Document 5DRBE2wNNr3aZgNbGjBBGJBBR

MOGUL Table Of Con t e n ts 2 Letter to Our Shareowners 6 Federal-Mogul* At A Glance 8 Powertrain Systems iO- Sealing Systems 12 General Products 14 Our Leadership Team 15 Our Management Team 16 Our Purpose and Core Values 17 Index/Financial Information Shareowner/Media Information Inside Back Cover !'?'/ A%"' <" * - f V - -v . s v\:: r ^: \% kv>' > " ' J. Howard Muzzy, Co-Founder After 14 years of workingfor a mill supply business, J. Howard Muzzy co-foundedacompanyofhis own in 1899 -- Muzzy-Lyon. Bom in 1865 in the rural town of Romeo,Michigan,northofDetroit, :>'/ -:''y he would prove to be a very shrewdbusipessman. Edward E Lyon, Co-Founder Edward F. Iyon had been Muzzy's assistant and a traveling salesman before the two teamed up to start their own company. He was a renowned salesman of babbitt metal and die-cast bearings for Muzzy and Lyon, butfinancial woes led him to sell his share of the company in 1912. W- W'gasy TBoyif ,t^'trj JVr' , High Mogul of All Babbitt Metals - ? - * . ~,".c >-*, `ij\ v***#*'} *; *' > '' Seeking a specialty to increase sales^ Muzzy and Lyori ' * "*' ' experimented withformulations ofbabbittmetal, used to make': i " ' - ^ bearingsfor automcMes,farm machinery and locomofiwes; They} ' J developed two drfferentjbrmtlasfonc ofwMdi th^tra^ s**' .* "* ?4y;*av.-* < ?<* -W* ~ Mogul Bearings Keep Good Company ThisMogul-bearing resembled a split cylinder. In the early 1900s, > Mogul bearing were standard in automobile gasoline engines ' built by Rolls-Royce, Stutz, Hudson and many other *. early car makers. ` Molding Metals Afactory worker pours molten metal at the Mogul Metal Company, a subsidiary companyformed by Muzzy and Lyon to produce the twoformulations they had developed -- hard metals backed with tin-based alloys, each suited to particular bearing load and speed requirements -- that were the basis of their metal bearing. ^ n\\M)\i Hu, Ml U.H ; ;i (Dollars in millions, except per share amounts) .... - . : 'Financial Information Net sales . Operating earnings Goss) : Net earnings Goss) ' .. =;': ! EBITDA - Operating cash flow -Workingcapital -- Total assets ' Total debt/capital -* " ' Capital expenditures Economic value added ' Number of.employees 1998 ":1997f: 1996 ^ . $4,468.7 $1,806.6 $2,032.7 :; - ( ; $ 386.6 $ 140.2 $ (180.1) r:" : $ 53.7 $ . 69.4 $ (206.3) , $ 579.3 $ -181.7 $ (122.4) ' r! : _ ; $ 325:5 $ 215.7 $ 149.0 ' > y:- $1,686.3 $ 382.3 $- 505.6 - : ;;'-tf $1,802.1 41^455:7^^^ ' ` 57% 24% ' - 61%; ; Cf`. 1 $ 228.5 13 .54,350 $ 49.7 , (18) 13,300 = $ 54.2 (my 15,700 ; Common Stock Information . .. `' 1998 1997 1996 V Price per share as of year end .$ : 59V2 $ 40 V2 $ 22 Net earnings Goss) per share assuming dilution i- $ 0.96 : $ 1.61 $ (6.20) Weighted average shares outstanding (millions, diluted) 53.7 41.9 34.7 Earnings Per Share from Operations* Number of Employees Net Sales $ billions Excludes restructuring, purchased-in-process research and development, reengineering, adjustment of assets held for sale to fair value, integration costs, net loss (gain) on British pound currency option and forward contract, extraordinary items and reversals of the acquired inventory fair market value wnteups. - M 4 - jr;! . <-1 I'll - >" K ro >1 ] .\K1 i1W \ 1 KS To Our Shareowners 1998 was a year of a tive asa i our shareowners. Oursuccessis I am: very^proud of their,te&t^effoirL a , When we started l998, we outlined three mandates: , as we created a stronger on our goals and , *,. Grow through acquisitions that deliver on our goals; and - Integrate our acquisitions to create a consolidated; united operation. :: Financial Performance '- ' We continued our strong financial performance in 1998 . building on' the solid results we delivered in 1997:' ' - In 1998, your team: ;f; : ! ,_ Generated $13 million in operating EVA; Delivered eamings per share from operations of $2.69, up 64% from 1997; Generated $167 million in cash flow from operations after capital expenditures; and Achieved $51 million in synergy savings from acquisitions. The stock market recognized our efforts as our stock price increased 47% by year end, outperforming EVA improvement in absolute dollars and as a percentage of capital in the auto parts industry. This was , particularly noteworthy, as 1998 was the first time in over a decade that Federal-Mogul reported to its: vSirKe;thbeghnirig of,1998i;we: ' ** T " Completed a $600 million equity offering and $1 billion global bond offering to support the T&N n . and'FeUPro acquisitions; V ^ ?I'-Ci'' ; Completed a $780 million equity offering and $1 billion global bond offering to support the Cooperacquisition; .. " Completed the FTC-required divestiture ofT&N's thinwall bearing business for $430 millionVlt'fAi Syndicated $2 billion in bank facilities to provide bridge financing for acquisitions; and : v);: Increased our revolving credit facilities to $1 billion. LI i rI R o SHA R1 OWN RS 1907 Gray Motor car This Gray Motor Car Company 1907 car was thefirst to use Mogul die-cast bearings. Muzzy and lyonforesaw the needfor bearings in standard sizes and shapes and made their second important breakthrough by developing a methodfor producing die-cast bearings -- experimenting with an old printer's typecasting machine. Model lO Buick A 1910 orderfor 10,000 connecting rods for use in this Model 10 Buick was a high pointfor the business, which took off around 1913 when sales of bronze-backed, babbitt-lined bearings necessitated expansion of the Lamed plant. Moving Up to Shoemaker Road The Muzzy-Lyon Company moved into this 36,000-squarefoot plant in 1922 -- a bigger, more modemfacility close to the majority ofauto plants. 1923 saw record profits. 5 'i' Competitors Become Partners Numerous automotive trade publications carried this announcement of the merger of Muzzy-lyon and Federal Bearing and Bushing. The name Federal-Mogul combined the two companies' trademarked products -- hyphenated so neither would be perceived as more important than the other. Targeting the Aftermarket Federal-Mogul went into the replacement parts business with the purchase in 1924 of thefailing Douglas Dahlin Company of St. Louis. Uhe this service center in Portland, Oregon, 16 branches opened around the country in the 1920s. Son Succeeds Thefounder's oldest son, H. Gray Muzzy, was Federal-Mogul'sfirst vice president and became president in 1926. Under his guidance the company established a Research Division in 1929 and purchased the Pacific Metal Bearing Company in San Francisco in 1930. ft-"': Growth Performance , -r - v 1998-was an extraordinary year of growth for-Federal-Mogul. We completed ten acquisitions and strengtfir*^; 4 ened.our iproduccoffering. and services to customers around the world: Ihree acquisitions were'sizable::-,-'. T&N, Fel-Pro and the automotive businesses of Cooper Industries. " r We developedVand'we follow a1very disaplined acquisition process that-has: strategic and financial hurdles T that must be met in order,to go forward. The;strategic hurdles were developed to better serve our^ customers by *- ^ s ` Expanding our core product-lines into systems andimodules to enhance value; .' Expanding globally to follow and serve original equipment customers; and Tr - *" . * Globally expanding our aftermarket parts manufacturing in those same regions.>, - . ' The financial hurdles are: '' -. ~ * EVA positive by the second year; ..... _ .............- ......... ' " - _> - Cash positive; ' . -Accretive to earnings in the near term; and J ,. Maintenance: of a strong balance sheet with the appropriate combination of equity and debt and an investment-grade objective. . ;; - The acquisitions of 1998 cleared these hurdles and.have positioned us with totally new growth platforms. . We've come a long way toward building a very solid'foundation for future growth, especially when taking into consideration'we are: . ' '. The first to offer a complete Power Cylinder System; A leader in total engine and transmission sealing; The world leader in friction products; The North American leader in passenger car lighting; The developer of a revolutionary Twin Disc braking system; A technical leader in the development of alloys, powdered metals, and advanced sealing ... : materials; and - -, An aftermarket powerhouse offering strong brand names such as Fel-Pro*, Moog*, Champion*, ANCO*, Wagner*, Ferodo* and National*. ~ - , ,V . Federal-Mogul is-the global leader in some very substantial consolidating sectors of the automobile industry. We are well positioned to capitalize on the major industry.trends of: OEM outsourcing,.. suppHer consolidation, systems and modules, and globalization. - ..T I. 1 1 t t. R TO S M A R 1. O W n r. R S Integration Progress `- . \ : We have a good, robust process for integrating our acquisitions. Our integration process is detailed " : : f and 'thorough 'beginningat'the due; diligence^;phase, enabling us to act quickly once we have acquired / r ~ ;vaicompa^*WifKilouf`199i8 acquisiuons,'we are on" sciehule"wm'our integration actions, including: ' . Closing manufacturing facilities in Hamburg, Germany and Salisbury and Ringwood, England; ; Closing aftermarket distribution facilities in Chapel-en-le-Frith, England and Burscheid, Germany, ^ r .Downsized a manufacturing facility in.Bridgwater, England; ,,., . Downsizing a French friction facility; , Closed FP Diesel warehouse in Florida and cylinder liner facility in South Africa; . Restructured Mexican sealing operations; Closed T&N's U.S. headquarters and downsized T&rN's U.K. headquarters; . - '; Consolidated marketing departments and sales forces; v Closed five sales:offices; '\ Consolidating raw material sourcing; <. Sold piston facility in Argentina; . Commenced restructuring of European aftermarket facilities; and , Announced closure of structural bearings operations in Ilminster, England. Alignment and Priorities ..Alignment to our purpose.and core values is a key factor to our success. Every member of the Federal-Mogul team operates by these values: ..' We are a team first. We respect, trust and help each other. We act with integrity. -: We are driven to mastery in all we do. .. > We celebrate our success. .-v . \ . Our core values are our enduring tenets, and they are never compromised. - " ' ; , r. We have also committed to continubus improvement inourqualityhealthand safety, and productivity -: l? ; through the: implementation of our constraint management process.. 1 y . .' . C. .^ QUALITY - :V' ~ ' ' WS -/-'-`S' -S/" ' : ... v'f vS' -We are dnving the organization to a. target of zero defects. .Our customers require defect-free quality not only in the iproduct,*;but also iri their entire interaction from order to delivery. Although our plants have??"7-'.:~ - recorded significant reductions;iirdefects and several are running defect-free, we have not concentrated?^ r . ?- 1. i i i t. R TO S M A R i: O W N 1. K S Equi-Poise Propeller Federal-Mogul introduced this new-formula bronze propeller in 1931, called the Equi-Poise, capable ofwithstanding the tremendous twistingforce ofpowerful racing engines. Research Division advances would help the company throughout the 1930s. Alloy Developed to Bear Heavy Loads This large bearingfor use in heavily loaded engines is made of C-S 50, a cadmium-based alloy developed by Federal-Mogul researchers, introduced in 1934. % 1935, C-S 50 bearings were used on the connecting rods of all Ford Motor Company cars. Federal-Mogul Gives Allies Extra Punch During World War II, Federal-Mogul ads oftenfeatured stories about battles won with equipment that used the company's products. In 1941, Federal-Mogul was the largest manufacturer of motorboat propellers in the world. At 50, Company Global This ceremony at the Coldwater service center celebrated Federal-Mogul'sfiftieth anniversary in 1949. Successfully converting the company to post-war civilian production 3 ;. K !\ fenough-energy on the^broader drive to zero defectsin our business. We will be-launching several . '^.initiatives in this area in 1999. J -- > r Health and Safety ' ; - v The: health and safety, of our employees >is;a high pnonty. The prevention of work-related injuries and : ^sL'.r` - :: . illnesses is not a program but a way of life at Federal-Mogul. I am a firm believer that a great health and , safety record is a sign of atweU-managed plant;-We have anumber of fecilitiespperatihg at several millioh:J~- \ . v direct labor hours with no loss-time accidents such as the Boaz, Alabama friction facility (5: million hours) - - ; .... - " and the'Liberty, SouthCarolinaignmonplant (3 million hours) , , Productivity Improvement ~ '^ , As part of our acquisitionintegration, we have been implementing our signature constraint management * ^ _ ,.:; ,process;to eliminate waste and embedded costs. For example,.our newly acquired gasket manu&ctinng'-rlw.y.-x , ` - - - .operation in Athens, Alabama has already reduced work-in-process inventory by 25%. The inventory ' reduction has resulted in 10% more floor space available for manufacturing capacity In Athens,'as well . V" ~ -r ..as m our other acquired fatihties^this implementanon effort is sail m its infancy and we are encouraged - . by its success. ` '1 Our Challenge In 1999, we celebrate a century, of people serving .customers through manufactunng mastery. Many - celebrations of this accomplishment around the worldieflect on bur proud heritage that we seek to ' . re-establish as the cornerstone of our success for the future. ,* ' ; . - With the substantial size and breadth of the company, we are very fortunate to acquire a person with the : skills and. experience of Gordon Ulsh to take over the operating structure of the company. Gordon is a .. . , seasoned automotive executive who began working in the auto industry with Ford in engineering and ; : - manufacturing, and most recently with Cooper Industries, rising to lead their entire automotive business. His experience is perfect for our operating needs and his personality fits very well into our culture of being . . driven towards mastery. . ... r ; 1 continue to be very excited about our prospects for the future. Our growth formula is working well. , ; We've established ourselves as the leading consolidator in the powertrain and sealing area and we have a good, proven formula for growth, which we will work to accelerate in the coming months. 5 : ' , Thank you for your continued support and encouragement. . ,. . l. 1 1 T 1 R TO S H A R Y. O W N i; K S Product Segmentation General Products 43% 39% 18% Powertrain Systems Sealing Systems Geographic Segmentation Other 7% 34% 59% Europe North America SPEED-PRO. FEDERAL MOSUL NationaP Oil Seals Unipiston APayen General Motors Ford DaimlerChrysler NAPA Fiat PSA CarQuest Auto Value Cummins Renault BRICO Carter' FERODO BentleyHarrii S/NTER7Ea Weybum-Barte PowerPath y<onnr f, F E o E R A 1. - M O G U 1 Power Cylinder Systems Engine Bearings Pistons Piston Pins Piston Rings Piston Liners Connecting Rods Bushings Washers Spark Plugs Ignition Wires and Cables Ignition Coils Ceramic Insulators Engine Bearings, Bushings and Washers Piston Rings and Liners Other Europe North America Total Engine Sealing Total Transmission Sealing Total Axle Seaung Cylinder Head Gaskets Ancillary Gaskets Dynamic Seals Bonded Pistons Wiper Products Heat Shields Noise and Vibration Seaung Systems Wiper Products Seals Gaskets Other North America Camshafts Brake and Friction Products Chassis Products Driveline Products Fuel System Components Lighting Products Sintered Products Systems Protection Products Other Chassis -Lyi JL Europe Other North America A T A C* L A N C fc 7 A STROKE OF GENIUS Powertrain Systems' comprehen sive expertise in pistons, piston rings, connecting rods, hearings and cylinder liners come together in the Power Cylinder System -- a totally integrated system that's lighter, more durable, less costly, and easier to install than conven tional!y assembled products. The Power Cylinder System represents the synergy inherent in our unique set of skills: core competencies in materials, atlqy development, surface technology and advanced design analysis; comprehensive research and development capabilities; extensive program management skills and manufacturing mastery. Powertrain Systems -- Greater than THE SUM OF THE PARTS Powertrain Systems leverages our strength as a leading MANUFACTURER OF HIGH-QUALITY PARTS AND COMPONENTS WITH NEW PRODUCT DEVELOPMENT AND SELECTIVE ACQUISITIONS, WHICH FURTHER INCREASE OUR CAPABILITIES. AS A RESULT, POWERTRAIN Systems is a systems supplier to a growing number of automo tive, INDUSTRIAL AND COMMERCIAL CUSTOMERS WORLDWIDE. Major products include aluminum, articulated and composite pistons and taper/chamfer pins; engine bearings, bushings and washers; two- and three-piece -. cast iron and steel piston rings FEATURING COMPLEX COATINGS SUCH AS plasma, chrome and CKS; wet/dry liners and LARGE BEARINGS, CONNECTING RODS AND IGNITION SYSTEM COMPONENTS, INCLUDING SPARK PLUGS. THESE PRODUCTS ARE SUPPUED FROM MORE THAN 55 LOCATIONS IN 16 COUNTRIES. Powertrain Systems tailors our products and services TO MATCH EACH CUSTOMER'S REQUIREMENTS. FROM MANU FACTURING AND ASSEMBLING PARTS TO DESIGNING ENTIRE NEW SYSTEMS, WE HAVE THE FLEXIBILITY, SKILLS AND RESOURCES TO RESPOND TO OUR CUSTOMERS' EVOLVING NEEDS. DURABLE SPUTTER BEARING SAVES MONEY OVER THE LONG HAUL ftrwertrain Systems sets a new standardfor bearing performance with the Sputter Bearing -- a bearing with a vacuum-deposited aluminum and tin coating, which enables it to withstand high engine loads and pressures. The Sputter Bearing's unsurpassed durability lowers costs over the product life cycle. 8 P O \V I- R T R A l N S Y S T I- M S Bearings that Roll The company added ball bearing products to its line with the acquisition of the Bearings Company of America (BCA) in 1953. Salesjumped almost 1,400 percent in a singleyear. Biggest Merger of the '50s In 1955, Federal-Mogul took a bold stepforward, merging with Bower Roller Bearing Company, more than doubling the employment roster to 62,000 people. Federal-Mogul-Bower had three manufacturing divisions. Sealing Another Deal Within months of the Federal-Mogul-Bower merger, the company acquired National Motor Bearing Compary, adding seals, shims and rubber parts to its product line. "Sealver Dollars," pictured here, reminded people to replace old oil seals. World Renowned Auto Supplier In 1956, Federal-Mogul-Bower debuted on the Fortune 500 list of top U.S. corporations at the 350th position. The three acquisitions of the early 50sforever changed the Detroit-based company. Federal-Mogul Manufactures Overseas The introduction of import vehicles like the low-priced Volkswagen Beetle made domestic cars no longer the only game in town. Anticipating the trend toward imports, Federal-MogulBower built its first overseas manufacturing plants in 1959. Aerospace Business Takes Off NASA's Saturn launch vehicle was equipped with a propellant ducting system designed and developed by Arrowhead Products, acquired by Federal-Mogul-Bower -- an example of the company's diversification strategy aimed at minimising its dependence on the auto industry. Artificial intelligence produces real quality and productivity gains A Powertrain Systems' pilot manufacturing process is producing connecting rod bearings using a state-of-the-art computerized system, which controls every aspect ofoperations. From the loading ofraw materials to the output of final product, the system's sophisticated artificial intelligencefunctions continuously direct and monitor activities, doubling productivity while achieving zero-defect quality levels. System Solutions Supported by Tom Program Management Powertrain Systems helps maximize value by working closely with our customers' engineer ing staffs beginning early in the development process. With a thorough understanding of the operating parameters of specific applica tions, we explore various material, design and process configurations to optimize a system solution. Depending on our customers' needs, dedicated teams of Powertrain Systems specialists are assigned to work on-site with customers' program staffs, sharing our extensive expertise in all aspects of design, development, testing and production. Our program management capabilities include total responsibility for the design of interfaces as well as components, and for all assembly, packaging, logistics and warranty management issues. Our relentless customer focus guides our efforts to develop innovative technological responses. And our vertical integration gives us the control necessary to develop, manage and deliver increasingly sophisticated services. The results are integrated systems such as our Power Cylinder Systems -- ready-to-install units comprised of pistons, piston rings, connecting rods, pins and bearings that out perform conventional assemblies in terms of development time, overall cost, and other characteristics. We can even supply the Champion ignition source best suited to the power cylinder's characteristics. Benefits like these reinforce our perspective that our real value to customers lies in understanding the complex relationships between the many parts that make up a system. Our four research and development centers in the United States and Europe use the world's most advanced analytical, testing and design technologies to develop Power Cylinder Systems and other custom products and processes that unlock the synergy of system solutions. Our highly integrated manufacturing tech niques incorporate many proprietary machine tools and processes that enable us to deliver these innovative solutions; on time and on cost, with the quality and performance levels our customers need to compete and win in today's marketplace. Aftermarket Advantages Powertrain Systems' extensive global sales and distribution network supplies replacement parts to the automotive, heavy-duty and industrial aftermarket, providing recognized, high-quality brands preferred by installers. Our world-class line-up of products includes such leading brand names as Champion, AE Goetze, Glyco and SPEED-PRO. In every region and distribution channel, our overriding goal is to provide fast, accurate shipment of products to meet customers' expectations of consistent timely delivery performance. Building on our brand strengths and integrated global distribution capabilities are teams of engineers who oversee the aftermarket applications of our powertrain products. These specialists work closely with customers to tailor our growing product line to meet their requirements. The result is uniquely differentiated aftermarket products whose superior quality and ease of installation builds customer preference. The world doesn't go to work without a little spark, and Champion is the undisputed heavyweight when it comes to ignition product recognitionfor world-wide markets. Champion is poised to offer vehicle manufacturers the spark plugs, ignition wires and coils they need to keep their products moving without fail. INSIDE INFORMATION VERIFIES LIVE ENGINE DYNAMICS Powertrain Systems developed a unique procedurefor measuring what's happening inside a cylinder when an engine is running -- an industryfirst that generated valuable data for engineers worhing to optimize system performance. The results of the live test were compared to the predictions generated by software modeling and analysis tools, allowing engineers to more precisely calibrate the tools to improve their accuracy and reliability. OW Mq Sealing Systems DELIVERS TOTAL SEALING SOLUTIONS THE SINGLE SOURCE FOR MULTIPLE SEALING REQUIREMENTS With our extensive line of dynamic seals, gaskets and sealing modules and global manufacturing capabilities, Sealing Systems truly offers customers one-stop-shopping when it comes to sealing an entire engine, transmission or axle. Our systems approach and program management capabilities streamline the integration of ourfull array ofsealing products. This approach creates engineering efficiencies that ultimately provide higher total delivered system value and performance. Xe Seaung Systems group offers a product portfo lio THAT IS UNRIVALED IN BREADTH AND QUALITY, ENABUNG US TO BE THE AUTOMOTIVE INDUSTRY'S FIRST TRUE SUPPUER OF TOTAL SEAUNG SYSTEMS. With 30 manufacturing facilities in 12 countries, Sealing Systems is the leading suppuer for many major AUTOMOTIVE, HEAVY-DUTY DIESEL AND INDUSTRIAL MANUFAC TURERS worldwide. Major products include multi layer STEEL, GRAPHITE AND EDGE-MOLDED METALPLATE GASKETS, A FULL RANGE OF DYNAMIC SEALS, BONDED PISTONS FOR TRANSMISSIONS AND WIPER PRODUCTS. Our TALENTED AND EXPERIENCED ENGINEERING TEAMS, COMBINED WITH OUR VERTICAL INTEGRATION IN MANY PHASES OF GASKET AND SEAL MANUFACTURING, GIVE US THE ABILITY TO DESIGN, DEVELOP AND DELIVER TOTAL SYSTEM SOLUTIONS FOR CUSTOMERS. Managing the Synergy of Systems More North American automotive and heavy-duty customers are seeking to place complete responsibility for an entire engine program on one supplier -- and Sealing Systems is taking up the challenge. Our capa bilities include providing comprehensive program and warranty management services as a Tier 1 provider of sealing systems, in addition to providing the correct designs for the application. Using the latest technologies and analytical tools, we optimize solutions for specific applications based on operating parameters and performance requirements, both for original equipment and aftermarket concerns. ro S 1- A I. 1 N c; SYSTE M S mm Investing in Core Competencies The company also continued to develop its core competencies, merging with Sterling Aluminum Products, a supplier ofpistons and valves, among maty other engine components, and acquiring Haller, Inc. of Northville, Michigan, a powdered metal parts manufacturer. Name Changes, New Headquarters Buiet The company became Federal-Mogul again in 1965, and corporate staffs were consolidated in 1966 into a newly built, 148,000-square foot complex in Southfield, Michigan, which also housed divisional management teams. 1966 sales topped $241 million; the worldwide workforce stood at 12,422. Management Pushes Diversification These abrasive grinding and diamond cutting wheels were products produced by the National Grinding Wheel Company, Inc. of North Tonawanda, New York, acquired by Federal-Mogul in 1967 as part of an aggressive diversification strategy. `T* Bendix Takeover Bid Causes Management Change 1960s' purchases ofdiversified companies proved unpopular with Federal-Mogul's board of directors. After an unsuccessful takeover attempt by Bendix Corporation in 1968, the board prompted a change in management, tapping insider Sam MacArthur as president. World's First High-Volume Hot-Forged Parts In 1972, Federal-Mogul boosted its metal powders operation with Sinta Forge -- a revolutionary process that used heat and pressure to convert metal powder intoformed parts. More than one million automatic transmission parts were made with the new process in thefirst year. FM Growth Goal Company management announced an aggressive 5-year sales growth plan -- called FM 500 -- to achieve $500 million inyearfy sales by 1976. Annual sales in 1972 when the program was launched were close to $290 million. Serving the aftermarket from the customer's point of view Installing an oil seal is one thing in the controlled, ergonomically correct environment of the assembly line. However, we recognize that aftermarket customers often tackle thejob in less than ideal conditions -- such as from underneath die vehicle. Therefore, our a/termarhel oil seals include a patented hole lock device that aligns and holds the oil seal in position, speeding installation and ensuring correct alignment between the engine and oil pan. Attention to detail like this is a hallmark ofSealing Systems' commitment to our aftermarket customers. Customers benefit from our knowledge of the best practices for mating surfaces before the design is finalized, gready reduc ing total implementation time and cost. This is the approach Sealing Systems is using to provide the total engine sealing package for DaimlerChrysler's new 5.7L RAM engine, which will contain approximately 25 differ ent applications including gaskets, dynamic seals and sealing modules. Technology Drives Development Sealing Systems' portfolio of analytical, computer-based tools streamline the design and development process. For example, our "Bookshelf" is a searchable database that contains information about our entire range of designs, materials and processes. Engineers access the bookshelf to quickly determine whether existing solutions will fit a customer's specific application, greatly reducing the up-front investment in time and resources for many programs. The system can also produce a complete "menu" of recommended analytical, bench mark and live testing procedures for a given application. Additional tests are added depending on customer requirements, with all knowledge gained added to the system to inform future projects. Finite Element Analysis and Verified Predictive Analysis are among many tools that enable Sealing Systems' engineers to accurately predict how effectively products and processes will behave in real-world conditions. This allows us to reduce the number of iterations and to "freeze" designs and processes faster -- critical capabilities that help customers achieve accelerated ramp-up schedules. In addition, there are verified bench tests that duplicate the results of expensive dynamometer testing at significantly reduced time and cost. Sealing Systems has access to more than one hundred dynamometers when these tests are required. Exploring Future Functionality Integrating several parts into one module -- such as bonding dynamic oil seals directly to oil pans -- is one way we're seeking to increase functionality for customets. The integrated oil pan modules could mean fewer parts to store, move and handle at assembly, while assuring precise alignment of the seal and mating surfaces. Wherever possible, Sealing Systems is tapping the synergy of other products and groups to create new value-added solutions for customers. Aftermarket Advantages Sealing Systems' full aftermarket product offering is supported by our excellent service, making us the recognized leader in all of our product categories. Our well-known brand names include Fel-Pro, Payen and AE Goetze gaskets, Mather seals, Unipiston bonded pistons, and ANCO wipers. Our proactive approach to customer service includes dedicated aftermarket engineers who tear down and analyze engines once their warranty period has expired. Their findings fuel development of differentiated products that address the most difficult sealing applications -- in many cases resulting in products that exceed original equipment specifications. Jj General Products OFFERS INDUSTRY-LEADING PRODUCT LINE-UP ^jEneral Products is comprised of some of the industry's leading engineering and manufacturing TEAMS, PRINCIPALLY SERVING THE AUTOMOTIVE AND COMMERCIAL VEHICLE MARKETS. THROUGH NEW PRODUCT DEVELOPMENT ACTIVITIES AND SELECTIVE ACQUISITION OF STRATEGIC CORPORATIONS THAT COMPLEMENT OUR CAPABILITIES, GENERAL PRODUCTS HAS ESTABLISHED A LEADERSHIP POSITION IN A VARIETY OF PRODUCT GROUPS AND MARKETS WORLDWIDE. NEW LOW-COSI LIGHTWEIGHT BRAKING SYSTEM STOPS TRAFFIC Starting with a clean sheet ofpaper, our engineers explored the trade-offs of various design, material and process combinations to arrive at a revolutionary braking system that delivers new levels offunction and valuefor customers. The "twin disc" brake system is significant lighter and less costly than conventional braking components, and may also offer reduced noise and vibration levels. Products for original equipment manufacturers and the after market INCLUDE CAMSHAFTS, CHASSIS PRODUCTS, BRAKE AND FRICTION PRODUCTS, FUEL SYSTEM COMPONENTS, HEAT TRANSFER PRODUCTS, LIGHTING PRODUCTS, SINTERED METAL COMPONENTS AND SYSTEMS protection. These are supplied from 86 manufacturing locations IN 17 COUNTRIES. Camshafts General Products is the world's number-one independent supplier of camshafts, with extensive design and manufacturing capabilities in all three major camshaft technologies -- cast, machined and assembled. Building on our strengths in a variety of cast iron and machined steel camshaft capabilities, General Products is also developing breakthrough materials and processes that can produce assembled camshafts, which require little or no machining. Brake and Friction Products Federal-Mogul enhances its position as the world's number-one fric tion manufacturer with expanded brake capabilities that offer expertise in virtually all related parts and components. Brake and friction prod ucts include disc brake pads, drum brakes, brake linings, wheels and master cylinders, calipers and rotors. This deep vertical integration, combined with our flair for innovation, are resulting in "step change" inventions like the "twin disc" brake, a revolutionary idea that reflects our creative approach to traditional design and engineering challenges. ]z G r. n 1: r a l P r o i> u c 1 s 'i-J&ix- ' j'.Siw ~ t -V -13'' . A>t * **A>\ ' ~ , * -': - -; - A \ ; >/; /a-A The Importance of Aftermarket Service Sam, a 1960s sales promotion character, put Federal-Mogul's name before consumers in service stations, reminding them to service their car's wheels. The company's aftermarket target, however, was the parts buyers who dealt with the service/distribution centers. The Velvet Hammer: From Office Boy to Chairman An office boy in 1942 who delivered mail and cleaned spittoons, Tom Russell rose to executive vice president at age 45. Enormously popular as president, he was nicknamed the "velvet hammer,"for his charm while driving uncom promising bargains. Chairman and CEO in the 1970s, hefocused on the aftermarket, helping the company through two recessions. Superior Customer Service In 1982, the company launched a customer service hotline that offered customers quick access to late-breaking product information in addition to technical assistance and compatibility issues. 1987 The $1 Billion Year Everything seemed to be going the right way when Federal-Mogul's sales broke the $1 billion mark in 1987 and earnings reached $3.24 per share. OEMs Squeeze Suppliers The economic downturn of the late 1980s andforeign competition caused U.S. big-three automakers to seek constant cost reductions from suppliers like Federal-Mogul. Marginsfell on OE products, and aftermarket sales looked more attractive to new management. Federal-Mogul Tries Retailing in Emerging Countries Federal-Mogul's extensive line ofautomotive replacement parts was sold in overseas retail stores as a move to increase profit margins. Manufacturing Mastery Restored Dick Snell, named chairman and chiefexecutive officer in late 1996, returns the company to manufacturing mastery. A Return to Roots Spurs Growth Goal Federal-Mogul announces restructuring a return to its manufacturing roots and a growth strategy based on systems and modules, expanding global manufacturing presence tofollow OEMs, and expanding global aftermarket sales. Sintered Products Federal-Mogul's expertise in powder metal technol ogy continues to translate into revolutionary new products and processes. Heavy-duty valve seats and guides, camshaft lobes, transmission components and various engine gears and sprockets are among the high-strength, high-density products made pos sible through our expertise in powder metallurgy. It is this expertise that has made Federal-Mogul the world leader in passenger car valve guides and seats. Technical developments in single-press, single sinter techniques and green machining are assisting in the production of novel cost-effective compo nents that will support our efforts to provide new customer solutions both directly and through our supply of systems. ...... Systems Protection As the market leader in Systems Protection products, General Products offers a comprehensive line of sleeving products, which are used to protect wire harnesses, hoses, tubing and cables. These products serve to solve thermal, mechanical/abra sion and acoustic problems. New products such as our reflective convolute are among recent customerdriven innovations that meet the demands posed by today's smaller engine compartments, hotter operating temperatures and the growing use of sensitive electronics. Chassis Products, Fuel System Components and Lighting Products General Products is number one in the U.S. after market in select chassis and driveline products, which include steering and suspension parts, coil springs and universal joints. General Products is also the U.S. aftermarket's leading manufacturer of Fuel System components. These products, designed for automotive, diesel and marine applications, include fuel pumps, fuel delivery modules and hanger assemblies. Our lighting products group offers bumper-tobumper capabilities in a broad range of exterior vehicular lighting, as well as innovative interior lighting solutions. Aftermarket Advantages General Product's line-up of exceptionally strong brand names include Vvhgner/Abex brakes and friction, Ferodo friction, Wagner/Blazer lighting and Moog chassis -- allowing us to provide our aftermarket customers with a wide selection of products that are highly regarded in the marketplace. Our expanding product offering also brings efficiencies to our operations that benefit customers, while our global manu facturing and distribution capabilities ensure responsive service and industry-leading fill rates. ASSEMBLED CAMSHAFT TECHNOLOGY REDUCES MACHINING COSTS BY HALF General Products is combining its expertise in powdered metals and camshafts to create mechanically bonded assembled camshafts using powder metal lobes. The process reduces machining costs by approximately 50 percent while producing a light, strong camshaft with optimisedfriction and wear characteristics. Engineers are currently developing the next generation of tubular assemblies with the aim of eliminating machining altogether. BRIGHT UGHT, BIG IDEA Another technology-driven response to customer requirements is our Distributive Lighting System, which uses die-cast light guides to direct light from one bulb to multiple points throughout a vehicle interior. G 1 N 1 R A I. PROD UCTS 1t Board of Directors pederal-Mogul's Board of Directors consists of eight members with impressive business experience and leadership. Seven directors are non-executives and three directors are cit izens outside of the United States, bringing Federal-Mogul a strong balance of business viewpoints and international perspectives. All directors are shareowners and collectively, the board owns and holds options to pur chase 720,482 shares. John J. Fannon, 65, is the retired vice chairman of Simpson Paper Company and a business consultant. He joined the board of directors in 1986. Roderick M. Hills, 68, is chairman of Hills Enterprises, Ltd., and a partner in Hills and Steins. He joined the board of directors in 1977. Paul Scott Lewis, 62, is chairman of Teiranova Foods pic. He joined the board of directors in 1998. Antonio Madero, 61, is founder, chairman of the board and chief executive officer of SANLUIS Corporacion S.A. de C.V He joined the Federal-Mogul board in 1994. Robert S. MillerJr., 57, is chairman of the board of Waste Management, Inc. He joined the board in 1993. John C. Pope, 50, is chairman of the board of MotivePower Industries, Inc. He joined Federal-Mogul's board in 1987. Richard A. Snell, 57, is chairman and chief executive officer of Federal-Mogul. He joined the board of directors in 1996. Sir Geoffrey Whalen, C.B.E., 63, is retired managing director and deputy chairman of Peugeot Motor Company pic. He joined the board of directors in 1998. IA ugo Michael Sek yra, a member of Federal-Mogul's Board of Directors since 1991, passed away in December 1998 at age 56. Sekyra was chairman of the supervisory board of Bohler Uddeholm AG and recently served as chairman and chief executive officer of C.H. CHEM, a.s. He was previously chairman and chief executive officer of Austrian Industries AG. A native of Austria, Sekyra was bom in Mannersdorf and earned his Doctor of Law degreefrom the University of Vienna. Sekyra sat on the compensation, nominating and pension committees. "Michael was an important catalyst for change and was fundamental to our recent successes, " said Dick Snell, chairman and chief executive officer. "His global experience and insight has been a strong influence on our strategic plans. Michael will be sincerefy missed as a friend and advisor." Ol K M.WAiil Ml M I i \M Gordon A. Uisr) PStSinSIVT and -Cnisv CVeryonc OiTKA-n I I'd v:;r I. G'l : U\ Vu'i MD: ' . .Al l; RJiASM.I- Sai AS AMO HbiiMiU TioM - Tut Amtrhas 1 (AMI'S ('.. isl':!MIAl!l V'k : i':!i SID; \ ; Si;niu;u I'i.w'ii'.i, \';n M 1:I\; iIMi, 1 AI AN Vu V. I I I NNOI lH. MA N AGEMENT TEA M 1? 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 to mastery in all we do. We celebrate our success. FED KRA L M O G U L. 19 9 8 FI \ v r i A i Table of Contents This annual report contains forward-looking statements relating to, among other things, the combination of the Company's business with those of T&N, Cooper Automotive, Fel-Pro and the ability to achieve operating improvements, conditions in the automotive components industry, and certain regional and global economic conditions. Consequently, actual events and results may vary significantlyfrom those included in or contemplated or implied by such statements. 18* Five-Year Financial Summary ; ,^ ^ 19 Management's Discussion1 And Analysis~ 07 Consolidated Statements of Operations ; ;K . vCi'C, C; Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareholders' Equity Notes to Consolidated Financial Statements Management's Responsibility for Financial Reporting ! Report of Independent Auditors ; _____________________________________________________ j j ------------------------------------------------------------------------------------------ Forward-Looking Statements ' : !,' *= ! 1-,-!- ` ................ 28 - r ;,- 7Q '' ;v - 31 48 48 r#-.v ; t-Urj; . rfev- 1-r: ,. i- :V : ...- " r4ii4-'V_"-r: I7 Consolidated Statement of Operations Data Net sales Costs and expenses Other expense Income tax (expense) benefit Net earnings (loss) before extraordinary items Extraordinary items -- loss on early retirement of debt, net of applicable income tax benefit Net earnings (loss) Common Share Summary (Diluted) -- Average shares and equivalents outstanding (in thousands) Earnings floss) per share: Before extraordinary items Extraordinary items -- loss on early retirement of debt, net of applicable ' income tax benefit Net earnings floss) per share Dividends declared per share Consolidated Balance Sheet Data Total assets Short-term debt Long-term debt Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely convertible subordinated debentures of the Company Shareholders' equity 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 s 1998 . $ 4,468.7 (4,266.9) (163) (93.6) 91.9 1997 1996 1995 (Millions of Dollars, Except Per Share Amounts) $ 1,806.6 (1,703.7) (3.4) (27.5) $ 2,032.7 (2,258.0)0) (3.4) 22.4 $ 1,999.8 (2,000.7) (2.4) (2.5) 72.0 (206.3) (5.8) 08.2) $ 53.7 - (2.6) $ 69.4 $ (206.3) $ (5.8) 53,748 -'*' h x ^ \ * "dt - $ 1.67 ' 41,854 $ 1.67 1 ` (.71) ' $ .96 - i .1275 - $ 9.940.L 211.0 ' 3,130.7, (.06) $ 1.61 i .48 $ 1,802.1 28.6 273.1 34,659 $ (6.20) $ (6.20) $ .48 $ 1,455.2 280.1 209.6 34,642 $ (.42) $ (.42) $ .48 $ 1,701.1 111.9 481.5 575.0 1,986.2 575.0 369.3 $ 325.5 228.5 ;V'C228.0)'/f- $ 215.7 49.7 51.5 318.5 $ 149.0 54.2 61.9 550.3 $ (34.7) 78.5 59.2 1994 $ 1,889.5 (1,795.5) (2.5) (31.8) 59.7 $ 59.7 41,800 $ 1.38 $ 1.38 $ .48 $ 1,481.7 74.0 319.4 588.5 $ 24.3 74.9 54.6 (1) Includes a $7.3 million net restructuring charge, a $19.0 million net chargefor adjustment of assets heldfor sale and other long-lived assets tofair value, an $18.6 million chargefor purchased in-process research and development, a $22.4 million chargefor integration costs, and a $13.3 million net gain related to the British pound currency option and forward contract. (2) Includes a $1.1 million net restructuring credit, a $2.4 million chargefor adjustment of assets heldfor sale and other long-lived assets tofair 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 andforward contract. (3) Includes a $57.6 million restructuring charge, a $151.3 million chargefor adjustment of assets heldfor sale and other long-lived assets tofair value, and $11.4 million relating to reengineering and other related charges. (4) Includes a $26.9 million restructuring charge, a $51.8 million chargefor adjustment of assets heldfor sale and other long-lived assets tofair value, and $13.9 million relating to reengineering and other related charges. (5) Includes current maturities oflongterm debt (see Note 6 to the consolidatedfinancial statements). i8 Fed E R A L Mogul Financial OVERVIEW_________________________ Federal-Mogul is a leading global manufacturer and distributor of a broad range of vehicular components for automobiles and light trucks, heavy-duty trucks, farm and construction vehicles and industrial products. The Company's principal customers include many of the world's major original equipment (OE) manufacturers of such vehicles and industrial products. The Company also manufactures and supplies its products and related parts to the aftermarket. ACQUISITIONS In 1998, the Company acquired T&N pic (T&N), the automotive division of Cooper Industries, Inc. (Cooper Automotive! Fel-Pro, Incorporated and certain affiliated entities, which constitute the operating businesses of the Fel-Pro group of companies (Fel-Pro), and various other acquisitions. For certain acquisitions, principally Cooper Automotive, the purchase price allocation may be adjusted as further information becomes available. Goodwill recognized in connection with these transactions, which were accounted for as purchases, is being amortized on a straight-line basis over 40 years. T&N In March 1998, the Company acquired T&N, a manufacturer based in Manchester, England, for consideration (including direct costs of the acquisition) of approximately $2.4 billion. The Company also assumed cash of approximately $185 million and debt of approximately $745 million. T&N manufactures and supplies high technology engineered automotive components and industrial materials. In 1997, T&N had sales of approxi mately 1.8 billion ($2.9 billion at the 1997 average exchange rate) with about 80% of such sales relating to the global automotive industry. At the time of its acquisition, T&N's major product lines consisted of piston products, bearings, friction products, composites and camshafts (incorpo rating sintered products) and sealing products servicing OE customers and the aftermarket. T&N operated in approximately 200 locations in 24 countries, employed over 28,000 people worldwide and served customers globally. T&N's operations included technical centers in the United Kingdom, Germany and North America. Cooper Automotive In October 1998, the Company acquired Cooper Automotive, headquar tered in St. Louis, Missouri, for initial consideration of approximately $1.9 billion. Cooper Automotive is a leading supplier of aftermarket parts for repair and maintenance and serves OE automobile manufacturers worldwide. In 1997, Cooper Automotive had sales of approximately $1.9 billion. At the time of the acquisition. Cooper Automotive's principal products consisted of brakes and friction, lighting, chassis parts, ignition and wiper blades. Cooper Automotive employed approximately 14,500 employees in 63 locations. Fel-Pro In February 1998, the Company acquired Fel-Pro, a privately owned gasket manufacturer headquartered in Skokie, Illinois, for total consideration of approximately $722 million, which included 1,030,325.6 shares of FederalMogul Series E Stock with an imputed value of $225 million and approxi mately $497 million in cash. Fel-Pro is a leading gasket manufacturer for the North American aftermarket and the OE heavy-duty market. In 1997, Fel-Pro had sales of approximately $500 million. At the time of the acquisition, Fel-Pro's primary product lines consisted of gaskets, heavy-duty diesel engine products, diesel products, high performance gaskets and other equipment and chemical products. Fel-Pro employed approximately 2,700 employees in 16 locations. Other Acquisitions During 1998, the Company acquired other complementary businesses and increased its ownership in certain joint ventures in order to expand its manufacturing and distribution capabilities. In the first quarter of 1998, the Company increased its ownership to 100% in its Summerton, South Carolina gasket manufacturing plant and also increased its ownership in KFM Bearing Company Ltd., a Korean joint venture with Kukje Special Metal Co., from 30% to 87%. In addition, the Company acquired Bimet, a Polish manufacturer of engine bearings, bushings and related products. During the fourth quarter of 1998, the Company acquired Tri-NMty Machine Limited, a Canadian manufacturer of machining systems for the metal cutting industry and Glockler Dichtsysteme Gunter Hemmrich GmbH, a manufacturer of rubber sealing components and acoustic decoupling for valve covers, intake manifolds and oil pans. Additionally, the Company increased its ownership from 50.6% to 100% in T&N Holdings Limited located in South Africa. Rationalization ofAcquired 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 provide for $180.0 million and $36.8 million in severance and exit costs, respectively, and were recorded as a component of goodwill in the purchase price allocation. The components of the integration plan include: closure of certain manufactunng facilities worldwide; relocation of highly manual manufacturing product lines to lower cost regions or more suitable locations; consolidation of overlapping manufacturing, technical and sales facilities and joint ven tures; consolidation of overlapping aftermarket warehouses; consolidation of aftermarket marketing and customer support functions; and streamlining of administrative, sales, marketing and product engineering staffs worldwide. An anticipated result of the integration plan and the restructuring will be a reduction of approximately 5,300 full-time employees. The Company paid $61.6 million related to these rationalization reserves in 1998. Divestitures ofAcquired Businesses In connection with securing regulatory approvals for the acquisition 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 management of those assets pending such divestiture. The agreement 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. 1998 ANNu Report On December 18, 1998, the Company completed the sale of 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 subsequendy used to pay down debt. Furthermore, the Company also expects to realize additional net proceeds of approximately $13 million from the collection of receivables of the business sold. Prior to the sale of the T&N Bearing? 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. RESULTS OF OPERATIONS Net Sales Sales by operating segment were: Powertrain Systems Sealing Systems Genera] Products Divested Activities Total Sales , 1998 . f1? $1,883 925 1,636 25 $4,469 1997 (Millions of Dollars) $ 782 333 577 115 $1,807 1996 $ 739 295 665 334 $2,033 Powertrain Systems sales increased 141% from 1997 to 1998 primarily due to the acquisitions of T&N and Cooper Automotive. Excluding the impact of these and other acquisitions, sales decreased 3% due to lower aftermarket sales and the impact of foreign exchange rate fluctuations, partially offset by certain original equipment volume increases. Sales in the aftermarket were impacted by an overall decrease in the engine parts market size due to improved original equipment quality, and the bankruptcy of a major cus tomer in North America. Sealing Systems sales increased 178% from 1997 to 1998 primarily due to the acquisitions of T&N, Cooper Automotive and Fel-Pro. Taking out the impact of these acquisitions, sales were essentially flat. Original equipment sales increased slightly due to certain model volume increases while after market sales decreased primarily due to the bankruptcy of a major customer in North America. General Products sales increased 184% from 1997 to 1998 primarily due to the acquisitions of T&N and Cooper Automotive. Excluding the impact of these acquisitions, sales decreased 4% primarily due to the impact of foreign exchange rates and the bankruptcy of a major customer in the North American aftermarket, slighdy offset by certain original equipment volume increases. Operational EBIT The accounting policies of the business segments are consistent with those described in Note 1, "Accounting Policies." Operational EBIT is defined as Operational Earnings before certain nonrecurring items (such as certain purchase accounting adjustments and integration costs associated with new acquisitions), interest and income taxes. Powertrain Systems Sealing Systems General Products Divested Activities Operational EBIT 1998 19971996 (Millions of Dollars) $223 $ 68 26 154 44 (8) ' 1 $502 - $139 $ 75 9 31 (22) $ 93 Operational EBIT in Powertrain Systems increased 228% in 1998 from 1997 due to the increase in sales noted above, as well as the streamlining of product engineering costs and the implementation of Federal-Mogul's constraint management programs across the combined companies. Sealing Systems 1998 operational EBIT rose 412% as compared to 1997 due to higher sales, reduced administrative costs and material sourcing savings as a result of the acquisitions. General Products operational EBIT in 1998 increased 250% versus 1997 due to increased sales, material sourcing savings and implementation of constraint management practices as a result of the acquisitions. Purchased In-Process Research and Development Charge In connection with the T&N acquisition, the Company recognized an $18.6 million charge in 1998 associated with the estimated faiT value of purchased in-process research and development for which technological feasibility had not been established and the in-process technology had no future alternative uses. Restructuring Charges (Credits) In 1998, as a result of the T&N, Cooper Automotive and Fel-Pro acquisi tions, the Company recognized $16.3 million of restructuring charges related to restructuring the Company's operations in place prior to these acquisitions. The restructuring charges were primarily for employee sever ance costs, which result from planned terminations in various business operations of the Company. The severance costs were based on the estimat ed 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 actions related to the 1998 restructuring plan will be substantially completed in 1999. 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. Primarily as a result of the amendments to the 1996 restructuring plan, (refer to Note 4, "Restructuring Charges"), the Company's 1997 operating results were increased by $23.1 million for the reversal of previously recognized 1996 and 1995 restructuring charges. Offsetting this reversal was a $22.0 million charge for new 1997 restructuring programs. The net impact on 1997 operations, as a result of the restructuring activities, was a credit of $1.1 million. The 1997 charge includes $3.1 million for exiting z o Federal - Mogul Financial certain European aftermarket product lines and the related employment reductions, $6.8 million for termination of certain European administrative and support personnel, $7.5 million for additional exit and severance costs related to the Puerto Rican retail operations, $2.6 million for consolidation and reconfiguration of the North American aftermarket service branch network and $2.0 million for other actions. The Company's 1997 progress and actual implementation of the 1996 restructuring plan resulted in 1997 operating results being increased by $20.8 million for severance and $1.4 million of exit and consolidation costs being reversed. In the fourth quarter of 1996, the Company recognized a restructuring charge of $57.6 million for costs associated with employee severance, exit and consolidation costs for 132 international retail operations and 30 wholesale aftermarket operations, rationalization of European manufac turing operations, consolidation of lighting products, consolidation or closure of certain North American warehouse facilities, consolidation of customer support functions in the United States and streamlining of administrative and operational staff functions worldwide. The charge consists of $22.7 million for the sale of 132 international retail aftermarket and 30 wholesale aftermarket operations, $14.7 million for corporate employee severance costs, $7.7 million for the rationalization of European manufacturing operations, $5.3 million for consolidation or closure of certain North American warehouse facilities, $2.8 million for consolidation of customer support functions in the United States, $2.5 million for closure of the Leiters Ford facility and $1.9 million for other miscellaneous actions, including the consolidation of the European aftermarket management function into the European manufactunng headquarters. Reengineering and Other Related Charges (Credits) In 1996, the Company initiated an extensive effort to strategically review its businesses and focus on its competencies of manufacturing, engineering and distribution. As a result of this process, the Company recognized a charge of $11.4 million for professional fees and personnel costs related to the strategic review of the Company and changes in management and related costs. Operating results for 1997 include a credit of $1.6 million relating to the reversal of certain 1996 reengineering and other related charges, as the actual costs were less than the initial estimates. Adjustment ofAssets Heldfor Sale and Other Long-Lived Assets to Fair Value In 1998, the Company decided to sell its subsidiary, Bertolotti Pietro e Figli, S.r.l. (Bertolotti), an Italian aftermarket operation. The carrying value of Bertolotti's long-lived assets was reduced to fair value based on estimates of selling values, less costs to sell, calculated using multiples of earnings similar to recent automotive industry transactions in Italy. The Company recognized a $20.0 million charge primarily associated with the write-down of Bertolotti's assets to the estimated fair value. Also in 1998, the Company recognized a $1.0 million benefit associated with the sale of certain international retail assets previously written down to their realized fair value. In 1997, the Company recognized a charge of $2.4 million to write down certain long-lived assets of the international retail aftermarket to fair value. These assets were sold in 1998 for approximately their adjusted value and no gain or loss was recorded. During 1996, management designed a restructuring plan to aggressively improve the Company's cost structure, streamline operations and divest the Company of underperforming assets. As part of this plan, the Company decided to sell 132 international retail aftermarket operations, sell or restructure 30 wholesale aftermarket operations and consolidate a North American manufacturing operation. The carrying value of assets held for sale was reduced to fair value based on estimates of selling values less costs to sell. Selling values used to determine the fair value of assets held for sale were determined using market prices (i.e., valuation multiples) of compara ble companies from other 1996 transactions. The resulting adjustment of $148.5 million to reduce assets held for sale to fair value was recorded in the fourth quarter of 1996. The Company has substantially completed the 1996 restructuring plan, selling its South Africa, Australia, Chile and Puerto Rico retail operations during 1997 and 1998. Also in 1996, based upon the final sale, the Company recognized an additional write-down of $2.8 million to the net asset value of the United States ball bearings operations. Integration Costs The Company recognized $22.4 million of integration costs in 1998 in connection with the previously discussed acquisitions. These expenses included 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. Interest Expense 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 expense decreased $11.1 million in 1997 to $33.3 million. The decrease was primarily due to a $188 million reduction of debt which resulted from improvements in working capital and the sale of the South African and Australian businesses. Interest Income The increase in interest income of $3.5 million in 1998 to $10.6 million and the increase of $4.2 million in 1997 are 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. International Currency Exchange Losses International currency exchange losses increased to $4.7 million in 1998 due primarily to the weakening of the Mexican peso. The decrease of $3.1 million from 1996 to 1997 is due to the 1997 sale of the Turkish operation and a devalued Venezuelan bolivar. 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 have 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. 1998 ANNU Report In January 1998, the Company settled the option and recognized an additional loss of S17.3 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." Other Expense, net The increase in other expense, net, of $12.9 million in 1998 to $16.3 million is due to the expense related to the Company-obligated mandatorily redeemable preferred securities, issued in December 1997, partially offset by an increase in earnings from equity investments acquired in the T&N acquisition and a gain on the divestiture of its minority interest in G. Bruss GmbH & Co. KG. Income Taxes The effective tax rate for 1998 was 50.5% compared to 27.6% in 1997. This difference was primarily due to non-deductible goodwill, the one-time charge for purchased in-process research and development and foreign tax rate differences. The effective tax rate on the loss in 1996 was 9.8% due to losses in foreign countries where no tax benefit was recorded. At December 31, 1998, the Company had deferred tax assets, net of a $66.2 million valuation allowance, of $894.0 million and deferred tax liabilities of $842.5 million. The valuation allowance reserve increased from $44.4 million in 1997 to $66.2 million in 1998 due to valuation allowances recorded on net operating loss carryforwards acquired with the acquisitions of T&N, Cooper Automotive and Fel-Pro. Future reductions to these valuation allowances, if any, will be applied to reduce goodwill related to the respective acquisitions. $37.5 million. Partially offsetting these items were payments against the asbestos liability of $89.2 million and restructuring and rationalization payments of $78.0 million. Cash Flow Used by Investing Activities Cash flow used by investing activities was primarily related to the acquisi tions of T&N, Cooper Automotive and Fel-Pro, net of proceeds from sales of the T&N Bearings Business and the Fel-Pro Chemical Business. The Company expects to pay approximately $50 million in taxes related to the sale of the T&N Bearings Business during the first quarter of 1999. In addition, capital expenditures of $228.5 million were made for property, plant and equipment to implement process improvements, information technology, replacement of existing machinery and equipment and introductions of new products. Capital expenditures are expected to be approximately $300 million in 1999. The Cooper Automotive purchase agreement includes a price adjustment based upon acquired net assets, as defined in the agreement, as of the acquisition date. The Company anticipates that an additional cash payment of approximately $100 million will be paid in 1999. Cash Flow Providedfrom Financing Activities Cash flow provided from financing activities was primarily from debt issued to fund the acquisitions of T&N, Cooper Automotive and Fel-Pro and the issuance of common stock, partially offset by principal payments on long-term debt. The Company had total debt of $3,341.7 million at December 31, 1998 compared to $301.7 million at December 31, 1997. At December 31, 1998, the Company had $400 million available under its revolving credit facility expiring on December 31, 2003. As of December 31, 1998, there were no borrowings outstanding against this facility. The Company entered into Senior Credit Agreements in connection with its acquisitions of T&N and Cooper Automotive totaling $4,625 billion and a Senior Subordinated Credit Agreement in connection with its acquisition of T&N of $500 million in 1998. The Senior Credit Agreements had $1,894 billion outstanding at December 31, 1998 with maturities ranging from 1999 through 2005. There were no borrowings outstanding against the Senior Subordinated Credit Agreement at December 31, 1998. The net deferred tax asset of $51.5 million included deferred tax assets of $429.1 million for asbestos liabilities and $165.2 million for postemploy ment benefit obligations and deferred tax liabilities of $379.4 million and $326.2 million for fixed asset and intangible asset basis differences, respec tively. The Company expects to realize the assets and liabilities related to these items over the next 40 years. Extraordinary Items The Company incurred extraordinary losses on the early retirement of debt of $38.2 million and $2.6 million, net of related tax benefits, in 1998 and 1997, respectively. LIQUIDITY AND CAPITAL RESOURCES Cash Flow Providedfrom Operating Activities Cash flow provided from operating activities was $325.5 million in 1998. Cash flow was generated primarily from operations, a decrease in inventories of $55.9 million and a decrease in accounts receivable of The Company issued 26.75 million shares of common stock, including 2.1 million shares which were convened to Series E Preferred Stock, in two equity offerings in 1998 generating proceeds of $1,373 billion. Proceeds were used to repay borrowings under die Senior Credit Agreements and Senior Subordinated Credit Agreement. The Company issued $1.0 billion of bonds with maturities ranging from six to twelve years, a weighted-average yield of 7.76% and a weighted-average coupon of 7.73% in 1998, and $1.0 billion in bonds with maturities ranging from seven to ten years, a weighted-average yield of 7.53% and a weighted-average coupon of 7.45% in January 1999. Proceeds from these transactions were used to repay borrowings under the Senior Credit Agreements. As a result of the 1999 transaction, the Company will recog nize an extraordinary charge in the first quarter of 1999 of approximately $8 million, net of tax, related to early extinguishment of debt. On February 24, 1999, the Company entered into a new $1.75 billion Federal - Mogul Financial 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. As a result of these transactions, the Company will recognize an extraordinary charge in the first quarter of 1999 of approxi mately $15 million, net of tax, related to the early extinguishment of debt. The Company believes that cash flows from operations, together with borrowings available under the Company's multicurrency revolving credit facility, will continue to be sufficient to meet its ongoing working capital requirements. LITIGATION AND ENVIRONMENTAL MATTERS___ T&N Asbestos Litigation In the United States, the Company's United Kingdom subsidiary, T&N Ltd., and two of T&N's United States subsidiaries (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 to property damage litigation in the United States based upon asbestos products allegedly installed in buildings. Because of the slow onset of asbestos-related diseases, management antici pates that similar claims will be made in the future. It is not known how many such claims may be made nor the expenditure which may arise therefrom. As of December 31, 1998, the Company has provided approxi mately $1.3 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. As of December 31, 1998, the T&N Companies had approximately 105,000 claims pending. During 1998, approximately 85,000 new claims were filed and 54,000 claims were settled, dismissed or otherwise resolved. In addition to the pending cases above, the T&N Companies have approxi mately 41,000 claims that have been setded 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. As of December 31, 1998, T&N is one of a large number of defendants named in three pending property damage cases pending in two jurisdic tions. Provision has been made in the asbestos reserve for anticipated expenditures in relation to such cases. The $1.3 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, 1998, the $1.3 billion total provision is comprised of approximately $460 million related to known claims and approximately $840 million related to IBNR claims. In arriving at the IBNR provision, assumptions have been made regarding the total number of claims which it is anticipated may 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. The T&N Companies have appointed the Center for Claims Resolution (CCR) as their exclusive representative in relation to all asbestos-related personal injury claims made against the T&N Companies in the United States. The CCR provides to its 20 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 is entitled to appoint a representative as one of the five voting direc tors 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. 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 amount 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 Company's reserve for claims filed after June 30, 1996 approximates 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 obliga tion 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 T&N's asbestos-related claims, given the nature and complexity of the factors affecting the estimated liability, the actual liability may differ. No absolute assurances can be given that T&N 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 adversely affected. The T&N Companies reserves will be reevaluated periodically as additional information becomes available. Federal-Mogul, Pel-Pro and Cooper Automotive Asbestos Litigation The Company also is one of a large number of defendants in a number of lawsuits brought by claimants alleging injury due to exposure to asbestos. Fel-Pro has been named as a defendant in a number of product liability cases involving asbestos, primarily involving gasket or packing products sold to ship owners. In addition, subsidiaries of Cooper Automotive have been named as defendants in a number of product liability cases involving asbestos, primarily involving friction products. The Company is defending 1998 ANNU Report all such claims vigorously and believes that it, Fel-Pro and the Cooper Automotive subsidiaries 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, Fel-Pro and the Cooper Automotive subsidiaries as of December 31, 1998, will not have a material effect on the Company's financial position. At December 31, 1998, approxi mately $20 million in related reserves have been provided in respect of the possible uninsured portion of the expenditures on asbestos claims pending against the Company, Fel-Pro and the Cooper Automotive subsidiaries. Environmental Matters The Company is a defendant in lawsuits filed in various jurisdictions 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 CERLCA 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 complexi ty 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 and legal reserve was approximately $50 million at December 31, 1998 and $11 million at December 31, 1997. The majority of the 1998 increase is attributable to the acquisitions of T&N and CoopeT Automotive. 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 instru ments for trading purposes. Foreign Currency Risk A substantial portion of the Company's operations consists of manufactur ing 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 income statements 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 interna tional operations are generally reinvested locally. As of December 31, 1998, the Company's net assets (defined as current assets less current liabilities) subject to foreign currency translation risk are $146.8 million. The potential decrease in net assets from a hypothetical 10% adverse change in quoted foreign currency exchange rates would be approximately $14.7 million. 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 monitors 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. The Company has 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 has 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. The Company has 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 are not material. All foreign currency forward contracts purchased will expire within the next twelve months. Z4 Federal - Mogul Financial Interest Rate Risk The Company's variable interest expense is sensitive to changes in the general level of United States interest rates. Some of the Company's interest expense is fixed through long-term borrowings to mitigate the impact of such potential exposure. The following table provides information about the Company's financial 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. 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. The net unrealized losses at December 31, 1998 for commodity contracts were $1.4 million. OTHER MATTERS Year 2000 Costs The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. The Company has established a team that has completed an awareness program and assess ment project to address the Year 2000 issue including information tech nology (I'D and non-IT systems. In addition, the Board of Directors has received status reports related to the Company's progress in addressing the Year 2000 issue. The Company has determined that it will be required to modify or replace portions of its software so that its computer systems will properly utilize dates beyond December 31, 1999. The Company has initiated remediation and testing, and is implementing the action plan to address the Year 2000 issue and estimates that the majority of testing will be completed by the end of the first quarter of 1999. A number of indepen dent third-party reviews have been performed and others are planned. The Company presently believes that with modifications to existing software and Interest Rate Sensitivity Principal Amount by Expected Maturity (Millions of Dollars) Liabilities Long-term debt, including current portion Fixed rate Average interest rate 1999 $ 52.1 7.80% Variable rate Average interest rate Rate sensitive derivative financial instruments Interest rate locks purchased Average strike rate Forward rate $ 56.4 7.33% $300.0 4.69% 4.66% 2000 $ 65.2 7.84% $409.9 7.33% -- -- 2001 $ 52.7 7.88% $ 86.4 7.33% -- -- 2002 2003 Thereafter Fair Value at Total December 31, 1998 $ 10.8 7.86% $115.9 7.33% $ 23.7. 7.86% $116.0 7.33% $1,141.1 7.85% $1,345.6 7.85% $1,109.0 7.33% $1,893.6 7.33% $1,381.2 $1,893.6 -- -- __ $ 300.0 __ _ _. $ (0.9) __ 1998 Annual Report 2. <; conversions to new software, the Year 2000 issue can be mitigated. However, if such modifications and conversions are not made, or are not completed in a timely manner, the Year 2000 issue could cause production interruptions that could have a material impact on the operations of the Company. The Company has initiated development of contingency plans and will continue to do so throughout the program. The Company has initiated formal communications with a substantial majority of its significant suppliers and large customers to determine their plans to address the Year 2000 issue. While the Company expects a suc cessful resolution of all issues, there can be no guarantee that the systems of other companies on which the Company's systems rely will be converted in a timely manner, or that a failure to convert by a supplier or customer or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. The Company has deter mined it has no exposure to contingencies related to the Year 2000 issue for the products it has sold. The Company has contracts in place with external resources and has allocated internal resources to reprogram or replace, and test the hardware and software for Year 2000 modifications. The total cost of the Year 2000 project is estimated to be $25 million and is being funded through operating cash flows. These estimates have been verified by independent third-party audit. Of the total project cost, approximately $10 million is attributable to the purchase of new hardware and software which will be capitalized. Maintenance and repair of existing systems to be expensed as incurred is expected to be approximately $15 million. As of December 31, 1998, the Company has incurred and expensed approximately $8 million and capitalized approximately $3 million. The costs of the project and the date which the Company plans to complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third-party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ material ly from those plans. Specific factors that might cause such material differ ences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes and similar uncertainties. Management of the Company believes it has an effective program in place to resolve the Year 2000 issue in a timely manner. As noted above, the Company has not yet completed all necessary phases of the Year 2000 program. In the event that the Company does not complete any additional phases, the Company would be unable to take customer orders, manufac ture and ship products, invoice customers or collect payments. In addition, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect the Company. The Company could be subject to litigation for computer systems product failure, for example, equipment shutdown or failure to properly date business records. The amount of potential liability and lost revenue cannot be reasonably estimated at this time. The Company has contingency plans for certain critical applications and is working on such plans for others. These contingency plans involve, among other actions, manual workarounds, increasing inventories, and adjusting staffing strategies. 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 accommodate 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 conversion to the Euro to have a material affect on its financial condition or results of operations. Effect ofAccounting Pronouncements 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 is 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 unamortized balance of start-up costs will be written off as a cumulative effect of an accounting change of approxi mately $13 million, net of tax, as ofJanuary 1, 1999. In 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accountingfor Derivative Instruments and Hedging Activities. The Company expects to adopt the new statement effective January 1, 2000. The statement requires the Company to recognize all derivatives on the balance sheet at fair value. The Company does not anticipate that the adoption of this statement will have a signifi cant effect on its results of operations or financial condition. z6 Federal Mogul Financial Net sales Cost of products sold Gross margin Selling, general and administrative expenses Amortization Purchased in-process research and development charge Restructuring charges (credits) Reengineering and other related charges (credits) Adjustment of assets held for sale and other long-lived assets to fair value Integration costs -- Interest expense Interest income International currency exchange losses Net (gain) loss on British pound currency option and forward contract Other expense, net Earnings floss) before income taxes and extraordinary items Income tax expense (benefit) Net earnings (loss) before extraordinary items Extraordinary items -- loss on early retirement of debt, net of applicable income tax benefit Net earnings floss) Preferred dividends Net Earnings (Loss) Available to Common Shareholders Earnings (Loss) Per Common Share: Income floss) before extraordinary items Extraordinary items Net Earnings (Loss) Per Common Share Eamings (Loss) Per Common Share Assuming Dilution: Income floss) before extraordinary items Extraordinary items Net Eamings (Loss) Per Common Share Assuming Dilution See accompanying Notes to Consolidated Financial Statements. Year Ended December 31 1998 - 1997 1996 ,, '. (Millions of Dollars, Except Per Share Amounts) $4,468.7, $1,806.6 $2,032.7 3,290.2 1,381.8 1,660.5 1,178.5 424.8 372.2 640.8 276.0 320.0 - :. 83.8 - - 8.9 12.0 ' 18.6 ' -- -- 73 . (1.1) 57.6 . rr (1.6) 11.4 19.0, 22.4 204.0 (10.6) T/-\ ' v>"4,7-> . * (133) V 185.5 * . 93.6 .* I ' , 91.9 38.2 53.7 3.6 $ 50.1 2.4 -- 33.3 (7.1) 0.6 10.5 3.4 99.5 27.5 72.0 2.6 69.4 5.5 $ 63.9 151.3 -- 44.4 (2.9) 3.7 3.4 (228.7) (22.4) (206.3) _ (206.3) 8.7 $ (215.0) $ 1.84 (.80) : $ = 1.04 ' $ 1.67 (.71) $ .96 $ 1.81 (.07) $ 1.74 $ 1.67 (.06) $ 1.61 $ (6.20) $ (6.20) $ (6.20) $ (6.20) 1998 Annual Repo r T z7 ASSETS Cash and equivalents Accounts receivable Investment in accounts receivable securitization Inventories Prepaid expenses and income tax benefits Total Current Assets Property, plant and equipment Goodwill Other intangible assets - Other noncurrent assets Total Assets LIABILITIES AND SHAREHOLDERS' EQUITY Short-term debt, including current portion of long-term debt Accounts payable Accrued compensation Restructuring and rationalization reserves Current portion of asbestos liability Income taxes payable Other accrued liabilities Total Current Liabilities Long-term debt Long-term portion of asbestos liability Postemployment benefits Other accrued liabilities Minority interest in consolidated subsidiaries Company-obligated mandatorily redeemable preferred securities of subsidiary trust holding solely convertible subordinated debentures of the Company^ Shareholders' Equity Series C ESOP preferred stock Series E preferred stock Common stock Additional paid-in capital Accumulated deficit Unearned ESOP compensation Accumulated other comprehensive income Other Total Shareholders' Equity Total Liabilities and Shareholders' Equity (1) The sole assets of the Trust are convertible subordinated debentures ofFederal-Mogul with an aggregate principal amount of $575.0 million, which bear interest at a rate of 7% per annum and mature on December 1, 2027. Upon repayment, the Company-obligated mandatorify redeemable preferred securities of subsidiary trust will be mandatorify redeemed. See accompanying Notes to Consolidated Financial Statements. December 31 1998 1997 I, . (Millions of Dollars) $ 77.2 1,025.0 91.1 .1,068.6 337.7 2399.6 . 2,477.5 3,398.4 . 886.4 5782 $9,940.1 L. _ V-` * $-211.0 * , 498.4 t 1 2003 178.9 125.0 142.2 673.7 2,0293 3,130.7 1,176.7 677.0 327.0 ' ," . f^ 38.0 , 1 ' 575.0 $ 541.4 158.9 48.7 277.0 113.2 1,139.2 313.9 143.8 48.4 156.8 $1,802.1 $ 28.6 102.3 36.8 33.9 -- 10.2 117.8 329.6 273.1 -- 190.9 50.6 13.6 575.0 44.4 132.7 336.8 1,665.8 (69.9) (15.1) (106.0) ________ Q-5) 1.986.2 $9,940.1 " 49.0 -- 201.0 332.6 (123.6) (21.8) (65.7) (2.2) 369.3 $1,802.1 2.8 Federal M o c u i. Cash Provided From (Used By) Operating Activities Net earnings Ooss) Adjustments to reconcile net earnings (loss) to net cash provided from operating activities'. Depreciation and amortization Purchased in-process research and development charge Restructuring charges (credits) Reengineering and other related charges (credits) Adjustment of assets held for sale and other long-lived assets to fair value Loss on early retirement of debt - Vesting of restricted stock Postemployment benefits Decrease in accounts receivable Decrease in inventories Increase (decrease) in accounts payable Increase (decrease) in current liabilities and other Payments against restructuring and rationalization reserves Payments against asbestos liability Net Cash Provided From Operating Activities Cash Provided From (Used By) Investing Activities Expenditures for property, plant and equipment and other long-term assets Proceeds from sale of business investments Proceeds from sale of options Businesses acquisitions, net of cash acquired Other Net Cash Used By Investing Activities Cash Provided From (Used By) Financing Activities Issuance of common stock Proceeds from issuance of long-term debt Principal payments on long-term debt Increase (decrease) in short-term debt Fees paid for debt issuance and other securities Fees for early retirement of debt Investment in accounts receivable securitization Issuance of Company-obligated mandatorily redeemable preferred securities Dividends Other Net Cash Provided From (Used By) Financing Activities Increase (Decrease) in Cash and Equivalents Cash and equivalents at beginning of year Cash and Equivalents at End of Year See accompanying Notes to Consolidated Financial Statements. Financial 1998 $ 53.7 Year Ended December 31 1997 (Millions of Dollars) $ 69.4 228.0 18.6 73 19.0 58.1 0.7 10.9 , 37.5 < 55.9. *....... *' (2.4) (78.0) (89.2) 325.5 . '. 51.5 -- (1.1) (1.6) 2.4 4.1 9.0 (7.7) 7.6 59.9 (19.5) 67.9 (26.2) -- 215.7 (228.5) 53.4 39.1 (4,225.2) (4.361.2) ' 1.382.2 ; 6,197.5 (3,927.6) . 0.5 - (76.6) : (27.4) ., w.;'::'42.6rV:-/;( (10.4) 3.57L5 (464.2) 541.4 - $ 77.2 (49.7) 73.6 -- (30.5) 1.1 (5.5) 14.2 179.6 (127.4) (235.8) (42.8) (4.1) (31.8) 575.0 (24.8) (4.0) 298.1 508.3 33.1 $ 541.4 1996 $(206.3) 61.9 -- 57.6 11.4 151.3 -- 0.4 (2.0) 46.5 54.5 (25.5) 16.8 (17.6) ____ 149.0 (54.2) 42.0 -- (0.3) -- (12.5) 0.6 -- (29.4) (61.4) -- -- -- _ (26.9) (5.7) (122.8) 13.7 19.4 $ 33.1 r 998 Annual Report (Millions of Dollars) Balance at December 31, 1995 Series C Retained Accumulated ESOP Series D & E Additional Eamings Unearned Other Preferred Preferred Common Paid-In (Accumulated ESOP Comprehensive Stock Stock Stock Capital Deficit) Compensation Income Other $56.8 $ 76.6 $175.2 $ 280.8 $ 40.2 $(34.3) $ (37.3) $ (7.7) Total $ 550.3 Net loss Currency translation Other Total Comprehensive Income Issuance of stock Retirement of Series C ESOP preferred stock Amortization of unearned ESOP compensation Dividends Preferred dividend tax benefits Balance at December 31, 1996 (3.7)53.1 76.6 0.5 175.7 (206.3) 1.3 1.4 283.5 (26.9) (193.0) 5.9 (28.4) (4.3) 1.5 (40.1) Net earnings Currency translation Other Total Comprehensive Income Conversion of Series D preferred stock Issuance of stock Retirement of Series C ESOP preferred stock Amortization of unearned ESOP compensation Dividends Preferred dividend tax benefits Balance at December 31, 1997 (4.1) 49.0 (76.6) 22.3 3.0 -- 201.0 69.4 54.3 14.7 (24.8) 4.9 332.6 (123.6) 6.6 (21.8) (27.4) 1.8 (65.7) Net eamings Currency translation Other Total Comprehensive Income Issuance of Series E preferred stock Issuance of stock Retirement of Series C ESOP preferred stock Amortization of unearned ESOP compensation Dividends Preferred dividend tax benefits Balance at December 31, 1998 53.7 (4.6) 225.0 (92.3) 135.8 1,338.4 (36.7) (3.6) $44.4 $132.7 $336.8 (10.4) 5.2 $1,665.8 $ (69.9) 6.7 $(15.1) $(106.0) (1.2) (206.3) (4.3) 1.5 $ (209.1) 0.6 (3.7) (8.9) 5.9 (26.9) 1.4 318.5 69.4 (27.4) 1.8 $ 43.8 -- 6.7 24.4 (4.1) (2.2) 6.6 (24.8) 4.9 369.3 (0.3) 53.7 (36.7) (3.6) $ 13.4 225.0 1,381.6 (4.6) $ (2.5) 6.7 (10.4) 5.2 $1,986.2 See accompanying Notes to Consolidated Rnancial Statements. 3o Federal Mogul Financial 1. Accounting Policies-----------------------------------------.-- Organization: Headquartered in Southfield, Michigan, Federal-Mogul is a global manufacturer and distributor of a broad range of vehicular compo nents for automobiles and light trucks, heavy-duty trucks, farm and con struction vehicles and industrial products. The Company's principal customers include many of the world's major original equipment (OE) manufacturers of such vehicles and industrial products. The Company also manufactures and supplies its products and related parts to the aftermarket. Intangible assets are periodically reviewed for impairment based on an assessment of future cash flows, or fair value for assets held for sale, to ensure that they are appropriately valued. Intangible assets are amortized on a straight-line basis over their estimated useful lives. Impairment charges recorded in 1998, 1997 and 1996 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. Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Inter company accounts and transactions have been eliminated in consolidation. Cash and Equivalents: 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 53% and 55% of the inventory at December 31, 1998 and 1997, respectively. The remaining inventories are costed using the first-in, first-out (FIFO) method. If inventories had been valued at current cost, amounts reported at December 31 would have been increased by $39.0 million in 1998 and $44.5 million in 1997. Inventory quantity reductions resulting in liquidations of certain LIFO inventory layers increased net earnings by $3.4 million, $3.2 million and $3.1 million ($.06, $.08 and $.09 per diluted share) in 1998, 1997 and 1996, respectively. At December 31, inventories consisted of the following: Finished products Work-in-process Raw materials Reserve for inventory valuation 1998 1997 . (Millions of Dollars) $ .737.9 $254.6 147.1 21.8 208.5' 15.7 1,093.5 292.1 (24.9) (15.1) $1,068.6 $277.0 Goodwill and Other Intangible Assets: At December 31, goodwill and other intangible assets which result principally from acquisitions, consisted of the following: Estimated Useful Life 1998 1997 (Millions of Dollars) Goodwill 40 years $3,481.8 $163.8 Accumulated amortization ; (83.4) (20.0) Total Goodwill $3,398.4 $143.8 Trademarks Developed technology Assembled workforce Other Accumulated amortization Total Other Intangible Assets 40 years 12-30 years 15 years 5-20 years $ 417.6 f? 390.1 : '14*88:1 . ; 39.9 935.7 (49.3) >`$ 886.4 $ 56.5 -- -- 20.8 77.3 (28.9) $ 48.4 Research and Development and Advertising Costs: The Company expenses research and development costs as incurred. Research and development expense was $80.5 million, $13.1 million and $14.4 million for 1998, 1997 and 1996, respectively. Costs associated with advertising and promotion are expensed as incurred. Advertising and promotion expense was $45.9 million, $31.8 million and $34.0 million for 1998, 1997 and 1996, respectively Currency Translation: Exchange adjustments related to international 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 consolidat ed financial statements as a component of accumulated other comprehen sive income. Effect of Accounting Pronouncements: In April 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 is 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 unamortized balance of start-up costs will be written off as a cumulative effect of an accounting change of approximately $13 million, net of tax, as ofJanuary 1, 1999. In 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accounting/or Derivative Instruments and Hedging Activities. The Company expects to adopt the new statement effective January 1, 2000. The statement requires the Company to recognize all derivatives on the balance sheet at fair value. The Company does not anticipate that the adoption of this statement will have a signifi cant effect on its results of operations or financial condition. Environmental Liabilities: The Company recognizes environmental liabilities when a loss is probable and estimable. Such liabilities are generally not subject to insurance coverage. Each environmental obligation is estimated by engineering and legal specialists within the Company based on current law and existing technologies. 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 20, "Litigation and Environmental Matters"). The Company regularly evaluates and revises its estimates for environmental obligations based on expenditures against established reserves and the availability of additional information. i99 8 ANNU Report Integration Costs: Incremental direct costs associated with integrating material acquisitions 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. Derivative Financial Instruments: The Company uses interest rate lock agreements to synthetically manage the interest rate characteristics of certain outstanding debt to a more desirable fixed rate basis ot to limit the Company's exposure to rising interest rates, 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 outstanding (collectively "Derivative Contracts''). Interest rate differentials to be paid or received as a result of 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 designated item are recorded in a manner consistent with the original designation of the derivative in view of the nature of the termination, 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. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Reclassifications: Certain items in the prior year financial statements have been reclassified to conform with the presentation used in 1998. 2, Acquisitions of Businesses T&N In March 1998, the Company acquired T&N pic (T&N), a manufacturer based in Manchester, England for consideration (including direct costs of the acquisition) of approximately $2.4 billion. The Company also assumed cash of approximately $185 million and debt of approximately $745 million. In connection with the acquisition of T&N, the Company entered into a $2,675 billion floating rate Senior Credit Agreement (consisting of a $2,275 billion term loan facility and a $400 million revolving loan facility) and a $500 million floating rate Senior Subordinated Credit Agreement. In addition, the Company funded a portion of the T&N acquisition through the December 1997 sale of 11.5 million shares of Company- obligated mandatorily redeemable preferred securities (generating gross proceeds of $575 million) by Federal-Mogul Financing Trust, a wholly owned subsidiary of the Company. T&N manufactures and supplies high technology engineered automotive components and industrial materials. In 1997, T&N had sales of approxi mately 1.8 billion ($2.9 billion at the 1997 average exchange rate) with about 80% of such sales relating to the global automotive industry. At the time of its acquisition, T&N's major product lines consisted of piston products, bearings, friction products, composites and camshafts (incorpo rating sintered products) and sealing products servicing OE customers and the aftermarket. T&N operated in approximately 200 locations in 24 countries, employed over 28,000 people worldwide and served customers globally. T&N's operations included technical centers in the United Kingdom, Germany and North America. The Company recognized an $18.6 million charge in the first quarter of 1998 associated with the estimated fair value of purchased in-process research and development for which technological 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 includes a price adjustment based upon acquired net assets, as defined in the agreement, as of the acquisition date. The Company anticipates additional cash payments of approximately $100 million will be paid. Cooper Automotive is a leading supplier of aftermarket parts for repair and maintenance and serves OE automobile manufacturers worldwide. In 1997, Cooper Automotive had sales of approximately $1.9 billion. At the time of the acquisition, Cooper Automotive's principal products consisted of brakes and friction, lighting, chassis parts, ignition and wiper blades. Cooper Automotive employed approximately 14,500 employees in 63 locations. 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 1,030,325.6 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 for the North American aftermarket and OE heavy-duty market. In 1997, Fel-Pro had sales of approximately $500 million. At the time of the acquisition, Fel-Pro's primary product lines consisted of gaskets, heavy-duty diesel engine products, diesel products, high performance gaskets and other equipment and chemical products. Fel-Pro employed approximately 2,700 employees in 16 locations. The T&N, Cooper Automotive and Fel-Pro acquisitions have been account ed 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 statement of operations for the t, 2. Federal Mogul IN N year ended December 31, 1998 includes 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 the acquisition dates. 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. In connection with the acquisition of Cooper Automotive, the Company is in the process of having valuations of acquired property, plant and equip ment and identifiable intangible assets completed. The related purchase price allocation will be finalized when such valuations and the final pur chase price adjustment are completed in 1999. Rationalization ofAcquired 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 provide for $180.0 million and $36.8 million in severance and exit costs, respectively, and were recorded as a component of goodwill in the purchase price allocation. The components of the integration plan include: closure of certain manufac turing facilities worldwide; relocation of highly manual manufacturing product lines to lower cost regions or more suitable locations; consolidation of overlapping manufacturing, technical and sales facilities and joint ven tures; consolidation of overlapping aftermarket warehouses; consolidation of aftermarket marketing and customer support functions; and streamlining of administrative, sales, marketing and product engineering staffs world wide. An anticipated result of the integration plan and the restructuring will be a reduction of approximately 5,300 full-time employees. The Company paid $61.6 million related to these rationalization reserves in 1998. Divestitures of Acquired Businesses In connection with securing regulatory approvals for the acquisition 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 management of those assets pending such divestiture. The agreement 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. On December 18, 1998, the Company completed the sale of 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 also expects to realize additional net proceeds of approximately $13 million from the collection of receivables of the business sold. Prior to the sale of the T&N Bearing 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. 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 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 comparative 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 v1998 1997 Net sales $6,4*411 $6,644.7 Net eamings (loss) $ .".'152.0 $ (4.9) Earnings Goss) per share $,. 2.12 $ (.19) Eamings Goss) per share assuming dilution ,$ ..1.95 $ (.19) Other Acquisitions During 1998, the Company acquired other complementary businesses and increased its ownership in certain joint ventures in order to expand its manufacturing and distribution capabilities. In the first quarter of 1998, the Company increased its ownership to 100% in its Summerton, South Carolina gasket manufacturing plant and also increased its ownership in KFM Bearing Company Ltd. (KFM), a Korean joint venture with Kukje Special Metal Co., from 30% to 87%. In addition, the Company acquired Bimet, a Polish manufacturer of engine bearings, bushings and related products. During the fourth quarter of 1998, the Company acquired Tri-Why Machine Limited (Tri-Why), a Canadian manufacturer of machining systems for the metal-cutting industry and Glockler Dichtsysteme Gunter Hemmrich GmbH (Glockler), a manufacturer of rubber sealing components and acoustic decoupling for valve covers, intake manifolds and oil pans. Additionally, the Company increased its ownership from 50.6% to 100% in T&N Holdings Limited located in South Africa. The Summerton, KFM, Bimet, Tri-Way, Glockler, and T&N Holdings Limited transactions have been accounted for as purchases and, accordingly, the total consideration was allocated to the acquired assets and assumed liabilities based on its estimated fair values as of the acquisition dates. The total cash consideration paid for these acquisitions approximated $93 million. The consolidated statement of operations for the year ended December 31, 1998 includes the operating results of the acquired busi nesses from the applicable date of acquisition. 19 9 8 NNU Report 3. Sales of Businesses------------------------------------------- Divestitures 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 (refer to Note 2, "Acquisitions of Businesses"). 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. During 1996, the Company received $42.0 million in net cash proceeds from the sale of its United States ball bearings and electrical products manufacturing operations. Except for the sales of Bruss and the electrical products manufacturing operations, sales of businesses in 1998, 1997 and 1996 relate to assets previously adjusted to fair value (refer to Note 7, "Adjustment of Assets Held for Sale and Other Long-Lived Assets to Fair Value"). Accordingly, no gain or loss was recognized on the date of sale related to these transactions. In addition, no gain or loss was recognized related to the sale of the electrical products manufacturing operations. The following is a summary of restructuring charges and related activity for 1996, 1997 and 1998 (in millions of dollars): 1995 Restructuring Provision Severance Exit Balance of restructuring reserves at December 31, 1995 $3.9 $6.8 1996 restructuring charge ---- Payments against restructuring reserves (3.9) (3.4) Balance of restructuring reserves at December 31, 1996 -- 3.4 1997 restructuring charge ---- Adjustment to restructuring reserves -- (.9) 1997 restructuring charges (net) -- (.9) Payments against restructuring reserves -- (1.7) Balance of restructuring reserves at December 31, 1997 -- 0.8 1998 restructuring charges ---- Adjustment to restructuring reserves ---- 1998 restructuring charges (net) Payments against restructuring reserves -- -- -- (0.8) Balance of restructuring reserves at December 31, 1998 $-- $-- 1996 Restructuring Provision Severance Exit -- $42.8 -- $14.8 (4.8) (1.0) 38.0 -- 13.8 -- (20.8) (20.8) (1.4) (1.4) (11.6) (3.7) 5.6 8.7 ---- -- -- (1.1) (2.4) (2.4) (5.0) $ 4.5 $ 1.3 1997 Restructuring Provision Severance Exit 1998 Restructuring Provision Severance Exit $16.7 -- 16.7 (0.1) 16.6 -- (4.6) (4.6) (6.1) $ 5.9 $5.3 -- 5.3 -- 5.3 -- (2.0) (2.0) (0.1) $3.2 f'<' -. ;u ' - V>' v $16.0 $0.3; 16.0 (3.3) $12.7 0.3 - $6.3 Total $10.7 57.6 (13.1) 55.2 22.0 (23.1) (1.1) (17.1) 37.0 16.3 (9.0) 7.3 (16.4) $27.9 The Company's total restructuring reserves at December 31, 1998 of $27.9 million include $4.2 million of severance, which was anticipated to be paid over the next two years, and was classified as noncurrent other accrued liabilities in the balance sheet. 1998 Restructuring Provision In 1998, as a result of the T&N, Cooper Automotive and Fel-Pro acquisi tions, 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 result from planned terminations of approximately 1,800 employees in various business operations of the Company. The severance costs were based on the estimated amounts that will be paid to the affected employees pursuant to the Company's work force reduction policies and certain foreign governmental regulations. The Company anticipates that the actions related to the 1998 restructuring plan will be substantially completed in 1999. 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. 34 Federal - Mogul Financial 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 result from the planned 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 opera tions in Puerto Rico, and the consolidation of certain European distribution, and North American and European manufacturing operations. As of December 31, 1998, employee severance actions related to the 1997 charges resulted in the termination of approximately 200 employees. 1996 Restructuring Provision Primarily due to the anticipated T&N and Fel-Pro transactions (refer to Note 2, "Acquisitions of Businesses"), the Company elected not to fully implement the following actions under the 1996 restructuring plan: Reductions to the operational and administrative staff were not made to the extent originally planned. Reconfiguration of the North American distribution network was altered to accommodate the planned integration of T&N and Fel-Pro aftermarket operations. Relocation of certain European manufacturing product lines to lower cost areas within Europe and related workforce reductions did not take place. Management of the Company decided not to pursue this action, primarily in anticipation of the integration of future acquisitions. Primarily as a result of actions not fully implemented under the 1996 restructuring plan, the Company's 1997 operating results were increased by $23.1 million for the reversal of previously recognized 1996 and 1995 restructuring charges. As of December 31, 1998, employee severance costs related to the 1996 charge have resulted in the termination of approximately 700 employees, primarily in the international retail aftermarket and wholesale aftermarket operations, the North American distribution business and a closed manu facturing operation. Exit costs for 1996 principally include lease termination costs of interna tional retail aftermarket stores and certain international wholesale aftermar ket operations, the consolidation of certain North American distribution facilities and the closing of a North American manufacturing operation. 5. 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 have been reflected in the results of operations in the fourth quarter of 1997. At December 31, 1997, the Company 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." 6. Debt_____________________________ Long-term debt at December 31 consists of the following: Senior Credit Agreements Notes due 2004 - 7.5%, issued in 1998 Notes due 2006 - 7.75%, issued in 1998 Notes due 2010 - 7.875%, issued in 1998 1998 1997 (Millions of Dollars) $1,893.6 $-- . 249.5 -- f 399.9 -- 349.2 -- Medium-term notes - due between 1999 and 2005, average rate of 8.4%, issued in 1994 and 1995 Senior notes - due in 2007, rate of 8.8%, issued in 1997 ESOP obligation - due in 1999 and 2000, average rate of 7.19% Other Less current maturities included in short-term debt 1 5 125.0 . 124.7 i 14.7 ; 82.6 3,239.2 108.5 $3,13017 125.0 124.6 21.9 11.8 283.3 10.2 $273.1 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 outstanding under these Senior Credit Agreements as of December 31, 1998 which are due from 1999 to 2005 with an average interest rate of 7.33%. 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 12, "Capital Stock and Preferred Share Purchase Rights") and the early retirement of private placement debt assumed in the T&N acquisition 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. 1998 ANNu Report The Company has pledged 100% of the capital stock of certain United States subsidiaries, 65% of capital stock of certain foreign subsidiaries and certain inter-company 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 22, "Audited 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 uncondi tionally guaranteed by the Company, and therefore, the unpaid principal balance of the borrowing is classified as long-term debt. Company contribu tions 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 obligation was refinanced on June 30,1995 at a fixed interest rate of 7.2%. The ESOP obligation matures in December 2000. In June 1997, the Company entered into a new $350 million multicurrency revolving credit facility, with a consortium of international banks, which matures in June 2002 which was subsequently replaced by the $400 million multicurrency revolving credit facility related to the T&N acquisi tion. As of December 31, 1998 and 1997, there were no borrowings outstanding against the multicurrency revolving credit facility. The weighted average interest rate for the Company's short-term debt was approximately 7.75% and 9.9% as of December 31, 1998 and 1997, respectively. On February 24, 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. As a result of these transactions, the Company will recognize an extraordinary charge in the first quarter of 1999 of approximately $15 million, net of tax, related to the early extinguishment of debt. Aggregate maturities of long-term debt for each of the years following 1999 are, in millions; 2000 -- $475.1; 2001 -- $139.1; 2002 -- $126.7; 2003 -- $139.7 and thereafter $2,250.1. Interest paid in 1998, 1997 and 1996 was $173.4 million, $30.7 million and $43.5 million, respectively. 7. Adjustment of Assets Held For Sale and Other Long-lived Assets to Fair Value In 1998, the Company decided to sell its subsidiary, Bertolotti Pietro e Figli, S.r.l. (Bertolotti), an Italian aftermarket operation. The carrying value of Bertolotti's long-lived assets was reduced to fair value based on estimates of selling values, less costs to sell, calculated using multiples of earnings similar to recent automotive industry transactions in Italy. The Company recognized a $20.0 million first quarter charge primarily associated with the write-down of Bertolotti's assets to the estimated fair value. Also in 1998, the Company recognized a $1.0 million benefit associated with the sale of certain international retail assets previously written down to their realized fair value. In 1997, the Company recognized a charge of $2.4 million to write down certain long-lived assets of the international retail aftermarket to fair value. These assets were sold in 1998 for approximately their adjusted value and no gain or loss was recorded. During 1996, management designed a restructuring plan to aggressively improve the Company's cost structure, streamline operations and divest the Company of underperforming assets. As pan of this plan, the Company decided to sell 132 international retail aftermarket operations, sell or restructure 30 wholesale aftermarket operations and consolidate a North American manufacturing operation. The carrying value of assets held for sale was reduced to fair value based on estimates of selling values less costs to sell. Selling values used to determine the fair value of assets held for sale were determined using market prices (i.e., valuation multiples) of compara ble companies from other 1996 transactions. The resulting adjustment of $148.5 million to reduce assets held for sale to fair value was recorded in the fourth quarter of 1996. The Company has substantially completed the 1996 restructuring plan, selling its South Africa, Australia, Chile and Puerto Rico retail operations during 1997 and 1998. Also in 1996, based upon the final sale, the Company recognized an additional write-down of $2.8 million to the net asset value of the United States ball bearings operations. 8. Reengineering and Other Related Charges (Credits)________________________________ In 1996, the Company initiated an extensive effort to strategically review its businesses and focus on its competencies of manufacturing, engineering and distribution. As a result of this process, the Company recognized a charge of $11.4 million for professional fees and personnel costs related to the strategic review of the Company and changes in management and related costs. Operating results for 1997 include a credit of $1.6 million relating to the reversal of certain 1996 reengineering and other related charges, as the actual costs were less than the initial estimates. 9. Changes in Accounting Estimates In 1996, the Company made certain changes in accounting estimates totaling $51 million ($34 million after tax, $.98 per share) attributable to 1996 events and new information becoming available. The changes in accounting estimates included increasing the provision for customer incentive programs and related sales initiatives by $18 million, increasing the provision for excess and obsolete inventory by $13 million, increasing the provision for bad debts by $3 million, increasing the provision for environmental and legal matters by $9 million and increasing various other provisions by approximately $8 million. ^6 Federal Mogul Financial 10. Financial Instruments 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, 1998, the Company has foreign exchange forward contracts principally for British pound exposures relating to the United States dollar and the South African rand totaling a notional amount of $127 million. At December 31, 1998, there was an unrealized loss of $9.1 million related to foreign exchange contracts. The Company did not have foreign exchange forward contracts or currency option contracts at December 31, 1997. The Company enters into copper 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. Under the agreements, the Company was committed to purchase 7.3 million pounds of copper. The net unrealized loss on these firm purchase commitments was $0.8 million at December 31, 1998. In addition, in 1998, the Company had also entered into aluminum and nickel contracts as a hedge to offset the effects of price changes. The net unrealized losses at December 31, 1998 were $0.4 million and $0.2 million for aluminum and nickel contracts, respectively. 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. installers of automotive aftermarket parts. The Company's credit evaluation process, reasonably short collection terms and the geographical dispersion 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 $60.4 million and $18.7 million at December 31, 1998 and 1997, 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 were $3,130.7 million and $3,166.3 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. 11. Property, Plant and Equipment Property, plant and equipment are stated at cost and include expenditures which 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, 1998, 1997 and 1996, was $144.2 million, $42.6 million and $49.8 million, respectively. Interest Rate Locks The Company had $300 million of interest rate locks outstanding as of December 31, 1998 with an unrealized loss of $0.9 million. These interest rate locks were entered into as a hedge in anticipation of the bond issuance of $1.0 billion in January 1999 (refer to Note 23, "Subsequent Events"). Accounts Receivable Securitization During 1998, the Company replaced an existing accounts receivable securitization program with a new program which provides up to $150 million of financing. 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 such receiv ables, without recourse, to a financial conduit. Amounts excluded from the balance sheets under these arrangements were $105.8 million and $63.2 million at December 31, 1998 and 1997, 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 concentra tions of credit risk consist primarily of accounts receivable and cash invest ments. The Company's customer base includes virtually every significant global automotive manufacturer and a large number of distributors and At December 31, property, plant and equipment consisted of the following: Land Buildings and building improvements Machinery and equipment Accumulated depreciation Estimated Useful Life 1998 1997 (Millions, of Dollars) $ 139.4 $ 29.1 24-40 years 3-12 years 2.097.6 2.797.1 ' (319.6) $2,477.5 124.0 363.4 516.5 (202.6) $313.9 Future minimum payments under noncancelable operating leases with initial or remaining terms of more than one year are, in millions: 1999 -- $52.9; 2000--$40.3; 2001 -- $33.6; 2002 -- $27.2; 2003 -- $24.0 and thereafter $73.8. Future minimum lease payments have been reduced by approximately $29.2 million for amounts to be received under sublease agreements. Total rental expense under operating leases was $46.5 million in 1998, $29.1 million in 1997 and $33.8 million in 1996, exclusive of property taxes, insurance and other occupancy costs generally payable by the Company. 1998 AN n u Report 12. Capital Stock and Preferred Share Purchase Rights_--_ person other than the plan trustee. The Series C ESOP preferred stock is redeemable, in whole or in part, at the option of the Company. The Company's articles of incorporation authorize the issuance of 260,000,000 shares of common stock, of which 67,233,216 shares, 40,196,603 shares and 35,130,359 shares were outstanding at December 31, 1998, 1997 and 1996, respectively. In February 1998, in connection with the Fel-Pro acquisition, the Company issued 1,030,325.6 shares Series E Stock with an imputed value of $225 million. The shares of Series E Stock are exchangeable into shares of the Company's common stock at a rate of five shares of common stock per share of Series E Stock. Subsequently, in conjunction with the June 1998 common stock offering described below, the Company converted 422,581 shares of Series E Stock into approximately 2.1 million shares of common stock. In February 1999, all outstanding shares of the Company's Series E Stock were exchanged into the Company's common stock (refer to Note 23, "Subsequent Events"). The charge to operations for the cost of the ESOP was $5.2 million in 1998, $5.2 million in 1997 and $4.2 million in 1996. The Company made cash contributions to the plan of $8.2 million in 1998 and $8.1 million in 1997 and 1996, including preferred stock dividends of $3.6 million in 1998, $3.8 million in 1997 and $4.1 million in 1996. 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 563,995 and 160,649 at December 31, 1998, and 512,147 and 250,792 at December 31, 1997, respectively. There were no committed-to-be-released shares at December 31, 1998 and December 31, 1997. Any repurchase of the ESOP shares is strictly at the option of the Company. In June 1998, the Company issued 12.7 million shares of common stock, including 2.1 million shares which were convened 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 "Acquisitions"). 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 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 Company's ESOP covers substantially all domestic salaried employees and allocates Series C ESOP Convertible Preferred Stock to eligible employ ees based on their contributions to the Salaried Employees' Investment Program. There were 724,644, 762,939 and 835,898 shares of Series C ESOP preferred stock outstanding at December 31, 1998, 1997 and 1996, respectively. The Series C ESOP preferred shares pay dividends at a rate of 7.5%. The Company repurchased and retired 38,295 Series C ESOP preferred shares valued at $4.6 million during 1998 and 72,959 Series C ESOP preferred shares valued at $4.1 million during 1997, all of which represent plan distributions or fund transfers for participants of the plan. 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. The Series C ESOP preferred stock may be issued only to a trustee acting on behalf of an employee stock ownership plan or other employee benefit plan of the Company. These shares are automatically converted into shares of common stock in the event of any transfer to any In 1988, the Company's Board of Directors authorized the distribution of one Preferred Share Purchase Right (Right) for each outstanding share of common stock of the Company. Each Right entitles shareholders to buy one-half of one-hundredth of a share of a new series of preferred stock at a price of $70. These Rights will expire on April 30, 1999, after which they will be replaced by Rights authorized under a new Shareholder Rights Plan adopted by the Board of Directors in February of 1999. Under the new plan, each Right will entitle shareholders to buy one-one thousandth of a share of a newly created Series F preferred stock at a price of $250. As distributed, the Rights trade together with the common stock of the Company. They may be exercised or traded separately only after the earlier to occur of (i) ten days following a public announcement that a person or group of persons has obtained the right to acquire 10% or more of the outstanding common stock of the Company (20% in the case of certain institutional investors), or (ii) ten business days (or such later date as may be determined by action of the Board of Directors) following the com mencement or announcement of an intent to make a tender offer or exchange offer which would result in beneficial ownership by a person or group of persons of 10% or more of the Company's outstanding common stock. Additionally, if the Company is acquired in a merger or other busi ness combination, each Right will entide its holder to purchase, at the Right's exercise price, shares of the acquiring Company's common stock (or stock of the Company if it is the surviving corporation) having a market value of twice the Right's exercise price. . The Rights may be redeemed at the option of the Board of Directors for $.01 per Right at any time before a person or group of persons acquires 10% or more of the Company's common stock. The Board may amend the Rights at any time without shareholder approval. The Rights will expire by their terms on April 30, 2009. 8 Federal Mogul Financial 13. Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Convertible Subordinated Debentures of the Company 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 security. The net proceeds from the TCP Securities were used to purchase 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. 14. Accumulated Other Comprehensive Income The components of other comprehensive income are as follows: Currency Translation Other Total (Millions of Dollars) Balance at December 31, 1996 $ (38.2) $(1.9) $ (40.1) Current period change (27.4) 1.8 (25.6) Balance at December 31, 1997 (65.6) (0.1) (65.7) Current period change (36.7) Balance at December 31, 1998 $(102.3) (3.6) $(3.7) (40.3) $(106.0) Distributions on the TCP Securities are cumulative and will be paid quarter ly 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 earnings associated with the Company's investment in its foreign subsidiaries are considered to be permanendy invested and no provision for United States Federal and state income taxes on those eamings or transla tion adjustments have been provided. . 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. 1998 Annual Report 39 15. 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 (loss) after extraordinary items Extraordinary items -- loss on early retirement of debt net of applicable tax benefit Net earnings floss) before extraordinary items Series C preferred dividend requirement Series D preferred dividend requirement Series E preferred dividend requirement Numerator for basic earnings per share -- income (loss) available to common shareholders before extraordinary items Effect of dilutive securities: Series C preferred dividend requirement Series D preferred dividend requirement Series E preferred dividend requirement Additional required ESOP contribution Numerator for diluted earnings per share -- income floss) available to common shareholders after assumed conversions, before extraordinary item Numerator for basic earnings per share -- income (loss) available to common shareholders after extraordinary item Numerator for diluted eamings per share -- income (loss) available to common shareholders after extraordinary item Denominator: Denominator for basic eamings 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 Dilutive potential common shares Denominator for dilutive eamings per share -- adjusted weighted average shares and assumed conversions Basic eamings (loss) per share before extraordinary items Basic eamings floss) per share after extraordinary items Diluted eamings floss) per share before extraordinary items Diluted eamings floss) per share after extraordinary items 4* f bo 1998 '' ::;138a^ 91.9 " (2.3) (13) $ 88.3 2.3 13. !_gi)________ $ 89.8 $ 50.1 $ 51.6 48.1 0.8 : 0.1 V.'i:5' : - ' ,----N ' '3.2- 5.6 53.7 $ 1.04 $ 1.67 $ ' .96 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 $ 1.81 $ 1.74 $ 1.67 $ 1.61 1996 $ (206.3) (206.3) (2.5) (6.2) -- $ (215.0) _ -- -- -- $ (215.0) $ (215.0) $ (215.0) 34.7 _ -- -- -- -- -- 34.7 $ (6.20) $ (6.20) $ (6.20) $ (6.20) For additional disclosures regarding the Series C, Series D and Series E preferred stock, the employee stock options and nonvested stock shares, refer to Note 12, "Capital Stock and Preferred Share Purchase Rights," and Note 16, "Incentive Stock Plans". Convertible preferred securities (refer to Note 13, "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 eamings per share because the effect would be antidilutive. 16. 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, 1998, there were 2,752,952 shares available for future grants under the plans. In October 1997, the Company met certain share price performance 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 $0.7 million, $9.0 million and $0.4 million in 1998, 1997 and 1996, respectively. 4O Federal Mogul Financial The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting/or 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 underly ing 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 (Statement 123) Accountingfor Stock Based Compensation, the Company's net earnings floss), in millions, and earnings floss) per share would have been adjusted to the pro forma amounts indicated below: 1998 Net earnings (loss) as reported $ 53.7 Pro forma |S Basic earnings (loss) per share as reported Pro forma Diluted earnings floss) per share as reported $ 0.96 Pro forma $ 0.86 1997 $ 69.4 $ 70.7 $ 1.74 1.78 $ 1.61 $ 1.64 1996 $ (206.3) $ (207.1) $ (6.20) $ (6.22) $ (6.20) $ (6.22) Pro forma information regarding net income and earnings per share is required by Statement 123 as if the Company had accounted for its employ ee 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 weighted-average assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates of 6.5%; dividend yields of 0.2%, 1.5% and 2.3%; volatility factors of the expected market price of the Company's common stock of 30.1%, 27.2% and 11.2% and a weighted average expected life of the option of five years. The fair value of nonvested stock awards is equal to the market pnce of the stock on the date of the grant. Since the above pro forma disclosures of results are required to consider only grants awarded in 1995 and thereafter, the pro forma effects during this initial phase-in period may not be representative of the effects on the reported results for future years. The weighted-average fair value and the total number (in millions) of options granted was $22.36, $9.99 and $3.34, and 1.1, 0.9 and 0.3 for 1998, 1997 and 1996, respectively. The weighted-average fair value and total number (in millions) of nonvested stock awards granted was $53.52, $24.47 and $18.90 and 0.1, 0.1 and 0.2 for 1998, 1997 and 1996, respectively. All options and stock awards that are not vested at December 31, 1998, vest solely on employees' rendering additional service. The following table summarizes the activity relating to the Company's incentive stock plans: Outstanding at December 31, 1995 Options/stock granted Options exercised Options/stock lapsed or canceled Outstanding at December 31, 1996 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 Number of Shares (In Millions) 2.6 .5 -- _____ L_______ 2.5 1.0 (1.0) (0.3) 2.2 1.2 (0.5) (0.1) 2.8 WeightedAverage Price $ 22.02 22.08 -- 22.32 $ 22.03 31.74 21.94 22.29 $ 26.46 57.94 21.85 31.49 $40.50 Options exercisable at December 31, 1998 Options exercisable at December 31, 1997 Options exercisable at December 31, 1996 0.6 $ 30.11 0.9 $ 23.07 1.3 $ 22.50 The following is a summary of the range of exercise prices for stock options that are outstanding and the amount of nonvested stock awards at December 31, 1998: Outstanding Weighted-Average RangeAwardsPriceRemaining Life Options: $15.69-$23.50 $23.51 - $35.25 $35.26 - $52.87 $52.88 - $70.69 Nonvested stock 0.5 0.7 0.4 1.1 0.1 $21.79 $28.16 $42.12 $59.32 3 years 3 years 5 years 5 years Total 2.8 17. Postemployment Benefits The Company sponsors several defined benefit pension plans (Pension Benefits) and health care and life insurance benefits (Other Benefits) for certain employees 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. 1998 Annual Report 41 Components of net periodic benefit cost for the year ended December 31: (Millions of Dollars) - Pension Benefits > 1998 ' 1997 Service cost $16.4 $ 7.8 Interest cost 29.9 a. 14.0 Expected return on plan assets ; (48.1) ; (24.2) Net amortization and deferral Curtailment loss (gains) (43) ! 1.6 : (4.2) --- Net periodic (benefit) cost $(4.5) ; $ (6.6) United States Plans Other Benefits 1996 1998 1997 $ 9.0 ' $ 4.4 $ 2.5 15.0 19.2 10.5 (24.3) -- (3.2) 3.7 (0.6) : "-f;-- ; (0.5) -- $ 0.2 $23.0 $12.5 1996 $ 2.8 10.8 -- (0.5) (7.5) $ 5.6 International Plans Pension Benefits 1998 1997 1996 $ 26.7 $ 0.3 $ 0.4 100.7 (123.6) \ : 1.9 -- ---- 2.5 -- -- -- $ . 3.8 $ 2.2 $ 2.9 Change in benefit obligation: (Millions of Dollars) Benefit obligation at beginning of year Service cost Interest cost Acquisitions Company contributions Benefits paid Plan amendments Actuarial gains and losses and changes in actuarial assumptions Settlements and curtailments Benefit obligation at end of year United States Plans . _ Pension Benefits Other Benefits 1998 1997 1998 1997 $197.2 $211.1 $150.4 $150.8 16.4 7.8 4.4 2.5 29.9 14.0 : 19.2 10.5 , 496.7 `C-' b-i -- *,, -- (26.0) 9.9 (20.6) -- (15.0) ^ --T (8.2) -- 4.8 (11.4) $ 717.5 -- (15.1) $197.2 12.6 $468.9 (5.2) -- $150.4 International Plans Pension Benefits ! 1998 1997 $ 26.6 $ 34.5 , 26.7 100.7 13.8343 0.3 1.9 -- -- . (1243) ?-- (1.7) -- 1613 -- $2,038.6 (3.5) (4.9) $ 26.6 Change in plan assets: (Millions of Dollars) Fair value of plan assets at beginning of year Actual return on plan assets Acquisitions Company contnbutions Benefits paid Settlements and curtailments Fair value of plan assets at end of year Funded status of the plan Unrecognized net asset at transition Unrecognized net actuanal (gain) loss Unrecognized prior service cost Prepaid (accrued) benefit cost 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 1998 - 1997 ' 1998 > 1997 :'-V ", - : $293.7 25.3.0; $262.6 61.8 $ .. -- $-- -- 487.1 -- -- 7.9 5.0 -- (26.0) (20.6) -- (12.6) (15.1) -- $775.4 $293.7 $ :-- $-- $ 57.9 (30.1) $ 45.7 $ 96.5 (2.0) (60.3) 9.7 $ 43.9 $(46819) r;./ : 8.9 (2.9) $(462.9) $(150.4) -- (3.8) (3.5) $(157.7) United States Plans Pension Benefits Other Benefits 1998 1997 1998 1997 7.25% 7.5% 7.25% 7.5% - 10% 10% -- 4.25-5% 4.5% i -- International Plans Pension Benefits : 1998 1997 - A - :$- . -- 157.6 1 1,918.4 $-- -- -- : 21.4 -- i (1243) 1.7 - __ $1,973.1 (1.7) $-- ,$ (65.5) ; {V 129.6. $ 64.1 $(26.6) -- _ 2.8 $(23.8) International Plans Pension Benefits P 1998: 1997 j .5.5-6%: 6.5% 7.5% ____ 2.5-3.9% 2.5% 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 : 1998 $138.1 ,137.9 126.6 1997 $56.4 55.5 49.9 International Plans Projected benefit obligation Accumulated benefit obligation Fair value of plan assets 1998 $180.0:' 171.6 1997 $26.6 26.6 -- Amounts recognized in the balance sheet consist of: Pension Benefits 1998 1997 Prepaid (accrued) benefit cost V $109.8 $20.1 Accrued benefit liability (12.7). (1.3) Intangible asset 73 1.1 Accumulated other comprehensive income 3.4 o.i Net amount recognized ; $107.8 $20.0 Other Benefits 1998 1997 $(462.9) . $(157.7) - ____ -- v. ____ ____ $(462.9) $(157.7) 4 2. Federal MoGUL Financial At December 31, 1998, the assumed annual health care cost trend used in measuring the APBO approximated 7.1% in 1998, declining to 6.7% in 1999 and to an ultimate annual rate of 5.5% estimated to be achieved in 2009. Increasing the assumed cost trend rate by 1% each year would have increased the APBO by approximately 11.5% and 8.3% at December 31, 1998 and 1997, respectively. Aggregate service and interest costs would have increased by approximately 13.3% for 1998 and 9.4% for 1997 and 1996. 18. 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 Goss) before income taxes and extraordinary items consisted of the following: The following table summarizes the Company's totalprovision for income taxes/(tax benefits): Income tax expense (benefit) Extraordinary items T&N Bearings Divestiture Allocated to equity: Currency translation Preferred dividends Incentive stock plans Investment securities Other 1998 > ;: : $ 93.6 (19.8) 56.1 1997 1996 (Millions of Dollars) $27.5 $(22.4) (1.5) '-- ---- 15.3 (1.2) (3.9) o;2 $140.3 (3.6) (1.3) (3.4) (0.6) 1.2 $18.3 (4.9) (1.5) -- 0.8 0.7 $(27.3) Domestic International 1998 1997 1996 (Millions of Dollars) $50.1 $ (88.3) 258.9 ; 49.4 (140.4) $185.5 $99.5 $(228.7) Significant components of the provision for income taxes (tax benefit) are as follows: Current: Federal State and local International Total current Deferred: Federal State and local International Total deferred 1998 v,,. . .. 1997 1996 (Millions of Dollars) $ (12.1) 10.0 65.4 > 6313: $ 9.6 0.2 6.6 16.4 $ i4.0) 2.3 6.3 4.6 , `- 33.0 2.1 (4.8) 30.3 $ 93.6 6.1 0.7 4.3 11.1 $27.5 (25.2) (1.8) -- (27.0) $ (22.4) The reconciliation of income taxes (tax benefit) computed at the United States federal statutory tax rate to income tax expense (benefit) is: 1998 1997 1996 (Millions of Dollars) Income taxes (tax benefits) at United States statutory rate $64.9 $34.9 $(80.1) Tax effect from: State income taxes 7.9 . 0.8 0.7 Foreign operations, net of foreign tax credits 5.6 (2.7) 55.9 Sale of international retail/ wholesale operations (11.5) (6.8) -- Goodwill amortization 19.7 -- -- Purchased in-process research and development if 6.5 ; -- -- Tax credits and other 0.5 1.3 1.1 $93.6 $27.5 $(22.4) Significant components of the Company's deferred tax assets and liabilities as of December 31 are as follows: Deferred tax assets: Asbestos Postemployment benefits Net operating loss carryforwards of international subsidiaries Restructuring reserves Inventory basis Allowance for doubtful accounts Other temporary differences Total deferred tax assets Valuation allowance for deferred tax assets Net deferred tax assets Deferred tax liabilities: Fixed asset basis differences Intangible asset basis differences Deferred gains Pension Total deferred tax liabilities 1998 ___________ 1997 (Millions of Dollars) $429.1 165.2 $-- 58.2 v: 121.5 98.8 34.2 15.2 96.2 960.2 45.0 -- 10.3 11.3 52.0 176.8 (66.2) 894.0 (44.4) 132.4 (379.4) (326.2) ! (130.0) ! (6.9) .. (8.42-f>)_____ . $ 51.5 ` (50.5) -- -- (17.3) (67.8) $64.6 Deferred tax assets and liabilities are recorded in the consolidated balance sheets as follows: Assets: Prepaid expenses and income tax benefits Noncurrent assets Liabilities: Other current accrued liabilities Other long-term accrued liabilities 1998 1997 (Millions of Dollars) ;-y $187.3 $46.6 26.7 (135.8) $ 51.5 (4.2) (4.5) $64.6 1998 Annual Repo R T 4 Income taxes paid in 1998, 1997 and 1996 were $34.7 million, $2.6 million and $6.7 million, respectively. Undistributed earnings of the Company's international subsidiaries amount ed to approximately $229 million at December 31, 1998 and $77 million at December 31, 1997. Since these earnings are considered by the Company to be permanently reinvested, no taxes were provided in 1998 or 1997. 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, 1998, the Company has $159 million in net operating loss carryforwards in the United Kingdom and Germany with no expiration date or valuation allowance. Also, the Company has $174 million of additional foreign net operating loss carryforwards with a full valuation allowance and various expiration dates. Included in the previous amounts are $145 million of net operating loss carryforwards acquired with the purchases of T&N, Cooper Automotive and Fel-Pro. A valuation allowance was recorded on $64 million of these purchased net operating loss carryfor wards, thereby increasing the balance in the valuation allowance reserve for 1998. The reduction in these valuation allowances, if any, will be applied to reduce goodwill related to the respective acquisitions. 19. Operations By Industry Segment and Geographic Area In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131 (Statement 131), Disclosures about Segments ojan Enterprise and Related Information, for the year ended December 31, 1998. Statement 131 established standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also established standards for related disclosures about products, services and geographic areas. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Company, in deciding how to allocate resources and in assessing performance. The Company operates in three fundamental business segments (excluding Divested Activities): Powertrain Systems, Sealing Systems and General Products. Powertrain Systems, which consist of internal engine components directly involved in creating a vehicle's movement. These components consist primarily of engine bearings, bushings, pistons, piston pins, rings, liners and ignition products. Sealing Systems, which provide for the encapsulation of fluids and gases from the engine, transmission and axle and also prevent external objects from entering the systems. They consist of dynamic seals (found between components that move in relation to one another) and gaskets (located between components that are static in relation to one another). General Products, which consist of the Company's remaining product lines, primarily camshafts, sintered products (engine components made from powdered metal), chassis components and systems protection products (used for shielding against heat, noise, abrasion and stone impingement) and friction products. Divested Activities include the historical operating results and assets of aftermarket operations in South Africa, Australia, Chile and its heavy wall bearing operations in Germany and Brazil which were sold or closed in 1997. During 1996, the Company divested its United States ball bearings and electrical products manufacturing operations. In addition, the Company divested its minority interest in G. Bruss GmbH & Co. (refer to Note 3, "Sales of Businesses"). 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 as defined as Operational Earnings before certain nonrecurring items (such as certain purchase accounting adjustments and integration costs associated with new acquisitions), interest and income taxes. Pursuant to Statement 131, Operational EBIT for each segment is shown below, as it is most consistent with the measurement principles used in measuring the corresponding amounts in the consolidated financial statements. Net Sales: Powertrain Systems Sealing Systems General Products Divested Activities Total 1998 1997 1996 ;. j; /`(Millions of Dollars) .$1,883 925 1,636 . ~ 25 . $4,469 $ 782 333 577 115 $1,807 $ 739 295 665 334 $2,033 Operational EBIT: Powertrain Systems Sealing Systems General Products Divested Activities Total 1998 1997 1996 (Millions of Dollars) $ 223, ,. 133 154 (8) $ 502 $ 68 26 44 1 $ 139 $ 75 9 31 (22) $ 93 1998 1997 1996 (Millions of Dollars) Reconciliation: Total segments operational EBIT $ 502 $' 139 $ 93 Net interest and other financing costs (233) (29) (39) Restructuring, impairment ;V : and other special charges (20) Acquisition related costs ? (63) Earnings (loss) before income * 'V ,; ' (10) (283) -- __ taxes and extraordinary item $ 186 $ 100 $ (229) 44 Federal - Mogul Financial Assets: Powertrain Systems Sealing Systems General Products Divested Activities Total 1998 1997 1996 ' (Millions of Dollars) $3,590 4,687 - 23 $9,940 $ 786 382 508 126 $1,802 $ 608 243 456 148 $1,455 Capital Expenditures: Powertrain Systems Sealing Systems General Products Divested Activities Total 1998 1997 1996 1 (Millions of Dollars) $ 116 33 . . 80 -- $ 229 $ 28 13 9 -- $ 50 $ 25 10 10 9 $ 54 -- 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. 1998 Net Sales 1997 United States Mexico Canada Total North America United Kingdom Germany France Italy Other Europe Total Europe $2,345 :.V;;.i'24v' 76 2,545 ^ii<K 478 327 j, 200 : 188 1,709 $1,111 87 58 1,256 21 126 33 71 117 368 1998 1997 1996 (Millions of Dollars) Depreciation and Amortization: Powertrain Systems s.$ 104 $ 28 $ 27 Sealing Systems 43 11 10 General Products , 81 12 14 Divested Activities >! ' 1 11 Total '228 $ 52 $ 62 Net Property, Plant and Equipment 1996 F1998W 1997 1996 (Millions of Dollars) $1,177 73 j$l,422:!i b>.'-36;. $166 7 $169 7 57 * 11 i,307 ;|i:,49i| 174 177 18 j|:,312. 175 318 35 >,^113'; 81 122 62 431 882 9 105 9 9 3 135 11 127 10 11 4 163 Rest of World Total 215 . $4,469 183 $1,807 295 $2,033 ' 104 .$2,477 5 $314 10 $350 20. litigation and Environmental Matters T&N Asbestos Litigation In the United States, the Company's United Kingdom subsidiary, T&N Ltd., and two of T&N's United States subsidiaries (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 to property damage litigation in the United States based upon asbestos products allegedly installed in buildings. 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 expenditure which may arise therefrom. As of December 31, 1998, the Company has provided approximately $1.3 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 pan on recent and historical claims experi ence, medical information and the cunent legal environment. As of December 31, 1998, the T&N Companies had approximately 105,000 claims pending. During 1998, approximately 85,000 new claims were filed and 54,000 claims were settled, dismissed or otherwise resolved. In addition to the pending cases above, the T&N Companies have approximately 41,000 claims that have been setded 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 administra tive (non-litigation) claims resolution mechanism. As of December 31, 1998, T&N is one of a large number of defendants named in three pending property damage cases pending in two jurisdictions. Provision has been made in the asbestos reserve for anticipated expenditures in relation to such cases. The $1.3 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, 1998, the $1.3 billion total provision is comprised of approximately $460 million related to known claims and approximately $840 million related to IBNR claims. In arriving at the IBNR provision, assumptions have been made regarding the total number of claims which it is anticipated may 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 jurisdic tion 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 subro gation claims brought by insurance companies. 1998 ANNU Report The T&N Companies have appointed the Center for Claims Resolution (CCR) as their exclusive representative in relation to all asbestos-related personal injury claims made against the T&N Companies in the United States. The CCR provides to its 20 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 is entitled to appoint a representative as one of the five voting direc tors 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. 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 amount 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 Company's reserve for claims filed afterJune 30,1996, approximates to 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. While management believes that reserves are appropriate for anticipated losses arising from T&N's asbestos-related claims, given the nature and complexity of the factors affecting the estimated liability, the actual liability may differ. No absolute assurances can be given that T&N will not be subject to matenal 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 adversely affected. The T&N Companies reserves will be reevaluated periodically as additional information becomes available. Federal-Mogul, Fel-Pro and Cooper Automotive Asbestos Litigation The Company also is one of a laige number of defendants in a number of lawsuits brought by claimants alleging injury due to exposure to asbestos. Fel-Pro has been named as a defendant in a number of product liability cases involving asbestos, primarily involving gasket or packing products sold to ship owners. In addition, subsidiaries of Cooper Automotive have been named as defendants in a number of product liability cases involving asbestos, primarily involving friction products. The Company is defending all such claims vigorously and believes that it, Fel-Pro and the Cooper Automotive subsidiaries 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, Fel-Pro and the Cooper Automotive subsidiaries as of December 31, 1998, will not have a material effect on the Company's financial position. At December 31, 1998, approxi mately $20 million in related reserves have been provided in respect of the possible uninsured portion of the expenditures on asbestos claims pending against the Company, Fel-Pro and the Cooper Automotive subsidiaries. Other The Company is involved in various other legal actions and claims, directly and through its subsidiaries (including T&N Limited and Fel-Pro). After taking into consideration legal counsel's evaluation of such actions, manage ment is of the opinion that its outcomes are not reasonably likely to have a material adverse affect on the Company's financial position, operating results or cash flows. The Company is a defendant in lawsuits filed in various jurisdictions 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 pray 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 CERLCA 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 complexi ty 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 and legal reserve was approximately $50 million at December 31, 1998 and $11 million at December 31, 1997. The majority of the 1998 increase is attributable to the acquisitions of T&N and Cooper Automotive. Management believes that such accruals will be adequate to cover the Company's estimated liability for its exposure in respect of such matters. Mogul Financial ^puau&ii; 1 uiaiiuai uaia vv Year ended December 31, 1998'. Net sales Gross margin Net earnings before extraordinary items Extraordinary item - loss on early retirement of debt, net of tax benefit Net earnings Goss) Diluted earnings per share Stock price High Low Year ended December 31, 1997: Net sales Gross margin Net earnings before extraordinary item Extraordinary item - loss on eady retirement of debt, net of tax benefit Net earnings Diluted earnings per share Stock price High Low -- First $658.0 161.3 (7.2) -- (7.2) (.20) $54.37 $39.00 First $485.6 112.1 13.9 -- 13.9 .32 $26.75 $21.63 Second Third Fourth (Millions of Dollars, Except Per Share Amounts) $1,214.0 317.4 28.4 $1,121.2 292.9 34.6 $1,475.5 406.9 36.1 (31.3) (2.9) (.07) -- 34.6 .58 (6.9) 29.2 .48 $ 69.25 $ 52.62 $ 72.00 $ 46.62 $ 63.00 $ 33.00 Second Third Fourth (Millions of Dollars, Except Per Share Amounts) $ 481.8 115.3 28.5 $ 424.2 102.8 17.4 $ 415.0 94.6 12.2 (2.6) 25.9 .61 -- 17.4 .40 -- 12.2 .28 $ 35.38 $ 24.50 $ 39.94 $ 32.75 $ 47.63 $ 36.75 Year $4,468.7 1,178.5 91.9 (38.2) 53.7 .96 Year $1,806.6 424.8 72.0 (2.6) 69.4 1.61 Dividends on the capital stock of the Company are payable at the discretion of the Company's Board of Directors. In May 1998, the Board of Directors reduced the quarterly dividendfrom $.12 per share and sub sequently declared cash dividends payable in the second, third andfourth quarters of 1998 m the amount of $.0025 per share of common stock. The Company, consistent with its growth strategy, intends to retainfuture earnings tn the business and therefore anticipates paying dividends at a comparable level in theforeseeablefuture. (1) Includes an $18.6 million chargefor purchased in-process research and development, a $10.5 million restructuring charge, a $19.0 million net chargefor an adjustment of assets heldfor sale and other long-lived assets tofair value and $ 1.0 milium of integration costs. (2) Includes $3.7 million of integration costs. (3) Includes $9.0 million of integration costs and a $6.6 million restructuring credit (5) Includes an income tax benefit of $6.8 million related to the sales of the South African and Australian businesses. (6) Includes $1.1 millionfor a net restructuring credit, a $2.4 million chargefor adjustment of assets held for sale tofair value, a $1.6 million creditfor reengineering and other related charges, and a $10.5 million charge related to the British pound currency optwn. (4) includes a $3.4 million net restructuring charge and $8.7 million of integration costs 22. Audited Consolidating Condensed Financial Information of Guarantor Subsidiaries Certain subsidianes of the Company (collectively the "Guarantor Subsidiaries") have guaranteed fully and unconditionally, on a joint and several basis, the obligation to pay principal and interest under the Company's Senior Credit Agreement with The Chase Manhattan Bank, NA, ("Chase"), The Company issued $1.0 billion of bonds on June 25, 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, 1998 Form 10-K, filed with the Securities and Exchange Commission. 23. Subsequent Events On January 7, 1999, the Company announced that it has agreed to acquire the piston division of Alcan Deutschland GmbH in Germany, a subsidiary of Alcan Aluminum Limited in Canada. Alcan's piston division manufactures high quality pistons for passenger cars and commercial vehicles under the highly regarded Nural brand name. The piston division employs approxi mately 1,100 people at its manufacturing facility in Nuremberg, Germany with annual sales in excess of $150 million. On January 14, 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 trans action, the Company will recognize an extraordinary charge in the first quarter of 1999 of approximately $8 million, net of tax, related to early extinguishment of debt. On January 20, 1999, the Company completed its acquisition of two camshaft machining plants from Crane Technologies Group Inc. to expand the capacity of its automotive products lines. The two plants located in Orland, Indiana and Jackson, Michigan employ approximately 230 people and have annual sales of approximately $36 million. On February 24, 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 com ponents 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&rN acquisition. As a result of these transactions, the Company will recognize an extraordi nary charge in the first quarter of 1999 of approximately $15 million, net of tax, related to early extinguishment of debt. On February 24, 1999, all outstanding shares of the Company's Series E Stock were exchanged into shares of the Company's common stock. Each of the 607,745 remaining shares of the Series E Stock were exchanged into five shares of the Company's common stock. 1998 Annual Report 47 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 four 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. Chairman and Chief Executive Officer Tom Ryan Executive Vice President and Chief Financial Officer 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, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial state ments based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 disclo sures 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, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Detroit, Michigan February 3, 1999, except for Note 23, as to which the date is February 24, 1999 48 Federal Mogul 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 10:30 a.m. on Wednesday, April 21, 1999 at Federal-Mogul World Headquarters. Stock listing New York Stock Exchange Ticker Symbol: FMO - Investor Relations Investors and security analysts should contact: Bonnie J. Price Vice President - Investor Relations Telephone: (248) 354-8847 Fax: (248) 354-7769 E-mail: Bonnie_Price@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 Security 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 PRNewswire): (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 1998 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 Shareholder Relations Department U-E P.O. Box 11258 Church Street Station New York, New York 10286-1258 www: http://stock.bankofny.com E-mail: shareowner-svcs@bankofiiy.com For transfer of stock ownership, address changes, or replacement of lost, stolen or destroyed certificates, please write: BONY Receive & Deliver Department - 11W PO. 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, 1998, the company had 67,450,799 shares of common stock outstanding owned by 8,463 shareholders of record. Management estimates there are an additional 12,000 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 Dividend Reinvestment Department EO. Box 11260, Church Street Station New York, New York 10277-0760 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 numberts) and your name exacdy as it appears on your stock certificate. . Quarterly Stock Price Information 4Q 1998 3Q 1998 2Q 1998 IQ 1998 4Q 1997 3Q 1997 2Q 1997 IQ 1997 High 63 72 69 1/4 54 3/8 47 5/8 39 15/16 35 3/8 26 3/4 Low 33 46 5/8 52 5/8 39 36 3/4 32 3/4 24 1/2 21 5/8 Close 59 1/2 46 3/4 67 1/2 ` 53 3/16 40 1/2 37 1/8 35 24 5/8 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 1999 Federal-Mogul Corporation. All Rights Reserved. Federal-Mogul and the Federal-Mogul design are registered trademarks. \ r* , - lirSL Federal-Mogul Corporation Wf driven ' * |*j .;* 1 %W*S $ ri ail we do. :'j v y Southfield, Michigan 48034 USA (248) 354-7700 htlp:/ww wfederal-niqgul.com 11 <t--* V V' s f.jf I'Hif success.