Summary of HAWK CORP - Yahoo! Finance

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS
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 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 expectations and beliefs concerning future events affecting us 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, that 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.
Friction Products Segment Information
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 business 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, military 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 brake and clutch friction materials for construction and mining equipment, agricultural equipment and trucks,

• the leading North American independent supplier of metallic 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 metallic friction materials for the general aviation market, including numerous new and existing series of Cessna, Hawker, Lear and Pilatus aircrafts,

• a leading domestic supplier of friction materials into performance, defense and specialty markets such as military vehicles, motorcycles, race cars, performance automobiles and ATVs, and

• a supplier of critical stack components used in the manufacture of phosphoric acid fuel cells. The fuel cells which use our stack components are a major presence in the on-site stationary fuel cell market.

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Critical Accounting Policies
The following discussion of our financial position and results of operations is based on the consolidated financial statements included in this Form 10-Q, which have been prepared in accordance with U.S. GAAP. 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 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. During the third quarter of 2009, there have been no significant changes to the critical accounting policies that we disclosed in Management's Discussion and Analysis of Financial Position and Results of Operations on our 2008 Form 10-K filed with the SEC on March 10, 2009. Recent Accounting Pronouncements
The following new accounting updates and guidance became effective for us commencing with our third fiscal quarter of 2009:
• In September 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2009-06, Income Taxes (ASU 2009-06), which provides implementation guidance on the accounting for uncertainty in income taxes and disclosure amendments for nonpublic entities. The adoption of ASU 2009-06 did not have any impact on our consolidated financial statements and disclosures.

• Effective July 1, 2009, the FASB launched the Accounting Standards Codification (ASC), which established a two-level GAAP hierarchy for nongovernmental entities: authoritative guidance and nonauthoritative guidance. The ASC is now the single source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with GAAP in the United States. All guidance in the ASC carries an equal level of authority. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The disclosures contained within our Form 10-Q for the period ended September 30, 2009, are in compliance with the requirements of the ASC.

In addition the following accounting updates and pronouncements have been issued by the FASB which will be adopted by us in future periods:
• In October 2009, the FASB issued ASU No. 2009-14, Certain Revenue Arrangements That Include Software Elements - a consensus of the FASB Emerging Issues Task Force (ASU 2009-14) which will become effective for all revenue arrangements entered into or materially modified by the Company beginning July 1, 2010, with earlier adoption permitted. Under the new guidance, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements and disclosures.

• In October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements - a consensus of the FASB Emerging Issues Task Force (ASU 2009-13), which will become effective for all revenue arrangements entered into or materially modified by the Company beginning July 1, 2010, with earlier adoption permitted. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement considerations using the relative selling price method. The guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements and disclosures.

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• In September 2009, the FASB issued a proposed ASU on the Emerging Issues Task Force consensus-for-exposure on Issue 09-2 that addresses the inconsistencies between the accounting for Research &Development (R&D) assets acquired in a business combination and those acquired in an asset acquisition. The proposed ASU requires an entity to capitalize R&D assets acquired in an asset acquisition as indefinite-lived intangible assets until completion or abandonment of the related R&D activities. The ASU also proposes that contingent consideration in an asset acquisition would be accounted for in accordance with other sections of the Codification and includes a principle under which the entity would analyze whether contingent consideration relates to the acquired asset or to future services provided by the seller. Comments on the proposed ASU are due by October 26, 2009 and we are currently evaluating the proposed ASU's requirements to determine what impact, if any, it will have on our consolidated financial statements and disclosures.

• In August 2009, the FASB issued ASU No. 2009-05, Measuring Liabilities at Fair Value(ASU 2009-05), which provides additional guidance clarifying the measurement of liabilities at fair value and addresses restrictions when estimating the fair value of a liability under FASB ASC Topic 820, Fair Value Measurements and Disclosures (ASC 820). When a quoted price in an active market for the identical liability is not available, ASU 2009-05 requires that the fair value should be measured using one of the following approaches a) the quoted price of the identical liability when traded as an asset, b) quoted prices for similar liabilities or similar liabilities when traded as assets or c) another valuation technique that is consistent with the principles of ASC 820. For us, ASU 2009-05 is effective for the quarter ended December 31, 2009. We intend to adopt the new accounting and disclosure requirements with our year ending December 31, 2009, and the adoption of this guidance is not expected to have a material impact on our consolidated financial statements and disclosures.

• In August 2009, the FASB issued an exposure draft (ED) of a proposed ASU, Improving Disclosures About Fair Value Measurements. The ED proposes new, and clarifies existing, disclosures about fair value measurements. The proposed disclosures would require more detail about transfers between Levels 1, 2 and 3 of the fair value hierarchy, as well as changes in Level 3 activity on a gross basis. In addition, the fair value disclosures would be disaggregated by each class of assets and liabilities (instead of by major category). The proposed disclosures would also include sensitivity analysis to show the effects on Level 3 measurements using reasonably possible alternate inputs. The amendments are anticipated to be effective for interim and annual reporting periods ending after December 15, 2009, except for the sensitivity disclosures about Level 3 measurements, which are anticipated to be effective for interim and annual periods ending after March 15, 2010. We are currently evaluating the ED's requirements and intend to adopt the new disclosure requirements when they become effective.

• In June 2009, the FASB issued SFAS 167, which amends the guidance on the consolidation of variable interest entities to require an analysis to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity. SFAS 167 requires an ongoing reassessment and eliminates the quantitative approach previously required for determining whether an entity is the primary beneficiary. SFAS 167 remains authoritative as it has not yet been integrated into the ASC. This statement is effective for fiscal years beginning on or after November 15, 2009. We do not expect the adoption of this statement to have an impact on our consolidated financial statements and disclosures.

• In June 2009, the FASB issued SFAS 166, which removes the concept of a qualifying special-purpose entity from SFAS 140 and removes the exception from applying FIN 46R. This statement also clarifies the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. SFAS 166 remains authoritative as it has not yet been integrated into the ASC. This statement is effective for fiscal years beginning on or after November 15, 2009. We do not expect the adoption of this statement to have an impact on our consolidated financial statements and disclosures.

• In December 2008, the FASB issued a technical amendment to employer's disclosure requirements for plan assets for defined benefit pensions and other postretirement plans, which is integrated into the ASC at ASC 715-20-50, Compensation - Retirement Benefits: Defined Benefit Plans - General: Disclosure. The objective 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. The new disclosure requirements are effective for fiscal years ending after December 15, 2009. We intend to adopt the new disclosure requirements with our year ending December 31, 2009.

Our management does not believe that any other recently issued, but not yet effective, accounting standards, if currently adopted, would have a material effect on the accompanying unaudited interim financial statements.

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Third Quarter of 2009 Compared to the Third Quarter of 2008 The following tables show our net sales by market segment and geographic location for the three months ended September 30, 2009 and 2008:

                                Sales by Market
                           Quarter Ended September 30

                                                  % of Sales
                    Market                     2009        2008
                    Construction and Mining      34.1 %      46.3 %
                    Aircraft and Defense         28.5 %      23.0 %
                    Agriculture                  14.5 %      14.2 %
                    Heavy Truck                   9.7 %       8.8 %
                    Performance Friction          7.6 %       3.6 %
                    Specialty Friction            3.4 %       3.8 %
                    Alternative Energy            2.2 %       0.3 %

                    Total                       100.0 %     100.0 %

Sales by Geographic Location of our Manufacturing Facilities

                           Quarter ended September 30

                                             % of Sales
                         Location         2009        2008
                         United States      73.3 %      60.1 %
                         Italy              22.4 %      34.9 %
                         Other Foreign       4.3 %       5.0 %

                         Total             100.0 %     100.0 %

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The following table summarizes our results of operations for the three month periods ended September 30, 2009 and 2008:

                                                       Three Months Ended September 30
                                                                % of                   % of
                                                   2009         Sales       2008       Sales
                                                            (dollars in millions)

Net sales                                        $   43.5        100.0 %   $ 74.2       100.0 %

Cost of sales                                    $   29.9         68.7 %   $ 49.1        66.1 %

Gross profit                                     $   13.6         31.3 %   $ 25.1        33.8 %

Selling, technical and administrative expenses   $    7.3         16.8 %   $  9.3        12.6 %

Income from operations                           $    6.1         14.0 %   $ 15.6        21.0 %

Interest expense                                 $   (2.0 )       -4.6 %   $ (2.0 )      -2.7 %

Interest income                                  $    0.1          0.2 %   $  0.5         0.7 %

Other income, net                                $    1.6          3.7 %   $  1.2         1.6 %

Income tax provision                             $    2.0          4.6 %   $  5.0         6.7 %

Net income                                       $    3.8          8.7 %   $ 10.3        13.9 %

Net Sales. Our net sales for the third quarter of 2009 were $43.5 million, a decrease of $30.7 million, or 41.4%, from the same period in 2008. Sales declines during the period resulted primarily from the continued economic downturn in most of our end-markets. Of our total sales decrease of 41.4% in the third quarter of 2009, volume represented approximately 41.0 of the total percentage point decrease, unfavorable foreign currency exchange rates represented 0.7 of the total percentage point decline and pricing accounted for a benefit of approximately 0.3 of the total percentage point change. Our aggregate aircraft and defense markets were down 27.4% in the third quarter of 2009, compared to the third quarter of 2008, due to a decrease in demand in both our aircraft and defense markets. Our sales to the construction and mining market, our largest, were down 56.9% in the third quarter of 2009, compared to the third quarter of 2008. Sales to our agriculture market were down 40.0% in the third quarter of 2009, compared to the third quarter of 2008, as a result of weak market conditions, especially in Europe. Sales to our heavy truck market decreased 35.6% during the third quarter of 2009, compared to the third quarter of 2008, due to the decline in truck production during the period and reduced freight volumes being shipped with existing vehicles. Sales in our friction direct aftermarket that we service through the Velvetouch® and Hawk Performance® brand names decreased 9.7% in the third quarter of 2009 compared to the third quarter of 2008. However, sales of our performance automotive brake product, which are part of this market segment, were up 24.2% in the third quarter of 2009 compared to the third quarter of 2008. Although still a small percentage of our total net sales, sales to the alternative energy market were up 277.9% in the third quarter of 2009 compared to the same period of 2008 as unit volume shipments of this product line continue to increase.
Net sales from our foreign facilities represented 26.7% of our total net sales in the third quarter of 2009 compared to 39.9% for the comparable period of 2008. The decline in our foreign facility revenues as a percent of total revenues was due primarily to the downturn in the European and Asian markets. Sales at our Italian operation, on a local currency basis, were down 60.6% in the third quarter of 2009, compared to the third quarter of 2008, and sales at our Chinese operation, on a local currency basis, were down 47.4% during the same period, primarily due to declines in the construction and agriculture markets served by those facilities.

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Cost of Sales. Cost of sales was $29.9 million during the third quarter of 2009, a decrease of $19.2 million, or 39.1%, compared to cost of sales of $49.1 million in the third quarter of 2008. The impact of decreased sales and production volumes through all of our manufacturing facilities, which represented approximately 37.4 percentage points of the total cost of sales decrease of 39.1%, was the primary driver of the reduction in our cost of sales in the third quarter 2009. Additionally, a slight shift in product mix represented 0.6 percentage points of the total decrease of 39.1% during the quarter. The effect of foreign currency exchange rates accounted for 0.8 percentage points of our total cost of sales decrease of 39.1% during the third quarter of 2009. As a percent of sales, our cost of sales represented 68.7% of our net sales in the third quarter of 2009 compared to 66.1% of net sales in the third quarter of 2008. The increase in our cost of sales percentage was driven primarily by lower production volumes, the impact of inventory reductions during the quarter and the effect of foreign currency exchange rates partially offset by labor reduction programs and favorable product mix during the quarter.
Gross Profit. Gross profit was $13.6 million during the third quarter of 2009, a decrease of $11.5 million, or 45.8%, compared to gross profit of $25.1 million in the third quarter of 2008. Our gross profit margin declined to 31.3% of our net sales in the third quarter of 2009 compared to 33.9% of our net sales in the third quarter of 2008. The factors impacting the change in gross margin are detailed under Net Sales and Cost of Sales.
Selling, Technical and Administrative Expenses. Selling, technical and administrative (ST&A) expenses decreased $2.0 million, or 21.5%, to $7.3 million in the third quarter of 2009 from $9.3 million during the third quarter of 2008. As a percentage of net sales, ST&A was 16.8% in the third quarter of 2009 compared to 12.6% in the third quarter of 2008. The decrease in ST&A expenses resulted primarily from a decrease in incentive compensation totaling approximately 8.6 percentage points of the 21.5% decrease in response to the lower levels of profitability during the quarter, compared to the third quarter of 2008. Wages and benefits decreased approximately 8.7%, or 3.9 percentage points of the total ST&A decrease of 21.5%, during the third quarter of 2009 compared to 2008 primarily as a result of headcount reductions taken in the early part of 2009. Decreases in legal and professional expenses represented approximately 4.2 percentage points of the 21.5% decrease primarily as a result of reduced expenditures related to the previously disclosed SEC investigation. Additionally, sales and marketing expenses, which were down in response to lower demand and reduced promotional activities, represented 4.3 percentage points of the total decrease of 21.5%. We spent $1.2 million, or 2.8% of our net sales on product research and development in the third quarter of 2009, compared to $1.3 million or 1.8%, of our net sales for the third quarter of 2008. Income from Operations. As a result of the factors discussed above, income from operations was $6.1 million in the third quarter of 2009, a decrease of $9.5 million or 60.9%, compared to $15.6 million during the third quarter of 2008. Income from operations as a percentage of net sales decreased to 14.0% in the third quarter of 2009 from 21.0% in the same period of 2008 for the reasons discussed above.
Interest Expense. Interest expense was flat at $2.0 million in both the third quarter of 2009 and 2008 as a result of fixed interest rates on our outstanding 83/4% senior notes of $87.1 million.
Interest Income. We invested our excess cash in various short-term interest bearing investments. Interest income was $0.1 million in the third quarter of 2009 compared to $0.5 million during the third quarter of 2008. The decrease was the result of lower invested cash balances during the period ended September 30, 2009 compared to the three months ended September 30, 2008. Additionally, effective interest rates on our investments were lower in the quarter ended September 30, 2009, compared to rates available to us in the quarter ended September 30, 2008.
Other Income, Net. Other income was $1.6 million during the third quarter of 2009, an increase of $0.4 million compared to income of $1.2 million reported in the third quarter of 2008. In the third quarter of 2009, we reported income of $1.5 million from a cash payment received from a third-party for cancellation of its obligation to develop a potential new product for us. In the third quarter of 2008, we reported income of $1.3 million as a result of a similar cancellation. We also reported net realized and unrealized gains of $0.2 million on our trading securities in the three months ended September 30, 2009 compared to net losses of $0.1 million in the three months ended September 30, 2008. Income Taxes. We recorded a tax provision from our continuing operations of $2.0 million for the quarter ended September 30, 2009, compared to a tax provision of $5.0 million in the comparable period of 2008. Our effective income tax rate of 34.6% in the third quarter of 2009 differs from the current federal U.S. statutory rate of 35.0%, primarily as a result of foreign withholding taxes on royalty income, additional tax credits generated on the U.S. federal income tax return and the impact of non-deductible expenses on our worldwide taxes. Our worldwide provision for income taxes is based on projected annual tax rates for the year applied to all of our sources of income.
Net Income. As a result of the factors noted above, we reported net income of $3.8 million in the third quarter of 2009, a decrease of $6.5 million compared to net income of $10.3 million during the third quarter of 2008.

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First Nine Months of 2009 Compared to the First Nine Months of 2008 The following tables show our net sales by market segment and geographic location for the nine months ended September 30, 2009 and 2008:

                                Sales by Market
                         Nine Months Ended September 30

                                                  % of Sales
                    Market                     2009        2008
                    Construction and Mining      34.5 %      47.8 %
                    Aircraft and Defense         28.5 %      19.8 %
. . .