The Company is primarily a manufacturer of piston rings for automotive and light duty truck applications for the replacement market. In addition, some of the Company's piston ring products are produced for original equipment applications. To a lesser extent, the Company packages and sells automotive mechanics' specialty tools. Prior to October 4, 1999, the Company directly administered and sold additives for engines, transmissions and cooling systems. Effective that day, the Company entered into a joint venture agreement for the marketing of those additive products worldwide. In addition, all of the Company's products are currently sold in Canada, where they are produced and/or packaged and distributed by the Company's Canadian subsidiary, Hastings, Inc., located in Barrie, Ontario. Effective in early 1999, that facility became responsible for all specialty tool packaging and distribution throughout the Canadian, U.S. and other foreign markets, reflecting the most efficient management of that product offering.

          The Company distributes its replacement products through numerous auto parts jobbers and warehouse distributors in the U.S. and Canada. These products are also distributed nationally and internationally through numerous large-scale engine rebuilders and various retailer outlets. The Company distributes the majority of its export sales on a country direct basis.

          Fiscal 1997 was a critical year for the Company as it returned to profitability for the first full year period since 1994. The Company built upon that success through the 1998 fiscal year, fueled by added sales growth and a continued commitment to control its operating costs. The Company made several significant operating changes in its way of conducting business through that period. During 1997, for instance, the Company made substantial progress in expanding its overseas distribution channels on a country direct basis. By the close of 1997, the Company had contracted new distribution in Australia, South Africa, the Middle East, Israel, Puerto Rico, and South America. The maturity of several of those markets contributed to the overall sales gain that the Company achieved in 1998. Conversely, a softening in some of those markets in 1999 contributed to the net sales decline reported for 1999. During 2000, the export volume recovered nearly one-half of the volume lost in 1999 from 1998. Further, in November of 2000, the Company hired its first full-time export sales representative dedicated to the Central and South American markets. Early indications are that volumes from those regions should strengthen through 2001 and beyond, although the Company cannot give any assurances that this will happen.

          The manufacturing demands required to support the 1998 sales increase revealed certain operating constraints within the Company's manufacturing capabilities. As a result, the Company experienced a period of product shortages through the latter half of 1998. In response to those pressures, the Company began the implementation of lean manufacturing principles, including the conversion to a cellular approach for some manufacturing processes. (Lean manufacturing refers to a discipline of arranging the workflow in such a manner as to minimize or eliminate any waste of materials or labor.) This conversion is expected to result in production efficiencies through both reduced product lead times and capacity improvements. This conversion process will continue through mid-to-late 2001 and will be followed by a period of continuous improvement as the Company further refines its lean manufacturing practices. The Company remains firmly committed to the lean manufacturing conversion with its related operating cost advantages.

          As noted, the Company consolidated its specialty tool operations at its Canadian subsidiary's facility in early 1999. In addition, that subsidiary enhanced its distribution capabilities in the Canadian automotive aftermarket throughout the remainder of 1999. That organization has now begun to distribute and administer products from other U.S.-based suppliers into the Canadian market. Those products complement the Company's current piston ring offering as to both distribution channels and customer base. Revenues from that activity, recognized as a commission amount only, are expected to increase as those complementary products expand. In early 2001, the Company entered into an agreement to market and distribute pistons into the U.S. market. Results of that alliance will be reported in a manner similar to the Canadian facility's offerings. Also, as noted above, the Company entered into a joint venture agreement in October 1999 for the purpose of expanding its additives offerings through both increased global market penetration and a significant increase in the product offering under the "Casite" brand name. The additional product offerings became available in mid-2000. The impact from that relationship was minimal throughout 2000.

          Beginning in 1996, and carrying over to 1997, the Company made substantial strides in its quality and business control operations. The Company's commitment to these initiatives was rewarded with QS-9000 and ISO-9002 quality registrations in July 1997. In February 1999, following several successful follow-up audits, the Company was recommended for upgrade to ISO-9001, thus giving recognition to its product design capabilities.

          The market for the Company's products is highly competitive. The principal methods of competition in the industry are price, service, product performance and product availability. The Company has two principal competitors in the piston ring market. The Company ranks among the three largest domestic producers of replacement piston rings.

          Among the Company's trade names used in marketing its products are "Hastings" and "Flex-Vent," which are registered trademarks in the United States and many foreign countries. The " Casite" trademark, used by the Company in the past for its additives line, has been transferred to the joint venture described above for use in its operations. The Company also holds a number of patents and licenses. In the opinion of management, the Company's business generally is not dependent upon patent protections.

          The Company ships orders to customers within a short period, ordinarily one week or less from the time orders are received. Accordingly, backlog is not significant in the Company's business and the Company does not keep separate figures of backlog. The Company's sales have limited seasonal fluctuations.

          None of the practices of the Company or the industries in which it operates create any unusual working capital requirements that would be material to an understanding of the Company's business taken as a whole.

          The Company's sales are made to many customers and are not dependent upon a single customer or a few customers. As stated in Note 11 to the Consolidated Financial Statements (included in Item 8), net sales to one customer (DaimlerChrysler AG), however, represented approximately $4,027,000 (11.4%), $4,242,000 (11.3%) and $3,874,000 (9.8%) of the Company's consolidated sales for 2000, 1999 and 1998, respectively.

          Raw materials essential to the production of the Company's products are standard items obtainable in the open market and are purchased from many vendors. The Company maintains its own foundry facility at its Hastings, Michigan location for producing the cast iron material required for many of its piston ring applications.

          Research and development are performed by the Company's engineering staff relating to improvements in products and production as well as the design and testing of new products. The Company's expenditures for research and development are not material.

          The Company has no material governmental contracts.

          Compliance with federal, state, and local environmental laws and regulations governing discharges into the environment is not expected to have a material effect upon the capital expenditures, earnings, or competitive position of the Company.

          As of December 31, 2000, the Company and its subsidiaries had a total employment of 417 employees. Subsequent to year-end, however, the Company announced a series of cost-containment measures, one of which is a reduction in the Company's salaried and hourly workforces. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources," in Item 7 below. Employee relations at both of the Company's plant locations are considered to be satisfactory.

          The Company's wholly owned Canadian subsidiary, Hastings, Inc., located in Barrie, Ontario, owns and operates manufacturing and warehouse facilities for piston rings, additives and mechanics' specialty tools and for the distribution of products of other U.S.-based suppliers into the Canadian market. This facility includes approximately 65,000 square feet of production and warehouse space and 4,000 square feet of office space.

ultimate chances of success are uncertain. If the retirees prevail, the Company anticipates that a requirement to provide postretirement benefits at the pre-amendment level would have a material adverse effect on the Company's future financial position, results of operations and cash flows.

          Through the first nine months of 2000, the Company had generated net income of $536,693. The fourth quarter of 2000, however, was negatively affected by several factors, each of which is described throughout the following discussion. Net sales in the fourth quarter of 2000 decreased $948,813 from the fourth quarter of 1999, primarily reflecting the softness observed throughout the automotive replacement parts and original equipment markets. Cost of sales increased $225,523 from the fourth quarter of 2000, primarily reflecting changes to the labor cost standards applied to inventory in the fourth quarter. Income tax expense for the fourth quarter of 2000 decreased only $92,000, whereas a larger decrease would have been expected as a result of the loss incurred in that quarter. This is due to an increase in the deferred income tax asset valuation allowance of approximately $300,000 related to foreign tax credits which management now anticipates, based on recent financial results, are likely to expire unutilized in future years. The net sales and cost of sales items described above are the primary cause for the fourth quarter pre-tax loss of $1,088,849 compared to a 1999 fourth quarter pre-tax loss of $38,010. The 2000 fourth quarter net loss was $995,849 compared to a net loss of $37,010 for the same period in 1999.

          Net sales for 2000 decreased $2,156,104, or 5.8%, from $37,411,532 in 1999 to $35,255,428. The decrease in net sales reflects sales declines in the domestic and Canadian aftermarket and the private brand and original equipment markets, partially offset by a modest increase in the export volume. The sales decreases in the domestic and Canadian aftermarket reflect an industry-wide softness in the automotive replacement parts industry. The decreases in the private brand and original equipment markets reflect the loss of certain customers through market consolidation and a sustained downturn in the original equipment market. In response to a decrease in export sales in 1999, and to help offset these negative domestic sales factors in 2000, the Company focused on increasing sales in the export market. As a result of this focus, the Company realized a modest increase in export piston ring sales in 2000. The total sales decrease in 2000 also reflects a reduction of approximately $600,000 in Casite additives sales. Prior to 2000, Casite sales were reflected in the Company's financial statements. In October 1999, the Company entered into a 50% owned joint venture for the purpose of expanding its additives offerings through both increased global market penetration and an expansion of the product offerings under the "Casite" name. As a result, Casite sales, beginning in 2000, are recorded in the unconsolidated financial statements of the joint venture rather than through net sales within the Company's financial statements.

          As noted earlier, net sales in the fourth quarter of 2000 decreased $948,813 in comparison to the same period in 1999. This decrease reflects the continued softness in the domestic piston ring aftermarket that had begun in the third quarter of 2000, combined with a sustained downturn in the original equipment market. Both of these events are considered temporary in nature. The effects of the downturn in the original equipment market, however, will negatively affect the Company's first quarter 2001 sales, as many original equipment manufacturers have implemented a series of plant shutdowns as a means of reducing their levels of inventory. These shutdowns will result in reduced sales by the Company to the original equipment market in the first quarter of 2001. Casite product sales in the fourth quarter of 1999 amounted to approximately $100,000, and thus represent a portion of the decrease when comparing net sales in 2000 and 1999.

1999 Compared to 1998

          Cost of sales for 2000 decreased $1,509,612, or 5.5%, from $27,251,022 in 1999 to $25,741,410. The Company's gross profit margin slightly decreased to 27.0% in 2000 from 27.2% in 1999. While the overall decrease in cost of sales is consistent with the decrease in net sales, several factors negatively affected the gross profit margin in 2000. During the last half of 2000, the Company experienced a change

in its sales mix. As noted earlier, domestic aftermarket sales were down in 2000 due to an overall softness in the replacement parts market. Sales in the domestic piston ring aftermarket have traditionally carried a higher gross profit margin in order to support the higher level of operating expenses that are necessary to support that volume. Export volume, as noted earlier, increased in 2000 as a result of the Company's focus on this market. The export volume has traditionally carried a lower gross profit margin than domestic sales as a result of the lower pricing offered due to the lower level of operating expenses (not included in cost of sales) that are required to service that volume. The Company's 2000 gross profit margin was also negatively affected by changes to the labor cost standards applied to inventory in the fourth quarter, as noted earlier. During the fourth quarter of 2000, the Company completed adjustments to the labor cost standards to reflect efficiencies obtained in its transition to a lean manufacturing environment. This transition, while an on-going effort during the past few years, was largely completed during the fourth quarter, at which time the Company was first able to fully measure, and adjust the inventory for, the impact of its reduced labor costs. Any future cost of sales effects from this inventory-driven absorption of labor efficiency gains will be reflected in cost of sales on a quarterly basis, as the Company further develops and refines its manufacturing capabilities. Material costs remained relatively unchanged from the prior year average, with increases in cast iron costs offset by reductions in rolled steel costs. Labor costs increased slightly from the prior year average, with a labor cost increase resulting from the collective bargaining agreement, partially offset by the effects of the labor efficiencies noted above. Overhead costs decreased at a rate lower than the sales decrease due to the fixed nature of a large portion of those costs. Specifically, overhead costs relating to on-going maintenance of plant equipment, and the tooling expense necessary to support a lean manufacturing environment, increased during the year, especially during the fourth quarter of 2000. Expenses related to enhanced education programs also increased overhead costs during the fourth quarter of 2000.

          Cost of sales for the fourth quarter of 2000 increased by $225,523, or 3.4%, over the fourth quarter of 1999. This increase was primarily the result of the changes to the labor cost standards applied to inventory, as noted earlier. The gross profit margin generated in the fourth quarter of 2000 (16.9%) was lower than the gross profit generated through the third quarter of 2000 (30.0%), reflecting the negative effect of the labor cost changes noted above, combined with the sales mix change noted earlier, the increase in overhead expenses noted above, an increase in group health insurance costs and the absence of gross profit from Casite sales in 2000.

1999 Compared to 1998

          Total operating expenses for 2000 increased $63,917, or 0.7%, from $8,944,694 in 1999 to $9,008,611. Advertising expenses increased $1,355, or 0.5%, from the 1999 total. This increase reflects increases in co-op advertising costs and advertising support salaries, largely offset by decreases in printed material and trade advertising costs. Selling expenses increased $45,704, or 1.5%, from the 1999 total. This increase reflects increases in salesmen's travel and various sales personnel and support costs, offset partially by a decrease in volume-driven agents' commissions. General and administrative expenses increased $16,858, or 0.3%, from the 1999 total. This increase reflects increases in the provision for doubtful accounts receivable, group health insurance, legal and professional fees, and property insurance costs, offset significantly by decreases in general personnel support costs. The increase in the provision for doubtful accounts receivable relates to write-offs of specific customer accounts. The increase in the group health insurance relates to increased claims activity throughout the year. The increase in legal and professional fees is related to the Company's retirees class-action lawsuit described in Note 7 to the accompanying Consolidated Financial Statements. The increased property insurance cost represents the deductible portion of an insured fire loss that took place in April 2000 within the finished goods storage area of the Company's U.S. production facility. The effect of this event on the Company's ability to service its customers, and its effect on earnings, has been minimal.

          Fourth quarter 2000 operating expenses were 5.5% lower than the 1999 total primarily due to decreases in volume-driven agents' commissions, legal and professional fees and general personnel support costs, partially offset by increases in salesmen's travel, the provision for doubtful accounts receivable and group health insurance costs, as discussed above.

1999 Compared to 1998

          Other expenses, net for 2000 increased by $54,517 over the 1999 net total. This increase reflects the increased interest expense arising from the added reliance on the Company's short-term lines of credit throughout 2000, offset slightly by the income recognized from the Company's investment in the Casite joint venture, which is recorded as other, net income. There was no income recognized from the joint venture in 1999.

          Fourth quarter 2000 other expenses, net increased $5,682 from the 1999 total. This increase was the result of the same factors noted in the above discussion.

1999 Compared to 1998

          As of December 31, 2000, the Company recorded net deferred income tax assets of $6,897,509. The major components include the tax effect of net operating loss carryforwards of $1,797,815 and net accrued retirement and postretirement benefit obligations totaling $4,582,838. The realization of these recorded benefits is dependent upon the generation of future taxable income.

          The net operating loss carryforwards expire in 2010, 2011, 2012, 2019 and 2020, if not previously utilized. Management has prepared projections of taxable income for future years indicating that the cumulative net operating loss carryforward is expected to be fully utilized by late 2004.

          The Company further expects to be able to realize the deferred tax assets related to the retirement and postretirement benefit obligations as it pays these benefits. Such payments will constitute an expense that is deductible for tax reporting purposes over many future years. During each of the ten years prior to when the recent net operating loss carryforwards arose, the Company has been able to deduct these benefit payments for tax reporting purposes and reduce its tax liability accordingly. As a result of the 1997 plan amendment to the retiree medical plan as discussed in Note 6 to the Consolidated Financial Statements, current tax deductible payments are expected to exceed the annual expense recognition for financial reporting purposes, thus accelerating the absorption of the future periods' tax benefit.

Company's primary sources of cash have been from operations and from bank borrowings. In late March 2000, the Company entered into an agreement with its primary lender to amend the terms of its short- and long-term debt obligations. The amendment increased the short-term line available to the Company from $3,000,000 to $3,500,000, modified the payment schedule of the Company's long-term debt obligation, and provided the primary lender with a security position in certain assets of the Company. Details of this amendment are described in Note 3 to the Consolidated Financial Statements. In late December 2000, the Company's loan agreement was amended to increase the short-term line from $3,500,000 to $4,000,000, while leaving the maturity date unchanged at September 30, 2002. Due to the Company's fourth quarter financial results, it was not in compliance with certain restrictive covenants contained in its loan agreement at December 31, 2000. As discussed in Note 13 to the Consolidated Financial Statements, the Company subsequently obtained a waiver from the bank for its noncompliance and further amended its loan agreement. The amendment increases the short-term line to $4,250,000 through October 30, 2001, at which time maximum borrowings revert to $4,000,000, and revises the maturity date from September 30, 2002 to May 30, 2002. The amendment also modifies the payment schedule of the Company's long-term debt obligation, requiring full payment by May 30, 2002. Among other changes to the restrictive covenants, capital expenditures are limited to $600,000 per fiscal year and the Company is prohibited from paying dividends and repurchasing its common stock through the revised loan agreement maturity date of May 30, 2002. As a result of these amendments, and based on an anticipated improvement in profitability, the Company expects to generate sufficient future funds from operations and bank borrowings to fund its growth and operating needs. Total short-term lines available to the Company as of December 31, 2000 totaled $6,200,000, of which $1,200,000 was unused ($6,450,000 and $1,450,000, respectively, after the March 21, 2001 amendment). In an effort to minimize its floating rate debt exposure, the Company is a party to an interest rate swap agreement essentially fixing the interest rate on that debt within a small range. The rate will fluctuate within 7.45% to 8.20% depending upon certain Company performance parameters. As of December 31, 2000 the "fixed" rate on those borrowings was 8.20%.

          During 2000, the Company generated $1,030,145 of net cash from operating activities. The realized depreciation, combined with decreases in accounts receivable, inventories, deferred income taxes and an increase in accounts payable and accruals, were partially offset by a decrease in the postretirement benefit obligation. The decrease in accounts receivable reflects the timing of customer sales and the related payment terms associated with those sales. The decrease in inventories reflects a reduction in inventory requirements in relation to customer demand. The decrease in deferred income taxes primarily reflects the increase in the valuation allowance for foreign tax credits that management anticipates are likely to expire unutilized in future years. The increase in accounts payable and accruals reflects an increase in general accounts payable, taxes, other and compensation, offset slightly by a decrease in miscellaneous payables. The decrease in the postretirement benefit obligation reflects the excess of actual postretirement benefit claims paid over the actuarially determined annual expense. The investing activities for 2000 reflect the Company's continued support of its "lean manufacturing" environment. The investing activities also reflect the previously discussed investment in a joint venture, in February 2000, related to the "Casite" brand additives products. The financing activities reflect the working capital requirements that were primarily needed to fund the operating activity needs noted above. The financing activities also reflect the amortization of the Company's long-term obligation that was amended in March 2000, as discussed above, and the purchase and retirement of 30,000 shares of the Company's common stock. This stock repurchase was part of the common stock repurchase program that the Company announced in February 2000. This program is described in Note 8 to the Consolidated Financial Statements.

          On February 22, 2001, the Company announced that it had instituted a series of cost-containment measures in an effort to reduce its operating expenses and improve its profitability. The cost-containment measures were in response to a continued softness in the domestic piston ring aftermarket and a downturn in the original equipment market. The cost-containment measures consisted of reductions in the salaried and hourly workforces and identification of reductions in various non-payroll related expenses. The

workforce reductions did not result in material severance payments. The Company has also announced an indefinite suspension of its regular quarterly cash dividend and has identified certain assets for possible future sale in an effort to further improve its cash position. The Company does not anticipate a loss on the disposal of these assets.

          During 1999, the Company generated $1,112,546 of net cash from operating activities. The realized net income and depreciation, combined with decreases in accounts receivable, prepaid pension cost and deferred income taxes, were partially offset by increases in inventories and decreases in accounts payable and accruals and the postretirement benefit obligation. The decrease in accounts receivable reflected the timing of customer sales and related payment terms associated with those sales. The decrease in the prepaid pension cost reflected the recognition of the pension expense for 1999. The decrease in the net deferred income tax asset reflected the reduction of several deferred tax items, partially offset by the deferred tax effect of the 1999 net operating loss for tax purposes. The increase in inventories reflected the Company's continued efforts toward having sufficient product on hand in order to maintain adequate order fill for its customers. The decrease in accounts payable and accruals primarily reflected the reduction in the compensation accrual, offset by slight increases in general accounts payable and miscellaneous payables. The decrease in the postretirement benefit obligation reflected the excess of actual postretirement benefits paid over the actuarially determined annual expense. The investing activities for 1999 reflected a decreased requirement for new capital equipment, as the Company moved to finalize its full transition into a lean manufacturing environment. The investing activities also reflected the proceeds from the sale of obsolete plant equipment. The financing activities for 1999 reflected the working capital requirements that were primarily needed to fund the operating activity items noted above. The financing activities also reflected the amortization of the Company's long-term debt obligation.

          In late August 1998, the Company entered into a $6,600,000 long-term debt agreement with its primary lender. This agreement allowed the Company to take advantage of favorable interest rate conditions. Borrowings under this long-term debt agreement were used for several purposes including: raising the Company's defined benefit plans to funding levels that would alleviate the payment of the variable rate PBGC premiums; consolidating the remaining long-term debt obligations; and paying down certain short-term notes payable. As a result of this agreement, the Company's short-term line with its primary lender was reduced from $5,000,000 to $3,000,000. (This amount has subsequently been raised to $4,250,000 in accordance with the amended short and long-term debt agreements described above.)

          During 1998, the Company used $1,192,259 of net cash for operating activities. The realized net income, depreciation and decrease in deferred income taxes were offset by increases in accounts receivable, inventories, prepaid pension cost, and a decrease in the postretirement benefit obligation. The decline in the deferred income tax asset was primarily the result of the additional funding of the Company's defined benefit pension plans, and the partial utilization of the net operating loss carryforwards. The increase in accounts receivable and inventories reflected the additional working capital requirements that were necessary to support the higher sales level. The increase in the prepaid pension cost of $2,675,688 reflected the funding of the Company's defined benefit plans to specified limits. As such, it did not have a direct effect on operations during 1998. Excluding this item, net cash generated from operating activities amounted to $1,483,429. The investing activities for 1998 reflected the Company's commitment to enhancing its production capabilities through the implementation of lean manufacturing principles. Investing activities also reflected the September 1998 release of escrowed funds relating to the 1995 sale of filter operations. These funds were subsequently used to reduce short-term notes payable. Financing activities reflected the increased reliance on short-term borrowings to help satisfy increased working capital needs. Financing activities also reflected the proceeds from the new long-term debt agreement and subsequent utilization of a portion of the proceeds to pay down short and long-term debt. Dividends paid increased in 1998 due to the improved operating results.

          SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, issued in June 1998, requires companies to recognize all derivative contracts as either assets or liabilities in the balance sheet and to measure them at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge, the objective of which is to match the timing of gain or loss recognition on the hedging derivative with the recognition of (1) the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk or (2) the earnings effect of the hedged forecasted transaction. For a derivative not designated as a hedging instrument, the gain or loss is recognized in income in the period of change. SFAS No. 133, as amended by SFAS Nos. 137 and 138, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000.

          Anticipated future sales are subject to competitive pressures from many sources. As an example, future sales could be affected by consolidation within the automotive replacement parts industry, whereby the Company could lose sales due to a competitor purchasing all of the assets of a current customer of the Company. Future sales could also be affected by current and future political and economic factors in the foreign markets where the Company conducts business.

          Cost of sales and operating expenses may be adversely affected by unexpected costs associated with various issues. For example, future cost of sales could be affected by unexpected expenses related to the future maintenance of a lean manufacturing environment. Future operating expenses could also be affected, for example, by such items as unexpected large claims within the Company's self-funded group health insurance plan, increased retiree health insurance claim exposure as a result of an adverse court ruling on the current retiree health issue, or bad debt expenses related to deterioration in the credit worthiness of a customer.

Hastings Manufacturing Company
Hastings, Michigan

We have audited the accompanying consolidated balance sheets of Hastings Manufacturing Company and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As described in Note 7, on January 24, 2000, a class action lawsuit was filed against the Company by its retirees with respect to the 1997 amendment of the Company's postretirement benefit plans. The outcome of the lawsuit is uncertain at this time.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hastings Manufacturing Company and subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.

/s/BDO Seidman, LLP
BDO Seidman, LLP
Grand Rapids, Michigan
March 1, 2001, except Note 13,
          which is dated March 21, 2001

Hastings Manufacturing Company and Subsidiaries
Notes to Consolidated Financial Statements
==================================================

Note 1 - Summary of Significant Accounting Policies

Nature of Operations

          Hastings Manufacturing Company and subsidiaries (Company) is primarily a manufacturer of automotive and light duty truck piston rings for the replacement market. In addition, some of the Company's piston rings are produced for original equipment applications. To a lesser extent, the Company packages and sells automotive mechanics' specialty tools and additives for engines, transmissions and cooling systems. The Company's headquarters and primary manufacturing facilities are located in Hastings, Michigan. All of the Company's products are also sold in Canada, where they are produced and/or packaged and distributed by the Company's Canadian subsidiary, Hastings, Inc., located in Barrie, Ontario.

          The Company distributes its replacement products through numerous auto parts jobbers and warehouse distributors for sale primarily in the automotive replacement market throughout the U.S. and Canada. These products are also distributed nationally and internationally through numerous large-scale engine rebuilders and various retailer outlets. The Company distributes the majority of its export sales on a country direct basis. During 1999, Hastings, Inc. began to distribute and administer products for other U.S.-based suppliers into the Canadian market. The products complement the current piston ring offerings as to both distribution channels and customer base.

          In October 1999, the Company entered into a joint venture agreement for the purpose of expanding its additives offerings through both increased global market penetration and through an expansion of the product offerings under the "Casite" brand name. The 50% owned joint venture company, Casite Intraco, LLC, does business as The Casite Company. Initial capitalization, amounting to $75,000 by each party, was in February 2000. There was no activity within the joint venture until the first quarter of 2000.

          The Company performs ongoing credit evaluations of its customers and provides reserves for probable credit losses.

          As defined by Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures About Segments of an Enterprise and Related Information, the Company has two operating segments, U.S. operations and Canadian operations, based on management's geographic reporting responsibilities. As discussed above, all of the Company's products are sold in both the U.S. and Canada. In addition, the operating segments' production processes, types of customers, distribution methods, regulatory environment and expected long-term financial performance are very similar. Because management believes aggregation of its two operating segments is consistent with the objective and basic principles of SFAS No. 131, financial information regarding its operating segments has been aggregated for financial reporting purposes. Additional information required to be disclosed by SFAS No. 131 is included in Note 11.

Principles of Consolidation

          The consolidated financial statements include the accounts of the parent company and its subsidiaries. Upon consolidation, all significant intercompany accounts and transactions are eliminated. The Company's investment in its 50% owned joint venture is accounted for on the equity method.

Use of Estimates in the Preparation of 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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Revenue Recognition

          The Company recognizes revenue when its products are shipped to its customers. Likewise, revenues from distribution of products for unaffiliated suppliers, which are not significant, are recognized on a commission-only basis at the time of shipment and are included in net sales.

Fair Value of Financial Instruments

          The fair value of the Company's financial instruments, comprised of cash, short-term receivables and payables, notes payable to banks (variable interest rate) and long-term debt (variable interest rate), approximates their carrying values. The fair value of the Company's interest rate swap agreement, as disclosed in Note 4, is not material.

Inventories

          Inventories are stated at cost, not in excess of market. The Company uses the last-in, first-out (LIFO) method of determining costs for U.S. raw material inventories. Remaining inventories are valued using the first-in, first-out (FIFO) method.

Property, Equipment and Depreciation

          Property and equipment are stated at cost, less accumulated depreciation. Depreciation is computed primarily by the straight-line method for financial reporting purposes, based on the estimated useful lives of the respective assets, and accelerated methods with minimum lives for income tax purposes. Useful lives range from 12-18 years for land improvements, 10-40 years for buildings, and 5-7 years for machinery and equipment.

Long-Lived Assets

          The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined that an impairment loss has occurred based on expected future undiscounted cash flows from operations, a current charge to income is recognized.

Retirement Plans

          The Company sponsors noncontributory, defined benefit plans which cover all employees of the Company who are covered by collective bargaining agreements. The plans provide benefits based on an employee's earnings and years of benefit service. The Company funds these plans in amounts consistent with the funding requirements of federal laws and regulations. As discussed in Note 4, the Company provided additional funding to the plans during 1998. The plans' assets are invested in stocks, bonds, annuities and short-term investments.

          The Company also sponsors defined contribution retirement savings plans for its employees and has entered into a deferred compensation agreement with a former officer as described in Note 5.

          The Company provides certain healthcare and life insurance benefits for eligible retired employees. Postretirement benefits are accounted for on the accrual basis, during the employee's years of service, based on the expected cost of providing benefits to that employee and the employee's beneficiaries and covered dependents.

Stock Options

          The Company applies the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations in accounting for its stock option plan. Because the exercise price of the Company's stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.

Advertising Costs

          All advertising costs are expensed in the period in which they are incurred.

Income Taxes

          The Company provides deferred income taxes based on enacted income tax rates in effect on the dates temporary differences between the financial reporting and tax bases of assets and liabilities reverse. The effect on deferred tax assets and liabilities of a change in income tax rates is recognized in income in the period that includes the enactment date. To the extent that available evidence about the future raises doubt about the realization of a deferred tax asset, a valuation allowance is established.

          As disclosed in Note 9, the Company has recorded deferred tax assets reflecting the benefit of net operating loss carryforwards expiring through 2020, foreign tax credit carryforwards expiring through 2005, accrued pension and postretirement obligations estimated to be payable in varying amounts over the next 25 to 30 years, and other net deductible temporary differences. Realization of the recorded income tax benefits is dependent on generating sufficient taxable income and foreign source income prior to expiration of the loss carryforwards and foreign tax credit carryforwards. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets, except for $311,508 of foreign tax credits, will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income and foreign source income during the carryforward periods are not achieved.

          No provision for income taxes has been made on the accumulated undistributed earnings of approximately $3,976,000 of the Company's Canadian subsidiary. These earnings are intended to be permanently reinvested in facilities and other assets and have borne income taxes that would offset, in major part, any tax liability resulting from their distribution.

Basic and Diluted Earnings Per Share

          Basic earnings per share (EPS) is based on the weighted average number of shares of common stock outstanding during each period. It excludes the dilutive effects of additional common shares that would have been outstanding if the shares, under the Company's stock option plan, had been issued. It also excludes the dilutive effect of contingently issuable shares, outstanding under the Company's restricted stock plan described in Note 8, to the extent those shares have not yet been vested. Diluted EPS includes the effects of the Company's stock options and, to a limited extent, contingently issuable shares. These shares are issuable upon meeting certain predetermined performance goals and are first considered outstanding, for dilutive EPS purposes, for the entire reporting period during which the performance goals are met. Basic and diluted EPS are retroactively adjusted for stock dividends and stock splits.

Comprehensive Income

          Total comprehensive income is reported in the consolidated statement of stockholders' equity and includes net income, the foreign currency translation adjustment relating to the Company's Canadian operations and the pension liability adjustment relating to the Company's underfunded pension plan, as disclosed in Note 5.

Interest Rate Swap Agreements

          The Company enters into interest rate swap agreements to reduce the impact of changes in interest rates on its floating rate borrowings. Interest rate swap agreements are contracts to exchange floating rates for fixed rate interest payments over the life of the agreements without the exchange of the underlying notional amounts. The notional amounts of interest rate swap agreements are used to measure interest to be paid or received and do not represent the amount of exposure to credit loss. The differential paid or received on interest rate agreements is recognized as an adjustment to interest expense.

          The counterparty to the Company's interest rate swap agreements is a commercial bank with which the Company has other financial relationships. While the Company is exposed to credit loss in the event of nonperformance by the counterparty, the Company does not anticipate nonperformance by the other party, and no material loss would be expected from such nonperformance.

          The Company does not enter into interest rate swap agreements, or other derivative financial instruments, for trading purposes.

Foreign Currency Translation

          The financial statements of the Company's Canadian operations, where the functional currency is the Canadian dollar, are translated at the exchange rate in effect at year-end for assets and liabilities. Income and expense items are translated at the average exchange rate for the year. Related translation adjustments are reported as a separate component of accumulated other comprehensive income. Gains and losses from foreign currency transactions, which are not significant, are included in current earnings.

New Accounting Standards

          Emerging Issues Task Force (EITF) 00-10, Accounting for Shipping and Handling Fees and Costs, issued during 2000, requires companies to record as revenue all amounts billed to customers for shipping and handling. The classification of related shipping and handling costs, while not permitted to be netted against revenues, is an accounting policy decision required to be disclosed. In accordance with EITF 00-10, shipping and handling costs incurred by the Company are included in cost of sales. In previous years, shipping and handling revenues and costs were included in revenues on a net basis. All periods presented have been reclassified to conform with the current year presentation.

          SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, issued in June 1998, requires companies to recognize all derivatives contracts as either assets or liabilities in the balance sheet and to measure them at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge, the objective of which is to match the timing of gain or loss recognition on the hedging derivative with the recognition of (1) the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk or (2) the earnings effect of the hedged forecasted transaction. For a derivative not designated as a hedging instrument, the gain or loss is recognized in income in the period of change. SFAS No. 133, as amended by SFAS Nos. 137 and 138, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000.

          Historically, the Company has not entered into derivatives contracts for speculative purposes. The Company does periodically enter into interest rate swap agreements to reduce the impact of changes in interest rates on its floating rate borrowings. However, the fair value of such derivatives are not significant. Accordingly, the adoption of the new standard on January 1, 2001 did not materially affect the Company's consolidated financial statements.

Note 2 - Inventories

          Inventories valued using the LIFO method were $2,414,000 and $2,604,000 at December 31, 2000 and 1999, respectively.

          If the FIFO method of inventory valuation had been used by the Company, inventories would have been $1,256,000 and $1,222,000 higher than reported at December 31, 2000 and 1999, respectively.

          Reduction of inventory quantities in 2000, 1999 and 1998 resulted in a liquidation of LIFO inventories carried at lower costs prevailing in prior years as compared to current years' purchases. The effect of these reductions increased net income, or reduced net loss, by $5,000, $50,000 and $40,000 ($.01, $.06 and $.05 per share, on a diluted basis, as adjusted for the stock split discussed in Note 8) for 2000, 1999 and 1998, respectively.

Note 3 - Short-Term Borrowings

          In August 1998, the Company entered into a loan agreement with its primary lender which provided for an unsecured $6,600,000 term credit loan (see Note 4) and an unsecured $3,000,000 credit authorization for revolving credit loans and letters of credit. Under the agreement, the Company's short-term line with its primary lender was reduced from $5,000,000 to $3,000,000.

          Effective March 30, 2000 and October 31, 2000, the loan agreement was amended. The primary changes to the loan agreement, effective with the March 30, 2000 amendment, included (1) an increase in the short-term line from $3,000,000 to $3,500,000, (2) an extension of the maturity date of the short-term line from May 31, 2000 to September 30, 2002, (3) a reduction in the quarterly principal payments on the long-term portion of the loan agreement, with a corresponding extended final maturity date from June 30, 2003 to December 31, 2003, and (4) an adjustment of certain restrictive covenants. In addition, borrowings under the amended loan agreement are secured by all accounts receivable, inventory, furniture and equipment, machinery and equipment and all other personal property of the Company, and are guaranteed by all subsidiaries of the Company. As part of the October 31, 2000 amendment the short-term line was increased from $3,500,000 to $4,000,000.

          Interest for both the short-term and long-term borrowings is based on three different pricing options: a negotiated rate, a Eurodollar rate plus a factor, and a floating rate (greater of the federal funds rate plus a factor or the prime rate). The effective Eurodollar rate and floating rate are increased by a

margin rate, ranging from 1.50% to 2.25%, which is based upon certain Company performance parameters.

          The Company maintains two additional unsecured lines of credit with banks aggregating $2,200,000, with interest rates based on prime. Of the $6,200,000 total short-term lines available to the Company at December 31, 2000, $1,200,000 was unused. Of the $5,200,000 total short-term lines available at December 31, 1999, $1,200,000 was unused.

          The weighted average interest rates on short-term borrowings outstanding at December 31, 2000 and 1999 were 9.87% and 9.10%, respectively. The interest rates on short-term borrowings in effect at December 31, 2000 and 1999 for the Company's primary lender were unusually high as they were based on the federal funds interest rate, which typically increases as of the last day of the calendar year. The weighted average interest rates on the Company's short-term borrowings for the seven-day periods preceding December 31, 2000 and 1999 were 8.99% and 8.08%, respectively.

          Subsequent to year-end, the Company's loan agreement with its primary lender relating to its short-term and long-term borrowings was further amended. See Note 13 regarding the primary changes to the loan agreement (e.g., credit line amount, maturity date, principal payments, restrictive financial covenants and collateralization).

Note 4 - Long-Term Debt

          As discussed in Note 3, the Company restructured its short-term and long-term borrowing arrangements in August 1998 and two amendments to the new agreement took effect in 2000. The entire $6,600,000 under the term loan portion of the loan agreement was borrowed in 1998 and was used to additionally fund the Company's defined benefit plans, to pay off the previously outstanding long-term debt and, as discussed in Note 3, to reduce short-term notes payable. The additional funding to the Company's defined benefit plans resulted in the $2,438,707 and $2,359,980 prepaid pension asset in the accompanying consolidated balance sheets at December 31, 2000 and 1999, respectively. The term loan, as amended, is payable in quarterly principal payments of $275,000 plus interest in 2001, followed by quarterly principal payments of $320,000 plus interest in 2002 and 2003. The interest is based on the pricing options discussed in Note 3. In connection with the $6,600,000 term loan, the Company entered into an interest rate swap agreement essentially to fix the interest rate on its long-term borrowings at 5.95% plus the margin discussed in Note 3, resulting in an interest rate range of 7.45% to 8.20%. At December 31, 2000, the interest rate in effect on these long-term borrowings was 8.20% and the notional amount of the swap agreement amounted to $3,660,000. Of the $3,660,000 outstanding long-term debt balance at December 31, 2000, $1,100,000 is due in 2001, with remaining maturities of $1,280,000 in 2002 and 2003.

          The term loan agreement requires the Company to maintain certain financial balances and ratios and limits the amount of cash dividends. Unrestricted retained earnings under the agreement amounted to $779,378 (prior to the amendment discussed below) at December 31, 2000. The Company has obtained a waiver from the bank for its noncompliance with certain of these restrictions as of December 31, 2000. The bank also agreed to modify the restriction levels as part of the impending restructuring of the Company's current loan agreement (see Note 13).

          As discussed above, subsequent to year-end, the Company's loan agreement with its primary lender relating to its short-term and long-term borrowings was amended (see Note 13).

Note 5 - Pension and Retirement Savings

          The Company's foreign subsidiary maintains a defined contribution retirement savings plan. Due to overfunding of the plan, there were no contributions in 2000, 1999 and 1998.

          The Company has two defined contribution retirement savings plans, covering substantially all domestic employees, which are funded solely through contributions based on formulas as defined in the plan agreements. The assets are held in trust for the sole benefit of the employees. Contribution expense was $619,000, $669,000 and $668,000 for 2000, 1999 and 1998, respectively, relating to these plans.

          As part of the sale of its filter operations in 1995, the Company entered into a deferred compensation agreement with a former officer of the Company. The related deferred compensation expense was included as a cost of the 1995 sale. The deferred compensation benefits are to be paid over a period of ten years, commencing in November 1995. At December 31, 2000 and 1999, respectively, the present value of the deferred compensation liability amounted to $199,895 and $232,480, of which $35,287 and $32,583 was due within one year.

Note 6 - Postretirement Benefit Plans