1
The Lubrizol Corporation
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Lubrizol Corporation is a fluid technology company concentrating on high
performance chemicals, systems and services for transportation and industry. We
develop, produce and sell specialty additive packages and related equipment used
in transportation and industrial finished lubricants. We create our products
through the application of advanced chemical and mechanical technologies to
enhance the performance, quality and value of the customer products in which
they are used. We group our product lines into two operating segments: chemicals
for transportation and chemicals for industry. Chemicals for transportation
comprised approximately 83% of our consolidated revenues and 87% of segment
pre-tax operating profit in 1999. This discussion and analysis of our financial
condition and results of operations is generally focused on the company as a
whole since we believe this provides the most appropriate understanding of our
business. Note 12 to the financial statements contains a further description of
the nature of our operations, the product lines within each of the operating
segments and related financial disclosures.
In 1999, we continued to pursue our strategies to expand into new market areas,
grow revenues and improve cost structure. We believe that the global growth rate
for lubricant additives is approximately 1% per year. Due to changing industry
market forces, such as improved engine design and longer drain intervals, we
do not expect the annual growth rate to exceed 1% in the future. However,
our 1999 shipment volume increased by 9% over 1998 due to acquisitions made
during 1998, improvement in the economies in the Asia-Pacific region and new
business in North America.
We also have continued implementation of various short- and long-term
initiatives relating to our cost structure, such as consolidation of component
production and simplification of product lines, to enhance further our
competitiveness and market leadership position. In response to market and
industry conditions, we began an initiative in November 1998 to reduce costs and
improve our worldwide operating structure. The first phase of this initiative,
which was completed by December 31, 1999, included the reorganization of our
commercial structure, changes in work processes using our new globally
integrated management information system, the shutdown of some production units
and the consolidation of some facilities and offices. We achieved savings of
approximately $24 million in 1999 related to the first phase of this initiative.
A second phase, which was announced in the third quarter of 1999, involves
primarily the downsizing of our Painesville, Ohio manufacturing facility. These
actions are discussed under the caption "Cost Reduction Program and Related
Special Charges" and in Note 15 to the financial statements.
Acquisitions are an important part of our strategy to strengthen our business
position and expand into new markets, even though only a small acquisition was
made during 1999. We continue to actively pursue acquisitions during 2000, with
particular focus on our chemicals for industry business.
[Bar graph of REVENUES (millions)]
95 96 97 98 99
1999 RESULTS OF OPERATIONS
IN 1999, we achieved record consolidated revenues of $1.75 billion, which
represented an increase of $130.1 million, or 8% (3% excluding acquisitions) as
compared with 1998. The primary factor causing the increase in revenues from the
prior year was a 9% increase in our shipment volume (5% excluding acquisitions).
Our average selling price declined 2% as compared with 1998, all of which was
due to lower product pricing and changing product mix. Chemicals for
transportation revenues increased $87.7 million, or 6%, over 1998. Approximately
two-thirds of the increase was due to our 1998 acquisition of Adibis. Chemicals
for industry revenues increased $42.4 million, or 17%, over 1998. Approximately
one-half of the increase was due to acquisitions, primarily our acquisition of
Carroll Scientific, Inc.
The increase in 1999 shipment volume, excluding acquisitions, was attributable
to North America and Asia-Pacific. Shipment volume to North American customers
increased 13% primarily due to new business awarded at the end of 1998 and in
1999. Shipments to Asia-Pacific customers in 1999, excluding acquisitions,
increased 14% compared to 1998 primarily due to the economic improvement in the
region. Shipments to European and Latin American customers in 1999, excluding
acquisitions, decreased 4% and 10% respectively, due primarily to sluggish
economies with some business loss. We believe consolidated 1999 results
benefited from some advance buying in late 1999 related to Year 2000 concerns,
and customer purchases in advance of an announced price increase. A number of
the factors that contributed to the strong volume growth in 1999 may not be
present in 2000, and we believe that volume in 2000 (excluding acquisitions) is
likely to be approximately the same as 1999.
Cost of sales for 1999, including acquisitions, increased 5% reflecting higher
shipment levels partially offset by lower average raw material cost compared
with 1998. On a sequential basis, we experienced a 4% increase in average raw
material cost during the third quarter and an additional 2% increase
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The Lubrizol Corporation
during the fourth quarter, as a result of higher crude oil pricing and its
downstream effect. In November 1999, we announced a global price increase
ranging from 3% to 7% depending on the product group, to recover the increasing
raw material cost. The price increase, which was effective December 15, 1999,
was successful and we believe it will result in an average increase of 4% to
4.5% when fully implemented. We began to see the impact on revenues in the first
quarter of 2000 and anticipate the full impact will be felt by the end of the
second quarter. We continue to experience material cost increases in the first
quarter of 2000, and further price increases will be necessary to enable us to
maintain our margins. Manufacturing costs, included in cost of sales, increased
7% (3% excluding acquisitions) in 1999 compared to 1998.
[Bar graph of GROSS PROFIT (millions)]
95 96 97 98 99
Gross profit (net sales less cost of sales) increased $67.4 million, or 14%,
in 1999 compared with 1998. Excluding acquisitions, gross profit increased $50.3
million, or 10%, in 1999 compared with 1998. Most of the increase was due to
higher volume and the impact of lower average raw material cost partially offset
by lower average selling price. Additionally, $10 million of the increased gross
profit was due to the impact on cost of sales of favorable changes in currency
exchange rates. Of the total gross profit increase, $54.1 million was
attributable to chemicals for transportation and $13.3 million was attributable
to chemicals for industry. This represented a 14% increase for each operating
segment. Acquisitions accounted for one-fourth of the chemicals for
transportation increase and one-half of the chemicals for industry increase, and
the remainder was due to the factors noted above.
The gross profit percentage (gross profit divided by net sales) improved to
31.5% for 1999 as compared with 29.8% for 1998 for the same reasons as discussed
above. In addition, the 1998 gross profit percentage was unusually low as
explained in the discussion of 1998 results of operations. The gross profit
percentages for chemicals for transportation and chemicals for industry were
30.6% and 35.4%, respectively, compared to 28.6% and 36.1% in 1998.
Selling and administrative expenses increased by $1.5 million, or 1%, in 1999
compared with 1998. Excluding acquisitions, selling and administrative expenses
decreased $4.4 million, or 2%, in 1999 due to lower legal expenses, efficiencies
from the integration of Adibis, lower pension costs, reduced spending on our
global enterprise-wide management information system and favorable currency
effects. These factors were partially off-set by higher variable pay and costs
associated with "Year 2000" compliance activities.
[Bar graph of RESEARCH TESTING & DEVELOPMENT (millions)]
95 96 97 98 99
Research, testing and development expenses (technology expenses) decreased $5.1
million, or 3%, in 1999 compared with 1998. Excluding acquisitions, technology
expenses decreased $8.3 million, or 6%. Product standards change periodically to
meet new emissions, efficiency, durability and other performance factors as
engine and transmission designs are improved by equipment manufacturers. These
changes influence the timing and amount of technology expense. Approximately 80%
of our technology cost is incurred in company-owned facilities and 20% is
incurred at third-party testing facilities. The reduction in technology expenses
was achieved, in part, by reduced spending in 1999 for engine tests conducted at
third party facilities. In addition, an industry delay in the effective date of
the proposed new U.S. passenger car motor oil technical standard, GF-3, has
resulted in a deferral of related testing activities. This delay, along with
savings generated from the first phase of our cost reduction program implemented
in late 1998, also contributed to lower technical expenses in 1999 compared with
1998. We believe technical spending will increase by about 5% in 2000 because of
the anticipated GF-3 testing requirements.
Primarily as a result of the factors previously discussed, consolidated
revenues increased $72.0 million more than the increase in total costs and
expenses in 1999.
We recorded special charges for the year of $19.6 million ($13.2 million
after-tax or $.24 per share) relating to both phases of our cost reduction
program. These special charges are discussed under the caption "Cost Reduction
Program and Related Special Charges" below and in Note 15 to the financial
statements.
On March 31, 1999 Lubrizol and Exxon Corporation reached a settlement of all
pending intellectual property litigation between the two companies and their
affiliates, except for litigation pending in Canada. Under the settlement
agreement, Exxon paid us cash of $16.8 million in April 1999. After deducting
related expenses, this settlement increased 1999 pre-tax income by $14.5 million
($9.0 million after-tax or $.16 per share). Further information regarding our
litigation with Exxon is contained in Note 16 to the financial statements.
Additionally,
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The Lubrizol Corporation
we recorded a pre-tax gain of $3.1 million ($1.9 million after-tax or $.04 per
share) in the fourth quarter for the settlement of litigation unrelated to
Exxon.
The change in other income (expense) unfavorably affected 1999 pre-tax income by
$5.6 million compared with 1998. The change resulted primarily from higher
goodwill amortization related to acquisitions made in the second half of 1998,
and higher currency translation and transaction losses, principally in Brazil,
partially offset by higher equity earnings of affiliated companies.
Interest expense increased $8.6 million in 1999 compared with 1998, principally
because of higher borrowings necessitated by the acquisitions made during the
second half of 1998 and 1998 share repurchases.
While changes in the dollar value of foreign currencies will affect earnings
from time to time, the longer-term economic effect of these changes should not
be significant given our net asset exposure, currency mix and use of U.S.
dollar-based pricing in certain countries. As the U.S. dollar strengthens or
weakens against other international currencies in which we transact business,
our financial results will be affected. Changes in currency exchange rates
during 1999 had a favorable effect on net income per share of $.07 for the year
as compared to exchange rates in effect during 1998. This was primarily a result
of the weakening of the U.S. dollar against the Japanese yen, partially offset
by a strengthening of the U.S. dollar against the pound sterling and other
currencies.
As a result of the factors discussed above, income before income taxes increased
by $76.5 million, or 64%, over 1998. After excluding from both years the special
charges and the gains from litigation settlements, income before income taxes
increased by $57.8 million, or 41%, over 1998. Segment operating profit before
tax, which excludes interest expense, increased $61.5 million, or 47%, for
chemicals for transportation, and increased $4.9 million, or 22%, for chemicals
for industry, as compared to 1998.
The effective tax rate on 1999 income, before litigation gains and special
charges, decreased to 36.5% as compared with 38.0% in 1998. This decrease, which
increased 1999 earnings before these items by $.05 per share, was primarily due
to improvement in the profitability of certain foreign subsidiaries with loss
carryforwards, a reduction in the amount of non-deductible translation losses at
certain foreign subsidiaries, and a significant increase in pre-tax profit which
diluted the effect of non-deductible items.
Net income in 1999 was $123.0 million, or $2.25 per share. In 1998, net income
was $71.2 million, or $1.27 per share. After excluding from 1999 and 1998 the
special charges and the gains from litigation settlements, net income in 1999
was $125.3 million, as compared to $86.5 million in 1998, an increase of 45%. On
this same basis, 1999 net income per share was $2.30, an increase of 48% over
the $1.55 per share earned in 1998.
COST REDUCTION PROGRAM AND RELATED
SPECIAL CHARGES
We initiated a series of steps in 1998 to reduce costs and improve our worldwide
operating structure and are executing these steps in two phases over a period
approximating two years. The first phase, which began in the fourth quarter of
1998, resulted in the reduction of approximately 7% of our workforce, or 300
employees, at both domestic and international locations. Approximately 55% of
this reduction occurred by December 31, 1998, a further 35% occurred in the
first quarter of 1999 and the remainder was substantially completed by the end
of the third quarter of 1999. Of the 300 employees, approximately 40% were in
the manufacturing area and 60% were in the selling, administrative, research and
testing areas. In addition, we permanently removed seven component production
units from service during this first phase.
We recorded a special charge of $23.3 million in the fourth quarter of 1998 for
the cost directly associated with this first phase of the cost reduction
program. In the first quarter of 1999, we recognized additional expense of $3.1
million ($2.9 million after-tax or $.05 per share) to reflect a greater amount
for separation benefits, principally in Japan. In the fourth quarter of 1999, an
adjustment was made to reduce the special charge by $4.3 million ($2.5 million
after-tax or $.05 per share) to reflect the settlement gain recorded as a result
of settling employee pension obligations and other accrual adjustments. As
adjusted, first phase employee severance costs approximated $20.0 million of the
total charge of $22.1 million and other exit costs approximated $2.1 million,
virtually all of which related to asset impairments for component production
units taken out of service. We spent approximately $5.0 million and $14.7
million in 1998 and 1999, respectively, related to this phase of the cost
reduction program. We estimate annualized savings of $28 million, of which
approximately $24 million was achieved in 1999.
The second phase of our cost reduction program, which began in the third quarter
of 1999, involves primarily the downsizing of our Painesville, Ohio
manufacturing plant. This will result in the additional reduction of
approximately 5% of our work-
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The Lubrizol Corporation
force, or 200 employees, and the shutdown of 23 of Painesville's 36 production
systems. Through December 31, 1999, we have shut down 12 of the 23 targeted
production systems and have completed approximately 22% of the anticipated
workforce reduction. We expect the remainder of the system shut downs and
workforce reduction to occur by the end of 2000. After restructuring, the
Painesville plant will continue to operate as a producer of small volume
specialized intermediates and as a blender of certain additive packages.
We recorded a special charge of $20.8 million ($12.9 million after-tax or $.24
per share) in the third quarter of 1999 relating to this second phase of our
cost reduction program. Employee severance costs are $8.5 million of the charge
and other exit costs are $12.3 million, including $8.9 million related to asset
impairment for component production units to be taken out of service. We spent
approximately $1.3 million in 1999 related to this phase of the cost reduction
program, and we expect to spend $10.6 million in 2000. Additionally, we will
spend approximately $8 million of capital to transfer a portion of the
Painesville capacity to our Deer Park, Texas plant. We expect to achieve annual
savings of $20 million following completion of these actions in the latter part
of 2000.
1998 RESULTS OF OPERATIONS
IN 1998, the continuing weak business environment of the lubricant additives
industry and poor economic conditions in Asia-Pacific and Latin America
negatively impacted the financial results for the year, particularly during the
second half of the year. Despite acquisitions contributing 5% to consolidated
revenues during 1998, annual revenues declined 3% as compared with 1997. Lower
average selling prices combined with relatively level material costs compressed
profit margins. In addition, higher interest expense and a higher effective tax
rate each contributed to 1998 earnings being significantly lower than 1997
earnings.
Consolidated revenues for 1998 of $1.62 billion decreased $55.9 million, or 3%,
as compared with the then-record 1997 annual revenues of $1.67 billion. The
primary factors causing the decline in revenues from 1997 were lower average
selling prices and lower pre-acquisition volume, which more than off-set the
year-over-year incremental revenues from acquisitions. Excluding acquisitions,
sales volume declined by 4% for 1998 and by 10% for the second half of 1998 as
compared with the comparable 1997 periods. The 1998 average selling price
declined 5% as compared with 1997, of which 75% was due to lower product pricing
and changing product mix and 25% was due to currency. The year-over-year
increase in revenues from acquisitions was $81.2 million, of which $38.0 million
pertained to chemicals for transportation and $43.2 million pertained to
chemicals for industry.
The slowing of lubricant additive demand in virtually all geographic areas
during 1998 and the economic conditions in Asia-Pacific caused difficult
comparisons against 1997, a year in which we achieved record revenues and sales
volume. Although sales volume in 1998 was flat with 1997, excluding
acquisitions, sales volume declined 4%. On this same basis, sales volume to
customers in North America during 1998 was level with 1997, but declined 7% to
international customers. For the 1998 second half compared with the same period
of 1997, sales volume (excluding acquisitions) decreased 3% to customers in
North America and decreased 15% to international customers.
The economic difficulties in the Asia-Pacific region had an accelerating,
unfavorable effect on our 1998 results. Products shipped to customers in
Asia-Pacific are manufactured primarily in production facilities in the United
States and comprised approximately 16% and 19% of our revenues in 1998 and 1997,
respectively. Sales volume to customers in Asia-Pacific during the first half of
1998 declined by only 1% as compared with the first half of 1997, but declined
by 21% in the 1998 second half as compared with the 1997 second half. Lower
sales volume into Asia-Pacific was the primary reason that overall sales volume
declined in 1998. Asia-Pacific revenues declined by $53 million, or 17%, for the
year 1998 and by $40 million, or 24%, for the second half of 1998 as compared
with the respective 1997 periods. Some forward buying during the second half of
1997 by customers in Asia-Pacific in a reaction to worsening economic conditions
exacerbated the comparison with 1998.
Cost of sales for the full year 1998, including acquisitions, increased only 1%
over 1997 as sales volume, average material unit costs and manufacturing costs
remained relatively constant between the comparable periods. Average material
unit costs declined less than 1% from 1997. Our manufacturing costs do not
fluctuate significantly with changes in production volume. The effects of our
ongoing manufacturing rationalization program and other cost management
initiatives helped keep manufacturing costs level as compared with the prior
year, despite a $12.2 million increase from acquisitions.
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The Lubrizol Corporation
Gross profit (net sales less cost of sales) decreased $64.4 million, or 12%, in
1998 compared with 1997. Excluding acquisitions, gross profit declined $82.3
million, or 15%, in 1998 compared with 1997. Gross profit decreased $30.2
million, or 11%, ($35.3 million, or 13%, excluding acquisitions) in the first
half of 1998 and decreased $34.2 million, or 13%, ($47.0 million, or 18%,
excluding acquisitions) in the second half of 1998 compared with the same 1997
periods. The decrease in gross profit for each of the respective periods was
primarily due to the decline in selling prices and, in the second half of 1998,
also due to the lower sales volume. The $17.9 million increase in gross profit
contributed from acquisitions made in 1998 was partially offset by unfavorable
currency effects of $7.4 million.
The gross profit percentage (gross profit divided by net sales) was 29.8% for
1998 as compared with 32.7% for 1997. This decrease in gross profit percentage
was attributable to the lower average selling price as well as the unfavorable
effect on per unit manufacturing costs resulting from lower production levels,
particularly in the fourth quarter of 1998. In addition, the gross profit
percentage of 27.6% in the fourth quarter of 1998 reflected a $4.3 million
inventory write down primarily due to a change in a customer product
specification.
Selling and administrative expenses increased by $8.5 million, or 5%, in 1998
compared with 1997. Excluding acquisitions, selling and administrative expenses
were $1.5 million, or 1%, lower compared with 1997. Selling and administrative
expenses in 1998 reflected increased spending of $11.3 million related to the
implementation of the new enterprise-wide, management information system, but
this was more than offset by lower variable pay expense, lower litigation
expense and other cost reductions.
Research, testing and development expenses (technology expenses) increased $4.3
million, or 3%, in 1998 compared with 1997. Excluding acquisitions, technology
expenses declined $1.9 million, or 1%, from 1997. During 1998, approximately 80%
of our technology cost was incurred in company-owned facilities and 20% was
incurred at third-party testing facilities. Testing expenses incurred at third
party testing facilities increased $5.5 million in 1998 over 1997 primarily due
to a new performance specification for heavy-duty engine oils. Our technology
expense in 1998, as well as in 1997, included costs related to new performance
specifications for heavy-duty engine oils, which were introduced into the market
in late 1998, and new performance specifications for passenger car engine oils
expected to become effective during 2000.
Primarily as a result of the factors previously discussed, the change in
revenues together with the change in total costs and expenses unfavorably
affected our pre-tax profits by $78.4 million for the full year 1998 and by
$45.3 million for the second half of 1998 as compared with respective 1997
periods.
In the fourth quarter of 1998, we recorded special charges aggregating $36.9
million. These special charges related to the first phase of our cost reduction
program, which amounted to $23.3 million, and the write-off of $13.6 million of
purchased technology under development originating from the Adibis acquisition.
After-tax, these special charges reduced 1998 net income by $25.8 million, or
$.47 per share.
On April 23, 1998, we reached a settlement with Exxon Corporation of a lawsuit
pending in federal court in Ohio and we received cash of $19 million from Exxon.
The pre-tax gain from this litigation settlement, net of related expenses, was
$16.2 million. After-tax, the litigation settlement increased net income by
$10.5 million, or $.19 per share. Further information regarding our litigation
with Exxon is contained in Note 16 to the financial statements.
The change in other income (expense) unfavorably affected 1998 pre-tax income by
$6.3 million compared with 1997. This change mostly occurred during the second
half of the year and resulted primarily from higher goodwill amortization,
higher currency exchange transaction losses and lower equity earnings from joint
venture companies.
Interest expense increased $8.2 million in 1998 compared with 1997, reflecting
significantly higher borrowings that were incurred primarily to finance
acquisitions during the year.
As the U.S. dollar strengthens or weakens against other international currencies
in which we transact business, our financial results will be affected. During
1998, the U.S. dollar strengthened and the change in currency exchange rates had
an unfavorable effect on net income per share of $.07 for the year 1998 as
compared with exchange rates in effect during 1997.
As a result of the factors discussed above, income before income taxes decreased
by $112.3 million for the full year 1998 and by $93.8 million for the second
half of 1998 as compared with the respective periods of 1997. Excluding from
1998 the litigation gain and special charges, income before income taxes
decreased by $91.6 million, or 40%, for the full year 1998 and by $56.9 million
for the second half of 1998 as compared with the respective periods of 1997.
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The Lubrizol Corporation
The 1998 effective tax rate on income, before the litigation gain and special
charges, increased to 38% as compared with 33% in 1997. This increase, which
lowered 1998 earnings before these items by $.12 per share, was primarily a
result of lower 1998 operating earnings and increased non-tax deductible 1998
translation losses incurred by our foreign subsidiaries using a U.S. dollar
functional currency. Other reasons for the change in the effective tax rate
included shifts in earnings among the various countries in which we operate and
the tax benefits recognized during the second half of 1997 resulting from
favorable tax law changes enacted by France, the United States and the United
Kingdom. Taking into account the litigation gain and the fourth quarter special
charges, the overall effective tax rate for 1998 was 40%.
Net income in 1998 was $71.2 million, or $1.27 per share. In 1997, net income
was $154.9 million, or $2.68 per share. After excluding from 1998 the litigation
gain and the special charges, net income in 1998 was $86.5 million, a decrease
of 44% from 1997. On this same basis, 1998 net income per share was $1.55, a
decline of 42% from the $2.68 per share earned in 1997.
1997 RESULTS OF OPERATIONS
IN 1997, we made significant progress with each of our strategies to grow our
business, improve our cost structure and build our franchise. During 1997,
revenues increased 5% as product shipments increased 17% over 1996 and our
market share grew. We continued our focus to improve our cost structure as
operating expenses were flat versus 1996, even with significantly higher
production throughput. Net income per share in 1997 increased 20%, after
excluding from 1996 the gain on investments. This record performance was
achieved despite the unfavorable effect on earnings of the stronger U.S. dollar.
In 1997, we had then-record revenues of $1.67 billion, an increase of $76.2
million over 1996. Increased revenues resulted from a 17% increase in specialty
chemical shipment volumes (contributing a 15% increase in consolidated
revenues), partially offset by a 10% decline in the average selling price.
Although the average selling price stabilized during the second half of the
year, the full-year decline for 1997 was attributable approximately 50% to
changing product mix, 30% to unfavorable currency effects and 20% to lower
product pricing. The unfavorable product mix effect resulted from volume gains
in product lines having lower than the overall average selling price. On
balance, our acquisition/divestiture activity did not significantly affect 1997
annual revenues as recent acquisitions offset a prior year disposition. However,
acquisitions contributed one-fourth, or $11.4 million, of the 13% increase in
consolidated revenues for the fourth quarter of 1997 compared with the fourth
quarter of 1996.
A primary strategy in 1997 was to grow our business. We had success building
global and regional alliances with targeted customers and continued actively
pursuing additional strategic relationships with finished lubricant suppliers.
As compared with 1996, sales volume increased throughout the year. Higher sales
volumes were realized in all geographic zones and across a broad customer base.
In 1997, sales volume increased 14% to North American customers and 18% to
international customers, primarily in Asia-Pacific, Western Europe and Latin
America. The growth in sales volume was derived principally from market share
gains within established markets rather than overall industry growth.
Cost of sales reflected the higher sales volume as well as lower average raw
material costs and level manufacturing costs. Compared with the respective prior
year periods, average material costs, including favorable currency effects and
the impact of less expensive product mix, were 10% lower in the first half of
1997, 6% lower in the second half of 1997 and 8% lower for the year. Our
manufacturing costs do not fluctuate significantly with changes in production
volume. The effects of our ongoing manufacturing rationalization program and
other cost management initiatives have improved manufacturing efficiency as we
are operating fewer manufacturing units at higher capacity levels. Manufacturing
costs, aided by currency effects, were flat in 1997 compared with 1996, even
though production activity was significantly higher in 1997 and we resumed pay
increases following the salary freeze in effect during 1996.
Gross profit increased $36.2 million, or 7%, in 1997 compared with 1996. This
improvement in gross profit amount was after unfavorable currency effects of
$20.0 million, which occurred evenly over the four quarters.
Acquisition/divestiture activity contributed $13.0 million to the increase in
gross profit for 1997. Gross profit improved to 32.7% of sales in 1997 compared
with 32.0% in 1996 as manufacturing efficiencies, lower material costs and the
effect of acquisition/divestiture activities more than offset the effect of
lower average selling price. Gross profit was 31.4% during the second half of
1997 due to sequentially lower average selling price, higher material costs and
the effect of asset impairment losses of $4.4 million principally in the fourth
quarter.
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The Lubrizol Corporation
Selling and administrative expenses increased $12.6 million, or 8%, in 1997
compared with 1996. These expenses, which were higher in the second half of the
year compared with the first half, increased primarily due to higher
patent-related litigation expenses, the effect of acquisitions, incremental
expenses related to the implementation of the new enterprise-wide management
information system and increased variable compensation as a result of higher
earnings.
During 1997, research, testing and development expense (technology expense)
decreased $14.3 million, or 9%, from 1996. The lower spending level in 1997 was
due to the timing of testing programs particularly within the engine oil and
gear oil product lines, greater internalization of testing activity that reduced
outside testing requirements and workforce reductions. Our technology expense in
1997 included some costs related to new performance specifications for
heavy-duty engine oils which became effective during 1998 and new performance
specifications for passenger car engine oils expected to become effective during
2000.
As discussed in Note 15 to the financial statements, in 1997, we provided $9.4
million for the impairment of long-lived assets. These charges related to a
shutdown of an intermediate manufacturing system and the write-off of certain
computer equipment and legacy software systems that were disposed of due to the
computer equipment standardization project and the new enterprise-wide
management information system being implemented.
Primarily as a result of these factors, consolidated revenues increased $37.7
million more than the increase in total costs and expenses in 1997.
Interest income in 1997 was lower than in 1996 as proceeds from the 1996 sale of
investments were temporarily invested in interest-bearing instruments until used
in our share repurchase program. Interest expense in 1997 was level with 1996.
The average daily balance of total debt outstanding during 1997 was $195 million
as compared with $188 million in 1996.
We conduct a significant amount of business outside of the United States and are
subject to certain related risks including currency fluctuations. The U.S.
dollar continued to strengthen during 1997, causing an unfavorable effect on net
income of approximately $10.0 million, or $.17 per share.
As a result of the factors discussed above and after excluding from 1996 the
gain on investments, income before income taxes increased 17%, or $33.8 million,
from 1996. We adjusted our tax provision in the third quarter of 1997 to reflect
a legislated increase in the statutory tax rate applicable to our earnings in
France, where we have significant operations. This adjustment resulted in an
effective tax rate of 33.0% for the full year 1997 as compared with 31.5% in
1996, after excluding the 1996 gain on investments on which a 35% tax rate
applied. The higher effective tax rate reduced net income by $3.5 million, or
$.06 per share in 1997.
Net income in 1997 was $154.9 million, or $2.68 per share. In 1996, net income
was $169.8 million, or $2.80 per share, which included investment gains. After
excluding from 1996 the non-recurring gains, net income in 1997 was 15% higher
than the $135.2 million for 1996. On this same basis, net income per share was
20% higher than the $2.23 per share for 1996, reflecting our share repurchase
program.
[Bar graph RETURN ON EQUITY (percent)
(Before investment gains, litigation gains
and special charges.)]
95 96 97 98 99
RETURN ON AVERAGE SHAREHOLDERS' EQUITY
Return on average shareholders' equity was 16% in 1999 (also 16% excluding the
litigation gains and special charges), 9% in 1998 (11% excluding the litigation
gain and the special charge) and 19% in 1997.
WORKING CAPITAL, LIQUIDITY
AND CAPITAL RESOURCES
Our cash flows for the years 1997 through 1999 are presented in the consolidated
statements of cash flows. We had strong cash flow in 1999, as cash provided from
operating activities increased by $133.8 million, or 86%, over 1998, to a total
of $289.0 million. This increase was primarily due to higher earnings, and a $52
million reduction in working capital in 1999 compared to $45 million growth in
working capital in 1998. The reduction in working capital resulted from
implementation of an initiative to reduce inventory, collection of a $15 million
income tax refund receivable and an increase in current liabilities.
We have been engaged in a multi-year project to implement a global
enterprise-wide management information system and standardize the computer
equipment among all of our major facilities. This project supports our strategy
to improve our cost structure by reducing complexity and increasing efficiency
and was a critical component in our "Year 2000" compliance plan for our business
information systems. This system provides internal access to company information
so that resources are shared and processes are standardized and integrated
world-
20
8
The Lubrizol Corporation
wide. We implemented the new enterprise-wide management information system in
the United States during April 1998 and in Europe during April 1999, and we
anticipate completing implementation in Singapore and Australia in April 2000.
[Bar graph showing CASH PROVIDED FROM
OPERATING ACTIVITIES (millions)]
95 96 97 98 99
Capital expenditures in 1999 were $64.9 million compared with $93.4 million in
1998. The reduction in capital spending was due to decreased expenditures
related to our multi-year project to implement the enterprise-wide management
information system ($7.6 million in 1999 as compared to $17.6 million in 1998)
and lower spending on manufacturing projects. We estimate capital expenditures
for 2000 will be approximately $80 million.
We made one acquisition in 1999 for $1.9 million. In 1998, we made six
acquisitions for cash of $155.4 million and one acquisition for 89,806 of our
common shares valued at $2.4 million. These acquisitions were in the areas of
lubricant additives, metalworking additives and coating additives and broaden
our base in performance chemicals.
We maintained an active share repurchase program for a number of years, but
suspended repurchases at the end of 1998 because net debt as a percent of
capitalization had reached our target level of 35% and we wanted to preserve
cash and borrowing capacity to fund potential acquisitions. During 1998, we
repurchased approximately 2.6 million common shares, or 4.6% of our common
shares outstanding at the beginning of 1998, for $80 million. Because of our
strong cash flow in 1999 and the completion of only one small acquisition during
the year, our net debt as a percent of capitalization decreased to 25% at
year-end. As a result, we resumed share repurchases late in the year. We
repurchased approximately 140,000 common shares for $4.2 million in 1999, and we
anticipate spending an aggregate of $20 million for share repurchases through
the end of the first quarter of 2000. Net debt is the total of short and
long-term debt, reduced by cash and short-term investments in excess of an
assumed operating cash level of $40 million. Capitalization is shareholders'
equity plus net debt.
The increase in cash flow from operating activities and the minimal amount of
share repurchases and acquisition activity enabled us to reduce our borrowings
by $27.9 million during 1999 and to increase our cash and short-term equivalents
by $131.8 million.
[Bar graph showing CAPITALIZATION (millions)]
95 96 97 98 99
Our net borrowings during 1998 totaled $201.7 million. These borrowings were
used primarily to finance $155 million of cash expended for acquisitions, most
of which occurred in the third quarter, and our share repurchase program. As
discussed in Note 4 to the financial statements, we replaced a significant
portion of outstanding commercial paper borrowings by issuing $200 million of
long-term debt in November 1998. We incurred debt issuance costs of $10.5
million in 1998, including a $6.5 million loss related to a hedge against
changes in interest rates relative to the anticipated issuance of this debt.
Debt increased during 1997 primarily to finance several acquisitions and the
increase in working capital.
Our financial position remains strong with a ratio of current assets to current
liabilities of 2.5:1 at both December 31, 1999 and 1998. Effective July 1, 1998,
we increased our committed revolving credit facilities from $75 million to $300
million. One-half of the aggregate amount of these facilities expired on June
30, 1999, and the remainder expires on June 30, 2003. We did not renew the $150
million in facilities that expired on June 30, 1999, because the November 1998
issuance of $200 million in long-term notes reduced our expected financing
requirements. The remaining $150 million in facilities, which were unused at
December 31, 1999, permit us to borrow at or below the U.S. prime rate. We
believe that our existing credit facilities, internally generated funds and
ability to obtain additional financing, if desired, will be sufficient to meet
our future capital needs.
21
9
The Lubrizol Corporation
YEAR 2000 MATTERS
We developed a global Year 2000 strategy covering each of our facilities
designed to minimize Year 2000 disruptions to our computer-based systems,
including business information systems and process control, testing and
laboratory equipment and embedded systems. Our Year 2000 compliance strategy
incorporated the conversion of most of our business information systems from
mainframe systems to compliant, client/server systems. Much of this conversion
was part of our implementation of our global enterprise-wide management
information system. We have not incurred any adverse impact on our operations
because of Year 2000 factors, including any inability or difficulty of our
suppliers or customers to operate in the Year 2000. We do not anticipate any
adverse impact on our 2000 financial results due to Year 2000 issues.
Through December 31, 1999, we had spent approximately $76.6 million related to
the implementation of our global enterprise-wide management information system,
of which approximately $53.6 million was capitalized and $23.0 million expensed.
We estimate additional costs in 2000 of approximately $1.5 million to continue
implementing this system. In addition, we spent approximately $6.3 million for
Year 2000 remedial activities not addressed by the global enterprise-wide
management information system, including $4.3 million in 1999.
CAUTIONARY STATEMENT FOR "SAFE HARBOR" PURPOSES
UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995
This Management's Discussion and Analysis of Financial Condition and Results of
Operations and the letter "To Our Shareholders" from W. G. Bares, Chairman,
President and Chief Executive Officer of Lubrizol, contain forward-looking
statements within the meaning of the federal securities laws. As a general
matter, forward-looking statements are those focused upon future plans,
objectives or performance as opposed to historical items and include statements
of anticipated events or trends and expectations and beliefs relating to matters
not historical in nature. Such forward-looking statements are subject to
uncertainties and factors relating to our operations and business environment,
all of which are difficult to predict and many of which are beyond our control.
Such uncertainties and factors could cause our actual results to differ
materially from those matters expressed in or implied by such forward-looking
statements.
We believe that the following factors, among others, could affect our future
performance and cause our actual results to differ materially from those
expressed or implied by forward-looking statements made in this annual report:
- - the overall demand for lubricant additives on a worldwide basis, which has a
slow growth rate in mature markets such as North America and Europe;
- - the effect on our business resulting from economic uncertainty within the
Asia-Pacific and Latin American regions;
- - the lubricant additive demand in developing regions such as China and India,
geographic areas which are an announced focus of our activities;
- - technology developments that affect longer-term trends for lubricant
additives, such as: improved engine design, fuel economy, longer oil drain
intervals, alternative fuel powered engines and emission system compatibility;
- - our success at continuing to develop proprietary technology to meet or exceed
new industry performance standards and individual customer expectations;
- - the frequency of change in industry performance standards, which affects the
level and timing of our technology costs, the product life cycles and the
relative quantity of additives required for new specifications;
- - the rate of progress in continuing to reduce complexities and conversion costs
and in modifying our cost structure to maintain and enhance our
competitiveness;
- - our success in strengthening and retaining relationships with lubricant
additive customers, growing sales at targeted accounts, and expanding
geographically;
- - the extent to which we are successful in expanding beyond our core chemicals
for transportation businesses and into new areas for our chemicals for
industry businesses;
- - our ability to identify, complete and integrate acquisitions for profitable
growth;
- - the recoveries, judgments, costs and future impact of legal proceedings,
including those relating to intellectual property litigation with Exxon
Corporation and its affiliates;
- - the potential impact of consolidation among lubricant additive manufacturers
and finished lubricant marketers;
22
10
The Lubrizol Corporation
- - the relative degree of competitive and customer price pressure on lubricant
additives;
- - the cost, availability and quality of raw materials, including petroleum-based
products, required for the manufacture of lubricant additives;
- - the effects of fluctuations in currency exchange rates upon our reported
results from international operations, together with non-currency risks of
investing in and conducting significant operations in foreign countries,
including those relating to political, social, economic and regulatory
factors;
- - the ability to achieve and timing of cost efficiencies resulting from the new
enterprise-wide management information system;
- - changes in significant government regulations affecting environmental
compliance.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Lubrizol operates manufacturing and blending facilities, laboratories and
offices around the world and utilizes fixed and floating rate debt to finance
our global operations. As a result, we are subject to business risks inherent in
non-U.S. activities, including political and economic uncertainty, import and
export limitations and market risk related to changes in interest rates and
foreign currency exchange rates. We believe the political and economic risks
related to our foreign operations are mitigated due to the stability of the
countries in which our largest foreign operations are located.
In the normal course of business, we use derivative financial instruments
including interest rate swaps and foreign currency forward exchange contracts to
manage our market risks. Additional information regarding our financial
instruments is contained in Notes 4 and 13 to the financial statements. Our
objective in managing our exposure to changes in interest rates is to limit the
impact of such changes on earnings and cash flow and to lower our overall
borrowing costs. Our objective in managing the exposure to changes in foreign
currency exchange rates is to reduce volatility on earnings and cash flow
associated with such changes. Our principal currency exposures are in the major
European currencies, the Japanese yen and certain Latin American currencies. We
do not hold derivatives for trading purposes.
We measure our market risk, related to our holdings of financial instruments
based on changes in interest rates and foreign currency rates utilizing a
sensitivity analysis. The sensitivity analysis measures the potential loss in
fair values, cash flows and income before tax based on a hypothetical 10% change
(increase and decrease) in interest and currency exchange rates. We used current
market rates on our debt and derivative portfolio to perform the sensitivity
analysis. Certain items such as lease contracts, insurance contracts and
obligations for pension and other post-retirement benefits were not included in
the analysis.
Our primary interest rate exposures relate to our cash and short-term
investments, fixed and variable rate debt and interest rate swaps. The
calculation of potential loss in fair values is based on an immediate change in
the net present values of our interest rate-sensitive exposures resulting from a
10% change in interest rates. The potential loss in cash flows and income before
tax is based on the change in the net interest income/ expense over a one-year
period due to an immediate 10% change in rates. A hypothetical 10% change in
interest rates would have a favorable/unfavorable impact on fair values of $19.9
million, cash flows of $.5 million and income before tax of $.5 million.
Our primary currency rate exposures are to foreign denominated debt,
intercompany debt, cash and short-term investments and foreign currency forward
exchange contracts. The calculation of potential loss in fair values is based on
an immediate change in the U.S. dollar equivalent balances of our currency
exposures due to a 10% shift in exchange rates. The potential loss in cash flows
and income before tax is based on the change in cash flow and income before tax
over a one-year period resulting from an immediate 10% change in currency
exchange rates. A hypothetical 10% change in currency exchange rates would have
a favorable/unfavorable impact on fair values of $4.5 million, cash flows of
$10.5 million and income before tax of $3.4 million.
23
11
The Lubrizol Corporation
Deloitte &
Touche LLP [Logo]
- -----------
INDEPENDENT AUDITORS' REPORT
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF
THE LUBRIZOL CORPORATION
We have audited the accompanying consolidated balance sheets of The Lubrizol
Corporation and its subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of The Lubrizol Corporation and its
subsidiaries at December 31, 1999 and 1998, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1999 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Cleveland, Ohio
February 3, 2000
24
12
The Lubrizol Corporation
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31
--------------------------------------------
(In Thousands of Dollars Except Per Share Data) 1999 1998 1997
- --------------------------------------------------------------------------------------------
Net sales ................................ $ 1,743,541 $ 1,614,558 $ 1,669,251
Royalties and other revenues ............. 4,462 3,361 4,531
----------- ----------- -----------
Total revenues ..................... 1,748,003 1,617,919 1,673,782
Cost of sales ............................ 1,194,945 1,133,327 1,123,602
Selling and administrative expenses ...... 181,292 179,759 171,244
Research, testing and development expenses 145,927 150,980 146,678
----------- ----------- -----------
Total cost and expenses ............ 1,522,164 1,464,066 1,441,524
Special charges .......................... (19,569) (36,892)
Gain from litigation settlements ......... 17,626 16,201
Other income (expense)-net ............... (6,704) (1,152) 5,104
Interest income .......................... 7,854 5,780 4,588
Interest expense ......................... (29,696) (18,976) (10,803)
----------- ----------- -----------
Income before income taxes ............... 195,350 118,814 231,147
Provision for income taxes ............... 72,358 47,614 76,278
----------- ----------- -----------
Net income ............................... $ 122,992 $ 71,200 $ 154,869
=========== =========== ===========
Net income per share ..................... $ 2.25 $ 1.27 $ 2.68
=========== =========== ===========
Net income per share, diluted ............ $ 2.25 $ 1.27 $ 2.66
=========== =========== ===========
Dividends per share ...................... $ 1.04 $ 1.04 $ 1.01
=========== =========== ===========
The accompanying notes to financial statements are an integral part of these
statements.
25
13
The Lubrizol
CORPORATION CONSOLIDATED BALANCE SHEETS
December 31
----------------------------
(In Thousands of Dollars) 1999 1998
- ------------------------------------------------------------------------------------------------------------
ASSETS
Cash and short-term investments ........................................... $ 185,465 $ 53,639
Receivables ............................................................... 301,256 301,644
Inventories ............................................................... 258,149 277,612
Other current assets ...................................................... 35,572 54,575
----------- -----------
Total current assets ................................................. 780,442 687,470
----------- -----------
Property and equipment - at cost .......................................... 1,598,264 1,608,500
Less accumulated depreciation ............................................. 927,752 889,650
----------- -----------
Property and equipment - net ............................................. 670,512 718,850
----------- -----------
Goodwill and intangible assets - net ...................................... 149,779 166,957
Investments in non-consolidated companies ................................. 30,441 26,490
Other assets .............................................................. 51,180 43,470
----------- -----------
TOTAL ............................................................ $ 1,682,354 $ 1,643,237
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Short-term debt and current portion of long-term debt ..................... $ 37,584 $ 38,926
Accounts payable .......................................................... 138,841 112,832
Accrued expenses and other current liabilities ............................ 134,875 118,270
----------- -----------
Total current liabilities ............................................ 311,300 270,028
----------- -----------
Long-term debt ............................................................ 365,372 390,394
Postretirement health care obligation ..................................... 108,717 106,641
Noncurrent liabilities .................................................... 45,054 48,950
Deferred income taxes ..................................................... 61,787 58,106
----------- -----------
Total liabilities .................................................... 892,230 874,119
----------- -----------
Contingencies and commitments
Preferred stock without par value - unissued
Common shares without par value - outstanding 54,477,292 shares in 1999 and
54,548,110 shares in 1998 .............................................. 85,984 84,651
Retained earnings ......................................................... 758,090 709,994
Accumulated other comprehensive loss ...................................... (53,950) (25,527)
----------- -----------
Total shareholders' equity ........................................... 790,124 769,118
----------- -----------
TOTAL ............................................................ $ 1,682,354 $ 1,643,237
=========== ===========
The accompanying notes to financial statements are an integral part of these
statements.
26
14
The Lubrizol Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
---------------------------------------
(In Thousands of Dollars) 1999 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
CASH PROVIDED FROM (USED FOR):
OPERATING ACTIVITIES:
Net income .................................................................. $ 122,992 $ 71,200 $ 154,869
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization .......................................... 99,720 88,047 87,217
Deferred income taxes .................................................. 1,312 5,732 8,585
Special charges and asset impairments .................................. 19,569 36,892 9,360
Change in current assets and liabilities net
of acquisitions and dispositions:
Receivables ........................................................ (10,749) 3,870 (47,313)
Inventories ........................................................ 13,500 9,839 (16,919)
Accounts payable, accrued expenses and other current liabilities ... 28,408 (41,749) 46,524
Other current assets ............................................... 19,052 (17,012) 4,101
Change in noncurrent liabilities ....................................... 370 5,357 (169)
Other items - net ...................................................... (5,153) (6,985) (11,889)
--------- --------- ---------
Total operating activities .................................... 289,021 155,191 234,366
INVESTING ACTIVITIES:
Proceeds from sale of investments ........................................... 3,500 12,117
Capital expenditures ........................................................ (64,872) (93,421) (100,700)
Acquisitions and investments in nonconsolidated companies ................... (1,923) (155,418) (23,636)
Other - net ................................................................. 2,246 749 5,164
--------- --------- ---------
Total investing activities .................................... (64,549) (244,590) (107,055)
FINANCING ACTIVITIES:
Short-term borrowing (repayment) ............................................ (8,404) 4,175 26,772
Long-term borrowing ......................................................... 5,000 203,059 5,572
Long-term repayment ......................................................... (24,447) (5,515) (4,159)
Debt issuance costs ......................................................... (10,523)
Dividends paid .............................................................. (56,757) (58,256) (58,469)
Common shares purchased, net of options exercised ........................... (2,625) (76,542) (63,391)
--------- --------- ---------
Total financing activities .................................... (87,233) 56,398 (93,675)
Effect of exchange rate changes on cash ..................................... (5,413) 136 (2,205)
--------- --------- ---------
Net increase (decrease) in cash and short-term investments .................. 131,826 (32,865) 31,431
Cash and short-term investments at the beginning of year .................... 53,639 86,504 55,073
--------- --------- ---------
Cash and short-term investments at the end of year .......................... $ 185,465 $ 53,639 $ 86,504
========= ========= =========
The accompanying notes to financial statements are an integral part of these
statements.
27
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The Lubrizol Corporation
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Shareholders' Equity
------------------------------------------------------------
Number of Accumulated Other
Shares Common Retained Comprehensive
(Dollars in Thousands) Outstanding Shares Earnings Income (Loss) Total
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 ...................... 58,522,676 $ 78,534 $ 744,310 $ (3,468) $ 819,376
-----------
Comprehensive income:
Net income 1997 ............................ 154,869 154,869
Other comprehensive loss ................... (36,937) (36,937)
-----------
Comprehensive income ............................ 117,932
Cash dividends .................................. (58,469) (58,469)
Common shares - treasury:
Shares purchased ........................... (1,812,841) (2,538) (67,526) (70,064)
Shares issued upon exercise of stock options 257,059 6,673 6,673
---------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1997 ...................... 56,966,894 82,669 773,184 (40,405) 815,448
-----------
Comprehensive income:
Net income 1998 ............................ 71,200 71,200
Other comprehensive income ................. 14,878 14,878
-----------
Comprehensive income ............................ 86,078
Cash dividends .................................. (58,256) (58,256)
Common shares issued for subsidiary acquisition . 89,806 2,390 2,390
Common shares - treasury:
Shares purchased ........................... (2,621,173) (3,944) (76,134) (80,078)
Shares issued upon exercise of stock options 112,583 3,536 3,536
---------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1998 ...................... 54,548,110 84,651 709,994 (25,527) 769,118
-----------
Comprehensive Income:
Net income 1999 ............................ 122,992 122,992
Other comprehensive loss ................... (28,423) (28,423)
-----------
Comprehensive income ............................ 94,569
Cash dividends .................................. (70,938)* (70,938)
Common shares - treasury:
Shares purchased ........................... (139,600) (220) (3,958) (4,178)
Shares issued upon exercise of stock options 68,782 1,553 1,553
---------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1999 ...................... 54,477,292 $ 85,984 $ 758,090 $ (53,950) $ 790,124
========== =========== =========== =========== ===========
* Includes dividends declared and unpaid at December 31, 1999.
The accompanying notes to financial statements are an integral part of these
statements.
28
16
The Lubrizol Corporation
NOTES TO FINANCIAL STATEMENTS
(In Thousands of Dollars Unless Otherwise Indicated)
NOTE 1 - NATURE OF OPERATIONS
The Lubrizol Corporation is a fluid technology company concentrating on high
performance chemicals, systems and services for transportation and industry.
The company develops, produces and sells specialty additive packages and related
equipment used in transportation and industrial finished lubricants. The
company's products are created through the application of advanced chemical and
mechanical technologies to enhance the performance, quality and value of the
products in which they are used. The company groups its product lines into two
operating segments: chemicals for transportation and chemicals for industry.
Chemicals for transportation comprise approximately 83% of the company's
consolidated revenues and 87% of segment pre-tax operating profit in 1999,
respectively. Refer to Note 12 for a further description of the nature of the
company's operations, the product lines within chemicals for transportation and
chemicals for industry and related financial disclosures.
NOTE 2 - ACCOUNTING POLICIES
CONSOLIDATION - The consolidated financial statements include the accounts of
The Lubrizol Corporation and its subsidiaries where ownership is greater than
50% and the company has effective controlling financial interest. For
nonconsolidated companies (affiliates), the equity method of accounting is used
when ownership, unless temporary, exceeds 20% and when the company has the
ability to exercise significant influence over the policies of the investee. The
book value of investments carried at equity was $29.7 million and $25.8 million
at December 31, 1999 and 1998, respectively. Investments carried at cost were
$.7 million at December 31, 1999 and 1998.
ESTIMATES - The preparation of consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions pending completion of related events. These estimates
and assumptions affect the amounts reported at the date of the consolidated
financial statements for assets, liabilities, revenues and expenses and the
disclosure of contingencies. Actual results could differ from those estimates.
CASH EQUIVALENTS - The company generally invests any of its excess cash in
short-term investments with various banks and financial institutions. Short-term
investments are cash equivalents, as they are part of the cash management
activities of the company and are comprised primarily of investments having
maturities of three months or less when purchased.
INVENTORIES - Inventories are stated at the lower of cost or market value. Cost
of inventories is determined by either first-in, first-out (FIFO) method or
moving average method, except in the United States for chemical inventories,
which are primarily valued using the last-in, first-out (LIFO) method.
PROPERTY AND EQUIPMENT - Property and equipment are carried at cost. Repair
and maintenance costs are charged against income while renewals and betterments
are capitalized as additions to the related assets. Costs incurred for computer
software developed or obtained for internal use are capitalized for application
development activities and immediately expensed for preliminary project
activities or post-implementation activities. Accelerated depreciation methods
are used in computing depreciation on certain machinery and equipment, which
comprise approximately 21% of the depreciable assets. The remaining assets are
depreciated using the straight-line method. The estimated useful lives are 10 to
40 years for buildings and land improvements and range from 3 to 20 years for
machinery and equipment.
GOODWILL AND INTANGIBLE ASSETS - Intangibles resulting from business
acquisitions including costs in excess of net assets of businesses acquired
(goodwill), purchased technology and trademarks are being amortized on a
straight-line method over periods ranging from 5 to 25 years. The recoverability
of good-will and intangible assets is evaluated at the business unit level by
analysis of operating results and consideration of other significant events or
changes in the business environment. If a business unit has operating losses and
based upon projections there is a likelihood that such operating losses will
continue, the company will evaluate whether impairment exists on the basis of
undiscounted expected future cash flows from operations before interest for the
remaining amortization period.
RESEARCH, TESTING AND DEVELOPMENT - Research, testing and development costs are
expensed as incurred. Research and development expenses, excluding testing, were
$78.3 million in 1999 and 1998, and $88.4 million in 1997.
ENVIRONMENTAL LIABILITIES - The company accrues for expenses associated with
environmental remediation obligations when such expenses are probable and
reasonably estimable. Such accruals are adjusted as further information develops
or circumstances change. Costs of future expenditures for environmental
remediation obligations are not discounted to their present value. The Company's
environmental reserves totaled $7.4 million and $7.9 million at December 31,
1999 and 1998, respectively. Of these amounts, $1.0 million was included in
other current liabilities at December 31, 1999 and 1998.
FOREIGN CURRENCY TRANSLATION - The assets and liabilities of certain of the
company's international subsidiaries are translated into U.S. dollars at
exchange rates in effect at the balance sheet date, and revenues and expenses
are translated at weighted average exchange rates in effect during the period.
Unrealized translation adjustments are recorded as a component of other
comprehensive income in shareholders' equity, except for subsidiaries for which
the functional currency is the
29
17
The Lubrizol Corporation
NOTES CONTINUED
U.S. dollar, where translation adjustments are realized in income. Transaction
gains or losses that arise from exchange rate changes on transactions
denominated in a currency other than the functional currency, except those
transactions that function as a hedge of an identifiable foreign currency
commitment or as a hedge of a foreign currency investment, are included in
income as incurred.
SHARE REPURCHASES - The company utilizes the par value method of accounting for
its treasury shares. Under this method, the cost to reacquire shares in excess
of paid-in capital related to those shares is charged against retained earnings.
REVENUE RECOGNITION - Substantially all revenues are recognized at the time of
shipment of products to customers with appropriate provision for uncollectible
accounts.
PER SHARE AMOUNTS - Net income per share is computed by dividing net income by
average common shares outstanding during the period. Net income per diluted
share includes the dilution effect resulting from outstanding stock options and
stock awards. Per share amounts are computed as follows:
1999 1998 1997
-------- -------- --------
Numerator:
Net income available to
common shareholders ............. $122,992 $ 71,200 $154,869
======== ======== ========
Denominator:
Weighted average common
shares outstanding .............. 54,577 55,939 57,843
Dilutive effect of stock
options and awards .............. 139 183 386
-------- -------- --------
Denominator for net income
per share, diluted ................. 54,716 56,122 58,229
======== ======== ========
Net income per share ................. $ 2.25 $ 1.27 $ 2.68
======== ======== ========
Net income per share,
diluted ............................ $ 2.25 $ 1.27 $ 2.66
======== ======== ========
ACCOUNTING FOR DERIVATIVE INSTRUMENTS - In June 1998, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Standards (SFAS)133,
"Accounting for Derivative Instruments and Hedging Activities," which was to
become effective for the company no later than January 1, 2000. In June 1999,
the FASB delayed the required effective date for SFAS 133, which delayed the
required effective date for the company until January 1, 2001. SFAS 133
establishes accounting and reporting standards for derivative instruments and
for hedging activities. It requires that all derivatives be measured at fair
value and recognized as either assets or liabilities in the balance sheet. The
accounting for changes in the fair value of a derivative (that is, gains or
losses) depends on the intended use of the derivative and its resulting hedge
designation. The company uses derivative financial instruments only to manage
well-defined foreign currency and interest rate risks. The company does not use
derivative financial instruments for trading purposes. The company is currently
evaluating the requirements of SFAS 133 but has not yet determined the impact on
its financial position and results of operations when adopted.
NOTE 3 - INVENTORIES
1999 1998
-------- --------
Finished products ........................ $118,135 $112,060
Products in process ...................... 56,855 66,485
Raw materials ............................ 66,102 80,134
Supplies and engine test parts ........... 17,057 18,933
-------- --------
$258,149 $277,612
======== ========
Inventories on the LIFO method were 28% and 27% of consolidated inventories at
December 31, 1999 and 1998, respectively. The current replacement cost of these
inventories exceeded the LIFO cost at December 31, 1999 and 1998, by $42.7
million and $41.1 million, respectively.
NOTE 4 - SHORT-TERM AND LONG-TERM DEBT
1999 1998
--------- ---------
Long-term debt consists of:
5.875% notes, due 2008 ................................. $ 200,000 $ 200,000
7.25% debentures, due 2025 ............................. 100,000 100,000
Debt supported by long-term
banking arrangements:
Commercial paper at weighted
average rates of 6.6% and 5.6% .................... 50,000 50,000
6.5% Marine terminal refunding
revenue bonds, due 2000 ........................... 18,375 18,375
Term loans:
Dollar denominated,
at 5.0% due 2000 .................................. 4,160 4,204
Yen denominated, at 1.6% to 2.8%,
due 2000-2003 ..................................... 19,766 18,656
Deutsche mark denominated,
4.1% to 6.0% ...................................... 19,648
French franc denominated, at 3.5%
to 5.0%, due 2000-2008 ............................ 495 645
--------- ---------
392,796 411,528
Less current portion ................................... (27,424) (21,134)
--------- ---------
$ 365,372 $ 390,394
========= =========
Short-term debt consists of:
Commercial paper at weighted
average rate of 5.6% .............................. $ 5,300
Other short-term debt at weighted
average rates of 2.6% and 2.8% .................... $ 10,160 12,492
Current portion of long-term debt ...................... 27,424 21,134
--------- ---------
$ 37,584 $ 38,926
========= =========
In November 1998, the company issued notes having an aggregate principal amount
of $200 million. The notes are unsecured, senior obligations of the company that
mature on December 1,
30
18
The Lubrizol Corporation
2008, and bear interest at 5.875% per annum, payable semiannually on June 1 and
December 1 of each year. The notes have no sinking fund requirement but are
redeemable, in whole or in part, at the option of the company. The company
incurred debt issuance costs aggregating $10.5 million, including a loss of $6.5
million related to closed Treasury rate lock agreements originally entered into
as a hedge against changes in interest rates relative to the anticipated
issuance of these notes. Debt issuance costs are deferred and then amortized as
a component of interest expense over the term of the notes. Including debt
issuance costs, these notes have an effective annualized interest rate of 6.6%
to the company.
The company issued debentures in June 1995 having an aggregate principal amount
of $100 million. These debentures are unsecured, senior obligations of the
company that mature on June 15, 2025, and bear interest at an annualized rate of
7.25%, payable semi-annually on June 15 and December 15 of each year. The
debentures are not redeemable prior to maturity and are not subject to any
sinking fund requirements.
Effective July 1, 1999, the company decreased its committed revolving credit
facilities from $300 million to $150 million. These credit facilities expire on
June 30, 2003, subject to annual extension provisions. These facilities, which
were unused at December 31,1999, permit the company to borrow at or below the
U.S. prime rate. These facilities also permit the company to refinance beyond
one year $150 million of debt, which by its terms is due within one year. As
permitted by these and previously existing credit facilities, the company
classified as long-term at each balance sheet date the portion of commercial
paper borrowings expected to remain outstanding throughout the following year
and for December 31, 1998, the amount due under the Marine Terminal Refunding
Revenue Bonds, whose bondholders have the right to put the bonds back to the
company.
Amounts due on long-term debt are $27.4 million in 2000, $3.6 million in 2001,
$1.5 million in 2002, $59.8 million in 2003, $.1 million in 2004 and $300.4
million thereafter.
The company has an interest rate swap agreement that effectively converts
variable rate interest payable on $18.4 million of Marine Terminal Refunding
Revenue Bonds due July 1, 2000, to a fixed rate of 6.5%. The company also has
interest rate swap agreements, which expire in March 2005, that exchange
variable rate interest obligations on a notional principal amount of $50 million
for a fixed rate of 7.6% (see Note 13).
Interest paid, net of amounts capitalized, amounted to $28.8 million, $18.3
million and $10.9 million during 1999, 1998 and 1997, respectively. The company
capitalizes interest on qualifying capital projects. The amount of interest
capitalized during 1999, 1998 and 1997 amounted to $.1 million, $1.2 million and
$2.1 million, respectively.
NOTE 5 - OTHER BALANCE SHEET INFORMATION
Receivables: 1999 1998
---------- ----------
Customers ............................... $ 273,054 $ 269,264
Affiliates .............................. 9,013 8,976
Other ................................... 19,189 23,404
---------- ----------
$ 301,256 $ 301,644
========== ==========
Receivables are net of allowance for doubtful accounts of $4.1 million in 1999
and $2.2 million in 1998.
Property and Equipment - at cost: 1999 1998
---------- ----------
Land and improvements .................. $ 105,984 $ 107,712
Buildings and improvements ............. 305,505 299,024
Machinery and equipment ................ 1,145,936 1,145,471
Construction in progress ............... 40,839 56,293
---------- ----------
$1,598,264 $1,608,500
========== ==========
Depreciation and amortization of property and equipment was $88.3 million
in 1999, $79.7 million in 1998 and $82.7 million in 1997.
Goodwill and Intangible Assets: 1999 1998
---------- ----------
Goodwill ............................... $ 151,492 $ 157,380
Intangible assets ...................... 34,411 34,271
---------- ----------
185,903 191,651
Less accumulated amortization .......... 36,124 24,694
---------- ----------
$ 149,779 $ 166,957
========== ==========
Accrued Expenses and Other
Current Liabilities: 1999 1998
---------- ----------
Employee compensation .................. $ 48,441 $ 36,094
Income taxes ........................... 25,890 16,910
Taxes other than income ................ 22,081 20,675
Special charges and acquisition
assimilation costs ................... 11,526 18,738
Other .................................. 26,937 25,853
---------- ----------
$ 134,875 $ 118,270
========== ==========
Noncurrent Liabilities: 1999 1998
---------- ----------
Employee benefits ...................... $ 30,000 $ 33,976
Other .................................. 15,054 14,974
---------- ----------
$ 45,054 $ 48,950
========== ==========
NOTE 6 - SHAREHOLDERS' EQUITY
The company has 147 million authorized shares consisting of 2 million shares of
serial preferred stock, 25 million shares of serial preference shares and 120
million common shares, each of which is without par value. Common shares
outstanding exclude common shares held in treasury of 31, 718,602 and 31,648,000
at December 31, 1999 and 1998 respectively.
The company has a shareholder rights plan under which one right to buy one-half
common share has been distributed for
31
19
The Lubrizol Corporation
NOTES CONTINUED
each common share held. The rights may become exercisable under certain
circumstances involving actual or potential acquisitions of 20% or more of the
common shares by a person or affiliated persons who acquire such stock without
complying with the requirements of the company's articles of incorporation. The
rights would entitle shareholders, other than such person or affiliated persons,
to purchase common shares of the company or of certain acquiring persons at 50%
of then current market value. At the option of the directors, the rights may be
exchanged for common shares, and may be redeemed in cash, securities or other
consideration. The rights will expire in 2007 unless redeemed earlier.
Accumulated other comprehensive income (loss) shown in the consolidated
statements of shareholders' equity at December 31, 1999, 1998 and 1997 is
comprised of the following, net of tax effects:
1999 1998 1997
-------- -------- --------
Foreign currency translation
adjustments ............................. $(27,923) $ 14,840 $(36,941)
Pension plan minimum
liability ............................... (838)
Income tax benefit ........................ 338 38 4
-------- -------- --------
$(28,423) $ 14,878 $(36,937)
======== ======== ========
NOTE 7 - OTHER INCOME (EXPENSE) - NET
1999 1998 1997
-------- -------- --------
Equity earnings of
nonconsolidated
companies ............................... $ 5,735 $ 2,602 $ 4,804
Amortization of goodwill
and intangible assets ................... (11,430) (7,512) (3,764)
Currency exchange/
transaction gain (loss) ................. (3,108) (1,260) 2,398
Other - net ............................... 2,099 5,018 1,666
-------- -------- --------
$ (6,704) $ (1,152) $ 5,104
======== ======== ========
NOTE 8 - INCOME TAXES
The provision for income taxes is based upon income before tax for financial
reporting purposes. Deferred tax assets and liabilities are recognized for the
expected future tax consequences of temporary differences between the tax bases
of assets and liabilities and their carrying values for financial reporting
purposes. In estimating future tax consequences, the company considers
anticipated future events, except changes in tax laws or rates, which are
recognized when enacted.
Income before income taxes consists of the following:
1999 1998 1997
-------- -------- --------
United States ............................ $113,904 $ 78,305 $154,589
Foreign .................................. 81,446 40,509 76,558
-------- -------- --------
Total .................................... $195,350 $118,814 $231,147
======== ======== ========
The provision for income taxes consists of the following:
1999 1998 1997
-------- -------- --------
Current:
United States ............................ $ 46,983 $ 16,649 $ 35,556
Foreign .................................. 24,063 25,233 32,137
-------- -------- --------
71,046 41,882 67,693
-------- -------- --------
Deferred:
United States ............................ (3,467) 3,385 8,784
Foreign .................................. 4,779 2,347 (199)
-------- -------- --------
1,312 5,732 8,585
-------- -------- --------
Total .................................... $ 72,358 $ 47,614 $ 76,278
======== ======== ========
The United States tax provision includes the U.S. tax on foreign income
distributed to the company. The portion of the tax provision for taxes outside
the United States includes withholding taxes.
The differences between the provision for income taxes at the U.S. statutory
rate and the tax shown in the consolidated statements of income are summarized
as follows:
1999 1998 1997
-------- -------- --------
Tax at statutory rate of 35% .............. $ 68,373 $ 41,585 $ 80,901
State and local taxes ..................... 2,815 2,261 2,683
Foreign sales corporation
earnings ................................ (1,923) (3,152) (4,704)
Equity income ............................. (875) (859) (2,775)
Foreign deferred tax
valuation allowance ..................... (3,904) 4,878 (60)
Other foreign tax differences ............. 3,954 5,995 3,523
Other - net ............................... 3,918 (3,094) (3,290)
-------- -------- --------
Provision for income taxes ................ $ 72,358 $ 47,614 $ 76,278
======== ======== ========
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities at December 31 are as follows:
1998 1997
-------- --------
Deferred tax assets:
Accrued compensation and benefits .................. $ 48,858 $ 48,178
Intercompany profit in inventory ................... 11,322 11,131
Net operating losses carried forward ............... 12,305 18,284
Other .............................................. 8,665 8,574
-------- --------
Total gross deferred tax assets ...................... 81,150 86,167
Less valuation allowance ............................. 5,153 9,057
-------- --------
Net deferred tax assets .............................. 75,997 77,110
-------- --------
Deferred tax liabilities:
Depreciation and other
basis differences ............................... 99,938 101,658
Undistributed foreign equity income ................ 5,566 3,894
Inventory basis differences ........................ 1,497 3,706
Other .............................................. 3,977 2,986
-------- --------
Total gross deferred tax liabilities ................. 110,978 112,244
-------- --------
Net deferred tax liabilities ......................... $(34,981) $(35,134)
======== ========
32
20
The Lubrizol Corporation
At December 31, 1999, certain foreign subsidiaries have net operating loss
carryforwards of $37.8 million for income tax purposes, of which $5.9 million
expire in years 2000 through 2009 and $31.9 million has no expiration. After
evaluating tax planning strategies and historical and projected profitability, a
valuation allowance has been recognized to reduce the deferred tax assets
related to those carryforwards to the amount expected to be realized. The net
change in the total valuation allowance for the years ended December 31,1999,
1998 and 1997, was a decrease of $3.9 million, an increase of $4.9 million and a
decrease of $.1 million, respectively.
U.S. income taxes or foreign withholding taxes are not provided on undistributed
earnings of foreign subsidiaries, which are considered to be indefinitely
reinvested in the operations of such subsidiaries. The amount of such earnings
was approximately $411.5 million at December 31, 1999. Determination of the net
amount of unrecognized U.S. income tax with respect to these earnings is not
practicable.
Income taxes paid during 1999, 1998 and 1997 amounted to $59.1 million, $52.0
million and $53.0 million, respectively.
NOTE 9 - PENSION, PROFIT SHARING AND OTHER
POSTRETIREMENT BENEFIT PLANS
The company has noncontributory defined benefit pension plans covering most
employees. Pension benefits under these plans are based on years of service and
the employee's compensation. The company's funding policy in the United States
is to contribute amounts to satisfy the Internal Revenue Service funding
standards and elsewhere to fund amounts in accordance with local regulations.
Several of the company's defined benefit plans are not funded. Plan assets are
invested principally in marketable equity securities and fixed income
instruments.
The company also provides certain non-pension postretirement benefits, primarily
health care and life insurance benefits, for retired employees. Substantially
all of the company's full-time employees in the U.S. become eligible for these
benefits after attaining specified years of service and age 55 at retirement.
Participants contribute a portion of the cost of such benefits. The company's
non-pension postretirement benefit plans are not funded.
Net periodic pension cost of the company's defined benefit pension plans
consists of:
1999 1998 1997
-------- -------- --------
Service cost - benefits earned
during period ........................... $ 11,843 $ 11,142 $ 10,269
Interest cost on projected
benefit obligation ...................... 17,589 17,519 17,704
Expected return on plan assets ............ (25,873) (23,818) (21,976)
Amortization of prior
service costs ........................... 1,771 1,718 1,827
Amortization of initial net
(asset) obligation ...................... (1,264) (753) (1,295)
Recognized net actuarial
(gain) loss ............................. 507 (381) (127)
Settlement (gain) ......................... (5,474)
-------- -------- --------
Net periodic pension cost ................. $ (901) $ 5,427 $ 6,402
======== ======== ========
The company also has defined contribution plans, principally involving profit
sharing plans and a 401(k) savings plan, covering most employees in the United
States and at certain non-U.S. subsidiaries. Expense for all defined
contribution retirement plans was $9.0 million in 1999, $8.1 million in 1998 and
$9.9 million in 1997.
As discussed in Note 15, the company initiated a cost reduction program and
recognized special termination benefits of $11.6 million in 1999, $3.1 million
and $8.5 million of which were included in the special charges recognized in the
first and third quarters of 1999, respectively. The company also recognized a
settlement gain of $10.0 million in the fourth quarter of 1999 in the United
States, $4.5 million of which was recorded as an adjustment to the special
charge and $5.5 million recorded as a reduction in net periodic pension cost.
The company also recognized special termination benefits of $18.3 million in
1998, which were included in the special charge recognized in the fourth quarter
of 1998.
Net non-pension postretirement benefit cost consists of:
1999 1998 1997
-------- -------- --------
Service cost - benefits earned
during period ........................... $ 1,468 $ 1,250 $ 1,465
Interest cost on accumulated
benefit obligation ...................... 4,728 4,415 4,989
Amortization of prior
service costs ........................... (3,218) (3,218) (3,218)
Recognized net actuarial
(gain) loss ............................. 23 (252)
-------- -------- --------
Net non-pension postretire-
ment benefits cost ...................... $ 3,001 $ 2,195 $ 3,236
======== ======== ========
33
21
The Lubrizol Corporation
NOTES CONTINUED
The change in benefit obligation, change in plan assets of the company's defined
benefit pension and non-pension postretirement plans and the amounts recognized
in the consolidated balance sheets at December 31 are as follows:
Pension Plans Other Benefits
------------------------ ------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
Change in benefit obligation:
Benefit obligation at beginning of year ............................. $ 297,483 $ 254,263 $ 72,047 $ 61,460
Service cost ...................................................... 11,843 11,142 1,468 1,250
Interest cost ..................................................... 17,589 17,519 4,728 4,415
Plan participants' contributions .................................. 48
Actuarial (gain) loss ............................................. (23,048) 27,096 (4,281) 8,352
Currency exchange rate change ..................................... (1,104) 2,834 49 (80)
Amendments ........................................................ 647 709
Curtailments ...................................................... (632) (195)
Settlements ....................................................... (3,325)
Special termination benefits ...................................... 1,691 4,684
Other ............................................................. 857
Benefits paid ..................................................... (37,172) (20,569) (2,511) (3,350)
--------- --------- --------- ---------
Benefit obligation at end of year ................................... 264,877 297,483 71,500 72,047
--------- --------- --------- ---------
Change in plan assets:
Fair value of plan assets at beginning of year .................... 300,573 298,130
Actual return on plan assets ................................... 54,984 16,786
Employer contributions ......................................... 6,510 4,719 2,511 3,350
Plan participants' contributions ............................... 48
Currency exchange rate change .................................. (1,003) 896
Other .......................................................... 594
Benefits paid .................................................. (37,172) (19,958) (2,511) (3,350)
--------- --------- --------- ---------
Fair value of plan assets at end of year .......................... 324,534 300,573
--------- --------- --------- ---------
Plan assets greater (less) than the benefit obligation .............. 59,657 3,090 (71,500) (72,047)
Unrecognized net loss (gain) ...................................... (52,315) (7,981) (5,521) (1,225)
Unrecognized net transition obligation (asset) .................... (3,853) (5,571)
Unrecognized prior service cost ................................... 8,472 9,785 (27,402) (30,620)
--------- --------- --------- ---------
Net amount recognized ............................................... $ 11,961 $ (677) $(104,423) $(103,892)
========= ========= ========= =========
Amount recognized in the statement of financial position consists of:
Prepaid benefit cost .............................................. $ 26,027 $ 15,885
Accrued benefit liability ......................................... (16,211) (20,120) $(104,423) $(103,892)
Accumulated other comprehensive income ............................ 838
Intangible asset .................................................. 1,307 3,558
--------- --------- --------- ---------
Net amount recognized ............................................... $ 11,961 $ (677) $(104,423) $(103,892)
========= ========= ========= =========
Pension Plans Other Benefits
------------------------ ------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
The weighted average assumptions as of December 31:
Discount rate for determining funded status ....................... 6.91% 6.08% 7.70% 6.71%
Expected return on plan assets .................................... 8.60% 9.01%
Rate of compensation increase ..................................... 3.94% 3.78%
The projected benefit obligation and fair value of plan assets for pension plans
with projected benefit obligations in excess of plan assets were $29.8 million
and $10.2 million, respectively, as of December 31, 1999, and $123.1 million and
$97.2 million, respectively, as of December 31, 1998. The accumulated benefit
obligation and fair value of plan assets for pension plans with accumulated
benefit obligations in excess of plan assets were $23.7 million and $9.5
million, respectively, as of December 31, 1999, and $31.6 million, and $13.9
million, respectively, as of December 31, 1998.
34
22
The Lubrizol Corporation
The weighted average of the assumed health care cost trend rates used in
measuring the accumulated postretirement benefit obligation for the company's
postretirement benefit plans at December 31, 1999, was 6.73%, (7.45% at December
31, 1998), with subsequent annual decrements to an ultimate trend rate of 5.00%.
The assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plan. A one-percentage-point change in the
assumed health care cost trend rate would have the following effects as of and
for the year ended December 31,1999:
One-Percentage-Point
--------------------
Increase Decrease
-------- --------
Effect on postretirement
benefit obligation ..................... $ 12,129 $ (9,344)
Effect on total service and interest
cost components ........................ $ 1,363 $ (1,028)
NOTE 10 - LEASES
The company has commitments under operating leases primarily for office space,
terminal facilities, land, railroad tank cars and various computer and office
equipment. Rental expense was $18.5 million in 1999, $18.7 million in 1998 and
$13.8 million in 1997. Future minimum rental commitments under operating leases
having initial or remaining noncancelable lease terms exceeding one year are
$13.6 million in 2000, $9.0 million in 2001, $5.0 million in 2002, $3.9 million
in 2003, $3.6 million in 2004 and $13.9 million thereafter.
NOTE 11 - ACQUISITIONS
In 1998, the company completed six acquisitions for cash of $155.4 million and
one acquisition for 89,806 of the company's common shares valued at $2.4
million. These acquisitions were in the company's existing business areas of
lubricant and fuel additives, metalworking additives and coating additives and
broaden the company's base in performance chemicals. These acquisitions were
accounted for using the purchase method of accounting.
The fair value of assets acquired and liabilities assumed in these acquisitions
is as follows:
Inventories .......................................... $ 20,713
Receivables .......................................... 26,424
Property and equipment ............................... 8,502
Other tangible assets ................................ 2,986
Goodwill ............................................. 97,882
Technology and other intangibles ..................... 16,173
Technology under development ......................... 13,598
Accounts payable and other liabilities assumed ....... (28,470)
--------
Fair value of net assets acquired,
less $2,165 of cash received ....................... $157,808
========
These acquisitions were made at various times throughout the year; however, the
two largest acquisitions were Adibis, formerly the lubricants and fuel additives
business of British Petroleum Company P.L.C., which was acquired effective
August 1, 1998, and Carroll Scientific, Inc., (Carroll), which was acquired in
July 1998. Carroll specializes in the development and supply of varnish and
wax-based performance additives to the ink market. The aggregate purchase price
of these two acquisitions was $134 million, of which $111 million was assigned
to good-will and intangible assets. During 1997, the annual revenues of Carroll
were approximately $30 million and of Adibis were approximately $150 million.
The impact of the acquisitions made in 1998 was not material in relation to the
company's results of operations; consequently, pro forma information is not
presented. However, these acquisitions had the following impact on revenues and
expenses for 1998:
Revenues .............................................. $ 71,662
Gross profit .......................................... $ 15,267
Selling and administration expenses ................... $ 7,397
Research, testing and development ..................... $ 5,591
After-tax loss, excluding write-off of technology under
development and interest on acquisition debt ........ $ (1,844)
In the fourth quarter of 1999, the company reduced the purchase price of the
Adibis acquisition by $2.5 million for anticipated reimbursement from the seller
of certain post-acquisition costs incurred by the company.
The company has substantially completed the process of assimilating the Adibis
additives business. The company's assimilation plan included separation of a
number of Adibis employees at an estimated cost of $3.9 million and terminating
certain Adibis contracts for tolling arrangements, office leases and sales
agents at an estimated cost of $2.7 million. Cash expenditures of $5.7 million
were made in 1999 and approximately $.9 million remains as an accrued liability
at December 31, 1999. The cost of these activities was included in the
allocation of the acquisition costs to the net assets acquired.
The company engaged an independent appraiser to provide a basis for allocating
the purchase price of Adibis to the acquired intangible assets for financial
reporting purposes. The appraisal included the determination of the amount to be
assigned to technology under development which, under purchase accounting, is
written off against income in the period of acquisition. Technology under
development comprises ongoing research and development projects that may form
the basis for new products or replacements for existing products. The fair
35
23
The Lubrizol Corporation
NOTES CONTINUED
value assigned to the Adibis technology under development was determined by the
independent appraiser applying the income approach and a valuation model,
incorporating among other assumptions revenue and expense projections,
probability of success and present value factors. The resulting value allocated
to each of the technology projects under development represents the product of
the present value of debt-free cash flows and the percent of research and
development completed. The fair value of technology under development was
comprised of three projects within engine oil additives aggregating $7.1
million; six projects within fuel additives aggregating $3.4 million; and two
projects within marine diesel additives aggregating $3.1 million. The amount of
the purchase price allocated to technology under development was $13.6 million
and was charged against income in the fourth quarter of 1998 upon completion of
the appraisal.
NOTE 12 - BUSINESS SEGMENTS AND
GEOGRAPHIC REPORTING
The company aggregates its product lines into two principal operating segments:
chemicals for transportation and chemicals for industry. Chemicals for
transportation is comprised of additives for lubricating engine oils, such as
for gasoline, diesel, marine and stationary gas engines and additive components
to its larger customers; additives for driveline oils, such as automatic
transmission fluids, gear oils and tractor lubricants; and additives for fuel
products and refinery and oil field chemicals. In addition, the company sells
additive components and viscosity improvers within its lubricant and fuel
additives product lines. The company's chemicals for transportation product
lines are generally produced in shared manufacturing facilities and sold largely
to a common customer base. Chemicals for industry includes industrial additives,
such as additives for hydraulic fluids, metalworking fluids and compressor
lubricants; performance chemicals, such as additives for coatings and inks and
process chemicals; and performance systems, comprised principally of fluid
metering devices and particulate emission trap devices.
The company's accounting policies for its operating segments are the same as
those described in Note 2. The company evaluates performance and allocates
resources based on segment contribution income, which is revenues less expenses
directly identifiable to the product lines aggregated within each segment. In
addition, the company allocates corporate research, testing, selling and
administrative expenses in arriving at segment operating profit before tax.
The following table presents a summary of the company's reportable segments for
the years ended December 31:
1999 1998 1997
----------- ----------- -----------
Chemicals for transportation:
Revenues from external
customers .......................... $ 1,448,978 $ 1,361,306 $ 1,446,342
Equity earnings ....................... 5,340 2,434 4,540
Goodwill and intangibles
amortization ....................... 5,012 2,964 1,239
Segment contribution
income ............................. 307,411 238,076 322,377
Operating profit before tax ........... 191,654 130,149 213,184
Segment total assets .................. 1,116,680 1,191,175 1,076,153
Capital expenditures .................. 58,123 90,369 98,482
Depreciation .......................... 82,129 74,023 76,134
Chemicals for industry:
Revenues from external
customers .......................... $ 299,025 $ 256,613 $ 227,440
Equity earnings ....................... 395 168 264
Goodwill and intangibles
amortization ....................... 6,418 5,414 3,274
Segment contribution
income ............................. 41,636 33,959 37,302
Operating profit before tax ........... 27,481 22,552 24,178
Segment total assets .................. 247,779 256,905 194,492
Capital expenditures .................. 6,749 3,052 2,218
Depreciation .......................... 6,161 5,646 6,570
Reconciliation to consolidated
income before tax:
Segment operating profit
before tax ......................... $ 219,135 $ 152,701 $ 237,362
Gain from litigation
settlements ........................ 17,626 16,201
Special charges ....................... (19,569) (36,892)
Interest expense - net ................ (21,842) (13,196) (6,215)
----------- ----------- -----------
Consolidated income
before tax ......................... $ 195,350 $ 118,814 $ 231,147
=========== =========== ===========
Revenues from external
customers by product group:
Engine oil additives .................. $ 916,755 $ 844,614 $ 920,971
Driveline oil additives ............... 408,488 384,880 400,154
Fuel additives and refinery
oil additives ...................... 103,271 78,023 69,904
Additive components ................... 20,464 53,789 55,313
----------- ----------- -----------
Chemicals for
transportation ................. 1,448,978 1,361,306 1,446,342
----------- ----------- -----------
Industrial additives .................. 156,996 149,087 133,200
Performance chemicals ................. 108,189 84,478 73,702
Performance systems ................... 33,840 23,048 20,538
----------- ----------- -----------
Chemicals for industry ........... 299,025 256,613 227,440
----------- ----------- -----------
Total revenues from
external customers .................... $ 1,748,003 $ 1,617,919 $ 1,673,782
=========== =========== ===========
36
24
The Lubrizol Corporation
Prior-year revenues from external customers by product group within the
chemicals for transportation segment have been restated to reflect a change in
the way the company reports these revenues for internal management reporting.
Revenues are attributable to countries based on the location of the customer.
The United States is the only country where sales to external customers comprise
in excess of 10% of the company's consolidated revenues. Revenues from external
customers by geographic area are as follows:
1999 1998 1997
---------- ---------- ----------
United States ............................ $ 673,579 $ 605,145 $ 602,918
Other North American ..................... 60,775 50,685 53,030
Europe, Middle East ...................... 572,854 551,633 539,654
Asia-Pacific ............................. 314,715 262,341 315,426
Latin America ............................ 126,080 148,115 162,754
---------- ---------- ----------
Total revenues from
external customers ..................... $1,748,003 $1,617,919 $1,673,782
========== ========== ==========
The company's sales and receivables are concentrated in the oil and chemical
industries. The company's lubricant and fuel additive customers consist
primarily of oil refiners and independent oil blenders and are located in more
than 100 countries. The ten largest customers, most of which are international
oil companies and a number of which are groups of affiliated entities, comprised
approximately 46% of consolidated sales in 1999, 42% of consolidated sales
in 1998 and 44% of consolidated sales in 1997. The company's largest single
customer, including its affiliated entities, accounted for revenues of $210.4
million in 1999, predominately within chemicals for transportation segment, less
than 10% in 1998 and revenues of $161.2 million in 1997, predominately within
chemicals for transportation segment.
The table below presents a reconciliation of segment total assets to
consolidated total assets for the years ended December 31:
1999 1998 1997
---------- ---------- ----------
Total segment assets ..................... $1,364,459 $1,448,080 $1,270,645
Corporate assets ......................... 317,895 195,157 191,647
---------- ---------- ----------
Total consolidated assets ................ $1,682,354 $1,643,237 $1,462,292
========== ========== ==========
Segment assets include receivables, inventories and long-lived assets including
goodwill and intangible assets. Corporate assets include cash and short-term
investments, investments accounted for on the cost basis and other current and
noncurrent assets.
The company's principal long-lived assets are located in the following
countries at December 31:
1999 1998
---------- ----------
United States ............................ $ 519,050 $ 554,983
France ................................... 91,413 109,990
England .................................. 124,138 134,127
All other ................................ 85,690 86,707
---------- ----------
Total long-lived assets $ 820,291 $ 885,807
========== ==========
Net income of non-U.S. subsidiaries was $53 million in 1999, $13 million in 1998
and $43 million in 1997; and dividends received from these subsidiaries were $22
million, $15 million and $7 million, respectively.
NOTE 13 - FINANCIAL INSTRUMENTS
The company has various financial instruments, including cash and short-term
investments, investments in nonconsolidated companies, foreign currency forward
contracts, interest rate swaps and short and long-term debt. The company has
determined the estimated fair value of these financial instruments by using
available market information and generally accepted valuation methodologies. The
use of different market assumptions or estimation methodologies could have a
material effect on the estimated fair value amounts. The estimated fair value of
the company's debt instruments at December 31, 1999, approximates $375.5 million
compared with the carrying value of $403.0 million. The company believes the
carrying values of its other financial instruments approximate their fair
values, except for certain interest rate swap agreements discussed below. The
company uses derivative financial instruments only to manage well-defined
foreign currency and interest rate risks. The company does not use derivative
financial instruments for trading purposes.
The company is exposed to the effect of changes in foreign currency rates on its
earnings and cash flow as a result of doing business internationally. In
addition to working capital management, pricing and sourcing, the company
selectively uses foreign currency forward contracts to lessen the potential
effect of currency changes. Such contracts are generally in connection with
transactions with maturities of less than one year.
37
25
The Lubrizol Corporation
NOTES CONTINUED
The maximum amount of foreign currency forward contracts outstanding at any one
time was $18.9 million in 1999, $65.0 million in 1998 and $58.4 million in 1997.
At December 31, 1999, the company had short-term forward contracts to sell
currencies at various dates during 2000 for $7.5 million. Realized and
unrealized gains or losses on these contracts are recorded in the statement of
income, or in the case of transactions designated as hedges of net foreign
investments, in the foreign currency translation adjustment account in other
comprehensive income. Additionally, foreign currency forward contract gains and
losses on certain future transactions may be deferred until the future
transaction is recorded. There were no deferred currency losses on foreign
exchange contracts at December 31, 1999.
The company is exposed to market risk from changes in interest rates. The
company's policy is to manage interest rate cost using a mix of fixed and
variable rate debt. To manage this mix in a cost-efficient manner, the company
may enter into interest rate swaps, in which the company agrees to exchange, at
specified intervals, the difference between fixed and variable interest amounts
calculated by reference to an agreed-upon notional principal amount. The company
has entered into interest rate swap agreements to convert variable rate debt to
fixed rates (see Note 4). Interest payments receivable and payable under the
terms of the interest rate swap agreements are accrued over the period to which
the payment relates and the net difference is treated as an adjustment of
interest expense related to the underlying liability. Changes in the underlying
market value of the remaining swap payments are recognized in income when the
underlying liability being hedged is extinguished or partially extinguished to a
level less than the notional amount of the interest rate swaps. Consequently,
market value losses of $1.0 million were accrued in 1997 and no amounts were
accrued in 1998 or 1999. The company would have paid approximately $2.4 million,
including accrued interest of $.9 million, if it had terminated these interest
rate swap agreements at December 31, 1999.
NOTE 14 - STOCK COMPENSATION PLANS
The 1991 Stock Incentive Plan provides for granting of restricted and
unrestricted shares and options to buy common shares up to an amount equal to 1%
of the outstanding common shares at the beginning of any year, plus any unused
amount from prior years. Options are intended either to qualify as "incentive
stock options" under the Internal Revenue Code or "non-statutory stock options"
not intended to so qualify.
Under the 1991 Plan, options generally become exercisable 50% one year after
grant, 75% after two years, 100% after three years, and expire up to ten years
after grant. "Reload options," which are options to purchase additional shares
if a grantee uses already-owned shares to pay for an option exercise, are
granted automatically under the 1991 Plan and may be granted at the discretion
of the administering committee under the 1985 Employee Stock Option Plan. The
1991 Plan generally supersedes the 1985 Plan, although options outstanding under
the 1985 Plan remain exercisable until the expiration dates. The option price
under the 1985 Plan is the fair market value of the shares on the date of grant.
The option price under the 1991 Plan is not less than the fair market value of
the shares on the date of grant. Both plans permit or permitted the granting of
stock appreciation rights in connection with the grant of options. In addition,
the 1991 Plan provides to each outside director of the company an automatic
annual grant of an option to purchase 2,000 common shares, with terms generally
comparable to employee stock options.
Under the 1991 Stock Incentive Plan, the company granted to certain executive
officers 3,000 and 65,000 performance share stock awards in 1998 and 1997,
respectively and none in 1999. Common shares equal to the number of performance
share stock awards granted will be issued if the market price of the company's
common stock reaches $45 per common share for ten consecutive trading days or
after six years from date of grant, whichever occurs first. Under certain
conditions such as retirement, a grantee of performance share stock awards may
be issued a pro-rata number of common shares. The market value of the company's
common shares at date of grant of the performance share stock awards was $38.25
per share in 1998 and $33.75 per share in 1997. The company recognizes
compensation expense related to performance share stock awards ratably over the
estimated period of vesting. Compensation costs recognized for performance share
stock awards were $.8 million in 1999 and 1998, and $.5 million in 1997. At
December 31, 1999, 67,000 performance share stock awards were outstanding.
Generally accepted accounting principles encourage the fair-value based method
of accounting for stock compensation plans, under which the value of stock-based
compensation is estimated at the date of grant using valuation formulas, but
permit the continuance of intrinsic-value accounting. The com-
38
26
The Lubrizol Corporation
pany accounts for its stock compensation plans using the intrinsic-value
accounting method (measured as the difference between the exercise price and the
market value of the stock at date of grant). If the fair value method to measure
compensation cost for the company's stock compensation plans had been used, the
company's net income would have been reduced by $2.5 million in 1999, $1.6
million in 1998 and $2.6 million in 1997 with a corresponding reduction in net
income per share of $.05 in 1999, $.03 in 1998 and $.05 in 1997.
Disclosures under the fair value method are estimated using the Black-Scholes
option-pricing model with the following weighted-average assumptions for grants
of stock options in the following years:
1999 1998 1997
---- ---- ----
1985 Plan:
Risk-free interest rate .................. 6.5% 4.6% 5.7%
Dividend yield ........................... 3.4% 4.0% 2.7%
Volatility ............................... 23% 21% 20%
Expected life (years) .................... .5 2.8 3.1
1991 Plan:
Risk-free interest rate .................. 6.4% 4.7% 5.8%
Dividend yield ........................... 3.4% 4.0% 2.7%
Volatility ............................... 24% 23% 22%
Expected life (years) .................... 9.9 9.5 9.9
The fair value per share of the performance share stock awards granted in 1998
and 1997 was $33.94 and $31.80, respectively, using the following assumptions in
1998 and 1997, respectively: risk-free interest rate of 4.58% and 5.7%;
volatility of 21% and 20%; and an expected life of three years. Dividends do not
accumulate on performance share stock awards.
Information regarding these option plans, excluding the performance share
stock awards, follows:
Weighted-
Average
Exercise
Shares Price
--------- -------
Outstanding, January 1, 1999 ................. 3,483,316 $ 32.64
Granted ...................................... 730,516 22.99
Exercised .................................... (79,675) 20.31
Forfeited .................................... (165,415) 33.98
---------
Outstanding, December 31, 1999 ............... 3,968,742 $ 31.06
========= =======
Options exercisable, December 31, 1999 ....... 2,993,380 $ 32.51
========= =======
Weighted-average fair value of
options granted during the year ............ $ 5.87
=======
Outstanding, January 1, 1998 ................. 3,212,157 $ 31.88
Granted ...................................... 410,248 37.69
Exercised .................................... (125,463) 29.38
Forfeited .................................... (13,626) 31.23
---------
Outstanding, December 31, 1998 ............... 3,483,316 $ 32.64
========= =======
Options exercisable, December 31, 1998 ....... 2,842,719 $ 31.97
========= =======
Weighted-average fair value of
options granted during the year ............ $ 7.74
=======
Outstanding, January 1, 1997 ................. 3,248,113 $ 30.93
Granted ...................................... 417,561 35.07
Exercised .................................... (361,179) 25.85
Forfeited .................................... (92,338) 35.88
---------
Outstanding, December 31, 1997 ............... 3,212,157 $ 31.88
========= =======
Options exercisable, December 31,1997 ........ 2,590,556 $ 31.67
========= =======
Weighted-average fair value of
options granted during the year ............ $ 9.37
=======
The following table summarizes information about stock options outstanding,
excluding the performance share stock awards, at December 31, 1999:
Options Outstanding Options Exercisable
-------------------------------------------------- -----------------------------
Number Weighted-Average Weighted- Number Weighted-
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices at 12/31/99 Contractual Life Exercise Price at 12/31/99 Exercise Price
----------- ---------------- -------------- ----------- --------------
$13 - $19 ................... 52,088 .2 Years $16.66 52,088 $16.66
19 - 25 .................... 553,619 8.9 21.42 25,369 22.94
25 - 31 .................... 1,286,224 4.3 28.68 1,097,224 28.86
31 - 38 .................... 2,016,393 4.8 35.28 1,761,281 35.09
38 - 45 .................... 60,418 1.8 41.63 57,418 41.76
--------- --- ------ --------- ------
3,968,742 5.1 $31.06 2,993,380 $32.51
========= === ====== ========= ======
39
27
NOTES CONTINUED
NOTE 15 - SPECIAL CHARGES AND ASSET IMPAIRMENTS
The company initiated a series of steps to reduce costs and improve its
worldwide operating structure and has been executing these steps in two phases
over a period of approximately two years. The first phase, which began in the
fourth quarter of 1998, resulted in the reduction of approximately 7% of the
company's workforce, or 300 employees worldwide. Approximately 55% of this
reduction occurred prior to December 31, 1998, a further 35% occurred in the
first quarter of 1999, and the remainder has been substantially completed by the
third quarter of 1999. Of the 300 employees, approximately 40% were in the
manufacturing area and 60% were in the selling, administrative, research and
testing areas. In addition, the company permanently removed seven component
production units from service during this first phase.
In the fourth quarter of 1998, the company recognized special charges of $36.9
million, comprised of $23.3 million related to the first phase of the company's
cost reduction program and $13.6 million for the write-off of purchased
technology under development resulting from the acquisition of Adibis (see Note
11). After-tax, these charges reduced net income by $25.8 million, or by $.47
per share. These special charges related predominately to the company's
chemicals for transportation segment.
In the first quarter of 1999, the company recognized an additional expense of
$3.1 million, related to the first phase of its cost reduction program to
reflect a greater amount for separation benefits, principally in Japan.
After-tax, this charge reduced net income by $2.9 million or $.05 per share. In
the third quarter of 1999, the company recognized special charges of $20.8
million related to the second phase of the company's cost reduction program.
After-tax, this special charge reduced net income by $12.9 million, or $.24 per
share. In the fourth quarter of 1999, the company recorded an adjustment of $4.3
million to reduce the special charge related to the first phase of the company's
cost reduction program, principally to reflect a gain related to the settlement
of pension obligations for work force reductions in the first phase of the
company's cost reduction program (see Note 9). After-tax, this adjustment
increased net income by $2.5 million or $.05 per share.
As adjusted, the first phase of the company's cost reduction program included
workforce reduction cost estimated at $20.0 million and other exit costs
estimated at $2.1 million, including $2.0 million related to asset impairments
for production units to be taken out of service. Cash expenditures of
approximately $5.0 million were made in 1998, and $14.7 million in 1999 related
to the cost reduction program. Approximately $.4 million remains as an accrued
liability at December 31, 1999, representing payments that will be made in 2000
relating to employees separated prior to December 31, 1999.
The second phase of the company's cost reduction program began in the third
quarter of 1999 and involves primarily the downsizing of the company's
Painesville, Ohio, manufacturing plant. This will result in the additional
reduction of approximately 5% of the company's workforce, or 200 employees, and
the shutdown of 23 of Painesville's 36 production systems. Through December 31,
1999, the company has shut down 12 of the 23 targeted production systems and has
completed approximately 22% of the workforce reduction.
The second phase of the company's cost reduction program included workforce
reduction cost estimated at $8.5 million and other exit costs estimated at $12.3
million, including $8.9 million related to asset impairments for production
units to be taken out of service. Cash expenditures of approximately $1.3
million were made in 1999 related to the cost reduction program. Approximately
$10.6 million remains as an accrued liability at December 31, 1999.
In 1997, the company provided $9.4 million for the impairment of long-lived
assets. This included $6.3 million to reduce the carrying value of certain
computer equipment and software made obsolete prior to expiration of their
original estimated useful lives due to new systems being implemented. Also,
during the fourth quarter the company decided to utilize a toll processor,
beginning in 1998, rather than to produce an intermediate internally. This
decision resulted in the permanent impairment of certain manufacturing
equipment, and a provision of $3.1 million was recorded to reduce the asset
carrying value to its estimated fair value. Fair value was determined by
estimating the present value of future cash flows. These impairment losses are
reflected in the consolidated statements of income for the year ended December
31, 1997, as follows: cost of sales - $4.4 million; research, testing and
development expenses - $.9 million; selling and administrative expenses - $1.8
million and other income (net) - $2.3 million.
NOTE 16 - LITIGATION
The company previously filed claims against Exxon Corporation and/or its
affiliates relating to various commercial matters, including alleged
infringements by Exxon of certain of the company's patents.
On March 31, 1999, the company and Exxon Corporation reached a settlement of all
pending intellectual property litigation between the two companies and their
affiliates, except for litigation pending in Canada. Under the settlement
agreement, Exxon paid the company cash of $16.8 million in April 1999. After
deducting related expenses, this settlement increased pre-tax income by $14.5
million in 1999.
40
28
On April 23, 1998, the company reached a settlement with Exxon of a lawsuit
pending in federal court in Ohio and received cash of $19.0 million. After
deducting related expenses, this settlement increased pre-tax income by $16.2
million in 1998.
The company has prevailed in a case brought in Canada against Exxon's Canadian
affiliate, Imperial Oil, Ltd., for infringement of the company's patent
pertaining to dispersants, the largest additive component used in motor oils. A
1990 trial court verdict in favor of the company regarding the issue of
liability was upheld by the Federal Court of Appeals of Canada in December 1992,
and in October 1993, the Supreme Court of Canada dismissed Imperial Oil's appeal
of the Court of Appeals' decision. The case has been returned to the trial court
for an assessment of compensation damages, but no date has been set for a
determination of such damages. In October 1994, the trial court judge determined
that Imperial Oil had violated an earlier injunction for the manufacture or sale
of the dispersant that is the subject of this case. The determination of penalty
damages, if any, on account of this violation will be made after the court has
determined the compensation damages for patent infringement. A reasonable
estimation of the company's potential recovery relating to this litigation
cannot be made at this time, and no amounts that may be recovered in the future
have been recorded in the company's financial statements as of December 31,
1999.
QUARTERLY FINANCIAL DATA (UNAUDITED)
Three Months Ended
--------------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
- ------------------------------------------------------------------------------------------
(In Thousands of Dollars Except Per Share Data)
1999
Net sales ......................... $ 446,627 $ 433,129 $ 431,978 $ 431,807
Gross profit ...................... 143,453 136,144 136,612 132,387
Net income ........................ 39,094 30,028 20,412 33,458
Net income per share .............. $ .72 $ .55 $ .37 $ .61
Net income per share, diluted ..... $ .72 $ .55 $ .37 $ .61
1998
Net sales ......................... $ 399,900 $ 405,160 $ 403,262 $ 406,236
Gross profit ...................... 122,865 126,143 120,252 111,971
Net income (loss) ................. 29,668 39,963 16,614 (15,045)
Net income (loss)per share ........ $ .52 $ .71 $ .30 $ (.27)
Net income (loss)per share, diluted $ .52 $ .71 $ .30 $ (.27)
In the first quarter of 1999, the company recorded a pre-tax special charge of
$3.1 million ($.05 per share) to reflect an additional amount for separation
benefits, principally in Japan, under its cost reduction program.
In the first quarter of 1999, the company recorded a pre-tax gain from
litigation settlement of $14.5 million ($.16) share.
In the third quarter of 1999, the company recorded a pre-tax special charge of
$20.8 million ($.24 per share) primarily related to the restructuring of its
Painesville, Ohio, manufacturing plant.
In the fourth quarter of 1999, the company recorded a pre-tax adjustment of $4.3
million ($.05 per share) to reduce the amount of the special charge principally
to reflect a gain related to the settlement of pension obligations for work
force reductions in the first phase of the company's cost reduction program.
In the fourth quarter of 1999, the company recorded a pre-tax gain from
litigation settlement of $3.1 million ($.04) share.
In the second quarter of 1998, the company recorded a pre-tax gain from
litigation settlement of $16.2 million ($.19 per share).
In the fourth quarter of 1998, the company recorded pre-tax special charges of
$23.3 million ($.30 per share) related to a cost reduction program and $13.6
million ($.17 per share) related to the write-off of purchased technology under
development resulting from the company's acquisition of Adibis.
41
29
The Lubrizol Corporation
HISTORICAL SUMMARY
(In Millions, Except Shareholders, Employees and Per Share Data) 1999 1998 1997
- --------------------------------------------------------------------------------------------------------
OPERATING RESULTS:
Revenues ....................................................... $ 1,748.0 $ 1,617.9 $ 1,673.8
Total cost and expenses ........................................ 1,522.2 1,464.1 1,441.5
Other income (charges) ......................................... (30.5) (35.0) (1.1)
Net income ..................................................... 123.0 71.2 154.9
- Before unusual items and accounting changes ................ 125.3 86.5 154.9
Net income per share ........................................... 2.25 1.27 2.68
- Before unusual items and accounting changes ................ 2.30 1.55 2.68
FINANCIAL RATIOS:
Gross profit percentage ........................................ 31.5 29.8 32.7
Percent of revenues:
Selling and administrative expenses .......................... 10.4 11.1 10.2
Research and testing expenses ................................ 8.3 9.3 8.8
Return on average shareholders' equity (%) ..................... 15.8 9.0 19.0
- Before unusual items and accounting changes (%) ............ 16.1 10.9 19.0
Debt to capitalization (%) ..................................... 33.8 35.8 21.3
Current ratio .................................................. 2.5 2.5 2.5
OTHER INFORMATION:
Dividends declared per share ................................... $ 1.04 $ 1.04 $ 1.01
Average common shares outstanding .............................. 54.6 55.9 57.8
Capital expenditures ........................................... $ 64.9 $ 93.4 $ 100.7
Depreciation expense ........................................... 88.3 79.7 82.7
At Year End:
Total assets ................................................. $ 1,682.4 $ 1,643.2 $ 1,462.3
Total debt ................................................... 403.0 429.3 220.3
Total shareholders' equity ................................... 790.1 769.1 815.4
Shareholders' equity per share ............................... 14.50 14.10 14.31
Common share price ........................................... 30.88 25.69 36.88
Number of shareholders ....................................... 5,126 5,609 5,661
Number of employees .......................................... 4,074 4,324 4,291
42
30
The Lubrizol Corporation
1996 1995 1994 1993 1992 1991 1990 1989
- ----------------------------------------------------------------------------------------------
$ 1,597.6 $ 1,663.6 $ 1,599.0 $ 1,525.5 $ 1,552.2 $ 1,476.3 $ 1,452.7 $ 1,227.9
1,403.0 1,478.0 1,397.0 1,362.2 1,390.5 1,308.7 1,288.4 1,109.7
56.1 40.0 49.4 (43.6) 15.4 10.5 106.9 19.5
169.8 151.6 175.6 45.6 124.6 123.7 190.0 94.0
135.2 126.6 148.8 113.5 124.6 123.7 133.5 94.0
2.80 2.37 2.67 .67 1.81 1.79 2.67 1.26
2.23 1.98 2.26 1.67 1.81 1.79 1.87 1.26
32.0 31.5 32.7 32.0 31.7 32.4 30.3 29.2
9.9 9.8 10.0 10.4 11.7 11.7 10.9 10.8
10.1 10.8 10.3 11.2 10.0 9.8 8.5 9.2
20.4 18.0 22.5 5.9 15.4 16.2 27.2 14.2
16.2 15.1 19.0 14.6 15.4 16.2 18.0 14.2
19.5 22.5 16.8 8.7 5.6 7.9 8.3 8.5
2.6 2.4 2.5 2.5 2.9 2.7 2.7 3.0
$ .97 $ .93 $ .89 $ .85 $ .81 $ .77 $ .73 $ .69
60.7 63.8 65.7 67.7 69.0 69.3 71.1 74.7
$ 94.3 $ 189.3 $ 160.5 $ 127.9 $ 95.8 $ 82.4 $ 77.4 $ 64.7
78.7 71.8 63.9 59.6 58.4 54.6 54.0 48.7
$ 1,402.1 $ 1,492.0 $ 1,394.4 $ 1,182.6 $ 1,127.1 $ 1,171.7 $ 1,114.6 $ 960.2
198.5 247.1 167.9 69.6 48.4 67.8 66.6 61.2
819.4 849.0 832.0 732.2 819.4 794.5 736.2 663.3
14.00 13.48 12.83 11.00 11.97 11.51 10.61 8.96
31.00 27.75 33.88 34.13 27.25 28.25 23.63 18.75
5,764 6,304 6,494 6,616 6,822 6,767 6,692 7,370
4,358 4,601 4,520 4,613 4,609 5,299 5,169 5,030
43