Registrant's telephone number, including area code: (765) 772-4000

FAIRFIELD MANUFACTURING COMPANY, INC.
Annual Report on Form 10-K
December 31, 2002
Table of Contents

FAIRFIELD MANUFACTURING COMPANY, INC.
Form 10-K
Fiscal Year Ended December 31, 2002

The Company owns and operates a facility in Lafayette, Indiana consisting of 39 acres of land, approximately 540,000 square feet of manufacturing space and approximately 60,000 square feet of office space. With the acquisition of FAL, the Company acquired additional manufacturing space of approximately 50,000 square feet, located near Belgaum, India. During 2001 the Company expanded its FAL operations to 170,000 square feet covering approximately 14 acres of land.

In June 1999, the Company experienced a fire at its manufacturing plant in Lafayette, Indiana. The fire damaged a portion of the facility and some of its equipment. By January 2000, the Company had restored its physical capabilities to the same level as before the fire. The damages of the fire, including the costs of clean-up and business interruption, were covered by insurance and, during the quarter ended June 30, 2000, the Company and its insurance carrier agreed to a final settlement of the resulting claims.

Direct costs associated with the clean-up and repair portion of the claim were $8.9 million, all of which was reimbursed by the insurance carrier by the third quarter of 2000. The business interruption portion of the claim was $16.5 million, all of which was reimbursed by the insurance carrier by the third quarter of 2000.

The Company is a party to routine litigation incidental to the conduct of its business, much of which is covered by insurance and none of which is expected to have a material adverse effect on the Company.

On or about February 26, 2002, Peter Joseph, a director and Vice President of the Company, commenced a lawsuit (the "Derivative Lawsuit") against the Company, the Company's sole shareholder, Lancer, and Paul Levy (also a director, Chairman of the Board and Vice President of the Company) in the Court of Chancery in Delaware, challenging certain corporate actions by Lancer and the Company. Both Messrs. Levy and Joseph are also directors, officers and shareholders of Lancer. Following commencement of the Derivative Lawsuit, special litigation committees ("SLCs") of the boards of each of Lancer and the Company investigated the allegations of the complaint and concluded that the suit was largely without merit. An agreement in principle to settle the Derivative Lawsuit has been reached by the parties and approved by the board of Lancer. The settlement remains subject to review and approval by the Court of Chancery in Delaware. The Company does not expect that the Derivative Lawsuit or the proposed settlement will have a material adverse effect on the Company.

On or about March 8, 2002, Kaydon Corporation ("Kaydon") commenced a lawsuit against the Company and several of the Company's employees who were formerly employed by Kaydon. Kaydon alleges that the Company and certain of its employees have appropriated Kaydon trade secrets, induced Kaydon employees to leave their employment at Kaydon, and are now competing with Kaydon unfairly. On March 14, 2002, the Ann Arbor court rejected Kaydon's motion for an injunction against the Company.  The court ruled that Kaydon had not established any of the requirements for an injunction, and that Kaydon had failed to establish it was likely to succeed on the merits of its allegations. The Company believes that the lawsuit is without merit and does not expect it to have a material adverse effect on the Company.

In connection with the Kaydon lawsuit, the Company has incurred legal fees through December 31, 2002, and accordingly has recognized a provision for these expenses. The Company carries directors and officers insurance coverage; however, the Company's insurance carrier has initially denied full coverage for the legal fees incurred to date to defend the Company in this lawsuit. The Company believes that this lawsuit and the legal fees generated by this lawsuit are covered under the Company's insurance policy. The Company has engaged legal counsel to assist in the negotiations with the insurance carrier and will likely continue through litigation if an agreeable solution is not reached. The Company does not believe it will be responsible for the legal fees incurred to date for the Kaydon lawsuit, but until such time these legal fees are recovered, the Company will continue to expense the fees as incurred.

No matters were submitted to a vote of the Company's security holders during the fourth quarter of the fiscal year ended December 31, 2002.

Market Information

There is currently no trading market for the Company's common stock which is wholly owned by Lancer.

Dividends

The Company did not declare or pay any dividends on its common stock in 2002, 2001 or 2000. There are restrictions on the Company's ability to pay dividends under the loan agreement for the Company's Credit Facility, the Indenture for the Company's 9-5/8% Senior Subordinated Notes due 2008 and the Certificate of Designation for the Company's 11-1/4% Series A Cumulative Exchangeable Preferred Stock.

Issuance of Common Stock

No shares were issued during the period covered by this report.

The following selected financial data for the Company for the five years ended December 31, 2002 has been derived from the audited consolidated financial information for the Company for such periods. The following selected financial data should be read in connection with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and is qualified in its entirety by reference to the Consolidated Financial Statements and Notes thereto of the Company contained in Item 8 to this Form 10-K.

Management's discussion and analysis, as set forth below, of the Company's financial condition and results of operations should be read in conjunction with, and is qualified by reference to, the Company's audited consolidated financial statements and related notes thereto and the description of the Company's business which are found under Items 8 and 1 of this Form 10-K, respectively.

Recent Developments

Goodwill
In June 2001, the Financial Accounting Standards Board ("FASB") approved Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets."

SFAS 141 requires the purchase method of accounting be used for all business combinations initiated after June 30, 2001, establishes specific criteria for the recognition of intangible assets separately from goodwill and requires unallocated negative goodwill to be written off immediately as an extraordinary gain. The Company believes that the adoption of SFAS 141 will have no impact on its results of operations and financial position.

SFAS 142 requires that goodwill and indefinite lived intangible assets no longer be amortized, goodwill and indefinite life intangibles be tested for impairment at least annually (or more frequently if impairment indicators arise) and that the amortization period of intangible assets no longer be limited to forty years. SFAS 142 is effective for fiscal years beginning after December 15, 2001, with earlier adoption permitted. The Company adopted SFAS 142 beginning with the first quarter of fiscal year 2002. Accordingly, the Company ceased amortization of all goodwill as of January 1, 2002.

Under SFAS 142, the impairment test for goodwill requires a two-step process. The first step is to compare the carrying amount of the reporting unit's assets to the fair value of the reporting unit. If the carrying amount exceeds the fair value then the second step is required to be completed, which involves the fair value of the reporting unit being allocated to each asset (recognized and unrecognized) and liability with the excess being implied goodwill. The impairment loss is the amount by which recorded goodwill exceeds the implied goodwill.

The Company was required to complete a "transitional" impairment test for goodwill as of the beginning of the fiscal year in which the statement was adopted on a "reporting unit" basis. A reporting unit is the operating segment unless, at businesses one level below that operating segment (the "component" level), discrete financial information is prepared and regularly reviewed by management. However, SFAS 142 requires that two or more component-level reporting units with similar economic characteristics be combined into a single reporting unit. The Company believes it should use one reporting unit in applying the provisions of this standard.

Upon adoption of SFAS 142, the Company recorded a one-time, non-cash charge of $46.5 million, which represents the Company's full, unamortized balance of goodwill and is reported in the caption, "Effect of change in accounting principle." In calculating the impairment charge, the Company estimated the fair value of its reporting unit by applying three valuation approaches: the market value of the Company's capital structure, discounted cash flow analysis, and public company capitalization multiples. For purposes of determining both the carrying value and fair value of the reporting unit, the obligations assigned to the reporting unit exclude the Company's long-term debt and preferred stock. The Company believes that a willing buyer in a hypothetical sale transaction would acquire the net operating assets of the Company, excluding the long-term debt and preferred stock. Accordingly, the carrying value used by the Company to assess the application of SFAS 142 is the Company's common stock value as adjusted to exclude the effects of its long-term debt and preferred stock.

The primary factors resulting in the impairment charge were the continued softness in the Company's core markets and increased competition from foreign competitors. These factors have had a negative impact on revised earnings forecasts. No impairment charge was appropriate under the FASB's previous goodwill impairment standard, which was based on undiscounted cash flows.

In accordance with this standard, the Company's first quarter 2002 results have been restated to reflect the effect of change in accounting principle. SFAS 142 does not provide for restatement of the Company's results of operations for periods ending prior to January 1, 2002. Goodwill amortization was $1.7 million in 2001.

Other Recent Accounting Pronouncements
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This standard is effective for fiscal years beginning after June 15, 2002, and provides accounting requirements for asset retirement obligations associated with tangible long-lived assets. The Company does not believe that the adoption of this standard will have a material impact on the Company's consolidated financial statements.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." This statement creates one accounting model, based on the framework established in SFAS 121, to be applied to all long-lived assets including discontinued operations. SFAS 144 was effective for the Company at the beginning of fiscal year 2002 and had no impact on the Company's financial statements.

In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." In addition to amending and rescinding other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions, SFAS 145 limits companies from recording gains and losses from the extinguishment of debt as an extraordinary item. SFAS 145 is effective for fiscal years beginning after May 15, 2002. The Company does not believe that the adoption of this standard will have a material impact on the Company's consolidated financial statements.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not believe that the adoption of this standard will have a material impact on the Company's consolidated financial statements.

In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions, an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9." The standard provides guidance for the accounting and reporting for the acquisition of all or part of a financial institution, excluding those transactions between two or more mutual enterprises. It also provides guidance for accounting for the impairment or disposal of long-term customer-relationship intangible assets of financial institutions, including the long-term customer-relationship intangibles of mutual enterprises. The provisions of this statement primarily take effect for relevant activities that occur on or after October 1, 2002, with earlier adoption permitted in some cases. The Company does not believe that the adoption of this standard will have a material impact on the Company's consolidated financial statements.

In November 2002, the FASB issued FASB Interpretation No. ("FIN") 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others." FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under the guarantee. Guarantors will also be required to meet expanded disclosure requirements. The initial recognition and measurement provisions of FIN 45 are effective for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of both interim and annual periods that end after December 15, 2002. The Company has adopted the disclosure provisions of this Interpretation in the Notes to the Consolidated Financial Statements included in this annual report. The Company will comply with the recognition and measurement provisions of FIN 45 beginning January 1, 2003. The Company does not be lieve that the adoption of this Interpretation will have a material impact on the Company's consolidated financial statements.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of SFAS No. 123." The standard provides additional transition guidance for companies that elect to voluntarily adopt the fair-value method of accounting for stock-based compensation. In addition, it requires more prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The standard is effective for annual financial statements for fiscal years ending after December 15, 2002 and for interim financial statements commencing after such date. The Company does not believe that the adoption of this standard will have a material impact on the Company's consolidated financial statements.

In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest Entities." The primary objectives of FIN 46 are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights ("variable interest entities" or more commonly referred to as "special purpose entities") and how to determine when and which business enterprise should consolidate the special purpose entity. The Interpretation applies immediately to entities created after January 31, 2003. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The Company does not believe that the adoption of this Interpretation will have a material impact on the Company's consolidated financial statements.

Deferred Income Taxes
During the current year, the Company sustained continuing losses that gave rise to net deferred tax assets of $6.3 million. As it is more likely than not that the Company will be unable to realize any tax benefit as a result of the current operating losses, the Company recorded a full valuation allowance against the deferred tax assets to reflect this uncertainty.

Additional Minimum Pension Liability
At the September 30, 2002 measurement date for the valuation of the Company's obligation for its defined benefit pension plan, the accumulated benefit obligation exceeded the fair value of plan assets and the Company's recorded accrued pension cost. As a result, under SFAS 87, the Company recorded an additional minimum liability in the amount of $7.4 million. Recognition of an additional minimum liability does not affect pension expense. Instead, a corresponding intangible asset was recognized equal to the amount of unrecognized prior service cost of $2.2 million. Since the additional minimum liability exceeded the unrecognized prior service cost, the Company reported the excess of $5.2 million, net of tax of $0, as a separate component of stockholder's equity (i.e. a reduction of comprehensive income).

Legal Proceedings
On or about February 26, 2002, Peter Joseph, a director and Vice President of the Company, commenced a lawsuit (the "Derivative Lawsuit") against the Company, the Company's sole shareholder, Lancer, and Paul Levy (also a director, Chairman of the Board and Vice President of the Company) in the Court of Chancery in Delaware, challenging certain corporate actions by Lancer and the Company. Both Messrs. Levy and Joseph are also directors, officers and shareholders of Lancer. Following commencement of the Derivative Lawsuit, special litigation committees ("SLCs") of the boards of each of Lancer and the Company investigated the allegations of the complaint and concluded that the suit was largely without merit. An agreement in principle to settle the Derivative Lawsuit has been reached by the parties and approved by the board of Lancer. The settlement remains subject to review and approval by the Court of Chancery in Delaware. The Company does not expect that the Derivative Lawsuit or the proposed settlement will have a material adverse effect on the Company.

On or about March 8, 2002, Kaydon Corporation ("Kaydon") commenced a lawsuit against the Company and several of the Company's employees who were formerly employed by Kaydon. Kaydon alleges that the Company and certain of its employees have appropriated Kaydon trade secrets, induced Kaydon employees to leave their employment at Kaydon, and are now competing with Kaydon unfairly. On March 14, 2002, the Ann Arbor court rejected Kaydon's motion for an injunction against the Company.  The court ruled that Kaydon had not established any of the requirements for an injunction, and that Kaydon had failed to establish it was likely to succeed on the merits of its allegations. The Company believes that the lawsuit is without merit and does not expect it to have a material adverse effect on the Company.

In connection with the Kaydon lawsuit, the Company has incurred legal fees through December 31, 2002, and accordingly has recognized a provision for these expenses. The Company carries directors and officers insurance coverage; however, the Company's insurance carrier has initially denied full coverage for the legal fees incurred to date to defend the Company in this lawsuit. The Company believes that this lawsuit and the legal fees generated by this lawsuit are covered under the Company's insurance policy. The Company has engaged legal counsel to assist in the negotiations with the insurance carrier and will likely continue through litigation if an agreeable solution is not reached. The Company does not believe it will be responsible for the legal fees incurred to date for the Kaydon lawsuit, but until such time these legal fees are recovered, the Company will continue to expense the fees as incurred.

Resignation of Chief Executive Officer
As reported on the Company's Form 8-K dated February 7, 2003, the Company announced that Stephen K. Clough resigned as its President and Chief Executive Officer to pursue other business interests and to spend more time in Florida with his family where it resides. Mr. Clough joined Fairfield in August 1998 and was responsible for its development of an offshore manufacturing facility and procurement function in India. Mr. Clough will continue to serve as a director of Fairfield. Mr. W.B. (Bill) Lechman, a director of Fairfield and its former President and Chief Executive Officer, will assume the duties of Interim President and Chief Executive Officer until a permanent replacement is found. Mr. Lechman has been a long-time resident of Lafayette, Indiana.

Results of Operations

The Company's net sales and profits have been adversely affected by the general slowdown in the economy and the continuing recession, as well as a result of pricing pressure from foreign competitors, principally due to the strong U.S. dollar during 2000 to 2002. Even though the U.S. dollar has recently weakened, the competitive pricing environment remains unchanged. In addition, the Company's profitability has suffered due to an unfavorable product mix, which is a result of the Company's decision to take on new business at lower margins to get through the economic downturn coupled with a decrease in volume on higher margin sales. The Company's current level of sales and profits has strained its liquidity and capital resources, and the present market conditions are expected to continue for the foreseeable future.

Fiscal Year 2002 Compared with Fiscal Year 2001
Net sales for 2002 increased $2.6 million to $140.9 million compared to $138.3 million in 2001, a 1.9% increase. The market downturn began in the second half of 2000 and has continued throughout 2002 for many of the Company's markets. The most severe market downturn occurred in the access platform market where the Company not only suffered the market downturn but also further margin erosion even with the implementation of its off-shore sourcing program and investment. New programs by the Company in the on-highway and industrial markets primarily drove the increase in sales. These new programs are at lower margins which the Company pursued to work through the economic downturn. The Company experienced a slight recovery in the agriculture market, and some recovery in the road rehabilitation market during 2002 as compared to 2001. While the Company's sales into mining, rail and oil related markets declined less than its sales in the access platform market, these markets suffered a steeper decline in t he fourth quarter. The Company believes that the downturn in several of its core markets is a direct result of the slowdown in the U.S. economy, tight lending and capital policies, and pricing pressure from foreign competition. The Company continues to execute its expansion plans at Fairfield Atlas Limited ("FAL"), the Company's subsidiary in India, to gain access to new markets and to develop a low cost manufacturing and procurement base for certain products. Those operations are growing more slowly than anticipated and recent world and regional events have continued to disrupt the benefits expected from them.

Cost of sales for 2002 increased $10.8 million to $135.3 million, or 96.0% of net sales, compared to $124.5 million, or 90.0% of net sales in 2001. The decrease in gross margin relates to the decision to accept lower margin new business through the economic downturn, production inefficiencies due to the launch of new business, higher healthcare costs, unfavorable product mix and continued pricing pressure.

Selling, general and administrative expenses ("SG&A") decreased to $14.2 million in 2002, compared to $14.7 million in 2001. The decrease in SG&A expenses reflects the fact that goodwill is no longer amortized under SFAS 142. Goodwill amortization was $1.7 million in 2001. The benefit of lower goodwill amortization in 2002 is offset by legal expenses incurred as a result of the Kaydon litigation discussed above and in Note 18 of this annual report.

Loss from operations increased $7.7 million, to $8.6 million compared to $0.9 million in 2001 due to the reasons stated above. Other expense for 2002 was $0.1 million.

Interest expense, including amortization of deferred financing costs, was $12.0 million for 2002 compared to $11.2 million in 2001. The increase reflects higher borrowings due to the FAL expansion, reduced short term interest rates on lower cash balances and increased margins over LIBOR on the Company's senior credit facility due to the amendments to the Company's senior debt agreement as discussed below and in Note 13 of this annual report.

The Company's 2002 net loss of $65.0 million includes a one-time, non-cash charge for goodwill impairment of $46.5 million recognized upon adoption of SFAS 142 discussed above and in Note 12 of this annual report. The Company's net loss in 2001 was $8.4 million.

Fiscal Year 2001 Compared with Fiscal Year 2000
Net sales for 2001 decreased $22.8 million to $138.3 million compared to $161.1 million in 2001, a 14.2% decrease. The market downturn began in the second half of 2000 and continued throughout all of 2001 for many of the Company's markets. The most severe market downturn occurred in the access platform market. Additional softness continued in the road rehabilitation and agriculture markets. Market demand for rail was higher in the first half of 2001 but declined during the second half of 2001 compared to 2000. Although the on-highway market continues to remain depressed, the Company introduced new programs in this market resulting in higher on-highway sales during the second half of 2001 versus 2000.

Cost of sales for 2001 decreased $10.7 million to $124.5 million, or 90.0% of net sales, compared to $135.2 million, or 83.9% of net sales in 2000. The decrease in cost of sales resulted primarily from the decrease in sales volume whereas the increase in cost of sales as a percentage of sales resulted from production inefficiencies due to the lower sales volume, unfavorable product mix, and pricing pressure.

Selling, general and administrative expenses ("SG&A"), including goodwill amortization, increased to $14.7 million in 2001, compared to $13.4 million in 2000. SG&A in 2000 includes $1.0 million of incentive compensation expense and a credit of $2.3 million related to the Incentive Plan for Senior Management recorded in 1999.

Operating income decreased $13.4 million, to $(0.9) million compared to $12.5 million in 2000 due to the reasons discussed above.

Interest expense, including amortization of deferred financing costs, was $11.2 million for 2001 compared to $9.8 million in 2000. The increase reflects higher borrowings due to the FAL expansion, reduced short term interest rates on lower cash balances and increased margins over LIBOR on the Company's senior credit facility due to weaker results (see "Liquidity and Capital Resources" below).

Other (income) expense includes $9.5 million from business interruption insurance income recorded in the first and second quarters of 2000 in final settlement of the insurance claim relating to the fire in the Company's facilities (see Item 2, "Properties").

The effective tax rates for 2001 and 2000 were 27.8% and 43.5% respectively. See Note 10 to this annual report for a further discussion of income taxes.

The Company's net income decreased $15.3 million to an $8.4 million loss for 2001 compared to $6.9 million for 2000 due to the reasons discussed above. Net income available to common stockholder for 2001 decreased $15.6 million to $(14.5) million compared to $1.1 million net income available to common stockholder for 2000.

Liquidity and Capital Resources

Net cash provided by operations decreased $4.7 million for the year ended December 31, 2002 compared to 2001. Net cash provided by operations was $(6.9), $(2.2) and $13.3 million for the years ended December 31, 2002, 2001 and 2000, respectively. This decrease is primarily due to lower profitability offset in part by an increase in accrued liabilities. Working capital less cash at December 31, 2002 decreased to $9.2 million from $14.1 million at December 31, 2001.

Net capital expenditures for various machine tools, equipment and building improvement items totaled $3.6, $7.9 and $3.9 million for the fiscal years ended December 31, 2002, 2001 and 2000, respectively, exclusive of $0.2, $1.1, and $0.8 million which was funded by accounts payable at the respective period end in 2002, 2001 and 2000. The capital expenditures for 2002, 2001 and 2000 have been primarily for the FAL expansion.

Net cash provided by financing activities was $7.7, $6.5 and $(6.7) million in 2002, 2001 and 2000, respectively. The additional proceeds from issuance of long-term debt relates to additional term loans used to finance the FAL expansion and operations. In similar respects to 2001, the net cash provided in 2002 resulted primarily from the preferred stock dividends paid in kind (described below) and the proceeds from the issuance of long-term debt.

Credit Facilities
The Company has a Credit Facility provided to it by General Electric Capital Corporation ("GE Capital"). At December 31, 2002, the Company has $15.0 million of term loans outstanding under the Credit Facility. In connection with the FAL acquisition in 2000, GE Capital extended a Credit Facility to FAL in India and, in June 2001, agreed to allow FAL to obtain multiple disbursements term loans and a working capital facility. Pursuant to the Credit Facilities, FAL is allowed to borrow up to $12.0 million, all of which borrowings are guaranteed by the Company. At December 31, 2002, FAL has approximately $11.8 million of loans outstanding. In addition, the Credit Facility provides for $20.0 million of revolving loans to the Company, including up to $4.0 million under a letter of credit subfacility of which $0.8 million is outstanding at December 31, 2002, subject to certain conditions described below.

At December 31, 2002, the Company has $8.3 million of availability under the revolver, calculated as the difference between the aggregate borrowing limit under the revolver and the Company's total revolving borrowings under the Credit Facility. An updated appraisal of the Company's inventory was completed in March 2003. Although not effective at the end of the year, if the updated appraisal value was applied to the revolver availability calculation at December 31, 2002, the availability would have been reduced by $2.3 million. The Company has the option of increasing the revolver availability by up to $5.0 million, subject to the satisfaction of certain conditions. Also, the Company may incur up to an additional $12.0 million of loans under the Credit Facility in the event it is required, under its guarantee, to repay GE Capital any loans made by GE Capital to FAL. Commitments under the revolver terminate on July 1, 2005. All borrowings outstanding under the credit facility are payable in a single p rincipal payment on July 1, 2005.

The Company's borrowing base for borrowings of revolving loans (which borrowing base is based on eligible accounts receivable and inventory) must exceed revolving loans by at least $7 million, which may have the effect of reducing the Company's availability under the revolving credit facility. The Company's availability under the revolver is subject to additional restrictions should the Company pay preferred stock dividends. Also, the Company's aggregate borrowings under the Credit Facility are capped by the sum of the Company's eligible accounts receivable and appraised values of inventory, real property and machinery and equipment. The Company and GE Capital amended the Credit Facility on September 5, 2002 to, among other matters, eliminate certain restrictive financial covenants. In connection with the amendment, the interest rates on the Company's borrowings were increased, and the Company incurred an amendment fee of $0.1 million.

As discussed above and in Note 12 of this annual report, the Company recorded a transitional impairment loss on goodwill of $46.5 million effective January 1, 2002 in accordance with SFAS 142. In conjunction with the amendment, the Company obtained written confirmation from its senior lender that the impairment loss would not result in the assertion of a default under the existing material adverse effect clause stated in the credit agreement. Per the credit agreement, the senior lender reserves the right to deem the Credit Facility in default, and in those limited circumstances, could accelerate payment of the outstanding loan balances under the Credit Facility, should the Company undergo a material adverse effect. While the criteria defining a material adverse effect are not objectively determinable, the Company does not believe its exercise is probable. In addition, the Company believes that the credit agreement entered into with its senior lender in form and intent is long-term in nature. Accordingly , the Company continues to consider classification of its senior term loans as long-term to be appropriate.

Indebtedness under the Credit Facility is collateralized by a pledge of the Company's common stock owned by Lancer and a lien on, and security interest in, substantially all of the Company's assets, including, without limitation, all capital stock of subsidiaries, real estate, equipment, inventory, accounts receivable and cash. The Credit Facility contains certain restrictive covenants limiting among other things, additional debt, additional liens, transactions with affiliates, mergers and consolidations, liquidations and dissolutions, sales of assets, dividends, capital expenditures, sales and leaseback transactions, operating leases, investments, loans and advances, prepayment and modification of debt instruments, the taking or the failure to take, certain actions with respect to the Tax Sharing Agreement and other matters customarily restricted in such agreements. In addition, the Credit Facility contains certain customary affirmative covenants and events of default.

Until recently, the Company has relied principally on cash flow from operations to pay operating expenses, capital expenditures, interest and other expenses, and has not had to rely on borrowings under its Credit Facility. Due to continuing losses incurred in 2002 and 2001, resulting in reductions in cash from operations, the Company may not be able to continue to rely on operating cash and may be required to borrow funds on the revolver under its Credit Facility. The Company's ability to borrow under the Credit Facility is subject to the conditions described above. The Company expects to meet these conditions and have borrowing capacity available during 2003, although no assurance can be given. If the Company's borrowing limit is reached and its senior lender does not agree to amend, and thereby extend the available borrowings, the Company will not be able to borrow under the Credit Facility and, as a result, may have liquidity concerns. In addition, if the Company fails to satisfy the covenants in its Credit Facility, the senior lender may accelerate the Company's obligations, in which case all loans under the Credit Facility would be immediately due and payable. If the senior lender so accelerates its loans, the Company's Senior Subordinated Notes and the Exchangeable Preferred Stock (described below) would also be immediately due and payable.

9-5/8% Senior Subordinated Notes due 2008
On May 19, 1999, the Company issued $100 million of 9-5/8% Senior Subordinated Notes due October 15, 2008. The proceeds of the offering were used by the Company as follows; 1) approximately $68.6 million was used to redeem the 11-3/8% Senior Subordinated Notes due 2001; 2) approximately $27.7 million was used to reduce outstanding amounts under its Credit Facility and; 3) approximately $3.7 million was used to pay the fees and expenses of the offering.

Exchangeable Preferred Stock
On March 12, 1997 the Company issued 50,000 shares of 11-1/4% Cumulative Exchangeable Preferred Stock, liquidation preference $1,000 per share, representing an aggregate liquidation preference of $50.0 million. The Exchangeable Preferred Stock is exchangeable at the option of the Company, in whole but not in part, for 11-1/4% Subordinated Exchange Debentures due 2009 (the "Exchange Debentures"), in aggregate principal amount equal to the liquidation preference of the Exchangeable Preferred Stock following the redemption of the Existing Notes, subject to the satisfaction of certain conditions.

The Company is required, subject to certain conditions, to redeem all of the Exchangeable Preferred Stock outstanding on March 15, 2009 at a redemption price equal to 100% of the liquidation preference thereof plus, without duplication, accumulated and unpaid dividends to the date of redemption. The maturity date of the Exchange Debentures is March 15, 2009.

The Exchangeable Preferred Stock pays dividends at a rate equal to 11-1/4% per annum of the liquidation preference per share, payable semiannually on each March 15 and September 15 in cash, or, on or prior to March 15, 2002, in kind on each March 15 and September 15. Interest on the Exchange Debentures is also 11-1/4% per annum. The Company elected to pay the March 15, 2001, September 15, 2001 and March 15, 2002 Exchangeable Preferred Stock dividends in kind and, in connection therewith, issued 2,812.5 and 2,970.7 and 3,137.8 shares of Exchangeable Preferred Stock to the holders of record as of March 1, 2001, September 1, 2001 and March 1, 2002, respectively.

The Company elected not to pay the September 15, 2002 Exchangeable Preferred Stock dividend. In addition, as reported in the Company's March 14, 2003 Form 8-K, the Company will not pay the March 15, 2003 Exchangeable Preferred Stock dividend. Accordingly, the dividends will continue to accrue in accordance with the terms of the agreement relating to the preferred stock. If the Company fails to pay dividends with respect to three or more semi-annual dividend periods (whether or not consecutive), the holders of the preferred stock, by majority vote, will be entitled to elect the lesser of two directors or that number of directors constituting at least 25% of the Company's board of directors.

In addition to the "Recent Accounting Pronouncements" and discussion of the Company's capital structure components described above, the Company believes the following accounting policies are significant and important to fully understanding the financial results of the Company:

Allowance for Doubtful Accounts. The Company's accounts receivable are comprised of amounts owed to the Company for the sales of its products net of an allowance for doubtful accounts. The Company's estimate of this allowance is based on historical customer payment experience and reflects the Company's best estimate of collectibility. Future events and circumstances related to the financial condition of the Company's customers could materially change these estimates.

Inventory Valuation. Inventories are valued at the lower of cost or market. Cost is generally determined on the last-in, first-out (LIFO) basis for U.S. inventories and on the first-in, first-out (FIFO) basis for non-U.S. inventories. Where appropriate, standard cost systems are utilized for purposes of determining costs. The standards are adjusted as necessary to ensure they approximate actual costs. Inventory values are reduced by the amount of inventory on hand that is identified to be slow-moving or obsolete.

Retirement Benefits. The Company's pension and other postretirement and postemployment benefit costs and obligations are dependent upon key assumptions used by actuaries in calculating such amounts. In addition, actuaries use similar assumptions and industry guidelines to calculate the funding contributions the Company must make to the pension plan. These assumptions include discount rates, wage rate increases, long-term return on plan assets, retirement rates, mortality rates and other factors. The Company is required to consider current market conditions, including changes in interest rates, in setting these assumptions. Changes in retirement benefit costs, the recognized obligation and employer funding requirements may occur in the future as a result of a number of factors, including changes to these assumptions. While the Company believes that the assumptions used are appropriate, no assurance can be given that actual experience will not differ from the chosen assumptions. See Note 9 of this annual report for more information regarding the Company's retirement benefits.

Open Market Purchases and Shareholder Contributions

The Company and its affiliates, including Lancer, have purchased and, from time to time, may purchase in open-market transactions the 9-5/8% Senior Subordinated Notes due 2008 and/or the 11-1/4% Cumulative Exchangeable Preferred Stock.

Under the Tax Sharing Agreement (as defined hereinafter), Lancer made capital contributions to the Company of $0, $0 and $2.1 million in 2002, 2001 and 2000, respectively. No contributions were made in 2002 or 2001 because the Company did not generate any income. See Note 10 to this annual report for a further discussion of capital contributions made pursuant to the Tax Sharing Agreement.

Inflation

The impact of inflation on the Company's operations has not been significant to date. However, there can be no assurance that a high rate of inflation in the future would not have an adverse effect on the Company's operating results.

Information Concerning Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933. Statements that are not simply statements of historical fact (such as when the Company describes what it believes, expects or anticipates will occur, and other similar statements), may not be correct, even though the Company currently believes they are reasonable. The Company does not guarantee that the transactions and events described in this report will happen as described (or that they will happen at all). This report should be read completely and with the understanding that actual future results may be materially different from what the Company expects. The Company will not update these forward-looking statements, even though its situation will change in the future. Whether actual results will conform to the Company's expectations and predictions is subject to a number of risks and uncertainties, including:

• the Company's outstanding indebtedness and leverage;
• restrictions imposed by the terms of the Company's indebtedness, and the acceleration of all of the Company's indebtedness in the event the senior lender accelerates amounts due under the Credit Facility;
• the high degree of competition in the Company's business;
• the strength of the U.S. dollar against foreign currencies;
• the susceptibility of the Company's business to general economic conditions;
• the cyclical nature of the Company's business;
• future modifications of existing environmental laws and human health regulations;
• discovery of unknown contingent liabilities, including environmental contamination at the Company's facilities;
• the Company's dependence on suppliers of raw materials and major customers;
• the effect of tightened liquidity markets on the Company's customers;
• the Company's ability to manage and execute its strategy with regard to the FAL acquisition;
• the control of Lancer, the Company's sole shareholder; and
• future capital requirements.

Reference is made to the Consolidated Financial Statements beginning at page F-1 herein.

None.

The following table sets forth certain information with respect to the directors and executive officers of the Company, including their respective ages as of March 3, 2003.

Mr. Levy was elected Chairman of the Board effective August 1998. Mr. Levy has been Vice President and Assistant Secretary and a Director of the Company since 1989. Mr. Levy has been a General Partner of JLL Partners since its inception in 1988. Mr. Levy has served as Chief Executive Officer and Chairman of the Board of Directors of Lancer since July 1989. Mr. Levy is also on the Board of Directors of Hayes Lemmerz International, Inc., New World Pasta Company, AdvancePCS, IASIS Healthcare, Motor Coach Industries International and Builders FirstSource, Inc.

Mr. Joseph has been Vice President, Director and Secretary of the Company since 1989. Mr. Joseph has served as President of Lancer since April 1992 and as Secretary and Director of Lancer since July 1989. Mr. Joseph has been a principal of Palladium Equity Partners, LLC since 1998. Prior to that, he was a partner of Joseph Littlejohn & Levy, since renamed JLL Partners.

Mr. Lechman was appointed the President and Chief Executive Officer effective February 7, 2003 upon the resignation of Mr. Clough. Mr. Lechman has been a Director of the Company since 1989. Mr. Lechman served as Chairman of the Board from October 1994 to July 1997 and as President and Chief Executive Officer of the Company from 1989 to October 1994. Mr. Lechman serves on the Board of Directors of Lafayette Junior Achievement and AGMA Foundation, and he is President Emeritus of the American Gear Manufacturers Association.

Mr. Clough was the President and Chief Executive Officer of the Company from August 1998 until February 7, 2003 when he resigned. Mr. Clough continues to serve as a director of the Company. Prior to his appointment, Mr. Clough was employed by Kaydon Corporation where he served as the President and Chief Executive Officer from June 1996 to June 1998 and the President and Chief Operating Officer from September 1989 to June 1996.

Mr. Heyer is a founder of Trimaran Capital Partners, a private asset management firm. Mr. Heyer is also a Vice Chairman of CIBC World Markets Corp., co-head of CIBC Argosy Merchant Banking Funds, and a member of CIBC's U.S. Management Committee. Prior to joining CIBC in 1995, Mr. Heyer was a founder and managing director or The Argosy Group L.P. Mr. Heyer serves as a director of Lancer, eLink Communications, Inc., Niagara Corporation, The Hain Celestial Food Group, Inc., Millennium Digital Media Holdings, L.L.C., and Village Voice Media, LLC.

Mr. Green was elected as a Director of the Company on March 15, 2002. Mr. Green has been the Chief Executive Officer of HFA Consulting Company and the President and Chief Executive Officer of Green Management and Investment Company since 1990 and 1985, respectively. Mr. Green is on the Board of Directors of Lancer.

Mr. Angel was elected as a Director of the Company on March 15, 2002. Mr. Angel has been the Senior Managing Shareholder of Angel & Frankel, P.C., a New York based law firm which has specialized in commercial insolvency for over 40 years. Mr. Angel is on the Board of Directors of Lancer, Dynacore Holdings Corporation and Cellular Technical Services Company, Inc.

Mr. Bush was appointed Vice President and Chief Financial Officer effective January 2000. Mr. Bush was the Vice President of Finance of the Company since November 1994. From 1990 to 1994, Mr. Bush was Controller for two aerospace units of Abex Inc. From 1980 to 1990, Mr. Bush was with Arthur Andersen & Co. in the audit and financial consulting practice.

Mr. Dammon has been Vice President Engineering since 1987. Prior to his present position, Mr. Dammon was Director of Engineering, Manager of New Product Development, Manager of Customer Engineering Service and Gear Design Engineer. Mr. Dammon has been with the Company for over 30 years.

Mr. Gustus has been Vice President and General Manager India Operations since June 2002. Prior to his present position, Mr. Gustus was Vice President Operations of the Lafayette, Indiana facility. Mr. Gustus has been with the Company for over 20 years.

Mr. Lewis has been Vice President Human Resources since July 1999. Prior to his present position, Mr. Lewis was Vice President, Human Resources, Manufacturing and Distribution for PolyGram and Universal Music Group from 1993 to June 1999. From 1972 to 1992, Mr. Lewis was with Aluminum Company of America (ALCOA) where he served in various human resource positions.

Mr. Russell has been Vice President Manufacturing since June 2002. Prior to his present position, Mr. Russell was Vice President Manufacturing Engineering since September 2001. Prior to joining Fairfield, Mr. Russell was with Kaydon Corporation for 22 years, most recently as Plant Manager from July 1993 to September 2001.

Mr. Schlueter has been Vice President Sales North America since March 2001. Prior to his present position, Mr. Schlueter was Vice President Sales and Marketing for Nueweb Interactive from July 2000 to February 2001. Prior to Nueweb he was with Kaydon Corporation for 12 years where he served as Vice President Sales and Marketing for the Electo-Tec Division from 1994 to 2000.

Mr. Strimel has been Vice President International Business Development since November 2000. Prior to his present position, Mr. Strimel was Vice President of Sales from March 1999 to October 2000. Prior to that, Mr. Strimel was the Director of Custom Sales from October 1996 to March 1999. Prior to joining Fairfield, Mr. Strimel was with United Defense for nine years where he served as a Program Manager from 1991 to October 1996.

Compensation of Directors

Each of Messrs. Lechman, Green and Angel is paid an annual fee of $10,000 and an additional $1,000 for every Board of Directors meeting attended. Mr. Lechman entered into a consulting agreement with the Company in August 1997 that expired July 2001. Beginning January 1, 2002, Mr. Lechman entered into a new consulting agreement with the Company (see Note 3 to the Consolidated Financial Statements and Item 11, "Employment and Consulting Agreements"). Effective February 7, 2003, Mr. Clough entered into a consulting agreement with the Company (see Note 3 to the Consolidated Financial Statements and Item 11, "Employment and Consulting Agreements"). No other directors receive any additional compensation for services performed as a director or for serving on committees of the Board of Directors of the Company or for meeting attendance.

The following table sets forth for each of the fiscal years ending December 31, 2002, 2001 and 2000, the compensation paid to or accrued by the Company for the Chief Executive Officer ("CEO") of the Company and each of the four most highly compensated executive officers other than the CEO (the "Named Executive Officers").

Mr. W. B. Lechman was appointed President and Chief Executive Officer effective February 7, 2003. In his role as President and Chief Executive Officer, Mr. Lechman's base compensation is $5,000 per week and is eligible for such other benefits as are customary provided to the Company's executive officers.

Incentive Plan for Senior Management

The Company has established an Incentive Plan for Senior Management (the "Plan") to provide incentive compensation for the Company's executive officers designated by the Board. Under the Plan, the Board grants Performance Units, at its discretion, to the Company's executive officers, and such Performance Units may vest in six equal annual installments on the last day of each of the six fiscal years of the Company beginning with the year ended December 31, 1998. Under the Plan, the holders of the Performance Units are entitled to share in the increase of the Company's equity value in the event the Performance Units vest. The Plan terminates after redemption and satisfaction of all then outstanding Performance Units at December 31, 2003 or upon a change of control.

Pension Plan Table

The Company maintains the Retirement Plan for Employees of Fairfield Manufacturing Company, Inc., a qualified defined benefit pension plan intended to be qualified under the Internal Revenue Code (the "Pension Plan").

Employment and Consulting Agreements

Effective January 1, 2002, Mr. Lechman entered into a consulting agreement with the Company. The compensation under this agreement to Mr. Lechman is $20,000 per year and is renewable annually (see Note 3 to the Consolidated Financial Statements and Item 10, "Compensation of Directors").

The Company was party to an employment agreement with Stephen K. Clough as the Company's President and Chief Executive Officer. Mr. Clough's agreement terminated on February 7, 2003 in connection with his resignation as President and Chief Executive Officer. Upon his resignation, Mr. Clough entered into a consulting agreement with the Company. The compensation under this agreement to Mr. Clough is an aggregate amount of $100,000 to be paid in monthly installments over the next 25-month period (see Note 3 to the Consolidated Financial Statements and Item 10, "Compensation of Directors").

The following table sets forth information regarding the beneficial ownership of the common stock of the Company as of December 31, 2002 by (i) each person known by the Company to beneficially own in excess of 5% of the outstanding shares of the Company's common stock, (ii) each director of the Company and (iii) the directors and executive officers of the Company as a group, as listed in Item 10, "Directors and Executive Officers of the Registrant."

Control by Lancer Industries Inc.

The Company is wholly owned by Lancer, a Delaware corporation. As a result, Lancer is able to direct and control the policies of the Company and its subsidiaries. Certain stockholders of Lancer are Directors and officers of the Company. Certain stockholders of Lancer are parties to a stockholders' arrangement relating to the composition of the Board of Directors of Lancer and certain other matters. See Item 12, "Security Ownership of Certain Beneficial Owners and Management." Circumstances could occur in which the interests of Lancer could be in conflict with the interests of the Company. In addition, Lancer may have an interest in pursuing acquisitions, divestitures or other transactions that Lancer believes would enhance its equity investment in the Company, even though such transactions might involve risks to the Company.

Tax Sharing Agreement

The Company is included in the affiliated group of which Lancer is the common parent, and the Company's federal taxable income and loss will be included in such group's consolidated federal tax return filed by Lancer. The Company and Lancer have entered into a tax sharing agreement (the "Tax Sharing Agreement") pursuant to which the Company has agreed to pay to Lancer amounts equal to the taxes that the Company would otherwise have to pay if it were to file a separate federal tax return (including amounts determined to be due as a result of a redetermination of the tax liability of Lancer). In addition, pursuant to the Tax Sharing Agreement, to the extent that the Company's separate return liability is absorbed by net operating losses or other credits and deductions of Lancer or its subsidiaries (other than the Company and its subsidiaries), Lancer will make a capital contribution to the Company in an amount equal to 50% of such separate return liability. Under certain circumstances, however, such as the Company ceasing to be a member of the Lancer consolidated group or the disallowance by the IRS of the use of Lancer's net operating losses, Lancer no longer would be required to make capital contributions under the Tax Sharing Agreement. See Note 10 to the Consolidated Financial Statements for a further discussion of income taxes.

Management Services

Prior to his resignation, Stephen Clough, the Company's President and Chief Executive Officer, was providing management services to Motor Coach Industries, Inc. ("MCI"), which is controlled and majority-owned by Joseph Littlejohn & Levy Fund III. Messrs. Levy and Joseph have an interest in MCI. An affiliate of CIBC, in which Mr. Heyer is a general partner, has an equity interest in MCI. See Item 10, "Directors and Executive Officers of the Registrant" and Item 12, "Security Ownership of Certain Beneficial Owners and Management."

Mr. Clough began rendering management services in January 2001 and continued to provide them to MCI during 2002. MCI is obligated to reimburse the Company for all expenses related to such services, including the salary of, and other compensation to, Mr. Clough (based on the portion of his time spent on MCI). In 2002 and 2001, MCI paid the Company $0.1 million annually as reimbursement of the Company's expenses related to the provision of such services by Mr. Clough (see Item 11, "Employment and Consulting Agreements").

Other Arrangements with Lancer

From time to time, Lancer incurs legal, accounting and miscellaneous other expenses on behalf of the Company. In fiscal 2002, 2001 and 2000, Lancer incurred reimbursable expenses on the Company's behalf of approximately $0.1, $0.2 and $0.2 million, respectively.

(a) Evaluation of disclosure controls and procedures. Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-14(c) under the Exchange Act) within 90 days prior to the filing date of this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective in timely alerting them to the material information relating to the Company and its consolidated subsidiaries required to be included in its periodic SEC filings.

(b) Changes in internal controls. There were no significant changes in the Company's internal controls or in other factors that could significantly affect those controls subsequent to the date of their last evaluation.

(a) (1) and (2):

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 31, 2003.

FAIRFIELD MANUFACTURING COMPANY, INC.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 31, 2003.

I, W. B. Lechman, certify that:

1. I have reviewed this annual report on Form 10-K of Fairfield Manufacturing Company, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 31, 2003

I, Richard A. Bush, certify that:

1. I have reviewed this annual report on Form 10-K of Fairfield Manufacturing Company, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 31, 2003

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND

FINANCIAL STATEMENT SCHEDULE

To the Board of Directors and Stockholder

of Fairfield Manufacturing Company, Inc.

As discussed in Note 13 to the consolidated financial statements, the Company's senior lender reserves the right to deem the credit facility in default, and in those limited circumstances, could accelerate payment of the outstanding loan balances should the Company undergo a material adverse effect. In addition and as discussed in Note 12 to the consolidated financial statements, the Company was required to adopt the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002.

/s/ PricewaterhouseCoopers LLP

Indianapolis, Indiana
March 26, 2003

1. Summary of Significant Accounting Policies

Fairfield manufactures high precision custom gears and assemblies and planetary gear systems at its Lafayette, Indiana and Belgaum, India facilities. Customers consist of original equipment manufacturers serving diverse markets which include on-highway, access platform, mining, rail, industrial, agricultural, road rehabilitation, construction, materials handling and forestry. T-H Licensing owns certain intangible assets including various patents and trademarks.

These consolidated financial statements include the accounts of Fairfield, T-H Licensing and FAL (collectively the "Company"). All significant intercompany accounts and transactions have been eliminated. The results of FAL are consolidated on a one-month lag.

Sales are recognized at the time of shipment to the customer. The Company records an allowance for sales returns based on experience and other relevant factors.

The Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents.

Inventory is valued at the lower of last-in, first-out (LIFO) cost or market and on a first-in, first out (FIFO) basis for domestic and foreign operations, respectively. Where appropriate, standard cost systems are utilized for purposes of determining costs. The standards are adjusted as necessary to ensure they approximate actual costs. Inventory values are reduced by the amount of inventory on hand that is identified to be slow-moving or obsolete.

Property, plant and equipment, net are carried at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of the assets which range from 15 to 30 years for land improvements, 5 to 40 years for buildings and improvements, and 3 to 15 years for machinery and equipment. Generally, when property is retired from service or otherwise disposed of, the cost and related amount of depreciation or amortization are eliminated from the asset and reserve accounts, respectively. The difference, if any, between the net asset value and the proceeds is charged or credited to income.

Income taxes are provided based on the liability method of accounting. The liability method measures the expected tax impact of future taxable income or deductions resulting from differences in the tax and financial reporting bases of assets and liabilities reflected in the consolidated balance sheets and the expected tax impact of carryforwards for tax purposes.

Debt issuance costs are being amortized by the use of the effective interest method over the expected term of the related debt agreement.

The financial statements of FAL, the Company's India operation, are measured in its local currency and then translated into U.S. dollars. All balance sheet accounts have been translated using the current rate of exchange at the balance sheet date. Results of operations have been translated using the average rates prevailing from the date of acquisition. Translation gains or losses resulting from the changes in the exchange rates from year-to-year are accumulated in a separate component of stockholder's equity.

In 1997, the Company adopted SFAS No. 130, Reporting Comprehensive Income. This statement establishes rules for the reporting of comprehensive income and its components. Comprehensive income consists of net income, additional minimum pension adjustment and foreign currency translation adjustments and is presented in the Consolidated Statements of Stockholder's Equity.

In August 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations." This standard is effective for fiscal years beginning after June 15, 2002, and provides accounting requirements for asset retirement obligations associated with tangible long-lived assets. The Company does not believe that the adoption of this standard will have a material impact on the Company's consolidated financial statements.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." This statement creates one accounting model, based on the framework established in SFAS 121, to be applied to all long-lived assets including discontinued operations. SFAS 144 was effective for the Company at the beginning of fiscal year 2002 and had no impact on the Company's financial statements.

In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." In addition to amending and rescinding other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions, SFAS 145 limits companies from recording gains and losses from the extinguishment of debt as an extraordinary item. SFAS 145 is effective for fiscal years beginning after May 15, 2002. The Company does not believe that the adoption of this standard will have a material impact on the Company's consolidated financial statements.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not believe that the adoption of this standard will have a material impact on the Company's consolidated financial statements.

In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions, an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9." The standard provides guidance for the accounting and reporting for the acquisition of all or part of a financial institution, excluding those transactions between two or more mutual enterprises. It also provides guidance for accounting for the impairment or disposal of long-term customer-relationship intangible assets of financial institutions, including the long-term customer-relationship intangibles of mutual enterprises. The provisions of this statement primarily take effect for relevant activities that occur on or after October 1, 2002, with earlier adoption permitted in some cases. The Company does not believe that the adoption of this standard will have a material impact on the Company's consolidated financial statements.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of SFAS No. 123." The standard provides additional transition guidance for companies that elect to voluntarily adopt the fair-value method of accounting for stock-based compensation. In addition, it requires more prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The standard is effective for annual financial statements for fiscal years ending after December 15, 2002 and for interim financial statements commencing after such date. The Company does not believe that the adoption of this standard will have a material impact on the Company's consolidated financial statements.

In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest Entities." The primary objectives of FIN 46 are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights ("variable interest entities" or more commonly referred to as "special purpose entities") and how to determine when and which business enterprise should consolidate the special purpose entity. The Interpretation applies immediately to entities created after January 31, 2003. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The Company does not believe that the adoption of this Interpretation will have a material impact on the Company's consolidated financial statements.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates.

The fair value of financial assets held by the Company approximate their carrying value. The fair value of financial liabilities, other than Senior Subordinated Notes ("Notes") and Cumulative Exchangeable Preferred Stock, also approximate their carrying value. The estimated fair value of the Notes and Cumulative Exchangeable Preferred Stock at December 31, 2002 were approximately 20.0% and 5.0% of their carrying value, respectively, based on quoted market prices and recent trades of similar issues.

Certain prior year amounts have been reclassified to conform with the current presentation.

2. Concentrations of Risk

The Company grants credit without collateral to most of its customers. No customer sales accounted for 10% or more of the Company's net sales in 2002. Sales to General Electric accounted for approximately 11.6% of the Company's net sales in 2001. Sales to JLG, General Electric and Genie accounted for approximately 12.6%, 10.1% and 10.0% of the Company's net sales in 2000, respectively. Raw material purchases from The Timken Company represented approximately 10.8% of raw material purchases in 2002, 10.4% in 2001 and 10.5% in 2000. Alternative sources are available to fulfill each of the Company's major raw material requirements.

3. Related Party Transactions

Effective January 1, 2002, Mr. W.B. Lechman, President and Chief Executive Officer effective February 7, 2003 (see Note 19), entered into a consulting agreement with the Company. The compensation under this agreement to Mr. Lechman is $20 per year and is renewable annually.

Upon the resignation of Stephen K. Clough as President and Chief Executive Officer effective February 7, 2003 (see Note 19), Mr. Clough entered into a consulting agreement with the Company. The compensation under this agreement to Mr. Clough is an aggregate amount of $100 to be paid in monthly installments over the next 25-month period.

Prior to his resignation (discussed above), Mr. Clough was providing management services to Motor Coach Industries, Inc. ("MCI"), which is controlled and majority-owned by Joseph Littlejohn & Levy Fund III. Messrs. Levy and Joseph have an interest in MCI. An affiliate of CIBC, in which Mr. Heyer is a general partner, has an equity interest in MCI.

Mr. Clough began rendering management services in January 2001 and continued to provide them to MCI during 2002. MCI is obligated to reimburse the Company for all expenses related to such services, including the salary of, and other compensation to, Mr. Clough (based on the portion of his time spent on MCI). In 2002 and 2001, MCI paid the Company $100 annually as reimbursement of the Company's expenses related to the provision of such services by Mr. Clough.

From time to time, Lancer incurs legal, accounting and miscellaneous other expenses on behalf of the Company. In fiscal 2002, 2001 and 2000, Lancer incurred reimbursable expenses on the Company's behalf of approximately $100, $200 and $200, respectively.

4. Acquisition

On October 3, 2000, the Company, through its wholly owned subsidiary T-H Licensing, acquired newly issued shares representing 75.77% of Atlas Gears Limited for $4,500. Atlas Gears Limited changed its name to Fairfield Atlas Limited (or FAL) in the first quarter of 2001. FAL, headquartered in Mumbai, India with manufacturing facilities located near Belgaum, India, manufactures custom gears primarily for the agricultural, off-road, and light commercial vehicle markets in India. The Company acquired FAL to gain a low cost manufacturing and procurement base.

The acquisition has been accounted for as a purchase and the results of the operations of the acquired business have been included in the consolidated financial statements since the date of acquisition on a one-month lag. The excess of the purchase price over the fair value of net assets acquired was approximately $2,100 and was recorded as goodwill. This goodwill was subsequently written off upon adoption of SFAS 142 discussed in Note 12 of this report.

5. Operations by Geographic Area

Revenues, loss from operations and total assets, net of eliminations, by domestic and foreign operations are as follows:

International sales, principally to India and Canada, accounted for $10,977, $11,193 and $8,752 of the Company's net sales in 2002, 2001 and 2000, respectively.

Custom gears and assemblies accounted for approximately $91,600, $79,700 and $76,900 of the Company's 2002, 2001 and 2000 net sales, respectively. Planetary gear systems accounted for approximately $49,300, $58,600 and $84,200 of the Company's 2002, 2001 and 2000 net sales, respectively.

6. Inventory

Inventory at December 31, consists of:

7. Property, Plant and Equipment, Net

Property, plant and equipment, net at December 31, includes the following:

Depreciation expense was $9,708, $10,604 and $11,109 for the years ended December 31, 2002, 2001 and 2000, respectively.

8. Accrued Liabilities

Accrued liabilities at December 31, are as follows:

9. Employee Benefit Plans

The following table presents information in regard to the Company's domestic defined benefit plans.