1] Basis of Presentation
The consolidated financial statements of Hawk Corporation and its wholly owned subsidiaries also include, effective January 2, 1997, the accounts of Hutchinson Products Corporation (Hutchinson); effective August 1, 1997, the accounts of Sinterloy Corporation (Sinterloy); and, effective June 1, 1998, the accounts of Clearfield Powdered Metals, Inc. (Clearfield) (collectively, the Company). See Note 3. All significant intercompany accounts and transactions have been eliminated in the accompanying financial statements. Certain 1996 and 1997 amounts have been reclassified to conform with the 1998 presentation. The Company, through its business segments, designs, engineers, manufactures and markets specialized components, used in a wide variety of aerospace, industrial and commercial applications. In May 1998, the Company completed an initial public offering ("IPO") of 3,500,000 shares of common stock at an offering price to the public of $17.00 per share. See Note 6.

2] Significant Accounting Policies
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

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

Property, Plant and Equipment
Property, plant and equipment are recorded at cost and include expenditures for additions and major improvements. Expenditures for repairs and maintenance are charged to operations as incurred. The Company principally uses either the straight-line or the unit method of depreciation for financial reporting purposes based on annual rates sufficient to amortize the cost of the assets over their estimated useful lives (3 to 40 years). Accelerated methods of depreciation are used for federal income tax purposes.

Intangible Assets
Intangible assets are amortized using the straight-line method over periods ranging from 3 to 40 years. The ongoing value and remaining useful life of intangible assets are subject to periodic evaluation, and the Company currently expects the carrying amounts to be fully recoverable. If events and circumstances indicate that intangible assets might be impaired, an undiscounted cash flows methodology would be used to determine whether an impairment loss should be recognized.

Foreign Currency Translation
The assets and liabilities of the Company's foreign subsidiaries are translated into U.S. dollars at year-end exchange rates. Revenues and expenses are translated at weighted average exchange rates. Gains and losses from transactions are included in results of operations. Gains and losses resulting from translation are included in accumulated other comprehensive loss, a component of shareholders' equity.

Revenue Recognition
Revenue from the sale of the Company's products is recognized upon shipment to the customer. Costs and related expenses to manufacture the products are recorded as costs of sales when the related revenue is recognized.

Significant Concentrations
The Company provides credit, in the normal course of its business, to original equipment and after-market manufacturers. The Company's customers are not concentrated in any specific geographic region. The Company performs ongoing credit evaluations of its customers and maintains allowances for potential credit losses, which, when realized, have been within the range of management's expectations.

Product Research and Development
Research and development costs are expensed as incurred. The Company's expenditures for product development and engineering were approximately $3,155 in 1998, $3,136 in 1997 and $2,639 in 1996.

Income Taxes
The Company uses the liability method in measuring the provision for income taxes and recognizing deferred tax assets and liabilities in the balance sheet. The liability method requires that deferred income taxes reflect the tax consequences of currently enacted rates for differences between the tax and financial reporting bases of assets and liabilities.

Fair Value of Financial Instruments
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Cash and Cash Equivalents
The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents approximate fair value.

Long-Term Debt (Including Current Portion)
The fair values of the Company's publicly traded debentures, shown in the following table, are based on quoted market prices. The fair values of the Company's non-traded debt, also shown in the following table, are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.

Interest Rate Swap
The Company has entered into an interest rate swap primarily to hedge against interest rate risks. This agreement generally involves the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amounts. Counterparties to this agreement are major financial institutions. Management believes the risk of incurring losses related to credit risk is remote. The fair values for the Company's off balance-sheet instruments, shown in the following table, are based on pricing models or formulas using current assumptions for comparable instruments.

Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, which requires all derivatives to be recognized as either assets or liabilities in the balance sheet and measured at fair value. The Company does not anticipate that the adoption of the statement will have a significant effect on its results of operations or financial position. The Company expects to adopt the new statement effective January 1, 2000.

In 1998, the Accounting Standards Executive Committee issued Statement of Position (SOP) 98-1, Accounting for the Cost for Computer Software Developed or Obtained for Internal Use. The SOP requires the Company to capitalize costs incurred in connection with developing or obtaining internal-use software. The Company adopted SOP 98-1 in 1998. The adoption did not have a material impact to the Company.

In April 1998, the Accounting Standards Executive Committee issued SOP 98-5, Reporting on the Costs of Start-Up Activities, which requires the expensing of start-up activities as incurred. The Company adopted SOP 98-5 in 1998. The adoption did not have a material impact to the Company.

3] Business Acquisitions
Effective January 2, 1997, the Company acquired all of the outstanding capital stock of Hutchinson Foundry Products Company for (1) $10,600 in cash; (2) $1,500 in 8% two-year convertible notes; and (3) contingent payments to be made by the Company if certain earnings targets are met. The acquisition was accounted for as a purchase. The excess of the purchase price over the estimated fair value of the capital stock acquired in the amount of $7,600 is being amortized over 30 years and is included in intangible assets. The results of operations of Hutchinson are included in the Company's consolidated statements of operations since the date of acquisition.

Effective August 1, 1997, the Company acquired substantially all of the assets (except cash) and assumed certain liabilities of Sinterloy, Inc., for $16,400 in cash. The acquisition was accounted for as a purchase. The excess of the purchase price over the estimated fair value of the assets less the assumed liabilities in the amount of $11,400 is being amortized over 30 years and is included in intangible assets. The results of operations of Sinterloy are included in the Company's consolidated statements of operations since the date of acquisition.

Effective June 1, 1998, the Company acquired all the outstanding capital stock of Clearfield Powdered Metals, Inc. for $9,100 in cash and other consideration. The acquisition was accounted for as a purchase. The excess of the purchase price over the estimated fair value of the capital stock acquired in the amount of $8,300 is being amortized over 30 years and is included in intangible assets. The results of operations of Clearfield are included in the Company's consolidated statements of operations since the date of acquisition.

The following unaudited pro forma consolidated results of operations give effect to the Sinterloy and Clearfield acquisitions as though they had occurred on January 1, 1997 and include certain adjustments, such as additional amortization expense as a result of goodwill and increased interest expense related to debt incurred for the acquisitions.

Pro forma net sales and net income are not necessarily indicative of the net sales and net income that would have occurred had the acquisitions been made at the beginning of the year or the results that may occur in the future.

4] Intangible Assets
The components of intangible assets and related amortization periods are as follows:

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

5] Financing Arrangements

In connection with the IPO in May 1998, the Company retired all of its outstanding $30,000 Senior Subordinated Notes, and incurred an extraordinary charge of $427 relating to the write-off of previously capitalized deferred financing costs. The Senior Subordinated Notes had detachable warrants to the lender, which terminated upon the closing of the Company's IPO and provided the lender the option to purchase 1,023,793 shares of the Company's common stock at a per share price of $.01. For financial reporting purposes, the carrying value of the warrants, including the put option, was classified as detachable stock warrant, subject to put option on the accompanying balance sheet. The warrant holders exercised the warrants on May 11, 1998 for 1,023,793 shares of the Company's common stock. As a result of the warrant termination, the corresponding carrying value of the warrants, less the par value of the common stock issued, including the put options, was reclassified as an addition to retained earnings.

In November 1996, the Company issued $100,000 in Senior Notes ("Senior Notes") due on December 1, 2003, unless previously redeemed at the Company's option, in accordance with the terms of the Senior Notes. Interest is payable semi-annually on June 1 and December 1 of each year commencing June 1, 1997, at a fixed rate of 10.25%. In March 1997, the Senior Notes were exchanged for notes registered with the Securities and Exchange Commission. In May 1998, concurrent with the IPO, the Company retired $35,000 of the then outstanding $100,000 Senior Notes and incurred extraordinary charges of $1,340 and $3,588 relating to the write-off of previously capitalized deferred financing costs and a prepayment premium on the early retirement of debt, respectively. The remaining $65,000 Senior Notes are fully and unconditionally guaranteed on a joint and several basis by each of the direct and indirect wholly owned domestic subsidiaries of the Company (Guarantor Subsidiaries). See Note 14.

In May 1998, the Company entered into a $35,000 unsecured term loan facility and replaced its previous $25,000 revolving credit facility with a $50,000 unsecured revolving credit facility. The term loan has quarterly maturities of $1,250, beginning September 30, 1998, with the remaining principal of $12,500 due on March 31, 2003. The revolving credit facility matures March 31, 2003. Interest is payable under both facilities, quarterly, at a variable rate based on a Eurodollar Rate, plus a margin, per annum or, at the Company's option, a variable rate based on the lending bank's prime rate. The margin is subject to increase or decrease based on achievement of certain financial covenants by the Company. The term loan and revolving credit facility require the Company to maintain certain conditions with respect to net worth and interest coverage ratios as defined in the agreement. There were no outstanding borrowings under the revolving credit facility at December 31, 1998.

Aggregate principal payments due on long-term debt as of December 31, 1998 are as follows: 1999 - $6,181; 2000 - $6,507; 2001 - $6,457; 2002 - $5,451; 2003 - $77,638; thereafter - $313.

The Company's short-term borrowings represent advances under unsecured lines of credit. The average borrowing rate was 8% during 1998. Unused amounts under these lines total approximately $1,251 at December 31, 1998.

6]Shareholders' Equity
On January 12, 1998, the Company amended its Certificate of Incorporation to increase the authorized shares of Class A and Class B common stock to 75,000,000 and 10,000,000, respectively. In addition, on January 9, 1998, the board of directors declared a 3.2299-for-one split of the Company's Class A and Class B common stock effective in the form of a stock dividend to holders of record on January 12, 1998. Accordingly, all numbers of common shares and per share data have been restated to reflect the stock split.

In connection with the IPO, the Company redeemed all 1,375 shares of its outstanding, $.01 par value, Series A preferred stock, 351 shares of its outstanding, $.01 par value, Series B preferred stock and 7 shares of its outstanding, $.01 par value, Series C preferred stock. The remaining 351 and 1,182 issued and outstanding shares of Series B and C preferred stock, respectively, were converted into 1,530 shares of $.01 par value, Series D preferred stock. Dividends on the Series D preferred stock are cumulative at a rate of 9.8%. Each share of Series D preferred stock is (1) entitled to a liquidation preference equal to $1 per share plus any accrued or unpaid dividends, (2) not entitled to vote, except in certain circumstances, and (3) redeemable in whole, at the option of the Company, for $1 per share plus all accrued dividends to the date of redemption. The Company also has 100,000 authorized shares of $.01 par value, Series E preferred stock, of which no shares are issued or outstanding. Each share of Series E preferred stock is (1) not redeemable and is entitled to dividends in the amount of 1,000 times the per share dividend received by the holders of common stock, (2) entitled to 1,000 votes per share, and (3) entitled to a liquidation right of 1,000 times the aggregate amount distributed per share to the holder of common stock.

On November 13, 1997, the board of directors declared a dividend of one Series E preferred share purchase right (a Right) for each outstanding share of common stock. The dividend is payable to the stockholders of record as of January 16, 1998, and with respect to common stock, issued thereafter until the Distribution Date, as defined in the Rights Agreement, and in certain circumstances, with respect to common stock issued after the Distribution Date. Except as set forth in the Rights Agreement, each Right, when it becomes exercisable, entitles the registered holder to purchase from the Company one one-thousandth of a share of Series E preferred stock at a price of $70 per one one-thousandth share of a Series E preferred stock, subject to adjustment.

7] Employee Stock Option Plan
In 1997, the Company established the Hawk Corporation 1997 Stock Option Plan. Under this plan, the Company may grant options to officers and other key employees to purchase an aggregate of 700,000 shares of Class A common stock. During 1998, the Company granted stock options to purchase an aggregate of 343,200 shares at exercise prices representing the fair market values of such shares at the date of grant. The options vest ratably over a five-year period. No options were exercisable at December 31, 1998.

The following table summarizes the stock option activity during the one-year period ending December 31, 1998:

The Company has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, but applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its plans. Accordingly, no compensation expense has been reflected in the accompanying consolidated financial statements related to the stock options issued pursuant to this plan. If the Company had elected to recognize compensation expense based on the fair value at the grant dates for awards under this plan consistent with the method prescribed by SFAS No. 123, net income and net income per share would have been changed to the pro forma amounts indicated below:

The weighted average fair value of stock options granted during 1998 was $8.92. The fair value of the options granted used to compute pro forma net income and earnings per share disclosures is the estimated present value at grant date using the Black-Scholes option-pricing model with the following assumptions:

8] Employee Benefits
In February 1998, the Financial Accounting Standards Board issued SFAS No. 132, Employers' Disclosures About Pensions and Other Postretirement Benefits. This statement does not change the recognition or measurement of pension or postretirement benefit plans, but standardizes disclosure requirements for pensions and other postretirement benefits, eliminates certain disclosures and requires additional information. The Company adopted SFAS No. 132 as of December 31, 1998. Accordingly, all disclosures for prior periods shown have been restated to conform to the disclosure requirements under SFAS No. 132.

The Company has several defined benefit pension plans that cover certain employees. Benefits pay- able are based primarily on compensation and years of service or a fixed annual benefit for each year of service. Certain hourly employees are also covered under collective bargaining agreements. The Company funds the plans in amounts sufficient to satisfy the minimum amounts required under ERISA.

The components of the defined benefit pension plans are as follows:

Amounts recognized in the balance sheet consist of the following:

Amounts applicable to the Company's underfunded pension plans at December 31 are as follows:

The plan's assets are primarily invested in fixed income and equity securities. In addition, certain of the defined benefit plans also contain investments in the Company's stock. As of December 31, 1998, 60,000 shares of the Company's stock had been purchased at a cost of $717. The market value as of December 31, 1998 was $503.

The following assumptions were used in accounting for the defined benefit plans:

The Company also sponsors several defined contribution plans which provide voluntary employee contributions and, in certain plans, matching and discretionary employer contributions. Expenses associated with these plans were approximately $844 in 1998, $786 in 1997 and $690 in 1996.

9] Lease Obligations
The Company has capital lease commitments for buildings and equipment. Future minimum annual rentals are: 1999 - $1,065; 2000 - $850; 2001 - $784; 2002 - $444; 2003 - $142; and thereafter - $237. Amount representing interest is $603. Total capital lease obligations are included in other long-term debt. Amortization of assets recorded under capital leases is included with depreciation expense.

The Company leases certain office and warehouse facilities and equipment under operating leases. Rental expense was approximately $939 in 1998, $875 in 1997 and $609 in 1996. Future minimum lease commitments under these agreements that have an original or existing term in excess of one year as of December 31, 1998 are as follows: 1999 - $756; 2000 - $591; 2001 - $536; 2002 - $432; 2003 - $137; and thereafter - $163.

10] Income Taxes
The provision for income taxes, including the effect of the extraordinary charge, consists of the following:

Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of December 31 are as follows:

The provision for income taxes, including the tax effect of the extraordinary charge, differs from the amounts computed by applying the federal statutory rate as follows:

Undistributed earnings of the Company's foreign subsidiaries are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal and state income taxes has been provided. Upon distribution of these earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes, which may be offset by foreign tax credits, and withholding taxes payable to various foreign countries.

11]Earnings Per Share
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, Earnings per Share. SFAS No. 128 replaced the previously reported primary and fully diluted earnings per share with basic earnings per share and diluted earnings per share. As required, the Company adopted SFAS No. 128 in the fourth quarter of 1997. Prior-year amounts have been restated to give effect to the stock split discussed in Note 6.
Basic and diluted earnings per share are computed as follows:

12] Related Parties
In July 1995, certain shareholders of the Company issued interest-bearing notes to the Company in the amount of $2,000, enabling them to repay certain indebtedness incurred by them with respect to an acquisition. The notes are due and payable on July 1, 2002 and bore interest at the prime rate plus 1.25% through September 30, 1996 and at the prime rate thereafter. The balance outstanding at December 31, 1998 is $1,000.

13] Business Segments
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. This statement establishes standards for reporting and descriptive information about operating segments. The Company adopted SFAS No. 131, effective December 31, 1998. The adoption of SFAS No. 131 did not affect results of operations or financial position, but did affect the disclosure of the segment information.

The Company operates in two primary business segments: friction products and powder metal. The Company's reportable segments are strategic business units that offer different products and services. They are managed separately based on fundamental differences in their operations.

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

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

The other segment consists of corporate and operating segments, which do not meet the quantitative thresholds for determining reportable segments. The operating segments include the manufacturing of die-cast aluminum rotors and a stamping operation.

Geographic information for the years ended December 31, 1998, 1997 and 1996 is as follows:

14] Supplemental Guarantor Information
As discussed in Note 5, each of the Guarantor Subsidiaries has fully and unconditionally guaranteed, on a joint and several basis, the obligation to pay principal, premium, if any, and interest with respect to the Senior Notes. The Guarantor Subsidiaries are direct or indirect wholly owned subsidiaries of the Company.

The following supplemental consolidating condensed financial statements present:

Consolidating condensed balance sheets as of December 31, 1998 and December 31, 1997, consolidating condensed statements of operations for the years ended December 31, 1998, 1997 and 1996 and consolidating condensed statements of cash flows for the years ended December 31, 1998, 1997 and 1996. Hawk Corporation (Parent), combined Guarantor Subsidiaries and combined Non-Guarantor Subsidiaries (consisting of the Company's subsidiaries in Canada and Italy acquired in 1995) with their investments in subsidiaries accounted for using the equity method.

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

Management does not believe that separate financial statements of the Guarantor Subsidiaries are material to investors. Therefore, separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not presented.