ORIGINAL: Baldeagle
Jim It could have been assembled dry at the factory and due to the humidity it rusted the cylinder. It is also not uncommon to find casting material in a motor. I sure hope it runs good. Good luck Rich.
It is highly unlikely that rust was the problem. Most gasser engines use either chrome plated or nicasil (sp?) treated cylinders with aluminum pistons and cast iron rings. The only component there that can rust is the ring. I might suspect corrosion of the alum. parts (would be visible on the returned parts) but the only problem that would cause is a stuck ring that would result in loss of compression.
I'm betting the engine just ingested something like a small washer or other part so common around our models. Might have been in the engine all along but I find that unlikely. Face facts, most of the time if an engine eats something, it had to come in through the carb and I suspect that was the problem with this engine.