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, our expectations about growth of existing markets and new products and our ability to expand into new markets and to identify and acquire complementary businesses, 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 expenditures 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 factors 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

Subsequent to September 30, 2008, economic events have resulted in a moderating effect on the cost of many of the raw materials that we use, including steel, copper and other metal commodities. Due to the uncertainty in the financial markets and due to the recent volatility in the commodity markets, we cannot determine if these cost fluctuations will be in effect for any length of time. In addition, during the third quarter of 2008 we benefited in part because of then lower cost steel inventories and first in first out (FIFO) inventory accounting. However, this FIFO benefit will not continue through the remainder of 2008 or into 2009, as our current higher priced inventory will be matched with sales on a going forward basis. With the financial and commodity markets uncertainty, we cannot predict what, if any, impact this will have on our operating results for 2009.

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, global 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 employees 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 businesses manufacture parts and components made from proprietary formulations of composite materials, primarily consisting of metal powders and synthetic and natural fibers applied to steel backing plates. 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 aircraft. 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,

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· 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.

· Accounts Receivable. We maintain an allowance for doubtful accounts for estimated losses from the failure of our customers to make required payments for products delivered. We estimate this allowance based on the age of the related receivable, knowledge of the financial condition of our customers, review of historical receivable and reserve trends and other pertinent information. If the financial condition of our customers deteriorates or we experience an unfavorable trend in receivable collections in the future, additional allowances may be required. Historically, our reserves have approximated actual experience.

· Inventory. Inventories are stated at the lower of cost or market. Cost includes materials, labor and overhead and is determined by the first-in, first-out (FIFO) method. We review the net realizable value of inventory in detail on an on-going basis, with consideration given to deterioration, obsolescence, and other factors. If actual market conditions differ from those projected by management, and our estimates prove to be inaccurate, write-downs of inventory values and adjustments to cost of sales may be required. Historically, our reserves have approximated actual experience.

· Fair Value Disclosures. We have certain financial assets recorded at fair value. In accordance with SFAS No. 157, Fair Value Measurement (SFAS 157), we have classified our financial assets as Level 1, 2 or 3 within the fair value hierarchy. Fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves. Fair values determined by Level 3 inputs are unobservable data points for the asset. The majority of our financial assets at September 30, 2008 have been classified as Level 2. These assets have been initially valued at the transaction price and subsequently valued utilizing third party pricing services. The pricing services use many inputs to determine value, including reportable trades, benchmark yields, credit spreads, broker/dealer quotes, bids, offers, current spot rates, and other industry and economic events. We validate the prices provided by our third party pricing services by understanding the models used, obtaining market values from other pricing sources, if appropriate, and challenging pricing data in certain instances. Excluding cash equivalents, the largest portion of our marketable securities are comprised of investments that may be sensitive to changes in economic factors such as interest rates or credit spreads. We have no financial assets classified as Level 3 as of September 30, 2008.

· Investments. As of September 30, 2008, and December 31, 2007, we accounted for all of our short-term investments as available-for-sale. We report our available-for-sale securities at fair value in our Consolidated Balance Sheets 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. We did not find it necessary to record any other-than-temporary impairment charges to our short-term investments in the three or nine months ended September 30, 2008 or 2007.

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· 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 nine months ended September 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. 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 pension cost was $0.1 million for the nine months ended September 30, 2008 and $0.3 million for the nine months ended September 30, 2007. For the potential impact to asset values of our pension plans in 2009, see "Item 3. Quantitative and Qualitative Disclosures About Market Risk - Benefit Plan Valuations."

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 FASB Interpretation 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement 109 (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 September 30, 2008, was $1.8 million (including $0.7 million of accrued interest and penalties), the recognition of which would have an effect of $0.6 million on our continuing operations effective tax rate.

We recognize interest and penalties related to unrecognized tax benefits in income tax expense. We recorded $0.02 million of interest and penalties in continuing operations tax expense for the three months ended September 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 September 30, 2008.

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· 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 nine months ended September 30, 2008 and 2007, revenue from non-U.S. countries represented 43.3% and 38.5% of our consolidated revenue, respectively. Other comprehensive income included translation losses of $3.5 million and $1.3 million for the three and nine months ended September 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. Foreign currency transaction gains or losses were not material to the results of operations for the three and nine months ended September 30, 2008 or September 30, 2007, respectively.

· Recent Accounting Developments

· In June 2008, the Financial Accounting Standard Board (FASB) issued Staff Position Emerging Issues Task Force (EITF) No. 03-6-1, Determining Whether Instruments Granted in Share-based Payment Transactions Are Participating Securities (FSP 03-6-1). Under FSP 03-6-1, unvested share-based payment awards that contain rights to receive non-forfeitable dividends (whether paid or unpaid) are participating securities, and should be included in the two-class method of computed EPS. FSP 03-6-1 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, Determination of the Useful Life of Intangible Assets (FSP 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). FSP 142-3 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 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141, Business Combinations. FSP 142-3 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. FSP 142-3 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, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (SFAS 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.

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· 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.

· On October 10, 2008, FASB issued FSP 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (FSP 157-3). FSP 157-3 clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP 157-3 was effective upon issuance, including prior periods for which financial statements have not been issued. The provisions of FSP 157-3 did not have an impact on our financial condition or results of operations.

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

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Nine Months ended September 30, 2008 Sales by Geographic Location of our Manufacturing Facilities

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Third Quarter of 2008 Compared to the Third Quarter of 2007

In the first quarter of 2008, we committed to selling our performance racing segment which was comprised of two operating facilities in the United States. We have classified the performance racing segment as a discontinued operation in our financial results for all periods presented. We sold Tex Racing Enterprises, Inc. in May 2008 as part of that commitment. Additionally, with the sale of our precision components segment in January 2007 and its prior classification as discontinued operations, our continuing operations are organized into one strategic segment, friction products.

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

                                                     Three Months Ended September 30
                                                           % of                           % of
                                            2008           Sales            2007          Sales
                                                          (dollars in millions)
Net sales                                $     74.2          100.0 %      $    51.5         100.0 %

Cost of sales                            $     49.1           66.1 %      $    39.8          77.2 %

Gross profit                             $     25.1           33.9 %      $    11.7          22.8 %

Selling, technical and administrative
expenses                                 $      9.3           12.6 %      $     7.0          13.6 %

Income from operations                   $     15.6           21.1 %      $     4.6           8.8 %

Interest expense                         $     (2.0 )         -2.7 %      $    (2.3 )        -4.4 %

Interest income                          $      0.5            0.7 %      $     1.1           2.0 %

Other income (expense), net              $      1.2            1.6 %      $    (0.5 )        -1.0 %

Income taxes                             $      5.0            6.8 %      $     0.9           1.8 %

Income from continuing operations,
after income taxes                       $     10.3           13.9 %      $     1.9           3.7 %

Discontinued operations, net of tax      $        -            0.0 %      $    (0.3 )        -0.5 %

Net income                               $     10.3           13.8 %      $     1.7           3.2 %

Net Sales. Our net sales for the third quarter of 2008 were $74.2 million, an increase of $22.7 million or 44.1% from the same period in 2007. Sales increases during the period resulted primarily from increased shipment volumes as a result of strong demand in all of our end markets and new product introductions, pricing actions pursuant to the terms of long-term supply agreements as well as to offset the increase in our raw material input costs, and favorable foreign currency exchange rates. Of our total sales increase of 44.1% in the third quarter of 2008, volume represented approximately 24.3% of the total percentage points, pricing accounted for approximately 14.4 percentage points, and favorable foreign currency exchange rates represented 5.4 percentage points.

We experienced sales increases in most of our major markets, primarily led by construction and mining, aircraft and defense and agriculture. Our sales to the construction and mining market, our largest, were up 50.9% in the third quarter of 2008, compared to the third quarter of 2007, as a result of strong global market conditions, especially in a number of developing countries. Sales in the agriculture sector were up 50.0% in the third quarter of 2008, compared to the third quarter of 2007, as a result of strong market conditions in North and South America. Our aircraft and defense markets were up 63.7% in the third quarter of 2008, compared to the third quarter of 2007, due to strong demand, especially in our defense market. Sales to our heavy truck market increased 7.8% during the third quarter of 2008, compared to the third quarter of 2007 as the impact of the 2007 emission standards change negatively impacted our third quarter 2007 sales. 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 $7.2 million in the third quarter of 2008, compared to $6.9 million in 2007, an increase of 4.3%.

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Net sales from our foreign facilities represented 39.9% of our total net sales in the third quarter of 2008 compared to 38.9% for the comparable period of 2007. Sales at our Italian operation, on a local currency basis, were up 38.4% in the third quarter of 2008, compared to the third quarter of 2007, and sales at our Chinese operation, on a local currency basis, were up 19.6% during the same period.

Cost of Sales. Cost of sales was $49.1 million during the third quarter of 2008, an increase of $9.3 million, or 23.4%, compared to cost of sales of $39.8 million in the third quarter of 2007. The primary driver of the increase in our cost of sales in the third quarter of 2008 was increased production volumes through our manufacturing facilities. Production volume increases represented approximately 19.1 percentage points of the total cost of sales increase of 23.4%. The effect of foreign currency exchange rates accounted for 4.8 percentage points of our total cost of sales increase of 23.4% during the third quarter of 2008. As a percent of sales, our cost of sales represented 66.1% of our net sales in the third quarter of 2008 compared to 77.2% of net sales in the third quarter of 2007. The improvement in our cost of sales percentage was driven by increase volumes, a FIFO benefit of lower cost steel inventories flowing out of inventory during the quarter and product mix partially offset by the effect of foreign currency exchange rates on our cost of sales and the impact of higher costs of a number of our raw material inputs. The FIFO . . .