10-Q 1 y63208e10vq.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 June 30, 2002 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 August 1, 2002, 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 JUNE 30, 2002 INDEX

1 Part I. Financial Information Item 1. Financial Statements Special Metals Corporation Condensed Consolidated Balance Sheets (Unaudited - In thousands, except share and per 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 June 30, 2002 (Unaudited) NOTE 1 - VOLUNTARY REORGANIZATION UNDER CHAPTER 11 AND ADMINISTRATION On March 27, 2002 (the "Petition Date"), Special Metals Corporation (the "Company) and its operating subsidiaries in the United States (collectively, the "Debtors"), filed voluntary petitions for reorganization under Chapter 11 (herein referred to as the "Restructuring Proceedings") of the United States Bankruptcy Code (the "Bankruptcy Code") in the U.S. Bankruptcy Court (the "Bankruptcy Court") for the Eastern District of Kentucky in Lexington. The Company is now operating its business as a debtor-in-possession under the jurisdiction of the Bankruptcy Court. The Company has entered into a debtor-in-possession credit facility (see Note 4 to the Consolidated Financial Statements - Debtor-In-Possession Financing). Continuation of the Company as a going concern is contingent upon, among other things, the confirmation of a Plan of Reorganization, future profitable operations, the ability to comply with the terms of its debtor-in-possession credit facility and the Company's ability to generate sufficient cash from operations and obtain other financing sources. As in any bankruptcy, should no reorganization plan be approved, it is possible that the Company's assets may be liquidated. As a result of the bankruptcy filing the Company's common stock was delisted from The Nasdaq Stock Market effective as of the opening of business on April 5, 2002. NOTE 2 - BASIS OF PRESENTATION The Company's consolidated financial statements have been prepared in accordance with the American Institute of Certified Public Accountants ("AICPA") Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by Entities In Reorganization Under the Bankruptcy Code". The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business during the Restructuring Proceedings. However, as a result of the Chapter 11 filings and circumstances related to this event, including the Company's leveraged financial structure and losses from operations, such realization of assets and liquidation of liabilities, without substantial adjustments and/or changes of ownership, are subject to significant uncertainty. While under the protection of Chapter 11, the Company may sell or otherwise dispose of assets and liquidate or settle liabilities, for amounts other than those reflected in the financial statements. Further, a plan of reorganization could materially change the amounts and classifications reported in the financial statements, which do not give effect to all adjustments of the carrying value of assets and liabilities that might be necessary as a consequence of a plan of reorganization. Under Chapter 11 proceedings, actions initiated by creditors to collect claims in existence prior to the Petition Date are stayed ("deferred"), absent specific Court authorization to pay such claims, while the Company continues to operate its business without interruption as a debtor-in-possession subject to the provisions of the Bankruptcy Code. Substantially all of the Debtor's prepetition secured debt is in default. The accompanying consolidated balance sheet as of June 30, 2002 reflects the classification of the Debtor's prepetition debt as a liability subject to compromise. The Company has received approval from the Court to pay or otherwise honor certain of its prepetition obligations, including employee wages and certain employee benefits. The Company believes that provisions have been made in the accompanying consolidated financial statements for the potential claims that could be estimated at the date of these financial statements. The amount of the claims to be filed by creditors could be significantly different than the amount of liabilities recorded by the Company. 5 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) As a result of the Chapter 11 filings, effective March 27, 2002 the Company has stopped accruing interest on its Subordinated Debt and stopped accruing dividends on its Senior Preferred Stock. As a result of the Chapter 11 filings, "Events of Default" as defined in the related debt agreements, have occurred with respect to substantially all of the Company's secured debt. The Company's prepetition secured and unsecured debt have been classified as liabilities subject to compromise in the consolidated balance sheets. Under Chapter 11, the rights of and ultimate payments by the Company to prepetition creditors and to the Company's shareholders may be substantially altered. This may result in claims being settled in the Chapter 11 proceedings for amounts less than 100% of their face value. The equity of the Company's common and preferred shareholders may be substantially diluted or cancelled. Certain claims filed in the Chapter 11 proceedings may also be given higher priorities in the Plan of Reorganization. In addition, the Company's prepetition creditors and shareholders, to the extent they are impaired under a proposed plan, will each have a vote in the Plan of Reorganization. The Company has not yet proposed a Plan of Reorganization. Due to inherent uncertainties in the bankruptcy process, it is not possible to determine, at this time, the additional amount of claims which may arise or ultimately be filed; to predict the length of time in which the Company will operate under the protection of Chapter 11; the outcome of the Chapter 11 proceedings in general; whether the Company will continue to operate under its current organizational structure; or the effect of the proceedings on the business of the Company or its subsidiaries and the interests of the various creditors and security holders. The accompanying unaudited condensed consolidated financial statements of 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 June 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. 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, 2001. 6 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) NOTE 3 - LIABILITIES SUBJECT TO COMPROMISE Pursuant to SOP 90-7, most of the liabilities of the Company which existed at the Petition Date have been classified as liabilities subject to compromise. Such liabilities have been reported separately on the consolidated balance sheet at the expected amount of the allowed claims. With the exception of the liabilities of the Company's non-US subsidiaries and certain liabilities related to employees and their benefits, all liabilities in existence at the filing date have been classified as liabilities subject to compromise and payments have been deferred. The Court has authorized payment of certain employee wages, employee benefits and limited other prepetition obligations in the amount of $7.6 million. Liabilities subject to compromise at June 30, 2002 were as follows:

NOTE 4 - DEBTOR-IN-POSSESSION FINANCING In connection with the Restructuring Proceedings, on April 26, 2002 the Company entered into a $60 million debtor-in-possession ("DIP") Credit Facility from a bank group led by Credit Lyonnais, to supplement liquidity and fund operations during the reorganization process. As of August 1, 2002, revolving credit loan availability under the DIP Credit Facility is $60 million (subject to compliance with a financial covenant concerning consolidated net cash flow) with a sublimit of $10 million available for letters of credit. The sublimit for letter of credit availability may be increased to $20 million with the consent of the lenders, upon request of the Company. Amounts outstanding under the Debtor-In-Possession Credit Facility bear interest at a rate per annum equal to the prime rate charged by Credit Lyonnais New York Branch plus 2%, payable monthly. A commitment fee of 0.75% per annum on the unused portion of the total availability under the Credit Facility is also due monthly. The lenders' commitment to make revolving credit loans under the Credit Facility terminate as of April 30, 2003. As of August 14, 2002, the Company had drawn $4.1 million in the form of a letter of credit against the availability of the Debtor-in-Possession Credit Facility. 7 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) NOTE 5 - DEBTOR'S FINANCIAL STATEMENTS The following unaudited condensed consolidated financial statements of the Debtors have been prepared on the same basis as the condensed consolidated financial statements and are presented below in accordance with SOP 90-7 (in thousands): STATEMENT OF OPERATIONS

8 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) NOTE 5 - DEBTOR'S FINANCIAL STATEMENTS (CONTINUED)

9 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) NOTE 5 - DEBTOR'S FINANCIAL STATEMENTS (CONTINUED)

10 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) NOTE 6 - INVENTORIES Inventories consist of the following (in thousands):

NOTE 7 - BUSINESS SEGMENT INFORMATION Segment information for the six months ended June 30, 2001 and 2002 is as follows.

11 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) NOTE 8 - CONTINGENCIES VOLUNTARY REORGANIZATION UNDER CHAPTER 11 See "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Voluntary Reorganization Under Chapter 11 and Administration" 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 June 30, 2002, the Company had total reserves of approximately $9.0 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, and 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 2002 capital budget provides $1.9 million for environmental protection and compliance matters. The Company incurred capital expenditures for environmental matters of $0.1 million during the six months ended June 30, 2002. The Company does not expect future costs of compliance with currently enacted and proposed Environmental Laws in respect of known remediation to have a material impact on its liquidity and capital resources. However, changes in Environmental Laws which result in the imposition of stricter standards 12 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) 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. 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. To date, no asbestos claims against Huntington have gone to trial. 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. 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. To attempt to comply with this mandate, the presiding judge of the Mass Litigation Panel has set a date of September 23, 2002 to commence a mass trial for the thousands of asbestos cases that were pending in West Virginia as of September 6, 2001. As contemplated by the court's order, Huntington would be one of numerous defendants in the mass trial. However, as a result of the Bankruptcy filing all claims against Huntington have been stayed. Because the court has so far permitted Huntington to engage in only limited discovery with respect to the merits of the claims asserted against it, 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 fifteen 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. However, as a result of the Bankruptcy filing all claims against Huntington have been stayed. Some of the cases involve multiple 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 five toxic tort exposure cases involving numerous plaintiffs. Discovery has not yet been conducted with respect of these claims and as a result of the Bankruptcy filing all claims against Huntington have been stayed. 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. 13 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) 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. 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 $90,000 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. 14 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) 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. 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 was approved by the Division as was a revised Voluntary Investigation Workplan for three of the Solid Waste Management Units. A Voluntary Investigation report was submitted to the Division. The Division commented upon the report and requested additional information. The Company has responded to the comments and requests, and awaits a reply from 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. 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. Under the European Solvent Emissions Directive, Special Metals Wiggin Ltd., a United Kingdom subsidiary of the Company ("Wiggin"), will be required to make an expenditure of approximately $1.5 million to upgrade or replace its degreasing operations at its facility in Hereford, England in order to reduce emissions of volatile organic compounds. This expenditure is likely to be incurred in 2003. 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 ($0.6 million has been incurred through June 30, 2002) and will be completed in 2002, at a remaining estimated cost of $0.2 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. 15 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) 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. The Agency is unlikely to take further administrative action. Tremont City Landfill Site. The United States Environmental Protection Agency (the "EPA") has identified Huntington as one of several PRPs under CERCLA at the Tremont City Landfill Site in Clark County, Ohio. The EPA has asked the PRPs to enter into an Administrative Order on Consent to perform or finance a Remedial Investigation and Feasibility Study (RI/FS) focusing on the barrelfill portion of the site. Huntington does not possess any records or information indicating that any of its wastes were ever transported to the site. Huntington's potential liability is premised on a reference in a facility customer list located by the EPA, although the EPA has attributed no waste volume to Huntington at this time. Huntington has declined the EPA's request to perform or finance an RI/FS and has requested the EPA to consider an appropriate de micromis or de minimis settlement. The EPA has not yet responded to Huntington's request. At this time, it is not possible to provide a reasonable estimate of the ultimate cost of any work which may be required at the Tremont City Landfill Site, or Huntington's share, if any, of such costs. Though the Company does not believe it likely that its 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 flow, this possibility cannot be excluded. Wiggin Acid Spill. Wiggin received an Enforcement Notice issued by the U.K. Environmental Agency when dilute chromic acid was accidentally released to a local stream. An action plan of improvements aimed at preventing a reoccurrence has been submitted to the Agency and accepted subject to Wiggin providing quarterly updates. The Agency is unlikely to take further administrative action. 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 and discovery has been on hold since the Bankruptcy filing. At this point in the 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. 16 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) 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. NOTE 9 - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share for the three month and six month periods ended June 30, 2001 and 2002:

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. 17 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) NOTE 10 - COMPREHENSIVE LOSS Comprehensive loss for the three month and six month periods ended June 30, 2001 and 2002 consisted of the following:

Accumulated other comprehensive loss consists of the following at December 31, 2001 and June 30, 2002:

18 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) NOTE 11 - 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 and foreign currency exchange rates. Financial instruments utilized include forward purchase contracts, forward currency and currency option contracts. As a result of the voluntary filing by the Company of a petition for relief under Chapter 11 of the U.S. Bankruptcy Code, the Company was notified by Credit Lyonnais that its' interest swap agreements would be cancelled effective April 1, 2002. For the six month period ended June 30, 2002, the Company recorded net gains to accumulated other comprehensive income of $728,000 for the change in fair value of derivatives designated as effective hedges. Additionally, losses of $1,324,000 were reclassified from accumulated other comprehensive income to earnings due to the cancelation or settlement of derivatives. The Company also recorded other expense of $860,000 related to its other hedging instruments. NOTE 12 - GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, the Company adopted the Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") relating to business combinations completed prior to June 30, 2001. Under the provisions of the standard, intangible assets deemed to have indefinite lives and goodwill are no longer subject to amortization. All other intangible assets with finite lives will continue to be amortized over their remaining useful lives. Intangible assets and goodwill are also subject to annual impairment testing, or more frequently, should impairment indicators arise. As a result of this adoption, the Company reduced goodwill amortization expense by $48,900 for the six month period ended June 30, 2002. The amount of unamortized goodwill as of June 30, 2002 was $2.5 million. During the second quarter of 2002, the Company completed the initial impairment review required by SFAS No. 142 and did not recognize any impairment losses as a result of this review. The following table provides comparative earnings and earnings per share data had the non-amortization provisions of SFAS No. 142 been adopted for all periods presented. 19 Special Metals Corporation Notes To Condensed Consolidated Financial Statements (Continued) June 30, 2002 (Unaudited) NOTE 12 - GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED)

20 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 the Company's possible inability to effect a plan of reorganization; the Company's ability to comply with the terms of its debtor-in-possession credit facility; the general effect of the Company's bankruptcy filing on its vendors, customers and other aspects of its business operations; 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; changes in payment terms extended to the Company by its suppliers; 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 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; and other factors detailed from time to time in the Company's filings with the Securities and Exchange Commission. OVERVIEW VOLUNTARY REORGANIZATION UNDER CHAPTER 11 AND ADMINISTRATION On March 27, 2002 (the "Petition Date"), the Company and its operating subsidiaries in the United States (collectively, the "Debtors"), filed voluntary petitions for reorganization under Chapter 11 (herein referred to as the "Restructuring Proceedings") of the United States Bankruptcy Code (the "Bankruptcy Code") in the U.S. Bankruptcy Court (the "Bankruptcy Court") for the Eastern District of Kentucky in Lexington. The Company is now operating its business as a debtor-in-possession under the jurisdiction of the Bankruptcy Court. The Company has entered into a debtor-in-possession credit facility (See Note 4 to the Consolidated Financial Statements - Debtor-In-Possession Financing). Continuation of the Company as a going concern is contingent upon, among other things, the confirmation of a Plan of Reorganization, future profitable operations, the ability to comply with the terms of its debtor-in-possession facility and the Company's ability to generate sufficient cash from operations and obtain other financing sources. As in any bankruptcy, should no reorganization plan be approved, it is possible that the Company's assets may be liquidated. In response to this situation and in order to ensure the Company's ability to continue as a going concern, management's plans include the following: Preparation and confirmation of a Plan of Reorganization which includes a restructuring of the capital structure of the balance sheet. The Company is in the process of implementing a corporate restructuring program and reducing salaried employment levels as part of its current effort to reduce costs. During 2002 the Company has eliminated 75 salaried positions with a projected annual savings of $5.0 million. The Company recorded a charge for severance of $1.1 million related to this restructuring program in the first quarter of 2002. Capital expenditures which are not deemed critical to ongoing operations will be deferred and strategies will be implemented to improve working capital management, particularly related to inventory. 21 Many of the factors listed in the first paragraph of this Item 2, over which the Company does not have complete control, may materially affect the performance, financial condition and liquidity of the Company. General 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 ingot, 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 ingot, 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 six months ended June 30, 2002, the Premium Alloys Division, the Huntington Alloys Division, and the Wiggin Alloys Division accounted for 17.9%, 54.7%, and 27.4%, respectively, of the Company's net sales of $298.9 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 six months ended June 30, 2002, sales by domestic businesses of the Company to purchasers outside of the United States totaled 11% of the Company's total net sales. Cost of Goods Sold. The high-performance nickel-based alloy and superalloy industry is characterized by high capital investment and high fixed costs, and 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. The Company from time to time locks in prices in connection with its natural gas requirements. 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 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 agreements, referred to as indexed 22 price sales contracts, provide for certain price adjustments to reflect changes in the price of raw materials, principally nickel. Most of the Company's product sales are made, and are expected to be made in the future, 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 product 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. In the past, 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. The Company is transitioning hedging to its entire nickel buy forwards using financial hedges which does not include taking possession of the inventory 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 June 30, 2002, the Company had open purchase contracts with a notional principal value of approximately $37.5 million. The fair value of the material covered by these contracts, based on the June 30, 2002 price quoted on the LME, was approximately $45.4 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 three month and six month periods ended June 30, 2001. This reclassification was recorded in order to be consistent with the terms of EITF 00-10 regarding the classification of freight and handling costs. 23 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 JUNE 30, 2002 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2001. NET SALES. Premium Alloys. Net sales decreased $26.4 million, or 57.2%, from $46.3 million in the three months ended June 30, 2001 to $19.9 million in the three months ended June 30, 2002. A decrease in sales volume accounted for $(32.8) million of the above decrease, offset by an increase in average realized selling prices which accounted for $6.4 million. This decrease in sales volume is primarily attributable to a significant reduction in demand for billet and rolled nickel-based superalloy and special alloy products supplied to the commercial aerospace and land-based power generation end-markets. Huntington Alloys. Net sales decreased $14.0 million, or 15.0%, from $94.0 million in the three months ended June 30, 2001 to $80.0 million in the three months ended June 30, 2002. A decrease in sales volume accounted for $(9.3) million of the above decrease and a decrease in average realized selling prices accounted for $(4.7) million. This decrease in sales volume is primarily attributable to a significant reduction in demand for billet and ingot nickel-based superalloy and special alloy products supplied to the commercial aerospace and land-based power generation end-markets. Wiggin Alloys. Net sales decreased $2.0 million, or 4.7%, from $42.3 million in the three months ended June 30, 2001 to $40.3 million in the three months ended June 30, 2002. A decrease in sales volume accounted for $(2.3) million of the above decrease, offset by an increase in average realized selling prices which accounted for $0.3 million. This decrease in sales volume is primarily attributable to a significant reduction in demand for billet and forged bar nickel-based superalloy and special alloy products supplied to the commercial aerospace and thermal processing end-markets. 24 COST OF GOODS SOLD. Premium Alloys. Cost of goods sold decreased $17.5 million, or 47.2%, from $37.1 million in the three months ended June 30, 2001 to $19.6 million in the three months ended June 30, 2002. A decrease in material costs accounted for $(15.5) million of the above decrease and a decrease in manufacturing costs accounted for $(2.0) million. As a percentage of net sales, cost of goods sold increased from 80.2% in the three months ended June 30, 2001 to 98.8% in the three months ended June 30, 2002, due to fixed costs being absorbed over a smaller volume of sales. Huntington Alloys. Cost of goods sold decreased $12.6 million, or 13.6%, from $92.3 million in the three months ended June 30, 2001 to $79.7 million in the three months ended June 30, 2002. A decrease in material costs accounted for $(9.4) million of the above decrease and a decrease in manufacturing costs accounted for $(3.2) million. As a percentage of net sales, cost of goods sold increased from 98.1% in the three months ended June 30, 2001 to 99.7% in the three months ended June 30, 2002, primarily as a result of reduced sales volume and selling prices as mentioned above. Wiggin Alloys. Cost of goods sold decreased $2.1 million, or 5.4%, from $40.3 million in the three months ended June 30, 2001 to $38.2 million in the three months ended June 30, 2002. A decrease in material costs accounted for $(3.4) million of the above decrease, offset by an increase in manufacturing costs which accounted for $1.3 million. As a percentage of net sales, cost of goods sold decreased from 95.3% in the three months ended June 30, 2001 to 94.6% in the three months ended June 30, 2002. Corporate. Cost of goods sold not allocated to an operating segment were $1.5 million in the three months ended June 30, 2001 and in the three months ended June 30, 2002. 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 decreased $8.9 million, or 97.4%, from $9.2 million in the three months ended June 30, 2001 to $0.3 million in the three months ended June 30, 2002. Huntington Alloys. Gross profit decreased $1.4 million, or 85.8%, from $1.7 million in the three months ended June 30, 2001 to $0.3 million in the three months ended June 30, 2002. Wiggin Alloys. Gross profit increased $0.1 million, or 10.9%, from $2.0 million in the three months ended June 30, 2001 to $2.1 million in the three months ended June 30, 2002. CHAPTER 11 REORGANIZATION AND RESTRUCTURING EXPENSES. Corporate. In connection with the Restructuring Proceedings, the Company recognized $4.1 million of Chapter 11 and administration related reorganization expenses in the three months ended June 30, 2002. These expenses consisted of legal, financial, advisory fees and fees incurred in connection with the debtor-in-possession financing. SELLING, GENERAL AND ADMINISTRATIVE. Premium Alloys. Selling, general and administrative expenses decreased $0.1 million, or 17.0%, from $1.4 million in the three months ended June 30, 2001 to $1.3 million in the three months ended June 30, 2002 as a result of reduced sales, marketing, administrative and research expenditures as well as an absorption of costs by other segments. Selling, general and administrative expenses as a percentage of net sales increased from 3.1% in the three months ended June 30, 2001 to 5.9% in the three months ended June 30, 2002. 25 Huntington Alloys. Selling, general and administrative expenses decreased $0.8 million, or 23.1%, from $3.4 million in the three months ended June 30, 2001 to $2.6 million in the three months ended June 30, 2002 as a result of reduced sales, marketing and research expenditures as well as an absorption of costs by other segments. Selling, general and administrative expenses as a percentage of net sales decreased from 3.6% in the three months ended June 30, 2001 to 3.3% in the three months ended June 30, 2002. Wiggin Alloys. Selling, general and administrative expenses were $0.6 million in the three months ended June 30, 2001 and in the three months ended June 30, 2002. Selling, general and administrative expenses as a percentage of net sales increased from 1.5% in the three months ended June 30, 2001 to 1.6% in the three months ended June 30, 2002. Corporate. Selling, general and administrative expenses not allocated to an operating segment decreased $1.8 million from $3.1 million in the three months ended June 30, 2001 to $1.3 million in the three months ended June 30, 2002 as a result of reduced legal expenditures associated with the Company's lawsuit against Inco and certain other administrative expenses. OPERATING INCOME (LOSS). Premium Alloys. Operating income decreased $8.8 million, from $7.8 million in the three months ended June 30, 2001 to $(1.0) million in the three months ended June 30, 2002. Operating income as a percentage of net sales decreased from 16.8% in the three months ended June 30, 2001 to (4.7)% in the three months ended June 30, 2002. Huntington Alloys. Operating income (loss) increased $(0.6) million from $(1.7) million in the three months ended June 30, 2001 to $(2.3) million in the three months ended June 30, 2002. Operating income (loss) as a percentage of net sales increased from (1.7)% in the three months ended June 30, 2001 to (3.0)% in the three months ended June 30, 2002. Wiggin Alloys. Operating income increased $0.1 million from $1.4 million in the three months ended June 30, 2001 to $1.5 million in the three months ended June 30, 2002. Operating income as a percentage of net sales increased from 3.2% in the three months ended June 30, 2001 to 3.8% in the three months ended June 30, 2002. INTEREST EXPENSE. Interest expense decreased $3.8 million, or 52.8%, from $7.2 million in the three months ended June 30, 2001 to $3.4 million in the three months ended June 30, 2002, primarily due to a decrease in indebtedness and interest rates, as well as the impact of not accruing interest on subordinated debt since the Chapter 11 filings. OTHER EXPENSE (INCOME). Other income increased $0.7 million, from $(0.6) million in the three months ended June 30, 2001 to $(1.3) million in the three months ended June 30, 2002. INCOME TAX EXPENSE (BENEFIT). Income tax expense (benefit) decreased $0.8 million from $(0.7) million in the three months ended June 30, 2001 to $0.1 million in the three months ended June 30, 2002, primarily due to the Company recording a valuation allowance on future income tax benefits related to losses of U.S. domestic operations. 26 NET INCOME (LOSS). Net loss increased $8.1 million from $(2.7) million in the three months ended June 30, 2001 to $(10.8) million in the three months ended June 30, 2002. Net loss as a percentage of net sales increased from (1.5)% in the three months ended June 30, 2001 to (7.7)% in the three months ended June 30, 2002. SIX MONTHS ENDED JUNE 30, 2002 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2001. NET SALES. Premium Alloys. Net sales decreased $41.9 million, or 44.0%, from $95.2 million in the six months ended June 30, 2001 to $53.3 million in the six months ended June 30, 2002. A decrease in sales volume accounted for $(32.4) million of the above decrease and a decrease in average realized selling prices which accounted for $(9.5) million. This decrease in sales volume is primarily attributable to a significant reduction in demand for billet and rolled nickel-based superalloy and special alloy products supplied to the commercial aerospace and land-based power generation end-markets. Huntington Alloys. Net sales decreased $29.8 million, or 15.4%, from $193.4 million in the six months ended June 30, 2001 to $163.6 million in the six months ended June 30, 2002. A decrease in sales volume accounted for $(23.8) million of the above decrease and a decrease in average realized selling prices accounted for $(6.0) million. This decrease in sales volume is primarily attributable to a significant reduction in demand for billet and ingot nickel-based superalloy and special alloy products supplied to the commercial aerospace and land-based power generation end-markets. Wiggin Alloys. Net sales decreased $7.2 million, or 8.1%, from $89.2 million in the six months ended June 30, 2001 to $82.0 million in the six months ended June 30, 2002. A decrease in sales volume accounted for $(5.4) million of the above decrease and a decrease in average realized selling prices accounted for $(1.8) million. This decrease in sales volume is primarily attributable to a significant reduction in demand for billet and forged bar nickel-based superalloy and special alloy products supplied to the commercial aerospace and thermal processing end-markets. COST OF GOODS SOLD. Premium Alloys. Cost of goods sold decreased $31.5 million, or 39.7%, from $79.2 million in the six months ended June 30, 2001 to $47.7 million in the six months ended June 30, 2002. A decrease in material costs accounted for $(27.9) million of the above decrease and a decrease in manufacturing costs accounted for $(3.6) million. As a percentage of net sales, cost of goods sold increased from 83.2% in the six months ended June 30, 2001 to 89.5% in the six months ended June 30, 2002. Huntington Alloys. Cost of goods sold decreased $21.7 million, or 11.5%, from $189.2 million in the six months ended June 30, 2001 to $167.5 million in the six months ended June 30, 2002. A decrease in material costs accounted for $(20.0) million of the above decrease and a decrease in manufacturing costs accounted for $(1.7) million. As a percentage of net sales, cost of goods sold increased from 97.8% in the six months ended June 30, 2001 to 102.4% in the six months ended June 30, 2002, primarily as a result of reduced sales volume and selling prices as mentioned above. Wiggin Alloys. Cost of goods sold decreased $5.8 million, or 6.9%, from $84.6 million in the six months ended June 30, 2001 to $78.8 million in the six months ended June 30, 2002. A decrease in material costs accounted for $(6.7) million of the above decrease, offset by an increase in manufacturing costs which accounted for $0.9 million. As a percentage of net sales, cost of goods sold increased from 94.8% in the six months ended June 30, 2001 to 96.0% in the six months ended June 30, 2002, primarily as a result of reduced sales volume and selling prices as mentioned above. 27 Corporate. Cost of goods sold not allocated to an operating segment increased $0.1 million, or 4.0%, from $2.9 million in the six months ended June 30, 2001 to $3.0 million in the six months ended June 30, 2002. 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 decreased $10.4 million, or 65.1%, from $16.0 million in the six months ended June 30, 2001 to $5.6 million in the six months ended June 30, 2002. Huntington Alloys. Gross profit (loss) decreased $8.1 million, or 192.3%, from $4.2 million in the six months ended June 30, 2001 to $(3.9) million in the six months ended June 30, 2002. Wiggin Alloys. Gross profit decreased $1.4 million, or 29.5%, from $4.6 million in the six months ended June 30, 2001 to $3.2 million in the six months ended June 30, 2002. CHAPTER 11 REORGANIZATION AND RESTRUCTURING EXPENSES. Corporate. In connection with the Restructuring Proceedings, the Company recognized $4.8 million of Chapter 11 and administration related reorganization expenses in the six months ended June 30, 2002. These expenses consisted of legal, financial, advisory fees and fees incurred in connection with the debtor-in-possession financing. SELLING, GENERAL AND ADMINISTRATIVE. Premium Alloys. Selling, general and administrative expenses decreased $0.4 million, or 18.4%, from $2.8 million in the six months ended June 30, 2001 to $2.4 million in the six months ended June 30, 2002 as a result of reduced sales, marketing, administrative and research expenditures as well as an absorption of costs by other segments. Selling, general and administrative expenses as a percentage of net sales increased from 3.0% in the six months ended June 30, 2001 to 4.4% in the six months ended June 30, 2002. Huntington Alloys. Selling, general and administrative expenses decreased $1.9 million, or 25.7%, from $7.2 million in the six months ended June 30, 2001 to $5.3 million in the six months ended June 30, 2002 as a result of reduced sales, marketing and research expenditures as well as an absorption of costs by other segments. Selling, general and administrative expenses as a percentage of net sales decreased from 3.7% in the six months ended June 30, 2001 to 3.2% in the six months ended June 30, 2002. Wiggin Alloys. Selling, general and administrative expenses increased $0.1 million, or 5.8%, from $1.2 million in the six months ended June 30, 2001 to $1.3 million in the six months ended June 30, 2002 as a result of increased sales and marketing expenditures and an absorption of costs from other segments. Selling, general and administrative expenses as a percentage of net sales increased from 1.4% in the six months ended June 30, 2001 to 1.6% in the six months ended June 30, 2002. Corporate. Selling, general and administrative expenses not allocated to an operating segment decreased $0.9 million from $4.4 million in the six months ended June 30, 2001 to $3.5 million in the six months ended June 30, 2002 as a result of reduced legal expenditures associated with the Company's lawsuit against Inco and certain other administrative expenses. 28 OPERATING INCOME (LOSS). Premium Alloys. Operating income decreased $10.0 million, or 75.3%, from $13.2 million in the six months ended June 30, 2001 to $3.2 million in the six months ended June 30, 2002. Operating income as a percentage of net sales decreased from 13.8% in the six months ended June 30, 2001 to 6.1% in the six months ended June 30, 2002. Huntington Alloys. Operating income (loss) increased $(6.2) million from $(3.0) million in the six months ended June 30, 2001 to $(9.2) million in the six months ended June 30, 2002. Operating income (loss) as a percentage of net sales increased from (1.5)% in the six months ended June 30, 2001 to (5.6)% in the six months ended June 30, 2002. Wiggin Alloys. Operating income decreased $1.5 million, or 42.6%, from $3.4 million in the six months ended June 30, 2001 to $1.9 million in the six months ended June 30, 2002. Operating income as a percentage of net sales decreased from 3.8% in the six months ended June 30, 2001 to 2.4% in the six months ended June 30, 2002. INTEREST EXPENSE. Interest expense decreased $6.4 million, or 43.8%, from $14.7 million in the six months ended June 31, 2001 to $8.3 million in the six months ended June 30, 2002, primarily due to a decrease in indebtedness and interest rates, as well as the impact of not accruing interest on subordinated debt since the Chapter 11 filings. OTHER EXPENSE (INCOME). Other expense (income) increased $(1.6) million, from $1.2 million in the six months ended June 30, 2001 to $(0.4) million in the six months ended June 30, 2002. INCOME TAX EXPENSE (BENEFIT). Income tax expense (benefit) decreased $2.4 million from $(2.2) million in the six months ended June 30, 2001 to $0.2 million in the six months ended June 30, 2002, primarily due to the Company recording a valuation allowance on future income tax benefits related to losses of U.S. domestic operations. NET INCOME (LOSS). Net loss increased $16.8 million from $(6.5) million in the six months ended June 30, 2001 to $(23.3) million in the six months ended June 30, 2002. Net loss as a percentage of net sales increased from (1.7)% in the six months ended June 30, 2001 to (7.8)% in the six months ended June 30, 2002. 29 LIQUIDITY AND CAPITAL RESOURCES The Company's liquidity needs arise primarily from capital investments, working capital requirements, and principal and interest payments on indebtedness. As a result of the Chapter 11 proceedings principal and certain interest payments have been deferred. 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 operating activities was $27.7 million and $45.6 million for the six months ended June 30, 2001 and 2002, respectively. Net cash provided by operating activities for the six months ended June 30, 2002 consisted primarily of a net loss of $23.3 million offset by depreciation and amortization expense of $20.4 million, charges for derivative and hedging activities of $1.6 million, Chapter 11 reorganization and restructuring items (net of payments) of $1.9 million and a decrease in working capital of $44.9 million, which included decreases in accounts receivable and inventory and an increase in accounts payable as a result of the Chapter 11 filings. Net cash provided by operating activities for the six months ended June 30, 2001 consisted primarily of a net loss of $6.5 million offset by depreciation and amortization expense of $20.5 million and a decrease in working capital of $12.8 million, which included decreases in accounts receivable and inventory. Capital expenditures were $2.1 million and $4.5 million for the six months ended June 30, 2001 and 2002, respectively. Before the Bankruptcy filings (as more fully discussed in Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations and in Note 4 to the Consolidated Financial Statements - Debtor-In-Possession Financing), the Company's principal sources of funds were (i) funds generated from operations; and (ii) borrowings under the Company's Senior Secured Credit Agreement with Credit Lyonnais New York Branch, as a lender and agent, and other financial institutions (as amended, the "Prepetition Credit Agreement"). Since the bankruptcy filing, the Company has generated sufficient cash to meet its liquidity needs (such funds received from the cash collateral at March 27, 2002 are deemed to be used to repay the Company's obligations under the Prepetition Credit Agreement and then reloaned to the Company, as described in more detail below). The Company and its U.S. subsidiaries also have entered into a Postpetition Credit Agreement with Credit Lyonnais New York Branch, as a lender and agent, and other financial institutions, which provides the Company and its U.S. subsidiaries with an additional source of funds. As of August 1, 2002, revolving credit loan availability under the DIP Credit Facility is $60 million (subject to compliance with a financial covenant concerning consolidated net cash flow) with a sublimit of $10 million available for letters of credit. The sublimit for letter of credit availability may be increased to $20 million with the consent of the lenders, upon request of the Company. Amounts outstanding under the Postpetition Credit Facility bear interest at a rate per annum equal to the prime rate charged by Credit Lyonnais New York Branch (the "Prime Rate") plus 2%, payable monthly. A commitment fee of 0.75% per annum on the unused portion of the total availability under the Postpetition Credit Agreement also is due monthly. The lender's commitment to make revolving credit loans under the Postpetition Credit Agreement terminate as of April 30, 2003. The Company's obligations under the Postpetition Credit Agreement are secured by valid and perfected first priority priming liens on substantially all of the assets of the Company and its domestic subsidiaries and by a pledge of capital stock of certain foreign subsidiaries. The Postpetition 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 Postpetition Credit Agreement also requires the Company to satisfy certain financial tests relating to, among other things, the Company's minimum consolidated earnings before interest, taxes, depreciation and amortization ("EBITDA"); consolidated 30 revenue; asset coverage ratio; consolidated net cash flow; and receivables from foreign subsidiaries. As of August 14, 2002 the Company had approximately $55.9 million in cash available (subject to the covenant concerning consolidated net cash flow) and approximately $4.1 million in the form of letters of credit drawn against the availability of the Postpetition Credit Facility. The Company failed to satisfy the financial test related to consolidated revenue for the periods ending May 31 and June 30, 2002 and does not expect to meet its accumulated sales revenue covenant for July 31, 2002. The lenders under the Postpetition Credit Agreement granted the Company waivers of these technical defaults and have also granted the Company a prospective waiver with respect to the consolidated revenue covenant for the period ending July 31, 2002. As of June 30, 2002, the Company's total outstanding debt under the Prepetition Credit Agreement was $235.2 million, representing amounts outstanding on a Tranche A term loan, a Tranche B term loan, a revolving credit facility and obligations owed to Credit Lyonnais New York Branch in connection with the cancellation of interest rate swap agreements entered into in accordance with the Prepetition Credit Agreement (collectively, the "Prepetition Indebtedness"). The lenders under the Prepetition Credit Agreement consented to the grant of priming liens to the lenders under the Postpetition Credit Agreement. In consideration of such consent, the lenders of the Prepetition Credit Agreement requested and the Bankruptcy Court subsequently has ordered that all cash collateral of the Company and its U.S. subsidiaries at March 27, 2002 shall be applied to permanently reduce the Prepetition Indebtedness until repaid in full. The Court has further ordered in conjunction with the Postpetition Credit Agreement, that such borrowings be readvanced to the Company and its U.S. subsidiaries as deemed Postpetition loans (the "Deemed DIP Loans"). The Deemed DIP Loans share in the collateral allocated to the loans under the Postpetition Credit Agreement, although the Deemed DIP Loans are junior to the loans under the Postpetition Credit Agreement. Any Prepetition Indebtedness that is not paid and readvanced as a Deemed DIP Loan shall be paid interest monthly in arrears at the following rates: the London Interbank Offered Rate ("LIBOR") plus 3.25% for Prepetition Indebtedness in respect of the Tranche A term loan, the revolving credit facility, and the swap agreements with Credit Lyonnais New York Branch; and LIBOR plus 3.75% for Prepetition Indebtedness in respect of the Tranche B term loan. Any Deemed DIP Loans shall be paid interest monthly at the Prime Rate. Effective December 17, 1999, the Company entered into 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 provided for a total of $50 million, $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 under the Prepetition Credit Agreement. 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. The Company's obligations under the Subordinated Loan Agreement are unsecured and expressly subordinated to its obligations under the Postpetition Credit Agreement and the Prepetition Credit Agreement. Pursuant to a Debt Subordination Agreement entered into by SIMA and the Company for the benefit of the lenders under the Prepetition Credit Agreement the Company may not repay the Subordinated Term Loans until all amounts due under the Prepetition Credit Agreement have been paid. As a result of the Chapter 11 Bankruptcy filing, effective March 27, 2002 the Company has stopped accruing interest on its Subordinated Term Loans. The Company's Series A Convertible Preferred Stock ("Senior Preferred Stock") was issued October 28, 1998 and 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 Dividend Payment Dates from April 28, 2000 through July 28, 2001, 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 and exercised this right with respect to all other Dividend Payment 31 Dates. As of June 30, 2002, the total amount of dividends accrued and unpaid was $13.9 million. Once the Company deferred payment of dividends for six quarterly dividend periods, in accordance with the terms of the Senior Preferred Stock, the number of directors constituting the Company's Board of Directors increased, and the holders of Senior Preferred Stock elected two individuals to fill the newly created directorships. As a result of the Chapter 11 Bankruptcy filing, effective March 27, 2002 the Company has stopped accruing dividends on its Senior Preferred Stock. 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." As noted above, the Company expects that amounts under the Postpetition Credit Agreement and the Prepetition Credit Agreement (available to the Company as Deemed DIP Loans), cash and cash equivalents and cash flow from operations will be adequate to meet its anticipated operating requirements as it seeks to negotiate and formalize a plan of reorganization. See " - Forward Looking Statements." BACKLOG As of June 30, 2002, the Company's backlog orders aggregated approximately $191.7 million, compared to approximately $309.1 million at June 30, 2001. The Company defines backlog as firm orders, which are generally subject to cancellation by the customer. Substantially all orders in the backlog at June 30, 2002 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. 32 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 various market risks, including changes in commodity prices, foreign currency exchange rates and interest rates. The Company has entered into financial instrument transactions which attempt to manage and reduce the impact of changes in commodity prices and foreign currency exchange rates. The Company does not enter into derivatives or other financial instruments for trading and speculative purposes. 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 $110,730. 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. 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 $645,000. However, since these contracts hedge foreign currency denominated transactions, any change in fair value of the contracts would be offset by changes in the underlying value of the transaction being hedged. At June 30, 2002, the Company had approximately $302.1 million of variable rate long-term debt. As required by the terms of the Prepetition Credit Agreement, the Company had entered into two interest rate swap agreements. The first agreement had a notional amount of $48,750,000 through September 15, 2003 based on LIBOR at 5.95%. The second agreement had a notional amount of $48,750,000 through September 15, 2003 based on LIBOR at 5.76%. Net payments or receipts under the swap agreements were recorded as adjustments to interest expense. Under these agreements, the Company also made or received payments equal to the difference between fixed and variable interest rate payments on the notional amount. As a result of the voluntary filing by the Company of a petition for relief under Chapter 11 of the U.S. Bankruptcy Code, the Company was notified by Credit Lyonnais that its interest rate swap agreements would be terminated effective April 1, 2002. Pursuant to this early termination, the Company's settlement amount in respect of this termination for any unpaid amount in respect of the terminated transactions is $3.3 million. Amounts owed subject to cancellation of the respective interest rate swap agreements have been included in the Company's consolidated balance sheet as a component of Secured Debt in Default. A 1% fluctuation in interest rates would have changed future interest expense on the $302.1 million of debt by approximately $3.0 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, 2001 and to Note 8 of the Notes to Condensed Consolidated Financial Statements included in Part I of this Report for descriptions of certain legal and environmental matters. 33 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 The annual meeting of stockholders of the Company was held on June 6, 2002 (the "Annual Meeting"). Holders of Common Stock were entitled to elect four Class II directors. On all matters which came before the Annual Meeting, holders of Common Stock were entitled to one vote for each share held. Proxies for 12,541,685 of the 15,479,000 shares of Common Stock entitled to vote were received in connection with the Annual Meeting. The following table sets forth the names of the four persons elected at the Annual Meeting to serve as directors until the first annual meeting of stockholders of the Company following the end of the Company's fiscal year ending December 31, 2004 and the number of votes cast for, against or withheld with respect to each person.

Other directors whose terms of office continued after the Annual Meeting are as follows: T. Grant John, Francis P. Avanzi, Raymond F. Decker, Michel Hemonnot, Alain A. Honnart, Edward C. Hutcheson, Jr., Edouard Duval, and J. Landis Martin. The following table sets forth the other matter which was submitted to the stockholders for approval at the Annual Meeting and the tabulation of the votes with respect to such matter.

34 ITEM 5. OTHER INFORMATION (a) PRESS RELEASES The Company issued a press release dated July 31, 2002 announcing that it failed to satisfy its June 30, 2002 cumulative sales revenue covenant contained in its Postpetition Credit Agreement but has obtained the agreement of its bank group to waive the technical default as of June 30, 2002 and the cumulative sales revenue covenant as of July 31, 2002. The Company issued a press release dated July 1, 2002 announcing that it failed to satisfy its May 31, 2002 sales revenue covenant contained in its Postpetition Credit Agreement but has obtained the agreement of its bank group to waive the technical default. (b) 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 factors include the Company's possible inability to effect a plan of reorganization; the Company's ability to comply with the terms of its debtor-in-possession credit facility; the general effect of the Company's bankruptcy filing on its vendors, customers and other aspects of its business operations; 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; changes in payment terms extended to the Company by its suppliers; 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 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; and other factors detailed from time to time in the Company's filings with the Securities and Exchange Commission. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS 10.1 First Waiver to the Postpetition Credit Agreement dated as of June 28, 2002. 10.2 First Amendment and Second Waiver to the Postpetition Credit Agreement dated as of July 29, 2002. 99.1 Certification by President pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification by Vice-President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 35 (b) REPORTS ON FORM 8-K The Company filed a Current Report on Form 8-K dated August 1, 2002 announcing that it failed to satisfy its June 30, 2002 cumulative sales revenue covenant contained in its Postpetition Credit Agreement but has obtained the agreement of its bank group to waive the technical default as of June 30, 2002 and the cumulative sales revenue covenant as of July 31, 2002. The Company filed a Current Report on Form 8-K dated July 2, 2002 announcing that it failed to satisfy its May 31, 2002 sales revenue covenant contained in its Postpetition Credit Agreement but has obtained the agreement of its bank group to waive the technical default. 36 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: August 14, 2002 By: /s/ T. Grant John -------------------------------------------- T. Grant John President (Principal Executive Officer) Date: August 14, 2002 By: /s/ Dennis L. Wanlass -------------------------------------------- Dennis L. Wanlass Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 37

SPECIAL METALS CORP 10-Q