UNIVERSAL STAINLESS & ALLOY PRODUCTS INC - Quarter Report: 2011 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

For the Quarterly Period Ended September 30, 2011

OR

For the Transition Period from              to             

Commission File Number 000-25032

UNIVERSAL STAINLESS & ALLOY PRODUCTS, INC.

(Exact name of Registrant as specified in its charter)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of October 31, 2011, there were 6,833,303 shares of the Registrant’s Common Stock outstanding.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Quarterly Report on Form 10-Q contain forward-looking statements that reflect the current views of Universal Stainless & Alloy Products, Inc. (the “Company”) 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 Quarterly Report on Form 10-Q pursuant to the “safe harbor” provision of the Private Securities Litigation Reform Act of 1995.

The Company’s actual results may be affected by a wide range of factors including future compliance with Section 404 of the Sarbanes-Oxley Act of 2002; 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; risks related to property, plant and equipment, including the Company’s reliance on the continuing operation of critical manufacturing equipment; risks associated with labor matters; the Company’s ongoing requirement for continued compliance with laws and regulations, including applicable safety and environmental regulations; the ultimate outcome of the Company’s current and future litigation matters; risks related to acquisitions that the Company has or may make; and the impact of various economic, credit and market risk uncertainties. 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.

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Part I. FINANCIAL INFORMATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except Per Share Information)

(Unaudited)

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

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in Thousands)

(Unaudited)

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

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CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)

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

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(Dollars in Thousands)

(Unaudited)

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

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Basis of Presentation

The accompanying unaudited condensed consolidated statements of operations and statements of comprehensive income for the three- and nine-month periods ended September 30, 2011 and 2010, balance sheets as of September 30, 2011 and December 31, 2010, and statements of cash flows for the nine-month periods ended September 30, 2011 and 2010, have been prepared by Universal Stainless & Alloy Products, Inc. (the “Company”) in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading. Accordingly, these statements should be read in conjunction with the audited financial statements, and notes thereto, as of and for the year ended December 31, 2010 included in the Company’s Annual Report on Form 10-K. 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, 2011 and December 31, 2010 and the consolidated results of operations and of cash flows for the periods ended September 30, 2011 and 2010, and are not necessarily indicative of the results to be expected for the full year.

Recently Adopted Accounting Pronouncement

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income,” which amends current comprehensive income guidance. This accounting update eliminates the option to present the components of other comprehensive income as part of the statement of shareholders’ equity. Instead, the Company must report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. The Company adopted this guidance during the nine-month period ended September 30, 2011. The adoption of this guidance had no material impact on the Company’s condensed consolidated financial statements, as it only required a change in the format of presentation.

New Accounting Pronouncements

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurements (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”)”. This amendment provides a consistent definition of fair value and ensures that the fair value measurement and disclosure requirements are similar between GAAP and IFRS. The amendment clarifies the application of existing fair value measurements and disclosures, and changes certain principles or requirements for fair value measurements and disclosures. These provisions are effective for reporting periods beginning on or after December 15, 2011. This amendment is not expected to have a material impact on the Company’s condensed consolidated balance sheets, results of operations or cash flows.

In September 2011, the FASB issued ASU 2011-09, “Compensation – Retirement Benefits – Multiemployer Plans (Topic 715)”. This update is intended to provide more information about an employer’s financial obligations to a multiemployer pension plan and, therefore, help financial statement users better understand the financial health of all of the significant plans in which the employer participates. The amended provisions are effective for fiscal years, and interim periods within those years, ending on or after December 15, 2011. Early adoption is permitted and retrospective application is required. This amendment impacts disclosures only, and therefore adoption will not have an impact on the Company’s condensed consolidated balance sheets, results of operations or cash flows.

In September 2011, the FASB issued ASU 2011-08, “Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment,” which permits an entity to perform a qualitative assessment to determine whether it is more likely than not that a reporting unit’s fair value is less than its carrying value before applying the two-step goodwill impairment model that is currently in place. If it is determined through the qualitative assessment that a reporting unit’s fair value is more likely than not greater than its carrying value, the remaining impairment steps would be unnecessary. The qualitative assessment is optional, allowing companies to go directly to the quantitative assessment. This update is effective for annual and interim goodwill impairment tests performed in fiscal years beginning after December 15, 2011. This update impacts testing steps only, and therefore adoption will not have an impact on the Company’s condensed consolidated balance sheets, results of operations or cash flows.

Certain prior year amounts have been reclassified to conform to the 2011 presentation.

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 2 – Acquisition

On August 18, 2011, the Company acquired substantially all the assets of Patriot Special Metals, Inc. and RSM Real Estate Holding, Inc., consisting of a specialty steel manufacturing facility located in North Jackson, Ohio (the “North Jackson Site”). The North Jackson Site began forging and finishing operations between the completion of the acquisition and September 30, 2011 and will have vacuum induction melting, remelting and thermal treatment capabilities once fully operational. The Company expects that the assets acquired in the North Jackson acquisition will be operational prior to the end of the first quarter of 2012. The Company believes that the acquisition of the North Jackson Site will broaden the Company’s production capabilities and expand its product range and market penetration. The aggregate purchase price for the North Jackson Site was $111.3 million, which was comprised of a $40.0 million term note, $40.0 million in borrowings under a new revolving credit facility, $20.0 million in aggregate principal amount of convertible promissory notes issued to the sellers of the North Jackson Site and the remainder from cash on-hand prior to the acquisition. At the same time, the Company entered into an escrow agreement with the sellers, pursuant to which $2.5 million of the purchase price was placed in escrow. The escrow agreement expires one year after the closing date. The Company assumed approximately $4.6 million of liabilities, primarily related to approved capital expenditure projects at the North Jackson Site.

For the three- and nine-month periods ended September 30, 2011, the Company incurred $1.1 million and $2.1 million, respectively, of acquisition related costs which are included as a component of selling and administrative expenses on the Condensed Consolidated Statements of Operations.

The following table summarizes the preliminary acquisition-date fair value of the assets acquired and the liabilities assumed in connection with the North Jackson Site acquisition (in thousands):

Assets acquired and liabilities assumed in connection with the acquisition have been recorded at their estimated fair values as of the acquisition date. Preliminary fair values were determined by management based, in part, on independent valuations performed by third party valuation specialists. The above preliminary fair values are subject to change based upon the finalization of the valuations. Under GAAP, the measurement period shall not exceed one year from the acquisition date. The Company will finalize the above amounts as the information necessary to complete the analysis is obtained. The fair value assigned to the non-compete agreement is subject to amortization over the five year life of the agreement.

Goodwill is calculated as the excess of the purchase price over the fair value of net assets acquired and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. Among the factors that contributed to a purchase price in excess of the fair value of the net tangible and intangible assets acquired were the acquisition of an assembled workforce and the expected synergies and other benefits that the Company believes will result from combining the operations of the North Jackson Site with the Company’s other operations. Goodwill related to the North Jackson Site acquisition was recorded in the Company’s Universal Stainless & Alloy Products reportable segment. The Company is currently evaluating the purchase price allocation for income tax purposes. Any value assigned to goodwill is expected to be deductible for income tax purposes.

The following is a summary of the changes in the carrying value of goodwill, from January 1, 2011 through September 30, 2011:

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As previously mentioned, the Company incurred debt in the form of a term loan, borrowings under a revolving credit facility and convertible notes issued to acquire the North Jackson Site. In accordance with GAAP, the Company has recorded this debt at fair value as of the acquisition date. The fair value of the term loan and borrowings under the revolving credit facility were determined to be the par value of the debt. The terms of the convertible notes were designed to and resulted in the fair value of the option to convert and the debt component aggregating to the par amount of the convertible notes. The Company evaluated the conversion feature of the convertible notes at issuance and determined that no beneficial conversion features exist, which would have required bifurcation.

The operating results of the North Jackson Site have been included in the Company’s consolidated financial statements since the acquisition date. The results for the three-month period ended September 30, 2011 include net external sales and net loss of $6,000 and $1.1 million, respectively, related to the North Jackson Site. The net loss at the North Jackson Site includes interest expense on debt incurred to finance the acquisition.

The following unaudited pro forma information presents the combined results as if the acquisition had occurred on January 1, 2010. The unaudited pro forma financial information was prepared to give effect to events that are (1) directly attributable to the acquisition; (2) factually supportable; and (3) expected to have a continuing impact on the combined company’s results. Pro forma adjustments have been made to reflect the incremental impact on earnings of amortization expense related to the acquired intangible asset and income tax expense. The Company has calculated the 2011 pro forma results using a 37% effective tax rate from January 1, 2011. As a result of no assets being placed in service prior to the acquisition date, the Company has not included any incremental interest expense resulting from the debt incurred to finance the acquisition. All incurred interest would have been capitalized prior to placing the assets in service. The Company has not included the dilutive effect of the convertible notes on the unaudited pro forma information. Due to the level of completion of the North Jackson Site on January 1, 2010, it is highly unlikely that the acquisition would have been partially financed through the issuance of convertible notes. Prior to the acquisition, the North Jackson Site’s only sales were derived from scrap sales. Pro forma adjustments were made to eliminate one-time acquisition related costs. The unaudited pro forma financial information does not reflect any cost savings, operating synergies or revenue enhancements that the combined company may achieve as a result of the acquisition or the costs to integrate the operations or the costs necessary to achieve cost savings, operating synergies or revenue enhancements. The pro forma results are not indicative of how the results will appear in the future.

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 3 – Net Income Per Common Share

The following table sets forth the computation of basic and diluted net income per common share:

There were 19,150 and 206,850 stock options outstanding, which were excluded from the computation of diluted net income per common share, at an average price of $41.27 and $32.51 at September 30, 2011 and 2010, respectively. These outstanding options were not included in the computation of diluted earnings per common share because their respective exercise prices were greater than the average market price of the Common Stock. These options were excluded from the computation of diluted earnings per common share under the treasury stock method.

Note 4 – Inventory

The major classes of inventory were as follows:

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 5 – Property, Plant and Equipment

Property, plant and equipment consisted of the following:

The Company acquired $94.1 million of property, plant and equipment as a result of the August 18, 2011 acquisition of the North Jackson Site.

Note 6 – Debt

Debt consisted of the following:

Credit Facility

On August 18, 2011, the Company and its wholly owned subsidiaries entered into a Credit Agreement (the “Credit Agreement”) which provides for a senior secured revolving credit facility in an aggregate principal amount not to exceed $75.0 million (the “Revolver”) and a $40.0 million senior secured term loan facility (the “Term Loan” and together with the Revolver, the “Facilities”). PNC Bank, National Association (“PNC”) serves as Administrative Agent with respect to the Facilities. The Facilities, which expire in August 2016, are collateralized by substantially all of the assets of the Company and its subsidiaries, except that no real property other than the North Jackson Site is collateral under the Facilities. The Company, Dunkirk Specialty Steel, LLC and North Jackson Specialty Steel, LLC are co-borrowers under the Facilities. The co-borrowers’ obligations under the Facilities have been guaranteed by USAP Holdings, Inc.

Availability under the Revolver is based on eligible accounts receivable and inventory, less outstanding letters of credit issued under the Revolver, which may not exceed $10.0 million at any given time. At September 30, 2011, the Company had borrowing capacity under the Revolver of $72.9 million. At any time prior to August 18, 2015, the Company may make up to two requests to increase the maximum aggregate principal amount of borrowings under the Revolver by at least $10.0 million, with the maximum aggregate principal amount of borrowings under the Revolver not to exceed $100.0 million in any event. The Company is required to pay a commitment fee based on the daily unused portion of the Revolver. At September 30, 2011, the commitment fee under the Revolver was 0.375%. The Revolver also provides for up to $7.0 million of swing loans so long as the sum of the outstanding swing loans and the outstanding borrowings under the Revolver does not exceed the aggregate borrowing capacity under the Revolver at any given time. The Term Loan is payable in quarterly installments in the principal amount of $1.5 million beginning on July 1, 2012, with the balance of the Term Loan payable in full on August 18, 2016.

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Amounts outstanding under the Facilities other than swing loans under the Revolver, at the Company’s option, will bear interest at either a base rate (the “Base Rate Option”) or a LIBOR-based rate (the “LIBOR Option”), in either case calculated in accordance with the terms of the Credit Agreement. The Company elected to use the LIBOR Option during the period from the entrance into the Credit Agreement through September 30, 2011, which was 2.49% at September 30, 2011. Interest on swing loans under the Revolver is calculated using the Base Rate Option, which was 4.50% at September 30, 2011. Interest on both the Facilities and the swing loans is payable monthly.

The Credit Agreement requires the Company to maintain a leverage ratio not less than a ratio decreasing from 3.25 to 1.00 to 2.50 to 1.00 during the term of the Facilities and a fixed charge coverage ratio not less than 1.20 to 1.00. At September 30, 2011, the Company was obligated to maintain a leverage ratio of not less than 3.25 to 1.00. The Company was in compliance with all covenants contained in the Credit Agreement at September 30, 2011.

As a result of entrance into the Credit Agreement, the Company recorded deferred finance costs of $1.4 million in the Condensed Consolidated Balance Sheet as a component of other long-term assets as of September 30, 2011. These costs are being amortized to interest expense over the life of the Credit Agreement.

Convertible Notes

In connection with the acquisition of the North Jackson Site, on August 18, 2011, the Company issued $20.0 million in convertible notes (the “Notes”) to the sellers of the North Jackson Site as partial consideration of the acquisition. The Notes are subordinated obligations of the Company and rank junior to the Credit Facility. The Notes bear interest at a fixed rate of 4.0% per annum, payable in cash semi-annually in arrears on each June 18 and December 18, beginning on December 18, 2011. Unless earlier converted, the Notes mature and the unpaid principal balance is due on August 17, 2017. The Notes and any accrued and unpaid interest are convertible into shares of the Company’s Common Stock at the option of the holder at an initial conversion price of $47.1675 per share of Common Stock. The conversion price associated with the Notes may be adjusted in certain circumstances. The Company may prepay any outstanding Notes, in whole or in part on any date after August 17, 2014 during a fiscal quarter if the Company’s share price is greater than 140% of the current conversion price for at least twenty of the trading days in the thirty consecutive trading day period ending on the last trading day of the immediately preceding quarter. The Company evaluated the conversion feature of the Notes and determined that no beneficial conversion feature exists.

Aggregate maturities of long-term debt are as follows:

Extinguished Debt

The Company had a credit agreement with PNC, which provided for an unsecured $12.0 million term loan (“Old Term Loan”) and an unsecured $15.0 million revolving credit facility. There was no balance outstanding under the revolving credit facility at December 31, 2010. Quarterly Old Term Loan principal payments of $600,000 began in May 2010. Interest on both facilities was based on short-term market rates. PNC charged a commitment fee payable on the unused portion of the revolving credit facility of 0.25%. The Old Term Loan was repaid in August 2011.

The Company maintained a $400,000 20-year loan agreement with the Commonwealth of Pennsylvania’s Department of Commerce (the “PADC”), which bore interest at 6% per annum. The Company repaid this PADC loan in August 2011. In addition, the Company had a $200,000 15-year loan with the PADC, which bore interest at 5% per annum and matured and was repaid in April 2011. The Company’s wholly-owned subsidiary, Dunkirk Specialty Steel, LLC had two ten-year, 5% interest-bearing notes payable to the New York Job Development Authority for the combined amount of $3.0 million. These notes payable were repaid in August 2011.

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 7 – Derivatives and Hedging Activities

To manage interest rate risk on the Old Term Loan, the Company had an interest rate swap that effectively converted the floating-rate Old Term Loan into a fixed-rate debt instrument. The interest rate swap agreement was executed to minimize the impact of interest rate changes on the Company’s floating-rate debt and was designated and accounted for as a cash flow hedge. The effective portion of the change in the fair value of the interest rate swap was recorded net of tax in accumulated other comprehensive loss (within stockholders’ equity) prior to extinguishing the Old Term Loan. The Company utilized the interest rate swap to maintain a fixed-rate of 4.515% on the Old Term Loan. During the three- and nine-month periods ended September 30, 2011, the Company recognized $34,000 and $139,000, respectively, of interest expense on the Condensed Consolidated Statements of Operations from the monthly settlement of the interest rate swap. As a result of extinguishing the Old Term Loan during the three-month period ended September 30, 2011, the interest rate swap no longer qualified for hedge accounting. The Company recorded a charge of $267,000 during the three-month period ended September 30, 2011 as a component of interest expense on the Condensed Consolidated Statement of Operations to terminate the interest rate swap.

In July 2009, the Company entered into nickel futures contracts to minimize the price change impact of anticipated purchases of nickel over the life of a customer short-term supply agreement. These contracts were designated as and accounted for as cash flow hedges. The effective portion of the change in the fair value of the nickel hedge agreements was recorded in accumulated other comprehensive loss until they expired on March 31, 2010.

The location and amounts recorded in the Condensed Consolidated Balance Sheets for the derivative instrument were as follows:

Note 8 – Fair Value Measurements

The fair value hierarchy has three levels based on the inputs used to determine fair value, which are as follows:

Level 1 — Unadjusted quoted prices available in active markets for the identical assets or liabilities at the measurement date.

Level 2 — Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.

Level 3 — Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.

The fair value hierarchy requires the use of observable market data when available. In instances where the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability. Prior to its termination, the interest rate swap was recorded at fair value based on Level 2 quoted LIBOR swap rates adjusted for credit and non-performance risk.

Financial instruments include cash, accounts receivable, other current assets, accounts payable, short-term debt and other current liabilities. The carrying amounts of these financial instruments approximated fair value at September 30, 2011 and December 31, 2010 due to their short-term maturities. The fair value of the Term Loan, Revolver and swing loans approximates the carrying amount as the interest rate is based upon floating short-term interest rates. At September 30, 2011, the fair value of the Notes approximated the carrying amount.

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 9 – Commitments and Contingencies

From time to time, various lawsuits and claims have been or may be asserted against the Company relating to the conduct of its business, including routine litigation involving commercial and employment matters. The ultimate cost and outcome of any litigation or claim cannot be predicted with certainty. Management believes, based on information presently available, that the likelihood that the ultimate outcome of any such pending matter will have a material adverse effect on its financial condition, or liquidity or a material impact to the results of operations is remote, however the resolution of one or more of these matters may have a material adverse effect on the results of operations for the period in which the resolution occurs.

At September 30, 2011, the Company maintained reserves that it believes are adequate for outstanding product claims and legal actions.

Note 10 – Income Taxes

The tax rate used for interim periods is the estimated annual effective tax rate, based on the current estimate of full year results, except that taxes related to specific events, if any, are recorded in the interim period in which they occur. On December 17, 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 was signed into law and extended 100% bonus depreciation on purchases of qualified business property through December 2011.

During the three-months ended September 30, 2011 the Company’s estimated annual effective tax rate increased to 37% from 35% recorded in the prior 2011 periods. As a result of the significant amount of machinery and equipment that has been placed into service in 2011 related to the North Jackson Site acquisition, the Company will benefit from the 100% bonus depreciation deduction on such equipment. The bonus depreciation deduction is expected to exceed the Company’s income before income taxes, thereby generating a net operating loss for the 2011 federal income tax return. The net operating loss is expected to be carried back to the 2010 tax year to recover all federal income taxes paid and any remaining net operating loss will be carried forward to the 2012 tax year to reduce income taxes otherwise payable. As a consequence of generating a 2011 net operating tax loss, the benefit of the domestic production activities deduction will no longer be available to the Company, resulting in the estimated annual effective tax rate increasing to 37%. The Company’s effective income tax rate in the three-month period ended September 30, 2011 was 42% as the entire impact of the year-to-date rate change from 35% to 37% was recorded in the third quarter. The effective tax rate for the three- and nine-month periods ended September 30, 2010 was 34%.

The Company has recorded refundable income taxes in the amount of $10.5 million as of September 30, 2011, which represents federal taxes paid during 2011 and a refund of all federal taxes paid for the 2010 tax year.

Note 11 – Business Segments

The Company is comprised of two reportable business segments: Universal Stainless & Alloy Products (“USAP”), which consists of the Bridgeville, North Jackson and Titusville facilities, and Dunkirk Specialty Steel. The USAP manufacturing process involves melting, remelting, heat treating, forging and hot and cold rolling of semi-finished and finished specialty steels. Dunkirk Specialty Steel’s manufacturing process involves hot rolling, heat treating and finishing of specialty steel bar, rod and wire products.

Management is currently evaluating the impact of the North Jackson Site acquisition on the Company’s externally reported segments in accordance with Accounting Standards Codification (“ASC”) Topic 280, “Segment Reporting”. From the North Jackson acquisition date through September 30, 2011, the Company has included the results of North Jackson in the USAP segment. The North Jackson operating segment was included in the USAP reporting segment as a result of North Jackson having consistent characteristics as identified in ASC Topic 280 with the USAP segment. The USAP segment also includes acquisition related costs. The segment data is as follows:

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NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(A) – September 30, 2011 includes $115.9 million of assets acquired as a result of the North Jackson Site acquisition.

(B) – Includes cash of $0.3 million and $34.4 million, respectively.

(C) – Includes investments in consolidated subsidiaries of $112.5 million and $1.5 million, respectively.

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Overview

The following Management Discussion and Analysis (“MD&A”) is intended to help the reader understand the results of operations and financial condition of Universal Stainless & Alloy Products, Inc. (the “Company”). This MD&A is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the accompanying notes to the financial statements.

We manufacture and market semi-finished and finished specialty steel products, including stainless steel, tool steel and certain other alloyed steels. Our manufacturing process involves melting, remelting, heat treating, hot and cold rolling, forging, machining and cold drawing of semi-finished and finished specialty steels. Our products are sold to rerollers, forgers, service centers, original equipment manufacturers and wire redrawers. Our customers further process our products for use in a variety of industries, including the aerospace, power generation, petrochemical and heavy equipment manufacturing industries. We also perform conversion services on materials supplied by customers that lack certain of our production capabilities or that are subject to their own capacity constraints.

We recognized net income for the quarter ended September 30, 2011 of $3.9 million, or $0.55 per diluted share, compared with net income of $4.1 million, or $0.60 per diluted share, for the third quarter of 2010.

During the third quarter of 2011, we acquired substantially all the assets of Patriot Special Metals, Inc. and RSM Real Estate Holding, Inc., consisting of a new specialty steel manufacturing facility located in North Jackson, Ohio (the “North Jackson Site”). We began forging and finishing operations at the North Jackson Site in September and will have vacuum induction melting, remelting and thermal treatment capabilities once the facility is fully operational. We expect that the assets acquired in the North Jackson Site acquisition will be operational prior to the end of the first quarter of 2012. We believe that the acquisition of the North Jackson Site will broaden our production capabilities and expand our product range and market penetration. The aggregate purchase price of the North Jackson Site was $111.3 million, which was funded with the proceeds of a $40.0 million term note under a new term loan facility, $40.0 million in borrowings under a new revolving credit facility, $20.0 million in aggregate principal amount of convertible promissory notes issued to the sellers of the North Jackson Site and the remainder from cash on-hand prior to the acquisition. At the same time, we entered into an escrow agreement with the sellers, pursuant to which $2.5 million of the purchase price was placed in escrow. The escrow agreement expires one year after the closing date. We assumed approximately $4.6 million of liabilities, primarily related to approved capital expenditure projects at the North Jackson Site.

Our net sales increased from $51.9 million in the third quarter of 2010 to a record $67.3 million for the current quarter. This $15.4 million, or 30%, increase is partially due to increased volume recognized in the current quarter. Tons shipped increased by 9% in the current quarter when compared to the prior year third quarter. Our net sales for the current quarter were also favorably affected by product mix. Our tool steel shipments as a percentage of total shipments decreased from 17% for the third quarter of 2010 to 11% in current quarter, while our shipments as a percentage of total shipments for stainless steel and high-strength low alloy steel increased from 74% and 3%, respectively, during the quarter ended September 30, 2010 to 77% and 5%, respectively, in the current quarter. Our stainless steel and high-strength low alloy products have a higher content of nickel and typically have a higher price per pound than our tool steel products.

Our results for the current quarter were negatively affected by increased acquisition related expenses, which are included within selling and administrative expenses. Selling and administrative expenses increased from $4.0 million for the third quarter of 2010 to $5.3 million in the current quarter. Increased acquisition related costs accounted for $1.1 million of this $1.3 million increase.

Interest expense increased from $0.1 million for the quarter ended September 30, 2010 to $0.6 million during the current quarter. This $0.5 million increase is primarily due to the settlement of our interest rate swap and the write-off of unamortized deferred financing costs related to our term loan that was repaid in conjunction with the new financing arrangement entered into to acquire the North Jackson Site. The write-off of these items in the current quarter, increased interest expense by $0.3 million. In addition, interest expense increased as a result of having significantly more debt during the current quarter than we did in the prior year third quarter.

Our estimated annual effective tax rate increased to 37% in the quarter ended September 30, 2011 from 35% recorded in prior 2011 periods and 34% recorded during the quarter ended September 30, 2010. The entire incremental change for the nine months ended September 30, 2011 resulting from the increase in the estimated annual effective tax rate is included in our current quarter results. This increase resulted in an effective tax rate of 42% for the current quarter. As a result of the North Jackson Site acquisition and the significant amount of machinery and equipment that has been placed in service in 2011, we will benefit from the 100% bonus depreciation deduction on such equipment. As a result, we expect to generate a net operating loss for the 2011 federal income tax return. As a consequence of generating a net operating tax loss, the benefit of the domestic production activities deduction will no longer be available to us, resulting in our estimated annual effective tax rate increasing to 37%.

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The acquisition related costs incurred, settlement of our interest rate swap, write-off of unamortized deferred financing costs and the increase in our effective tax rate as a result of the acquisition of the North Jackson Site negatively affected our current quarter results by $1.4 million, net of tax, or $0.19 per diluted share.

Results of Operations

Three-month period ended September 30, 2011 as compared to the three-month period ended September 30, 2010

An analysis of our operations for the three-month periods ended September 30, 2011 and 2010 is as follows:

Market Segment Information

Net sales for the quarter ended September 30, 2011 increased $15.4 million, as compared to the similar period in 2010. The increase reflects a 9% increase for the quarter ended September 30, 2011 in consolidated shipments, combined with pricing increases and a change in product mix, which favorably affected our net sales. Shipments of aerospace products, petrochemical, power generation, conversion services and general industrial products increased 19%, 16%, 12%, 40% and 17%, respectively, and were partially offset by a decrease in service center plate products of 29%, for the quarter ended September 30, 2011.

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Cost of products sold, as a percentage of net sales, was 81% and 80% for the quarters ended September 30, 2011 and 2010, respectively. This increase is primarily due to the acquisition of the North Jackson Site. During the current quarter, the North Jackson Site incurred operating costs of $0.6 million, primarily in the form of fixed costs such as depreciation expense, but only recognized $6,000 in external sales. Although the North Jackson Site had minimal external sales in the current quarter, the facility provided conversion services for our Bridgeville facility.

Selling and administrative expenses increased by $1.3 million for the quarter ended September 30, 2011, as compared to the similar period in 2010. Selling and administrative expenses as a percentage of net sales was 8% for the quarters ended September 30, 2011 and 2010. The dollar increase largely relates to $1.1 million of expenses related to the acquisition of the North Jackson Site. We do not expect to incur any additional significant acquisition related expenses.

On December 17, 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 was signed into law and extended 100% bonus depreciation on purchases of qualified business property through December 2011. Our effective income tax rate in the quarter ended September 30, 2011 increased to 42% from 35% recorded in the prior 2011 periods and 34% recorded during the quarter ended September 30, 2010. The entire incremental change for the nine months ended September 30, 2011, resulting from the increase in the estimated annual effective tax rate, is included in our current quarter results. As a result of the North Jackson Site acquisition and the significant amount of machinery and equipment that has been placed in service in 2011, we will claim the 100% bonus depreciation deduction on such equipment. As a result, we expect to generate a net operating loss for the 2011 federal income tax return. As a consequence of generating a net operating tax loss, the benefit of the domestic production activities deduction will no longer be available to us, resulting in our year-to-date and estimated annual effective tax rate increasing to 37%.

Business Segment Results

We are comprised of two reportable business segments: Universal Stainless & Alloy Products (“USAP”), which consists of the Bridgeville, North Jackson and Titusville facilities, and the Dunkirk Specialty Steel facility. The USAP manufacturing process involves melting, remelting, heat treating, forging and hot and cold rolling of semi-finished and finished specialty steels. Dunkirk Specialty Steel’s manufacturing process involves hot rolling, heat treating and finishing of specialty steel bar, rod and wire products.

Management is currently evaluating the impact of the North Jackson Site acquisition on its externally reported segments in accordance with Accounting Standards Codification (“ASC”) Topic 280, “Segment Reporting”. We have included the results of North Jackson in the USAP segment from the acquisition date through September 30, 2011. The North Jackson operating segment was included in the USAP reporting segment as a result of North Jackson having consistent characteristics as identified in ASC Topic 280 with the USAP segment. An analysis of net sales and operating income for the reportable segments for the quarters ended September 30, 2011 and 2010 is as follows:

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Universal Stainless & Alloy Products Segment

Our USAP segments net sales for the quarter ended September 30, 2011 increased by $14.4 million, or 31%, in comparison to the quarter ended September 30, 2010. This increase reflects an 11% increase in shipments for the three months ended September 30, 2011, as well as pricing increases and a change in product mix. Increases in shipments of aerospace products, petrochemical, power generation, conversion services and general industrial products of 36%, 14%, 9%, 14% and 6%, respectively, were partially offset by a decrease in service center plate products of 29%, for the quarter ended September 30, 2011, when compared to the prior year third quarter.

Operating income increased by $0.4 million during the quarter ended September 30, 2011 when compared to the prior year third quarter. Cost of goods sold as a percentage of net sales remained consistent at 85% for both the current and prior year third quarter. Selling and administrative expenses as a percentage of net sales increased from 6% for the quarter ended September 30, 2010 to 7% in the current quarter. The increase in selling and administrative expenses is primarily due to the inclusion of acquisition related costs within the USAP segment. The USAP segment’s results include acquisition related costs of $1.1 million and $52,000 incurred during the quarters ended September 30, 2011 and 2010, respectively.

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Dunkirk Specialty Steel Segment