Document 4QVz370MGRrOk9OoO147O53Jj

Letter to Shareowners To Our Shareowners: 1999 was our year to celebrate a century of people serving customers through manufacturing mastery. Your team diligently worked to integrate 13 acquisitions since 1997, making Federal-Mogul a global technology leader in powertrain systems and brake systems. Innovative technology resulting from these acquisitions underscored many new product launches for our customers around the world. We increased sales revenue by 3.5 times and operating profit by 6 times. We have built a solid foundation for the next century, making operational excellence our highest priority. 1999 Financial Results Federal-Mogul had record earnings from operations of $4.04 per share, a 50 percent increase from the $2.69 per share in 1998. Earnings per share from operations exclude integration costs, extraordinary and other non-recurring items. Including these items, Federal-Mogul earned $3.16 per share compared to $.96 in 1998. For 1999, Federal-Mogul had record sales of $6,488 million, compared to $4,469 million in 1998, a 45 percent increase. The company generated $167 million in free cash flow from opera tions in 1999, an improvement of $100 million over 1998. Over the past two years, after having expended more than $600 million for capital investments and nearly $500 million on restructuring, integration and asbestos payments, our operations still generated cash of well over $200 million. Even though tremendous acquisition, restructuring, consolida tion and integration activities have marked the past two years, our key credit ratios have continued to improve. As a result, our borrowing costs under our bank credit agreements have recently been reduced by 25 basis points. Despite the dedicated attention that we had to give to the consolidation and integration of our acquisitions, the financial performance of our company has steadily improved. The fourth quarter of 1999 marked the twelfth consecutive quarter of increased year-over-year earnings per share. Operational Excellence We have dedicated the coming year to operational excellence. Our focus will be in three areas -- customer delight, becoming the low-cost provider in all product categories, and substantially reducing our invested capital base. Growth Strategy We have both a solid financial foundation and a sound strategy for long-term growth. We follow a very disciplined acquisition process that has strategic and financial hurdles that must be met. The strategic hurdles were developed to better serve our customers by: Expanding our product lines into systems and modules to enhance value; Expanding globally to follow and serve original equipment customers; and Leveraging our global manufacturing base into local aftermarkets. The financial hurdles are: EVA positive; Cash positive; Accretive to earnings in the near term; and Maintenance of a strong balance sheet with the appropriate combination of equity and debt with an investment grade objective. Our Future We will maintain and grow our position as a global leader in the automotive industry with our focus on operational excellence in the year 2000 and beyond - keeping relentless focus on the customer, being the low-cost provider of our value package, and reducing our invested capital base. I can assure you that our entire organization is on the same page and committed to these imperatives. We're starting our second hundred years, clearly a company on the move delivering value. Dick Snell Chairman and Chief Executive Officer FEDERAL MOGUL People serving customers through manufacturing mastery. We are a team first. We respect, trust and help each other. We act with integrity. We are driven toward mastery in all we do. We CELEBRATE our success. 2 Federal Mogul Five-Year Financial Summary Consolidated Statement of Operations Data Net sales Costs and expenses Other expense Income tax (expense) benefit Net earnings (loss) before extraordinary items and net effect of cumulative effect of change in accounting principle Extraordinary items -- loss on early retirement of debt, net of applicable income tax benefits Cumulative effect of change in accounting for costs of start-up activities, net of applicable income tax benefit Net earnings (loss) 1999 1998 1997 1996 (Millions of Dollars, Except Per Share Amounts) 1995 $ 6,487.5 $ 4,468.7 $ 1,806.6 $ 2,032.7 $ 1,999.8 (6,006.2)(1) (4,266.9)(2) (1,703.7)(3) (2,258.0)(4) (2,000.7)(5) (21.4) (16.3) (3.4) (3.4) (2.4) (180.9) (93.6) (27.5) 22.4 (2.5) 279.0 (23.1) 91.9 (38.2) 72.0 (2.6) (206.3) -- (5.8) -- (12.7)_____________ -- $ 243.2 $ 53.7 $ 69.4 $ (206.3) $ (5.8) Common Share Summary (Diluted) Average shares and equivalents outstanding (in thousands) Earnings (loss) per share: Before extraordinary items and cumulative effect of a change in accounting principle $ Extraordinary items -- loss on early retirement of debt, net of applicable income tax benefits Cumulative effect of change in accounting for costs of start-up activities, net of applicable income tax benefit Net earnings (loss) per share $ Dividends declared per share $ 84,206 3.59 (.28) (.15) 3.16 .01 53,748 $ 1.67 (.71) $ .96 $ .1275 41,854 $ 1.67 (.06) $ 1.61 $ .48 34,659 34,642 $ (6.20) $ -- (.42) -- $ (6.20) $ $ .48 $ (.42) .48 Consolidated Balance Sheet Data Total assets Short-term debt(6) Long-term debt Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely convertible subordinated debentures of the Company Shareholders' equity $ 9,945.2 190.8 3,020.0 575.0 2,075.2 $ 9,940.1 211.0 3,130.7 575.0 1,986.2 $ 1,802.1 28.6 273.1 575.0 369.3 $ 1,455.2 280.1 209.6 $ 1,701.1 111.9 481.5 318.5 550.3 Other Financial Information Net cash provided from (used by) operating activities Expenditures for property, plant, equipment and other long-term assets Depreciation and amortization expense $ 562.4 395.2 354.9 $ 325.5 228.5 228.0 $ 215.7 49.7 51.5 $ 149.0 54.2 61.9 $ (34.7) 78.5 59.2 (1) Includes a $46.9 million charge for integration costs and a $7.9 million charge for adjustment of assets held for sale and other longlived assets to fair value. (2) Includes a $7.3 million net restructuring charge, a $19.0 million net charge for adjustment of assets held for sale and other long-lived assets to fair value, an $18.6 million charge for purchased in process research and development, a $22.4 million charge for integration costs and a $13.3 million net gain related to the British pound currency option and forward contract. (3) Includes a $1.1 million net restructuring credit, a $2.4 million charge for adjustment of assets held for sale and other long-lived assets to fair value, a $1.6 million credit for reengineering and other related charges, and a $10.5 million charge related to the British pound currency option and forward contract. (4) Includes a $57.6 million restructuring charge, a $151.3 million charge for adjustment of assets held for sale and other long-lived assets to fair value, and $11.4 million relating to reengineering and other related charges. (5) Includes a $26.9 million restructuring charge, a $51.8 million charge for adjustment of assets held for sale and other long-lived assets to fair value, and $13.9 million relating to reengineering and other related charges. (6) Includes current maturities of long-term debt (see Note 6 to the consolidated financial statements). 4 Federal Mogul Management ' s Discussion and Analysis Interest expense increased $170.7 million in 1998 to $204.0 million due to debt financing of the T&N, Cooper Automotive, Fel-Pro and other acquisitions, offset slightly by debt reductions from cash flow generated from operations. Interest Income Interest income decreased $6.0 million in 1999 to $4.6 million in 1998. The decrease in interest income is due to the Company using the proceeds of the Company-obligated mandatorily redeemable preferred securities for the purchase of T&N and improved cash management. Interest income increased $3.5 million in 1998 to $10.6 million due to interest earned on the proceeds of the December 1997 sale of Company-obligated mandatorily redeemable preferred securities, which were used in March 1998 to finance a portion of the T&N acquisition. Net (Gain) Loss on British Pound Currency Option and Forward contract In the fourth quarter of 1997, in anticipation of the then pending T&N acquisition, the Company purchased a British pound currency option for $28.1 million with a notional amount of $2.5 billion. The cost of the option and its change in fair value has been reflected in the results of operations in the fourth quarter of 1997. At December 31, 1997, the Company had recognized a net loss of $10.5 million on the transaction. In January 1998, the Company settled the option and recognized an additional loss of $17.3 million. Also in January 1998, in anticipation of the then pending T&N acquisition, the Company entered into a forward contract to purchase 1.5 billion for approximately $2.45 billion. As a result of favorable fluctuations in the British pound/United States dollar exchange rate during the contract period, the Company recognized a $30.6 million gain. The Company entered into the above transactions to serve as economic hedges for the purchase of T&N. Such transactions, however, do not qualify for hedge accounting under GAAP, and therefore both the loss on the British pound currency option and the gain on the British pound forward contract are reflected in the consolidated statement of operations caption "Net (gain) loss on British pound currency option and forward contract.'' Income Taxes The effective tax rates for 1999, 1998 and 1997 were 39.3%, 50.5% and 27.6%, respectively. The decrease in 1999 was primarily due to the reduction in valuation allowances and the dilutive effect of the increase in pretax earnings on non-deductible goodwill. The Company reduced its valuation allowance related to deferred tax assets in 1999 as a result of regulatory approvals and other events establishing that it is more likely than not that certain deferred tax assets related to foreign tax attributes will be realized. Also, to the extent the Company utilized pre-acquisition net operating loss carryforwards during the year, the related valuation allowance was reduced with a corresponding reduction to goodwill. The increase in 1998 was primarily due to non-deductible goodwill, a one-time charge for purchased in-process research and development and foreign tax rate differences. Extraordinary items As a result of certain financing transactions (see Liquidity and Capital Resources), the Company incurred extraordinary losses on the early retirement of debt of $23.1 million and $38.2 million, net of related tax benefits of $13.5 million and $19.9 million, in 1999 and 1998, respectively. Cumulative Effect of Change in Accounting Principle In 1998, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 98-5, Reporting the Costs of Start-Up Activities. SOP 98-5 was effective January 1, 1999 and requires that start-up costs capitalized prior to January 1, 1999 be written off and any future start-up costs be expensed as incurred. The Company adopted SOP 98-5 on January 1, 1999 and subsequently wrote off, as a cumulative effect of change in accounting principle, the unamortized balance of start-up costs totaling $12.7 million, net of applicable income tax benefits of $6.8 million, in the quarter ended March 31, 1999. Effect of Accounting Pronouncements In 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. In June 1999, the effective date of SFAS No. 133 was delayed by one year to January 1, 2001. The statement requires the Company to recognize all derivatives on the balance sheet at fair value. The effect of adoption of this statement on the Company's earnings or financial position has not been finalized. In 1999, the Emerging Issues Task Force ("EITF") of the FASB reached consensus on issue No. 99-5, Accounting for Pre-Production Costs Related to Long-Term Supply Arrange ments. The EITF addresses the accounting for pre-production costs relating to design and development of production parts and tooling. The EITF is required to be applied beginning January 1, 2000. The Company does not believe the adoption of this pronouncement will have a material effect on the Company's financial position or financial operations as its current accounting practices are consistent with the pronouncement. L C Riquidity and apital esources Cash Flow Provided from Operating Activities Cash flow provided from operating activities was $562.4 million in 1999. Cash flows were generated primarily from net earnings plus depreciation and amortization. Additional cash flow was generated primarily from an increase in accounts payable of $149.7 million, a decrease in inventories of $117.2 million, and certain non-recourse sales of foreign accounts receivables of $115.0 million. These items were offset by payments related to restructuring and rationalization reserves of $80.6 million and asbestos payments of $178.2 million. 1999 Annual Report 7 Management ' s Discussion and Analysis Cash Flow Used by Investing Activities Cash flow used by investing activities was $713.1 million in 1999. The Company used $371.2 million to fund business acquisitions, including the piston division of Alcan, Crane and the final pay ments of $154.9 million related to its 1998 acquisition of Cooper Automotive. Capital expenditures of $395.2 million were to imple ment process improvements, increase manufacturing capacity, information technology, integration of acquired businesses and new product introductions. Cash Flow Provided from Financing Activities Cash flow provided from financing activities was $138.0 million in 1999, primarily arising from proceeds of $2,123.0 million from the issuance of long-term debt and $304.3 million provided by the investment in accounts receivable securitization. This was offset primarily by principal payments on long-term debt of $2,251.5 million. In July 1999, the Company entered into a new $450 million accounts receivable securitization agreement replacing the exist ing $150 million agreement. The facility maturity date is June 28, 2000. Net proceeds were used to repay borrowings under the Senior Credit Agreement's multicurrency revolving credit facility. In February 1999, the Company entered into a new $1.75 billion Senior Credit Agreement at variable interest rates, which contains a $1.0 billion multicurrency revolving credit facility and two term loan components. The revolving credit facility has a five-year maturity. The term loan components of $400 million and $350 million mature in five and six years, respectively. The proceeds of this Senior Credit Agreement were used to refinance the prior Senior Credit Agreements entered into in connection with the T&N and Cooper Automotive acquisitions as well as the $400 million multicurrency revolving credit facility related to the T&N acquisition. In January 1999, the Company issued $1.0 billion of bonds with maturities ranging from seven to ten years, a weighted average yield of 753% and a weighted average coupon of 745%. Proceeds were used to repay borrowings under the Senior Credit Agreements. The Company believes the cash flows from operations, together with borrowings available under the Compnay's multicurrency revolving credit facility will continue to be sufficient to meet its ongoing working capital requirements. L E Mitigation and nvironmental atters T&N Asbestos Litigation In the United States, the Company's United Kingdom subsidiary, T&N Ltd., and two former United States subsidiaries of T&N, plc (the "T&N Companies") are among many defendants named in numer ous court actions alleging personal injury resulting from exposure to asbestos or asbestos-containing products. T&N is also subject to asbestos-disease litigation, to a lesser extent, in the United Kingdom and France. Because of the slow onset of asbestosrelated diseases, management anticipates that similar claims will be made in the future. It is not known how many such claims may be made nor the expenditures which may arise therefrom. As of December 31, 1999, the T&N Companies had approximately 95,000 claims pending. During 1999, approximately 49,000 new claims were filed and 60,000 claims were settled, dismissed or otherwise resolved. In addition to the pending cases above, the T&N Companies have approximately 64,000 claims that have been settled but will be paid over time. There are a number of factors that could impact the settlement costs into the future, including but not limited to: changes in legal environment; possible insol vency of co-defendants; and the establishment of an acceptable administrative (non-litigation) claims resolution mechanism. The $1.1 billion total provision held for the T&N Companies is comprised of an estimate for known claims (pending and settled but not paid) and possible future claims (IBNR). As of December 31, 1999, the $1.1 billion total provision is comprised of approxi mately $520 million related to known claims and approximately $620 million related to IBNR claims. In arriving at the IBNR provision for the T&N Companies, assumptions have been made regarding the total number of claims anticipated to be received in the future, the typical cost of settlement (which is sensitive to the industry in which the plaintiff claims exposure, the alleged disease type and the jurisdiction in which the action is being brought), the rate of receipt of claims and the timing of settlement and, in the United Kingdom, the level of subrogation claims brought by insurance companies. T&N Ltd. has appointed the Center for Claims Resolution (CCR) as its exclusive representative in relation to all asbestos-related per sonal injury claims made against it in the United States. The CCR provides to its member companies a litigation defense, claimshandling and administration service in respect to United States asbestos-related disease claims. Pursuant to the CCR Producer Agreement, T&N Ltd. is entitled to appoint a representative as one of the five voting directors on the CCR's Board of Directors. Members of the CCR contribute towards indemnity payments in each claim in which the member is named. Contributions to such indemnity payments are calculated on a case by case basis according to sharing agreements among the CCR's members. Effective January 18, 2000, the two United States subsidiaries withdrew from the CCR membership and appointed a law firm specializing in asbestos matters as their claims handling defense and administrative service provider. Indemnity and defense obligations incurred while members of the CCR will continue to be honored. This change is intended to create greater economic and defense efficiencies for the two companies. In 1996, T&N purchased a 500 million (approximately $845 million at the insurance agreement exchange rate of $1.69/) layer of insurance which will be triggered should the aggregate costs of claims filed after June 30, 1996, where the exposure occurred prior to that date, exceed 690 million (approximately $1,166 million at the $1.69/ exchange rate). The initial reserve provided for the T&N Companies for claims filed after June 30, 1996 approximated the trigger point of the insurance. The Company has reviewed the financial viability and legal obligations of the three reinsurance companies involved and has concluded, at this time, that there is little risk of the reinsurers not being able to meet their obligation to pay, should the claims filed after June 30, 1996 exceed the 690 million trigger point. 8 Federal - Mogul Management ' s Discussion and Analysis While management believes that reserves are appropriate for anticipated losses arising from asbestos-related claims against the T&N Companies, given the nature and complexity of the factors affecting the estimated liability, the actual liability may differ. No absolute assurance can be given that the T&N Companies will not be subject to material additional liabilities and significant additional litigation relating to asbestos. In the possible, but unlikely event that such liabilities exceed the reserves recorded by the Company and the additional 500 million of insurance coverage, the Company's results of operations, business, liquidity and financial condition could be materially adversely affected. The reserve for the T&N Companies is re-evaluated periodically as additional information becomes available. During 1999, T&N Ltd. was named in a complaint filed in the United States District Court for the Eastern District of Texas by Owens-Illinois alleging that T&N is liable to Owens-Illinois for Owens-Illinois' own indemnity and defense costs pertaining to asbestos-related personal injury claims. The Company believes it has meritorious defenses to the claim and has successfully defended against similar underlying claims in the past. Cooper Automotive Asbestos Litigation Former businesses of Cooper Automotive, primarily Abex and Wagner, are involved as defendants in numerous court actions in the United States alleging personal injury from exposure to asbestos or asbestos-containing products, mainly involving friction products. In 1998, the Company acquired the capital stock of a Cooper Automotive entity resulting in the assumption by a Company subsidiary of contractual liability, under certain circumstances, for all claims pending and to be filed in the future alleging exposure to certain Wagner automotive and industrial friction products and for all claims filed after August 29, 1998, alleging exposure to certain Abex (non-railroad and non-aircraft) friction products. As of December 31, 1999, Abex has approxi mately 10,500 claims pending and Wagner has approximately 13,700 claims pending. The Company has completed its assess ment of the potential liability and related potential insurance recoveries related to the Cooper Automotive acquisition and has recorded a $325.9 million insurance recoverable asset and a liability of the subsidiaries involved of approximately $400 million. This is the Company's estimate, after taking into account legal counsel's evaluation related to amounts expected to be paid or reimbursed by insurers. In arriving at these provisions, certain assumptions have been made regarding the total number of claims which may be received in the future against these two entities and the average costs associated with such claims. Abex maintained product liability insurance coverage for most of the time that it manufactured products that contained asbestos. The subsidiary of the Company that may be liable for the post-August 1998 asbestos claims against Abex has the benefit of that insurance. Abex has been in litigation since 1982 with the insurance carriers of its primary layer of liability concerning coverage for asbestos claims. Abex also has substantial excess layer liability insurance coverage which, barring unforeseen insolvencies of excess carriers or other adverse events, should provide coverage for asbestos claims against Abex. Wagner also maintained product liability insurance coverage for some of the time that it manufactured products that contained asbestos. The subsidiary of the Company that may be liable for asbestos claims against Wagner has the benefit of that insurance. Primary layer liability insurance coverage for asbestos claims against Wagner is the subject of an agreement with Wagner's solvent primary carriers. The agreement provides for partial reimbursement of indemnity and defense costs for Wagner asbestos claims until exhaustion of aggregate limits. Wagner also has substantial excess layer liability insurance coverage which, barring unforeseen insolvencies of excess carriers or other adverse events, should provide coverage for asbestos claims against Wagner. The ultimate exposure of the Company's subsidiary with respect to claims against Abex and Wagner will depend upon the extent to which the insurance described above will be available to cover such claims, the amounts paid for indemnity and defense, changes in the legal environment and other factors. While the Company believes that the liability and receivable recorded for these claims are reasonable and appropriate, given the nature and complexity of factors affecting the estimated liability and potential insurance recovery, the actual liability and insurance recovery may differ. In the event that the actual liability net of insurance proceeds recovered exceeds the reserve net of insurance receivable recorded by the Company, the Company's results of operations, business, liquidity and financial condition could be materially adversely affected. The asbestos reserves for the businesses acquired as part of the Cooper Automotive acquisition will be re-evaluated periodically as additional information becomes available. Federal-Mogul and Fel-Pro Asbestos Litigation The Company also is sued in its own name as one of a large number of defendants in a number of lawsuits brought by claimants alleging injury due to exposure to asbestos. The Company's Fel-Pro subsidiary has been named as a defendant in a number of product liability cases involving asbestos, primarily involving gasket or packing products. The Company is defending all such claims vigorously and believes that it and Fel-Pro have substantial defenses to liability and adequate insurance coverage for defense and indemnity. While the outcome of litigation cannot be predicted with certainty, management believes that asbestos claims pending against the Company and Fel-Pro as of December 31, 1999, will not have a material effect on the Company's financial position. Aggregate of Asbestos Liability As of December 31, 1999, the Company has provided a total reserve for all of its subsidiaries and businesses with potential asbestos liability of approximately $1.5 billion as its best estimate for future costs related to resolving asbestos claims. The Company estimates claims will be filed and paid in excess 1999 Annual Report 9 Management ' s Discussion and Analysis of the next 20 years. This estimate is based in part on recent and historical claims experience, medical information and the current legal environment. The company has a corresponding receivable from certain insurance carriers of approximately $325.9 million. Environmental Matters The Company is a defendant in lawsuits filed in various jurisdic tions pursuant to the federal Comprehensive Environmental Response Compensation and Liability Act of 1980 (CERCLA) or other similar federal or state environmental laws which require responsible parties to pay for cleaning up contamination resulting from hazardous wastes which were discharged into the environ ment by them or by others to which they sent such wastes for disposition. In addition, the Company has been notified by the United States Environmental Protection Agency and various state agencies that it may be a potentially responsible party (PRP) under such law for the cost of cleaning up certain other haz ardous waste storage or disposal facilities pursuant to CERCLA and other federal and state environmental laws. PRP designation requires the funding of site investigations and subsequent reme dial activities. At most of the sites that are likely to be costliest to clean up, which are often current or former commercial waste disposal facilities to which numerous companies sent waste, the Company's exposure is expected to be limited. Despite the joint and several liability which might be imposed on the Company under CERCLA and some of the other laws pertaining to these sites, the Company's share of the total waste is usually quite small; the other companies which also sent wastes, often num bering in the hundreds or more, generally include large, solvent publicly owned companies; and in most such situations the government agencies and courts have imposed liability in some reasonable relationship to contribution of waste. In addition, the Company has identified certain present and former properties at which it may be responsible for cleaning up environmental contamination. The Company is actively seeking to resolve these matters. Although difficult to quantify based on the complexity of the issues, the Company has accrued the estimated cost associ ated with such matters based upon current available information from site investigations and consultants. The environmental reserve was approximately $74.5 million at December 31, 1999, and $50.0 million at December 31, 1998. The 1999 increase results from a number of factors, including retaining liabilities from the divestiture of the T&N Bearings Business. Management believes that such accruals will be adequate to cover the Company's estimated liability for its exposure in respect of such matters. Market Risk In the normal course of business, the Company is subject to market exposure from changes in foreign exchange rates, interest rates, and raw material prices. To manage a portion of these inherent risks, the Company purchases various derivative financial instruments and commodity futures contracts. The Company does not hold or issue derivative financial instruments for trading purposes. Foreign Currency Risk A substantial portion of the Company's operations consist of manufacturing and sales activities in foreign jurisdictions. The Company manufactures and sells its products in North America, Europe, South America, Africa and Asia. As a result, the Company's financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company distributes its products. The Company's operating results are primarily exposed to changes in exchange rates between the United States dollar and European currencies. As currency exchange rates change, translation of the statements of operation of the Company's international businesses into United States dollars affects year-over-year comparability of operating results. The Company does not generally hedge operating translation risks because cash flows from international operations are generally reinvested locally. As of December 31, 1999 and 1998, the Company's net current assets (defined as current assets less current liabilities) subject to foreign currency translation risk were $187.4 million and $146.8 million, respectively. The potential decrease in net assets from a hypothetical 10% adverse change in quoted foreign currency exchange rates would be approximately $18.7 million and $14.7 million, respectively. The sensitivity analysis presented assumes a parallel shift in foreign currency exchange rates. Exchange rates rarely move in the same direction. This assumption may overstate the impact of changing exchange rates on individual assets and liabilities denominated in a foreign currency. The Company manages certain aspects of its foreign currency activities and larger transactions through the use of foreign currency options or forwards. The Company generally tries to utilize natural hedges within their foreign currency activities, including the matching of revenues and costs. As of December 31, 1999, the Company had entered into foreign currency forward contracts to hedge the British pound against the United States dollar and the Euro against the United States dollar in the amount of $41.3 million and $45.1 million, respectively, with an average contract rate of $1.62/ and $1.01/Euro. The Company had also entered into foreign currency forward contracts to hedge the British pound against the Euro, French franc and Italian lira in the amounts of $28.4 million, $25.7 million and $41.8 million with average contract rates of 1.58 Euro/, 10.06 franc/, 2,982.93 lira/, respectively. At December 31, 1999, the unrealized gains or losses on these contracts were not material. As of December 31, 1999, the Company had also entered into foreign currency forward contracts to hedge foreign currency debt exposures from the British pound to the Australian dollar, Belgium franc, Czech koruna, Dutch guilder, Danish krone, 10 Federal Mogul Management ' s Discussion and Analysis German mark, Irish punt, Japanese yen, South African rand and Spanish peseta whose notional amounts and related unrealized gains or losses were not material. As of December 31, 1998, the Company had entered into foreign currency forward contracts to hedge the British pound against the United States dollar in the amount of $66 million with an average contract rate of $1.62/ and an unrealized loss of $3.5 million at December 31, 1998. The Company had also entered into foreign currency forward contracts to hedge the British pound against the South African rand in the amount of $19 million with an average contract rate of 9.99 rand/ and an unrealized loss of $4.3 million at December 31, 1998. As of December 31, 1998, the Company had also entered into foreign currency forward contracts to hedge foreign currency debt exposures from the British pound to the Australian dollar, Swiss franc, German mark, Danish krone, Spanish peseta, French franc, Hong Kong dollar, Italian lira, Japanese yen and Swedish krona whose notional amounts and related unrealized gains or losses were not material. All foreign currency forward contracts purchased will expire within the next twelve months. Interest Rate Risk The Company's variable interest expense is sensitive to changes in the general level of United States interest rates. Most of the Company's interest expense is fixed through long-term borrow ings to mitigate the impact of such potential exposure. The following table provides information about the Company's finan cial instruments that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted-average interest rates by expected maturity dates. Weighted-average variable rates are based upon spot rate observations as of the reporting date. Liabilities Long-term debt, including current portion Fixed rate Average interest rate Variable rate Average interest rate Interest Rate Sensitivity Principal Amount by Expected Maturity As of December 31, 1999 (Millions of Dollars) 20002001200220032004 Thereafter Total Fair Value at December 31, 1999 $ 33.0 $ 44.8 $ 5.8 $ 20.9 $ 250.5 $1,885.0 $2,240.0 $ 2,040.0 7.71% 7.70% 7.70% 7.68% 7.68% 7.69% 7.69% $ 57.8 $ 111.6 $ 118.7 $ 134.5 $ 261.5 $ 186.7 $ 870.8 $ 870.8 7.32% 7.37% 7.38% 7.37% 7.36% 7.43% 7.37% Liabilities Long-term debt, including current portion Fixed rate Average interest rate Variable rate Average interest rate 1999 Interest Rate Sensitivity Principal Amount by Expected Maturity As of December 31, 1998 (Millions of Dollars) 2000 2001 2002 2003 Thereafter Total Fair Value at December 31,1998 $ 52.1 $ 65.2 $ 52.7 $ 10.8 $ 23.7 $1,141.1 $1,345.6 $ 1,381.2 7.80% 7.84% 7.88% 7.86% 7.86% 7.85% 7.85% $ 56.4 $ 409.9 $ 86.4 $ 115.9 $ 116.0 $1,109.0 $1,893.6 $ 1,893.6 7.33% 7.33% 7.33% 7.33% 7.33% 7.33% 7.33% Rate sensitive derivative financial instruments Interest rate locks purchased Average strike rate Forward rate $ 300.0 4.69% 4.66% -- -- -- -- -- -- -- -- -- -- -- $ 300.0 $ (0.9) -- ---- -- -- ---- -- 1999 Annual Report 11 Management ' s Discussion and Analysis Commodity Price Risk The Company is dependent upon the supply of certain raw materials in the production process and has entered into firm purchase commitments for copper, aluminum and nickel. The Company uses forward contracts to hedge against the changes in certain specific commodity prices of the purchase commitments outstanding. As of December 31, 1999, the Company had net unrealized gains for commodity contracts of $0.7 million. As of December 31, 1998, the Company had net unrealized losses for commodity contracts of $1.4 million. Other Matters Impact of Year 2000 In prior years, the Company discussed the nature and progress of its plans to become Year 2000 compliant. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in missioncritical information technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. As of December 31, 1999, the Company incurred and expensed approximately $12.1 million and capitalized $7.7 million. Year 2000 program costs incurred during 2000 are not expected to be material and will be funded from operations. The Company will continue to monitor its mission-critical computer applications and those of its suppliers and vendors throughout 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly. Euro Conversion On January 1, 1999, certain member countries of the European Union irrevocably fixed the conversion rates between their national currencies and a common currency, the "Euro," which became their legal currency on that date. The participating countries' former national currencies continue to exist as denominations of the Euro until January 1, 2002. The Company has established a steering committee that is monitoring the business implications of conversion to the Euro, including the need to adapt internal systems to accom modate Euro-denominated transactions. The acquisition of T&N has provided the Company with a strong knowledge base in which to assist with the conversion. While the Company is still in various stages of assessment and implementation, the Company does not expect the conver sion to the Euro to have a material effect on its financial condition or results of operations. Status of Lighting, Wiper and Fuel Businesses During the third quarter of 1999, the Company announced plans to sell its lighting, wiper blade and fuel systems businesses. Accordingly, the Company accounted for these businesses as held for sale in its press release on February 2, 2000, and did not include pretax depreciation and amortization totaling $5.2 million related to these businesses in its operating results at such time. Subsequent to the Company's February 2, 2000 press release relative to fourth quarter and total year financial results, the Company, in recognition of the market price available for the businesses held for sale and the continued profitability of these businesses, decided to retain its light ing, wiper blade and fuel systems businesses. As a result, the $5.2 million of depreciation and amortization is reflected in the fourth quarter and total year 1999 financial results. 2000 Restructuring Program On February 23, 2000, the Board of Directors of the Company approved a restructuring plan to reduce costs in the Company's aftermarket and OE businesses. Under the restructuring plan, the Company expects to incur restructuring charges of approximately $100 million which it expects to incur over the next two years, the majority of which will be recognized in 2000 when specific actions are finalized. The Company will also incur an additional $100 million in incremental expenses and capital expenditures associated with this plan that will be expensed or capitalized as incurred. The majority of these expenses will occur in 2000 with the remainder over the subsequent two years. As a result of this restructuring plan, the Company may also take a non-cash asset writedown of approximately $35 million to adjust certain assets to their fair value. The Company anticipates recognizing the first of these charges in the first quarter of 2000. It is possible the Company may identify additional areas of potential improvements requiring further restructuring plans. 12 Federal Mogul Notes to Consolidated Financial Statements 1. Accounting Policies Organization: Federal-Mogul is an automotive parts manufacturer providing innovative solutions and systems to global customers in the automotive, small engine, heavy-duty, and industrial markets. The Company manufactures engine bearings, sealing systems, fuel systems, lighting products, pistons, ignition, brake, friction and chassis products. The Company's principal customers include many of the world's original equipment ("OE") manufacturers of such vehicles and industrial products. The Company also manufac tures and supplies its products and related parts to the aftermarket. Trademarks Developed technology Assembled workforce Other Estimated Useful Life 40 years 12-30 years 15 years 5-20 years Accumulated amortization Total Other Intangible Assets 1999 1998 (Millions of Dollars) $ 415.7 $ 417.6 368.1 390.1 76.9 88.1 14.4 39.9 875.1 935.7 (78.8) (49.3) $ 796.3 $ 886.4 Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. Cash andEquivalents: The Company considers all highly liquid investments with maturities of 90 days or less from the date of purchase to be cash equivalents. Inventories: Inventories are stated at the lower of cost or market. Cost determined by the last-in, first-out (LIFO) method was used for 50% and 53% of the inventory at December 31, 1999 and 1998, respectively. The remaining inventories are recorded using the first-in, first-out (FIFO) method. If inventories had been valued at current cost, amounts reported would have been increased by $45.0 million and $39.0 million as of December 31, 1999 and 1998, respectively. Inventory quantity reductions resulting in liquidations of certain LIFO inventory layers increased net earnings by $3.2 million, $3.4 million and $3.2 million ($.04, $.06 and $.08 per diluted share) in 1999, 1998 and 1997, respectively. At December 31, inventories consisted of the following: Finished products Work-in-process Raw materials Reserve for inventory valuation 1999 1998 (Millions of Dollars) $ 638.9 $ 737.9 133.1 147.1 138.1 208.5 910.1 1,093.5 (26.5) (24.9) $ 883.6 $ 1,068.6 Goodwill and Other Intangible Assets: At December 31, goodwill and other intangible assets, which result principally from acquisi tions, consisted of the following: Goodwill Accumulated amortization Total Goodwill Estimated Useful Life 40 years 1999 1998 (Millions of Dollars) $ 3,725.7 $ 3,481.8 (177.9) (83.4) $ 3,547.8 $ 3,398.4 Intangible assets are periodically reviewed for impairment based on an assessment of future cash flows, or fair value for assets held for sale. Intangible assets are amortized on a straight-line basis over their estimated useful lives. Impairment charges recorded in 1999, 1998 and 1997 related primarily to assets held for sale. Revenue Recognition: The Company recognizes revenue and estimated returns from product sales and the related customer incentive and warranty expense when goods are shipped to the customer. Research andDevelopment andAdvertising Costs: The Company expenses research and development costs as incurred. Research and development expense was $128.0 million, $85.0 million and $13.1 million for 1999, 1998 and 1997, respectively. Costs associated with advertising and promotion are expensed as incurred. Advertising and promotion expense was $59.8 million, $45.9 million, $31.8 million for 1999, 1998 and 1997, respectively. CurrencyTranslation: Exchange adjustments related to interna tional currency transactions and translation adjustments for subsidiaries whose functional currency is the United States dollar (principally those located in highly inflationary economies) are reflected in the consolidated statements of operations. Translation adjustments of international subsidiaries for which the local currency is the functional currency are reflected in the consoli dated financial statements as a component of accumulated other comprehensive income. Environmental Liabilities: The Company recognizes environmental liabilities when a loss is probable and estimable. Such liabilities are generally not subject to insurance coverage. Engineering and legal specialists within the Company, based on current law and existing technologies, estimate each environmental obligation. Such estimates are based primarily upon the estimated cost of investigation and remediation required and the likelihood that other potentially responsible parties will be able to fulfill their commitments at the sites where the Company may be jointly and severally liable with such parties (refer to Note 16, "Litigation and Environmental Matters"). The Company regularly evaluates and revises its estimates for environmental obligations based on expenditures against estab lished reserves and the availability of additional information. 1999 Annual Report 17 Notes to Consolidated Financial Statements Integration Costs: These are incremental direct costs associated with integrating material acquisitions and include such one-time items as brand integration, costs to pack and move productive inventory and fixed assets from one location to another, and costs to change the identity of entities acquired. Such costs are expensed as incurred. Derivative Financial Instruments: The Company has used interest rate lock agreements to synthetically manage the interest rate characteristics of certain outstanding debt to a more desirable fixed rate basis or to limit the Company's exposure to rising interest rates, and uses forward foreign exchange contracts to minimize and lock the amount of currency payments for certain transactions that are denominated in certain foreign currencies, and forward contracts to hedge against the changes in certain specific commodity prices of the purchase commitments out standing (collectively "derivative contracts"). Interest rate differentials to be paid or received as a result of settled interest rate lock agreements are accrued and recognized as an adjustment of interest expense related to the designated debt. Recorded amounts related to derivative contracts are included in other assets or liabilities. The fair values of interest rate lock agreements and forward contracts are not recognized in the financial statements. Realized and unrealized gains or losses at the time of maturity, termination, sale or repayment of a derivative contract or desig nated item are recorded in a manner consistent with the original designation of the derivative in view of the nature of the termina tion, sale or repayment transaction. Amounts related to interest rate locks are deferred and amortized as an adjustment to interest expense over the original period of interest exposure, provided the designated liability continues to exist or is probable of occurring. Realized and unrealized changes in fair value of derivatives designated with items that no longer exist or are no longer probable of occurring are recorded as a component of the gain or loss arising from the disposition of the designated item. Comprehensive Income: The Company displays comprehensive income in the Consolidated Statements of Shareholders' Equity. At December 31, 1999 and 1998, comprehensive income con sisted of $252.0 million and $102.3 million of foreign currency translation adjustments, respectively, and $10.1 million and $3.7 million of other comprehensive income, primarily minimum pen sion funding, respectively. Use ofEstimates: 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. Reclassifications: Certain items in the prior year financial state ments have been reclassified to conform with the presentation used in 1999. Effect of Accounting Pronouncements: Effective January 1, 1999, the Company adopted AICPA Statement of Position (SOP) 98-5, Reporting the Costs of Start-Up Activities. SOP 98-5 requires that start-up costs capitalized prior to January 1, 1999 be written off and any future start-up costs be expensed as incurred. The unamortized balance of start-up costs written off as a cumulative effect of an accounting change was approximately $12.7 million, net of tax. The following table summarizes the pro forma net earnings and per share amounts for each period presented. Pro forma amounts assume the change in application of accounting principle was applied retroactively (unaudited): Net earnings as reported Pro forma Basic earnings per share as reported Pro forma Diluted earnings per share as reported Pro forma 1999 $243.2 $255.9 $ 3.44 $ 3.63 $ 3.16 $ 3.31 1998 $ 53.7 $ 45.3 $ 1.04 $ .87 $ .96 $ .80 1997 $ 69.4 $ 65.1 $ 1.74 $ 1.62 $ 1.61 $ 1.51 In 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. In June 1999, the effective date of SFAS No. 133 was delayed by one year to January 1, 2001. The statement requires the Company to recognize all derivatives on the balance sheet at fair value. The effect of adoption of this statement on the Company's earnings or financial position has not been finalized. In 1999, the Emerging Issues Task Force ("EITF") of the FASB reached consensus on issue No. 99-5, Accounting for Pre Production Costs Related to Long-Term Supply Arrangements. The EITF addresses the accounting for pre-production costs relating to design and development of production parts and tooling. The EITF is required to be applied beginning January 1, 2000. The Company does not believe the adoption of this pronouncement will have a material effect on the Company's financial position or financial operations as its current accounting practices are consistent with the pronouncement. 2. Acquisitions of Businesses 1999 Acquisitions: In January 1999, the Company completed its acquisition of the piston division of Alcan Deutschland GmbH (Alcan) in Germany, a subsidiary of Alcan Aluminum Ltd. in Canada. The division manufactures pistons for passenger cars and commercial vehicles under the Nural brand name. The piston division employs approximately 1,100 people with 1998 annual sales of approximately $150 million. Also in January 1999, the Company completed its acquisition of certain manufacturing operations of Crane Technologies, Inc. (Crane) to increase its camshaft capacity. Its two plants, located in Orland, Indiana and Jackson, Michigan, employ approximately 230 people with 1998 annual sales of approximately $36 million. 18 Federal Mogul Notes to Consolidated Financial Statements 1998 Acquisitions: T&N In March 1998, the Company acquired T&N pic (T&N), a manu facturer of high technology engineered automotive components and industrial materials, based in Manchester, England for consideration (including direct costs of the acquisition) of approx imately $2.4 billion. The Company also assumed cash of approxi mately $185 million and debt of approximately $745 million. The Company recognized an $18.6 million charge in the first quarter of 1998 associated with the estimated fair value of pur chased in-process research and development for which techno logical feasibility had not been established and the in-process technology had no future alternative uses. Cooper Automotive In October 1998, the Company acquired the automotive division of Cooper Industries, Inc. (Cooper Automotive), headquartered in St. Louis, Missouri, for initial consideration of approximately $1.9 billion. The Cooper Automotive purchase agreement included a price adjustment based upon acquired net assets, as defined in the agreement, under which, the Company made additional cash payments of $154.9 million in 1999. Cooper is a leading supplier of aftermarket parts for repair and maintenance and serves OE automobile manufacturers worldwide. Fel-Pro In February 1998, the Company acquired Fel-Pro, Incorporated and certain affiliated entities which constitute the operating businesses of the Fel-Pro group of companies (Fel-Pro), a privately owned gasket manufacturer headquartered in Skokie, Illinois, for a total consideration of approximately $722 million, which included 1,030,326 shares of Federal-Mogul Series E Stock with an imputed value of $225 million and approximately $497 million in cash. Fel-Pro is a leading gasket manufacturer in the North American aftermarket and OE heavy-duty market. The Alcan, Crane, T&N, Cooper Automotive and Fel-Pro acquisi tions have been accounted for as purchases and, accordingly, the total consideration was allocated to the acquired assets and assumed liabilities based on estimated fair values as of the acquisition dates. The consolidated statements of operations for the years ended December 31, 1999 and 1998 include the operating results of the acquired businesses, exclusive of the T&N Bearings Business and the Fel-Pro Chemical Business (refer to "Divestiture of Acquired Businesses" below) from their respective acquisition dates. Rationalization of Acquired Businesses In connection with the T&N, Cooper Automotive and Fel-Pro acquisitions in 1998, the Company recognized $216.8 million as acquired liabilities related to the rationalization and integration of acquired businesses. The rationalization reserves provided for $180.0 million in relocation and severance costs, and $36.8 million in exit costs and were recorded as a component of goodwill in the purchase price allocation. The components of the integration plan included: closure of certain manufacturing facilities worldwide; relocation of highly manual manufacturing product lines to more suitable locations; consolidation of overlapping manufacturing, technical and sales facilities and joint ventures; consolidation of overlapping aftermar ket warehouses; consolidation of aftermarket marketing and customer support functions; and streamlining of administrative, sales, marketing and product engineering staffs worldwide. The Company paid $72.2 million and $61.6 million related to these rationalization reserves in 1999 and 1998, respectively. Also during 1999, the Company made adjustments to reduce the rationalization reserves, with an offsetting amount to goodwill, by $47.9 million. These adjustments related to the finalization of rationalization plans. As of December 31, 1999, remaining rationalization reserves were $30.3 million, primarily relating to the closure of several Powertrain Systems facilities in Europe and the consolidation of aftermarket warehouses in Europe. These costs are expected to be paid in 2000. Divestitures of Acquired Businesses In connection with securing regulatory approvals for the acquisi tion of T&N, the Company executed an Agreement Containing Consent Order with the Federal Trade Commission on February 27, 1998. Pursuant to this agreement, the Company divested of the T&N Bearings Business and provided for independent man agement of those assets pending such divestiture. The agree ment stipulated that the T&N Bearings Business be maintained as a viable, independent competitor of the Company and that the Company not attempt to direct the activities of, or exercise control over, the T&N Bearings Business or have contact with the T&N Bearings Business outside of normal business activities. In December 1998, the Company sold the T&N Bearings Business, consisting of the Glacier Vandervell Bearings Group and the AE Clevite North American non-bearing aftermarket engine hard parts business, to Dana Corporation for $430 million. These proceeds were subsequently used to pay down debt. Furthermore, the Company realized additional net proceeds of approximately $13 million from the collection of receivables of the business sold. Prior to the sale of the T&N Bearings Business to Dana Corporation, a portion of the business was sold for approximately $12 million in August 1998. In July 1998, the Company sold the Fel-Pro Chemical Business to Loctite Corporation, a part of Henkel KGaA, a global specialist in applied chemistry headquartered in Dusseldorf, Germany, for $57 million. Operating results for the T&N Bearings and Fel-Pro Chemical Businesses (which include interest expense of $30 million relating to the holding costs of the businesses) have been excluded from the consolidated statement of operations for the year ended December 31, 1998. Pro Forma Results The following unaudited pro forma financial information for the years ended December 31, 1998 and 1997 assume the T&N, Cooper Automotive and Fel-Pro acquisitions occurred as of the 1999 Annual Report 19 Notes to Consolidated Financial Statements beginning of the respective periods, after giving effect to certain adjustments, including the amortization of intangible assets, interest expense on acquisition debt, divestitures of the T&N Bearings Business and Fel-Pro Chemical Business, 1998 equity offerings and income tax effects. The pro forma results (in millions of dollars, except per share data) have been prepared for com parative purposes only and are not necessarily indicative of the results of operations which may occur in the future or that would have occurred had the acquisitions of T&N, Cooper Automotive and Fel-Pro been consummated on the dates indicated, nor are they necessarily indicative of the Company's future results of operations. Unaudited Pro Forma Financial Information (Millions of Dollars, Except Per Share Amounts) Year Ended December 31 1998 1997 Net sales Net earnings (loss) Earnings (loss) per share Earnings (loss) per share $ 6,444.1 $ 152.0 $ 2.12 $ 6,644.7 $ (4.9) $ (.19) assuming dilution $ 1.95 $ (.19) 3. Sales of Businesses In 1999, the Company sold its subsidiary, Bertolotti Pietro e Figli, S.r.l. (Bertolotti), an Italian aftermarket operation. In 1998, the Company recognized a $20.0 million charge primarily associated with the writedown of Bertolotti's assets to their estimated fair value. In 1999, the Company recognized an additional $7.9 million loss associated with the writedown of Bertolotti's assets to their fair value resulting from the sale. Offsetting the loss was a tax benefit of $7.9 million resulting from the sale. Also during 1999, the Company sold its South African heat transfer business. The business had sales of approximately $56 million in 1998 in four South African locations and employed approximately 1,200 people. The Company did not realize a significant gain or loss on this transaction. In February 1998, the Company divested its minority interest in G. Bruss GmbH & Co. KG (Bruss), a German manufacturer of seals and gaskets. As part of the divestiture agreement the Company increased its ownership to 100% in its Summerton, South Carolina, gasket manufacturing plant. The Company received net proceeds of approximately $46 million related to the divestiture agreement and recognized a gain on the divestiture of $6.0 million. The gain on the divestiture is included as a component of other expense. In addition, the Company closed or sold substantially all its remaining retail aftermarket operations during 1998. During 1997, the Company received $73.6 million in net cash proceeds from the sale of its aftermarket operations in South Africa, Australia and Chile, and its heavy wall bearing operations in Germany and Brazil. 4. Restructuring Charges_____________________________________________________________________________________ The following is a summary of restructuring charges and related activity for 1997, 1998 and 1999 (in millions of dollars): 1995 and 1996 Restructuring Provisions severance Exit 1997 Restructuring Provision Severance Exit 1998 Restructuring Provision Severance Exit 1999 Restructuring Provision Severance Exit Total Balance of restructuring reserves at January 1, 1997 $ 1997 restructuring charge Adjustment to restructuring reserves 1997 restructuring charges (net) Payments against restructuring reserves Balance of restructuring reserves at December 31, 1997 1998 restructuring charges Adjustment to restructuring reserves 1998 restructuring charges (net) Payments against restructuring reserves Balance of restructuring reserves at December 31, 1998 1999 restructuring charges Adjustment to restructuring reserves 1999 restructuring charges (net) Payments and charges against restructuring reserves Balance of restructuring reserves at December 31, 1999 $ 38.0 $ (20.8) (20.8) (11.6) 5.6 -- -- -- (1.1) 4.5 -- (0.9) (0.9) (3.6) --$ 17.2 --$ (2.3) (2.3) (5.4) 9.5 -- (2.4) (2.4) (5.8) 1.3 -- (0.6) (0.6) (0.7) --$ 16.7 $ 16.7 (0.1) 16.6 -- (4.6) (4.6) (6.1) 5.9 -- (3.1) (3.1) (2.8) --$ 5.3 5.3 -- 5.3 -- $ 16.0 (2.0) -- (2.0) 16.0 (0.1) (3.3) 3.2 -- (2.3) (2.3) 12.7 -- (6.1) (6.1) (0.9) (0.8) --$ 5.8 $ 0.3 -- 0.3 -- 0.3 -- $ 11.1 (0.2) -- (0.2) 11.1 $ (0.1) (3.1) $ -- $ 8.0 $ $ 55.2 22.0 (23.1) (1.1) (17.1) 37.0 16.3 (9.0) 7.3 (16.4) 27.9 2.1 13.2 -- (13.2) 2.1 (0.2) (12.2) 1.9 $ 15.7 20 Federal Mogul Notes to Consolidated Financial Statements 1999 Restructuring Provision In 1999, the Company recognized $13.2 million of restructuring charges related to severance and exit costs. Employee sever ance costs of $11.1 million resulted from planned terminations in certain European operations of the Company, employees at the Company's Milan, Michigan plant, and certain executive severances. The severance costs were based on the estimated amounts that will be paid to the affected employees pursuant to the Company's workforce reduction policies and certain foreign governmental regulations. Total headcount reductions are expected to be approximately 250 employees. Exit costs of $2.1 million were related to the closing of the Company's Milan plant and French bearing operations. These actions are expected to be primarily completed in 2000. Also in 1999, the Company recognized $13.2 million reversals of restructuring charges recorded in previous years. These reversals resulted primarily from lower than expected employee severance costs principally associated with the reduction of the aftermarket sales force and consolidation of certain operations in the Americas. 1998 Restructuring Provision In 1998, as a result of the T&N, Cooper Automotive and Fel-Pro acquisitions, the Company recognized $16.3 million of restructuring charges related to restructuring the Company's operations in place prior to these acquisitions. Employee severance costs resulted from planned terminations of approximately 1,800 employees in various business operations of the Company. The severance costs were based on the estimated and actual amounts that will be paid to the affected employees pursuant to the Company's workforce reduction policies and certain foreign governmental regulations. The Company anticipates that the remaining actions related to the 1998 restructuring plan will be completed in 2000. Also in 1998, the Company recognized restructuring credits of $9.0 million for a reversal of charges recorded in previous years. The Company was able to sell, rather than liquidate, its retail operations in Puerto Rico causing this reversal. 1997 Restructuring Provision Results of operations in 1997 include a $22.0 million charge for 1997 severance and exit costs. The restructuring actions were designed to improve the Company's cost structure, streamline operations and divest the Company of underperforming assets. Employee severance costs for 1997 resulted from the planned and actual termination of approximately 500 employees, in various business operations of the Company. The severance costs were based on the minimum levels that will be paid to the affected employees pursuant to the Company's workforce reduction policies and certain foreign governmental regulations. Exit costs for 1997 principally include lease termination costs for certain North American distribution service branches and retail aftermarket operations in Puerto Rico, and the consolidation of certain European distribution, and North American and European manufacturing operations. The 1997 restructuring actions were completed during 1999. 5. British Pound C Ourrency ption F Cand orward ontract In the fourth quarter of 1997, in anticipation of the then pending T&N acquisition, the Company purchased a British pound curren cy option for $28.1 million with a notional amount of $2.5 billion. The cost of the option and its change in fair value has been reflected in the results of operations in the fourth quarter of 1997. At December 31, 1997, the Company had recognized a net loss of $10.5 million on the transaction. In January 1998, the Company settled the option and recognized an additional loss of $17.3 million. Also in January 1998, in anticipation of the then pending T&N acquisition, the Company entered into a forward contract to purchase 1.5 billion for approximately $2.45 billion. As a result of favorable fluctuations in the British pound/United States dollar exchange rate during the contract period, the Company recog nized a $30.6 million gain. The Company entered into the above transactions to serve as economic hedges for the purchase of T&N. Such transactions, however, did not qualify for hedge accounting under GAAP, and therefore both the loss on the British pound currency option and the gain on the British pound forward contract are reflected in the consolidated statement of operations caption "Net (gain) loss on British pound currency option and forward contract." 6. Debt________________________________________________ Long-term debt at December 31 consists of the following: 1999 1998 (Millions of Dollars) Senior Credit Agreements: Term loans $ 750.0 $1,893.6 Multi-currency revolving credit facility 65.0 -- Notes due 2004 -- 7.5%, issued in 1998 249.6 249.5 Notes due 2006 -- 7.75%, issued in 1998 399.9 399.9 Notes due 2006 -- 7.375%, issued in 1999 398.6 -- Notes due 2009 -- 7.5%, issued in 1999 597.6 -- Notes due 2010 -- 7.875%, issued in 1998 349.2 349.2 Medium-term notes -- due between 2000 and 2005, average rate of 8.8%, issued in 1994 and 1995 104.0 125.0 Senior notes -- due in 2007, rate of 8.8%, issued in 1997 124.7 124.7 ESOP obligation -- due in 2000, average rate of 7.19% 7.9 14.7 Other 64.3 82.6 3,110.8 3,239.2 Less current maturities included in short-term debt 90.8 108.5 $3,020.0 $3,130.7 In February 1999, the Company entered into a new $1.75 billion Senior Credit Agreement at variable interest rates, which contains a $1.0 billion multicurrency revolving credit facility and two term loan components. The revolving credit facility has a five-year maturity. The term loan components of $400 million 1999 Annual Report 21 Notes to Consolidated Financial Statements and $350 million mature in five and six years, respectively. The proceeds of this Senior Credit Agreement were used to refinance the prior Senior Credit Agreements entered into in connection with the T&N and Cooper Automotive acquisitions as well as the $400 million multi-currency revolving credit facility related to the T&N acquisition. As a result of these transactions, the Company recognized an extraordinary charge in the first quarter of 1999 of approximately $14.6 million, net of tax, related to the early extinguishment of debt. The Company had $815.0 million outstanding under these Senior Credit Agreements as of December 31, 1999, which were due from 2000 to 2005 with an average interest rate of 7.36%. In January 1999, the Company issued $1.0 billion of bonds with maturities ranging from seven to ten years, a weighted average yield of 7.53% and a weighted average coupon of 7.45%. Proceeds were used to repay borrowings under the Senior Credit Agreements. As a result of this transaction the Company recognized an extraordinary charge in the first quarter of 1999 of approximately $8.5 million, net of tax, related to early extinguishment of debt. In 1998, in connection with the acquisitions of T&N and Cooper Automotive, the Company entered into Senior Credit Agreements. The Company had $1,893.6 million outstanding under these Senior Credit Agreements as of December 31, 1998, which were due from 1999 to 2005 with an average interest rate of 7.33%. These Agreements were replaced with the 1999 Senior Credit Agreements discussed above. The proceeds from the 2004, 2006 and 2010 notes were used to repay amounts previously outstanding under the Senior Credit Agreements. Such repayments and other repayments resulting from the proceeds of equity offerings (refer to Note 9, "Capital Stock and Preferred Share Purchase Rights") and the early retirement of private placement debt assumed in the T&N acqui sition and related make-whole payment resulted in the extraordi nary loss on the early retirement of debt in 1998 of $38.2 million, net of applicable income tax benefits of $19.9 million. The Company has pledged 100% of the capital stock of certain United States subsidiaries, 65% of capital stock of certain foreign subsidiaries and certain intercompany loans to secure the Senior Credit Agreements of the Company; certain of such pledges also extend to the Notes, Medium-term notes and Senior notes. In addition, certain subsidiaries of the Company have guaranteed the senior debt (refer to Note 18, "Consolidating Condensed Financial Information of Guarantor Subsidiaries"). The ESOP obligation represents the unpaid principal balance on an 11-year loan entered into by the Company's ESOP in 1989. Proceeds of the loan were used by the ESOP to purchase the Company's Series C ESOP preferred stock. Payment of principal and interest on the notes is unconditionally guaranteed by the Company, and therefore, the unpaid principal balance of the borrowing is classified as long-term debt. Company contributions and dividends on the preferred shares held by the ESOP are used to meet semi-annual principal and interest obligations. The original ESOP obligation bore an annual interest rate of 11.5%. The obliga tion was refinanced on June 30, 1995 at a fixed interest rate of 7.2%. The ESOP obligation matures in December 2000. The weighted average interest rate for the Company's short-term debt was approximately 7.42% and 7.75% as of December 31, 1999 and 1998, respectively. Aggregate maturities of long-term debt for each of the years following 2000 are, in millions: 2001 --$156.4; 2002 -- $124.5; 2003 -- $155.4; 2004 -- $512.0 and thereafter $2,071.7. Interest paid in 1999, 1998 and 1997 was $240.3 million, $173.4 million and $30.7 million, respectively. 7. F Iinancial nstruments Foreign Exchange Risk and Commodity Price Management The Company is subject to exposure to market risks from changes in foreign exchange rates and raw material price fluctuations. Derivative financial instruments are utilized by the Company to reduce those risks. Except for the British pound currency option and forward contract discussed in Note 5, the Company does not hold or issue derivative financial instruments for trading purposes. As of December 31, 1999, the Company has foreign exchange forward contracts principally for British pound exposures relating to the United States dollar, Euro, French franc and Italian lira. The Company also has foreign exchange forward contracts for United States dollar exposure relating to the Euro. At December 31, 1999, the unrealized gains or losses relating to these contracts were not material. The Company enters into copper, aluminum and nickel contracts to hedge against the risk of price increases. These contracts are expected to offset the effects of price changes on the firm purchase commitments for copper, aluminum and nickel. Under the agreements, the Company was committed to purchase approximately 3.6, 6.4 and 0.5 million pounds of copper, aluminum, and nickels respectively. The net unrealized gain on these firm purchase commitments were not material. Deferred gains and losses are included in other assets and liabilities and recognized in operations when the future purchase, sale or payment (in the case of the asbestos liability) occurs, or at the point in time when the purchase, sale or payment is no longer expected to occur. Accounts Receivable Securitization In July 1999, the Company entered into a new $450 million accounts receivable securitization agreement replacing the existing $150 million agreement. The facility maturity date is June 28, 2000. Net proceeds were used to repay borrowings under the Senior Credit Agreement's multicurrency revolving credit facility. On an ongoing basis, the Company sells certain accounts receivable to Federal-Mogul Funding Corporation (FMFC), a wholly owned subsidiary of the Company, which then sells 22 Federal Mogul Notes to Consolidated Financial Statements such receivables, without recourse, to a financial conduit. Amounts excluded from the balance sheets under these arrange ments were $410.1 million and $105.8 million at December 31, 1999 and 1998, respectively. The Company's retained interest in the accounts receivable sold to FMFC is included in the consolidated balance sheet caption "Investment in Accounts Receivable Securitization." Concentrations of Credit Risk Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of accounts receiv able and cash investments. The Company's customer base includes virtually every significant global automotive manufacturer and a large number of distributors and installers of automotive aftermarket parts. The Company's credit evaluation process, reasonably short collection terms and the geographical disper sion of sales transactions help to mitigate any concentration of credit risk. The Company requires placement of investments in financial institutions evaluated as highly creditworthy. The Company does not generally require collateral for its trade accounts receivable or those assets included in the investment in accounts receivable securitization. The allowance for doubtful accounts of $69.3 million and $60.4 million at December 31, 1999 and 1998, respectively, is based upon the expected collectibility of trade accounts receivable. Fair Value of Financial Instruments The carrying amounts of certain financial instruments such as cash and equivalents, accounts receivable, accounts payable and short-term debt approximate their fair values. The carrying amounts and estimated fair values of the Company's long-term debt, including the current portion, were $3,110.8 million and $2,910.8 million, respectively, at December 31, 1999. The carrying amounts and estimated fair values of the Company's long-term debt, including the current portion, were $3,239.2 million and $3,274.8 million, respectively, at December 31, 1998. The fair value of the long-term debt is estimated using discounted cash flow analysis and the Company's current incremental borrowing rates for similar types of arrangements. 8. Property, Plant and Equipment Property, plant and equipment are stated at cost and include expenditures that materially extend the useful lives of existing buildings, machinery and equipment. Depreciation is computed principally by the straight-line method for financial reporting purposes and by accelerated methods for income tax purposes. Depreciation expense for the years ended December 31, 1999, 1998 and 1997, was $221.4 million, $144.2 million and $42.6 million, respectively. At December 31, property, plant and equipment consisted of the following: Land Buildings and building improvements Machinery and equipment Accumulated depreciation Estimated Useful Life 1999 1998 (Millions of Dollars) --$ 145.7 $ 139.4 24-40 years 3-12 years 496.1 2,402.9 3,044.7 (541.0) $ 2,503.7 560.1 2,097.6 2,797.1 (319.6) $ 2,477.5 Future minimum payments under noncancelable operating leases with initial or remaining terms of more than one year are, in millions: 2000 -- $41.7; 2001 -- $33.1; 2002 -- $27.1; 2003 -- $21.6; 2004 -- $19.8 and thereafter $45.2. Total rental expense under operating leases was $52.6 million in 1999, $46.5 million in 1998 and $29.1 million in 1997, exclusive of property taxes, insurance and other occupancy costs generally payable by the Company. 9. Capital Stock and Preferred Share Purchase Rights The Company's articles of incorporation authorize the issuance of 260,000,000 shares of common stock, of which 70,422,525 shares, 67,233,216 shares and 40,196,603 shares were outstand ing at December 31, 1999, 1998 and 1997, respectively. In December 1998, the Company completed an equity offering of 14.1 million shares of common stock. The net proceeds from the sale of the common stock of $781.2 million were used to reduce the Senior Credit Agreements associated with the acquisition of Cooper Automotive. In June 1998, the Company issued 12.7 million shares of common stock, including 2.1 million shares which were converted from Series E Stock. The net proceeds from the sale of the common stock of $592 million were used to prepay the entire outstanding principal amount under the Senior Subordinated Credit Agreement and partially repay the Senior Credit Agreement (refer to Note 2, "T&N" in "1998 Acquisitions"). In February 1998, in connection with the Fel-Pro acquisition, the Company issued 1,030,326 shares Series E Stock with an imputed value of $225 million. The shares of Series E Stock were exchangeable into shares of the Company's common stock at a rate of five shares of common stock per share of Series E Stock. In conjunction with the June 1998 common stock offering described above, the Company converted 422,581 shares of Series E Stock into approximately 2.1 million shares of common stock. On February 24, 1999, the remaining 607,745 shares of the Company's Series E Stock were exchanged into shares of the Company's common stock. 1999 Annual Report 23 Notes to Consolidated Financial Statements In August 1997, the Company announced a call for the redemption of all its outstanding $3.875 Series D Convertible Exchangeable Preferred Stock. These preferred stockholders elected to convert each preferred share into 2.778 shares of common stock. The Company issued 4.4 million shares of common stock in exchange for all the outstanding Series D Convertible Exchangeable Preferred Stock. The Series C ESOP Convertible Preferred Stock shares of stock are used to fund a portion of the Company's matching contribu tions with in the Salaried Employees' Investment Program. The Series C ESOP preferred stock is convertible into shares of the Company's common stock at a rate of two shares of common stock for each share of preferred stock. There were 701,758, 724,644 and 762,939 shares of Series C ESOP preferred stock outstanding at December 31, 1999, 1998 and 1997, respectively. The Series C ESOP preferred shares pay dividends at a rate of 7.5%. The Company repurchased and retired 28,549, 38,295 and 72,959 Series C ESOP preferred shares valued at $2.9 million, $4.6 million and $4.1 million during 1999, 1998 and 1997, respec tively. All of the repurchases represent plan distributions or fund transfers for participants of the plan. The charge to operations for the cost of the ESOP was $5.5 million in 1999, $5.2 million in 1998 and $5.2 million in 1997. The Company made cash contributions to the plan of $8.2 million in 1999, $8.2 million in 1998 and $8.1 million in 1997, including preferred stock dividends of $3.4 million in 1999, $3.6 million in 1998 and $3.8 million in 1997. ESOP shares are released as principal and interest on the debt is paid. The ESOP Trust uses the preferred dividends not allocated to employees to make principal and interest payments on the debt. Compensation expense is measured based on the fair value of shares committed to be released to employees. Dividends on ESOP shares are treated as a reduction of retained earnings in the period declared. The number of allocated shares and suspense shares held by the ESOP were 621,088 and 80,670 at December 31, 1999, 563,995 and 160,649 at December 31, 1998, and 512,147 and 250,792 at December 31, 1997, respec tively. There were no committed-to-be-released shares at December 31, 1999, 1998 and 1997. Any repurchase of the ESOP shares is strictly at the option of the Company. 10. Company-Obligated Mandatorily Redeemable P S S Treferred ecurities of ubsidiary rust H S C Solding olely onvertible ubordinated D Cebentures of the ompany In December 1997, the Company's wholly owned financing trust ("Affiliate") completed a $575 million private issue of 11.5 million shares of 7.0% Trust Convertible Preferred Securities ("TCP Securities") with a liquidation value of $50 per convertible securi ty. The net proceeds from the TCP Securities were used to pur chase an equal amount of 7.0% Convertible Junior Subordinate Debentures ("Debentures") of the Company. The TCP Securities represent an undivided interest in the Affiliate's assets, with a liquidation preference of $50 per security. Distributions on the TCP Securities are cumulative and will be paid quarterly in arrears at an annual rate of 7.0%, and are included in the consolidated statements of operations as a component of "Other Expense, Net." The Company has the option to defer payment of the distributions for an extension period of up to 20 consecutive quarters if the Company is in compliance with the terms of the TCP Securities. The shares of the TCP Securities are convertible, at the option of the holder, into the Company's common stock at an equivalent conversion price of approximately $51.50 per share, subject to adjustment in certain events. The TCP Securities and the Debentures will be redeemable, at the option of the Company, on or after December 6, 2000 at a redemption price, expressed as a percentage of principal which is added to accrued and unpaid interest. The redemption price range is from 104.2% on December 6, 2000 to 100.0% after December 1, 2007. All outstanding TCP Securities and Debentures are required to be redeemed by December 1, 2027. The Company's common stock is subject to a Rights Agreement under which each share has attached to it a Right to purchase one one-hundredth of a share of a new series of Preferred Stock, at a price of $250 per Right. In the event an entity acquires or attempts to acquire 10% (20% in the case of an institutional investor) or more of the then outstanding shares, each Right would entitle the holder to purchase a number of shares of common stock pursuant to a formula contained in the Agreement. These Rights will expire on April 30, 2009, but may be redeemed at a price of $.01 per Right at any time prior to a public announcement that the above event has occurred. The Board may amend the Rights at any time without shareholder approval. 24 Federal Mogul Notes to Consolidated Financial Statements 11. Earnings Per Share__________________________________________________________________________________________ The following table sets forth the computation of basic and diluted earnings per share (in millions, except per share data): Numerator: Net earnings Extraordinary items -- loss on early retirement of debt, net of applicable tax benefits Cumulative effect of change in accounting for costs of start-up activities, net of applicable income tax benefits Earnings before extraordinary items and cumulative effect of change in accounting principle Series C preferred dividend requirement Series D preferred dividend requirement Series E preferred dividend requirement Numerator for basic earnings per share -- income available to common shareholders before extraordinary items and cumulative effect of change in accounting principle Effect of dilutive securities: Series C preferred dividend requirement Series D preferred dividend requirement Series E preferred dividend requirement Minority interest -- preferred securities of an affiliate Additional required ESOP contribution Numerator for diluted earnings per share -- income available to common shareholders after assumed conversions, before extraordinary items and cumulative effect of change in accounting principle Numerator for basic earnings per share -- income available to common shareholders after extraordinary items and cumulative effect of change in accounting principle Numerator for diluted earnings per share -- income available to common shareholders after extraordinary items and cumulative effect of change in accounting principle Denominator: Denominator for basic earnings per share -- weighted average shares Effect of dilutive securities: Dilutive stock options outstanding Nonvested stock Conversion of Series C preferred stock Conversion of Series D preferred stock Conversion of Series E preferred stock Conversion of Company-obligated mandatorily redeemable preferred securities Contingently issuable shares of common stock Dilutive potential common shares Denominator for dilutive earnings per share -- adjusted weighted average shares and assumed conversions 1999 1998 $ 243.2 $ 53.7 23.1 38.2 12.7 279.0 (2.2) -- (0.2) -- 91.9 (2.3) -- (1.3) $ 276.6 $ 88.3 2.2 -- 0.2 25.4 (2.2) 2.3 -- 1.3 -- (2.1) $ 302.2 $ 89.8 $ 240.8 $ 50.1 $ 266.4 $ 51.6 69.8 48.1 0.5 0.8 0.1 0.1 1.4 1.5 ---- 0.5 3.2 11.2 -- 0.7 -- 14.4 5.6 84.2 53.7 1997 $ 69.4 2.6 -- 72.0 (2.4) (3.1) -- $ 66.5 2.4 3.1 -- -- (1.9) $ 70.1 $ 63.9 $ 67.5 36.6 0.4 0.3 1.6 3.0 -- -- -- 5.3 41.9 Basic earnings per share before extraordinary items and cumulative effect of change in accounting principle Basic earnings per share after extraordinary items and cumulative effect of change in accounting principle Diluted earnings per share before extraordinary items and cumulative effect of change in accounting principle Diluted earnings per share after extraordinary items and cumulative effect of change in accounting principle $ 3.96 $ 1.84 $ 1.81 $ 3.44 $ 1.04 $ 1.74 $ 3.59 $ 1.67 $ 1.67 $ 3.16 $ .96 $ 1.61 For additional disclosures regarding the Series C, Series D and Series E preferred stock, the employee stock options and non-vested stock shares, refer to Note 9, "Capital Stock and Preferred Share Purchase Rights," and Note 12, "Incentive Stock Plans." Convertible preferred securities (refer to Note 10, "Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Convertible Subordinated Debentures of the Company") redeemable for 11.2 million shares of common stock were outstanding for 1998 and a portion of 1997 but were not included in the computation of diluted earnings per share because the effect would be antidilutive. These shares were dilutive in 1999 and therefore included in the computation of earnings per share. 1999 Annual Report 25 Notes to Consolidated Financial Statements 12. Incentive Stock Plans The Company's shareholders adopted stock option plans in 1976 and 1984 and performance incentive stock plans in 1989 and 1997. These plans provide generally for awarding restricted shares or granting options to purchase shares of the Company's common stock. Restricted shares entitle employees to all the rights of common stock shareholders, subject to certain transfer restrictions and to forfeiture in the event that the conditions for their vesting are not met. Options entitle employees to purchase shares at an exercise price not less than 100% of the fair market value on the grant date and expire after a five- or ten-year period as determined by the Board of Directors. Under the plans, awards vest from six months to five years after their date of grant, as determined by the Board of Directors at the time of grant. At December 31, 1999, there were 513,836 shares available for future grants under the plans. In October 1997, the Company met certain share price perfor mance criteria under the 1989 Long-Term Incentive Plan, which resulted in the recognition of $5.4 million in compensation expense relating to the vesting of restricted stock awards. The total compensation cost that has been charged to operations for vesting of restricted stock awards was $1.4 million, $0.7 million and $9.0 million in 1999, 1998 and 1997, respectively. The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations in accounting for its employee stock awards. Accordingly, no compensation cost has been recognized for its stock option grants, as the exercise price of the Company's employee stock options equals the underlying stock price on the date of grant. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of Statement of Financial Accounting Standards No. 123 (SFAS 123) Accounting for Stock BasedCompensation, the Company's net earnings, in millions, and earnings per share would have been adjusted to the pro forma amounts indicated below: 1999 1998 1997 Net earnings as reported Pro forma Basic earnings per share as reported Pro forma Diluted earnings per share as reported Pro forma $ 243.2 $ 230.3 $ 3.44 $ 3.27 $ 3.16 $ 3.01 $ 53.7 $ 48.3 $ 1.04 $ .93 $ .96 $ .86 $ 69.4 $ 70.7 $ 1.74 $ 1.78 $ 1.61 $ 1.64 Pro forma information regarding net income and earnings per share is required by SFAS 123 as if the Company had accounted for its employee stock options under the fair value method. The fair value for options is estimated at the date of grant using a Black-Scholes option pricing model with the following weightedaverage assumptions for 1999, 1998 and 1997, respectively: risk-free interest rates of 6.2%; dividend yields of 0.03%, 0.2% and 1.5%; volatility factors of the expected market price of the Company's common stock of 48.0%, 30.1%, and 27.2% and a weighted average expected life of the option of five years. The fair value of nonvested stock awards is equal to the market price of the stock on the date of the grant. The weighted-average fair value and the total number (in millions) of options granted was $16.81, $22.36 and $9.99, and 2.7, 1.1 and 0.9 for 1999, 1998 and 1997, respectively. The weightedaverage fair value and total number (in millions) of nonvested stock awards granted was $53.52 and $24.47 and 0.1 and 0.1 for 1998 and 1997, respectively. There were no stock awards granted in 1999. All options and stock awards that are not vested at December 31, 1999, vest solely on employees' rendering additional service. The following table summarizes the activity relating to the Company's incentive stock plans: Number Weightedof Shares Average (In Millions) Price Outstanding at January 1, 1997 Options/stock granted Options exercised/stock vested Options/stock lapsed or canceled Outstanding at December 31, 1997 Options/stock granted Options exercised/stock vested Options/stock lapsed or canceled Outstanding at December 31, 1998 Options granted Options exercised/stock vested Options/stock lapsed or canceled Outstanding at December 31, 1999 Options exercisable at December 31, 1999 Options exercisable at December 31, 1998 Options exercisable at December 31, 1997 2.5 1.0 (1.0) (0.3) 2.2 1.2 (0.5) (0.1) 2.8 2.7 (0.1) (0.3) 5.1 0.9 0.6 0.9 $ 22.03 31.74 21.94 22.29 $ 26.46 57.94 21.85 31.49 $ 40.50 33.85 25.98 41.86 $ 37.14 $ 31.04 $ 30.11 $ 23.07 The following is a summary of the range of exercise prices for stock options that are outstanding and the amount of non-vested stock awards at December 31, 1999: Range Options: $15.69-$23.50 $23.51-$35.25 $35.26-$52.87 $52.88-$70.69 Nonvested stock Total outstanding Awards (In Millions) Weighted-Average Price Remaining Life 1.8 $ 20.18 4 years 0.6 $ 27.98 2 years 1.6 $ 46.17 4 years 1.0 $ 59.15 4 years 0.1 5.1 26 Federal Mogul Notes to Consolidated Financial Statements 13. Postemployment Benefits The Company sponsors several defined benefit pension plans (Pension Benefits) and health care and life insurance benefits (Other Benefits) for certain employees and retirees around the world. The Company funds the Pension Benefits based on the funding requirements of federal and international laws and regulations in advance of benefit payments and the Other Benefits as benefits are provided to the employees. Components of net periodic benefit United States Plans International Plans cost for the year ended December 31: ________Pension Benefits______ ________ Other Benefits_______ _______ Pension Benefits (Millions of Dollars) 1999 1998 1997 1999 1998 1997 1999 1998 1997 Service cost Interest cost Expected return on plan assets Net amortization and deferral Curtailment loss (gains) Net periodic (benefit) cost $ 26.4 51.0 (79.8) (3.0) 0.1 $ (5.3) $ 16.4 29.9 (48.1) (4.3) 1.6 $ (4.5) $ 7.8 14.0 (24.2) (4.2) -- $ (6.6) $ 4.7 31.0 -- (2.7) (12.5) $ 20.5 $ 4.4 $ 2.5 $ 26.8 $ 26.7 $ 19.2 10.5 112.0 100.7 -- -- (144.8) (123.6) (0.6) (0.5) 9.2 -- -- -- (3.1) -- $ 23.0 $ 12.5 $ 0.1 $ 3.8 $ 0.3 1.9 -- -- -- 2.2 Change in benefit obligation: (Millions of Dollars) Benefit obligation at beginning of year Service cost Interest cost Acquisitions Employee contributions Benefits paid Plan amendments Actuarial (gains) and losses and changes in actuarial assumptions Settlements and curtailments Prior service cost Currency translation adjustment Benefit obligation at end of year United States Plans Pension Benefits Other Benefits 1999 1998 1999 1998 $ 717.5 26.4 51.0 -- -- (60.2) 12.3 $ 197.2 16.4 29.9 496.7 -- (26.0) 9.9 $ 468.9 $ 150.4 4.7 4.4 31.0 19.2 2.9 297.3 ---- (39.6) (15.0) ---- (31.8) -- -- -- $ 715.2 4.8 (11.4) -- -- $ 717.5 (28.5) 12.6 (12.5) -- (2.0) -- -- -- $ 424.9 $ 468.9 International Plans Pension Benefits 1999 1998 $2,099.3 $ 26.6 26.8 26.7 112.0 100.7 (0.2) 1,895.0 9.3 13.3 (139.9) (124.3) ---- 19.8 161.3 (3.3) -- ---- (63.6) -- $2,060.2 $2,099.3 Change in plan assets: (Millions of Dollars) Fair value of plan assets at beginning of year Actual return on plan assets Acquisitions Company contributions Benefits paid Settlements and curtailments Currency translation adjustment Fair value of plan assets at end of year United States Plans Pension Benefits Other Benefits 1999 1998 1999 1998 $ 775.4 83.9 -- 6.5 (60.2) -- -- $ 805.6 $ 293.7 25.3 487.1 7.9 (26.0) (12.6) -- $ 775.4 $-- -- -- -- -- -- -- $-- $-- -- -- -- -- -- -- $-- International Plans Pension Benefits 1999 1998 $2,034.5 $ -- 325.3 157.6 -- 1,979.8 19.1 21.4 (139.9) (124.3) ---- (54.0) -- $2,185.0 $2,034.5 Funded status of the plan Unrecognized net asset at transition Unrecognized net actuarial (gain) loss Unrecognized prior service cost Prepaid (accrued) benefit cost $ 90.4 0.3 (60.9) 27.6 $ 57.4 $ 57.9 0.3 (30.1) 17.6 $ 45.7 $ (424.9) -- (19.5) (2.4) $ (446.8) $(468.9) -- 8.9 (29) $(462.9) $ 124.8 $ (64.8) ---- (46.3) -- 128.9 -- $ 78.5 $ 64.1 Weighted-average assumptions as of December 31: (Millions of Dollars) Discount rate Expected return on plan assets Rate of compensation increase United States Plans Pension Benefits Other Benefits 1999 1998 1999 1998 7.75% 7.25% 10% 10% 4-4.75% 4.25-5% 7.75% -- -- 7.25% -- 1999 An Z C r> International Plans Pension Benefits 1999 1998 6.25-6.5% 5.5-6% 6.5-8.5% 7.5% 3-4.4% 2.5-3.9% Report 27 Notes to Consolidated Financial Statements Amounts applicable to the Company's pension plans with accumulated benefit obligations in excess of plan assets are as follows: United states Plans Projected benefit obligation Accumulated benefit obligation Fair value of plan assets 1999 $ 362.8 359.1 336.8 1998 $ 138.1 137.9 126.6 International Plans Projected benefit obligation Accumulated benefit obligation Fair value of plan assets 1999 $ 157.4 156.9 0.2 1998 $ 180.0 171.0 Amounts recognized in the balance sheet consist of: Prepaid (accrued) benefit cost Accrued benefit liability Intangible asset Accumulated other comprehensive income Net amount recognized Pension Benefits 1999 1998 Other Benefits 1999 1998 $ 135.9 $ 109.8 $(446.8) $(462.9) (20.5) (12.7) ---- 7.2 7.3 ---- 10.1 3.4 $ 132.7 $ 107.8 $(446.8) $(462.9) At December 31, 1999, the assumed annual health care cost trend used in measuring the APBO approximated 6.7% in 1999, declining to 6.5% in 2000 and to an ultimate annual rate of 5.5% estimated to be achieved in 2010. Increasing the assumed cost trend rate by 1% each year would have increased the APBO by approximately 9.5% and 11.5% at December 31, 1999 and 1998, respectively. Aggregate service and interest costs would have increased by approximately 10.4%, 13.3% and 9.4% for 1999, 1998 and 1997, respectively. During 1999, the Company decided to curtail retiree healthcare benefits for approximately 4,000 employees. As a result, the Company reduced its postretirement liability and recognized a one-time benefit of approximately $8.0 million, net of applicable taxes. 14. Income Taxes Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The components of earnings before income taxes, extraordinary items and cumulative effect changes consisted of the following: Domestic International 1999 1998 1997 (Millions of Dollars) $ 237.8 $ (73.4) $ 50.1 222.1 258.9 49.4 $ 459.9 $ 185.5 $ 99.5 Significant components of the provision for income taxes (tax benefit) are as follows: Current: Federal State and local International Total current 1999 1998 1997 (Millions of Dollars) $ 49.3 $ (12.1) $ 9.6 11.6 10.0 0.2 45.7 65.4 6.6 106.6 63.3 16.4 Deferred: Federal State and local International Total deferred 29.2 (2.1) 47.2 74.3 $ 180.9 $ 33.0 2.1 (4.8) 30.3 93.6 $ 6.1 0.7 4.3 11.1 27.5 The reconciliation of income taxes computed at the United States federal statutory tax rate to income tax expense is: Income taxes at United States statutory rate Tax effect from: State income taxes Foreign operations, net of foreign tax credits Sale of international retail/ wholesale operations Goodwill amortization Purchased in-process research and development Valuation allowance reductions Tax credits and other 1999 1998 1997 (Millions of Dollars) $ 161.0 $ 64.9 $ 34.9 9.5 7.9 0.8 6.4 5.6 (2.7) (4.7) 28.1 (11.5) 19.7 (6.8) -- -- (21.4) 2.0 $ 180.9 $ 6.5 -- ---- 0.5 1.3 93.6 $ 27.5 The following table summarizes the Company's total provision for income taxes/(tax benefit) by component: Income tax expense Extraordinary items and cumulative effect of change in accounting principle T&N Bearings divestiture Allocated to equity: Currency translation Preferred dividends Incentive stock plans Investment securities Pension Other 1999 1998 1997 (Millions of Dollars) $ 180.9 $ 93.6 $ 27.5 (20.3) -- (19.8) 56.1 (1.5) -- -- 15.3 (1.2) (0.3) (1.2) (3.9) (0.1) (4.5) -- 0.2 ---- $ 154.5 $ 140.3 $ (3.6) (1.3) (3.4) (0.6) (0.9) 2.1 18.3 28 Federal Mogul Notes to Consolidated Financial Statements Significant components of the Company's deferred tax assets and liabilities as of December 31 are as follows: 1999 1998 (Millions of Dollars) Deferred tax assets: Asbestos $ 399.1 $ 429.1 Postemployment benefits 178.2 165.2 Net operating loss carryforwards of international subsidiaries 103.0 110.9 Restructuring and rationalization reserves 20.9 98.8 Inventory basis 19.9 34.2 Allowance for doubtful accounts 25.6 15.2 Other temporary differences 105.5 117.6 Total deferred tax assets 852.2 971.0 Valuation allowance for deferred tax assets (54.5) (77.0) Net deferred tax assets 797.7 894.0 Deferred tax liabilities: Fixed asset basis differences (351.1) (379.4) Intangible asset basis differences (289.5) (326.2) Deferred gains (130.0) (130.0) Pension Total deferred tax liabilities (33.3) (803.9) (69. (842.5) $ (6.2) $ 51.5 Deferred tax assets and liabilities are recorded in the consolidated balance sheets as follows: 1999 1998 (Millions of Dollars) Assets: Prepaid expenses and income tax benefits $ 128.2 $ 187.3 Other noncurrent assets 148.8 -- Liabilities: Other current accrued liabilities (24.3) -- Other long-term accrued liabilities (258.9) (135.8) $ (6.2) $ 51.5 Income taxes paid in 1999, 1998 and 1997 were $87.5 million, $34.7 million and $2.6 million, respectively. The 1999 provision includes the estimated U.S. federal income tax effects of retained earnings of subsidiaries expected to be distributed to the Company. No provision was made with respect to $417.3 million of undistributed earnings at December 31, 1999, since these earnings are considered by the Company to be permanently reinvested. Upon distribution of these earnings, the Company would be subject to United States income taxes and foreign withholding taxes. Determining the unrecognized deferred tax liability on the distribution of these earnings is not practicable as such liability, if any, is dependent on circumstances existing when remittance occurs. At December 31, 1999, the Company has $162 million in net operating loss carryforwards in the United Kingdom with no expiration date or valuation allowance. Also, the Company has $155 million of additional foreign net operating loss carryforwards with a full valuation allowance and various expiration dates. Included in the previous amounts are $168 million of net operat ing loss carryforwards acquired with the purchases of T&N, Cooper Automotive and Fel-Pro. A valuation allowance was recorded on $90 million of these purchased net operating loss carryforwards, and to the extent such benefits are ever realized, such benefits will be recorded as a reduction of goodwill. 15. Operations by Industry Segment G Aand eographic rea During 1999, the Company reorganized its operating segments. Prior to the internal reorganization, the Company's three operating segments were Powertrain Systems, Sealing Systems and General Products. As a result of the Company's internal reorganization, integrated operations are conducted under three operating segments corresponding to major product areas: Powertrain Systems; Sealing Systems, Visibility and Systems Protection Products; and Brake, Chassis, Ignition and Fuel Products. The segment information to follow has been restated to reflect the internal reorganization changes announced in 1999. Powertrain Systems Products are used primarily in automotive, light truck, heavy duty, industrial, marine, agricultural, power generation and small air-cooled engine applications. The primary products of this operating unit include camshafts, sintered products, engine bearings, large bearings, pistons, piston pins, rings, cylinder liners and connecting rods. Sealing Systems, Visibility and Systems Protection Products are used in automotive, light truck, heavy-duty, agricultural, off-highway, marine, railroad, high-performance and industrial applications. The primary products of this operating unit include dynamic seals, gaskets, lighting products, wiper blades and systems protection products. Brake, Chassis, Ignition and Fuel Products are used in automotive, light truck, heavy-duty, agricultural, off-highway, marine, and high-performance applications. The primary prod ucts of this operating unit include brake and friction products, chassis products, ignition products and fuel system components. Divested Activities include the historical operating results and assets of aftermarket operations in South Africa, Australia, Chile and heavy wall bearing operations in Germany and Brazil which were sold or closed in 1997. The accounting policies of the business segments are consistent with those described in the summary of significant accounting policies. The Company evaluates segmental performance based on several factors, including both Economic Value Added (EVA) and Operational EBIT. Operational EBIT is defined as earnings before interest, income taxes, extraordinary items and certain nonrecurring items such as certain acquisition-related adjustments and integration costs associated with new acquisi tions. Operational EBIT for each segment is shown on the next page, as it is most consistent with the measurement principles used in measuring the corresponding amounts in the consolidated financial statements. 1999 Annual Report 29 Notes to Consolidated Financial Statements Net Sales: Powertrain Systems Sealing Systems, Visibility and Systems Protection Products Brake, Chassis, Ignition and Fuel Products Divested Activities Total 1999 1998 1997 (Millions of Dollars) $2,459 $2,107 $ 782 1,887 1,252 333 2,123 19 $6,488 1,036 74 $4,469 577 115 $1,807 Depreciation and Amortization: Powertrain Systems Sealing Systems, Visibility and Systems Protection Products Brake, Chassis, Ignition and Fuel Products Divested Activities Total 1999 1998 1997 (Millions of Dollars) $ 151 $ 115 $ 28 94 50 11 109 1 $ 355 62 1 $ 228 12 1 $ 52 Operational EBIT: Powertrain Systems Sealing Systems, Visibility and Systems Protection Products Brake, Chassis, Ignition and Fuel Products Divested Activities Total 1999 1998 1997 (Millions of Dollars) $ 262 $ 248 $ 68 297 154 26 277 (1) $ 835 104 (4) $ 502 44 1 $ 139 Reconciliation: Total segments operational EBIT Net interest and other financing costs Restructuring, impairment and other special charges Acquisition-related costs Earnings before income taxes, extraordinary items and cumulative effect of change in accounting principle 1999 1998 1997 (Millions of Dollars) $ 835 $ 502 $ 139 (309) (233) (29) (8) (20) (10) (58) (63) -- $ 460 $ 186 $ 100 Assets: Powertrain Systems Sealing Systems, Visibility and Systems Protection Products Brake, Chassis, Ignition and Fuel Products Divested Activities Total Capital Expenditures: Powertrain Systems Sealing Systems, Visibility and Systems Protection Products Brake, Chassis, Ignition and Fuel Products Total 1999 1998 1997 (Millions of Dollars) $ 3,526 $3,467 $ 786 3,000 2,925 382 3,419 -- $ 9,945 3,471 77 $9,940 508 126 $1,802 1999 1998 1997 (Millions of Dollars) $ 229 $ 153 $ 28 79 41 13 87 35 9 $ 395 $ 229 $ 50 Included in the consolidated financial statements are amounts relating to geographic locations listed below. This geographic information is based on the location of Federal-Mogul operations. Net Property, Plant Net Sales___________ and Equipment 1999 1998 1997 1999 1998 1997 (Millions of Dollars) United States Mexico Canada Total North America United Kingdom Germany France Italy Other Europe Total Europe Rest of World Total $3,922 $2,345 $1,111 $1,492 $1,422 $ 166 153 124 87 28 30 7 162 76 58 43 39 1 4,237 2,545 1,256 1,563 1,491 533 516 21 305 312 630 478 126 344 318 303 327 33 79 113 252 200 71 77 77 295 188 117 55 62 2,013 1,709 368 860 882 238 215 183 81 104 $6,488 $4,469 $1,807 $2,504 $2,477 $ 174 9 105 9 9 3 135 5 314 16. Litigation and Environmental Matters T&N Asbestos Litigation In the United States, the Company's United Kingdom subsidiary, T&N Ltd., and two former United States subsidiaries of T&N, plc (the "T&N Companies") are among many defendants named in numerous court actions alleging personal injury resulting from exposure to asbestos or asbestos-containing products. T&N is also subject to asbestos-disease litigation, to a lesser extent, in the United Kingdom and France. Because of the slow onset of asbestos-related diseases, management anticipates that similar claims will be made in the future. It is not known how many such claims may be made nor the expenditures which may arise therefrom. As of December 31, 1999, the T&N Companies had approximately 95,000 claims pending. During 1999, approximately 49,000 new claims were filed and 60,000 claims were settled, dismissed or otherwise resolved. In addition to the pending cases above, the T&N Companies have approximately 64,000 claims that have been settled but will be paid over time. There are a number of factors that could impact the settlement costs into the future, including but not limited to: changes in legal environment; possible insolvency of co-defendants; and the establishment of an accept able administrative (non-litigation) claims resolution mechanism. 30 Federal Mogul Notes to Consolidated Financial Statements The $1.1 billion total provision held for the T&N Companies is comprised of an estimate for known claims (pending and settled but not paid) and possible future claims (IBNR). As of December 31, 1999, the $1.1 billion total provision is comprised of approxi mately $520 million related to known claims and approximately $620 million related to IBNR claims. In arriving at the IBNR provision for the T&N Companies, assumptions have been made regarding the total number of claims anticipated to be received in the future, the typical cost of settlement (which is sensitive to the industry in which the plaintiff claims exposure, the alleged disease type and the jurisdiction in which the action is being brought), the rate of receipt of claims and the timing of settlement and, in the United Kingdom, the level of subrogation claims brought by insurance companies. T&N Ltd. has appointed the Center for Claims Resolution (CCR) as its exclusive representative in relation to all asbestos-related personal injury claims made against it in the United States. The CCR provides to its member companies a litigation defense, claims-handling and administration service in respect to United States asbestos-related disease claims. Pursuant to the CCR Producer Agreement, T&N Ltd. is entitled to appoint a represen tative as one of the five voting directors on the CCR's Board of Directors. Members of the CCR contribute towards indemnity payments in each claim in which the member is named. Contributions to such indemnity payments are calculated on a case by case basis according to sharing agreements among the CCR's members. Effective January 18, 2000, the two United States subsidiaries withdrew from the CCR membership and appointed a law firm specializing in asbestos matters as their claims handling defense and administrative service provider. Indemnity and defense obligations incurred while members of the CCR will continue to be honored. This change is intended to create greater economic and defense efficiencies for the two companies. In 1996, T&N purchased a 500 million (approximately $845 million at the insurance agreement exchange rate of $1.69/) layer of insurance which will be triggered should the aggregate costs of claims filed after June 30, 1996, where the exposure occurred prior to that date, exceed 690 million (approximately $1,166 million at the $1.69/ exchange rate). The initial reserve provided for the T&N Companies for claims filed after June 30, 1996 approximated the trigger point of the insurance. The Company has reviewed the financial viability and legal obliga tions of the three reinsurance companies involved and has concluded, at this time, that there is little risk of the reinsurers not being able to meet their obligation to pay, should the claims filed after June 30, 1996 exceed the 690 million trigger point. While management believes that reserves are appropriate for anticipated losses arising from asbestos-related claims against the T&N Companies, given the nature and complexity of the factors affecting the estimated liability, the actual liability may differ. No absolute assurance can be given that the T&N Companies will not be subject to material additional liabilities and significant additional litigation relating to asbestos. In the possible, but unlikely event that such liabilities exceed the reserves recorded by the Company and the additional 500 million of insurance coverage, the Company's results of operations, busi ness, liquidity and financial condition could be materially adverse ly affected. The reserve for the T&N Companies is re-evaluated periodically as additional information becomes available. During 1999, T&N Ltd. was named in a complaint filed in the United States District Court for the Eastern District of Texas by Owens-Illinois alleging that T&N is liable to Owens-Illinois for Owens-Illinois' own indemnity and defense costs pertaining to asbestos-related personal injury claims. The Company believes it has meritorious defenses to the claim and has successfully defended against similar underlying claims in the past. Cooper Automotive Asbestos Litigation Former businesses of Cooper Automotive, primarily Abex and Wagner, are involved as defendants in numerous court actions in the United States alleging personal injury from exposure to asbestos or asbestos-containing products, mainly involving friction products. In 1998, the Company acquired the capital stock of a Cooper Automotive entity resulting in the assumption by a Company subsidiary of contractual liability, under certain cir cumstances, for all claims pending and to be filed in the future alleging exposure to certain Wagner automotive and industrial friction products and for all claims filed after August 29, 1998, alleging exposure to certain Abex (non-railroad and non-aircraft) friction products. As of December 31, 1999, Abex has approxi mately 10,500 claims pending and Wagner has approximately 13,700 claims pending. The Company has completed its assess ment of the potential liability and related potential insurance recoveries related to the Cooper Automotive acquisition and has recorded a $325.9 million insurance recoverable asset and a liability of the subsidiaries involved of approximately $400 million. This is the Company's estimate, after taking into account legal counsel's evaluation related to amounts expected to be paid or reimbursed by insurers. In arriving at these provisions, certain assumptions have been made regarding the total number of claims which may be received in the future against these two entities and the average costs associated with such claims. Abex maintained product liability insurance coverage for most of the time that it manufactured products that contained asbestos. The subsidiary of the Company that may be liable for the post-August 1998 asbestos claims against Abex has the benefit of that insurance. Abex has been in litigation since 1982 with the insurance carriers of its primary layer of liability concerning coverage for asbestos claims. Abex also has substantial excess layer liability insurance coverage which, barring unforeseen insolvencies of excess carriers or other adverse events, should provide coverage for asbestos claims against Abex. Wagner also maintained product liability insurance coverage for some of the time that it manufactured products that contained asbestos. The subsidiary of the Company that may be liable for asbestos claims against Wagner has the benefit of that insurance. 1999 Annual Report 31 Notes to Consolidated Financial Statements Primary layer liability insurance coverage for asbestos claims against Wagner is the subject of an agreement with Wagner's solvent primary carriers. The agreement provides for partial reimbursement of indemnity and defense costs for Wagner asbestos claims until exhaustion of aggregate limits. Wagner also has substantial excess layer liability insurance coverage which, barring unforeseen insolvencies of excess carriers or other adverse events, should provide coverage for asbestos claims against Wagner. The ultimate exposure of the Company's subsidiary with respect to claims against Abex and Wagner will depend upon the extent to which the insurance described above will be available to cover such claims, the amounts paid for indemnity and defense, changes in the legal environment and other factors. While the Company believes that the liability and receivable recorded for these claims are reasonable and appropriate, given the nature and complexity of factors affecting the estimated liability and potential insurance recovery, the actual liability and insurance recovery may differ. In the event that the actual liability net of insurance proceeds recovered exceeds the reserve net of insurance receivable recorded by the Company, the Company's results of operations, business, liquidity and financial condition could be materially adversely affected. The asbestos reserves for the businesses acquired as part of the Cooper Automotive acquisition will be re-evaluated periodically as additional information becomes available. Federal-Mogul and Fel-Pro Asbestos Litigation The Company also is sued in its own name as one of a large number of defendants in a number of lawsuits brought by claimants alleging injury due to exposure to asbestos. The Company's Fel-Pro subsidiary has been named as a defendant in a number of product liability cases involving asbestos, primarily involving gasket or packing products. The Company is defending all such claims vigorously and believes that it and Fel-Pro have substantial defenses to liability and adequate insurance coverage for defense and indemnity. While the outcome of litigation cannot be predicted with certainty, management believes that asbestos claims pending against the Company and Fel-Pro as of December 31, 1999, will not have a material effect on the Company's financial position. Aggregate ofAsbestos Liability As of December 31, 1999, the Company has provided a total reserve for all of its subsidiaries and businesses with potential asbestos liability of approximately $1.5 billion as its best estimate for future costs related to resolving asbestos claims. The Company estimates claims will be filed and paid in excess of the next 20 years. This estimate is based in part on recent and historical claims experience, medical information and the current legal environment. The company has a corresponding receivable from certain insurance carriers of approximately $325.9 million. Environmental Matters The Company is a defendant in lawsuits filed in various jurisdic tions pursuant to the federal Comprehensive Environmental Response Compensation and Liability Act of 1980 (CERCLA) or other similar federal or state environmental laws which require responsible parties to pay for cleaning up contamination resulting from hazardous wastes which were discharged into the environment by them or by others to which they sent such wastes for disposition. In addition, the Company has been notified by the United States Environmental Protection Agency and various state agencies that it may be a potentially responsible party (PRP) under such law for the cost of cleaning up certain other hazardous waste storage or disposal facilities pursuant to CERCLA and other federal and state environmental laws. PRP designation requires the funding of site investigations and subsequent remedial activities. At most of the sites that are likely to be costliest to clean up, which are often current or former commercial waste disposal facilities to which numerous companies sent waste, the Company's exposure is expected to be limited. Despite the joint and several liability which might be imposed on the Company under CERCLA and some of the other laws pertaining to these sites, the Company's share of the total waste is usually quite small; the other companies which also sent wastes, often numbering in the hundreds or more, generally include large, solvent publicly owned companies; and in most such situations the government agencies and courts have imposed liability in some reasonable relationship to contribution of waste. In addition, the Company has identified certain present and former properties at which it may be responsible for cleaning up environmental contamination. The Company is actively seeking to resolve these matters. Although difficult to quantify based on the complexity of the issues, the Company has accrued the estimated cost associated with such matters based upon current available information from site investigations and consultants. The environmental reserve was approximately $74.5 million at December 31, 1999, and $50.0 million at December 31, 1998. The 1999 increase results from a number of factors, including retaining liabilities from the divestiture of the T&N Bearings Business. Management believes that such accru als will be adequate to cover the Company's estimated liability for its exposure in respect of such matters. 32 Federal Mogul Notes to Consolidated Financial Statements 17. Quarterly Financial Data (Unaudited) First(l) Second(2) Third(3) Fourth(4) (Millions of Dollars, Except Per Share Amounts) Year ended December 31, 1999: Net sales $ 1,642.2 $ 1,687.1 $ 1,583.9 $ 1,574.3 Gross margin 449.5 482.6 441.2 405.1 Earnings before extraordinary items and cumulative effect of change in accounting principle 61.4 87.3 70.1 60.2 Extraordinary items -- loss on early retirement of debt, net of applicable income tax benefits 23.1 -- -- -- Cumulative effect of change in accounting for costs of start-up activities, net of applicable income tax benefit 12.7 -- -- -- Net earnings 25.6 87.3 70.1 60.2 Diluted earnings per share .38 1.11 .91 .79 Stock price High $ 64.88 $ 53.81 $ 55.00 $ 29.13 Low $ 40.63 $ 41.94 $ 23.38 $ 17.56 Dividend per share $ .0025 $ .0025 $ .0025 $ .0025 Year $ 6,487.5 1,778.4 279.0 23.1 12.7 243.2 3.16 Year ended December 31, 1998: Net sales Gross margin Net earnings before extraordinary items Extraordinary items -- loss on early retirement of debt, net of tax benefits Net earnings Diluted earnings per share Stock price High Low Dividend per share First(5) Second(6) Third(7) Fourth(8) (Millions of Dollars, Except Per Share Amounts) $ 658.0 $ 1,214.0 $ 1,121.2 $ 1,475.5 161.3 317.4 292.9 406.9 (7.2) 28.4 34.6 36.1 -- (7.2) (.20) (31.3) (2.9) (.07) -- 34.6 .58 (6.9) 29.2 .48 $ 54.37 $ 69.25 $ 72.00 $ 63.00 $ 39.00 $ 52.62 $ 46.62 $ 33.00 $ .12 $ .0025 $ .0025 $ .0025 Year $ 4,468.7 1,178.5 91.9 (38.2) 53.7 .96 (1) Includes $10.1 million of integration costs. (2) Includes $13.3 million of integration costs. (3) Includes $13.2 million of integration costs, and a $7.9 million charge for adjustment of assets held for sale and other long-lived assets to fair value. (4) Includes $10.3 million of integration costs. (5) Includes $1.0 million of integration costs, an $18.6 million charge for purchased in-process research and development, a $10.5 million restructuring charge, and a $19.0 million net charge for an adjustment of assets held for sale and other long-lived assets to fair value. (6) Includes $3.7 million of integration costs. (7) Includes $9.0 million of integration costs, and a $6.6 million restructuring credit. (8) Includes $87 million of integration costs, and a $3.4 million net restructuring charge. 18. Consolidating Condensed Financial Information G Sof uarantor ubsidiaries Certain subsidiaries of the Company (as listed below, collectively the "Guarantor Subsidiaries") have guaranteed fully and uncondi tionally, on a joint and several basis, the obligation to pay prin cipal and interest under the Company's Senior Credit Agreement with the Chase Manhattan Bank, NA ("Chase"). The Company issued notes in 1998, which are guaranteed by the Guarantor Subsidiaries. The Guarantor Subsidiaries also guarantee the Company's previously existing publicly registered Medium-term notes and Senior notes. The Company has included audited consolidating condensed financial statements based on the Company's understanding of the Securities and Exchange Commission's interpretation and application of Rule 3-10 of the Securities and Exchange Commission's Regulation S-X and Staff Accounting Bulletin 53 in its December 31, 1999 Form 10-K, filed with the Securities and Exchange Commission. 1999 Annual Report 33 Management ' s Responsibility for Financial Reporting To Our Shareholders: The management of Federal-Mogul has the responsibility for preparing the accompanying financial statements and for their integrity and objectivity. The financial statements were prepared in accordance with generally accepted accounting principles and include amounts based on the best estimates and judgments of management. Management also prepared the other financial information in this report and is responsible for its accuracy and consistency with the financial statements. Federal-Mogul has retained independent auditors, ratified by election by the shareholders, to audit the financial statements. Federal-Mogul maintains internal accounting control systems which are adequate to provide reasonable assurance that assets are safeguarded from loss or unauthorized use and which produce records adequate for preparation of financial information. The systems controls and compliance are reviewed by a program of internal audits. There are limits inherent in all systems of internal accounting control based on the recognition that the cost of such a system not exceed the benefits derived. We believe Federal-Mogul's system provides this appropriate balance. The Audit Committee of the Board of Directors, comprised of five outside directors, performs an oversight role related to financial reporting. The Committee periodically meets jointly and separately with the independent auditors, internal auditors and management to review their activities and reports and to take any action appropriate to their findings. At all times, the independent auditors have the opportunity to meet with the Audit Committee, without management representatives present, to discuss matters related to their audit. Dick Snell Chairman and Chief Executive Officer Kenneth P. Slaby Vice President and Controller Report of Independent Auditors To the Shareholders and Board of Directors, Federal-Mogul Corporation: We have audited the accompanying consolidated balance sheets of Federal-Mogul Corporation and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. 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 Federal-Mogul Corporation and subsidiaries at December 31, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. VovmlLL? Detroit, Michigan (J February 16, 2000 v 34 Federal Mogul B Doard of irectors Federal-Mogul's Board of Directors consists of eight members with impressive business experience and leadership. Seven directors are non-executives and three directors are citizens outside the United States, bringing Federal-Mogul a strong balance of business viewpoints and international perspectives. All directors are shareowners and collectively, own and hold options to purchase 1,038,142 shares. John J. Fannon, 66 Retired Vice Chairman Simpson Paper Company Director since 1986 Roderick M. Hills, 69 Chairman, Hills Enterprises, Ltd. Partner, Hills & Sterns Director since 1977 Paul Scott Lewis, 63 Former Chairman, Terranova Foods, plc Director since 1998 Antonio Madero, 62 Founder, Chairman, and Chief Executive Officer SANLUIS Corporacion S.A. de C.V. Director since 1994 Robert S. Miller Jr., 58 Former President, Reliance Group Holdings Director since 1993 John C. Pope, 51 Chairman, PFI Group Director since 1987 Richard A. Snell, 58 Chairman, Chief Executive Officer and President Director since 1996 Sir Geoffrey Whalen, C.B.E., 64 Retired Managing Director and Deputy Chairman Peugeot Motor Company plc Director since 1998 C Bhairman of the oard Richard A. Snell A Cudit ommittee John C. Pope (Chair) Roderick M. Hills Paul Scott Lewis Antonio Madero Robert S. Miller Jr. C Compensation ommittee John J. Fannon (Chair) Paul Scott Lewis Antonio Madero John C. Pope Sir Geoffrey Whalen Governance and Nominating Committee____________ Roderick M. Hills (Chair) John J. Fannon Paul Scott Lewis Antonio Madero Robert S. Miller Jr. John C. Pope Sir Geoffrey Whalen P Cension ommittee Robert S. Miller Jr. (Chair) John J. Fannon Roderick M. Hills Sir Geoffrey Whalen L Teadership eam Richard A. Snell Chairman of the Board, Chief Executive Officer and President Alan R. Begg Vice President, Technology James C. Burkhart Vice President, Strategic Planning and Marketing Robert F. Egan Vice President, Aftermarket Sales - Americas Steven C. Feeny Vice President, Investor Relations Charles B. Grant Vice President, Corporate Development David Krohn Senior Vice President, Brake/Chassis/Ignition/Fuel Bonnie J. Price Vice President, Customer Service and Distribution Richard P Randazzo Senior Vice President, Human Resources David A. Bozynski Chief Financial Officer Wilhelm A. Schmelzer Executive Vice President, Europe Rick Streicher Senior Vice President, Sealing Systems/Visibility/Systems Protection Kimberly A. Welch Vice President, Corporate Communications Michael C. Verwilst Senior Vice President, Powertrain Systems James J. Zamoyski Senior Vice President and General Counsel 1999 Annual Report 35 Shareowner Information World Headquarters Federal-Mogul Corporation 26555 Northwestern Highway Southfield, Michigan 48034 USA Telephone: (248) 354-7700 Fax: (248) 354-8950 Internet address: http://www.federal-mogul.com Annual Meeting The annual meeting of shareholders will be held at 8:30 am on Wednesday, April 19, 2000 at Federal-Mogul World Headquarters. Stock Listing New York Stock Exchange Ticker Symbol: FMO Investor Relations Investors and security analysts should contact: Steve Feeny Vice President - Investor Relations Telephone: (248) 354-8847 Fax: (248) 354-7769 E-mail: Steve_Feeny@fmo.com Investor Services The following information is available without charge to shareholders and other interested parties: Annual Report to Shareholders Form 10-K Annual Report and Form 10-Q Quarterly Reports filed with the Securities and Exchange Commission To request these publications, please contact: Kathy Fauls Federal-Mogul Investor Relations 26555 Northwestern Highway Southfield, Michigan 48034 USA Telephone: (248) 354-7069 Toll-free number for U.S. calls: (800) 521-8607 E-mail: Kathy_Fauls@fmo.com Company News On-Call (through PR Newswire): (800) 758-5804. Faxed news releases issued by Federal-Mogul are available in the U.S. and Canada by calling the above number and entering Federal-Mogul's code: 306225 followed by the caller's fax number. Annual Report on the Internet The 1999 Federal-Mogul Annual Report is available on Federal-Mogul's World Wide Web site at http://www.federal-mogul.com under the Investor Relations section. Stock Transfer Agent and Registrar Federal-Mogul's transfer agent and registrar is The Bank of New York (BONY). General shareholder inquiries should be directed to: BONY Investor Relations Department 11-E P.O. Box 11258 Church Street Station New York, New York 10286-1258 www: http://stock.bankofny.com E-mail: shareowner-svcs@bankofny.com For transfer of stock ownership, address changes, or replacement of lost, stolen or destroyed certificates, please write: BONY Receive & Deliver Department - 11W P.O. Box 11002 Church Street Station New York, New York 10286-1002 Independent Auditors Ernst & Young LLP Detroit, Michigan, USA Stock and Dividend Information As of December 31, 1999, the company had 70,422,525 shares of common stock outstanding owned by 8,000 shareholders of record. Management estimates there are an additional 19,000 beneficial owners of the company's stock held in street name. Quarterly dividends are customarily mailed to shareholders on or about the 10th of March, June, September and December. Dividend Reinvestment Plan Federal-Mogul's Dividend Reinvestment Plan (DRIP) provides shareholders the opportunity to purchase additional shares of the company's common stock for a minimal fee through automatic reinvestment of dividend and optional cash payments. Cash payments may range from a minimum of $10 a month to a maximum of $25,000 annually. A detailed brochure and authorization form are available from: BONY Investor Relations Department P.O. Box 11258, Church Street Station New York, New York 10286-1258 USA Or call: BONY Shareholder Relations Department at (800) 524-4458 between 9 a.m. and 6 p.m. EST. When calling, please be prepared to give your account/tax identification number(s) and your name exactly as it appears on your stock certificate. Quarterly Stock Price Information HighLowClose 4Q 1999 29 1/8 17 9/16 20 1/8 3Q 1999 55 23 3/8 27 9/16 2Q 1999 53 13/16 41 15/16 52 1Q 1999 64 7/8 40 5/8 42 3/4 4Q 1998 63 33 59 1/2 3Q 1998 72 46 5/8 46 3/4 2Q 1998 69 1/4 52 5/8 67 1/2 1Q 1998 54 3/8 39 53 3/16 Media Information Journalists and media representatives should contact: Kimberly A. Welch Vice President - Corporate Communications Federal-Mogul Corporation 26555 Northwestern Highway Southfield, Michigan 48034 USA Telephone: (248) 354-1916 Fax: (248) 354-7999 E-mail: Kim_Welch@fmo.com Copyright 2000 Federal-Mogul Corporation. All Rights Reserved. Federal-Mogul and the Federal-Mogul design are registered trademarks. 36 Federal - Mogul