SECURITIES AND EXCHANGE COMMISSION
                                        
                             WASHINGTON, D.C.  20549
                                        
                                    Form 10-K

            [ X ]  ANNUAL REPORT PURSUANT TO SECTION 13 or 15 (d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                  For the Fiscal Year Ended:  December 31, 1998

                                       OR

            [   ]  TRANSITION REPORT PURSUANT TO SECTION 13 or 15 (d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                 For the transition period from _______ to _______

                         Commission File No.:  33-62598


                          Fairfield Manufacturing Company, Inc.
             (Exact name of Registrant as specified in its charter)


          Delaware                      63-0500160
  (State of incorporation)        (I.R.S. Employer Identification No.)


U. S. 52 South, Lafayette, IN             47905
(Address of principal executive offices)(Zip Code)

     Registrant's telephone number, including area code:  (765) 474-3474

Securities registered pursuant to Section 12(b) of the Act:  None
Securities registered pursuant to Section 12(g) of the Act:
   $67,150,000 11-3/8% Senior Subordinated Notes
   $50,000,000 11-1/4% Series A Cumulative Exchangeable Preferred Stock


Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                             Yes   X             No

At December 31, 1998 there were 8,480,000 shares of the Company's Common Stock
issued and outstanding.

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                      FAIRFIELD MANUFACTURING COMPANY, INC.

                           Annual Report on Form 10-K

                                December 31, 1998

                                Table of Contents

  Item                                                       Page
 Number                                                     Number
                              PART I                           
   1     Business                                             1
   2     Properties                                           6
   3     Legal Proceedings                                    6
   4     Submission of Matters to a Vote of Security          6
           Holders
                                                               
                             PART II                           
   5     Market for the Registrant's Common Equity and         
           Related Stockholder Matters                        7
   6     Selected Financial Data                              8
   7     Management's Discussion and Analysis of               
           Financial Condition and Results of Operations      9
   8     Financial Statements and Supplementary Data          13
   9     Changes in and Disagreements with Accountants         
           on Accounting and Financial Disclosure             13
                                                               
                             PART III                          
   10    Directors and Executive Officers of the              14
           Registrant
   11    Executive Compensation                               16
   12    Security Ownership of Certain Beneficial Owners      19
           and Management
   13    Certain Relationships and Related Transactions       20
                                                               
                             PART IV                           
   14    Exhibits, Financial Statement Schedules, and         21
         Reports on Form 8-K
                                                               
         Signatures                                           26
         Index to Consolidated Financial Statements and        
           Financial Statement Schedule                      F-1

<PAGE>

                      FAIRFIELD MANUFACTURING COMPANY, INC.
                                    Form 10-K
                       Fiscal Year Ended December 31, 1998

                                     PART I


Item 1.   BUSINESS

General

Fairfield Manufacturing Company, Inc. (the "Company") believes that it is the
leading independent manufacturer (based on sales) of high precision custom gears
and assemblies and planetary gear systems in North America, with an estimated
market share in each of the custom gear and planetary gear system markets of
more than two times that of its nearest competitors.  The majority of the
Company's custom gears and assemblies and planetary gear systems are used by
original equipment manufacturers ("OEMs") as components in various kinds of
heavy mobile equipment.  The Company's customers include many industry leaders.
For the year ended December 31, 1998, the Company had net sales of $220.3
million and EBIDTA (as defined) of $37.1 million.

Custom gears and assemblies accounted for $118.5 million (or 53.8%) of the
Company's 1998 net sales.  Custom gears are components of larger systems such as
axles, drive differentials and transmission units and are generally produced by
the Company for large OEMs.  Custom assemblies are differentials, wheel drives,
power transmissions and conveyer/tram drives that are generally produced as a
complete unit.  The Company's custom gear and assembly customers consist
primarily of OEMs of rail, mining, agricultural, industrial, construction and
materials-handling equipment.  The Company is the sole independent supplier of
selected gear products for many of these OEMs.

Planetary gear systems, which accounted for $101.8 million (or 46.2%) of the
Company's 1998 net sales, are integrated, self-contained power transmission and
torque conversion systems that provide propulsion, swing and/or rotation to
wheels, axles and other components in applications where the use of axles would
otherwise present design difficulties.  The Company markets its planetary gear
systems under its Torque-Hub  name ("Torque-Hub").  The Company believes that,
as a result of the performance history and reputation for quality of the
Company's Torque-Hub products, the Torque-Hub name has become closely identified
with planetary gear systems.  Customers for the Company's Torque-Hub products
include OEMs of access platform, road rehabilitation, construction, forestry and
agricultural equipment.

The Company has been granted "preferred supplier" status by a majority of our
customers based on our ability to meet their business requirements.  The 
Company has also been certified as meeting "ISO-9001" standards, which are 
increasingly being used by OEMs in lieu of individual certification procedures.
In addition, the Company has been certified as meeting "QS-9000" standards, 
which became the standard level of certification required by automotive OEMs in
1998.  The Company believes that certification provides it with a competitive 
advantage because a number of OEMs require certification as a condition to doing
business.

The Company believes that its strong market position in the custom gear and
planetary gear systems markets is the result of its (i) breadth and quality of
product offerings, (ii) longstanding relationships (in many cases of 20 years or
more) with its major custom gear and planetary gear system customers, (iii)
state-of-the-art engineering and manufacturing technology, including in-

<PAGE>

house heat treating facilities, computer-aided design and manufacturing systems
and computer numerically-controlled machine tools and gear grinders, (iv) cost
competitiveness, (v) experienced engineering staff, which together with the
Company's sales force, work closely with customers in designing and developing
products to meet customers' needs and (vi) stable, knowledgeable sales force,
many of whose members have engineering degrees and have worked with the same
customers for many years.  In addition, the Company believes that its management
team, which has an average of over 20 years of experience in general
manufacturing, will be instrumental in further strengthening the Company's
market position.

The Company was founded in 1919 as a manufacturer of custom gear products and
was family-owned until 1977.  At that time, the Company was purchased by Rexnord
Corporation, which subsequently sold the Company in 1987 to Neoax Inc.  Lancer
Industries Inc. ("Lancer") purchased the Company in 1989.  The Company's
principal executive offices are located at U.S. 52 South, Lafayette, Indiana
47905.  The Company's telephone number is (765) 474-3474.

Products

Custom Products.  Custom gears and assemblies accounted for approximately
$118.5, $107.1 and $112.3 million of the Company's net sales in 1998, 1997 and
1996, respectively.  The Company manufactures a wide variety of custom gears,
ranging in type (e.g. helical, spiral bevel, spur and HYPOID) and size (from one
inch to five feet in diameter), and has manufacturing capabilities which the
Company believes are the broadest in the custom gear business.  The Company
manufactures custom gears and assemblies to customers' specifications, which are
often developed by or with the assistance of the Company. Our custom gears and
assemblies are used in a wide variety of applications and markets, ranging from
off-highway heavy equipment to high speed precision gears for industrial
purposes.

Historically, the Company has focused on severe application custom business.
These custom products, which are design and engineering intensive, are used in
rail, mining, agricultural, construction, materials-handling and other equipment
demanding a high degree of product quality and reliability.  Many customers in
these markets do not have the necessary engineering and/or manufacturing
facilities, and/or personnel to design and manufacture their gear requirements
in-house.  In addition, the trend among OEMs to focus on their core competencies
(final assembly and system integration) rather than produce gears and gear
related assemblies in-house appears to be continuing.

Torque-Hub Products.  Torque-Hub products accounted for approximately $101.8,
$85.2 and $82.9 million of the Company's net sales in 1998, 1997 and 1996,
respectively.  The Company believes that the Torque-Hub name has become closely
identified with planetary gear systems, which provide drive, swing, and/or
rotation to the equipment in which they are used and are primarily employed in
cases where the use of axles present design difficulties.  The Company produces
a broad line of planetary gear systems under its Torque-Hub trade name,
including wheel drives (used to propel off-highway equipment), shaft outputs
(used to power remote in-plant machinery like mixers as well as mobile aerial
lifts and cranes) and spindle outputs (which power the drive wheels of vehicles
with small diameter wheels such as small lift trucks and mowers).

The Company has introduced a number of new Torque-Hub products in recent years,
including two-speed drives (Torque II series) and compact drives (CW and CT
series) for wheeled or tracked vehicles.  The Company believes that the two-
speed drive is ideal for machinery requiring low- and high-speed settings, such
as road paving equipment.  The compact drive incorporates the brakes and
hydraulic drive systems into a single compact unit, which the 

<PAGE>

Company believes allows for better flexibility and is well-suited for a variety
of applications.  These products are used in a wide range of industrial and 
construction equipment, including excavators, crawler dozers and loaders, 
rubber-tired pavers and multi-speed winches.

Marketing and Distribution

The Company's customers are almost exclusively OEMs and include many industry
leaders with whom the Company has had relationships of 20 years or more.  Sales
to General Electric accounted for approximately 10.6% of the Company's net sales
in 1998.  No customer accounted for more than 10% of total net sales in 1997 or
1996.

The Company has been granted "preferred supplier" status by a majority of  our
customers based on our ability to meet their business requirements.   The
Company has also been certified as meeting "ISO-9001" standards, which are
increasingly being used by OEMs in lieu of individual certification procedures.
In addition, the Company has been certified as meeting "QS-9000" standards,
which became the level of certification required by automotive OEMs in 1998.
The Company believes that certification provides it with a competitive advantage
because a number of OEMs require certification as a condition to doing business.

The Company believes its stable, experienced sales force is a primary reason for
the Company's success in maintaining customer loyalty and building new customer
relationships.  The Company's sales department is organized geographically and
consists primarily of sales engineers, who have an average of over 14 years of
experience with the Company and many of whom have worked with the same customers
for many years.  In addition, each sales engineer has substantial expertise
concerning the Company's products and product applications.  Application
engineers work closely with the Company's sales department and provide customers
with guidance concerning product applications and specific design problems.  By
becoming a part of the customer's purchasing and design decisions, the Company
has developed close working relationships with many of its customers.  Customer
loyalty to the Company is further enhanced by the development, tooling and
production costs associated with changing gear sources, as such costs are
typically borne by the customer.

All of the Company's custom gear products and approximately 70% of its Torque-
Hub products are sold directly to OEMs.  Since Torque-Hub products can be sold
to more than one customer, the Company uses distributors to increase its
penetration of the planetary gear systems market.  The Company sells
approximately 30% of its Torque-Hub line through a network of approximately 40
distributors located in the United States and abroad.

International sales, principally Canada, accounted for approximately $16.2,
$13.3 and $11.3 million of the Company's net sales in 1998, 1997 and 1996,
respectively.

Design and Manufacturing

The Company believes that its state-of-the-art technology and experienced
engineering staff provide it with a competitive advantage and are major factors
behind the Company's strong market position.

The Company has selectively invested in state-of-the-art manufacturing
technology in recent years to improve product quality and price competitiveness,
and to reduce lead time.  The Company's manufacturing technology includes the
latest computer-aided design and manufacturing (CAD/CAM) systems, and over 150
computer numerically controlled (CNC) lathes, machine tools and gear grinders.

<PAGE>

The Company's engineering department consists of over 65 engineers and
technicians, including specialists in product, tool, manufacturing, and
industrial engineering.  In addition, the Company has a metallurgy laboratory
which determines the appropriate metallurgy for a specific gear application.
These engineering groups, with their distinct specialties, work together as a
team to develop solutions to specific customer requirements.  These capabilities
enable the Company to service clients who demand high quality, creative
solutions to their product needs.

The Company's engineers and designers are skilled in the use of, and have
available, certain of the latest tools and techniques to create cost efficient
designs.  Procedures such as finite element analysis are routinely used by the
Company's engineers and designers to optimize material content and insure
functional reliability of components designed.  This type of analysis and
simulation allows many aspects of a design to be evaluated prior to production,
resulting in lower tooling costs, reduced testing requirements and quicker time
to market.  In addition, the Company's CNC gear cutting machines allow for many
different styles and sizes of gears to be run quickly in small lot sizes with a
high degree of accuracy.

The Company has its own comprehensive heat treating facilities.  These in-house
facilities allow the Company to control the annealing and carburizing processes
that determine the load-carrying capacity of the final product.  The Company's
heat treating operations help ensure proper development and maintenance of gear
tooth characteristics.  As a result, the Company believes that it is able to
provide its customers with improved quality and reduced lead times in filling
orders.

Materials and Supply Arrangements

The Company generally manufactures its custom and Torque-Hub products to
its customers' specifications and, as a result, does not generally contract for
or maintain substantial inventory in raw materials or components.  The Company
purchases its three principal raw material needs (steel forgings, steel bars and
castings) on a spot basis based on specific customer orders.  Raw material
purchases from one supplier represented approximately 13.9% of raw material
purchases in 1998 and 1997.  During 1996 purchases from a single supplier did
not exceed 10% of raw material purchases.  Alternative sources are available to
fulfill each of the Company's major raw material requirements.  The Company has
never experienced a delay in production as a result of a supply shortage of a
major raw material.

Competition

The North American custom gear business is highly competitive but very
fragmented.  Competition can be broken down into four principal groups: major
domestic manufacturers, regional domestic manufacturers, foreign producers and
captive gear manufacturers.  Although captive gear manufacturers supply all or a
portion of their internal gear requirements and constitute a significant portion
of the custom gear market, the Company believes there is a trend among such
manufacturers to outsource, or purchase their gears from independent
manufacturers such as the Company.  The North American planetary gear market is
also highly competitive and is concentrated among several large competitors,
with the remaining market divided among a large number of relatively small
suppliers.  The Company competes with other manufacturers based on a number of
factors, including delivery capability, quality and price.  The Company believes
that its breadth of manufacturing, engineering and technological capabilities
provide it with a competitive advantage.

<PAGE>

Employees

At December 31, 1998, the Company had 1,322 employees, of whom approximately 92%
were employed in manufacturing.  The Company's production and maintenance
employees, representing approximately 84% of the Company's employees, became
members of the United Auto Workers (UAW) union in October 1994.  In October 1998
a new three labor year agreement was ratified by the Company's union employees.
The Company considers its relations with its employees to be satisfactory.

Backlog

The Company had total order backlog of approximately $121.2 and $110.8 million
as of December 31, 1998 and 1997, respectively, for shipments due to be
delivered by the Company for the six-month period following such dates.  The
increase in backlog is primarily attributable to increased market demand for the
Company's products.

Environmental Matters

The Company's operations and properties are subject to a wide variety of
increasingly complex and stringent environmental laws.  As such, the nature of
the Company's operations exposes it to the risk of claims with respect to such
matters and there can be no assurance that material costs or liabilities will
not be incurred in connection with such claims.  The Company believes its
operations and properties are in substantial compliance with such environmental
laws.  Based upon its experience to date, the Company believes that the future
cost of compliance with existing environmental laws, and liability for known
environmental claims pursuant to such environmental laws, will not have a
material adverse effect on the Company's business, financial condition or
operating results.  However, future events, such as changes in existing
environmental laws or their interpretation and more vigorous enforcement
policies of regulatory agencies, may give rise to additional expenditures or
liabilities that could be material.

Recent Developments

During the second half of 1998, the Company took advantage of the depressed high
yield bond market and repurchased $17.9 million of Senior Subordinated Notes
("Notes") on the open market.  While the Company recorded an extraordinary loss
(approximately $0.4 million net of tax) related to deferred financing and
premiums paid on repurchase, the repurchases were made at prices significantly
below the call premium.

<PAGE>

Susceptibility to General Economic Conditions

The Company's revenues and results of operations will be subject to fluctuations
based upon general economic conditions.  If there were to be a general economic
downturn or a recession in the United States or certain other markets, the
Company believes that certain of its customers may reduce or delay their demand
for the Company's products which may have a negative effect on the Company's
revenues.  Most of the factors that might influence customers and prospective
customers to reduce their capital budgets under these circumstances are beyond
the Company's control.  During prior recessionary periods, the Company's
operating performance has been negatively affected, and there can be no
assurance that any future economic downturn would not materially and adversely
affect the Company's business, financial condition and operating results.  In
addition, there can be no assurance that growth in the markets from the
Company's products will occur or that such growth will result in increased
demand for the Company's products.

Intellectual Property

The trade names Torque-Hub and Torque II are registered trademarks.  The
Company's planetary gear systems are sold under the Torque-Hub trade name.  The
Company, directly and through its wholly-owned subsidiary, T-H Licensing, Inc.,
owns numerous patents worldwide.  None of such patents is individually
considered material to the Company's business.

Item 2.PROPERTIES

The Company owns and operates a single 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.  The Lafayette facility is
well maintained and is in good condition.

Item 3.LEGAL PROCEEDINGS

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.

Item 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the Company's security holders during the
fourth quarter of the fiscal year ended December 31, 1998.

<PAGE>

                                     PART II


Item 5.MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

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

Dividends

During February 1997, the Company declared a $3.1 million dividend to Lancer.
The dividend was used to repay a $3.0 million advance to Lancer and accrued
interest of $0.1 million.

On March 12, 1997, the Company used the net proceeds of $47.7 million from the
offering of its 11-1/4% Series A Cumulative Exchangeable Preferred Stock to fund
a dividend to Lancer.  Lancer used the dividend to redeem approximately $47.7
million of its Series C Preferred Stock.

Issuance of Common Stock

The Company issued 73,000, 94,000, 50,000, and 73,000 additional shares of its
common stock on March 31, June 30, September 30, and December 31, 1998,
respectively, to Lancer in consideration of certain capital contributions made
by Lancer to the Company pursuant to the Tax Sharing Agreement (as defined in
Item 13) and other capital contributions.

The Company issued 52,000, 53,000 and 280,000 additional shares of its common
stock on March 31, June 30, and  December 31, 1997, respectively, to Lancer in
consideration of certain capital contributions made by Lancer to the Company
pursuant to the Tax Sharing Agreement.

<PAGE>

Item 6.  SELECTED FINANCIAL DATA

The following selected financial data for the Company for the five years ended
December 31, 1998 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 "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.


                                                 
($ in millions)                       Year Ended December 31,
                                 1998     1997      1996      1995     1994
Income Statement Data:                                        
Net sales                       $220.3    $192.3    $195.2    $192.1   $150.7
Cost of sales                    178.9     157.7     158.6     151.9    123.1
Selling, general and                                      
administrative expenses           16.8      17.0      16.9      14.7     15.9
Operating income                  24.6      17.6      19.7      25.5     11.7
Interest expense, net             12.7      12.7      11.9      12.9     12.4
Net income (loss) (1)              6.1       2.2       3.9       6.9     (2.3)
Preferred stock dividends                                 
and discount accretion            (5.8)     (4.7)      --         --      --
Net income (loss)                                 
available to                       0.3      (2.5)     3.9        6.9     (2.3)  
 common stockholder
                                                              
                                                              
Balance Sheet Data:                                             
Working capital                  $15.9      $7.8    $12.1      $17.3     $8.3
Total assets                     175.1     173.2    176.4      183.2    170.6
Total debt (2)                   112.2     114.0    118.0      113.0    115.0
Long-term obligations (3)        160.2     157.9    115.0      110.0    111.5
Stockholder's equity             (49.0)    (52.2)    (4.6)      10.0      0.0
(deficit)
                                                              
Other Data:                                                   
EBITDA (4)                       $37.1     $30.1    $32.0     $ 37.0    $22.6
Depreciation                      11.0      11.0     10.8       10.0      9.5
Amortization (5)                   2.3       2.3      2.3        2.2      2.3
Cash interest expense, net (6)    12.0      12.0     11.3       12.3     11.7
Capital expenditures              10.5      10.9     11.2       11.6      9.2
                                                              
                                                              
(1)  During 1998, the Company recorded an extraordinary loss of $0.4 million,
     net of tax, relating to the early extinguishment, of $17.9 million in
     Senior Subordinated Notes.  During 1994, the Company recorded a one-time
     non-cash charge of $1.6 million, net of tax, relating to the cumulative 
     effect of adopting Statement of Financial Accounting Standards No. 112, 
     "Employers Accounting for Postemployment Benefits."
(2)  Includes current maturities of $4.0, $3.0, $3.0 and $3.5 for 1997, 1996,
     1995 and 1994, respectively.
(3)  Includes long-term portion of total debt and redeemable preferred stock.
(4)  EBITDA represents income (loss) before income taxes, preferred stock
     dividends and discount accretion, extraordinary item, cumulative effect of
     a change in accounting principle, interest expense, net, depreciation and
     amortization.  EBITDA is not presented herein as an alternative measure of
     operating results or cash flow but rather to provide additional information
     related to debt service capability.
(5)  Includes the amortization of both deferred financing costs and the excess
     of investment over net assets acquired.
(6)  Cash interest expense, net includes interest income, but excludes
     amortization of deferred financing costs of $0.7, $0.7, $0.6, $0.6, and
     $0.7 million for fiscal years 1998, 1997, 1996, 1995 and 1994, 
     respectively.

<PAGE>

Item 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

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.

Results of Operations

Fiscal Year 1998 Compared with Fiscal Year 1997
Net sales for 1998 increased $28.0 million to $220.3 million compared to $192.3
million in 1997.  This 14.6% increase was due to strong market demand for the
Company's products in specific markets  as well as a strong overall economy.
Net sales of the Company's Torque Hub products increased 19.5% to $101.8 million
compared to 1997 primarily due to strong demand in the access platform and road
rehabilitation markets.  Net sales of custom gears and assemblies increased
10.6% to $118.5 million compared to 1997 primarily due to strong demand in the
rail, mining and off highway industries.

Cost of sales for 1998 increased $21.2 million to $178.9 million, or 81.2% of
net sales, compared to $157.7 million, or 82.0% of net sales in 1997.  Cost of
sales increased over 1997 in conjunction with the increase in sales.  The 0.8%
improvement in cost of sales, as a percentage of net sales, was due to operating
efficiencies from increased volumes and favorable sales mix.

Selling, general and administrative expenses ("SG&A"), including goodwill
amortization, decreased to $16.8 million in 1998, compared to $17.0 million in
1997.  SG&A expenses for 1997 included a charge of $1.1 million primarily
related to a consulting agreement with the Company's former Chairman of the
Board (see Note 2 to the Consolidated Financial Statements).

Operating income increased $7.0 million, or 39.8%, to $24.6 million compared to
$17.6 million in 1997 due to the reasons discussed above.

Interest expense, including amortization of deferred financing costs, was $12.7
million for 1998 and 1997.  Although interest rates decreased slightly in 1998,
interest expense was essentially unchanged from 1997 due to higher average
outstanding principal throughout the year.

The effective tax rates for 1998 and 1997 were 44.9% and 54.8%, respectively.
See Note 7 to the Consolidated Financial Statements for a further discussion of
income taxes.

The Company's net income increased $3.9 million to $6.1 million for 1998
compared to $2.2 million for 1997.

The Company recorded a loss on early extinguishment of debt, net of tax, of $0.4
million in 1998 related to the repurchase of $17.9 million of the Company's
Senior Subordinated Notes (see Note 8 to the Consolidated Financial Statements).

Net income available to common stockholder for 1998 increased $2.8 million to
$0.3 million compared to a $2.5 million net loss available to common stockholder
for 1997.

<PAGE>

Fiscal Year 1997 Compared with Fiscal Year 1996
Net sales for 1997 decreased by $2.9 million, or 1.5%, to $192.3 million
compared to $195.2 million in 1996 principally due to weaker demand for the
Company's products during the first quarter of 1997 versus the first quarter of
1996.  Net sales of custom gears for 1997 decreased $5.2 million (or 4.6%) to
$107.1 million compared to 1996 due primarily to the end of programs related to
the defense industry.  The decrease in custom net sales was partially offset by
an increase of $2.3 million (or 2.8%) in net sales of Torque Hub products
primarily due to demand for compact units.

Cost of sales for 1997 decreased by $0.9 million, or 0.6%, to $157.7 million, or
82.0% of net sales, compared to $158.6 million, or 81.3% of net sales in 1996.
This decrease is primarily due to the decrease in net sales partially offset by
increased employment and training costs during the second half of 1997 to meet
increased demand.

SG&A increased to $17.0 million in 1997, compared to $16.9 million in 1996.
SG&A expenses for 1997 included a $1.1 million charge primarily related to a
consulting agreement with the Company's former Chairman of the Board (see Note 2
to the Consolidated Financial Statements) and for 1996 included a $0.5 million
write-off of a receivable due to a customer's bankruptcy.

Earnings from operations for 1997 decreased $2.1 million to $17.6 million,
compared to $19.7 million in 1996, primarily due to the factors above.

Interest expense, including amortization of deferred financing costs, was $12.7
million for 1997, compared to $11.9 million for 1996.  The principal reason for
the increase was higher outstanding debt levels during 1997 due to a $15.0
million increase in debt during December 1996 which was used to fund a $17.0
million dividend to Lancer.

The effective tax rates for 1997 and 1996 were 54.8% and 48.8%, respectively.
See Note 7 to the Consolidated Financial Statements for a further discussion of
income taxes.

The Company's net income for 1997 was $2.2 million compared to $3.9 million for
1996.

Net loss available to common stockholder for 1997 was $2.5 million, as compared
to $3.9 million in net income available to common stockholder for 1996.

Liquidity and Capital Resources

The Company uses funds provided by operations and short-term borrowings under
its Revolving Credit Facility to meet liquidity requirements.  Net cash provided
by operations increased $3.3 million for the year ended December 31, 1998
compared to 1997.  Net cash provided by operations was $15.4, $12.1 and $26.6
million for the years ended December 31, 1998, 1997 and 1996, respectively.

Working capital at December 31, 1998 increased to $15.9 million from $7.8
million at December 31, 1997.  The increase was primarily due to increases in
accounts receivable and inventory in conjunction with higher sales levels and a
decrease in current maturities of long term debt due to the amendment of the
Company's loan agreement (see Note 8 to the Consolidated Financial Statements
and discussion below).

Capital expenditures for various machine tools, equipment and building
improvement items totaled $10.0 million for each of the fiscal years ended
December 31, 1998, 1997 and 1996, respectively, of which $0.8, $1.4, and $2.3
million was funded by an increase in accounts payable at the

<PAGE>

respective period end in 1998, 1997 and 1996. Capital expenditures for this
period have been primarily for increased capacity and productivity to support
increased sales demand.

Net cash used by financing activities was $5.1, $4.3 and $13.6 million in 1998,
1997 and 1996, respectively.  Net use in 1998 resulted primarily from cash
payment of dividends on the Company's outstanding preferred stock.  Net use in
1997 resulted primarily from cash dividends on preferred stock and repayment of
long-term debt.     A $47.7 million dividend to Lancer in 1997 was offset by the
net proceeds from issuance of preferred stock of $47.7 million.   Net use in
1996  resulted primarily from a $17.0 million dividend to Lancer, partially
offset by $5.0 million in net additional borrowings under the Company's senior
credit facilities.

Under the Tax Sharing Agreement (as defined hereinafter), Lancer made capital
contributions to the Company of $2.7, $2.6 and $1.6 million in 1998, 1997 and
1996, respectively.  See Note 7 to the Consolidated Financial Statements for a
further discussion of capital contributions made pursuant to the Tax Sharing
Agreement.

The Company completed an amendment to its loan agreement with a senior lending
institution in October 1998 (see Note 8 to the Consolidated Financial
Statements).  The Company's relationship with this senior lending institution
was established in 1993 in conjunction with the initial loan agreement.  The
credit facilities provided under this loan agreement, as amended, consist of a
Revolving Credit Facility ("Revolver"), a Term Loan and a Debt Repurchase Line,
and are jointly referred to as the "Credit Facilities."  Prior to amendment in
1998, the loan agreement provided for a Revolver, due July 1, 2001 and a Term
Loan, due in quarterly installments through December 2000.  In general, the
October 1998 amendment extended the maturity of the Revolver and Term Loan to
July 1, 2005, lowered the interest rate and established the Debt Repurchase
Line.

The loan agreement as amended provides for $20 million in credit under the
Revolver, subject to borrowing base availability (as defined in the agreement),
a $35 million Term Loan, and a $10 million Debt Repurchase Line to be used for
repurchases of the Company's Senior Subordinated Notes.  At December 31, 1998,
the Company has $18.0 million available under the Revolver and $1.0 million
available under the Debt Repurchase Line (subject to certain conditions).  The
Company additionally has the option to exercise two $5.0 million increases
(subject to certain conditions) to the Revolver.

On July 7, 1993, the Company completed the sale of $85.0 million of 11-3/8%
Senior Subordinated Notes (the "Notes").  The Notes mature on July 1, 2001 and
are redeemable at the option of the Company, in whole or in part, on or after
July 1, 1998, at certain specified redemption prices.  During 1998 the Company
repurchased $17.9 million of Notes on the open market with funds provided under
the Credit Facilities.  The Company recorded a $0.4 million loss, net of tax, in
conjunction with these repurchases related to the write-off of deferred
financing charges and premium paid on repurchase.  At December 31, 1998, $67.1
million of Notes remain outstanding.

Management expects to use cash flows from operations to fund the Company's
planned capital requirements for 1999, including capital expenditures, interest
on long term debt and preferred stock dividends.  The Company's Credit
Facilities, as discussed above, may also be utilized to meet additional
liquidity needs.

<PAGE>

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.

Impact of the Year 2000

During 1997 the Company began the process of assessing the magnitude of the year
2000 ("Y2K") on the Company's primary computer systems ("Business System"). Upon
completing the assessment of the Business System, a plan was established to
modify, upgrade, or replace non compliant hardware and software applications
with a target completion date of March 1999 for all "critical" applications and
continuing through 1999 for "non-critical" applications.  The Company is
currently on schedule with regard to critical applications.  Testing is being
performed on an ongoing basis upon completion of an application and is expected
to continue throughout 1999.  As of December 31, 1998 approximately 75% of
critical applications and approximately 59% of all Business System applications
have been remediated and tested. The Company has not developed a comprehensive
contingency plan with regard to the Business System as all critical applications
are expected to be Y2K ready.  If progress toward Y2K readiness deviates from
the anticipated time line or the Company identifies significant additional
risks, appropriate contingency plans will be developed at that time.

None of the Company's products contain imbedded electronics or other potentially
date sensitive components and as such do not require any Y2K compliance effort.

Several types of systems and equipment (phones, facilities, manufacturing
equipment, etc. - collectively "non-IT systems") that are not typically thought
of as computer systems may contain imbedded hardware or software that may have a
time element.  The Company is in the process of gathering data, identifying and
developing remediation plans for effected non-IT systems and equipment.  The
Company has not developed a comprehensive contingency plan with regard to non-IT
systems and equipment as all identified mission critical systems and equipment
are expected to be Y2K ready by the end of 1999.  If progress toward Y2K
readiness deviates from the anticipated time line or the Company identifies
significant additional risks, appropriate contingency plans will be developed at
that time.

The Company is primarily utilizing internal IT resources with the additional
assistance of contract programmers who are familiar with the software.  It is
currently estimated that the total cost associated with required modifications
for both the Business System and non IT systems to become Y2K ready will be
approximately $0.4 to $0.5 million, of which approximately $0.2 million has been
spent as of December 31, 1998.  These costs are being expensed as incurred and
are being funded from existing operating budgets.

The Company relies on third party suppliers for raw materials, water, utilities,
transportation, and other services.  Interruption of supplier operations due to
Y2K issues could affect the Company's operations.  The Company is in the process
of evaluating and monitoring the status of key suppliers' progress toward Y2K
compliance.  As a component of this process, the Company has sent a
questionnaire to suppliers inquiring about their Y2K plan and stage of
readiness.  At December 31, 1998 the Company has received responses from 23 key
suppliers, which together represented over 70% of the Company's total material
purchases in 1998.  All respondents have acknowledged the issues surrounding
Y2K, have a plan in place, and have stated their intent to be compliant by the
end of 1999 or earlier.  The Company will continue to monitor the progress of
key suppliers during 1999 and if necessary determine potential alternative
suppliers and/or 

<PAGE>

develop contingency requirements.  These activities, while a means of risk
management, cannot eliminate the potential for disruption of the Company's
operations due to third party failure.

The Company is also dependent upon our customers for sales and cash flow.  The
Company is in the process of contacting key customers to ascertain their Y2K
readiness through questionnaires.  The progress of key customers toward Y2K
compliance will continue to be monitored throughout 1999.

The failure to correct a material Y2K problem in the Company's critical Business
System applications and non-IT systems, could result in an interruption in, or
failure of certain normal business activities or operations.  Additionally, in
the event that any of the Company's key suppliers and customers fail to
successfully and timely achieve Y2K compliance and the Company is unable to
replace them with alternate suppliers or new customers, the Company's normal
business activities could be adversely affected.  Such interruptions or failures
could have a material adverse impact on the Company's results of operations,
cash flows, and financial condition.

The above discussion of Y2K and its potential impact on the Company contains
forward looking statements that are based on management's best estimates of
future events. Specific factors that could effect the actual outcome of these
estimates and conclusions include a possible loss of technical resources to
perform the work, failure to identify all susceptible systems, non-compliance by
third parties whose operations impact the Company, and other similar
uncertainties.

Information Concerning Forward-Looking Statements

This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933.  Such statements are subject to a
number of risks and uncertainties, including among other things, competition,
susceptibility of the Company's business to general economic conditions, control
of the Company by Lancer, environmental regulation, significant degree of
leverage, restrictive covenants related to the Company's indebtedness and
preferred stock, dependence on suppliers and major customers, Y2K compliance by
the Company and third parties with whom the Company does business, and risks
related to a unionized workforce.  Actual results in the future could differ
materially from those described in the forward-looking statements as a result of
such risk factors.  The Company undertakes no obligation to publicly release the
result of any revisions of these forward-looking statements that may be made to
reflect any future events or circumstances.

Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

Item 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

None.

<PAGE>

                                    PART III


Item 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth certain information with respect to the directors
and executive officers of the Company.

     Name             Age    Position
                             
     Paul S. Levy       51     Chairman of the Board, Vice
                               President and Assistant Secretary
     Peter A. Joseph    46     Director, Vice President and Secretary
     Stephen K. Clough  45     Director, President and Chief Executive Officer
     W. B. Lechman      66     Director
     Jess C. Ball       57     Director
     Andrew R. Heyer    41     Director
     Richard A. Bush    41     Vice President Finance
     James R. Dammon    55     Vice President Engineering
     Mark D. Gustus     39     Vice President Operations
     Dan E. Phebus      41     Acting Vice President Sales and Marketing

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 Joseph Littlejohn & Levy 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 Jackson Automotive Mechanism, Inc., Hayes Lemmerz
International, Inc., New World Paste Company, and Stonegate Resources LLC.

Mr. Joseph has been Vice President and Secretary and a Director 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. Clough was appointed President and Chief Executive Officer and elected to
the Board of Directors effective August 1998.  Prior to his appointment, Mr.
Clough was with 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. 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 Bank One Lafayette, Lafayette Life Insurance
Co., Lafayette Community Foundation, Lafayette Junior Achievement, The Salvation
Army and is President Emeritus of the American Gear Manufacturers Association.

Mr. Ball has been a Director of the Company since 1991.  Mr. Ball was President
and Chief Executive Officer of the Company from October 1994 to May 1996. From
December 1991 through September 1994, Mr. Ball was President and Chief Executive
Officer of Alford Industries (a company which filed for bankruptcy protection
and has been liquidated).

<PAGE>

Mr. Heyer has been a Director of the Company since August 1998.  Mr. Heyer is a
Managing Director at CIBC Oppenheimer Corp. ("CIBC Oppenheimer"), where he
serves as co-head of The High Yield Group. Prior to joining CIBC Oppenheimer,
Mr. Heyer was founder and Managing Director of the Argosy Group L.P. which was
acquired by CIBC Oppenheimer in 1995.  Mr. Heyer is also Chairman of the Board
of Directors of The Hain Food Group, and serves on the Board of Directors of
Niagara Corporation and Hayes Lemmerz International, Inc.

Mr. Bush has been Vice President of Finance of the Company since November 1994.
From 1990 to 1994, Mr. Bush was Controller for two different 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 of 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 of Operations since July 1997.  Prior to his
present position, Mr. Gustus was Director of Materials and Assembly.  Mr. Gustus
has been with the Company for over 15 years.

Mr. Phebus has been serving as the Acting Vice President Sales and Marketing
since May, 1998.  Prior to his present position, Mr. Phebus was Director of
Business Development, Quality Assurance Manager, and Sales Engineer.  Mr. Phebus
has been with the Company for nearly 20 years.

Compensation of Directors

Messrs. Ball and Lechman each receive an annual fee of $30,000 per year for
services as a director.  Mr. Lechman entered into a consulting agreement with
the Company (see Note 2 to the Consolidated Financial Statements) in August
1997.  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.

<PAGE>

Item 11.    EXECUTIVE COMPENSATION

The following table sets forth for each of the fiscal years ending December 31,
1998, 1997 and 1996, the compensation paid to or accrued for (i) the Chief
Executive Officer ("CEO") of the Company and (ii) the most highly compensated
executive officers other than the CEO.

                                      Summary Compensation Table
         Name and              Annual Compensation           All Other
        Principal            Year   Salary   Bonus(1)     Compensation(2)
         Position
                                                              
     Stephen K. Clough        1998  $154,872  $155,600     $18,869
     President and                               
     Chief Executive
     Officer
                                                
     Richard A. Bush          1998  $107,500   $44,000      $6,038
     Vice President           1997   104,004    30,000       6,874
     Finance                  1996   103,537    52,000       5,950
                                                
     James R. Dammon          1998  $118,560   $47,424      $6,852
     Vice President           1997   114,000    30,000       6,079
     Engineering              1996   114,437    57,000       4,988
                                                
     Mark D. Gustus           1998  $110,000   $44,000      $3,698
     Vice President           1997    91,272    30,000       3,475
     Operations               1996    84,536    41,094       3,460
                                                
     Kenneth A. Burns (3)     1998  $166,671   $    --    $198,324 (4)
                              1997   250,000    65,000      12,900
                              1996   185,279   100,000       3,325

(1)  Amounts shown were earned under the Fairfield Manufacturing Company
     Management Incentive Compensation Plan.
(2)  Amounts shown include contributions by the Company to The Savings Plan For
     Employees of Fairfield Manufacturing Company, Inc. ("Savings Plan") for the
     benefit of the named executives and imputed value of life insurance
     benefits provided by the Company.  Other compensation for Mr. Clough also
     includes moving expenses and the value of other fringe benefits provided by
     the Company.
(3)  Mr. Burns resigned as Chairman of the Board, President and Chief Executive
     Officer of the Company effective August 12, 1998.
(4)  Other compensation for Mr. Burns includes Company contributions to the
     Savings Plan, imputed value of life insurance benefits provided by the 
     Company, severance and the value of other benefits provided by the Company.
     As of December 31, 1998 the Company has no further obligations due
     Mr. Burns.

<PAGE>

                           Fiscal Year-End SAR Values

                      No. of Unexercised      Value of
                        SARs at FY-End       Unexercised
                         Exercisable/      SARs at FY-End
       Name           Unexercisable (1)     Exercisable/
                                            Unexercisable
                                                  
James R. Dammon            0/10,800              0/0


(1)  Equity Participation Rights (the "Rights" issued to participants in the
     Fairfield Manufacturing Company, Inc. Equity Participation Plan (the
     "Equity Participation Plan").  Mr. Dammon holds 10,800 Rights, under the
     Equity Participation Plan, all of which are fully vested.  Each Right
     entitles Mr. Dammon to receive, upon the occurrence of a Trigger Event (as
     defined in the Equity Participation Plan), an amount in cash equal to the
     difference between the Fair Market Value of a Right (as of the Trigger
     Event) and $16.67, the initial value assigned to each Right.

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").

                       Estimated Annual Benefits for
                   Years of Benefit Service Indicated(2)
Average Annual                                            
 Compensation (1)       5       10       15        20       25       30
$100,000             $6,705    $13,411  $20,116  $26,821  $33,526  $40,232
$125,000              8,518     17,036   25,553   34,071   42,589   51,107
$150,000             10,330     20,661   30,991   41,321   51,651   61,982
$160,000 and over    11,055     22,111   33,166   44,221   55,276   66,332

(1)  The preceding table illustrates the pension benefits provided by the
     Pension Plan, calculated on a straight life annuity basis for an eligible
     employee retiring at age 65 in1998. Average annual compensation covered
     under the Pension Plan is the highest average annual total compensation
     received from the Company for any 5 calendar years during the 10 years
     immediately preceding the participant's separation from service.  Annual
     total compensation for Pension Plan purposes includes all compensation
     disclosed in the Summary Compensation Table excluding moving expenses and
     fringe benefits provided by the Company.  Average annual compensation, used
     in determining a participant's pension benefit, is limited under the
     Pension Plan to comply with the Internal Revenue Code.  This limit was
     $160,000 for 1998.

(2)  At December 31, 1998 Messrs. Clough, Bush, Dammon, and Gustus had 0, 4, 33,
     and 17 years of credited service, respectively, for purposes of calculating
     their benefits under the Pension Plan.

<PAGE>

Employment, Consulting and Change in Control Agreements

Effective July 31, 1997, W. B. Lechman resigned as Chairman of the Company's
Board of Directors (the "Board") but continues as a member of the Board.

Effective August 1, 1997, Mr. Lechman entered into a consulting agreement (the
"Agreement") with the Company.  In consideration for services to be rendered
under the Agreement, Mr. Lechman will receive quarterly payments through July
31, 2001 ("the consulting period") totaling $1.0 million.  In the event that Mr.
Lechman dies prior to the end of the consulting period or is unable to perform
the services requested due to mental or physical disabilities, the Company shall
pay to his legal representatives or beneficiaries the remaining unpaid balance
under the Agreement which would have been due under the agreement had Mr.
Lechman continued to provide such services for the term of the Agreement.  Due
to the provisions of the agreement, the Company has recognized the entire $1.0
million as expense in 1997.

The Company entered into an employment agreement with Stephen K. Clough,
effective August 12, 1998 in connection with his appointment as President and
Chief Executive Officer of the Company.  The agreement is for a three year term
expiring on August 12, 2001.  The agreement provides for Mr. Clough to receive a
base salary of $400,000 or such greater amount as may be determined by the Board
of Directors of the Company upon periodic review.  In addition, Mr. Clough is
eligible to receive bonuses in each fiscal year covered by the agreement based
on the achievement of target performance objectives for himself and the Company
as established by the Board of Directors.  Mr. Clough is eligible to participate
in any other benefit plan that the Company provides to its executives and
employees from time to time.

<PAGE>

Item 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information regarding the beneficial ownership of
the common stock of the Company as of December 31, 1998 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."

                                       Shares          
                                         of              Percent
Name                                    Common           of Class
                                         Stock
                                                        
Lancer Industries Inc. (1)            8,480,000            100%
450 Lexington Avenue, Suite 3350
New York, New York 10017
Paul S. Levy                                 --   (2)        --
Peter A. Joseph                              --   (2)        --
Andrew R. Heyer                              --   (2)        --
All directors and executive officers                     
as a group (10 persons)                      --   (2)        --

(1)  100% of the capital stock of the Company is owned by Lancer.  Lancer has
     pledged such shares to the lender under the GE Credit Agreement (as
     defined) as collateral for the Company's obligations thereunder.

(2)  Lancer has one class of common stock, Class B Common Stock, with a par
     value of $478.44 per share.  Lancer's common stock is held as follows: (i)
     Canadian Imperial Bank of Commerce ("CIBC") beneficially owns approximately
     25% of Lancer's common stock, (ii) certain entities affiliated with Mutual
     Series Fund (the "Mutual Entities") own approximately 29% of Lancer's
     common stock, (ii) Mr. Paul S. Levy, the Chairman of the Board, directly
     and through his participation in the Lancer Employee Stock Ownership Plan
     (the "ESOP") beneficially owns approximately 21% of Lancer's common stock,
     and through a proxy in his favor to vote the shares of Lancer's common
     stock beneficially owned by CIBC, has the right to direct the voting of
     approximately 46% of Lancer's common stock, and (iii) Mr. Peter A. Joseph,
     a Director, directly, through a trust and through his participation in the
     ESOP, beneficially owns and has the right to direct the voting of
     approximately 17% of Lancer's common stock.  Mr. Heyer, a Director, is a
     Managing Director of an affiliate of CIBC.  Mr. Levy, the Mutual Entities
     and an affiliate of CIBC are parties to a stockholders' arrangement
     relating to the composition of the Board of Directors of Lancer and certain
     other matters.  Mr. Levy and Mr. Joseph hold warrants to acquire additional
     shares of Lancer's common stock.

<PAGE>

Item 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

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 7 to the Consolidated Financial Statements for a further
discussion of income taxes.

Other Arrangements with Lancer

From time to time, Lancer incurs legal, accounting and miscellaneous other
expenses on behalf of the Company. In fiscal 1998, 1997 and 1996, the Company
made aggregate payments to Lancer in respect of such expenses incurred by Lancer
on the Company's behalf in the amounts of approximately $0.7, $0.5 and $0.6
million, respectively.

<PAGE>

                                     PART IV


Item 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a) (1) and (2):

   See Index to Consolidated Financial Statements and Financial Statement
   Schedule appearing on page F-1.

(3)The following is a list of exhibits hereto required to be filed by Item 601
   of Regulation S-K of the Securities and Exchange Commission:

Exhibit                    Description
No.
(2) (a)     Merger Agreement under the State of Delaware between
            First Colony Farms, Inc. ("First Colony") and
            Fairfield Manufacturing Company, Inc. ("Fairfield"
            or the "Company") dated as of March 24, 1997,
            incorporated by reference from Exhibit 2(c) to the
            Company's Form S-4 as filed with the Securities and
            Exchange Commission on April 9, 1997 (the "1997 Form
            S-4").
(2) (b)     Certificate of Merger, merging First Colony with and
            into Fairfield, incorporated by reference from
            exhibit 2(d) to the 1997 Form S-4.
(3) (a)     Restated Certificate of Incorporation of Fairfield,
            together with the Certificate of Amendment, dated
            March 7, 1997, and filed on March 11, 1997,
            incorporated by reference from Exhibit 3(a) to the
            1997 Form S-4.
(3) (b)     By-Laws of Fairfield, incorporated by reference from
            Exhibit 3(c) to the Company's Form 10-K as filed
            with the Securities and Exchange Commission on March
            22, 1995 (the "1994 Form 10-K").
(4) (a)     Indenture, dated as of July 7, 1993, between
            Fairfield and First Fidelity Bank, National
            Association, New York, as trustee, incorporated by
            reference from Exhibit 4(a) to the Company's Form 10-
            Q as filed with the Securities and Exchange
            Commission on August 16, 1993 (the "1993 Second
            Quarter Form 10-Q").
(4) (b)     Supplemental Indenture No. 1, dated as of March 31,
            1995, between CAG as successor-in-interest to
            Fairfield and First Fidelity Bank, National
            Association, as trustee, incorporated by reference
            from Exhibit 4(b) to the 1994 Form 10-K.
(4) (c)     Indenture, dated as of March 12, 1997, between
            Fairfield and United States Trust Company of New
            York as Trustee, incorporated by reference from
            Exhibit 4(c) to the 1997 Form S-4.
(4) (d)     Certificate of Designation, dated March 12, 1997,
            for the 11-1/4% Cumulative Exchangeable Preferred
            Stock, incorporated by reference from Exhibit 4(d)
            to the 1997 Form S-4.
(9)         Voting Trust Agreement
               Not Applicable.

<PAGE>

(10) (a)    Loan Agreement, dated as of July 7, 1993, among
            Fairfield, the lenders named therein and General
            Electric Capital Corporation ("GECC"), as agent,
            incorporated by reference from Exhibit 10(a) to the
            1993 Second Quarter Form 10-Q.
(10) (b)    Security Agreement, dated as of July 7, 1993,
            between T-H Licensing, Inc. ("T-H Licensing") and
            GECC, as agent, incorporated by reference from
            Exhibit 10(d) to the 1993 Second Quarter Form 10-Q.
(10) (c)    Stock Pledge Agreement, dated as of July 7, 1993,
            between Fairfield and GECC, as agent, incorporated
            by reference from Exhibit 10(e) to the 1993 Second
            Quarter Form 10-Q.
(10) (d)    Trademark Security Agreement, dated as of July 7,
            1993, between Fairfield and GECC, as agent,
            incorporated by reference from Exhibit 10(g) to the
            1993 Second Quarter Form 10-Q.
(10) (e)    Trademark Security Agreement, dated as of July 7,
            1993, between T-H Licensing and GECC, as agent,
            incorporated by reference from Exhibit 10(h) to the
            1993 Second Quarter Form 10-Q.
(10) (f)    Patent Security Agreement, dated as of July 7, 1993,
            between Fairfield  and GECC, as agent, incorporated
            by reference from Exhibit 10(i) to the 1993 Second
            Quarter Form 10-Q.
(10) (g)    Patent Security Agreement, dated as of July 7, 1993,
            between T-H Licensing and GECC, as agent,
            incorporated by reference from Exhibit 10(j) to the
            1993 Second Quarter Form 10-Q.
(10) (h)    Subsidiary Guaranty, dated as of July 7, 1993,
            between T-H Licensing and GECC, as agent,
            incorporated by reference from Exhibit 10(k) to the
            1993 Second Quarter Form 10-Q.
(10) (i)    Mortgage, Assignment of Leases, Rents and Profits,
            Security Agreement and Fixture Filing, dated as of
            July 7, 1993, between Fairfield and GECC, as agent,
            incorporated by reference from Exhibit 10(l) to the
            1993 Second Quarter Form 10-Q.
(10) (j)    Collection Account Agreement, dated as of July 7,
            1993, among Fairfield and GECC, and acknowledged by
            Bank One, Lafayette, N.A., incorporated by reference
            from Exhibit 10(m) to the 1993 Second Quarter Form
            10-Q.
(10) (k)    Used Machinery Account Agreement, dated as of July
            7, 1993, among Fairfield and GECC, and acknowledged
            by Bank One, Lafayette, N.A., incorporated by
            reference from Exhibit 10(n) to the 1993 Second
            Quarter Form 10-Q.
(10) (l)    Quitclaim Grant of Security Interest, dated as of
            July 7, 1993, between Fairfield and GECC, as agent,
            incorporated by reference from Exhibit 10(o) to the
            1993 Second Quarter Form 10-Q.
(10) (m)    Supplemental Quitclaim Grant of Security Interest
            (Patents only), dated as of July 7, 1993, between
            Fairfield and GECC, as agent, incorporated by
            reference from Exhibit 10(p) to the 1993 Second
            Quarter Form 10-Q.

<PAGE>

(10) (n)    First Amendment to Loan Agreement, dated as of
            September 30, 1994, among Fairfield, the lenders
            named therein and GECC, as agent, incorporated by
            reference from Exhibit 10(q) of the Company's Form
            10Q as filed with the Securities and Exchange
            Commission on November 14, 1994.
(10) (o)    Second Amendment to Loan Agreement, dated as of
            March 30, 1995, among Fairfield, the lenders named
            therein and GECC, as agent, incorporated by
            reference from Exhibit 10(r) to the 1994 Form 10-K.
(10) (p)    Third Amendment to Loan Agreement, dated as of March
            31, 1995, among Fairfield, the lenders named therein
            and GECC, as agent, incorporated by reference from
            Exhibit 10(s) to the 1994 Form 10-K.
(10) (q)    First Amendment to Mortgage Assignment of Leases,
            Rents and Profits, Security Agreement and Fixture
            Filing, dated as of March 31, 1995, between
            Fairfield and GECC, as agent,  incorporated by
            reference from Exhibit 10(t) to the 1994 Form 10-K.
(10) (r)    Stock Pledge Agreement, dated as of March 31, 1995,
            between Lancer Industries Inc. ("Lancer") and GECC,
            as agent, incorporated by reference from Exhibit
            10(u) to the 1994 Form 10-K.
(10) (s)    Amended and Restated Security Agreement, dated as of
            March 31, 1995, between Fairfield and GECC, as
            agent, incorporated by reference from Exhibit 10(v)
            to the 1994 Form 10-K.
(10) (t)    The Fairfield Manufacturing Company, Inc. Equity
            Participation Plan, dated August 21, 1989
            incorporated by reference from Exhibit 10(x) to the
            Company's Form 10-K as filed with the Securities and
            Exchange Commission on March 15, 1996 (the "1995
            Form 10-K").
(10) (u)    The Tax Sharing Agreement, dated as of July 18,
            1990, between Fairfield and Lancer, incorporated by
            reference from Exhibit 10(z) to the 1995 Form 10-K.
(10) (v)    The Fairfield Manufacturing Company, Inc. (1992)
            Supplemental Executive Retirement Plan incorporated
            by reference from Exhibit 10(aa) to the 1995 Form 10-
            K.
(10) (w)    Letter Agreement, dated December 29, 1989, granting
            exclusive license from T-H Licensing to Fairfield
            incorporated by reference from Exhibit 10(bb) to the
            1995 Form 10-K.
(10) (x)    Fourth Amendment to Loan Agreement, dated as of
            December 5, 1996, among Fairfield, the lenders named
            therein and GECC, as agent, incorporated by
            reference from Exhibit 10(cc) to the Company's Form
            10-K as filed with the Securities and Exchange
            Commission on February 25, 1997 (the "1996 Form 10-
            K").
(10) (y)    Second Amendment to Mortgage Assignment of Leases,
            Rents and Profits, Security Agreement and Fixture
            Filing, dated as of December 5, 1996, between
            Fairfield and GECC, as agent, incorporated by
            reference from Exhibit 10(dd) to the 1996 Form 10-K.
(10) (z)    Fifth Amendment to the Loan Agreement, dated as of
            February 26, 1997, among Fairfield, the lenders
            named therein and GECC, as agent, incorporated by
            reference from Exhibit 10(ee) to the 1997 Form S-4.

<PAGE>

(10) (aa)   Consent and Amendment, dated as of March 27, 1997,
            among Fairfield and GECC, as sole lender and agent,
            incorporated by reference from Exhibit 10(gg) to the
            1997 Form S-4.
(10) (bb)   Securities Purchase Agreement, dated March 7, 1997,
            between Fairfield and the Initial Purchaser,
            incorporated by reference from Exhibit 10(hh) to the
            1997 Form S-4.
(10) (cc)   Share Registration Rights Agreement, dated March 12,
            1997, between Fairfield and the Initial Purchaser,
            incorporated by reference from Exhibit 10(ii) to the
            1997 Form S-4.
(10) (dd)   Consulting Agreement, dated August 1, 1997, between
            Fairfield and Wolodymyr B. Lechman, incorporated by
            reference from Exhibit 10(hh) to the Company's Form
            10-Q as filed with the Securities and Exchange
            Commission on November 12, 1997.
(10) (ee)   Sixth Amendment to the Loan Agreement, dated as of
            October 12, 1998, among Fairfield, the lenders named
            therein, and GECC, as agent, incorporated by
            reference from Exhibit 10(gg) to the Company's Form
            10Q as filed with the Commission on November 13,
            1998 (the "1998 Third Quarter Form 10-Q").
(10) (ff)   Third Amendment to Mortgage Assignment of Leases,
            Rents and Profits, Security Agreement and Fixture
            Filing, dated as of October 12, 1998 between
            Fairfield and GECC, as agent, incorporated by
            reference from Exhibit 10(hh) to the 1998 Third
            Quarter Form 10-Q.
(10) (gg)   Employment Agreement dated as of August 4, 1998,
            between Fairfield and S. K. Clough, incorporated by
            reference from Exhibit 10(ii) to the 1998 Third
            Quarter Form 10-Q.
(11)        Statement re computation of per share earnings.
               Not Applicable.
(12)        Statement re Computation of ratios.
               Not Applicable.
(13)        Annual Report to Security Holders, Form 10-Q or
            Quarterly Report to Security Holders.
               Not Applicable.
(16)        Letter regarding Change in Certifying Accountant.
               Not Applicable.
(18)        Letter regarding change in accounting principles.
               Not Applicable.
(21)        Subsidiaries of Fairfield Manufacturing Company,
            Inc.
               T-H Licensing, Inc.
(22)        Published report regarding matters submitted to vote
            of security holders.
               Not Applicable.

<PAGE>

(23)        Consents of experts and counsel.
               Not Applicable.
(24)        Power of attorney.
               Not Applicable.
(27)        Financial Data Schedule
(28)        Information from Reports Furnished to State
            Insurance Regulatory Authorities.
                 Not Applicable.
(99)        Additional exhibits.
               Not Applicable.

(b)    No reports on Form 8-K have been filed during the last quarter of the
  period covered by this report.

<PAGE>

                           SIGNATURES

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 February 24, 1999.

                              FAIRFIELD MANUFACTURING COMPANY, INC.


                              By:      /s/ Richard A. Bush
                                         Richard A. Bush
                                      Vice President Finance
                              (Principal Financial and Accounting Officer)


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 February 24, 1999.


                                   
      /s/ Paul S. Levy                /s/ Stephen K. Clough
        Paul S. Levy                    Stephen K. Clough
   Chairman of the Board,            Director, President and
Vice President and Assistant         Chief Executive Officer
         Secretary
                                   
                                   
                                   
    /s/ Peter A. Joseph                 /s/ W. B. Lechman
      Peter A. Joseph                     W. B. Lechman
  Director, Vice President                   Director
       and Secretary
                                   
                                   
                                   
      /s/ Jess C. Ball                 /s/ Andrew R. Heyer
        Jess C. Ball                     Andrew R. Heyer
          Director                           Director
                                   
<PAGE>

                      FAIRFIELD MANUFACTURING COMPANY, INC.
                 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
                          FINANCIAL STATEMENT SCHEDULE



                                                           Page
                                                             
Report of Independent Accountants                         F - 2
                                                             
Consolidated Balance Sheets, December 31, 1998 and        F - 3
1997
                                                          
Consolidated Statements of Operations for the             
three years ended December 31, 1998                       F - 4
                                                          
Consolidated Statements of Stockholder's Equity           
(Deficit) for the three years ended December 31,          F - 5
1998
                                                             
Consolidated Statements of Cash Flows for the             
three years ended December 31, 1998                       F - 6
                                                             
Notes to Consolidated Financial Statements                F - 7
                                                                  
Financial Statement Schedule:                           
                                                                  
Schedule II - Valuation and Qualifying Accounts and               
Reserves, for the three years ended December 31,         F - 17
1998

<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS





Board of Directors and Stockholder
of Fairfield Manufacturing Company, Inc.


In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholder's equity (deficit), and of
cash flows  present fairly, in all material respects, the financial position of
Fairfield Manufacturing Company, Inc. and its subsidiary (collectively the
"Company") at December 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles.  In
addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements.  These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits.  We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.



/s/ PricewaterhouseCoopers LLP

Indianapolis, Indiana
January 28, 1999

<PAGE>
                                        
                      FAIRFIELD MANUFACTURING COMPANY, INC.
                           CONSOLIDATED BALANCE SHEETS
                           December 31, 1998 and 1997
                        (In thousands, except share data)

                                                                 
                                                1998           1997
ASSETS                                                             
Current assets:                                           
     Cash and cash equivalents                 $ 2,822        $3,059
     Trade receivables, less allowance                    
     of $700 and $600 in 1998 and 1997,
     respectively                               27,368        22,733
     Inventory                                  25,519        23,875
     Prepaid expenses                              369         1,048
        Total current assets                    56,078        50,715
                                                          
Property, plant and equipment, net              68,239        69,227
                                                          
Other assets:                                             
     Excess of investment over net                        
     assets acquired, less accumulated                    
     amortization of $15,082 and $13,475
     in 1998 and 1997, respectively             49,277        50,884
     Deferred financing costs, less                       
     accumulated amortization of $3,684 
     and $3,026 in 1998 and 1997,
     respectively                                1,524         2,386
        Total other assets                      50,801        53,270
                                                          
        Total assets                          $175,118      $173,212
                                                          
LIABILITIES AND STOCKHOLDER'S EQUITY                      
     (DEFICIT)
Current liabilities:                                      
     Current maturities of long-term           $   -         $ 4,000
     debt
     Accounts payable                           13,967        10,896
     Due to parent                                 482         2,208
     Accrued liabilities                        23,712        22,987
     Deferred income taxes                       2,047         2,800
     Total current liabilities                  40,208        42,891
                                                          
Accrued retirement costs                        16,278        15,778
Deferred income taxes                            7,460         8,881
Long-term debt                                 112,150       110,000
Commitments and contingencies (Note 11)             --            --
                                                          
11-1/4% Cumulative exchangeable preferred
     stock                                      48,042        47,850
                                                          
Stockholder's equity (deficit):                           
     Common stock: par value $.01 per                     
     share, 10,000,000 shares                             
     authorized, 8,480,000 and 8,190,000
     issued and outstanding in 1998 and
     1997, respectively                             85            82
     Additional paid-in capital                 42,322        39,414
     Accumulated deficit                       (91,427)      (91,684)
     Total stockholder's deficit               (49,020)      (52,188)
                                                          
     Total liabilities and stockholder's      $175,118      $173,212
     deficit

The accompanying notes are an integral part of these consolidated financial
statements.

<PAGE>
                                        
                      FAIRFIELD MANUFACTURING COMPANY, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                   For the Three Years Ended December 31, 1998
                                 (In thousands)

                                                         
                                        1998       1997       1996
                                                         
Net sales                           $220,316   $192,281   $195,205
Cost of sales                        178,933    157,715    158,668
Selling, general and
 administrative expenses              16,816     16,989     16,868
                                                         
Operating income                      24,567     17,577     19,669
                                                         
Interest expense, net                 12,697     12,676     11,930
Other expense, net                        70         80         90
                                                         
Income before income taxes            11,800      4,821      7,649
                                                         
Provision for income taxes             5,300      2,640      3,730
                                                         
Net income before 
 extraordinary item                    6,500      2,181      3,919
                                                         
Loss on early extinguishment of
 debt, net of tax                       (426)        --         --
                                                         
Net income                            $6,074      $2,181     $3,919
                                                         
Preferred stock dividends and
 discount accretion                   (5,817)     (4,686)        --
                                                         
Net income (loss) available to                       
 common stockholder                   $  257     $(2,505)    $3,919

The accompanying notes are an integral part of these consolidated financial
statements.
                                                        
<PAGE>
                                      
                      FAIRFIELD MANUFACTURING COMPANY, INC.
            CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)
                   For the Three Years Ended December 31, 1998
                                 (In thousands)

                                     Additonal                        Stock-
                             Common    Paid-in  Accumlated           Holder's
                              Stock    Capital     Deficit    Equity (Deficit)
                                                            
Balance, January 1, 1996     $  77     $35,209   $(25,328)            $ 9,958
Capital contribution             1       1,579        --                1,580
Common stock dividend           --          --    (17,000)            (17,000)
Advance to parent               --          --     (3,027)             (3,027)
Net income                      --          --      3,919               3,919
Balance, December 31, 1996  $   78     $36,788   $(41,436)            $(4,570)

Capital contribution        $    4     $ 2,616     $   --             $ 2,620
Common stock dividends          --          --    (50,770)            (50,770)
Preferred stock dividends       --          --     (4,536)             (4,536)
Preferred stock discount        --          --       (150)               (150)
     accretion
Advance to parent               --          --      3,027               3,027
Merger with First Colony        --          10         --                  10
     Farms
Net income                      --          --      2,181               2,181
Balance, December 31, 1997  $   82     $39,414   $(91,684)           $(52,188)

Capital contribution        $    3     $ 2,908     $   --            $  2,911
Preferred stock dividends       --          --     (5,625)             (5,625)
Preferred stock discount        --          --      (192)                (192)
     accretion
Net income                      --          --      6,074               6,074
Balance, December 31, 1998  $   85     $42,322   $(91,427)           $(49,020)

The accompanying notes are an integral part of these consolidated financial
statements.

<PAGE>

                      FAIRFIELD MANUFACTURING COMPANY, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                   For the Three Years Ended December 31, 1998
                                 (In thousands)
                                                                                
                                                  1998      1997       1996
Operating Activities:                                              
Net income                                      $6,074   $ 2,181    $ 3,919
  Adjustments to reconcile net income to net                       
    cash provided by
      operating activities:
    Depreciation and amortization               13,267    13,277     13,108
    Deferred income tax benefit                 (2,097)   (4,107)      (170)
    Increase in accrued retirement costs           687       355        665
    Loss on early extinguishment of debt           426        --         --
    Changes in working capital:                                    
    Trade receivables                           (5,085)    1,963       (368)
    Inventory                                   (1,644)   (4,957)     5,994
    Prepaid expenses                               679      (195)        44
    Accounts payable                             3,595    (1,467)     3,289
    Due to parent                               (1,726)    1,921       (520)
    Accrued liabilities                          1,188     3,128        658
                                                                   
    Net cash provided by operating activities   15,364    12,099     26,619
                                                                   
Investing Activities:                                              
Additions to property, plant                   (10,536)  (10,902)   (11,165)
 and equipment, net                                                            

    Net cash used by investing activities      (10,536)  (10,902)   (11,165)
                                                                   
Financing Activities:                                              
Capital contributions, principally under tax     2,911     2,620      1,580  
    sharing agreement
Payment of dividends                                --   (50,770)   (17,000)
Advance to Parent                                   --     3,027     (3,027)
Proceeds from issuance of long-term debt        19,000       --      15,000
Repayment of long-term debt                    (20,218)   (6,000)    (3,000)
Net change in revolving credit facility         (1,000)    2,000     (7,000)
Proceeds of preferred stock offering                --    50,000         --
Payment of preferred stock issuance costs           --    (2,300)        --
Payment of debt issuance costs                    (133)      (41)      (146)
Payment of preferred stock dividends            (5,625)   (2,859)        --
                                                                   
    Net cash used by financing activities       (5,065)   (4,323)   (13,593)
                                                                   
Cash and Cash Equivalents:                                         
Increase (decrease) in cash and cash             (237)    (3,126)     1,861
 equivalents
Beginning of year                                3,059     6,185      4,324
                                                                   
End of year                                     $2,822    $3,059     $6,185
                                                                   
Supplemental Disclosures:                                          
Cash paid for:                                                     
    Interest                                   $13,442   $12,135    $11,627
    Federal taxes to parent under tax sharing     7,710    4,020      4,030
      agreement (Note 7)
    State taxes                                  1,550       120      1,310
                                                                   
  Non-cash investing and financing activities:                     
    Additions to property, plant and equipment                     
    included in
       accounts payable at end of period        $  845    $1,369     $2,266
    Preferred stock dividends accrued            1,677     1,677         --

The accompanying notes are an integral part of these consolidated financial 
statements.

<PAGE>

Fairfield Manufacturing Company, Inc.
Notes to Consolidated Financial Statements
($ in thousands, except share data)
    
1. Summary of Significant Accounting Policies

Organization
Fairfield Manufacturing Company, Inc. ("Fairfield") is wholly owned by Lancer
Industries Inc. ("Lancer").  Fairfield has one wholly owned subsidiary, T-H
Licensing, Inc. (T-H Licensing").  Fairfield, T-H Licensing and Lancer are all
Delaware corporations.

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

Principles of Consolidation
These consolidated financial statements include the accounts of Fairfield and T-
H Licensing (jointly the "Company").  All significant inter-company accounts and
transactions have been eliminated.

Concentrations of Risk
The Company grants credit without collateral to most of its customers.  Sales to
one customer accounted for 10.6% of total net sales in 1998.  No customer
accounted for more than 10% of total net sales in 1997 or 1996.

Revenue
Sales are recognized at the time of shipment to the customer.  International
sales, as determined by ship to location, accounted for $16,195, $13,286 and
$11,312 of the Company's net sales in 1998, 1997 and 1996, respectively, and
were primarily to Canada.  Custom gears and assemblies accounted for
approximately $118,500, $107,100 and $112,300 of the Company's 1998, 1997 and
1996 net sales, respectively.  Planetary gear systems accounted for
approximately $101,800, $85,200 and $82,900 of the Company's 1998, 1997 and 1996
net sales, respectively.

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

Inventory
Inventory is valued at the lower of last-in, first-out (LIFO) cost or market.

Property, Plant and Equipment, Net
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 20 years
for machinery and equipment.

Income Taxes
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.

<PAGE>

Excess of Investment Over Net Assets Acquired
Excess of investment cost over net assets acquired is amortized using the
straight-line method over 40 years.  The Company's criteria for periodically
evaluating the carrying value of the excess of investment over net assets
acquired includes evaluation of products and markets as well as current and
expected levels of undiscounted cash flow from operations.  The Company has
concluded the excess of investment over net assets acquired is not impaired and
the products and markets continue to support a 40-year life.

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

Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
effect 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.

Fair Value of Financial Instruments
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"), also approximate their carrying value.  The
estimated fair value of the Notes at December 31, 1998 was approximately 102% of
carrying value based on recent market purchases by the Company.

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

2. Related Party Transactions

On December 5, 1996, the Company advanced $3,000 to Lancer.  This advance was
classified as a component of stockholder's equity (deficit) at December 31,
1996, at which date the related accrued interest was $27.  During February 1997,
the Company declared a dividend $3,070 ($0.39 per share) in settlement of the
advance and the accrued interest of $70.

Effective August 1, 1997, Mr. Lechman, former Chairman of the Board, and
Director, entered into a consulting agreement (the "Agreement") with the
Company.  In consideration for services to be rendered under the Agreement, Mr.
Lechman will receive quarterly payments through July 31, 2001 ("the consulting
period") totaling $1.0 million.  In the event that Mr. Lechman dies prior to the
end of the consulting period or is unable to perform the services requested due
to mental or physical disabilities, the Company shall pay to his legal
representatives or beneficiaries the remaining unpaid balance under the
Agreement which would have been due under the agreement had Mr. Lechman
continued to provide such services for the term of the Agreement.  Due to the
provisions of the agreement, the Company recognized the entire $1.0 million as
expense in 1997.

<PAGE>

3. Inventory

Inventory at December 31, consists of:

                                         1998        1997
                                                   
     Raw materials                      $3,852     $3,495
     Work in process                    11,933     11,892
     Finished products                   9,734      8,488
                                                   
                                        25,519     23,875
     Less:  Excess of FIFO cost over        --         --
     LIFO cost
                                                   
                                       $25,519    $23,875

4. Property, Plant and Equipment, Net

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

                                         1998        1997
                                                   
     Land and improvements              $1,346     $ 1,256
     Buildings and improvements         20,758      19,248
     Machinery and equipment           141,091     133,024
                                       163,195     153,528
     Less:  Accumulated                (94,956)    (84,301)
     depreciation
                                                   
                                       $68,239     $69,227

Depreciation expense was $11,000, $11,000 and $10,830 for the years ended
December 31, 1998, 1997 and 1996, respectively.

5. Accrued Liabilities

Accrued liabilities at December 31, are as follows:

                                         1998        1997
                                                   
     Compensation and employee         $ 6,940     $ 6,610
     benefits
     Accrued retirement and              3,058       2,902
     postemployment
     Interest payable                    4,340       5,075
     Other                               9,374       8,400
                                                   
                                       $23,712     $22,987

<PAGE>

6. Employee Benefit Plans

                                                      Other
                               Pension Benefits   Postretirement
                                                     Benefits
                                 1998      1997      1998      1997
Change in benefit obligation                              
Benefit obligation at
beginning of year              $43,671   $42,972    $9,433    $9,329
Service cost                     1,622     1,445       362       342
Interest cost                    3,099     2,911       658       646
Participant contributions          --         --       184       208
Amendments                         758        --        --        --
Actuarial loss (gain)            3,522    (2,055)      620        (9)
Benefits paid                   (1,663)   (1,602)   (1,102)   (1,083)
                                                          
Benefit obligation at end of                              
year                            51,009    43,671    10,155     9,433
                                                          
Change in plan assets                                     
Fair value of plan assets at                               
beginning                                                 
 of year                        33,684    31,348        --        --
Actual return on plan assets     2,831     2,109        --        --
Company contribution             1,731     1,829       918       875
Participant contributions           --        --       184       208
Benefits paid                   (1,663)   (1,602)   (1,102 )  (1,083)
                                                          
Fair value of plan assets at                              
end of year                     36,583    33,684        --        --
                                                          
Funded status                  (14,426)   (9,987)  (10,155)   (9,433)
Unrecognized actuarial loss      2,040    (1,512)    3,145     2,676
Unrecognized prior service                                
cost                             2,302     1,733      (188      (251)
Accrued benefit               $(10,084)  $(9,766)  $(7,198)  $(7,008)
                                                          
Weighted average assumptions                               
as of December 31:
Discount rate                     6.50%     7.25%     6.50%     7.25%
Expected return on plan                                   
assets                            8.50%     8.50%

Other postretirement benefits provided by the Company include limited health
care and life insurance benefits for certain retired employees.  The health care
cost trend rate is not a factor in the calculation of the other postretirement
benefit obligation as the plan limits per capita benefits to a fixed level.
Claims in excess of this amount are the responsibility of the retiree.

<PAGE>
                                                              Other
                         Pension Benefits                Postretirement
                                                             Benefits
Components of net        1998     1997     1996       1998     1997     1996
periodic benefit cost:
Service cost           $1,622     $1,445   $1,387     $362     $342     $332
Interest cost           3,099      2,911    2,862      658      646      656
Expected return on     (2,861)    (2,685)  (2,549)      --       --       --
 plan assets
Recognized actuarial      --          --       --      151      166      214
 loss
Amortization of prior    189         189      189      (63)     (63)     (63)
 service cost
                                                           
Net periodic benefit 
 cost                 $2,049      $1,860   $1,889     1,108    1,091   1,139

As discussed above, healthcare benefits provided by the Company are set at a
fixed per capita amount.  Consequently changes in health care rates have no
effect on the other postretirement benefit obligation, service cost or interest
cost.

The Company has a contributory defined contribution savings plan which covers
all of its eligible employees.  Eligibility in the plan is obtained the month
following hire with no minimum age requirement.  A participant may make a basic
contribution to the plan ranging from 2% to 6% of the participant's salary and a
supplemental contribution of 2%, 4%, or 6% of the participant's salary.  The
Company matches 70% of the participant's basic contribution.  Expense recognized
each of the years ended December 31, 1998, 1997 and 1996 was $1,510, $1,347 and
$1,356, respectively.

The Company provides postemployment benefits to certain former and inactive
employees.  Net periodic postemployment benefit cost for years ended December
31, included the following components:

                                  1998     1997      1996
                                                     
     Service cost                $153      $137      $115
     Interest cost                185       179       157
     Amortization of               19        --        --
     unrecognized losses
                                                     
                                 $357      $316      $272

The recorded liabilities for these postemployment benefits, none of which have
been funded, are $2,053 and $1,906 at December 31, 1998 and 1997, respectively.

7. Income Taxes

The Company files separate state income tax returns and is included in the
consolidated federal income tax return of its parent company, Lancer.  The
Company and Lancer have entered into a Tax Sharing Agreement under which the
Company is required to calculate its federal income tax liability on a separate
return basis.

<PAGE>

The expense equivalent to provision for income taxes in each of the three years
in the period ended December 31, consists of:

                                       1998      1997      1996
                                                    
     Current, principally federal    $7,397    $5,120    $3,900
     Deferred, principally federal   (2,097)   (2,480)     (170)
                                     $5,300    $2,640    $3,730
                                                    
     Tax benefit of
     extraordinary loss               $(277)      $--       $--

The expense equivalent to provision for income taxes for 1998, 1997 and 1996
results principally from current year operating results.

A reconciliation of the expected expense equivalent to provision for income
taxes at the statutory federal income tax rate and the actual tax provision each
of the three years ended December 31, is as follows:
            
                                      1998     1997    1996
                                                   
     Tax provision at 35%
      statutory rate                $4,130  $1,687  $2,677
     State taxes, net of federal       519     370     231
     Non-deductible amortization of                  
      excess of investment over                     
      net assets acquired              555     555     555
     Other, net                         96      28     267
     
                                    $5,300  $2,640  $3,730
                                                      
     Effective Rate                  44.9%    54.8%   48.8%

Deferred income taxes applicable to temporary differences at December 31, 1998
and 1997 (net of a $1.6 million reclassification from deferred tax liabilities
to currently payable taxes made in conjunction with the filing of  the 1996 tax
return) are as follows:
    
                                           1998        1997
     Assets:                                        
      Employee benefits                  $9,646      $9,450
      Gross deferred tax assets           9,646       9,450
                                                    
     Liabilities:                                   
      Inventory basis difference         (4,864)     (4,824)
      Property, plant and equipment                 
     basis difference                   (14,022)    (16,242)
      Other, net                           (267)        (65)
      Gross deferred tax liabilities    (19,153)    (21,131)
                                                    
      Net deferred tax liability        $(9,507)   $(11,681)

<PAGE>

Under the Tax Sharing Agreement between the Company and Lancer, the Company is
required to pay Lancer an amount equal to the Company's current federal income
tax liability calculated on a separate return basis.  To the extent such tax
liability subsequently reduces Lancer's available tax benefits, Lancer is
required to reimburse the Company in an amount equivalent to 50% of such
reduction by making a capital contribution to the Company.  Lancer made capital
contributions to the Company pursuant to this agreement of $2,710, $2,620, and
$1,580 during 1998, 1997 and 1996, respectively.  The Company issued common
stock to Lancer in recognition of these capital contributions (see Note 10).

The Company has certain federal net operating loss carryforwards of
approximately $200,000 from its merger with First Colony Farms, Inc. which begin
expiring in 2001.  These carryforwards are subject to limitations imposed by the
Internal Revenue Code.  At December 31, 1998 and 1997, these carryforwards have
been fully reduced by a valuation allowance.

8. Long-Term Debt

Long-term debt consists of the following at December 31:
    
                                                     1998        1997
     Senior Revolving Credit Facility,              
     due July 1, 2005                      
     Rate at December 31, 1998: 6.8%               $1,000      $2,000
                                                    
     Senior Term Loan, due July 1, 2005             
     Rates at December 31, 1998:  6.6% - 6.8%      35,000      27,000
                                                    
   Senior Debt Repurchase Line, due in              
     20 equal quartely installments                 
     beginning August 15, 2000                      
    Rates at December 31, 1998:  6.9% - 7.3%        9,000         --
                                                    
     Senior Subordinated Notes, 11.375%,            
     due July 1, 2001                              67,150      85,000
       Total debt                                 112,150     114,000
                                                    
     Less:  Current maturities                        --       (4,000)
                                                    
       Total long-term debt                      $112,150    $110,000

The Company's Senior Subordinated Notes (the "Notes") are redeemable at the
option of the Company, in whole or in part, at certain specified call prices on
or after July 1, 1998.

During the third and fourth quarters of 1998, the Company repurchased $17,850 of
Notes on the open market.  The loss on early extinguishment of debt represents
the write off of related deferred financing charges and premium paid on
repurchase, net of a $277 tax benefit.

In 1993 concurrent with the issuance of the Notes, the Company entered into a
loan agreement (the "Loan Agreement') with a senior lending institution which
established the Revolving Credit Facility ("Revolver") and Term Loan
(collectively with the Debt Repurchase Line the "Credit Facilities").  This Loan
Agreement was most recently amended in October 1998, to extend the maturity of
the Revolving Credit Facility and Term Loan to July, 1, 2005, lower the interest
rate,

<PAGE>

and establish the Debt Repurchase Line, to be used for repurchases of the
Company's Notes up to $10,000.

The Revolver permits the Company to borrow up to $20,000 subject to borrowing
base availability (as defined in the agreement) and, at the option of the
Company (subject to certain conditions), may be increased by two additional
$5,000 options.

The Loan Agreement was also amended during March 1997, to allow the sale of the
Preferred Stock (see Note 9) and the $47,700 dividend to Lancer.

Interest under the Credit Facilities is payable at varying rates based on prime
or LIBOR. The unused Revolving Credit Facility at December 31, 1998, net of $449
of outstanding letters of credit, was $18,551.  The unused Debt Repurchase Line
(subject to certain conditions) at December 31, 1998 was $1,000.

Borrowings under the Credit Facilities are collateralized by substantially all
the assets of the Company, including the assignment of all leases and rents and
a pledge of the outstanding common stock of the Company.  The Credit Facilities
and the Notes contain various restrictive covenants that, among other
restrictions, require the Company to maintain certain financial ratios.  The
Credit Facility and the Notes allow the payment of dividends provided certain
financial covenants are met.

The future maturities of long-term debt at December 31, 1998 are as follows:

     1999                           $    --
     2000                               900
     2001                            68,950
     2002                             1,800
     2003                             1,800
     Thereafter                      38,700
                                
                                   $112,150

9. Redeemable Exchangeable Preferred Stock

On March 12, 1997, the Company completed a private offering of 50,000 shares of
11-1/4% Series A Cumulative Exchangeable Preferred Stock ("Preferred Stock").
Each share has a liquidation preference of one thousand dollars, plus
accumulated and unpaid dividends.  The Company is required, subject to certain
conditions, to redeem all of the Preferred Stock outstanding on March 15, 2009
at a redemption price equal to 100% of the liquidation preference.  Dividends
are payable semi-annually at an annual rate of 11-1/4%, and may (prior to March
15, 2002) be paid, at the Company's option, either in cash or in additional
shares of Preferred Stock.  Semi-annual dividends have been paid in cash since
issuance.

The net proceeds from this offering of $47,700 were used to fund a dividend to
Lancer, and used by Lancer to redeem approximately $47,700 of its Series C
Preferred Stock.

<PAGE>

10. Stockholder's Equity

Merger
On March 27, 1997, First Colony Farms, Inc., a Delaware corporation and wholly-
owned subsidiary of Lancer ("First Colony"), merged with and into the Company,
with the Company being the surviving corporation of the merger.  Immediately
prior to the merger, First Colony had (i) no known liabilities (including
contingent liabilities) and (ii) assets consisting of approximately $10 in cash
and certain net operating loss carryforwards.

Issuance of Common Stock
The Company issued 73,000, 94,000, 50,000, and 73,000 additional shares of its
common stock on March 31, June 30, September 30, and December 31, 1998,
respectively, to Lancer in consideration of certain capital contributions made
by Lancer to the Company pursuant to the Tax Sharing Agreement and other capital
contributions.

The Company issued 52,000, 53,000 and 280,000 additional shares of its common
stock on March 31, 1997, June 30, 1997 and December 31, 1997, respectively, to
Lancer in consideration of certain capital contributions made by Lancer to the
Company pursuant to the Tax Sharing Agreement and other capital contributions.

Dividends
On March 12, 1997 and December 5, 1996 the Company, with the approval of its
senior lender, declared and paid dividends of $47,700 ($6.11 per share) and
$17,000 ($2.19 per share), respectively, to Lancer.

11. Commitments and Contingencies

Operating Leases
The Company is obligated to make payments under noncancellable operating leases
expiring at various dates through 2003.

Future minimum payments by year under operating leases consist of the following
at December 31, 1998:

          Year              Minimum Rental
                                   
          1999                   $ 518
          2000                     430
          2001                     133
          2002                      86
          2003                      30
                           
                                $1,197

<PAGE>

Rental expense for the years ended December 31, 1998, 1997 and 1996 was $506,
$447, and $446, respectively.

Equity Participation Plan
The Company maintains an Equity Participation Plan (the "Plan") which provides
for the award of up to an aggregate of 180,000 Equity Participation Rights
("Rights") to certain current and past officers and key employees.  At December
31, 1998, all 180,000 rights were granted and have vested and 117,000 rights
were outstanding.

Under the Plan, each participant is entitled to receive, upon the occurrence of
a Trigger Event, (as defined below) and exercise of a Right, an amount in cash
equal to the difference between the fair market value of a share of the
Company's common stock on the date the Trigger Event occurs and the initial
value assigned to each Right.  A Trigger Event means (a) any of the following
transactions which results in a change in control:  (i) a merger or
consolidation of the Company with or into another corporation; (ii) the sale or
exchange for cash, securities or other consideration of all or substantially all
of the assets of the corporation; or (iii) the sale or exchange for cash,
securities or any other consideration of all or substantially all of the
outstanding common equity of the Company or (b) the later of the fifth
anniversary of the date the Right was granted or the date the participant
retires from the Company at or after age 60.

During the period that a stock appreciation right (or Right) is outstanding, the
ultimate amount of compensation inherent in the Right is indeterminate.  APB
Opinion No. 25 and FASB Interpretation No. 28 require interim calculations of
the amount of compensation inherent in the stock appreciation right.  This
amount is generally equal to the increase in the fair market value since date of
grant or award multiplied by the total number of share or rights outstanding,
regardless of the exercisable status of the rights.

At December 31, 1998 and 1997 the exercise price exceeds estimated fair market
value of the Company's common stock.  During 1997, the Company paid $25 to
redeem 63,000 rights.  No additional compensation was charged to earnings for
this plan during 1998, 1997 or 1996.

<PAGE>


                      FAIRFIELD MANUFACTURING COMPANY, INC.
          Schedule II - Valuation and Qualifying Accounts and Reserves
                   for the three years ended December 31, 1998
                                ($ in thousands)
                                        
                                        
                     Balance at   Charged to   Charged              Balance at
                      Beginning   Costs and    to other                 End of 
     Description      of Period   Expenses     Accounts    Deductions   Period
                                                                       
     1998                                                     
     Allowance for
     doubtful
     accounts           $600      $100           $--       $--         $700
                                                              
     1997                                                     
     Allowance for   
     doubtful
     accounts           $600       $32           $--       $(32)       $600
                                                              
     1996                                                     
     Allowance for 
     doubtful
     accounts           $600      $520            $--      $(52)       $600