UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ________
Commission File Number 1-5263
THE LUBRIZOL CORPORATION
(Exact name of registrant as specified in its charter)
Ohio 34-0367600
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Identification No.)
29400 Lakeland Boulevard
Wickliffe, Ohio 44092-2298
(Address of principal executive offices)
(Zip Code)
(440) 943-4200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ]
Number of the registrant's common shares, without par value, outstanding, as of
September 30, 2003: 51,557,528.
PART I. FINANCIAL INFORMATION
Item 1 Financial Statements
THE LUBRIZOL CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
(In Thousands of Dollars) 2003 2002
------------------------------------------------------ ------------- ------------
ASSETS
Cash and short-term investments ...................... $ 215,158 $ 266,428
Receivables .......................................... 331,015 295,508
Inventories:
Finished products .................................. 153,832 148,478
Products in process ................................ 80,194 58,643
Raw materials ...................................... 80,020 76,779
Supplies and engine test parts ..................... 19,727 19,068
------------ ------------
333,773 302,968
------------ ------------
Other current assets ................................. 39,795 44,875
------------ ------------
Total current assets ............. 919,741 909,779
Property and equipment - net ......................... 676,554 679,155
Goodwill ............................................. 205,524 168,352
Intangible assets - net .............................. 63,827 43,162
Investments in nonconsolidated companies ............. 6,689 6,690
Other assets ......................................... 51,088 52,999
------------ ------------
TOTAL ....................... $ 1,923,423 $ 1,860,137
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Short-term debt and current portion of long-term debt. $ 11,031 $ 17,046
Accounts payable ..................................... 149,639 140,424
Accrued expenses and other current liabilities ....... 132,969 150,271
------------ ------------
Total current liabilities ........ 293,639 307,741
------------ ------------
Long-term debt ....................................... 382,755 384,845
Postretirement health care obligation ................ 97,935 96,495
Noncurrent liabilities ............................... 100,083 92,655
Deferred income taxes ................................ 60,024 55,761
------------ ------------
Total liabilities ................ 934,436 937,497
------------ ------------
Minority interest in consolidated companies .......... 52,792 53,388
Contingencies and commitments
Shareholders' equity:
Preferred stock without par value - authorized
and unissued:
Serial Preferred Stock - 2,000,000 shares
Serial Preference Shares - 25,000,000 shares
Common shares without par value:
Authorized 120,000,000 shares
Outstanding- 51,557,528 shares as of September 30,
2003 after deducting 34,638,366 treasury
shares, 51,457,642 shares as of December 31,
2002 after deducting 34,738,252 treasury shares 122,805 118,985
Retained earnings .................................. 867,834 828,318
Accumulated other comprehensive loss ............... (54,444) (78,051)
------------ ------------
Total shareholders' equity ....... 936,195 869,252
------------ ------------
TOTAL ....................... $ 1,923,423 $ 1,860,137
============ ============
Amounts shown are unaudited.
See accompanying notes to the financial statements.
Page 2
THE LUBRIZOL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three Month Period Nine Month Period
Ended September 30 Ended September 30
--------------------------- ---------------------------
(In Thousands Except Per Share Data) 2003 2002 2003 2002
------------------------------------------- ------------ ------------ ------------ ------------
Net sales ................................. $ 509,107 $ 509,427 $ 1,530,383 $ 1,483,645
Royalties and other revenues .............. 760 876 2,374 2,554
------------ ------------ ------------ ------------
Total revenues .................. 509,867 510,303 1,532,757 1,486,199
Cost of sales ............................. 377,486 358,850 1,118,360 1,051,830
Selling and administrative expenses ....... 48,647 49,530 149,613 146,700
Research, testing and development expenses. 41,022 42,774 123,265 124,674
Restructuring charge ...................... 409 - 7,447 -
------------ ------------ ------------ ------------
Total cost and expenses ......... 467,564 451,154 1,398,685 1,323,204
Other income (expense) - net .............. (2,573) (3,042) (2,906) (7,084)
Interest income ........................... 913 1,796 3,015 5,005
Interest expense .......................... (6,611) (5,791) (18,669) (16,941)
------------ ------------ ------------ ------------
Income before income taxes and cumulative
effect of change in accounting principle.. 34,032 52,112 115,512 143,975
Provision for income taxes ................ 9,734 15,634 35,808 43,193
------------ ------------ ------------ ------------
Income before cumulative effect of change
in accounting principle .................. 24,298 36,478 79,704 100,782
Cumulative effect of change in accounting
principle ................................ - - - (7,785)
------------ ------------ ------------ ------------
Net income ................................ $ 24,298 $ 36,478 $ 79,704 $ 92,997
============ ============ ============ ============
Net income per share:
Income before cumulative effect of change
in accounting principle ................. $ 0.47 $ 0.71 $ 1.54 $ 1.96
Cumulative effect of change in accounting
principle ............................... - - - (0.15)
------------ ------------ ------------ ------------
Net income per share ...................... $ 0.47 $ 0.71 $ 1.54 $ 1.81
============ ============ ============ ============
Net income per share, diluted:
Income before cumulative effect of change
in accounting principle ................. $ 0.47 $ 0.71 $ 1.54 $ 1.95
Cumulative effect of change in accounting
principle ............................... - - - (0.15)
------------ ------------ ------------ ------------
Net income per share, diluted ............ $ 0.47 $ 0.71 $ 1.54 $ 1.80
============ ============ ============ ============
Dividends per share ....................... $ 0.26 $ 0.26 $ 0.78 $ 0.78
============ ============ ============ ============
Weighted average common shares outstanding. 51,717 51,569 51,680 51,475
Amounts shown are unaudited.
See accompanying notes to the financial statements.
Page 3
THE LUBRIZOL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Month Period
Ended September 30
----------------------------
(In Thousands of Dollars) 2003 2002
------------------------------------------------------------ ------------ ------------
Cash provided from (used for):
Operating activities:
Net income ............................................... $ 79,704 $ 92,997
Adjustments to reconcile net income to cash provided
by operating activities:
Depreciation and amortization .......................... 74,146 70,898
Deferred income taxes .................................. 4,146 (616)
Restructuring charge ................................... 3,327 -
Cumulative effect of change in accounting principle .... - 7,785
Change in current assets and liabilities:
Receivables .......................................... (18,846) 7,452
Inventories .......................................... (13,324) (13,930)
Accounts payable and accrued expenses ................ (24,259) 4,712
Other current assets ................................. 2,923 (3,215)
Other items - net ...................................... 5,882 7,069
------------ ------------
Total operating activities ....................... 113,699 173,152
Investing activities:
Capital expenditures ..................................... (59,485) (45,976)
Acquisitions and investments in nonconsolidated
companies .............................................. (67,532) (69,438)
Other - net .............................................. 484 2,882
------------ ------------
Total investing activities ....................... (126,533) (112,532)
Financing activities:
Short-term borrowings(repayments)-net .................... (6,426) 6,715
Long-term repayments ..................................... (227) (1,654)
Long-term borrowings ..................................... 15 -
Dividends paid ........................................... (40,161) (40,043)
Proceeds from termination of interest rate swaps ......... - 18,134
Stock options exercised .................................. 3,658 8,203
------------ ------------
Total financing activities ....................... (43,141) (8,645)
Effect of exchange rate changes on cash .................... 4,705 8,485
------------ ------------
Net increase (decrease) in cash and short-term
investments .............................................. (51,270) 60,460
Cash and short-term investments at beginning of period ..... 266,428 189,095
------------ ------------
Cash and short-term investments at end of period ........... $ 215,158 $ 249,555
============ ============
Amounts shown are unaudited.
See accompanying notes to the financial statements.
Page 4
THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
Amounts in thousands (except per share data)
September 30, 2003
1. The accompanying unaudited consolidated financial statements contain
all adjustments (consisting only of normal recurring accruals unless
otherwise noted) necessary to present fairly the financial position as
of September 30, 2003 and December 31, 2002, and the results of
operations and cash flows for the applicable periods ended September
30, 2003 and 2002.
2. 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 dilutive
effect resulting from outstanding stock options and stock awards.
Per share amounts are computed as follows:
Three Month Period Nine Month Period
Ended September 30 Ended September 30
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Numerator:
Income before cumulative
effect of change in
accounting principle $ 24,298 $ 36,478 $ 79,704 $ 100,782
Cumulative effect of change
in accounting principle - - - (7,785)
------------ ------------ ------------ ------------
Net income $ 24,298 $ 36,478 $ 79,704 $ 92,997
============ ============ ============ ============
Denominator:
Weighted average common
shares outstanding 51,717 51,569 51,680 51,475
Dilutive effect of stock
options and awards 297 172 189 323
------------ ------------ ------------ ------------
Denominator for net income
per share, diluted 52,014 51,741 51,869 51,798
============ ============ ============ ============
Net Income Per Share:
Income before cumulative
effect of change in
accounting principle $ 0.47 $ 0.71 $ 1.54 $ 1.96
Cumulative effect of change
in accounting principle - - - (0.15)
------------ ------------ ------------ ------------
Net income per share $ 0.47 $ 0.71 $ 1.54 $ 1.81
============ ============ ============ ============
Diluted Net Income Per Share:
Income before cumulative
effect of change in
accounting principle $ 0.47 $ 0.71 $ 1.54 $ 1.95
Cumulative effect of change
in accounting principle - - - (0.15)
------------ ------------ ------------ ------------
Net income per share,
diluted $ 0.47 $ 0.71 $ 1.54 $ 1.80
============ ============ ============ ============
Weighted average shares issuable upon the exercise of stock options
which were excluded from the diluted earnings per share calculations
because they were antidilutive for the three- and nine-month periods
ended September 30, 2003 were 2.0 million and 2.7 million, respectively,
and for the three- and nine-month periods ended September 30, 2002 were
3.7 million and 1.9 million, respectively.
5
THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
Amounts in thousands (except per share data)
September 30, 2003
3. Total comprehensive income for the three- and nine-month periods ended
September 30, 2003 and 2002 is comprised as follows:
Three Month Period Nine Month Period
Ended September 30 Ended September 30
----------------------- -----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income $ 24,298 $ 36,478 $ 79,704 $ 92,997
Foreign currency translation adjustment 3,618 767 23,168 26,492
Unrealized gains (losses)- natural gas hedges (267) - (757) -
Unrealized gains (losses)- interest rate swaps 434 (836) 1,038 (857)
Pension plan minimum liability 158 - 158 -
---------- ---------- ---------- ----------
Total comprehensive income $ 28,241 $ 36,409 $ 103,311 $ 118,632
========== ========== ========== ==========
4. The company aggregates its product lines into four principal operating
segments: fluid technologies for transportation, fluid technologies for
industry, advanced fluid systems and emulsified products. Fluid
technologies for transportation (FTT) 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, this segment 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
(FTI) includes industrial additives, such as additives for hydraulic,
grease and metalworking fluids and compressor lubricants; and
performance chemicals, such as additives for coatings and inks,
defoamers, process chemicals and surfactants for personal care and
industrial cleaners. The advanced fluid systems and emulsified products
operating segments do not constitute reportable business segments. The
results of these two operating segments have been aggregated into the
all other segment. Advanced fluid systems is comprised of fluid
metering devices, particulate emission trap devices, and FluiPak(TM)
sensor systems, and emulsified products is comprised of PuriNOx(TM)
low-emissions diesel fuel.
The company primarily evaluates performance and allocates resources
based on segment contribution income, defined as revenues less expenses
directly identifiable to the product lines aggregated within each
segment, as well as projected future returns. In addition, in
calculating segment operating profit before tax, the company allocates
corporate research, testing, selling and administrative expenses,
primarily based upon revenues, and assigns excess capacity costs to the
segments to which it applies. The company calculates the cost of excess
production capacity at our manufacturing facilities and excludes this
amount from product costs when reporting segment gross profit and
segment contribution income.
6
THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
Amounts in thousands (except per share data)
September 30, 2003
The following table presents a summary of the company's reportable
segments for the three- and nine-month periods ended September 30, 2003
and 2002, based on the current reporting structure. Prior-year amounts
have been restated to reflect reclassifications of products between
reporting segments and changes in allocation methodology of corporate
expenses:
Three Month Period Nine Month Period
Ended September 30 Ended September 30
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues from external customers:
FTT $ 382,299 $ 400,736 $ 1,165,891 $ 1,187,322
FTI 117,833 102,627 342,008 279,889
All other 9,735 6,940 24,858 18,988
------------ ------------ ------------ ------------
Total revenues $ 509,867 $ 510,303 $ 1,532,757 $ 1,486,199
============ ============ ============ ============
Segment contribution income(loss):
FTT $ 65,440 $ 84,585 $ 222,556 $ 243,360
FTI 19,005 18,922 55,491 53,565
All other (1,271) (2,412) (5,192) (7,455)
------------ ------------ ------------ ------------
Total segment contribution income $ 83,174 $ 101,095 $ 272,855 $ 289,470
============ ============ ============ ============
Segment operating profit(loss) before tax:
FTT $ 32,795 $ 45,703 $ 118,551 $ 129,055
FTI 10,040 13,875 29,791 37,756
All other (2,696) (3,471) (9,729) (10,900)
------------ ------------ ------------ ------------
Total segment operating profit before tax 40,139 56,107 138,613 155,911
Restructuring charge (409) - (7,447) -
Interest expense - net (5,698) (3,995) (15,654) (11,936)
------------ ------------ ------------ ------------
Income before income taxes and cumulative
effect of an accounting change $ 34,032 $ 52,112 $ 115,512 $ 143,975
============ ============ ============ ============
7
THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
Amounts in thousands (except per share data)
September 30, 2003
5. The company has elected the intrinsic value method to account for
employee stock options. The following table shows the pro forma effect
on net income and earnings per share if the company had applied the
fair value recognition provisions of SFAS 123, "Accounting for
Stock-Based Compensation," to stock-based employee compensation:
Three Month Period Nine Month Period
Ended September 30 Ended September 30
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Reported net income $ 24,298 $ 36,478 $ 79,704 $ 92,997
Plus: Stock-based employee
compensation (net of
tax) included in
net income (3) 8 365 114
Less: Stock-based employee
compensation (net of
tax) using the fair
value method (1,078) (1,517) (3,881) (4,551)
------------ ------------ ------------ ------------
Pro forma net income $ 23,217 $ 34,969 $ 76,188 $ 88,560
------------ ------------ ------------ ------------
Reported net income per
share $ 0.47 $ 0.71 $ 1.54 $ 1.81
------------ ------------ ------------ ------------
Pro forma net income per
share $ 0.45 $ 0.68 $ 1.47 $ 1.72
============ ============ ============ ============
Reported net income per
share, diluted $ 0.47 $ 0.71 $ 1.54 $ 1.80
============ ============ ============ ============
Pro forma net income per
share, diluted $ 0.45 $ 0.68 $ 1.47 $ 1.71
============ ============ ============ ============
6. In February 2003, the company notified employees at its Bromborough,
England facility of plans to restructure and reduce operational costs
to remain competitive. The facility consolidated various operational
activities to achieve greater efficiency through improved business
processes. There will be a reduction of 40 employees, or approximately
35% of the facility's headcount, by the end of 2003. These changes
began during the first quarter of 2003 and are expected to be completed
by the end of 2003. As a result of these changes, the company recorded
a restructuring charge for Bromborough of $.4 million in the third
quarter and $6.7 million in the first nine months of 2003. The charge
in the third quarter was primarily due to severance costs. The charge
in the first nine months of 2003 consisted of $3.2 million in severance
costs, $3.3 million in asset impairments and $.2 million in other
miscellaneous costs. Cash expenditures in the third quarter of 2003
were $.4 million and in the first nine months of 2003 were $2.9
million. An accrued liability of $.5 million remains at September 30,
2003, relating to employee severance costs. Additional severance costs
of approximately $.3 million are expected to be incurred during the
remainder of 2003 for those employees that will be separated after 90
days of the legal notification date of the restructuring. The
restructuring charge in the first nine months of 2003 also includes $.7
million for a voluntary separation program to employees at the
company's India joint venture, Lubrizol India Private Limited, which is
accounted for using the consolidated method. Cash expenditures for
India were $.7 million in both the second quarter and the first nine
months of 2003. The charge for both cost reduction initiatives are
reported as a
8
THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
Amounts in thousands (except per share data)
September 30, 2003
separate line item in the consolidated income statement, entitled
"Restructuring charge" and are included in the "Total cost and
expenses" subtotal on the consolidated income statement. The charge
relates primarily to the fluid technologies for transportation segment.
The following table shows the reconciliation of the September 30, 2003
liability balance for the third quarter of 2003 and the first nine
months of 2003:
Three Month Period Nine Month Period
Ended September 30, 2003 Ended September 30, 2003
------------------------ ------------------------
Beginning balance $ 500 $ -
Restructuring charge 409 7,447
Less cash paid (356) (3,581)
Less asset impairments (3,327)
Translation adjustments 1 15
-------- ---------
September 30, 2003 Balance $ 554 $ 554
======== =========
On November 4, 2003 the company announced workforce reductions,
primarily in the United States, designed to improve profitability to
reposition the company for stronger growth. The reductions are expected
to be completed by year-end, 2003 and are estimated to result in annual
pretax savings of approximately $15 million beginning in 2004. These
savings are in addition to approximately $4.5 million of pre-tax
savings from the restructuring programs at Bromborough and India. The
company will record a fourth quarter, 2003 restructuring charge that is
projected to be approximately $13 million.
7. The company has various financial instruments, including cash and
short-term investments, investments in nonconsolidated companies,
foreign currency forward contracts, commodity hedges, 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 company
uses derivative financial instruments including interest rate and
commodity hedges and forward foreign currency exchange contracts to
manage market risks. The company does not use derivative financial
instruments for trading purposes.
The company recognizes 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 company is exposed to the effect of changes in commodity prices for
natural gas and electric utility expenses on its earnings and cash
flow. In the second quarter of 2003, the company modified its commodity
hedging program for natural gas and electricity purchasing by using
financial instruments to reduce the volatility on earnings of utility
expense. These contracts relate to transactions with maturities of less
than one year and
9
THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
Amounts in thousands (except per share data)
September 30, 2003
are accounted for as cash flow hedges and any effective unrealized
gains or losses on open contracts are recorded in other comprehensive
income, net of tax. At September 30, 2003 open contracts totaled $7.0
million. A hedge liability was recorded at September 30, 2003 of $1.2
million, which represents the unrealized loss at that date based upon
current futures prices. The loss, net of deferred taxes of $.4 million,
is included as a charge of $.8 million in other comprehensive income
loss. The company expects all of the unrealized hedge gains or losses
to be reclassified into earnings within the next 12 months.
8. In the third quarter of 2003, the company completed two acquisitions in
the fluid technologies for industry segment for cash of $67.5 million.
In July, 2003 the company purchased the product lines of the North
American-based silicones business from BASF, which expanded our foam
control additives business to about $40 million in annual revenues.
Assets acquired from BASF included customer lists, certain trademarks,
manufacturing technology and other related intellectual property
specifically developed for silicone products in the North America
region, and finished goods inventory. Silicones are used in the
manufacture of sealants, caulks and water proofing products. Historical
annual revenues for these silicone products approximate $6 million. In
late September, 2003 the company completed an acquisition of selected
personal care ingredients business from Amerchol Corporation, a
subsidiary of The Dow Chemical Company. Products from this business go
into a wide range of end uses, including skin care and hair
conditioners. Products include methyl glucoside derivatives, lanoline
derivatives and Promulgen(TM) personal care ingredients. Annualized
revenues of the acquisition are approximately $30 million.
The company is currently in the process of allocating the purchase
price for both of these acquisitions, so it is possible the assignment
of value among assets acquired may change once the purchase price
allocation is complete.
10
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
RESULTS OF OPERATIONS
Our revenues in the third quarter of 2003 were generally even with revenues in
the same period in 2002 and increased in the first nine months of 2003 compared
with the first nine months of 2002. However, net income decreased in both the
third quarter and first nine months of 2003 compared to the same periods in
2002. The primary operating drivers of the lower earnings were lower shipment
volume, higher average raw material cost and higher manufacturing expenses,
which more than offset a higher average selling price. A detailed discussion of
these and other factors that affected the third quarter and nine months follows.
We group our product lines into three reportable segments: fluid technologies
for transportation, fluid technologies for industry and all other. Fluid
technologies for transportation comprised approximately 76% of our consolidated
revenues and 86% of our segment pre-tax operating profits in the first nine
months of 2003. See Note 4 to the financial statements for further financial
disclosures by reporting segment.
Our consolidated revenues decreased $.4 million, or less than 1%, in the third
quarter of 2003 compared with the same period in 2002, due to a 10% decline in
shipment volume that was partially offset by a 9% increase in average selling
price. Excluding the impact of acquisitions (Dock Resins Corporation,
Intermountain Specialties, Inc., also known as Brose Chemical Company, and
certain product lines of BASF), third quarter revenues decreased $6.6 million,
or 1%, compared with the third quarter of the prior year. Consolidated revenues
increased $46.6 million, or 3%, in the first nine months of 2003 compared with
the same period in 2002, due to an 8% increase in average selling price,
partially offset by a 5% decline in shipment volume. Excluding the impact of
acquisitions (Kabo Unlimited, Inc., Dock, Chemron, Brose and certain product
lines of BASF), revenues increased $13.7 million, or 1%, in the first nine
months of 2003 compared with 2002, due to an 8% increase in average selling
price and higher revenues by our equipment companies, partially offset by an 8%
decline in shipment volume.
The following table shows our shipment volume by geographic zone in the third
quarter and the first nine months of 2003.
3rd Qtr YTD
2003 2003
Volume Volume
------- ------
North America 46% 46%
Europe 28% 28%
Asia-Pacific/Middle East 19% 19%
Latin America 7% 7%
--- ---
Total 100% 100%
=== ===
11
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
Changes in our shipment volume vary in different geographic zones. The following
table shows the changes in shipment volume by geographic zone in the third
quarter and first nine months of 2003 compared with the same periods in 2002.
3rd Qtr YTD
2003 vs. 2002 2003 vs. 2002
Increase (Decrease) Increase (Decrease)
------------------------- ---------------------------
Excluding Excluding
Total Acquisitions Total Acquisitions
--------- ------------ ---------- ------------
North America (13%) (14%) (5%) (10%)
Europe (13%) (13%) (9%) (9%)
Asia-Pacific/Middle East (3%) (3%) (5%) (5%)
Latin America 8% 8% 4% 4%
Total (10%) (11%) (5%) (8%)
Excluding acquisitions, total shipment volume decreased 11% in the third quarter
of 2003 and 8% in the first nine months of 2003 compared with the same periods
in 2002. Approximately 9% of the decrease in the third quarter of 2003 and 25%
of the decrease in the first nine months of 2003 was due to a shift in our
viscosity modifier product line from liquids to a higher-value concentrated
solid form. All zones were affected by the shift to solid viscosity modifiers,
though the effects were mostly seen in North America and Europe. The remaining
shipment volume decrease for both periods was primarily due to losses associated
with a major international customer, which mainly affected North America and
Europe, along with weak worldwide demand for lubricants. We believe that the
severe acute respiratory syndrome (SARS) outbreak in Southeast Asia along with
weakness stemming from economic and political conditions within certain
countries of the Asia-Pacific / Middle East region contributed to the decline in
the Asia-Pacific / Middle East zone during the first nine months of 2003. See
the "Segment Analysis" section for additional explanation of shipment volume
variances by business segment and geographic zone in 2003 compared with 2002.
Our average additive selling price increased 9% in the third quarter of 2003
compared to the same period in 2002 due to a 6% increase in the combination of
price and product mix and 3% favorable currency effects. Our average additive
selling price increased 8% in the first nine months of 2003 compared to the
first nine months of 2002 equally due to favorable currency effects and an
increase in the combination of price and product mix. Sequentially, the third
quarter 2003 average additive selling price was even with the second quarter and
3.5% higher than the first quarter of 2003, due to favorable currency effects
and the implementation of a price increase in the form of a surcharge at the end
of the first quarter of 2003. This surcharge was designed to cover the
continuing rise in raw material prices and natural gas-fired utility costs,
since our last price increase in the fourth quarter of 2002.
Our cost of sales increased $18.6 million, or 5% ($14.4 million, or 4%,
excluding acquisitions), in the third quarter of 2003 and $66.5 million, or 6%
($43.2 million, or 4%, excluding acquisitions), in the first nine months of 2003
compared with the same periods in 2002. The increase for both periods was
primarily due to higher average raw material cost and higher manufacturing
expenses. Average raw material cost increased 11% in the third quarter of 2003
and 9% in the first nine months of 2003 compared with the same periods of 2002
primarily due to higher raw material prices, mainly driven by higher prices of
crude oil and natural gas, and unfavorable currency effects. Sequentially,
average raw material cost in the third quarter of 2003 increased 2% from the
second quarter of 2003.
12
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
Total manufacturing expenses increased 15% (14% excluding acquisitions) in the
third quarter of 2003 and 13% (11% excluding acquisitions) in the first nine
months of 2003 compared with the same periods in 2002. We built inventories in
the third quarter of 2002 and drew down inventories in the third quarter of
2003. Excluding acquisitions and the impact of changes in inventory levels,
manufacturing expenses increased 7% in the third quarter of 2003 and 10% in the
first nine months of 2003 compared with the same periods in 2002, primarily due
to unfavorable currency effects, higher utilities and higher salary and benefit
expenses, partially offset by a reduction in variable pay expense. In addition,
total manufacturing expenses included a reclassification of expenses at certain
subsidiaries of our fluid technologies for industry (FTI) and advanced fluid
systems (AFS) operating segments that were charged in 2002 to selling and
administrative expenses or material costs. The reclassification increased
manufacturing expenses by $.9 million in the third quarter of 2003 and $3.6
million in the first nine months of 2003. We estimate the total impact of this
reclassification to manufacturing expenses for 2003 will be approximately $5.0
million.
Cost of sales for the first nine months of 2003 included approximately $3
million in manufacturing expenses to cover costs associated with two fires that
occurred during the second quarter of 2003. In April 2003, an
after-working-hours fire destroyed a metalworking additive blending facility we
leased in Detroit. There were no injuries, nor any damage to a nearby warehouse
where we stored finished goods. We were able to supply customers from this
warehouse and we have permanently shifted production to our Painesville, Ohio
plant. Also in April 2003, a fire associated with a maintenance shutdown
occurred in a dispersant production unit at our plant in Le Havre, France.
Gross profit (net sales less cost of sales) decreased $19.0 million, or 13%
($21.0 million, or 14%, excluding acquisitions), in the third quarter of 2003
and $19.8 million, or 5% ($29.3 million, or 7%, excluding acquisitions), in the
first nine months of 2003 compared with the same periods in 2002. The decrease
for both periods was primarily due to lower shipment volume, higher average raw
material cost and higher manufacturing expenses, partially offset by higher
average selling price. Our gross profit percentage (gross profit divided by net
sales) decreased to 25.9% for the third quarter of 2003 and 26.9% for the first
nine months of 2003, compared with 29.6% in the third quarter of 2002 and 29.1%
in the first nine months of 2002. The decrease in the gross profit percentages
for both periods was due to the reasons previously described. The impact of
acquisitions and the reclassification of certain expenses to manufacturing, as
described above, accounted for a decrease of 60 basis points (of the total 220
basis point decline) in our gross profit percentage in the first nine months of
2003. Sequentially, the gross profit percentage decreased from 27.5% in the
second quarter of 2003.
Our selling and administrative expenses decreased $.9 million, or 2% ($1.5
million, or 3%, excluding acquisitions), in the third quarter of 2003 and
increased $2.9 million, or 2% (decreased $.1 million excluding acquisitions), in
the first nine months of 2003 compared with the same periods in 2002. Excluding
acquisitions, the decrease for both periods was primarily due to a reduction in
our variable pay expense and the reclassification of certain 2002 selling and
administrative expenses for our FTI and AFS operating segments, which was
partially offset by unfavorable currency effects and higher salary and benefit
expenses.
Our research, testing and development expenses (technology expenses) decreased
$1.8 million, or 4% ($2.1 million, or 5%, excluding acquisitions), in the third
quarter of 2003 and $1.4 million, or 1% ($2.7 million, or 2%, excluding
acquisitions), in the first nine months of 2003 compared with the same periods
in 2002. The decrease for both periods, excluding acquisitions, was due to
13
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
lower testing at outside laboratories and a reduction in our variable pay
expense, partially offset by unfavorable currency effects. In addition,
technology expenses included a write-down of $1.1 million in the first nine
months of 2003 related to a former technical facility in Japan that we sold
during the third quarter of 2003.
In the first nine months of 2003, we recorded a restructuring charge of $7.4
million, or $.10 per share, consisting of $6.7 million for our Bromborough,
England intermediate production and blending facility and $.7 million for a
voluntary separation program at our joint venture in India. The Bromborough
charge primarily consisted of $3.2 million in employee separation benefits and
$3.3 million in asset impairments for production units taken out of service. In
the third quarter the Bromborough charge was $.4 million, or $.01 per share, for
severance costs. We have eliminated some capacity at this facility and have
planned a reduction of 40 positions. We expect the Bromborough restructuring
initiative will be completed by year-end. We estimate the full year
restructuring charge will be approximately $7.5 million, or $.10 per share, and
total annualized savings from the combined restructuring activities are
projected to be $4.5 million, of which approximately $2.0 million is expected to
be realized in 2003.
The change in other income (expense) favorably affected pre-tax income by $.5
million in the third quarter of 2003 and $4.2 million in the first nine months
of 2003 compared with the same periods in 2002. The favorable variance for the
first nine months of 2003 was primarily due to increased currency translation
gains.
Interest income decreased $.9 million in the third quarter of 2003 and $2.0
million in the first nine months of 2003 compared with the same periods in 2002
as a result of lower interest rates. Interest expense increased $.8 million in
the third quarter of 2003 and $1.7 million in the first nine months of 2003,
compared with the same periods in 2002, due to the absence of the interest rate
swap agreements that we utilized in the third quarter of 2002 and, in the third
quarter of 2003, interest on a European tax settlement. In 2002, we had swap
agreements that reduced interest expense by approximately $.8 million ($.3
million impact from outstanding swap and $.5 million amortization of deferred
gain) in the third quarter of 2002 and $3.6 million ($3.1 million impact from
outstanding swap and $.5 million amortization of deferred gain) in the first
nine months of 2002. As a result of the interest rate swap agreements that were
terminated in 2002, the unrecognized gain is being amortized as a reduction of
interest expense through December 1, 2008. Amortization of the unrealized gain
reduced interest expense in the third quarter of 2003 by approximately $.7
million and in the first nine months of 2003 by approximately $2.0 million.
As a result of the above factors, our income before income taxes and the
cumulative effect of a change in accounting principle decreased 35% to $34.0
million in the third quarter of 2003, and 20% to $115.5 million in the first
nine months of 2003, compared with $52.1 million and $144.0 million for the
respective corresponding periods in 2002.
We had an effective tax rate of 28.6% for the third quarter of 2003 and 31.0%
for the first nine months of 2003, compared with 30.0% for both periods in 2002.
The lower effective tax rate in the third quarter of 2003 increased earnings by
$.01 per share and the higher effective tax rate for the first nine months of
2003 reduced earnings by $.03 per share, compared to the same periods in 2002.
The increase in the effective tax rate for the first nine months of 2003, as
compared to the first nine months of 2002, mainly was due to a non-recurring
2002 charitable contribution of technology, offset in part by the impact of
higher expected levels of non-taxable currency translation gains.
14
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
We lowered our estimated 2003 effective tax rate in both the second quarter and
the third quarter, mainly due to higher expected levels of non-taxable currency
translation gains for the full year.
As a result of the factors described above, income before the cumulative effect
of a change in accounting principle decreased $12.2 million, or 33% in the third
quarter of 2003 and $21.1 million, or 21%, in the first nine months of 2003
compared with the same periods in 2002. Income per share, before the cumulative
effect of a change in accounting principle, was $.47 in the third quarter of
2003 and $1.54 in the first nine months of 2003, compared with $.71 and $1.96
for the respective corresponding periods in 2002.
During the first half of 2002, we completed the impairment analysis required for
Statement of Financial Accounting Standards 142 (SFAS 142), "Goodwill and Other
Intangible Assets," which we adopted on January 1, 2002. There was no impairment
either in the fluid technologies for transportation segment or in the fluid
technologies for industry operating segment. However, for the advanced fluid
systems operating segment, which is included in the all other reporting segment,
we recorded an impairment of $7.8 million, thus eliminating all the goodwill for
the all other reporting segment. The charge was recorded as a cumulative effect
of a change in accounting principle as of January 1, 2002.
Primarily as a result of the above factors, our net income in the third quarter
of 2003 decreased 33% to $24.3 million ($.47 per share), compared with $36.5
million ($.71 per share) in the third quarter of 2002. Net income in the first
nine months of 2003 decreased 14% to $79.7 million ($1.54 per share) compared
with $93.0 million ($1.81 per share) in the first nine months of 2002.
On November 4, 2003 the company announced workforce reductions, primarily in the
United States, designed to improve profitability to reposition the company for
stronger growth. The reductions are expected to be completed by year-end, 2003
and are estimated to result in annual pretax savings of approximately $15
million beginning in 2004. These savings are in addition to approximately $4.5
million of pre-tax savings from the restructuring programs at Bromborough and
India. The company will record a fourth quarter, 2003 restructuring charge that
is projected to be approximately $13 million.
15
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
SEGMENT ANALYSIS
A description of the company's operating segments along with the products,
services and markets for each of the operating segments is included in Note 4 to
the financial statements. Prior year amounts have been restated to reflect
reclassifications of products among the reportable segments.
OPERATING RESULTS BY BUSINESS SEGMENT
Three Month Period Nine Month Period
Ended September 30 Ended September 30
(in Millions of Dollars) 2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues:
Fluid technologies for transportation $ 382.3 $ 400.7 $ 1,165.9 $ 1,187.3
Fluid technologies for industry 117.8 102.6 342.0 279.9
All other 9.8 7.0 24.9 19.0
------------ ------------ ------------ ------------
Total $ 509.9 $ 510.3 $ 1,532.8 $ 1,486.2
============ ============ ============ ============
Gross Profit:
Fluid technologies for transportation $ 104.7 $ 123.9 $ 335.6 $ 358.6
Fluid technologies for industry 35.9 33.8 104.2 95.6
All other 2.6 1.9 6.4 4.6
------------ ------------ ------------ ------------
Total $ 143.2 $ 159.6 $ 446.2 $ 458.8
============ ============ ============ ============
Segment Contribution Income(Loss):
Fluid technologies for transportation $ 65.4 $ 84.6 $ 222.6 $ 243.4
Fluid technologies for industry 19.0 18.9 55.5 53.6
All other (1.3) (2.4) (5.2) (7.5)
------------ ------------ ------------ ------------
Total $ 83.1 $ 101.1 $ 272.9 $ 289.5
============ ============ ============ ============
Fluid Technologies for Transportation Segment
Segment revenues decreased $18.4 million, or 5%, in the third quarter of 2003
compared with the same period in 2002, due to a 13% decline in shipment volume,
partially offset by an 8% increase in average selling price. The increase in
average selling price for the third quarter of 2003 primarily was due to an
increase in the combination of price and product mix along with 3% favorable
currency effects. Segment revenues decreased $21.4 million, or 2%, in the first
nine months of 2003 compared with the first nine months of 2002 due to a 10%
decrease in shipment volume partially offset by an 8% increase in average
selling price. The increase in average selling price in the first nine months of
2003 primarily was due to favorable currency effects of 5% and the remainder was
due to an increase in the combination of price and product mix.
The fluid technologies for transportation segment implemented a price increase
in December 2002 for the North America zone and in January 2003 for the rest of
the world. In addition, a second price increase that was structured as a
surcharge was implemented in late March for North America and in late April for
products sourced from Asia and Latin America as well as select products in
Europe. This surcharge was designed to cover the continuing rise in raw material
prices and natural gas-fired utility costs, since our last price increase in the
fourth quarter of 2002.
16
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
The following table shows the changes in shipment volume by geographic zone in
the third quarter and first nine months of 2003 compared with the same periods
in 2002.
3rd Qtr YTD
2003 vs. 2002 2003 vs. 2002
Increase (Decrease) Increase (Decrease)
------------------- ------------------
North America (18%) (13%)
Europe (15%) (9%)
Asia-Pacific/Middle East (4%) (6%)
Latin America 7% 3%
Total (13%) (10%)
The shipment volume decline in both the third quarter and the first nine months
of 2003 partially was due to lower unit sales of viscosity modifiers,
principally caused by a shift from liquid polymers to solid polymers. Generally,
solids are one-tenth the volume of liquids. Excluding this shift in our
viscosity modifier product line, total shipment volume decreased 12% in the
third quarter and 8% in the first nine months of 2003. About half of the
shipment volume decreases in North America and Europe were due to losses in our
engine oils business and specialty driveline business associated with a major
international customer. The declines in North America for the third quarter and
the first nine months of 2003 also were due to our shifting of some products in
our specialties business to more concentrated formulations. In addition, weak
worldwide demand for lubricants contributed to the declines in the North America
and Europe zones for both the third quarter and the first nine months of 2003.
The third quarter decrease in Asia-Pacific/Middle East volume primarily was due
to the weak business environment stemming from economic and political conditions
in certain parts of this region. During the first nine months of 2003, we
believe SARS also negatively impacted business activity primarily in the
Asia-Pacific / Middle East zone.
Segment gross profit decreased $19.2 million, or 16%, in the third quarter of
2003 and $23.0 million, or 6%, in the first nine months of 2003 compared with
the same periods in 2002. The decrease for both periods primarily was due to
lower shipment volume, higher average raw material cost and higher manufacturing
expenses, partially offset by higher average selling price due to favorable
currency effects and an increase in the combination of price and product mix. In
calculating gross profit at the operating segment level, we exclude our estimate
of the cost of excess capacity from product costs (See Note 4 to the financial
statements.) The gross profit percentage for this segment was 27.4% in the third
quarter of 2003 and 28.8% in the first nine months of 2003, compared with 30.9%
and 30.2% in the respective comparable periods in 2002. The decrease in the
gross profit percentage for both comparison periods was due to the reasons
previously explained.
Direct selling, marketing and technical expenses were flat in the third quarter
of 2003 and decreased $3.3 million, or 3%, in the first nine months of 2003
compared with the same periods in 2002, primarily due to lower technical
spending at outside test laboratories. Segment contribution income decreased
$19.1 million, or 23%, in the third quarter of 2003 compared with the third
quarter of 2002 entirely due to lower gross profit. Segment contribution income
decreased $20.8 million, or 9%, in the first nine months of 2003 compared with
the same period in 2002 as a result of lower gross profit and lower equity
earnings, partially offset by lower technical expenses.
17
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
Fluid Technologies for Industry Segment
Segment revenues increased $15.2 million, or 15% ($8.9 million, or 9%, excluding
acquisitions), in the third quarter of 2003 and $62.1 million, or 22% ($29.2
million, or 10%, excluding acquisitions), in the first nine months of 2003
compared with the same periods in 2002. Acquisitions contributed $6.2 million of
the segment revenue increase in the third quarter of 2003, due to Dock Resins,
Brose and the product lines of BASF, and $32.9 million of the segment revenue
increase in the first nine months of 2003, primarily due to Dock Resins and
Chemron. The 9% increase in segment revenues during the third quarter of 2003,
excluding acquisitions, was due to a 5% increase in shipment volume along with a
4% increase in average selling price compared to the third quarter of 2002. The
10% increase in segment revenues during the first nine months of 2003, excluding
acquisitions, was primarily due to a 9% increase in shipment volume.
The shipment volume increase in both periods primarily was due to ongoing
business growth as the result of new business gains and the introduction of new
products in our personal care, defoamers, specialty monomers and mining
chemicals businesses. The third quarter increase in average selling price
primarily was due to 3% favorable currency effects and a slight increase in the
combination of price and product mix, partially due to favorable product mix in
our personal care business. Average selling price increased 1% for the first
nine months of 2003 compared with the same period in 2002, due to 4% favorable
currency effects partially offset by a decrease in the combination of price and
product mix. The decrease occurred in our inks additives business, specialty
monomers business and compressor lubricant business and primarily was due to
lower priced product mix. Slightly higher royalty income in our synthetic
refrigerant lubricants business of $.1 million in the third quarter of 2003 and
$.5 in the first nine months of 2003, compared with the same periods in 2002,
also contributed to the increased segment revenues.
The following table shows the changes in shipment volume by geographic zone in
the third quarter and first nine months of 2003 compared with the same periods
in 2002.
3rd Qtr YTD
2003 vs. 2002 2003 vs. 2002
Increase (Decrease) Increase (Decrease)
------------------- -------------------
Excluding Excluding
Total Acquisitions Total Acquisitions
----- ------------ ----- ------------
North America 8% 2% 32% 7%
Europe 7% 7% 10% 10%
Asia-Pacific / Middle East 15% 15% 18% 18%
Latin America 27% 27% 15% 15%
Total 9% 5% 25% 9%
Excluding acquisitions, the increase in the third quarter of 2003 for North
America and Europe primarily was due to increases in the coatings and inks
business. The shipment volume increase in North America in the first nine months
of 2003 primarily was due to the 2002 acquisitions of Chemron and Dock Resins.
Excluding acquisitions, the increase in North America in the first nine months
of 2003 partially was due to market share gains in our personal care and
compressor lubricant businesses along with increases in the coatings and inks
business from the introduction of new products. The increase in Europe in the
first nine months of 2003 was related to increases in our metalworking and
compressor lubricant businesses and new applications in our specialty monomers
business. The increase in the third quarter of 2003 for the Asia-Pacific /
Middle East zone was spread across many of the FTI businesses. Approximately
18
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
half of the increase in the first nine months of 2003 for Asia-Pacific / Middle
East was due to increased shipments in our metalworking business as a result of
a distributor relationship that was terminated at the beginning of 2002. Our
metalworking sales in this zone in the first half of 2002 were below normal
levels because our customers were buying from the distributor's inventory. Our
customers subsequently resumed purchasing the products from us, beginning in the
second half of 2002. The increase in Latin America in both the third quarter of
2003 and the first nine months of 2003 was due to a shift of our specialty
emulsifiers business with some of our existing customers from North America to
Latin America along with some business gains in our coatings and inks business.
Segment gross profit increased $2.1 million, or 6% ($.1 million, or less than
1%, excluding acquisitions), in the third quarter of 2003, and $8.6 million, or
9% ($.9 million decrease, or 1%, excluding acquisitions), in the first nine
months of 2003 compared with the same periods in 2002. Excluding acquisitions,
the third quarter increase was due to higher shipment volume that was partially
offset by higher manufacturing expenses. The increase in manufacturing expenses
primarily was due to the reclassification to manufacturing expenses of $.9
million in FTI expenses charged in 2002 as selling and administrative expenses,
and costs associated with the integration of a multi-purpose chemical production
facility in Spartanburg, South Carolina that was purchased in the second quarter
of 2003. In addition, unfavorable product mix in the anti-wear hydraulics
business lowered segment gross profit in the third quarter of 2003. Excluding
acquisitions, the decrease in segment gross profit in the first nine months of
2003 was due to higher manufacturing expenses and higher average raw material
cost, which more than offset higher shipment volume and higher average selling
price. The increase in manufacturing expenses primarily was due to the
reclassification to manufacturing expenses of $3.6 million of FTI expenses
charged in 2002 as selling and administrative expenses, and costs relating to
the fire at the Detroit manufacturing facility. The gross profit percentage for
this segment was 30.6% in the third quarter of 2003 and 33.1% in the first nine
months of 2003, compared with 30.6% and 34.3% in the respective corresponding
periods in 2002. The decrease in the gross profit percentage for the first nine
months of 2003 compared with the same period in 2002 was due to the impact of
the Chemron acquisition, higher raw material costs and increased manufacturing
expenses as a result of the metalworking fire and the reclassification of
certain FTI selling and administrative expenses to manufacturing expenses.
Segment contribution income increased $.1 million, or less than 1%, in the third
quarter of 2003 and increased $1.9 million, or 4%, in the first nine months of
2003 compared with the same periods in 2002. The increase for both periods
primarily was due to higher gross profit, partially offset by higher direct
technical and selling expenses and higher amortization expenses resulting from
2002 acquisitions.
WORKING CAPITAL, LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $113.7 million in the first nine
months of 2003 compared with $173.2 million in the first nine months of 2002.
The decrease in cash from operating activities of $59.5 million in the first
nine months of 2003 primarily was due to lower earnings and an increase in
working capital items. Increased receivables consumed cash of $18.8 million,
partially due to fire insurance receivables in 2003 of approximately $5.0
million to reimburse the company for expenditures associated with the fire. In
addition, average days sales outstanding in the first nine months of 2003 were
54.5 days, compared with 53.5 days in the first nine months of 2002. Increased
inventory consumed cash of $13.3 million, due to higher unit values, some
slowing of sales and a build-up of strategic stock in certain key materials to
ensure customers of supply and to protect them during planned maintenance
shutdowns. We paid down accounts payable and accrued liabilities by $24.3
19
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
million since year-end compared with a build up of $4.7 million in the first
nine six months of 2002, due to the timing of procurement and payment to
vendors. We have not changed our payment terms to suppliers.
Our capital expenditures in the first nine months of 2003 were $59.5 million,
compared with $46.0 million for same period in 2002. In 2003, we estimate
capital expenditures will be in the range of $80 million to $90 million as
compared with $65.3 million in 2002. Capital expenditures included the purchase
of a multipurpose chemical production facility in Spartanburg, South Carolina
with additional adjacent land in April 2003 for $2.8 million. The facility is
capable of producing several products used in a variety of applications for the
fluid technologies for industry segment.
We completed two acquisitions in the third quarter of 2003 for $67.5 million. In
July, 2003 we purchased the product lines of the North American-based silicones
business from BASF, which expands our foam control additives business to about
$40 million in annual revenues. Assets acquired from BASF's North American-based
silicones business included customer lists, certain trademarks, manufacturing
technology and other related intellectual property specifically developed for
silicone products in the North America region, and finished goods inventory.
Silicones are used in the manufacture of sealants, caulks and water proofing
products. Historical annual revenues for these silicone products approximate $6
million. In late September, 2003 we completed an acquisition of selected
personal care ingredients business from Amerchol Corporation, a subsidiary of
The Dow Chemical Company. Products from this business go into a wide range of
end uses, including skin care and hair conditioners. Products include methyl
glucoside derivatives, lanoline derivatives and Promulgen(TM) personal care
ingredients. Historical annualized revenues of this acquisition approximate $30
million.
Our net debt to capitalization ratio at September 30, 2003 was 18.0%. 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. Total debt as a percent of capitalization was 28.9% at September
30, 2003.
Our share repurchase program has been suspended indefinitely as we are holding
our financial resources in reserve for future acquisitions. Primarily as a
result of all of the above activities and the payment of dividends, our balance
of cash and short-term investments decreased $51.3 million at September 30, 2003
compared with December 31, 2002.
We made a U.S. pension contribution for the 2002 plan year of approximately $3.6
million late in September 2003. We also anticipate making a 2003 plan year
contribution of approximately $3.0 million in September 2004. This latter amount
may change depending on asset and liability valuations as of year end.
Our financial position remains strong with a ratio of current assets to current
liabilities of 3.1 to 1 at September 30, 2003, compared with 3.0 to 1 at
December 31, 2002. We currently have $350 million of committed revolving credit
facilities that will expire in July 2006. We had an additional $175 million of
committed revolving credit facilities that expired in July 2003, which we chose
not to renew. We believe our existing credit facilities, internally generated
funds and ability to obtain additional financing, if desired, will be sufficient
to meet our future capital needs, including acquisitions to expand into new and
existing fluid technology markets.
20
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
In the second quarter of 2003, we modified our commodity hedging program for
natural gas and electricity purchases by using financial instruments. These
contracts are accounted for as cash flow hedges and any effective unrealized
gains or losses on open contracts are recorded in other comprehensive income,
net of tax. At September 30, 2003, open contracts totaled $7.0 million.
Maturities ranged from one to twelve months. A hedge liability was recorded at
September 30, 2003 of $1.2 million, which represented the unrealized loss at
that date based upon current future prices as of that date. The loss, net of
deferred taxes of $.4 million, was included as a charge of $.8 million in other
comprehensive income loss.
CAUTIONARY STATEMENT FOR SAFE HARBOR PURPOSES
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements within the meaning of the federal
securities laws. As a general matter, forward-looking statements are those
focused upon future plans, objectives or performance as opposed to historical
items and include statements of anticipated events or trends and expectations
and beliefs relating to matters not historical in nature. Such forward-looking
statements are subject to uncertainties and factors relating to our operations
and business environment, all of which are difficult to predict and many of
which are beyond our control. These uncertainties and factors could cause our
actual results to differ materially from those matters expressed in or implied
by such forward-looking statements.
We believe that the following factors, among others, could affect our future
performance and cause our actual results to differ materially from those
expressed or implied by forward-looking statements made in this quarterly
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, Middle East and Latin American
regions;
- the lubricant additive demand in developing regions such as China and
India, which geographic zones are an announced focus of our activities;
- the potential negative impact on product pricing and shipment volume demand
from the consolidation of finished lubricant marketers;
- the degree of competition resulting from lubricant additive industry
overcapacity;
- 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 global economic environment, which affects the operating
results of fluid technologies for industry in particular;
- 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;
21
THE LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
- 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, including those with affiliated lubricant additive
companies, and retaining the business of our largest 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.
22
THE LUBRIZOL CORPORATION
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We operate manufacturing and blending facilities, laboratories and
offices around the world and utilize fixed and variable 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
uncertainties, import and export limitations, and market risks related
to changes in interest rates, commodity prices and foreign currency
exchange rates. We believe the political and economic risks related to
our foreign operations are largely 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 and commodity hedges and forward
foreign currency exchange contracts to manage our market risks. Our
objective in managing our exposure to changes in interest rates is to
limit the impact of such changes on earnings and cash flow and to lower
our overall borrowing costs. Our objective in managing our exposure to
changes in foreign currency exchange rates is to reduce volatility of
our earnings and cash flow associated with such changes. Our principal
currency exposures are the euro, the pound sterling, the Japanese yen
and certain Latin American currencies. Our objective in managing our
exposure to changes in commodity prices is to reduce the volatility on
earnings of utility expense. We do not purchase derivatives for trading
purposes.
Our primary commodity hedge exposures relate to natural gas and
electric utility expenses. The calculation of potential loss in fair
value is based on an immediate change in the U.S. dollar equivalent
balances of our commodity exposures due to a 10% shift in the
underlying commodity prices. The potential loss in cash flow 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
commodity prices. A hypothetical 10% increase in commodity prices for
the first nine months of 2003 would have had a favorable impact and a
hypothetical 10% decrease in commodity prices would have had an
unfavorable impact on fair value of $.6 million, cash flow of $.6
million, and income before tax of $.6 million in 2003.
A quantitative and qualitative discussion about our market risk is
contained on page 21 of our 2002 Annual Report to our shareholders.
There have been no material changes in the market risks faced by us
since December 31, 2002.
Item 4. Controls and Procedures
We carried out an evaluation, under the supervision and with the
participation of our chief executive officer and chief financial
officer, of the effectiveness of our disclosure controls and procedures
(as defined in Exchange Act Rule 13a-15(e)) as of September 30, 2003.
Based on that evaluation, our chief executive officer and chief
financial officer concluded that, as of September 30, 2003, our
disclosure controls and procedures are effective in timely alerting
them to material information relating to the company and its
consolidated subsidiaries required to be included in our periodic SEC
filings. There were no significant changes in our internal control over
financial reporting that occurred during the third quarter of 2003 that
has materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting.
23
THE LUBRIZOL CORPORATION
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
(c) On September 4, 2003, we issued 1,500 common shares in a
private placement transaction exempt from registration under
the Securities Act of 1933 pursuant to Section 4(2) of that
Act. We issued the shares to a consultant as partial payment
for services rendered in accordance with a consulting
agreement.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31 Rule 13a-14(a) Certifications
32 Certification of Chief Executive Officer and Chief
Financial Officer of The Lubrizol Corporation
Pursuant to 18 U.S.C. Section 1350
(b) Reports on Form 8-K
On July 22, 2003, we furnished a Form 8-K to the Securities
and Exchange Commission with respect to our news release dated
July 22, 2003, announcing our results for the three months
ended June 30, 2003.
On July 24, 2003, we furnished a Form 8-K to the Securities
and Exchange Commission with respect to the transcript of our
teleconference on July 22, 2003, relating to the results for
the three months ended June 30, 2003.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE LUBRIZOL CORPORATION
/s/ John R. Ahern
------------------------------------
John R. Ahern
Chief Accounting Officer and
Duly Authorized Signatory of
The Lubrizol Corporation
Date: November 6, 2003
24