<PAGE> 1
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, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ..... to .....
Commission File 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, 1998 55,122,204
<PAGE> 2
PART I. FINANCIAL INFORMATION
Item 1 Financial Statements
THE LUBRIZOL CORPORATION
========================
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
- -------------------------------------------------------------------------------------------------------------
September 30 December 31
(In Thousands of Dollars) 1998 1997
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and short-term investments....................... $ 65,484 $ 86,504
Receivables........................................... 318,917 273,505
Inventories:
Finished products................................... 115,337 94,010
Products in process................................. 74,830 67,246
Raw materials....................................... 85,065 81,079
Supplies and engine test parts...................... 19,245 17,783
---------- ----------
294,477 260,118
---------- ----------
Other current assets.................................. 29,033 36,949
---------- ----------
Total current assets.............. 707,911 657,076
Property and equipment - net.......................... 711,858 692,677
Investments in nonconsolidated companies.............. 25,697 25,904
Goodwill and intangible assets - net.................. 170,766 58,066
Other assets.......................................... 31,529 28,569
---------- ----------
TOTAL........................ $1,647,761 $1,462,292
=========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Short-term debt and current portion of long-term debt. $ 104,580 $ 38,095
Accounts payable...................................... 123,782 127,347
Income taxes and other current liabilities............ 96,339 96,488
---------- ----------
Total current liabilities......... 324,701 261,930
Long-term debt........................................ 301,104 182,165
Postretirement health care obligation................. 106,400 105,962
Noncurrent liabilities................................ 45,179 42,878
Deferred income taxes................................. 55,410 53,909
---------- ----------
Total liabilities................. 832,794 646,844
---------- ----------
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 - 55,232,004 shares as of September 30,
1998 after deducting 30,963,890 treasury shares,
56,966,894 shares as of December 31,
1997 after deducting 29,229,000 treasury shares. 83,434 82,669
Retained earnings................................... 758,473 773,184
Accumulated other comprehensive income (loss)....... (26,940) (40,405)
---------- ----------
Total shareholders' equity........ 814,967 815,448
---------- ----------
TOTAL........................ $1,647,761 $1,462,292
=========== ==========
</TABLE>
Amounts shown are unaudited.
2
<PAGE> 3
<TABLE>
<CAPTION>
THE LUBRIZOL CORPORATION
========================
CONSOLIDATED STATEMENTS OF INCOME
- ---------------------------------------------------------------------------------------------------
Third Quarter Nine Months
Ended September 30 Ended September 30
------------------------------------------------------------
(In Thousands Except Per Share Data) 1998 1997 1998 1997
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales ......................... $ 403,262 $ 426,824 $ 1,208,322 $ 1,247,129
Royalties and other revenues ...... 782 912 2,054 3,137
----------- ----------- ----------- -----------
Total revenues .......... 404,044 427,736 1,210,376 1,250,266
Cost of sales ..................... 283,010 290,284 839,062 831,404
Selling and administrative expenses 45,042 43,259 130,062 125,603
Research, testing and development
expenses ........................ 40,328 36,772 110,700 107,861
----------- ----------- ----------- -----------
Total cost and expenses . 368,380 370,315 1,079,824 1,064,868
Gain from litigation settlement ... 16,201
Other income (expense) - net ...... (1,714) 2,749 (51) 5,085
Interest income ................... 1,272 1,307 4,003 3,081
Interest expense .................. (5,447) (2,840) (12,385) (7,873)
----------- ----------- ----------- -----------
Income before income taxes ........ 29,775 58,637 138,320 185,691
Provision for income taxes ........ 13,161 19,985 52,075 61,278
----------- ----------- ----------- -----------
Net income ........................ $ 16,614 $ 38,652 $ 86,245 $ 124,413
=========== =========== =========== ===========
Net income per share .............. $ 0.30 $ 0.67 $ 1.53 $ 2.14
=========== =========== =========== ===========
Net income per diluted share ...... $ 0.30 $ 0.66 $ 1.53 $ 2.13
=========== =========== =========== ===========
Dividends per share ............... $ 0.26 $ 0.25 $ 0.78 $ 0.75
=========== =========== =========== ===========
Average common shares outstanding . 55,625 57,620 56,265 58,078
</TABLE>
Amounts shown are unaudited.
3
<PAGE> 4
THE LUBRIZOL CORPORATION
========================
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ---------------------------------------------------------------------------------------------------
Nine Months Ended
September 30
----------------------------
(In Thousands of Dollars) 1998 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash provided from (used for):
Operating activities:
Net income ........................................................ $ 86,245 $ 124,413
Adjustments to reconcile net income to cash provided
by operating activities:
Depreciation and amortization ................................. 66,944 63,716
Deferred income taxes ......................................... 4,678 742
Equity earnings, net of distributions ......................... (1,706) (3,409)
Change in current assets and liabilities - net of acquisitions:
Receivables ................................................. (6,609) (55,528)
Inventories ................................................. (12,871) (9,454)
Accounts payable and accrued expenses ....................... (31,387) 61,968
Other current assets ........................................ 3,765 10,039
Other items - net ............................................. 1,096 (6,101)
--------- ---------
Total operating activities .............................. 110,155 186,386
Investing activities:
Capital expenditures ............................................ (68,320) (72,218)
Proceeds from sale of investments ............................... 12,117
Acquisitions and investments in nonconsolidated
companies ..................................................... (149,485) (22,885)
Other - net ..................................................... 2,493 5,789
--------- ---------
Total investing activities .............................. (215,312) (77,197)
Financing activities:
Short-term borrowing ............................................ 183,516 13,517
Long-term borrowing ............................................. 2,762 5,572
Long-term repayments ............................................ (2,147) (2,864)
Dividends paid .................................................. (43,924) (43,636)
Common shares purchased, net of options exercised ............... (56,267) (43,709)
--------- ---------
Total financing activities .............................. 83,940 (71,120)
Effect of exchange rate changes on cash ........................... 197 (946)
--------- ---------
Net increase (decrease) in cash and short-term
investments ..................................................... (21,020) 37,123
Cash and short-term investments at the beginning
of period ....................................................... 86,504 55,073
--------- ---------
Cash and short-term investments at end of period .................. $ 65,484 $ 92,196
========= =========
</TABLE>
Amounts shown are unaudited.
4
<PAGE> 5
THE LUBRIZOL CORPORATION
========================
Notes to Consolidated Financial Statements
September 30, 1998
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, 1998 and December
31, 1997, and the results of operations and cash flows for the applicable
periods ended September 30, 1998 and 1997.
2. Net income per share is computed by dividing net income by average common
shares outstanding during the period. Net income per diluted share,
includes the dilution effect resulting from outstanding stock options and
stock awards.
Per share amounts are computed as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
-------------------- --------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Numerator:
Net income available to
common shareholders ........ $ 16,614 $ 38,652 $ 86,245 $124,413
======== ======== ======== ========
Denominator:
Weighted average common
shares outstanding ......... 55,625 57,620 56,265 58,078
Dilutive effect of stock
options and awards ......... 68 598 219 365
-------- -------- -------- --------
Denominator for net income
per share, diluted ........... 55,693 58,218 56,484 58,443
======== ======== ======== ========
Net income per share ........... $ .30 $ .67 $ 1.53 $ 2.14
======== ======== ======== ========
Net income per diluted
share ........................ $ .30 $ .66 $ 1.53 $ 2.13
======== ======== ======== ========
</TABLE>
3. The company elected to adopt early SFAS 130 - Reporting Comprehensive
Income for its fiscal year ended December 31, 1997. Total comprehensive
income for the three- and nine-month periods ended September 30, 1998 and
1997 is comprised as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
---------------------- ----------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net income ............... $ 16,614 $ 38,652 $ 86,245 $ 124,413
Other comprehensive
income (loss) .......... 16,964 (7,571) 13,465 (32,754)
--------- --------- --------- ---------
Total comprehensive income $ 33,578 $ 31,081 $ 99,710 $ 91,659
========= ========= ========= =========
</TABLE>
Other comprehensive income (loss) in each of the periods above is comprised
solely of foreign currency translation adjustments, net of related tax
effects.
5
<PAGE> 6
THE LUBRIZOL CORPORATION
========================
Notes to Consolidated Financial Statements
September 30, 1998
4. On July 7, 1998, the company purchased Carroll Scientific, Inc., which
specializes in the development and supply of varnish and wax-based
performance additives to the ink market. Also, effective August 1, 1998,
the company purchased Adibis, the lubricants and fuel additives business
of British Petroleum Company P.L.C. During 1997, the annual revenues of
Carroll Scientific were approximately $30 million and of Adibis were
approximately $150 million. The aggregate purchase price of these
acquisitions was approximately $135 million, of which $103 million was
assigned to goodwill and intangible assets. Amortization of goodwill and
intangible assets is on a straight-line basis over periods approximating
15 years. The company has engaged an independent appraiser to determine
the fair value of the intangible assets acquired related to the Adibis
transaction, including the amount to be assigned to in-process research
and development. A final determination of the fair value to be assigned to
the intangible assets will be made during the fourth quarter of 1998. Any
portion of the purchase price allocated to in-process research and
development will be written off in the fourth quarter of 1998 and such
amount may be material to the company's operating results for the fourth
quarter. These acquisitions were temporarily financed primarily through
increased commercial paper borrowings.
5. The company anticipates replacing a significant portion of its outstanding
commercial paper borrowings with a long-term debt issuance prior to
December 31, 1998. On July 29, 1998, the company filed a shelf
registration statement with the Securities and Exchange Commission to
enable the company to offer public debt securities of up to $200 million
in aggregate principal amount. The company has entered into several
Treasury rate lock agreements, having an aggregate notional amount of $160
million, to hedge its exposure to changes in interest rates relative to
this anticipated debt issuance. Any realized gains or losses under these
agreements will be deferred and amortized as a component of interest
expense over the life of the debt issue being anticipated. Unrealized
gains or losses under these agreements are not immediately recognized in
income unless the anticipated debt issuance is not completed or becomes
probable of not being completed. The company would have paid approximately
$11.8 million if it had terminated these Treasury rate lock agreements at
September 30, 1998. Unrealized losses related to these agreements have not
been recorded in the company's financial statements.
6. Effective July 1, 1998, the company increased its committed revolving
credit facilities from $75 million to $300 million, of which $150 million
would permit the company to refinance short-term borrowings for a period
beyond one year. These credit facilities, under which the company may
borrow at or below the U.S. prime rate, were unused at September 30, 1998.
As permitted by these and previously existing facilities, the company
classified as long-term debt at September 30, 1998 and December 31, 1997,
respectively, $150 million and $75 million of debt that, by its terms or
conditions, would otherwise be classified as short-term debt.
6
<PAGE> 7
THE LUBRIZOL CORPORATION
========================
Notes to Consolidated Financial Statements
September 30, 1998
7. The company has filed claims against Exxon Corporation and/or its
affiliates relating to various commercial matters, including alleged
infringements by Exxon of certain of the company's patents.
These suits are pending in the United States (in Ohio) and Canada.
On April 23, 1998, the company reached a settlement with Exxon of a lawsuit
pending in federal court in Ohio and received cash of $19 million. After
deducting related expenses, this settlement increased pre tax income by
$16.2 million for the nine-month period ended September 30, 1998. Other
lawsuits between the company and Exxon pending in the United States, Canada
and the United Kingdom were not settled by this agreement.
The company has prevailed in a case brought in Canada against Exxon's
Canadian affiliate, Imperial Oil, Ltd., for infringement of the company's
patent pertaining to dispersants, the largest additive component used in
motor oils. A 1990 trial court verdict in favor of the company regarding
the issue of liability was upheld by the Federal Court of Appeals of Canada
in December 1992, and in October 1993, the Supreme Court of Canada
dismissed Imperial Oil's appeal of the Court of Appeals' decision. The case
has been returned to the trial court for an assessment of compensation
damages, but no date has been set for a determination of such damages. In
October 1994, the trial court judge determined that Imperial Oil had
violated an earlier injunction for the manufacture or sale of the
dispersant that is the subject of this case. The determination of penalty
damages, if any, on account of this violation will be made after the court
has determined the compensation damages for patent infringement.
In November 1996, a patent trial court in London declared a Lubrizol United
Kingdom patent invalid, which patent was the subject of litigation brought
by the company against Exxon in that country. Although the trial court
decision did not involve any damage payments, the court awarded Exxon its
recoverable legal costs in the case, as is customary under U.K. practice.
Exxon originally filed with the court a request for legal costs of
approximately $12.0 million. The company made a $3.0 million contingent
payment to Exxon in July 1997, which was fully expensed in that year. On
April 30, 1998, some, but not all, of the findings against the company were
reversed and the percentage of Exxon's legal costs which are recoverable
was reduced from 90 percent to 25 percent. The proceedings in this case are
completed except for the final determination of Exxon's recoverable legal
costs. The company presently believes it will not be required to make any
further payments to Exxon for this matter.
A reasonable estimation of the company's potential recovery relating to the
Exxon litigation referenced above can not be made at this time, and no
amounts that may be recovered in the future have been recorded in the
company's financial statements as of September 30, 1998.
7
<PAGE> 8
THE LUBRIZOL CORPORATION
========================
Notes to Consolidated Financial Statements
September 30, 1998
8. In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
131 - Disclosures About Segments of an Enterprise and Related Information.
SFAS 131 redefines how operating segments are determined and requires
disclosure of certain financial and descriptive information about a
company's operating segments. Under currently effective accounting
standards, the company's operations are considered to be a single
reportable segment. Applying SFAS 131, the company believes it will have
two reportable segments: Chemicals for Transportation and Chemicals for
Industry. Chemicals for Transportation would likely be comprised of the
specialty additive packages used in finished lubricants such as gasoline
and diesel engine lubricating oils, automatic transmission fluids, gear
oils, marine and tractor lubricants and fuel products. Chemicals for
Industry would likely include industrial fluids, coatings and ink
additives, specialty monomers, process chemicals, synthetic refrigerant
compressor lubricants and performance systems, including fluid metering
devices and particulate emission trap devices. The company will adopt SFAS
131 for its financial statement disclosures in its annual report for the
year ending December 31, 1998.
In June 1998, the FASB issued SFAS 133, Accounting for Derivative
Instruments and Hedging Activities, which becomes effective for the
company no later than January 1, 2000. SFAS 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities.
It requires that all derivatives be measured at fair value and recognized
as either assets or liabilities in the statement of financial position.
The accounting for changes in the fair value of a derivative (that is
gains or losses) depends on the intended use of the derivative and its
resulting hedge designation. The company uses derivative financial
instruments only to manage well-defined foreign currency and interest rate
risks. The company does not use derivative financial interests for trading
purposes. The company is currently evaluating the requirements of SFAS 133
but, based on its limited use of derivative financial instruments,
believes SFAS 133 will not have a significant effect on the company's
reported financial position or results of operations when adopted.
8
<PAGE> 9
THE LUBRIZOL CORPORATION
========================
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations
RESULTS OF OPERATIONS
The continuing weak business environment of the lubricant additives industry and
poor economic conditions in Asia Pacific and Latin America negatively impacted
the results for third quarter and nine-month periods ended September 30, 1998.
Despite acquisitions contributing 7% and 4%, respectively, to revenues for the
three- and nine-month periods ended September 30, 1998, revenues declined 6% for
the third quarter and 3% for the nine months as compared with the respective
1997 periods. Lower average selling prices combined with relatively level
material costs have compressed profit margins. In addition, lower other income,
higher interest expense and a higher effective tax rate contributed to earnings
being significantly lower for the three- and nine-month periods ended September
30, 1998, as compared with the respective periods of 1997. More detailed
comments relating to the company's results of operations and financial position
follow below.
Consolidated revenues decreased $23.7 million or 6% for the third quarter of
1998 compared with the third quarter of 1997 and decreased $39.9 million or 3%
for the first nine months of 1998 compared with the same 1997 period. The
primary factors causing the revenue decreases in each of the periods were lower
average selling prices and lower volume. For the third quarter of 1998 compared
with the third quarter of 1997, the average selling price declined 5% and sales
volume declined 4%. Without acquisitions, which added $29.4 million to revenues,
third quarter 1998 sales volume would have declined 8%. The decrease in average
selling price for the third quarter was due 75% to lower product pricing and
changing product mix, including Adibis, and 25% to currency. For the first nine
months of 1998 compared with the same 1997 period, the average selling price
declined 5% and sales volume increased 1%. Without acquisitions, which added
$45.2 million to revenues during the nine-month 1998 period, sales volume would
have declined 1%. The decline in average selling price for the comparable 1998
and 1997 nine-month periods was due 66% to lower product pricing and changing
product mix, including Adibis, and 34% to currency.
The slowing of lubricant additive demand in virtually all geographic areas
during the first nine months of 1998 and the current economic conditions in Asia
Pacific will cause difficult comparisons against 1997, a year in which the
company achieved record revenues and sales volume. For the full year 1997, the
company increased its global specialty chemical shipments by 17% over 1996, as
shipments to North American customers rose 14% and shipments to international
customers grew 18%, including a 29% increase to customers in the Asia Pacific
region. However, for the first nine months of 1998 compared with the same period
of 1997, sales volume (excluding acquisitions) increased only 2% to North
American customers and declined 3% to international customers. For the 1998
third quarter, sales volume (excluding acquisitions) decreased 3% to North
American customers and declined 12% to international customers.
The continuing economic difficulties in certain countries within the Asia
Pacific region have had an accelerating, unfavorable effect on the company's
1998 results. Approximately 20% of the company's 1997 revenues were generated
from sales to customers in Asia Pacific. Manufacturing of products shipped to
customers in Asia Pacific is primarily from production facilities in the United
States. Sales volume to Asia Pacific customers during the first half of 1998
declined by only 1% as compared with the first half of 1997, but declined by 28%
in the 1998 third quarter as compared to the same 1997 quarter. Lower sales
volume into Asia Pacific was the dominant reason that overall sales volume
declined in the 1998 third quarter. Revenues from Asia Pacific declined by $28
9
<PAGE> 10
THE LUBRIZOL CORPORATION
=========================
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
million or 33% in the 1998 third quarter and by $40 million or 17% in the first
nine months of 1998 as compared with the respective 1997 periods.
Cost of sales for the three- and nine-month periods ended September 30, 1998,
primarily reflect the change in shipment levels from the comparable periods of
1997 as average raw material unit costs and total manufacturing unit costs were
relatively level with such 1997 periods.
Gross profit (net sales less cost of sales) for the three- and nine-month
periods ended September 30, 1998 was below that earned in the respective periods
of 1997, despite recent acquisitions. Gross profit decreased $16.3 million or
12% ($22.8 million or 17%, excluding acquisitions) for the third quarter of
1998, compared with the third quarter of 1997. It decreased $46.5 million or 11%
($58.0 million or 14%, excluding acquisitions) for the first nine months of 1998
compared with the same 1997 period. The decrease in gross profit for each of the
respective periods was primarily due to the decline in selling prices and, in
the 1998 third quarter, also due to lower sales volume as previously discussed.
The incremental gross profit contributed by acquisitions made over the past year
was mitigated by unfavorable currency effects of $2.6 million and $8.2 million
for the respective three- and nine-month periods ended September 30, 1998.
The gross profit percentage (gross profit divided by net sales) of 29.8% in the
third quarter of 1998 was slightly lower than that achieved in each of the first
two quarters of 1998, and below the 32.0% earned during the 1997 third quarter.
For the nine months ended September 30, 1998, the gross profit percentage was
30.6%, lower than the 31.4% earned during the second half of 1997 and lower than
the 33.3% earned during the first nine months of 1997.
In September 1998, the company announced a general price increase for its
products sold in North America, Europe and parts of Asia Pacific. This is the
first general price increase the company has introduced since early 1995.
Although the increases are scheduled to go into effect at various times during
the fourth quarter, these increases are not expected to have a noticeable affect
on revenues during the fourth quarter of 1998. Discussions with customers are
continuing and it is too early to determine the precise timing and amount of
impact that this general price increase will have on 1999 revenues.
Selling and administrative expenses increased by approximately 4% for both the
three- and nine-month periods ended September 30, 1998 compared with the same
1997 periods. Recent acquisitions contributed to this increase, as selling and
administrative expenses would have declined by 2% for the third quarter and 1%
for the nine months, after excluding acquisitions. Selling and administrative
expenses for the 1998 nine-month period reflect increased spending of
approximately $10.1 million related to the implementation of the new management
information system, but this was offset by lower litigation expenses and lower
variable pay expense.
Research, testing and development expenses (technology expenses) in the third
quarter of 1998 increased 10% over the third quarter of 1997. Approximately
one-half of this increase was related to new performance specifications for
heavy-duty engine oils to become effective during 1998 as well as new
performance specifications for passenger car engine oils expected to become
effective during 2000. Recent acquisitions accounted for the remainder of the
increase in technical expense for the third quarter. For the first nine months
of 1998, technology expenses were 3%
10
<PAGE> 11
THE LUBRIZOL CORPORATION
=========================
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
higher than the same 1997 period, but excluding acquisitions would have been
flat.
Primarily as a result of the above factors, the change in revenues together with
the change in total costs and expenses unfavorably affected the company's
pre-tax profits by $21.8 million and by $54.9 million, respectively, for the
three- and nine-month periods ended September 30, 1998, as compared with the
same 1997 periods.
The change in other income (expense) unfavorably affected pre-tax income by $4.5
million and $5.1 million, respectively, for the three- and nine-month periods
ended September 30, 1998 as compared with the same 1997 periods. This
unfavorable change, most of which occurred during the third quarter, was
primarily due to higher currency translation and transaction losses, a greater
amount of goodwill amortization and lower equity earnings from joint venture
companies.
Interest expense increased $2.6 and $4.5 million, respectively, for the three-
and nine-month periods ended September 30, 1998 as compared with the same 1997
periods. The higher interest expense reflects the significantly higher
borrowings necessitated by acquisition activities.
The company is involved in litigation with Exxon Corporation in various
countries. On April 23, 1998, the company reached a settlement with Exxon of a
lawsuit pending in federal court in Ohio and the company received cash of $19
million from Exxon. The pre-tax gain from this litigation settlement, net of
related expenses, was $16.2 million, which contributed $.19 to consolidated
earnings per share for the second quarter and first nine months of 1998. Other
lawsuits between the company and Exxon pending in the United States and Canada
were not settled by this agreement. Refer to Note 7 to the financial statements
for further discussion regarding the company's litigation with Exxon.
The company transacts business in over 100 countries. As the U.S. dollar
strengthens or weakens against other international currencies in which the
company transacts business, the financial results of the company will be
affected. The principal currencies, other than the U.S. dollar, in which the
company transacts business are the French franc, German mark, British pound
sterling and Japanese yen. Currency fluctuations had an unfavorable effect on
net income per share of $.04 and $.07, respectively, for the 1998 third quarter
and nine-month periods as compared with exchange rates in effect during the
respective 1997 periods.
In the third quarter of 1998, the company retroactively increased its annual
effective tax rate (ETR) to 38%, which disproportionately affected the ETR for
the third quarter. This followed an increase in the annual ETR from 34.5% to 36%
in the second quarter of 1998. The ETR was 44% and 34%, respectively, for the
1998 and 1997 third quarter periods and was 38% and 33%, respectively, for the
1998 and 1997 nine-month periods. The higher effective tax rate in 1998 lowered
earnings per share by $.05 and $.11, respectively, for the three- and nine-month
periods ended September 30, 1998, as compared with the respective 1997 periods.
11
<PAGE> 12
THE LUBRIZOL CORPORATION
========================
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
The increase in the 1998 ETR made in the 1998 third quarter is attributable
primarily to increasing non-tax deductible translation losses for the company's
foreign subsidiaries utilizing the U.S. dollar as its functional currency. In
addition, the 1998 ETR was increased to 38% from 33% in 1997 to reflect an
anticipated shift in earnings among the various taxing jurisdictions in which
the company operates and the impact of certain tax law changes enacted by
France, the United States and the United Kingdom during the second half of 1997.
Primarily as a result of the above factors, net income for the third quarter of
1998 was $16.6 million or $.30 per share as compared to $38.7 million or $.67
per share for the third quarter of 1997. For the 1998 nine-month period net
income was $86.2 million or $1.53 per share as compared to $124.4 million or
$2.14 per share for the 1997 nine-month period. After excluding from 1998 the
gain from the Exxon litigation settlement that was recognized in the second
quarter, net income for the first nine months of 1998, was $75.7 million or
$1.34 per share.
WORKING CAPITAL, LIQUIDITY AND CAPITAL RESOURCES
- ------------------------------------------------
Cash provided from operating activities was $110.2 million for the first nine
months of 1998 as compared with $186.4 million for the first nine months of
1997. Approximately three-fourths of the $76.2 million decline in cash flow from
operations was due to lower net income earned and the timing of income tax
payments during the comparable periods. Working capital increased during 1998,
which also affected operating cash flow for the period. The company carried
higher inventory balances for strategic reasons to help ensure meeting customer
delivery targets as the company stabilized under its new management information
system and in anticipation of forward buying resulting from the company's
announced price increase. The inventory levels also were affected by lower than
anticipated sales volumes in the third quarter of 1998. In addition, the company
has experienced a slowing in the collection of its trade receivables due from
customers, primarily in North America. The company is taking actions during the
fourth quarter to lower its working capital.
Capital expenditures in the first nine months of 1998 were $68.3 million as
compared with $72.2 million for same 1997 period and included $12.4 million and
$18.7 million, respectively, related to the company's multi-year project to
implement an enterprise-wide management information system. The company
implemented the new enterprise-wide management information system in the United
States in March 1998, and will continue to implement this system globally over
the next two years. The return on this investment is expected to be realized,
beginning in 1999, by reducing costs and delivering products and services more
cost-effectively to the company's customers. Capital expenditures for the full
year 1998 are expected to be slightly lower than the 1997 amount, which was $100
million.
During 1998, the company completed two acquisitions in the first quarter and two
acquisitions in the third quarter. Cash expended for these acquisitions
aggregated $149.5 million, of which $134.9 million was spent in the third
quarter of 1998. The acquisitions were in the company's existing business areas
of lubricant additives, metal working additives and coating additives and
broaden the company's base in performance chemicals.
12
<PAGE> 13
THE LUBRIZOL CORPORATION
=========================
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
The company maintains a share repurchase program, and during the first nine
months of 1998 repurchased approximately 1,847,000 of its common shares for $60
million. The company currently plans to expend approximately $20 million during
the 1998 fourth quarter to repurchase its shares. There were 2.9 million shares
remaining under the company's repurchase authorization at September 30, 1998.
The company's net borrowings during the first nine months of 1998 totaled $184.1
million, of which $163.7 million occurred during the third quarter. This
increase primarily was through commercial paper borrowings incurred to finance
the 1998 acquisitions and continue the company's share repurchase program. The
company intends to replace a significant portion of the outstanding commercial
paper borrowings with long-term debt prior to December 31, 1998 (see Note 5 to
the financial statements). The company's debt as a percent of total
capitalization (shareholders' equity plus short-term and long-term debt)
increased to 33% at September 30, 1998, as compared to 21% at December 31, 1997.
Primarily as a result of these activities and the payment of dividends, the
balance of cash and short-term investments decreased $21.0 million at September
30, 1998 compared with December 31, 1997.
The company's financial position remains strong with a ratio of current assets
to current liabilities of 2.2 to 1 at September 30, 1998, compared to 2.5 to 1
at December 31, 1997. Management believes the company's existing credit
facilities, internally generated funds and ability to obtain additional
financing will be sufficient to meet its future capital needs.
COST REDUCTION PROGRAM
- ----------------------
Over the past three years, the company has made progress on its strategies to
grow its revenues, improve its cost structure and expand into new market areas.
Market share has been increased, costs have been lowered, acquisitions to
broaden business areas have been completed and, recently, steps have been taken
to increase the selling prices of the company's products. Unfortunately, these
steps are not enough given the present conditions within the lubricant additives
industry.
The global market growth rate for lubricant additives, which the company
estimated in 1997 as approximately 1% per year, has slowed at a time when the
requirement for investment to meet new performance specifications is
accelerating. The poor economic environment in Asia Pacific and Latin America,
which prior to 1998 were the faster growing markets, along with industry market
forces, such as improved engine design, longer drain intervals and product
specification changes, suggest that higher growth rates for lubricant additives
are not likely to return. The effects from these conditions have been declining
shipment volumes, industry overcapacity and increased consolidation among both
customers and additive producers. This has also resulted in a decline in the
financial returns on the assets invested in this business.
In response to these market and industry conditions, the company will initiate a
series of steps to reduce costs and improve its worldwide operating structure
over the next two years. These steps, which will occur in two phases, will
include reorganization of the company's commercial structure, changes in work
processes using the company's new globally integrated management information
system, the shutdown of production units and consolidation of facilities and
offices.
13
<PAGE> 14
THE LUBRIZOL CORPORATION
========================
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
In the first phase, the company will be reducing primarily selling, general,
administrative and testing expenses, which will result in staff reductions of
approximately 6 percent, or 250 employees, by the end of the first quarter of
1999. During this phase, the company will implement a new commercial structure
for its chemicals for transportation business and for a portion of its
chemicals for industry business. It will also consolidate certain sales offices
and testing functions. At the same time, the company will be continuing the
rapid consolidation of its recently acquired Adibis additives business. Savings
from these steps are estimated to be $26 million per year beginning in 1999.
The company anticipates a special charge of approximately $32 million in the
fourth quarter of 1998 to cover both the costs associated with these steps and
the write-off of in-process research and development acquired from Adibis. The
company has not made a final determination of the amount to be assigned to
in-process research and development. The amount of the special charge in the
fourth quarter of 1998 may be higher than $32 million depending on the amount
assigned to in-process research and development.
The second phase is focused on lowering costs and improving efficiency in
production and distribution activities. The company will continue to reduce its
number of intermediate components and product platforms, which will enable the
number of its production units to be reduced by an additional 20 percent over a
two-year period. This will occur through the shutdown of certain production
units and facilities worldwide. During this phase, the company will complete
installation of its new globally integrated management information system and
implement a shared service structure in Europe. A further 5 percent reduction in
employee staffing is expected to result from these steps. Additional charges are
anticipated over the next two years related to the costs of facility write-downs
and employee separations. However, specific actions must be further developed
before the company is able to reasonably estimate the amounts of these expected
charges. Such charges may be material to the operating results of the company
for the period(s) in which they are recognized.
YEAR 2000 MATTERS
- -----------------
The company relies on its computer-based management information systems, as well
as computer-based systems used for other purposes, in conducting its normal
business activities. Certain of these computer-based programs may not have been
designed to function properly with respect to the application of dating systems
relating to the Year 2000 and beyond. The company has developed a global "Year
2000" strategy covering each of its facilities designed to minimize Year 2000
disruptions to its computer-based systems, including business information
systems and process control, testing and laboratory equipment and embedded
systems.
Implementation of the new enterprise-wide management information system is a key
component for addressing business information systems in the company's "Year
2000" compliance strategy. In March 1998, the company implemented its new
enterprise-wide management information system in the United States and will
continue to implement this system globally over the next two years, with
implementation in Europe scheduled for mid-1999. The company believes that
implementation of such systems permits it to avoid approximately 80% of the
remediation activities that otherwise would have been required. Although the
implementation date for the global enterprise-wide management system at a number
of company facilities outside of the United States and Europe is anticipated to
be after January 1, 2000, the company has developed Year 2000 compliance plans
to address business information systems at those facilities.
14
<PAGE> 15
THE LUBRIZOL CORPORATION
========================
Management's Discussion and Analysis of
Financial Condition and Results of Operations
---------------------------------------------
In addition, the company has substantially completed its assessment of the
actions necessary with respect to all of its other date-based computer systems
in order to minimize Year 2000-related disruptions. The company has completed
compiling, categorizing as between critical and non-critical and prioritizing
all of its date-based computer systems at each of its facilities. Plans for
remediation, testing and certification of such systems have been developed for
each site and are in the process of being implemented. Contingency plans are in
the process of being developed.
The company has also surveyed suppliers critical to its business for the
purpose of obtaining assurance regarding their ability to properly operate
their systems in the Year 2000. The company will begin surveying customers for
this same purpose during the first quarter of 1999. The company has targeted
completion of all remedial activities, including testing and certification, by
mid-1999. However, the company has no contractual or other right to compel its
suppliers or customers to be Year 2000 compliant.
In addition to expenditures related to the implementation of the new
enterprise-wide management information system, the company estimates the total
costs of conducting its Year 2000 remedial activities will approximate $10
million. The company expects to complete its Year 2000 activities within a time
frame that will enable its computer-based systems to function without
significant disruption in the Year 2000. If the company's contingency plans are
not adequate or its suppliers or customers fail to remedy their own Year 2000
matters, the company's results of operations and financial condition may be
materially adversely affected.
CAUTIONARY STATEMENT FOR SAFE HARBOR PURPOSES
- ---------------------------------------------
This Management's Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) 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
the company's operations and business environment that could cause actual
results of the company to differ materially from those matters expressed in or
implied by such forward-looking statements. All of such uncertainties and
factors are difficult to predict and many are beyond the control of the company.
The company identified certain, but not necessarily all, of these uncertainties
and factors in its MD&A contained on pages 21 - 22 of its 1997 Annual Report to
its shareholders, to which reference is made and which are incorporated by
reference herein.
15
<PAGE> 16
THE LUBRIZOL CORPORATION
========================
Item 3. Quantitative and Qualitative Disclosures About Market Risk
-----------------------------------------------------------
Not Applicable.
PART II. OTHER INFORMATION
--------------------------
Item 5. Other Information
-----------------
The deadline for shareholders to submit proposals pursuant to Rule
14a-8 under the Securities Exchange Act of 1934 for inclusion in the
company's proxy statement for its 1999 Annual Meeting of Shareholders
is November 18, 1998. Any proposals submitted other than pursuant to
Rule 14a-8 must be received by the company no later than February 25,
1999 or such proposals will be considered untimely, in which case the
company's proxy for its 1999 Annual Meeting of Shareholders may confer
discretionary voting authority regarding such matters.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
(27) Financial Data Schedule
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the Quarter ended
September 30, 1998.
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/Gregory P. Lieb
----------------------------
Gregory P. Lieb
Chief Accounting Officer and
Duly Authorized Signatory of
The Lubrizol Corporation
Date: November 12, 1998
16
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION
EXTRACTED FROM CONSOLIDATED BALANCE SHEET AND CONSOLIDATED
STATEMENTS OF INCOME AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
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<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 65,484
<SECURITIES> 0
<RECEIVABLES> 281,518
<ALLOWANCES> 1,659
<INVENTORY> 294,477
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<PP&E> 1,592,383
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<TOTAL-ASSETS> 1,647,761
<CURRENT-LIABILITIES> 324,701
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0
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<COMMON> 83,434
<OTHER-SE> 731,533
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<SALES> 1,208,322
<TOTAL-REVENUES> 1,210,376
<CGS> 839,062
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<OTHER-EXPENSES> 0
<LOSS-PROVISION> 487
<INTEREST-EXPENSE> 12,385
<INCOME-PRETAX> 138,320
<INCOME-TAX> 52,075
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