This discussion includes forward-looking statements which are subject to certain risks and uncertainties as discussed in Item 1A "Risk Factors" and elsewhere in this report.

Results of Operations

Through our 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 customer demand for our products, competition, raw material pricing and availability, labor relations with our personnel, political conditions in the countries in which we operate and general economic conditions. We sell a wide range of products that have a corresponding range of gross margins. Our consolidated gross profit 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.

Hawk reported record net sales and net income in 2008, despite the significant economic turmoil that began in the fourth quarter. During 2008, we faced fluctuating commodity costs, competitive pricing pressures and softening demand during the fourth quarter of 2008 in most of our markets. Income from continuing operations, after taxes in 2008 benefited from the sales volume increase during the first part of the year, market share gains at all of our operating facilities and new product introductions. The challenges encountered in the second half of 2008 are expected to have a deepening impact during 2009. Refer to our "Outlook for 2009" for a further discussion.

During the first quarter of 2008, we committed to a plan to sell our performance racing segment, with two operating facilities in the United States. This former segment, which engineered, manufactured and marketed premium branded clutches, transmissions and driveline systems for the performance racing market, failed to achieve a certain level of profitability and, after completing an extensive analysis, we determined that a divestiture of this segment would allow us to concentrate on our remaining friction products segment. On May 30, 2008, we completed the sale of the performance racing facility in North Carolina and on December 22, 2008, we completed the sale of our performance racing facility in Illinois. As a result, there are no remaining assets or liabilities of the performance racing segment classified as discontinued operations in the December 31, 2008 balance sheet. The results of operations and assets and liabilities of this segment were classified as discontinued for all periods presented in this report and their results are not included in this discussion of our results of operations.

In February 2007, we completed the sale of the precision components segment for approximately $93.9 million consisting of $93.2 million in cash and the assumption by the purchaser of $0.7 million in debt. The results of operations and assets and liabilities of this segment were classified as discontinued for all periods presented in this report, and their results are not included in this discussion of our results of operations.

Outlook for 2009

The 2009 year will be challenging for us as we adjust our production levels to correspond to lower demand in our end-markets. Forecasting is difficult as the economic outlook is unclear given the dramatic declines in demand experienced in the fourth quarter of 2008, and which have continued into the first quarter of 2009 and the uncertainty surrounding the impact of the stimulative spending programs being initiated by numerous industrialized countries.

In virtually every market that we serve, we expect declining volumes compared to extremely strong volumes experienced in 2008. We are forecasting revenues in 2009 to be in the range of $180.0 million to $200.0 million, which represents a reduction of between 25.8% to 33.2% from the all-time record revenues posted in 2008 of $269.6 million.

We have aggressively pursued cost reduction initiatives in response to volume reductions that began in the fourth quarter of 2008, including salary, hourly and temporary workforce reductions representing approximately 19% of our global workforce from employment levels as of the end of the third quarter of 2008. We have also decreased discretionary spending, reduced employee benefit programs, and frozen salary pay rates of our global workforce. Our variable incentive compensation program will also contribute to an expense reduction as it is designed to fluctuate responsively to the overall profitability of the organization.

We took these actions proactively to better match operational resources with our current outlook of demand. However, we cannot predict whether these actions will be sufficient should volumes continue to decline. If demand returns, we expect that we can move quickly to increase production levels to meet increased demand requirements.

Including the anticipated cost savings from our initiatives, we expect our income from operations in 2009 to be between $16.0 and $20.0 million. This represents a decrease of between 49.0% to 59.2% from income from operations of $39.2 million reported in 2008.

We continue to focus on our previously stated goals of utilizing our significant cash position to aggressively pursue strategic acquisition opportunities, execute on share and bond repurchase opportunities and make investment in long-term research and development projects. However, we cannot predict timing of the implementation of any these projects or the impact that any of these projects may have on our earnings.

We expect our capital spending in 2009 to be between $8.0 and $10.0 million compared to $15.2 million spent during 2008. Our effective tax rate is expected to be between 43.0% and 45.0% for the year ending December 31, 2009 compared to 35.0% in 2008. The expected increase in the effective tax rate in 2009 is primarily the result of anticipated lower foreign taxable earnings and the impact these reduced earnings will have on our consolidated effective tax rate.

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 revenue from the sale of our products when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) shipment has occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of the resulting receivable is reasonable assured. Revenue is generally recognized at the point of shipment; however in certain instances as shipping terms dictate, revenue is recognized when the product reaches the point of destination, and title to the customer is transferred.

· 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. In cases where we are aware of circumstances that may impair a specific customer's ability to meets its financial obligations subsequent to the original sale, we record an allowance against amounts due, and thereby reduce the net recognized receivable to the amount we reasonable believe will be collected. 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. Our financial instruments include cash and cash equivalents, short-term investments, accounts receivable, accounts payable, short-term and long-term notes receivable and debt instruments, certain of which are 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. The fair value of our financial assets is determined based on either Level 1 or level 2 inputs. 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. Excluding cash equivalents, the largest portion of our short-term investments are comprised of investments that may be sensitive to changes in economic factors such as interest rates or credit spreads.

· Investments. As of December 31, 2008 and December 31, 2007, we accounted for all of our short-term investments as available-for-sale under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and FASB Staff Position No. 115-1, The Meaning of Other-Than Temporary Impairment and Its Application to Certain Investments. 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 Operations. 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 years ended December 31, 2008, 2007 or 2006.

· 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 years ended December 31, 2008, 2007 or 2006.

· Pension Benefits. We maintain a number of defined benefit and one defined contribution plan to provide retirement benefits for employees. These plans are maintained and minimum contributions are made in accordance with the requirements of the Employee Retirement Income Security Act of 1974 (ERISA). 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 (loss) income. Pension expense continues to be recognized in the financial statements on an actuarial basis.

One significant element in determining our net pension expense is the expected return on plan assets. At the end of each year, the expected return on plan assets is determined based on the expected return of the various asset classes in the plan's portfolio and the targeted allocation of plan assets. The asset return is developed using historical asset return performance as well as current and anticipated market conditions such as inflation, interest rates and market performance. We assumed that the expected weighted average long-term rate of return on plan assets would be 8.25% for our U.S. plans at December 31, 2008 and 2007, respectively. 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 and 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 (loss) income, and the amortization of the net deferral of past losses will increase future pension expense. Asset returns for our defined benefit pension plans have been significantly impacted through December 31, 2008 by the overall decrease in fair market value on our pension plan assets. We expect that the net effects of actual returns based on the lower value of plan assets at December 31, 2008 will lead to a significantly higher pension expense in 2009 of approximately $1.7 million as compared to 2008. Net periodic pension expense was $0.2 million for the year ended December 31, 2008, $0.4 million for the year ended December 31, 2007, and $1.2 million for the year ended December 31, 2006.

Another significant element in determining our pension expense is the discount rate for plan liabilities. To develop the discount rate assumption to be used, we match projected pension payments to the yield derived from a spot-rate yield curve that contains a portfolio of available non-callable bonds rated AA or higher with comparable maturities. At December 31, 2008, 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 December 31, 2008, was $0.6 million (including $0.05 million of accrued interest and penalties), the recognition of which would have an effect of $0.03 million on our continuing operations' effective tax rate.

We recognize interest and penalties related to unrecognized tax benefits as income tax expense. The interest and penalties in continuing operations tax expense for the twelve months ended December 31, 2008 was immaterial.

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 the year ended December 31, 2008 for deferred taxes attributed to financial reserves in China. The valuation allowance was recorded due to prior history of operating losses and the uncertainty of earnings in future periods at our China facility. We also reversed the valuation allowance previously recorded for minimum pension liability at our Canadian subsidiary for the year ended December 31, 2008. We have determined that no additional valuation allowances are necessary as of December 31, 2008.

· Foreign Currency Translation and Transactions. We have foreign manufacturing operations in Italy, China and Canada, and revenue and expenses from these operations are denominated in local currency, thereby creating exposures to changes in exchange rates. For the years ended December 31, 2008, 2007 and 2006, revenue from non-U.S. countries represented 41.6%, 39.0% and 32.3% of our consolidated revenue, respectively. 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. Accumulated other comprehensive (loss) income included translation (losses) gains of $(2.6) million, $3.5 million and $2.1 million for the years ended December 31, 2008, 2007 and 2006, 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 Operations. Foreign currency transaction gains or losses were not material to the results of operations for the years ended.

· Recent Accounting Developments

· In December 2008, the FASB issued FASB Staff Position (FSP) SFAS 132 (R)-1, Employers' Disclosures about Postretirement Benefit Plan Assets (FSP 132R-1). FSP 132-1 amends the disclosure requirements for employer's disclosure of plan assets for defined benefit pensions and other postretirement plans. The objective of this FSP is to provide users of financial statements with an understanding of how investment allocation decisions are made, the major categories of plan assets held by the plans, the inputs and valuation techniques used to measure the fair value of plan assets, significant concentration of risk within the company's plan assets, and for fair value measurements determined using significant unobservable inputs a reconciliation of changes between the beginning and ending balances. FSP 132R-1 is effective for fiscal years ending after December 15, 2009. We are currently evaluating the impact of FSP 132R-1 on our financial statements and intend to adopt the new disclosure requirements in the 2009 annual reporting period.

· In November 2008, the FASB ratified Emerging Issues Task Force (EITF) issue No. 08-7, Accounting for Defensive Intangible Assets (EITF 08-7). EITF 08-7 applies to defensive intangible assets, which are acquired intangible assets that the acquirer does not intend to actively use but intends to hold to prevent its competitors from obtaining access to them. As these assets are separately identifiable, EITF 08-7 requires an acquiring entity to account for defensive intangible assets as a separate unit of accounting which should be amortized to expense over the period the asset diminished in value. Defensive intangible assets must be recognized at fair value in accordance with SFAS No. 141(R), Business Combinations, (SFAS 141(R)) and SFAS 157. EITF 08-7 is effective for financial statements issued for fiscal years beginning after December 15, 2008. We expect EITF 08-7 could have an impact on our consolidated financial statements, but the nature and magnitude of the specific effects will depend on the nature, terms and value of the intangible assets purchased after the effective date.

· 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 position or results of operations.

· In June 2008, the FASB issued Staff Position 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 earnings per share. 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 any impact on our results of operations, financial position or liquidity.

· In April 2008, the FASB issued FSP 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 SFAS 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 material impact on our results of operations, financial position 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 any impact on our results of operations, financial position or liquidity.

· In December 2007, the FASB issued SFAS 141(R), which 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. We expect SFAS 141(R) could have an impact on our consolidated financial statements, but the nature and magnitude of the specific effects will depend on the nature, terms and size of the acquisitions we consummate after the effective date of January 1, 2009.

Our continuing operation is organized into one strategic segment, friction products. In the fourth quarter of 2008 we committed to selling our performance racing segment, and both operating facilities were divested as of December 31, 2008. In the fourth quarter of 2006 we committed to selling our precision components segment which was sold in February 2007. As a result, we have classified the performance racing and precision components segments as discontinued operations in our financial results.

The following table summarizes our results of operations for the year ended December 31, 2008 and 2007:

                                                         Year Ended December 31
                                                           % of                        % of
                                             2008          Sales         2007          Sales
                                                          (dollars in millions)
Net sales                                  $   269.6         100.0 %   $   215.9         100.0 %
Cost of sales                              $   192.5          71.4 %   $   164.5          76.2 %
Gross profit                               $    77.1          28.6 %   $    51.4          23.8 %
Selling, technical and administrative
expenses                                   $    37.3          13.8 %   $    31.2          14.5 %
Income from operations                     $    39.2          14.5 %   $    19.5           9.0 %
Interest expense                           $     8.1           3.0 %   $     9.4           4.4 %
Interest income                            $     2.1           0.8 %   $     3.8           1.8 %
Other income (expense), net                $     1.5           0.6 %   $    (0.3 )        -0.1 %
Income taxes                               $    12.1           4.5 %   $     5.8           2.7 %
Income from continuing operations, after
income taxes                               $    22.6           8.4 %   $     7.8           3.6 %
Discontinued operations, net of tax        $    (1.7 )        -0.6 %   $     9.5           4.4 %
Net income                                 $    20.8           7.7 %   $    17.3           8.0 %

Net Sales. Our net sales for 2008 were $269.6 million, an increase of $53.7 million, or 24.9% from 2007 despite the economic slowdown which began to affect us in the last quarter of 2008. Sales increases during the year resulted primarily from increased shipment volumes as a result of strong demand in all of our end markets through the first 10 months of 2008, 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 primarily in the first half of 2008. Of our total sales increase of 24.9% in the year ended December 31, 2008, volume represented approximately 10.0 percentage points, pricing accounted for approximately 10.7 percentage points, and favorable foreign currency exchange rates represented 4.1 percentage points.

. . .