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, 2001
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 and 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 [ ]
Number of the registrant's common shares, without par value, outstanding, as of
October 31, 2001: 51,115,322.
PART I. FINANCIAL INFORMATION
Item 1 Financial Statements
THE LUBRIZOL CORPORATION
CONSOLIDATED BALANCE SHEETS
---------------------------------------------------------------------------------------------------------
September 30 December 31
(In Thousands of Dollars) 2001 2000
---------------------------------------------------------------------------------------------------------
ASSETS
Cash and short-term investments .............................. $ 168,665 $ 145,937
Receivables .................................................. 319,219 290,556
Inventories:
Finished products .......................................... 131,345 124,755
Products in process ........................................ 52,912 56,908
Raw materials .............................................. 65,079 61,706
Supplies and engine test parts ............................. 16,423 16,764
----------- -----------
265,759 260,133
----------- -----------
Other current assets ......................................... 25,663 31,282
----------- -----------
Total current assets ..................... 779,306 727,908
Property and equipment - net ................................. 655,141 677,242
Goodwill and intangible assets - net ......................... 170,513 170,593
Investments in nonconsolidated companies ..................... 30,707 34,247
Other assets ................................................. 72,082 49,500
----------- -----------
TOTAL ............................... $ 1,707,749 $ 1,659,490
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Short-term debt and current portion of long-term debt ........ $ 12,529 $ 17,152
Accounts payable ............................................. 141,319 141,574
Accrued expenses and other current liabilities ............... 123,420 123,520
----------- -----------
Total current liabilities ................ 277,268 282,246
----------- -----------
Long-term debt ............................................... 393,338 378,783
Postretirement health care obligation ........................ 100,356 100,275
Noncurrent liabilities ....................................... 55,897 52,821
Deferred income taxes ........................................ 59,692 60,614
----------- -----------
Total liabilities ........................ 886,551 874,739
----------- -----------
Minority interest in consolidated companies .................. 32,875 32,470
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 - 51,115,322 shares as of Sept. 30,
2001 after deducting 35,080,572 treasury
shares, 51,307,688 shares as of December 31,
2000 after deducting 34,888,206 treasury shares ........ 108,447 82,128
Retained earnings .......................................... 769,151 750,779
Accumulated other comprehensive loss ....................... (89,275) (80,626)
----------- -----------
Total shareholders' equity ............... 788,323 752,281
----------- -----------
TOTAL ............................... $ 1,707,749 $ 1,659,490
=========== ===========
Amounts shown are unaudited.
2
THE LUBRIZOL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------------------------------------------------------------------------------------------------
Third Quarter Nine Month
Ended September 30 Period Ended September 30
----------------------------------------------------------------------------
(In Thousands Except Per Share Data) 2001 2000 2001 2000
---------------------------------------------------------------------------------------------------------------------------
Net sales .......................... $ 461,109 $ 432,442 $ 1,400,828 $ 1,325,429
Royalties and other revenues ....... 1,317 954 4,031 3,293
----------- ----------- ----------- -----------
Total revenues ........... 462,426 433,396 1,404,859 1,328,722
Cost of sales ...................... 332,887 310,818 1,017,571 946,631
Selling and administrative expenses 42,602 41,790 131,402 128,655
Research, testing and development
expenses ......................... 42,467 39,051 119,828 110,154
----------- ----------- ----------- -----------
Total cost and expenses .. 417,956 391,659 1,268,801 1,185,440
Special credit ..................... 2,577
Other income (expense) - net ....... (5,726) (5,661) (13,520) (10,014)
Interest income .................... 1,282 1,820 4,614 6,342
Interest expense ................... (5,746) (6,427) (18,479) (20,480)
----------- ----------- ----------- -----------
Income before income taxes ......... 34,280 31,469 108,673 121,707
Provision for income taxes ......... 11,483 8,214 35,355 36,635
----------- ----------- ----------- -----------
Net income ......................... $ 22,797 $ 23,255 $ 73,318 $ 85,072
=========== =========== =========== ===========
Net income per share ............... $ 0.45 $ 0.44 $ 1.43 $ 1.59
=========== =========== =========== ===========
Net income per share, diluted ...... $ 0.44 $ 0.44 $ 1.42 $ 1.59
=========== =========== =========== ===========
Dividends per share ................ $ 0.26 $ 0.26 $ 0.78 $ 0.78
=========== =========== =========== ===========
Weighted average common shares
outstanding ...................... 51,121 52,790 51,202 53,546
Amounts shown are unaudited.
-3-
THE LUBRIZOL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------------------------------------------------------
Nine Month Period Ended
September 30
------------------------------------
(In Thousands of Dollars) 2001 2000
-----------------------------------------------------------------------------------------------
Cash provided from (used for):
Operating activities:
Net income .......................................... $ 73,318 $ 85,072
Adjustments to reconcile net income to cash provided
by operating activities:
Depreciation and amortization ................... 74,084 73,221
Deferred income taxes ........................... 3,174 3,524
Special credit .................................. (2,577)
Change in current assets and liabilities:
Receivables ................................... (34,774) (19,981)
Inventories ................................... (6,289) (39,261)
Accounts payable and accrued expenses ......... 19,791 19,902
Other current assets .......................... 3,051 2,907
Other items - net ............................... 10,685 2,873
--------- ---------
Total operating activities ................ 143,040 125,680
Investing activities:
Capital expenditures .............................. (48,365) (59,566)
Acquisitions and investments in nonconsolidated
companies ....................................... (14,989) (41,141)
Other - net ....................................... (1,335) 1,680
--------- ---------
Total investing activities ................ (64,689) (99,027)
Financing activities:
Short-term borrowings (repayments) ................ (2,824) 2,211
Long-term borrowing ............................... 18,375
Long-term repayments .............................. (2,044) (26,720)
Dividends paid .................................... (39,927) (41,858)
Common shares purchased ........................... (30,039) (55,920)
Stock options exercised ........................... 21,410 1,318
--------- ---------
Total financing activities ................ (53,424) (102,594)
Effect of exchange rate changes on cash ............. (2,199) (3,371)
--------- ---------
Net increase (decrease) in cash and short-term
investments ....................................... 22,728 (79,312)
Cash and short-term investments at the beginning
of period ......................................... 145,937 185,465
--------- ---------
Cash and short-term investments at end of period .... $ 168,665 $ 106,153
========= =========
Amounts shown are unaudited.
-4-
THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2001
1. The accompanying unaudited consolidated financial statements contain all
adjustments (consisting only of normal recurring accruals) necessary to
present fairly the financial position as of September 30, 2001 and December
31, 2000, and the results of operations and cash flows for the applicable
periods ended September 30, 2001 and 2000.
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 share, diluted, includes the dilution effect
resulting from outstanding stock options and stock awards.
Per share amounts are computed as follows:
Third Quarter Ended Nine Month Period Ended
September 30 September 30
------------------------------------ ------------------------------------
2001 2000 2001 2000
---- ---- ---- ----
Numerator:
Net income available to
common shares $22,797 $23,255 $73,318 $85,072
======= ======= ======= =======
Denominator:
Weighted average common
shares outstanding 51,121 52,790 51,202 53,546
Dilutive effect of stock
options and awards 439 65 290 117
------- ------- ------- -------
Denominator for net income
per share, diluted $51,560 $52,855 $51,492 $53,663
======= ======= ======= =======
Net income per share $ .45 $ .44 $ 1.43 $ 1.59
======= ======= ======= =======
Net income per share,
diluted $ .44 $ .44 $ 1.42 $ 1.59
======= ======= ======= =======
3. Total comprehensive income for the three- and nine-month periods ended
September 30, 2001 and 2000 is comprised as follows:
Third Quarter Ended Nine Month Period Ended
September 30 September 30
---------------------------------- ----------------------------------
2001 2000 2001 2000
---- ---- ---- ----
Net income $ 22,797 $ 23,255 $ 73,318 $ 85,072
Foreign currency
translation adjustment 14,692 (14,104) (5,652) (32,623)
Cumulative effect of
accounting change (1,314)
Net unrealized losses
on derivative contracts (1,327) (1,683)
-------- -------- -------- --------
Total comprehensive
income $ 36,162 $ 9,151 $ 64,669 $ 52,449
======== ======== ======== ========
5
THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2001
4. 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 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. In
addition, the company allocates corporate research, testing, selling and
administrative expenses, and excess production capacity costs, in arriving
at segment operating profit before tax.
The following table presents a summary of the company's reportable segments
for the three- and nine-month periods ended September 30, 2001 and 2000 on
a basis of segmentation consistent with the previous year-end:
Third Quarter Ended Nine Month Period Ended
September 30 September 30
----------------------------------- -----------------------------------
2001 2000 2001 2000
------------ ------------- ------------ ------------
Revenue from external customers:
Fluid technologies for
transportation $ 385,222 $ 355,273 $ 1,166,402 $ 1,090,753
Fluid technologies for industry 77,204 78,123 238,457 237,969
----------- ----------- ----------- -----------
Total revenues $ 462,426 $ 433,396 $ 1,404,859 $ 1,328,722
=========== =========== =========== ===========
Segment contribution income:
Fluid technologies for
transportation $ 74,227 $ 65,156 $ 219,542 $ 217,189
Fluid technologies for industry 3,596 9,569 18,053 34,100
----------- ----------- ----------- -----------
Total segment contribution
income $ 77,823 $ 74,725 $ 237,595 $ 251,289
=========== =========== =========== ===========
Segment operating profit
before tax:
Fluid technologies for
transportation $ 38,974 $ 30,660 $ 117,103 $ 112,074
Fluid technologies for industry (230) 5,416 5,435 21,194
----------- ----------- ----------- -----------
Total segment operating
profit before tax 38,744 36,076 122,538 133,268
Special credit 2,577
Interest expense - net (4,464) (4,607) (13,865) (14,138)
----------- ----------- ----------- -----------
Consolidated income before tax $ 34,280 $ 31,469 $ 108,673 $ 121,707
=========== =========== =========== ===========
Prior - year amounts have been restated to reflect reclassifications of
products between fluid technologies for transportation and fluid
technologies for industry operating segments and changes in allocation
methodology for corporate expenses.
6
THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2001
5. The company had an effective tax rate of 33.5% for the three-month period
ended September 30, 2001 and 32.5% for the nine-month period ended
September 30, 2001, compared to 26.1% and 30.1% for the corresponding
periods in 2000. The effective tax rate for the third quarter was higher
than the effective rate for the nine months ended September 30, 2001, due
in large part to a non-recurring benefit of revaluation of deferred taxes
to reflect a statutory tax rate change in India enacted during the second
quarter. The effective tax rate for the nine months ended September 30,
2001 was higher than the corresponding period in 2000, primarily due to the
U.S. tax benefit of a non-recurring charitable contribution made in 2000.
6. In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities". In June 2000, the FASB
amended certain provisions of that statement by issuing SFAS No. 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
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.
Effective January 1, 2001, the company adopted the provisions of these
statements. 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 SFAS 133 did
not have a material 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.
Interest Rate Contracts
The company is exposed to market risk from changes in interest rates. The
company's policy is to manage interest costs using a mix of fixed and
variable rate debt. To manage this mix, 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.
At September 30, 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 $16.1 million. These swaps are designated
as fair value hedges of underlying fixed rate debt obligations and are
recorded as an increase in non-current 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 changes in fair value of the underlying debt. As a
result, there was no impact to earnings for the third quarter of 2001 due
to hedge ineffectiveness.
7
THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2001
At September 30, 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 $5.7 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 the third quarter of 2001 of $2.0 million ($1.3
million net of tax) unrealized loss was recorded in other comprehensive
income. Ineffectiveness was determined to be immaterial during the third
quarter of 2001. The company does not expect any significant portion of
these existing losses to be reclassified into earnings within the next 12
months.
Currency Contracts
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 are
generally in connection with specific transactions having maturities of
less than one year.
At September 30, 2001, the company had short-term forward contracts to sell
currencies at various dates during 2001 and through January 2002 for $10.2
million. These forward contracts are not designated as hedges. Any
unrealized gains or losses on these contracts are recorded in other income.
The fair value of these instruments at September 30, 2001 was not material,
and the net impact of the related gains and losses on other income was a
loss of $.1 million in the quarter ended September 30, 2001 and for the
nine months ended September 30, 2001.
7. 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. Any business
combinations the company enters into after June 30, 2001 will be accounted
for under the provisions of this statement.
In June 2001 the FASB also issued SFAS 142, "Goodwill and Other Intangible
Assets" which will become effective for the company on January 1, 2002.
Under the provisions of SFAS 142 there will be no goodwill amortization for
business combinations that occur after June 30, 2001 and amortization of
goodwill on pre-June 30, 2001 acquisitions will cease effective January 1,
2002. The adoption of this statement will result in the elimination of
approximately $10 million of annual goodwill amortization expense beginning
on January 1, 2002. Goodwill amortization will be 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
requirement to test goodwill for impairment will have on its consolidated
financial position or results of operations.
8
THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
September 30, 2001
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 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.
In August 2001 the FASB issued SFAS 144, "Impairment or Disposal of
Long-Lived Assets" which will become effective for the company on January
1, 2002. This statement further refines the rules for accounting for
long-lived assets and long-lived assets to be disposed of. The company has
not determined the impact, if any, that this statement will have on its
consolidated financial position or results of operations.
8. Effective July 17, 2001, the company increased its committed revolving
credit facilities from $150 million to $575 million. This resulted from the
addition of $525 million in new facilities, $175 million of which expires
on July 16, 2002 and $350 million of which expires on July 16, 2006, and
the cancellation of $100 million in existing facilities that would have
expired on June 30, 2003. There were no borrowings under these credit
facilities at September 30, 2001.
9
LUBRIZOL CORPORATION
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
RESULTS OF OPERATIONS
Our revenues increased in the 2001 third quarter as compared to the 2000
third quarter, primarily as a result of higher shipment volume during the
quarter. However, higher operating expenses, unfavorable impact from
currency and a higher effective tax rate in the 2001 third quarter resulted
in a 2% decrease in net income from the 2000 third quarter. Revenues also
increased for the first nine months of 2001 compared to the first nine
months of 2000. However, after excluding the special credit taken in 2000,
net income decreased 12% due to these same factors and higher average
year-to-date material cost.
We group our product lines into two operating segments: fluid technologies
for transportation and fluid technologies for industry. Fluid technologies
for transportation comprised approximately 82% of our consolidated revenues
and 85% of our segment pre-tax operating profits for the full year 2000
(83% of revenues and 96% of operating profits for the nine months ended
September 30, 2001). This discussion and analysis of our financial
condition and results of operations is primarily focused upon the company
as a whole, since we believe this provides the most appropriate
understanding of our business. See Note 4 to the financial statements for
further financial disclosures by operating segment.
Our consolidated revenues increased $29.0 million, or 7% (4% excluding
acquisitions), for the 2001 third quarter compared with the 2000 third
quarter, and increased $76.1 million, or 6% (3% excluding acquisitions),
for the first nine months of 2001 compared with the first nine months of
2000. On a year-to-year comparative basis, fluid technologies for
transportation revenues increased $29.9 million, or 8%, for the third
quarter and $75.6 million, or 7%, for the nine months. On a similar basis,
fluid technologies for industry revenues decreased $.9 million, or 1%, for
the third quarter and increased $.5 million, or less than 1%, for the nine
months.
Our shipment volume increased 10% in the 2001 third quarter (7% excluding
acquisitions) and increased 6% (4% excluding acquisitions) for the first
nine months of 2001, compared with the same periods in 2000. The percentage
changes in 2001 shipment volume by geographical area, as compared with
comparable prior-year periods, were:
Increase/(Decrease)
-------------------
3rd Quarter Nine Months
----------- -----------
North America 11% 7%
Europe, Middle East 12% 7%
Asia-Pacific 9% 6%
Latin America (2%) 1%
The increases are primarily due to business gains in our engine oil
additives product group in North America and strong shipments to many of
our global engine oil customers in Europe. The increase in Asia-Pacific is
primarily due to consolidation of our new China subsidiaries during the
fourth quarter of 2000. Excluding China, Asia-Pacific volume would have
declined 2% for the third quarter, primarily due to general economic
weakness in the region.
11
THE LUBRIZOL CORPORATION
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Average additive selling price decreased 3% for the 2001 third quarter and
was flat for the first nine months of 2001, as compared with the same
periods in 2000. The decrease for the quarter resulted from the impact of
unfavorable currency and product mix partially offset by 2% higher product
prices. Product pricing was 5% higher for the first nine months of 2001
than for the same period of 2000 but this was offset approximately equally
by unfavorable currency and product mix. Sequentially, average selling
price decreased 1% from the second quarter of 2001 due to lower product
prices and unfavorable product mix.
Cost of sales increased 7% for both the 2001 third quarter and for the
first nine months of 2001, compared to the same periods in 2000. The
increase for the quarter was due to increased shipment levels and higher
manufacturing expenses, partially offset by lower raw material costs. The
increase for the nine months was due to increased shipment levels, higher
manufacturing expenses and higher raw material costs. Average raw material
cost decreased 3% for 2001 third quarter compared with the 2000 third
quarter due to lower raw material prices and the effect of favorable
currency and product mix. Average raw material cost increased 3% for the
first nine months of 2001 compared to the same period of 2000 due to 5%
higher raw material prices, partially offset by the effect of favorable
currency and product mix. The variations in raw material prices during the
year were due to changes in the cost of crude oil and natural gas. During
the first half of 2001, raw material costs were affected by 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 prices started to come down during the 2001 second quarter and
continued to decrease during the third quarter. We believe that raw
material costs will continue to decline to some extent during the fourth
quarter.
Manufacturing costs were 6% higher for the 2001 third quarter and 4% higher
for the first nine months of 2001, as compared with the same periods in
2000. The increases were due to higher production volume, higher utility
costs in the first half of the year in the U.S. as a result of increased
natural gas costs, and acquisitions, partially offset by the effect of
favorable currency.
Gross profit (sales less cost of sales) increased $6.6 million, or 5%, for
the 2001 third quarter and increased $4.5 million, or 1%, for the first
nine months of 2001, compared with the same periods in 2000. The third
quarter gross profit rose because the effect of higher volume and lower raw
material costs more than offset increased manufacturing expenses. Gross
profit for the nine months increased due to higher volume, partially offset
by higher material cost and higher manufacturing expense. Gross profit for
fluid technologies for transportation increased $11.8 million, or 12%, for
the 2001 third quarter and $13.6 million, or 5%, for the first nine months
of 2001 due to the factors mentioned above. Gross profit for fluid
technologies for industry decreased $5.2 million, or 19%, for the 2001
third quarter and $9.1 million, or 11%, for the first nine months of 2001,
primarily because the weak manufacturing sector in North America adversely
affected our metalworking and paints, coatings and inks additive
businesses. We also had a write-off of $2.3 million for obsolete inventory
in our performance systems product group during the 2001 third quarter.
These factors caused our consolidated gross profit percentage (gross profit
divided by net sales) to be 27.8% in the 2001 third quarter (as compared to
28.1% in the 2000 second
11
THE LUBRIZOL CORPORATION
Management's Discussion and Analysis of
Financial Condition and Results of Operations
quarter) and 27.4% in the first nine months of 2001 (as compared with 28.6%
in the same period of 2000). Sequentially, gross profit decreased 6% from
the second quarter of 2001 primarily due to lower shipment volume. The
gross profit percentage decreased from 28.0% in the second quarter of 2001.
Selling and administrative expenses increased $.8 million, or 2%, for the
third quarter of 2001 and $2.7 million, or 2%, for the first nine months of
2001 compared with the respective 2000 periods, primarily due to the impact
of acquisitions.
Our research, testing and development expenses (technology expenses)
increased $3.4 million, or 9%, for the 2001 third quarter and increased
$9.7 million, or 9%, for the first nine months of 2001 compared to the same
periods of 2000. The increases 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
testing for the next diesel engine oil specification, PC-9.
Other income (expense) for the 2001 third quarter was basically unchanged
from the 2000 third quarter and negatively affected pre-tax income by $3.5
million for the first nine months of 2001 compared with the same period in
2000. The unfavorable change for the nine-month period was primarily due to
higher expenses for our joint venture with GE and higher goodwill
amortization during 2001.
Interest income decreased $.5 million for the 2001 third quarter and $1.7
million for the first nine months of 2001, compared to the same periods in
2000, principally because we had a lower level of cash investments in 2001.
Interest expense decreased $.7 million for the 2001 third quarter and $2.0
million for the first nine months of 2001, compared to the same periods in
2000, principally because of lower interest rates due to the interest rate
swap agreements we entered into during the first half of 2000.
As a result of the above factors, our income before income taxes increased
9% for the 2001 third quarter and decreased 11% for the first nine months
of 2001 (9% excluding the 2000 second quarter special charge adjustment),
as compared to the same periods in 2000. For fluid technologies for
transportation, segment operating profit before tax, which excludes
interest expense, increased $8.3 million, or 27%, for the 2001 third
quarter and increased $5.0 million, or 4%, for the first nine months of
2001 compared to the same periods in 2000. These increases resulted from
the same factors that caused the changes in consolidated gross profit as
described above. For fluid technologies for industry, segment operating
profit before tax decreased $5.6 million, or 104%, for the 2001 third
quarter (which resulted in a loss of $.2 million) and decreased $15.8
million, or 74%, for the first nine months of 2001, as compared to the same
periods in 2000. These decreases were due to weak demand in the
manufacturing sector in North America and spending to commercialize
PuriNOx(TM) and other products in our performance systems product group.
We also had a write-off of $2.3 million for obsolete inventory in our
performance systems group during the 2001 third quarter.
We had an effective tax rate of 33.5% for the 2001 third quarter and 32.5%
for the first nine months of 2001 compared to 26.1% and 30.1% for the
corresponding periods in 2000. The effective tax rate for the first nine
months of 2001 was lower than the effective rate for the 2001 third
quarter, due in large part to the non-recurring benefit of a revaluation
12
THE LUBRIZOL CORPORATION
Management's Discussion and Analysis of
Financial Condition and Results of Operations
of deferred taxes to reflect a statutory tax rate change in India enacted
during the 2001 second quarter. The effective tax rate for the first nine
months of 2001 was higher than the corresponding period in 2000, primarily
due to the U.S. tax benefit of a non-recurring charitable contribution made
in 2000. We anticipate an effective tax rate of 33.5% for the fourth
quarter of 2001. The higher tax rate used for the 2001 third quarter and
the first nine months of 2001 had an unfavorable impact of $.05 per share
when compared to each of the same periods in 2000.
Currency exchange rates in effect during the third quarter and first nine
months of 2001 had an unfavorable effect on net income per share of $.07
and $.19 per share, respectively, as compared to exchange rates in effect
during the comparable periods in 2000.
Primarily as a result of the above factors net income for the 2001 third
quarter was $22.8 million or $.45 per share, as compared to $23.3 million
or $.44 per share for the 2000 third quarter. Net income for the first nine
months of 2001 was $73.3 million or $1.43 per share, as compared to $83.4
million or $1.56 per share for the first nine months of 2000 (after
excluding from 2000 the positive adjustment to the special charge).
WORKING CAPITAL, LIQUIDITY AND CAPITAL RESOURCES
Cash provided from operating activities was $143.0 million for the first
nine months of 2001 compared with $125.7 million for the first nine months
of 2000. The increase was caused principally by a lower rate of increase in
working capital in 2001 compared to 2000, as the result of a company
initiative to focus on working capital management and some inventory build
up during September 2000 that did not occur during September 2001.
Our capital expenditures in the first nine months of 2001 were $48.4
million compared with $59.6 million for the same 2000 period. The lower
level of capital expenditures is primarily due to delays in various
environmental and process improvement projects. We estimate capital
spending for the full year 2001 will be approximately $70 million as
compared with $85.8 million in 2000.
During the first quarter of 2001 we completed one acquisition for $15.0
million. The business acquired, ROSS Chem, Inc., produces defoamers and
anti-foam agents that expand our product lines in metalworking and paints,
coatings and inks.
During the first half of 2001 we repurchased approximately 968,000 of our
shares for $30.0 million. We did not repurchase any of our shares during
the 2001 third quarter and do not have any plans to resume share repurchase
activity during the fourth quarter of 2001.
Our net debt to capitalization ratio at September 30, 2001 was 24.9%. 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.
Primarily as a result of these activities and the payment of dividends, our
balance of cash and short-term investments increased $22.7 million at
September 30, 2001 compared with December 31, 2000.
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THE LUBRIZOL CORPORATION
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Our financial position is strong with a ratio of current assets to current
liabilities of 2.8 to 1 at September 30, 2001 compared with a ratio of 2.6
to 1 at December 31, 2000. We believe our current credit facilities,
internally generated funds and our ability to obtain additional financing
will enable us to meet our future spending needs.
Effective July 17, 2001, we increased our committed revolving credit
facilities from $150 million to $575 million. This resulted from the
addition of $525 million in new facilities ($175 million of which expires
on July 16, 2002 and $350 million of which expires on July 16, 2006) and
the cancellation of $100 million in existing facilities that would have
expired on June 30, 2003. We currently have no borrowings under these
credit facilities.
COST REDUCTION PROGRAMS
We initiated a series of steps in 1998 to reduce costs and improve our
worldwide operating structure and executed these steps in two programs over
a two-year period, completing the process at December 31, 2000. The first
program of this initiative was substantially completed by the end of the
third quarter of 1999. The second program, which began in the third quarter
of 1999 and involved primarily the downsizing of our Painesville, Ohio
manufacturing facility, was completed at December 31, 2000. Approximately
$.4 million remains as an accrued liability at September 30, 2001, for
severance-related payments for employees separated prior to December 31,
2000 and costs to complete the dismantling of assets that were taken out of
service as of December 31, 2000. We expect these expenditures to be
incurred before the end of 2001.
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. Such uncertainties and factors could cause
our actual results to differ materially from those matters expressed in or
implied by such forward-looking statements.
We believe that the following factors, among others, could affect our
future performance and cause our actual results to differ materially from
those expressed or implied by forward-looking statements made in this
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 and Latin American regions;
14
THE LUBRIZOL CORPORATION
Management's Discussion and Analysis of
Financial Condition and Results of Operations
- the lubricant additive demand in developing regions such as China and
India, which geographic areas are an announced focus of our
activities;
- 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 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 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;
- our ability to identify, complete and integrate acquisitions for
profitable growth;
- 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;
- 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.
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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 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. 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 the economic effect on earnings and cash flow
associated with such changes. Our principal currency exposures are in the
major European currencies, the Japanese yen and certain Latin American
currencies. We do not hold derivatives for trading purposes.
A quantitative and qualitative discussion about our market risk is
contained on page 23 of our 2000 Annual Report to our shareholders. There
have been no material changes in the market risks faced by us since
December 31, 2000.
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PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
(c) On August 31, 2001, 1,500 common shares were issued in a private
placement transaction exempt from registration under the
Securities Act of 1933 pursuant to section 4(2) of that Act. The
company issued the shares to a consultant as partial payment for
services rendered in accordance with a consulting agreement.
On September 4, 2001, 47 common shares were issued in a
transaction exempt from registration under the Securities Act of
1933 pursuant to Regulation S. The common shares were issued
pursuant to an employee benefit plan to a former employee of a
wholly-owned Canadian subsidiary of the company.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
There are no exhibits for the quarter ended September 30, 2001.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended
September 30, 2001.
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 9, 2001
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