Hawk Corporation 2006 Third Quarter Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

Commission File Number 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)

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 reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £

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 Rule 12b-2 of the Exchange Act). Yes £ No R

As of November 1, 2006, the Registrant had the following number of shares of common stock outstanding:

Class A Common Stock, $0.01 par value:	9,007,454
Class B Common Stock, $0.01 par value:	None (0)

As used in this Form 10-Q, 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-Q is as of September 30, 2006.

			Page
PART I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements (Unaudited)	3
	Item 2.	Management’s Discussion and Analysis of Financial	24
		Condition and Results of Operations
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	37
	Item 4.	Controls and Procedures	37
PART II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	38
	Item 1A.	Risk Factors	38
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39
	Item 3.	Defaults upon Senior Securities	39
	Item 4.	Submission of Matters to a Vote of Security Holders	39
	Item 5.	Other Information	39
	Item 6.	Exhibits	39
	SIGNATURES		40

PART 1 FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

HAWK CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

	September 30		December 31
	2006		2005
	(Unaudited)		(Note A)
Assets
Current assets:
Cash and cash equivalents	$	5,893	$	7,111
Accounts receivable, less allowance of $1,330 in 2006 and $1,046 in 2005		48,506		36,225
Inventories:
Raw materials		16,747		13,881
Work-in-process		16,010		14,433
Finished products		17,718		18,065
Total inventories		50,475		46,379
Deferred income taxes		4,546		4,430
Taxes receivable		42		347
Other current assets		5,245		5,660
Assets held for sale		-		1,644
Assets of discontinued operations		3,980		3,633
Total current assets		118,687		105,429

Property, plant and equipment:
Land and improvements		1,357		1,340
Buildings and improvements		19,412		18,539
Machinery and equipment		136,214		126,201
Furniture and fixtures		10,117		9,365
Construction in progress		3,496		5,317
		170,596		160,762
Less accumulated depreciation		99,770		89,844
Total property, plant and equipment		70,826		70,918

Other assets:
Goodwill		32,495		32,495
Finite-lived intangible assets		8,056		8,435
Deferred income taxes		916		916
Other		7,728		8,035
Total other assets		49,195		49,881
Total assets	$	238,708	$	226,228

HAWK CORPORATION

CONSOLIDATED BALANCE SHEETS (Continued)

(In thousands, except share data)

	September 30			December 31
	2006			2005
	(Unaudited)			(Note A)
Liabilities and shareholders' equity
Current liabilities:
Accounts payable	$	31,785		$	30,444
Accrued compensation		8,336			6,102
Accrued interest		2,494			4,895
Accrued taxes		3,260			664
Other accrued expenses		9,434			7,968
Short-term debt		1,146			1,386
Current portion of long-term debt		247			307
Liabilities of discontinued operations		2,693			3,334
Total current liabilities		59,395			55,100

Long-term liabilities:
Long-term debt		117,321			115,892
Deferred income taxes		1,026			885
Pension liabilities		10,554			10,522
Other accrued expenses		3,580			3,113
Total long-term liabilities		132,481			130,412

Shareholders' equity
Series D preferred stock, $.01 par value; an aggregate liquidation value of $1,530, plus any unpaid dividends with 9.8% cumulative dividend (1,530 shares authorized, issued and outstanding)		1			1
Series E preferred stock, $.01 par value; 100,000 shares authorized; none issued or outstanding		-			-
Class A common stock, $.01 par value; 75,000,000 shares authorized; 9,187,750 issued; 9,007,334 and 8,935,659 outstanding in 2006 and 2005, respectively		92			92
Class B common stock, $.01 par value; 10,000,000 shares authorized none issued or outstanding		-			-
Additional paid-in capital		53,425			53,349
Retained deficit		(544	)		(4,845	)
Accumulated other comprehensive loss		(4,715	)		(5,986	)
Treasury stock, at cost, 180,416 and 252,091 shares in 2006 and 2005, respectively		(1,427	)		(1,895	)
Total shareholders' equity		46,832			40,716
Total liabilities and shareholders' equity	$	238,708		$	226,228

Note A: The balance sheet at December 31, 2005 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. See notes to consolidated financial statements (unaudited).

HAWK CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

	(Unaudited)
	Three Months Ended						Nine Months Ended
	September 30						September 30
	2006			2005			2006			2005
Net sales	$	73,673		$	62,808		$	228,375		$	205,753
Cost of sales		55,776			52,952			180,114			159,693
Gross profit		17,897			9,856			48,261			46,060

Operating expenses:
Selling, technical and administrative expenses		11,202			8,429			31,898			29,568
Restructuring costs		-			1,977			-			3,880
Employee benefit curtailment		-			(424	)		-			(424	)
Amortization of finite-lived intangible assets		126			184			379			552
Total operating expenses		11,328			10,166			32,277			33,576
Income (loss) from operations		6,569			(310	)		15,984			12,484

Interest expense		(2,852	)		(2,625	)		(8,508	)		(7,866	)
Interest income		40			6			63			21
Other income (expense), net		52			(51	)		132			(307	)
Income (loss) from continuing operations, before income taxes		3,809			(2,980	)		7,671			4,332

Income tax provision (benefit)		2,012			(1,273	)		3,820			2,501

Income (loss) from continuing operations, after income taxes		1,797			(1,707	)		3,851			1,831
Income from discontinued operations, net of tax of $165 and $302 for the three and nine months ended September 30, 2006 respectivly, and $7 and $67 for the three and nine months ended September 30, 2005		307			14			562			125

Net income (loss)	$	2,104		$	(1,693	)	$	4,413		$	1,956

Earnings (loss) per share:
Basic earnings (loss) per share:
Earnings from continuing operations, after income taxes	$	0.20		$	(0.19	)	$	0.42		$	0.19
Discontinued operations		0.03			-			0.06			0.01
Net earnings (loss) per basic share	$	0.23		$	(0.19	)	$	0.48		$	0.20

Diluted earnings (loss) per share:
Earnings (loss) from continuing operations, after income taxes	$	0.19		$	(0.19	)	$	0.39		$	0.19
Discontinued operations		0.03			-			0.06			0.01
Net earnings (loss) per diluted share	$	0.22		$	(0.19	)	$	0.45		$	0.20

Average shares outstanding - basic		9,007			8,880			8,988			8,854

Average shares and equivalents outstanding - diluted		9,498			8,880			9,518			9,345

See notes to consolidated financial statements (unaudited).

HAWK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	(Unaudited)
	Nine Months Ended
	September 30			September 30
	2006			2005
Cash flows from operating activities
Net income	$	4,413		$	1,956
Adjustments to reconcile net income to net cash provided by operating activities:
Income from discontinued operations, net of tax		(562	)		(125	)
Depreciation and amortization		9,615			8,743
Loss on sale or disposal of fixed assets		39			682
Changes in operating assets and liabilites:
Accounts receivable		(11,528	)		(2,147	)
Inventories		(3,614	)		(5,056	)
Other assets		784			(73	)
Accounts payable		1,090			3,850
Accrued expenses		3,727			682
Other liabilities and other		510			(136	)
Net cash provided by operating activities of continuing operations		4,474			8,376

Net cash (used in) provided by operating activities of discontinued operations		(426	)		686

Cash flows from investing activities
Purchases of property, plant and equipment		(8,840	)		(11,664	)
Proceeds from sale of property, plant and equipment		1,668			76
Net cash used in investing activities of continuing operations		(7,172	)		(11,588	)

Net cash used in investing activities of discontinued operations		-			(42	)

Cash flows from financing activities
Proceeds from short-term debt		457			(125	)
Payments on short-term debt		(739	)		-
Proceeds from long-term debt		65,378			63,624
Payments on long-term debt		(63,974	)		(61,655	)
Stock options and issuance of treasury stock as compensation, net		545			518
Payments of preferred stock dividends		(113	)		(113	)
Net cash provided by financing activities of continuing operations		1,554			2,249
Net cash provided by financing activities of discontinued operations		-			-
Effect of exchange rate changes on cash		352			(439	)
Net cash used in continuing operations		(792	)		(1,402	)
Net cash (used in) provided by discontinued operations		(426	)		644
Net decrease in cash and cash equivalents		(1,218	)		(758	)
Cash and cash equivalents at beginning of period		7,111			6,785
Cash and cash equivalents at end of period	$	5,893		$	6,027

See notes to consolidated financial statements (unaudited).

HAWK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 30, 2006

(In thousands, except share data)

NOTE 1 - BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in conformity with U.S generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2006 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2006. For further information, refer to the consolidated financial statements and footnotes thereto in the Form 10-K for Hawk Corporation (Company) for the year ended December 31, 2005.

The Company, through its business segments, designs, engineers, manufactures and markets specialized components used in a variety of industrial, commercial and aerospace applications.

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in the accompanying financial statements.

Certain amounts have been reclassified to conform to the 2006 reporting presentation.

NOTE 2 - FINITE-LIVED INTANGIBLE ASSETS

The components of finite-lived intangible assets are as follows:

	September 30, 2006						December 31, 2005
	Gross		Accumulated Amortization		Net		Gross		Accumulated Amortization		Net
Product certifications	$	20,820	$	12,812	$	8,008	$	20,820	$	12,441	$	8,379
Other intangible assets		2,719		2,671		48		2,719		2,663		56

	$	23,539	$	15,483	$	8,056	$	23,539	$	15,104	$	8,435

Product certifications were acquired and valued based on the acquired company’s position as a certified supplier of friction materials to the major manufacturers of commercial aircraft brakes.

The Company estimates that amortization expense for finite-lived intangible assets in 2006 will be approximately $500.

NOTE 3 - COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) is as follows:

	Three months ended					Nine months ended
	September 30					September 30
	2006		2005			2006		2005
Net income (loss)	$	2,104	$	(1,693	)	$	4,413	$	1,956
Foreign currency translation		214		(20	)		1,271		(1,363	)
Comprehensive income (loss)	$	2,318	$	(1,713	)	$	5,684	$	593

NOTE 4 - INVENTORIES

Inventories are stated at the lower of cost or market. Cost includes materials, labor and overhead and is determined by the first-in, first-out (FIFO) method.

NOTE 5 - STOCK COMPENSATION PLAN

On January 1, 2006 the Company adopted the provisions of SFAS No. 123R, Share-Based Payment (SFAS 123R), using the modified prospective transition method. The modified prospective transition method requires that compensation cost be recognized in the financial statements for all awards granted after the date of adoption as well as for existing awards for which the requisite service has not been rendered as of the date of adoption. This method also requires that prior periods not be restated. The Company’s stock compensation plans provide for the granting up to 1,400,000 shares of common stock of the Company. Options generally vest over a five year period after the grant date and expire no more than ten years after grant. Prior to the adoption of SFAS 123R, the Company used the intrinsic-value based method to account for stock options and made no charges against earnings with respect to options granted.

The adoption of SFAS 123R reduced income before income taxes for the three months ended September 30, 2006 by $65 and for the nine months ended September 30, 2006 by $167. No stock-based employee compensation cost is reflected in net income prior to the adoption of SFAS 123R, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant. In accordance with SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure (SFAS 148), the following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 Accounting for Stock-Based Compensation (SFAS 123) in 2005:

	Three months ended			Nine months ended
	September 30, 2005			September 30, 2005
Net (loss) income as reported	$	(1,693	)	$	1,956
Employee stock-based compensation expense determined under fair value based methods, net of tax of $46 for the three months ended September 30, 2006 and $125 for the nine months ended September 30, 2005		74			200
Pro forma net (loss) earnings	$	(1,767	)	$	1,756

Basic (loss) earnings per share:
As reported	$	(0.19	)	$	0.20
Pro forma	$	(0.20	)	$	0.19
Diluted (loss) earnings per share:
As reported	$	(0.19	)	$	0.20
Pro forma	$	(0.20	)	$	0.19

Stock-based option activity during the nine months ended September 30, 2006 is as follows:

Options

Weighted

Average

Exercise

Price

Weighted

Average

Remaining Contractual Term

Aggregate Intrinsic Value

(in thousands)

Options outstanding at December 31, 2005

942,080

5.13

Granted

20,000

13.97

Exercised

(66,363

)

4.90

Forfeited or expired

(8,000

)

7.70

Options outstanding at September 30, 2006

887,717

5.33

5.8 yrs.

4,730

Exercisable at September 30, 2006

716,833

4.93

5.4 yrs.

3,537

Substantially all outstanding stock-based awards are expected to vest. Net cash proceeds from the exercise of stock options was $7 for the three months ended September 30, 2006 and $337 for the nine months ended September 30, 2006.

As of September 30, 2006 there was $371 of total unrecognized compensation cost related to the non-vested share-based compensation arrangements under the Company’s stock compensation plans. The cost is expected to be recognized over the next five years.

NOTE 6 - DISCONTINUED OPERATIONS

During the fourth quarter of 2003, the Company committed to a plan to sell its 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, the Company determined that a divestiture of this segment would allow the Company to concentrate on its major business segments.

The disposition of the Alton facility was completed in 2004. On March 29, 2006, the Company entered into an agreement to sell the Monterrey, Mexico operations contingent on several closing conditions and anticipates the closing to occur prior to the end of 2006.

Operating results from discontinued operations are summarized as follows:

	Three months ended				Nine months ended
	September 30				September 30
	2006		2005		2006		2005
Net sales	$	2,587	$	2,036	$	7,520	$	6,809

Income from discontinued operations before income taxes	$	472	$	21	$	864	$	192
Income tax expense		165		7		302		67
Income from discontinued operations, net of tax	$	307	$	14	$	562	$	125

The assets and liabilities of this segment, which have been classified as assets and liabilities of discontinued operations in the Consolidated Balance Sheets, consist of the following at September 30, 2006 and December 31, 2005:

	September 30		December 31
	2006		2005
Accounts receivable	$	2,361	$	1,926
Inventory		626		490
Other current assets		665		889
Property, plant and equipment		328		328
Total assets of discontinued operations	$	3,980	$	3,633

Accounts payable	$	2,507	$	3,135
Other accrued expenses		186		199
Total liabilities of discontinued operations	$	2,693	$	3,334

NOTE 7 - RESTRUCTURING

In accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS 146), the Company recorded liabilities for costs associated with exit or disposal activities, including restructuring costs, when the liability is incurred instead of at the date of commitment to an exit or disposal activity.

In the fourth quarter of 2003, the Company committed to a restructuring program in its friction products segment to achieve cost savings and expand its capacity by moving operations from its Brook Park, Ohio location to a new production facility in Tulsa, Oklahoma. During 2004, the Company substantially completed the construction of its new and larger, leased facility. During 2005, all manufacturing was transferred to Tulsa and the Brook Park operation was closed. This restructuring program was completed in 2005, therefore the Company did not incur any restructuring charges in the nine months ended September 30, 2006 and does not anticipate incurring any restructuring charges for the remainder of 2006. However, the Company continues to manage transitional issues during the current period. In the three and nine months ended September 30, 2005, the Company incurred $2,217 and $4,288 of restructuring costs, respectively, $240 and $408 of which were included in “Cost of sales” in the Consolidated Statements of Income.

The following table sets forth the cash flow activity related to restructuring accrual for the nine months ended September 30, 2006:

Restructuring cost accrual as of January 1, 2006	$	473
Cash payments through September 30, 2006		473
Restructuring cost accrual as of September 30, 2006	$	-

During the third quarter of 2005, the Company entered into a contract to sell the Brook Park, Ohio manufacturing facility. The assets under contract were reported as “Assets held for sale” on the December 31, 2005 Consolidated Balance Sheet, in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The Company completed the sale of the Brook Park facility and received net cash proceeds of $1.6 million during the third quarter of 2006, resulting in a net gain of $15 on the transaction.

NOTE 8 - EMPLOYEE BENEFITS

A summary of the components of net periodic benefit cost of the Company’s defined benefit pension plans for the three and nine months ended September 30 is as follows:

	Three months ended					Nine months ended
	September 30						September 30
	2006			2005			2006			2005
Service cost – benefits earned during the period	$	52		$	265		$	678		$	796
Interest cost on projected benefit obligation		427			379			1,324			1,137
Expected return on plan assets		(485	)		(453	)		(1,438	)		(1,360	)
Amortization of prior service cost		58			2			81			7
Pension settlement / curtailment		-			-			42			-
Recognized net actuarial loss		75			67			389			200
Net periodic benefit cost	$	127		$	260		$	1,076		$	780

As of September 30, 2006, $1,433 of contributions have been made on a cash basis to the Company’s defined benefit pension plans. Hawk presently anticipates contributing an additional $337 to fund its defined benefit pension plans in 2006 for a total of $1,768.

The Company froze one of its defined benefit pension plans effective May 31, 2006 as part of the Company’s move to a common 401(k) retirement plan program for all non-union salary and hourly employees in the United States as of June 1, 2006.

In September 2006, FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No 87, 88, 106 and 132(R) (SFAS 158). SFAS 158 requires the recognition of the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in the statement of financial position and the recognition of changes in that funded status in the year in which the changes occur through comprehensive income. SFAS 158 also requires the measurement of the funded status of a plan as of the date of the year-end statement of financial position. This statement is effective for the Company as of December 31, 2006. The Company is currently in the process of evaluating SFAS 158 on its consolidated financial statements and expects to adopt this statement as of December 31, 2006.

NOTE 9 - INCOME TAXES

The effective income tax rates from continuing operations for the nine months ended September 30, 2006 and 2005 are 49.8% and 57.7%, respectively. The Company’s effective tax rate is higher than the statutory rate primarily due to higher tax rates in its foreign jurisdictions and the lack of state tax benefits for domestic entities in a net loss position. The lower effective tax rate in 2006 compared to 2005 is the result of improved domestic earnings.

In July 2006, FASB issued Financial Interpretation No. 48 Accounting for Uncertainty in Income Taxes - an amendment of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes by establishing minimum standards for the recognition and measurement of tax positions taken or expected to be taken in a tax return. Under the requirements of FIN 48, the Company must review all of its uncertain tax positions and make a determination as to whether the Company’s position is more-likely-than-not to be sustained upon examination by regulatory authorities. If a position meets the more-likely-than-not criteria, then the related tax benefit is measured based on the cumulative probability analysis of the amount that is more-likely-than-not to be realized upon ultimate settlement. For the Company, FIN 48 is effective on January 1, 2007. FIN 48 represents a significant change in accounting for income taxes. Accordingly, the Company is currently evaluating the impact of this interpretation on its financial statements and will adopt FIN 48 as required.

NOTE 10 - EARNINGS PER SHARE

Basic and diluted earnings per share are computed as follows:

	Three months ended September 30					Nine months ended September 30
	2006		2005			2006		2005
Income (loss) from continuing operations, after income taxes	$	1,797	$	(1,707	)	$	3,851	$	1,831
Less: Preferred stock dividends		37		38			113		113
Income (loss) from continuing operations, after income taxes available to common shareholders	$	1,760	$	(1,745	)	$	3,738	$	1,718

Net income (loss)	$	2,104	$	(1,693	)	$	4,413	$	1,956
Less: Preferred stock dividends		37		38			113		113
Net income (loss) available to common shareholders	$	2,067	$	(1,731	)	$	4,300	$	1,843

Weighted average shares outstanding (in thousands):
Basic weighted average shares outstanding		9,007		8,880			8,988		8,854
Diluted:
Basic weighted average shares outstanding		9,007		8,880			8,988		8,854
Dilutive effect of stock options		491		-			530		491
Diluted weighted average shares outstanding		9,498		8,880			9,518		9,345

Earnings (loss) per share:
Basic earnings (loss) from continuing operations, after income taxes	$	0.20	$	(0.19	)	$	0.42	$	0.19
Discontinued operations		0.03		-			0.06		0.01
Net earnings (loss) per basic share	$	0.23	$	(0.19	)	$	0.48	$	0.20

Diluted earnings (loss) from continuing operations, after income taxes	$	0.19	$	(0.19	)	$	0.39	$	0.19
Discontinued operations		0.03		-			0.06		0.01
Net earnings (loss) per diluted share	$	0.22	$	(0.19	)	$	0.45	$	0.20

NOTE 11- BUSINESS SEGMENTS

The Company operates in three business segments: friction products, precision components and performance racing. The Company's reportable segments are strategic business units that offer different products and services. They are managed separately based on fundamental differences in their operations.

The friction products segment engineers, manufactures and markets specialized components, used in a variety of industrial, commercial and aerospace applications. The Company, through this segment, is a worldwide supplier of friction components for brakes, clutches and transmissions.

The precision components segment engineers, manufactures and markets specialized powder metal components, used primarily in industrial and consumer applications. The Company, through this segment, targets four areas of the powder metal component marketplace: high precision components that are primarily used in fluid power applications, large structural powder metal parts used in construction, agricultural and truck applications, smaller high-volume parts and metal injected molded powder metal parts.

The performance racing segment engineers, manufactures and markets premium branded clutch, transmissions and driveline systems. The Company, through this segment, targets leading teams in the National Association for Stock Car Auto Racing (NASCAR), the American LeMans Racing Series (ALMS), weekend enthusiasts in the Sports Car Club of America (SCCA) and other road racing and oval track competition cars.

Information by segment is as follows:

	Three months ended						Nine months ended
	September 30						September 30
	2006			2005			2006			2005
Net sales to external customers:
Friction products	$	50,140		$	40,192		$	149,379		$	130,205
Precision components		20,717			19,134			69,106			63,146
Performance racing		2,816			3,482			9,890			12,402
Consolidated	$	73,673		$	62,808		$	228,375		$	205,753

Depreciation and amortization: (1)
Friction products	$	1,776		$	1,681		$	5,225		$	5,196
Precision components		1,321			1,014			3,885			3,053
Performance racing		61			58			177			170
Consolidated	$	3,158		$	2,753		$	9,287		$	8,419

Gross profit:
Friction products	$	14,347		$	6,262		$	33,726		$	30,988
Precision components		3,139			3,096			12,787			12,162
Performance racing		411			498			1,748			2,910
Consolidated	$	17,897		$	9,856		$	48,261		$	46,060

Income (loss) from operations:
Friction products	$	7,346		$	(404	)	$	13,815		$	9,480
Precision components		(251	)		380			3,249			2,589
Performance racing		(526	)		(286	)		(1,080	)		415
Consolidated	$	6,569		$	(310	)	$	15,984		$	12,484

____________

(1)

Depreciation and amortization outlined in this table does not include deferred financing amortization of $109 and $328 in the first three and nine months ended September 30, 2006 and $108 and $324 in the first three and nine months ended September 30, 2005, which is included in Interest expense on the Consolidated Statements of Income.

The following section discloses adjusted income (loss) from operations for each business segment. This disclosure differs from income (loss) from operations, the most directly comparable measure calculated in accordance with GAAP. A reconciliation of this financial measure to the most comparable GAAP measure is included in the table below.

Reconciliation of adjusted income (loss) from operations to income from operations determined in accordance with GAAP:

	Three months ended						Nine months ended
	September 30						September 30
	2006			2005			2006			2005
Income (loss) from operations - Friction products	$	7,346		$	(404	)	$	13,815		$	9,480
Restructuring costs		-			2,217			-			4,288
Loan forgiveness costs		-			-			-			593
Employee benefit curtailment income		-			(424	)		-			(424	)
Adjusted income from operations – Friction products	$	7,346		$	1,389		$	13,815		$	13,937

(Loss) income from operations - Precision components	$	(251	)	$	380		$	3,249		$	2,589
Loan forgiveness costs		-			-			-			443
Adjusted (loss) income from operations – Precision components	$	(251	)	$	380		$	3,249		$	3,032

(Loss) income from operations - Performance racing	$	(526	)	$	(286	)	$	(1,080	)	$	415
Loan forgiveness costs		-			-			-			64
Adjusted (loss) income from operations – Performance racing	$	(526	)	$	(286	)	$	(1,080	)	$	479

The Company has presented this non-GAAP financial measure because it believes that meaningful analysis of its financial performance is enhanced by an understanding of isolated factors underlying that performance. In addition, the Company’s chief operating decision makers use this adjusted measure in monitoring and evaluating both its overall performance and the ongoing performance of each of its business segments. This non-GAAP financial measure should not be considered an alternative to measures required by GAAP. Refer to the section “Non-GAAP Financial Measure” in the MD&A section of this Form 10-Q for more detailed disclosure.

NOTE 12 - RELATED PARTIES

In July 1995, two of the Company’s senior executive officers were issued interest-bearing notes by the Company in the amount of $1,604, enabling them to repay certain indebtedness incurred by them with respect to an acquisition. The notes bore interest at the prime rate. The notes were due and payable on July 1, 2005. In May 1998, $604 of the principal balance of the notes was repaid by the senior executive officers. On January 30, 2004, the compensation committee of the Company’s Board of Directors approved the forgiveness of the shareholder notes of these two senior executive officers by July 1, 2005 if specific operating targets were achieved. As of March 31, 2005, the remaining $600 of the shareholder notes was forgiven by the compensation committee of the Company’s Board of Directors, based on the achievement of similar specified operating targets. In addition, the Board of Directors awarded $500 to the senior executive officers to pay the taxes associated with the forgiveness of this portion of their debt. As of September 30, 2006, and December 31, 2005, there were no shareholder notes outstanding. The forgiveness of the shareholder notes and the associated taxes were reported as compensation expense and included in Selling, technical and administrative expenses in the Company’s Consolidated Statements of Income for the nine months ended September 30, 2005.

NOTE 13 - SUPPLEMENTAL GUARANTOR INFORMATION

Each of the guarantor subsidiaries has fully and unconditionally guaranteed, on a joint and several basis, to pay principal, premium, and interest with respect to the Company’s 8¾% senior notes due November 1, 2014 (senior notes). The guarantor subsidiaries are direct or indirect wholly-owned subsidiaries of the Company.

The following supplemental condensed consolidating financial statements present:

Condensed consolidating balance sheets as of September 30, 2006 and December 31, 2005, condensed consolidating statements of income for the three and nine months ended September 30, 2006 and 2005, and condensed consolidating statements of cash flows for the nine months ended September 30, 2006 and 2005.

·	Hawk Corporation (Parent), combined guarantor subsidiaries consisting of the Company’s domestic subsidiaries and combined non-guarantor subsidiaries consisting of the Company's subsidiaries in Canada, Italy, and China, with their investments in subsidiaries accounted for using the equity method.

·	Elimination entries necessary to consolidate the financial statements of the Parent and all of its subsidiaries.

The Company does not believe that separate financial statements of the guarantor subsidiaries are material to investors. Therefore, separate financial statements and other disclosures concerning the guarantor subsidiaries are not presented. The Credit and Security Agreement, dated November 1, 2004, with KeyBank National Association, serving as Administrative Agent and Letter of Credit Issuer (the bank facility) contains covenants with respect to the Company and its subsidiaries that, among other things, would prohibit the payment of dividends to the Company by the subsidiaries (including guarantor subsidiaries) in the event of a default under the terms of the bank facility. The indenture governing the senior notes permits the payment of any dividends to the Company by the subsidiaries (including guarantor subsidiaries) provided that no event of default has occurred under the terms of the indenture.

Supplemental Condensed Consolidating

Balance Sheet

September 30, 2006 (Unaudited)

Parent

Combined Guarantor Subsidiaries

Combined

Non-Guarantor Subsidiaries

Eliminations

Consolidated

Assets

Current assets:

Cash and cash equivalents

141

251

5,501

5,893

Accounts receivable, net

30,602

17,904

48,506

Inventories, net

(867

)

38,250

13,889

(797

)

50,475

Deferred income taxes

4,252

294

4,546

Taxes receivable

Other current assets

1,300

1,813

2,133

)

5,245

Assets held for sale

Assets of discontinued operations

3,980

Total current assets

4,868

70,916

43,701

(798

)

118,687

Investment in subsidiaries

793

(793

)

Inter-company advances, net

(675

)

2,801

(2,114

)

(12

)

Propery, plant and equipment, net

59,451

11,375

70,826

Other assets:

Goodwill and other intangible assets

40,479

40,551

Other

1,335

5,837

945

527

8,644

Total other assets

1,407

46,316

945

527

49,195

Total assets

6,393

179,484

53,907

(1,076

)

238,708

Liabilities and shareholders' equity

Current liabilities:

Accounts payable

20,105

11,636

31,785

Accrued compensation

1,552

4,827

1,957

8,336

Accrued interest

2,484

2,494

Accrued taxes

866

282

2,383

(271

)

3,260

Other accrued expenses

1,568

7,000

866

9,434

Short-term debt

1,146

Current portion of long-term debt

120

127

247

Liabilities of discontinued operations

2,662

2,693

Total current liabilities

6,514

32,365

20,787

(271

)

59,395

Long-term liabilities:

Long-term debt

116,636

603

117,321

Deferred income taxes

947

1,026

Other

663

9,549

3,922

14,134

Inter-company advances, net

(189,140

)

178,429

10,711

Total long-term liabilities

(71,762

)

188,581

15,662

132,481

Shareholders' equity

71,641

(41,462

)

17,458

(805

)

46,832

Total liabilities and shareholders' equity

6,393

179,484

53,907

(1,076

)

238,708

Supplemental Condensed Consolidating

Balance Sheet

	December 31, 2005 (Unaudited)
	Parent			Combined Guarantor Subsidiaries			Combined Non-Guarantor Subsidiaries			Elimination			Consolidated
Assets
Current assets:
Cash and cash equivalents	$	229		$	45		$	6,837		$	-		$	7,111
Accounts receivable, net		-			25,989			10,236			-			36,225
Inventories, net		(716	)		37,119			10,543			(567	)		46,379
Deferred income taxes		4,112			-			318			-			4,430
Taxes receivable		347			-			-			-			347
Other current assets		1,258			2,481			2,038			(117	)		5,660
Assets held for sale		-			1,644			-			-			1,644
Assets of discontinued operations		-			5			3,628			-			3,633
Total current assets		5,230			67,283			33,600			(684	)		105,429
Investment in subsidiaries		793			-			-			(793	)		-
Inter-company advances, net		(800	)		2,593			(1,793	)		-			-
Property, plant and equipment, net		-			60,856			10,062			-			70,918
Other assets:
Goodwill and other intangible assets		286			40,644			-			-			40,930
Other		916			8,034			897			(896	)		8,951
Total other assets		1,202			48,678			897			(896	)		49,881
Total assets	$	6,425		$	179,410		$	42,766		$	(2,373	)	$	226,228
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable	$	-		$	20,620		$	9,824		$	-		$	30,444
Accrued compensation		286			3,987			1,829			-			6,102
Accrued interest		4,863			-			32			-			4,895
Accrued taxes		603			197			37			(173	)		664
Other accrued expenses		1,203			6,164			601			-			7,968
Short-term debt		-			-			1,386			-			1,386
Current portion of long-term debt		-			165			142			-			307
Liabilities of discontinued operations		-			67			3,267			-			3,334
Total current liabilities		6,955			31,200			17,118			(173	)		55,100
Long-term liabilities:
Long-term debt		115,041			689			162			-			115,892
Deferred income taxes		-			-			885			-			885
Other		-			10,156			3,479			-			13,635
Inter-company advances, net		(186,777	)		178,420			8,846			(489	)		-
Total long-term liabilities		(71,736	)		189,265			13,372			(489	)		130,412
Shareholders’ equity		71,206			(41,055	)		12,276			(1,711	)		40,716
Total liabilities and shareholders’ equity	$	6,425		$	179,410		$	42,766		$	(2,373	)	$	226,228

Supplemental Condensed Consolidating

Statement of Income

Three Months Ended September 30, 2006 (Unaudited)

Parent

Combined Guarantor Subsidiaries

Combined

Non-Guarantor Subsidiaries

Eliminations

Consolidated

Net sales

59,170

17,213

(2,710

)

73,673

Cost of sales

44,670

13,816

(2,710

)

55,776

Gross profit

14,500

3,397

17,897

Operating expenses:

Selling, technical and administrative expenses

956

8,703

1,543

11,202

Amortization of intangibles

126

Total operating expenses

956

8,829

1,543

11,328

(Loss) income from operations

(956

)

5,671

1,854

6,569

Interest income (expense), net

891

(3,702

)

(2,812

)

Income from equity investee

2,608

1,185

(3,793

)

Other (expense) income, net

(56

)

Income from continuing operations, before income taxes

2,487

3,169

1,946

(3,793

)

3,809

Income tax provision

383

613

1,016

2,012

Income from continuing operations, after income taxes

2,104

2,556

930

(3,793

)

1,797

Discontinued operations, net of tax

255

307

Net income

2,104

2,608

1,185

(3,793

)

2,104

Supplemental Condensed Consolidating

Statement of Income

	Three Months Ended September 30, 2005 (Unaudited)
	Parent			Combined Guarantor Subsidiaries			Combined Non-Guarantor Subsidiaries			Eliminations			Consolidated
Net sales	$	-		$	49,825		$	15,347		$	(2,364	)	$	62,808
Cost of sales		-			43,327			11,989			(2,364	)		52,952
Gross profit		-			6,498			3,358			-			9,856
Operating expenses:
Selling, technical and administrative expense		42			6,996			1,391			-			8,429
Restructuring costs		-			1,977			-			-			1,977
Employee benefit curtailment		-			(424	)		-			-			(424	)
Amortization of intangibles		-			184			-			-			184
Total operating expenses		42			8,733			1,391			-			10,166
(Loss) income from operations		(42	)		(2,235	)		1,967			-			(310	)
Interest income (expense), net		892			(3,491	)		(20	)		-			(2,619	)
(Loss) income from equity investee		(2,352	)		1,204			-			1,148			-
Other (expense) income, net		-			(109	)		58			-			(51	)
(Loss) income from continuing operations, before income taxes		(1,502	)		(4,631	)		2,005			1,148			(2,980	)
Income tax provision (benefit)		191			(2,237	)		773			-			(1,273	)
(Loss) income from continuing operations, after income taxes		(1,693	)		(2,394	)		1,232			1,148			(1,707	)
Discontinued operations, net of tax		-			42			(28	)		-			14
Net (loss) income	$	(1,693	)	$	(2,352	)	$	1,204		$	1,148		$	(1,693	)

Supplemental Condensed Consolidating

Statement of Income

Nine Months Ended September 30, 2006 (Unaudited)

Parent

Combined Guarantor Subsidiaries

Combined

Non-Guarantor Subsidiaries

Eliminations

Consolidated

Net sales

183,400

55,556

(10,581

)

228,375

Cost of sales

147,252

43,443

(10,581

)

180,114

Gross profit

36,148

12,113

48,261

Operating expenses:

Selling, technical and administrative expenses

1,057

25,965

4,876

31,898

Amortization of intangibles

379

Total operating expenses

1,057

26,344

4,876

32,277

(Loss) income from operations

(1,057

)

9,804

7,237

15,984

Interest income (expense), net

2,674

(11,084

)

(35

)

(8,445

)

Income from equity investee

4,000

4,332

(8,332

)

Other (expense) income, net

(26

)

132

Income from continuing operations, before income taxes

5,591

3,151

7,261

(8,332

)

7,671

Income tax provision (benefit)

1,178

(716

)

3,358

3,820

Income from continuing operations, after income taxes

4,413

3,867

3,903

(8,332

)

3,851

Discontinued operations, net of tax

133

429

562

Net income

4,413

4,000

4,332

(8,332

)

4,413

Supplemental Condensed Consolidating

Statement of Income

	Nine Months Ended September 30, 2005 (Unaudited)
	Parent			Combined Guarantor Subsidiaries			Combined Non-Guarantor Subsidiaries			Eliminations			Consolidated
Net sales	$	-		$	164,105		$	50,165		$	(8,517	)	$	205,753
Cost of sales		-			129,969			38,241			(8,517	)		159,693
Gross profit		-			34,136			11,924			-			46,060
Operating expenses:
Selling, technical and administrative expenses		970			24,272			4,326			-			29,568
Restructuring costs		-			3,880			-			-			3,880
Employee benefit curtailment		-			(424	)		-			-			(424	)
Amortization of intangibles		-			552			-			-			552
Total operating expenses		970			28,280			4,326			-			33,576
(Loss) income from operations		(970	)		5,856			7,598			-			12,484
Interest income (expense), net		2,686			(10,463	)		(68	)		-			(7,845	)
Income from equity investee		1,767			4,624			-			(6,391	)		-
Other (expense) income, net		(34	)		(268	)		(5	)		-			(307	)
Income (loss) from continuing operations, before income taxes		3,449			(251	)		7,525			(6,391	)		4,332
Income tax provision (benefit)		1,493			(1,926	)		2,934			-			2,501
Income from continuing operations, after income taxes		1,956			1,675			4,591			(6,391	)		1,831
Discontinued operations, net of tax		-			92			33			-			125
Net income	$	1,956		$	1,767		$	4,624		$	(6,391	)	$	1,956

Supplemental Condensed Consolidating

Cash Flow Statement

	Nine Months Ended September 30, 2006 (Unaudited)
	Parent			Combined Guarantor Subsidiaries			Combined Non-Guarantor Subsidiaries			Eliminations		Consolidated
Net cash (used in) provided by operating activities of continuing operations	$	(2,115	)	$	4,480		$	2,109		$	-	$	4,474
Net cash provided by (used in) operating activities of discontinued operations		-			102			(528	)		-		(426	)
Cash flows from investing activities:
Purchases of property, plant and equipment		-			(5,890	)		(2,950	)		-		(8,840	)
Proceeds from sale of property, plant and equipment		-			1,644			24			-		1,668
Net cash used in investing activities of continuing operations		-			(4,246	)		(2,926	)		-		(7,172	)
Net cash used in investing activities of discontinued operations		-			-			-			-		-
Cash flows from financing activities:
Proceeds from short-term debt		-			-			457			-		457
Payments on short-term debt		-			(29	)		(710	)		-		(739	)
Proceeds from long-term debt		65,378			-			-			-		65,378
Payments on long-term debt		(63,783	)		(101	)		(90	)		-		(63,974	)
Stock options and issuance of treasury stock as compensation, net		545			-			-			-		545
Payments of preferred stock dividend		(113	)		-			-			-		(113	)
Net cash provided by (used in) financing activities of continuing operations		2,027			(130	)		(343	)		-		1,554
Effect of exchange rate changes on cash		-			-			352			-		352
Net cash (used in) provided by continuing operations		(88	)		104			(808	)		-		(792	)
Net cash provided by (used in) discontinued operations		-			102			(528	)		-		(426	)
Net (decrease) increase in cash and cash equivalents		(88	)		206			(1,336	)		-		(1,218	)
Cash and cash equivalents, at beginning of period		229			45			6,837			-		7,111
Cash and cash equivalents, at end of period	$	141		$	251		$	5,501		$	-	$	5,893

Supplemental Condensed Consolidating

Cash Flow Statement

	Nine Months Ended September 30, 2005 (Unaudited)
	Parent			Combined Guarantor Subsidiaries			Combined Non-Guarantor Subsidiaries			Eliminations		Consolidated
Net cash (used in) provided by operating activities of continuing operations	$	(4,255	)	$	10,160		$	2,471		$	-	$	8,376
Net cash provided by operating activities of discontinued operations		-			-			686			-		686
Cash flows from investing activities
Purchases of property, plant and equipment		-			(10,129	)		(1,535	)		-		(11,664	)
Proceeds from sale or property, plant and equipment		-			64			12			-		76
Net cash used in investing activities of continuing operations		-			(10,065	)		(1,523	)		-		(11,588	)
Net cash used in investing activities of discontinued operations		-			-			(42	)		-		(42	)
Cash flows from financing activities
Payment on short-term debt		-			(116	)		(9	)		-		(125	)
Proceeds from long-term debt		63,474			150			-			-		63,624
Payments on long-term debt		(61,400	)		(139	)		(116	)		-		(61,655	)
Net proceeds from exercise of stock options		518			-			-			-		518
Payments of preferred stock dividends		(113	)		-			-			-		(113	)
Net cash provided by (used in) financing activities of continuing operations		2,479			(105	)		(125	)		-		2,249
Effect of exchange rate changes on cash		-			-			(439	)		-		(439	)
Net cash (used in) provided by continuing operations		(1,776	)		(10	)		384			-		(1,402	)
Net cash provided by discontinued operations		-			-			644			-		644
Net (decrease) increase in cash and cash equivalents		(1,776	)		(10	)		1,028					(758	)
Cash and cash equivalents, at beginning of period		1,967			49			4,769			-		6,785
Cash and cash equivalents, at end of period	$	191		$	39		$	5,797		$	-	$	6,027

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read this discussion in conjunction with the consolidated financial statements, notes and tables included in Part I, Item 1 of this Form 10-Q. Statements that are not historical facts, including statements about our confidence in our prospects and strategies and our expectations about growth of existing markets and our ability to expand into new markets, to identify and acquire complementary businesses and to attract new sources of financing, are forward-looking statements that involve risks and uncertainties. In addition to statements 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 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.

NON-GAAP FINANCIAL MEASURE

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 (SEC). 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 tables presented in this section of this Form 10-Q.

This non-GAAP financial measure is defined by us as income from operations as presented in our Consolidated Statements of Income plus restructuring costs and loan forgiveness costs, less income from a reversal of a post retirement benefit liability. 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 Tulsa, Oklahoma from Ohio, we incurred significant non-recurring restructuring costs related to this one-time event that impacted our financial results for 2005. This restructuring program was completed as of December 31, 2005. 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. Additionally, we reported income in the third quarter of 2005 as a result of a reduction in an actuarially computed post retirement benefit liability no longer owed by us. There were no comparable restructuring costs, loan forgiveness costs, or other non-cash income relating to the reversal of a pension liability in the third quarter or first nine months of 2006.

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. 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.

GENERAL

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 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.

·	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 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 supplier of friction products into performance and specialty markets such as motorcycles, race cars, performance automobiles, military Hummers, ATV’s and snowmobiles.

·	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 automobiles. 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,

·	high volume parts for the lawn and garden, appliance, automotive and other markets, and

·	metal injection molded parts for a variety of industries, including small hand tools and medical.

·	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.

The following chart shows our net sales by segment during the first nine months of 2006:

Net Segment Sales

Nine Months Ended September 30, 2006

As of September 30, 2006, our continuing operations had approximately 1,800 employees at 17 manufacturing, research, sales and administrative sites in 5 countries.

Recent Event

On October 26, 2006, we announced that we had retained Jefferies and Company, Inc. to act as our exclusive financial advisor to assist us in exploring the possible sale of our precision components group. That business segment manufactures and sells powder metal precision components and metal injection molded components used in industrial, consumer and other applications. At this point in time, there can be no assurance that any discussions will result in a transaction.

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

Goodwill. 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 No. 142, Goodwill and Other Intangible Assets (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 any impairment loss identified 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 three or nine month periods ended September 30, 2006 and 2005.

Long-Lived Assets. 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. 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. We did not record any impairment charges in the three and nine month periods ended September 30, 2006 and 2005.

Pension Benefits. We account for our defined benefit pension plans in accordance with SFAS No. 87, Employers' 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 would be 8.2% 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). Net periodic benefit cost was $1.1 million for the nine month period ended September 30, 2006 and $0.8 million for the nine month period ended September 30, 2005. See “Note 8 - Employee Benefits” in the accompanying unaudited Consolidated Financial Statements of this Form 10-Q for details regarding the action taken on one of our defined benefit plans as of May 31, 2006.

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 5.5%. 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.

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 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 not record a valuation allowance for deferred tax assets. 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 September 30, 2006.

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’ equity. Other comprehensive income includes a translation gain of $1.3 million for the nine months ended September 30, 2006. 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. Foreign currency transaction gains and losses were not material to the results of operations for the three and nine months ended September 30, 2006 and 2005.

·	Recent Accounting Developments.

In September 2006, FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No 87, 88, 106 and 132(R) (SFAS 158). SFAS 158 requires the recognition of the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in the statement of financial position and the recognition of changes in that funded status in the year in which the changes occur through comprehensive income. SFAS 158 also requires the measurement of the funded status of a plan as of the date of the year-end statement of financial position. This statement is effective for us as of December 31, 2006. We are currently in the process of evaluating SFAS 158 on our consolidated financial statements and will adopt this statement as of December 31, 2006.

In September 2006, FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements, rather it applies whenever existing accounting pronouncements require or permit fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of SFAS No. 157 on our financial statements and will adopt SFAS 157 as required.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements in Current Year Financial Statements (SAB 108). SAB 108 provides guidance on quantifying financial statement misstatements, including the effects of prior year errors on current year financial statements. SAB 108 is effective for periods ending after November 15, 2006. We will adopt SAB 108 as required.

In June 2006, FASB issued Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an amendment of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements. Additionally, FIN 48 provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for us as of January 1, 2007. We are currently evaluating the impact of this interpretation on our financial statements and will adopt FIN 48 as required.

In March 2006, FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets — an amendment of FASB Statement No. 140 (SFAS 156). SFAS 156 establishes the accounting for all separately recognized servicing assets and servicing liabilities. SFAS 156 amends SFAS 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This statement is effective in 2007. We are evaluating SFAS 156, however we do not expect adoption of SFAS 156 to have a material impact on our consolidated financial statements.

On February 16, 2006, FASB issued SFAS No. 155, Accounting for Certain Hybrid Instruments (SFAS 155), which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133) and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities (SFAS 140). SFAS 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the instrument on a fair value basis. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. This statement is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. We are evaluating SFAS 155, however we do not expect adoption of SFAS 155 to have a material impact on our consolidated financial statements.

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 September 21, 2005, the SEC published a ruling 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, 2007. On August 9, 2006, the SEC published a new rule that would extend the compliance date for the report on management's assessment of the effectiveness of internal control over financial reporting until fiscal years ending on or after December 15, 2007 for non-accelerated filers. The rule would also extend the non-accelerated filer compliance date for the auditor attestation report on internal control over financial reporting until fiscal years ending on or after December 15, 2008.

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, 2007. Our compliance initiatives are proceeding. We anticipate being compliant with the requirements of Section 404 as of December 31, 2007.

THIRD QUARTER OF 2006 COMPARED TO THE THIRD QUARTER OF 2005

Our continuing operations are organized into three strategic segments. These segments include friction products, precision components and performance racing. In the fourth quarter of 2003, we committed to selling our motor segment. As a result, we have classified this business as a discontinued operation.

Net Sales. Our consolidated net sales for the third quarter of 2006 were $73.7 million, an increase of $10.9 million or 17.4% from the same period in 2005. We experienced record net sales in our friction products segment, as a result of price increases, continuing economic strength during the third quarter of 2006 in the industrial markets we serve, new product introductions and continued market share gains during the period.

	Three months ended September 30
Net Segment Sales:	2006		2005		$ Change			% Change
		(dollars in millions)
Friction products	$	50.2	$	40.2	$	10.0			24.9	%
Precision components		20.7		19.1		1.6			8.4	%
Performance racing		2.8		3.5		(0.7	)		-20.0	%
Consolidated	$	73.7	$	62.8	$	10.9			17.4	%

Friction Products. Net sales in the friction products segment, our largest segment, were $50.2 million in the third quarter of 2006, an increase of $10.0 million, or 24.9%, compared to $40.2 million in 2005. As a result of customer price increases, new product introductions, general economic strength and market share gains, we experienced sales increases in most of our major markets, including construction and mining, heavy truck, performance automotive and aerospace increased sales volumes to our direct aftermarket customer base. This segment continued to experience strong sales growth from our international operations in the third quarter of 2006.

Precision Components. Net sales in our precision components segment were $20.7 million in the third quarter of 2006, an increase of $1.6 million, or 8.4% compared to 2005. The increase in net sales was the result of strong end market demand and new product introductions, primarily in the fluid power and appliance markets during the quarter. The new product introductions were enabled in large part because of the segment’s recent investments in innovative manufacturing capacity. We also experienced sales increases in the fluid power market served by this segment during the quarter. This increase was partially offset by a decline in our automotive, lawn and garden and appliance markets during the quarter.

Performance Racing. Net sales in our performance racing segment were $2.8 million, a decrease of 20.0% compared to net sales of $3.5 million in the comparable period of 2005. The decrease in revenues was primarily attributable to a realignment of our strategic customer focus and increased competition in this marketplace. At the end of 2005, we made a significant change in the management of our driveline business, and in so doing, began repositioning this business in the marketplace by increasing the level of engineering support and product design capabilities.

Gross Profit. Gross profit increased $8.0 million to $17.9 million during third quarter of 2006, an 80.8% increase compared to gross profit of $9.9 million in the third quarter of 2005. Our gross profit margin increased to 24.3% of our net sales in the third quarter of 2006 compared to 15.8% of our net sales in the comparable period of 2005. The increase is primarily the result of price increases in our friction products segment, partially offset by continuing start-up costs incurred at our facility in Tulsa, including logistic and scrap expenses, volume reduction in our performance racing segment, increased medical expenses, raw material cost increases and increased depreciation expense during the period. Included in our gross profit for the third quarter 2005 are significant costs incurred as a result of operating inefficiencies associated with the relocation of our Ohio friction products facility to Tulsa, including increased labor, overtime, maintenance, employee benefit, training, freight and outsourcing costs as a result of the start-up of operations in Tulsa and operating both the Ohio and Tulsa facilities during the production transition period.

	Three months ended September 30
Gross Profit Margin:	2006			2005			Change
Friction products		28.7	%		15.7	%		13.0	%
Precision components		15.0	%		16.2	%		-1.2	%
Performance racing		14.3	%		14.3	%		0.0	%
Consolidated		24.3	%		15.8	%		8.5	%

Friction Products. Our friction products segment reported gross profit of $14.4 million or 28.7% of its net sales in the third quarter of 2006 compared to $6.3 million or 15.7% of its net sales in 2005. The increase in our gross profit margin was primarily the result of price increases taken with respect to certain customers, increased production flow from our facility in Tulsa, improved control of manufacturing expenses as the facility benefited from improved manufacturing efficiencies and margin improvements from volume related absorption of fixed overhead. The increase was partially offset by expenses incurred due to the continuation of our Tulsa plant start-up costs, including logistic and scrap expenses, increased raw material costs, and increased medical and incentive compensation expenses during the period.

Precision Components. Gross profit in our precision components segment was flat at $3.1 million in both the third quarter of 2006 and 2005. The segment’s gross profit was 15.0% of its net sales in the third quarter of 2006 compared to 16.2% of its net sales in 2005. The decrease in this segment’s margins was primarily the result of increases in medical and raw material costs, product mix and increased depreciation expense related to the new technology equipment placed into service in 2005 and first half of 2006.

Performance Racing. Our performance racing segment reported gross profit of $0.4 million in the third quarter of 2006 compared to $0.5 million of net sales in the comparable period of 2005. In both periods our net margin was 14.3% of net sales. The gross profit in the third quarter of 2006 was primarily affected by the result of the reduced sales volumes in the quarter as well as less favorable product mix.

Selling, Technical and Administrative Expenses. Selling, technical and administrative (ST&A) expenses increased $2.8 million, or 33.3%, to $11.2 million in the third quarter of 2006 from $8.4 million during 2005. As a percentage of net sales, ST&A increased to 15.2% in 2006 compared to 13.4% in 2005. The increase in ST&A expenses resulted primarily from an increase in incentive compensation expense during the third quarter of 2006 compared to a reversal of previously accrued compensation during the third quarter of 2005. We spent $1.7 million, or 2.2% of our net sales on product research and development in the third quarter of 2006 compared to $1.7 million, or 2.6%, in 2005.

Income (Loss) from Operations. Income from operations was $6.6 million for the three months ended September 30, 2006 compared to a loss from operations of $0.3 million during the comparable period of 2005. Income from operations as a percentage of net sales increased to 9.0% for the three month period ended September 30, 2006 from (0.5%) in the comparable period of 2005. The increase was primarily the result of pricing actions, operational improvements at our Tulsa facility partially offset by continued start-up costs associated with the Tulsa facility, decreased sales volume in our performance racing segment, increased incentive compensation and medical expenses, raw material cost increases and increased depreciation expense.

As a result of the items discussed above, income (loss) from operations at each of our segments was as follows:

	Three months ended September 30
Income (loss) from operations by segment:	2006			2005			$ Change
	(dollars in millions)
Friction products	$	7.4		$	(0.4	)	$	7.8
Precision components		(0.3	)		0.4			(0.7	)
Performance racing		(0.5	)		(0.3	)		(0.2	)
Consolidated	$	6.6		$	(0.3	)	$	6.9

Included in our income from operations for the third quarter of 2005 was $2.2 million of direct restructuring costs related to the Tulsa plant relocation and $0.4 million of other income, net. Adjusted income from operations before these charges was $1.5 million or 2.4% of net sales in 2005. There were no comparable charges in the third quarter of 2006.

	Three months ended September 30
	Income (loss) from operations, as reported (GAAP)						Restructuring costs				Other (income) costs, net					Adjusted income (loss) from operations
	2006			2005			2006		2005		2006		2005			2006			2005
		(dollars in millions)
Friction products	$	7.4		$	(0.4	)	$	-	$	2.2	$	-	$	(0.4	)	$	7.4		$	1.4
Precision components		(0.3	)		0.4			-		-		-		-			(0.3	)		0.4
Performance racing		(0.5	)		(0.3	)		-		-		-		-			(0.5	)		(0.3	)
Total	$	6.6		$	(0.3	)	$	-	$	2.2	$	-	$	(0.4	)	$	6.6		$	1.5

Operating margin		9.0	%		-0.5	%											9.0	%		2.4	%

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 SEC. 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 captioned “Non-GAAP Financial Measure” in this Form 10-Q for more detailed disclosure.

Interest Expense. Interest expense increased $0.3 million during the third quarter ended September 30, 2006 to $2.9 million from $2.6 million in the comparable period of 2005. Higher levels of total borrowings as well as increased interest rates on our variable rate debt during the period were the reason for the increase in interest expense. The amortization of deferred financing costs is included as a component of interest expense in our financial statements. Amortization of deferred financing costs included in interest expense was $0.1 million for the third quarters ended September 30, 2006 and 2005.

Income Taxes. We recorded a tax provision for our continuing operations of $2.0 million for the quarter ended September 30, 2006 compared to an income tax benefit of $1.3 million in the comparable period of 2005. Our effective income tax rate differs from the current federal U.S. statutory rate of 35.0%, primarily as a result of tax rate differences on our foreign income and the lack of state tax benefits for domestic entities in a loss position for the three month periods ended September 30, 2006 and 2005. Our worldwide provision for income taxes of 52.8% in the third quarter of 2006 is based on annual tax rates for the year applied to all of our sources of income.

Discontinued Operations, net of tax. We have committed to a plan to divest our motor segment operations. In accordance with GAAP, we have accounted for the motor segment in our financial statements on the line item “Discontinued operations, net of tax.” The following is a summary of the results of discontinued operations for the third quarter ended September 30, 2006 and 2005. An analysis of Discontinued Operations is contained in “Note 6 — Discontinued Operations” in the accompanying unaudited Consolidated Financial Statements of this Form 10-Q.

	Three months ended
	September 30
	2006		2005
		(dollars in millions)
Net sales	$	2.6	$	2.0

Income from discontinued operations before income taxes	$	0.5	$	-
Income taxes		0.2		-
Income from discontinued operations, net of tax	$	0.3	$	-

Net Income. As a result of the factors noted above, we reported net income of $2.1 million, or $ .22 cents per diluted share in 2006 compared to a net loss of $1.7 million or a loss of $.19 per diluted share in 2005.

FIRST NINE MONTHS OF 2006 COMPARED TO THE FIRST NINE MONTHS OF 2005

Net Sales. Our consolidated net sales for the first nine months of 2006 were $228.4 million, an increase of $22.6 million or 11.0% from the same period in 2005. We experienced sales increases as a result of price increases, new product introductions and market share gains in our friction products and precision component segments and the continuing economic expansion in the industrial markets we serve during the period.

		Nine months ended September 30
Net Segment Sales:		2006		2005		$ Change			% Change
	(dollars in millions)
Friction products		$	149.4	$	130.2	$	19.2			14.7	%
Precision components			69.1		63.2		5.9			9.3	%
Performance racing			9.9		12.4		(2.5	)		-20.2	%
Consolidated		$	228.4	$	205.8	$	22.6			11.0	%

Friction Products. Net sales in the friction products segment were $149.4 million for the first nine months of 2006, an increase of $19.2 million, or 14.7%, compared to $130.2 million in the comparable period of 2005. Net sales increased as a result of price increases taken with respect to certain customers, new product introductions, continued market share gains in the construction and mining markets, improving economic conditions in our industrial markets and increased sales to our aftermarket. We experienced sales increases in our aerospace, construction and mining, heavy truck, aftermarket and agriculture markets during the nine month period. Net sales, on a local currency basis, at our Italian facility increased 14.4% in the first nine months of 2006 compared to the comparable period of 2005.

Precision Components. Net sales in our precision components segment were $69.1 million in first nine months of 2006, an increase of $5.9 million, or 9.3%, compared to $63.2 million in the comparable period of 2005. The increase in net sales was primarily attributable to improving conditions in the general industrial segments of the domestic economy as well as new product introductions associated with the new technology equipment initiative.

Performance Racing. Net sales in our performance racing segment were $9.9 million in the first nine months of 2006, a decrease of $2.5 million, or 20.2%, compared to $12.4 million in the comparable period of 2005. The decrease in revenues was primarily attributable to a realignment of our strategic customer focus and increased competition in this marketplace. At the end of 2005, we made a significant change in the management of our driveline business, and in so doing, began repositioning this business in the marketplace by increasing the level of engineering support and product design capabilities.

Gross Profit. Gross profit increased $2.2 million to $48.3 million during the first nine months of 2006, a 4.8% increase compared to gross profit of $46.1 million in the comparable period of 2005. The gross profit margin decreased to 21.1% of net sales in 2006 from 22.4% of net sales in the comparable period of 2005. Included in our gross profit for the nine months ended September 30, 2005 are significant costs incurred as a result of operating inefficiencies associated with the relocation of our Ohio friction products facility to Tulsa, including increased labor, overtime, maintenance, employee benefit, training, freight and outsourcing costs as a result of the start-up of operations in Tulsa and operating both the Ohio and Tulsa facilities during the production transition period.

	Nine months ended September 30
Gross Profit Margin:	2006			2005			Change
Friction products		22.6	%		23.8	%		-1.2	%
Precision components		18.5	%		19.3	%		-0.8	%
Performance racing		18.2	%		23.4	%		-5.2	%
Consolidated		21.1	%		22.4	%		-1.3	%

Friction Products. Our friction products segment reported gross profit of $33.7 million or 22.6% of its net sales in the first nine months of 2006 compared to $31.0 million or 23.8% of its net sales in the comparable period of 2005. The decrease in our gross profit margin was primarily the result of the continuation of our Tulsa plant start-up costs, increased raw material costs and increased medical and incentive compensation costs during the period. This decrease in gross margin was partially offset by pricing actions taken with respect to certain customers and margin improvements from volume related absorption of fixed overhead.

Precision Components. Gross profit in our precision components segment was $12.8 million or 18.5% of its net sales in the first nine months of 2006 compared to $12.2 million or 19.3% of its net sales in comparable period of 2005. The decrease in this segment's gross profit margin was primarily the result of higher medical, depreciation and raw material costs, product mix and the continued support of our China precision components facility during the period. The decline in the segment’s gross margin was partially offset by margin improvements from volume related absorption of fixed overhead and product mix.

Performance Racing. Our performance racing segment reported gross profit of $1.8 million or 18.2% of net sales in the first nine months of 2006 compared to $2.9 million or 23.4% of net sales in the comparable period of 2005. The decrease in the gross profit and gross profit percentage during the period was primarily the result of reduced sales volumes during the nine month period as well as less favorable product mix.

Selling, Technical and Administrative Expenses. ST&A expenses increased $2.3 million, or 7.8%, to $31.9 million in the first nine months of 2006 from $29.6 million in the comparable period of 2005. As a percentage of net sales, ST&A expenses decreased to 14.0% of net sales in the first nine months of 2006 compared to 14.4% of net sales in the comparable period of 2005. The increase in ST&A expenses resulted primarily from increased incentive compensation costs. We spent $4.9 million on product research and development in the first nine months of 2006 compared to $4.7 million in the comparable period of 2005.

Restructuring Costs. We incurred no direct restructuring costs during the first nine month of 2006. Direct restructuring costs for the nine months ended September 30, 2005, including the $0.4 million recorded in our costs of sales, were $3.9 million, consisting of severance, planning, recruiting, relocation and other costs associated with the start-up of our manufacturing facility in Tulsa, Oklahoma.

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 which provided for medical benefits to individuals who met certain age and service requirements at termination of employment. This action resulted in reported income of $0.4 million for the nine months ended September 30, 2005. There was no comparable action taken during the nine months ended September 30, 2006.

Income from Operations. Income from operations increased $3.5 million or 28.0% to $16.0 million in the first nine months of 2006 from $12.5 million in the comparable period of 2005. Income from operations as a percentage of net sales increased to 7.0% in the first nine months of 2006 from 6.1% in the comparable period of 2005. The increase was primarily the result of price increases taken with respect to certain customers and operational improvements at our Tulsa facility. This improvement in earnings was partially offset by continued start-up costs associated with the Tulsa facility, decreased sales volume in our performance racing segment, product mix, increased incentive compensation and medical expenses, raw material cost increases and increased depreciation expense.

As a result of the items discussed above, income from operations at each of our segments was as follows:

	Nine months ended September 30
Income (loss) from operations by segment:	2006			2005		$ Change			% Change
	(dollars in millions)
Friction products	$	13.8		$	9.5	$	4.3			45.3	%
Precision components		3.3			2.6		0.7			26.9	%
Performance racing		(1.1	)		0.4		(1.5	)		-375.0	%
Consolidated	$	16.0		$	12.5	$	3.5			28.0	%

Included in our income from operations in the first nine months of 2005 was $4.3 million of direct restructuring costs related to the plant relocation ($0.4 million of which was included in cost of sales), a $1.1 million charge related to the previously disclosed forgiveness of the remaining balance of shareholder loans outstanding as of March 31, 2005 and other non-cash non-recurring income of $0.4 million relating to a reversal of a post retirement benefit liability no longer owed by us. There were no comparable charges incurred by us in the comparable nine month period ended September 30, 2006. Adjusted income from operations before these charges for the first nine months of 2005 was $17.5 million, or 8.5% of net sales.

	Nine months ended September 30
	Income (loss) from operations, as reported (GAAP)						Restructuring costs*				Other (income) costs, net				Adjusted income (loss) from operations
	2006			2005			2006		2005		2006		2005		2006			2005
	(dollars in millions)
Friction products	$	13.8		$	9.5		$	-	$	4.3	$	-	$	0.2	$	13.8		$	14.0
Precision components		3.3			2.6			-		-		-		0.4		3.3			3.0
Performance racing		(1.1	)		0.4			-		-		-		0.1		(1.1	)		0.5
Total	$	16.0		$	12.5		$	-	$	4.3	$	-	$	0.7	$	16.0		$	17.5

Operating margin		7.0	%		6.1	%										7.0	%		8.5	%

*Restructuring costs in this table for the nine months ended September 30, 2005 include $0.4 million classified in the Company’s Consolidated Statements of Income as cost of sales items.

Interest Expense. Interest expense increased $0.6 million in the first nine months of 2006 to $8.5 million from $7.9 million in the comparable period of 2005. The increase is attributable to higher levels of total borrowings during the nine month period ended September 30, 2006 as well as higher borrowing rates on our variable rate debt during the period. Included as a component of interest expense in our financial statements are deferred financing costs. Deferred financing costs included in interest expense in the first nine months of 2006 and 2005 were $0.3 million.

Income Taxes. We recorded a tax provision for our continuing operations of $3.8 million in the first nine months of 2006 compared to $2.5 million in the comparable period of 2005. Our effective income tax rate of 49.8% and 57.7% for the nine month periods ended September 30, 2006 and 2005, respectively, exceed the current federal U.S. statutory rate of 35.0%, primarily as a result of tax rate differences on our expected foreign income and expected individual state tax liabilities. Our worldwide provision for income taxes is based on our estimated annual tax rates for the year applied to all of our sources of income.

		Nine months ended September 30
		2006		2005
	(dollars in millions)
Net sales		$	7.5	$	6.8

Income from discontinued operations before income taxes		$	0.9	$	0.2
Income taxes			0.3		0.1
Income from discontinued operations, net of tax		$	0.6	$	0.1

Net Income. As a result of the factors noted above, we reported net income of $4.4 million in the first nine months of 2006 compared to $2.0 million in the comparable prior year period, an increase of $2.4 million, or 120.0%.

LIQUIDITY AND CAPITAL RESOURCES

Our primary financing requirements are:

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

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

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

Hawk’s primary source of funds for conducting its business activities and servicing its indebtedness has been cash generated from operations and borrowings under our bank facility and senior notes. The following selected measures of liquidity and capital resources outline various metrics that are reviewed by our management and are provided to enhance the understanding of our business.

Selected Measures of Liquidity and Capital Resources from Continuing Operations

	September 30,2006			December 31, 2005
	(dollars in millions)
Cash and cash equivalents	$	5.9		$	7.1
Working capital ⁽¹⁾	$	59.3		$	50.3
Current ratio ⁽²⁾		2.0 to 1.0			1.9 to 1.0
Net debt as a % of capitalization ⁽³⁾		70.7	%		73.1	%
Average number of days sales in accounts receivable		56 days			51 days
Average number of days sales in inventory		78 days			77 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. Capitalization is defined as net debt plus shareholders’ equity.

As part of our working capital management program, we review certain working capital measures on a continuous basis. The $9.0 million increase in our net working capital from December 31, 2005 resulted primarily from increased receivables and inventory levels to support our increased sales volumes during the period. Our accounts receivable and inventory levels are reviewed through the computation of days sales outstanding and inventory turnover, respectively. The number of days sales outstanding in accounts receivable was 56 days compared to 51 days at December 31, 2005. The increase is mainly attributable to the sales increases during recent months in addition to a reduction of a receivable factoring program at our Italian facility during 2006.

Average inventory days increased to 78 days at September 30, 2006 as compared to 77 days at December 31, 2005. Our overall inventory investment has increased approximately $4.1 million at September 30, 2006 as compared to December 31, 2005 levels, primarily to support our increased sales volumes during the recent period as well as increased inventories in transit from our China facilities.

Debt

The following table summarizes the components of our indebtedness:

	September 30		December 31
	2006		2005
	(dollars in millions)
Short-term debt	$	1.1	$	1.4
Senior notes		110.0		110.0
Bank facility		6.6		5.0
Other		1.0		1.2
Total debt	$	118.7	$	117.6

At September 30, 2006, we had $6.6 million outstanding under the bank facility and $2.2 million of letters of credit outstanding under the letter of credit sub-facility. At September 30, 2006, we had $21.2 million available to borrow under the bank facility. Borrowings under credit facilities and bankers acceptances with local financial institutions at our facilities in Italy and China totaled $1.1 million as of September 30, 2006.

As of September 30, 2006, we were in compliance with the provisions of all of our debt instruments.

Cash Flow

The following table summarizes the major components of cash flow:

	Nine months ended September 30
	2006			2005
	(dollars in millions)
Cash provided by operating activities of continuing operations	$	4.5		$	8.4
Cash used in investing activities of continuing operations		(7.2	)		(11.6	)
Cash provided by financing activities of continuing operations		1.5			2.2
Effect of exchange rates on cash		0.4			(0.4	)
Cash (used in) provided by discontinued operations		(0.4	)		0.6
Net decrease in cash and cash equivalents	$	(1.2	)	$	(0.8	)

At September 30, 2006, we had cash and cash equivalents of $5.9 million compared to $6.0 million at September 30, 2005. The cash on the balance sheet at September 30, 2006 and 2005 is primarily held at our foreign operations. Excess domestic cash is used to pay down the outstanding loans of our bank facility.

Net cash provided by our operating activities was $4.5 million for the nine months ended September 30, 2006 compared to $8.4 million in the comparable nine month period of 2005. The decrease in cash provided by our operations in 2006 compared to 2005 was primarily the result of the increased working capital requirements required to support our sales growth during the 2006 period and the reduction of a receivable factoring program at our Italian facility. Our net working capital was $59.3 million as of September 30, 2006 compared to $54.1 million as of September 30, 2005.

We used cash in our investing activities of $8.8 million during the first nine months of 2006 and $11.7 million in the comparable period of 2005 for the purchase of property, plant and equipment. In addition, we received net cash proceeds from the sale of our Brook Park, Ohio facility of $1.6 million during the third quarter of 2006, which is included in the proceeds from sale of property, plant and equipment on the Consolidated Statement of Cash Flows for the nine months ended September 30, 2006.

Cash provided by financing activities was $1.5 million for the nine months ended September 30, 2006 compared to $2.2 million during the first nine months of 2005. The decrease in 2006 financing activities primarily resulted reduced net borrowings under our bank facility during the third quarter of 2006.

We believe that cash flow from operating activities and borrowings under our bank facility will be sufficient to satisfy our working capital, capital expenditures, debt requirements and to finance our internal growth needs for the next twelve months.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk Disclosures. The following discussion about our market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. In seeking to minimize the risks and costs associated with market risk, we manage our exposures to interest rates and foreign currency exchange rates through our regular operating and financial activities and through foreign currency hedge contracts. We had no foreign currency hedge contracts outstanding as of September 30, 2006. We do not use derivative financial instruments for speculative or trading purposes.

Interest Rate Sensitivity. At September 30, 2006, approximately 6.4%, or $7.6 million, of our total debt bore interest at a variable rate. Our primary interest rate risk exposure results from floating rate debt. If interest rates were to increase 100 basis points (1%) from September 30, 2006 rates, and assuming no changes in debt from September 30, 2006 levels, our additional annual interest expense would be approximately $0.1 million.

Inflation Risk. We manage our inflation risks by ongoing review of product selling prices and production costs. In spite of the recent surcharges and prices increases on a number of our raw materials, we historically have been able to pass these increased costs to our customers, though we do experience a delay between our cost increases and sales price increases. Currently, we do not believe that inflation risks are material to our business, its consolidated financial position, results of operations, or cash flows.

Foreign Currency Exchange Risk. The majority of our receipts and expenditures are contracted in U.S. dollars, and we do not consider the market risk exposure relating to currency exchange to be material at this time. We have operations outside the United States with foreign currency denominated assets and liabilities, primarily denominated in Euros, Canadian dollars, and Chinese Yuan. Because we have foreign currency denominated assets and liabilities, financial exposure may result, primarily from the timing of transactions and the movement of exchange rates. We do not expect that our unhedged foreign currency balance sheet exposure as of September 30, 2006 will result in a significant impact on our earnings or cash flows. We also monitor exposure to transactions denominated in currencies other than the functional currency of each country in which Hawk operates, and have periodically entered into forward contracts to mitigate that exposure. As of September 30, 2006, we have no derivative instruments outstanding.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures. As of September 30, 2006, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. The evaluation was carried out under the supervision of and with the participation of our management, including our Chief Executive Officer, Chief Financial Officer and Vice President - Finance. Based on this evaluation, our Chief Executive Officer, Chief Financial Officer and Vice President - Finance each concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to Hawk, including our consolidated subsidiaries, required to be included in reports we file with or submit to the SEC under the Securities Exchange Act of 1934. We continue to evaluate the need for improvements in our disclosure controls and procedures, including further formalizing our processes, procedures and policies and remediate when appropriate.

On August 9, 2006, the SEC published a new proposed rule that would defer the compliance date for the report on management’s assessment of the effectiveness of internal control over financial reporting until fiscal years ending on or after December 15, 2007 for non-accelerated filers. The proposed rule would also defer the non-accelerated filer compliance date for the auditor attestation report on internal control over financial reporting until fiscal years ending on or after December 15, 2008. However, we anticipate being compliant with Section 404 by December 31, 2007, the currently required compliance date for us based on our non-accelerated filer status.

Changes in Internal Control. There have been no changes in our internal control over financial reporting during the most recent fiscal quarter that are judged to have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. 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, results of operations or cash flows.

ITEM 1A. RISK FACTORS

The risk factors included in our Annual Report on Form 10-K for the year ended, December 31, 2005, as filed with the SEC on March 29, 2006 have not materially changed with the exception of the addition of a risk factor related to our exploration of a possible sale of our precision components segment.

Our ability to sell the precision components segment depends upon market conditions.

On October 26, 2006, we announced that we were exploring the possible sale of our precision components segment. We cannot assure you when a transaction involving the precision components segment will occur, or if a transaction will occur at all.

Our focus on growth opportunities available to us in our friction products and performance racing segments after the proposed sale of our precision components segment may not be available or available to us at a suitable price.

Upon the proposed sale of our precision components segment, we intend to focus on growth opportunities available to us in our friction products and performance racing segments. If we are unable to successfully implement our strategy, our business, results of operations, financial condition and stock price could be materially adversely affected.

Our business may be harmed if the proposed sale disrupts our business and prevents us from realizing intended benefits.

Our business may be harmed if the proposed sale disrupts our business and prevents us from realizing intended benefits due to problems that may arise, such as:

·	loss of key employees;

·	failure to adjust or implement our future business plans; and

·	diversion of management’s attention from operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5. OTHER INFORMATION

On November 10, 2006, Hawk entered into an Amendment to Agreements with Joseph J. Levanduski, Hawk’s Chief Financial Officer (the “Levanduski Amendment”). On November 10, 2006, Hawk Corporation and Wellman Products Group, Inc. (“Wellman”) entered into an Amendment to Agreements with B. Christopher DiSantis, President of Wellman Products Group, Inc. (the “DiSantis Amendment”)(the Levanduski Amendment and the DiSantis Amendment shall collectively be referred to as the “Amendments”).

The Amendments modify the Employment Agreements of Mr. Levanduski and Mr. DiSantis, each dated August 14, 2006, and certain stock option agreements between Hawk and Mr. Levanduski and Mr. DiSantis to provide that in the event of the termination of either Mr. Levanduski’s or Mr. DiSantis’ employment for any reason other than Cause (as such term is defined in the Employment Agreements), any stock options granted under one or more of the stock option plans of Hawk shall become immediately vested, effective on or before the date of termination.

The Levanduski Amendment is filed herewith as Exhibit 10.1. The DiSantis Amendment is filed herewith as Exhibit 10.2. The descriptions of the Amendments set forth above are qualified in their entirety by reference to the Amendments and incorporated herein by reference.

ITEM 6. EXHIBITS

Exhibits:

10.1*	Amendment to Agreements, dated November 10, 2006, between Hawk Corporation and Joseph J. Levanduski
10.2*	Amendment to Agreements, dated November 10, 2006, among Hawk Corporation, Wellman Products Group, Inc. and B. Christopher DiSantis
31.1*	Certification of the Chairman of the Board, Chief Executive Officer and President pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2*	Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1*	Certification of the Chairman of the Board, Chief Executive Officer and President pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2*	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

____________

* Filed or furnished herewith

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: November 13, 2006 HAWK CORPORATION

By: /s/ Ronald E. Weinberg

Ronald E. Weinberg

Chairman of the Board, CEO and President

By: /s/ Joseph J. Levanduski

Joseph J. Levanduski

Chief Financial Officer