Back to GetFilings.com

Table of Contents

UNITED STATES

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

HAWK CORPORATION

Registrant’s telephone number, including area code: (216) 861-3553

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:  None

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report(s)), and (2) has been subject to such filing requirements for the past 90 days.   YES x  NO o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  YES o  NO x

      The aggregate market value of the voting common equity held by non-affiliates as of June 28, 2002 was $39,945,687 (based on the closing price as quoted on the New York Stock Exchange on that date).

      As of February 14, 2003, the Registrant had 8,557,990 shares of Class A Common Stock, net of treasury shares, and 0 shares of Class B non-voting Common Stock outstanding. As of that date, non-affiliates held 5,386,609 shares of Class A Common Stock and 0 shares of Class B non-voting Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the 2003 Proxy Statement of Hawk Corporation are incorporated by reference into Part III of this Form 10-K.

      As used in this Form 10-K, the terms “Company,” “Hawk,” “Registrant,” “we,” “us” and “our” mean Hawk Corporation and its consolidated subsidiaries, taken as a whole, unless the context indicates otherwise. Except as otherwise stated, the information contained in this Form 10-K is as of December 31, 2002.

Table of Contents

Part I

ITEM 1. BUSINESS

Our Company

      Hawk Corporation, founded in 1989, primarily is a leading supplier of friction products and precision components for industrial, agricultural and aerospace applications. We focus on designing, manufacturing and marketing products requiring sophisticated engineering and production techniques for applications in markets in which we have achieved a significant market share. Our products include friction parts for brakes, clutches and transmissions used in construction vehicles, agricultural vehicles, trucks, motorcycles and race cars, and parts for brake systems used in commercial and general aviation. Our precision components are used in pumps, motors, transmissions, anti-lock brake systems and other applications for industrial equipment, lawn and garden equipment, appliances, small hand tools and trucks. Our friction and precision components are made principally from proprietary formulations and designs of composite materials and metal powders.

      We benefit from a deep and diversified customer base, with approximately 2,500 total customers, none of which accounted for more than 5% of our net sales in 2002. We are a preferred supplier to many of the world’s largest and well known brand name original equipment manufacturers, deriving more than 80% of our sales from products for which we are the sole source provider for specific customer applications. We offer our customers full service capabilities, from design through production, and work closely with original equipment manufacturers to improve performance and develop product innovations to generate increased sales. We also benefit from a diversified product list, with over 5,000 total products, none of which accounted for more than 5% of our net sales in 2002. We do not target the cyclical consumer automotive sector. Consequently, less than 7% of our net sales in any of the last five years was to the consumer automotive or light truck market. For the year ended December 31, 2002, we generated net sales of $197.3 million and income from operations of $9.8 million. For the year ended December 31, 2001, we had net sales of $184.4 million and income from operations of $3.6 million. Our common stock has been publicly traded since 1998.

      Hawk is a holding company, the principal assets of which consist of the capital stock of its manufacturing subsidiaries, Friction Products Co., S.K. Wellman Corp., S.K. Wellman SpA, S.K. Wellman of Canada Limited, Hawk Composites (Suzhou) Company Limited, Helsel, Inc., Sinterloy Corporation, Allegheny Clearfield, Inc., Hawk MIM, Inc., Hawk Motors, Inc., Hawk Motors de Mexico, Quarter Master Industries, Inc., Tex Racing Enterprises, Inc. and Logan Metal Stampings, Inc. Through our subsidiaries, we operate primarily in four reportable segments: friction products, precision powder metal components, performance automotive and motor components:

	•	Friction Products

We believe that, based on net sales, we are one of the top worldwide manufacturers of friction products used in industrial, agricultural and aerospace applications. Our friction products segment manufactures parts and components made from proprietary formulations of composite materials, primarily consisting of metal powders, synthetic and natural fibers. Friction products are the parts used in brakes, clutches and transmissions to absorb vehicular energy and dissipate it through heat and normal mechanical wear. The principal markets served by our friction products segment include construction vehicles, agricultural vehicles, trucks, commercial aviation and general aviation. We believe we are:

	•	a leading domestic supplier of friction products for construction equipment, agricultural equipment and trucks,
	•	the only 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 used by commuter airlines, 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

2

Table of Contents

	•	a leading domestic supplier of friction products into specialty markets such as motorcycles, all terrain vehicles (ATVs) and snowmobiles.

	For the years ended December 31, 2002 and 2001, our friction products segment generated net sales of $106.2 million and $104.1 million, representing 54% and 56% of our total net sales, respectively and income from operations of $7.5 million and $6.4 million, representing 77% and 178%, of our total income from operations, respectively.

	•	Precision Components

We are a leading supplier of powder metal components for industrial equipment, lawn and garden equipment, appliances, hand tools and trucks. We use composite metal alloys in powder form to manufacture high quality custom-engineered metal components. According to the Metal Powder Industries Foundation, the powder metal market is growing at approximately 10% per year as original equipment manufacturers substitute precision components made from metal powders for forged, cast or stamped parts. 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 and other markets, and
	•	metal injection molded parts for a variety of industries, including small hand tools and telecommunications.

	For the years ended December 31, 2002 and 2001, our precision components segment generated net sales of $65.8 million and $58.3 million, representing 34% and 32% of our total net sales, respectively and income from operations of $4.1 million and $0.3 million, representing 42% and 8% of our total income from operations, respectively.

	•	Performance Automotive

We engineer, manufacture and market premium branded clutch, transmissions and driveline systems for the performance automotive racing market. Through this segment, we supply parts for the National Association for Stock Car Auto Racing (NASCAR), the Championship Auto Racing Teams (CART) and the Indy Racing League (IRL) racing series and for the weekend enthusiasts in the Sports Car Club of America (SCCA) and the American Speed Association (ASA) racing clubs and other road racing and competition cars. For the years ended December 31, 2002 and 2001, our performance automotive segment generated net sales of $12.6 million and $13.0 million, representing 6% and 7% of our total net sales, respectively and income from operations of $1.0 million and $0.3 million, representing 10% and 8% of our total income from operations, respectively.

	•	Motor

We design and manufacture die-cast aluminum rotors for fractional and subfractional horsepower electric motors. These parts are used in a wide variety of motor applications, including appliances, business equipment, pumps and fans. We believe our motor segment is the largest independent U.S. manufacturer of die-cast aluminum rotors for use in fractional and subfractional horsepower electric motors. We also believe our motor segment has significant growth opportunities arising from the trend by original equipment motor manufacturers, which we estimate still produce more than half of all rotors in the U.S. fractional and subfractional horsepower motor market, to outsource their production of rotors to independent suppliers. For the years ended December 31, 2002 and 2001, our motor segment generated net sales of $12.7 million and $9.0 million, representing 6% and 5% of our total net sales, respectively and operating losses of $2.8 million and $3.4 million, respectively. Our facility in Mexico accounted for $1.5 million of the operating loss in 2002 and $2.3 million of the operating loss in 2001, as it experienced higher than expected operating costs.

3

Table of Contents

Business Strategy

      Our business strategy includes the following principal elements:

	•	Focus on High-Margin, Specialty Applications. We focus on markets that require sophisticated engineering and production techniques and in which we have achieved a significant market share. In developing new applications, we seek to compete in markets requiring a high level of engineering expertise and technical capability, rather than in markets in which the primary competitive factor is product pricing. We believe margins for our products in these markets are higher than in other manufacturing markets that use standardized products. Our gross margins were 22.2% and 21.7% for the years ended December 31, 2002 and 2001, respectively.
	•	Introduce New Products. A key part of our strategy is the introduction of products for new applications, which incorporate improved performance characteristics or reduced costs in response to customer needs. Our engineers proactively focus on developing new product solutions that enhance performance and reduce manufacturing costs, including instances where we are the incumbent supplier. We also grow by applying our existing products and technologies to new specialized applications where our products have a performance or technological advantage.
	•	Expand Customer Relationships. We seek to provide advanced solutions to customers, enhancing our long-term relationships. Our engineers work closely with customers to develop and design new products and improve the performance of existing products. We believe that more than 80% of our net sales are from products and materials for which we are the sole source provider for specific customer applications. Our predecessors formed, and we have continued to build, relationships with a number of customers dating back over 50 years. Our commitment to quality, service and just-in-time delivery enables us to build and maintain strong and stable customer relationships. We believe that strong relationships with our customers provide us with significant competitive advantages in obtaining and maintaining new business opportunities.
	•	Capitalize on Aftermarket Opportunities. Our stable aftermarket sales enable us to minimize our exposure to adverse economic cycles. Because friction products are the consumable, or wear, component of brake, clutch and transmission systems, the use of our friction products in conjunction with a new or existing system provides us with the opportunity to supply the aftermarket for the life of the system, typically through sales to the original equipment manufacturer. For example, the ability to service the aftermarket for a particular aircraft braking system will likely provide us with a stable market for our friction products for the life of the product, which can be 30 years or more. Aftermarket sales of friction products have comprised approximately 50% of our friction product sales in recent years.
	•	Selectively Expand Internationally. Through our friction and motor segments, which have foreign manufacturing facilities in Italy, Canada, China and Mexico, and our friction segment’s worldwide distribution network, we continue to selectively expand our international operations in established markets throughout Europe, Asia, North America and Australia. In our friction products segment, we have recently established a market presence in Latin America. Our international net sales represented $31.1 million, or 15.8%, of our consolidated net sales for the year ended December 31, 2002, and $23.6 million, or 12.8%, of our consolidated net sales in 2001.

Our Principal Markets and Products

      We focus on supplying the industrial, agricultural, aerospace, performance automotive and motor markets with components that require sophisticated engineering and production techniques for applications where we have achieved a significant market share. We have diversified our end markets through acquisitions and product line expansions. We believe that diversification has reduced our economic exposure to the cyclical effects of any particular industry.

4

Table of Contents

      Friction products are the replacement elements used in brakes, clutches and transmissions to absorb vehicular energy and dissipate it through heat and normal mechanical wear. For example, the friction components in construction vehicles enable their braking systems to slow and stop the vehicles and enable their clutches and transmissions to perform their part in controlling the motion of the vehicles. Our friction products also include friction components for use in automatic and power shift transmissions, clutch facings that serve as the main contact point between an engine and a transmission, and brake components for use in many truck, construction, agriculture, aircraft and specialty vehicle braking systems. Our friction products segment manufactures products made from proprietary formulations of composite materials that primarily consist of metal powders, synthetic and natural fibers.

      Our friction products are custom-designed to meet the performance requirements of a specific application and must meet temperature, pressure, component life and noise level criteria. The engineering required in designing a friction material for a specific application dictates a balance between the component life cycle and the performance application of the friction material in, for example, stopping or starting movement. Friction products are consumed through customary use in a brake, clutch or transmission system and require regular replacement. Because the friction material is the consumable, or wear, component of these systems, new friction product introduction in conjunction with a new system provides us with the opportunity to supply the aftermarket with that friction product for the life of the system.

      The principal markets served by our friction segment include manufacturers of truck clutches, heavy-duty construction and agricultural vehicle brakes, aircraft brakes, motorcycle and snowmobile brakes and transmissions. Based on net sales, we believe that we are among the top worldwide manufacturers of friction products used in industrial and aerospace applications. We estimate that aftermarket sales of friction products have comprised approximately 50% of our net friction product sales in recent years. We believe that our stable aftermarket sales component enables us to minimize our exposure to adverse economic cycles.

      Construction/ Agriculture/ Trucks/ Specialty. We supply a variety of friction products for use in brakes, clutches and transmissions on construction and agriculture equipment, trucks and specialty vehicles. These components are designed to precise friction characteristics and mechanical tolerances permitting brakes to stop or slow a moving vehicle and the clutch or transmission systems to engage or disengage. We believe we are a leading supplier to original equipment manufacturers and to the aftermarket. We also believe that our trademarks, including Velvetouch® and Sheepbridge®, are well known in the aftermarket for these components. The use of our friction products in conjunction with a new or existing brake, clutch or transmission system provides us with the opportunity to supply the aftermarket with the friction product for the life of the system.

	•	Construction Equipment. We supply friction products such as transmission discs, clutch facings and brake components to manufacturers of construction equipment, including Caterpillar. We believe we are the second largest domestic supplier of these types of friction products. Replacement components for construction equipment are sold through original equipment manufacturers as well as various aftermarket distributors.
	•	Agriculture Equipment. We supply friction products such as clutch facings, transmission discs and brake components to manufacturers of agriculture equipment, including John Deere and CNH (formerly Case New Holland). We believe we are the second largest domestic supplier of these friction products. Replacement components for agricultural equipment are sold through original equipment manufacturers as well as various aftermarket distributors.
	•	Medium and Heavy Trucks. We supply friction products for clutch facings used in medium and heavy trucks to original equipment manufacturers, such as Eaton. We believe we are the leading domestic supplier of replacement friction products used in these applications. Replacement components are sold through original equipment manufacturers and various aftermarket distributors.
	•	Specialty Friction. We supply friction products for use in specialty applications, such as brake pads for Harley-Davidson motorcycles, General Motors’ Hummer and Bombardier, Polaris and Arctic Cat snowmobiles. We believe that these markets are experiencing significant growth, and that we have

5

Table of Contents

		increased our market share with our combination of superior quality and product performance. Replacement components are sold through original equipment manufacturers and various aftermarket distributors.

      Aerospace. We believe we are the only independent supplier of friction materials to the manufacturers of braking systems for the Boeing 727, 737 and 757, the DC-9, DC-10, MD-80 and Bombardier’s Canadair regional jet series used by commuter airlines. We believe we are also the largest supplier of friction materials to the general aviation (non-commercial airline, non-military) market, supplying friction materials for aircraft manufacturers such as Cessna, Lear, Gulfstream and Beech.

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

      Our friction products for commercial aerospace applications are primarily used on “single-aisle” aircraft that are flown on shorter routes, resulting in more takeoffs and landings than those experienced by “wide body” aircraft. We believe our friction products provide an attractive combination of performance and cost effectiveness in these applications. According to Boeing’s 2002 Current Market Outlook, approximately 65% of the 15,271 airplanes in the world fleet are single-aisle commercial aircraft. The report also forecasts single-aisle aircraft to more than double by approximately 12,350 to 23,850 by the end of 2021. The Boeing report also states that world airline passenger traffic is projected to increase 4.9% per year through 2021. We expect that long-term growth in world airline traffic, combined with the increasing number of single-aisle aircraft, will cause long-term demand for our aerospace friction products to be stable, although this market remained soft in 2002 and we expect this softness to continue in 2003.

      As a result of the terrorist attacks on September 11, 2001, the aerospace markets we serve suffered an immediate downturn. Air travel schedule curtailments by the airlines were significant as a result of the steep declines in customer traffic. Many older airplanes were among the first to be put out of service by the airlines, including DC-9 and 727 models that were among our market’s highest margin products. The weakness in customer traffic continues as evidenced by the bankruptcy filings of some major U.S. airlines and the weak financial condition of others. We are expecting a further decline in our aerospace market for the full year of 2003 of approximately 15 percent compared to 2002.

      Our precision components segment is a leading supplier of powder metal components consisting primarily of pump, motor and transmission elements, gears, pistons and other component parts for applications ranging from lawn and garden tractors to industrial equipment. Since we were founded, we have participated in the growing powder metal products industry with a focus on the North American industrial market. The Metal Powder Industries Federation, an industry trade group, estimates that the powder metal market for automotive and non-automotive applications in North America had sales of over $5.0 billion in 2001.

      Applications. We manufacture a variety of components made from powder metals for use in (1) fluid power applications, such as pumps and other hydraulic mechanisms, (2) transmissions, other drive mechanisms and anti-lock braking systems used in trucks and off-road and lawn and garden equipment, (3) gears and other components for use in home appliances, small hand tools and office equipment and (4) components used in automotive applications. Powder metal components can often be produced at a lower cost per unit than products manufactured with forging, casting or stamping technologies due to the elimination of, or substantial reduction in, secondary machining, lower material costs and the virtual elimination of raw material waste. In addition, we expect advances in our core powder metal technology to permit production of powder metal components with

6

Table of Contents

      Our precision component segment proactively targets four specific niches in the market place:

	•	High Precision. Our pressing and finishing capabilities enable us to specialize in tight tolerance fluid power components such as pump elements and gears. In addition, we believe that our machining capabilities provide us with a competitive advantage by giving us the ability to supply a completed part to our customers, typically without any subcontracted precision machining. We expect that our growth in this niche will be driven by existing customers’ new design requirements and new product applications primarily for pumps, motors and transmissions.
	•	Large Size Capability. We have the capability to make powder metal components that are among the largest used in North America. For example, we make reactor plates having diameters up to 19 inches for use in transmissions in construction equipment. We expect our sales of large powder metal components to continue to grow as we create new designs for existing customers and benefit from market growth, primarily in current construction, agricultural and truck applications.
	•	High Volume. We also target smaller, high volume parts where we can use efficient pressing and sintering capabilities to our best advantage. In this niche, our primary markets have been powder metal components for the lawn and garden, home appliance, power hand tool, truck, automotive and business equipment markets. We believe that our high volume capabilities will provide us with opportunities to cross-sell numerous of our other precision components. Several of our leading original equipment customers have a variety of applications that we supply from both our friction and precision components segments.
	•	Metal Injection Molding. We also manufacture small, complex metal injection molded parts for a variety of industries, such as small hand tools and telecommunications. We believe that many of our traditional powder metal customers may also be attractive prospects for metal injected molded parts. For instance, we were able to provide one of our powder metal customers with a hydraulic valve component with a precisely controlled flow path because of the fine details achievable in metal injected molded parts as compared to standard powder metal components.

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

      We believe our motor segment is the largest independent U.S. manufacturer of die-cast aluminum rotors for use in fractional and subfractional horsepower electric motors. These motors are used in a wide variety of applications such as small household appliances, business equipment, pumps and fans. We believe our motor segment has significant growth opportunities arising from the trend by original equipment motor manufacturers, which we estimate still produce more than half of all rotors in the U.S. fractional and subfractional horsepower motor market, to outsource their production of rotors to independent suppliers. In 2000, we commenced production at our rotor manufacturing factory in Monterrey, Mexico, a city where a large portion of fractional and subfractional motors are manufactured. We also design and market integral horsepower custom motors and generators through a manufacturing and sales relationship with Potencia Industrial, located in Mexico City, Mexico.

7

Table of Contents

Information About Our Business Segments

      The following table sets forth comparative operating results and total assets (in millions) by each of our operating segments:

(1)	In accordance with the non-amortization provisions of SFAS 142 (see “Note B-Significant Accounting Policies” to the accompanying consolidated financial statements beginning on page 27 of this Form 10-K), the Company eliminated the amortization of goodwill in 2002.

	The following table illustrates the pro forma effect on income (loss) from operations had we applied the non-amortization provisions of SFAS 142 for the years ended December 31, 2001 and 2000 by segment:

(2)	As of January 1, 2002, we reclassified an operating unit formerly associated with our performance automotive segment to our friction products segment as a result of changes in the internal operating responsibility of that unit. We have reclassified all prior periods discussed in this Form 10-K to reflect this change.

8

Table of Contents

Our Manufacturing Processes

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

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

      Some of our friction products, including those used in oil-cooled brakes and power shift transmissions, do not require all of the foregoing steps. For example, composite friction materials are molded under high temperatures and cured in electronically-controlled ovens and then bonded to a steel plate or core with a resin-based polymer.

      Our die-cast aluminum rotors are produced in a three-step process. Steel stamped disks forming the laminations of the rotors are first skewed (stacked) and then loaded into dies into which molten aluminum is injected to create the rotors. The rotor castings created in the dies are then machined to produce finished rotors. We manufacture these rotors in a variety of sizes and shapes to customers’ design specifications.

Our Quality Control Procedures

      Throughout our design and manufacturing process, we focus on quality control. For product design, each manufacturing facility uses state-of-the-art testing equipment to replicate virtually any application required by our customers. This equipment is essential to our ability to manufacture components that meet stringent customer specifications. To ensure that tolerances have been met and that the requisite quality is inherent in our finished products, we use statistical process controls, a variety of electronic measuring equipment and computer-controlled testing machinery. We have also established programs within each of our facilities to detect and prevent potential quality problems.

      In 2001, we launched a Six Sigma initiative focused on creating a culture of continuous improvement. Six Sigma is a discipline that aims to eliminate costly process variation in a company’s operations and bring more value to its customers. To achieve this, Six Sigma managers use statistical analysis to locate process and product errors. As of December 31, 2002, we have trained approximately 250 employees and have over 80 Six Sigma projects in process throughout our business segments. We completed 40 projects in 2002, many of which involved direct customer participation.

9

Table of Contents

Our Foreign Operations

      Our foreign operations are subject to the usual risks of operating in foreign jurisdictions. They include, but are not limited to, exchange controls, currency restrictions and fluctuations, changes in local economic and political conditions, changes in laws, regulations, tariffs or taxes, the establishment of trade barriers and difficulties in management and staffing. For financial information regarding our international operations, see “Note M — Business Segments” and “Note N — Supplemental Guarantor Information” to the accompanying consolidated financial statements beginning on page 27 of this Form 10-K.

Our Technology

      We believe we are an industry leader in the development of systems, processes and technologies that enable the manufacturing of friction products with numerous performance advantages, such as greater wear resistance, increased stopping power, lower noise and smoother engagement. Our expertise is evidenced by our aircraft brake components, which are currently being installed on many of the braking systems of the Boeing 737-600, -700, -800 and -900 commercial airliners and Bombardier’s Canadair regional jet series of commuter aircraft, as well as new series of industrial equipment from various original equipment manufacturers.

      We maintain an extensive library of proprietary friction product formulas that serve as starting points for new product development. Each formula has a specific set of ingredients and processes to generate repeatability in production. A slight change in a mixture can produce significantly different performance characteristics. We use a variety of technologies and materials in developing and producing our products, such as graphitic and cellulose composites. We believe our expertise in the development and production of products using these different technologies and materials gives us a competitive advantage over other friction product manufacturers, which typically have expertise in only one or two types of friction material.

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

      Our motor business is able to produce a wide range of rotors for the fractional and subfractional motor industries. We have developed customized manufacturing processes for rotors and created specialty rotor die construction techniques. We have also designed highly automated machines necessary for the production of our rotors.

Our Customers

      We seek to provide advanced solutions to customers, enhancing our long-term relationships. Our engineers work closely with our customers to develop and design new products and improve the performance of existing products. We believe that more than 80% of our sales are from products and materials for which we are the sole source provider for specific customer applications. Our predecessors formed, and we have continued to build, relationships with a number of customers dating back over 50 years. Our commitment to quality, service and just-in-time delivery have enabled us to build and maintain strong and stable customer relationships. We believe that strong relationship with our customers provide us with significant competitive advantages in obtaining and maintaining new business opportunities.

      Through various acquisitions since our formation, we have broadened our product lines, increased our technological capabilities, further enhance our customer relationships and further expanded our preferred supplier status. As a result of our commitment to customer service and satisfaction, we are a preferred supplier to many of the world’s leading original equipment manufacturers, including Aircraft Braking Systems, Goodrich, Caterpillar, Eaton, Deere, CNH, Hydro-Gear, Sauer-Danfos, Parker Hannifin, Electrolux, Haldex, AO Smith, Emerson and FASCO.

10

Table of Contents

      Our top five customers accounted for 21.6% of our consolidated net sales in 2002, and 24.4% of our consolidated net sales in 2001.

How We Market and Sell Our Products

      We market our products globally through product managers and direct sales professionals, who operate primarily from our facilities in the United States, Italy, China and Canada and a sales office in Germany. Our product managers and sales force work directly with our engineers who provide the technical expertise necessary for the development and design of new products and for the improvement of the performance of existing products. Our friction products are sold both directly to original equipment manufacturers and to the aftermarket through our original equipment customers and a network of distributors and representatives throughout the world. We also sell our precision components and motor components to original equipment manufacturers through independent sales representatives. Sales to customers in our performance automotive segment are sold directly to race teams and distributors throughout the United States.

Our Competition

      The principal segments in which we operate are competitive and fragmented, with many small manufacturers and only a few manufacturers that generate annual sales in excess of $50.0 million. We compete for new business principally at the beginning of the development of new applications and at the redesign of existing applications by our customers. For example, new model development for our aircraft braking system customers generally begins two to five years before full-scale production of new braking systems. Initiatives by customers to upgrade existing products typically involve long lead times as well. We also compete with manufacturers using different technologies, such as carbon composite (“carbon-carbon”) friction materials for aircraft braking systems. Carbon-carbon braking systems are significantly lighter than the metallic aircraft braking systems that we supply friction materials for, but are generally more expensive. The carbon-carbon brakes are typically used on wide-body aircraft, such as the Boeing 747, and on military aircraft, where the advantages in reduced weight may justify the additional expense.

      In addition, as our powder metal components are increasingly substituted for wrought steel or iron components due to advances in our powder metal technology, we increasingly compete with companies using forging, casting or stamping technologies to produce precision components. Powder metal components can often be produced at a lower cost per unit than products manufactured with forging, casting or stamping technologies due to the elimination of, or substantial reduction in, secondary machining, lower material costs and the virtual elimination of raw material waste.

The Suppliers and Prices of the Raw Materials We Use

      The principal raw materials that we use are copper, steel and iron powders, aluminum ingot and custom-fabricated cellulose sheet. We have generally been able to obtain sufficient supplies of raw materials for our operations, and changes in prices of our supplies over the past few years have not had a significant effect on our operations.

Government Regulation of Our Businesses

      Our sales to manufacturers of aircraft braking systems represented 11.1% of our consolidated net sales in 2002 and 14.1% of our consolidated net sales in 2001. Each aircraft braking system, including the friction products supplied by us, must meet stringent Federal Aviation Administration criteria and testing requirements. We have been able to meet these requirements in the past and we continuously review Federal Aviation Administration compliance procedures to help ensure our continued and future compliance.

Environmental, Health and Safety Matters

      We are subject to stringent environmental standards imposed by federal, state, local and foreign environmental laws and regulations, including those related to air emissions, wastewater discharges, chemical and hazardous waste management and disposal. Some of these environmental laws hold owners or operators of land or

11

Table of Contents

Our Intellectual Property

      Our federally registered trademarks include Hawk®, Wellman Friction Products®, Velvetouch®, Fibertuff®, Feramic®, Velvetouch Feramic®, Velvetouch Organik®, Hawk Brake®, Hawk Precision Components®, Hawk Motors®, Quarter Master®, and Hawk Performance®. Velvetouch® and Sheepbridge® are our principal trademarks for use in the friction products aftermarket segment and are registered in 26 countries. We have applied for the registration of the Hawk Precision Components Group, Hawk Racing International, Pro V, Tex Racing and Wellman Products Group trademarks. Although we maintain patents related to our business, we do not believe that our competitive position is dependent on patent protection or that our operations are dependent on any individual patent. To protect our intellectual property, we rely on a combination of internal procedures, confidentiality agreements, patents, trademarks, trade secrets law and common law, including the law of unfair competition.

Personnel

      At December 31, 2002, we had approximately 1,260 domestic employees and 420 international employees. Approximately 190 employees at our Brook Park, Ohio plant are covered under a collective bargaining agreement with the Paper, Allied Industrial, Chemical and Energy Workers International Union expiring in October 2004; approximately 60 employees at our Akron, Ohio facility are covered under a collective bargaining agreement with the United Automobile Workers expiring in July 2003; approximately 70 hourly employees at our Alton, Illinois facility are covered under a collective bargaining agreement with the International Association of Machinists and Aerospace Workers expiring in June 2004; approximately 100 employees at our Monterrey, Mexico plant are represented by the Federacion Nacional de Sindicatos Independientes union under a national union agreement which expires in August 2003; and approximately 200 employees at our Orzinuovi, Italy plant are represented by a national mechanics union agreement that expired in December 2002. Negotiations are ongoing between the parties at the national level. The Italian employees are also covered by an local union agreement that expires in December 2004. We have experienced no strikes and believe we have good relations with our employees and their unions.

      Hawk’s world headquarters is located in Cleveland, Ohio. We maintain manufacturing and research and development facilities at 16 locations in 5 countries. We are a lessee under operating leases for some of our properties and equipment. Hawk’s principal research facility is located in Solon, Ohio. In addition, research is also performed in a number of the operating divisions’ facilities. We believe that substantially all of our property and equipment is maintained in good condition, adequately insured and suitable for its present and intended use.

      We are involved in several 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.

      No matters were submitted to a vote of security holders during the fourth quarter of 2002.

12

Table of Contents

Part II

      Our Class A Common Stock has been traded on the New York Stock Exchange since our initial public offering on May 12, 1998 under the symbol “HWK.” The following table sets forth, for the fiscal periods indicated, the high and low closing prices of our Common Stock as reported on the New York Stock Exchange.

  Quarterly Stock Prices

      The closing sale price for our common stock on December 31, 2002 was $2.32.

      Shareholders of record as of February 14, 2003 numbered 84. We estimate that an additional 1,000 shareholders own stock in their accounts at brokerage firms and other financial institutions.

      We have never declared or paid, and do not intend to declare or pay, any cash dividends for the foreseeable future and intend to retain earnings for the future operation and expansion of our business. Currently, our Bank Facility and Senior Note indenture prohibit the payment of cash dividends on the Class A Common Stock.

      Effective October 25, 2002, we issued 750 shares of our Class A Common Stock, having a market value at the time of issuance of $1,875, to Andrew T. Berlin as part of his annual compensation for services as a director of Hawk. The shares were issued without registration in an offering not involving any public offering as permitted by Section 4(2) of the Securities Act of 1933.

13

Table of Contents

(1)	Reflects primarily a work force reduction at our domestic facilities for approximately 160 salaried and production personnel.
(2)	In accordance with the non-amortization provisions of SFAS 142 (see “Note B — Significant Accounting Policies” to the accompanying consolidated financial statements beginning on page 27 of this Form 10-K), the Company eliminated the amortization of goodwill in 2002.
(3)	Reflects premium paid on partial redemption of Senior Notes and write-off of deferred financing costs in conjunction with the Company’s initial public offering, net of $2.3 million in income taxes.

14

Table of Contents

      You should read this discussion in conjunction with the consolidated financial statements, notes and tables included in Part II, Item 8 of this Form 10-K. Management’s discussion and analysis may contain forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, this performance involves risks and uncertainties that may cause actual results to differ materially from those expressed in the forward-looking statements. Some of the important factors that could cause our actual results or outcomes to differ from those discussed are listed under “Forward-Looking Statements.”

Results of Operations

      Through our subsidiaries, we operate primarily in four reportable segments: friction products, precision components, performance automotive and motors. Our results of operations are affected by a variety of factors, including but not limited to, general economic conditions, 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 corresponding range of gross margins. Our consolidated gross margin is affected by product mix, selling prices, material and labor costs as well as our ability to absorb overhead costs resulting from fluctuations in demand for our products.

      In 2002, our income from operations increased to $9.8 million, or 172 percent, over the prior year. This increase was attributable primarily to sales volume increases in most of the end-markets we serve in our friction and precision component segments with the notable exception of aircraft, improved absorption of fixed costs as a result of the volume increases, cost reduction initiatives and decreased goodwill amortization expense. Partially offsetting these improvements were higher than expected operating costs incurred at our Mexican facility.

      Despite the sales increases we achieved during 2002, we expect that early 2003 will continue to be challenging in most of the markets we serve. Based on discussions with our customer base, we expect our revenue growth during the year will be weighted toward the second half of 2003. We believe that the aerospace market will decline approximately 15% for the full year 2003 compared to 2002, as a result of the continuing softness in that market. Other than aerospace, we expect that our overall sales growth will continue primarily from new product introductions across our segments and sales made from our international facilities. For the full year of 2003, with a gradually improving economy, we are anticipating our segments to provide revenue growth of approximately 10 percent. Although we anticipate improvement in our motor segment as we continue to take steps to improve manufacturing efficiency, we expect that the margins in this segment will continue to lag significantly behind our other segments.

Critical Accounting Policies

      Hawk’s critical accounting policies, including the assumptions and judgments underlying them are more fully described in “Note B — Significant Accounting Policies” of the notes to the accompanying consolidated financial statements beginning on page 27 of this Form 10-K. 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. 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. Hawk’s critical accounting policies include the following:

	•	Revenue Recognition. Revenues are recognized when products are shipped and title has transferred to the customer.
	•	Allowance for Doubtful Accounts. Our policy regarding the collectibility of accounts receivables is based on a number of factors. In circumstances where a specific customer is unable to pay its obligations, we record a specific allowance for bad debts against amounts due to reduce the net recognized receivable

15

Table of Contents

		to the amount that we reasonably expect to collect. If circumstances change, estimates of the recoverability of the amounts due us could change.
	•	Inventory Reserves. Reserves for slow moving and obsolete inventories are developed based on historical experience and product demand. We continuously evaluate the adequacy of our inventory reserves and make adjustments to the reserves as required.
	•	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 Statement of Financial Accounting Standard (SFAS) No. 142, “Goodwill and Other Intangible Assets” (SFAS 142), our policy is to periodically, and in no case less than annually, review our goodwill and other intangible assets based upon the evaluation of such factors as the occurrence of a significant adverse event or change in the environment in which one of our business unit operates would become less than the amount of the asset as reflected in our financial statements. An impairment loss would be recorded in the period such determination is made based on the fair value of the related assets.
	•	Pension and Postretirement 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 element in determining our pension income (expense) in accordance with SFAS 87 is the expected return on plan assets. We have assumed that the expected weighted average long-term rate of return on plan assets will be 8.6 percent. 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. 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).
		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, 2002, we determined this rate to be 6.75 percent. 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, have been deferred as allowed by SFAS 87.

      We expect pension expense to be approximately $1.5 million in 2003, compared to $0.4 million in 2002.

	•	Insurance. We use a combination of insurance and self-insurance for a number of risks including property, general liability, directors’ and officers’ liability, workers’ compensation, vehicle liability and employee-related health care benefits. Liabilities associated with the risks that are retained are estimated by considering various historical trends and forward-looking assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends.

Over the past year, the cost and availability of commercial insurance as a result of significant changes in the insurance market have impacted our insurance coverages. We have renewed all of our insurance policies for 2003, although at additional premium cost, and with increased exposures to losses.

	•	Contingencies. Our treatment of contingent liabilities in the financial statements is based on the expected outcome of the applicable contingency. In the ordinary course of business, we consult with legal counsel on matters related to litigation and other experts both within and outside of the Company. We will accrue a liability if the likelihood of an adverse outcome is probable of occurrence and the amount is estimable. We will not accrue a liability if either the likelihood of an adverse outcome is only reasonably possible or an estimate is not determinable.

16

Table of Contents

	•	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.
	•	Foreign Currency Translation and Transactions. Assets and liabilities of our foreign operations are translated using year-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 shareholder’s equity. 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. Accounts receivable or payable in foreign currencies, other than the subsidiary’s local currency, are translated at the rates of exchange prevailing at the balance sheet date. The effect of the transaction’s gain or loss is included in other income (expense) in our statement of operations.

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

      Net Sales. Our consolidated net sales for 2002 were $197.3 million, an increase of $12.9 million or 7 percent from the same period in 2001. The increase in net sales, primarily a result of a gradual economic recovery during the year in the industrial markets we serve, resulted in all of our segments, with the exception of performance automotive. Additionally, net sales in our motor segment were positively impacted by increased sales originating from our Mexican facility.

	•	Friction Segment. Net sales in the friction segment, our largest, were $106.2 million in 2002, an increase of 2 percent compared to 2001. As a result of improved operating environments in the United States and Europe, we experienced increases in most of our major markets, including construction, agriculture and automotive. The notable exception was our aerospace market. As a result of the continuing softness in the commercial aerospace market during 2002, our sales to this market were down 16 percent from the comparable period in 2001. This segment also experienced strong sales growth out of our international operations in 2002. Net sales, exclusive of any translation gains, at our Italian facility increased 14 percent compared to 2001, as a result of new product introductions and market share gains. Net sales at our Chinese facility were up 251 percent compared to 2001.
	•	Precision Component Segment. Net sales in the precision components segment were $65.8 million, an increase of 13 percent compared to 2001. The increase in net sales was primarily attributable to gradually improving conditions in the general industrial segments of the domestic economy. We experienced sales increases in nearly all of the major markets served by this segment, including pump and motor, lawn and garden, truck and appliance.
	•	Performance Automotive. Net sales in our performance automotive segment were $12.6 million, a decrease of 3 percent compared to net sales of $13.0 million in 2001. The decrease in revenues was primarily attributable to the softness in the end markets we serve from our clutch manufacturing operation. Net sales at our transmission and driveline systems manufacturing facility benefited from the continued popularity of racing, particularly in the NASCAR racing series.
	•	Motor Segment. Net sales in our motor segment were $12.7 million, an increase of 41 percent from the same period in 2001. While a majority of the sales growth came as a result of the production ramp up at our Monterrey, Mexico facility, the segment benefited from the establishment of a number of new customer relationships serviced from our U.S. and Mexican facilities.

      Gross Profit. Gross profit increased $3.7 million to $43.7 million during 2002, a 9 percent increase compared to gross profit of $40.0 million in 2001. The gross profit margin increased to 22.2 percent of net sales in 2002 from 21.7 percent of net sales in the comparable period of 2001.

	•	Friction Segment. Our friction segment reported gross profit of $25.4 million or 24 percent of net sales in 2002 compared to $24.9 million or 24 percent of net sales in 2001. The flat gross profit margin was primarily the result of product mix, especially in our aerospace market, as older aircraft, which have higher margins for us, were retired or put out of service by the commercial airlines. We also continued to support our new facility in China during 2002. Although the facility operated at negative margins for the

17

Table of Contents

		full year, it achieved break even results for the last half of 2002. The decline in gross margin was partially offset by reductions in incentive compensation costs.
	•	Precision Components Segment. Gross profit in our precision components segment was $14.6 million or 22 percent of net sales in 2002 compared to $11.5 million or 20 percent of net sales in 2001. The increase in this segment’s margins was primarily the result of the volume increases and our ability to leverage and absorb the fixed charges generated by the segment and reductions in incentive compensations costs.
	•	Performance Automotive Segment. Our performance automotive segment reported gross profit of $3.7 million or 29 percent of net sales in 2002 compared to $3.9 million or 30 percent of net sales in 2001. The decline in gross profit was primarily the result of volume declines at our performance clutch manufacturing facility.
	•	Motor Segment. Our motor segment reported break even gross profit in 2002. This compared to a gross margin loss of $0.3 million in 2001. Despite ongoing manufacturing inefficiencies at our facilities, the improvement in our gross margin was primarily the result of the sales volume increases and the resulting absorption of fixed costs at our Mexican facility in 2002.

      Selling, Technical and Administrative Expenses. Selling, technical and administrative (ST&A) expenses increased $1.8 million, or 6 percent, to $32.6 million in 2002 from $30.8 million during 2001. As a percentage of net sales, ST&A remained stable at 17 percent in 2002 and 2001. The increase in ST&A expenses resulted primarily from continuing start-up expenditures incurred at our Mexican rotor manufacturing and Chinese friction material facilities, increased insurance and personnel costs associated with our long-term sales and growth initiatives. Additionally, we incurred legal expenses in our performance automotive segment related to litigation that was resolved in the second quarter of 2002. These cost increases were partially offset by reductions in incentive compensation costs. We spent $3.5 million, or 2 percent of our net sales on product research and development compared to $3.9 million in 2001.

      Amortization of Intangibles. Results for the year ended December 31, 2002 were favorably impacted by the adoption of SFAS 142 on January 1, 2002, which eliminated the amortization of goodwill on indefinite-life intangible assets. This accounting change reduced our amortization expense for the year by $3.2 million compared to 2001.

      Income from Operations. Income from operations increased $6.2 million or 172 percent to $9.8 million in 2002 from $3.6 million in 2001. Income from operations as a percentage of net sales increased to 5 percent in 2002 from 2 percent in 2001. The increase was primarily the result of the increased sales volume, improved absorption of fixed costs as a result of the volume increases, cost reduction initiatives and a reduction of amortization expense of $3.2 million as a result of the adoption of SFAS 142. This improvement to income from operations was partially offset by continuing support of our operations in China, higher than anticipated operating costs incurred at our Mexican rotor manufacturing facility and continued support of our metal injection molding facility during the year. During the year ended December 31, 2001, we recognized an expense of $1.1 million in restructuring charges to adjust our business plan to reflect the economic slowdown. No such charge was taken in 2002.

      As a result of the items discussed above, results from operations at our segments were as follows:

	•	Our friction segment’s income from operations increased $1.1 million or 17 percent to $7.5 million in 2002 from $6.4 million in 2001.
	•	Income from operations at our precision components segment was $4.1 million in 2002, an increase of $3.8 million, or 8 percent, compared to $0.3 million in 2001.
	•	Income from operations at our performance automotive segment was $1.0 million in 2002, an increase of $0.7 million, compared to $0.3 million in 2001.
	•	The loss from operations in our motor segment decreased to $2.8 million in 2002 from $3.4 million in 2001.

18

Table of Contents

      Other Expense. Other Expense was $0.7 million in 2002 compared to $0.5 million in 2001. The major expense items in 2002 included, fees paid by us in the first quarter of 2002 to effect an amendment to our Term Loan and Revolving Credit Facility, costs associated with our termination of a product licensing agreement in our precision components segment, and to a lesser extent, foreign exchange transaction losses. In 2001, other expense was primarily comprised of the recognition of the fair value of our then outstanding swap agreement, in addition to foreign currency transaction losses.

      Interest Expense. Interest expense increased $0.3 million, or 3 percent, to $9.8 million in 2002 from $9.5 million in 2001. The increase is primarily attributable to increased borrowings during the year and an increase in the interest rate on our Senior Notes. Following our exchange offer in October 2002, the interest rate on our Senior Notes increased from 10.25% to 12%. This increase was partially offset by lower interest rates paid under our new Bank Facility, which was also entered into in October 2002. Additionally, we recorded $0.1 million in interest expense in December 2002, to reflect the issuance of payment in kind (PIK) interest under the terms of the Senior Notes leverage ratio test for the period ended December 31, 2002.

      Exchange Offer Costs. During the year ended December 31, 2002, we incurred third-party fees and expenses of $1.9 million related to the exchange of our Senior Notes for our then outstanding Old Senior Notes.

      Income Taxes. We recorded a tax benefit of $1.5 million, or 59 percent of pre-tax loss, in 2002 compared to a benefit of $1.9 million, or 30 percent of pre-tax loss in 2001. The increase in the effective benefit is primarily the result of the reversal of tax accruals due to the expiration of various statutes of limitations covering periods in which we provided for potential tax liabilities. An analysis of changes in our income taxes and our effective tax rate is contained in “Note J — Income Taxes” in the accompanying consolidated financial statements beginning on page 27 of this Form 10-K.

      Cumulative Effect of Change in Accounting Principle. In accordance with the requirements of SFAS 142, we recorded a charge for the cumulative effect of change in accounting principle of $17.2 million for the year ended December 31, 2002. See “Note B — Significant Accounting Policies” in the accompanying consolidated financial statements beginning on page 27 of this Form 10-K. This charge represents the write-off of $21.5 million of goodwill ($17.2 million, net of income taxes of $4.3 million).

      Net (Loss) Income. As a result of the factors noted above, we reported a net loss of $18.2 million in 2002, compared to a net loss of $4.3 million in 2001.

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

      Net Sales. Our consolidated net sales for 2001 were $184.4 million, a decrease of $17.9 million or 9% from the same period in 2000. The decline in net sales, primarily a result of the prolonged weakness in the markets we serve, resulted in a difficult operating environment in most of our reporting segments. The terrorist attacks on September 11, 2001, in particular, had a significant negative impact on our aircraft friction business.

	•	Friction Segment. Net sales in the friction segment were $104.1 million in 2001, a decrease of 10% compared to 2000. The major markets served by this segment all experienced weak operating conditions in 2001. We experienced declines in heavy truck, agriculture, construction and specialty friction for the full year 2001 as a result of the soft operating conditions in the United States and Europe. Net sales in the aerospace market showed a decline for the year, most notably in the fourth quarter of 2001, as a result of the events of September 11.
	•	Precision Components Segment. Net sales in the precision components segment were $58.3 million, a decrease of 19% compared to 2000. The decrease was primarily attributable to continuing softness in the general industrial segments of the domestic economy. We experienced sales weakness in nearly all of the markets served by this segment, including heavy truck, lawn and garden, pump and motor, appliance and office equipment. While net sales in the segment were down as a result of the general softness of economic operating environment, we feel the sales declines were further exacerbated by negative inventory realignments by our customers in the last half of 2001.

19

Table of Contents

	•	Performance Automotive Segment. Net sales in our performance automotive segment were $13.0 million, an increase of 132% compared to net sales of $5.6 million in 2000. The increase in revenues was primarily attributable to the acquisition of our Tex Racing subsidiary in November 2000. Additionally, net sales in this segment benefited from the continued popularity of racing, particularly in the NASCAR and CART racing series, both served by us.
	•	Motor Segment. Net sales in our motor segment were $9.0 million, an increase of 7% from the same period in 2000. The sales growth in the motor segment came from our new rotor manufacturing facility in Monterrey, Mexico, which began shipments in 2001. This facility is expected to service the growing motor manufacturing base in that region. Net sales from our Alton, Illinois facility were flat in 2001 as a result of the soft economic conditions experienced in the United States.

      Gross Profit. Gross profit decreased $14.9 million to $40.0 million during 2001, a 27% decrease compared to gross profit of $54.9 million in 2000. The gross profit margin decreased to 22% of net sales in 2001 from 27% of net sales in the comparable period in 2000. Each of our segments experienced decreased margins primarily as a result of the deteriorating economic conditions experienced in 2001.

	•	Friction Segment. Our friction segment reported gross profit of $24.9 million or 24% of net sales in 2001 compared to $30.9 million or 27% of net sales in 2000. The decline in our gross profit margin was the result of lower sales volumes, product mix and our inability to absorb all of the fixed costs of our manufacturing facilities as a result of the deteriorated economic conditions experienced in 2001; especially the impact of the reduction in sales to the aircraft market in the fourth quarter as a result of the events of September 11. We also continued to support our start-up facility in China during 2001. Although the facility began shipments in 2001, it operated at negative margins for the entire year.
	•	Precision Components Segment. Gross profit in the precision components segment was $11.5 million or 20% of net sales in 2001 compared to $19.4 million or 27% of net sales in 2000. The sharp decline in this segment’s margins was primarily the result of the severe economic downturn and the resulting volume declines and our inability to cover all of the unabsorbed fixed charges generated by the segment. We also provided operating support to our start-up metal injection molding company, Net Shape, which was acquired in December 2000.
	•	Performance Automotive Segment. Our performance automotive segment reported gross profit of $3.9 million or 30% of net sales in 2001 compared to $2.8 million or 50% of net sales in 2000. The decline in gross profit was primarily the result of manufacturing inefficiencies and inventory realignments at our performance clutch manufacturing facility.
	•	Motor Segment. We reported a gross margin loss in the motor segment for 2001. The loss was $0.3 million compared to a gross profit of $1.8 million in 2000. The negative gross margin was primarily the result of our continued support of our start-up rotor manufacturing facility in Mexico during 2001. Additionally, as a result of softness in the domestic motor business in 2001, our domestic margin declined in 2001, since we were unable to absorb all of the fixed costs.

      Selling, Technical and Administrative Expenses. ST&A expenses decreased $0.5 million, or 2%, to $30.8 million in 2001 from $31.3 million during 2000. As a percentage of net sales, ST&A increased to 17% in 2001 from 15% in 2000. The increase in ST&A expenses as a percentage of net sales resulted primarily from sales volume reductions, continuing start-up expenditures incurred at our Mexican rotor manufacturing and Chinese friction material facilities, personnel costs associated with our long-term sales and growth initiatives and charges to settle litigation in our friction segment. We spent $3.9 million, or 2% of our net sales on product research and development compared to $3.5 million in 2000.

      Restructuring Costs. In June 2001, we announced a restructuring program to adjust our near-term business plan to reflect the current economic slowdown. This restructuring initiative included a workforce reduction at our domestic facilities and other charges. As a result of the restructuring initiative, we recorded an expense of $1.1 million in 2001. The restructuring program included a reduction of approximately 160 employees, including salary and production personnel, primarily at our domestic locations. Restructuring activities were substantially completed in the first quarter of 2002.

20

Table of Contents

      Income from Operations. Income from operations decreased $15.9 million or 82% to $3.6 million in 2001 from $19.5 million in 2000. Income from operations as a percentage of net sales decreased to 2% in 2001 from 10% in 2000. The decline was primarily the result of the sales volume declines due to the economic slowdown affecting our markets, continuing support of our start-up operations, charges to settle litigation in our performance automotive segment, increased depreciation expense and the restructuring charge we took in the second quarter of 2001.

      As a result of the items discussed above, results from operations at our segments were as follows:

	•	Our friction segment’s income from operations decreased $5.1 million or 44% to $6.4 million in 2001 from $11.5 million in 2000,
	•	Income from operations at the precision components segment was $0.3 million in 2001, a decrease of $8.1 million or 96% compared to $8.4 million in 2000,
	•	The performance automotive segment reported income from operations of $0.3 million, a decrease of $0.6 million in 2001 compared to 2000, and
	•	The loss from operations in the motor segment increased to $3.4 million in 2001 from $1.3 million in 2000.

      Other Expense. Other expense was $0.5 million in 2001, the same as reported in 2000. The expense in 2001 primarily reflected the fair value of our interest rate swap agreement and foreign currency transaction losses we incurred primarily through our Italian facility.

      Interest Expense. Interest expense increased $0.5 million, or 6%, to $9.5 million in 2001 from $9.0 million in 2000. The increase is primarily attributable to increased borrowings by us during the year partially offset by lower interest rates.

      Income Taxes. The provision for income taxes decreased $6.2 million to a benefit of $1.9 million in 2001 from a tax expense of $4.4 million in 2000 primarily because of the losses incurred in 2001. Our effective tax benefit for the year ended is 30% compared to a tax provision of 43% in 2000. The primary factors affecting our effective tax rate in 2001 are nondeductible goodwill amortization and required state and local tax provisions. An analysis of changes in our income taxes and our effective tax rate is contained in “Note J — Income Taxes” in the accompanying consolidated financial statements beginning on page 27 of this Form 10-K.

      Net (Loss) Income. As a result of the factors noted above, we reported a net loss of $4.3 million in 2001, compared to net income of $5.8 million in 2000.

Liquidity and Capital Resources

      Our primary financing requirements are (1) for capital expenditures for maintenance, replacement and acquisitions of equipment, expansion of capacity, productivity improvements and product development, (2) for funding our day-to-day working capital requirements and (3) 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 credit facility.

      In October 2002, we entered into a new senior secured credit facility (the Bank Facility). The Bank Facility, which is available for general corporate purposes, has a maximum commitment of $53.0 million, including a letter of credit facility of up to $5.0 million, comprised of a $50.0 million revolving credit component and a $3.0 million capital expenditure loan component. The capital expenditure loan component, available to us after December 31, 2002, may be used to finance 80% of the cost of new equipment purchased after October 18, 2002. At the end of each calendar year, beginning with the year ending December 31, 2003, the principal amount of all loans under the capital expenditure facility borrowed during the applicable calendar year will begin to amortize on a seven year, straight-line basis. The remaining unamortized principal balance under the capital expenditure loan facility is due and payable on the final maturity date of the Bank Facility.

      The Bank Facility is collateralized by a security interest in the accounts receivable, inventory, equipment and real estate and other assets of Hawk and our domestic subsidiaries, and we have pledged the stock of all of our domestic subsidiaries and up to 65% of the stock of certain of our foreign subsidiaries as collateral. Restrictive

21

Table of Contents

      Emerging Issues Task Force (EITF) Issue No. 95-22 “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements That Include both a Subjective Acceleration Clause and a Lock-Box Arrangement”, we are required to classify all of our outstanding debt under the Bank Facility as a current liability. However, it is our intention to manage the bank credit facility as long-term debt with a final maturity date in 2006, as provided for in the agreement that we signed. We expect the long-term availability under the revolving credit portion of the Bank Facility to be $50.0 million for the next twelve month period, subject to the borrowing base.

      In October 2002, we exchanged $64.4 million of our $65.0 million, 10 1/4% Senior Notes due December 1, 2003 (Old Senior Notes), for 12% Senior Notes due December 1, 2006 (Senior Notes). The Senior Notes were issued on October 23, 2002. The remaining principal of the Old Senior Notes in the amount of $0.6 million remain outstanding and will mature on December 1, 2003. In addition, the holders of the Old Senior Notes that participated in the exchange for Senior Notes received a consent payment of $25.63 for each $1,000 of Old Senior Notes held as of October 23, 2002. The consent payment which totaled $1.6 million, was issued in the form of additional Senior Notes and is payable to the holders at maturity of the Senior Notes. We incurred $1.9 million of third party costs in connection with the exchange. The Senior Notes are general unsecured senior obligations of Hawk and are fully and unconditionally guaranteed, on a joint and several basis, by all of our domestic wholly-owned subsidiaries. The Senior Notes accrue interest at a rate of 12% per annum on the principal amount commencing October 23, 2002. Interest payments are due December 31 and June 30. In addition, in the event that our leverage ratio exceeds 4.0 to 1.0 for the most recently ended four quarters beginning with the semi-annual period ended December 31, 2002, we will be required to pay additional PIK interest at a rate ranging from .25% to 2.00% until the next semi-annual test period. Any interest payment under this test will be made by issuing additional Senior Notes. As of December 31, 2002, the leverage ratio test will require us to issue $0.1 million of PIK interest, calculated at a rate of 1.00%, in the form of additional Senior Notes.

      We have the option to redeem the Senior Notes in whole or in part during the twelve months beginning December 1, 2002 at 105% of the aggregate principal amount thereof, beginning December 1, 2003 at 102.5% of the aggregate principal amount thereof and beginning December 1, 2004 at 100% of the aggregate principal amount thereof together with any interest accrued and unpaid to the redemption date. Upon a change of control as defined in the Senior Note indenture, each holder of the notes will have the right to require us to repurchase all or any part of their notes at a purchase price equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest to the date of purchase.

      The Senior Notes permit Hawk and its subsidiaries to incur additional indebtedness without limitation, provided that we continue to meet a cash flow coverage ratio. As of December 31, 2002, we did not meet the prescribed ratio. The failure to meet the ratio does not constitute a default under the Senior Note indenture. Rather, the Senior Note indenture continues to permit indebtedness subject to limitations. Our Bank Facility, which is secured by liens on all of our assets and the assets of our subsidiaries, is permitted. We do not believe that our operations will be materially impacted by the limitation on indebtedness arising under the Senior Note indenture.

      The Senior Notes prohibit the payment of cash dividends on the Company’s Class A Common Stock. The Senior Notes also contain other covenants limiting our ability to make certain restricted payments, make certain investments, permit liens, incur dividend and other payment restrictions affecting subsidiaries, enter into consolidation, merger, conveyance, lease or transfer transactions, make asset sales, enter into transactions with affiliates or engage in unrelated lines of business. These covenants are subject to certain exceptions and qualifications. The Senior Notes considers non-compliance with the limitations events of default. In addition to

22

Table of Contents

      Net cash used in operating activities was $2.7 million in 2002 compared to cash provided by operating activities of $14.5 million in 2001. Cash used in our operations in 2002 was primarily attributable to the loss we incurred in 2002, an increase in our receivables, inventories, other working capital assets and the continued operating support of our foreign facilities, partially offset by non-cash charges of depreciation and amortization. Cash provided by operations in 2001 was primarily attributable to non-cash charges of depreciation and amortization partially offset by the loss we experienced in 2001. Our net working capital, exclusive of the outstanding debt under the Bank Facility, which is classified as a current liability for accounting purposes, was $46.3 million at year-end 2002 compared to $31.5 million at year-end 2001.

      We used cash in investing activities of $11.5 million in 2002 and $9.1 million in 2001 for the purchase of property, plant and equipment.

      Cash provided by financing activities was $12.8 million in 2002. The increase in 2002 was the primarily the result of our additional borrowings to support the increase in working capital assets, the support of our facilities in Mexico and China and our purchases of property, plant and equipment during the year. Our net cash used in financing activities was $6.2 million in 2001 primarily for the payment of long-term debt.

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

Net Operating Loss Carrybacks

      As of December 31, 2002, we have available to us U.S. net operating loss tax carrybacks which will result in approximately $3.5 million in federal income tax refunds, which we expect to receive in the first half of 2003.

Forward-Looking Statements

      Statements that are not historical facts, including statements about our confidence in our prospects and strategies and our expectations about growth of existing markets and our ability to expand into new markets, to identify and acquire complementary businesses and to attract new sources of financing, are forward-looking statements that involve risks and uncertainties. In addition to statements which are forward-looking by reason of context, the words “believe,” “expect,” “anticipate,” “intend,” “designed,” “goal,” “objective,” “optimistic,” “will” and other similar expressions identify forward-looking statements. In light of the risks and uncertainties inherent in all future projections, the inclusion of the forward-looking statements should not be regarded as a representation by us or any other person that our objectives or plans will be achieved. Many factors could cause our actual results to differ materially and adversely from those in the forward-looking statements, including the following:

	•	our ability to continue to meet the terms of our debt and bank credit facilities which contain a number of significant financial covenants and other restrictions;
	•	the effect of our debt service requirements on funds available for operations and future business opportunities and our vulnerability to adverse general economic and industry conditions and competition;
	•	the continuing impact of the reduction in air travel, the bankruptcy filings by a number of major airline companies and the weak financial condition of other airlines on our aircraft brake business, including the decline in gross profit margins in this market as a result of the retirement of many older airplanes that used our product;
	•	our ability to effectively utilize all of our manufacturing capacity as the industrial and commercial end-markets we serve gradually improve;

23

Table of Contents

	•	our ability to generate profits at our facility in Mexico, including our ability to resolve the manufacturing inefficiencies being incurred at that facility;
	•	the effect of competition by manufacturers using new or different technologies;
	•	the effect on our international operations of unexpected changes in regulatory requirements, export restrictions, currency controls, tariffs and other trade barriers, difficulties in staffing and managing foreign operations, political and economic instability, fluctuations in currency exchange rates, difficulty in accounts receivable collection and potentially adverse tax consequences;
	•	our ability to negotiate new agreements, as they expire, with our unions representing certain of our employees, on terms favorable to us or without experiencing work stoppages;
	•	the effect of any interruption in our supply of raw materials or a substantial increase in the price of any of the raw materials;
	•	the continuity of business relationships with major customers; and
	•	the ability of our products to meet stringent Federal Aviation Administration criteria and testing requirements.

      You must consider these risks and others that are detailed in this Form 10-K in deciding whether to invest.

Effects of Recently Issued Accounting Pronouncements

      In October 2001, the FASB issued SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 supersedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”, however it retains the fundamental provisions of that statement related to the recognition and measurement of the impairment of long-lived assets to be “held and used.” In addition, SFAS 144 provides more guidance on estimating cash flows when performing a recoverability test, requires that a long-lived asset (group) to be disposed of other than by sale (e.g. abandoned) be classified as “held and used” until it is disposed of, and establishes more restrictive criteria to classify an asset (group) as “held for sale.” SFAS 144 was effective for us in 2002. The adoption of SFAS 144 did not have a material impact on our financial results.

      In June 2002, the FASB issued SFAS No. 146, “Accounting for Exit or Disposal Activities” (SFAS 146). SFAS 146 addresses significant issues regarding the recognition, measurement and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for pursuant to the guidance of EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS 146 will be effective in 2003. The adoption of SFAS 146 is not expected to have a material impact on our financial results.

      In December 2002, we adopted the disclosure provisions of SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (SFAS 148). SFAS 148 requires prominent disclosure regarding the method used by us to account for stock based employee compensation and the effect of the method used on reported results.

      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. We do not use derivative financial instruments for speculative or trading purposes.

      Interest Rate Sensitivity. At December 31, 2002, approximately 33 percent, or $36.3 million, of our debt obligations bear 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 (1.0%) from December 31, 2002 rates, and assuming no changes in debt from December 31, 2002 levels, our additional annual interest expense would be approximately

24

Table of Contents

      The interest rates on our long-term debt reflect market rates and therefore, the carrying value of long-term debt approximates fair value.

      The following table presents our total contractual obligations and other commercial commitments as of December 31, 2002 (in millions):

      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 currently do not hedge our foreign currency exposure and, therefore, have not entered into any forward foreign exchange contracts to hedge foreign currency transactions. We have operations outside the United States with foreign currency denominated assets and liabilities, primarily denominated in Euro, Canadian dollars, Mexican pesos and Chinese renminbi. 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 December 31, 2002 will result in a significant impact on our earnings or cash flows.

25

Table of Contents

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

AUDITED CONSOLIDATED FINANCIAL STATEMENTS

Hawk Corporation and subsidiaries

26

Table of Contents

HAWK CORPORATION

AUDITED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2002, 2001 and 2000

Contents

Audited Consolidated Financial Statements

27

Table of Contents

REPORT OF INDEPENDENT AUDITORS

Shareholders and Board of Directors
Hawk Corporation

      We have audited the accompanying consolidated balance sheets of Hawk Corporation and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hawk Corporation and subsidiaries at December 31, 2002 and 2001 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States.

      As discussed in Note B to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill.

	/s/ Ernst & Young LLP

Cleveland, Ohio

28

Table of Contents

HAWK CORPORATION

CONSOLIDATED BALANCE SHEETS

(In Thousands, except share data)

29

Table of Contents

CONSOLIDATED BALANCE SHEETS — (continued)