| HAWK CORP 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 "e believe, "e "e expect, "e "e anticipate, "e "e intend, "e "e designed, "e "e goal, "e "e objective, "e "e optimistic, "e "e will "e 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 "e Risk Factors "e 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 dlra5dtta5 million in 2005 (of which dlra0dtta5 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 dlra5dtta5 million (dlra0dtta5 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 dlra1dtta3 million compared to net income of dlra1dtta1 million for the year ended December 31, 2004 and a net loss of dlra5dtta4 million for the year ended December 31, 2003 |
| Of the 2005 net loss, dlra5dtta5 million (dlra0dtta5 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 dlra27dtta5 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 Nodtta 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, 12dtta4prca 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 20dtta2prca of net sales compared to our precision components segment gross profit margin of 18dtta9prca of net sales |
| Our consolidated gross margin was 19dtta7prca for the year ended 2005 compared to 23dtta4prca 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 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 dlra50dtta0 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 dlra110dtta5 million of net debt outstanding compared to dlra106dtta2 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 Nodtta 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 10dtta2prca 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 US 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 US 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 dlra55dtta0 million, or 27dtta2prca 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 dlra1dtta0 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 45prca, 45prca and 10prca, respectively, of the outstanding shares of our Series D preferred stock as well as 14prca, 13prca and 3prca, 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 |
| discussed are listed under Item 1A Risk Factors |
| 21 Results of Operations Through our subsidiaries, we operate in three reportable segments: friction products, precision components and performance racing |
| Our results of operations are affected by a variety of factors, including but not limited to, general customer demand for our products, competition, raw material pricing and availability, labor relations with our personnel, political conditions in the countries in which we operate and general economic conditions |
| We sell a wide range of products that have a corresponding range of gross margins |
| Our consolidated gross 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 |
| In the fourth quarter of 2003, we committed to a plan to sell our motor segment, which had operations in Alton, Illinois and Monterrey, Mexico |
| This segment, which manufactures die-cast aluminum rotors for fractional and sub-fractional 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 core segments of friction products and precision components |
| 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 recognized a fair market value adjustment (loss) of dlra0dtta3 million (dlra0dtta2 million, net of tax) on the sale of the land and building of this facility, which was included in the results of discontinued operations |
| 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 for this segment to reclassify its net operations, assets and liabilities as discontinued for all periods presented in this report and these results are not included in this discussion of our results of operations |
| Also in the fourth quarter of 2003, we committed to a restructuring program to achieve cost savings in our friction products segment by moving operations at our Brook Park, Ohio location to a new production facility in Tulsa, Oklahoma |
| Manufacturing in the Oklahoma facility began in late 2004 and the facility became operational in 2005 |
| Additionally, we completed the closure of our Brook Park, Ohio operation during the fourth quarter of 2005 |
| When fully operational, we expect annual savings of approximately dlra2dtta0 million from the new facility |
| In connection with the closure of the Ohio facility, we reported pre-tax restructuring costs of dlra5dtta5 million (dlra0dtta5 million is included in cost of goods sold in our Consolidated Statement of Operations) for the year ended December 31, 2005 and dlra1dtta1 million in the comparable period of 2004 related to relocation and employee severance expenses |
| This decrease in operating income was primarily the result of the direct restructuring costs, operating inefficiencies and duplicate manufacturing costs associated with the transition of operations to our new Oklahoma manufacturing facility from Ohio |
| In addition, we incurred increased loan forgiveness costs and research and development spending |
| These increased costs were partially offset by sales increases in most of our end markets and favorable product mix |
| We expect that we will continue to see strength through 2006 in the majority of our end markets including, construction and mining, heavy-duty truck, specialty friction and fluid power |
| Furthermore, we expect that our net sales will be positively impacted by continued new business awards in all of our business segments, increased sales in the friction products segment direct aftermarket and continued strong performance from our international operations |
| We expect our income from operations to increase to a range of dlra23dtta0 million and dlra25dtta0 million representing an increase of 49dtta4prca to 62dtta3prca from adjusted income from operations of dlra15dtta4 million reported for the full year 2005 |
| Our adjusted income from operations in 2005 excludes restructuring charges of dlra5dtta5 million related to the move of our friction products segment facility to Oklahoma and other net costs of dlra0dtta7 million relating to pension curtailment income and loan forgiveness costs |
| Our 2006 outlook gives continuing effect to the manufacturing start-up costs we expect to incur at our Oklahoma facility during the first and second quarters of the year |
| Our common stock outstanding during the period is estimated to be 9dtta4 million fully diluted shares |
| 22 Critical Accounting Policies Some of our accounting policies require the application of significant judgment by us in the preparation of our 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 |
| Goodwill represents the excess of the cost of companies we acquired over the fair value of their net assets as of the date of acquisition |
| In accordance with SFAS 142, our policy is to evaluate the carrying value of our goodwill and indefinite-lived intangible assets at least annually, or more frequently if there is a significant adverse event or change in the environment in which one of our business unit operates |
| We will record an impairment loss in the period such determination is made |
| 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 |
| If actual results are materially different than the assumptions used, impairment could result |
| We did not record any impairment charges in the periods ended December 31, 2005, 2004 and 2003 |
| · Asset Impairment |
| We review long-lived assets (excluding goodwill) 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 |
| If our estimates or underlying assumptions change in the future, we may be required to record impairment charges |
| We did not record any impairment charges in any of the periods ended December 31, 2005, 2004 or 2003 |
| We account for our defined benefit pension plans in accordance with SFAS Nodtta 87, Employers &apos Accounting for Pensions (SFAS 87), which requires that amounts recognized in financial statements be determined on an actuarial basis |
| The most significant elements in determining our pension income (expense) in accordance with SFAS 87 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 will be 8dtta6prca for 2006 |
| 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 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 produces the expected return on plan assets that is included in pension income (expense) |
| The difference between this expected return and the actual return on plan assets is deferred |
| The net deferral of past asset gains (losses) affects the calculated value of plan assets and, ultimately, future pension income (expense) |
| Our cumulative unrecognized net actuarial loss on pension assets as of December 31, 2005 and 2004 was dlra13dtta5 million and dlra7dtta8 million, respectively |
| 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, 2005, we determined this rate to be 5dtta5prca |
| Changes in discount rates over the past three years have not materially affected pension income (expense), and the net effect of changes in the discount rate, as well as the net effect of other changes in actuarial assumptions and experience, has been deferred as permitted by SFAS 87 |
| 23 · 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 |
| SFAS Nodtta 109, provides certain guidelines to follow in making the determination of the need for a valuation allowance |
| We must show that taxable income is expected to be available for future periods sufficient to realize the benefits of temporary differences and carryforwards to not record an allowance |
| We have identified strategies which, if implemented, would enable us to realize the aforementioned tax benefits, and therefore, we have determined that no valuation allowance is required as of December 31, 2005 |
| On June 30, 2005, the Governor of Ohio signed House Bill 66 into law which significantly changed the corporate tax structure in Ohio |
| The major provisions of the bill include phasing-out the Ohio Franchise Tax and phasing-in a Commercial Activities Tax |
| The tax changes did not have a material effect on our tax provision for the year ended December 31, 2005 |
| · 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 a separate component of our shareholders &apos equity |
| Other comprehensive income includes a translation loss of dlra1dtta4 million for the year ended December 31, 2005 |
| 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 |
| The effect of transaction gains or losses are included in "e Other (expense) income, net "e in our Consolidated Statements of Operations |
| Foreign currency transaction gains and losses were not material to the results of operations in 2005 and 2004 |
| · Recent Accounting Developments |
| In December 2004, the FASB issued SFAS Nodtta 123(R), Share-Based Payment (SFAS 123(R)), which is a revision of SFAS 123 |
| This statement addresses the accounting transactions in which a company exchanges its equity instruments for goods or services |
| It also addresses transactions in which a company incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments |
| SFAS 123(R) eliminates the ability to account for share-based compensation transactions using the intrinsic value method and requires instead that such transactions be accounted for using a fair-value-based method |
| SFAS 123(R) covers a wide range of share-based compensation arrangements, including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans |
| On April 14, 2005, the US Securities and Exchange Commission (SEC) announced a deferral of the effective date of SFAS 123(R) for calendar year companies until the beginning of 2006 |
| Effective January 1, 2006, we have elected to expense employee stock-based compensation using the fair value based method prospectively for all awards granted, modified, or settled on or after January 1, 2006 |
| The fair value at the grant date of the stock options is estimated using the Black-Scholes option pricing model |
| Expense associated with share-based paymentsissued to employees will be included in our Consolidated Statement of Operations beginning on January 1, 2006 |
| We expect that our pre-tax compensation expense for the year ended December 31, 2006 related to the implementation of SFAS 123(R) will be approximately dlra0dtta2 million |
| Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404) contains provisions requiring an annual assessment by management, as of the end of the fiscal year, of the effectiveness of internal control for financial reporting |
| Section 404 also requires attestation and reporting by independent auditors on management’s assessment as well as other control-related matters |
| On March 2, 2005, the SEC published a final rule extending for one year the compliance dates for non-accelerated filers to report on internal control over financial reporting |
| For these issuers, Section 404 now will be effective for fiscal years ending on or after July 15, 2006 |
| At this time, we continue to qualify for non-accelerated filer status and therefore, will not need to comply with Section 404 until December 31, 2006 |
| Our compliance initiatives are moving forward and we anticipate being compliant with requirements of Section 404 as of December 31, 2006 |
| In November 2004, the FASB issued SFAS Nodtta 151, Inventory Costs (SFAS 151) |
| SFAS 151 amends the guidance in ARB Nodtta 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage), and requires such costs to be recognized as current period charges |
| In addition, this statement requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities |
| SFAS 151 will be effective for us beginning January 1, 2006 and we do not believe the adoption will have a material effect on our results of operations, financial condition or liquidity |
| 24 Year Ended December 31, 2005 Compared to Year Ended December 31, 2004 Our continuing operations are organized into three strategic segments |
| These segments include friction products, precision components and performance racing |
| As a result, we have classified this business as discontinued |
| Our consolidated net sales in 2005 were dlra265dtta4 million, an increase of dlra24dtta2 million or 10dtta0prca from the same period in 2004 |
| We experienced sales increases in all of our segments, primarily as a result of the continuing economic expansion during 2005 in the industrial markets we serve, new product introductions and market share gains during the year |
| Net Segment Sales: 2005 2004 $ Change % Change (dollars in millions) Friction products $ 167dtta0 $ 148dtta3 $ 18dtta7 12dtta6 % Precision components 83dtta6 78dtta6 5dtta0 6dtta4 % Performance racing 14dtta8 14dtta3 0dtta5 3dtta5 % Consolidated $ 265dtta4 $ 241dtta2 $ 24dtta2 10dtta0 % · Friction Products |
| Net sales in the friction products segment, our largest, were dlra167dtta0 million in 2005, an increase of dlra18dtta7 million, or 12dtta6prca, compared to dlra148dtta3 million in 2004 |
| As a result of new product introductions, general economic expansion and market share gains, we experienced increases in most of our major markets, including construction and mining, heavy truck and aerospace, increased sales to the direct aftermarket |
| This segment continued to experience strong sales growth from our international operations in 2005 |
| Net sales at our Italian facility, on a local currency basis, increased 10dtta3prca in 2005 compared to 2004, as a result of new product introductions and market share gains |
| Total shipments at our Chinese facility, on a local currency basis, were up 36dtta0prca in 2005 compared to 2004 |
| Our sales to the construction and mining, our largest market, were up 16dtta4prca in 2005 compared to 2004, as a result of strong economic conditions in that market as well as market share gains achieved by us |
| Our sales to the truck market increased by 22dtta5prca in 2005 compared to 2004 as our customers supported the continued growth in new truck builds and aftermarket service requirements to existing truck fleets during the year |
| Our sales to the aerospace market were up 12dtta4prca in 2005 compared to 2004 as world-wide commercial air travel continued its positive growth trend |
| Our sales to the agriculture market decreased 3dtta2prca during the year as a result of a weak farm economies in North America and Europe |
| During 2005, we continued to focus our efforts on the friction direct aftermarket that we service through the Velvetouch® and Hawk Performance® brand names |
| · Precision Components |
| Net sales in our precision components segment were dlra83dtta6 million in 2005, an increase of 6dtta4prca compared to 2004 |
| The increase in net sales was primarily attributable to continued improving conditions in the general industrial segments of the domestic economy served by this segment |
| We experienced sales increases in the fluid power, automotive and power tool markets served by this segment |
| These increases were partially offset by a slight decline in the lawn and garden and appliance markets during the year due primarily to a customer-designed engineering change that eliminated a product previously supplied by us |
| Our precision component segment began production and sale of product from its new powder metal production facility in China during the fourth quarter of 2003 |
| For the year ended December 31, 2005, total shipments from this facility, on a local currency basis, were up 211dtta5prca for the comparable period of 2004 |
| · Performance Racing |
| Net sales in our performance racing segment were dlra14dtta8 million, an increase of 3dtta5prca compared to net sales of dlra14dtta3 million in 2004 |
| The increase in revenues was primarily attributable to the introduction of new clutch and transmission products during the year |
| Gross Profit |
| Our gross profit margin declined to 19dtta8prca of our net sales in 2005 compared to 23dtta4prca of our net sales in 2004 |
| The decline is primarily the result of significant costs incurred during the year as a result of operating inefficiencies associated with the relocation of our Ohio friction products facility to Oklahoma, including increased labor, overtime, maintenance, training, freight and outsourcing costs as a result of the start-up of operations in Oklahoma and operating both the Ohio and Oklahoma facilities during the production transition period |
| In addition we incurred phase-in costs associated with our technology initiatives in our precision components segment and increased inventory reserves in our performance racing segment primarily as a result of rule changes in the racing circuits served by us that rendered portions of our inventory obsolete |
| 25 Gross Profit Margin: 2005 2004 Change Friction products 20dtta1prca 24dtta6 % (4dtta5 %) Precision components 18dtta9prca 21dtta1 % (2dtta2 %) Performance racing 20dtta3prca 23dtta8 % (3dtta5 %) Consolidated 19dtta7prca 23dtta4 % (3dtta7 %) · Friction Products |
| Our friction products segment reported gross profit of dlra33dtta7 million or 20dtta1prca of its net sales in 2005 compared to dlra36dtta5 million or 24dtta6prca of its net sales in 2004 |
| The decrease in our gross profit margin was primarily the result of operating inefficiencies and direct restructuring costs associated with the transition of operations to our new facility in Oklahoma |
| The decrease was partially offset by the impact of sales volume increases during the period and favorable product mix |
| Gross profit in our precision components segment was dlra15dtta8 million or 18dtta9prca of its net sales in 2005 compared to dlra16dtta6 million or 21dtta1prca of its net sales in 2004 |
| The decrease in this segment’s margins was primarily the result of phase-in costs associated with our new technology initiative, higher raw material and energy costs, continuing start-up costs associated with this segment’s operations in China and outsourcing costs required as a result of the overall segments’ sales volume increase to meet customer delivery schedules |
| Our performance racing segment reported gross profit of dlra3dtta0 million or 20dtta3prca of net sales in 2005 compared to dlra3dtta4 million or 23dtta8prca of net sales in 2004 |
| The decline in gross profit in 2005 was primarily the result of cost increases on certain driveline components, reserves created to reflect inventory rendered obsolete as a result of rule changes increased employee benefit costs and product mix |
| Selling, Technical and Administrative Expenses |
| Selling, technical and administrative (ST&A) expenses increased dlra0dtta5 million, or 1dtta3prca, to dlra37dtta9 million in 2005 from dlra37dtta4 million during 2004 |
| The slight increase in ST&A expenses resulted primarily from increased personnel costs to support the sales volume increase in each of our business segments marketing expenses to support our direct aftermarket marketing programs, higher levels of research and development spending and loan forgiveness costs during 2005, offset by reductions in incentive compensation expense for the year |
| Incentive compensation expense declined 38dtta2prca in 2005 compared to 2004 levels |
| We spent dlra6dtta5 million, or 2dtta5prca of our net sales on product research and development in 2005 compared to dlra5dtta6 million, or 2dtta3prca, in 2004 |
| Restructuring Costs |
| Direct restructuring costs (excluding the dlra0dtta5 million recorded in our Cost of sales) for the year ended 2005 were dlra5dtta0 million, consisting of severance, planning, recruiting, relocation and other costs associated with our new manufacturing facility in Oklahoma |
| In the comparable period of 2004, we incurred direct restructuring costs of dlra1dtta1 million |
| The costs reflected in 2005 and 2004 are part of the same initiative relating to the closure of our Brook Park, Ohio facility and its transition to the Tulsa, Oklahoma facility |
| Employee Benefit Curtailment |
| As a result of employment reductions at our Brook Park, Ohio facility as of September 30, 2005, we reduced an actuarially computed liability relating to a benefit no longer owed by us |
| The benefit provided for medical benefits to individuals who met certain age and service requirements at termination of employment |
| This action resulted in reported income of dlra0dtta4 million for the year ended December 31, 2005 |
| There were no employee benefit curtailment charges in 2004 |
| Income from operations decreased dlra8dtta0 million or 46dtta2prca to dlra9dtta3 million for the year ended December 31, 2005, from dlra17dtta3 million in the comparable period of 2004 |
| Income from operations as a percentage of net sales decreased to 3dtta5prca for the year ended December 31, 2005 from 7dtta2prca in the comparable period of 2004 |
| The decrease was primarily the result of direct restructuring costs, operating inefficiencies and duplicate manufacturing costs associated with the transition of operations to our Oklahoma facility from Ohio, increased loan forgiveness costs and increased research and development costs, partially offset by product mix and dlra0dtta4 million of employee benefit curtailment income |
| As a result of the items discussed above, income from operations at each of our segments was as follows: 26 Income (loss) from operations by segment: 2005 2004 $ Change % Change (dollars in millions) Friction products $ 5dtta7 $ 13dtta1 $ (7dtta4 ) (56dtta5 %) Precision components 4dtta1 3dtta5 0dtta6 17dtta1 % Performance racing (0dtta5 ) 0dtta7 (1dtta2 ) (171dtta4 %) Consolidated $ 9dtta3 $ 17dtta3 $ (8dtta0 ) (46dtta2 %) Included in our income from operations for the year ended December 31, 2005 was dlra5dtta5 million of direct restructuring costs related to the plant relocation (dlra0dtta5 million of which was included in our cost of sales), a dlra1dtta0 million charge related to forgiveness of shareholder loans outstanding as of March 31, 2005 and other non-recurring income of dlra0dtta4 million relating to a reversal of a post retirement benefit liability no longer owed by us |
| For the year ended December 31, 2004, income from operations included direct restructuring costs of dlra1dtta1 million and loan forgiveness costs of dlra0dtta7 million |
| Income from operations before these charges was dlra15dtta4 million, or 5dtta8prca of net sales in 2005, a decrease of dlra3dtta7 million, or 19dtta4prca, from dlra19dtta1 million, or 7dtta9prca of net sales in the comparable period of 2004 |
| Years ended December 31 Income (loss) from operations, as reported (GAAP) Restructuring costs ^(1) Other costs, net ^(2) Adjusted income (loss) from operations 2005 2004 2005 2004 2005 2004 2005 2004 (dollars in millions) Friction products $ 5dtta7 $ 13dtta1 $ 5dtta5 $ 1dtta1 $ 0dtta1 $ 0dtta4 $ 11dtta3 $ 14dtta6 Precision components 4dtta1 3dtta5 0dtta4 0dtta3 4dtta5 3dtta8 Performance racing (0dtta5 ) 0dtta7 0dtta1 (0dtta4 ) 0dtta7 Total $ 9dtta3 $ 17dtta3 $ 5dtta5 $ 1dtta1 $ 0dtta6 $ 0dtta7 $ 15dtta4 $ 19dtta1 Operating margin 3dtta5 % 7dtta2 % 5dtta8 % 7dtta9 % (1) Restructuring costs in this table for the period ended December 31, 2005 include dlra0dtta5 million classified in our Consolidated Statement of Operations as cost of sales items |
| (2) Other costs, net includes loan forgiveness costs of dlra1dtta0 million for the year ended December 31, 2005 and dlra0dtta7 million for the year ended December 31, 2004, net of employee benefit curtailment income of dlra0dtta4 million for the year ended December 31, 2005 |
| The table above discloses “Adjusted income (loss) from operations,” which is considered to be a “non-GAAP financial measure” under the rules and regulations of the |
| 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 our 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 See the section in |