You should read this discussion in conjunction with the consolidated financial statements, notes and tables included in Part I, Item 1 of this Form 10-Q. Statements that are not historical facts, including statements about our confidence in our prospects and strategies and our expectations about growth of existing markets and our ability to expand into new markets, to identify and acquire complementary businesses and to attract new sources of financing, are forward-looking statements that involve risks and uncertainties. In addition to statements that are forward-looking by reason of context, the words "believe," "expect," "anticipate," "intend," "designed," "goal," "objective," "optimistic," "will" and other similar expressions identify forward-looking statements. In light of the risks and uncertainties inherent in all future projections, the inclusion of the forward-looking statements should not be regarded as a guarantee of performance. Although we believe that our plans, objectives, intentions and expenditures reflected in our forward-looking statements are reasonable, we can give no assurance that our plans, objectives, intentions and expectations will be achieved. Our forward-looking statements are made based on expectations and beliefs concerning future events affecting us and are subject to uncertainties, risks and factors relating to our operations and business environments, all of which are difficult to predict and many of which are beyond our control, that could cause our actual results to differ materially from those matters expressed or implied by our forward-looking statements.

When considering these risk factors, you should keep in mind the cautionary statements elsewhere in this report and the documents incorporated by reference. New risks and uncertainties arise from time to time, and we cannot predict those events or how they may affect us. We assume no obligation to update any forward-looking statements or risk factor after the date of this report as a result of new information, future events or developments, except as required by the federal securities law.

Recent Developments

During the first quarter of 2008, our Board of Directors made a strategic decision to focus our management resources on the friction products business and committed to a plan to sell the performance racing segment, which has operations in the United States. This segment engineers, and manufactures premium branded clutch, transmissions and driveline systems for the performance racing market. As a result of the decision to sell the performance racing segment, our unaudited consolidated financial statements, accompanying notes and other information provided in this Form 10-Q reflect the performance racing segment as a discontinued operation for all periods presented. After reclassifying the performance racing segment to discontinued operations, we have one remaining operating segment, the friction products segment. The Company will retain its Hawk Performance® brake business, which has always been and will continue to be a component of its friction products segment.

General

Through our various subsidiaries, we operate in one reportable segment: friction products. Our results of operations are affected by a variety of factors, including but not limited to, general economic conditions, manufacturing efficiency, customer demand for our products, competition, raw material pricing and availability, labor relations with our personnel 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, 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,

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· the leading North American independent supplier of friction materials for braking systems for new and existing series of many commercial and military aircraft models, including Boeing, EADS, Lockheed and United Technologies as well as the Canadair regional jet series,

· the largest supplier of friction materials for the growing general aviation market, including numerous new and existing series of Cessna, Hawker, Lear and Pilatus aircrafts, and

· a leading domestic supplier of friction products into performance and specialty markets such as motorcycles, race cars, performance automobiles, military vehicles, ATV's and snowmobiles.

Critical Accounting Policies

Some of our accounting policies require the application of significant judgment by us in the preparation of our consolidated financial statements. In applying these policies, we use our best judgment to determine the underlying assumptions that are used in calculating the estimates that affect the reported values on our financial statements. On an ongoing basis, we evaluate our estimates and judgments based on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

We review our financial reporting and disclosure practices and accounting policies quarterly to ensure that they provide accurate and transparent information relative to the current economic and business environment. We base our estimates and assumptions on historical experience and other factors that we consider relevant. If these estimates differ materially from actual results, the impact on our consolidated financial statements may be material. However, historically our estimates have not been materially different from actual results. Our critical accounting policies include the following:

· Revenue Recognition. We recognize revenues when products are shipped and title has transferred to our customer.

· Marketable Securities. As of March 31, 2008, we accounted for all of our marketable securities as available-for-sale. We report our available-for-sale securities at fair value in our Consolidated Balance Sheet with unrealized holding gains and losses, net of tax, included in Accumulated other comprehensive income (loss). Dividend and interest income, including the amortization of any discount or premium, as well as realized gains or losses, are included in Interest income in our Consolidated Statements of Income. We periodically evaluate our investments for other-than-temporary impairment.

· Long-Lived Assets. We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In assessing the recoverability of our long-lived assets, we consider changes in economic conditions and make assumptions regarding estimated future cash flows and other factors. Estimates of future undiscounted cash flows are highly subjective judgments based on our experience and knowledge of our operations. These estimates can be significantly impacted by many factors including changes in global and local business and economic conditions, operating costs, inflation and competitive trends. If our estimates or underlying assumptions change in the future, we may be required to record impairment charges. In our continuing operations, we did not record any impairment charges to our tangible or indefinite lived intangible assets in the three months ended March 31, 2008 or 2007.

· Pension Benefits. We account for our defined benefit pension plans in accordance with SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans (SFAS 158), an amendment of FASB Statements No. 87, 88, 106 and 132 which requires the recognition of the overfunded or underfunded status of a plan as an asset or liability in the statement of financial position and the recognition of changes in the funded status in the year in which the changes occur through Accumulated other comprehensive income (loss). Pension expense continues to be recognized in the financial statements on an actuarial basis. The most significant elements in determining our net pension expense are the expected return on plan assets and appropriate discount rates. We assumed that the expected weighted average long-term rate of return on plan assets would be 8.25% for 2008. Based on our existing and forecasted asset allocation and related long-term investment performance results, we believe that our assumption of future returns is reasonable. However, should the rate of return differ materially from our assumed rate, we could experience a material adverse effect on the funded status of our plans and our future pension

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expense. The assumed long-term rate of return on assets is applied to a calculated value of plan assets, which recognizes changes in the fair value of plan assets in a systematic manner over five years. This calculation produces the expected return on plan assets that is included in net pension expense. The difference between this expected return and the actual return on plan assets is recorded to Comprehensive income. Net periodic benefit cost was $0 for the three months ended March 31, 2008, and $0.1 million for the three months ended March 31, 2007.

We determine the discount rate to be used to discount plan liabilities at their measurement date, December 31. The discount rate reflects the current rate at which the pension liabilities could be effectively settled at the end of the year. At December 31, 2007, we determined this rate to be 6.0%. Changes in discount rates over the past three years have not materially affected net pension expense.

· Income Taxes. Our effective tax rate, taxes payable and other tax assets and liabilities reflect the current tax rates in the domestic and foreign tax jurisdictions in which we operate. Deferred income taxes reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for reporting and income tax purposes. Our effective tax rate is substantially driven by the impact of the mix of our foreign and domestic income and losses and the federal and local tax rate differences on each.

We have adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, we were not required to recognize any change in the liability for unrecognized tax benefits. The total amount of unrecognized tax benefits as of March 31, 2008, is $1.8 million (including $692 of accrued interest and penalties), the recognition of which would have an effect of $0.6 million on our continuing operations effective tax rate.

We recognize interest and penalties related to unrecognized tax benefits in income tax expense. We had no interest and penalties in continuing operations tax expense for the three months ended March 31, 2008.

SFAS No. 109, Accounting for Income Taxes (SFAS 109), provides certain guidelines to follow in making the determination of the need for a valuation allowance. We must demonstrate that taxable income is expected to be available for future periods sufficient to realize the benefits of temporary differences and carryforwards to avoid recording a valuation allowance against deferred tax assets. We recorded a valuation allowance for our Canadian subsidiary for the year ended December 31, 2007. We have determined that no additional valuation allowance was necessary as of March 31, 2008.

· Foreign Currency Translation and Transactions. Assets and liabilities of our foreign operations are translated using period-end exchange rates and revenues and expenses are translated using exchange rates as determined throughout the year. Gains or losses resulting from translation are included in Accumulated other comprehensive income (loss) in Shareholders' equity in our Consolidated Balance Sheet. Other comprehensive income (loss) included translation gains of $2.2 million for the three months ended March 31, 2008. 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 (expense) income, net in our Consolidated Statements of Income. We reported foreign currency transaction gains of $0.3 million for the three months ended March 31, 2008. Foreign currency transaction gains or losses were not material to the results of operations for the three months ended March 31, 2007.

· Recent Accounting Developments

· In December 2007, the FASB issued SFAS 141(R). SFAS 141(R) modifies the accounting for business combinations by requiring that acquired assets and assumed liabilities be recorded at fair value, contingent consideration arrangements be recorded at fair value on the date of the acquisition and pre-acquisition contingencies will generally be accounted for in purchase accounting at fair value. The pronouncement also requires that transaction costs be expensed as incurred, acquired research and development be capitalized as an indefinite-lived intangible asset and the requirements of SFAS No. 146, be met at the acquisition date in order to accrue for a restructuring plan in purchase accounting. SFAS 141(R) is required to be adopted prospectively effective for fiscal years beginning after December 15, 2008. SFAS 141(R) may not be adopted early.

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· In March 2008, the FASB issued SFAS No. 161. SFAS 161 requires enhanced disclosures about an entity's derivative and hedging activities in order to improve the transparency of financial reporting. SFAS 161 is effective prospectively for fiscal years beginning after November 15, 2008. We do not expect the adoption of SFAS 161 will have a material impact on our financial statements.

Due to the discontinued operations classification of the precision components and performance racing segments, our continuing operation is organized into one strategic segment, friction products. In the first quarter of 2008 we committed to selling our performance racing segment. During the first quarter of 2007, we sold the precision components segment. As a result, we have classified the performance racing and precision components segments as discontinued operations in our financial results.

The following table summarizes our results of operations for the three month periods ended March 31, 2008 and 2007:

                                                      Three Months Ended March 31
                                                       2008                 2007

 Net sales                                        $       65,779       $       54,175

 Gross profit                                     $       17,411       $       13,997

 Selling, technical and administrative expenses   $        9,691       $        8,620

 Income from continuing operations                $        7,546       $        5,196

 Interest expense                                 $       (2,015 )     $       (2,560 )

 Interest income                                  $          666       $          741

 Other income (expense), net                      $          291       $          110

 Income taxes                                     $        2,662       $        1,542

 Discontinued operations, net of tax              $         (675 )     $       10,841

 Net income                                       $        3,151       $       12,786

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The following charts show our net sales by market segment and geographic location for the three months ended March 31, 2008:

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Net Sales. Our net sales for the first quarter of 2008 were $65.8 million, an increase of $11.6 million or 21.4% from the same period in 2007. We experienced sales increases primarily as a result of strong economic conditions in most of our end markets, pricing actions, new product introductions and favorable foreign currency exchange rates during the period. Net sales from our foreign facilities represented 45.0% of our total net sales in 2008, compared to 38.7% for the comparable period of 2007. The effect of foreign currency exchange rates accounted for 6.6% of our total net sales increase of 21.4% during the first quarter of 2008. 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 and performance automotive. Our sales to the construction and mining market, our largest, were up 25.1% in the first quarter of 2008, compared to the first quarter of 2007, as a result of strong global market conditions. Sales in the agriculture sector were up 46.3% in the first quarter of 2008, compared to the first quarter of 2007, as a result of strong market conditions in North and South America as well as Europe. Our aircraft and defense businesses were up 20.4% in the first quarter of 2008, compared to the first quarter of 2007, as demand remained strong in both markets. As expected, sales to our heavy truck market declined 6.5% during the first quarter of 2008, compared to the first quarter of 2007. We continued to experience strong sales growth from our operations in Italy and China and favorable foreign currency exchange rates during the first quarter of 2008, compared to the prior year period. Sales at our Italian operation, on a local currency basis, were up 22.5% in the first quarter of 2008 compared to the first quarter of 2007, while sales at our Chinese operation, on a local currency basis, were up 60.6% during the same period. 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 $9.9 million in the first quarter of 2008 compared to $8.1 million in 2007, an increase of 22.2% primarily due to new customers and product introductions during the period.

Gross Profit. Gross profit increased $3.4 million to $17.4 million during the first quarter of 2008, a 24.3% increase compared to gross profit of $14.0 million for the first quarter of 2007. This increase was due to margin improvement from volume related absorption of fixed overhead, the strength of the Euro and Yuan, pricing actions and operating improvements at our facilities. Our gross profit margin increased to 26.4% of our net sales in the first quarter of 2008, compared to 25.8% of our net sales in the first quarter of 2007.

Selling, Technical and Administrative Expenses. Selling, technical and administrative (ST&A) expenses increased $1.1 million, or 12.8%, to $9.7 million in the first quarter of 2008, from $8.6 million during the first quarter of 2007. As a percentage of net sales, ST&A decreased to 14.6% in the first quarter of 2008 compared to 15.9% for the first quarter of 2007. The increase in ST&A expenses resulted primarily from an increase in salary and wages, employee benefit and incentive compensation expense during the first quarter of 2008, compared to the first quarter of 2007. During the first quarter of 2008, we spent $0.3 million in legal expenses net of insurance reimbursement related to the previously disclosed Securities and Exchange Commission (SEC) and Department of Justice investigations compared to $0.5 million in the first quarter of 2007. Additionally, we spent $1.3 million, or 2.0%, of our net sales on product research and development in the first quarter of 2008, compared to $1.1 million or 2.1%, of our net sales for the first quarter of 2007.

Income from Continuing Operations. Income from continuing operations was $6.5 million in the first quarter of 2008, an increase of $3.0 million or 85.7%, compared to $3.5 million during the first quarter of 2007. Income from operations as a percentage of net sales increased to 9.9% in the first quarter of 2008 from 6.5% in the same period of 2007. The increase was primarily the result of increased sales and margin improvements. The effect of foreign currency exchange rates accounted for 17.1% of our total income from continuing operations increase of 85.7% during the first quarter of 2008.

Interest Expense. Interest expense decreased $0.6 million during the first quarter of 2008 to $2.0 million from $2.6 million in the first quarter of 2007 as a result of lower debt levels outstanding during the period. Included as a component of Interest expense in our Consolidated Statements of Income is the amortization of deferred financing costs. Amortization of deferred financing costs was $0.1 million in the first quarter of 2008 and 2007.

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 our operations, interest income was $0.7 million in both the first quarter of 2008 and 2007. Effective interest rates on our investments have dropped by approximately 55.0% as of March 31, 2008, compared to rates available to us as of March 31, 2007.

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Other (Expense) Income, Net. We reported foreign exchange currency transaction income of $0.3 million during the first quarter of 2008 compared to $0.1 million in the first quarter of 2007.

Income Taxes. We recorded a tax provision for our continuing operations of $2.7 million for the quarter ended March 31, 2008, compared to $1.5 million in the comparable period of 2007. Our effective income tax rate of 41.0% in the first quarter of 2008 differs from the current federal U.S. statutory rate of 35.0%, primarily as a result of state and local income taxes, foreign withholding taxes on royalty income 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.

Discontinued Operations, Net of Tax. During the first quarter of 2008, we committed to a plan to divest our performance racing segment. On February 2, 2007, we sold our precision components segment. The activity of our discontinued 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 first quarter of 2008 and 2007. An analysis of discontinued operations is contained in Note 3 "Discontinued Operations" in the accompanying Consolidated Financial Statements of this Form 10-Q.

                                                                  Three Months Ended
                                                                       March 31
                                                               2008                 2007
                                                                 (dollars in millions)
Net sales                                                  $         3.9        $       11.3
Loss from discontinued operations, before income taxes     $        (1.1 )      $       (1.4 )
Gain on sale of discontinued operations, before income
taxes                                                                  -                15.0
Income tax (benefit) expense                                        (0.4 )               2.8
(Loss) income from discontinued operations, after income
taxes                                                      $        (0.7 )      $       10.8

Net Income. As a result of the factors noted above, including the gain on the sale of the precision components segment of $15.0 million in the first quarter of 2007, we reported net income of $3.2 million in the first quarter of 2008, a decrease of $9.6 million compared to net income of $12.8 million during the first quarter of 2007.

Liquidity and Capital Resources

Our primary financing requirements are:

· for capital expenditures for maintenance, replacement and acquisition of equipment, expansion of capacity, productivity improvements, research and product development,

· for funding our day-to-day working capital requirements, and

· to pay interest on, and to repay principal of, our indebtedness.

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. Recently, we also have available to us the sale proceeds of the precision components segment. The following selected measures of liquidity and capital resources outline various metrics that are reviewed by our management and are provided to our stockholders to enhance the understanding of our business.

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Selected Measures of Liquidity and Capital Resources from Continuing Operations

                                                                 March 31
                                                          2008               2007
                                                           (dollars in millions)
 Cash and cash equivalents                             $      70.9       $       45.0
 Marketable securities                                 $         -       $       45.2
 Working capital (1)                                   $     118.1       $      133.0
 Current ratio (2)                                      3.4 to 1.0         4.2 to 1.0
 Net debt as a % of capitalization (3)                        18.3 %             25.9 %
 Average number of days sales in accounts receivable       78 days            69 days
 Average number of days sales in inventory                 76 days            80 days

(1) Working capital is defined as current assets minus current liabilities.

(2) Current ratio is defined as current assets divided by current liabilities.

(3) Net debt is defined as long-term debt, including current portion, and short-term borrowings, less cash and marketable securities. Capitalization is defined as net debt plus shareholders' equity.

As of March 31, 2008, we reported $57.3 million of investments in Cash and cash equivalents in our Consolidated Balance Sheet. Our investments generally have a maturity of six months or less at the date of purchase. The longest maturity date for marketable securities held by us as of March 31, 2008, is June 25, 2008. The overall decrease in cash, cash equivalents and marketable securities of $19.3 million between these periods is primarily due to the redemption of $22.9 million of senior notes in the third quarter of 2007.

As part of our working capital management program, we review working capital measures on a continuous basis. The $14.9 million decrease in our net working capital from March 31, 2007, resulted primarily from the redemption of $22.9 million of our senior notes in the third quarter of 2007, which reduced our overall cash position period over period. In addition, we reported increases in accounts receivable of $10.2 million and inventory of $2.1 million related to sales volume, offset by an increase in accounts payable levels of $7.1 million . . .