grant John ------------------------------------------ T. Grant John President (Principal Executive Officer) Date: November 14, 2001 By: /s/ Dennis L. Wanlass ------------------------------------------ Dennis L. Wanlass Vice President and Chief Financial Officer (Principal Accounting Officer) 32

SPECIAL METALS CORP 10-Q