10-K 1 hawkannualreportform10_k.htm HAWK CORPORATION - ANNUAL REPORT FORM 10-K Hawk Corporation - Annual Report Form 10-K

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, 2005
Commission File No. 001-13797
Hawk Corporation
(Exact name of registrant as specified in its charter)

Delaware
34-1608156
(State of incorporation)
(I.R.S. Employer Identification No.)
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:
Title of Each Class
Name of Exchange on Which Registered
Class A Common Stock, par value $.01
American Stock Exchange
8 3/4% Senior Notes due 2014
American Stock Exchange

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. See definition of “accelerated filer and large accelerated filer” in rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer £ Accelerated Filer £ Non-accelerated Filer R

Indicate by check mark whether the registrant is a shell company as defined in Rule12b-2 of the Act: Shell Company YES £ NO R 

The aggregate market value of the voting common equity held by non-affiliates as of June 30, 2005 was $70,222,862 (based on the closing price as quoted on the American Stock Exchange on that date).

As of March 23, 2006, the Registrant had 8,989,427 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 6,130,008 shares of Class A Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the 2006 Proxy Statement of Hawk Corporation 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, 2005.
 

PART I

ITEM 1. BUSINESS
 
Our Company
 
Hawk Corporation is a leading supplier of friction products and powder metal precision components for industrial, agricultural, performance and aerospace 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 precision and metal injection molded components are used in industrial, consumer and other applications, such as pumps, motors and transmissions, lawn and garden equipment, appliances, small hand tools, trucks and telecommunications equipment. Our performance racing products include premium clutch, transmissions and driveline systems. Our friction products and precision components 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”.

Today, we benefit from a deep and diversified customer base, with approximately 2,500 total customers, none of which accounted for more than 10.3% of our net sales for the year ended December 31, 2005. We are a preferred supplier to many of the world’s largest and most well-known brand name original equipment manufacturers, including Caterpillar, Aircraft Braking Systems, Goodrich, Eaton, Deere, CNH, Hydro-Gear, Sauer-Danfoss, Parker Hannifin, Electrolux and Haldex. 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 2005. We do not target the cyclical consumer automotive sector. Consequently, less than 9% of our net sales in any of the last five years were to the consumer automotive market, and this percentage declined to approximately 5% of our net sales for the year ended December 31, 2005. For the year ended December 31, 2005, we generated record net sales of $265.4 million and income from operations of $9.3 million, representing an operating margin of 3.5%. We define operating margin as our income from operations as a percentage of our net sales. Our margins in 2005 were negatively impacted by costs related to a move of a friction products manufacturing facility from Ohio to Oklahoma.

Through our subsidiaries, we operate in three reportable segments: friction products, precision components and performance racing.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
2

2005 Sales by Segment
• Friction 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 aerospace applications. Our friction products segment manufactures parts and components made from proprietary formulations of composite materials, primarily consisting of metal powders and synthetic and natural fibers. Friction products are used in brakes, clutches and transmissions to absorb vehicular energy and dissipate it through heat and normal mechanical wear. Our friction products include parts for brakes, clutches and transmissions used in construction and mining vehicles, agricultural vehicles, trucks, motorcycles and race cars, and brake parts for landing systems used in commercial and general aviation. We believe we are:

·  
 
a leading domestic and international supplier of friction products for construction and mining equipment, agricultural equipment and trucks,
 
·  
 
the leading North American independent supplier of friction materials for braking systems for new and existing series of many commercial aircraft models, including the Boeing 737 and 757 and the MD-80, and several regional jets including the Canadair regional jet series,
 
·  
 
the largest supplier of friction materials for the growing general aviation market, including numerous new and existing series of Gulfstream, Cessna, Lear and Beech aircraft, and
 
·  
 
a leading domestic supplier of friction products into performance and specialty markets such as motorcycles, race cars, performance automobiles, military Hummers, ATV’s and snowmobiles.
 
For the years ended December 31, 2005 and 2004, our friction products segment generated net sales of $167.0 million and $148.3 million, representing 62.9% and 61.5% of our total net sales, respectively and reported income from operations of $5.7 million and $13.1 million, representing 61.3% and 75.7%, of our total income from operations, respectively. The foreign operations of our friction products segment represented 32.9% of total friction segment net sales in 2005 compared to 32.5% in 2004.
 
• Precision Components 

We are a leading supplier of powder metal and metal injection molded precision components used in industrial, consumer and other applications, such as pumps, motors and transmissions, lawn and garden equipment, appliances, small hand tools and telecommunications equipment. We use composite metal alloys in powder form to manufacture high quality custom-engineered metal components. Our precision components segment serves four specific areas of the powder metal marketplace:
 
·  
 
tight tolerance fluid power components such as pump elements and gears,
 
·  
 
large powder metal components used primarily in construction equipment, agricultural equipment and trucks,
 
3
 
·  
 
high volume parts for the lawn and garden, appliance and other markets, and
 
·  
 
metal injection molded parts for a variety of industries, including small hand tools, medical and telecommunications.
 
For the years ended December 31, 2005 and 2004, our precision components segment generated net sales of $83.6 million and $78.6 million, representing 31.5% and 32.6% of our total net sales, respectively and reported income from operations of $4.1 million and $3.5 million, representing 44.1% of our total income from operations in 2005 and 20.2% of our total income from operations in 2004.

• Performance Racing 
 
We engineer, manufacture and market premium branded clutch, transmissions and driveline systems for the performance racing market. Through this segment, we supply parts for the National Association for Stock Car Auto Racing (NASCAR), the American LeMans Series (ALMS) and by weekend enthusiasts in the Sports Car Club of America (SCCA) racing clubs, as well as for other road racing and competition cars. For the years ended December 31, 2005 and 2004, our performance racing segment generated net sales of $14.8 million and $14.3 million, representing 5.6% and 5.9% of our total net sales, respectively and reported a loss from operations of $0.5 million and income from operations of $0.7 million, representing (5.4%) and 4.1% of our total (loss) income from operations, respectively.

Discontinued Operations

During the fourth quarter of 2003, we committed to a plan to sell our motor segment, with operations in Monterrey, Mexico and Alton, Illinois. This segment, which manufactures die-cast aluminum rotors for fractional and subfractional horsepower electric motors, 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 major lines of business.

In the fourth quarter of 2004, we sold certain fixed assets of our Alton, Illinois facility, which had been previously adjusted to their fair market value as of December 31, 2003. In addition, we sold the land and building of this facility, and recognized a $0.3 million ($0.2 million, net of tax) fair market value adjustment (loss) in the results of discontinued operations.

In addition, we continue to actively negotiate the sale of the Monterrey, Mexico facility and anticipate selling the remaining portion of the business during the first half of 2006.

We restated our results of operations to reclassify the net earnings, assets, and liabilities of the motor segment as discontinued operations for all periods presented in this report. Corporate expenses previously allocated to this segment have been reallocated to the remaining continuing operations, resulting in a restatement of operating profit by segment (see “Note 3 - Discontinued Operations” to the accompanying Consolidated Financial Statements of this Form 10-K).

Operating results from discontinued operations are summarized as follows:

 
  
2005
  
2004
  
2003
  
 
(dollars in millions)
Net sales
  
$
8.9
  
$
13.0
  
$
14.5
  
Income (loss) from operations, net of tax
  
$
0.0
  
$
(0.3
)
$
(5.0
)

Business Strategy

Our business strategy builds on our corporate strengths and includes the following principal elements:
 
 
 
 
 
 
 
4
 
·  
 
Continued Product Innovation. We believe that 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. We are committed to maintaining our technological advantages. As a result, we are focusing our research and development efforts on improving our existing products and developing materials and technologies for new applications for our existing end markets. For example, in our precision components segment, we have embarked on a strategic initiative by investing in advanced equipment that enables us to manufacture parts in higher densities and more complex shapes than our competitors. Across all of our business segments, we seek new product developments and production techniques that will enable us to develop new applications for our existing end markets. For the year ended December 31, 2005, we spent $6.5 million, or 2.5% of our net sales, on research and development which represents a 16.1% increase from 2004.
 
·  
 
Focus on High-Margin, Specialty Applications. We focus on markets that require sophisticated engineering and production techniques and in which we have achieved a significant market share. We seek to compete in markets requiring a high level of engineering expertise and technical capability, rather than in markets in which the primary competitive factor is product pricing. We believe margins for our products in these markets are higher than in other manufacturing markets that use standardized products and that this strategy will continue to provide market stability going forward. Our gross margins were 19.7% for the year ended December 31, 2005 and 23.4% for the year ended December 31, 2004. Our margins in 2005 were negatively impacted by costs related to the relocation of one of our friction products manufacturing facilities from Ohio to Oklahoma and production inefficiencies associated with the start-up of operations in Oklahoma.
 
 
 
 
 
 
Capitalize on Aftermarket Opportunities. We estimate that aftermarket sales of friction products have comprised approximately 40% of friction product sales in recent years. Our aftermarket sales enable us to reduce our exposure to adverse economic cycles. Sales of our friction products can offer decades of continued sales for products such as aircraft brakes, heavy duty trucks and construction equipment. We have expanded our friction products segment aftermarket sales force to focus on increasing direct aftermarket sales to fleets and retail customers. For the year ended December 31, 2005 our direct aftermarket sales were $27.1 million, or 16.2% of our friction products sales, an increase of 5.7% from 2004.
 
·  
 
Institute Cost-Reduction Initiatives. To maintain our profit margins in highly competitive markets and in periods of rising raw material costs, we aggressively manage our operating cost structure. Through various cost reduction programs, lean manufacturing initiatives and Six Sigma projects, we continue to look for ways to lower the total cost of producing our products. We use an incentive based compensation system to further align our employees with our focus on providing products of the highest quality and at the lowest cost.
 
·  
 
Globalization. We have manufacturing facilities in Italy, Canada and China and a sales office in Argentina. Through our friction products segment’s worldwide distribution network, we continue to selectively expand our international operations in established markets throughout Europe, Asia, North America, South America and Australia. In 2003, we constructed our second facility in China giving us the ability to manufacture powder metal components in addition to the friction products we were already manufacturing in China. We experienced our first sales from this facility at the end of 2003, and achieved rapid sales growth at this facility in 2005, which we expect to continue into the future, as many of our existing customers are looking to us to provide a high quality source of products for their facilities located in Asia. We also market to domestic Asian customers from our facilities in China. Our international net sales represented $55.9 million, or 21.1%, of our consolidated net sales for the year ended December 31, 2005, and $48.4 million, or 20.1%, of our consolidated net sales in 2004.
 
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, aerospace, 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 acquisitions and 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, 2005, our sales by principal markets were:
 

 
 
5
2005 Sales by Principal Markets
 

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 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 aerospace applications. We estimate that our direct and indirect aftermarket sales of friction products have comprised approximately 40% 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.

Construction/Mining/Agriculture/Trucks/Performance and Specialty. We supply a variety of friction products for use in brakes, clutches and transmissions on construction, mining and agriculture equipment, 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®, Fibertuff® 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.
 
·  
 
Construction and Mining Equipment. We supply friction products such as transmission discs, clutch facings and brake components to manufacturers of construction and mining equipment, including Caterpillar. We believe we are one of the largest domestic supplier of these types of friction products. Replacement components for construction equipment are sold through original equipment manufacturers as well as directly to aftermarket distributors.
6
·  
 
Agriculture Equipment. We supply friction products such as clutch facings, transmission discs and brake components to manufacturers of agriculture equipment, including John Deere and CNH. We believe we are the one of the largest domestic suppliers of these types of friction products. Replacement components for agricultural equipment are sold through original equipment manufacturers, as well as directly to aftermarket distributors.
 
·  
 
Medium and Heavy Trucks. We supply friction products for clutch buttons and facings used in medium and heavy trucks to original equipment manufacturers, such as Eaton and ZF Sachs. We believe we are the leading domestic supplier of replacement friction products used in these applications. Replacement components are sold through original equipment manufacturers and directly to aftermarket distributors.
 
·  
 
Performance and Specialty Friction. We supply friction products for use in specialty applications, such as brake pads for Harley-Davidson motorcycles, Bombardier, Polaris and Arctic Cat snowmobiles, race cars and performance automotive vehicles and the military version of the Hummer. We believe that these markets are experiencing significant growth, and that we have increased our market share with our combination of superior quality and product performance. Our replacement components are sold through original equipment manufacturers, directly to aftermarket distributors and through relationships with national automotive retailers such as Pep Boys.
 
Aerospace. We believe we are a leading independent supplier of friction products to the manufacturers of aircraft braking systems for the Boeing 727, 737 and 757, the DC-9, DC-10, MD-80 and Bombardier’s Canadair regional jet series used by commuter airlines. We believe we are also the largest supplier of metallic friction products to the general aviation (non-commercial airline, non-military) market, supplying friction materials for aircraft such as Cessna, Lear, Gulfstream and Beechcraft.

Each aircraft braking system, including the friction products supplied by us, must meet stringent Federal Aviation Administration criteria and certification requirements. New model development and Federal Aviation Administration testing for our aircraft braking system customers generally begins two to five years before full scale production of new braking systems. If we and our aircraft brake system manufacturing partner are successful in obtaining the rights to supply a particular model of aircraft, we will typically supply our friction products for that model’s aircraft braking system for as long as the model continues to fly because it is generally not economically feasible to redesign a braking system once it is certified by the Federal Aviation Administration. Moreover, Federal Aviation Administration maintenance requirements mandate that brake lining components be changed after a specified number of take-offs and landings, which results in a continued and steady market for our aerospace friction products.

Precision Components

Our precision components segment is a leading supplier of powder metal components consisting primarily of pump, motor and transmission elements, gears, pistons and other component parts for applications ranging from lawn and garden tractors to industrial equipment. The Metal Powder Industries Federation, an industry trade group, estimates that the powder metal market size for automotive and non-automotive applications in North America was over $5 billion in 2005.

We manufacture a variety of components made from powder metals for use in:

·  
 
fluid power applications, such as pumps and other hydraulic mechanisms,
 
·  
 
transmissions, other drive mechanisms and anti-lock braking systems used in trucks, off-road and lawn and garden equipment,
 
·  
 
gears and other components for use in home appliances, small hand tools, office equipment, medical, and telecommunication equipment, and
·  
 
components used in automotive applications.
 
 
Powder metal components can generally be produced at a lower cost per unit than products manufactured with forging, casting or machining technologies due to the elimination of, or substantial reduction in, secondary machining, lower material costs and the virtual elimination of raw material waste. Consequently, there has been a trend of substituting powder metal for forged, cast or machined components. In addition, we are advancing in our core powder metal technology to enable production of powder metal components with improved strength, hardness and durability and greater dimensional precision thereby expanding the number of customer applications available to us.
 
 
7
 
Our precision component segment proactively targets four specific niches in the market place:
 
·  
 
High Precision. Our pressing and finishing capabilities enable us to specialize in tight tolerance fluid power components such as pump elements and gears. In addition, we believe that our machining capabilities provide us with a competitive advantage by giving us the ability to supply a completed part to our customers, typically without any subcontracted precision machining. We expect that our growth in this niche will be driven by customers’ new design requirements and new product applications primarily for pumps, motors and transmissions.
 
·  
 
Large Size Capability. We have the capability to make powder metal components that are among the largest used in North America. For example, we make reactor plates, which serve as an opposing surface to friction disks made by us, having diameters of up to 19 inches for use in transmissions in construction and mining equipment. We expect our sales of large powder metal components to continue to grow as we create new designs for existing customers and benefit from market growth, primarily in construction, mining, agricultural and truck applications.
 
·  
 
Large Size Capability. We have the capability to make powder metal components that are among the largest used in North America. For example, we make reactor plates, which serve as an opposing surface to friction disks made by us, having diameters of up to 19 inches for use in transmissions in construction and mining equipment. We expect our sales of large powder metal components to continue to grow as we create new designs for existing customers and benefit from market growth, primarily in construction, mining, agricultural and truck applications.
 
·  
 
High Volume. We also target smaller, high volume parts where we can use efficient pressing and sintering capabilities to our best advantage. In this niche, our primary markets have been powder metal components for the lawn and garden, home appliance, power hand tool, truck, automotive and business equipment markets. We believe that our high volume capabilities provide us with opportunities to cross-sell numerous of our other precision components to customers of high precision and large size parts. Several of our leading original equipment customers have a variety of applications that we supply from both our friction and precision components segments.
 
·  
 
Metal Injection Molding. We also manufacture small, complex metal injection molded parts for a variety of industries, such as small hand tools, medical and telecommunications. We believe that many traditional powder metal customers may also be attractive prospects for metal injected molded parts.
 
Performance Racing

We supply premium clutch, transmissions and driveline systems under our Quarter Master and Tex Racing brands. These products are used by leading teams in NASCAR, ALMS and by weekend enthusiasts in the SCCA racing clubs, as well as in other road racing and oval track competition cars. We supply the official brake pad of the SCCA and are a participating sponsor of the SCCA and several other racing series.
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
8
Our Business Segments

The following table set forth comparative operating results and total assets by each of our operating segments:
   
Year ended December 31 
  
   
2005
  
2004
  
2003
  
   
(dollars in millions)
  
Net sales to external customers:
                          
Friction products
  
$
167.0
    
62.9
%
$
148.3
    
61.5
%
$
121.6
    
60.0
%
Precision components (1)
    
83.6
    
31.5
%
  
78.6
    
32.6
%
  
68.1
    
33.6
%
Performance racing
    
14.8
    
5.6
%
  
14.3
    
5.9
%
  
12.9
    
6.4
%
Consolidated
  
$
265.4
    
100.0
%
$
241.2
    
100.0
%
$
202.6
    
100.0
%
                                       
Gross profit:
                                      
Friction products
  
$
33.6
    
64.1
%
$
36.5
    
64.6
%
$
29.5
    
62.2
%
Precision components (1)
    
15.8
    
30.2
%
  
16.6
    
29.4
%
  
14.5
    
30.6
%
Performance racing
    
3.0
    
5.7
%
  
3.4
    
6.0
%
  
3.4
    
7.2
%
Consolidated
  
$
52.4
    
100.0
%
$
56.5
    
100.0
%
$
47.4
    
100.0
%
                                       
Income (loss) from operations
                                      
Friction products
  
$
5.7
    
61.3
%
$
13.1
    
75.7
%
$
8.3
    
76.1
%
Precision components (1)
    
4.1
    
44.1
%
  
3.5
    
20.2
%
  
2.2
    
20.2
%
Performance racing
    
(0.5
)
  
(5.4)
%
  
0.7
    
4.1
%
  
0.4
    
3.7
%
Consolidated
  
$
9.3
    
100.0
%
$
17.3
    
100.0
%
$
10.9
    
100.0
%
                                       
Adjusted income (loss) from operations (2)
                                      
Friction products
  
$
11.3
    
73.4
%
$
14.6
    
76.4
%
$
10.2
    
79.7
%
Precision components
   
4.5
    
29.2
%
  
3.8
    
19.9
%
  
2.2
    
17.2
%
Performance racing
    
(0.4
)
  
(2.6)
%
  
0.7
    
3.7
%
  
0.4
    
3.1
%
Consolidated
  
$
15.4
    
100.0
%
$
19.1
    
100.0
%
$
12.8
    
100.0
%
 
 
  
December 31 
  
 
  
2005 
  
2004 
  
Total assets:
          
Friction products
  
$
121,128
  
$
114,608
  
Precision components
   
89,210
    
85,545
  
Performance racing
    
12,257
    
12,365
  
Continuing operations
    
222,595
    
212,518
  
Discontinued operations
    
3,633
    
4,499
  
Consolidated
  
$
226,228
  
$
217,017
  
____________
(1)  
A line of business formerly associated with our motor segment, which was discontinued as of December 31, 2003, was retained by us and production was transferred to a facility within our precision components segment effective July 1, 2004. Net sales from this line of business were $0.8 million through the date of transfer effective July 1, 2004 and $1.2 million for the year ended December 31, 2003.
(2)  
See the disclosure set forth in the following section captioned “Hawk’s Use of Non-GAAP Financial Measures” for further explanation.

Hawk’s Use of Non-GAAP Financial Measures

In our discussion and analysis of our financial condition and results of operations, we may refer to financial measures which are considered to be “non-GAAP financial measures” under the rules and regulations of the Securities and Exchange Commission. The non-GAAP financial measure used by us is “Adjusted income from operations”. This measure is reconciled to the most comparable GAAP financial measure in the tables presented in this Form 10-K.
9
The “Adjusted income from operations” non-GAAP financial measure is defined by us as “Income from operations” as presented in our Consolidated Statement of Income plus restructuring and loan forgiveness costs less employee benefit curtailment income. We use this measure to more accurately gauge the ongoing day to day operating activities of our business. As a result of our decision to relocate one of our friction products manufacturing facilities to Oklahoma from Ohio, we have incurred significant non-recurring costs related to this one-time event that has impacted the financial results for 2005 and 2004. Additionally, in conjunction with the closure of our Ohio facility, for the period ended December 31, 2005, we reported employee benefit curtailment income due to the termination of employees upon the closure of the facility. This non-recurring income resulted from the reduction of a liability computed by our actuary to reflect the portion of benefits based on age and years of service requirements that are no longer owed by us at the date of termination. The loan forgiveness expense resulted from a one-time, non-recurring action taken by our compensation committee on January 30, 2004 approving the forgiveness of the shareholder notes of two of our senior executive officers. The action required the full forgiveness of the shareholder notes by July 1, 2005 if specific operating targets were met. Based on our performance, a portion of the shareholder notes was forgiven as of March 31, 2004 and the remainder in March 2005.
 
We have presented this non-GAAP financial measure because we believe that meaningful analysis of our financial performance is enhanced by an understanding of isolated factors underlying that performance. By excluding our non-recurring restructuring and other costs, we believe that this non-GAAP financial measure allows our investors to more easily compare the Company’s financial performance period to period. In addition, our chief operating decision makers use this measure in monitoring and evaluating both our overall performance and the ongoing performance of each of our business segments. This non-GAAP financial measure should not be considered an alternative to measures required by GAAP.
 
Reconciliation of Income from operations to Adjusted income from operations determined in accordance with GAAP:
 
   
Year ended December 31 
  
   
2005  
  
2004  
  
2003  
  
Income from operations - Friction products:
 
$
5.7
  
$
13.1
  
$
8.3
  
Restructuring costs
   
5.5
    
1.1
        
Employee benefit curtailment (income) expense
    
(0.4
)
        
1.9
  
Loan forgiveness costs
    
0.5
    
0.4
        
Adjusted income from operations - Friction products
  
$
11.3
  
$
14.6
  
$
10.2
  
                     
Income from operations - Precision components:
 
$
4.1
  
$
3.5
  
$
2.2
  
Loan forgiveness costs
    
0.4
    
0.3
        
Adjusted income from operations - Precision components
  
$
4.5
  
$
3.8
  
$
2.2
  
                     
(Loss) income from operations - Performance racing:
  
$
(0.5
)
$
0.7
  
$
0.4
  
Loan forgiveness costs
    
0.1
              
Adjusted (loss) income from operations - Performance racing
  
$
(0.4
)
$
0.7
  
$
0.4
  

Our Manufacturing Processes

The manufacturing processes for most of our friction products, performance brake products and powder metal precision components are similar. In general, all use composite metal alloys in powder form to make high quality powder metal components. The basic manufacturing steps of blending/compounding, molding/compacting, sintering (or bonding) and secondary machining/treatment are as follows:

·  
 
Blending/compounding: Composite metal alloys in powder form are blended with lubricants and other additives according to scientific formulas, many of which are proprietary. The formulas are designed to produce precise performance characteristics necessary for a customer’s particular application. We often work together with our customers to develop new formulas that will produce materials with greater energy absorption characteristics, durability and strength.
 
·  
 
Molding/compacting: At room temperature, a specific amount of a powder alloy is compacted under pressure into a desired shape. Our molding presses are capable of producing pressures of up to 3,000 tons. We believe that we have some of the largest presses in the powder metal industry, enabling us to produce large, complex components. We can also create complex shapes not obtainable with conventional powder metal presses with our metal injection molding and advanced technology equipment.
 
10
·  
 
Sintering: After compacting, molded parts are heated in furnaces to specific temperatures slightly below melting, enabling metal powders to metallurgically bond, harden and strengthen while retaining their desired shape. For friction materials, the friction composite part is also bonded directly to a steel plate or core, creating a strong continuous metallic part.
 
·  
 
Secondary machining/treatment: If required by customer specifications, a sintered part undergoes additional processing. This processing is generally necessary to attain increased hardness or strength, tighter dimensional tolerances or corrosion resistance. To achieve these specifications, parts are heat or steam treated, precision coined or flattened, ground, machined or treated with a corrosion resistant coating.
 
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. Also, our metal injection molding operation does not compact a powder alloy under pressure, but rather injects a powder slurry into a mold to form the desired shape.

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, a variety of electronic measuring equipment and computer-controlled testing machinery. We have also established quality control programs within each of our facilities to detect and prevent potential quality problems.

Since 2001, we utilize 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

We operate friction manufacturing facilities in Orzinuovi, Italy; Ontario, Canada; and Suzhou, China. We also operate a powder metal manufacturing facility in Suzhou, China. Our international operations are subject to the usual risks of operating in foreign jurisdictions. Risks inherent in international operations include the following:

·  
 
foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs or adopt other restrictions on foreign trade or investment, including exchange controls,
 
·  
 
fluctuations in exchange rates may affect product demand and may adversely affect the profitability in U. S. dollars of products and services provided by us in foreign markets where payment for our products is made in local currency,
 
·  
 
unexpected adverse changes in foreign laws or regulatory requirements may occur,
 
·  
 
compliance with a variety of foreign laws and regulations may be difficult, and
 
·  
 
overlap of different tax laws may subject us to additional taxes.
 
Net sales from our international facilities represented $55.9 million, or 21.1% of our consolidated net sales in 2005 compared to $48.4 million or 20.1% of our consolidated net sales in 2004.

For information regarding our net sales, income from operations, net income, and total assets by geographic area see “Note 14 - Business Segments” and the accompanied Consolidated Financial Statements of this Form 10-K.

 
 

 
11
 
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 the Boeing 737-600, -700, -800 and -900 commercial airliners 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, which typically have expertise in only one or two types of friction material.

We also believe that our precision components business is able to produce a wide range of products from small precise components to large parts. We have presses that produce some of the largest powder metal parts in the world, and our powder metal technology permits the manufacture of complex components with specific performance characteristics and close dimensional tolerances that would be impractical to produce using conventional metalworking processes such as forging, casting or machining. With our metal injection molding technology, we are able to create complex shapes previously not available using conventional powder metal technology.

Our expenditures for product research and development and engineering were $6.5 million, or 2.5% of net sales for the year ended December 31, 2005 compared with $5.6 million in 2004, an increase of 16.1%.

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 have 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 relationship with our customers provide us with significant competitive advantages in obtaining and maintaining new business opportunities.

We sell our friction products and powder metal components to a diversified group of original equipment manufacturers, second tier component suppliers, retailers and distributors in a wide variety of markets. In addition, through our performance racing segment we sell transmissions, clutches and other driveline components directly to some of the most recognizable race teams in NASCAR as well as to distributors serving other race enthusiasts. Our top five customers represented 29.0% of our consolidated net sales in 2005, and 28.5% of our consolidated net sales in 2004. No one customer exceeded 10.3% of our consolidated net sales in 2005 or 2004.

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, a sales office in Argentina. 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. We also sell our precision components to original equipment manufacturers through independent sales representatives. Sales to customers in our performance racing segment are sold directly to race teams and distributors 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.
 
 
12
 
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 that we supply friction materials for, but are generally more expensive. The carbon-carbon brakes are typically used on wide-body aircraft, such as the Boeing 747, 767 and 777, and on military aircraft, where the advantages in reduced weight may justify the additional expense.
 
In addition, as our powder metal components are increasingly substituted for wrought steel or iron components due to advances in our powder metal technology, we increasingly compete with companies using forging, casting or machining technologies to produce precision components. Powder metal components can often be produced at a lower cost per unit than products manufactured with forging, casting or machining technologies due to the elimination of, or substantial reduction in, secondary machining, lower material costs and the virtual elimination of raw material waste.
 
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 condition 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

Our sales to manufacturers of aircraft braking systems represented 10.2% of our consolidated net sales in 2005 and 10.0% of our consolidated net sales in 2004. Each aircraft braking system, including the friction products supplied by us, must meet stringent Federal Aviation Administration criteria and testing requirements. We have been able to meet these requirements in the past and we continuously review Federal Aviation Administration 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 review 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. 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 Precision Components Group®, Velvetouch®, Hawk Brake®, Hawk Performance®, Fibertuff®, Feramic®, Velvetouch Feramic®, Velvetouch Organik®, Conversioneering®, Quarter Master® and Tex Racing®. Velvetouch®, Fibertuff® and Hawk Performance® are our principal trademarks for use in the friction products direct aftermarket segment. Although we maintain patents related to our business, we do not believe that our competitive position is dependent on patent protection or that our operations are dependent on any individual patent. 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.

 
13
Personnel

At December 31, 2005, we had approximately 1,400 domestic employees and 400 international employees at our continuing operations. Approximately 30 employees at our Akron, Ohio facility are covered under a collective bargaining agreement with the United Automobile Workers expiring in July 2006; and approximately 200 employees at our Orzinuovi, Italy facility are represented by a national mechanics union agreement that expires in June 2007. The Italian employees are also covered by a local union agreement that expires in June 2007. We have experienced no material work stoppages and believe we have good relations with our employees and their unions.
 
 
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.
 
 
We continue to experience manufacturing inefficiencies at our Oklahoma friction products facility
  

     We have relocated one of our friction products manufacturing facilities from Brook Park, Ohio to a new facility in Tulsa, Oklahoma. We began production in the new facility at the beginning of 2005. Our Brook Park facility ceased operations at the end of the third quarter of 2005.

     In connection with the relocation, we incurred costs at levels higher than we originally anticipated, and we continue to incur additional costs. Expenses related to the relocation and employee severance costs associated with the closure of our Brook Park, facility were $5.5 million in 2005 (of which $0.5 million was included in Cost of sales). We incurred significant additional expenses as of result of manufacturing inefficiencies related to the move of that facility to Oklahoma. We expect to incur additional expenses during the first half of 2006, as we continue to experience manufacturing inefficiencies at the Oklahoma facility.

     Future success at the Oklahoma facility depends on our ability to:

·  
 
hire, train and retain a qualified workforce,
 
·  
 
manufacture friction products without causing customer delays or dissatisfaction, and
 
·  
 
achieve the projected cost savings including whether the cost savings can be achieved in a timely fashion.
 
     Failure to successfully complete the transition of our business to the new facility may have a material adverse effect on our financial condition, results of operations and prospects.

 
 
14
 
     Expenses related to the relocation and employee severance costs associated with closure of our Brook Park, Ohio facility were $5.5 million ($0.5 million included in Cost of sales) in 2005. We incurred significant additional expenses as of result of manufacturing inefficiencies related to the move of the facility to Oklahoma. We expect to incur additional expenses during the first half of 2006 as we continue to experience manufacturing inefficiencies at the Oklahoma facility.
 
We have incurred losses in the past and may incur losses in future years.

For the year ended December 31, 2005, we reported a net loss of $1.3 million compared to net income of $1.1 million for the year ended December 31, 2004 and a net loss of $5.4 million for the year ended December 31, 2003. Of the 2005 net loss, $5.5 million ($0.5 million in Cost of sales) resulted from a pre-tax charge related to the relocation of our friction products facility from Brook Park, Ohio to Tulsa, Oklahoma.
 
If we incur additional losses in the future or do not increase net income, then our growth potential and our ability to execute our business strategy may be constrained. In addition, our ability to service our debt, may be harmed because we may not generate sufficient cash flow from operations to pay principal or interest when due.    
 
We may be unable to generate sufficient taxable income from future operations to fully utilize our significant tax net operating loss carryforwards or maintain our deferred tax assets.

We have a recent history of unprofitable operations primarily due to domestic operating losses. These losses have generated significant federal tax net operating losses, or NOLs. We had available at December 31, 2005, total NOL carryforwards for federal tax purposes of approximately $27.5 million that will begin to expire in the year 2023. Further, even though we expect to be profitable and generate taxable income in 2006 and beyond, we may not be able to sustain the necessary levels of taxable income to fully utilize our significant NOL carryforwards prior to expiration. There is considerable management judgment necessary to determine future taxable income, and accordingly, actual results could vary significantly from such estimates. Accordingly, the recorded amount of the deferred tax assets considered realizable could be reduced in the near term if estimates of our tax planning strategy or our future taxable income are reduced. If actual results differ from our plans or we do not achieve profitability, we may be required to incur a valuation allowance on our tax assets by taking a charge to our tax provision in our Statement of Operations. Accordingly, our inability to generate domestic pre-tax profit may require us to record a tax valuation allowance in accordance with SFAS No. 109, Accounting for Income Taxes (SFAS 109). If this occurs, our results of operations, financial condition and cash flows could be materially and adversely affected.
 
Our China precision component facility and metal injection molding operation have yet to achieve profitability.

     Our precision components operation in China commenced operations in 2003, and we began our metal injection molding operation, which is also a part of our precision component segment, in 2000. We expect that our precision components operations in China and our metal injection molding operation will have operating losses in 2006. We cannot be certain when, or if, either of these operations will be profitable.
 
Our precision components segment may be adversely affected by low-cost production in China.
 

     Our precision components segment is able to produce powder metal components at a lower cost per unit than products manufactured with forging, casting or stamping technologies due to the reduction in secondary machining, lower material costs and the virtual elimination of raw material waste. However, we may not be able to successfully compete with components manufactured in China at a lower cost using these traditional manufacturing technologies.

Our net income may be impacted by the sale of our motor segment.
 

     We anticipate selling the balance of our motor segment as an ongoing business during the first half of 2006 and are accounting for the results of the motor segment as a discontinued operation in our financial statements. We cannot be certain that we will be successful in divesting the motor segment, or if divested, that the terms of the transaction will be satisfactory to us. There may be additional charges required to reflect actual results of a sale.

Work stoppages by union employees may negatively impact our business.
 


15
 
     As of December 31, 2005, 12.4% of our employees were represented by unions. If it is necessary to negotiate new agreements or extensions with the unions, we cannot be certain that we will be able to do so on favorable terms or without experiencing work stoppages. Any work stoppage may have a material adverse effect on our financial condition, results of operations and prospects.
 
Our gross margins are subject to fluctuation because of product mix.
 

     Certain of our friction products have lower gross margins than our other friction products, and in general, our precision component products have lower gross margins than our friction products. For the year ended December 31, 2005, our friction products segment gross profit was 20.2% of net sales compared to our precision components segment gross profit margin of 18.9% of net sales. Our consolidated gross margin was 19.7% for the year ended 2005 compared to 23.4% for the year ended 2004. Our margins in 2005 were negatively impacted by costs related to a move of a friction products manufacturing facility from Ohio to Oklahoma. 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 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 condition, 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. We also compete with manufacturers using more traditional forging, casting and stamping technology. Our competitors’ use of different technology may adversely affect our ability to compete and negatively impact our financial condition, results of operations and prospects.
 
Our debt could adversely affect our financial condition and prevent us from fulfilling our obligations.
 

    As of December 31, 2005, we had $110.5 million of net debt outstanding compared to $106.2 million as of December 31, 2004.

     Our high level of debt could have important consequences, including the following:

·  
 
it may make it difficult for us to satisfy our obligations under our debt and contractual and commercial commitments,
 
·  
 
we must use a substantial portion of our cash flow from operations to pay interest on our debt, which reduces funds available to us for other purposes,
 
·  
 
all of the debt outstanding under our Bank Facility is secured by certain of our assets,
 
·  
 
our Bank Facility has a variable rate of interest, which exposes us to the risk of increased interest rates,
 
·  
 
our ability to obtain additional debt financing in the future for working capital, capital expenditures, acquisitions or general corporate purposes may be limited,
 
·  
 
our high level of debt could limit our flexibility in reacting to changes in the industry and make us more vulnerable to adverse changes in our business or economic conditions in general,
 
·  
 
our high level of debt could place us at a competitive disadvantage to those of our competitors who operate on a less leveraged basis, and
 
16
 
·  
 
our high level of debt could place us at a competitive disadvantage to those of our competitors who operate on a less leveraged basis, and
·  
 
if we fail to comply with the covenants in the instruments governing our other debt, such failure could have material adverse effect on our business and our ability to repay our debt.
 
     Our ability to make payments on our debt obligations will depend on our future operating performance and our ability to refinance our debt, which could be affected by prevailing economic conditions and financial, business and other factors, certain of which are beyond our control.

We may require significant ongoing and recurring additional capital expenditures and investment in research and development, manufacturing and other areas to remain competitive.
 
We cannot assure you that we will be able to achieve the technological advances or introduce new products that may be necessary to remain competitive within our business. In addition, we cannot assure you that any technology development by us can be adequately protected such that we can maintain a sustainable competitive advantage.
 
Our goodwill may be subject to asset impairment charges.
 
In 2002 we adopted SFAS No. 142 Goodwill and Other Intangible Assets (SFAS 142), and in the year of adoption recognized impairment of a portion of our goodwill. We test the remaining goodwill reported in our precision components and performance racing segments annually, and have determined that no further impairment has occurred. In assessing the recoverability of our goodwill, we consider changes in economic conditions and make assumptions regarding estimated future cash flows and other factors. Estimates of future discounted cash flows are highly subjective judgments based on our experience and knowledge of operations. These estimates can be significantly impacted by many factors including changes in global and local business and economic conditions, operating costs, inflation, and competitive trends. We cannot assure you that future goodwill impairment will not occur or that if such impairment occurs that it will not adversely affect our financial position and results of operations.

We are subject to governmental regulations that may affect our ability to implement our business objectives.
 

     Our net sales to manufacturers of aircraft braking systems represented 10.2% of our consolidated net sales for the year ended December 31, 2005. Every aircraft braking system, including those containing components supplied by us, must satisfy Federal Aviation Administration 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 Federal Aviation Administration 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 Federal Aviation Administration criteria and testing requirements, which are subject to change in the discretion of the Federal Aviation Administration.

Environmental and health and safety liabilities and requirements could require us to incur material costs.
 

     We are subject to various U.S. and foreign laws and regulations relating to environmental protection and worker health and safety, including those governing:

·  
 
discharges of pollutants into the air and water,
 
·  
 
the management and disposal of hazardous substances, and
 
·  
 
the cleanup of contaminated properties.
 
     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:

 
·  
 
the discovery of new information concerning past releases of hazardous substances,
17
 
·  
 
the discovery or occurrence of compliance problems relating to our operations, and
·  
 
changes in existing environmental laws or their interpretation.
 
     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 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 and iron powders, steel and custom-fabricated cellulose sheet and 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 condition 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. 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 financial results.
 
We are subject to risks associated with international operations.
 

     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:

·  
 
foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs or adopt other restrictions on foreign trade or investment, including exchange controls,
 
·  
 
fluctuations in exchange rates may affect product demand and may adversely affect the profitability in U.S. dollars of products and services provided by us in foreign markets where payment for our products is made in local currency,
 
·  
 
unexpected adverse changes in foreign laws or regulatory requirements may occur,
 
·  
 
compliance with a variety of foreign laws and regulations may be difficult, and
 
·  
 
overlap of different tax laws may subject us to additional taxes.
 
     Our international net sales represented $55.0 million, or 27.2% of our consolidated net sales, for the year ended December 31, 2005.

We depend on our key personnel.
 

     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 condition, results of operations and prospects. Hawk has an employment agreement with Ronald E. Weinberg, its Chairman of the Board, Chief Executive Officer and President, and maintains a “key person” life insurance policy on the life of Mr. Weinberg in the face amount of $1.0 million.


 
18
 
     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.
 
Our existing preferred shareholders have the ability to exert voting control with respect to the election of directors.
 
      Ronald E. Weinberg, Chairman of the Board, Chief Executive Officer and President, 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.
 
 
 
ITEM 1B. UNRESOLVED STAFF COMMENTS
 
None
 
 
ITEM 2. PROPERTIES
 
Hawk’s world headquarters is located in Cleveland, Ohio. We maintain manufacturing, research and development, sourcing, sales and administrative facilities at 17 locations in 5 countries. We are a lessee under operating leases for some of our properties. Hawk’s principal research and development facility is located in Solon, Ohio. In addition, research and development is also performed in a number of the operating divisions’ facilities. 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.


ITEM 3. LEGAL PROCEEDINGS
 
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. In our opinion, the outcome of these legal actions will not have a material adverse effect on our financial condition or results of operations.


ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matters were submitted to a vote of security holders during the fourth quarter of 2005.


PART II


ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND  ISSUER PURCHASES OF EQUITY SECURITIES

Our Class A Common Stock has traded on the American Stock Exchange under the symbol “HWK” since January 7, 2004. Through January 6, 2004, our stock traded on the New York Stock Exchange. The following table sets forth, for the fiscal periods indicated, the high and low closing prices of our common stock as reported on the American and New York Stock Exchanges.
 
 
 
19
 
Quarterly Stock Prices

Quarter Ended 
  
High 
  
Low 
  
2005
          
December 31, 2005
  
$
14.99
  
$
12.45
  
September 30, 2005
  
$
13.64
  
$
11.48
  
June 30, 2005
  
$
11.80
  
$
10.15
  
March 31, 2005
  
$
10.20
  
$
8.01
  
2004
              
December 31, 2004
  
$
8.98
  
$
7.42
  
September 30, 2004
  
$
8.19
  
$
6.26
  
June 30, 2004
  
$
6.99
  
$
4.25
  
March 31, 2004
  
$
5.90
  
$
3.62
  

The closing sale price for our common stock on December 31, 2005 was $14.67.

Shareholders of record as of March 10, 2006 numbered 77. 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 and 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.
 
 
ITEM 6. SELECTED FINANCIAL DATA
 
Years ended December 31 
  
2005 
  
2004 
  
2003 
  
2002 
  
2001 
  
   
(in millions, except per share data)
  
Statement of Operations Data:
                      
Net sales
  
$
265.4
  
$
241.2
  
$
202.6
  
$
185.9
  
$
176.9
  
Gross profit
    
52.4
    
56.5
    
47.4
    
44.2
    
40.7
  
Restructuring costs (1)
    
5.5
    
1.1
                
1.1
  
Employee benefit curtailment (income) (2)
    
(0.4
)
                        
Pension curtailment and contractual termination benefit costs (3)
                
1.9
              
Income from operations (4)
    
9.3
    
17.3
    
10.9
    
13.0
    
7.2
  
Adjusted income from operations (5)
    
15.5
    
19.1
    
12.8
    
13.0
    
7.2
  
(Loss) income from continuing operations before income taxes
    
(1.2
)
  
1.5
    
(0.4
)
  
0.8
    
(2.2
)
Discontinued operations, net of tax
          
(0.3
)
  
(5.0
)
  
(1.9
)
  
(2.1
)
Cumulative effect of change in accounting principle, net of tax (6)
                      
(17.2
)
      
Net (loss) income
  
$
(1.3
)
$
1.1
  
$
(5.4
)
$
(18.3
)
$
(4.3
)
Earnings (Loss) Per Share:
                                
   Basic (loss) earnings per share
  
$
(.17
)
$
.11
  
$
(.65
)
$
(2.15
)
$
(.52
)
   Diluted (loss) earnings per share
  
$
(.17
)
$
.11
  
$
(.65
)
$
(2.14
)
$
(.52
)
Other Data:
                                
Depreciation
  
$
10.7
  
$
10.1
  
$
10.1
  
$
10.2
  
$
10.7
  
Amortization(7)
    
0.7
    
0.7
    
0.8
    
0.8
    
3.8
  
Capital expenditures (including capital leases and financed capital expenditures)
    
14.2
    
18.3
    
11.2
    
9.7
    
8.5
  
 
 
20
 

December 31 
  
2005 
  
2004 
  
2003 
  
2002 
  
2001 
  
   
(In millions)
  
Balance Sheet Data:
                      
Cash and cash equivalents
  
$
7.1
  
$
6.8
  
$
3.4
  
$
1.7
  
$
3.1
  
Working capital (8)
    
50.3
    
51.1
    
13.5
    
9.1
    
31.5
  
Property plant and equipment, net
    
70.9
    
70.0
    
63.1