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Executives

Ronald Weinberg - Chairman and CEO

Joe Levanduski - VP and CFO

Tom Gilbride - VP of Finance.

Analysts

Joe Giamichael - Rodman & Renshaw

Ivan Marcuse - KeyBanc Capital Markets

Beth Lilly - Gabelli

Richard Marshall - Longbow Research

Hawk Corp. (HWK) Q4 2007 Earnings Call March 17, 2008 11:00 AM ET

Operator

Good day and welcome to today's Hawk Corporation fourth quarter Earnings Call. (Operator Instructions)

At this time, I would like to turn the conference over to your host Mr. Ronald Weinberg. Please go ahead.

Ronald Weinberg

Thank you. Good morning, everybody and thank you for joining us today. This call as you know is to discuss our fourth quarter and year-end '07 results. Conducting the call is myself, Ron Weinberg, I am the Chairman; Joe Levanduski, Vice President and CFO; and Tom Gilbride, Vice President of Finance.

As you know, we released earnings this morning. During our call today we will review the financials, give you an operating report on the business including some discussion of guidance, and after that we will open the call up to questions.

I would like to remind you that statements made during this conference call which are not historical facts may be considered forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied. For further information concerning issues that could materially affect financial performance related to forward-looking statements, please refer to our quarterly earnings releases and our periodic filings with the SEC.

I will begin by covering some of the broad points and issues that I would like to emphasize and then turn this over to Joe and Tom and then after that we will be glad to take questions.

We are very pleased with the year. We had sales that were up 7.8% over the previous year at $288.7 million. And that for our friction business and for our continuing operations represents a record. Our income from continuing operations was up 87.9%, which we're very, very pleased with and that is $18.6 million.

Now to drill down in that just a little bit, in the prior year there was an impairment charge that may make that year look a little bit worse, but if you continue to analyze it and look at just our friction business alone, our income from continuing operations with that regard to that impairment charge was up 23% and our total was 29%. So that gives a little bit more of a pro forma apples-to-apples comparison, which is an interesting analysis and our earnings per share was $0.75.

We completed the year with cash and marketable securities of $81 million, which gives us nice financial strength at particularly unusual time in the economies of the world and gives us untapped potential for looking at acquisitions. We continue to look at acquisitions in friction related business, and we will continue to stay focused in that area. Because we are staying within a tighter time, a tighter industry frame, it makes it a little bit slower for us to be able to achieve an acquisition because we are going after a defined population of companies. We continue to look and feel encouraged.

The markets that we serve were strong. And that was an important contributor to our sales gains for last year. One of the interesting things and we are certainly not unaware of the fiscal crisis going on in the world and some of the softness in certain markets. Within the industries we serve, there are specific dynamics that are driving them. As one of our customers said, if they are holding a recession, they forgot to invite me. And so we are aware and we are the beneficiary of that, we certainly do keep our eyes on the economy as a whole.

And I think I am proud to say it is one of the reasons we were forward in thinking and making sure that we have a lot of cash at this time. But our markets continue to look good at this time. We have gotten the discussions of Tulsa behind us which were an issue for us in past years. And I think it is important to note that the management changes that we made in the business going back two years ago when the management of Wellman was changed, and then the operational leadership changed one year ago. And those things have led to further implementation of our lean manufacturing and operational improvements. And that has had the effect of driving our margins up in '07.

Some of the projects that we work on include leaning out our operations and also rationalizing our (inaudible) of any part we make so that we eliminate freight and just put things more local to where they are needed and it's going to continue to make a difference. We have expanded our capital budget for '08 as a result to give us increased capacity and increased stability to do these lean things that I am talking about.

Another factor that I would point out for '07 is we did benefit from a number of the issues that are cited in the release and in our 10-K. Those include strength in the economy. They include the strength of the Euro in relation to the dollar and our currency translations. In addition I think there is a factor that we haven't seen is much obviously I would like to think we'll in the future and that is getting what I call our selling cycle reactivated.

During '05 and '06 when our shipments were poor because of the move to Tulsa, it was more difficult to get new business awards, then it will be one we're rolling along nicely. And because of the selling cycle, we weren't able to get those activated as quickly as some of the other lean activities. So I think as we go forward, our goal will be to restore sales momentum and that's something that we look forward to clicking in the future.

At this point we continue to work on our three key imperatives that we talk about regularly in the business, both internally and externally. They are operations, getting ourselves lean, flawless delivery, flawless quality of the Six Sigma level, enhancing our technology so that we'll bring in fresh ideas to our customers in the marketplace and what we call customer intimacy, understanding what our customers want, anticipating it, and knowing how to supply that. And it's just a constant theme of what we talk about internally that we keep focusing on those three items.

In addition, we are building our after-market business. We have applied more management focus on it. We think it's a very attractive area for us. And because we make parts that are wear parts that wear out, the after-market business is good, both the direct after-market and the after-market we served through our OE customers.

In addition, we are working on some of longer-range projects that we think have good potential. One is the manufacturer of fuel cell components and the second is manufacturer of carbon composite materials that would have friction and other usage. We have been funding research on those two activities. We are gearing up with equipment for the fuel cell production and we think in the future there will be more talk about those and more to show.

At this point we have nothing new to announce on the SEC investigation, it continues, we continue to cooperate and when there is something to announce, of course we will.

At this point I will turn this over to Joe Levanduski and also Tom Gilbride who will give further financial details and guidance.

Joe Levanduski

Thank you, Ron. Hawk Corporation set a new record for revenues for the 2007 year, finishing at $228.7 million, up 7.9%. We do expect this record to be short-lived, but I will refrain from discussing that until I get to the guidance section of this presentation relating to the 2008 year.

Friction segment was up $16 million to $215 million versus just under $200 million in 2006. All our markets or the majority of the markets were reporting strong numbers, except for our truck market which we had anticipated. Pricing actions, new business awards that Ron alluded to and the strength of Euro contributed to the success of the Friction segment numbers. Our Racing segment was up 5.8% to $12.8 million versus $12.1 million, driven by the success of the initial introduction of the 'Car of Tomorrow' concept in NASCAR.

The currency exchange rate accounted for approximately 3.2% of total net sales increase. The diversity of our market pie chart is obviously the strength of our organization and is led by construction of mining which is our largest segment reported, was up 15.1% for the year. Our Aerospace and defense was up about 5.6%, agriculture was up 18.2% and specialty friction was up 5.3%.

As we mentioned, the truck market which was coming off of a soft year in 2007 was extremely strong in 2006's volume per new truck sales in advance of the '07 emissions standard change positively affected the 2007 sales in this market. Truck was down 18% in 2007 which was better than we had originally anticipated. Gross margins improved to 23.2% versus 22% in 2006. Operating margins also improved to 8.1% from a reported 4.7%. Ron mentioned the goodwill impairment charge in 2006, taking that into account operating margins in 2006 adjusted were 6.8%, so apples-to-apples comparison 8.1% versus 6.8%.

Pricing actions and continued improvements from our lean thinking initiatives have been responsible for driving the improved results and offsetting these improvements with a legal cost from the SEC investigation and increased incentive compensation expense that was variable and based upon the operating performance of our organization.

Interest expense lowered to $9.4 million versus $11.2 million in the prior year. That resulted from our successful tender of our bonds in August of this year, and the overall lowering of our borrowing levels throughout the course of the year. Interest income driven marginally by the cash position that Ron mentioned, driven by the sale of our Precision Components Group and cash from operations was $3.8 million in 2007. The resulting net income from continuing operations was $7.2 million versus a loss of $2 million in 2006 or roughly $0.75 per share versus a loss of $0.22 per share on a fully diluted basis.

Our discontinued operation reported an income of $10.1 million versus $4.9 million in the prior year, reflecting the gain on sale of the Precision Components Group. The $10.1 million equates to a roughly $1.08 per share. All in our net income was $17.3 million versus $3 million in 2006 or $1.83 per share versus $0.30 per share on roughly $9.4 million shares outstanding as of December 31st '07 versus $9.5 million shares outstanding in 2006.

Our balance sheet remains very strong at December 31st '07 with cash and marketable securities of $81 million versus $6.2 million in the prior year, and net cash is what is remaining post bond tender from the sale of Precision Components Group. Our inventory and accounts receivable have increased year-over-year, reflecting higher sales volumes. Our working capital overall reduced to $113.3 million versus $115.8 million in the prior year. And our current ratio now stands at 3.1 to 1.

Long-term debt is approximately $87 million versus a $110 million in 2006, again reflecting the successful bond tender in August of 2007. We have $17.9 million available under our current credit facility. The credit facility is in total $30 million and based upon the collateral calculation we have $17.9 million available with the collateral we have today. Total shareholders' equity is $67.3 million versus $46.7 million in the prior year. One other point I want to mention we have substantially completed our share repurchase program as of December 31st consuming approximately $3.7 million of the $4 million program that we announced earlier this year.

Turning to guidance, we're coming off of a good 2007 and we anticipate even better 2008 numbers. Although there are risks and uncertainties in today's economic climate, the global position of our major customers and diversities of the markets that we serve lend itself to Hawk expecting to experience another solid year. We are guiding to 2008 revenues of $245 million to $250 million which should represent a 7.1% to 9.3% increase over our 2007 published numbers.

We continue to extend our reach into markets in Russia, China, and India, and our operating income we continue to watch the inflationary pressures on many of our raw material components that we consume in our manufacturing process and we do attempt to shield ourselves as best as possible against these cost increases, but we are subject to certain expenses increasing as we go through this year.

We also anticipate investing in human capital as we've strengthened our commitment to many of the internal growth initiatives and Ron mentioned a few of those. The resulting guidance from income from operation is between $20 million to $22 million which represents roughly a 7.5% to 18.3% increase over the 2007 year. Our effective tax rate we anticipate being similar to the 2007 actual rate that we reflected in our income statement which is approximately 43.4%.

Ron mentioned that we are going to aggressively continue to fund our internal projects, such as fuel cell and carbon composites. We have a very aggressive capital spending plan being budgeted for 2008 and expect has been $15 million versus $7.9 million that was spent in 2007. Depreciation and amortization is also expected to fall similar to the 2007 rate and we anticipated be an approximately $8 million for the 2008 year.

With that, I will turn it back to Ronald Weinberg.

Ronald Weinberg

Thanks Joe. At this time, we are prepared to take questions. So anyone that has them, operator would you queue them in.

Question-and-Answer Session

Operator

(Operators Instructions) And our first question comes from Joe Giamichael from Rodman & Renshaw

Joe Giamichael - Rodman & Renshaw

Good afternoon, gentlemen.

Joe Levanduski

Hi, Joe, how are doing?

Joe Giamichael - Rodman & Renshaw

Not too bad. Congratulations on the quarter. Just a couple of quick questions for you. The friction products gross margins were down several 100 basis points from Q1, which had similar revenues. Other than the inflationary pressures in steel that you talked about, what are some of the reasons that we are seeing this pressure?

Joe Levanduski

I think part of it is just relating to the segments and the calendar. During the fourth quarter, we do experience the holiday shutdown cycle in working capital management from many of our customers in the marketplace.

Ronald Weinberg

Joe, also I think in the fourth quarter, there is some product mix issues in which we had some deliveries in the first quarter, that were not repeating in the fourth quarter at that same product level or mix level.

Joe Giamichael - Rodman & Renshaw

Got it, okay. Do you think with your return, do you expect to see sort of more normalized gross margin in that segment, of not nearly where you are in Q1, but maybe somewhere between the difference in Q1 and Q4?

Ronald Weinberg

Let me answer in a different way, and Joe and Tom can answer. Q4 is always kind of a micro challenge for us, if you will. This is because of the seasonality, and these holidays the end of the year, and those kind of things begin to affect us. In Q1 generally, while there aren't official seasons in our business, it just seems to be the customers managed inventory at the end of the year and then Q1 is always an iceberg.

Joe Giamichael - Rodman & Renshaw

Okay, that's fine. You gave pretty aggressive capital expenditure anticipations for '08. What are the locations and for what are the related products that you are planning to add all this capacity?

Joe Levanduski

Well, typically the locations are a little bit all over. In Italy, we are constrained and we're running flat out, so we are working on increasing capacity in our U.S. plants. We've actually downloaded or whatever phrase you want to use, some of our Italian demand and our European demand to our plant in China, so we're expanding there. Then in addition in the U.S., we're looking at expanding capacity in and where we have constrained areas, wherever these bottlenecks and we are also working hard on the lean process that I talked about.

And specifically the phase of lean we are really working on right now is very simple and logical frankly. It is cutting back the travel time for a given part, in other words we want to localize production. So if we are making a given part in Tulsa, we don't want that part to have to travel very far around the country, if at all, and we are working on being able to do that. Because see in some cases we have had stamping capacity at certain places and not in others, as an example.

So those are the areas we are working on and it defines more in terms of process than it does in particular product lines because any of these pieces of equipment because we are so focused, we are a friction supplier. These affect all of our product lines particularly when it comes to the steel which is the backing place for all of them.

Joe Giamichael - Rodman & Renshaw

Got it. Thank you. The performance racing, I know it's a very small piece of the total business. What needs to be done here for this just start making a positive contribution on the operating line?

Joe Levanduski

Well, it has been a frustrating process for us because we have gotten half of it where it is doing okay that is the Quarter Master part. And the tax part of it has still been the culprit. The answer to it is we have made a transition from call it so the old style NASCAR where teams want greater technology and greater support, product development we have been doing that. I think that we have got to restore our customer intimacy to use a phrase we use with the customer there we are working on doing that.

So those are the kind of things that really have to happen. People have asked us about that. We have also defined it not as a core business. So we don't see expanding it like we see some of our others, but we definitely see that as a pathway to fixing it.

Ronald Weinberg

Joe, the other thing I want to mention from the racing side, in 2007 from the revenue standpoint, we did see improvement in the top line, and it was offset by a lot of the engineering costs that are going in new product development areas. 2007 was the first year that NASCAR introduced on a limited schedule the 'Car of Tomorrow' initiative that they uncorked.

We did extremely well in terms of the performance of our product and we expect to see continued strength from that program as it becomes fully implemented in 2008 that we'll be racing that new car platform on every race in 2008. So hopefully we'll see continued success from that platform.

Joe Levanduski

When we talk about racing somehow we just want to point our racing segment includes only our clutches and transmissions, it does not include the brake materials, the friction materials we make for racing, both professional and the amateur enthusiasts, that's within our Wellman Division.

Joe Giamichael - Rodman & Renshaw

Okay, great. And just one last question and I'll get out of the way here. Can you just give us what the legal expense was for the quarter?

Tom Gilbride

For full year, it was $1.1 million. I don't think we didn't disclose it for the quarter itself.

Joe Levanduski

Yeah, I think it was pretty much a wash because I think in the third quarter year-to-date was something similar to the $1.1 million, so you can squeeze the number out then.

Joe Giamichael - Rodman & Renshaw

Okay, that's fine. Is that an expense that in terms of the ongoing, would you expect to see there?

Joe Levanduski

We're not giving guidance as to the number. I mean, as long as we're working on the project, it's not going to go away, but we haven't quantified it. But by taking what we've reported, you can squeeze out the number of what it was for the quarter. So it gives some idea of current run rate for Q4.

Joe Giamichael - Rodman & Renshaw

That's all. Thank you. Congratulation on the quarter.

Joe Levanduski

Thanks.

Operator

Our next question comes from Ivan Marcuse from KeyBanc Capital Markets.

Ivan Marcuse - KeyBanc Capital Markets

Hey, guys.

Ronald Weinberg

Hi, Ivan.

Ivan Marcuse - KeyBanc Capital Markets

How much year-to-date are you seeing steel up, I guess that's risen 30% or 40% since December?

Ronald Weinberg

Yeah. It's really kind of coming down the pipe. We are sensing that there are price increases coming through. But we really haven't seen a significant impact as of the current time. And remember, we use a lot of specialty grade steel. It was not just tied to commodity steel prices. So we are getting sensitive that price increases are coming. We haven't really seen a significant amount of price increases today.

Ivan Marcuse - KeyBanc Capital Markets

How much of your clog is steel?

Ronald Weinberg

It's one of our largest, because obviously every friction material gets on a steel backing plate. So it is something that's consumed on every piece that we ship out the door. So it's a pretty significant number. I don't have the percentage breakdown in terms of what steel is to our cost.

Ivan Marcuse - KeyBanc Capital Markets

Got you. And then you mentioned in your release that you are, I don't really understand, that you are not able to pass any of it through to your customers because you have a year long contract, or…?

Ronald Weinberg

No, we didn't say that. In 2004, which was a cycle where steel, we got hit with steel surcharges during the course of the year.

Ivan Marcuse - KeyBanc Capital Markets

Got you.

Ronald Weinberg

There is always the time lag between when the steel vendors set you with price increases and when we're able to negotiate with customers. And it did hit us with an expense in that era. So the trick is to be able to be quick in negotiating those surcharge pass-throughs, and we would anticipate doing that. I think what we mentioned in our guidance was that there are no guarantees.

Ivan Marcuse - KeyBanc Capital Markets

Great.

Ronald Weinberg

How quickly can we pass those costs along, and if we will be successful from a timing standpoint. So there is always that risk of negative impact, but our intent would be to try to negotiate those through the channel as best as possible.

Ivan Marcuse - KeyBanc Capital Markets

Historically, what's the time lag between passing through the prices from the cost?

Joe Levanduski

It varies. I mean, I am trying to think back in that era. It was some number of months ago. We spend a lot of time working on this from a management perspective, as we described in there. And we do some forward buying in some of the other commodities.

Ivan Marcuse - KeyBanc Capital Markets

Great.

Joe Levanduski

Copper, tin, and we try and match it, so we don't get caught in currency swings either way. Steel is a little different, but Joe described it well. We stay right on top of it. We're not bullish well about seeking to cover those costs when they come and sometimes we get a lag, and that's probably the best we can do in terms of really quantifying it for you.

Ivan Marcuse - KeyBanc Capital Markets

Got you. And then how much did FX account for your fourth quarter revenue growth? Of the 8% revenue growth, how much of that was FX?

Ronald Weinberg

We indicated in the release it was about 3.2% was from foreign exchange translation.

Ivan Marcuse - KeyBanc Capital Markets

Was that for the full year or is that just for the fourth quarter?

Ronald Weinberg

I'm sorry that wasn't fourth quarter, full year. The fourth quarter wasn't all that different.

Ivan Marcuse - KeyBanc Capital Markets

Okay. So that's pretty much at 3%, it's about FX for fourth quarter.

Ronald Weinberg

Yeah.

Ivan Marcuse - KeyBanc Capital Markets

And then last question, you talked about your new business awards. Could you give an idea what these are and what business lines and a little bit more detail about it?

Joe Levanduski

Yeah. We haven't given any public discussion of that. The point I was just making is the sales cycle had hampered us up until now. People would ask when we're having slow delivery, did we burn any relationship. So we continue to have relationships with companies, but particularly our OE customers would be saying to us that we are not giving new business until you catch up and shipping me old. We are past that now and as we think, it is fair to say that we are queued up and competitive to get new business and let's call it fully-energized to go after it. I don't have exact numbers for you other than you can see the kind of thinking we are doing within our guidance for '08.

Ivan Marcuse - KeyBanc Capital Markets

Okay. Actually one more question was that you said truck was only down 18%, which is less. I think in the beginning of the year you are expecting to be down about 30. What is your anticipation for 2008, and has it started off slow? Has it started off stronger than expected, or can you give a little color on that?

Ronald Weinberg

Yeah. We don't provide guidance in terms of percentage change in our forward-looking statements. However, the information that we get from our customers and from the industry analysts that follow the truck market and the new truck builds, we anticipate to see a rebounding. That number has softened slightly in the last six months or so in terms of what the expectation is for 2008 and 2009.

There is a 2010 emission standard change that is looming out there. So there is a lot of discussion as to what that will mean as we go through the 2008-2009 era. I think just overall, we anticipate it to be rebound from the 2007 year. But we don't guide to market performance.

Ivan Marcuse - KeyBanc Capital Markets

Great. Thanks a lot. Great year.

Joe Levanduski

Thank you.

Ronald Weinberg

Thank you.

Operator

(Operator Instructions) Next we will go to Beth Lilly from Gabelli.

Beth Lilly - Gabelli

Good morning.

Ronald Weinberg

Hi, Beth, how are you?

Beth Lilly - Gabelli

Good, how are you?

Ronald Weinberg

Good.

Beth Lilly - Gabelli

I wanted to just spend a minute and talk about your '08 guidance in terms of your operating margin and you've been implementing leans now for a while and you've got the Tulsa's issues behind you. And so I wanted to just better understand why your operating margins are not going to expand much, I mean from the 8% revenue, you give a range of 8% to 9%. But can you just talk about that for a minute and then going forward, do you think those margins can get the double-digit level?

Joe Levanduski

Well, in terms of the first part of your question, a lot of the things that we think are going to improve the margins result from the CapEx initiatives localizing our production and it's hard for us to anticipate the timing of these things and when we don't have a firm fix on it, we opt for conservatism, equipment coming in, when does it get run in, when do we see the benefits of it. So that's probably a large part of the answer to the timing, why you don't see more.

We always are going to work for more, but we don't have any assurance or guidance that we'll have a bigger expansion in the margin. In terms of where we could see it going again I am not going to guide to it, but we certainly have goals and ambitions of raising our operating margins. We think it's possible in the business and I don't have much more I can add to it in that. The process of lean is you the phrase continuing improvement and we plan to do that.

Beth Lilly - Gabelli

And were there some issues geographically right, I mean you're very profitable overseas, correct?

Joe Levanduski

Yes.

Beth Lilly - Gabelli

Yeah. And I am trying to remember, is it the U.S. business that needs to get the margins up?

Joe Levanduski

It is the U.S. business where we've had that discussion in the past when it comes to federal income taxes and why are higher tax rate because we and a little bit of that, we sort of have to be careful, how we describe it because it can be misleading. In other words, financially you are exactly right, we would be showing what is an affect, a minor profit or loss domestically on being very profitable overseas. In our opinion unfortunately, we have all of our overhead costs here and it can lead to little bit of a, it can be somewhat misleading I think.

The other part of that is we have a Tulsa startup and that really did make a reality where we weren't showing profits here that we wanted to and expect to in the future. But it will become a misnomer to define our domestic business as a loser and our foreign business as profitable.

Beth Lilly - Gabelli

Okay. But the improvement that you are going to get going forward or continue to get going forward that should drive the margin higher, it's clearly going to come from the U.S. business?

Ronald Weinberg

A lot of it will but we have been so busy in Italy, we have frankly, you can get topped out up to a certain point you absorb more overhead when you feel a plan and then you can get to the point where you are scrambling and incurring different inefficiencies there. We have almost reached that point in Italy. So I think it's fair to say we have got some opportunities in both places.

Beth Lilly - Gabelli

Okay. So and how much of rising raw material cost is an issue of your margin is not going up very much next year?

Ronald Weinberg

I guess it's fair to say we, on the one hand we manage very aggressively against that, on the other hand we are cautious. We are aware of that. It is a very, very important part the way we manage the business. I can't overemphasize that too much, because if you fall in this commodity market we are in, if you are slipped it to switch a week, you can get caught with it.

But having said that we don't call up the customers and talk about any surcharge or increase and have them greed with open arm so there is always some negotiation and there is some time lag that they fight for. So that's something embedded in. I can't quantify for you, but it's a factor.

Beth Lilly - Gabelli

Okay. But to the extent though that you are able to recover your raw material costs from the customers?

Ronald Weinberg

Typically we have been able to, as Joe said for the record is never an assurance, we're not bashful about it and the other thing is we have an important part of our business one of the fundamental things here is that our products are an important part of the operation of the piece of equipment that they are on, the way a clutch performs, the way a break performs and it's very fundamental to our business, we're engineered in. So our customers need us and with reason we can get an understanding of what it takes to offset a commodity price increase.

Beth Lilly - Gabelli

Okay, great. Very helpful. Thank you.

Ronald Weinberg

I'm sorry.

Beth Lilly - Gabelli

No go ahead, I was just, go ahead.

Ronald Weinberg

As we had spoken before in some cases we try to match our expected demand with purchases, so that we don't get hit with constant fluctuation in commodity prices. In some of the raw materials that we buy, it's not really possible to do that. So there are some fluctuations that we will have to take on; on a continuous basis or an ongoing basis, and others we have fixed. So depending on what commodity we will need to negotiate with customers at the time when those prices go up.

Beth Lilly - Gabelli

Okay, very helpful. Thank you very much.

Ronald Weinberg

Thank you, Beth.

Operator

Our next question comes from Richard Marshall from Longbow Research.

Richard Marshall - Longbow Research

Good morning. This is Richard Marshall.

Ronald Weinberg

Good morning.

Joe Levanduski

Hi, Richard.

Richard Marshall - Longbow Research

Hi, I'm sitting for Eli this morning. This has been asked a little bit, but I want to try to maybe ask the cost price question a little bit differently, looking at profitability in the friction product segment. I guess looking at the full year '07, do you guys see a cost price squeeze, and do you expect cost price pressure in '08? I mean, you have addressed it a little bit. But I just wanted to address that directly.

Joe Levanduski

You mean do we see a cost squeeze in '08? Is that what you refer to?

Richard Marshall - Longbow Research

Yes.

Joe Levanduski

Well, I think to the extent of what we just described, we don't see commodities going down. We have tried to anticipate and do forward buying for certain commodities. And we think we are sort of, let's say, on guard for steel prices going up. And so I mean, I think the answer is yes, we see pressures and we have talked about how we seek to manage them. And I think we will do pretty well. Do we ever get away completely unscathed? It's never perfect, but we think we can manage them pretty well.

Richard Marshall - Longbow Research

Okay, you mentioned your outlook for the truck market. Can you talk a little bit about your outlook maybe for farm and construction, both domestically and looking at foreign markets?

Joe Levanduski

Well, in the other markets we see firmness and strength. Our assessment: I was at an industry trade show last week called CONEXPO construction industry show. It has some people that deal with AG, who deal with construction and with mining and heavy equipment in the light. And the markets there look strong. I mean, there is nobody looking down. They are seeing infrastructure building around the world. They are seeing energy prices staying up.

They are seeing infrastructure building in foreign countries. And so that's what we see. We tamper our thinking and are constantly asking us the question of is that going to continue just because when we talked to the financial community there's so much obvious caution in the air right now don't see anything different when we look at our end markets, I don't know if we have a better crystal ball than anybody else but right now things are going strong and steady.

Ronald Weinberg

There are also some discussions that in relation to the new tax relief act that was passed recently, and the impact that some of the accelerated depreciation aspects of that relief measure will have on the equipment buying decisions, down the pipe is the positive thing as well. So in terms of construction and agriculture, we believe that in North America that could have a positive impact as well. The only other market that we've mentioned in our guidance is the aircraft, which we anticipate showing a modest growth in 2008.

Richard Marshall - Longbow Research

Okay, great. So couple other things, do you guys have any forward guidance profitability or sales on the performance auto?

Ronald Weinberg

The performance auto or performance racing?

Richard Marshall - Longbow Research

Sorry performance racing excuse me, just wanted to see if you had a sales guidance and/or profitability?

Joe Levanduski

We haven't dissected any specific sales guidance for it. I mean we see it as a good sector for us, but we haven't quantified any guidance. It's about approximately 5% of our overall sales in that market segment. We just have been guiding in and having discussions on our major markets.

Richard Marshall - Longbow Research

All right. A couple of housekeeping things and then that will be it. Outlook for interest charges and interest income in '08?

Ronald Weinberg

Interest expense assuming status quo, it will be pretty easy to compute as the only debt that we have on our books as of December 31st and of significance is our bonds which are roughly $87 million and it carries a fixed rate of 8.75%. So you could do the math on that. As you had come obviously based upon the calculation be lower than we had in 2007, given that we had $110 million through the beginning of August of 2007.

Interest income; I think the debt probably has a little bit of influence on that as you go through this year. The rates in terms of what we have been able to reinvest in has been lowering since we have cash from early part of '07 to where we are at today, so it's not going to be significant number just in terms of the interest rate percentage that we were able to achieve on high grade investment vehicles.

Richard Marshall - Longbow Research

All right. And then just the last thing, you mentioned tax rate is going to about the same for '08. Is that staying at 43.4% I think you said?

Ronald Weinberg

Yeah, based upon what we see today. There are other things that are affecting that and the performance of both domestic and foreign operations that we discussed in the past. They are still there. There are certain things that are being positive as well as somethings that working the other way. There are some tax law changes in Italy that should affect us positively, and as we go forward domestically there will be a shift hopefully with more profitability affecting our effective tax rate, but for the time being we are kind of keeping it similar to where we are at in 2007.

Richard Marshall - Longbow Research

Okay. And what about '09 tax rate?

Ronald Weinberg

We haven't guided to anything in 2009 at this point.

Richard Marshall - Longbow Research

Okay. All right. Thank you very much.

Ronald Weinberg

Thank you.

Operator

(Operators Instructions) Our next question comes from Bob Labick from CJS Securities.

Unidentified Analyst

Good morning gentlemen, this is (inaudible) filling in for Bob Labick.

Ronald Weinberg

Good morning.

Unidentified Analyst

Good morning. Can you give us a sense of how you see international operations contributing to your top line in '08, '09, '10?

Ronald Weinberg

Well, we see them continuing to grow. When you talk about international, it comes to us in two different directions, one is our international plants obviously Italy and China. And then a lot of our international business is a little bit hidden to us in the sense of when we ship to our aircraft customers, our large OE construction mining customers, we don't know where it goes expect that Caterpillar for example probably have their businesses overseas.

So we estimate that roughly 50% of our sales and that's kind of a swag number overall is driven by the international markets and we have the same view of those that there is a lot of growth potential internationally. We are responding to it by giving a special attention we've talked in the past about how we've opened up Russia. We have sales representative office there and we are giving it greater attention and we are going to do the similar things with other big countries.

Unidentified Analyst

Okay.

Joe Levanduski

Just from a footprint standpoint, I just want to point that at the end of last year we were able through the sale of the Precision Components Group there was equipment in a facility that was adjacent to our friction facility, that's not been vacated and we are taken full ownership of that space going forward and so in 2008 we will be consuming that square footage and that should benefit us there in China.

Ron also mentioned that some of the overflow from Italy will also be moving over to the China facility and in 2007, we did discuss the fact that we did purchase some land adjacent to our Italian facility and we continue to look at plants to how the best utilize that land in terms of bricks and mortar. So we will continue to focus on expanding those two areas.

Unidentified Analyst

Okay, great. Thank you. Also you said you haven't seen steel price increases so far but industry dairy shows that steel is up roughly 25% this quarter. Can you help me understand how you guys have avoided those price increases given the rise in steel?

Joe Levanduski

Again we use specialty grade of steel and we do some forward buying in the steel market. So that's why currently we are not seeing it, but as we go back into the marketplace we do anticipate that it will be there.

Unidentified Analyst

Okay. How far forward do you generally look when doing that buying?

Joe Levanduski

Only a few months at a time.

Unidentified Analyst

Okay. And turning to the domestic side, can you remind us of your exposure to residential construction?

Ronald Weinberg

Well, residential construction is very low. I mean it would be our primary, our largest customers cap. Although most of our product, we have indicated is really to the larger construction, larger mining equipment. So there is probably some but it's relatively small.

Unidentified Analyst

Okay. All right. Thank you.

Joe Levanduski

It tends to get lost in the overall buy. We know there are small construction home building is soft, but it so eclipsed by everything else going on there, we don't get a clear picture of it.

Unidentified Analyst

I understand. And my last question, can you tell us about the audit assessment charge, the audit assessment charge, I am sorry that you took this quarter and what do you expect the outcome of that to be?

Ronald Weinberg

You are talking about Mexico?

Unidentified Analyst

Yes.

Ronald Weinberg

It's a tax that related to a prior year audit. We are contesting it. We are vigorously going after all our avenues to try to make sure that is not something that will wind up having to seek an issue that is not something that will end up having to see cash outlay on to the best that's possible. Obviously we're dealing with the foreign government in this area and we have legal advisors on the ground there that are helping us through that process.

So at this point it's not something that we can determine probability of when or how much, but from the accounting standpoint we took a very conservative position and we booked the full amount of the liability.

Unidentified Analyst

Okay. And just want to clear, that charge is the $839,000 loss from discontinued operations from this quarter, correct?

Ronald Weinberg

That's the bulk of it.

Unidentified Analyst

Okay, great. That's all I have. Thank you.

Ronald Weinberg

All right. Thanks.

Operator

Our next question comes from (inaudible) Private Investors.

Unidentified Analyst

Hello. Thanks for taking my call this morning.

Ronald Weinberg

Hi, Tony.

Unidentified Analyst

I just had a quick question about your cash balance and what your plans were for that. You said you used about $3.7 million of your $4 million repurchase plan, are you anticipating going back to the Board to increase that amount or ask for another $4 million? And also kind of, can you comment on maybe the market for acquisitions, I know you probably won't talk about anything specific, but are you looking three months, six months as sitting on this or how is the market for that looking?

Joe Levanduski

Well, here’s the fact, on the first part the amount of stock repurchase we do is governed by a feature of our indenture for the outstanding bonds.

Unidentified Analyst

Okay.

Joe Levanduski

So if we were to do that and trying to more we would have to get a waiver of the limitation on the bonds, so it's more than just a Board issue.

Unidentified Analyst

Okay.

Joe Levanduski

So there is nothing doing there right now on that. As far as the market for acquisitions, two things govern the pace of what's going on here because we've targeted friction related things, we know where most of the focus needs to be and so it's made him much slower, I mean we are just saying we are go buying and industrial manufacturer or performance automotive manufacturer.

We are just seeing 20 things right now, probably be negotiating for 3M. We remained very focused. As we go forward, the current economic climate, I know from just other things I here on the financial market place has made a little easier to see acquisitions. So it's probably a plus for us. I am not going put a time frame on how long it will be before we make an acquisition or if we do because these things are they are sort of out of our control so to speak, in other words we are careful about how much money we will spend in terms of a multiple.

We are staying somewhat focused. We are pro active, I mean so the odds are with us but it could be four months, it could be a year, we are not trying to pass those down because we want to get a deal that works for us.

Unidentified Analyst

Okay. And so if you won't able to find any thing, or do you have ideas of what you would do with that money, would you buy back some more debt?

Joe Levanduski

Yeah. I mean we will do something useful with it. We haven't crossed that bridge, and I think it's unlikely that we won't find something. But we would explore all alternatives. I mean if the world were to say there are no more acquisitions to be done because this is very hypothetical and silly but we would look for ways to return it to our stakeholders.

Unidentified Analyst

And would you be looking overseas for these acquisitions, or with these U.S. acquisitions?

Joe Levanduski

We could look overseas. I mean those are important markets. So we have talked publicly about Eastern Europe, India, being of interest to us. In the past we have been shown things in Brazil. I don't know whether we have any write-down from it but it is a good market.

Unidentified Analyst

Okay. Well, that's it for me. Thank you very much.

Joe Levanduski

Okay. Thank you.

Operator

And we have a follow-up question from Joe Giamichael.

Joe Giamichael - Rodman & Renshaw

Thanks. I just want to touch on the fuel cell and the carbon composite product. Something you've just recently begin to speak more about. And I just want to try to get a sense of what the development costs have been so far in those projects and if you have any sense for when you anticipate starting to see a revenue stream from this?

Joe Levanduski

On the fuel cell, I don't have good number on each of those that we've quantified publicly, but on fuel cell, that is something that we're starting buy equipment for and establishing the manufacturing cell. And so I think it's fair to say that we expect to see something this year, but we haven't quantified how much because that will start up in the very beginning, but it's an attractive area and we think it's got good potential.

As far as the carbon goes, it's a similar thing and I think it's fair to say we've spent good amount of money every year. It's been expensed and capitalized, and I think we should begin to see some sales trickle in beginning this year.

Ronald Weinberg

Joe, historically we've always invested a significant amount in R&D. We don't break it out for competitive reasons to specific projects, but currently in 2007 we've spent just over $5 million in research and development costs, which equates to about 2.3% that was up from about $4.5 million in the prior year. So we continue to see continued investment in these types of both R&D project initiatives within the organization to ensure continued growth in the long-term.

Joe Giamichael - Rodman & Renshaw

And could you briefly explain again how the core friction business relates itself to both of those new potential business segments?

Ronald Weinberg

When we talk about that, let's start with what we call carbon composite. As you may recall, a lot of the world of friction is carbon. In fact, even one of our materials that we sell to Caterpillar is a carbon-based paper; carbon paper. And so it is very much part of the friction world. And we decided to make, let's say, the stronger statement with some new ways of making carbon. So that what that is all about.

Now we refer to it as carbon composites because as luck would have it, the products that we are coming up with seem to have other applications beyond friction. And so where that can happen, of course, and we can make the material, we are going to take advantage of it. But it has a friction orientation to it. That is what it is all about.

As far as fuel cells, the process for making components for fuel cells is very closely related to the process of making friction material. It is the ability to press powders; the idea that when you press powders and fuse them or center them, you end up with the continued porosity. And that is important in a fuel cell, because fuel solves your migrating some of the mediums, and in some cases you are placing barriers and others. And this is the quality you have.

So we actually were approached by our largest customers who were interested in having us manufacture for them. And that is how this happened. We are not a designer of fuel cells. We make the components as a tier I supplier.

Joe Giamichael - Rodman & Renshaw

Okay, thank you.

Operator

(Operator Instructions) And at this time, we have no more further questions and I will turn the call back over to you, Mr. Weinberg for any closing or additional remarks.

Ronald Weinberg

Okay. Well, I just want to thank everyone for joining us and we are always happy to talk and give additional information where we can. Thank you very much.

Operator

That does conclude today's presentation. Thank you for attending and have a great day.

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