<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report: May 14, 1998
(Date of earliest event reported)
FEDERAL-MOGUL CORPORATION
-------------------------
(Exact name of registrant as specified in its charter)
Michigan
--------
(State or other jurisdiction of incorporation)
1-1511 38-0533580
------ ----------
(Commission File Number) (IRS Employer Identification Number)
26555 Northwestern Highway, Southfield, Michigan 48034
- ------------------------------------------------ -----
(Address of principal executive offices) (Zip Code)
(248) 354-7700
--------------
(Registrant's telephone number including area code)
The total number of pages is
<PAGE>
INFORMATION TO BE INCLUDED IN THE REPORT
ITEM 5. Other Events.
On May 14, 1998 the Corporation filed an amended Registration Statement on
Form S-3 relating to shelf registration of $2.5 billion of its debt securities,
preferred stock and common stock, including a prospectus supplement relating to
the first offering planned thereunder. The prospectus supplement contained in
the Registration Statement filed May 14, 1998 includes certain information
regarding the operations of the Corporation and its subsidiaries not previously
filed with the Securities and Exchange Commission under the Securities Exchange
Act of 1934. Reprinted below are the following sections from the prospectus
supplement: "Business," "Management's Discussion and Analysis of Financial
Condition and results of Operations T&N," and "Management's Discussion and
Analysis of Financial Condition and results of Operations Fel-Pro."
BUSINESS
For purposes of this section ("Business"), references to "Federal-Mogul" or
the "Company" include operations acquired in the acquisitions of T&N (as
hereinafter defined) and Fel-Pro (as hereinafter defined) and statistics have
been prepared on a pro forma basis, giving effect to the acquisitions of T&N and
Fel-Pro and the disposition of the T&N Bearings Business (as hereinafter
defined) as if they had occurred on January 1, 1997, unless otherwise noted.
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. Such components
include powertrain systems components (primarily bearings, rings and pistons),
sealing systems components (dynamic seals and gaskets) and general products
(primarily camshafts, friction products, sintered products and systems
protection products). Federal-Mogul markets its products to many of the world's
major original equipment ("OE") manufacturers. Federal-Mogul also manufactures
and supplies its products and related parts to the aftermarket relating to each
of these categories of equipment.
Founded in 1899, Federal-Mogul traditionally focused on the manufacture and
distribution of engine bearings and sealing systems. From 1990 through 1996,
Federal-Mogul pursued a strategy of opening retail auto stores in various
domestic and international locations. These geographically-dispersed stores
proved burdensome to manage and resulted in substantial operating losses. In
the fourth quarter of 1996, Federal-Mogul underwent a change of management,
following which the Company initiated a significant restructuring program
designed to refocus the Company on its core competency of manufacturing. As
part of such restructuring, Federal-Mogul took the following actions: (i)
closed international aftermarket distribution centers in Malaysia and
Singapore; (ii) divested 72 international retail aftermarket operations and
sold or restructured 25 wholesale aftermarket operations; (iii) closed its
Leiters Ford, Indiana manufacturing facility and consolidated its lighting
products operations in Juarez, Mexico; (iv) consolidated certain of its North
American warehouse facilities; (v) consolidated its customer support functions
previously housed in Phoenix, Arizona into the Company's Southfield
headquarters; (vi) consolidated its European aftermarket management functions
in Geneva, Switzerland into the Wiesbaden, Germany manufacturing headquarters;
and (vii) streamlined certain of its administrative and operational staff
functions worldwide. In addition, by the end of the first quarter of 1998, the
Company expects to have successfully exited all of its retail businesses,
except for Puerto Rico where the Company continues to seek a buyer. Federal-
Mogul also began to pursue a growth strategy of acquiring complementary
manufacturing companies that enhance the Company's product base, expand its
global manufacturing operations and provide opportunities to capitalize on the
Company's aftermarket distribution network and technological resources.
In connection with its growth strategy, on March 6, 1998 Federal-Mogul
acquired T&N plc ("T&N"), a U.K. based supplier of engine and transmission
products, for total consideration of approximately (Pounds)1.46 billion ($2.42
billion (converted at a blended exchange rate of 1 pound sterling to 1.6510 U.S.
dollars). T&N manufactures and supplies high technology engineered automotive
components and industrial materials including pistons, friction products,
bearings, systems protection, camshafts and sealing products. On February 24,
1998, Federal-Mogul 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 automotive parts manufacturer, for
total consideration of approximately $717 million. Fel-Pro is a premier gasket
manufacturer for the North American aftermarket and OE heavy duty market.
Federal-Mogul currently operates facilities at over 240 locations in 24
countries. On a pro forma basis (giving effect to the acquisitions of T&N and
Fel-Pro and the disposition of the T&N Bearings Business as if they had
occurred on January 1, 1997), Federal-Mogul's total sales for 1997 were $4.8
billion.
2
<PAGE>
The following charts set forth Federal-Mogul's net sales by customer group,
geographic region and manufacturing division as a percentage of total net sales
for the year ended December 31, 1997, on a pro forma basis.
[GRAPH APPEARS]
1997 Net Sales 1997 Net Sales 1997 Net Sales
by Customer Group by Geographic Region by Manufacturing Division
52% Original 49% U.S. and Canada 38% General Products
Equipment (OE) 40% Europe 40% Powertrain
48% Aftermarket 11% Rest of World 22% Sealing Systems
Among Federal-Mogul's largest customers are Caterpillar, Chrysler, Cummins,
Ford, General Motors, Mercedes-Benz, NAPA, Peugeot and Volkswagen/Audi (in
alphabetical order).
BUSINESS STRATEGY
The Company believes its recent restructuring program, which refocused the
Company on its core competency of manufacturing, and the acquisitions of T&N and
Fel-Pro, which expanded the Company's product base and geographic reach,
significantly enhanced its position within the automobile, truck and other
vehicular components markets. The Company believes that opportunities exist to
continue its growth and further enhance its market presence through the
following initiatives:
Systems Approach
The breadth of the Company's manufacturing capabilities and product offerings
enable it to be one of a small number of manufacturers with the ability to seal
entire engine, transmission and axle systems and to be a single source supplier
of engine and sealing components. In addition, Federal-Mogul is committed to
becoming a provider of a complete engine and transmission modules for its OE
customers. The Company believes that OE manufacturers of automobiles, trucks and
other vehicles are increasingly seeking to reduce the number of suppliers from
which they source parts and to develop relationships with suppliers that can
offer integrated systems and modules in order to lower production costs,
increase quality, provide better technology and shorten product development
cycles. The T&N and Fel-Pro acquisitions, which expanded the Company's gasket,
cast aluminum piston, large bearing and sealing product lines and added product
lines for articulated pistons, cylinder liners and piston rings, are major steps
toward Federal-Mogul's strategic goal of developing global engine and sealing
systems for its OE customers.
Continue Focus on New Product Innovation
The Company's expertise in engineering and research and development has made
Federal-Mogul a leader in virtually all of the products segments in which it
competes. The Company utilizes the latest technologies, processes and materials
to solve problems for customers and to bring new, innovative products to market.
The Company has special competencies in alloy development, customized materials
formulations, surface technology, advanced modeling and testing and systems
engineering. These capabilities allow the Company to reduce production costs and
to develop products that are more durable and exhibit better interaction with
surrounding components. These innovative products better serve OE customers and
aid brand development, resulting in a higher margin product mix.
3
<PAGE>
Extend Global Manufacturing Reach
The Company is committed to extending its manufacturing capabilities worldwide
in response to the global expansion of its OE manufacturing customers. The
acquisition of T&N and Fel-Pro have substantially increased the Company's
manufacturing presence, particularly in North America and Europe. Management
believes expansion of manufacturing operations to follow the expansion of OE
manufacturers into Latin America, Eastern Europe and Asia provides significant
growth opportunities for the Company in the future.
Pursue Strategic Acquisitions
The vehicular engine and sealing component industry is large and highly
fragmented. The Company believes that as OE manufacturers continue to outsource
and reduce the number of suppliers, opportunities will exist for further
consolidation within industry. The Company believes that, through its
established presence in these markets and its strong relationships with OE
manufacturers worldwide, the Company is in a favorable position to capitalize on
future industry consolidation. The Company's management has substantial
experience in completing and integrating acquisitions within the automobile
parts industry and believes that this experience will help it select and pursue
acquisition opportunities that can enhance the Company's product base, expand
its global manufacturing operations and further capitalize on the Company's
aftermarket distribution network and technological resources.
Expand Aftermarket Presence
Approximately 48% of the Company's 1997 sales, on a pro forma basis, were
generated from the aftermarket. The Company believes that opportunities exist to
further leverage its broad product offerings, reputation for new product
innovation and presence within the OE market to increase its penetration of the
worldwide aftermarket. In addition, the Company believes that its ability to
sell products developed for the OE market to aftermarket customers reduces the
impact of adverse changes in demand for new vehicles.
EVA Focus
In 1997, the Company adopted Economic Value Added (EVA(R)) as its primary
financial measurement and incentive compensation metric. EVA is equal to net
operating profits after economic taxes and a charge for capital invested in
the Company, which is equal to the product of the total capital invested in
the Company and the weighted average cost of capital for the Company's target
blend of debt and equity. The Company's management has placed significant
emphasis on improving the Company's financial performance and achieving
various operating efficiencies through technical development, manufacturing,
marketing and administrative rationalization in connection with this effort.
The Company's EVA improved significantly in 1997 due primarily to improved
operating margins (4.9% in 1996 and 7.7% in 1997) combined with $166 million
of cash flow from continuing operations (net of expenditures for property,
plant and equipment) in 1997. EVA is also being applied to the integration of
T&N and Fel-Pro to optimize synergies and cost savings. As the Company
continues to expand both its product base and its geographic scope, management
will evaluate investments and acquisitions based on both EVA and strategic
importance. In addition, the Company currently determines compensation for
certain top managers using an EVA based system and expects to increase the
number of managers participating in its EVA based compensation system to over
200 in 1999.
REORGANIZATION
Following the acquisitions of T&N and Fel-Pro, Federal-Mogul's integrated
operations are being reorganized to realize synergies and effectively
coordinate operations. Operations will be conducted through three
manufacturing operating units corresponding to major product areas: Powertrain
Systems, Sealing Systems and General Products. The major product categories in
Powertrain Systems include engine bearings and piston products. Sealing
Systems includes dynamic seals and gaskets. General Products include
camshafts, friction products, sintered products, systems protection products
and a number of smaller product lines. The Worldwide Aftermarket organization
is responsible for Federal-Mogul's global aftermarket sales, marketing and
distribution.
4
<PAGE>
The components of Federal-Mogul's plan for integrating operations acquired
with T&N and Fel-Pro include: closure of four manufacturing 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 ventures; closure of
two aftermarket central warehouses and five in-country 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 is a reduction of approximately 4,200 employees.
In connection with securing regulatory approvals for the acquisition of
T&N, Federal-Mogul executed an Agreement Containing Consent Order with the U.S.
Federal Trade Commission (the "FTC") on February 27, 1998. Pursuant to this
agreement Federal-Mogul must divest T&N's thinwall and dry bearings (polymer
bearings) operations (the "T&N Bearings Business"), consisting principally of
T&N's thinwall and dry bearings (polymer bearings) operations, within six months
after the FTC declares the consent order final and must provide for independent
management of those assets pending such divestiture. The agreement stipulates
that the T&N Bearings Business is to be maintained as a viable, independent
competitor of Federal-Mogul and that Federal-Mogul shall 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.
The T&N Bearings Business accounted for approximately $393.1 million of T&N's
1997 revenues and employed approximately 4,000 people. In addition, T&N's North
American aftermarket business is being held separately (on an interim basis) as
an independent business pursuant to the Agreement Containing Consent Order.
MANUFACTURING DIVISIONS
Federal-Mogul has three manufacturing divisions as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
% of
1997
Manufacturing Division Product Sales Brand Names Application
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Powertrain Systems Engine Bearings, Bushings, Washers Federal-Mogul(R), Glyco(R), automotive, light truck,
and Large Bearings 40.0% AE Goetze(R) and Sterling(R) heavy duty, industrial,
($1.9 billion of Pistons and Piston Pins 33.0% marine, agricultural,
consolidated sales Rings and Liners 27.0% power generation and
in 1997) ------ small air-cooled engine
100.0%
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Sealing Systems Dynamic Seals 30.0% National(R), Mather(R), STS(R), automotive, light truck,
($1.1 billion of Gaskets 70.0% Redi-Seal(R), Redi-Sleeve(R), heavy duty truck,
consolidated sales in ------ Unipiston(R), Engine Seal(R), Fel- agricultural, off-highway,
1997) 100.0% Pro(R), Payen(R) and McCord(R) marine, railroad, high
performance and
industrial
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
General Products Camshafts 13.0% Weyburn-Bartel(R), Weyburn- vehicular and industrial
($1.2 billion of Friction Products 42.0% Lydmet(R), Brico(R), Sintertech(R),
consolidated sales in Sintered Products 17.0% Bentley-Harris(R), Silverton(R),
1997)(1) Systems Protection Products 9.0% FHE(R), Connoisseur Auto
Other General Products 19.0% Air Conditioning(R), Carter(R)
------ and Signal-Stat(R)
100.0%
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- -----------
(1) Excluding $600 million of sourced aftermarket product.
POWERTRAIN SYSTEMS
Federal-Mogul's Powertrain Systems products are used in automotive, light
truck, heavy duty, industrial, marine, agricultural, power generation and
small air-cooled engine applications. The Powertrain Systems (not including
the T&N Bearings Business to be divested) accounted for $1.9 billion of
Federal-Mogul's 1997 pro forma consolidated sales, of which 41% were in North
America, 52% were in Europe and 7% were in the rest of the world. In 1997,
5
<PAGE>
Powertrain Systems unit's five largest customers by sales volume were
Caterpillar, Cummins, Ford, General Motors and Volkswagen/Audi (in
alphabetical order). Approximately 68% of the sales in 1997 for Powertrain
Systems were to OE customers while 32% were to aftermarket customers.
Federal-Mogul's Powertrain Systems operations combine large bearings and
piston products operations acquired in the T&N acquisition with pre-existing
powertrain assets of Federal-Mogul, primarily bearings operations. The
addition of T&N greatly expanded Federal-Mogul's presence in cast aluminum
pistons and large bearings as well as adding four additional product lines,
articulated pistons, piston rings, cylinder liners and piston pins. The
Company's Powertrain Systems maintains 57 manufacturing locations in 16
countries. (T&N's other Powertrain Systems operations--thinwall bearings and
dry bearings--are to be divested for regulatory reasons and are held
separately, in the interim, see "--Reorganization.")
Engine Bearings, Bushings, Washers and Large Bearings. Engine bearings,
bushings, washers and large bearings accounted for approximately 40% of the
sales for Powertrain Systems. Federal-Mogul manufactures thin wall engine
bearings, bushings and washers for original equipment and aftermarket sales.
These products include bimetallic and trimetallic journal bearings (main,
connecting rod, thrust and tilting pad), bimetallic and trimetallic bushings
and washers, valve plates, labyrinth seals, dry bearings and sputter bearings.
Federal-Mogul's large bearings products--heavy wall bearings, rotating plant
bearings and structural products--are sold only to OE customers. Engine
bearings, bushings, washers and large bearings are sold under the brand names
Federal-Mogul(R) and Glyco(R).
Pistons and Piston Pins. Pistons and piston pins accounted for
approximately 33% of the sales for Powertrain Systems. Federal-Mogul designs and
manufactures cast aluminum pistons for all gasoline and diesel engine
applications, articulated aluminum body/steel crown pistons for heavy duty
diesel applications, piston rings for all classes of internal combustion
engines, cylinder liners in cast iron for new generation aluminum block engines
and piston pins from steel. The addition of T&N has significantly expanded the
technology, scope and range of pistons offered by Federal-Mogul, most notably in
the OE market. The T&N acquisition has also added piston rings and a wide range
of high strength steel piston pins (also known as wrist pins or gudgeon pins) to
the Federal-Mogul product line. Pistons and piston rings are sold under the
brand names AE Goetze(R) and Sterling(R).
Rings and Liners. Rings and liners accounted for approximately 27% of the
sales for Powertrain Systems. Federal-Mogul manufactures a wide range of cast
iron or steel rings, plasma, chrome and CKS coatings and wet, dry and cast
liners. Federal-Mogul now designs and manufactures a wide range of cast iron
and steel piston rings. With the addition of T&N and Fel-Pro, Federal-Mogul
added cylinder liners to its product line. Rings and liners are marketed under
the brand name AE Goetze(R).
SEALING SYSTEMS
Federal-Mogul's Sealing Systems products are used in automotive, light
truck, heavy duty diesel, agricultural, off-highway, marine, railroad, high
performance and industrial applications. Sealing Systems accounted for $1.1
billion of Federal-Mogul's 1997 consolidated sales, of which 66% were in North
America, 23% were in Europe and 11% were in the rest of the world. In 1997,
this division's five largest customers by sales volume were Chrysler, Cummins,
Fiat, Ford and General Motors (in alphabetical order). Approximately 47% of
the sales in 1997 for Sealing Systems division were to OE customers while 53%
were to aftermarket customers.
Federal-Mogul's Sealing Systems operations combine the gaskets operations
acquired in the T&N and Fel-Pro acquisitions with the pre-existing Federal-
Mogul dynamic seals business. The acquisitions of T&N and Fel-Pro have made
Federal-Mogul one of a select number of manufacturers with the ability to seal
entire engines, transmission and axle systems. The Company's Sealing Systems
maintains 23 manufacturing locations in 12 countries.
6
<PAGE>
Dynamic Seals. Dynamic seals accounted for approximately 30% of the sales
for Sealing Systems division. Federal-Mogul manufactures a line of dynamic
seals consisting of oil seals (for engine, transmissions and axles),
crankshaft seal carrier assemblies, valve stem seals, air conditioning
compressor seals, bonded pistons for transmissions, 24-hour made-to-order oil
seals, wear sleeves for shaft sealing surface repair and truck hub seals.
These products are marketed under the brand names National(R), Mather(R),
STS(R), Redi-Seal(R), Redi-Sleeve(R) and Unipiston(R).
Gaskets. Gaskets accounted for approximately 70% of the sales for Sealing
Systems. Federal-Mogul utilizes a wide range of material technologies to
manufacture a full range of gasket types, including cylinder head gaskets in
multi-layer steel, graphite, edge molded metal plate and other composites,
valve and rocker cover gaskets, intake and exhaust manifold gaskets and
miscellaneous gaskets in steel, composite, elastomeric and spiral wound.
Federal-Mogul also offers a complete line of repair kits for professional
installers under the brand name of Fel-Pro(R). Federal-Mogul established a
strong presence in the heavy duty OE market for gaskets (including, primarily,
gaskets for light and heavy duty diesel engines) through its acquisition of
Fel-Pro. While Fel-Pro's market share of automotive OE gaskets was more
limited, T&N's Sealing Products division has a stronger presence in the
automotive OE market, adding balance to Federal-Mogul's overall OE gasket
activities.
GENERAL PRODUCTS
Federal-Mogul's General Products includes four primary product lines, which
were primarily acquired with T&N: camshafts, friction products, sintered
products and systems protection products. In addition, General Products
includes a number of smaller product lines, some of which (fuel systems
components and lighting products) pre-date the acquisition of T&N and others
of which (heat transfer products and textiles) were acquired with T&N.
Products Federal-Mogul sources from other manufacturers, which are not related
to Powertrain Systems and Sealing Systems, are included in General Products
and distributed by Worldwide Aftermarkets.
Products manufactured by Federal-Mogul's General Products accounted for
$1.2 billion of Federal-Mogul's 1997 consolidated sales (excluding $600 million
of sourced aftermarket product). Approximately 34% of the unit's manufactured
sales were in North America, 57% were in Europe and 9% were in the rest of the
world. In 1997, General Products' five largest customers by sales volume were
Ford, General Motors, LucasVarity, Peugeot and Renault (in alphabetical order).
Approximately 64% of the sales in 1997 for General Products of products it
manufactures were to OE customers while 36% were to aftermarket customers. The
Company's General Products maintains 53 manufacturing locations in 17 countries.
Camshafts. Camshafts accounted for approximately 13% of Federal-Mogul
manufactured products sales for General Products. Federal-Mogul casts,
machines and assembles camshafts primarily for the automotive market. These
products are marketed under the brand names Weyburn-Bartel(R) and Weyburn-
Lydmet(R).
Friction Products. Friction products accounted for approximately 42% of
Federal-Mogul manufactured products sales for General Products. Federal-Mogul
manufactures disc brake pads, drum brakes and brake linings for the automotive
and commercial vehicle sector. These products are marketed under the brand
name Ferodo(R) and are sold primarily in Europe.
Sintered Products. Sintered products accounted for approximately 17% of
Federal-Mogul manufactured products sales for General Products. Federal-Mogul
utilizes advanced powder metallurgy techniques for the manufacture of a wide
range of automotive components including valve guides, valve seat inserts, ABS
sensor rings and other transmission components, together with engine
components, principally pulleys, gears and sprockets. These products are
marketed under the brand names Brico(R) and Sintertech(R), solely to OE
customers.
Systems Protection Products. Systems protection products accounted for
approximately 9% of Federal-Mogul manufactured products sales for General
Products. Federal-Mogul manufactures a wide variety of
7
<PAGE>
products used for automotive under body and under hood protection from heat,
noise, abrasion and stone impingement. Most of these products are based on
braided, knitted and non-woven fabrics. Products based on the same
technologies are sold in the electrical, white goods and aerospace industries.
These products are marketed under the brand name Bentley-Harris(R), solely to
OE customers, and are sold primarily in North America.
Other General Products. Other general products--primarily consisting of
heat transfer products, fuel system components and lighting products--accounted
for approximately 19% of Federal-Mogul manufactured products sales for General
Products. Federal-Mogul is in the process of reselling the chemical
manufacturing operations acquired with Fel-Pro (representing approximately $32.8
million of Fel-Pro's 1997 net sales and $2.6 million of Fel-Pro's 1997 net
income). The primary components of other general products are:
. heat transfer products (engine cooling radiators in both aluminum and
copper brass construction and heater, ventilator and air conditioning
units for automotive in-cab use) manufactured in South Africa for sale
in the South African market and for global export under the brand names
Silverton(R), FHE(R) and Connoisseur Auto Air Conditioning(R);
. fuel system components (a full line of fuel pumps including mechanical
fuel pumps, diesel lift pumps, electric fuel pumps, electric fuel
modules and hanger assemblies) marketed in North America, under the
brand name Carter(R); and
. lighting products (clearance marker lamps, front, side and rear signal
lamps, stop, tail and turn lights, emergency lighting, turn signal
switches, auxiliary lighting and back-up lamps) marketed under the brand
name Signal-Stat(R).
Worldwide Aftermarket
Federal-Mogul's North American distribution centers in Jacksonville,
Alabama, LaGrange, Indiana, and Maysville, Kentucky (the "Distribution
Centers"), served as the core of Federal-Mogul's domestic aftermarket
distribution network prior to the acquisitions of T&N and Fel-Pro. Products
are shipped from these Distribution Centers to service centers in the United
States and Canada. For Latin American sales, products are shipped through a
facility in Weston, Florida to two international regional distribution centers
and 15 Latin American branches. For European sales, products are shipped
through Federal-Mogul's facility in Kontich, Belgium.
T&N and Fel-Pro each brought with them developed aftermarket operations
duplicating, in part, Federal-Mogul's existing capabilities. T&N was, at the
time of its acquisition, the world's largest supplier of engine parts to the
independent aftermarket, as measured by revenues (with approximately 80% of
the parts distributed having been produced by T&N). Fel-Pro also brought
significant aftermarket penetration with it, built on the substantial brand
loyalty its gasket lines have acquired through a history of technological
innovations, merchandising and marketing, which have differentiated them in
the market, particularly among professional installers. Management thus
believes that aftermarket distribution provides significant opportunities for
realization of synergies.
T&N's aftermarket distribution system at the time of the acquisition
included 36 major distribution centers and sales offices utilizing over 1,600
employees worldwide to distribute over 200,000 component parts of 5,000 engine
models via its AE and Goetze marketing networks. The Company's Worldwide
Aftermarket includes 119 distribution facilities in 19 countries.
Fel-Pro's domestic aftermarket business, focused primarily on gaskets,
primarily distributed from a state-of- the-art facility inside its Skokie,
Illinois plant, using a highly automated, virtually paperless process.
Customers
Among Federal-Mogul's largest customers are Caterpillar, Chrysler, Cummins,
Ford, General Motors, Mercedes-Benz, NAPA, Peugeot and Volkswagen/Audi (in
alphabetical order).
Original Equipment. Federal-Mogul's OE customers consist primarily of
automotive and heavy duty vehicle customers, as well as farm and industrial
equipment manufacturers, agricultural, off-highway, marine, railroad, high
performance and industrial applications. Federal-Mogul has well-established
relationships with substantially
8
<PAGE>
all major North American and European automotive OE manufacturers, some pre-
existing and others resulting from the acquisitions of T&N and Fel-Pro.
Management believes there are additional system opportunities with OE
manufacturers in the Asia-Pacific and Latin American regions. In addition,
management believes that the acquisitions of T&N and Fel-Pro have positioned
Federal-Mogul to take advantage of developing OE customer demand for single
supplier systems and modules in the future, particularly in light of Federal-
Mogul's global reach and capabilities. See "--Strategy."
Aftermarket. Federal-Mogul's domestic and international customers include
independent warehouse distributors who redistribute products to local parts
suppliers called "jobbers," industrial bearing distributors, distributors of
heavy duty vehicular parts, engine rebuilders and retail parts stores. The
breadth of Federal-Mogul's product lines, together with the strength of its
brand names and sales force, are central to Federal-Mogul's aftermarket
operations.
Research and Development
Federal-Mogul maintains technical centers in Europe and North America to
develop and provide advanced materials, products and manufacturing processes
for all of its manufacturing units, including facilities acquired with T&N and
Fel-Pro. Federal-Mogul's expertise in engineering, research and development
ensures that the latest technologies, processes and materials are considered
in solving problems for customers and bringing new, innovative product to
market. Federal-Mogul provides its customers with real-time engineering
capabilities and design development in their home countries. In recognition of
the importance of technology throughout its operations, following the
acquisitions, Federal-Mogul created the post of Vice President--Technology to
coordinate technological activities throughout its operations.
The acquisitions of T&N and Fel-Pro provided Federal-Mogul with substantial
additional technological expertise. In particular, the newly acquired
technical centers in the United Kingdom and the United States bring a new
depth of capability in materials development, surface engineering,
computational analysis, engine testing and systems engineering. Recent
achievements of these centers include development of advanced piston alloys,
novel bearing coatings, brake pads for motor sport applications, engine
structure modeling to predict gasket performance and test techniques for
measurement of bore distortion in running engines.
The Fel-Pro acquisition brought substantial research operations focusing on
gaskets and their manufacture, including complete material, application design
and process development capabilities and a dedicated design/engineering staff
of over 100 employees. Recent technology innovations pioneered by Fel-Pro
include PermaDry Plus(R), multi-layered steel head gaskets, noise and
vibration dampening devices and rubber edge molded gaskets. In the past, Fel-
Pro has introduced several product innovations including Fel-Coprene(R),
Print-O-Seal(R) and Perma-Torque Blue(R), which have become market standards
in the gasket aftermarket.
Technological activities are conducted at facilities Federal-Mogul acquired
from T&N including, in particular, its central technical center at Cawston,
England, its facility at Burscheid, Germany and its technical center at
Plymouth, Michigan, and at Fel-Pro's facilities in Skokie, Illinois, as well
as at Federal-Mogul's major pre-existing technological centers, in Ann Arbor,
Michigan, Logansport, Indiana, Malden, Missouri, and Wiesbaden, Germany. Each
of Federal-Mogul's operating units is engaged in various engineering, research
and development efforts working side by side with customers to develop custom
solutions unique to their needs.
Total expenditures for research and development activities, on a pro forma
basis, were approximately $102.8 million in 1997, $101.6 million in 1996 and
$99.8 million in 1995.
Suppliers
Federal-Mogul sells its manufactured parts as well as parts manufactured by
other manufacturers to the aftermarket. In 1997, no outside supplier of
Federal-Mogul provided products that accounted for more than 5% of Federal-
Mogul's net sales.
9
<PAGE>
Federal-Mogul does not normally experience supply shortages of raw
materials. Certain of Federal-Mogul's relationships with its long-term
suppliers are contractual.
In connection with the acquisition of the automotive aftermarket business of
TRW, Inc. ("TRW") in 1992, Federal-Mogul and TRW entered into a Supply
Agreement for an initial term of 15 years (the "Supply Period"), pursuant to
which TRW agreed to supply Federal-Mogul with parts manufactured by TRW and
distributed by Federal-Mogul. During the first five years of the Supply Period
(the "Exclusive Period"), Federal-Mogul is an exclusive distributor of such
TRW parts and thereafter will be a nonexclusive distributor for the remaining
term of the Supply Agreement, subject to certain exceptions. Thereafter, both
the Exclusive Period and the Supply Period are automatically renewable for
one-year periods and are terminable upon one year's notice by either party.
Legal Proceedings
T&N Asbestos
In the United States, Federal-Mogul's subsidiary T&N plc and two of T&N
plc's U.S. 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 plc is also subject to asbestos-
disease litigation, to a lesser extent, in the UK and to property damage
litigation based upon asbestos in the United States. 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. T&N has appointed the Center for
Claims Resolution ("CCR") as its exclusive representative in relation to all
asbestos-related personal injury claims made against the T&N Companies in the
United States. As of March 31, 1998, the Company has provided $1.351 million
as its estimate for future costs to resolve asbestos claims.
Prior to its acquisition by Federal-Mogul, T&N secured, by payment of a
premium of (Pounds)92 million, a (Pounds)500 million layer of insurance cover
which will be triggered should the aggregate number of claims notified after
June 30, 1996, where the exposure occurred prior to that date ("IBNR claims"),
exceed (Pounds)690 million. At March 31, 1998, Federal-Mogul has recorded
reserves for IBNR claims up to the insurance level, which is (Pounds)690
million. For discussion of asbestos-related liabilities and reserves, see
Notes 19 and 28 to the T&N Financial Statements and "Management's Discussion
and Analysis of Financial Condition and Results of Operations--T&N--Asbestos."
While management believes that estimated reserves, which have not been
reduced by any potential insurance proceeds, coupled with T&N's asbestos-
related claims insurance policy, are appropriate for anticipated losses
arising from T&N's asbestos related claims, no assurance can be given that T&N
will not be subject to material additional liabilities and significant
additional litigation relating to asbestos. Any such liabilities or litigation
could have a material adverse effect on Federal-Mogul's results of operations,
business, liquidity and financial condition.
Federal-Mogul and Fel-Pro Asbestos
Federal-Mogul also is one of a large number of defendants in a number of
lawsuits brought by claimants alleging injury due to exposure to asbestos. In
addition, Fel-Pro has been named as a defendant in approximately 18,000
product liability cases involving asbestos, primarily involving gasket or
packing products sold to ship owners. Federal-Mogul is defending all such
claims vigorously and believes that it and Fel-Pro have substantial defenses
to liability and adequate insurance coverage for defense costs (though Fel-Pro
has agreed with its insurers to pay approximately 20% of defense costs, in
exchange for the right to a significant role in decisions regarding the
litigation). While the outcome of litigation cannot be predicted with
certainty, after consulting with
10
<PAGE>
the office of Federal-Mogul's general counsel, management believes that
asbestos claims pending against Federal-Mogul and Fel-Pro as of March 31, 1998
will not have a material effect on Federal-Mogul's financial position.
Other
Federal-Mogul is involved in various other legal actions and claims,
directly and through its subsidiaries (including T&N and Fel-Pro). After
taking into consideration legal counsel's evaluation of such actions,
management is of the opinion that their outcomes are not reasonably likely to
have a material adverse effect on Federal-Mogul's financial position operating
results or cash flow.
Employee Relations
On March 31, 1998, Federal-Mogul had approximately 45,000 full-time
employees (including the T&N Bearings Business), of whom approximately 17,500
were employed in the United States. Approximately 13,700 of these employees
work for operations predating the acquisitions of T&N and Fel-Pro,
approximately 28,600 work for operations acquired with T&N and approximately
2,700 work for operations acquired with Fel-Pro. An anticipated result of the
integration plan and restructuring relating to the acquisitions of T&N and
Fel-Pro is a reduction of approximately 4,200 employees.
Approximately 45% of Federal-Mogul's United States employees are represented
by six unions. Approximately 50% of Federal-Mogul's foreign employees are
represented by various unions. Each of Federal-Mogul's unionized manufacturing
facilities has its own contract with its own expiration date and, as a result,
no contract expiration date affects more than one facility. Federal-Mogul
believes its labor relations to be good.
Environmental Regulations
Federal-Mogul's operations, in common with those of industry generally, are
subject to numerous existing and proposed laws and governmental regulations
designed to protect the environment, particularly regarding plant wastes and
emissions and solid waste disposal. Capital expenditures for property, plant
and equipment for environment control activities did not have a material
impact on Federal-Mogul's financial position or results of operations in 1997
and are not expected to have a material impact on Federal-Mogul's financial
position or results of operations in 1998 or 1999.
Backlog
The majority of Federal-Mogul's products are not on a backlog status. They
are produced from readily available materials and have a relatively short
manufacturing cycle. For products supplied by outside suppliers, Federal-Mogul
generally purchases products from more than one source. Federal-Mogul expects
to be capable of handling the anticipated 1998 sales volumes.
Patents and Licenses
Federal-Mogul is committed to protecting its technology investments and
market share through an active and growing international patent portfolio.
Federal-Mogul's patent portfolio is composed of a large number of foreign and
U.S. patents and pending patent applications which relate to a wide variety of
products and processes. In the aggregate, Federal-Mogul's international patent
portfolio is of material importance to its business; however, Federal-Mogul
does not consider any international patent or group of international patents
relating to a particular product or process to be of material importance when
judged from the standpoint of the business as a whole.
11
<PAGE>
COMPETITION
The global vehicular parts business is highly competitive. Federal-Mogul
competes with many of its customers that produce their own components as well as
with independent manufacturers and distributors of component parts in the United
States and abroad. In general, competition for such sales is based on price,
product quality, customer service and the breadth of products offered by a given
supplier. Federal-Mogul has attempted to meet these competitive challenges
through more efficiently integrating its manufacturing and distribution
operations, expanding its product coverage within its core businesses, and
expanding its worldwide distribution network.
PROPERTIES
Federal-Mogul conducts its business from its World Headquarters complex in
Southfield, Michigan, which is leased pursuant to a sale/leaseback arrangement.
At March 31, 1998, Federal-Mogul had over 120 manufacturing facilities with in
excess of 16 million square feet (approximately 80% of which were owned and 20%
were leased) and over 100 aftermarket facilities with in excess of 3.5 million
square feet (approximately 10% of which were owned and 90% were leased). Over
half of the manufacturing facilities (by square footage) were in Europe and
approximately one third were in North America. Over 85% of aftermarket
facilities (by square footage) were in North America, with a strong majority of
the remainder in Europe. Federal-Mogul also had other facilities (primarily
research and office only sites) accounting for approximately 800,000 square
feet.
All owned and leased properties are well maintained and equipped for the
purposes for which they are used. Federal-Mogul believes that its facilities are
suitable and adequate for the operations involved. In the case of leased
properties, Federal-Mogul believes that the leases could be renewed or
comparable facilities could be obtained without materially affecting operations.
12
<PAGE>
T&N
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
AND YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995
On March 6, 1998, Federal-Mogul completed its cash offer to acquire all
outstanding common stock of T&N for 260 pence per share. Total consideration
paid was (Pounds)1.4636 billion ($2.4164 billion, converted at a blended
exchange rate of 1 pound sterling to 1.6510 U.S. dollars). In connection with
securing regulatory approvals for the acquisition of T&N, Federal Mogul agreed
subsequently to divest certain assets, consisting principally of T&N's
thinwall and dry bearings (polymer bearings) operations. See "Business--
Reorganization." These assets are a subset of the operations T&N included in
its bearings product group and the discussion below of such product group does
not, therefore, directly correspond to the assets to be divested (which are
referred to herein as the "T&N Bearings Business").
The following discussion is based upon the audited consolidated financial
statements of T&N (the "T&N Financial Statements") which have been prepared in
conformance with generally accepted accounting principles in the United Kingdom
("U.K. GAAP"). U.K. GAAP differ in certain significant respects from generally
accepted accounting principles in the United States ("U.S. GAAP"). The
significant differences between U.S. GAAP and U.K. GAAP as they relate to T&N
are summarized in Note 29 to the T&N Financial Statements.
RESULTS OF OPERATIONS
Turnover (Net Sales)
T&N's consolidated turnover excluding associated undertakings (hereinafter
referred to as net sales) decreased by 8.0% in 1997. The 1997 decrease was
primarily due to the effects of adverse foreign exchange fluctuations, 1997
divestitures and the full year impact of 1996 divestitures. These decreases
were partially offset by the 1997 acquisition of Metal Leve, Inc., which
expanded T&N's product offerings in piston-related products, and certain
volume improvements for continuing businesses. Excluding 1997 acquisitions
(which added (Pounds)30 million to 1997 net sales) and the impact of
divestitures, 1997 net sales decreased 4.4% as compared to 1996.
The primary source of the foreign exchange fluctuation impact on T&N in 1997
was the continued appreciation of the pound sterling in relation to other
European currencies (and, to a lesser extent, the U.S. dollar) through the
year. This appreciation resulted in an adverse currency translation effect
upon overseas earnings and erosion of margins on exports billed in foreign
currency. These effects were partially offset by reduced expense for materials
imported into the U.K. Excluding the effects of (Pounds)153 million in adverse
foreign currency fluctuations and acquisitions, net sales from continuing
operations increased by approximately 4.0%.
Net sales by market were:
<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- ---------------
(POUNDS STERLING IN MILLIONS)
<S> <C> <C> <C>
Light vehicle original
equipment............... (Pounds) 731.2 (Pounds) 772.9 (Pounds) 756.6
Automotive aftermarket... 497.1 529.4 480.1
Industrial and heavy duty
original equipment...... 570.8 653.7 854.8
--------------- --------------- ---------------
(Pounds)1,799.1 (Pounds)1,956.0 (Pounds)2,091.5
=============== =============== ===============
</TABLE>
Net sales by product group (as these were configured prior to Federal-
Mogul's acquisition of T&N) were:
<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- ---------------
(POUNDS STERLING IN MILLIONS)
<S> <C> <C> <C>
Bearings................. (Pounds) 329.6 (Pounds) 333.1 (Pounds) 342.5
Sealing products......... 195.1 216.0 227.0
Friction products........ 293.9 309.5 319.0
Piston products.......... 572.8 574.7 559.6
Composites and camshafts. 372.9 381.1 328.9
--------------- --------------- ---------------
Continuing operations.... 1,764.3 1,814.4 1,777.0
Discontinued operations.. 34.8 141.6 314.5
--------------- --------------- ---------------
(Pounds)1,799.1 (Pounds)1,956.0 (Pounds)2,091.5
=============== =============== ===============
</TABLE>
13
<PAGE>
Decreases in sealing products net sales were primarily attributable to
German and French businesses. Piston products net sales, which declined by
0.3% in 1997 as compared with 1996, were affected by the acquisition of Metal
Leve, Inc. (excluding that acquisition, piston products net sales from
continuing operations decreased 5.2%).
During 1997, 1996 and 1995, T&N divested certain non-core businesses with
net sales of (Pounds)34.8 million, (Pounds)141.6 million and (Pounds)314.5
million. These divestitures included the disposition of T&N's entire
construction materials and engineering products business.
Net sales for businesses divested by product group were:
<TABLE>
<CAPTION>
DISCONTINUED OPERATIONS
----------------------------------------
1997 1996 1995
------------ ------------- -------------
(POUNDS STERLING IN MILLIONS)
<S> <C> <C> <C>
Sealing products................ (Pounds)12.1 (Pounds) 49.8 (Pounds) 49.6
Friction products............... 12.5 18.6 10.9
Composites and camshafts........ 10.2 18.9 103.5
Construction materials and
engineering.................... -- 54.3 150.5
------------ ------------- -------------
(Pounds)34.8 (Pounds)141.6 (Pounds)314.5
============ ============= =============
</TABLE>
Cost of Sales
Cost of sales as a percentage of net sales was 71.8%, 72.5% and 72.1% for
1997, 1996 and 1995, respectively. The 1997 acquisition and 1997 and 1996
divestitures had an immaterial impact on cost of sales as a percentage of net
sales. Excluding the impact of 1995 divestitures, cost of sales as a
percentage of net sales was 71.3% in 1995.
Federal-Mogul Bid Related Costs
T&N incurred (Pounds)10 million of costs in 1997 related to the acquisition
bid by Federal-Mogul. These fees were primarily for professional services
provided with respect to the offer to purchase the entire outstanding share
capital of T&N.
Other Operating Expenses
Significant components of other operating expenses were:
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------- -------------
(POUNDS STERLING IN MILLIONS)
<S> <C> <C> <C>
Selling and distribution
costs........................ (Pounds)148.8 (Pounds)168.6 (Pounds)173.5
Administrative expenses....... 130.7 148.7 144.0
Research & development........ 52.1 53.0 52.2
------------- ------------- -------------
(Pounds)331.6 (Pounds)370.3 (Pounds)369.7
============= ============= =============
</TABLE>
Selling and distribution costs as a percentage of net sales were 8.3%, 8.6%
and 8.3% for 1997, 1996 and 1995, respectively. Administrative expenses as a
percentage of net sales were 7.3%, 7.6% and 6.9% for 1997, 1996 and 1995,
respectively. The 1997 acquisition and 1997, 1996 and 1995 divestitures impact
on selling and distribution costs as a percentage of net sales and
administrative expenses as a percentage of net sales were immaterial.
Research and development costs as a percentage of net sales were 2.9%, 2.7%
and 2.5% for 1997, 1996 and 1995, respectively, and reflect T&N's continuing
commitment to investment in innovation and technology.
14
<PAGE>
ASBESTOS
In the U.S., T&N plc and two of its U.S. 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 plc is also, to a lesser extent, subject to asbestos-disease litigation in
the U.K. and to property damage litigation in the U.S. 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.
In 1996, T&N secured a (Pounds)500 million layer of insurance which will be
triggered should the aggregate cost to resolve claims notified after June 30,
1996, where the exposure occurred prior to that date (incurred but not
reported, or "IBNR," claims), exceed (Pounds)690 million. For additional
information regarding asbestos-related liabilities and reserves, see Notes 19
and 28 to the T&N Financial Statements.
Asbestos Charges Recognized in 1996 and 1997
T&N recognized two charges to establish provisions for IBNR claims for the
year ended December 31, 1996, one in the amount of (Pounds)323 million
((Pounds)550 million on an undiscounted basis) and a second in the amount of
(Pounds)50 million. The latter charge was related to the risk that U.S. courts
would reject a class action settlement to which the T&N Companies were party
(in Georgine et al v. Amchem et al). This settlement was ultimately rejected
by the U.S. Supreme Court in 1997 and some increase in new IBNR claims filed
has resulted. T&N also recognized a (Pounds)50 million charge in 1996 for
claims notified and outstanding as of June 30, 1996. In addition, T&N recorded
the (Pounds)92 million cost of the (Pounds)500 million layer of insurance in
1996, and the premium was paid in 1997. T&N recognized no additional
provisions relating to asbestos in 1997.
Asbestos-Related Payments in 1996 and 1997
T&N paid (Pounds)149.4 million for asbestos-related claims, including the
(Pounds)92 million insurance premium, during 1997 and (Pounds)64.8 million in
1996.
RELEASE OF PROVISION/(PROVISION AGAINST) FIXED ASSET INVESTMENTS:
KOLBENSCHMIDT COSTS
In March 1995, T&N entered into option arrangements for 1,345,452 shares of
Kolbenschmidt AG ("KS"), which represented approximately 49% of the
outstanding share capital of KS. In 1995, T&N recognized a charge of
(Pounds)19.5 million related to the creation of provisions relating to the
reduction of the value of fixed asset investments (the Kolbenschmidt options).
In 1996, KS issued nine shares for each share already outstanding such that
the option arrangements increased to 13,454,520 shares. In December 1996,
options over 6,727,260 shares expired and T&N recognized a (Pounds)23.4
million related charge.
In 1997, Commerzbank subsequently sold the KS shares and, subject to the
option arrangement, T&N received part of the proceeds and recognized a gain of
(Pounds)13.2 million, accordingly. In addition, T&N received an offer to
purchase its remaining interest in KS, and, as a result, T&N recognized in
1997 an additional (Pounds)19.2 million gain (the sale of such remaining
interest occurred in March 1998). (See Note 4 to the T&N Financial
Statements.)
NET INTEREST PAYABLE AND SIMILAR CHARGES - GROUP
Net interest payable and similar charges - group (hereinafter referred to as
interest expense or interest income) was (Pounds)28.4 million in 1997 as
compared to (Pounds)26.8 million in 1996.
15
<PAGE>
Gross interest expense was (Pounds)39.3 million in 1997 as compared to
(Pounds)32.5 million in 1996. The 1997 increase of (Pounds)6.8 million in
gross interest expense is primarily attributable to higher interest rates,
partially offset by lower average borrowings arising from continued
improvements in working capital. In addition, 1997 gross interest expense
includes (Pounds)2.5 million for the amortization of T&N's discounted asbestos
provision.
Gross interest income was (Pounds)10.9 million in 1997 as compared to
(Pounds)5.7 million in 1996. The 1997 increase was primarily attributable to
earnings on funds reserved for asbestos liabilities.
Net interest expense in 1996 decreased (Pounds)9.0 million as compared to
1995. The 1996 decrease was primarily due to lower debt levels and interest
rates as compared with 1995.
TAX ON PROFIT/(LOSS) ON ORDINARY ACTIVITIES (INCOME TAXES)
Income tax expense was (Pounds)62.8 million in 1997 resulting in an
effective tax rate of 33.0% compared with the statutory U.K. corporation tax
of 31.5%. The difference between the effective tax rate and U.K. corporation
rate is attributable to a number of factors, none of which are material.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows from operating activities (including asbestos) were (Pounds)111.4
million in 1997 as compared to (Pounds)215.7 million in 1996. The 1997
decrease is primarily attributable to the strong sales performance and the
increase in orders for 1998 shipment in the fourth quarter of 1997 which
limited T&N's ability to reduce debtors (accounts receivable) and stocks
(inventory) as compared to the 1996 reductions.
Capital expenditures in 1997 were (Pounds)103.9 million compared to
(Pounds)114.3 million in 1996. The 1997 decrease is primarily attributable to
the disposal of certain businesses and foreign currency fluctuations.
Proceeds from business disposals were (Pounds)75.7 million in 1997 compared
to (Pounds)74.8 million in 1996.
T&N paid (Pounds)32.6 million in 1997 for the acquisition of businesses. The
most significant acquisition in 1997 was that of Metal Leve, Inc., a
manufacturer of articulated pistons based in the United States.
LEGAL MATTERS
In addition to the asbestos litigation, T&N is engaged in various actions
arising in the ordinary course of its business. Management is of the opinion
that the outcome of these matters will not have a material adverse effect on
T&N's financial condition.
FOREIGN CURRENCY AND COMMODITY CONTRACTS
T&N was subject to exposure to market risks from changes in foreign exchange
rates and raw material price fluctuations. Derivative financial instruments
were utilized by T&N to reduce those risks. T&N does not hold or issue
derivative financial instruments for trading purposes.
OTHER MATTERS - YEAR 2000 COSTS
T&N has established a Year 2000 steering group to coordinate and address the
Year 2000 issue. Awareness and assessment stages have been completed. T&N is
currently implementing its action plan with a target completion date of
September 1998. Total costs for repair and maintenance of existing systems are
expected to approximate (Pounds)5 million ($8 million).
16
<PAGE>
FEL-PRO
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
AND YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995
On January 9, 1998, Fel-Pro's owners signed an agreement to sell the Fel-Pro
group, consisting of Fel-Pro Inc., certain operating businesses and holding
companies affiliated with Fel-Pro Inc. and certain real estate owned by Fel-Pro
Inc. or its affiliates to Federal-Mogul. The transaction closed on February 24,
1998, at which time Federal-Mogul acquired all equity interests in the specified
Fel-Pro entities for approximately $717 million, which included 1,030,325.6
shares of Series E Mandatory Exchangeable Preferred Stock ("Series E Stock")
with an imputed value of $225 million and approximately $492 million in cash.
Federal-Mogul is in the process of reselling the chemical manufacturing
operations acquired with Fel-Pro (representing approximately $32.8 million of
Fel-Pro's 1997 net sales and $2.6 million of Fel-Pro's 1997 net income).
RESULTS OF OPERATIONS
Net Sales
Fel-Pro's consolidated net sales increased 9.2% in 1997 as compared to 1996,
primarily due to volume increases from new and existing customers in the
aftermarket business. Consolidated net sales increased 15.5% in 1996 as
compared to 1995 primarily due to volume increases from new and existing
customers in the aftermarket business, as well as the acquisition of TCI, a
high performance transmission and torque converter manufacturer in December of
1995 and the acquisition of Korody-Colyer ("KC") in October of 1995 for $12.3
million and $7.1 million, respectively. Excluding the effect of the
acquisitions of TCI and KC, Fel-Pro's net sales increased 6.4% in 1995.
Original equipment and aftermarket sales of Fel-Pro were:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
(DOLLARS IN
MILLIONS)
<S> <C> <C> <C>
Original Equipment:
Americas................................................. $ 94.6 $ 88.4 $ 85.8
Aftermarket:
United States and Canada................................. 299.8 282.9 246.4
International............................................ 94.9 76.6 55.5
------ ------ ------
Total sales............................................ $489.3 $447.9 $387.7
====== ====== ======
</TABLE>
Original equipment sales increased 7.0% in 1997 as compared to 1996 due to
volume increases of gaskets for the heavy duty market partially offset by
volume decreases in the automotive market related to the end of certain
products' life cycles. Fel-Pro's original equipment sales increased 3.0% in
1996 as compared to 1995.
Aftermarket sales in the United States and Canada increased 6.0% in 1997 as
compared to 1996 primarily due to new customer business. Sales increased 14.8%
in 1996 as compared to 1995 due to the following: (i) volume increases from
new and existing customers; (ii) the December 1995 acquisition of TCI; and
(iii) the full year impact of the October 1995 acquisition of KC.
Excluding the effect of the 1995 acquisitions, Fel-Pro's aftermarket sales
in the United States and Canada increased 7.8% in 1996.
International aftermarket sales increased 23.9% in 1997 as compared to 1996
primarily due to volume increases in heavy duty diesel engine parts.
International aftermarket sales increased 38.0% in 1996 as compared to 1995
primarily due to volume increases in heavy duty engine parts which included
the full year impact of the October 1995 KC acquisition. Excluding the effect
of the acquisition, international aftermarket sales increased 22.7% in 1996.
Cost of Goods Sold
Cost of goods sold as a percent of net sales was flat in 1997 at 54.8% as
compared to 1996. Cost of goods sold as a percent of net sales decreased to
54.8% in 1996 compared to 56.0% in 1995. The decrease is primarily
attributable to cost reductions and productivity improvement efforts.
17
<PAGE>
Operating Expenses
Operating expenses as a percentage of net sales decreased to 35.5% in 1997
compared to 36.4% in 1996. The 1997 decrease is primarily attributable to Fel-
Pro's increases in sales volume exceeding the corresponding increase in
variable operating expenses. Operating expenses as a percentage of net sales
were relatively flat in 1996 as compared to 1995.
Income Taxes
Fel-Pro's $15.7 million deferred tax assets at December 29, 1996 were
written off in 1997 due to the conversion from C corporation status to
Subchapter S corporation status of its principal operating company effective
1997.
The difference between Fel-Pro's effective income tax rate and the statutory
tax rate is also due to the conversion of Fel-Pro's principal operating
company from C corporation status to Subchapter S corporation status in 1997.
In 1997, upon conversion of the principal operating company (Felt Products
Mfg. Co. and subsidiaries) to Subchapter S corporation status and in addition
to writing off the deferred tax assets, Fel-Pro recognized $7.4 million of
expense associated with LIFO recapture taxes.
LIQUIDITY AND CAPITAL RESOURCES
Cash flow from operations of $51.7 million in 1997 increased significantly
during 1997 primarily due to the write-off of $16.8 million in deferred taxes
and an $11.3 million improvement in accounts receivable over the prior year.
Cash flow used by investing activities of $18.5 million in 1997 include $3.5
million for the September purchase of certain operating assets of Biwax
Corporation. Capital expenditures were $18.3 million in 1997, primarily for
enhanced manufacturing capabilities and process improvements. Partially
offsetting these outflows were $3.9 million related to proceeds from available
for sale marketable securities.
Cash flows used by 1997 financing activities were $33.2 million, a decrease
of $32.7 million from 1996. The 1997 decrease was primarily due to lower
amounts provided to fund Fel-Pro's affiliates.
LEGAL MATTERS
Fel-Pro is engaged in various legal actions arising in the ordinary course
of its business. Management, after taking into consideration legal counsel's
evaluation of such actions, is of the opinion that it has adequate legal
defenses or insurance coverage and that the outcome of these matters will not
have a material adverse effect on Fel-Pro's financial position.
OTHER MATTERS
Year 2000 Costs
Fel-Pro is presently implementing an enterprise resource planning system
using Oracle software. This system is expected to be Year 2000 compliant. This
project was undertaken in late 1996 recognizing that information will be a key
driver for growth in the 21st century and that business needs are changing.
The system solution provides the ability to handle multiple product lines,
currencies, businesses, and locations. The existing mainframe systems lack
functionality and flexibility in addition to being incompatible with the Year
2000. The total project is expected to be completed by February 1999. The
expected cost related to Fel-Pro's Year 2000 project is immaterial.
Customer Bankruptcy Reorganization
On February 2, 1998, APS filed for reorganization protection under Chapter
11 of the United States Bankruptcy Code.
Fel-Pro believes that the allowance established related to receivables from
APS is adequate to cover any uncollectible amounts.
SIGNATURE
FEDERAL-MOGUL CORPORATION
By: /s/ Edward W. Gray, Jr.
--------------------------------------
Edward W. Gray, Jr.
Title: Sr. Vice President,
General Counsel
and Secretary
18
