<PAGE>   1
                                                                    Exhibit 13.1
--------------------------------------------------------------------------------
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 
     The management's discussion and analysis that follows provides information
with respect to the results of operations of J&L Specialty Steel, Inc. (the
"Company") for the years ended December 31, 1996, 1995 and 1994.
 
YEAR ENDED 1996 COMPARED TO YEAR ENDED 1995
 
U.S. Stainless Steel Market.  Apparent consumption of stainless steel sheet and
strip in the United States increased 7.4% to 1,669,453 tons in 1996 from
1,553,906 tons in 1995. In 1996, stainless steel sheet and strip imports were
337,068, up 9.0% due to a firming dollar and excess worldwide manufacturing
capacity. Reported domestic shipments of stainless steel sheet and strip by the
U.S. stainless steel industry (excluding exports) were 1,332,385, an increase of
7.0% compared to the 1,244,664 tons in 1995. Imports of stainless steel sheet
and strip comprised the remaining tons in 1996, or approximately 20% of the
domestic market.
 
     Net Sales.  Net sales for the Company decreased 27.6% to $628.0 million
from a record $867.0 million in 1995. The decrease in net sales was due to lower
selling prices and lower shipments. Import prices placed downward pressure on
domestic prices. Selling prices for 1996 were also negatively impacted by lower
raw material surcharges than were realized in 1995. Shipments for 1996 totaled
306,791 tons and were 16.4% lower than the 367,030 tons shipped in 1995. The
lower shipments in 1996 were the result of a decrease in exports and a decrease
in sales to the hot rolled market. Exports decreased from 8% of sales in 1995 to
4% of sales in 1996 due to low international selling prices, which the Company
elected not to meet. The lower sales to the hot rolled market were due to lower
demand in 1996 for finished goods manufactured from this product and from
increased competition.
 
     Cost of Products Sold, Excluding Depreciation and Amortization Expenses.
 As a percentage of net sales, cost of products sold, excluding depreciation and
amortization expenses, increased to 84.0% in 1996 compared with 76.7% in 1995.
The higher cost of products sold as a percentage of net sales in 1996 was
largely due to significantly lower selling prices during 1996. Lower raw
material costs partially offset the effect of these lower selling prices.
Included in 1995 was a $4,000 per union employee signing bonus under the July 1,
1995, labor agreement and the receipt of $2.5 million relating to the settlement
of an insurance claim for property damage and business interruption losses
resulting from a 1993 industrial accident at the Midland plant.
 
     Depreciation and Amortization Expenses.  Depreciation and amortization
expenses were relatively unchanged, increasing by $.2 million in 1996 to $23.0
million compared with $22.8 million in 1995.
 
     Selling, General and Administrative Expenses.  Selling, general and
administrative expenses increased by 1.8%, or $.4 million, to $20.1 million in
1996 compared with $19.7 million in 1995. Significantly higher engineering and
environmental consulting costs were mostly offset by reductions in the stock
appreciation right accrual.
 
     Research and Technology Expense.  Research and technology expense increased
to $6.0 million in 1996 from $4.0 million in 1995. The additional expense was
primarily due to the scheduled increase in fees paid under the Company's
ten-year research and technology agreement with Ugine. The agreement has
provided the Company with a broad spectrum of patents, know-how and future
research and development services, including any commercially viable thin strip
casting technology developed by Ugine.
 
     Interest Income.  The significant decrease in interest income in 1996 was
the result of lower cash balances available for investment.
 
     Interest Expense.  Interest expense decreased by 54.2% in 1996. The
significant decrease in interest expense was due to the capitalization of $6.1
million of interest related to capital projects in 1996 versus $2.0 million in
1995. Separately, the effect of higher average debt outstanding during 1996 was
proportionately offset by lower effective borrowing rates.
 
                                       5
<PAGE>   2
 
--------------------------------------------------------------------------------
 
     Other Expense.  Other expense decreased to $.4 million in 1996 from $2.7
million in 1995. The decrease in expense was due to a reduction in demolition
and disposal projects related to nonoperating facilities at the Midland plant.
 
     Income Tax Provision.  The effective income tax rate of 48.4% for 1996 was
higher than the 42.6% rate for 1995 due to the fact that the amortization of the
purchase accounting adjustment, primarily goodwill which is not deductible for
income tax purposes, was a relatively larger component of pretax income for
1996.
 
     Net Income.  Due to the items described above, net income decreased 71.3%
to $24.3 million in 1996 from $84.4 million in 1995.
 
YEAR ENDED 1995 COMPARED TO YEAR
ENDED 1994
 
     U.S. Stainless Steel Market.  Apparent consumption of stainless steel sheet
and strip in the United States increased .6% to 1,553,906 tons in 1995 from
1,544,217 tons in 1994. Demand for stainless steel remained high for most of
1995; however, demand weakened in the later part of the year. Reported domestic
shipments of stainless steel sheet and strip by the U.S. stainless steel
industry (excluding exports) were 1,244,664 tons in 1995, an increase of 5.1%
compared to the 1,184,199 tons in 1994. Imports of stainless steel sheet and
strip comprised the remaining 309,242 tons in 1995, or a decrease of 14.1%
compared to 1994.
 
     Net Sales.  Net sales for the Company increased 21.8% to a record $867.0
million from $711.7 million in 1994. The higher sales in 1995 were the result of
increased stainless steel prices and the addition of raw material sales price
surcharges which the Company implemented during 1995. Shipments of 367,030 tons
were just short of the record of 367,742 tons set in 1994. The year ended with
weak demand in the fourth quarter, resulting in falling prices for the Company's
products.
 
     Cost of Products Sold, Excluding Depreciation and Amortization Expenses.
 As a percentage of net sales, cost of products sold, excluding depreciation and
amortization expenses, decreased to 76.7% in 1995 compared with 78.9% in 1994.
The improvement in cost of products sold as a percentage of net sales was
largely due to the increased selling prices and, to a lesser extent, lower
quality related costs. Partially offsetting these improvements was an increase
in raw material costs, somewhat higher planned maintenance spending, higher
labor costs due to a $4,000 per union employee signing bonus and increased wages
provided under the new labor agreement that became effective on July 1, 1995.
This four-year labor agreement with the United Steelworkers of America provides
for wage and benefit cost increases averaging slightly less than 3% annually
over the contract term. Also reducing cost of products sold in 1995 was the
receipt of $2.5 million relating to the settlement of an insurance claim for
property damage and business interruption losses resulting from a 1993
industrial accident at the Midland plant.
 
     Depreciation and Amortization Expenses.  Depreciation and amortization
expenses were relatively unchanged, increasing by $.3 million in 1995 to $22.8
million compared with $22.5 million in 1994.
 
     Selling, General and Administrative Expenses.  Selling, general and
administrative expenses increased by 11.4%, or $2.0 million, to $19.7 million in
1995 compared with $17.7 million in 1994. The increase was due to a
reclassification of costs due to the restructuring of functions formerly
included in costs of products sold and increased costs related to employee
compensation.
 
     Research and Technology Expense.  Research and technology expense increased
to $4.0 million in 1995 from $1.4 million in 1994. The additional expense was
primarily due to the scheduled increase in the fees paid under the Company's
ten-year research and technology agreement with Ugine. The agreement has
provided the Company with a broad spectrum of patents, know-how and future
research and development services, including any commercially viable thin strip
casting technology developed by Ugine.
 
     Interest Income.  The significant increase in interest income in 1995 was
the result of an increase in invested cash generated from the high level of
operations.
 
     Interest Expense.  Interest expense decreased slightly, $.3 million, from
1994. Although average interest rates were higher in 1995, the decrease in
 
                                        6
<PAGE>   3
 
--------------------------------------------------------------------------------
 
interest expense was due to lower levels of outstanding borrowings and the
capitalization of interest. This capitalization of interest, which reduced
interest expense in 1995 by $2.0 million, primarily related to the Direct Roll
Anneal and Pickle Line capital project.
 
     Other Expense.  Other expense increased to $2.7 million in 1995 from $.3
million in 1994. This increase was due to voluntary demolition and disposal
costs related to certain nonoperating facilities at the Midland plant.
 
     Income Tax Provision.  The effective income tax rate of 42.6% for 1995 was
lower than the 45.8% rate for 1994 due to the fact that the amortization of the
purchase accounting adjustment, primarily goodwill which is not deductible for
income tax purposes, was a relatively smaller component of pretax income for
1995.
 
     Net Income.  Due to the items described above, net income increased 57.5%
to $84.4 million in 1995 from $53.6 million in 1994.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Working capital decreased by $44.3 million from the prior year-end to $68.8
million as of December 31, 1996. Cash and cash equivalents decreased $34.9
million during 1996 primarily due to a reduction in net income of $60.1 million,
capital expenditures of $103.3 million and dividend payments of $15.1 million.
Lower business activity levels contributed to the other major changes in working
capital, including a decrease in inventories of $18.2 million, which was offset
by a decrease in accounts payable of $14.4 million. This working capital change
and the significant amount of capital expenditures, discussed below, required
the Company to utilize established credit facilities as a supplemental source of
working capital during 1996. The Company had outstanding borrowings of $5.6
million under short-term lines of credit as of December 31, 1996, and $20.0
million under its $100.0 million revolving credit facility. The latter is
included in long-term debt as of December 31, 1996.
 
     During 1996, total debt increased by $28.6 million, increasing the
Company's borrowed debt to total capitalization ratio to 31.1% as of December
31, 1996. Capital expenditures increased to $103.3 million in 1996, compared
with $94.1 million in 1995. A significant portion of the 1996 expenditures were
for the largest of the Company's five-year capital plan projects, the Direct
Roll Anneal and Pickle ("DRAP") Line. The construction phase of the DRAP Line at
the Company's Midland, Pa., plant was substantially completed at the end of
1996. Commissioning is anticipated to be completed during the first half of
1997, while full production of the line is expected to be achieved by the end of
1997. The Company believes, based on its current commissioning plan, that the
net impact of starting up the new line, including depreciation, will reduce 1997
net income by $.30 to $.35 per share. This impact will occur predominately in
the second, third and fourth quarters.
 
     The forward-looking statements contained in this report involve risks and
uncertainties that could cause actual results to differ materially from those in
such forward-looking statements. Notably, the new DRAP Line utilizes novel
technology which could cause unforeseen start-up expense or benefits.
 
     Two other significant finishing expansion projects were recently completed
and commissioned in early 1997 at the Company's Louisville, Ohio, plant: a new
coil slitting and packaging line and major improvements to the bright anneal
line. The latter project is part of the upgrade of the Company's bright anneal
capabilities, which also includes the installation of a new temper mill expected
to be completed in 1999.
 
     Total capital expenditures for 1997 are expected to approximate $50 million
and will, with the commissioning of the equipment mentioned above, substantially
complete the finishing capacity expansion objectives of the five-year capital
plan. The Company believes that its cash flow provided by operating activities
and amounts available under its financing sources will enable it to satisfy its
planned capital expenditures and other cash requirements for the foreseeable
future.
 
     The Company paid dividends to its shareholders of $15.1 million during
1996. On February 20, 1997, the Company declared a quarterly cash dividend of
$.10 per share payable on April 23, 1997, to
 
                                        7
<PAGE>   4
 
--------------------------------------------------------------------------------
 
shareholders of record as of the close of business on April 9, 1997.
 
OTHER MATTERS
 
     Imports of stainless steel sheet and strip were up 9.0% in 1996 compared to
1995, capturing approximately 20% of the domestic market and absorbing a
significant portion of the 7.4% increase in domestic consumption. This increase
in imports adversely affected the Company's shipments and pricing for its
products in 1996. However, the Company is implementing a 5% price increase
effective March 2, 1997, and has announced a second 5% price increase effective
May 4, 1997, that will offset a recent rise in raw material costs.
 
     In late January 1997, the Company reached a settlement with an unrelated
third-party vendor concerning a commercial dispute relating to the quality of
certain material purchased by the Company from 1991 to 1996. As a result of this
settlement, the Company received a $5.9 million cash payment. This $5.9 million
pretax gain will be recognized in the first quarter of 1997.
 
     The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS
No. 123") in October 1995. This statement establishes a fair value based method
of financial accounting and related reporting standards for stock-based employee
compensation plans, such as the Company's 1993 Stock Incentive Plan. SFAS No.
123 became effective for calendar year 1996 and provides for adoption in the
income statement or through footnote disclosure only. The Company has continued
to account for its 1993 Stock Incentive Plan under APB Opinion No. 25,
"Accounting for Stock Issued to Employees," as permitted by SFAS No. 123. Had
the recognition requirements been adopted in 1995 and 1996, the effect would
have been immaterial.
 
                                        8
<PAGE>   5
 
--------------------------------------------------------------------------------
 
                           J&L Specialty Steel, Inc.
 
                          CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 1996 AND 1995
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                          1996          1995
                                                                        --------      --------
<S>                                                                     <C>           <C>
Current assets:
  Cash and cash equivalents..........................................   $    499      $ 35,428
  Trade receivables, less allowances of $3,869 and $4,336,
     respectively....................................................     55,153        64,575
  Trade receivables from affiliates..................................      6,191         7,523
  Inventories........................................................    143,576       161,787
  Deferred income taxes..............................................      7,172         9,326
  Prepaid expenses and other current assets..........................        605         1,192
                                                                        --------      --------
       Total current assets..........................................    213,196       279,831
                                                                        --------      --------
Property, plant and equipment, net...................................    304,721       217,060
Goodwill, net of accumulated amortization of $68,194 and $61,066,
  respectively.......................................................    238,209       245,337
Deferred income taxes................................................      3,587            --
Other noncurrent assets..............................................     12,215        11,590
                                                                        --------      --------
       Total assets..................................................   $771,928      $753,818
                                                                        ========      ========
 
                             LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Common stock dividend payable......................................   $  3,867      $  3,480
  Short-term debt....................................................      6,205           402
  Trade accounts payable.............................................     72,621        86,976
  Construction accounts payable......................................     22,914        24,246
  Accrued employee compensation and benefits.........................     19,571        30,741
  Accrued income taxes...............................................      3,360         3,882
  Reserve for claims and allowances..................................      6,090         9,445
  Other accrued liabilities..........................................      9,810         7,635
                                                                        --------      --------
       Total current liabilities.....................................    144,438       166,807
                                                                        --------      --------
Long-term debt.......................................................    170,452       147,620
Deferred income taxes................................................         --           302
Postretirement benefits liability....................................     48,729        46,786
Other noncurrent liabilities.........................................     17,571        12,078
Shareholders' equity:
  Preferred stock (par value $.01 per share; 2,000,000 shares
     authorized, no shares issued and outstanding)...................         --            --
  Common stock (par value $.01 per share; 100,000,000 shares
     authorized, 38,670,000 shares issued and outstanding)...........        387           387
  Additional paid-in capital.........................................    308,378       306,662
  Retained earnings..................................................     81,973        73,176
                                                                        --------      --------
       Total shareholders' equity....................................    390,738       380,225
                                                                        --------      --------
       Total liabilities and shareholders' equity....................   $771,928      $753,818
                                                                        ========      ========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                        9
<PAGE>   6
 
--------------------------------------------------------------------------------
 
                           J&L Specialty Steel, Inc.
 
                       CONSOLIDATED STATEMENTS OF INCOME
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                           1996           1995           1994
                                                         --------       --------       --------
<S>                                                      <C>            <C>            <C>
Trade sales, net.....................................    $579,500       $797,044       $638,624
Sales to affiliates, net.............................      48,522         69,978         73,036
                                                         --------       --------       --------
       Total sales, net..............................     628,022        867,022        711,660
 
Cost of products sold................................     527,805        665,040        561,565
Depreciation and amortization expenses...............      23,031         22,797         22,469
                                                         --------       --------       --------
       Gross profit..................................      77,186        179,185        127,626
 
Selling, general and administrative expenses.........      20,102         19,739         17,716
Research and technology expense......................       6,049          4,033          1,351
                                                         --------       --------       --------
       Operating income..............................      51,035        155,413        108,559
 
Interest income......................................        (225)        (2,915)          (273)
Interest expense.....................................       3,909          8,534          8,822
Interest (income) expense with affiliates, net.......         (37)           185            868
Other expense, net...................................         378          2,682            274
                                                         --------       --------       --------
       Income before income taxes....................      47,010        146,927         98,868
Income taxes.........................................      22,745         62,525         45,293
                                                         --------       --------       --------
 
       Net income....................................    $ 24,265       $ 84,402       $ 53,575
                                                         ========       ========       ========
Per share data:
       Net income....................................    $    .63       $   2.18       $   1.39
                                                         ========       ========       ========
 
Weighted average number of common shares.............  38,670,000     38,670,000     38,670,000
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       10
<PAGE>   7
 
--------------------------------------------------------------------------------
 
                           J&L Specialty Steel, Inc.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                             (DOLLARS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                              1996          1995         1994
                                                            ---------     --------     ---------
<S>                                                         <C>           <C>          <C>
Cash flows from operating activities:
  Net income.............................................   $  24,265     $ 84,402     $  53,575
  Adjustments to reconcile net income to net cash
     provided by operating activities:
     Amortization of intangibles and depreciation........      23,031       22,797        22,469
     Deferred income taxes...............................      (1,735)      (3,891)       (4,699)
  Changes in certain assets and liabilities:
     Trade receivables...................................      10,754       25,695       (30,064)
     Inventories.........................................      18,211      (25,309)      (10,473)
     Prepaid expenses and other current assets...........         587         (418)         (452)
     Trade accounts payable..............................     (14,355)       2,537        24,358
     Construction accounts payable.......................      (1,332)      23,789           (78)
     Accrued employee compensation and benefits..........      (9,570)        (265)        1,622
     Accrued income taxes................................       1,194       (2,072)        8,363
     Reserve for claims and allowances...................      (3,355)         235         2,729
     Other accrued liabilities...........................       2,175       (1,918)        3,308
     Postretirement benefits liability...................       2,143        3,747         3,655
     Other, net..........................................       2,820        3,447          (400)
                                                            ---------     --------     ---------
       Net cash provided by operating activities.........      54,833      132,776        73,913
                                                            ---------     --------     ---------
Cash flows from investing activities:
  Capital expenditures...................................    (103,316)     (94,060)       (7,590)
  Proceeds from sale of property, plant and equipment....          --           --         4,350
                                                            ---------     --------     ---------
       Net cash used by investing activities.............    (103,316)     (94,060)       (3,240)
                                                            ---------     --------     ---------
Cash flows from financing activities:
  Borrowings on lines of credit, net.....................       5,600           --            --
  Borrowings on revolving credit facility, net...........      20,000           --            --
  Refinancing of long-term bank loan.....................          --      125,000            --
  Repayment of long-term bank loan.......................          --     (145,000)           --
  Borrowings of industrial development notes, net........       3,035        2,414           (62)
  Repayments of revolving credit loans with affiliates...          --           --       (35,000)
  Common stock dividends paid............................     (15,081)     (13,921)      (13,921)
                                                            ---------     --------     ---------
       Net cash provided (used) by financing
          activities.....................................      13,554      (31,507)      (48,983)
                                                            ---------     --------     ---------
Net (decrease) increase in cash and cash equivalents.....     (34,929)       7,209        21,690
Cash and cash equivalents at beginning of year...........      35,428       28,219         6,529
                                                            ---------     --------     ---------
Cash and cash equivalents at end of year.................   $     499     $ 35,428     $  28,219
                                                            =========     ========     =========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       11
<PAGE>   8
 
--------------------------------------------------------------------------------
 
                           J&L Specialty Steel, Inc.
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                               ADDITIONAL     RETAINED
                                                   COMMON       PAID-IN       EARNINGS/
                                                   STOCK        CAPITAL       (DEFICIT)      TOTAL
                                                  --------     ----------     ---------     --------
<S>                                               <C>          <C>            <C>           <C>
Balance at December 31, 1993...................   $    387      $ 304,088     $ (36,959)    $267,516
 
  Net income...................................         --             --        53,575       53,575
  Common stock dividends paid ($.27 per
     share)....................................         --             --       (10,441)     (10,441)
  Common stock dividends payable ($.09 per
     share)....................................         --             --        (3,480)      (3,480)
  Income tax benefit from exercised stock
     warrant...................................         --            858            --          858
                                                  --------     ----------     ---------     --------
Balance at December 31, 1994...................        387        304,946         2,695      308,028
 
  Net income...................................         --             --        84,402       84,402
  Common stock dividends paid ($.27 per
     share)....................................         --             --       (10,441)     (10,441)
  Common stock dividends payable ($.09 per
     share)....................................         --             --        (3,480)      (3,480)
  Income tax benefit from exercised stock
     warrant...................................         --          1,716            --        1,716
                                                  --------     ----------     ---------     --------
Balance at December 31, 1995...................        387        306,662        73,176      380,225
 
  Net income...................................         --             --        24,265       24,265
  Common stock dividends paid ($.30 per
     share)....................................         --             --       (11,601)     (11,601)
  Common stock dividends payable ($.10 per
     share)....................................         --             --        (3,867)      (3,867)
  Income tax benefit from exercised stock
     warrant...................................         --          1,716            --        1,716
                                                  --------     ----------     ---------     --------
Balance at December 31, 1996...................   $    387      $ 308,378     $  81,973     $390,738
                                                  ========       ========      ========     ========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       12
<PAGE>   9
 
--------------------------------------------------------------------------------
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
 
NOTE 1   ORGANIZATION AND NATURE OF OPERATIONS
 
     J&L Specialty Steel, Inc. (the "Company") is a leading manufacturer of flat
rolled stainless steel. On June 14, 1990, Ugine s.a. ("Ugine"), a French
corporation, became the sole shareholder of a predecessor to the Company. On
December 6, 1993, two predecessors to the Company were merged with and into a
newly formed corporation, J&L Specialty Steel, Inc., with the Company being the
surviving entity. On December 15, 1993, the Company completed an initial public
offering of common stock. At December 31, 1996 and 1995, Usinor Sacilor
("Usinor"), successor by merger to Ugine, owned 53.6% of the Company's issued
and outstanding shares of common stock.
 
     Flat rolled stainless steel is the Company's only product line. The Company
produces both austenitic and ferritic flat rolled stainless steels; austenitic
stainless steel represents the largest part of the domestic stainless steel
market. The Company manufactures various grades of stainless steel in the form
of cold rolled stainless steel sheet and strip, hot rolled stainless steel sheet
and strip and continuous mill plate, as well as stainless steel slabs. The
Company operates within a single business segment, stainless steel, and
predominantly within a single geographic area, the continental United States.
 
     The principal raw materials used to produce stainless steel are stainless
steel scrap, nickel, ferrochromium, carbon steel scrap, molybdenum,
ferrosilicon, manganese and manganese alloys. Certain of these raw materials,
including the key raw materials nickel and chromite ore (which is the source of
ferrochromium), can be acquired by the Company and its competitors only from
foreign sources, some of which are located in countries which may be subject to
unstable political and economic conditions. These conditions might disrupt
supplies or affect the prices of these raw materials. In addition, the prices of
many of the Company's raw materials are cyclical as a result of being dependent
on international supply and demand relationships. A substantial increase in raw
material prices or a continued interruption in supply could have a material
adverse effect on the Company's financial condition and results of operations.
 
     At present, an integral part of the Company's stainless steel production
process involves the use of a hot strip mill. The Company does not operate a hot
strip mill and maintains tolling arrangements with two other companies for the
use of their hot strip mills. The Company's dependence on these arrangements
could subject it to interruption in service due to strikes and other production
disruptions at the providers' facilities, which are not within the Company's
control. Should this interruption occur, it could have a material adverse effect
on the Company's financial condition and results of operations.
 
     Virtually all of the Company's hourly labor force is represented by the
United Steelworkers of America, AFL-CIO ("USWA"). The USWA workers located at
the Company's three manufacturing facilities are covered by separate collective
bargaining agreements. These three agreements expire on July 1, 1999.
 
     The Company's stainless steel is used in a wide variety of industrial,
commercial and consumer products, including pressure vessels, chemical and
refinery equipment, environmental control equipment, cargo containers, sinks,
transportation equipment, beer kegs, fast food equipment, automated bank teller
machines, automobile trim, exhaust systems, and kitchen appliances and utensils.
Approximately 50% of the Company's products are sold to steel service centers.
The remainder of the Company's products are sold to stainless steel converters,
manufacturers of finished industrial and consumer products and exporters. The
Company's customer base has been relatively stable. Sales to a principal
customer accounted for 12.7% of net sales in 1996.
 
                                       13
<PAGE>   10
 
--------------------------------------------------------------------------------
 
NOTE 2   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Basis of Consolidation and Presentation
 
     The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
  Cash Equivalents
 
     Cash equivalents, consisting primarily of commercial paper and money market
funds, are stated at cost which approximates fair market value. For purposes of
the statements of cash flows, the Company considers all highly liquid
investments with a maturity of three months or less at acquisition to be cash
equivalents.
 
  Inventories
 
     Inventories are stated at the lower of cost or market. Prior to 1994, the
cost of raw materials was determined by the first-in, first-out ("FIFO") method
and the cost of semifinished and finished steel inventories was determined by
the specific identification cost method. Effective January 1, 1994, the Company
changed its method of determining the cost for raw materials only, including raw
materials in all steel inventories, to the last-in, first-out ("LIFO") method.
This change affects the raw material cost in all steel inventory including raw
material, work-in-process and finished goods. This change was made to better
match current costs with current revenues.
 
     The remaining costs of work-in-process and finished goods inventories are
not valued by the LIFO method; instead, they are determined by the specific
identification cost method.
 
     Inventories include material, labor and overhead costs.
 
  Property, Plant and Equipment
 
     Property, plant and equipment are stated at cost. Expenditures for
additions and betterments are capitalized, while those for maintenance, repairs
and minor renewals are expensed as incurred. For financial reporting purposes,
the Company provides for depreciation on the straight-line method over the
estimated useful lives of the related assets. Accelerated depreciation methods
are utilized for federal income tax purposes.
 
  Intangible Assets
 
     Goodwill is being amortized on a straight-line basis over 40 years. Other
noncurrent assets include patents and manufacturing know-how that are valued on
a continued-use basis with lives not exceeding 15 years.
 
     The Company evaluates the recoverability of intangible assets, including
goodwill, at each balance sheet date based on forecasted future operations and
undiscounted cash flows and other subjective criteria. Based upon historical
data, management believes that the carrying amount of these intangible assets
will be realizable over their respective amortization periods.
 
  Postemployment Benefits
 
     The Company recognizes the liability for postemployment benefits for former
and inactive employees and their dependents, other than retirees, based on
guidelines recommended by Statement of Financial Accounting Standards No. 112,
"Employers' Accounting for Postemployment Benefits," which was adopted by the
Company effective January 1, 1994.
 
  Financial Instruments
 
     The Company enters into nonleveraged interest rate swap agreements to
manage interest rate exposure. The differential to be paid or received is
accrued as interest rates change and is recognized as interest expense or income
in the current period.
 
                                       14
<PAGE>   11
 
--------------------------------------------------------------------------------
 
  Earnings Per Share
 
     Net income per share of common stock has been determined by dividing net
income by the weighted average number of common shares outstanding during each
period. Common stock equivalents resulting from the assumed exercise of stock
options without stock appreciation rights are not dilutive in the calculation of
earnings per share.
 
  Stock-Based Compensation
 
     The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS
No. 123") in October 1995. This statement establishes a fair value based method
of financial accounting and related reporting standards for stock-based employee
compensation plans, such as the Company's 1993 Stock Incentive Plan. SFAS No.
123 became effective for calendar year 1996 and provides for adoption in the
income statement or through footnote disclosure only. The Company has continued
to account for its 1993 Stock Incentive Plan under APB Opinion No. 25,
"Accounting for Stock Issued to Employees," ("APB No. 25") as permitted by SFAS
No. 123, and has provided the new disclosure in Note 16.
 
NOTE 3   INVENTORIES
 
     Effective January 1, 1994, the method for valuing costs of raw materials in
all levels of inventory was changed to the LIFO method to better match current
costs with current revenues.
 
     Inventory balances as of December 31 consisted of the following:
 
<TABLE>
<CAPTION>
                                1996         1995
                              --------     --------
<S>                           <C>          <C>
Raw materials..............   $ 14,567     $ 29,559
Work-in-process............    104,512      157,236
Finished goods.............     39,448       22,426
                              --------     --------
Total inventories at
  current cost.............    158,527      209,221
Less allowance to reduce
  current cost values to
  LIFO basis...............    (14,951)     (47,434)
                              --------     --------
Total inventories..........   $143,576     $161,787
                              ========     ========
</TABLE>
 
    At December 31, 1996 and 1995, inventories not valued on the LIFO method
totaled $72,452 and $70,016, respectively. Cost of products sold was increased
by approximately $1,433 in 1996 as a result of the liquidation of LIFO
inventories.
 
     The Company enters into fixed price raw material contracts to hedge its
exposure to price fluctuations. Currently, none of these contracts are for more
than one year. The Company's requirement for raw materials is expected to
significantly exceed the amounts under contract.
 
NOTE 4   PROPERTY, PLANT AND EQUIPMENT
 
     Property, plant and equipment and their related allowances for depreciation
as of December 31 were:
 
<TABLE>
<CAPTION>
                                1996         1995
                              --------     --------
<S>                           <C>          <C>
Land.......................   $  3,325     $  3,325
Buildings..................     21,242       20,057
Machinery and equipment....    191,165      184,478
Construction-in-progress...    183,158       87,848
                              --------     --------
Total property, plant and
  equipment................    398,890      295,708
Less allowance for
  depreciation.............    (94,169)     (78,648)
                              --------     --------
Property, plant and
  equipment, net...........   $304,721     $217,060
                              ========     ========
</TABLE>
 
     Interest capitalized during 1996 and 1995 was $6,097 and $1,996,
respectively. As of December 31, 1996 and 1995, purchase commitments for capital
expenditures were approximately $18 million and $26 million, respectively.
 
NOTE 5   SHORT-TERM BORROWING FACILITIES
 
     The Company has $50,000 of unsecured, uncommitted, short-term lines of
credit with various banks. Borrowings under these lines of credit are available
to finance the Company's working capital requirements and for other general
corporate purposes. Interest rates are quoted by each bank on an "as offered"
basis depending on the terms of the borrowing (from one day to six months). The
Company had outstanding borrowings of $5,600 under these lines of credit as of
December 31, 1996. The maximum outstanding borrowing in 1996 was
 
                                       15
<PAGE>   12
 
--------------------------------------------------------------------------------
 
$20,600, and the average amount outstanding during the borrowing period was
$10,190. The weighted daily average interest rate was 5.7% for the year ended
December 31, 1996. The Company did not borrow under these lines of credit during
1995. The maximum borrowing available under these lines of credit at December
31, 1996, after considering the short-term borrowing limitations provided in the
revolving credit facility, was $34,400.
 
NOTE 6   LONG-TERM DEBT
 
     Long-term debt as of December 31 consisted of the following:
 
<TABLE>
<CAPTION>
                                1996         1995
                              --------     --------
<S>                           <C>          <C>
Term loan..................   $125,000     $125,000
Revolving credit
  facility.................     20,000           --
7% pollution control
  revenue bonds due June 1,
  1998 through June 1,
  2008.....................     11,975       11,975
6.6% pollution control
  revenue refunding bonds
  due September 1, 2006
  through September 1,
  2010.....................      8,000        8,000
2%-3% industrial
  development notes........      6,082        3,047
                              --------     --------
                               171,057      148,022
Current maturities.........       (605)        (402)
                              --------     --------
Total long-term debt.......   $170,452     $147,620
                              ========     ========
</TABLE>
 
     In July 1995, the Company entered into a $125,000 term loan with a group of
banks. The term loan agreement matures on July 14, 2002. The term loan allows
the Company to borrow up to $125,000 at either the bank's base rate or LIBOR
plus a fixed margin, based on the Company's financial performance, for either
one, two or three-month interest rate periods. The weighted average interest
rate was 6.0% in 1996 and 6.4% in 1995.
 
     In July 1995, the Company entered into a five-year $100,000 revolving
credit facility with a group of banks. The credit agreement provides for
borrowings at either the bank's base rate or LIBOR plus a margin based upon the
Company's financial performance. The Company is obligated to pay a commitment
fee on the unused portion of the loan commitment. The Company had outstanding
borrowings of $20,000 under the revolving credit facility as of December 31,
1996. The maximum outstanding borrowing in 1996 was $20,000, and the average
amount outstanding during the borrowing period was $9,745. The weighted daily
average interest rate was 5.9% for the year ended December 31, 1996. The
available portion of this line was $80,000 at December 31, 1996. There was no
balance outstanding as of December 31, 1995, or at any time during 1995.
Borrowings under the revolving credit facility are available to finance the
Company's working capital requirements and for other general corporate purposes.
 
     Both the term loan and the revolving credit facility are unsecured but
contain certain financial covenants that the Company is required to meet,
including a minimum consolidated tangible net worth covenant and consolidated
leverage ratio covenant. The agreements also contain a put event based on the
continued ownership of a majority of the issued and outstanding shares of common
stock of the Company by Usinor and an event of default in certain situations if
Usinor becomes involved in bankruptcy or insolvency proceedings. The agreements
do not contain any material limitations on the Company's ability to pay
dividends. The Company is in compliance with all applicable covenants.
 
     An $8,300 stand-by letter of credit is outstanding to secure the 6.6%
pollution control revenue refunding bonds. An additional $7,211 in letters of
credit are outstanding with several banks in support of certain other Company
obligations.
 
     During 1996, the Company entered into $3,500 of industrial development
loans with maturities between seven and 20 years. The industrial development
notes are secured by certain related facilities or equipment.
 
     Maturities of long-term debt in each of the next five years are as follows:
1997--$605; 1998--$982; 1999--$32,268; 2000--$52,315; and 2001--$32,356.
 
     Cash paid for interest was $8,869, $11,162 and $9,783 for the years ended
December 31, 1996, 1995 and 1994, respectively. Included in interest paid in
1995 and 1994 is a loan guarantee fee payable to Usinor on the former term loan.
 
                                       16
<PAGE>   13
 
--------------------------------------------------------------------------------
 
Amounts paid were $604 and $435 for the years ended December 31, 1995 and 1994,
respectively.
 
NOTE 7   FINANCIAL INSTRUMENTS
 
     The Company's usage of derivative financial instruments has been limited to
nonleveraged interest rate swaps to manage well-defined interest rate risk.
 
     The following table provides information on the interest rate swaps:
 
<TABLE>
<CAPTION>
                                            WEIGHTED
                                             AVERAGE
                           NOTIONAL       INTEREST RATE
               NOTIONAL     AMOUNT       ---------------
CLASSIFICATION   AMOUNT   OUTSTANDING    RECEIVED   PAID
-------------- --------   -----------    --------   ----
<S>           <C>        <C>            <C>        <C>
             YEAR ENDED DECEMBER 31, 1996
SWAP........  $11,975     $11,975          7.0%     5.6%
SWAP........   62,375      62,375          5.7      6.2             
             YEAR ENDED DECEMBER 31, 1995
SWAP........  $11,975     $11,975          7.0%     6.3%
SWAP........   70,000          --          6.3      6.2
</TABLE>
 
     The Company entered into interest rate swap agreements in July 1996 that
had the effect of converting $62,375 of variable rate debt into a fixed rate
obligation. The expiration date of the interest rate swap agreements is October
1997. The cash settlement of the transactions occurs on a quarterly basis, with
the Company either paying or receiving the difference between the fixed rate of
interest and three-month LIBOR.
 
     An interest rate swap agreement was entered into in June 1992 that has the
effect of converting $11,975 of fixed rate borrowings into a variable rate
obligation. The expiration date of the interest rate swap agreement is June
1999. The cash settlement of the transaction occurs on a quarterly and
semiannual basis, with the Company either paying or receiving the difference
between the fixed rate of interest and the three-month LIBOR.
 
     The Company entered into a $70,000 interest rate swap agreement with a
major international financial institution for the period November 14, 1994,
through September 15, 1995, that had the effect of converting $70,000 of
variable rate obligations into a fixed rate obligation. The cash settlement of
the transaction occurred on a quarterly basis, with the Company either paying or
receiving the difference between the fixed rate of interest and the three-month
LIBOR.
 
     The effect of the interest rate swaps was to decrease the Company's
interest expense by $14 and $111 in 1996 and 1995, respectively.
 
NOTE 8   SHAREHOLDERS' EQUITY
 
     In 1988, The LTV Corporation ("LTV"), a former shareholder, exercised its
warrant to purchase 200,000 shares of common stock of J&L Specialty Products
Corporation, predecessor to the Company. A condition to the exercise of the
warrant was an extension of the Tolling Agreement between a subsidiary of LTV
and the Company pursuant to which LTV agreed to convert the Company's steel
slabs into hot bands. The Company believes that for income tax purposes, the
difference between the exercise price plus the amount paid for the warrant and
the fair value of the common stock on the date of exercise is deductible by the
Company over the term of the Tolling Agreement. Accordingly, the Company has
increased additional paid-in capital by $1,716 in 1996 and 1995 and $858 in 1994
to reflect the income tax benefit recognized for this amortization.
 
NOTE 9   INCOME TAXES
 
     The consolidated provision for income tax expense includes current and
deferred taxes as follows for the years ended December 31:
 
<TABLE>
<CAPTION>
                      1996        1995        1994
                     -------     -------     -------
<S>                  <C>         <C>         <C>
CURRENT TAXES:
  Federal.........   $21,237     $54,862     $39,124
  State and
    local.........     3,243      11,554      10,868
                     -------     -------     -------
    Total.........    24,480      66,416      49,992
                     -------     -------     -------
DEFERRED TAXES:
  Federal.........    (1,452)     (3,196)     (3,651)
  State and
    local.........      (283)       (695)     (1,048)
                     -------     -------     -------
    Total.........    (1,735)     (3,891)     (4,699)
                     -------     -------     -------
Total current and
  deferred
  taxes...........   $22,745     $62,525     $45,293
                     =======     =======     =======
</TABLE>
 
     Income tax expense varies from the amount that would be provided by
applying the federal
 
                                       17
<PAGE>   14
 
--------------------------------------------------------------------------------
 
statutory income tax rate to earnings before income taxes as reflected below:
 
<TABLE>
<CAPTION>
                           1996      1995      1994
                           -----     -----     -----
<S>                        <C>       <C>       <C>
Federal statutory income
  tax rate..............    35.0%     35.0%     35.0%
State and local income
  taxes, net of federal
  income tax benefit....     2.9       4.3       5.7
Amortization of purchase
  accounting
  adjustment............    10.5       3.3       5.1
                           -----     -----     -----
Effective income tax
  rate..................    48.4%     42.6%     45.8%
                           =====     =====     =====
</TABLE>
 
     Net deferred income tax assets (liabilities) are composed of the following
as of December 31:
 
<TABLE>
<CAPTION>
                                 1996        1995
                               --------    --------
<S>                            <C>         <C>
Deferred income
  tax--current..............   $  7,172    $  9,326
Deferred income
  tax--long-term............      3,587        (302)
                               --------    --------
Net deferred income tax
  assets....................   $ 10,759    $  9,024
                               ========    ========
 
    Consisting of:
                                   1996        1995
                               --------    --------
Financial reserves not yet
  deductible................   $ 13,563    $ 14,115
Postretirement benefits
  other than pensions.......     19,116      18,194
Depreciation................    (20,161)    (20,619)
Other, net..................     (1,759)     (2,666)
                               --------    --------
                               $ 10,759    $  9,024
                               ========    ========
</TABLE>
 
     Cash paid for income taxes for 1996, 1995 and 1994 was $23,287, $68,488 and
$41,629, respectively.
 
NOTE 10   COMMITMENTS
 
     During 1996, the Company entered into a noncancelable contract to purchase
certain manufacturing support services for the Company's new Direct Roll Anneal
and Pickle Line at its Midland, Pa. plant. The five-year contract provides the
Company with per unit prices for services to be provided under the contract plus
a minimum monthly obligation related to such contractor's fixed costs. The
contract takes effect February 1, 1997, and the Company's annual minimum
obligation under the contract is approximately $2 million per year.
 
     The Company leases certain property, plant and equipment under various
operating lease agreements. The total rent expense for the years ended December
31, 1996, 1995 and 1994, was $2,362, $2,271 and $2,423, respectively.
 
     Future minimum lease payments required under noncancelable operating leases
that have initial or remaining lease terms in excess of one year as of December
31, 1996, are: 1997--$1,234; 1998--$966; 1999--$783; 2000--$681; and 2001--$681.
 
NOTE 11   PENSION BENEFITS
 
     The Company provides retirement benefits under a variety of employee
benefit plans. Virtually all hourly employees are covered by a defined benefit
plan and all salaried employees, and certain hourly employees, are covered by a
defined contribution plan. A group of salaried employees also has benefits under
the qualified defined benefit plan which was frozen as of January 1, 1993.
Certain key management employees are also covered by a nonqualified, unfunded
supplemental defined benefit plan.
 
     Periodic pension expense for the defined benefit plan is actuarially
determined utilizing the projected unit credit method. The Company funds pension
costs for the defined benefit plan in accordance with the funding requirements
of the Employee Retirement Income Security Act of 1974. Pension costs for the
salaried and hourly defined contribution plans are based upon a percentage of
compensation for salaried employees or a multiple of hours worked for hourly
employees, respectively, and are funded monthly.
 
     The following table summarizes total pension expense for the years ended
December 31:
 
<TABLE>
<CAPTION>
       PLAN TYPE            1996      1995      1994
------------------------   ------    ------    ------
<S>                        <C>       <C>       <C>
Defined benefit.........   $4,171    $4,445    $2,548
Defined contribution....    1,602     1,478     1,429
                           ------    ------    ------
Total...................   $5,773    $5,923    $3,977
                           ======    ======    ======
</TABLE>
 
     Net periodic pension expense for the defined benefit plans in 1996, 1995
and 1994 was determined assuming discount rates of 7.0%, 8.0% and
 
                                       18
<PAGE>   15
 
--------------------------------------------------------------------------------
 
7.25%, respectively, and an expected rate of return on plan assets of 9.0% for
1996, 1995 and 1994. Components of net periodic pension expense are as follows:
 
<TABLE>
<CAPTION>
                        1996        1995       1994
                       -------    --------    -------
<S>                    <C>        <C>         <C>
Service cost........   $ 2,930    $  2,391    $ 2,376
Interest cost on
  projected benefit
  obligation........     5,533       5,745      4,514
Actual return on
  assets............    (8,005)    (14,678)       869
Net amortization and
  deferral..........     3,713      10,987     (5,211)
                       -------    --------    -------
Net periodic pension
  expense...........   $ 4,171    $  4,445    $ 2,548
                       =======    ========    =======
</TABLE>
 
     The Company's projected, accumulated and vested defined benefit pension
obligations as of December 31, 1996 and 1995, were determined assuming discount
rates of 7.25% and 7.0%, respectively. The assumed rate of salary increase was
4.0% as of December 31, 1996 and 1995. Plan assets consist primarily of common
stocks, fixed income securities and short-term investments that are
professionally managed.
 
<TABLE>
<CAPTION>
            BENEFITS              1996       1995
-------------------------------- -------    -------
<S>                              <C>        <C>
Actuarial present value of:
  Vested benefit obligation..... $61,491    $61,654
  Nonvested benefit
    obligation..................  10,299      9,715
                                 -------    -------
Accumulated benefit
  obligation....................  71,790     71,369
Additional obligation for
  projected compensation
  increases.....................  11,914      7,770
                                 -------    -------
Projected benefit obligation....  83,704     79,139
Plan assets at market value.....  67,588     59,974
                                 -------    -------
Projected benefit obligation in
  excess of plan assets.........  16,116     19,165
Unrecognized prior service
  cost..........................  (6,857)    (6,154)
Unrecognized net actuarial
  gain..........................   6,521      1,198
                                 -------    -------
Accrued pension cost............ $15,780    $14,209
                                 =======    =======
</TABLE>
 
NOTE 12   RETIREMENT BENEFITS OTHER THAN PENSIONS
 
     The Company maintains unfunded postretirement health care and life
insurance benefit plans covering most hourly and salaried employees.
Substantially all of the Company's employees may become eligible for these
benefits if they retire while working for the Company. The basic hourly health
care and life insurance benefit plans are noncontributory, while the major
medical options of the health care plan are contributory. Generally, the
postretirement salaried benefit plans are contributory. In 1995, the Company
agreed to establish a Voluntary Employee Beneficiary Association Trust ("VEBA")
to prefund a portion of health care and life insurance benefits for retirees
covered under the USWA union agreement. In December 1996, the Company funded the
VEBA with a cash contribution of $1,800. Additionally, the Company is required
to make minimum cash contributions of $1,800 in each succeeding contract year of
the USWA union agreement.
 
     Postretirement benefit expenses for 1996, 1995 and 1994 were determined
assuming discount rates of 7.0%, 8.0% and 7.25%, respectively. Components of
postretirement benefit expense are as follows:
 
<TABLE>
<CAPTION>
                            1996      1995      1994
                           ------    ------    ------
<S>                        <C>       <C>       <C>
Cost of benefits earned
  during the year.......   $1,865    $1,670    $1,769
Interest on APBO........    3,344     3,249     2,972
Net amortization........        2       (54)        6
                           ------    ------    ------
Total postretirement
  benefit expense.......   $5,211    $4,865    $4,747
                           ======    ======    ======
</TABLE>
 
                                       19
<PAGE>   16
 
--------------------------------------------------------------------------------
 
     The accumulated postretirement benefit obligation ("APBO") as of December
31 was:
 
<TABLE>
<CAPTION>
                                 1996        1995
                                -------     -------
<S>                             <C>         <C>
Retirees.....................   $15,653     $14,066
Fully eligible plan
  participants...............     7,599       7,294
Other active plan
  participants...............    27,168      27,653
                                -------     -------
Total APBO...................    50,420      49,013
Plan assets at market
  value......................     1,800          --
                                -------     -------
APBO in excess of plan
  assets.....................    48,620      49,013
Unrecognized prior service
  cost.......................       (42)        (48)
Unrecognized net actuarial
  gain.......................     3,451         921
                                -------     -------
Accrued postretirement
  benefit cost...............   $52,029     $49,886
                                =======     =======
</TABLE>
 
     Postretirement benefit liabilities as of December 31 are reported on the
balance sheets as follows:
 
<TABLE>
<CAPTION>
                                 1996        1995
                                -------     -------
<S>                             <C>         <C>
Accrued compensation and
  benefits...................   $ 3,300     $ 3,100
Postretirement benefits
  liability..................    48,729      46,786
                                -------     -------
Total postretirement benefits
  liability..................   $52,029     $49,886
                                =======     =======
</TABLE>
 
     The discount rate used to determine the APBO was 7.25% at December 31,
1996, and 7.0% at December 31, 1995. The assumed medical cost trend rate at
December 31, 1996, was 10.0%, grading down to an ultimate rate of 5.0% in 2007
and remaining at that level thereafter. The assumed medical cost trend rate at
December 31, 1995, was 11.0%, grading down to an ultimate rate of 5.0% in 2007
and remaining at that level thereafter. A one percentage point increase in the
assumed health care cost trend rates for each future year increases annual
postretirement benefit expense by $1,091 and the APBO by $8,575.
 
     The actual cash payments of postretirement benefits, excluding the $1,800
contribution to the VEBA, totaled $1,271, $1,118 and $1,313 in 1996, 1995 and
1994, respectively.
 
NOTE 13   RELATED-PARTY TRANSACTIONS
 
     Effective October 1, 1993, the Company entered into a ten-year research and
technology agreement (the "Agreement") with Ugine that provides the Company with
a broad spectrum of patents, know-how and future research and development
services concerning the manufacturing and processing of flat rolled stainless
steel. The Company made an initial $5,000 cash payment to Ugine for the transfer
of rights to existing patents and know-how and for research and development
services provided during the first year of the Agreement. Ongoing annual fees
for the years ended December 31, 1996 and 1995, were $5,000 and $3,000,
respectively, for these research and development services. Ongoing annual fees
to be paid to Ugine for research and development services will be $5,000 in 1997
and each year thereafter for the term of the Agreement.
 
     In addition to the research and technology agreement, the Company has
purchased various steel products and other services from Usinor or its
affiliates. Payments to Usinor relating to certain insurance premiums for the
Company amounted to $57, $391 and $741 in 1996, 1995 and 1994, respectively. The
payments in 1996 and 1995 represented coverage for a one-year period; the
payment in 1994 represented coverage for a two-year period. Purchases of steel
from Usinor or its affiliates during the three-year period were insignificant.
 
     See also Note 6 for certain additional related-party transactions.
 
NOTE 14   DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
 
     The following table presents the carrying amounts and estimated fair values
of the Company's financial instruments as of December 31, 1996 and 1995.
Statement of Financial Accounting Standards No. 107, "Disclosure About Fair
Value of Financial Instruments," defines the fair value of a financial
instrument as the amount at which the instrument
 
                                       20
<PAGE>   17
 
--------------------------------------------------------------------------------
 
could be exchanged in a current transaction between willing parties.
 
<TABLE>
<CAPTION>
                           1996                  1995
                    -------------------   -------------------
<S>                 <C>        <C>        <C>        <C>
                    CARRYING     FAIR     CARRYING     FAIR
                     AMOUNT     VALUE      AMOUNT     VALUE
                    --------   --------   --------   --------
FINANCIAL ASSETS:
  Cash and cash
    equivalents...  $    499   $    499   $ 35,428   $ 35,428
 
FINANCIAL
  LIABILITIES:
  Interest rate
    swaps.........        --       (108)        --       (592)
  Term loan.......   125,000    125,000    125,000    125,000
  Revolving credit
    facility......    20,000     20,000         --         --
  Short-term
    borrowings....     5,600      5,600         --         --
  Pollution
    control
    revenue
    bonds.........    19,975     20,162     19,975     20,135
  Industrial
    development
    notes.........     6,082      3,997      3,047      2,382
</TABLE>
 
     The following methods and assumptions were used to estimate the fair value
of each financial instrument:
 
     Cash and cash equivalents:  The carrying amounts approximate fair value
because of the short term to maturity of these financial instruments.
 
     Interest rate swaps:  The fair value of these instruments is based on the
difference between the interest rates either received or paid on the notional
amount of the underlying liability. The calculation of the fair value was
computed on a net present value basis as if the financial instruments were
terminated on the reporting date. A relationship spread was developed based on
the difference between the three-month LIBOR and quoted three-month treasuries.
This spread was added to the quoted treasury yield for the respective maturity
period of the financial instruments and used to compute the net present value.
The negative or positive fair value is an estimate of the amounts that the
Company would either pay or receive to cancel the contracts at the reporting
date.
 
     Term loan:  The carrying amount approximates the fair value of the term
loan as this instrument is variable interest debt with the interest rates reset
at least each quarter.
 
     Revolving credit facility:  The carrying amount approximates the fair value
of the revolving credit facility as this instrument is variable interest debt
with the interest rates reset at least each quarter.
 
     Short-term borrowings:  The carrying amount approximates the fair value of
the short-term borrowings as these borrowings are variable interest debt with
the interest rates reset from 1 to 180 days.
 
     Pollution control revenue bonds:  The estimated fair value of the pollution
control revenue bonds was computed based on quoted market prices as of the
reporting date obtained from an independent financial trading institution.
 
     Industrial development notes:  The fair value of these industrial
development notes was computed by discounting expected cash flows at the rates
currently offered to the Company for debt of similar remaining maturities.
 
     Other assets and liabilities:  The Company believes that the carrying value
of its other assets and liabilities represent their fair value as of the
reporting date as a result of the short maturity and the reset interest rate
periods for such financial instruments.
 
NOTE 15   SUBSEQUENT EVENT
 
     In late January 1997, the Company reached a settlement with an unrelated
third-party vendor concerning a commercial dispute relating to the quality of
certain material purchased by the Company from 1991 to 1996. As a result of this
settlement, the Company received a $5.9 million cash payment. This $5.9 million
pretax gain will be recognized in the first quarter of 1997.
 
                                       21
<PAGE>   18
 
--------------------------------------------------------------------------------
 
NOTE 16   STOCK OPTION PLAN
 
     On October 26, 1993, the Company's Board of Directors authorized the
adoption of the 1993 Stock Incentive Plan under which 2,000,000 shares of common
stock have been reserved for issuance to employees pursuant to the exercise of
incentive stock options ("ISOs") and for issuance to employees and the Chairman
of the Board of Directors of the Company pursuant to the exercise of
nonstatutory stock options. The 1993 Stock Incentive Plan also provides for
alternative stock appreciation rights ("SARs") with respect to both ISOs and
nonstatutory stock options. The SARs generally give the grantee the right to
either receive shares upon exercise of the option or, at the discretion of the
Board of Directors, cash, shares or a combination thereof equal in value to 100%
of the excess of the fair market value of the common stock on the date of
exercise of the option over the option price.
 
     Under the 1993 Stock Incentive Plan, the exercise price of each option
equals the market price of the Company's stock on the date of grant. The stock
options and stock appreciation rights under the 1993 Stock Incentive Plan are
exercisable over a period determined by the Board of Directors, but no longer
than ten years after the date they are granted. Following are the options
granted under the 1993 Stock Incentive Plan:
 
<TABLE>
<CAPTION>
                                                     OPTIONS     NUMBER                       NUMBER
             DATE OF GRANT                 PRICE     GRANTED    EXERCISED    OUTSTANDING    WITH SARS     EXERCISABLE
----------------------------------------   ------    -------    ---------    -----------    ----------    -----------
<S>                                        <C>       <C>        <C>          <C>            <C>           <C>
October 1993............................   $14.00    568,000      20,000       548,000        548,000       209,333
December 1995...........................   $15.63    330,000          --       330,000        165,000        25,000
June 1996...............................   $16.94     30,000          --        30,000         15,000            --
December 1996...........................   $12.00     27,000          --        27,000         13,500            --
</TABLE>
 
     During 1995, 20,000 of the October 1993 stock appreciation rights were
exercised, resulting in a cash payment of $163. There were 20,000 stock options
exercisable at December 31, 1995, and 234,333 exercisable at December 31, 1996.
The Company accounts for the 1993 Stock Incentive Plan by application of APB No.
25 and related Interpretations. For the years ended December 31, 1996, 1995 and
1994, the compensation (income) expense related to the stock appreciation rights
was $(1,390), $404 and $524, respectively.
 
     Had compensation cost for the 1993 Stock Incentive Plan been determined
based on the fair value at the grant dates for awards under the 1993 Stock
Incentive Plan consistent with the method of SFAS No. 123, the Company's 1996
net income and earnings per share would have been $24,075 and $.63,
respectively. The pro forma effect on 1995 was insignificant. Because the SFAS
No. 123 method of accounting has not been applied to options granted prior to
January 1, 1995, the resulting pro forma compensation cost may not be
representative of that to be expected in future years. The fair value of each
option grant was estimated on the date of grant using the Black-Scholes
option-pricing model with the following assumptions:
 
<TABLE>
<CAPTION>
                                                        FAIR     DIVIDEND     EXPECTED       RISK-FREE      EXPECTED
                     GRANT DATE                         VALUE     YIELD      VOLATILITY    INTEREST RATE     LIVES
-----------------------------------------------------   -----    --------    ----------    -------------    --------
<S>                                                     <C>      <C>         <C>           <C>              <C>
December 1995........................................   $5.98       2.4%         35%            5.8%            8
June 1996............................................    6.89       2.4          35             6.9             8
December 1996........................................    4.20       3.3          35             6.4             8
</TABLE>
 
                                       22
<PAGE>   19
 
--------------------------------------------------------------------------------
 
NOTE 17   SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
 
<TABLE>
<CAPTION>
                                           FIRST          SECOND           THIRD          FOURTH
                                          QUARTER         QUARTER         QUARTER         QUARTER
                                        -----------     -----------     -----------     -----------
                1996
-------------------------------------
<S>                                     <C>             <C>             <C>             <C>
Net sales............................   $   184,926     $   163,704     $   146,816     $   132,576
Gross profit.........................        27,186          21,782          15,143          13,075
Operating income.....................        20,805          15,546           8,913           5,771
Net income...........................        10,682           7,773           3,834           1,976
Net income per common share..........           .28             .20             .10             .05
Weighted average number of common
  shares.............................    38,670,000      38,670,000      38,670,000      38,670,000
</TABLE>
 
<TABLE>
<CAPTION>
                1995
-------------------------------------
<S>                                     <C>             <C>             <C>             <C>
Net sales............................   $   241,647     $   241,439     $   220,972     $   162,964
Gross profit.........................        40,007          62,605          47,173          29,400
Operating income.....................        34,405          56,789          40,593          23,626
Net income...........................        17,961          31,325          22,625          12,491
Net income per common share..........           .46             .81             .59             .32
Weighted average number of common
  shares.............................    38,670,000      38,670,000      38,670,000      38,670,000
</TABLE>
 
                                       23
<PAGE>   20
 
--------------------------------------------------------------------------------
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Board of Directors,
J&L Specialty Steel,
Inc.:
 
     We have audited the accompanying consolidated balance sheets of J&L
Specialty Steel, Inc., a Pennsylvania corporation, and subsidiaries as of
December 31, 1996 and 1995, and the related consolidated statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of J&L Specialty Steel, Inc.
and subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
 
     As more fully explained in Note 2 to the consolidated financial statements,
the Company changed from the first-in, first-out to the last-in, first-out
method of determining the cost of its raw material components of inventories as
of January 1, 1994.
 
                                          /s/ ARTHUR ANDERSEN LLP
                                          ---------------------------------
                                          ARTHUR ANDERSEN LLP
 
Pittsburgh, Pennsylvania,
January 28, 1997
 
                                       24
<PAGE>   21
 
--------------------------------------------------------------------------------
 
        MANAGEMENT'S REPORT ON RESPONSIBILITY FOR FINANCIAL INFORMATION
 
     The accompanying consolidated financial statements of J&L Specialty Steel,
Inc. have been prepared in accordance with generally accepted accounting
principles and include some amounts that are based upon management's best
estimates and judgments. Management has the primary responsibility for the
information contained in the consolidated financial statements and other
sections of this Annual Report.
 
     The Company has a system of internal controls in place to provide
reasonable assurance of the safeguarding of assets and reliability of financial
reporting. Management is aware of the inherent limitations in all systems of
control; however, it believes that through a formal set of procedures and
policies, a structured program of review by local management and an internal
audit program with appropriate management follow-up, the Company has an
effective and responsive system of internal controls.
 
     As part of their audit of the Company's consolidated financial statements,
Arthur Andersen LLP, independent public accountants, considered the Company's
system of internal control to the extent they deemed necessary to determine the
nature, timing and extent of their audit tests. The audit was done in accordance
with generally accepted auditing standards.
 
     The Audit Committee of the Board of Directors is composed of three outside
members. The Audit Committee has the responsibility to make recommendations
concerning the engagement of the independent public accountants, to review with
the independent public accountants the plans and results of the audit
engagement, to review the independence of the independent public accountants, to
consider the range of audit and nonaudit fees and to review the adequacy of the
Company's internal controls. The Audit Committee meets with the independent
public accountants and the Company's internal auditors jointly and separately to
evaluate the controls in place.
 
/s/ CLAUDE F. KRONK
------------------------------------------------------
Claude F. Kronk
Vice Chairman and Chief Executive Officer
 
/s/ KIRK F. VINCENT
------------------------------------------------------
Kirk F. Vincent
Vice President-Finance and Law
 
/s/ JOSEPH F. BROZICK
------------------------------------------------------
Joseph F. Brozick
Controller
 
                                       25
<PAGE>   22
 
--------------------------------------------------------------------------------
 
                           J&L Specialty Steel, Inc.
 
                            SELECTED FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                                                YEAR ENDED DECEMBER 31,
                                            ----------------------------------------------------------------
                                              1996          1995          1994          1993          1992
                                            --------      --------      --------      --------      --------
                                                     (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                         <C>           <C>           <C>           <C>           <C>
INCOME STATEMENT DATA:
Total sales, net.........................   $628,022      $867,022      $711,660      $648,192      $667,451
Operating income.........................     51,035       155,413       108,559        83,671        67,933
Income before extraordinary item and
  cumulative effect of accounting
  change.................................   $ 24,265      $ 84,402      $ 53,575      $ 36,444      $ 19,925
Extraordinary item.......................         --            --            --        (4,134)(1)        --
Cumulative effect of accounting change...         --            --            --       (13,526)(2)        --
                                            --------      --------      --------      --------      --------
Net income(3)............................   $ 24,265      $ 84,402      $ 53,575      $ 18,784      $ 19,925
                                            ========      ========      ========      ========      ========
PER COMMON SHARE DATA:
Income before extraordinary item and
  cumulative effect of accounting
  change.................................   $    .63      $   2.18      $   1.39      $   1.15      $    .63
Extraordinary item.......................         --            --            --          (.13)           --
Cumulative effect of accounting change...         --            --            --          (.43)           --
                                            --------      --------      --------      --------      --------
Net income...............................   $    .63      $   2.18      $   1.39      $    .59      $    .63
                                            ========      ========      ========      ========      ========
Weighted average number of common
  shares................................. 38,670,000    38,670,000    38,670,000    31,815,231    31,500,000
Dividends declared on common stock.......   $ 15,468      $ 13,921      $ 13,921      $ 23,480      $ 34,000
 
OTHER DATA:
Tons shipped.............................    306,791       367,030       367,742       331,404       342,202
 
BALANCE SHEET DATA:
Working capital..........................   $ 68,758      $113,024      $132,949      $108,951      $ 97,574
Property, plant and equipment, net.......    304,721       217,060       138,551       146,736       152,495
Total assets.............................    771,928       753,818       674,361       626,038       664,529
Total debt...............................    176,657       148,022       165,608       200,670       315,731
Shareholders' equity.....................    390,738       380,225       308,028       267,516       177,472
</TABLE>
 
------------
(1) In December 1993, the Company terminated a $120.0 million interest rate swap
    agreement scheduled to expire in June 1995. This termination resulted in an
    extraordinary charge of $4.1 million.
 
(2) Effective January 1, 1993, the Company adopted Statement of Financial
    Accounting Standards No. 106, "Employers' Accounting for Postretirement
    Benefits Other Than Pensions." The Company elected to recognize the
    cumulative effect of the accounting change by recording a one-time,
    after-tax charge to net income of $13.5 million in 1993.
 
(3) Included in the 1994 results was a $6.6 million after-tax charge for the
    adoption of the LIFO inventory accounting method.
 
                                       26
<PAGE>   23
 
--------------------------------------------------------------------------------
 
STOCK EXCHANGE LISTING
 
     The common stock of J&L Specialty Steel, Inc. is listed on the New York
Stock Exchange under the symbol "JL."
 
COMMON STOCK DATA
<TABLE>
<CAPTION>
                      MARKET PRICE RANGES
                -------------------------------
<S>             <C>      <C>       <C>      <C>
   QUARTER          1996               1995
-------------   ------------       ------------
 
<CAPTION>
                HIGH     LOW       HIGH     LOW
                ----     ---       ----     ---
<S>             <C>      <C>       <C>      <C>
First........   $18-3/4  $15-5/8   $21      $16-3/4
Second.......    19-1/4   14-3/8    20       17-1/2
Third........    15-3/8   13-1/8    27-1/4   19-1/8
Fourth.......    14       10-3/4    21-1/4   14-7/8
</TABLE>
 
     A $.09 per share quarterly dividend was paid in 1995. In February 1996, the
quarterly dividend was increased to $.10 per share.
 
     As of March 3, 1997, there were 38,670,000 shares of common stock
outstanding that were held by 230 shareholders of record.
 
 
                                       29