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Hawk 10-K 2009 Documents found in this filing:UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For
the Fiscal year ended December 31, 2008
Commission
File No. 001-13797
 HAWK
CORPORATION
(Exact
name of Registrant as specified in its charter)
200
Public Square, Suite 1500,
Cleveland, Ohio 44114
(Address
of principal executive offices) (Zip Code)
(216)
861-3553
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. YES £ NO
R
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. YES £ NO
R
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such report(s)), and (2) has been subject to such filing requirements
for the past 90 days. YES R NO
£
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. £
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer or a smaller reporting
company. See definitions of “accelerated filer”, “large accelerated
filer” and “smaller reporting company” in rule 12b-2 of the Exchange
Act. (Check one):
Large
Accelerated Filer £ Accelerated
Filer R Non-accelerated
Filer £ Smaller
Reporting Company £
Indicate
by check mark whether the registrant is a shell company as defined in Rule 12b-2
of the Act: YES £ NO
R
The
aggregate market value of the voting common equity held by non-affiliates as of
June 30, 2008 was $112,599,676 (based on the closing price as quoted on the
American Stock Exchange on that date).
As of
March 2, 2009, the registrant had 8,689,109 shares of Class A Common Stock, net
of treasury shares, and 0 shares of Class B non-voting Common Stock outstanding.
As of that date, non-affiliates held 5,781,967 shares of Class A Common
Stock.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the registrant’s definitive proxy statement for the annual meeting of
stockholders of Hawk Corporation to be held on May 19, 2009 are incorporated by
reference into Part III of this Form 10-K.
As used
in this Form 10-K, the terms “Company,” “Hawk,” “Registrant,” “we,” “us” and
“our” mean Hawk Corporation and its consolidated subsidiaries, taken as a whole,
unless the context indicates otherwise. Except as otherwise stated, the
information contained in this Form 10-K is as of December 31, 2008.
PART
I
Our
Company
Hawk
Corporation is a leading supplier of friction products for industrial, aircraft,
agricultural and performance applications. We focus on designing, manufacturing
and marketing products requiring sophisticated engineering and production
techniques for applications in markets in which we have achieved a significant
market share. 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. Our friction products are made
principally from proprietary formulations and designs of composite materials and
metal powders.
Founded
in 1989, Hawk Corporation is a holding company that through our subsidiaries,
enjoys customer relationships that span 50 years or more and has a manufacturing
history dating back to 1920. Our common stock has been publicly traded since
1998 under the symbol “HWK”.
Friction
Products Segment Information
We
benefit from a deep and diversified customer base, with approximately 500 total
customers. While we are dependent on a small number of customers for
a large portion of our sales, we sell multiple product applications to each of
those customers. For the year ended December 31, 2008, our top five
customers made up approximately 43.9% of our total net sales. Our
largest customer, Caterpillar, accounted for approximately 19.1% of our total
net sales in 2008. We are a preferred supplier to many of the world’s
largest and most well-known brand name original equipment manufacturers,
including Caterpillar, Meggitt Aircraft Braking Systems, Eaton, Goodrich, CNH,
Volvo and Carraro. We believe that more than 80% of our net sales are from
products for which we are the sole source provider for the specific customer
application. We offer our customers full service capabilities, from design
through production, and work closely with original equipment manufacturers to
improve performance and develop product innovations to generate increased sales.
We also benefit from a diversified product list, with over 5,000 total products,
none of which accounted for more than 5% of our net sales in 2008. We do not
target the cyclical consumer automotive sector. For the year ended
December 31, 2008, we generated net sales of $269.6 million and income from
operations of $39.2 million, representing an operating margin of
14.5%. We define operating margin as our income from operations as a
percentage of our net sales.
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 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, military
vehicles, trucks, motorcycles and race cars, and brake parts for landing systems
used in commercial and general aviation. We believe we are:
2
Discontinued
Operations
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
segment, which engineers, manufactures and markets 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 our performance racing facility in North Carolina
and reported a loss on sale of $1.9 million ($1.3 million, net of
tax). This loss is reported in (Loss) income from discontinued
operations, net of tax in the Consolidated Statement of Operations for the year
ended December 31, 2008. On December 22, 2008, we completed the sale
of our performance racing facility in Illinois and reported no gain or loss on
the transaction. As a result, there are no remaining assets or
liabilities of the performance racing segment classified as discontinued
operations in the Consolidated Balance Sheet at December 31, 2008.
As
previously reported in our Form 10-K for the year ended December 31, 2007, the
sale of our precision components segment closed in the first quarter of 2007,
and we reported a gain on sale of the precision components segment of $15.0
million ($11.9 million, net of tax). This gain is reported in (Loss)
income from discontinued operations, net of tax in the Consolidated Statement of
Operations for the year ended December 31, 2007. There are no
remaining assets or liabilities of the precision components segment classified
as discontinued operations recorded in the Consolidated Balance Sheets for any
period presented in this Form 10-K.
On March
29, 2006, we entered into an agreement to sell the Monterrey, Mexico facility
which was finalized in the fourth quarter of 2006. We received $0.1
million in cash and a note receivable of $1.2 million for the inventory and
certain other assets of this facility, and recognized no gain or loss on the
transaction. During the fourth quarter of 2008, the note holder
defaulted on its repayment obligation and we recorded a reserve of $1.0 due to
our uncertainty of collecting the remaining outstanding balance of the note
receivable. This expense is reported in (Loss) income from
discontinued operations, after income taxes in the Consolidated Statement of
Operations for the year ended December 31, 2008. Also during the
fourth quarter of 2008, we received a favorable ruling from the Mexican tax
authority related to a tax assessment that had been received in the fourth
quarter of 2007. (Loss) income from discontinued operations, after
income taxes was favorably impacted by approximately $0.8 million for the year
ended December 31, 2008 as a result of this favorable ruling. There
are no remaining assets or liabilities of the motor segment classified as
discontinued operations recorded in the Consolidated Balance Sheet for any
period presented in this Form 10-K.
Operating
results from discontinued operations are summarized as follows:
Business
Strategy
Our
business strategy includes the following principal elements:
3
Our
principal offices are located at 200 Public Square, Suite 1500, Cleveland, Ohio
44114-2301, and we can be reached by telephone at (216) 861-3553. Our
web site address is: www.hawkcorp.com.
Our
Principal Markets and Products
We focus
on supplying the off-highway, on-highway, industrial, agricultural, aircraft,
and performance racing markets with components that require sophisticated
engineering and production techniques for applications where we have achieved a
significant market share. We have diversified our end markets through product
line expansions. We believe that diversification has reduced our economic
exposure to the cyclical effects of any particular industry. For the year ended
December 31, 2008, our sales by principal markets were:
2008
Sales by Principal Markets
 4
Friction
Products
Friction
products are the replacement elements used in brakes, clutches and transmissions
to absorb vehicular energy and dissipate it through heat and normal mechanical
wear. For example, the friction components in construction vehicles enable their
braking systems to slow and stop the vehicles and enable their clutches and
transmissions to function in controlling the motion of the vehicles. Our
friction products also include friction components for use in automatic and
power shift transmissions, clutch facings that serve as the main contact point
between an engine and a transmission, and brake components for use in many
truck, construction, mining, agriculture, aircraft and specialty vehicle braking
systems. Our friction products segment manufactures products made from
proprietary formulations of composite materials that primarily consist of metal
powders and synthetic and natural fibers.
Our
friction products are custom-designed to meet the performance requirements of a
specific application and must meet temperature, pressure, component life and
noise level criteria. The engineering required in designing a friction material
for a specific application dictates a balance between the component life cycle
and the performance application of the friction material in, for example,
stopping or starting movement. Friction products are consumed through customary
use in a brake, clutch or transmission system and require regular replacement.
Because the friction material is the consumable or wear-related component of
these systems, a new friction material introduction engineered for a new system
provides us with a long-term opportunity to supply that friction
product.
The
principal markets served by our friction products segment include manufacturers
of truck clutches, transmissions, heavy-duty construction, mining and
agricultural vehicle brakes, aircraft brakes, motorcycle, snowmobile and racing
and performance automotive brakes. Based on net sales, we believe that we are
among the top worldwide manufacturers of friction products used in industrial,
agricultural and aircraft applications. We estimate that our direct and indirect
aftermarket sales of friction products have comprised approximately 40% to 50%
of our net friction product sales in recent years. We believe that our
aftermarket sales component enables us to reduce our exposure to adverse
economic cycles.
End Markets. We supply a
variety of friction products for use in brakes, clutches and transmissions on
construction, mining and agriculture equipment, aircraft, trucks and specialty
vehicles. These components are designed to precise friction characteristics and
mechanical tolerances, permitting brakes to stop or slow a moving vehicle and
the clutch or transmission systems to engage or disengage. We believe we are a
leading supplier to original equipment manufacturers and to the aftermarket. We
also believe that our trademarks, including Velvetouch® and Hawk
Performance®, are
well known to the direct aftermarket for these components. The use of our
friction products in conjunction with a new or existing brake, clutch or
transmission system provides us with the opportunity to supply the aftermarket
with the friction product for the life of the system.
5
Our
Manufacturing Processes
The
manufacturing processes for most of our friction products and performance brake
products are similar. In general, all use composite materials or metal alloys in
powder form to make high quality friction components. The basic manufacturing
steps of blending/compounding, molding/compacting, sintering (or bonding) and
secondary machining/treatment are as follows:
Some of
our friction products, including those used in oil-cooled brakes and power shift
transmissions, do not require all of the foregoing steps. For example, composite
cellulose friction materials are molded under high temperatures and cured in
electronically-controlled ovens and then bonded to a steel plate or core with a
resin-based polymer.
Our
Quality Control Procedures
Throughout
our design and manufacturing process, we focus on quality control. For product
design, each manufacturing facility uses state-of-the-art testing equipment to
replicate virtually any application required by our customers. This
equipment is essential to our ability to manufacture components that meet
stringent design and customer specifications. To ensure that tolerances have
been met and that the requisite quality is inherent in our finished products, we
use statistical process controls and a variety of electronic measuring equipment
and computer-controlled testing machines. We have also established quality
control programs within each of our facilities to detect and prevent potential
quality problems.
Since
2001, we have utilized Six Sigma and lean manufacturing initiatives focused on
creating a culture of continuous improvement. These tools are
data-driven programs of continuous improvement designed to eliminate waste,
reduce process variations, improve productivity, and eliminate costs throughout
the organization.
Our
Global Operations
In
addition to the United States, we operate friction manufacturing facilities in
Orzinuovi, Italy, Suzhou, China, and Ontario, Canada. In addition, we
operate sales offices in Russia, India and Mexico. Our international
operations are subject to the usual risks of operating in foreign jurisdictions.
Risks inherent in international operations include the following:
Net sales
from our international facilities represented $112.2 million, or 41.6% of our
consolidated net sales in 2008 compared to $84.2 million, or 39.0% of our
consolidated net sales in 2007, an increase of 33.3% in 2008.
6
2008 Sales by Geographic Location of our Manufacturing Facilities  For
information regarding our net sales, income from operations, net income, and
total assets by geographic area see Note 16
"Business Segments” in the accompanying Consolidated Financial Statements
of this Form 10-K.
Our
Technology
We
believe we are an industry leader in the development of systems, processes and
technologies that enable the manufacturing of friction products with numerous
performance advantages, such as greater wear resistance, increased stopping
power, lower noise and smoother engagement. Our expertise is evidenced by our
aircraft brake components, which are currently being installed on many of the
braking systems of Boeing Company’s commercial aircraft and Bombardier’s
Canadair regional jet series of commuter aircraft, as well as new series of
industrial equipment from various original equipment manufacturers.
We
maintain an extensive library of proprietary friction product formulas that
serve as starting points for new product development. Each formula has a
specific set of ingredients and processes to generate repeatability in
production. A slight change in a mixture can produce significantly different
performance characteristics. We use a variety of technologies and materials in
developing and producing our products, such as graphitic and cellulose
composites. We believe our expertise in the development and production of
products using these different technologies and materials gives us a competitive
advantage over other friction product manufacturers.
Our
expenditures for product research and development and engineering were $5.4
million, or 2.0% of net sales, for the year ended December 31, 2008, compared
with $4.6 million, or 2.1% of net sales, in 2007.
Our
Customers
We seek
to provide advanced solutions to customers, enhancing our long-term
relationships. Our engineers work closely with our customers to develop and
design new products and improve the performance of existing products. We believe
that more than 80% of our sales are from products and materials for which we are
the sole source provider for the specific customer application. Our predecessors
developed, and we continued to build relationships with a number of customers
dating back over 50 years. Our commitment to quality, service and on-time
delivery has enabled us to build and maintain strong and stable customer
relationships. We believe that strong relationships with our customers provide
us with significant competitive advantages in obtaining and maintaining new
business opportunities.
We sell
our friction products to a diversified group of original equipment
manufacturers, second tier component suppliers, retailers and distributors in a
wide variety of markets. Our top five customers represented 43.9% of
our consolidated net sales in 2008 compared to 45.2% of our consolidated net
sales in 2007. Our largest customer, Caterpillar, represented approximately
19.1% of our consolidated net sales in 2008 and 17.7% in 2007.
7
How
We Market and Sell Our Products
We market
our products globally through product managers and direct sales professionals,
who operate primarily from our facilities in the United States, Italy, China and
Canada, and sales offices in Russia, India and Mexico. Our product managers and
sales force work directly with our engineers who provide the technical expertise
necessary for the development and design of new products and for the improvement
of the performance of existing products. Our friction products are sold both
directly to original equipment manufacturers and to the aftermarket through our
original equipment customers and a network of distributors and representatives
throughout the world.
Our
Competition
Our
success depends on our ability to continue to meet our customers’ changing
specifications with respect to reliability and timeliness of delivery, technical
expertise, product design capability, manufacturing expertise, operational
flexibility and customer service.
We
compete for new business principally at the beginning of the development of new
applications and at the redesign of existing applications by our customers. For
example, new model development for our aircraft braking system customers
generally begins two to five years before full-scale production of new braking
systems. Initiatives by customers to upgrade existing products typically involve
long lead times as well. We also compete with manufacturers using different
technologies, such as carbon composite (carbon-carbon) friction materials for
aircraft braking systems. Carbon-carbon braking systems are significantly
lighter than the metallic aircraft braking systems for which we supply friction
materials, however they are generally more expensive. The carbon-carbon brakes
are typically used on wide-body aircraft, such as the Boeing 747, 767, 777 and
787, and on military aircraft, where the advantages in reduced weight may
justify the additional expense.
The
Suppliers and Prices of Raw Materials We Use
We
require substantial amounts of raw materials, including copper and iron powders,
steel and custom-fabricated cellulose sheet. Substantially all of the raw
materials we require are purchased from third party suppliers and are generally
in adequate supply. However, the availability and costs of raw materials may be
subject to change due to, among other things, new laws or regulations,
suppliers’ allocation among their customers to other purchasers, interruptions
in production by suppliers and changes in exchange rates and worldwide price and
demand levels. We are not currently party to any material long-term supply
agreements. Our inability to obtain adequate supplies of raw materials for our
products at favorable prices could have a material adverse effect on our
business, financial position or results of operations by decreasing our profit
margins and by hindering our ability to deliver products to our customers on a
timely basis.
Government
Regulation of Our Businesses
Each
aircraft braking system, including the friction products supplied by us, must
meet stringent FAA criteria and testing requirements. We have been able to meet
these requirements in the past, and we continuously review FAA compliance
procedures to help ensure our continued and future
compliance.
Environmental,
Health and Safety Matters
We are subject to stringent
environmental standards imposed by federal, state, local and foreign
environmental laws and regulations, including those related to air emissions,
wastewater discharges, chemical and hazardous waste management and disposal.
Some of these environmental laws hold owners or operators of land or businesses
liable for their own and for previous owners’ or operators’ releases of
hazardous or toxic substances, materials or wastes, pollutants or contaminants.
Our compliance with environmental laws also may require the acquisition of
permits or other authorizations for some kinds of activities and compliance with
various standards or procedural requirements. We are also subject to the federal
Occupational Safety and Health Act and similar foreign and state laws. The
nature of our operations, the long history of industrial uses at some of our
current or former facilities, and the operations of predecessor owners or
operators of some of the businesses expose us to risk of liabilities or claims
with respect to environmental and worker health and safety matters. We reviewed
our procedures and policies for compliance with environmental and health and
safety laws and regulations and believe that we are in substantial compliance
with all material laws and regulations applicable to our operations. We are not
aware of any instance in which we have contravened federal, state, or local
provisions enacted for or relating to protection of the environment or in which
we otherwise may be subject under environmental laws to liability for
environmental conditions that could materially affect operations. Our
costs of complying with environmental, health and safety requirements have not
been material.
Our
Intellectual Property
Our
federally registered trademarks include Hawk®, Wellman
Friction Products®, Wellman
Products Group®, Hawk
Brake®, Hawk
Performance®,
Fibertuff®,
Feramic®,
Velvetouch®,
Velvetouch Feramic®, Velvetouch®,
Fibertuff®, Hawk
Performance®, and
Black HawkÔ are our
principal trademarks for use in our direct aftermarket sales effort. To protect
our intellectual property, we rely on a combination of internal procedures,
confidentiality agreements, patents, trademarks, trade secrets law and common
law, including the law of unfair competition.
8
Personnel
At
December 31, 2008, we had approximately 670 domestic employees and 440
international employees at our operations. Approximately 270 employees at our
Orzinuovi, Italy facility are represented by a national mechanics union
agreement that expires in December 2009 and approximately 30 employees at our
Akron, Ohio facility are covered under a collective bargaining agreement with
the United Automobile Workers expiring in July 2009. Additionally,
267 of our Italian employees are also covered by an internal facility agreement
that expired in December 2008. Contract negotiations for a new agreement are
ongoing. We expect that the expired agreement will be renewed shortly
and the expiring contracts will be renewed on a timely basis. Our
labor relations are generally satisfactory, and there have been no major work
stoppages in recent years.
ITEM
1A. RISK
FACTORS
Cautionary
Note Regarding Forward-Looking Statements
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 which 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 guarantees
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 expenditures 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. These risks and
other factors include those listed under Item 1A "Risk Factors" and elsewhere in
this report.
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 laws.
Current
economic conditions and uncertain economic outlook could adversely affect our
results of operations and financial position.
The
deterioration and instability of the financial markets could expose us to
investment risk, including the risks that the value and liquidity of our
investments could deteriorate significantly and the issuers of the securities we
hold could be subject to credit rating downgrades. Any loss of value
could result in future impairment charges with respect to our investment
portfolio and cash flows and our operating results could be negatively
affected. As of March 2009, substantially all of our cash equivalents
and short-term investments were invested in U.S. Government agency notes,
corporate commercial paper and money market funds, which are guaranteed under a
recently adopted money market fund guarantee program by the Board of Governors
of the Federal Reserve System.
In
November 2008, we began implementing cost reduction initiatives, which included
work force reductions, discretionary spending cut-backs, freezing of pay rates
for salaried employees and continued focus on lean manufacturing. No
assurance can be given that the implementation of the cost reduction initiatives
will generate all of the anticipated cost savings and other benefits or that
future or additional measures are not required. We may have
incorrectly anticipated the extent and term of the market decline and weakness
for our products and we may be forced to restructure further or may incur future
operating charges due to poor business conditions.
9
We
are the subject of investigations by the Securities and Exchange Commission
(SEC) and the Department of Justice (DOJ) which may harm our business and
results of operations.
As we
have previously disclosed, the SEC provided Hawk with a formal order of private
investigation that relates to the informal inquiry commenced by the
SEC. The investigation concerns activity from June 2006 involving (1)
Hawk’s preparations for compliance with Section 404 of the Sarbanes-Oxley Act of
2002 (Section 404), (2) the maintenance and evaluation of the effectiveness by
Hawk of disclosure controls and procedures and internal controls over financial
reporting, (3) transactions in Hawk’s common stock by a stockholder that is not
affiliated with Hawk, including the impact of those transactions on the date
when Hawk would have been required to comply with Section 404, (4) the
calculation of the amount of Hawk common stock held by non-affiliates and the
effect of the calculation on the date when Hawk would have been required to
comply with Section 404, (5) communications between Hawk and third parties
regarding Section 404 compliance and (6) Hawk’s periodic disclosure requirements
related to the foregoing. We fully cooperated with the informal
inquiry and continue to cooperate fully with the formal investigation by the
SEC.
As
previously disclosed, Hawk has also been contacted by the DOJ in connection with
the DOJ’s investigation.
We cannot
predict the outcome of any of these investigations. We will continue
to incur additional expenses related to the SEC and DOJ investigations, and the
expenses may be substantial, including indemnification costs for which we may be
responsible. In the event that there is an adverse development in
connection with the SEC or DOJ investigations, our business and results of
operations may be adversely impacted. Furthermore, responding to the
SEC and DOJ investigations may require significant diversion of management’s
attention and resources.
We
have broad discretion over the use of proceeds from the sale of our precision
components and performance racing segments.
We
invested the net cash proceeds from the sale of our precision components and
performance racing segment in short-term investments and we can use the proceeds
at our discretion, provided we comply with the terms of our 8-3/4% senior notes
due November 1, 2014 (the senior notes) and the Credit and Security Agreement,
dated November 1, 2004, with KeyBank National Association, serving as
Administrative Agent and Letter of Credit Issuer (the bank
facility).
We
continue to explore options to utilize our cash holding, including
acquisitions. The terms of any investment or transaction including
acquisitions have not yet been determined, and no assurances can be made as to
the structure, price or other terms of such investment or transaction, the
impact of such investment or transaction on our business, results of operations
and financial position or that such investment or transaction will be available
to us on favorable terms or at all. If we fail to apply these funds
effectively, our business, results of operations and financial position may be
adversely affected.
Certain of our products have lower gross profit margins than our other
products. Our consolidated gross margin was 28.6% for the year ended
2008 compared to 23.8% for the year ended 2007. Our margins in
2008 were positively impacted by increased pricing taken beginning in the
last half of 2007 and continued operating improvements in our domestic
facilities, including Tulsa, compared to 2007. We cannot guarantee
that, in the future, our product mix will continue to be made up of higher gross
margin product sales.
We
operate in a highly competitive industry, which may prevent us from growing and
may decrease our business.
We
operate in an industry that is highly competitive and fragmented. There are many
small manufacturers in our industry, and only a few generate annual sales in
excess of $50.0 million. Our larger competitors may have greater financial
resources to devote to manufacturing, promotion and sales, which could adversely
affect our customer relationships or product mix.
We compete for new business primarily when our existing customers develop new
applications or redesign existing applications, which may involve lengthy
periods of development and testing. For example, developing new aircraft braking
systems typically begins two to five years before full-scale production.
Although we have successfully obtained this business from our customers in the
past, we may be unable to obtain this business in the future, which could
adversely affect our financial position, results of operations and prospects.
Our success will depend on our ability to continue to meet our customers’
changing specifications with respect to reliability and timeliness of delivery,
technical expertise, product design capability, manufacturing expertise,
operational flexibility, customer service and overall management.
Some of our competitors use different technologies, such as carbon composite
friction material for aircraft braking system components. Our
competitors’ use of different technology may adversely affect our ability to
compete and negatively impact our financial position, results of operations and
prospects.
In
addition, we may lose business to competitors that may be able to offer products
at lower costs. Some competitors may be able to transfer the
manufacturing of their products to lower wage locations resulting in lower
production costs which may be passed through to customers. Increased
competition may exert strong pressures on our profitability and impair our
ability to successfully grow.
10
As of December 31, 2008, approximately 26.6% of our employees were represented
by unions. The majority of our union employees are located in our Orzinuovi,
Italy facility. We cannot be certain that we will be able to
negotiate new agreements or extensions with the unions on favorable terms or
without experiencing work stoppages. The national mechanics union agreement
covering our Italian employees expires in December 2009 and the local union
agreement expired in December 2008. The extension of the local union
agreement is currently being negotiated with the union
membership. The union agreement covering our Akron, Ohio employees
expires in July 2009. Any work stoppage may have a material adverse
effect on our financial position, results of operations and
prospects.
Every
aircraft braking system, including those containing components supplied by us,
must satisfy FAA criteria and testing requirements. If we fail to meet these
requirements or any new or changed requirements, then our results of operations
may be adversely affected or we may not be able to meet our business objectives.
There can be no assurance that FAA review of an aircraft braking system
containing components supplied by us will result in a favorable determination or
that we or our customers will continue to meet FAA criteria and testing
requirements, which are subject to change in the discretion of the
FAA.
We are subject to various U.S. and foreign laws and regulations relating to
environmental protection and worker health and safety, including those
governing:
The nature of our operations exposes us to the risk of liabilities or claims
with respect to environmental matters, including on-site and off-site disposal
matters. Future events could require us to make additional expenditures to
modify or curtail our operations, install pollution control equipment or
investigate and cleanup contaminated sites, such as:
We are also subject to the federal Occupational Safety and Health Act and
similar foreign and state laws. The nature of our operations, the extensive uses
of our existing and former facilities, and the operations of prior owners and
operators expose us to the risk of liabilities or claims concerning
environmental and health and safety laws and regulations. We are not aware of
any instance in which we have contravened federal, state, or local provisions
enacted for or relating to protection of the environment or in which we
otherwise may be subject under environmental laws to liability for environmental
conditions that could materially affect operations.
We
are dependent upon the availability of raw materials, and we may not be able to
receive favorable prices for, or continued supplies of, raw materials, which may
affect our ability to obtain enough supplies to conduct our
business.
We
require substantial amounts of raw materials, including copper powders, steel
and custom-fabricated cellulose sheet. Substantially all of the raw
materials we require are purchased from third party suppliers and are generally
in adequate supply. However, the availability and costs of raw materials may be
subject to change due to, among other things, new laws or regulations,
suppliers’ allocation to other purchasers, interruptions in production by
suppliers and changes in exchange rates and worldwide price and demand levels.
We are not currently party to any long-term supply agreements. Our inability to
obtain adequate supplies of raw materials for our products at favorable prices
could have a material adverse effect on our business, financial position or
results or operations by decreasing our profit margins and by hindering our
ability to deliver products to our customers on a timely basis. Recently, we
have experienced an increase in the costs of our copper and iron powders and
steel. Although we may determine that it is necessary to pass on the raw
material price increases to our customers, in certain circumstances, it may not
be possible or practicable for us to pass on these increases, and even if we are
able to pass on some or all of these increases, there may be a delay between
when we have to pay for the increases and when our customers pay us based on the
increased prices. If we are not able to reduce or eliminate the effect of these
cost increases through lowering other costs of production or successfully
implementing price increases to our customers, such raw material cost increases
could have a negative effect on our operating and financial
results.
11
We conduct business outside the United States which subjects us to the risks
inherent in international operations. Risks inherent in international operations
include the following:
Our international net sales represented $112.2 million, or 41.6% of our
consolidated net sales, for the year ended December 31, 2008 compared to $84.2
million, or 39.0% of our consolidated net sales for the year ended December 31,
2007.
We
are dependent on a small number of customers for a large portion of our
sales.
In 2008,
our top five customers made up approximately 43.9% of our total net
sales. Our largest customer, Caterpillar, accounted for approximately
19.1% of our total net sales in 2008. While we sell multiple product
applications to each of our top five customers, the loss of any of those
customers or significant changes in prices or other terms with any of those
customers could adversely affect our business, results of operations and
financial position. Additionally, business layoffs, downsizing,
industry slowdowns and other similar factors that affect our customers may
adversely impact our business and financial condition.
Our performance depends on our ability to retain and motivate officers and key
employees. The loss of any of our executive officers or other key employees
could materially and adversely affect our financial position, results of
operations and prospects. We have employment agreements with Ronald E. Weinberg,
Chairman of the Board and Chief Executive Officer, B. Christopher Disantis,
President and Chief Operating Officer and Joseph J. Levanduski, Vice President -
Chief Financial Officer. Hawk maintains a “key person” life insurance policy on
the life of Mr. Weinberg in the face amount of
$1.0 million.
Our future success also depends on identifying, attracting, hiring, training,
retaining and motivating other highly skilled technical, managerial and
marketing personnel. Competition for these employees is intense, and we may be
unable to successfully attract, integrate or retain sufficiently qualified
personnel.
Ronald E. Weinberg, Chairman of the Board and Chief Executive Officer,
Norman C. Harbert, Chairman Emeritus and Founder, and Byron S. Krantz, Secretary
and Director, beneficially own 45%, 45% and 10%, respectively, of the
outstanding shares of our Series D preferred stock as well as 14%, 13% and
3%, respectively, of our Class A common stock. The holders of our Series D
preferred stock are entitled to elect a majority of the members of our Board of
Directors. Accordingly, if any two of these shareholders vote their shares of
Series D preferred stock in the same manner, they will have sufficient
voting power (without the consent of our holders of Class A common stock)
to elect a majority of the Board of Directors and to thereby control and direct
the policies of the Board of Directors.
Our
defined benefit plans have significant deficits that could grow in the future
and cause us to incur additional costs.
We have
defined benefit pension plans for certain of our employees in the United States
and Canada. At December 31, 2008, our defined benefit pension plans had an
aggregate deficit (the excess of projected benefit obligations over the fair
value of plan assets) of approximately $11.3 million. In the future,
our pension deficits may increase or decrease depending on changes in the levels
of interest rates, pension plan performance and other factors. If we are forced
or elect to make up all or a portion of the deficit for unfunded benefit plans,
our profits could be materially and adversely affected.
12
None.
Hawk’s
world headquarters is located in Cleveland, Ohio. We maintain manufacturing,
research and development, sourcing, sales and administrative facilities at 11
locations in 7 countries.
Our
manufacturing and research and development operations are conducted through the
following facilities, all of which are owned by us except as noted
below:
__________
We
believe that substantially all of our property and equipment is maintained in
good condition, adequately insured and suitable for its present and intended
use.
We are
involved in lawsuits that have arisen in the ordinary course of our business. We
are contesting each of these lawsuits vigorously and believe we have defenses to
the allegations that have been made.
13
In our
opinion, the outcome of these legal actions will not have a material adverse
effect on our financial position, cash flows or results of operations, except as
described above.
No
matters were submitted to a vote of security holders during the fourth quarter
of 2008.
PART
II
Our Class
A common stock has traded publicly under the symbol “HWK” since May 12,
1998. Prior to October 1, 2008, our stock was traded on the American
Stock Exchange (AMEX). NYSE Euronext acquired the AMEX on October 1,
2008. Post merger, the AMEX equities business has been re-branded
NYSE Alternext US LLC (NYSE Alternext). Our common stock is now
traded on the NYSE Alternext. The following table sets forth, for the
fiscal periods indicated, the high and low closing prices of our common
stock.
Quarterly
Stock Prices
The
closing sale price for our common stock on December 31, 2008 was
$16.60.
14
Issuer
Purchases of Equity Securities
Shareholders
of record as of March 2, 2009 numbered 74. We estimate that an additional 1,100
shareholders own stock in their accounts at brokerage firms and other financial
institutions.
We have
never declared or paid, and do not intend to declare or pay, any cash dividends
on Class A common stock for the foreseeable future. We intend to
retain earnings for the future operation and expansion of our business. If we
were to pay dividends, we are limited to $2.0 million in dividend payments per
annum, under the terms of our bank facility. In addition, under our
bank facility, we may pay dividends only as long as there is no event of default
and we have availability under our bank facility in excess of $10.0
million. As of December 31, 2008, we had $18.3 million of
availability under our bank facility.
Performance
Graph
The
following graph compares the cumulative return on our Class A common stock with
the cumulative total return of the Russell 2000 Index and the S&P Industry
Group Index - Industrial Machinery. Cumulative total return for each of
the periods shown in the Performance Graph is calculated from the last sale
price of our Class A common stock at the end of the period and assumes an
initial investment of $100 on December 31, 2003 and the reinvestment of any
dividends.
 15
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.
16
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.
17
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:
18
19
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.
20
The
following table summarizes our results of operations for the year ended December
31, 2008 and 2007:
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.
We
experienced sales increases in all 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 28.3% in 2008,
compared to 2007, as a result of strong global market conditions through the
first 10 months of 2008. Sales in the agriculture sector were up
38.0% in 2008, compared to 2007, as a result of strong market conditions in
North and South America during the first half of 2008. Our rate of
increase in this market slowed significantly during the fourth quarter of 2008,
especially in our European market. Our aircraft and defense markets
were up 26.4% in 2008 compared to 2007, due to strong demand, especially in our
defense market. We experienced aircraft volume declines during the
last quarter of 2008 as airlines reduced schedules to reflect reduced global
passenger traffic. Sales to our heavy truck market increased
6.8% during the year ended December 31, 2008 compared to the year ended December
31, 2007, as the impact of the 2007 emission standards change negatively
impacted our 2007 sales. We also experienced reduced volumes in this
market in the last half of 2008. 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 $28.9 million in 2008 compared to $26.1 million in 2007, an
increase of 10.7%.
Net sales
from our foreign facilities represented 41.6% of our total net sales in 2008
compared to 39.0% for 2007. Sales at our Italian operation, on a
local currency basis, increased 23.3% in 2008, compared to 2007, and sales at
our Chinese operation, on a local currency basis, increased 33.3% during the
same period despite the economic downturn in the last quarter of
2008.
Cost of
Sales. Cost of sales was $192.5 million during 2008, an
increase of $28.0 million, or 17.0%, compared to cost of sales of $164.5 million
in 2007. The primary driver of the increase in our cost of sales in
2008 was increased production volumes through our manufacturing
facilities. Production volume increases represented approximately 9.0
percentage points of the total cost of sales increase of
17.0%. Increased manufacturing costs, including commodity costs,
represented 4.8 percentage points and the effect of foreign currency exchange
rates accounted for 3.3 percentage points. As a percent of sales, our
cost of sales represented 71.4% of our net sales in 2008 compared to 76.2% of
net sales in 2007. The improvement in our cost of sales percentage
was driven by increased volumes 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.
Gross
Profit. Gross profit was $77.1 million, an increase of $25.7
million, or 50.0%, during 2008, compared to gross profit of $51.4 million for
2007. Our gross profit margin improved to 28.6% of our net sales in
2008 compared to 23.8% of our net sales in 2007. 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 increased $6.1 million, or 19.6%, to $37.3 million in 2008
from $31.2 million during 2007. As a percentage of net sales,
ST&A was 13.8% in 2008 compared to 14.5% in 2007. The increase in ST&A
expenses in 2008 compared to 2007 resulted primarily from an increase in
incentive compensation of approximately 8.8 percentage points and increased
salary and benefit costs of approximately 3.6 percentage points of the total
ST&A increase of 19.6% to support the higher levels of business activity and
increased profitability during the year. Increased legal expense,
excluding expenses associated with the previously disclosed SEC and DOJ
investigations represented approximately 2.0 percentage points of the total
19.6% increase. During 2008 we incurred $0.6 million in legal
expenses net of insurance reimbursement, related to the SEC and DOJ
investigations, compared to $1.1 million in 2007. Sales and marketing
expense increases, including advertising and catalog expense, represent
approximately 2.0 percentage points of the total 19.6%
increase. Additionally, we spent $5.4 million, or 2.0%, of our net
sales on product research and development in 2008, compared to $4.6 million, or
2.1%, of our net sales for 2007.
Income from
Operations. As a result of the factors discussed above, income
from operations was $39.2 million in 2008, an increase of $19.7 million,
or 101.0%, compared to $19.5 million during 2007. Income from
operations as a percentage of net sales increased to 14.5% in 2008
from 9.0% in 2007. The effect of foreign currency exchange rates
accounted for 14.5 percentage points of our total operating income increase of
101.0% during 2008.
21
Interest
Expense. Interest expense decreased $1.3 million during 2008
to $8.1 million from $9.4 million in 2007, as a result of the redemption of
$22.9 million our senior notes in August 2007 resulting in lower average debt
levels outstanding during 2008 compared to 2007. Included as a
component of Interest expense in our Consolidated Statements of Operations is
the amortization of deferred financing costs. Amortization of
deferred financing costs was $0.4 million in both 2008 and 2007.
Interest
Income. We invested our excess cash in various
short-term interest bearing investments. Interest income was $2.1
million in 2008 compared to $3.8 million during 2007. Effective
interest rates on our investments decreased significantly in 2008, compared to
rates available to us in 2007.
Other Income (Expense),
Net. Other income was $1.5 million during 2008, an increase of
$1.8 million compared to expense of $0.3 million reported in
2007. During 2008, we reported income of $1.3 million from a
cancellation fee derived from discontinuing a specific portion of a joint
development project. In 2007, as a result of partial senior note
redemption, we recorded an expense of $0.6 million related to the write-off of
deferred financing costs. There was no comparable expense in
2008. We reported foreign currency exchange transaction gains of $0.5
million during 2008 compared to foreign currency exchange transaction gains of
$0.3 million in 2007.
Income Taxes. We
recorded a tax provision for our continuing operations of $12.1 million in 2008,
compared to $5.8 million in 2007. Our effective rate decreased to
35.0% in 2008 compared to 42.8% in 2007, primarily as a result of higher
domestic earnings and lower statutory tax rates in our Italian and Canadian
jurisdictions. This decrease was partially offset by the impact of
non-deductible expenses on our U.S. based taxes. Our worldwide provision
for income taxes is based on annual tax rates for the year applied to all of our
sources of income. An analysis of changes in our income taxes and our
effective tax rate is contained in Note 13 “Income Taxes” in the accompanying
audited Consolidated Financial Statements of this Form 10-K.
Income from continuing operations,
After income taxes. We reported income from continuing operations, after
income taxes of $22.6 million in 2008, or $2.40 per diluted share, an increase
of $14.8 million, or 189.7% compared to income from continuing operations, after
income taxes of $7.8 million, or $0.82 per diluted share, during
2007.
Discontinued Operations,
Net of Tax. During the first quarter of
2008, we committed to a plan to divest our performance racing segment which
operated two facilities in the United States. In May 2008, we sold
our North Carolina facility and in December 2008, we sold our Illinois
facility. In February 2007, we sold our precision components
segment. As of December 31, 2008, there were no remaining assets or
liabilities classified as discontinued operations in our Consolidated Balance
Sheet. The operating activity of the performance racing segment and
precision components segment is reflected in the following summary of results of
our discontinued operations for the years ended December 31, 2008 and
2007. An analysis of discontinued operations is contained in Note 4
“Discontinued Operations” in the accompanying Consolidated
Financial Statements of this Form 10-K.
Net Income. We
reported net income of $20.8 million in 2008, or $2.21 per diluted share, an
increase of $3.5 million, or 20.2% compared to net income of $17.3 million, or
$1.83 per diluted share, during 2007.
Year
Ended December 31, 2007 Compared to Year Ended December 31, 2006
Our
continuing operation is organized into one strategic segment, friction
products. In the fourth quarter of 2006 we committed to selling our
precision components segment which was sold in February 2007. The
remaining assets of our motor segment were sold in the fourth quarter of
2006. As a result, we have classified the precision components and
motor segments as discontinued operations in our financial
results.
22
The
following table summarizes our results of operations for the year ended December
31, 2007 and 2006, respectively:
Net Sales. Our
consolidated net sales in 2007 were $215.9 million, an increase of $16.0
million, or 8.0% from 2006. We experienced sales increases in our
friction products segment, primarily as a result of strong economic conditions
in most of our end markets, continued pricing actions, new product introductions
and favorable foreign currency exchange rates during the period. Net
sales from our foreign facilities represented 39.0% of our total net sales in
2007 compared to 32.3% for 2006. The effect of foreign currency
exchange rates accounted for 3.3% of our total net sales increase of 8.0% during
2007.
As a
result of general economic strength, customer price increases, new business
awards, and the strength of the Euro, we experienced sales increases in most of
our major markets, including construction and mining, aircraft and defense,
agriculture, specialty friction, and performance automotive. Our
sales to the construction and mining market, our largest, were up 15.1% in 2007
compared to 2006 as a result of strong global market
conditions. Sales in the agriculture sector were up 18.2% in 2007
compared to 2006 as a result of strong market conditions in North and South
America. Additionally, we experienced increases in our aircraft and
defense, specialty friction and performance automotive markets in
2007. Sales to our heavy truck market declined 18.1% during
2007 compared to 2006 due to the implementation of the new vehicle emission
control standards at the beginning of 2006. The friction products
segment continued to experience strong sales growth from our operations in Italy
and China and favorable foreign currency exchange rates during 2007 compared to
the prior year. Sales at our Italian operation, on a local currency basis, were
up 19.8% in 2007 compared to 2006 while sales at our Chinese operation, on a
local currency basis, were up 34.4% during the same period. During
2007, 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 $23.9 million in 2007 compared to $24.1 million in
2006, a decrease of 1.4% primarily due to reduced sales to the heavy truck
aftermarket.
Gross Profit.Gross profit
increased $6.5 million to $51.4 million during 2007, a 14.5% increase compared
to gross profit of $44.9 million for 2006. This increase was due to
margin improvement from volume related absorption of fixed overhead, continued
pricing actions and operating improvements at our domestic friction products
facilities, particularly Tulsa. Our gross profit margin increased to
23.8% of our net sales in the 2007 compared to 22.5% of our net sales in
2006.
Selling, Technical and
Administrative Expenses. Selling, technical and administrative
(ST&A) expenses increased $2.2 million, or 7.6%, to $31.2 million in 2007
from $29.0 million during 2006. As a percentage of net sales, ST&A was flat
at 14.5% in 2007 and 2006. The increase in ST&A expenses resulted primarily
from an increase in incentive compensation expense during 2007 and by the
incurrence of $1.1 million of legal expenses net of insurance reimbursement
related to the previously announced SEC and DOJ
investigations. Additionally, we spent $4.6 million, or 2.1%, of our
net sales on product research and development in 2007, compared to $4.0 million,
or 2.0%, of our net sales for 2006. The increase in ST&A expense
was partially offset by lower employee salary and employee benefit expense
during 2007 compared to 2006.
Income from
Operations. Income from operations was $19.5 million in 2007,
an increase of $4.1 million, or 26.6%, compared to $15.4 million
during 2006. Income from operations as a percentage of net sales
increased to 9.0% in 2007 from 7.7% in 2006. The increase was
primarily the result of margin improvements from volume related absorption of
fixed overhead, pricing actions and operational improvements at our domestic
facilities, including our facility in Tulsa. This increase was
partially offset by increased legal costs and incentive compensation costs in
2007, compared to 2006.
Interest
Expense. Interest expense decreased $1.8 million during 2007
to $9.4 million from $11.2 million in 2006. We had minimal borrowings
under our bank facility during the first quarter of 2007, and we redeemed $22.9
million of our senior notes in August 2007. In addition, our Chinese
facility repaid $1.0 million of debt it had with a local bank during the second
quarter of 2007. Included as a component of Interest expense in our
Consolidated Statements of Operations is the amortization of deferred financing
costs. Amortization of deferred financing costs was $0.4 million in
2007 and 2006.
Interest
Income. We invested the net cash proceeds from the sale of our
precision components segment in various interest bearing
investments. As a result of these investments, as well as investments
made from additional cash generated from operations, interest income was $3.8
million during 2007. There was no comparable interest income in
2006.
23
Other (Expense) Income,
Net. As a result of the redemption of $22.9 million of our
senior notes in August 2007, we recorded an expense of $0.6 million related to
the write-off of deferred financing costs during 2007. There was no
related write-off of deferred financing expense in the comparable period of
2006. In addition, we reported foreign exchange currency transaction
income of $0.3 million during 2007.
Income Taxes. We
recorded a tax provision for our continuing operations of $5.8 million
for 2007, compared to $2.8 million in 2006. Our effective rate of
42.8% differs from the U.S. statutory rate primarily due to lower rates at our
foreign subsidiaries and the impact of non-deductible expenses on our U.S.
taxes. Our worldwide
provision for income taxes is based on annual tax rates for the year applied to
all of our sources of income. An analysis of changes in our income taxes and our
effective tax rate is contained in Note 13
“Income Taxes” in the accompanying audited Consolidated Financial
Statements of this Form 10-K.
Discontinued Operations, Net of Tax.
In 2006, we committed to a plan to divest our precision components
segment operations. On February 2, 2007, we sold the precision
components segment. Additionally, in the fourth quarter of 2003, we
committed to a plan to divest our motor segment operations. As of
December 31, 2006, all operational activities of the motor segment
ceased. However, during the fourth quarter of 2007 we received an
audit assessment from the Mexican tax authority related to our Monterrey, Mexico
discontinued operation which we are vigorously contesting. Income
from discontinued operations, after income taxes was impacted by approximately
$1.0 million for the year ended December 31, 2007 as a result of this
assessment. We have accounted for both of these business segments in
our Consolidated Statement of Operations on the line item Income from
discontinued operations, after income taxes. The activity of both
segments and the gain on the sale of the precision components segment are
reflected in the following summary of results of our discontinued operations for
the years ended December 31, 2007 and 2006. An analysis of
discontinued operations is contained in Note 3
“Discontinued Operations” in the accompanying Consolidated Financial
Statements of this Form 10-K.
Net Income. We
reported net income of $17.3 million in 2007, an increase of $14.3 million, or
476.7% compared to net income of $3.0 million in 2006.
Liquidity
and Capital Resources
Our
primary financing requirements are:
Historically,
our primary source of funds for conducting our business activities and servicing
our indebtedness has been cash generated from operations and borrowings under
our bank facility and our senior notes. Currently, we also have
available to us the proceeds from the sale of the precision components and
performance racing segments. The following selected measures of liquidity and
capital resources outline various metrics that are reviewed by our management
and are provided to our shareholders to enhance the understanding of our
business.
24
Selected
Measures of Liquidity and Capital Resources from Continuing
Operations
Cash and
cash equivalents increased $40.5 million to $62.5 million as of December 31,
2008, from $22.0 million at December 31, 2007. This compares to a
$15.8 million increase in cash and cash equivalents during
2007. Short-term investments decreased $28.2 million to $30.8 million
as of December 31, 2008, from $59.0 million at December 31, 2007. We
did not have any short-term investments at December 31, 2006. The net
increase in cash and cash equivalents and short-term investments of $12.3
million during 2008 was primarily driven by our cash provided by operational
activities. The net increase during 2007 resulted primarily from the
receipt of the cash purchase price from the sale of our precision components
segment, which was invested in cash equivalents and short-term investments, and
cash generated by our operational activities.
In
assessing liquidity, we review working capital measurements to identify areas
for improvement. At December 31, 2008, our working capital was $126.0
million, an increase of $12.7 million from December 31, 2007. This
compares to a $2.5 million decrease in working capital during
2007. The increase in working capital in 2008 was primarily due
to the $1.3 million increase in accounts receivable that resulted from increased
sales in 2008, the $4.7 million increase in inventory to support our higher
levels of sales, and the $12.3 million increase in the sum of cash and cash
equivalents and short-term investments. Current liabilities remained
relatively flat during 2008, declining by $0.3 million in 2008. In
addition, our accounts receivable and inventory levels are reviewed through the
computation of days sales outstanding and inventory turnover. Days
sales in accounts receivable decreased to 52.0 days at December 31, 2008 from
63.0 days at December 31, 2007. Days sales in inventory improved to
78.0 days at December 31, 2008 from 81 days at December 31, 2007. The
improvements are mainly attributable to a strong focus on accounts receivable
collection and on controlling levels of inventory to meet current customer
demands.
At
December 31, 2008, our current ratio was 3.4, an increase from the current ratio
of 3.1 at December 31, 2007 and 3.0 at December 31, 2006. The
improvement in the current ratio was due primarily to increases in cash and cash
equivalents, short-term investments, accounts receivable and inventory
that more than offset increases in accounts payable, accrued
taxes and other current accruals.
Net debt
as a percentage of capitalization is negative at December 31, 2008 because our
cash, cash equivalents and short-term investments were $6.2 million higher than
total debt. This compares to total net debt of $6.2 million at
December 31, 2007 and $105.0 million at December 31, 2006. The
overall increase in our cash and equivalents and short-term investment balances
and decrease in our debt levels in 2007 and 2008 is due primarily to (1) the
sale of our precision components segment in the first quarter of 2007 and our
reinvestment of the cash proceeds into cash equivalents and short-term
investments, (2) the repayment of $22.9 million of senior notes related to our
tender offer that was completed during the third quarter of 2007, and
(3) positive cash generated from continuing operations in both 2008
and 2007.
Cash
Flow
The
following table summarizes the major components of cash flow:
25
Cash
provided by our operating activities from continuing operations was $23.6
million for the year ended December 31, 2008, compared to cash provided by
operations of $20.4 million for the same period in 2007. This
compares to cash used by our operating activities of $1.0 million for the year
ended December 31, 2006. Our income from continuing operations, after
income taxes increased to $22.6 million in the year ended December 31, 2008
compared to $7.8 million in the same period in 2007 and $1.6 million in
2006. However, operating cash flows have been impacted by the use of
$2.3 million and $5.3 million, respectively, of cash related to increases in
accounts receivable and inventory in the 2008 period resulting from increased
sales volume. In addition, fluctuations in our accounts payable
resulted in a use of cash of $0.5 million in the 2008 period as compared to a
source of cash of $7.3 million in the 2007 period.
Our
investing activities from continuing operations provided $16.7 million for the
period ended December 31, 2008, compared to cash provided by investing
activities of $29.7 million for the period ended December 31,
2007. During 2008, we received total cash proceeds of $2.7 million
from the sale of our performance racing facilities in North Carolina and
Illinois, which were reported as discontinued operations as of March 31,
2008. During 2007, we received cash proceeds from the sale of our
precision components segment of $93.4 million. In the 2006 period, we
received net cash proceeds from the sale of our Brook Park, Ohio facility of
$1.6 million. Net short-term investment purchases and sales during
the year ended December 31, 2008 generated $29.2 million of cash compared to the
use of $56.1 million in the prior year.
We used
$15.2 million, $7.6 million and $7.9 million for the purchase of property, plant
and equipment in the periods ended December 31, 2008, 2007 and 2006,
respectively. The principal sources of financing for these capital
expenditures were existing cash and internally generated funds.
Cash used
in financing activities was $0.7 million for the period ended December 31, 2008,
compared to cash used of $26.6 million for the period ended December 31,
2007. We used $2.3 million and $3.7 million to repurchase shares of
our common stock pursuant to our stock repurchase programs in the periods ended
December 31, 2008 and 2007, respectively. In addition, we received
$0.7 million in government grants during 2008. In the 2007 period, we
repaid $35.0 million of outstanding debt, including the repayment of $1.0
million of local debt of our Chinese facility and $22.9 million of senior notes
related to our tender offer completed during the third quarter of
2007. We had no outstanding borrowings under our bank facility at
December 31, 2008, 2007 or 2006. The change in 2006 financing
activities primarily resulted from reduced net borrowings under our bank
facility during the third and fourth quarters of 2006.
We
believe that cash, cash equivalents, interest on and proceeds from short-term
investments, cash flow from operating activities and borrowing availability
under our bank facilities will be sufficient to satisfy our working capital,
capital expenditures, debt requirements and to finance our internal growth needs
for the next twelve months.
Debt
The
following table summarizes the components of our indebtedness:
Senior
Notes
On
November 1, 2004, we completed a public offering of $110.0 million aggregate
principal amount of our senior notes. The senior notes are senior unsecured
obligations, rank senior in right of payment to all of Hawk’s existing and
future subordinated debt and rank equally in right of payment with all of Hawk’s
existing and future senior debt, including the bank facility, which is described
in more detail below. In February 2007, we completed the sale of our
precision components segment. Pursuant to the terms of the indenture
relating to our senior notes, we had until July 31, 2007, to apply the net
proceeds of the sale to repay indebtedness, make open market purchases of the
senior notes, acquire property, plant and equipment, make an acquisition or
enter into any combination of any of the above. On July 11, 2007, we
made an offer to purchase, on a pro rata basis, $84.9 million of our senior
notes, at a price equal to 100% of the principal amount plus accrued
interest. The offer was accepted by our senior note holders holding
$22.9 million of senior notes. We invested the remaining net
cash proceeds in liquid investments and marketable securities and can use these
remaining proceeds at our discretion, provided we comply with the terms of our
senior notes and bank facility.
Interest
is payable on the senior notes each January 1 and July 1.
The
senior notes are unconditionally guaranteed on a senior unsecured basis by all
of our existing and future domestic restricted subsidiaries (the Guarantors).
The guarantees rank senior in right of payment to all of the existing and future
subordinated debt of the Guarantors and equally in right of payment with all
existing and future senior debt of the Guarantors, including the bank facility.
The senior notes and the guarantees are effectively subordinated to all of
Hawk’s and our Guarantors’ secured debt, including the bank facility, to the
extent of the value of the assets securing that debt.
26
On or
after November 1, 2009, we may, at our option, redeem some or all of the senior
notes at the following redemption prices, plus accrued and unpaid interest and
additional interest, if any, to the date of redemption:
Upon a
change of control as defined in the indenture, dated November 1, 2004, among
Hawk, the Guarantors and HSBC Bank USA, National Association, as trustee, each
holder of the senior notes will have the right to require us to repurchase all
or any part of such holder’s senior notes at a purchase price equal to 101% of
the aggregate principal amount thereof, plus accrued and unpaid interest and
additional interest, if any, to the date of purchase.
The
senior notes are governed by the indenture. The indenture also contains certain
covenants, subject to a number of important limitations and exceptions that
limit our ability to:
The
indenture considers non-compliance with the limitations set forth above events
of default. The indenture also considers non-payment of interest and principal
amounts on the senior notes and certain payment defaults with respect to other
debt in excess of $5.0 million to be events of default. In the event of a
default, the principal and interest could be accelerated upon written notice by
more than 25% or more of the holders of the senior notes.
The
indenture permits us to incur additional debt without limitation, provided that
we continue to meet a cash flow ratio greater than 2.0 to 1.0 for the most
recently ended four quarters. We may pay cash dividends on our Class A common
stock under the indenture provided:
As of
December 31, 2008, we were in compliance with the provisions of our senior notes
and met the cash flow ratio requirement that would permit us to incur additional
debt.
27
Bank
Facility
Our bank
facility, which is available for general corporate purposes, has a maximum
commitment of $30.0 million, including a letter of credit sub-facility of up to
$5.0 million. The bank facility matures on November 1, 2009, subject
to extension at our request on an annual basis thereafter, with the consent of
the lender. The interest rates on the bank facility range from 150 to 250 basis
points over the London Interbank Offered Rates, or alternatively, 0 basis points
over the prime rate, and the commitment fee is 25 basis points on the unused
portion of the bank facility. At December 31, 2008, we had nothing outstanding
under the bank facility and $0.9 million of letters of credit outstanding under
the letter of credit sub-facility. At December 31, 2008, we had $18.3
million available to borrow under the bank facility based on our eligible
collateral less the letters of credit outstanding at that date. To
ensure continued borrowing capabilities, we are currently in negotiations with
our current lender and others to negotiate an extension of the current credit
facility or a new credit facility to go beyond the November 1, 2009 maturity
date.
The bank
facility is collateralized by a security interest in our cash, accounts
receivable, inventory and certain intangible assets. We also pledged the stock
of our guarantor subsidiaries and 65% of the stock of certain of our foreign
subsidiaries as collateral. The restrictive terms of the bank facility require
that we maintain a minimum amount of shareholders’ equity as determined by
reference to an adjusted shareholders’ equity at September 30, 2004 plus net
income earned by us after such date. The bank facility also requires that we
maintain an earnings before interest, taxes, depreciation and amortization to
interest expense ratio of at least 1.0 to 1.0, although the lender will test
this ratio only if our borrowing availability falls below $10.0
million. This test was not required to be performed as of December
31, 2008, as a result of our excess borrowing availability. Under the bank
facility, we may pay cash dividends on our Class A common stock in an amount up
to $2.0 million per year under certain circumstances.
As of
December 31, 2008, we were in compliance with the provisions of our bank
facility.
Other
Debt
We have
entered into a short-term, variable-rate, debt agreement of up to $3.2 million
(2.3 million Euro) with a local Italian financial institution at our facility in
Italy. There were no borrowings under this credit facility at
December 31, 2008. As of December 31, 2008, we were in compliance
with the terms of this debt obligation.
Market Risk
Disclosures. The following discussion about our market risk
disclosures involves forward-looking statements. Actual results could
differ materially from those projected in the forward-looking
statements. We are exposed to market risk related to changes in
interest rates and foreign currency exchange rates. In seeking to
minimize the risks and costs associated with market risk, we manage our
exposures to interest rates and foreign currency exchange rates through our
regular operating and financial activities and through foreign currency hedge
contracts. We had no foreign currency hedge contracts outstanding as
of December 31, 2008. We do not use derivative financial instruments
for speculative or trading purposes.
Interest Rate
Sensitivity. At December 31, 2008, none of our total
outstanding debt bore interest at a variable rate. Typically, our
primary interest rate risk exposure results from floating rate debt and
investment instruments. Our cash is primarily invested in bank
deposits, money market funds and other marketable debt securities, including
commercial paper and U.S. agency debt. The assets held
by our non-qualified deferred compensation plan are invested in equity
securities. The primary objective of our investments is to
preserve principal while maximizing yields without significantly increasing
risk. In undertaking this strategy, we are exposed to financial
market risks including default risk, cash balances included in bank deposits
exceeding insurance limits set by the Federal Deposit Insurance Corporation,
changes in marketable debt prices, equity security prices and interest
rates. Due to the short-term nature of our investments, a 1% change
in market interest rates would have an impact of approximately $0.9 million on
an annual basis as of December 31, 2008.
The
interest rates on our long-term debt reflect market rates and therefore, the
carrying value of long-term debt approximates fair value. An analysis
of our obligations is further discussed in Note 7 “Financing
Arrangements” and Note 12
“Lease Obligations” in the
accompanying audited Consolidated Financial Statements of this Form
10-K.
Inflation/Deflation Risk. We manage our inflation
risks by ongoing review of product selling prices and production
costs. Overall, the impact of inflation has not been significant to
us because of the relatively low rates of inflation experienced by
us during the last few years. During the second and third quarters of
2008, we faced inflationary and other pricing pressures with respect to steel,
copper and fuel, which have been partially mitigated by pricing adjustments to
our customers, though we do usually experience delays between our raw material
cost increases and sales price increases. The
ability to pass on these expected price increases to our customers is dependent
on market conditions. It is difficult to predict the impact that
possible future raw material cost decreases might have on our
profitability. The effect of deflation in raw material costs would
depend on the extent to which we had to lower selling prices of our products to
respond to sales price competition in the market. Consequently, it is
difficult for us to accurately predict the impact that inflation or deflation
might have on our operations. Based on current information, we expect
that neither inflation nor deflation will have a material impact on our
operations during the next twelve months.
28
Foreign Currency Exchange
Risk. 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. 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.
Benefit Plan
Valuations. 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. Overall, we expect
that the net effects of actual plan asset returns due to the lower value of plan
assets will lead to significantly higher pension expense in 2009 compared to
2008. We expect that our pension expense in 2009 will be
approximately $1.7 million compared to $0.2 million in 2008.
Contractual
Obligations. The following table presents our total
contractual obligations and other commercial commitments as of December 31,
2008:
____________
29
AUDITED
CONSOLIDATED FINANCIAL STATEMENTS
Hawk
Corporation
December
31, 2008, 2007 and 2006
Audited
Consolidated Financial Statements
30
REPORT
OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
Shareholders
and Board of Directors
Hawk
Corporation
We have
audited the accompanying consolidated balance sheets of Hawk Corporation as of
December 31, 2008 and 2007, and the related consolidated statements of
operations, shareholders’ equity, and cash flows for each of the three years in
the period ended December 31, 2008. Our audits also included the
financial statement schedule listed in the Index at Item 15(a). These
financial statements and schedule are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Hawk
Corporation at December 31, 2008 and 2007, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2008, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
As
explained in Notes 2, 10, 11, and 13 to the consolidated financial statements,
on January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123(R) Share Based Payment and at December 31, 2006, the Company
adopted Statement of Financial Accounting Standards No. 158, Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans, and on
January 1, 2007, the Company adopted FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Hawk Corporation’s internal control over
financial reporting as of December 31, 2008, based on criteria established in
Internal Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated March 9, 2009
expressed an unqualified opinion thereon.
/s/Ernst
& Young LLP
Cleveland,
Ohio
March 9,
2009
31
REPORT
OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
Shareholders
and Board of Directors
Hawk
Corporation
We have
audited Hawk Corporation’s internal control over financial reporting as
of December 31, 2008, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (the COSO criteria). Hawk Corporation’s management is
responsible for maintaining effective internal control over financial reporting,
and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Management’s Report on Internal Control
Over Financial Reporting (Item 9A). Our responsibility is to express an opinion
on the company’s internal control over financial reporting based on our
audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our
opinion, Hawk Corporation maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2008, based on the COSO criteri.
We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Hawk
Corporation as of December 31, 2008 and 2007, and the related consolidated
statements of operations, shareholders’ equity, and cash flows for each of the
three years in the period ended December 31, 2008 and our report dated March 9,
2009 expressed an unqualified opinion thereon.
/s/Ernst
& Young LLP
Cleveland,
Ohio
March 9,
2009
32
HAWK
CORPORATION
CONSOLIDATED
BALANCE SHEETS
(In
Thousands, except share data)
33
HAWK
CORPORATION
CONSOLIDATED
BALANCE SHEETS
(In
Thousands, except share data)
See
notes to consolidated financial statements.
34
HAWK
CORPORATION
CONSOLIDATED
STATEMENTS OF OPERATIONS
(In
Thousands, except per share data)
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