You should read this discussion in conjunction with the consolidated financial statements, notes and tables included in Part I, Item 1 of this Form 10-Q. Statements that are not historical facts, including statements about our confidence in our prospects and strategies and our expectations about growth of existing markets and our ability to expand into new markets, to identify and acquire complementary businesses and to attract new sources of financing, are forward-looking statements that involve risks and uncertainties. In addition to statements that are forward-looking by reason of context, the words "believe," "expect," "anticipate," "intend," "designed," "goal," "objective," "optimistic," "will" and other similar expressions identify forward-looking statements. In light of the risks and uncertainties inherent in all future projections, the inclusion of the forward-looking statements should not be regarded as a guarantee of performance. Although we believe that our plans, objectives, intentions and expectations reflected in our forward-looking statements are reasonable, we can give no assurance that our plans, objectives, intentions and expectations will be achieved. Our forward-looking statements are made based on our current expectations and beliefs concerning future events and are subject to uncertainties, risks and factors relating to our operations and business environments, all of which are difficult to predict and many of which are beyond our control. Future events could cause our actual results to differ materially from those matters expressed or implied by our forward-looking statements.

When considering these risk factors, you should keep in mind the cautionary statements elsewhere in this report and the documents incorporated by reference. New risks and uncertainties arise from time to time, and we cannot predict those events or how they may affect us. We assume no obligation to update any forward-looking statements or risk factor after the date of this report as a result of new information, future events or developments, except as required by the federal securities law.

Recent Developments

During the first quarter of 2008, we made a strategic decision to focus management resources on the friction products business and committed to a plan to sell our performance racing segment. On May 30, 2008, we sold Tex Racing Enterprises, Inc. We continue to negotiate with potential buyers for the sale of our remaining performance racing operation, Quarter Master Industries, Inc. As a result of the decision to sell the performance racing segment, our unaudited consolidated financial statements, accompanying notes and other information provided in this Form 10-Q reflect the performance racing segment as a discontinued operation for all periods presented. After reclassifying the performance racing segment to discontinued operations, we have one remaining operating segment, our friction products segment. We will retain our Hawk Performance® brake business, which is a component of our friction products segment.

General

Through our various subsidiaries, we operate in one reportable segment: friction products. Our results of operations are affected by a variety of factors, including but not limited to, general economic conditions, manufacturing efficiency, customer demand for our products, competition, raw material pricing and availability, our ability to pass through to our customers increases in raw material prices, labor relations with our personnel and political conditions in the countries in which we operate. We sell a wide range of products that have a correspondingly wide range of gross margins. Our consolidated gross margin is affected by product mix, selling prices, material and labor costs, as well as our ability to absorb overhead costs resulting from fluctuations in demand for our products.

We believe that, based on net sales, we are one of the top worldwide manufacturers of friction products used in off-highway, on-highway, industrial, agricultural, performance and aircraft applications. Our friction products segment manufactures parts and components made from proprietary formulations of composite materials, primarily consisting of metal powders and synthetic and natural fibers. Friction products are used in brakes, clutches and transmissions to absorb vehicular energy and dissipate it through heat and normal mechanical wear. Our friction products include parts for brakes, clutches and transmissions used in construction and mining vehicles, agricultural vehicles, trucks, motorcycles and race cars, and brake parts for landing systems used in commercial and general aviation. We believe we are:

· a leading domestic and international supplier of friction products for construction and mining equipment, agricultural equipment and trucks,

· the leading North American independent supplier of friction materials for braking systems for new and existing series of many commercial and military aircraft models, including Boeing, EADS, Lockheed and United Technologies, as well as the Canadair regional jet series,

· the largest supplier of friction materials for the growing general aviation market, including numerous new and existing series of Cessna, Hawker, Lear and Pilatus aircraft, and

· a leading domestic supplier of friction products for performance and specialty markets, such as motorcycles, race cars, performance automobiles, military vehicles, ATV's and snowmobiles.

Critical Accounting Policies

Some of our accounting policies require the application of significant judgment by us in the preparation of our consolidated financial statements. In applying these policies, we use our best judgment to determine the underlying assumptions that are used in calculating the estimates that affect the reported values on our financial statements. On an ongoing basis, we evaluate our estimates and judgments based on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

We review our financial reporting and disclosure practices and accounting policies quarterly to ensure that they provide accurate and transparent information relative to the current economic and business environment. We base our estimates and assumptions on historical experience and other factors that we consider relevant. If these estimates differ materially from actual results, the impact on our consolidated financial statements may be material. However, historically our estimates have not been materially different from actual results. Our critical accounting policies include the following:

· Revenue Recognition. We recognize revenues when products are shipped and title has transferred to our customer.

· Marketable Securities. As of June 30, 2008, we accounted for all of our marketable securities as available-for-sale. We report our available-for-sale securities at fair value in our Consolidated Balance Sheet with unrealized holding gains and losses, net of tax, included in Accumulated other comprehensive income. Dividend and interest income, including the amortization of any discount or premium, as well as realized gains or losses, are included in Interest income in our Consolidated Statements of Income. We periodically evaluate our investments for other-than-temporary impairment.

· Long-Lived Assets. We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In assessing the recoverability of our long-lived assets, we consider changes in economic conditions and make assumptions regarding estimated future cash flows and other factors. Estimates of future undiscounted cash flows are highly subjective judgments based on our experience and knowledge of our operations. These estimates can be significantly impacted by many factors including changes in global and local business and economic conditions, operating costs, inflation and competitive trends. If our estimates or underlying assumptions change in the future, we may be required to record impairment charges. In our continuing operations, we did not find it necessary to record any impairment charges to our tangible or indefinite lived intangible assets in the three or six months ended June 30, 2008 or 2007.

· Pension Benefits. We account for our defined benefit pension plans in accordance with SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans (SFAS 158), an amendment of FASB Statements No. 87, 88, 106 and 132 which requires the recognition of the overfunded or underfunded status of a plan as an asset or liability in the statement of financial position and the recognition of changes in the funded status in the year in which the changes occur through Accumulated other comprehensive income. Pension expense continues to be recognized in the financial statements on an actuarial basis. The most significant elements in determining our net pension expense are the expected return on plan assets and appropriate discount rates. We assumed that the expected weighted average long-term rate of return on plan assets would be 8.25% for 2008. Based on our existing and forecasted asset allocation and related long-term investment performance results, we believe that our assumption of future returns is reasonable. However, should the rate of return differ materially from our assumed rate, we could experience a material adverse effect on the funded status of our plans and our future pension expense. The assumed long-term rate of return on assets is applied to a calculated value of plan assets, which recognizes changes in the fair value of plan assets in a systematic manner over five years. This calculation produces the expected return on plan assets that is included in net pension expense. The difference between this expected return and the actual return on plan assets is recorded to Accumulated other comprehensive income. Net periodic benefit cost was $0.1 million for the six months ended June 30, 2008 and $0.2 million for the six months ended June 30, 2007.

We determine the discount rate to be used to discount plan liabilities at their measurement date, December 31. The discount rate reflects the current rate at which the pension liabilities could be effectively settled at the end of the year. At December 31, 2007, we determined this rate to be 6.0%. Changes in discount rates over the past three years have not materially affected net pension expense.

· Income Taxes. Our effective tax rate, taxes payable and other tax assets and liabilities reflect the current tax rates in the domestic and foreign tax jurisdictions in which we operate. Deferred income taxes reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for reporting and income tax purposes. Our effective tax rate is substantially driven by the impact of the mix of our foreign and domestic income and losses and the federal and local tax rate differences on each.

We adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, we were not required to recognize any change in the liability for unrecognized tax benefits. The total amount of unrecognized tax benefits as of June 30, 2008, was $1.9 million (including $0.7 million of accrued interest and penalties), the recognition of which would have an effect of $0.7 million on our continuing operations effective tax rate.

We recognize interest and penalties related to unrecognized tax benefits in income tax expense. We recorded $6 of interest and penalties in continuing operations tax expense for the three months ended June 30, 2008.

SFAS No. 109, Accounting for Income Taxes (SFAS 109), provides certain guidelines to follow in making the determination of the need for a valuation allowance. We must demonstrate that taxable income is expected to be available for future periods sufficient to realize the benefits of temporary differences and carryforwards to avoid recording a valuation allowance against deferred tax assets. We recorded a valuation allowance for our Canadian subsidiary for the year ended December 31, 2007. We have determined that no additional valuation allowance was necessary as of June 30, 2008.

· Foreign Currency Translation and Transactions. We have foreign manufacturing operations in Italy, China and Canada. Revenue and expenses from these operations are denominated in local currency, thereby creating exposures to changes in exchange rates. As such, fluctuations in these operations' respective currencies may have an impact on our business, results of operations and financial position. We currently do not use financial instruments to hedge our exposure to exchange rate fluctuations with respect to our foreign operations. As a result, we may experience substantial foreign currency translation gains or losses due to the volatility of other currencies compared to the U.S. dollar, which may positively or negatively affect our results of operations attributed to these operations. For the six months ended June 30, 2008 and 2007, revenue from non-U.S. countries represented 45.4% and 47.9% of our consolidated revenue, respectively. Other comprehensive income included translation gains of $0.1 million and $2.3 million for the three and six months ended June 30, 2008, respectively. Gains or losses resulting from foreign currency transactions are translated to local currency at the rates of exchange prevailing at the dates of the transactions. Sales or purchases in foreign currencies, other than the subsidiary's local currency, are exchanged at the date of the transaction. The effect of transaction gains or losses is included in Other income (expense), net in our Consolidated Statements of Income. We reported foreign currency transaction gains of $0.1 million and $0.4 million for the three and six months ended June 30, 2008, respectively. Foreign currency transaction gains or losses were not material to the results of operations for the three and six months ended June 30, 2007, respectively.

· Recent Accounting Developments

· In June 2008, the Financial Accounting Standard Board (FASB) issued FSAB Staff Position (FSP) Emerging Issues Task Force (EITF) No. 03-6-1, "Determining Whether Instruments Granted in Share-based Payment Transactions Are Participating Securities." Under the FSP, unvested share-based payment awards that contain rights to receive nonforfeitable dividends (whether paid or unpaid) are participating securities, and should be included in the two-class method of computed EPS. The FSP is effective for fiscal years beginning after December 15, 2008, and interim periods within those years, and is not expected to have a significant impact on our results of operations, financial condition or liquidity.

· In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles SFAS 162)." The statement is intended to improve financial reporting by identifying a consistent hierarchy for selecting accounting principles to be used in preparing financial statements that are prepared in conformance with generally accepted accounting principles. Unlike Statement on Auditing Standards No. 69, "The Meaning of Present in Conformity With Generally Accepted Accounting Principles," SFAS 162 is directed to the entity rather than the auditor. The statement is effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board (PCAOB) amendments to AU Section 411, "The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles," and is not expected to have any impact on our results of operations, financial condition or liquidity.

· In April 2008, the FASB issued FSP SFAS No. 142-3 SFAS 142-3, which amends the factors that must be considered in developing renewal or extension assumptions used to determine the useful life over which to amortize the cost of a recognized intangible asset under FAS No. 142, "Goodwill and Other Intangible Assets (SFAS 142)." The FSP requires an entity to consider its own assumptions about renewal or extension of the term of the arrangement, consistent with its expected use of the asset, and is an attempt to improve consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141, "Business Combinations." The FSP is effective for fiscal years beginning after December 15, 2008, and the guidance for determining the useful life of a recognized intangible asset must be applied prospectively to intangible assets acquired after the effective date. The FSP is not expected to have a significant impact on our results of operations, financial condition or liquidity.

· In March 2008, the FASB issued SFAS No. 161. SFAS 161 requires enhanced disclosures about an entity's derivative and hedging activities in order to improve the transparency of financial reporting. SFAS 161 is effective prospectively for fiscal years beginning after November 15, 2008. We do not expect the adoption of SFAS 161 will have a material impact on our results of operations, financial condition, or liquidity.

· In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, (SFAS 141(R)). SFAS 141(R) modifies the accounting for business combinations by requiring that acquired assets and assumed liabilities be recorded at fair value, contingent consideration arrangements be recorded at fair value on the date of the acquisition and pre-acquisition contingencies will generally be accounted for in purchase accounting at fair value. The pronouncement also requires that transaction costs be expensed as incurred, acquired research and development be capitalized as an indefinite-lived intangible asset and the requirements of SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, be met at the acquisition date in order to accrue for a restructuring plan in purchase accounting. SFAS 141(R) is required to be adopted prospectively effective for fiscal years beginning after December 15, 2008. SFAS 141(R) may not be adopted early.

Second Quarter of 2008 Compared to the Second Quarter of 2007

In the first quarter of 2008 we committed to selling our performance racing segment. We sold Tex Racing Enterprises, Inc. in May 2008 as part of that commitment. As a result, we have classified the performance racing segment as a discontinued operation in our financial results. With the sale in January 2007, of our precision components segment and its prior classification as discontinued operations, our continuing operations is organized into one strategic segment, friction products.

The following table summarizes our results of operations for the three and six month periods ended June 30, 2008 and 2007, respectively:

                                               Three Months Ended June 30             Six Months Ended June 30
                                               2008                  2007              2008               2007
                                                                    (dollars in millions)
Net sales                                  $        71.8         $        55.3     $      137.6       $      109.5

Gross profit                               $        21.1         $        13.5     $       38.5       $       27.5

Selling, technical and administrative
expenses                                   $        10.4         $         8.0     $       20.1       $       16.6

Income from operations                     $        10.6         $         5.3     $       18.1       $       10.5

Interest expense                           $        (2.0 )       $        (2.6 )   $       (4.0 )     $       (5.1 )

Interest income                            $         0.5         $         1.1     $        1.2       $        1.8

Other income (expense), net                $         0.1         $           -     $        0.4       $        0.1

Income taxes                               $         3.0         $         1.9     $        5.6       $        3.4

Income from continuing operations, after
income taxes                               $         6.2         $         1.9     $       10.0       $        3.8

Discontinued operations, net of tax        $        (1.2 )       $         0.2     $       (1.8 )     $       11.1

Net income                                 $         5.0         $         2.1     $        8.2       $       14.9

The following charts show our net sales by market segment and geographic location of our manufacturing facilities for the six months ended June 30, 2008:

Six Months Ended June 30, 2008 Sales by Geographic Location of our Manufacturing Facilities

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Net Sales. Our net sales for the second quarter of 2008 were $71.8 million, an increase of $16.5 million or 29.8% from the same period in 2007. We experienced sales increases primarily as a result of strong economic conditions in all of our end markets, pricing actions, new product introductions and favorable foreign currency exchange rates during the period. Net sales from our foreign facilities represented 45.4% of our total net sales in 2008 compared to 47.9% for the comparable period of 2007. The effect of foreign currency exchange rates accounted for 7.8% of our total net sales increase of 29.8% during the second quarter of 2008. Our sales to the construction and mining market, our largest, were up 39.7% in the second quarter of 2008, compared to the second quarter of 2007, as a result of strong global market conditions. Sales in the agriculture sector were up 32.7% in the second quarter of 2008, compared to the second quarter of 2007, as a result of strong market conditions in North and South America as well as Europe. Our aircraft and defense businesses were up 13.7% in the second quarter of 2008, compared to the second quarter of 2007, as demand remained strong in both product lines. Sales to our heavy truck market increased 36.4% during the second quarter of 2008, compared to the second quarter of 2007 as the impact of the 2007 emission standards change negatively impacted our second quarter 2007 sales. In addition, we continued to experience strong sales growth from our operations in Italy and China and favorable foreign currency exchange rates during the second quarter of 2008, compared to the prior year period. Sales at our Italian operation, on a local currency basis, were up 32.5% in the second quarter of 2008, compared to the second quarter of 2007, and sales at our Chinese operation, on a local currency basis, were up 82.1% during the same period. During 2008, we continued to focus our efforts on the friction direct aftermarket that we service through the Velvetouch® and Hawk Performance® brand names. Sales in this product category were $8.9 million in the second quarter of 2008, compared to $6.7 million in 2007, an increase of 32.8% primarily due to strong markets, new customers and product introductions during the period.

Gross Profit. Gross profit increased $7.6 million to $21.1 million during the second quarter of 2008, a 56.3% increase compared to gross profit of $13.5 million for the second quarter of 2007. This increase was due to margin improvement from volume related absorption of fixed overhead, the strength of the Euro and Yuan, pricing actions and operating improvements at our facilities. Our gross profit margin increased to 29.4% of our net sales in the second quarter of 2008, compared to 24.4% of our net sales in the second quarter of 2007. The increase in our gross margin was partially offset by the beginning effects of raw material price increases being passed on by our vendors. As previously disclosed, we are initiating price increases to our customers to offset the impact of these increases.

Selling, Technical and Administrative Expenses. Selling, technical and administrative (ST&A) expenses increased $2.4 million, or 30.0%, to $10.4 million in the second quarter of 2008 from $8.0 million during the second quarter of 2007. As a percentage of net sales, ST&A was 14.5% in both the second quarter of 2008 and 2007. The increase in ST&A expenses resulted primarily from an increase in incentive compensation, salary and wages, and employee benefit expense during the quarter, compared to last year. During the second quarter of 2008, we spent $0.2 million in legal expenses net of insurance reimbursement related to the previously disclosed SEC and DOJ investigations compared to $0.4 million in the second quarter of 2007. Additionally, we spent $1.3 million, or 1.8%, of our net sales on product research and development in the second quarter of 2008, compared to $1.1 million or 2.0%, of our net sales for the second quarter of 2007.

Income from Operations. Income from operations was $10.6 million in the second quarter of 2008, an increase of $5.3 million or 100.0%, compared to $5.3 million during the second quarter of 2007. Income from operations as a percentage of net sales increased to 14.8% in the second quarter of 2008 from 9.6% in the same period of 2007. The increase was primarily the result of increased sales and margin improvements. The effect of foreign currency exchange rates accounted for 16.1% of our increase.

Interest Expense. Interest expense decreased $0.6 million during the second quarter of 2008 to $2.0 million from $2.6 million in the second quarter of 2007, as a result of lower debt levels outstanding during the period. Included as a component of Interest expense in our Consolidated Statements of Income is the amortization of deferred financing costs. Amortization of deferred financing costs was $0.1 million in both the second quarter of 2008 and 2007.

Interest Income. We invested our excess cash in various interest bearing investments. As a result of these investments, interest income was $0.5 million in the second quarter of 2008 compared to $1.1 million during the second quarter of 2007. Effective interest rates on our investments have dropped by approximately 57.5% as of June 30, 2008, compared to rates available to us as of June 30, 2007.

Other Income (Expense),Net. We reported foreign exchange currency transaction income of $0.1 million during the second quarter of 2008 compared to $0.1 million in the first quarter of 2007.

Income Taxes. We recorded a tax provision for our continuing operations of $3.0 million for the quarter ended June 30, 2008, compared to $1.9 million in the comparable period of 2007. Our effective income tax rate of 32.3% in the second quarter of 2008 differs from the current federal U.S. statutory rate of 35.0%, primarily as a result of a favorable one-time adjustment recorded at a foreign subsidiary related to a tax law change in the country in which the subsidiary operates. Without the adjustment, our tax rate in the second quarter of 2008 would have been 36.6%. Our worldwide provision for income taxes is based on annual tax rates for the year applied to all of our sources of income.

Discontinued Operations, Net of Tax. During the first quarter of 2008, we committed to a plan to divest our performance racing segment. In May 2008, we sold Tex Racing Enterprises, Inc. and reported a loss on the sale of $1.1 million in the second quarter of 2008. Additionally, during the first quarter of 2007 we sold our precision components segment. The operating activity of the performance racing and precision components segments are reflected in the following summary of results of our discontinued operations for the three months ended June 30, 2008 and 2007. An analysis of discontinued operations is contained in Note 3 "Discontinued Operations" in the accompanying Consolidated Financial Statements of this Form 10-Q.

                                                                 Three Months Ended
                                                                       June 30
                                                              2008                 2007
                                                                (dollars in millions)
Net sales                                                $          1.9        $         3.6
. . .