Exhibit 13
The Lubrizol Corporation - 2001 Annual Report
[PICTURES]
Why Lubrizol?
THE LUBRIZOL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Lubrizol Corporation is a global fluid technology company that develops,
produces and sells high-performance chemicals, systems and services for industry
and transportation. We create these products, including specialty additive
packages and related equipment, for use in transportation and industrial
lubricant and other markets. We do this by applying advanced chemical and
mechanical technologies in order to enhance the performance, quality and value
and reduce the environmental impact of the customer products in which our
products are used.
We are a geographically diverse company operating manufacturing and blending
facilities, laboratories and offices around the world, through the efforts of
approximately 4,500 employees. Our product lines are grouped into two operating
segments: fluid technologies for transportation and fluid technologies for
industry. Fluid technologies for transportation comprised approximately 83% of
our consolidated revenues and 96% of segment pre-tax operating profit in 2001.
This discussion and analysis of our financial condition and results of
operations generally is focused on Lubrizol in its entirety, 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, segment
operating profit and related financial disclosures.
We believe the global growth rate for transportation lubricant additives is
approximately 1% per year. A variety of industry market forces and conditions
continues to present significant challenges in this business. Among these market
factors are improved engine design and longer drain intervals, industry
overcapacity, frequent product specification changes and consolidation of the
customer base. Although we are the market leader in this business, the
marketplace continues to be extremely competitive.
We plan to continue to invest in and run our traditional transportation
lubricant additive business so as to remain the market leader and generate
strong cash flows consistent with our historical track record. In addition, we
believe there are opportunities for growth in both the transportation market and
the faster-growing industrial markets. Accordingly, we are expanding beyond our
traditional business by using our strengths, including our technology and broad
geographic infrastructure, to develop and invest in new fluid technology
applications that will expand the markets in which we participate. In addition
to internal investment in research and development, prudent acquisitions will be
key to our growth.
2001 RESULTS OF OPERATIONS
In 2001, our results reflected the competitive conditions in our industry and
the economic uncertainty and weak business environment within the global
economy. Although we had record shipment volume, 2001 earnings were lower than
the prior year due primarily to our inability to recover higher average raw
material cost. Higher operating expenses (manufacturing, selling and
administrative, research, development and testing expenses), a higher effective
tax rate and a prior year gain from a litigation settlement and special charge
adjustments that did not recur in 2001 also contributed to the lower earnings.
In 2001, we achieved record consolidated revenues of $1.84 billion, which
represented an increase of $68.9 million, or 4% (2% excluding acquisitions),
compared with 2000. The revenue increase was due to a 4% increase in shipment
volume, one-half of which was due to acquisitions including the consolidation of
our China subsidiaries in the fourth quarter of 2000. Average additive selling
price for 2001 remained flat with the prior year. This was the result of a 3%
increase in product selling prices due to the price increases initiated during
2000 and offsetting unfavorable currency effects and product mix changes. Fluid
technologies for transportation revenues increased $68.9 million, or 5%,
compared with 2000 primarily due to increased shipment volume from acquisitions
and market share gains. Fluid technologies for industry revenues were
approximately the same as 2000, as the impact of the weak manufacturing sector
in North America offset the additional revenues from an acquisition in 2001. The
$1.0 million increase in royalties and other revenues was primarily due to
increased royalties for synthetic refrigeration lubricants.
[GRAPH]
Changes in our shipment volume vary in different geographical areas. The
following table shows our 2001 shipment volume by geographic area as well as the
corresponding changes compared with 2000:
Increase
2001 Volume (Decrease)
- --------------------------------------------------------------
North America 42% 7%
Europe, Middle East 33% 5%
Asia-Pacific 18% (1%)
Latin America 7% (3%)
-----
Total 100% 4%
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THE LUBRIZOL CORPORATION
The 2001 increases over 2000 were primarily due to business gains in our engine
oil additives product group in North America and strong shipments to many of our
multinational engine oil customers in Europe. The 1% decrease in Asia-Pacific
includes the favorable impact of the consolidation of our China subsidiaries
during the fourth quarter of 2000. Excluding China, Asia-Pacific volume would
have declined 9% for the year, primarily due to the economic weakness in the
region and some lost engine oil additive business in Japan. In Latin America,
shipment volume was down due to order patterns and the economic slowdown in the
region.
Cost of sales for 2001 increased 4% (2% from acquisitions) from 2000 due to
increased shipment levels and higher raw material costs. Average raw material
cost in 2001 increased 2% over the prior year because of the higher cost of
crude oil and natural gas and the use of higher-cost raw materials to meet the
new U.S. engine oil specification. During the first half of 2001, our raw
material costs were higher than the first half of 2000 due to the impact of
higher crude oil costs on petrochemical prices and the impact of higher natural
gas costs on our butylene-based raw materials. Crude oil and natural gas costs
started to come down during the second quarter and sequentially declined in the
third and fourth quarters of 2001. Although there have been some announced raw
material price decreases early in 2002, we are uncertain as to the level of raw
material prices for the remainder of the year. Manufacturing costs, which are
included in cost of sales, increased by 1% in 2001 compared with 2000, but
decreased by 2% after excluding acquisitions. Unit manufacturing costs
(manufacturing costs per metric ton sold) were down 3% compared with 2000.
Gross profit (net sales less cost of sales) increased by $10.7 million, or 2%
($3.1 million, or less than 1%, excluding acquisitions), in 2001 compared with
2000 primarily for the reasons expressed above. Gross profit for fluid
technologies for transportation increased by $12.6 million, or 3%, for 2001
compared with 2000, for the same reasons. Gross profit for fluid technologies
for industry decreased by $9.7 million, or 9%, in 2001 compared with 2000.
Excluding the impact of acquisitions, this gross profit decreased by $14.4
million, or 13%, primarily because the weak manufacturing sector in North
America adversely affected our industrial additives and performance chemicals
product groups. We also incurred a write-off of $2.8 million for obsolete
inventory in our performance systems product group during the second half of
2001. In calculating gross profit at the operating segment level, we exclude
excess capacity from product costs. (See Note 12 to the financial statements.)
[GRAPH]
The gross profit percentage (gross profit divided by net sales) decreased to
27.4% for 2001 as compared with 27.8% for 2000 due to the reasons explained
previously. The corresponding gross profit percentages for fluid technologies
for transportation and fluid technologies for industry (excluding excess
capacity) were 28.4% and 32.8% in 2001, respectively, compared with 28.8% and
35.8% in 2000.
Selling and administrative expenses increased $9.4 million, or 6% ($6.7 million,
or 4%, excluding acquisitions), in 2001 compared with 2000. The non-acquisition
increase was primarily due to higher salary and employee benefit costs for
existing businesses and incremental staffing and other costs associated with our
strategy to expand into new markets, partially offset by lower legal expenses
and favorable currency effects.
Research, testing and development expenses (technology expenses) increased $7.7
million, or 5% ($6.9 million, or 5%, excluding acquisitions), in 2001 compared
with 2000. 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. The increases during 2001 were due to
high levels of testing, primarily for GF-3, which is the new U.S. passenger car
motor oil technical standard, along with increased development spending for
growth programs and product development costs for the next diesel engine oil
specification, PC-9. We expect PC-9 testing will continue at a high pace in the
first half of 2002. During 2001, approximately 76% of our technology cost was
incurred in company-owned facilities and 24% was incurred at third-party testing
facilities.
[GRAPH]
The change in revenues together with the change in total costs and expenses had
an unfavorable effect of $5.5 million for 2001.
Unusual items for the year 2000 consisted of $19.4 million for a litigation
settlement gain and $4.5 million for favorable adjustments to previously taken
special charges related to the
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THE LUBRIZOL CORPORATION
restructuring of the Painesville, Ohio, manufacturing facility. (See "2000
Results of Operations.") There were no similar items in 2001.
The change in other income (expense) had an unfavorable effect of $1.0 million
for 2001 as compared with 2000. Higher currency exchange translation losses and
increased goodwill amortization expense were partially offset by higher equity
earnings from joint ventures and lower losses from the disposal of assets.
Goodwill amortization expense will be eliminated in 2002 due to a change in
accounting standards. Our goodwill amortization expense in 2001 was $11.4
million. (See Note 2 to the financial statements.)
Net interest expense was approximately the same in 2001 and 2000. Interest
income decreased $1.8 million in 2001 compared with 2000 due to lower interest
rates and lower levels of cash investments during 2001. Interest expense also
decreased $1.8 million in 2001 compared with 2000, principally because of lower
interest rates.
We conduct a significant amount of our business outside of the U.S. and are
subject to business risks inherent in non-U.S. activities, including currency
exchange rate fluctuations. 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 some countries. As the U.S.
dollar strengthens or weakens against other international currencies in which we
transact business, our financial results will be affected. During 2001, the U.S.
dollar strengthened against most other currencies, especially the euro and the
yen, and the change in currency exchange rates had an unfavorable effect on net
income as compared with exchange rates in effect during 2000.
As a result of the factors previously discussed and after excluding from 2000
the litigation settlement gain and adjustments to special charges, 2001 income
before taxes decreased by $6.5 million, or 4%, compared with 2000. Including the
unusual items, income before income taxes decreased by $30.4 million, or 18%, as
compared with 2000. Segment operating profit before tax, which excludes interest
expense and unusual items and allocates corporate technology, selling and
administrative expenses to the segments, increased $10.9 million, or 8%, for the
fluid technologies for transportation segment and decreased $17.4 million, or
75%, for the fluid technologies for industry segment.
The effective tax rate on 2001 income was 32.7%, compared with 29.6% on 2000
income, excluding the litigation settlement gain and adjustments to special
charges in 2000. The increase in the effective tax rate, which decreased 2001
earnings before these items by $.08 per share, was primarily due to the U.S. tax
benefit of a charitable contribution made in 2000, which did not recur in 2001.
The overall effective tax rate for 2000 including the special charge adjustments
and the litigation gain was 30.7%. Based upon the information currently
available, we expect our effective tax rate for 2002 to be reduced to
approximately 30% as a result of enacted tax rate reductions, the anticipated
tax benefits of a charitable contribution of technology and other factors.
Net income in 2001 was $94.1 million, or $1.84 per share. In 2000, net income
was $118.0 million, or $2.22 per share. After excluding from 2000 income the
litigation settlement gain and the adjustments to special charges, 2001 net
income decreased 9% compared with 2000 net income of $103.1 million. On this
same basis, 2001 net income per share decreased 5% from the 2000 net income per
share of $1.94.
2000 RESULTS OF OPERATIONS
In 2000, our results reflected the challenging economic and competitive
conditions within our industry. We experienced significant increases in raw
material costs that we did not fully recover despite a series of product price
increases and we were unfavorably affected by the stronger U.S. dollar. These
factors caused our gross profit and gross profit percentage to decline. Although
we benefited from lower operating expenses, unusual items and a lower effective
tax rate, 2000 earnings were lower than the prior year's earnings.
Our consolidated revenues for 2000 were $1.78 billion, which was a decrease of
$4.5 million, or less than 1%, from 1999 revenues. Excluding acquisitions, the
decrease was $26.9 million, or 2%. The revenue decrease was attributable to a
reduction in our shipment volume, which decreased 1% from the prior year (2%
excluding acquisitions). Higher product selling prices in 2000 were completely
offset by product and regional mix effects and a significant negative impact
from the stronger U.S. dollar. Fluid technologies for transportation revenues
decreased $16.7 million, or 1%, compared with 1999 primarily due to a decrease
in shipment volume. Fluid technologies for industry revenues increased $12.2
million, or 4%, over 1999 primarily due to an acquisition that offset some
business losses in our industrial product group, and stronger volume in our
compressor lubricant business.
Changes in our shipment volume vary in different geographical areas. The
percentage changes in our 2000 shipment volume by geographical area, as compared
with 1999, are:
Increase
(Decrease)
- -------------------------------------------------------------
North America (4%)
Europe, Middle East (3%)
Asia-Pacific 9%
Latin America 9%
We believe 1999 results benefited from advance customer purchases in late 1999
related to "Year 2000" concerns and an announced price increase. The weakness in
North America
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THE LUBRIZOL CORPORATION
also reflected the timing of some passenger car business shifting from late 2000
into the first quarter of 2001 and a decline in driveline factory-fill volumes
resulting from automobile and diesel truck production slowdowns. We lost some
business at smaller accounts in Europe due to recent price increases. The
favorable comparisons in Asia-Pacific and Latin America primarily were due to
business gains mostly related to our new heavy-duty diesel platform and sales by
our new subsidiaries in China.
Cost of sales for 2000, including acquisitions, increased 4% from 1999,
reflecting higher average raw material cost partially offset by lower
manufacturing cost. The prices we paid for raw materials increased every quarter
throughout 2000 due to the impact of higher crude oil costs on petrochemical
prices, and as a result, our average raw material cost increased 9% compared
with 1999. We implemented three price increases in 2000, but they did not fully
recover the higher raw material costs and we began a fourth price increase,
which was announced in November 2000. In addition, our average raw material cost
was further affected in 2001 by increases in natural gas prices.
Manufacturing costs, which are included in cost of sales, decreased 6% (8%
excluding acquisitions) in 2000 compared with 1999. Approximately two-thirds of
this decrease was due to the favorable impact of currency. Manufacturing savings
also resulted from the full integration of our Adibis business, which we
purchased in 1998, and the cost reduction program at our Painesville plant.
Gross profit (net sales less cost of sales) decreased $55.5 million, or 10%
($62.0 million, or 11%, excluding acquisitions), in 2000 compared with 1999. The
decrease primarily was due to the impact of higher raw material costs partially
offset by product price increases and lower manufacturing costs. Additionally,
approximately $18 million of the decrease in gross profit was due to the impact
of unfavorable changes in currency exchange rates. In calculating gross profit
at the operating segment level we exclude excess production capacity from
product costs. (See Note 12 to the financial statements.) On that basis, fluid
technologies for transportation gross profit decreased $61.1 million, or 13%, in
2000 compared with 1999 due to the same factors noted above. Fluid technologies
for industry gross profit decreased $1.0 million, or 1%, in 2000 compared with
1999. Excluding the Alox acquisition, this gross profit decreased $7.0 million,
or 6%, primarily due to business losses in our industrial products group.
The gross profit percentage (gross profit divided by net sales) decreased to
27.8% for 2000 as compared with 30.9% for 1999 due to the reasons explained
above. The gross profit percentages for fluid technologies for transportation
and fluid technologies for industry were 28.8% and 35.8%, respectively, compared
with 32.4% and 37.4% in 1999.
Selling and administrative expenses decreased $13.3 million, or 7%, in 2000
compared with 1999 ($14.4 million, or 8%, excluding acquisitions) due to lower
variable compensation costs, lower implementation costs for our enterprise-wide
management information system, lower legal expenses and favorable currency
effects.
Research, testing and development expenses (technology expenses) increased $4.9
million, or 3%, in 2000 compared with 1999. During 2000, approximately 80% of
our technology cost was incurred in Lubrizol-owned facilities and 20% was
incurred at third-party testing facilities. Our technology expenses were
favorably affected in the first half of the year because of lower activity at
third-party testing facilities in the first quarter of the year, resulting in
part from an industry delay in finalizing specifications for the U.S. passenger
car motor oil technical standard GF-3. Once these specification issues were
resolved, we began related testing in the third quarter of 2000, which resulted
in technology costs being 12% higher in the second half than in the first half
of 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 $47.1 million for 2000 compared with 1999.
During 2000, we recorded adjustments relating to our Painesville cost reduction
program to reduce the special charge accrual by $4.5 million ($2.9 million
after-tax or $.05 per share). These adjustments to the special charge are
discussed under the caption "Cost Reduction Programs and Related Special
Charges" below and in Note 15 to the financial statements.
On October 12, 2000, we reached a settlement of pending patent litigation with
Imperial Oil Limited (Imperial), a Canadian affiliate of Exxon Mobil
Corporation. Under the settlement agreement, Imperial paid us $25.0 million in
October 2000. After deducting related expenses, this settlement increased
pre-tax income by $19.4 million ($12.0 million after-tax, or $.23 per share). We
also entered into a ten-year agreement for the supply of $490 million (Canadian
dollars) of product to Imperial. Further information regarding our litigation
with Exxon Mobil Corporation is contained in Note 16 to the financial
statements.
The change in other income (expense) unfavorably affected 2000 pre-tax income by
$7.4 million compared with 1999. The change primarily resulted from lower equity
earnings of affiliated companies and losses on miscellaneous sales of assets.
Net interest expense decreased $3.6 million in 2000 compared with 1999
principally because of lower interest rates due to interest rate swap agreements
entered into in the first half of 2000.
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THE LUBRIZOL CORPORATION
As the U.S. dollar strengthens or weakens against other international currencies
in which we transact business, our financial results will be affected. During
2000 the U.S. dollar strengthened against most other currencies, especially the
euro and British pound sterling, and the change in currency exchange rates had
an unfavorable effect on net income for the year as compared with exchange rates
in effect during 1999.
As a result of the factors discussed above, income before income taxes decreased
by $25.0 million, or 13%, as compared with 1999. After excluding from both years
the special charges and the gains from litigation settlements, income before
income taxes decreased by $50.8 million, or 26%, compared with 1999. Segment
operating profit before tax, which excludes interest expense, decreased $51.5
million, or 27%, for fluid technologies for transportation, and decreased $2.9
million, or 11%, for fluid technologies for industry, as compared with 1999.
The effective tax rate on 2000 income, before litigation gains and special
charges, decreased to 29.6% as compared with 36.5% in 1999. This decrease, which
increased 2000 earnings before these items by $.19 per share, primarily was due
to the U.S. tax benefit from charitable contributions of technology to an
educational institution, the favorable impact of statutory tax rate changes for
certain of our foreign subsidiaries and an increase in the U.S. Foreign Sales
Corporation tax benefit on export sales. The overall effective tax rate for 2000
including the special charge adjustments and the litigation gain was 30.7%.
Net income in 2000 was $118.0 million, or $2.22 per share. In 1999, net income
was $123.0 million, or $2.25 per share. After excluding from 2000 and 1999 the
special charges and the gains from litigation settlements, net income in 2000
was $103.1 million, as compared with $125.3 million in 1999, a decrease of 18%.
On this same basis, 2000 net income per share was $1.94, a decrease of 16% from
the $2.30 per share earned in 1999.
1999 RESULTS OF OPERATIONS
In 1999, our consolidated revenues were $1.78 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 1998 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. Fluid technologies for transportation revenues
increased $87.6 million, or 6%, over 1998. Approximately two-thirds of the
increase was due to our 1998 acquisition of Adibis. Fluid technologies for
industry revenues increased $42.5 million, or 16%, 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 with 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 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.
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 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 resulted in an average increase of 4% to 4.5%. We began to see the impact on
revenues in the first quarter of 2000, and the full impact was felt by the end
of the second quarter. Manufacturing costs, included in cost of sales, increased
7% (3% excluding acquisitions) in 1999 compared with 1998.
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, $10.0 million of the increased
gross profit was due to the impact on cost of sales of favorable changes in
currency exchange rates. Fluid technologies for transportation gross profit
increased $53.6 million, or 13%, and fluid technologies for industry gross
profit increased $13.7 million, or 14%. Acquisitions accounted for one-fourth of
the fluid technologies for transportation increase and one-half of the fluid
technologies 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
30.9% for 1999 as compared with 29.2% 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.
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THE LUBRIZOL CORPORATION
The gross profit percentages for fluid technologies for transportation and fluid
technologies for industry were 32.4% and 37.4%, respectively, compared with
30.6% and 38.3% 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 offset by higher variable pay and costs
associated with "Year 2000" compliance activities.
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%. During 1999, approximately 80% of our
technology cost was incurred in company-owned facilities and 20% was 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 new U.S. passenger car motor oil technical standard, GF-3, 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.
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 programs of our cost reduction
initiative. These special charges are discussed under the caption "Cost
Reduction Programs 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 that was 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, 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.
Net 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.
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 as
compared with 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 fluid
technologies for transportation, and increased $4.9 million, or 22%, for fluid
technologies for industry, as compared with 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 with $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% from
the $1.55 per share earned in 1998.
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THE LUBRIZOL CORPORATION
COST REDUCTION PROGRAMS AND
RELATED SPECIAL CHARGES
We have completed the cost reduction programs initiated in November 1998 to
reduce costs and improve our operating structure. The first program, which was
completed by the end of 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 have achieved annual savings of
approximately $28 million related to this first program. The second program,
which was completed by the end of 2000, involved primarily the downsizing of our
Painesville, Ohio, manufacturing facility. We achieved approximately $19 million
of savings in 2001 from the second program. (See also Note 15 to the financial
statements.)
The first program, 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 program.
We recorded a special charge of $23.3 million in the fourth quarter of 1998 for
the cost directly associated with this first 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, 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 $.4 million, $14.7 million and $5.0 million in 2000, 1999
and 1998, respectively, related to this program.
The second program, which began in the third quarter of 1999, resulted in the
additional reduction of approximately 5% of our workforce, or 187 employees, and
the shutdown of 20 of Painesville's 36 production systems. The Painesville plant
continues 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 in the third quarter of 1999
relating to this second program. In the second quarter of 2000, we recorded a
pre-tax adjustment of $2.6 million ($1.7 million after-tax or $.03 per share) to
reduce the amount of the special charge. The cost of workforce reductions at
Painesville was less than originally anticipated because of an increase in the
planned number of employees due to the assumption of Alox production, retention
of a waste incineration process and higher than expected throughput. We also
eliminated a number of positions without severance pay cost through the transfer
of employees to other facilities outside of Painesville. In the fourth quarter
of 2000, we recorded a pre-tax adjustment of $1.9 million ($1.2 million
after-tax or $.02 per share) to reduce further the amount of the special charge
due to lower than anticipated equipment dismantling costs ($1.5 million) and
lower workforce reduction costs ($.4 million) because additional employees
transferred to other Lubrizol locations. As adjusted, employee severance costs
were $5.5 million of the charge and other exit costs were $10.8 million,
including $7.4 million related to asset impairment for component production
units taken out of service. We spent approximately $1.8 million, $.9 million and
$1.3 million in 2001, 2000 and 1999, respectively, related to this program.
Additionally, we have spent approximately $6.8 million of capital to transfer a
portion of the Painesville capacity to our Texas facilities.
RETURN ON AVERAGE SHAREHOLDERS' EQUITY
Return on average shareholders' equity was 12% in 2001, 15% in 2000 and 16% in
1999 (12%, 13% and 16%, respectively, excluding litigation gains and special
charges and credits).
[GRAPH]
WORKING CAPITAL, LIQUIDITY AND
CAPITAL RESOURCES
Our cash flows for the years 1999 through 2001 are presented in the consolidated
statements of cash flows. Cash provided from operating activities decreased by
$30.3 million, or 13%, compared with 2000, to a total of $195.8 million in 2001.
This decrease primarily was due to lower earnings significantly impacted by the
non-recurrence in 2001 of the litigation settlement gain as well as an $8.5
million increase in working capital items in 2001 compared with a $2.0 million
increase in working capital items in 2000.
[GRAPH]
Capital expenditures in 2001 were $66.3 million compared with $85.8 million in
2000. The lower level of capital expenditures in 2001 is primarily due to the
timing of various envi-
20
THE LUBRIZOL CORPORATION
ronmental and process improvement projects. Prior-year expenditures included
capital spent to transfer capacity from our Painesville to our Texas facilities
as part of our cost reduction program, which was completed in 2000. Capital
expenditures have been below depreciation expense in each of the past three
years. In 2002, we estimate expenditures will approximate depreciation expense
and be in the range of $85 million to $90 million.
In 2001 we spent $14.7 million on an acquisition to purchase ROSS Chem, Inc., a
manufacturer and supplier of antifoam and defoaming agents, with annual sales of
$10 million, that expanded our product lines in metalworking and paints,
coatings and inks. We spent $35.7 million on two acquisitions in 2000 in which
we purchased certain production assets and working capital of Alox Corporation,
a supplier of additives for corrosion prevention in metalworking products, and
acquired an additional 10% interest in our India joint venture, increasing our
ownership interest to 50%. We also made a $5.0 million investment in 2000 in a
joint venture with GE Transportation Systems. We made one acquisition in 1999
for $1.9 million.
In 2001, we dissolved our joint venture with GE Transportation Systems and
replaced the joint venture with separate cross-licensing agreements. We have
entered into a technical services agreement to license our FluiPakTM technology
(i.e., fluid management technology for use in monitoring fluids in machines and
services) for railroad applications to GE Transportation Systems. This is
expected to result in an additional royalty stream beginning in 2003, after
design changes are made to the FluiPak unit.
In the first quarter of 2002, we completed one acquisition and signed a
definitive agreement for a second acquisition for a total estimated cost of $71
million. In January 2002, we acquired Kabo Unlimited, Inc., which specializes in
the development, manufacture and sale of antifoam and defoaming agents to the
food, fermentation, mining and wastewater industries. Kabo's product lines
expand the defoamer offering and capabilities of our fluid technologies for
industry business. In January 2002, we signed a definitive agreement to acquire
Chemron Corporation, a supplier of specialty surfactants. This acquisition, upon
completion, would extend our business into high-growth surfactants markets,
including personal care products and industrial and institutional cleaners, in
which we currently do not compete. During 2001, the annual revenues of Kabo and
Chemron were approximately $14 million and $55 million, respectively.
Our net debt to capitalization ratio at December 31, 2001, was 23%, compared
with 28% at December 31, 2000, due to strong net operating cash flow in 2001 and
the completion of only one acquisition during the year. 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 and excluding unrealized gains
and losses on derivative instruments designated as fair value hedges of fixed
rate debt. Capitalization is shareholders' equity plus net debt. Debt as a
percent of capitalization, without adjusting for cash and derivative
instruments, was 34% in both 2001 and 2000.
[GRAPH]
During the first half of 2001, we repurchased approximately 1.0 million common
shares for $30.0 million dollars. During 2000 we repurchased 3.2 million shares
for $76.0 million and in 1999 we repurchased approximately 140,000 shares for
$4.2 million.
Our financial position remains strong with a ratio of current assets to current
liabilities of 2.9:1 at December 31, 2001, compared with 2.6:1 at December 31,
2000. In July 2001, we increased our committed revolving credit facilities to
$575 million by adding $525 million of new facilities and canceling $100 million
in existing facilities due to expire in June 2003. These credit facilities may
be used for working capital requirements, capital expenditures, acquisitions or
other corporate purposes and also to support commercial paper borrowings made
under our $525 million commercial paper program. There were no borrowings under
these credit facilities at December 31, 2001. These facilities allow us to
borrow at or below the U.S. prime rate and expire in the amount of $175 million
on July 16, 2002, $50 million on June 30, 2003, and $350 million on July 16,
2006.
The following table shows our contractual cash obligations (in millions of
dollars) under debt agreements, leases and contracts at December 31, 2001.
Additional information on debt and operating leases can be found in Notes 4 and
10 to the financial statements.
Payments Due by Period
--------------------------------------------------
Less
Contractual Cash Than 1 1-3 4-5 After 5
Obligations Total Year Years Years Years
- --------------------------------------------------------------------------------
Debt ....................... $ 397.2 $ 9.1 $ 7.6 $ 50.0 $ 330.5
Operating Leases ........... 49.3 12.5 15.6 9.2 12.0
Natural Gas
Purchase Contracts ......... 5.9 5.9
Service Contracts .......... 2.0 1.0 1.0
-------- ------- ------- ------- --------
Total Contractual
Cash Obligations ........... $ 454.4 $ 28.5 $ 24.2 $ 59.2 $ 342.5
======== ======= ======= ======= ========
In addition, we have contingent obligations aggregating
$12.4 million under standby letters of credit issued to financial institutions,
customers and insurance companies to secure short-term support for a variety of
commercial transactions and insurance and benefit programs undertaken in the
ordinary course of business. These standby letters of credit expire in 2002.
21
THE LUBRIZOL CORPORATION
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 and growth needs, including acquisitions to expand into new
and existing fluid technology markets. If we were to incur significant
additional indebtedness (for example, to make a large acquisition) that caused a
change in our current long-term debt ratings, we would expect to be able to
continue to meet our liquidity needs but at some increased cost for interest and
commitment fees under our credit facilities. We do not believe any such
increased costs would have a material impact upon our results of operations or
financial condition.
ACCOUNTING POLICIES AND RECENT
ACCOUNTING PRONOUNCEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires us to make assumptions and estimates regarding
future events. These assumptions and estimates affect the amounts reported in
our financial statements. Accounting policies for which our subjective judgment
is particularly important include estimating valuation reserves for slow moving
or obsolete inventory, estimating the cost of future environmental remediation
obligations in order to establish reserves, and providing reserves for tax
exposure in the various taxing jurisdictions in which we conduct business. To
the extent actual experience differs from our assumptions and estimates, we may
have to increase or decrease these reserves and earnings could be affected.
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) 142, "Goodwill and Other Intangible
Assets" which became effective for us on January 1, 2002. Under SFAS 142, there
is no goodwill amortization for business combinations that occur after June 30,
2001 and amortization of goodwill on pre-June 30, 2001 acquisitions ceased
effective January 1, 2002. Goodwill amortization, which was $11.4 million in
2001, is replaced with a requirement to test goodwill annually for impairment.
Our initial impairment test must be completed by June 30, 2002. We have not
determined the impact, if any, that the initial goodwill impairment test will
have on our financial position or results of operations. We expect acquisitions
to play an important role in our future growth strategy and accordingly expect
SFAS 142 to be important to the presentation of our financial condition and
results of operations. The annual goodwill impairment test will require us to
make a number of assumptions and estimates concerning future levels of earnings
and cash flow and any impairment of goodwill will reduce earnings.
In June 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement
Obligations" which will become effective for us on January 1, 2003. This
statement requires entities to record a liability for an asset retirement
obligation in the period in which it is incurred. The amount recorded as a
liability is capitalized by increasing the carrying amount of the related
long-lived asset, which is then depreciated over its useful life. We have not
determined the impact, if any, that SFAS 143 will have on our financial position
or results of operations.
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. 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.
These uncertainties and factors could cause our actual results to differ
materially from those matters expressed in or implied by any 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 and fuel 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 and political
uncertainty within the Asia-Pacific and Latin American regions;
- - the lubricant additive demand in developing regions such as China and
India, which geographic areas are an announced focus of our activities;
- - the potential negative impact on product pricing and volume demand from the
consolidation of finished lubricant marketers;
- - the degree of competition resulting from lubricant additive industry over
capacity;
- - technology developments that affect longer-term trends for lubricant
additives, such as improved equipment design, fuel economy, longer oil
drain intervals, alternative fuel powered engines and emission system
compatibility;
- - the overall economic uncertainty and weak business environment within the
global economy, which is affecting fluid technologies for industry in
particular;
22
THE LUBRIZOL CORPORATION
- - the extent to which we are successful in expanding our business in new and
existing fluid technology markets incorporating chemicals, systems and
services for industry and transportation;
- - our ability to identify, complete and integrate acquisitions for profitable
growth;
- - our success at continuing to develop proprietary technology to meet or
exceed new industry performance standards and individual customer and
original equipment manufacturers' 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;
- - our ability to continue to reduce complexities and conversion costs and
modify our cost structure to maintain and enhance our competitiveness;
- - our success in strengthening relationships and growing business with our
largest customers, and retaining the business of these customers over
extended time periods;
- - the cost, availability and quality of raw materials, including
petroleum-based products;
- - the cost and availability of energy, including natural gas and electricity;
- - 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 extent to which we achieve market acceptance of our PuriNOx(TM)
low-emission, water-blend fuel product;
- - significant changes in government regulations affecting environmental
compliance.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We operate manufacturing and blending facilities, laboratories and offices
around the world and utilize 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 our 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 our 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 earnings 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 had a favorable/unfavorable impact on fair values of
$20.2 million, cash flows of $1.0 million and income before tax of $1.0 million
in 2001, and $22.4 million, $1.2 million and $1.2 million in 2000, respectively.
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
had a favorable/unfavorable impact on fair values of $7.4 million, cash flows of
$13.3 million and income before tax of $3.7 million in 2001, and $7.8 million,
$16.4 million and $5.3 million in 2000, respectively.
23
THE LUBRIZOL CORPORATION
QUARTERLY FINANCIAL DATA (UNAUDITED)
Three Months Ended
------------------------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
- -------------------------------------------------------------------------------------------------------------------
(In Thousands of Dollars Except Per Share Data)
2001
Net sales ...................................... $453,791 $485,928 $461,109 $438,416
Gross profit ................................... 119,109 135,926 128,222 120,526
Net income ..................................... 18,506 32,015 22,797 20,798
Net income per share ........................... $.36 $.63 $.45 $.41
Net income per share, diluted .................. $.36 $.62 $.44 $.40
2000
Net sales ...................................... $444,008 $448,979 $432,442 $445,888
Gross profit ................................... 127,326 129,848 121,624 114,332
Net income ..................................... 30,105 31,712 23,255 32,937
Net income per share ........................... $.55 $.59 $.44 $.64
Net income per share, diluted .................. $.55 $.59 $.44 $.63
In the second quarter of 2000, the company recorded a pre-tax adjustment of $2.6
million ($.03 per share) to reduce the amount of the special charge to reflect a
lower cost of workforce reductions than was anticipated.
In the fourth quarter of 2000, the company recorded a pre-tax adjustment of $1.9
million ($.02 per share) to further reduce the amount of the special charge due
to lower-than-anticipated equipment dismantling costs ($1.5 million) and lower
workforce reduction costs ($.4 million) because additional employees transferred
to other company locations.
In the fourth quarter of 2000, the company recorded a pre-tax gain from
litigation settlement of $19.4 million ($.23 per share).
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT DELOITTE
& TOUCHE
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, 2001 and 2000 and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the three years in the period ended December 31, 2001. 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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the 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, 2001 and 2000, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 2001 in conformity with accounting principles generally accepted in the
United States of America.
/s/ Deloitte & Touche LLP
Cleveland, Ohio
February 4, 2002
24
THE LUBRIZOL CORPORATION
Consolidated Statements of Income Year Ended December 31
----------------------------------------------
(In Thousands of Dollars Except Per Share Data) 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------
Net sales ................................ $ 1,839,244 $ 1,771,317 $ 1,775,867
Royalties and other revenues ............. 5,400 4,463 4,462
----------- ----------- -----------
Total revenues ...................... 1,844,644 1,775,780 1,780,329
Cost of sales ............................ 1,335,461 1,278,187 1,227,271
Selling and administrative expenses ...... 177,431 167,999 181,292
Research, testing and development expenses 158,473 150,805 145,927
----------- ----------- -----------
Total cost and expenses ............. 1,671,365 1,596,991 1,554,490
Special (charges) credits ................ 4,484 (19,569)
Gain from litigation settlements ......... 19,395 17,626
Other income (expense) - net ............. (15,076) (14,062) (6,704)
Interest income .......................... 6,787 8,611 7,854
Interest expense ......................... (25,041) (26,869) (29,696)
----------- ----------- -----------
Income before income taxes ............... 139,949 170,348 195,350
Provision for income taxes ............... 45,833 52,339 72,358
----------- ----------- -----------
Net income ............................... $ 94,116 $ 118,009 $ 122,992
=========== =========== ===========
Net income per share ..................... $ 1.84 $ 2.22 $ 2.25
=========== =========== ===========
Net income per share, diluted ............ $ 1.83 $ 2.22 $ 2.25
=========== =========== ===========
Dividends per share ...................... $ 1.04 $ 1.04 $ 1.04
=========== =========== ===========
The accompanying notes to financial statements are an integral part of these
statements.
25
THE LUBRIZOL CORPORATION
CONSOLIDATED BALANCE SHEETS December 31
----------------------------
(In Thousands of Dollars) 2001 2000
- -------------------------------------------------------------------------------------------------------
ASSETS
Cash and short-term investments ....................................... $ 189,095 $ 145,937
Receivables ........................................................... 279,013 290,556
Inventories ........................................................... 254,610 260,133
Other current assets .................................................. 34,006 31,282
----------- -----------
Total current assets ............................................. 756,724 727,908
----------- -----------
Property and equipment - at cost ...................................... 1,648,096 1,641,046
Less accumulated depreciation ......................................... 1,003,815 963,804
----------- -----------
Property and equipment - net ..................................... 644,281 677,242
----------- -----------
Goodwill and intangible assets - net .................................. 166,558 170,593
Investments in non-consolidated companies ............................. 30,915 34,247
Other assets .......................................................... 63,841 49,500
----------- -----------
TOTAL ........................................................ $ 1,662,319 $ 1,659,490
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Short-term debt and current portion of long-term debt ................. $ 9,120 $ 17,152
Accounts payable ...................................................... 129,833 141,574
Accrued expenses and other current liabilities ........................ 120,261 123,520
----------- -----------
Total current liabilities ........................................ 259,214 282,246
----------- -----------
Long-term debt ........................................................ 388,111 378,783
Postretirement health care obligation ................................. 97,878 100,275
Noncurrent liabilities ................................................ 55,140 52,821
Deferred income taxes ................................................. 56,207 60,614
----------- -----------
Total liabilities ................................................ 856,550 874,739
----------- -----------
Minority interest in consolidated companies ........................... 32,577 32,470
Contingencies and commitments
Preferred stock without par value - unissued
Common shares without par value - outstanding 51,152,107 shares in 2001
and 51,307,688 shares in 2000 ...................................... 109,692 82,128
Retained earnings ..................................................... 763,312 750,779
ACCUMULATED OTHER COMPREHENSIVE LOSS .................................. (99,812) (80,626)
----------- -----------
Total shareholders' equity ....................................... 773,192 752,281
----------- -----------
TOTAL ........................................................ $ 1,662,319 $ 1,659,490
=========== ===========
The accompanying notes to financial statements are an integral part of these
statements.
26
THE LUBRIZOL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31
(In Thousands of Dollars) 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------------
CASH PROVIDED FROM (USED FOR):
OPERATING ACTIVITIES:
Net income .................................................................. $ 94,116 $ 118,009 $ 122,992
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization .......................................... 98,832 100,834 99,720
Deferred income taxes .................................................. (2,392) 7,799 1,312
Special charges (credits) .............................................. (4,484) 19,569
Change in current assets and liabilities net of acquisitions:
Receivables ........................................................ 2,217 542 (10,749)
Inventories ........................................................ 866 (6,124) 13,500
Accounts payable, accrued expenses and
other current liabilities ........................................ (8,399) 2,981 28,408
Other current assets ............................................... (3,171) 582 19,052
--------- --------- ---------
(8,487) (2,019) 50,211
Change in noncurrent liabilities ....................................... 4,740 1,250 370
Other items - net ...................................................... 9,029 4,775 (5,153)
--------- --------- ---------
TOTAL OPERATING ACTIVITIES .................................... 195,838 226,164 289,021
INVESTING ACTIVITIES:
Capital expenditures ........................................................ (66,316) (85,757) (64,872)
Acquisitions and investments in nonconsolidated companies ................... (14,989) (41,476) (1,923)
Other - net ................................................................. (340) 1,997 2,246
--------- --------- ---------
Total investing activities .................................... (81,645) (125,236) (64,549)
FINANCING ACTIVITIES:
Short-term borrowing (repayment) ............................................ (4,579) 4,099 (8,404)
Long-term borrowing ......................................................... 18,428 5,000
Long-term repayment ......................................................... (3,120) (29,015) (24,447)
Debt issuance costs ......................................................... (351)
Dividends paid .............................................................. (53,218) (55,370) (56,757)
Common shares purchased ..................................................... (30,039) (75,957) (4,178)
Common shares issued upon exercise of stock options ......................... 22,294 1,310 1,553
--------- --------- ---------
Total financing activities .................................... (68,662) (136,856) (87,233)
Effect of exchange rate changes on cash ..................................... (2,373) (3,600) (5,413)
--------- --------- ---------
Net increase (decrease) in cash and short-term investments .................. 43,158 (39,528) 131,826
Cash and short-term investments at the beginning of year .................... 145,937 185,465 53,639
--------- --------- ---------
Cash and short-term investments at the end of year .......................... $ 189,095 $ 145,937 $ 185,465
========= ========= =========
The accompanying notes to financial statements are an integral part of these
statements.
27
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, 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
--------
Comprehensive income:
Net income 2000.......................... 118,009 118,009
Other comprehensive loss................. (26,676) (26,676)
--------
Comprehensive income.......................... 91,333
Cash dividends................................ (54,529) (54,529)
Common shares - treasury:
Shares purchased......................... (3,232,096) (5,166) (70,791) (75,957)
Shares issued upon exercise of stock
options............................... 62,492 1,310 1,310
---------- -------- -------- --------- --------
BALANCE, DECEMBER 31, 2000.................... 51,307,688 82,128 750,779 (80,626) 752,281
--------
Comprehensive income:
Net income 2001.......................... 94,116 94,116
Other comprehensive loss (19,186) (19,186)
--------
Comprehensive income.......................... 74,930
Cash dividends................................ (53,206) (53,206)
Deferred stock compensation................... 5,474 5,474
Common shares - treasury:
Shares purchased......................... (967,610) (1,662) (28,377) (30,039)
Shares issued upon exercise of stock
options............................... 812,029 23,752 23,752
---------- -------- -------- --------- --------
BALANCE, DECEMBER 31, 2001.................... 51,152,107 $109,692 $763,312 $ (99,812) $773,192
========== ======== ======== ========= ========
*Represents five dividends declared, of which four were paid in 1999.
The accompanying notes to financial statements are an integral part of these
statements.
28
NOTES TO FINANCIAL STATEMENTS
(In Thousands of Dollars Unless Otherwise Indicated)
NOTE 1-- NATURE OF OPERATIONS
The Lubrizol Corporation is a global fluid technology company that develops,
produces and sells high-performance chemicals, systems and services for industry
and transportation. We create these products, including specialty additive
packages and related equipment, for use in transportation and industrial
lubricant and other markets. We do this by applying advanced chemical and
mechanical technologies in order to enhance the performance, quality and value
and reduce the environmental impact of the customer products in which our
products are used. The company groups its product lines into two operating
segments: fluid technologies for transportation and fluid technologies for
industry. Fluid technologies for transportation comprise approximately 83% of
the company's consolidated revenues and 96% of segment pre-tax operating profit
in 2001. Refer to Note 12 for a further description of the nature of the
company's operations, the product lines within fluid technologies for
transportation and fluid technologies 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 50% or greater
and the company has effective management control. 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 $30.0 million and $32.7 million at December
31, 2001 and 2000, respectively. Investments carried at cost were $.9 million
and $1.5 million at December 31, 2001 and December 31, 2000, respectively.
ESTIMATES - The preparation of consolidated financial statements in conformity
with accounting principles generally accepted in the United States of America
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 invests 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 of investments having maturities of three months or fewer 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 of America 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 16% and 18% in 2001 and 2000, respectively, 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 and
building 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 goodwill 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. When estimated future discounted cash flows are
less than the carrying amount of the net assets (tangible and identifiable
intangibles) and related goodwill, impairment losses of goodwill are charged to
operations. Impairment losses, limited to the carrying amount of goodwill,
represent the excess of the sum of the carrying amount of the net assets
(tangible and identifiable intangibles) and goodwill in excess of the discounted
cash flows of the business unit being evaluated.
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) 141, "Business Combinations," which
prohibits the pooling-of-interests method for business combinations completed
after June 30, 2001 and includes criteria for recognition of intangible assets
separate from goodwill. The company did not enter into any business combinations
in the second half of 2001.
In June 2001, the FASB also issued SFAS 142, "Goodwill and Other Intangible
Assets," which became effective for the company on January 1, 2002. Under the
provisions of SFAS 142 there is no goodwill amortization for business
combinations that occur after June 30, 2001, and amortization of goodwill on
pre-June 30, 2001 acquisitions ceased effective January 1, 2002. The Company's
goodwill amortization expense in 2001 was $11.4 million. Goodwill amortization
is
29
NOTES CONTINUED
replaced with the requirement to test goodwill annually for impairment. The
initial impairment test must be completed within six months of adoption of the
new standard. The company has not determined the impact, if any, that the test
of goodwill for impairment will have on its consolidated financial position or
results of operations.
RESEARCH, TESTING AND DEVELOPMENT - Research, testing and development costs are
expensed as incurred. Research and development expenses, excluding testing, were
$87.6 million in 2001, $86.4 million in 2000 and $78.3 million in 1999.
ENVIRONMENTAL LIABILITIES - The company accrues for expenses associated with
environmental remediation obligations when such expenses are probable and
reasonably estimable. These 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 $9.5 million and $7.3 million at December 31,
2001 and 2000, respectively. Of these amounts, $.5 million and $1.0 million was
included in other current liabilities at December 31, 2001 and 2000,
respectively.
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 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 - Revenues are recognized at
the time of shipment of products to customers, or at the time of transfer of
title if later, with appropriate provision for uncollectible accounts. All
amounts billed to a customer in a sales transaction related to shipping and
handling are reported as revenues.
PER SHARE AMOUNTS - Net income per share is computed by dividing net income by
average common shares outstanding during the period, including contingently
issuable shares. Net income per diluted share includes the dilution effect
resulting from outstanding stock options and stock awards. Per share amounts are
computed as follows:
2001 2000 1999
-------- -------- --------
Numerator:
Net income ..................... $ 94,116 $118,009 $122,922
======== ======== ========
Denominator:
Weighted average
common shares
outstanding .................. 51,209 53,116 54,577
Dilutive effect of stock
options and awards ........... 285 104 139
-------- -------- --------
Denominator for net income
per share, diluted ............. 51,494 53,220 54,716
======== ======== ========
Net income per share .............. $ 1.84 $ 2.22 $ 2.25
======== ======== ========
Net income per share,
diluted ........................ $ 1.83 $ 2.22 $ 2.25
======== ======== ========
Weighted average shares issuable upon the exercise of stock options which were
excluded from the diluted earnings per share calculation because they were
antidilutive were 1.8 million in 2001, 3.8 million in 2000 and 3.1 million in
1999.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS - Effective January 1, 2001, the company
adopted SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities." These statements require the
company to recognize all derivatives on the balance sheet at fair value and
establish criteria for designation and effectiveness of hedging relationships.
Derivatives that are not hedges must be adjusted to fair value through income.
Depending upon the nature of the hedge, changes in fair value of the derivative
are either offset against the change in fair value of assets, liabilities or
firm commitments through earnings or recognized in other comprehensive income
until the hedged item is recognized in earnings. The ineffective portion of a
derivative's change in value is immediately recognized in earnings. The company
uses derivative financial instruments only to manage well-defined interest rate
and foreign currency risks. The company does not use derivatives for trading
purposes. The adoption of these statements did not have a material cumulative
effect on net income as of January 1, 2001, but did result in a $2.0 million
reduction ($1.3 million net of tax) of other comprehensive income (See notes 6
and 13).
ASSET RETIREMENT OBLIGATIONS - In June 2001, the FASB issued SFAS 143,
"Accounting for Asset Retirement Obligations," which will become effective for
the company on January 1, 2003. This statement requires entities to record the
fair value of a liability for an asset retirement obligation in the period in
which it is incurred. The amount recorded as a liability will be capitalized by
increasing the carrying amount of the related long-lived asset. Subsequent to
initial measurement, the liability is accreted to the ultimate amount
anticipated to be paid and is also adjusted for revisions to the timing or
amount of estimated cash flows. The capitalized cost is depreciated over the
useful life of the related asset. Upon settlement of the liability, an entity
either settles the
30
THE LUBRIZOL CORPORATION
obligation for its recorded amount or incurs a gain or loss upon settlement. The
company has not determined the impact, if any, that this statement will have on
its consolidated financial position or results of operations.
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS - In August 2001, the FASB issued
SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
which became effective for the company on January 1, 2002. This statement
further refines the rules for accounting for long-lived assets and measuring
impairment. The company believes the adoption of this statement will not have a
material impact on its consolidated financial position or results of operations.
Note 3 -- Inventories
2001 2000
-------- --------
Finished products............. $124,503 $124,755
Products in process........... 48,859 56,908
Raw materials................. 64,504 61,706
Supplies and engine test
parts....................... 16,744 16,764
-------- --------
$254,610 $260,133
======== ========
Inventories on the LIFO method were 27% and 22% of consolidated inventories at
December 31, 2001 and 2000, respectively. The current replacement cost of these
inventories exceeded the LIFO cost at December 31, 2001 and 2000, by $49.7
million and $54.5 million, respectively. During 2000, some inventory quantities
were reduced, resulting in a liquidation of certain LIFO inventory quantities
carried at lower costs in prior years as compared with costs at December 31,
2000. The effect of this liquidation increased income before income taxes by
$1.4 million.
Note 4 -- Short-term and Long-term Debt
2001 2000
-------- --------
Long-term debt consists of:
5.875% notes, due 2008,
including fair value
adjustment of $11,851 for
derivative hedge instruments
in 2001 ..................... $211,851 $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 2.1%
and 6.5% .................. 50,000 50,000
Marine terminal refunding
revenue bonds, at 1.7% and
4.9%, due 2018 ............ 18,375 18,375
Term loans:
Yen denominated, at 1.6% to
2.8%, due 2002 - 2003 ..... 8,728 13,253
Euro denominated, at 3.5%
to 5.0%, due 2004 - 2010 .. 372 458
-------- --------
389,326 382,086
Less current portion ........... (1,215) (3,303)
-------- --------
$388,111 $378,783
======== ========
2001 2000
-------- --------
Short-term debt consists of:
Commercial paper at weighted
average rate of 6.5% ......... $ 1,300
Other short-term debt at
weighted average rates of
1.1% and 3.6% ................ $ 7,905 $ 12,549
Current portion of long-term
debt ......................... 1,215 3,303
------- --------
$ 9,120 $ 17,152
======= ========
In May 2000, the company borrowed $18,375,000 through the issuance of marine
terminal refunding revenue bonds, the proceeds of which were used to repay
previously issued marine terminal refunding revenue bonds. The bonds have a
stated maturity of July 1, 2018, and bear interest at a variable rate which is
determined weekly by the remarketing agent (the interest rate at December 31,
2001, was 1.65%). The bonds may be put to the company by the bondholders at each
weekly interest reset date; however, the company expects that these bonds would
then be remarketed.
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, 2008, and bear interest at 5.875% per annum, payable
semi-annually 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 has debentures outstanding in 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.
The company has committed revolving credit facilities of $575 million. $175
million of these facilities expire on July 16, 2002; $50 million on June 30,
2003; and $350 million on July 17, 2006. These facilities, which were unused at
December 31, 2001, permit the company to borrow at or below the U.S. prime rate.
These facilities also permit the company to refinance beyond one year $400
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
31
NOTES CONTINUED
throughout the following year and 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 $1.2 million in 2002, $7.6 million in 2003,
$50.0 million in 2006 and $330.5 million thereafter.
The company 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%. The company also has interest rate swap
agreements, which expire in December 2008, which effectively convert the
interest on $100 million of outstanding 5.875% notes due 2008 to a variable rate
of three-month LIBOR less 159.125 basis points (see Note 13).
Interest paid, net of amounts capitalized, amounted to $23.3 million, $26.9
million and $28.8 million during 2001, 2000 and 1999, respectively. The company
capitalizes interest on qualifying capital projects. The amount of interest
capitalized during 2001, 2000 and 1999 amounted to $.2 million, $.2 million and
$.1 million, respectively.
Note 5 -- Other Balance Sheet Information
Receivables: 2001 2000
-------- --------
Customers .......................... $242,408 $261,881
Affiliates ......................... 6,664 6,408
Other .............................. 29,941 22,267
-------- --------
$279,013 $290,556
======== ========
Receivables are net of allowance for doubtful accounts of $5.3 million in 2001
and $5.7 million in 2000.
Property and Equipment - at cost: 2001 2000
---------- ----------
Land and improvements .................. $ 105,795 $ 106,009
Buildings and improvements ............. 303,924 311,683
Machinery and equipment ................ 1,190,710 1,174,254
Construction in progress ............... 47,667 49,100
---------- ----------
$1,648,096 $1,641,046
========== ==========
Depreciation and amortization of property and equipment was $84.7 million in
2001, $88.0 million in 2000 and $88.3 million in 1999.
Goodwill and Intangible Assets - net: 2001 2000
-------- --------
Goodwill ................................... $187,978 $177,686
Intangible assets .......................... 41,669 41,878
-------- --------
229,647 219,564
Less accumulated amortization .............. 63,089 48,971
-------- --------
$166,558 $170,593
======== ========
Dividends payable was $13.3 million at the end of both 2001 and 2000 and is
included in accounts payable.
Accrued Expenses and Other
Current Liabilities: 2001 2000
-------- --------
Employee compensation ........................ $ 41,728 $ 39,888
Income taxes ................................. 28,885 34,403
Taxes other than income ...................... 19,502 18,109
Special charges and acquisition
assimilation costs ........................ 150 1,886
Other ........................................ 29,996 29,234
-------- --------
$120,261 $123,520
======== ========
Noncurrent Liabilities: ...................... 2001 2000
-------- --------
Employee benefits ............................ $ 36,807 $ 39,250
Other ........................................ 18,333 13,571
-------- --------
$ 55,140 $ 52,821
======== ========
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 35,043,787 and 34,888,206
at December 31, 2001 and 2000, respectively.
The company has a shareholder rights plan under which one right to buy one-half
common share has been distributed for 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 stock without complying with the requirements of the
company's articles of incorporation. The rights would entitle shareholders,
other than this 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.
32
THE LUBRIZOL CORPORATION
Accumulated other comprehensive income (loss) shown in the consolidated
statements of shareholders' equity at December 31, 2001, 2000 and 1999 is
comprised of the following:
Foreign Accumulated
Currency Unrealized Pension Plan Other
Translation Losses Interest Minimum Comprehensive
Adjustment Rate Swaps Liability Loss
-------------------------------------------------------------
December 31, 1998 ........................................ $(25,527) $(25,527)
Other Comprehensive Income:
Pre-tax ............................................... (27,923) $ (838) (28,761)
Tax benefit ........................................... 45 293 338
-------- -------- --------
Total ................................................. (27,878) (545) (28,423)
-------- -------- --------
December 31, 1999 ........................................ (53,405) (545) (53,950)
-------- -------- --------
Other Comprehensive Income:
Pre-tax ............................................... (26,543) (738) (27,281)
Tax benefit ........................................... 300 305 605
-------- -------- --------
Total ................................................. (26,243) (433) (26,676)
-------- -------- --------
December 31, 2000 ........................................ (79,648) (978) (80,626)
-------- -------- --------
Other Comprehensive Income:
Pre-tax cumulative effect of accounting
change - SFAS 133...................................... (2,021) (2,021)
Pre-tax ................................................. (17,022) (1,715) (538) (19,275)
Tax benefit ............................................. 528 1,308 274 2,110
-------- -------- -------- --------
Total ................................................. (16,494) (2,428) (264) (19,186)
-------- -------- -------- --------
December 31, 2001 ........................................ $(96,142) $ (2,428) $ (1,242) $(99,812)
======== ======== ======== ========
- -------------------------------------------------------------------------------
NOTE 7 -- OTHER INCOME (EXPENSE) - NET
2001 2000 1999
-------- -------- --------
Equity earnings of noncon-
solidated companies ... $ 2,196 $ 1,483 $ 5,735
Amortization of goodwill
and intangible
assets................ (14,118) (12,847) (11,430)
Currency exchange/
transaction loss ...... (3,041) (1,528) (3,108)
Other - net .............. (113) (1,170) 2,099
-------- -------- --------
$(15,076) $(14,062) $ (6,704)
======== ======== ========
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:
2001 2000 1999
-------- -------- --------
United States ... $ 79,576 $ 94,016 $113,904
Foreign ......... 60,373 76,332 81,446
-------- -------- --------
Total ........... $139,949 $170,348 $195,350
======== ======== ========
The provision for income taxes consists of the following:
2001 2000 1999
-------- -------- --------
Current:
United States... $ 25,891 $ 14,679 $ 46,983
Foreign ........ 22,334 29,861 24,063
-------- -------- --------
48,225 44,540 71,046
-------- -------- --------
Deferred:
United States... (4,992) 6,613 (3,467)
Foreign ........ 2,600 1,186 4,779
-------- -------- --------
(2,392) 7,799 1,312
-------- -------- --------
Total .......... $ 45,833 $ 52,339 $ 72,358
======== ======== ========
The United States tax provision includes the U.S. tax on foreign income
distributed to the company. The 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:
2001 2000 1999
-------- -------- --------
Tax at statutory rate of
35%....................... $ 48,982 $ 59,622 $ 68,373
State and local taxes ....... 1,230 1,081 2,815
Foreign sales corporation
earnings ................. (4,223) (4,767) (1,923)
Technology donation ......... (6,027)
Foreign deferred tax
valuation allowance ...... 124 (974) (3,904)
Other foreign tax
differences............... 1,034 3,388 3,954
Equity income ............... (3,857) (267) (875)
Other - net ................. 2,543 283 3,918
-------- -------- --------
Provision for income taxes .. $ 45,833 $ 52,339 $ 72,358
======== ======== ========
33
NOTES CONTINUED
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and liabilities at December 31 are as follows:
2001 2000
--------- ---------
Deferred tax assets:
Accrued compensation
and benefits .................. $ 46,595 $ 46,489
Intercompany profit in
inventory...................... 9,267 11,163
Net operating losses
carried forward ............... 6,151 7,687
Other ........................... 9,436 7,613
--------- ---------
Total gross deferred tax assets .... 71,449 72,952
Less valuation allowance ........... (4,303) (4,179)
--------- ---------
Net deferred tax assets ............ 67,146 68,773
--------- ---------
Deferred tax liabilities:
Depreciation and other
basis differences ............. 91,580 95,049
Undistributed foreign
equity income ................. 4,501 6,662
Inventory basis differences ..... 177 2,227
Other ........................... 7,545 5,954
--------- ---------
Total gross deferred tax
liabilities.................... 103,803 109,892
--------- ---------
Net deferred tax liabilities ....... $ 36,657 $ 41,119
========= =========
At December 31, 2001, certain foreign subsidiaries had net operating loss
carryforwards of $20.1 million for income tax purposes, of which $1.2 million
expire in years 2001 through 2011 and $18.9 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, 2001,
2000 and 1999, was an increase of $0.1 million, a decrease of $1.0 million and a
decrease of $3.9 million, respectively.
U.S. income taxes and 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
these earnings was approximately $409.6 million at December 31, 2001.
Determination of the net amount of unrecognized U.S. income tax with respect to
these earnings is not practicable.
Income taxes paid during 2001, 2000 and 1999 were $49.7 million, $36.4 million
and $59.1 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. Most of the
company's full-time employees in the U.S. become eligible for health care
benefits after attaining specified years of service and age 55 at retirement.
Full-time employees who retire before January 1, 2003 are also eligible for life
insurance benefits. Participants contribute a portion of the cost of these
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:
2001 2000 1999
-------- -------- --------
Service cost - benefits
earned during period .. $ 11,673 $ 10,379 $ 11,843
Interest cost on projected
benefit obligation .... 20,425 17,972 17,589
Expected return on
plan assets ........... (26,860) (25,809) (25,873)
Amortization of prior
service costs ......... 3,127 2,124 1,771
Amortization of initial
net asset ............. (1,218) (1,106) (1,264)
Recognized net actuarial
(gain) loss ........... (1,045) (2,370) 507
Settlement (gain) loss ... 142 (5,474)
-------- -------- --------
Net periodic pension
cost................... $ 6,244 $ 1,190 $ (901)
======== ======== ========
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 $9.6 million in 2001, $7.9 million in 2000 and
$9.0 million in 1999.
As discussed in Note 15, the company initiated a cost reduction program and
recognized special termination benefits of $11.6 million in 1999, comprised of
$3.1 million and $8.5 million included in the special charges recognized in the
first and third quarters of 1999, respectively. The $8.5 million of special
termination benefits includes $3.2 million and $1.5 million of special
termination benefits that were recognized as part of the U.S. pension benefit
obligation in 2000 and 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.
34
THE LUBRIZOL CORPORATION
Net non-pension postretirement benefit cost consists of:
2001 2000 1999
------- ------- -------
Service cost - benefits earned during period......................... $ 1,569 $ 1,326 $ 1,468
Interest cost on accumulated benefit obligation...................... 6,387 5,387 4,728
Amortization of prior service costs.................................. (4,501) (3,173) (3,218)
Recognized net actuarial loss........................................ 944 7 23
Curtailment gain..................................................... (1,358)
Settlement loss...................................................... 853
------- ------- -------
Net non-pension postretirement benefits cost......................... $ 3,894 $ 3,547 $ 3,001
======= ======= =======
The change in benefit obligation and plan assets for 2001 and 2000 and the
amounts recognized in the consolidated balance sheets at December 31 of the
company's defined benefit pension and non-pension postretirement plans are as
follows:
Pension Plans Other Benefits
------------------------- --------------------------
2001 2000 2001 2000
-------- -------- --------- ---------
Change in benefit obligation:
Benefit obligation at beginning of year.............. $294,835 $264,877 $ 74,659 $71,500
Service cost...................................... 11,673 10,379 1,569 1,326
Interest cost..................................... 20,425 17,972 6,387 5,387
Plan participants' contributions.................. 202 114
Actuarial loss.................................... 15,269 961 42,846 426
Currency exchange rate change..................... (5,147) (9,165) (114) (96)
Amendments........................................ 2,592 21,368 (26,312) 504
Acquisitions...................................... 2,110 719
Curtailments...................................... (1,600)
Special termination benefits...................... 3,226
Benefits paid..................................... (27,890) (17,007) (6,408) (4,388)
-------- -------- --------- ---------
Benefit obligation at end of year.................... 311,959 294,835 91,746 74,659
-------- -------- --------- ---------
Change in plan assets:
Fair value of plan assets at beginning of year.... 319,635 324,534
Actual return on plan assets.................... (21,145) 13,427
Acquisition..................................... 3,130
Employer contributions.......................... 4,400 4,255 6,408 4,388
Plan participants' contributions................ 202 114
Currency exchange rate change................... (1,488) (8,818)
Benefits paid................................... (27,890) (17,007) (6,408) (4,388)
-------- -------- --------- ---------
Fair value of plan assets at end of year.......... 273,714 319,635
-------- -------- --------- ---------
Plan assets greater (less) than the benefit
obligation........................................ (38,245) 24,800 (91,746) (74,659)
Unrecognized net loss (gain)...................... 24,138 37,419) 35,755 (5,083)
Unrecognized net transition obligation (asset).... (1,488) (1,839)
Unrecognized prior service cost................... 26,847 26,509 (45,556) (23,725)
-------- -------- --------- ---------
Net amount recognized................................ $ 11,252 $ 12,051 $(101,547) $(103,467)
======== ======== ========= =========
Amount recognized in the statement of financial
position consists of:
Prepaid benefit cost.............................. $ 27,934 $ 25,031
Accrued benefit liability......................... (20,361) (16,365) $(101,547) $(103,467)
Accumulated other comprehensive income............ 2,114 1,576
Intangible asset.................................. 1,565 1,809
-------- -------- --------- ---------
Net amount recognized................................ $ 11,252 $ 12,051 $(101,547) $(103,467)
======== ======== ========= =========
35
NOTES CONTINUED
<Table>
<Caption>
Pension Plans Other Benefits
------------------- -------------------
2001 2000 2001 2000
---- ---- ---- ----
The weighted average assumptions as of December 31:
Discount rate for determining funded status............. 6.67% 7.00% 7.31% 7.69%
Expected return on plan assets.......................... 8.45% 8.55%
Rate of compensation increase........................... 3.82% 3.93%
</Table>
The projected benefit obligation and fair value of plan assets for pension plans
with projected benefit obligations in excess of plan assets were $304.2 million
and $265.6 million, respectively, as of December 31, 2001, and $30.0 million and
$9.4 million, respectively, as of December 31, 2000. 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 $7.1
million, respectively, as of December 31, 2001, and $23.2 million and $7.9
million, respectively, as of December 31, 2000.
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, 2001, was 8.82%, (5.99% at December
31, 2000), with subsequent annual decrements to an ultimate trend rate of 4.95%
by 2009. The assumed health care cost trend rates have a significant effect on
the amounts reported for the health care plans. 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, 2001:
One-Percentage-Point
-------------------------
Increase Decrease
-------- --------
Effect on postretirement
benefit obligation....................... $13,228 $(11,105)
Effect on total service and interest
cost components.......................... $ 1,681 $ (1,281)
- -------------------------------------------------------------------------------
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 $14.0 million in 2001, $16.2 million in 2000 and
$18.5 million in 1999. Future minimum rental commitments under operating leases
having initial or remaining noncancelable lease terms exceeding one year are
$12.5 million in 2002, $9.1 million in 2003, $6.5 million in 2004, $5.9 million
in 2005, $3.3 million in 2006 and $12.0 million thereafter. Minimum rental
commitments are net of estimated credits for railroad usage of $2.3 million in
2002, $1.8 million in 2003, $1.5 million in 2004, $1.3 million in 2005, $.7
million in 2006 and $.5 million thereafter.
NOTE 11 -- ACQUISITIONS
In 2001, the company spent $14.7 million on an acquisition to purchase ROSS
Chem, Inc., a manufacturer and supplier of antifoam and defoaming agents, with
annual revenues of $10.0 million, that expanded the company's product lines in
metalworking and paints, coatings and inks. Also in 2001, the company dissolved
the joint venture with GE Transportation Systems and replaced the joint venture
with separate cross-licensing agreements.
In 2000, the company acquired certain assets of a metalworking additive company
with 1999 revenues of approximately $20 million; acquired an additional 10%
interest in its India joint venture, bringing the ownership interest up to 50%;
and invested in a joint venture with GE Transportation Systems relating to
products and services for diesel engine fluids. The company's aggregate
investment in these acquisitions was approximately $41 million.
NOTE 12 -- BUSINESS SEGMENTS AND GEOGRAPHIC REPORTING
The company aggregates its product lines into two principal operating segments:
fluid technologies for transportation and fluid technologies for industry. Fluid
technologies for transportation is comprised of additives for lubricating engine
oils, such as for gasoline, diesel, marine and stationary gas engines and
additive components; 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 fluid technologies for transportation
product lines are generally produced in shared manufacturing facilities and sold
largely to a common customer base. Fluid technologies 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.
36
The following table presents a summary of the company's reportable segments for
the years ended December 31:
2001 2000 1999
----------- ----------- -----------
Fluid technologies for
transportation:
Revenues from
external customers ........................... $ 1,531,542 $ 1,462,601 $ 1,479,331
Equity earnings (loss) ......................... 4,091 3,064 5,288
Goodwill and intangibles
amortization ................................. 5,595 5,290 5,100
Segment contribution
income ....................................... 288,385 277,879 345,276
Operating profit
before tax ................................... 152,474 141,609 193,094
Segment total assets ........................... 1,084,084 1,132,782 1,116,680
Capital expenditures ........................... 60,304 78,887 58,123
Depreciation ................................... 78,208 81,769 82,129
Fluid technologies for industry:
Revenues from external
customers .................................... $ 313,102 $ 313,179 $ 300,998
Equity earnings (loss) ......................... (1,895) (1,581) 447
Goodwill and intangibles
amortization ................................. 8,523 7,557 6,330
Segment contribution
income ....................................... 23,605 39,695 45,827
Operating profit
before tax ................................... 5,729 23,118 26,041
Segment total assets ........................... 237,259 249,782 247,779
Capital expenditures ........................... 6,012 6,870 6,749
Depreciation ................................... 6,506 6,218 6,161
Reconciliation to consolidated
income before tax:
Segment operating profit
before tax ................................... $ 158,203 $ 164,727 $ 219,135
Gain from litigation
settlements .................................. 19,395 17,626
Special (charges) credits ...................... 4,484 (19,569)
Interest expense - net ......................... (18,254) (18,258) (21,842)
----------- ----------- -----------
Consolidated income
before tax ................................... $ 139,949 $ 170,348 $ 195,350
=========== =========== ===========
Revenues from external customers
by product group:
Engine oil additives ........................... $ 1,019,465 $ 944,538 $ 942,618
Driveline oil additives ........................ 407,514 401,267 414,929
Fuel additives and
refinery oil additives ....................... 74,730 90,262 105,406
Additive components ............................ 29,833 26,534 16,378
----------- ----------- -----------
Fluid technologies for
transportation ............................. 1,531,542 1,462,601 1,479,331
----------- ----------- -----------
Industrial additives ........................... 171,566 173,262 158,147
Performance chemicals .......................... 117,850 112,142 108,692
Performance systems ............................ 23,686 27,775 34,159
----------- ----------- -----------
Fluid technologies
for industry ............................... 313,102 313,179 300,998
----------- ----------- -----------
Total revenues from
external customers ............................. $ 1,844,644 $ 1,775,780 $ 1,780,329
=========== =========== ===========
In order to conform amounts to current-year classifications, prior-year amounts
have been restated to reflect reclassifications of products between fluid
technologies for transportation and fluid technologies for industry operating
segments. Segment results reflect the exclusion for internal management
reporting purposes, effective January 1, 2000, of excess production capacity
from product costs (this change has no effect on segment operating profit before
tax).
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:
2001 2000 1999
---------- ---------- ----------
United States ......................... $ 740,786 $ 692,720 $ 684,037
Other North American................... 82,962 66,478 60,994
Europe, Middle East ................... 551,691 533,049 583,475
Asia-Pacific .......................... 337,185 347,658 324,349
Latin America ......................... 132,020 135,875 127,474
---------- ---------- ----------
Total revenues from
external customers.................. $1,844,644 $1,775,780 $1,780,329
========== ========== ==========
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 53% of consolidated sales in 2001, 48% of consolidated sales in
2000 and 46% of consolidated sales in 1999. In 2001, there was no single
customer that accounted for more than 10% of revenues. The company's largest
single customer, including its affiliated entities, predominantly within fluid
technologies for transportation segment, accounted for revenues of $185.3
million in 2000 and $214.4 million in 1999.
The table below presents a reconciliation of segment total assets to
consolidated total assets for the years ended December 31:
2001 2000 1999
---------- ---------- ----------
Total segment assets ................... $1,321,343 $1,382,564 $1,364,459
Corporate assets ....................... 340,976 276,926 317,895
---------- ---------- ----------
Total consolidated assets............... $1,662,319 $1,659,490 $1,682,354
========== ========== ==========
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.
37
NOTES CONTINUED
The company's principal long-lived assets are located in the following countries
at December 31:
2001 2000
-------- --------
United States........................... $532,827 $535,909
France.................................. 66,638 77,806
England................................. 106,008 114,174
All other............................... 105,366 119,946
-------- --------
Total long-lived assets................. $810,839 $847,835
======== ========
Net income of non-U.S. subsidiaries was $35 million in 2001, $45 million in 2000
and $53 million in 1999; and dividends received from these subsidiaries were $55
million, $31 million and $22 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, 2001 approximates $391.6 million
compared with the carrying value of $397.2 million. 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.
Effective January 1, 2001, the company adopted Statement of Financial Accounting
Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities"
(SFAS 133), as amended. SFAS 133 requires the company to recognize all
derivatives on the balance sheet at fair value and establishes criteria for
designation and effectiveness of hedging relationships. Derivatives that are not
hedges must be adjusted to fair value through income. Depending upon the nature
of the hedge, changes in fair value of the derivative are either offset against
the change in fair value of assets, liabilities or firm commitments through
earnings or recognized in other comprehensive income until the hedged item is
recognized in earnings. The ineffective portion of a derivative's change in
value is immediately recognized in earnings. The adoption of SFAS 133 did not
have a material cumulative effect on net income as of January 1, 2001, but did
result in a $2 million reduction ($1.3 million net of tax) of other
comprehensive income.
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. These contracts generally relate to transactions
with maturities of less than one year. The maximum amount of foreign currency
forward contracts outstanding at any one time was $17.9 million in 2001, $24.3
million in 2000 and $18.9 million in 1999. At December 31, 2001, the company had
short-term forward contracts to sell currencies at various dates during 2002 for
$4.9 million. These forward contracts are not designated as hedges. Any changes
in the fair value of these contracts are recorded in other income. The fair
value of these instruments at December 31, 2001 and the related adjustment
recorded in other income was an unrealized loss of $.2 million.
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. 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.
At December 31, 2001, the company had interest rate swap agreements to convert
existing fixed-rate debt to variable rates. The fair value of these swaps was an
unrealized gain of $11.9 million. These swaps are designated as fair value
hedges of underlying fixed rate debt obligations and are recorded as an increase
in noncurrent assets and long-term debt. These interest rate swaps qualify for
the short-cut method for assessing hedge effectiveness per SFAS 133. Changes in
fair value of the interest rate swaps are offset by the change in fair value of
the underlying debt. As a result, there was no impact to earnings in 2001 due to
hedge ineffectiveness.
At December 31, 2001, the company had interest rate swap agreements to convert
existing variable rate debt to fixed rates. The fair value of these swaps was an
unrealized loss of $4.8 million. These swaps are designated as cash flow hedges
of underlying variable rate debt obligations and are recorded as a noncurrent
liability. The adjustment to record the net change in fair value during 2001 of
$3.7 million ($2.4 million net of tax) unrealized loss was recorded in other
comprehensive income. This includes the transition adjustment of $2.0 million
($1.3 million net of tax) as of January 1, 2001. Ineffectiveness was determined
to be immaterial in 2001. The company does not expect any significant portion of
these existing losses to be reclassified into earnings within the next 12
months.
38
THE LUBRIZOL CORPORATION
NOTE 14 -- STOCK COMPENSATION PLANS
The 1991 Stock Incentive Plan provides for the 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 to be "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 once per year for options
granted prior to March 28, 2000 under the 1991 Plan; and may be granted at the
discretion of the administering committee under the 1985 Employee Stock Option
Plan and for options granted on or after March 28, 2000 under the 1991 Plan. The
1991 Plan generally supersedes the 1985 Plan, although options outstanding under
the 1985 Plan remain exercisable until their expiration dates. The option price
for stock options under the 1985 Plan is the fair market value of the shares on
the date of grant. The option price for stock options 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 2,500
common shares in 2001 and 2000 and 2,000 common shares in 1999, with terms
generally comparable to employee stock options. In 2001, the 1991 Plan provided
for the grant to each outside director of a one-time additional option to
purchase 2,500 common shares as an incentive relating to Lubrizol's five-year
strategic initiatives.
Under the 1991 Stock Incentive Plan, the company has granted performance share
stock awards to certain executive officers. 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 on March 24, 2003, 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 $30.40 per
share (for 750 awards) in 2001, $28.06 per share (for 3,000 awards) and $25.38
(for 1,500 awards) in 2000. No awards were granted in 1999. 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 approximately $50,000 in 2001, $.1 million
in 2000 and $.8 million in 1999.
Under the deferred stock compensation plan for outside directors, each
nonemployee director receives 500 share units on each October 1 and is credited
with additional share units for quarterly dividends paid on the company's
shares. When a participant ceases to be a director, the company issues shares
equal to the number of share units in the director's account. The company has
allocated to nonemployee directors 6,028, 6,210 and 5,932 share units under this
plan in 2001, 2000 and 1999, respectively. Director fee expense recognized for
share units was approximately $.2 million in 2001, $.1 million in 2000 and $.2
million in 1999. At December 31, 2001, 37,229 share units for nonemployee
directors were outstanding.
Under the deferred compensation plan for executive officers, participants may
elect to defer any amount of their variable pay. Deferred amounts are converted
into share units based on the current market price of the company's shares,
which are then multiplied by 1.25. Additional share units are credited for
quarterly dividends paid on the company's shares. At the end of the deferral
period, which is at least three years, the company issues shares equal to the
number of share units in the participant's account. The company has allocated to
executive officers 16,628, 26,787 and 862 share units under this plan in 2001,
2000 and 1999, respectively. Compensation costs recognized for share units were
approximately $.5 million in 2001, $.7 million in 2000 and $20,000 in 1999. At
December 31, 2001, 54,925 share units for executive officers were outstanding.
Accounting principles generally accepted in the United States of America
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 use of intrinsic-value
accounting. The company 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, excluding the performance share stock awards, the company's
net income would have been reduced by $6.0 million in 2001, $3.5 million in 2000
and $2.5 million in 1999 with a corresponding reduction in net income per share
of $.12 in 2001, $.07 in 2000 and $.05 in 1999.
39
NOTES CONTINUED
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:
2001 2000 1999
---- ---- ----
1985 Plan:
Risk-free interest rate............. 6.5%
Dividend yield...................... 3.4%
Volatility.......................... 23%
Expected life (years)............... .5
1991 Plan:
Risk-free interest rate............. 5.1% 6.0% 6.4%
Dividend yield...................... 2.9% 4.0% 3.4%
Volatility.......................... 25% 27% 24%
Expected life (years)............... 9.7 9.8 9.9
The fair value per share of the performance share stock awards granted in 2001
was $28.69, using the following assumptions: risk-free interest rate of 3.15%;
dividend yield of 2.9%; volatility of 25%; and an expected life of two years.
The fair value per share of the performance share stock awards granted in 2000
was $24.90 (for 3,000 awards) and $22.52 (for 1,500 awards), using the following
assumptions: risk-free interest rate of 6.49%; dividend yield of 4.0%;
volatility of 27%; and an expected life of three years. There was no activity
for 1999. Dividends do not accumulate on performance share stock awards.
Information regarding these option plans, excluding the performance share stock
awards, follows:
Weighted-
Average
Shares Exercise Price
--------- --------------
Outstanding, January 1, 2001................... 4,624,135 $30.68
Granted........................................ 1,461,945 30.39
Exercised...................................... (911,696) 28.05
Forfeited...................................... (347,118) 35.64
---------
Outstanding, December 31, 2001................. 4,827,266 $30.74
========= ======
Options exercisable,
December 31, 2001........................... 2,850,184 $31.73
========= ======
Weighted-average fair value of
options granted during the year............. $ 8.69
======
Weighted-
Average
Shares Exercise Price
--------- --------------
Outstanding, January 1, 2000.................. 3,968,742 $31.06
Granted....................................... 816,136 28.02
Exercised..................................... (77,898) 20.41
Forfeited..................................... (82,845) 32.08
---------
Outstanding, December 31, 2000................ 4,624,135 $30.68
========= ======
Options exercisable,
December 31, 2000.......................... 3,415,820 $31.87
========= ======
Weighted-average fair value of
options granted during the year............ $ 7.49
======
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
======
Information regarding the performance share stock awards follows:
Shares
------
Outstanding, January 1, 2001.................. 65,500
Granted....................................... 750
------
Outstanding, December 31, 2001................ 66,250
======
Outstanding, January 1, 2000.................. 67,000
Granted....................................... 4,500
Forfeited..................................... (3,043)
Common Shares Issued.......................... (2,957)
------
Outstanding, December 31, 2000................ 65,500
======
Outstanding, January 1, 1999.................. 67,166
Forfeited..................................... (166)
------
Outstanding, December 31, 1999................ 67,000
======
- -------------------------------------------------------------------------------
The following table summarizes information about stock options outstanding,
excluding the performance share stock awards, at December 31, 2001:
Options Outstanding Options Exercisable
------------------------------------------------- ---------------------------------
Number Weighted-Average Weighted- Number Weighted-
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices at 12/31/01 Contractual Life Exercise Price at 12/31/01 Exercise Price
----------- ---------------- -------------- ------------ --------------
$19 - $25.......... 379,104 7.1 Years 21.35 257,597 21.35
25 - 31.......... 2,963,906 7.6 29.49 1,114,331 28.95
31 - 38.......... 1,477,832 3.5 35.62 1,471,832 35.62
38 - 45.......... 6,424 5.9 38.46 6,424 38.46
--------- ---------
4,827,266 6.3 $30.74 2,850,184 $31.73
========= === ====== ========= ======
40
THE LUBRIZOL CORPORATION
NOTE 15 -- SPECIAL CHARGES
In January 1998, the company initiated a series of steps to reduce costs and
improve its worldwide operating structure and executed these steps in two
programs over a period of approximately two years. The first program, 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 was 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 program.
As adjusted, the first 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 taken out of service.
Cash expenditures of approximately $.4 million were made in 2000 and $14.7
million in 1999 related to the cost reduction program.
The second program began in the third quarter of 1999 and involved primarily the
downsizing of the company's Painesville, Ohio, manufacturing plant. This
resulted in the additional reduction of approximately 5% of the company's
workforce, or 187 employees, and the shutdown of 20 of Painesville's 36
production systems. Approximately 23% of the workforce reduction and shutdown of
12 of the production systems occurred during 1999. The remainder of the
workforce reduction and production system shutdowns was completed in 2000.
As adjusted, the second program included workforce reduction cost estimated at
$5.5 million and other exit costs estimated at $10.8 million, including $7.4
million related to asset impairments for production units to be taken out of
service. Cash expenditures of approximately $1.8 million, $.9 million and $1.3
million were made in 2001, 2000 and 1999, respectively, related to the second
cost reduction program. Additionally, $3.2 million and $1.5 million of special
termination benefits were recognized as part of the U.S. pension benefit
obligation in 2000 and 1999, respectively (see Note 9). Approximately $.2
million remains as an accrued liability at December 31, 2001, for equipment
dismantling.
In the first quarter of 1999, the company recognized an expense of $3.1 million,
related to the first program to reflect an adjustment 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 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 program principally to reflect a gain
related to the settlement of pension obligations for workforce reductions (see
Note 9). After-tax, this adjustment increased net income by $2.5 million or $.05
per share.
In the second quarter of 2000, the company recorded an adjustment of $2.6
million to reduce the amount of the special charge related to the second
program, principally because the cost of workforce reductions at the company's
Painesville facility was less than originally anticipated. After-tax this
adjustment increased net income by $1.7 million or $.03 per share. In the fourth
quarter of 2000, the company recorded a pre-tax adjustment of $1.9 million ($1.2
million after-tax or $.02 per share), to further reduce the amount of the
special charge due to lower-than-anticipated equipment dismantling costs ($1.5
million) and lower workforce reduction costs ($.4 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 October 12, 2000, the company reached a settlement of all pending patent
litigation with Imperial Oil Limited (Imperial), a Canadian affiliate of Exxon
Mobil Corporation. Under the settlement agreement, Lubrizol received cash of
$25.0 million in October 2000. After deducting related expenses, this settlement
increased pre-tax income by $19.4 million in 2000.
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.
The company is party to lawsuits, threatened lawsuits and other claims arising
out of the normal course of business. Management is of the opinion that any
liabilities that may result are adequately covered by insurance, or to the
extent not covered by insurance, are adequately accrued for at December 31,
2001, or would not be significant in relation to the company's financial
position at December 31, 2001, or its results of operations for the year then
ended.
41
THE LUBRIZOL CORPORATION
HISTORICAL SUMMARY
(In Millions, Except Shareholders, Employees and Per Share Data)
2001 2000 1999 1998
- ----------------------------------------------------------------------------------------------------------------------
OPERATING RESULTS:
Revenues....................................... $1,844.6 $1,775.8 $1,780.3 $1,650.2
Total cost and expenses........................ 1,671.4 1,597.0 1,554.5 1,496.3
Other income (charges)......................... (15.1) (8.4) (30.5) (35.0)
Net income..................................... 94.1 118.0 123.0 71.2
- Before unusual items and
accounting changes............................. 94.1 103.1 125.3 86.5
Net income per share........................... 1.84 2.22 2.25 1.27
- Before unusual items and
accounting changes............................. 1.84 1.94 2.30 1.55
FINANCIAL RATIOS:
Gross profit percentage........................ 27.4 27.8 30.9 29.2
Percent of revenues:
Selling and administrative expenses......... 9.6 9.5 10.2 10.9
Research and testing expenses............... 8.6 8.5 8.2 9.1
Return on average shareholders' equity (%)..... 12.3 15.3 15.8 9.0
- Before unusual items and
accounting changes (%)......................... 12.3 13.4 16.1 10.9
Debt to capitalization (%)..................... 33.9 34.5 33.8 35.8
Current ratio.................................. 2.9 2.6 2.5 2.5
OTHER INFORMATION:
Dividends declared per share................... $1.04 $1.04 $1.04 $1.04
Average common shares outstanding.............. 51.2 53.1 54.6 55.9
Capital expenditures........................... $66.3 $85.8 $64.9 $93.4
Depreciation expense........................... 84.7 88.0 88.3 79.7
At Year End:
Total assets................................ $1,662.3 $1,659.5 $1,682.4 $1,643.2
Total debt.................................. 397.2 395.9 403.0 429.3
Total shareholders' equity.................. 773.2 752.3 790.1 769.1
Shareholders' equity per share.............. 15.10 14.66 14.50 14.10
Common share price.......................... 35.09 25.75 30.88 25.69
Number of shareholders...................... 4,335 4,681 5,126 5,609
Number of employees......................... 4,530 4,390 4,074 4,324
Unusual items include special charges and credits for restructuring and for
write-off of purchased technology, gains on investments, litigation settlement
gains and accounting changes.
In 2000 the company began reporting shipping fees and shipping costs gross in
net sales and cost of sales, respectively. The company had previously netted
shipping fees against shipping costs in cost of sales. This change has no effect
on the dollar amount of the company's gross profit or net income. Revenues,
total cost and expenses, and gross profit percentage for 1996-1999 have been
reclassified to conform with current period classification.
42
THE LUBRIZOL CORPORATION
1997 1996 1995 1994 1993 1992 1991
- ---------------------------------------------------------------------------------------------------------------------------
$1,706.9 $1,629.2 $1,663.6 $1,599.0 $1,525.5 $1,552.2 $1,476.3
1,474.6 1,434.6 1,478.0 1,397.0 1,362.2 1,390.5 1,308.7
(1.1) 56.1 40.0 49.4 (43.6) 15.4 10.5
154.9 169.8 151.6 175.6 45.6 124.6 123.7
154.9 135.2 126.6 148.8 113.5 124.6 123.7
2.68 2.80 2.37 2.67 .67 1.81 1.79
2.68 2.23 1.98 2.26 1.67 1.81 1.79
32.1 31.4 31.5 32.7 32.0 31.7 32.4
10.0 9.7 9.8 10.0 10.4 11.7 11.7
8.6 9.9 10.8 10.3 11.2 10.0 9.8
19.0 20.4 18.0 22.5 5.9 15.4 16.2
19.0 16.2 15.1 19.0 14.6 15.4 16.2
21.3 19.5 22.5 16.8 8.7 5.6 7.9
2.5 2.6 2.4 2.5 2.5 2.9 2.7
$1.01 $.97 $.93 $.89 $.85 $.81 $.77
57.8 60.7 63.8 65.7 67.7 69.0 69.3
$100.7 $94.3 $189.3 $160.5 $127.9 $95.8 $82.4
82.7 78.7 71.8 63.9 59.6 58.4 54.6
$1,462.3 $1,402.1 $1,492.0 $1,394.4 $1,182.6 $1,127.1 $1,171.7
220.3 198.5 247.1 167.9 69.6 48.4 67.8
815.4 819.4 849.0 832.0 732.2 819.4 794.5
14.31 14.00 13.48 12.83 11.00 11.97 11.51
36.88 31.00 27.75 33.88 34.13 27.25 28.25
5,661 5,764 6,304 6,494 6,616 6,822 6,767
4,291 4,358 4,601 4,520 4,613 4,609 5,299
43